The Fourth Circuit recently affirmed insurance coverage for a South Carolina policyholder based on the “axiomatic principle” that an insurer which fails to fully and fairly articulate its potential coverage defenses in a reservation of rights letter loses the right to contest coverage on those grounds. Stoneledge at Lake Keowee Owner’s Assoc. v. Cincinnati Ins. Co., No. 19-2009, 2022 WL 17592121 (4th Cir. 2022) (quoting Harleysville Group Insurance v. Heritage Communities, Inc., 803 S.E.2d 288 (S.C. 2017)). More particularly, in Stoneledge, the Fourth Circuit affirmed per curiam a South Carolina District Court’s grant of summary judgment in favor of a homeowners association that had successfully sued its general contractors for construction defects and was seeking to recover the damages owed from the contractors’ insurers. The Fourth Circuit agreed that the insurers’ vague reservation of rights letters failed to reserve the defenses on which the insurers purported to deny coverage.
The question before the court in Stoneledge was whether the two insurers that had each agreed to defend their respective general-contractor insureds in the homeowner association’s underlying litigation had sufficiently informed their policyholders of their coverage positions. Specifically, the court considered whether the insurers provided notice of their intention to challenge coverage on specific bases and explained why those bases applied in their respective reservation of rights letters. Both of the insurers’ letters followed the typical approach of identifying various policy provisions and exclusions and outlining the general mechanics of those provisions, but they fell short of applying the provisions or exclusions to the facts in the case at hand. Further, the letters stated that the insurers would reevaluate how the provisions applied as the underlying case progressed. One of the insurer’s letters expressed doubt as to coverage but did not offer any analysis on the reasons for the prospective coverage denial.
The Fourth Circuit concluded that the insurers in Stoneledge had not sufficiently reserved their rights to deny coverage because their reservations of rights letters were simply copy-and-paste documents employing wait-and-see tactics. Adopting the “axiomatic principle” of insurance law from Harleysville, 803 S.E.2d 288, that “an insured must be provided sufficient information to understand the reasons the insurer believes the policy may not provide coverage,” the court agreed that “generic denials of coverage coupled with furnishing the insured with a copy of all or most of the policy provisions (through a cut-and-paste method) [are] not sufficient.” Id. at 297. The court also confirmed that an insurer saying “we will let you know later” does not constitute a valid reservation of rights. Id. at 299. Simply put, the Stoneledge court reaffirmed that the onus is on the insurers to show their work when writing their reservation of rights letters.
The Fourth Circuit also rejected the insurers’ contention that the court was creating coverage where none existed by finding that the insurers had waived defenses unarticulated in their respective reservation of rights letters. Looking to settled South Carolina law, the court concluded that an inadequate reservation of rights letter operated as an implied waiver of defenses and prevented a later coverage denial, even if the insurer disputed whether a covered event ever occurred. Ex parte Builders Mutual Insurance Company, 847 S.E.2d 87, 94 (S.C. 2020).
The Fourth Circuit opinion highlights that policyholders should evaluate reservations of rights from their insurers as comprehensive statements of the grounds on which the insurers intend to challenge coverage, and that the following shortcomings in reservation of rights letters may limit the insurer’s ability to pursue unarticulated or ill-defined coverage defenses down the road:
- mere identification of policy information and policy terms without substantive analysis;
- no discussion of the insurer’s position as to the relevant policy provisions mentioned;
- no explanation of reasons for potentially denying coverage; and
- failure to reserve rights on specific issues.
In sum, policyholders should be mindful to scrutinize reservation of rights letters and consult coverage counsel if faced with insurers employing claims-handling strategies that leave open questions about the scope of the insurer’s reservation of rights.