Generic Reservation of Rights Letters Are Inadequate Notice of Coverage Issues

A common practice in reservation of rights letters has been heavily criticized by the South Carolina Supreme Court. In fact, the court rejected a generic reservation of rights letter. It stated: “It is axiomatic that an insured must be provided sufficient information to understand the reasons the insurer believes the policy may not provide coverage. We agree with the [trial court] that generic 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.”

The underlying claims concerned design and construction of two condominium complexes in Myrtle Beach, with lawsuits seeking damages measured in the millions of dollars for each complex against the related development and construction entities, referred to in the decision as “Heritage.” Harleysville insured the Heritage entities. After receiving notice of the lawsuits, Harleysville indicated it would provide a defense, but issued a reservation of rights letter. The court noted that such a letter “is intended to benefit the policyholder by alerting the policyholder to the potential that coverage may be inapplicable for a loss; that conflicts may exist as between the policyholder and the insurer; and, that the policyholder should take steps necessary to protect its potentially uninsured interests . . .”

But the generic letter with multiple policy provisions that were cut and pasted into the letter failed to do just that. Where Harleysville undertook the defense, where its counsel conceded on behalf of the Heritage defendants – at trial! – that liability was not disputed, and where there was no effort to obtain a verdict or decision that allocated between insurable claims and non-insurable claims, “Harleysville did not effectively reserve the right to contest coverage.” (emphasis added)

The court noted that for one claim, punitive damages, Harleysville did provide detail as to its reason for potential denial of coverage. But for all other claims, “the letters failed to specify the particular grounds upon which Harleysville did, or might thereafter, dispute coverage.” The trial court decision, allocating extensive portions of the underlying claims against the Harleysville policies, was largely upheld.

This is a wake-up call to carriers. Although I have not read the reservation of rights letters, they sound typical, and familiar. This statement of policy (no pun intended), if adopted by other jurisdictions, will shine a light on reservation of rights letters and require such letters to more thoughtfully and thoroughly discuss the reasons why coverage may not apply. The case is Harleysville Grp. Ins. v. Heritage Cmtys., Inc., 2017 S.C. LEXIS 8 (Jan. 11, 2017).