A Little Knowledge Goes A Long Way Against Defense and Indemnity Reimbursement

When faced with a mixed complaint against the insured, including covered and uncovered claims, insurers oftentimes will reserve their right to seek reimbursement for defense and indemnification payments attributable to the uncovered portion of the claim. The question of reimbursement rights recently came before the Georgia Court of Appeals in Facility Investments, LP v. Homeland Ins. Co. of New York, 321 Ga.App. 103, 741 S.E.2d 228 (Ct. App. 2013). In Facility Investments, the Court held that the insurance company had waived its right to pursue recovery of uncovered amounts of a settlement payment when it made payment with knowledge of the grounds for non-coverage.

Under the facts of the case, Homeland Insurance Company of New York (Homeland), issued a Long-Term Care Organizations Professional and General Liability policy to Facility Investment, LP’s (Facility) covering Facility’s nursing home. The policy contained an exclusion regarding “dishonest, fraudulent, criminal or intentionally malicious acts, errors or omissions, and willful violations of law, statutes, rules or regulations.” Facility was sued for professional negligence arising from the care of a patient at the nursing home. The lawsuit alleged that Facility had engaged in fraud, intentional misconduct and willful and wanton conduct. Homeland agreed to defend Facility under a reservation of rights. Homeland specifically reserved its rights regarding any loss or defense expenses arising out of the allegations of fraud, malice or violations of state and federal regulations. However, Homeland did not reserve any right to pursue claims for breach of contract, recoupment, allocation or contribution.

As the underlying case progressed, evidence of fraud regarding the nursing home’s patient medical chart was uncovered. Plaintiff’s attorney in the underlying case made a demand for the policy limit with a 30-day expiration period assigned. The demand letter indicated that plaintiff was going to pursue punitive damages based on the evidence of fraud. The demand advised the insured that if the policy limits were not paid within the 30-day time limit, plaintiff would seek to enforce a verdict in excess of the policy limit.

Three days before the expiration of the 30-day time demand, Facility sent a letter to Homeland demanding that Homeland settle the underlying suit within the policy limit. Facility’s demand letter noted that the discovery of the case had revealed several major hurdles to the defense, including significant charting problems that would inflame the jury. Facility opined in the letter that the identified hurdles, together with medical expenses in excess of $800,000, created a likely excess judgment potential.

Homeland responded to Facility’s request with an offer to settle the case for an amount up to the policy limit. However, Homeland noted that Facility was obligated to determine a fair and proper allocation of all amounts attributed to covered and uncovered claims. Homeland requested a contribution from Facility of 50 percent of the settlement amount based upon Homeland’s opinion that a significant portion of the claimed loss was not covered under the policy due to the fraudulent charting that had been uncovered. In the responsive letter, Homeland also noted that if the parties could not reach an agreement regarding allocation that Homeland was still obligated to make an interim payment of the amount of the loss that the parties agreed was not in dispute. For the first time, Homeland advised Facility that it would pursue recoupment/contribution if Facility did not pay its share of the uncovered losses.

On the day before expiration of the 30-day demand, Facility notified Homeland that it would not contribute to the settlement or otherwise do an allocation between covered and uncovered losses because Facility believed Homeland was obligated to settle the underlying suit on Facility’s behalf. This prompted another letter from Homeland to Facility indicating that Homeland was reserving its rights to pursue claims for breach of contract, recoupment, allocation and contribution. After sending this letter, Homeland then made the required interim payment to settle the underlying suit.

Homeland filed the lawsuit against Facility to recover the portion of the settlement amount attributed to the uncovered losses. It was Homeland’s position that Facility had breached the policy terms by failing to contribute to the settlement and by failing to meet its contractual obligation to indemnify Homeland for uncovered losses based upon an uncovered loss allocation provision of the policy.

Facility moved to dismiss the Homeland claims but its motion was denied. Thereafter, an interlocutory appeal was taken to the Georgia Court of the Appeals.

On appeal, Facility argued that Homeland waived its right to pursue the uncovered amounts of the settlement payment because it made the settlement payment with knowledge of the circumstances that gave rise to its coverage defense. The Court of Appeals agreed.

The Court of Appeals began its analysis by recognizing that the express terms of the Homeland policy excluded losses and defense expenses arising out of fraudulent conduct. Homeland was aware that the plaintiffs were seeking punitive damages for the alleged fraudulent conduct but, nevertheless, agreed to defend Facility under a reservation of rights. The Court recognized that risks that are not covered or excluded from an insurance policy are not normally subjected to the doctrines of waiver and estoppel, citing Prescott’s Altama Datsun v. Monarch Ins. Co., 253 Ga. 317, 318, 319 S.E.2d 445 (1984). However, the Court then noted that where an insurance company does not unambiguously reserve its rights, uncovered claims may in fact be subject to the doctrines of waiver and estoppel when the insurer assumes the defense or continues with the defense with knowledge that a claim is not covered, citing World Harvest Church v. Guide One Mut. Ins. Co., 287 Ga 149, 153(2), 695 S.E.2d 6 (2010).

Under the facts, Homeland had defended Facility in the underlying case with knowledge that the plaintiffs were asserting claims for losses that were not covered under the Homeland policy. Although Homeland undertook the defense of the case subject to a reservation of rights letter specifically reserving rights with regard to losses or defense expenses arising out of allegations of fraud, the letter sent to Facility did not provide Facility with any notice that Homeland intended to settle an uncovered claim and sue for reimbursement/contribution under the uncovered loss allocation provision of the policy. Homeland’s attempt to reserve additional policy defenses based upon boilerplate language in the letter was ineffective under Georgia law, citing Hoover v. Maxim Indem. Co., 291 Ga. 402, 406(2), 730 S.E.2d 413 (2012).

The Court rejected Homeland’s contention that it had reserved its rights under the uncovered loss allocation provision in its subsequent letter to Facility on the day before the actual settlement occurred. Homeland argued that because Facility did not object to the reservation of rights or the settlement terms that Facility acquiesced. The Court found these arguments to be unavailing. Homeland unilaterally had reserved its rights under the uncovered loss allocation provision after Facility had objected to any allocation of covered and uncovered claims and after Facility informed Homeland that it would not contribute to the settlement. In rejecting Homeland’s argument, the Court stated (Citing Richmond v. Georgia Farm Bureau Mut. Ins. Co., 140 Ga.App. 215, 219(1), 231 S.E.2d 245 (1976):
An insurer may not give an insured a unilateral notice of reservation of rights and thereupon proceed with a complete defense [and settlement] of the main claim absent [the] insured’s express or implied consent. This course of action may well result in prejudice to an insured. Upon learning of facts reasonably putting it on notice that there may be grounds for noncoverage and where the insured refuses to consent to a defense under a reservation of rights, the insurer must thereupon (a) give the insured proper unilateral notice of its reservation of rights, (b) take necessary steps to prevent the main case from going into default or to prevent the insured from being otherwise prejudiced, and (c) seek immediate declaratory relief including a stay of the main case pending final resolution of the declaratory judgment action.

According to the Court in Facility Investments, a reservation of rights gives the insurance company, who is uncertain of its obligations to provide coverage, the ability to investigate the claims. However, once that investigation showed uncovered claims, the insurer was then required to either deny coverage or to file a declaratory judgment action to determine its obligations. In this case, Homeland had learned the facts giving grounds for noncoverage based on fraud. When Homeland sent its subsequent reservation of rights letter, the claims of fraud were supported by evidence. When Facility refused to contribute to Homeland’s proposed settlement of the underlying case, Homeland only had two options at that point: deny coverage or seek immediate declaratory relief. Homeland had defended and settled the underlying suit with knowledge of the uncovered claim of fraud and without specifically reserving its rights with regard to the uncovered loss allocation provision. At the time of the settlement Homeland did not deny coverage or seek a declaratory relief action and, therefore, Homeland waived any right to seek reimbursement for uncovered amounts of the settlement.

Courts are split on whether insurance companies can unilaterally reserve the right to seek reimbursement for defending and indemnifying uncovered claims. See, Steven Plitt and Jordan R. Plitt, Practical Tools for Handling Insurance Cases, § 2:25 (Thomson Reuters 2011).

Irrespective of which jurisdiction the claim arises in, insurers should always reserve their right to seek reimbursement of defense costs and indemnity payments with the first reservation of rights letter that is issued. Some jurisdictions require insurers to file declaratory judgment actions contemporaneously with the initiation of a reservation of rights defense. Claim adjusters should check the governing law within the jurisdiction that the claim is presented in.

Under Georgia law, apparently, the insurer’s obligation to initiate a declaratory judgment action exists on a sliding scale requiring the filing of a declaratory judgment action when some evidence comes to light supporting the view that the claims are uncovered. The real question is how much knowledge is enough to trigger the obligation to file the declaratory judgment action. In Georgia, a little bit of knowledge may eviscerate a reservation of rights defense and result in waiver and estoppel of policy language if the insurer does not immediately deny the claim or file a declaratory judgment action.