The Supreme Court of South Carolina has issued a decision that could have a great impact on how insurers issue reservation of rights letters. In Harleysville Group Ins. v. Heritage Group Communities, Inc., No. 27698, 2017WL105021 (S.C. Jan. 11, 2017), the Court held that Harleysville Group Insurance (Harleysville) failed to properly reserve its right to contest coverage of an underlying construction defect case because, even though Harleysville issued “reservation of rights” letters to the insured, these letters were ineffective because they "included no discussion of Harleysville’s position as to the various [policy] provisions or explanation of its reasons for relying thereon” and “failed to specify the particular grounds upon which Harleysville did, or might thereafter, dispute coverage.” Id. at *6.
The letters issued by Harleysville included much of the stock language used by insurers in issuing reservation of rights letters. They identified the insured and the lawsuit at issue, summarized the allegations in the complaint, identified the policy numbers and policy periods for policies that potentially provided coverage and, “through a cut-and-paste approach,” incorporated excerpts of various policy terms, provisions relating to the insuring agreement and Harleysville’s duty to defend, and policy exclusions and definitions. However, the letters failed to make any connection between the cited policy provisions, the facts of the claim and how coverage may not apply.
"Specifically, Harleysville did not expressly put its insureds on notice that it intended to litigate the issues of whether any damages resulted from acts meeting the definition of occurrence, whether any damages occurred during the applicable policy periods, what damages were attributable to non-covered faulty workmanship, and whether certain damages resulted from intentional acts by the insured and were thus excluded. And in no way did the letters inform the insureds that a conflict of interest may have existed or that they should protect their interests by requesting an appropriate verdict. As the Fifth Circuit found in Duke v. Hoch, Harleysville’s reservation of rights “was no more than a general warning” and “too imprecise to shield [the insurer].” 468 F.2d 973, 979 (5th Cir. 1972).
Id. at *7.
In finding the letters ineffective to properly reserve the insurer’s right to contest coverage, the Court explained,
“It is axiomatic that an insured must be provided sufficient information to understand the reasons the insurer believes the policy may not provide coverage. … [G]eneric 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) is not sufficient.” Id. at *5.
The Court provided a lengthy and helpful examination of case law across the country concerning insurers’ reservation of rights to contest coverage. Some of the highlights are:
- “A reservation of rights letter must give fair notice to the insured that the insurer intends to assert defenses to coverage or to pursue a declaratory relief action at a later date.” United Nat’l Ins. Co. v. Waterfront N.Y. Realty Corp., 948 F.Supp. 263, 268 (S.D.N.Y. 1996).
- “If the insured does not know the grounds on which the insurer may contest coverage, the insured is placed at a disadvantage because it loses the opportunity to investigate and prepare a defense on its own.” Desert Ridge Resort LLC v. Occidental Fire & Cas. Co. of N.C., 141 F.Supp.3d 962, 967 (D.Ariz. 2015).
- Where the insurer undertakes and exclusively controls the insured's defense under a reservation of rights, the insurer, prior to undertaking the defense, must specify in detail any and all bases upon which it might contest coverage in the future since “[g]rounds not identified in the reservation of rights may not be asserted later by the insurer.” Id. at 966-68.
- Where the insurer fails to adequately reserve the right to contest coverage, the insurer may be precluded from doing so. See World Harvest Church, Inc. v. GuideOne Mut. Ins. Co., 695 S.E.2d 6, 10-11 (Ga. 2010).
- “For a reservation of rights to be effective, the reservation 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.” Id. at 10.
Harleysville, at *5-6.
While Harleysville is a significant decision for insurers covering losses in South Carolina, the Court's approach is not a novel one, as courts across the country have issued similarly reasoned decisions. Osburn, Inc. v. Auto Owners Ins. Co., No. 242313, 2003 WL 22718194, at *3 (Mich. Ct. App. Nov. 18, 2003) (“[W]e conclude that, because Auto Owners’ reservation of rights letter was not sufficiently specific to inform plaintiffs of the policy defenses the insurer might assert, the letter did not constitute ‘reasonable notice.’”); Hoover v. Maxum Indem. Co., 730 S.E.2d 413 (Ga. 2012)(holding “[a] reservation of rights letters is not valid if it does not fairly inform the insured of the insurer’s position); Advantage Builders & Exteriors, Inc. v. Mid-Continent Casualty Co., 449 S.W.3d 16 (Mo. Ct. App. 2014)(finding reservation of rights letters ineffective where the letters did not adequately explain why the defendant may not have owed coverage to its insured). Therefore, insurers need to make sure that their reservation of rights letters comply with these stricter standards.
Following are some tips to keep in mind when drafting reservation of rights letters to ensure that the letter effectively and adequately informs the insured of the insurer’s coverage positions.
- Use the words “reservation of rights.”
- Identify the policy at issue.
- Quote relevant policy provisions and identify any terms, conditions or exclusions that may apply.
- Specifically refer to the relevant allegations in the complaint.
- Identify which claims may not be covered.
- Explain in detail the basis for the insurer’s coverage position.
- Advise the insured of any actual or potential conflicts of interest between the insurer and the insured.
- Depending on the situation and jurisdiction, advise the insured of its right to independent defense counsel.
- Set forth the proposed arrangement for providing a defense.
- Default language (e.g., “If you do not object, then we will deem you agree with this approach”).
- Identify the counsel selected to defend, along with the counsel's contact information.
- If the insured has selected counsel, advise that that insurer will pay up to the hourly rate that it would have paid to its own panel counsel.
- Reserve the right to withdraw from the defense should there appear to be no coverage.
- Reserve the right to file a declaratory judgment action to determine rights and obligations.
- Reserve the right to recoup defense costs pertaining to the claim (or some claims) if not covered.
- Reserve the right to allocate payment of settlement or judgment that is partially covered.
- End with a general reservation of rights, including"
- Right to amend position upon learning new facts; and
- Right to amend position if claim or litigation change.
- All letters, like all actions, should be adapted to the particular circumstances of the claim.
- Be aware of the particular risks of reserving rights in the applicable jurisdiction.
- All letters must be clear whether the insurer is:
- Accepting coverage without reservation; or
- Defending and/or investigating under reservation; or
- Denying coverage.