Applying Virginia law, the United States Court of Appeals for the Fourth Circuit has held that a Virginia statute imposing a forty-five day deadline for a coverage denial based on an insured’s breach of a liability policy does not apply to a denial based on a claim reported outside the policy period under a claims made and reported policy.  See Gateway Residences at Exchange, LLC v. Illinois Union Ins. Co., 2019 WL 963238 (4th Cir. Feb. 28, 2019).

The insured, a contractor, was hired to install power generators for an apartment complex.  After the project was complete, the owner of the building was not satisfied with the insured’s work.  Nineteen months after the insured’s claims made and reported liability policy expired, the owner of the building filed suit against the insured.  The insurer denied coverage on the basis that the claim was reported outside the policy period.  The building owner obtained a default judgment against the insured and brought suit to recover the judgment against the insurer.

In the resulting litigation, the building owner argued that the insurer waived the right to deny coverage because the insurer failed to comply with Virginia Code 38.2-2226, which sets a forty-five day deadline to deny coverage based on “a breach of the terms or conditions of the insurance contract by the insured[.]”

The court of appeals rejected the argument, holding that the statute applies to a denial based on an insured’s breach and not to a denial based on lack of coverage.  The court of appeals stated, “[t]he argument that a claim is outside the scope of coverage is not about an insured’s ‘breach’ of contract.  A ‘breach’ assumes a legal duty on the insured’s part, but the insured obviously has no legal duty to incur covered claims.  Likewise, a denial based on scope of coverage is not a ‘defense.’”

The building owner also argued that, because the insured and the owner were both citizens of Virginia, the district court lacked diversity jurisdiction under 28 U.S.C. 1332(c), which provides that “in any direct action against the insurer of a policy … to which action the insured is not joined as a party-defendant, such insurer shall be deemed a citizen of … every State and foreign state of which the insured is a citizen.”

The court of appeals interpreted the term “direct action” to narrowly mean “a suit in which the plaintiff sues a wrongdoer’s liability insurer without joining or first obtaining a judgment against the insured.”  Noting that Virginia law does not provide for a direct action by a third-party claimant against an insurer, the appeals court rejected that the federal statute applied.