Delaware Court disregards policy language and rules that excess insurers are liable even though underlying insurers have not paid full limits.

In a decision with potential implications for the entire Directors and Officers Insurance industry, the Delaware Superior Court has held that an excess insurance policy is triggered when total costs incurred by the insured exceed underlying policy limits regardless of whether the underlying insurers themselves pay such limits and regardless of the express requirements of the excess policy. HLTH Corporation v. Agricultural Excess and Surplus Insurance Company, 2008 WL 3413327 (Del. Super. July 31, 2008). Although this is only one decision from one lower court in one state, it reflects a trend toward settlement and compromise – and away from strict interpretation of contract language – that all D&O insurers should be aware of.

The Facts

In HLTH, the insured made claims against its D&O insurers for the enormous defense costs it incurred in defending certain former officers and directors against allegations of conspiracy to fraudulently inflate earnings. When those defense costs exceeded the limits of one $20 million D&O tower, it sought coverage under another $100 million D&O tower (issued to a related HLTH entity). HLTH settled for less than policy limits with two of its underlying D&O carriers in the $100 million tower, and then sought coverage from its excess insurers. HLTH’s excess insurers refused coverage on the grounds that their policies were not triggered because the underlying insurers did not “pay ... in legal currency” the full limits, as the excess policy required1 and HLTH sued.

The Decision

The Court ruled against the excess insurers, holding that the underlying insurance was exhausted when the insured’s losses reached underlying limits, regardless of whether underlying insurers themselves paid those limits. The Court cited as precedent two cases, a Delaware federal court decision, Stargatt v. Fidelity and Casualty Co. of New York, 67 F.R.D. 689 (D.Del. 1975, aff’d, 578 F.2d 1375 (3d Cir. 1978), and a New Jersey state court decision, Westinghouse Electric Corp. v. American Home Assurance Co, 2004 WL 1878764 (N.J.Super.Ct. Jul. 8, 2004), and explicitly adopted the Westinghouse reasoning that focused on the amount of the insured’s losses rather than who paid those losses:

“[T]he excess policy was triggered when the underlying policy limit was reached by the total costs incurred by the insured, regardless of whether the total payments to the insured reached those limits, because the excess insurance company could not possibly claim to have a stake in whether the insured actually received all of the underlying insurance limits.” Id. at 14.

The Court also based its decision on public policy – the importance of encouraging compromise and settlement – and fundamental fairness:

“Settlements avoid costly and needless delays and are desirable alternatives to litigation where both parties can agree to payment and leave other separately underwritten risks unchanged. The Court sees unfairness in allowing the excess insurance companies in the instant case to avoid payment on an otherwise undisputedly legitimate claim. Therefore, to the extent that Plaintiffs’ defense costs exceed any loss they may have imposed on themselves by accepting settlements with underlying insurers for less than the policy limit, the Court holds that those underlying policies have been exhausted as a matter of law.” Id. at 15.

While the Court cited two recent cases that enforced language in excess policies that provided that the excess policies were triggered only after the underlying limits were paid by the insurer, Qualcomm, Inc. v. Certain Underwriters at Lloyd’s, London, 2008 WL 763483 (Cal.App. Mar. 25, 2008) and Comerica Inc. v. Zurich American Insurance Co., 498 F.Supp.2d 1019 (E.D. Mich. 2007), it explicitly declined to follow them – and it did so in the face of the Qualcomm court’s statement that the phrase “have paid ... the full amount of the Underlying Limit’ cannot have any other reasonable meaning than actual payment.”2

Our Analysis

Although the HLTH court expressly relied on the holdings in Stargatt and Westinghouse, the language of the policies in those cases was different from the language of the excess policy in HLTH. Neither the Stargatt nor Westinghouse policy included language that required the underlying insurer to “pay” the underlying limit “in legal currency.” The HLTH Court made no attempt to reconcile that discrepancy. By holding as it did, and ignoring the policy requirement that the underlying insurers “pay ... in legal currency” in favor of a public policy encouraging settlement, the HLTH court reflected a significant split of authority in the jurisdictions: some courts will enforce excess policy language that requires the underlying insurer to pay underlying limits and other courts will ignore such language.

This highlights a problem that has been brewing for years. As we noted in our Insurance and Reinsurance Update dated September 2005 (McCarrick, “Developments in Excess Insurance”), there has been a trend by policyholders and brokers to seek compromises of potential coverage defenses in a way that provides benefits to every affected layer of insurance, and that trend continues to date. So what is an excess carrier to do? It can try to buck the trend by drafting an “airtight” exhaustion clause3 and pray that the court enforces its contract; or it can do what some excess insurers are already doing and adopt an exhaustion clause that defines exhaustion as payment of underlying limits by either the underlying insurers or the Insured (and adjust premiums accordingly); or it can follow a middle path such as requiring the consent of the excess insurer to any payment of the underlying limit by the insured.