Untimely Reservation of Rights Estops Insurer from Denying Coverage

The United States District Court for the Southern District of New York, applying New Jersey law, has held that an insurer was estopped from denying coverage under a retroactivity provision in an engineering firm’s professional liability policy because the insurer’s reservation of rights, which was issued three years after accepting control of the insured’s defense, was untimely and defective.  RLI Ins. Co. v. AST Eng’g Corp., 2019 WL 7114986 (S.D.N.Y. Dec. 20, 2019).

The insured, an engineering firm, designed part of a concrete wall for a residential building.  The concrete wall damaged an adjoining building, and the owner sued the owner of the residential project and a subcontractor.  During the policy period, the subcontractor filed a third-party complaint against the engineering firm, alleging that the firm had failed to provide adequate engineering services for the design.  The complaint asserted that the alleged error occurred before the policy period and the retroactive date.

The insurer agreed to defend the engineering firm and selected defense counsel.  Nearly three years later, the insurer issued a reservation of rights, raising the retroactivity provision – which barred coverage for a “wrongful act” occurring before the retroactive date – as a possible basis for a denial.  Several years later, the insurer filed a coverage action seeking a declaration that no coverage existed because the alleged “wrongful act” occurred before the retroactive date and because the engineering firm knew that a claim might be brought against it before the policy period.

The insured argued in coverage litigation that the insurer was estopped from denying coverage.  The district court agreed, noting that, under New Jersey law, prejudice to an insured is generally assumed when an insurer controls the defense.  The district court held that the insurer could have timely reserved its rights and informed the engineering firm that it could accept or reject the defense, but the insurer had failed to timely do so.

The district court also held that the insurer waived a claim for fraud against the insured.  The district court, however, declined to award attorney’s fees to the insured, noting that “the record reflects a substantial likelihood that [the insured] knew of the factual basis for the claims against it before it applied . . . for insurance and procured the Policy through fraud.  Equity does not support an award of attorneys’ fees.”