In June, the Second Circuit held that two Federal Insurance Company ("FIC") excess D&O insurance policies would not be triggered until the full policy limits of the underlying insurance were paid. Ali et al. v. Federal Ins. Co. et al., 2013 U.S. App. LEXIS 11384 (2d Cir. June 4, 2013). The Second Circuit held that the language of the FIC excess insurance policies required the "payment of losses," not merely the accrual of liability, in order to reach the relevant attachment points and trigger the excess coverage. The result in Ali was a gap in coverage created by insolvent insurance companies, even though the insureds faced liability well above the solvent excess policy's attachment point. Although at first blush the Ali case appears to add the Second Circuit to those jurisdictions requiring that underlying insurers pay policy limits before excess policy limits may be attached, the result in Ali makes clear that the triggering and exhaustion requirements are a function of specific policy language. Ali highlights the importance of paying close attention to exhaustion language both in the placement process and when settling contested claims in a tower of coverage.
In Ali, former directors and officers of defunct computer company Commodore International Limited sought a declaration that excess D&O insurance policies issued to Commodore by FIC were triggered when the directors' obligations reached the attachment points of the FIC policies. Commodore had in place a $51 million tower of D&O insurance that included a $10 million primary policy topped by eight excess policies issued by five different insurance companies. By the time of the claim, two of those excess insurers were insolvent. FIC provided the second and fifth layers of coverage, with attachment points of $15 million and $30 million, respectively. Both of those policies sat above an insolvent policy. The Commodore directors, who faced costs and settlements totaling more than $15 million, sought a declaration that the excess liability coverage obligations are triggered when the total amount of "defense and/or indemnity obligations" reach the attachment point, as opposed to when actual payments on liability claims had been made.
The FIC policies stated that excess liability coverage "shall attach only after all . . . 'Underlying Insurance' has been exhausted by payment of claim(s)", and that "exhaustion" of the underlying insurance occurs "solely as a result of payment of losses thereunder." Id. at *10. The policy also stated that "depletion" of the underlying insurance shall occur "solely as a result of payment of losses thereunder."
The Second Circuit found that the "plain language of the contracts specifies that the coverage obligation is not triggered until payments reach the respective attachment points." Id. at 20. The Court rejected the directors' position that the excess coverage should be triggered by the "aggregation of the [Directors'] covered losses." Id. However, and notably, the Court pointedly avoided reaching the question as to whether such payments must be made by the underlying insurers, the Directors or some other party. Id. at 22.
Although the Court distinguished Zeig v. Massachusetts Bonding & Ins. Co., 23 F. 2d 665 (2nd Cir. 1928), the seminal case relied upon by insureds for the proposition that excess policies could be triggered by settlements, not actual payments, Zeig remains good law. Zeig found that a Manhattan dressmaker's excess policy was triggered for a burglary even through the primary insurer paid less than its policy limit to settle the claim. The Second Circuit declined to follow the rule in Zeig because Ali involved liability coverage while Zeig interpreted a first-party property insurance policy and that distinction justified requiring actual payment rather than mere accrual of liability.
Zeig still represents the rule followed by most courts, although a number of recent cases have demonstrated the danger that courts will depart from the rule in Zeig based on particular policy wordings. See e.g., Qualcomm, Inc. v. Certain Underwriters at Lloyd's, London, 161 Cal. App. 4th 184 (2008); JP Morgan Chase & Co. v. Indian Harbor Insurance Co., et al., 98 A.D.3d 18 (2012); Citigroup Inc. v. Fed. Ins. Co., 649 F.3d 367 (2011); Goodyear Tire & Rubber Co. v. Nat'l Union Fire Insurance Company of Pittsburgh, PA, 694 F.3d 781 (6th Cir. 2012). Each of these cases turned on the interpretation of the exhaustion language in the policies and teaches that insureds must carefully review their policies at placement and take care to review excess policies' exhaustion wording before settling claims under underlying insurance.
Goodyear Tire & Rubber provides a case in point on the potential implications for settlement strategy these policy interpretations create. Goodyear incurred more than $30 million in legal and accounting costs relating to a 2003 earning restatement that triggered shareholder lawsuits and an SEC investigation and sought recovery from its primary insurer, National Union Fire Insurance Company, and excess carrier Federal Insurance Company. FIC was excess to the $15 million National Union primary policy. National Union disputed coverage but eventually settled with Goodyear for a payment of $10 million—far less than the total of $30 million Goodyear had incurred in the aftermath of the restatement. FIC argued that its coverage obligation was not triggered because of the $5 million gap created by the National Union settlement.
The Sixth Circuit interpreted language in the policy that stated "Coverage hereunder shall attach only after [National Union] shall have paid in legal currency the full amount of the Underlying Limit [i.e., National Union's policy limit of $15 million] for such Policy Period." The Sixth Circuit found that FIC was not obligated to cover any of the loss until National Union paid out the full amount of its liability limit. The Court rejected Goodyear's argument that public policy in favor of encouraging settlements should compel the Court to not "strictly enforce" the exhaustion provision. In this scenario, Goodyear was left completely without excess coverage having settled for less than policy limits with the primary carrier. Importantly, the policy language in Goodyear required payment specifically by the insurer; by contrast, the "passive" policy language in Ali that left open the possibility that the insured could cover the gap.
The Second Circuit's decision in Ali reinforces the trend of courts enforcing excess exhaustion terms to the detriment of the policyholder. However Ali leaves open the possibility that the insured can pay the difference between the full underlying policy limit and the settled amount—thus, closing the gap and triggering the excess policy, if the policy language allows. As we have seen with other cases, courts have not been reluctant to find that excess policy exhaustion language can obliterate excess coverage altogether.
Policyholders should be attentive to exhaustion language in their excess policies. At a minimum, policyholders should ensure that such policies expressly provide that insolvency by an underlying carrier will not result in eliminating all higher layers of coverage. Before entering into a policy, make sure to check the exhaustion language and try to negotiate language that does not make the excess carrier's obligation to pay contingent upon actual payment by an underlying insurer. Before settling a contested claim, check the language in all of your policies, including each and every excess policy regardless of amount, to make sure that you fully understand the exhaustion terms of each policy and whether and how a below policy limits settlement of one policy will implicate policies higher in the tower. And, importantly, before settling a coverage dispute with an underlying insurer, obtain the excess insurers' agreement that any "gap" resulting from a below-limits settlement will not be used as a defense against coverage.