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Vol. 6, Iss. 9
December 13, 2017

Harleysville Group Insurance v. Heritage Communities, 803 S.E.2d 288 (S.C. 2017)

Loudest, Longest And Clearest Decision Ever Declaring A ROR Ineffective – And For A Common Reason

Heritage Communities is the loudest, longest and clearest decisions that I have seen holding that a reservation of rights letter – despite being many pages -- can be ineffective because it failed to adequately inform the insured of the reasons why the insurer may not be obligated to provide coverage. Such a strong decision, from a supreme court, not to mention on the heels of others, sets the stage for the possibility of Heritage Communities being followed by courts on a national basis.

In addition, decisions addressing the manner of reservation of rights letters -- because they are relevant to every type of liability policy, and without regard to the claim facts -- have the potential for the widest impact of all coverage cases. For this reason, Heritage Communities was an easy one to make the annual Top 10. The decision generated lots of buzz in coverage circles after it was issued. While the ten cases are not listed in order of importance, Heritage Communities would be at the top if they were.

I have lost track of the number of times that I’ve addressed in Coverage Opinions and this annual Top Ten cases of the year article and client seminars and webinars and to the guy next to me in line at Trader Joes, that for a reservation if rights letter to be effective it must fairly inform the insured of the reasons why the insurer, despite that it is providing a defense to the insured, may not be obligated to provide coverage for certain claims or damages in a suit. The only other reminder I’ve given more often is to my ten year old daughter – that she not talk to strangers.

We have all seen reservation of rights letters that set forth a brief factual summary of the claim, followed by several pages of policy language – some completely irrelevant – and then a concluding statement that, viola, the insurer reserves its rights.

But drafting a reservation of rights letter takes more than simply addressing the facts [in detail, hopefully] and citing policy provisions [and not numerous irrelevant ones, hopefully]. The important step is to then tie these two aspects together. In other words, if a policy provision is being cited in the reservation of rights letter, because it may preclude coverage, it should be accompanied by the allegations in the complaint that support this potential coverage defense. A letter may not be a reservation of rights letter simply because it calls itself one. Nor because it says, sometimes multiple times throughout, that the insurer is reserving its rights to deny coverage.

Lots of courts have concluded that reservation of rights letters, lacking specificity in why coverage may not be owed, do not make the grade, no matter how many times they may use the words reservation of rights. As such, the reservation of rights letter is ineffective. Translation – the insurer does not have the coverage defenses that it thought it did. The loudest cases of late to make this point have been Hoover v. Maxum Indem. Co., 730 S.E.2d 413 (Ga. 2012) (Top Ten Case of 2012) and Advantage Builders & Exteriors, Inc. v. Mid-Continent Casualty Co., 449 S.W.3d 16 (Mo. Ct. App. 2014) (Top Ten Case of 2014).

In Hoover, the court stated: “In order to inform an insured of the insurer’s position regarding its defenses, a reservation of rights must be unambiguous. If it is ambiguous, the purported reservation of rights must be construed strictly against the insurer and liberally in favor of the insured. A reservation of rights is not valid if it does not fairly inform the insured of the insurer’s position.” (internal quotes and citations omitted). Hoover at 417.

In Advantage Builders, a Missouri trial court found that an insurer, after undertaking its insured’s defense, owed no coverage. But that decision went by the wayside at the appeals court because the reservation of rights letters – despite containing a lot of pages, setting out the facts at issue, voluminous policy language and a statement that the insurer was reserving its rights – were found to be not effective. The court put it like this: “The letters generally discussed the nature of the underlying lawsuit and set forth various provisions of Advantage’s general liability policy. Neither letter clearly and unambiguously explained how those provisions were relevant to Advantage’s position or how they potentially created coverage issues.” Advantage Builders at 23.

In Harleysville Group Insurance v. Heritage Communities, the Supreme Court of South Carolina held that an insurer’s “reservations of rights” letter, despite setting out many pages of policy provisions, and other information usually contained in a reservation of rights letter, was ineffective because it failed to adequately inform the insured of the reasons why the insurer may not be obligated to provide coverage. [The Heritage Communities decision was first issued by the court on January 11, 2017. But then, for procedural reasons (that I didn’t try to figure out), that decision was vacated and replaced with a decision issued on July 26, 2017.]

Specifically, the court held: “At the hearing before the Special Referee, Harleysville produced letters it sent to former Heritage principals and counsel between December 2003 and February 2004. These letters explained that Harleysville would provide a defense in the underlying suits and listed the name and contact information for the defense attorney Harleysville had selected to represent Heritage in each matter. These letters identify the particular insured entity and lawsuit at issue, summarize the allegations in the complaint, and identify the policy numbers and policy periods for policies that potentially provided coverage. Additionally, each of these letters (through a cut-and paste approach) incorporated a nine- or ten-page excerpt of various policy terms, including the provisions relating to the insuring agreement, Harleysville's duty to defend, and numerous policy exclusions and definitions. Despite these policy references, the letters included no discussion of Harleysville’s position as to the various provisions or explanation of its reasons for relying thereon. With the exception of the claim for punitive damages, the letters failed to specify the particular grounds upon which Harleysville did, or might thereafter, dispute coverage.”

The court further criticized the reservation of rights letter: “[I]t is axiomatic that an insured must be provided sufficient information to understand the reasons the insurer believes the policy may not provide coverage. We agree with the Special Referee that generic denials of coverage coupled with furnishing the insured with a copy of all or most of the policy provisions (through a cut-and-paste method) is not sufficient. That is precisely what happened here, with the exception of the coverage dispute concerning punitive damages.”

As an aside, but an important one, Heritage Communities involved coverage for construction defects. The jury in underlying litigation awarded damages to homeowners’ associations against the developers of their condominium complexes. The awards were in the manner of general verdicts. However, under South Carolina law, the cost of repairing faulty workmanship is not covered; but resulting property damage, beyond the defective work itself, is covered. In addition to the court’s pronouncement, that the reservation of rights letters were ineffective, the court also took the insurer to task for not advising the insured of the need for allocation between covered and uncovered damages. As a result, “the Special Referee found coverage under the policies was triggered because the juries’ general verdicts included some covered damages. Although the Special Referee found that the costs to remove and replace the faulty workmanship were not covered under the policies, the Special Referee concluded that it would be improper and purely speculative to attempt to allocate the juries’ general verdicts between covered and non-covered damages. Accordingly, the Special Referee ordered the full amount of the actual damages in the construction-defect suits would be subject to Harleysville’s duty to indemnify in proportion with its time on the risk.” This approach was affirmed by the Supreme Court.

This is no small point. Even though the insurer’s liability was limited to its time on the risk – an issue that the court spent considerable effort addressing – the fact remains that, on account of the general verdicts, the insurer’s time on the risk share included uncovered “faulty workmanship” damages. Paying for uncovered damages was the insurer’s consequence for not addressing, in the reservation of rights letter, the need for allocation between covered and uncovered damages.

“What’s in a name? That which we call a rose by any other name would smell as sweet.” William Shakespeare, “Romeo and Juliet,” Act II, Scene 2. But the same cannot be said of reservation of rights letters. In fact, just the opposite. A letter that is called a reservation of rights may be nothing of the sort.


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