Reservation of Rights and Duty to Defend

 The United States Court of Appeals certified questions to the Georgia Supreme Court pertaining to the reservation of rights and the insurer's duty to defend. This case is World Harvest Church v. Guideone Mutual Insurance Company, 695 S.E.2d 6 (2010).

Between 1995 and 1999, Homa and Gause operated an auto title lending business that actually constituted a huge Ponzi scheme. During that time, Gause donated large sums of money to World Harvest Church. The SEC filed a civil enforcement action in federal court and demanded that the Church return about $1.8 million of Gause's donations. The SEC eventually brought a lawsuit against the church asserting claims of fraudulent transfer and unjust enrichment. The church turned the lawsuit over to its insurer, Guideone. The insurer did not issue a written reservation of rights and assumed the defense of the insured for over 10 months. At the end of that time period, the insurer informed the insured that it would stop defending the action in 30 days because there was no coverage. The insured then settled the case and brought a lawsuit against the insurer for allegedly breaching the insurance contract. The trial court found in favor of the insurer.

 On appeal, the U.S. Court of Appeals for the Eleventh Circuit certified the following questions to the Georgia Supreme Court: does an insurer effectively reserve its right to deny coverage if it merely informs its insured that it does not see coverage or is an actual written reservation of rights letter required; when an insurer assumed defense without notifying the insured that it is doing so with a reservation of rights, is the insurer then estopped from asserting the defense of noncoverage only if the insured can show prejudice?

 The Georgia Supreme Court noted that the insured argued that a reservation of rights has to be in writing. However, the court said that, although a written notification is preferable, the complaint that the reservation of rights was inadequate because it was oral is without legal authority. At a minimum, the court said, the reservation of rights must inform the insured that, notwithstanding the insurer's defense of the action, it disclaims liability and does not waive the defenses available to it against the insured; the reservation of rights must be unambiguous. In this instance, the court found that, although a reservation of rights is not required to be in writing, the insurer failed to comply with the minimum standards. The oral statement delivered to the insured was not adequate to fairly inform the insured of the insurer's position.

 As for the second certified question, the Supreme Court stated that where there was no effective reservation of rights, the question of whether the insurer is estopped from asserting noncoverage depends upon whether, with actual or constructive knowledge of noncoverage, the insurer assumed or continued the defense, and whether a showing of prejudice is required. The court pointed out that there are three different views currently existing among the jurisdictions regarding the requirement of demonstrating prejudice. Some jurisdictions take the view that where an insurer, without reservation of rights and with actual or presumed knowledge, assumes the exclusive control of the defense, it cannot thereafter withdraw and deny liability; prejudice to the insured is conclusively presumed. Other jurisdictions hold that the issue as to prejudice has to be met directly by merely holding that the loss of the right of the insured to control and manage the defense is, in itself, prejudice without any further proof. The third view holds that where an insurer defends an action against the insured with knowledge of a defense to coverage, the insurer is thereafter estopped from asserting that the policy does not cover the claim if the insured has demonstrated that it has been prejudiced by the insurer's actions.

The court said that the first two views have been held to amount to the same thing and have sometimes been identified and adopted as the majority rule. In Georgia, the courts have agreed with the majority and found that prejudice to the insured is conclusively presumed when the insured looses the right to control and manage the case. In this instance, the insurer assumed and conducted a defense without effectively notifying the insured that it was doing so with a reservation of rights. The insured thus in effect surrendered innumerable rights associated with the control of the defense, including choice of counsel, the ability to negotiate a settlement, and the ability to decide when and if certain defenses or claims will be asserted. Therefore, the insurer was estopped from asserting noncoverage; the insured did not need to show prejudice since prejudice to the insured was presumed by the facts.

 Editor's Note: This case is cited for two main reasons. First, the Georgia Supreme Court in answering certified questions, states that a reservation of rights need not be in writing. As long as the insurer clearly informs the insured that, notwithstanding the insurer's defense of the action, the insurer disclaims liability and does not waive the defenses available to it. Second, the Supreme Court notes that the majority opinion of jurisdictions around the country (and the opinion of the Georgia Supreme Court) is that prejudice to the insured is conclusively presumed when the insured loses the right to control and manage the lawsuit against it by the insurer's assuming the exclusive control of the defense.