Insurer’s “Generic” Reservation of Rights Letters Found Inadequate by South Carolina Supreme Court

February 21, 2017 | Insurance Coverage

The South Carolina Supreme Court has found that letters issued by a commercial general liability insurer to its insureds were inadequate to reserve its rights as they amounted to “generic denials of coverage coupled with furnishing the insured with a verbatim recitation of all or most of the policy provisions (through a cut-and-paste method).”

The Case

After construction was completed on two condominium complexes in Myrtle Beach, South Carolina, and the units were sold, the purchasers became aware of construction problems including building code violations, structural deficiencies, and water intrusion.

The property owners’ associations (POAs) filed separate lawsuits seeking actual and punitive damages for the construction defects under theories of negligent construction, breach of fiduciary duty, and breach of warranty. Individual homeowners in one of the developments also filed a class action to recover damages for the loss of use of their property during the repair period.

The defendants in the underlying suits were the related corporate entities that had developed and constructed the condominium complexes: the parent development company, the project-specific subsidiary companies for each separate development, and the general contracting subsidiary (collectively, “Heritage”).

After receiving notice of the lawsuits, Heritage’s commercial general liability insurance carrier informed Heritage that it would provide a defense under a reservation of rights.

Ultimately, a jury returned a general verdict in favor of one POA for $6.5 million in actual damages and $2 million in punitive damages. A second jury returned a general verdict of $4.25 million in actual damages and $250,000 in punitive damages in favor of the other POA. The individual homeowners were awarded $250,000 in loss-of-use damages and $750,000 in punitive damages in their class action.

Following these jury verdicts against its insureds, the insurer went to court seeking a determination as to what portion of the judgments in the underlying construction defect lawsuits were covered under Heritage’s policies. Under South Carolina law, the cost of repairing faulty workmanship is not covered under a commercial general liability policy, but resulting property damage beyond the defective work product itself is covered.

A special referee decided that the insurer had not properly reserved the right to contest coverage as to the underlying damages that constituted faulty workmanship. The special referee concluded that the general verdicts included some covered damages but found it would be purely speculative to allocate the juries’ general verdicts between covered and non-covered claims. The special referee then calculated the insurer’s pro rata portion of the progressive damages caused by repeated water intrusion based on the insurer’s time on the risk. The referee also found that punitive damages were covered and that no policy exclusion applied to preclude coverage for any portion of those damages.

The dispute reached the South Carolina Supreme Court.

The South Carolina Supreme Court’s Decision

In the key portion of the ruling, the court rejected the insurer’s contention that the special referee had erred in finding that it had not properly reserved the right to contest coverage as to the underlying damages constituting faulty workmanship.

The court declared that the insurer’s reservation of rights letters (except with respect to punitive damages) were “generic denials of coverage coupled with furnishing the insured with a verbatim recitation of all or most of the policy provisions (through a cut-and-paste method),” and that they were “not sufficient.”

The court said that the insurer’s letters:

  • Explained that the insurer would provide a defense in the underlying suits;
  • Listed the name and contact information for the defense attorney the insurer had selected to represent Heritage in each matter;
  • Identified the particular insured entity and lawsuit at issue;
  • Summarized the allegations in the complaint;
  • Identified the policy numbers and policy periods for policies that potentially provided coverage; and
  • Incorporated “through a cut-and-paste approach” a nine- or 10-page excerpt of various policy terms, including the provisions relating to the insuring agreement, the insurer’s duty to defend, and “numerous policy exclusions and definitions.

”The court added that despite the policy references, the letters included “no discussion” of the insurer’s position as to the various provisions or explanation of its reasons for relying thereon. According to the court, with the exception of the claim for punitive damages, the letters “failed to specify the particular grounds” upon which the insurer did, or might thereafter, dispute coverage.

These letters, the court concluded, were not sufficiently specific to put Heritage on notice of the insurer’s specific defenses, particularly as to the need for an allocated verdict. As such, the court agreed with the referee’s conclusion that the insurer did not effectively reserve the right to contest coverage.

Rivkin Radler Comment

This decision should act as a reminder to insurers that to be effective, a reservation of rights letter must be specific and fairly inform the policyholder of the reason why the insurer may ultimately deny coverage. But, the South Carolina Supreme Court’s decision was notable for two other holdings. First, it affirmed the special referee’s time-on-the-risk computation for loss-of-use actual damages in the construction defect context. Second, it rejected the insurer’s contention that punitive damages – which it found covered in this case – were subject to allocation based on time on the risk, although it said that it was not establishing a “categorical rule” to that effect. The court found that all of Heritage’s reprehensible acts that justified the juries’ imposition of punitive damages took place entirely during the time that the insurer’s (Harleysville’s) policies were in effect.

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  • Robert Tugander

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