Court of Appeal rules on excess professional liability insurance policies
On November 12, 2013, in Quellos Group LLC v Federal Insurance Co, the Court of Appeals of Washington, Division One, applying Washington law, held that two excess professional liability insurance policies were not triggered where the insured entered into a global settlement with the underlying primary carrier, such that the insured accepted less than the primary policy limit in payment of the subject loss.
The Quellos coverage case involved claims arising from an offshore tax shelter strategy that federal authorities found to be fraudulent and in violation of US tax law. Quellos paid tens of millions of dollars in legal fees and settlements for claims against the company and its directors and officers. Before Quellos directors’ guilty pleas were entered, the American International Specialty Lines Insurance Company (AISLIC), the primary carrier, had paid $4,982,974 of its $10 million policy limit to Quellos. However, Quellos and AISLIC later entered into a global settlement encompassing multiple claims and policy periods without AISLIC paying any additional amounts for the tax shelter matter. . In an attempt to trigger excess coverage under its policies with Federal Insurance Company and Indian Harbor, Quellos agreed to pay the gap between the $10 million primary limit and the approximately $5 million paid by AISLIC. Quellos filed a declaratory judgment action against the two excess insurers to compel coverage. Federal Insurance Company and Indian Harbor Insurance Company thereafter moved for summary judgment on multiple grounds, including the lack of underlying exhaustion.
Each of the insured’s excess policies specified in its insuring agreement that the excess coverage would be triggered “only after” the underlying policies were exhausted by the applicable insurer’s “actual payment of loss”. The Washington trial court granted the excess carrier’s motion for summary judgment for failure to exhaust the underlying coverage. The court ruled that, under the “plain and unambiguous language” of the policies, Quellos did not exhaust the underlying limits of liability.
Quellos appealed and the Court of Appeals of Washington affirmed, adopting the trial court’s interpretation of the plain and unambiguous language of the insuring agreements. The court also rejected Quellos’s argument that the excess insurers’ use of the phrase ‘only after’ in their insuring agreements rendered the exhaustion provision a condition. Rather, the court held, the phrase “reflects the distinguishing characteristic and function of an excess insurance policy”. The court similarly rejected Quellos’s argument that the exhaustion requirement should be treated in the same manner as conditions related to cooperation or notice – that it is merely a function of claims handling. Rather, the court found that the insuring agreement language was “where the rubber meets the road”, defining the very parameters of excess insurance.
In the alternative, Quellos asserted that a literal interpretation of the “standardized language in the excess policies” would contravene the Washington public policy in favour of settlement, and would produce an “absurd result”. The court noted, however, that Quellos had obtained an excess coverage policy in a previous period that specifically allowed the insured to settle with an underlying carrier and then fill the gap with the insured’s own payment of losses. Furthermore, Indian Harbor, one of the excess carriers in this matter, produced an endorsement available in the timeframe of the Quellos coverage that would have amended the policy agreement to allow the insured to fill the gap and thereby trigger the excess policy. The court held that neither the Washington Supreme Court decision in Seafirst Center Limited Partnership v Erickson nor the 85-year old Second Circuit decision in Zeig v Massachusetts Bonding & Insurance Co supports the argument that public policy should override the “unambiguous exhaustion language” in the excess policies.
This decision will obviously affect excess insurers. Notwithstanding the primary AISLIC policy referred to above, the issues at play here apply equally to any excess insurer seeking a buy-back of coverage for an amount less than policy limits, giving rise to the potential that upper excess carriers will subsequently raise an argument with the insured that underlying excess coverage was not exhausted as provided for in the insuring agreement.
Another recent decision regarding an excess insurer’s duty to indemnify that adopts the Quellos line of reasoning is the New York Appellate Division, First Department, ruling in JP Morgan v Indian Harbour Ins Co.1 For further details, please see “Settlement and the requirement of underlying exhaustion”. A recent Pennsylvania Superior Court decision in Lexington Ins. Co. v. Charter Oak Fire Ins. Co. applied the same reasoning to an excess insurer’s duty to defend.2 In Lexington, the court held that an excess insurer’s duty to defend was not triggered by an agreement to settle for primary policy limits, but only by actual payment of the limits.
(1) 947 NYS 2d 17 (2011).
(2) 2013 PA Super 286 (Pa. Super. Ct. Nov. 6, 2013).