The Duty to Defend and Reservation of Rights: What Rights is Your Insurer Reserving?

The Duty to Defend and Reservation of Rights: What Rights is Your Insurer Reserving?

August 9, 2022

By Colin M. Bruns



Colin is a member of the firm’s Construction Law Department. He can be reached at 612.359.7665 or




       When facing a claim asserted by a third party, one of the first steps a contractor may take is to tender the claim to its CGL insurance carrier for defense and indemnification.  Upon receipt of the tender, the insurer typically has three options: (1) accept the tender; (2) deny the tender; or (3) accept the tender under a “reservation of rights.”  This article focuses on the third option and analyzes the risks that the insurer’s reservation may contain.

What is a Reservation of Rights Letter?

        When an insurer issues a reservation of rights letter to its insured, it agrees to accept defense of the claim while reserving the right to later contest coverage under the policy depending on the facts developed through its investigation.  If the insurer accepts the defense without expressly notifying its insured that it reserves its right to contest coverage, the insurer will typically be prevented from later denying coverage.  In other words, an insurer cannot agree to defend its insured and then later contest coverage unless it explicitly tells the insured it reserves the right to do so.

       The good news for a contractor receiving a reservation of rights letter is that the insurer agrees to defend against the claim, at the insurer’s expense.  Given the potential cost of litigation, this can be a significant benefit to the contractor.  On the other hand, the insurer reserves the right to contest coverage, which may present issues for the contractor down the road.  It is important to remember that not all reservation of rights letters are the same; as is the case with many agreements, the devil is in the details.  Before agreeing to accept the conditions imposed by the insurer, it is critical for the insured to understand exactly what obligations the insurer agrees to undertake, and what rights it reserves to assert later.  Below are a few key issues for contractors to consider if they receive a reservation of rights letter from their insurer.

Can an Insurer Reserve the Right to Recover Defense Costs?

       When an insurer accepts defense subject to a reservation of rights, it agrees (at least initially) to defend against the claim at the insurer’s expense.  Of course, this provides a significant benefit to the insured.  In some circumstances, however, the insurer may attempt to reserve the right to recover its defense costs if a court later determines that the insurer did not have a duty to defend some or all of the claims in the first place.  In this scenario, the insurer essentially reserves the right to take away the benefit it has agreed to provide to its insured by defending against the claim at the insurer’s expense.

        Whether the insurer will ultimately be successful in recovering its defense costs will depend on a variety of factors, including the jurisdiction of the action, the terms of the insurance policy, and the specific language of the reservation of rights letter.  Contractors should be wary of such a provision in a reservation of rights letter.  Many insurance policies do not grant the insurer the right to later recover the costs of defense from its insured once it has accepted the defense.  As a result, many jurisdictions hold that an insurer’s reservation of rights letter cannot unilaterally create a right to recover defenses costs.

         Nevertheless, some jurisdictions have allowed insurers to recover defense costs if the insurer expressly reserves the right to do so in its reservation of rights letter and the insured does not object.  Therefore, contractors should look for any attempt by their insurer in its reservation of rights letter to later recover the cost of defense that the insurer is agreeing to provide, and object in writing to that attempted reservation.  Courts have held that if the insured expresses disagreement with this particular reservation, then no such right will have been created.

Does the Reservation of Rights Create a Conflict of Interest?

        When an insurer is obligated to defend its insured and contests coverage in the same suit, a conflict of interest may exist for the counsel appointed by the insurer to defend the insured.  In this scenario, the insurer may be required to take one position at trial to defend its insured against the claims asserted against it and, at the same time, take an opposing position to defend itself on the question of coverage.  This situation presents a conflict for the attorneys appointed by the insurer to represent the insured.  As one court has put it, “if, in the underlying suit, insurer-retained counsel would have the opportunity to shift facts in a way that takes the case outside the scope of policy coverage, then the insured is not required to defend the underlying suit with insurer-retained counsel.”[1]

        The existence of a conflict of interest does not relieve the insurer of its duty to defend.  Rather, the duty to defend is transformed into a duty to reimburse the insured for reasonable attorneys’ fees incurred in defending the lawsuit.  As a result, if an insurer’s reservation of rights presents a conflict of interest, the insured may be entitled to appoint its own selected attorneys to defend against the claims, at the insurer’s expense, rather than accept a defense from counsel appointed by the insurer.

Does the Reservation of Rights Include Notice of the Insured’s Right to an Allocated Verdict?

       An insurer that accepts the duty to defend, but reserves the right to contest its duty to indemnify, may bring a separate declaratory judgment action to determine coverage while the third party action is pending, or it may seek to have the jury make findings in the third party action to resolve coverage issues.[2]  An award entered against the insured may include sums for claims covered under the policy and sums for claims not covered by the policy.  As a result, the total award must be allocated between covered and non-covered claims, which allocation may need to be resolved by the court in a subsequent coverage action.  In such a case, the insured generally bears the burden of proof with respect to covered elements of damages and, thus, has the burden to allocate a verdict between covered and non-covered claims. Therefore, the consequence to an insured of an unallocated verdict may result in “the catastrophic total loss of coverage.”[3]

        In some states, including Minnesota, an insurer that has a duty to defend and is controlling the defense has a duty to inform the insured of its interest in obtaining an allocated award, and the insured is entitled to make the decision whether to seek the allocated award.  If the insurer accepts defense of the third party action under a reservation of rights but fails to disclose to the insured its interest in obtaining an allocated award, then the insured’s burden to allocate the award between covered and uncovered claims is shifted to the insurer in the post-award coverage or declaratory judgment action.  Courts have held that an insurer that fails to meet its duty to notify its insured of its interest in obtaining an allocated award is prevented from “protecting its interest and secur[ing] for itself an escape from responsibility at the expense of the insureds.”[4]

       Where a contractor faces both covered and non-covered claims, whether the reservation of rights letter includes notice of the insured’s interest in obtaining an allocated award may have significant ramifications, for both the insurer and the insured.

Key Takeaways for Contractors

       When an insurer accepts defense of claims asserted against a contractor under a reservation of rights, the contractor obtains the benefit of a defense of the claims, at the insurer’s expense.  The rights reserved by the insurer, however, can later create significant issues for the contractor, some of which are discussed above.  Ultimately, the resolution of any specific issues that arise will depend on various factors including the relevant jurisdiction, the terms of the policy at issue, and the language in the reservation of rights letter.  Nevertheless, if a contractor receives a reservation of rights letter from its insurer, it can better protect itself by understanding what obligations the insurer agrees to undertake and what rights it reserves to assert in the future.

[1] American Family Mut. Ins. Co. v. W.H. McNaughton Builders, Inc. 363 Ill. App. 3d 505, 843 N.E.2d 492, 498 (Ill. App. 2006).

[2] The latter situation may create a conflict of interest, as discussed above.

[3] Duke v. Hoch, 468 F.2d 973, 979 (5th Cir. 1972).

[4] Remodeling Dimensions, Inc. v. Integrity Mut. Ins. Co., 819 N.W.2d 602, 618 (Minn. 2012) (citing Duke v. Hoch, 468 F.2d 973, 979 (5th Cir. 1972)).


Matt Collins is presenting a continuing legal education seminar for Minnesota CLE on August 30, 2022, in Minneapolis on 10 Practice Tips for Successful Construction Arbitrations and Mediations.  Contact Matt for more information:  

Fabyanske, Westra, Hart & Thomson, P.A. is pleased to announce that Dean Thomson and Julia Douglass will be speaking on Mediation Strategies on October 17th to the Florida Bar Association Section on Construction Law. For more information click here.

Congratulations to the nine attorneys from Fabyanske, Westra, Hart & Thomson, P.A. who have been named 2022 “Minnesota Super Lawyers”. The polling, researching, and selecting of “Super Lawyers” is designed to identify Minnesota lawyers who have attained a high degree of peer recognition and professional achievement. Only five percent of Minnesota attorneys receive this honor. FWHT’s 2022 “Minnesota Super Lawyers” include Mark BeckerJulia Douglass, Gary EidsonMarv FabyanskeKyle HartTeresa Molinaro, Jesse OrmanDean Thomsonand Tom VollbrechtDean Thomson was also selected as a Top 100 “Super Lawyer”. For more information click here.

This discussion is generalized in nature and should not be considered a substitute for professional advice. © 2022 FWH&T