Most courts hold that an insurance company will not be estopped from denying coverage, even if the insurance company participates in the defense, provided it gives timely notice to the policyholder through a reservation of rights letter. There is one very important caveat. In order for the reservation of rights to be effective, it must be timely and be sent directly to the policyholder. As shown in the recent case of Erie Ins. Exchange v. Lobenthal, 2015 WL 1668183 (Pa. Super. Ct. Apr, 15, 2015), when an insurance company fails to give a policyholder adequate notice of its reservation of rights, the insurance company will be estopped from disclaiming coverage as to that policyholder.

In Erie, the underlying case involved a September 26, 2010, car accident for which the passengers sued the driver for their injuries. The passengers also sued Michaela Lobenthal and her parents, alleging that she permitted the “possession and consumption” of controlled substances by the driver at a property owned by her parents. Ms. Lobenthal’s parents were quickly dismissed from the suit. Ms. Lobenthal was an additional insured under her parents’ policy. Erie filed a declaratory judgment action based on a controlled substance exclusion in the policy and was granted summary judgment.

Erie sent two reservation of rights letters, one on April 28, 2011, before the underlying complaint was filed, and another on February 7, 2012. Both letters were addressed only to the named insureds, Ms. Lobenthal’s parents, and neither letter mentioned Ms. Lobenthal, the defendant in the underlying tort action. These letters reserved Erie’s right to disclaim coverage and liability for any judgment “that may be rendered against” the parents. Only the second reservation of rights letter, sent approximately three-and-one-half months after the court made the liability determination, referenced the controlled substances exclusion in the policy.

The Superior Court held that Ms. Lobenthal, as the defendant, was entitled to notice of Erie’s reservation of its right to disclaim liability. The court rejected Erie’s argument that notice should be imputed to Ms. Lobenthal, finding that notice to her parents, the named insureds, and to insurance defense counsel provided by Erie, was ineffective as to Ms. Lobenthal. The court held that Ms. Lobenthal was entitled to have a reservation of rights letter addressed directly to her.

The court further found Erie’s reservation untimely. Erie waited more than three months after the liability ruling to send its second letter referencing the controlled substance exclusion. The court noted that Ms. Lobenthal could have retained separate counsel to manage her defense from the outset if Erie had informed her when the suit was filed of its intention to deny coverage on this basis. When an insurer fails clearly to communicate its reservation of rights, prejudice to the policyholder may be fairly presumed.

This case has important implications for commercial policies. Companies are frequently additional insureds under insurance policies. Under the rule set forth in Erie, insurance companies must give separate and timely notice of any reservation of rights to all insureds involved in a lawsuit. Knowledge of the named insured or defense counsel will not be imputed to additional insureds. Should the named insured be dismissed from the case, the insurer has an ongoing duty to keep additional insureds informed of its coverage position. Insureds accordingly must be diligent in analyzing any correspondence from the insurer and should seek counsel’s assistance to analyze that correspondence.