Drafting an effective reservation of rights letter is not as simple and straight forward as it may seem. A reservation of rights is a notice given by an insurer that it will defend the insured in the lawsuit but reserves all rights it has based on non-coverage under the policy. Often these letters merely set forth a brief factual summary followed by lengthy quotations of various provisions of the policy and a conclusion that the insurer reserves its right to deny coverage. However, this type of reservation letter won't cut it anymore in most states. Case in point: Harleysville Grp. Ins. v. Heritage Communities, Inc., No. 2013-001281, 2017 WL 105021 (S.C. Jan. 11, 2017). In Heritage, South Carolina Supreme Court ruled that the insurer's reservation of rights letter was ineffective because it was "too generic" to reasonably inform the insured of the possible grounds for denial of coverage.
The underlying lawsuits in Heritage involved damages arising from the construction defects at two condominium complexes in Myrtle Beach. The developer was insured under CGL policies with Harleysville. After receiving notice of the lawsuits, Harleysville sent the insured a reservation of rights letter stating that it would provide a defense subject to a complete reservation of rights. At trial, the juries returned multi-million dollar verdicts against the insured. Following the jury verdicts, Harleysville sought a declaratory judgment on its portion of liability under the policy for the judgments.
The South Carolina Supreme Court held that Harleysville had waived the right to contest its liability for the judgments because its reservation of rights letter was "too generic" to effectively preserve its rights. The reservation letter included only "…general denials of coverage coupled with furnishing the insured with a verbatim recitation of all or most of the policy provision (through a cut-and-paste method)..." Despite the fact that the letter included approximately 10 pages of policy excerpts, there was no discussion of the particular grounds upon which Harleysville was disputing coverage of actual damages. The court held that this letter was not sufficient because the insured loses the opportunity to investigate and prepare a defense on its own if it does not have notice of the specific grounds on which the insurer may contest coverage.
The primary take away from Heritage is that under South Carolina law a reservation of rights letter must unambiguously specify the particular grounds that an insurer will or may subsequently contest coverage and must provide an application of the relevant facts to the relevant policy language. Simply referencing relevant policy provisions without discussing their applicability just won't cut it. Moreover, the court also stated that a proper reservation of rights letter should put the insured on notice that the insurer may pursue a declaratory judgment action, that potential conflicts of interest may exist, and that the insured may need to request special interrogatories at trial.
Although Heritage only dealt with South Carolina law, a number of other states have held that for a reservation of rights letter to be effective it must be detailed enough to reasonably inform the insured of the reasons why the insurer may not be obligated to provide coverage. Therefore, this requirement should be a starting point for anyone drafting a reservation of rights letter regardless of the jurisdiction. However, just as there were additional requirements set forth in Heritage, there may well be additional requirements in other jurisdictions. The bottom line is that the Courts will require the letter to explain the interaction between the facts and the policy language, not merely a recitation of the policy language that may be applicable. Insurance companies have always been concerned about committing to facts early in the investigation, but a proper reservation can leave factual issues open while still connecting policy language to the acts as they appear "at this time." Once again, extra effort on the front end may prove invaluable down the road.
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