Where an insured has assigned away its rights to recover available insurance, the insured’s “empty shoes” do not necessarily prevent an excess carrier that pays defense costs rightfully owed by primary carriers from pursuing the primary carriers based a contractual subrogation theory.  An excess carrier proceeding on this basis typically “stands in the shoes of the insured,” obtaining only those rights held by the insured.  Nonetheless, the Fifth Circuit Court of Appeals found last week that where an excess carrier picks up the bill for an insured’s defense, it may recover from primary carriers that wrongfully refuse to provide a defense, even when the insured has transferred its own rights against the primary carriers.  Continental Casualty Co. v. North American Capacity Insurance Co.,  __ F.3d __ (5th Cir. 2012).  The court also found that where a bankrupt insured agrees to cede its rights against insurers to a third-party claimant, conditioned on the claimant securing a judgment against the insured, the insured does not divest itself of its right to a defense against the third party’s claims. Id.

In Continental, a diversity action under Texas and California law, an excess carrier had taken over the defense after the lone primary carrier that had agreed to defend the insured entered into a settlement agreement with a third-party claimant to whom the insured had assigned its rights against insurers.  Two other primary carriers to which the insured had tendered the claim refused to defend.  One of the two nonetheless settled with the claimant.  The excess carrier’s policy contained a provision by which the insured assigned to the excess carrier all rights to recover payment that the excess carrier makes under the policy.

The three primary carriers in Continental argued that because an insurer proceeding on a theory of contractual subrogation must “stand in the shoes” of the insured, no recovery is allowed where the insured’s shoes are empty.  Such was purportedly the case, as the insured had entered into a bankruptcy settlement with the claimant whereby the insured assigned to the claimant its rights to available insurance coverage.  Since the insurer no longer held any rights against them, argued the primary carriers, the excess carrier stood in “empty shoes” and could not recover.

The Fifth Circuit disagreed, finding that the bankruptcy settlement did not and should not preclude the excess carrier from pursuing its contractual subrogation rights.  “Disallowing [the excess carrier] to recover from the primary carriers when those carriers had an obligation to protect the insured would encourage the primary carriers to breach their duties to defend rather than place their insured’s interests above their own by defending and seeking reimbursement later.”  Id.  The court rejected the primary carriers’ arguments that they owed no defense to the insured, finding that each had been obliged to defend throughout the arbitration in question. 

In addition, the court found that the bankruptcy settlement did not, in fact, empty the insured’s shoes, as its “right to demand a defense from the insurers who owed that defense could not flow to its adversary in the very action that it was actively contesting.”  Id.  The bankruptcy settlement was intended to assist the claimant in collection of any judgment against the insured, once procured, “not to empty [the insured’s] shoes” of rights related to its defense.  Thus, at all times, the primary insurers retained their contractual obligation to provide a defense, and the insured retained the right to demand a defense.