Fourth Circuit Reaffirms South Carolina Prohibition on Generic Reservation of Rights Letters
The Fourth Circuit Court of Appeals recently upheld a federal trial court ruling that found that two insurers had insufficiently reserved their rights when sending reservation of rights letters to their insureds such that they could not disclaim coverage for a construction defect judgment under South Carolina law.
Stoneledge at Lake Keowee Owners’ Association, Inc. v. Cincinnati Insurance Company arose out of a construction defect lawsuit brought by an HOA against a general contractor and its managing member alleging that an entire townhome community was improperly constructed, resulting in water intrusion and other physical damage to the homes. The contractor tendered the claims to two general liability insurers, both of which agreed to defend it against the suit subject to reservations of rights. Both carriers issued reservation of rights letters to the contractor.
Ultimately, a judgment was entered against the contractor and its member for a total of more than $1.6 million. The HOA, the contractor, and both carriers settled additional claims for $2 million, subject to the agreement to litigate coverage issues. The trial court awarded the HOA summary judgment in finding that the carriers had improperly reserved their rights to contest coverage such that they were responsible for the judgment and settlement, and the carriers appealed.
The Fourth Circuit first reaffirmed the South Carolina Supreme Court’s widely-known Harleysville Group Insurance v. Heritage Communities Inc. decision as governing South Carolina law generally applicable to reservation of rights letters. Harleysville generally found that under South Carolina law, an insurer must properly inform the insured of the issues upon which it might later disclaim coverage by connecting the facts and allegations with the potentially implicated language of the insurance policy in order to appropriately reserve rights in a reservation of rights letter. The carriers attempted to differentiate the case by arguing that it was limited to its own facts, that the settlement agreement into which the carriers entered on some of the underlying claims operated as an additional reservation of rights, and that it should not be applied retroactively to reservation of rights letters that were sent in 2009 and 2010.
The Fourth Circuit firmly rejected these arguments and affirmed its understanding that Harleysville applies broadly to reservations of rights letters issued in South Carolina and applies even to those letters written before the decision was issued.
The Court then analyzed the reservation of rights letters as potentially having waived the carriers’ rights to later contest coverage. The court describe one carrier’s letter as merely referring “the insured to certain policy exclusions and summariz[ing] the general nature of those exclusions” – the type of letter that the Fourth Circuit found the Harleysville court to deem insufficient to reserve the right to disclaim.
The Court described the second carrier’s letter as a closer call, but ultimately found that it too was insufficient to have reserved rights under Harleysville.
This letter set forth the reasons that the carrier thought the insuring agreement might not be implicated: the letter contained statements such as that “[i]t is doubtful that the claim alleges the happening of an ‘occurrence’” or that the “claim alleges ‘property damage’ within the policy definition” and that as a result, there could be “no coverage” for the claims. The Court found these statements insufficient because, while they identified the potential coverage issues, the letter “is devoid of any explanation for why [the carrier] finds it ‘doubtful’ that there is an ‘occurrence’ or ‘property damage’ within the meaning of the policy.”
Under South Carolina law, a carrier’s failure to explain the bases upon which a lawsuit might seek damages outside of a policy’s coverage in its reservation of rights letter can operate as a waiver of the carrier’s right to later disclaim coverage for a judgment entered against or settlement entered into by the insured.
The Fourth Circuit reiterated the proper means to do so: by identifying the relevant policy provisions and explaining, by reference to the known facts and allegations, why or under what circumstances the policy might not apply. To the extent that the carrier might initiate a declaratory relief action, the reservation of rights letter should reserve the carrier’s right to do so. Absent these crucial indications to the insured, the carrier might later find itself responsible for the entire judgment entered against the insured, both covered and any non-covered damages.
The Fourth Circuit’s recent decision in Stoneledge serves as an important reminder to carriers of the very high costs in South Carolina of issuing a generic reservation of rights letter.
Please contact Christy Maple or any member of the Phelps Insurance team if you have questions or need advice or guidance.
