Kansas Supreme Court Rules that Insurer’s Failure to Timely Reserve Rights may Expand Scope of Coverage
In October 2018, the Kansas Supreme Court ruled that a liability insurer may be estopped (or in plain English, prevented) from denying coverage because of its failure to issue a timely reservation of rights letter, even if the estoppel results in the expansion of coverage beyond the scope provided under the insurance policy. See Becker v. The Bar Plan Mut. Ins. Co., 429 P.3d 212 (Kan. 2018). In support of its decision, the court applied “a longstanding rule in this jurisdiction,” citing a string of Kansas cases going back to 1948. Id. at 218. The Becker court acknowledged the existence of the alternative rule relied on by the trial court and the court of appeals, which is that estoppel cannot be used to expand coverage. Id. at 218. But in reversing and remanding the case, the Kansas Supreme Court held that the “expansion of coverage rule” is trumped by the “reservation of rights rule,” which permits the application of estoppel to expand coverage when an insurer does not reserve rights in a timely manner. Id. at 218-19.
The facts of Becker provide a good example of what it means to “expand coverage” by operation of estoppel. Becker involved a “claims made” legal malpractice liability insurance policy. As the Kansas Supreme Court explained, “[c]laims made policies cover losses that are claimed during the policy period. By contrast, ‘occurrence policies’ cover losses that occur during the policy period—regardless of when the claim is made.” Id. at 217 (italics in original; citation omitted). The trial court found that the insured suffered a malpractice claim during the October 2011 to October 2012 policy period, but because she didn’t report the claim to the insurer, “she was not entitled to coverage under the clear terms of the insurance contract.” Id. Both the trial court and the court of appeals validated the insurer’s denial of coverage. They reasoned that the malpractice claim fell outside of the scope of coverage of the insurance policy, so application of estoppel “would functionally ‘expand’ the coverage.” Those lower courts thought such an expansion of coverage was prohibited by earlier Kansas cases. Id. The Kansas Supreme Court, however, concluded that the district court and the Kansas Court of Appeals erred in rejecting estoppel solely based on the “expansion of coverage rule.” “Instead, the lower courts should have continued their analysis to see if estoppel was appropriate to apply to our facts under the ‘reservation of rights’ rule.” Id.
Why is this important for Kansas business insureds? The Kansas Supreme Court emphasized that the “reservation of rights rule” facilitates the insured’s informed decisionmaking. Id. at 220. An insured that is timely warned in a reservation of rights letter that the insurer may later deny coverage, and why, is armed to make decisions about whether to give up control of the defense or to pursue other means of resolving the lawsuit. Id. An insured that does not receive a timely warning may give up control of the defense and unknowingly forfeit its options, only for the insurer to pull out the rug by later denying coverage. Indeed, the Kansas Supreme Court pointed out that if an insurer does not provide a timely reservation of rights letter, and if the insured relies on that omission, then “prejudice to the insured will be assumed.” Id. at 219. While the court expressly declined “to make a bright line rule” about when a reservation of rights is timely, Becker strongly implies that, at a minimum, the reservation must be provided before the insurer takes over the defense of the lawsuit. See, e.g., id. at 220.
The takeaways from Becker are that Kansas insureds should pay close attention to any reservation of rights letters and evaluate all options before allowing the insurer to take over the defense of a lawsuit. If an insurer attempts to limit or deny coverage after failing to provide a timely reservation of rights letter, the insured should consider challenging the insurer’s position.