On September 21, 2018, the Second Circuit issued a decision in SPARTA Ins. Co. v. Technology Ins. Co., Inc., Case No. 17‐3441, holding that a liability insurer that assumed the defense of a claim was estopped from disclaiming coverage based on a nine-month delay in asserting coverage defenses and resulting prejudice to the insured.
In SPARTA Ins. Co., a subcontractor’s liability carrier (SPARTA) assumed the defense of a property owner and general contractor in an injury lawsuit brought by the subcontractor’s employee, without a reservation of rights. In later correspondence, SPARTA attempted to make a generic reservation of rights, invoking “the terms and conditions of the policy it issued” but did not “spell what terms and conditions might bear on its obligation.” More than nine months later, SPARTA “argued that it was not required to indemnify the property owner because the property owner allegedly caused the worker’s injury through its negligence.” The Second Circuit affirmed the District Court’s holding that SPARTA was estopped from asserting this coverage defense, explaining:
An insurer who undertakes the defense of an insured, may be estopped from asserting a defense to coverage, no matter how valid, if the insurer unreasonably delays in disclaiming coverage and the insured suffers prejudice as a result of that delay. Prejudice may be presumed where an insurer, though in fact not obligated to provide coverage, without asserting policy defenses or reserving the privilege to do so, undertakes the defense of the case, in reliance on which the insured suffers the detriment of losing the right to control its own defense. In such cases, though coverage as such does not exist, the insurer will not be heard to say so. These principles apply to coverage allocation disputes between insurers as well as to coverage disputes between insurers and insureds.
SPARTA undertook the defense and indemnification of the general contractor and property owner without asserting policy defenses or reserving the privilege to do so. . . .
SPARTA’s assertion of defenses to coverage for the defense and indemnification came after an unreasonable delay. The reasonableness of any delay is judged from the time that the insurer is aware of sufficient facts to issue a disclaimer. As the district court observed, SPARTA’s arguments regarding its coverage obligations are based on the terms of SPARTA’s own policy issued to the subcontractor and the contract between the general contractor and subcontractor, facts known to SPARTA at the time it agreed to undertake the defense and indemnification. Yet SPARTA failed to assert that it had reserved its rights‐‐let alone reach its ultimate conclusion regarding the extent of its coverage‐‐until April 28, 2014, more than nine months later. . . . [A] nine‐month delay is plainly unreasonable under New York law.
Finally, allowing SPARTA to assert defenses to complete coverage would prejudice the general contractor and Technology. In reliance on SPARTA’s undertaking of the defense and indemnification, the general contractor chose to forgo filing a third‐party complaint against the subcontractor for indemnification in the underlying tort suit. Because that suit has been readied for trial during SPARTA’s control of the defense, the general contractor and Technology have lost the opportunity to pursue third‐party claims against the subcontractor. The general contractor and Technology would therefore face actual prejudice from SPARTA’s assertion of defenses to coverage after an unreasonable delay.
SPARTA is therefore estopped from seeking reimbursement of past and accruing defense costs in the underlying tort suit.
This decision illustrates the importance of the insurer’s reservation of rights letter. The failure to issue such a letter, or to invoke specific defenses in the letter, can impact the insurer’s ability to disclaim coverage down the road.