Federal Court Raises Stakes for an Insurer’s Denial of Coverage

On April 18, a federal appeals court issued a ruling that should cause trepidation in even the most obstinate insurance adjuster. In short, the court ruled that a policyholder may recover treble damages under the North Carolina Unfair and Deceptive Trade Practices Act where an insurer fails to adequately explain a denial of coverage. The ruling extends UDTPA liability to conduct that is routine in the insurance industry, and may change the playing field in coverage disputes governed by North Carolina law.   

The UDTPA is North Carolina’s flagship consumer protection law, entitling claimants to mandatory treble damages (and likely recovery of attorneys’ fees) where a business engages in “unfair” or “deceptive” conduct. Subject to a few exceptions, the UDTPA applies to the full spectrum of commercial activities, including insurance. This is particularly true for how insurers respond to their policyholders’ claims for coverage. A separate North Carolina law, the Unfair Claims Settlement Practices statute, prohibits 14 “unfair” actions by insurers in their handling of coverage claims. Each of these 14 unfair actions constitutes an automatic violation of the UDTPA.        

Over the past 20 years, UDTPA claims have become ubiquitous in insurance coverage litigation. The threat of treble damages, the thinking goes, intimidates insurers into submission. However, perhaps because UDTPA claims have become so common, they rarely move the needle on insurers’ coverage positions. The relatively few cases in which treble damages have been awarded have for the most part involved egregious conduct. Consequently, insurers have tended to disregard the risk of treble damages. This attitude may change following the Fourth Circuit Court of Appeals’ April 18 ruling in DENC, LLC v. Philadelphia Indem. Ins. Co., 34 F.4th 38 (4th Cir. 2022). 

The events giving rise to the lawsuit involved a January 2018 party at The Crest, a student housing apartment building in Elon, North Carolina. While the partying scholars were “jumping” to a popular song, the breezeway on which they stood partially collapsed. The next day, the building owner made a claim for coverage under its property insurance policy issued by Philadelphia Indemnity Insurance Company. Shortly thereafter, Philadelphia issued a “reservation of rights” letter, and informed the owner that it would investigate the claim. Days later, Philadelphia sent the owner a second letter, announcing that it would pay for “for damages or injuries sustained.”

Meanwhile, the adjuster and engineer Philadelphia hired to evaluate the loss concluded that “long-term water intrusion” caused the partial collapse, and the engineer blamed faulty construction. Upon considering the conclusions of its adjuster and engineer, Philadelphia issued a third letter to the building owner, this time denying coverage. The letter stated that Philadelphia denied coverage because the damage resulted from “long-term water intrusion” attributed to faulty construction, but the letter did not explain why the policy’s operative “collapse endorsement” did not provide coverage. Moreover, the letter recited in “rote” fashion a “morass” of policy provisions, none of which used the term “water intrusion,” and some of which were plainly inapplicable. The letter did not refer to Philadelphia’s previous letter informing the owner that it would pay for damages sustained. The lawsuit ensued. 

The trial court considered the parties’ competing arguments, and ruled that the policy provided coverage. The court further ruled that Philadelphia was liable under the UDTPA due to the inadequacy of its coverage denial letter. Specifically, the trial court found that Philadelphia violated the statutory prohibition against denying a claim without “promptly provid[ing] a reasonable explanation of the basis in the insurance policy in relation to the facts.” The trial court found, and the Court of Appeals agreed, that Philadelphia violated this provision by first telling the policyholder that the claim would be paid, and later denying coverage in a “confusing” letter that failed to explain the change. The Court of Appeals ruled that a coverage denial letter must “reasonably explain the denial’s basis in the insurance policy in relation to the facts.” Philadelphia’s letter fell short. Therefore, Philadelphia was liable for three times the policyholder’s actual damages. Adding insult to injury, both courts found that Philadelphia’s violation was willful, so it was also liable for the policyholder’s $221,000 in legal fees.  

Philadelphia’s coverage denial letter was not unusual. To the contrary, most coverage denial letters recite policy provisions in “rote” fashion and are “confusing.” If this becomes the standard against which denial letters are judged under North Carolina law, insurers will need to take great care to explain their coverage determinations in the first instance, rather than the common practice of throwing everything against the wall and waiting to see what sticks. Anything less may open the door to liability for treble damages and attorneys’ fees.

Reach out to our insurance coverage attorneys the next time your company receives a "confusing" coverage denial letter.