Pereira v. National Union Fire Ins. Co.

Issue Discussed: Exhaustion of Underlying Policy Limits

Submitted by Cecilia Froelich Moss, Karen C. Baswell

Date Promulgated: July 12, 2006

Pereira v. National Union Fire Ins. Co., 2006 WL 1982789 (S.D.N.Y. July 12, 2006)

Court: United States District Court for the Southern District of New York

Issues Decided: Whether there is coverage under an excess layer insurance policy that requires exhaustion of underlying policies “by actual payment of claims or losses thereunder” when the underlying insurance carrier is insolvent and cannot pay claims?

Background

Trustee for bankrupt estate sought coverage under the estate’s primary and excess D&O policies for a judgment against several current and former officers and directors for violation of their fiduciary duties.  The primary carrier and the second and third layer excess layer carriers all moved to dismiss the complaint.  (The carrier that issued the first and fourth layer excess policies was in liquidation, and was therefore not named as a defendant in the litigation.)

The primary carrier moved to dismiss the complaint on the basis that its policy had been exhausted by payment of defense costs in connection with the underlying litigation against the officers and directors.  It also argued that its payment of defense costs was appropriate and reasonable and that the Trustee had no standing to challenge the reasonableness of the costs paid.  The court rejected both arguments, holding that “the question of exhaustion is a factual issue that cannot be resolved at [the motion to dismiss] stage,” and that it could not conclude “as a matter of law at this stage that the Trustee does not have standing to question the reasonableness of the payments of defense costs.” 2006 WL 1982789, at *8.

The second and third layer excess carriers moved to dismiss on several grounds, including an argument that there was no coverage under the excess policies because they require underlying policy limits to be exhausted by actual payment of claims, and that because the first layer excess carrier was in liquidation, it would never exhaust its policy limits.

Key Holdings

In its analysis of the argument that the excess policies would never be triggered because the first excess layer would never be exhausted by actual payment of claims, the court first looked to the language of the excess policies, which provided (in relevant part):

The Company shall provide the Insured with insurance excess of the Underlying Insurance . . . only after all Underlying Insurance has been exhausted by actual payment of claims or losses thereunder.

. . . .

In the event of the depletion of the limits of liability of the Underlying Insurance solely as a the result of actual payment of claims or losses thereunder by the applicable insurers, this policy shall . . . apply to claims or losses as excess insurance over the amount of insurance remaining under such Underlying Insurance.

The court looked to Zeig v. Massachusetts Bonding & Ins. Co., 23 F.2d 665 (2d Cir. 1928), which held that interpreting the policy language to require exhaustion of underlying insurance by actual collection was “harmful to the insured and of no rational advantage to the insurer [and] ought only to be reached when the terms of the contract demand it.”  23 F.2d at 666.  Relying on this decision, the court held that “[i]nterpreting the policy to excuse the excess insurers from providing coverage within their respective layers on account of the unrelated insolvency of an intermediary insurer would work a similar hardship on the insureds, who have already been deprived of a layer of coverage by the insolvency, and provide a windfall to the excess insurers.”  2006 WL 1982789, at *7.  Therefore, the court denied the motion to dismiss on this argument.

*  Cecilia Froelich Moss is a founding partner of Chaffetz Lindsey LLP, where her practice focuses on representing major insurance companies in reinsurance disputes and in coverage litigation.  Ms. Moss also handles large scale commercial disputes in court and in international arbitration.

*  Karen C. Baswell is an associate of Chaffetz Lindsey LLP, focusing on insurance and reinsurance dispute resolution.