On June 4, 2013, the Second Circuit Court of Appeals in Ali v. Federal Insurance Company, et al., No. 11-5000-cv, affirmed a lower court’s decision declaring that the coverage obligations of excess D&O insurers are not implicated until the underlying insurance has been exhausted by actual payment of loss, even when the underlying carriers are insolvent. The appeal was taken from the United States District Court for the Southern District of New York. A copy of the Second Circuit’s decision is available here.

The case arose out of the 1994 bankruptcy of Commodore International Limited (“Commodore”), maker of one of the first popular personal computers, the “Commodore 64.” In anticipation that former directors and officers of Commodore (including former US Secretary of State Alexander Haig) would tender claims under its policy as a result of a lawsuit pending against them in the Bahamas, Federal Insurance Company (“Federal”), Commodore’s second and fifth-layer D&O insurer, brought a declaratory judgment action, seeking a declaration that it was not required to “drop down” to cover liability that would have otherwise been covered by Reliance Insurance Company (“Reliance”) and Home Insurance Company (“Home”), both of which were in liquidation. In turn, the directors filed a counterclaim against Federal, and sued Travelers Casualty and Surety Company of America (“Travelers”), seeking a declaration that the excess policies at issue were triggered once the total amount of the directors’ defense and/or indemnity obligations reached the policies’ attachment points, irrespective of whether those amounts had been paid or not. The Southern District of New York ruled in favor of Federal and Travelers, and denied the directors’ motion for partial summary judgment. The court’s opinion contains a detailed and thoughtful discussion of subsequent procedural maneuvering, but the result was that the Second Circuit concluded that it could review the denial of the directors’ motion.

Affirming the trial court’s judgment, the Second Circuit found that the excess D&O attachment points had not been implicated because there was no exhaustion of the underlying limits by actual payment of loss, due to the insolvencies of Reliance and Home. Relying on the “plain language” of the “exhaustion clause” contained in the applicable policies, the court stated that such language “requires the ‘payment of losses’ – not merely the accrual of liability – in order to reach the relevant attachment points and trigger the excess coverage.” In reaching this decision, the court also distinguished longstanding Second Circuit precedent in Zeig v. Massachusetts Bonding & Insurance Co., noting that the 1928 Zeig decision (which allowed recovery under an excess property policy when the loss exceeded underlying limits) involved a first-party property policy, rather than third-party excess liability policies, and that requiring actual payment, as the policies in issue required, protected the insurers against collusive settlements.

The Second Circuit’s ruling in Ali is consistent with other decisions in recent years finding that excess D&O coverage is triggered only when the underlying insurance has been exhausted by the actual payment of losses. See Comerica Inc. v. Zurich Am. Ins. Co., 498 F. Supp. 2d 1019 (E.D. Mich. 2007); Qualcomm, Inc. v. Certain Underwriters at Lloyds, London, 73 Cal. Rptr. 3d 770 (Cal. App. 2008).