Why it matters

A federal court in South Carolina ruled that absent a showing by an insurer of substantial prejudice caused by the insured’s late notice, an insurer that breached its duty to defend will be liable for reasonable costs of defense, including pre-tender costs. The court reasoned that the duty to defend exists before notice is required, since it is triggered when the underlying claim was filed. If the alleged delay was not a factor in the decision not to defend, then it should not later be used by the insurer to refuse to pay any incurred costs. Further, the court held that because the insurer breached its duty to defend, the insurer lost its right to later control the defense and select defense counsel.

Detailed Discussion

Facing doctrinal differences, a group of churches broke away from the Episcopal Church in South Carolina (TEC-SC). However, the breakaway churches continued to use the same intellectual, real, and personal property they used prior to the split. In order to clarify ownership of the property rights, the breakaway churches filed a declaratory judgment action in state court.

TEC-SC’s insurer Church Insurance Company of Vermont (CIC-VT) denied coverage for the underlying litigation, contending that because the policy required prompt notice of a suit, such notice is a condition precedent to the duty to defend.

According to CIC-VT, allowing an insured that disregarded a policy’s notice provision to recover its pre-tender expenses would render meaningless contractual terms necessary to trigger the insurer’s performance under the policy. CIC-VT further asserted that because the policy provides that an “insured must not make payments or assume obligations or other costs except at the insured’s own cost,” the pre-tender costs were costs voluntarily assumed by the insured. The court disagreed.

The court determined that “an insurer’s duty to defend arises upon the filing of the underlying complaint, and late notice from the insured does not excuse the insurer from complying with its duty to defend except where the insurer can show substantial prejudice.”

If the delay in giving notice is not a factor in the insurer’s decision not to defend – if it would have declined the defense in any event based on its mistaken conclusion that there was no potential coverage – the insurer should not later be allowed to use the delay as a bar to reimbursing the insured for the reasonable expenses incurred in defending the covered claim, the court ruled.

Further, the court rejected CIC-VT’s position that breach of the duty to defend does not prevent the insurer from later selecting defense counsel and controlling the defense. “Plaintiff has hired counsel to put forth a vigorous defense in the Underlying Action and wishes to continue with its chosen counsel rather than change attorneys at a late stage in the litigation. Given the complex nature of the claims involved in the Underlying Action, it will suffer substantial prejudice if CIC-VT can take over control of Plaintiff’s defense more than a year following the initiation of the lawsuit.

To read the opinion in The Episcopal Church in South Carolina v. Church Insurance Company of Vermont, click here.