Ambiguous Reservation of Rights Letter Converts Duty To Defend Into Duty to Reimburse Defense Costs.

A Minnesota federal court recently held that an ambiguous reservation of rights letter created a conflict of interest requiring the insurer to reimburse the insured’s reasonable attorneys’ fees in the underlying action.  Select Comfort Corp. v. Arrowood Indem. Co., No. CIV. 13-2975 JNE/FLN (D. Minn. Aug. 26, 2014), arose from a class action in California alleging Select Comfort’s mattresses had a propensity to develop and incubate mold, leading to adverse health effects.  Select Comfort tendered its defense to Arrowood Indemnity Company.  Arrowood issued a series of reservation of rights letters based on the “occurrence,” “damages,” and “bodily injury” definitions in its insuring agreement, and its “intentional act” exclusion.  Arrowood assigned the defense to a firm in California, and asserted there was no conflict of interest in doing so.  Arrowood informed Select Comfort it could associate counsel “at its own expense.”

Select Comfort’s attorneys responded that the reservation of rights letter created a conflict of interest that converted Arrowood’s duty to defend into a duty to reimburse its reasonable defense costs because Arrowood’s reserved coverage defenses turned on the development of the factual record in the underlying case.  Select Comfort asserted it had the right to select counsel to litigate the California action and the potential coverage suit.  Arrowood agreed only to reimburse its share of the defense costs.

At resolution of the underlying suit, Arrowood and two other insurers had paid $557,251 of $1,033,779 in fees invoiced by Select Comfort’s attorneys.  Select Comfort brought suit seeking a declaration that Arrowood’s reservation of rights letters converted its duty to defend into a duty to indemnify.

U.S. District Court Judge Joan Erickson held that Arrowood’s reservation of rights against damages for intentional injury alone was sufficient to create a conflict.  Arrowood contended that its letters did not reserve the right to challenge coverage based on intentional or knowing conduct.  The Court disagreed, finding Arrowood’s communications amounted to an attempt to create an ambiguity as to whether it was, or was not, reserving rights.  Because ambiguities must be construed against the insurer, the Court held Arrowood’s communications would be reasonably interpreted as reserving the right to exclude coverage for intentional conduct.  As a result, the Court required Arrowood to reimburse Select Comfort’s reasonable attorneys’ fees incurred in defense of the underlying suit.

This case is significant for its potential impact on reservation of rights letters and insurer’s duty to defend.  If the insurer reserves rights, ambiguously or not, and development of the underlying case will either prove or disprove facts relevant to coverage, the policyholder may claim a right to reimbursement.  If Select Comfort is affirmed on appeal, the case expands a policyholder’s right to select defense counsel.

If you have any questions about this or any other matter, please contact Bob Kuderer, Matt Johnson or Tom Brock.