NO BAD FAITH WHERE NO DUTY TO DEFEND; COURT ADDRESSES RESERVATION OF RIGHTS LETTERS AND ESTOPPEL (Philadelphia Federal)

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This case involves attorney malpractice insurance, and when a carrier is estopped from denying coverage for failing to issue a timely reservation of rights letter.

The underlying plaintiff brought two actions against the attorney arising out of the same underlying medical malpractice action: (1) a 2017 legal malpractice action and (2) a 2019 disgorgement action seeking return of a referral fee paid to the insured attorney.

As to the 2019 claim, the underlying plaintiff had demanded return of the referral fee even prior to the disgorgement action. The record indicates that at some point prior to the disgorgement action being filed, the carrier issued a reservation of rights letter, stating the attorney would not be covered for any disgorgement. Another reservation of rights letter was issued after the 2019 suit was filed.  The carrier defended the disgorgement action, but refused to indemnify after judgment was entered against the attorney, who had to disgorge his referral fee and pay treble damages.

The carrier brought a declaratory judgment action seeking a ruling that it had no duty to indemnify either the 2017 or 2019 actions. The insured counterclaimed for coverage, based on estoppel, and bad faith.  The underlying plaintiff, a party to the case, also asserted estoppel.

The present posture involved cross-motions for summary judgment.

Carrier estopped from denying coverage for failing to issue timely reservation of rights letter

As to the 2017 case, the malpractice carrier defended the first action without timely issuing any reservation of rights letter. Thus, the court held the insurer was estopped from later denying coverage in the 2017 malpractice action.

In reaching this conclusion, Judge Kearney provides a detailed analysis of when an insurer may be estopped from denying coverage for failing to issue a reservation of rights letter, which is worth reading in detail for any attorney doing coverage work. Without reciting every detail, Judge Kearney outlines the basic issues as follows:

  1. To estop an insurer from denying defense or coverage, the insured must show the insurer induced a belief in facts on which the insured relied to his detriment.

  2. In determining detrimental reliance, courts will assess whether the insured suffered actual prejudice.

  3. “Actual prejudice occurs when an insurer assumes the insured’s defense without timely issuing a reservation of rights letter asserting all possible bases for a potential denial of coverage.”

  4. “When an insurer receives notice of a claim, it has a duty ‘immediately to investigate all the facts in connection with the supposed loss as well as any possible defense on the policy.’”

  5. “[The insurer] cannot play fast and loose, taking a chance in the hope of winning, and, if the results are adverse, taking advantage of a defect in the policy.”

  6. “The insured loses substantial rights when he surrenders, as he must, to the insurance carrier the conduct of the case.”

No estoppel in second action and no bad faith

Earlier in the case, the court dismissed the insured’s bad faith counterclaims on the 2017 action, but had allowed the bad faith counterclaims on the 2019 action to proceed.

As to the 2019 action, the insurer promptly issued a reservation of rights and denial of coverage when it learned of the potential disgorgement claim. Moreover, it had even informed the insured prior to the second action’s actual filing that there was no coverage for disgorgement claims.

The court found the carrier was not estopped from asserting it owed no duties in the second action. Judge Kearney especially focused on the absence of prejudice to the insured.  Clearly, the court further agreed that the carrier had no indemnification duty toward the insured in the 2019 case, absent an effective estoppel argument.

As to bad faith, once the court found the insurer had reserved its rights and properly denied coverage in the second action, it rejected the bad faith claim.

Judge Kearney observed there is no common law bad faith claim in Pennsylvania, only statutory bad faith and the contractual breach of the implied duty of good faith and fair dealing. In this case, the insured did not raise statutory bad faith, so the court solely looked at the contractual duty of good faith and fair dealing claim.

“An insurer violates its implied contractual duty to act in good faith when it gives a ‘frivolous’ or ‘unfounded’ excuse not to pay insurance proceeds. As we find [the insurer] has no duty to defend or indemnify [the insured attorney], we cannot find its decision not to do so ‘unfounded’ or ‘frivolous.’”

Finally, the court found the underlying plaintiff had no standing to bring an estoppel counterclaim, even if she did have standing to argue for coverage.

Thus, the insured won summary judgment on coverage in the 2017 claim, but the insurer was successful on the 2019 claim.

Date of Decision: October 8, 2020

Westport Insurance Corporation v. McClellan, U.S. District Court Eastern District of Pennsylvania No. 20-1372, 2020 WL 5961047 (E.D. Pa. Oct. 8, 2020) (Kearney, J.)

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