The insurance relationship is contractual, but when policyholders claim insurers failed to honor their obligations, they typically invoke the tort of “bad faith.” When courts try to explain this anomaly, they cite features of insurance making it uniquely important that parties respect each other’s interests. Courts often say these features make the duty of good faith “reciprocal.” Twin City v. Country Mutual Insurance, 23 F.3d 1175, 1180 (7th Cir. 1994); Charter Oak Fire Insurance v. Blue Sky Partnership, 2001 WL 1178318 (Conn. Super. Aug. 30, 2001). But this reciprocity has its limits because courts typically will not permit insurers to assert a tort claim for consequential damages based on a policyholder’s breach of that duty. State Auto Property & Cas. v. Hargis, 785 F.3d 189 (6th Cir. 2015); Kransco v. American Empire, 2 P.3d 1 (Cal. 2000).

This imbalance warrants another look, because recent developments provide policyholders with new ways to prejudice their insurers’ interests. Several courts have held that a reservation of rights divests an insurer of control over settlement. E.g., Babcock & Wilcox v. American Nuclear Insurers, 76 A.3d 1 (Pa. 2015). Where an insured fails to cooperate in its defense, therefore, the insurer confronts the Hobson’s choice of either (a) issuing a reservation, and thereby forfeiting the ability to block a collusive settlement; or (b) assuming full responsibility for an impaired defense. Several courts have also found novel bases for establishing a breach of the insurer’s duty to defend, see, e.g., World Harvest Church v. Grange Mutual Casualty, 2013 WL 6843615 (Ohio Ct. App. 2013); Great Divide Insurance v. Carpenter, 79 P.3d 599 (Alaska 2003), and they have done so at a time when the penalties for breach of that duty are increasing. Employers Ins. of Wausau v. EHLCO Liquidating Trust, 186 Ill.2d 127 (1999) (breaching insurer estopped from asserting coverage defenses). Insureds that have previously laid traps for bad faith, such as time-limited demands, will now seek to manipulate insurers into alleged breaches of the duty to defend.

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