A Defending Insurer’s Reserving Rights and Seeking Declaratory Judgment Does Not Constitute Bad Faith in California

A California federal court has held that neither sending a reservation of rights letter nor the mere filing of a suit seeking recission or declaratory relief while an insurer defends the insured amounts to a breach of an insurance policy or bad faith.  Associated Indus. Ins. Co., Inc. v. Geragos & Geragos, APC, 2022 WL 601046 (C.D. Cal. Feb. 15, 2022). 

The insured, an attorney and his law firm, were sued for their alleged involvement in a conspiracy to extort a major shoe manufacturer.  The insured tendered the suit to its professional liability insurer, and the insurer agreed to defend the suit subject to a reservation of rights.  The insurer then sought to rescind the policy based on the insured’s asserted failure to disclose material facts in the application for the policy, including the insured’s knowledge of and role in the underlying suit at the time the application was submitted to the insurer.  While the underlying suit was pending, the insurer brought a coverage action against the insured seeking recission of the policy and declaratory relief.  The insured answered and counterclaimed for (1) breach of contract for the covenant of good faith and fair dealing, (2) tortious breach of the covenant of good faith and fair dealing, and (3) declaratory relief concerning the duty to defend and indemnify the insured in the underlying suit.  The insurer filed a motion to dismiss the first two counterclaims pled by the insured.

In analyzing whether the insured’s bad faith counterclaims would survive the insurer’s motion to dismiss, the court observed that there were “at least two separate requirements to establish breach of the implied covenant: (1) benefits due under the policy must have been withheld; and (2) the reason for withholding benefits must have been unreasonable or without proper cause.”  In this case, because the insurer was offering a defense, the insurer had not actually withheld any benefits under the policy.  The court rejected the insured’s other bad faith theories, expressing that “[s]ending a reservation of rights letter does not amount to a breach of an insurance policy or bad faith, nor does filing suit for rescission or a declaration of non-coverage while still providing coverage in the interim.”