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This is the first in a series of discussions about issues that arise on a regular basis after policyholders file an insurance claim.

Many liability insurance policies require the insurer to defend the insured. This “duty to defend” usually includes the right to select defense counsel – typically “panel counsel” from a list of pre-approved law firms – and control the defense. The relationship between the insurer, defense counsel, and the policyholder is known the “insurance triangle” (think Bermuda triangle) because it is laden with pitfalls.

Specifically, when an insurer reserves its right to later deny coverage, the interests of the policyholder and insurer are not aligned. The policyholder is not only confronted with potentially uninsured liability, but the possibility that at any point, the insurer may cease paying attorneys’ fees and costs, and perhaps assert it is entitled to reimbursement of the fees and costs already paid.

Conflicts That Can Arise from a Reservation of Rights

A reservation of rights may also create a conflict of interest that entitles the policyholder to select its own counsel paid for by the insurer. Conflicts most frequently arise when a complaint alleges a mix of claims, with some claims covered and others not. Mutually exclusive claims are especially problematic – for example, if negligence is established, the insured has coverage, but if intentional conduct is proved, there is none. 

The crux of the problem is the insurer’s financial interest in a result supporting non-coverage. The chief concern is “steering” – the possibility that defense counsel could steer the litigation in favor of non-coverage by developing facts or pursuing a strategy that leads to judgment on an uncovered cause of action. The insurer and panel counsel likely have a long-standing relationship and panel counsel has a personal financial interest in continuing to get the insurer’s work. If the insurer believes there will ultimately be no coverage, defense counsel may mount a less than robust defense.

When Is Independent Counsel Required?

States have taken different approaches to determining when a reservation of rights triggers the right to independent counsel. In a few states, like Mississippi, the right arises automatically when an insurer reserves rights. On the opposite end of the spectrum, there is no right to independent counsel in Hawaii, where defense counsel are solely responsible for managing conflicts of interests under rules of ethics. Some states, like Washington and Alabama, impose an enhanced obligation of good faith on both appointed counsel and the insurer.

Most states, like Texas, require a case-by-case examination of the facts and a showing of an actual, present conflict of interest. The analysis focuses on how the potential coverage issues intersect with the issues of fact in the underlying litigation. Generally, if coverage depends on the same facts to be decided in the underlying suit, the insured is entitled to independent counsel. Another relevant factor is whether the insurer could obtain privileged information from defense counsel that could be used to defeat coverage. When there is a conflict of interest, the insured’s contractual duty to cooperate with the insurer does not require waiver of the attorney-client privilege.

Policyholders should routinely consider potential conflicts of interest upon receipt of a reservation of rights letter and reassess periodically as the underlying litigation progresses.  Insurers are unlikely to raise the issue unprompted.

Invoking the independent counsel rule, when warranted, not only prevents entanglement in a conflict of interest, but it may ultimately prevent a second litigation between the policyholder and insurer over coverage.

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It is long-standing law in Florida (and elsewhere) that an insurer can deny a claim when it was prejudiced by a policyholder’s failure to provide timely notice. However, there has been some debate in recent years about whose burden it is to prove that the insurer was prejudiced, especially in property insurance claims involving Citizens Property Insurance Corporation — one of the state’s largest homeowners insurance companies.

Traditionally, Florida courts have found that once an insurer can establish that notice of a claim was untimely, the burden shifts to the policyholder to show that the delay did not prejudice the insurer. If the policyholder can show that the insurer was not prejudiced by the delay, then the insurer cannot deny the claim based on untimely notice. 

In 2022, the Fourth District Court of Appeal entered an opinion analyzing a provision common to Citizens’ homeowners policies. The court determined that the policy language created an obligation for Citizens to prove that it was prejudiced by the late notice in order to deny the claim — shifting the burden of proof to the insurer (Perez v. Citizens Prop. Ins. Corp., 345 So. 3d 893 (Fla. 4th DCA 2022)). The specific policy language provided as a condition to coverage that “Citizens has ‘no duty to provide coverage under this Policy if the failure to comply with the following conditions is prejudicial to us.’” Citing a 2021 case involving similar language, the court ruled “the policy language . . . requires an express showing of prejudice by the insurer in order for the insured’s failure to comply with policy conditions to constitute a material breach and permit an insure to deny coverage for a claim.”Ultimately, the court held that the presumption of prejudice did not apply because of the policy language, reversing the trial court’s entry of summary judgment.

Perez has not been overturned and remains good precedent in the circuits in the Fourth District Court of Appeal. However, in a recent decision, the Third District Court of Appeal expressly rejected the policy interpretation in Perez and declared a conflict among the circuits (Arce v. Citizens Prop. Ins. Corp., 2024 WL 24945, — So. 3d — (Jan. 3, 2024)). The issue in Arce was a property damage claim on a homeowners policy that was not reported to the carrier for nearly three years.  The trial court had granted summary judgment in favor of the carrier, and the insured appealed arguing that Citizens had not presented evidence of prejudice, relying in part on Perez. The Arce court analyzed the same policy language as Perez but came to the opposite result. Interestingly, the Arce court determined that shifting the burden to show prejudice to the carrier would “frustrate[] the very purpose of the prompt notice provision.” This is interesting because typically the carrier is in the best position to show it was prejudiced by the late notice. The Arce court went on to look at the actual language itself and noted that the provision was silent as to the respective burden-shifting, and the court would not read such burden-shifting language into the policy..

It will be interesting to see when and if the Florida Supreme Court decides this conflict between the districts. The courts in Florida are typically required to read policies in a manner that most affords coverage, but that theory does not necessarily apply to the burden of proof. Under both Perez and Arce, if the carrier is not prejudiced by any late notice, then the carrier cannot avoid coverage — and the only question is who has the burden of proof. As it currently stands, the policyholder must establish the carrier’s lack of prejudice in the courts under the Third District Court of Appeal.

Of course, for policyholders, the best advice is to review your policy and be sure to submit a timely notice of any claims to avoid the issue altogether. But in cases where timely notice is not possible, then policyholders must be prepared to show lack of prejudice to the carrier caused by such late notice regardless of the policy language, especially in Miami-Dade and Monroe counties.

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The United States District Court for the Middle District of Florida recently granted summary judgment for an insurer on a pollution liability policy for lack of timely notice. The court agreed with the insurer that the insured gas station operator had knowledge of “pollution conditions” in 2017 and 2018, yet failed to provide notice to its insurer until 2019 (L. Squared Indus., Inc. v. Nautilus Ins. Co., — F. Supp. 3d. —, 2023 WL 4227568 (granting summary judgment for insurer), 2023 WL 6194226 (M.D. Fla. Aug. 29, 2023) (denying insured’s motion for reconsideration)).

Nautilus Insurance Company issued the claims made policy for the July 18, 2018, to July 18, 2019, policy period covering “storage tank systems cleanup costs, third-party bodily injury, property damage liability, and defense.” The issue before the court was whether Nautilus owed a duty to cover clean-up and defenses costs associated with the accidental release of petroleum from an underground storage tank (UST). The insured L. Squared Industries, Inc. is a Florida corporation that operates gas stations.

On May 2, 2017, the Florida Department of Environmental Protection (FDEP) inspected L. Squared’s gas station in St. Augustine. This FDEP inspection identified two violations involving cracked boot gaskets and directed L. Squared to take corrective action, including hydrotesting to determine whether any discharge could have occurred. L. Squared hired a contractor to repair the cracked boot gaskets and to conduct the hydrotesting, which failed, necessitating sampling of the surrounding soil.  Following the sampling, L. Squared submitted a Discharge Report Form (DRF) to the FDEP on March 18, 2018, stating a release was discovered in July 2017. The DRF also stated discharged or released gasoline and diesel were affecting the soil and groundwater.

 In 2018, L. Squared replaced a dispenser sump. In connection with that replacement activity, L. Squared hired an environmental consultant who identified some groundwater contamination in a 2018 report. This same consultant conducted further sampling on April 5, 2019, and found what appeared to a be a petroleum release. L. Squared provided a notice of occurrence/claim to Nautilus on April 19, 2019. Nautilus denied coverage and litigation ensued.  Both parties moved for summary judgment.

In deciding whether the insured’s notice was timely, the court focused on the Reporting of a Pollution, Condition, Claim or Suit provision of the policy, which requires the insured to provide notice to the insurer within seven days after the insured “first became aware of, or should have become aware of, a pollution condition.” Nautilus argued L. Squared was aware of a pollution condition in May 2017, when the FDEP notified L. Squared of violations and directed L. Squared to take corrective actions, or at the latest in July 2017, the date L. Squared identified in its DRF report that a release had been discovered. 

L. Squared argued, however, that the 2017 notice and DRF report were related to a pre-existing 1985 release or discharge, and that it was not until 2019 that L. Squared had any knowledge of a new release, and that this new release was “first discovered” through April 2019 correspondence from the FDEP and promptly reported to Nautilus. In rejecting this position, the court noted that within the April 2019 correspondence, the FDEP specifically referenced the 2018 consulting report associated with the dispenser sump replacement, the contents of which L. Squared was aware of in 2018. 

In granting summary judgment for the insurer, the court found the plain language of the policy required L. Squared to notify Nautilus within seven days of the 2018 consultant report, which L. Squared failed to do. The court subsequently denied L. Squared’s motion for reconsideration, which L. Squared has appealed to the United States Court of Appeals for the Eleventh Circuit.

Regardless of the outcome of the appeal, the case highlights the significance of prompt reporting of claims, or even circumstances that may lead to a claim, to insurers – and particularly the repercussions of failing to do so. To avoid waiver of any available insurance coverage, it is critical that companies have a claims management system in place to ensure insurance carriers are timely notified when appropriate. Policyholder attorneys can review notice requirements of existing policies and assist in creating claims management systems to minimize the possibility of late notice of potentially covered claims.

*Andy Tao is a co-author of this post. Andy Tao is not yet a licensed attorney.