Insurer Barred From Contesting Coverage Due to Generic Reservation of Rights Letter

In an opinion filed January 11, 2017, the South Carolina Supreme Court held that an insurer’s reservation of rights must contain more than verbatim recitation of policy provisions to properly reserve its right to later dispute coverage. Harleysville Group Insurance v. Heritage Communities, Inc., et al., 2017 S.C. LEXIS 8 (Jan. 11, 2017). The state supreme court also upheld a pro rata allocation of progressive damages under a time-on-risk analysis, and rejected the argument that punitive damages were subject to the time-on-risk allocation. The decision emphasizes the importance of drafting reservations of rights specific to the facts of the case, and informing the insured of why certain provisions may limit coverage under the facts of the case.

The coverage action arose out of two underlying construction defect actions. Harleysville Group Insurance (“Harleysville”) insured related corporate entities that developed and constructed two separate condominium complexes (collectively referred to as “Heritage”), who were sued for damages arising out of alleged construction defects, including significant water intrusion damages. Harleysville agreed to defend under a reservation of rights and retained defense counsel. After verdicts against Heritage for actual and punitive damages were rendered, Harleysville filed a declaratory relief action to determine the amount of covered damages. The matter came before the state supreme court after certification by the court of appeals.

The court first addressed the adequacy of Harleysville reservation of rights, and concluded that the letters were not specific enough to contest coverage. Although Harleysville had quoted policy language verbatim in its initial reservation of rights, the court found that – except with regard to punitive damages – the letters failed to explain how specific policy provisions might preclude coverage and, to the extent exclusions may apply, did not inform the insured that Harleysville may seek declaratory judgment to allocate between covered and non-covered damages. As a result, Harleysville was precluded from raising coverage defenses regarding compensatory damages.

Although the court found Harleysville had properly reserved its rights regarding punitive damages, neither the policy’s insuring agreement nor its “expected or intended” exclusion applied to preclude coverage for punitive damages. According to the court, absent explicit language that excluded coverage for punitive damages, the insuring agreement could not be construed as limiting coverage to compensatory damages only. Regarding the exclusion, the court found Harleysville failed to meet its burden that Heritage acted intentionally and intended the specific type of loss or injury.

Finally, with regard to the compensatory damage award, the court upheld a pro rata allocation of the progressive damage. Because some definable portion of the damage in the underlying cases was unrelated to an injury during the policy period, a progressive damages analysis was proper for the compensatory damages, but not the punitive damage award.

There are various takeaways from this decision, but the most concerning is that the South Carolina Supreme Court expanded the scope of coverage beyond that provided by the policy because it found that the insurer did not properly reserve rights. To avoid such an absurd result, and to properly preserve coverage defenses, insurers should revisit the use of generic or form reservation of rights letters, and consider updating the reservation of rights letter during the life of the underlying case if certain provisions appear to be particularly relevant.

Cumis Counsel Rule Adopted by Nevada Supreme Court

In response to certified questions from the U.S. District Court for the District of Nevada, the Nevada Supreme Court has adopted the Cumis independent counsel rule established by California courts requiring an insurer to provide independent counsel for its insured when a conflict of interest arises between the insurer and insured. State Farm Mut. Auto Ins. Co. v. Hansen, 131 Nev. Adv. Op. 74 (Sept. 24, 2015). The court also rejected application of a standard that creates a per se conflict of interest to every case in which there is a reservation of rights. Instead, Nevada courts must ask, on a case-by-case basis, whether an actual conflict exists.

In the underlying litigation, State Farm’s insured was sued for negligence and various intentional torts following an altercation at a house party and subsequent auto collision. State Farm agreed to defend under a reservation of rights, but did not agree to provide independent counsel to its insured. In subsequent coverage litigation, the federal district court initially found that State Farm breached its contractual duty to defend because it had not provided independent counsel to its insured.  The court then reconsidered and asked the Nevada Supreme Court to resolve questions concerning the state’s conflict of interest rules in insurance litigation.

Recognizing that Nevada, like California, is a dual-representation state – meaning that insurer appointed counsel represents both the insurer and insured – the Nevada Supreme court held that “counsel may not represent both the insurer and the insured when their interests conflict and no special exception applies.” This justified application of the Cumis rule in Nevada.

The Court then considered what circumstances created a conflict of interest and, in particular, whether a reservation of rights created a per se right to independent counsel. The Court concluded that even when there is a reservation of rights and insurer-appointed counsel has control over an issue in the case that will also decide the coverage issue, courts must still determine whether there is an actual conflict of interest. Relying on Nevada’s Rule of Professional Conduct 1.7, the Court explained, “[t]his means that there is no conflict if the reservation of rights is based on coverage issues that are only extrinsic or ancillary to the issues actually litigated in the underlying action.”

The decision provides useful guidance to Nevada litigants and trial courts for resolving conflict of interests in insurance litigation. However, the opinion leaves unaddressed other Cumis-type issues such as the reasonable amount of fees for independent defense counsel. As such, more litigation and possible legislation to clarify the rule should be expected.

Seventh Circuit Court Applies “Continuous” Trigger Theory To A First Party Property Claim

In Strauss v. Chubb Indem. Ins. Co., the Seventh Circuit U.S. Court of Appeals (applying Wisconsin law) declined to adopt the “manifestation” trigger theory in all first-party property insurance claims, and instead found that the policy terms unambiguously required application of a “continuous” trigger theory.

The insureds constructed a home in 1994.  They purchased insurance for the residence from a number of insurers from October 1994 to October 2005 (collectively, “the Chubb Defendants”).  Water infiltrated and damaged the home as the result of construction defects, but the damage was not discovered until 2010.  The Chubb Defendants denied the insureds’ request for coverage because the damage first manifested in 2010, well after the last of the Chubb Defendants’ one-year policies expired.  The Chubb Defendants’ maintained that a “manifestation trigger” applied to first-party property insurance, meaning that the insureds should seek coverage under the policy it had in place at the time it discovered the damage.  The Chubb Defendants also asserted that the claim was time barred under Wisconsin statutory law and a suit limitation clause.

The insureds filed suit within one year of their discovery of the damage caused by the water intrusion.  In cross-motions for summary judgment, the Chubb Defendants argued that public policy and case law from across the country supported application of a “manifestation” trigger.  The insurers also argued that the insureds filed suit too late, past either a statutory deadline or a time limit imposed by the policies.  The district court disagreed and concluded that the “continuous” trigger theory applied to the “occurrence-based” policies at issue.  Since the “continuous” trigger theory applied, the district court also found that the insureds’ claim was not time-barred.

The Seventh Circuit affirmed.   While acknowledging that jurisdictions across the country utilize the manifestation trigger in first-party claims, the court explained that no Wisconsin court had so held.  Rather, the court noted that in Miller v. Safeco Ins. Co of Am., 683 F.3d 805, 810-11 (7th Cir. 2012), the court had declined to adopt a bright-line rule requiring use of the manifestation trigger theory in all first-party property insurance coverage disputes.  Instead, the court looked to the policy language and its definition of “occurrence,” as “a loss or accident to which this insurance applies occurring within the policy period. Continuous or repeated exposure to substantially the same general conditions unless excluded is considered to be one occurrence.”  This language unambiguously contemplated a long-lasting occurrence that could give rise to a loss over an extended period of time.  The court dismissed public policy concerns raised by the Chubb Defendants that by not adopting a bright-line manifestation trigger, it created uncertainty for insurers because it allowed liability arising on stale policies.  Finally, because the loss was ongoing and occurred with each rainfall, the loss was continuous from the date of faulty construction until the damage manifested in October 2010 for purposes of the statute of limitations.

Arguably, the occurrence definition was designed to apply to the liability coverage part of the policy.  However, the first-party portion of the policy also referenced the word “occurrence,” so the court found it applicable in the first party context as well.