The South Carolina Supreme Court reaffirmed that when an insurer reserves rights to deny coverage, the specific grounds stated in the insurer’s reservation of rights letter are critical. In reaffirming a much-discussed decision from earlier this year, the court refused to consider policy defenses asserted by an insurer because the insurer failed to properly reserve its rights to contest coverage. According to the opinion, the insurer’s letter (1) failed to notify the policyholders of the particular grounds upon which it might dispute coverage; (2) did not advise of the need to allocate damages between covered and non-covered losses; and (3) did not inform the policyholders that the insurer would seek a declaratory judgment if there were adverse jury verdicts.
The insurer’s reservation of rights letters, which were sent between December 2003 and February 2004, set out excerpts of relevant policy language. The insurer then reserved rights based on a list of issues, including whether property damage or bodily injury was caused by an occurrence during the policy period and a catch-all reservation based on “whether or not any exclusion applies to preclude coverage under any policy or policies.” The court held that the insurer could not contest coverage on issues not specifically listed but within the “catch-all” because the reservation of rights was not specific enough. In particular, the insurer did not specify that it would contest coverage based on whether the damages in the underlying suit were to the policyholder’s own faulty work or to other parts of the construction project that were damaged as a result of the policyholder’s faulty work.
Notably, at the time the insurer issued its reservation of rights letters, South Carolina law did not distinguish between faulty workmanship itself and damages to other property caused by faulty workmanship. South Carolina courts did not even hint at the distinction until 2005, and a decision finally making the distinction did not come down until 2008. The Supreme Court found those facts unavailing. The court noted that the insurer was aware of South Carolina law on those issues, as demonstrated by an amicus brief the insurer filed in the 2008 case. However, the insurer did not update its reservation of rights letter as South Carolina law changed. This left the insurer responsible to indemnify the entire verdict, even though what drove the verdict was the cost of replacing the policyholder’s own faulty work.
Although the court’s decision is based on South Carolina law, the lessons learned extend further. The decision serves as an important reminder of the need to update reservation of rights letters based on changes in the law and facts learned during the course of discovery. Failure to do so may leave insurers on the hook for damages that ordinarily would not be covered.
Harleysville Group Insurance v. Heritage Communities, Inc., No. 2013-001291 (S.C. July 26, 2017)