With very limited exceptions, liability policies provide insureds with two primary benefits: ­a defense paid for by the insurance carrier and indemnity for covered claims. These benefits to the insured are purchased with premium dollars and remain available if the insured complies with its policy obligations.

What is less clear is what happens when the insured apparently does not wish to receive these benefits from the insurer and does not “cooperate” with the insurer after a claim is made. At least in South Carolina, the answer appears to depend on the insurer’s claims handling conduct and what information is provided to the insured.

Portrait Homes-South Carolina, LLC v. Pennsylvania National Mutual Insurance Company, 2023 WL 8610277 (S.C. Court App. Dec. 13, 2023)

Relevant Parties

Portrait Homes involved numerous parties and claims. This newsletter focuses on only the claims involving coverage for JJA Framing. The primary players in those claims and a brief description of their involvement in the issues is provided below:

• Persimmon Hills Homeowner’s Association (the “HOA”): The Homeowner’s Association for a 388-townhome community built by Portrait Homes and JJA Framing.
• Portrait Homes-South Carolina, LLC (“Portrait Homes”): The general contractor for the Persimmon Hills’ townhome community. Portrait Homes hired JJA Framing and was deemed an additional inured under the JJA Framing’s Penn National policy.
• JJA Framing: The subcontractor on Persimmon Hills’ townhome community, and named insured under the policy issued by Penn National.
• Jose Castillo (“Castillo”): Owner of JJA Framing.
• Pennsylvania National Mut. Ins. Co. (“Penn National”): Provided CGL coverage for JJA Framing as the named insured and Portrait Homes as an additional insured.

Background Facts

Beginning in roughly 2003, Portrait Homes began developing the 388-unit Persimmon Hill townhome community. Portrait Homes served as the general contractor for the project and hired JJA Framing as a subcontractor to provide most of the framing and exterior window work. JJA Framing was the named insured under a CGL policy issued by Penn National and added Portrait Homes as an additional insured under the Penn National Policy.

A short time after completion, the townhomes at Persimmon Hills began to have significant issues with water intrusion. One of the townhome’s owners along with the HOA sued Portrait Homes (the “Underlying Lawsuit”). JJA Framing was later added as a defendant to that lawsuit.

Penn National’s Claims Activity During Underlying Lawsuit

After the Underlying Lawsuit was filed, Penn National was alerted to its existence when Portrait Homes requested a defense and indemnity based on its status as an additional insured. Penn National declined to provide Portrait Homes with a defense. Additionally, the HOA’s attorney informed Penn National of the suit and informed Penn National that JJA Framing was added as a party and a default would be taken if no answer was filed. Penn National had also received a report in this early time frame from an engineer indicating that JJA Framing’s liability exposure for the HOA’s claims was fairly clear and in the millions of dollars.

After becoming aware of the suit, Penn National chose to send three reservation of rights letters to JJA Framing. However, Penn National sent these letters to an incorrect address and misstated/misapplied JJA Framing’s obligations under the policy to provide notice and cooperate with Penn National. Further, Penn National actually had JJA Framing’s correct contact information in its system but “made no meaningful effort to locate” the correct information. Penn National also decided early on that it would not retain any counsel for JJA Framing unless JJA Framing specifically requested that Penn National provide a defense. This decision came despite no policy provision requiring JJA Framing to specifically request a defense from Penn National.

After sending the reservation of rights letters to the incorrect address, Penn National hired an independent adjuster to randomly show up at Castillo’s home. The adjuster was tasked with asking whether Castillo wanted Penn National to provide JJA Framing with a defense. Apparently, Castillo indicated he did not want Penn National to provide a defense for JJA Framing in the Underlying Lawsuit. However, Castillo was not told by the adjuster or Penn National that Penn National would pay for the entire defense or that he was likely facing significant, seven-figure liability.

JJA Defaults in the Underlying Lawsuit

Consistent with its previous decision, Penn National chose not to retain an attorney for JJA Framing and JJA Framing did not enter an appearance in the Underlying Lawsuit. An order of default was entered against JJA Framing and eventually a judgment totaling $4,156,976.89 was entered in favor of the HOA. After the judgment became final, JJA assigned all its rights and claims against Penn National to the HOA.

The HOA’s Collection and Bad Faith Action

As the assignee and judgment creditor of JJA Framing, the HOA sued Penn National to collect its judgment. As it related to these claims, Penn National argued that it could have no liability for the judgment or for any extra-contractual claims because (1) JJA Framing waived its right to a defense when Castillo informing the independent adjuster that he did not want Penn National to provide a defense, (2) Penn National had no obligation to provide JJA Framing with a defense until requested by JJA Framing and any attorney retained by Penn National could not ethically provide a defense to JJA Framing without the approval of JJA Framing, and (3) JJA Framing had breached the notice and cooperation clauses of the Penn National policy by not cooperating with Penn National, not informing Penn National of the Underlying Lawsuit directly and defaulting.

The trial court addressed each of these arguments and determined that Penn National could not show JJA Framing had waived its right to a defense in the Underlying Lawsuit. While it was undisputed that Castillo had told the independent adjuster he did not want Penn National to provide a defense, this was insufficient to show a knowing waiver of a right. Penn National had not informed JJA Framing that Penn National would pay for the entire defense and failed to inform JJA Framing that it faced certain liability and seven-figure liabilities in the Underlying Lawsuit. When provided this information in the collection lawsuit, Castillo testified his answer would have been different and he would have requested a defense. This concealment of important facts was enough to show Castillo’s previous statements could not constitute a knowing waiver of the right to a defense.

The trial court next addressed Penn National’s argument that unless JJA Framing specifically requested a defense, it had no obligation to provide a defense in the Underlying Lawsuit. The Court noted that the terms of the Penn National policy required it to provide a defense to JJA Framing–there was nothing in the terms of JJA Framing’s policy that required JJA Framing to specifically request a defense and Penn National could not change the terms of the policy without informing JJA Framing of the changes in writing via an endorsement. This was not done. Further, the trial court noted that JJA Framing had been sued in a different lawsuit and Penn National had retained an attorney to defend JJA Framing in that lawsuit despite no evidence that JJA Framing requested Penn National do so.

The trial court then tossed aside Penn National’s argument that any attorney it might have retained was not permitted to ethically provide a defense to JJA Framing without JJA Framing’s specific authorization. The trial court determined this was an after-the-fact argument to justify Penn National’s failure to adhere to its policy obligations. Penn National never asserted this argument in its reservation of rights letters or claims file, Penn National never communicated this to JJA Framing, and it was never a considered as justification for Penn National not providing a defense to JJA Framing.

Finally, the trial court determined that Penn National could not demonstrate it suffered prejudice due to JJA Framing’s failure to personally notify Penn National of the Underlying Lawsuit. The purpose of the notice requirement is to ensure the insurance company has an opportunity to investigate the claim/lawsuit. Penn National knew of the Underlying Lawsuit when Portrait Homes and the HOA made contact and tendered the claims before JJA Framing was even served. After being notified, Penn National had the opportunity to investigate but did little other than finding ways to not provide coverage.

Based on these findings, the trial court determined that Penn National had an obligation to provide coverage and was responsible for the judgment entered against JJA Framing. The trial court also found Penn National had acted in bad faith and was liable for punitive damages.

Penn National appealed.

Court of Appeal’s Opinion

The Court of Appeals agreed with the trial court that Penn National was obligated to provide coverage for the judgment and rejected Penn National’s arguments against coverage for primarily the same reasons outlined by the trial court. Additionally, the Court of Appeals added that Penn National arguing it was prejudiced because it could not ethically hire an attorney to defend JJA Framing was very unpersuasive. Certain ethics opinions in South Carolina had addressed the issue previously and found that retained counsel are permitted to defend claims made against an insured when instructed to do so by an insurer when the insurance policy delegates the right to defend to the insurer, as long as the insured does not provide contrary instructions. Further, Penn National never even attempted to hire an attorney to defend JJA Framing or to contact JJA Framing and explain the entire situation.

Most collection cases involving a default judgment turn out to be a strike out instead of a home run. When looking at the facts, Portrait Homes would have appeared to fall into the first category. It is exceptionally rare that indemnity coverage would be provided for a default judgment especially when the insured apparently declined an “invitation” for a defense. But like so many other coverage and extra-contractual cases, the result turns on the claims handling details. Early missteps in claims handling by the carrier, like Penn National’s failure to fully inform the insured of relevant facts or creation of fictional policy obligations for the insured, can lead to unique results on coverage.