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Posted by H. Lee Pruett

Answering certified questions from the U.S. Court of Appeals for the Eleventh Circuit, the Georgia Supreme Court recently ruled that when an insurer enters into a defense of its insured without effectively reserving its right to deny coverage, prejudice to the insured is presumed, and the insurer is estopped from asserting noncoverage. In World Harvest Church, Inc. v. GuideOne Mut. Ins. Co., Case No. S10Q0341 (Ga. S. Ct., May 3, 2010), GuideOne insured the church under a general liability policy. The Securities and Exchange Commission sued the church for fraudulent transfer and unjust enrichment stemming from donations to the church from two men who had pled guilty to securities fraud. The action was first brought in federal court in Illinois, and a sister company of GuideOne sent a written reservation of rights to the church and ultimately denied coverage. After dismissal of the Illinois action for lack of jurisdiction, the SEC filed suit in the U.S. District Court for the Northern District of Georgia.

The adjuster for GuideOne informed attorneys for the church that GuideOne “didn’t see coverage,” but would have to evaluate any coverage issues. GuideOne then assumed the defense of the case without issuing a written reservation of rights. Over ten months later, GuideOne told the church there was no coverage for the claim and that the defense would be withdrawn. The SEC eventually won summary judgment and $1.8 million in damages. After settling with the SEC for $1 million, the church brought suit against GuideOne for breach of contract. On cross motions for summary judgment, the U.S. District Court for the Northern District of Georgia ruled that GuideOne was not estopped to deny coverage because the insured church had failed to show it was prejudiced by GuideOne’s initial defense of the case.

The first question was whether the insurer effectively reserves its right to deny coverage when it informs the insured it does “not see coverage,” and a sister company had previously sent a written reservation of rights in a similar lawsuit, or whether the reservation must be in writing or more unequivocal. The Georgia Supreme Court answered that, although the reservation of rights does not have to be in writing, it must “fairly inform” the insured that the insurer was not waiving any policy defenses even though it was defending the insured, and the reservation must state the basis for the doubts about coverage. Here, the adjuster’s statement that GuideOne did “not see coverage” was not enough. The Court further ruled that the prior written reservation of rights and denial of coverage by the sister company in a similar case did not overcome the deficiencies in the instant case.

The second question was whether the insured must show prejudice. The Georgia Supreme Court held that “where, as here, an insurer assumes and conducts an initial defense without effectively notifying the insured that it is doing so with a reservation of rights, the insurer is deemed estopped from asserting the defense of noncoverage regardless of whether the insured can show prejudice.” It appears from the Court’s analysis of the issue that prejudice is actually presumed. Citing numerous cases from the Georgia Court of Appeals, the Court agreed that prejudice is conclusively established because the insured has given gave up the right to control the defense, choose counsel, negotiate a settlement, and assert defenses. In such cases, there may be no coverage, but “the insurer will not be heard to say so.”