In January, the SC Supreme Court issued its original opinion in Harleysville Group Insurance, a Pennsylvania Corporation v. Heritage Communities, Inc, a South Carolina Corporation; Heritage Magnolia North, Inc., et al. and Harleysville Group Insurance, a Pennsylvania Corporation v. Heritage Communities, Inc., a South Carolina Corporation; Heritage Riverwalk, a South Carolina Corporation, et al., 2017 WL 105021 (Jan. 11, 2017). Hailed by some as one of the most important coverage opinions issued, Harleysville left many reeling. The historically utilized template for a reservation of rights letter was deemed insufficient. Insurers questioned who has standing to assert the insufficiency of that letter. Coverage counsel scrambled to file motions to intervene in ongoing construction, and perhaps other, cases. Defense counsel were scratching their heads about what to do next- how they could seek an allocated verdict as to covered versus noncovered damages. The opinion may have created as many questions as it answered; everyone needed clarity. The court provides some, albeit limited, in its slightly modified opinion, all the while continuing its mark as to coverage issues. Id., Opinion No. 27698 (July 26, 2017).
The underlying cases were filed in 2003 by the respective property owners’ associations of Magnolia North and Riverwalk (POA) against the developer/general contractor entities (Heritage) alleging significant construction defect claims. Counsel for Heritage conceded liability in both trials resulting in directed verdicts in favor of the POA as to the negligent construction claims, leaving the nature and extent of damages as the only contested issue. Both resulted in substantial general verdicts against Heritage. Harleysville filed declaratory judgment actions, asserting it had no duty of indemnity under its policies. Alternatively, if the court determined any of the damages were covered, Harleysville sought a determination of which part of the general verdicts represented covered damages. The matters were referred to a Special Referee. These cases represent cross-appeals from the Special Referee’s findings.
During construction, from 1997 to 2000, the various Heritage entities purchased several Commercial General Liability (CGL) policies from Harleysville. Heritage was uninsured after the last policy ended in 2001, the same year the parent development company filed for bankruptcy protection. Heritage went out of business in 2003 due to the financial strain of several construction defect lawsuits. Upon notice of the suits, Harleysville informed its insureds it would defend the cases; Harleysville asserts this was done under a full reservation of rights. Its reservations of rights letters were comprised of generic statements of potential non-coverage along with cut and paste references to the policies. Harleysville contends all coverage issues would be litigated following any adverse verdict.
What Constitutes an Effective Reservation of Rights?
The fundamental purpose of a reservation of rights letter is to inform the insured that the insurer will defend the lawsuit, but reserves all rights based on noncoverage under the policy. In order to be effective, it must specify in detail any and all bases upon which the insurer may contest coverage in the future. It must address the specific type of damages at risk and must clearly inform the insured it intends to litigate whether any damages resulted from covered acts, whether any damages occurred during the policy period and what damages are attributed to non-covered faulty workmanship. The letter must also inform the insured of a potential conflict of interest. Significantly, the letter must necessarily inform the insured of the need for an allocation of damages between those that are covered and those that are not.
This opinion sheds light as to the revisions that must be made to the typical reservation of rights letter in order to be effective, confirming the oft-used letter quoting selected policy provisions and generally denying coverage is insufficient. What this opinion also tells us is the insurer’s right to control the litigation carries with it certain duties, including the duty not to prejudice the insured’s rights by failing to request special interrogatories or a special verdict form, clarifying which damages are covered.
Unfortunately, the opinion leaves some, including this writer, perplexed. Here, the insurer failed to inform the insured of the necessity of an allocated verdict, and it likewise failed to undertake this task. The court logically offered no criticism of the Special Referee’s refusal to engage in speculation with respect to the allocation of damages and upheld the determination that absent an allocation, the insurer had no grounds upon which to challenge the general verdicts. Harleysville provides no real guidance as why it is in the insured’s best interest to secure an allocated verdict if the insurer fails to do so. The reasoning seems counterintuitive. Additionally, it is extremely troubling to think the court is suggesting defense counsel should seek such an allocation, thereby potentially exposing their client to individual liability that may be otherwise avoided.
Who May Challenge The Reservation of Rights?
Acknowledging that generally a third party has no standing to assert inadequacies in an insurer’s reservation of rights, the court rejected Harleysville’s argument that the POA lacked standing to raise the issues of deficiencies in the reservation of rights letters. Heritage was defunct and failed to defend or otherwise appear in the action. The POA secured final judgments by virtue of which the subject policies expressly provided they were entitled to sue Harleysville directly in order to recover. Not mentioned by the court, but revealed upon a brief review of SC case law, a judgment creditor of an insured can pursue a direct action against an insurer. See Adcox v. Am. Home Assur. Co., 258 S.C. 331, 188 S.E.2d 785, 786–89 (1972). While the court recognized that allowing a third party to challenge the adequacy of an insurer’s reservation of rights is the exception and not the rule, it actually seems to follow precedent as well as logic. It makes little sense to allow a third party to directly sue an insurer, yet preclude it from asserting deficiencies in the insurer’s efforts to deny coverage.
Punitive Damages – Contemplated Under the Policy?
Harleysville contended from the beginning that punitive damages were not covered under its policies. Found to be the only effective reservation made by Harleysville, it informed the insured of its position that punitive damages would not arise from an “occurrence,” do not qualify as “bodily injury” or “property damage” and were “expected and intended,” within the meaning of exclusions in the policies.
The subject policies included the standard CGL definition of an “occurrence” as an “accident, including continuous or repeated exposure to substantially the same general harmful conditions.” In its argument that punitive damages are not “accidental” and therefore not an occurrence, Harleysville ignored the progressive-damage facet of the definition of occurrence. Thus, Harleysville’s argument failed and it was obligated to indemnify Heritage for sums Heritage became legally obligated to pay because of progressive damage. Because the policies did not limit such sums to compensatory or actual damages, Harleysville is responsible for punitive damages. Notably, the court mentions Harleysville could have written its policies to exclude punitive damages and intimates that had it done so in an unambiguous fashion, it may have been effective. This is not the court’s first mention of the failure of a policy to specifically limit recovery to actual damages, suggesting that perhaps a clear limitation may be favorably viewed. See S.C. State Budge & Control Bd. V. Prince 403 S.E.2d 643 (1991).
Punitive Damages – Were the Insured’s Acts Intentional and Thereby Excluded
In its continued attempts to avoid liability for punitive damages, Harleysville also argued that punitive damages fall within the policy exclusion barring coverage for “expected or intended” acts. It contends the punitive damages award means the jury necessarily found Heritage’s wrongdoing was a “conscious failure” and involved a “present consciousness of wrongdoing” excluded under the policy. This argument also failed.
For an action to be excluded from coverage under the policy exclusion for “expected or intended” losses, the act causing the loss as well as the results of the act must have been intentional. While an insured’s negligent conduct may be so gross that it forms a basis for punitive damages, that negligence may not rise to the level of intentional conduct sufficient to fall under the expected or intended policy exclusion. Here, the court notes some evidence that Heritage approached construction with the intent of doing as little as possible. However, the Special Referee found Heritage intended to build quality projects, and that Harleysville failed to meet its burden of proving that Heritage both intended to perform poor work and the damage resulting therefrom.
Time on Risk – Does the Analysis Apply to Punitive Damages
When property damage is progressive, it is often impossible to determine precisely the amount of damages that occurred during each particular policy period. As a result, the judicially created doctrine of the time on the risk allocation was devised. The analysis begins with a determination of when triggering losses occurred, following which the losses are allocated based on the period of time each insurer was on the risk. Historically, the time on risk analysis has been utilized to apportion actual damages where injury progressed over time. In an attempt to avoid liability for the entire punitive damages award, Harleysville argued that punitive damages are likewise subject to a time on risk allocation. Because punitive damages address the defendant’s behavior, and thus are not compensatory in nature, the logic of the time on risk theory is more attenuated than when applied to actual damages.
Here, Harleysville failed to present any evidence that any of the acts upon which the punitive damages were awarded occurred outside the relevant policy periods. Rather, the evidence established that all of Heritage’s wrongful acts occurred during the effective periods of Harleysville’s policies. Being careful to warn that it does not intend to create a rule of law, the court concluded that the punitive damage award in the instant matter was not subject to a time on risk analysis, leaving Harleysville responsible for the entire award.
What Do We Know Now
It is fair to summarize Harleysville as resolving some issues while perhaps creating others.
We know an insurer cannot rely on a reservation of rights that provides only a copy of policy provisions and corresponding generic denials of coverage. In order to be effective, the reservation of rights must provide specific details of any and all bases upon which the insurer may contest coverage in the future, including the specific type of damages at risk. The insurer must also clearly inform the insured that it intends to file suit to contest coverage issues, clearing stating each issue which it intends to challenge. The reservation must also inform the insured of a potential conflict of interest and the insured should protect its interests by requesting an allocated verdict. We do not know, however, the extent of the insured’s obligation to secure a verdict that allocates covered to noncovered damages, nor we know how to reconcile any such obligation with the general benefit bestowed upon the insured if there is a general verdict which cannot be effectively challenged by the insurer.
It appears a safe conclusion, at least at this juncture, that an insurer must undertake the effort necessary to clarify damages by way of special interrogatories or special verdict form if it intends to question coverage. Unfortunately, we are left to question when and how the insurer pursues this effort. A motion to intervene seems the logical vehicle. If so, the next question is when the intervention is appropriately made. Trial courts are likewise left with little guidance. An attempted intervention on the eve of trial may be seen as untimely and overly intrusive, and therefore denied. If allowed, at any point, how are the special interrogatories or the special verdict presented in a fashion so not to prejudice either party?
We now also know that in certain circumstances a third party may contest the adequacy of an insurer’s reservation of rights. This seems to logically follow established law that a judgment creditor may file a direct action against an insurer.
We are reminded that punitive damages are covered as they constitute a sum the insured is “legally obligated to pay as damages” as defined in the standard CGL policy. We are also reminded, however, an insurer is free to draft its policy as it wishes, assuming it does so in an unambiguous manner. With these reminders, is the court sending a message to insurers?
The court has also confirmed in order to qualify as an excluded or intended act as defined in the typical policy, the insured must have intended both the act and the result. It is the insurer’s burden to establish this intent. Negligence, even gross negligence, does rise to that level.
Finally, while refusing to apply the time on risk analysis to punitive damages in the present case, we know the court has not foreclosed the possibility that it may do so under certain circumstances.