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In Important Win for Policyholders, Fourth Circuit Holds that Generic Reservation of Rights Letters are Ineffective

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Last week, the U.S. Court of Appeals for the Fourth Circuit affirmed a grant of summary judgment in favor of a homeowners association in a declaratory judgment action against the insurers of a contractor and its principal that were found liable to the association in a construction defect lawsuit relating to construction of the development.

In Stoneledge, the homeowners association of a community of townhomes in South Carolina originally brought suit against a general contractor and its managing member that participated in the construction of the townhomes, alleging construction defects in the homes that resulted in water intrusion and other damage.  The contractor and managing member were insured by Cincinnati and Builders Mutual under commercial general liability policies.  The insureds sent notice of the litigation to both insurers, and both insurers sent reservations of rights letters.

The underlying trial was divided into two phases: during the first phase, Stoneledge (the homeowners association) received judgments against the defendants exceeding $1.5M.  Prior to the second phase, the parties entered into a settlement agreement that included Stoneledge, the insureds, and the two insurers.

Stoneledge brought a declaratory judgment action against the insurers, seeking coverage for its damages.  Stoneledge argued that the insurers failed to reserve the right to contest coverage.  The Fourth Circuit agreed, finding that the reservations of rights letters and settlement agreement were insufficient to contest coverage.

The Fourth Circuit relied on the South Carolina Supreme Court’s decision in Harleysville Group Ins. v. Heritage Cmtys., Inc., 803 S.E.2d 288 (S.C. 2017), noting that the Harleysville court found that generic reservations of rights that merely identify the policy numbers and policy periods, and excerpt various policy exclusions, were not sufficient to reserve rights with respect to the coverage defenses the insurers subsequently raised.  The court stated that the insurer should at least discuss its position as to the various provisions and explain the reasons denying coverage.

The Fourth Circuit found, as in Harleysville, the insurers’ reservations of rights failed to inform the insureds of the insurers’ intent to litigate coverage issues, noting that Builders Mutual similarly referred to policy exclusions and summarized the general nature of those exclusions, and generally advised the insureds that the work product was not covered.  The court found Cincinnati’s reservation to be a closer question, noting that while its letter did list policy exclusions and indicate that other exclusions may apply, the letter went on to state that it was doubtful that the claim alleged an “occurrence” or “property damage.”  However, the court still found the communication insufficient because the insurer did not explain why it found it “doubtful” that there was an “occurrence” or “property damage,” and the letter was therefore, at best, ambiguous, and should be construed in favor of the insureds.  The court also found that, even if the settlement agreement supplemented the insurers’ letters, the settlement agreement did not contain a more specific reservation of rights; simply agreeing to litigate coverage in a subsequent declaratory judgment action did not create a sufficient reservation of rights.

The case is Stoneledge at Lake Keowee Owners’ Ass’n v. Cin. Ins. Co., No. 19-2009, 2022 U.S. App. LEXIS 34292 (4th Cir. Dec. 13, 2022).

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