In part one of this blog I discussed intervention, one option insurers may have when coverage questions arise. As I noted in my prior blog, procedures for intervention vary by state, and some states simply do not allow an insurer to intervene in an underlying lawsuit against its insured. In part two of my blog on litigating insurance coverage issues, I will discuss another option, the declaratory judgment action (DJ).
A DJ usually involves an insurer suing its own insured in a completely new lawsuit, to have a court determine coverage. The downside to this is (1) it requires the insured to retain separate counsel (the attorney retained by the insurer to defend the insured in the underlying action is usually prohibited from litigating coverage issues); (2) it can result in a bad faith counterclaim (where, for example, the insurer has refused to provide a defense to the insured); and (3) it raises the question of why an insurance company needs a court to interpret policy language that it (the insurance company) drafted (and I have been in court when judges asked that very question).
A DJ is, by far, the most called upon method to adjudicate the construction and operation of an insurance policy with respect to the rights of the parties to the contract. A DJ is often employed to determine whether or not an insurer has a duty to defend, whether an insured has violated a condition such as reporting an occurrence as soon as possible, to determine if one claiming coverage is an insured under the policy, whether an injury was "expected or intended" by an insured, and other coverage matters.
A DJ is frequently employed to avoid the allegation of bad faith refusal to pay a claim under a policy, especially where the insurer is providing a reservation of rights defense to its insured. A DJ may be brought in either state or federal court. However, in some jurisdictions a DJ may not be permitted where its resolution requires an adjudication of an issue pending in the underlying liability action. In addition, some courts may only decide the question of duty to defend in a DJ, ruling that the issue of duty to indemnify is not yet ripe if there has been no verdict against the insured in the underlying litigation.
Regardless of what method is used to litigate a coverage question, an insurer should keep its insured informed of the process and the coverage questions at issue, through a detailed reservation of rights letter. How to craft such a letter will be the topic for a future blog.