When faced with claims that may not be covered, an insurer can take a number of paths. This includes denying coverage, defending under a reservation or defending under a reservation while seeking a declaratory judgment on the issue of coverage. Some states may also permit the insurer to seek a stay of the claims while the insurer litigates coverage. Each comes with its own risks for the insurer but generally coverage defenses are preserved.
Riskier for an insurer is assuming the insured’s defense without immediately informing the insured that the defense is subject to a reservation of the right to deny coverage at a later date. In some jurisdictions, doing so results in an automatic forfeiture of coverage defenses. However, many require the insured demonstrate prejudice. In those that require prejudice, the District Court of Illinois’ recent decision may provide some guidance on the needed showing.
NorGUARD Ins. Co. v. MB Real Estate Services, Inc.,
2025 WL 358967
Background
NorGuard originates from an injury sustained by Martin Kraslen. Kraslen was an employee of MB Real Estate Services, Inc. (MBRE) and was working at a site for MBRE as the Chief Operating Engineer. While at the location, Kraslen fell through an access cover and into a pit.
At the time, MBRE was insured by NorGuard under a policy of insurance covering workers’ compensation and employer’s liability. As an employee, Kraslen sought and obtained workers’ compensation benefits from MBRE via the NorGuard policy.
Underlying Lawsuit
Kraslen eventually filed a lawsuit against multiple defendants he believed were responsible for his injuries. (“Kraslen 1”) One of those defendants filed a third party contribution claim against MBRE. NorGuard agreed to provide MBRE a defense without a reservation of rights and NorGuard selected and retained counsel to defend MBRE.
After roughly two years of litigating Kraslen 1, Kraslen discovered that MBRE had not preserved video footage of his fall. Kraslen amended his Petition to include a claim for spoliation directly against MBRE. NorGuard claimed that retained counsel for MBRE did not inform it of the amendment and NorGuard continued to provide a defense to MBRE without issuing a reservation. Retained counsel during this time represented MBRE at an unsuccessful mediation and filed a summary judgment motion on behalf of MBRE that was apparently poorly received by the trial court. For five months, NorGuard continued the defense of MBRE through retained counsel it selected without issuing a reservation of rights. This five-month period became critical in the later litigation.
After those five months, NorGuard sent MBRE a reservation of rights contending that no coverage was available for Kraslen’s spoliation claim. Even though NorGuard asserted that no coverage was available, it acknowledged that it would provide MBRE with a defense to the spoliation claim through retained counsel but was reserving its right to deny coverage on that claim.
Several months later, Kraslen dismissed Kraslen I. Several months after that,, Kraslen refiled his spoliation claim against MBRE. (“Kraslen II”). MBRE sought coverage for Kraslen II from NorGuard. NorGuard assigned the same adjuster to the claim but ultimately disclaimed any coverage for Kraslen II including a defense under a reservation of rights. There is no mention of whether a judgment has been entered in Kraslen II.
Federal Declaratory Judgment
During the pendency of Kraslen I and four months after it issued a reservation of rights, NorGuard filed a Declaratory Judgment Action (“DJA”) in federal court. The DJA was amended upon the filing of Kraslen II but the basis for the action both before and after amendment was NorGuard’s request that the court declare that the NorGuard Policy did not provide coverage for the spoliation claim against MBRE. NorGuard argued that the spoliation claim did not fit under the workers’ compensation or employers’ liability coverage provided by the policy.
MBRE’s opposition to the DJA didn’t center on whether the terms of the policy provided coverage for the spoliation claim. Instead, MBRE focused on the five months NorGuard defended Kraslen I after the spoliation claim was amended but without issuing a reservation of rights. Specifically, MBRE argued that NorGuard was estopped from denying coverage under the NorGuard Policy because it defended the spoliation claim for five months without issuing a reservation of rights.
Both parties ultimately moved for summary judgment. MBRE essentially acknowledged the terms of the NorGuard Policy did not provide coverage for the spoliation claim but argued NorGuard was estopped as a matter of law to deny coverage. NorGuard took the opposite position and argued that MBRE could not show any prejudice from its failure to issue a reservation of rights.
District Court Decision
After reviewing the briefing, the District Court determined that neither MBRE nor NorGuard were entitled to summary judgment. The District Court agreed that the terms of the NorGuard Policy did not cover the spoliation claim but there were fact questions on whether MBRE has sustained prejudice from NorGuard’s five-month delay in issuing a reservation of rights.
In making its decision, the District Court went into significant detail on what must be shown to find an insurer is estopped from denying coverage under a policy by defending without a reservation. The Court noted that an insurer’s assumption of the defense by having retained counsel enter an appearance is not enough and the amount of time an insurer defends without a reservation is important but not dispositive. Instead, the primary factor to consider when determining prejudice is whether the insurer’s assumption of the defense without reservation induced the insured to surrender control of his own defense and ability to protect its interests. The ultimate issue of whether an insured suffered prejudice is a fact question.
The District Court further went on to note that when the insured has personal counsel also actively participating with retained counsel in the defense, prejudice is less likely to be shown. However, when retained counsel completely takes over the defense of the insured and effectively discharges the insured’s hand-picked counsel, prejudice is more likely to be found as the insurer is exercising greater control over the defense.
While the District Court did not determine whether prejudice had been established and thus whether the estoppel claims would succeed at the summary judgment stage, NorGuard provides a decent discussion on the showing needed in order to prevail on an estoppel claim. The time period between an insurer assuming the defense of the insured and issuing a reservation of right is certainly relevant and the bigger the gap, the more likely prejudice can be shown. Certainly an extended gap coupled with retained counsel assuming complete control of the defense and the discharge of the insured’s chosen counsel appears to be a winning formula in states requiring a showing of prejudice on estoppel claims.
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