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June 2013

Second Circuit: Excess D&O Policies Not Triggered Absent Exhaustion of Underlying Limits

The appellants, former directors and officers (the directors) of defunct computer technology company Commodore International Limited, sought review of a decision of the U.S. District Court for the Southern District of New York denying summary judgment on their claim for declaratory relief. The directors had sought a declaration that high-level excess D&O insurance policies issued to Commodore by appellees Federal Insurance Co. (FIC) and Travelers Casualty and Surety Company of America were triggered when the directors’ obligations reached the attachment points of the FIC and Travelers policies. Certain underlying policies had been issued by insurers that are now insolvent.

In June 4’s Ali v. Federal Ins. Co., the U.S. Court of Appeals for the Second Circuit affirmed the decision of the District Court, finding that the “plain language” of the FIC and Travelers policies provided that the excess coverage would only be triggered if liability payments, not just obligations, reached the attachment points of the FIC and Travelers policies. 

Commodore filed for bankruptcy in 1994. At the time, it had in place a directors and officers liability insurance tower totaling $51 million, consisting of nine policies issued by six insurance carriers. FIC issued the second- and fifth-layer excess policies in the tower, and Travelers issued the seventh-layer excess policy.  

Since Commodore’s bankruptcy, the directors have been named in a variety of lawsuits in jurisdictions throughout the world. At the time of the District Court’s decision, all but one of the lawsuits had been resolved, and the directors had incurred approximately $14 million in losses as a result of the lawsuits. (The Second Circuit observed in a footnote that the directors had asked the court, during the pendency of the appeal, to take judicial notice of a large settlement in the remaining lawsuit.) 

The dispute between the parties developed because two of the insurers on underlying layers, Reliance Insurance Co. and Home Insurance Co., ceased operations and liquidated their assets. Anticipating that the directors would seek coverage for the underlying lawsuits, FIC filed a declaratory relief action in the District Court seeking a declaration that its policies would not drop down to fill the gaps in coverage caused by the insolvency of Reliance and Home. (FIC was granted judgment on that claim; the directors did not appeal that aspect of the District Court’s decision.)

In the same proceeding, the directors filed a counterclaim against FIC and third-party defendant Travelers seeking a declaration that “[FIC] and Travelers’ coverage obligations are triggered once the total amount of [the directors’] defense and/or indemnity obligations exceeds the limits of any insurance policies underlying their respective policies, regardless of whether such amounts have actually been paid by those underlying insurance companies.” The District Court denied the directors’ motion for summary judgment on their claim for declaratory relief, because the excess policies issued by FIC and Travelers expressly state that coverage does not attach until there is payment of underlying losses.

In affirming the decision of the District Court, the Second Circuit noted that the policies of FIC and Travelers required exhaustion “solely as a result of payment of losses thereunder.” The FIC policies provide further that coverage “shall attach only after all . . . ‘Underlying Insurance’ has been exhausted by payment of claim(s),” whereas the Travelers policy provides that excess coverage “shall attach only after all such Underlying Insurance has been exhausted.” Observing that the “plain language” of the contracts specifies that coverage is not triggered until payments reach specific attachment points, the Second Circuit found that the District Court properly denied the directors’ argument that the policies were triggered once their defense and indemnity obligations reached the attachment points. 

In its decision, the Second Circuit distinguished its 1928 decision of Zeig v. Massachusetts Bonding & Ins. Co., 23 F.2d 665. In Zeig, the plaintiff insured had purchased a property policy with $15,000 in coverage, and an excess policy that attached after the primary policy was “exhausted in the payment of claims to the full amount of the expressed limits.” Following a burglary resulting in a loss of more than $15,000 in property, the insured settled his claims under the primary policy for $6,000, and filed claims under the excess policy. In the ensuing coverage litigation, the court found that the insured only had to exhaust his primary claims, whether through full payment or settlement, to trigger his excess policy. The court reasoned that it would serve no rational interest of the excess insurer to require actual payment, as long as the excess insurer was only called upon to pay the portion of the loss in excess of the primary limits. The court explained that the insured could only harm his own interests by settling the primary claims for less than face value. 

The Second Circuit distinguished Zeig on the basis that the Ali case involved liability insurance, as opposed to a first-party property policy. Declaring that policy language must be interpreted in context, the court explained that in Zeig, the amount of the insured’s loss was liquidated at the time he settled with the primary carrier, and that he was seeking coverage from the excess carrier for out-of-pocket losses. In contrast, the directors sought coverage for obligations to third parties. The Second Circuit held that the excess carriers were entitled to enforce the plain language of their policies and could not be compelled to make any payment until the underlying policies had been paid. 

Click here for opinion in Ali v. Federal Ins. Co., 2013 U.S. App. LEXIS 11157, Docket No. 11-5000-cv (2d Cir.).

This opinion is not final. It may be withdrawn from publication, modified on rehearing, or review may be granted by the U.S. Supreme Court. These events would render the opinion unavailable for use as legal authority.

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