For insurers, litigating third-party coverage disputes in South Carolina has always proved formidable. Insurers can be liable for “bad faith” even if there is no coverage; they may be required to pay an insured’s attorney’s fees if the insurer commences a coverage action against its insured and loses; and extra-contractual claims may proceed simultaneously with a breach of contract claim. See Tadlock Painting Co. v. Maryland Cas. Co., 322 S.C. 498, 473 S.E.2d 52 (S.C. 1996); and Hegler v. Gulf Ins. Co., 270 S.C. 548, 243 S.E.2d 443 (S.C. 1978). In sum, there is no shortage of pitfalls. Now, with the South Carolina Supreme Court’s substituted opinion in Harleysville Group Ins. v. Heritage Communities, Inc., et al., issued on July 26, 2017, litigation of third-party coverage disputes will be even more precarious. Below is a discussion of the new Harleysville opinion, as well as some suggested actions insurers should consider before litigating third-party coverage disputes in South Carolina.
Harleysville Group Ins. v. Heritage Communities, Inc., et al.
Background
Many may already be familiar with the Supreme Court’s initial opinion in Harleysville Group Ins. v. Heritage Communities, Inc., et al., issued on January 11, 2017. The substituted opinion was issued after the Court granted re-hearing and replaces the prior opinion. Following is a brief summary of the matter.
Between 1997 and 2000, related corporate entities Heritage Communities, Heritage Magnolia North, Inc., and Heritage Riverwalk, Inc. (collectively “Heritage”) constructed two residential developments entitled “The Riverwalk” and “Magnolia North” in South Carolina. In 2003, each development’s property owners’ association (“POA”) filed suit against Heritage seeking actual and punitive damages for negligent construction, breach of fiduciary duty, and breach of warranty. Heritage tendered defense to its carrier, Harleysville Group Insurance (“Harleysville”), who agreed to defend Heritage subject to its reservation of rights. At trial, Heritage conceded liability; thus, the only contested issue was damages. Relative to The Riverwalk matter, the jury returned a general verdict of $6,500,000 and $2,000,000 in punitive damages. In the Magnolia North matter, the jury returned verdicts totaling $4,550,000 in actual damages and $1 million in punitive damages. Following these verdicts, Harleysville commenced separate declaratory judgment actions against Heritage.
In those actions, a special referee presided. He ultimately held that Harleysville’s commercial general liability policies did obligate Harleysville to indemnify Heritage. Perhaps most notable of the Referee’s holdings are the following:
1. Although the juries’ verdicts included damages attributable to faulty workmanship, which the policies’ excluded, it would be improper and speculative to allocate the verdicts between covered and non-covered losses; and
2. No policy exclusion precluded coverage for punitive damages.
1. The POAs Could Sue Harleysville Directly and Challenge the Sufficiency of Harleysville’s RORs. The Court conceded that “generally a third-party will have no basis to assert any perceived inadequacies in an insurer’s purported reservations of rights’ correspondences.” However, without creating a bright-line rule as to when a third-party may challenge an insurer’s coverage position, the Court noted that the following facts in these cases: (a) Heritage was defunct; (b) it failed to appear or defend either liability action; (c) the POAs obtained a final judgment; and (d) the Harleysville policies permitted a direct action from the POAs upon the entrance of a final judgment. Based upon the foregoing “specific circumstances in this case”, the Court held that the POAs did have standing to challenge Harleysville’s coverage position.
2. Because Harleysville’s RORs Were Deficient, Its Coverage Defenses Were Waived.
This is perhaps the most seminal part of the Harleysville opinion. According to the Court, RORs must provide an insured “sufficient information to understand the reasons the insurer believes the policy may not provide coverage.” If an ROR fails to specify the bases as to why coverage may not apply, the insurer will be “preclude[d] … from raising new grounds … in a subsequent action….” “[G]eneric denials” and “cut-and-paste[d]” policy provisions are insufficient.
Further, among other requirements, the Court held that an ROR must (a) advise “the policyholder [to] take steps necessary to protect its potentially uninsured interests”; (b) advise the insured if the insurer may later pursue a coverage action; and (c) “inform the insured of the need for an allocated verdict as to covered versus noncovered damages”. Although Harleysville’s RORs identified the relevant parties, lawsuit, allegations in the complaint, policies, and policy provisions, they did not advise Heritage of why coverage may not apply, with the exception of punitive damage. In addition, they did not apprise Heritage of the need of an allocation of damages; or the potential of future coverage litigation. Accordingly, the Court deemed Harleysville’s RORs deficient, except on the issue of punitive damages, and as a result, held that Harleysville had waived its defenses on all coverage issues, except for punitive damages.
3. Punitive Damages Are Covered by the Policies.
Because the Court ruled that Harleysville had preserved its rights to contest coverage only on the issue of punitive damages, the Court examined whether punitive damages were covered by the Policies. Examining the Policies through the lens that coverage is construed broadly and exclusions are construed narrowly, the Court noted that if Harleysville intended to exclude coverage for punitive damages, it should have done so specifically, as the Policies’ coverage clause only stated that the Policies covered all damages, without distinction, arising from an occurrence. Harleysville next argued that because punitive damages entail some level of intent, they implicate the Policies’ intentional act exclusion. Again, the Court disagreed; asserting that an insured’s conduct may be so grossly negligent to form a basis for punitive damages, yet not rise to the level of an intentional act. Thus, the Court concluded that the Policies covered the POAs’ awarded punitive damages.
4. Actual Damages Were Subject to Time on Risk Allocation, But Punitives Were Not.
The final issue the Court decided was the allocation of the actual and punitive damages among the Policies due to the damages’ progressive nature. The Court began this analysis by affirming its “Time on Risk” approach enunciated in Crossman Cmtys. of N.C. v. Harleysville Mut. Ins. Co., 395 S.C. 40, 717 S.E.2d 589 (S.C. 2011) (Crossman II). Under this approach, the Court held that for the actual damages awarded to the POAs, Harleysville was liable only for those amounts which occurred during the Policies’ effective dates. The Court, though, did not apply this approach to the punitive damages awarded. On this issue, the Court held that “under the facts of these cases”, which included “no evidence, that any of the reprehensible acts upon which punitive damages are predicated occurred outside [of] the relevant policy periods”, Harleysville’s punitive damages liability should not be reduced. Thus, the entirety of the punitive damages award was assessed against Harleysville.
The Pitfalls to Avoid in Light of the Harleysville Substituted Opinion
The Harleysville decision is obviously significant. In addition to the already-present risks of potential attorneys’ fees and non-contingent extra-contractual relief present in third-party coverage disputes, now, under Harleysville, third-parties, in certain circumstances, may contest coverage and policies may include coverage for punitive damages without allocation for time on risk. Accordingly, there are a number of actions insurers should undertake, prior to instituting a coverage action in South Carolina against its insured. Below is a list of the three important actions insurers should consider.
1. Insurers’ RORs must be particular.
This is perhaps the greatest take-away from Harleysville. An ROR may make or break an insurer’s coverage defense. Per the South Carolina Supreme Court, an insurer’s ROR must be sent prior to the insurer assuming the defense of a matter for the insured, and it must include the following: (i) a recitation of the relevant facts and policy provisions; (ii) an explanation as to why the cited policy provisions are relevant; (iii) a statement as to whether the insurer may later pursue a coverage action; (iv) an identification of any actual or potential conflicts of interest; and (v) an advisement that if some damages may not be covered, the need for allocation exists and that the insured may wish to obtain separate counsel on any such issues. The failure to assert even one of these may constitute waiver of a policy’s defenses. Accordingly, a properly drafted ROR is vital.
2. During the underlying liability action, obtain an allocation of damages if the potential exists for covered and non-covered damages.
If a jury’s verdict against an insured may include covered and non-covered damages, failure to obtain an allocation of the damages may subject the insurer to liability for the entire lot. Although the Harleysville decision did not articulate a bright line rule as to when intervention or allocation should occur, an insurer should closely monitor an underlying liability action to determine the proper instance to address this situation without prejudice to an insured’s defense. One possible scenario is to advise the parties and the court in the underlying action, but not the jury, of possible intervention and then intervene for a damages allocation, such as by special interrogatories, only after the jury has returned a verdict against the insured. Ultimately, this can be a tricky situation and must be assessed on a case-by-case basis.
3. When pursuing a declaratory judgment action, determine if a non-named insured has standing to sue and what particular defenses and exclusionary language is viable.
Determining whether parties other than the named insured have standing to sue provides an insurer notice of the potential parties in interest and arguments that may be asserted. With Harleysville, the standing of third-parties and the defenses to coverage that third-parties may assert broaden the issues involved. Accordingly, a careful assessment of each party’s standings and the coverage defenses that may or may not apply will be instrumental when prosecuting (or defending) a third-party coverage dispute.
In sum, for years to come, the Harleysville decision is and will be significant for insurers litigating third-party coverage matters in South Carolina. Although the decision does not prescribe specific tests as to when an insurer must intervene, when third-parties have standing, and when punitive damages are not covered by policies or are subject to the “Time on Risk” approach, these are questions with which the South Carolina appellate courts will likely grapple in the foreseeable future. In the meantime, an insurer may begin to protect its position and defenses by undertaking the suggestions noted above.
