The D&O Report|
Issue No. 75
This is not an offering of insurance. ACE Bermuda’s products are only available through non US-based brokers.
The Relationship between Excess Follow Form and Excess Side A Policies: An Important Marriage
A critically important feature of any Side A Excess DIC Policy is a broad difference-in-conditions (“DIC”) provision which states that the Side A Excess Policy drops down into any underlying layer of coverage to the extent the underlying insurer does not pay a Side A loss which is otherwise covered under the broad Side A Excess Policy. Such a provision is contained in virtually all Side A Excess Policies today and is intended to minimize the risk that the insured directors and officers have a gap in their personal asset protection. However, that provision standing alone does not necessarily create the seamless coverage which Insureds expect and brokers intend. As demonstrated by several recent court decisions, the excess follow-form policies which underlie the Side A Excess DIC Policy should expressly recognize that a drop down payment by a Side A Excess DIC policy erodes the underlying limit for purposes of liability attaching to the underlying excess follow-form policies. Absent this express integration of the excess follow-form policies and the Side A Excess DIC Policies, the Insureds may encounter problematic coverage gaps within the underlying follow-form policies.
Until recently, courts were somewhat divided on whether liability attaches to an excess follow-form policy where the Insureds incur loss in excess of the underlying limits but the underlying insurers pay less than their full limits for some reason. The courts which ruled that liability attaches to the excess policy even though the full amount of the underlying limit was not paid by the underlying insurers frequently relied upon a 1928 Second Circuit case applying New York law which held that an insured’s settlement with a primary insurer constitutes exhaustion of the primary limit of liability if the Insured fills the gap between the amount paid by the primary insurer and the full primary limit of liability (i.e., the excess policy is not dropping down, but is merely paying loss which is within the excess policy’s layer of coverage). Zeig v. Massachusetts Bonding & Insurance Co., 23 F.2d 665 (2d Cir. 1928). However, other courts rejected or distinguished Zeig and held that liability does not attach to an excess follow-form policy unless and until the underlying limit is paid in full by the underlying insurers (i.e. payments by Insureds or others do not erode the underlying limit).
As evidenced by four court decisions in the last few months addressing attachment issues under excess follow-form policies, there is now a clear trend by courts to reject Zeig and to enforce the unambiguous attachment language in excess policies. If that attachment language requires payment by the underlying insurers of the full amount of the underlying limit, then payments by Insureds or drop-down payments by Excess Side A DIC Policies do not erode the excess follow-form policy’s underlying limit. In that situation, a Side A Policy drop down payment into an underlying follow-form policy may preclude payment by any other higher layer follow-form policy unless the higher layer policy expressly recognizes erosion of its underlying limit by Side A Policy drop down payments. The lessons learned from those cases and the resulting increased importance of a fully integrated D&O insurance program are summarized below.
1. CitiGroup, Inc. v. Federal Ins. Co.
In CitiGroup, Inc. v. Federal Ins. Co., 649 F.3d 367 (5th Cir. 2011), the Fifth Circuit Federal Court of Appeals, applying Texas law, held that coverage under four excess policies did not attach where the insured settled with the primary insurer for less than the primary policy’s limit of liability. In that case, the insured settled two lawsuits for $263 million and sought coverage for that settlement under the insureds’ $200 million insurance tower. The insurers initially denied coverage for the settlement, but the primary insurer eventually paid $15 million of its $50 million limit of liability to settle that coverage dispute. Four of the excess insurers then argued that liability did not attach to them because the primary insurer did not pay the full amount of the primary limit of liability. Each of those excess policies contained somewhat different attachment language. One excess policy stated that liability attached only after the underlying insurers “have paid in cash the full amount of their respective liabilities.” Another excess policy required that “the total amount of the Underlying Limit of Liability has been paid in legal currency by the insurers of the Underlying Insurance.” A third excess policy attached only after each underlying insurer “pa[id] or have been held liable to pay the full amount of its respective limits.” The fourth excess policy stated that liability attached only after “exhaustion of all of the limits of liability of such Underlying Insurance solely as a result of payment of Loss thereunder.”
The Fifth Circuit held that all of those attachment provisions unambiguously required actual payment by the primary insurer of the full amount of the primary limit of liability. Because the primary insurer paid less than its full limit in exchange for a release from the insureds, the court held that none of the four excess insurers were liable for any portion of the $263 million settlement, even though the insureds paid the balance of the primary insurer’s limit of liability.
2. JPMorgan Chase & Co. v. Indian Harbor Ins. Co.
JPMorgan Chase & Co. v. Indian Harbor Ins. Co., 2011 N.Y. Misc. LEXIS 2767 (N.Y. Sup. Ct. May 26, 2011) involved a somewhat more complicated version of the Citigroup case. Instead of a single tower of insurance, JPMorgan Chase involved two separate insurance towers: (i) a $250 million D&O tower; and (ii) a $175 million bankers’ professional liability (“BPL”) tower. The insured settled several lawsuits for a total of $718 million and submitted the loss to both its D&O and BPL carriers. One insurer issued a $15 million excess policy in the BPL tower, and had a $15 million quota share participation in two $100 million excess policies in the D&O tower. That insurer settled with the insured for a total payment of $17 million. In the settlement agreement with that insurer, the insured added a self-serving statement that the insurer’s payment “exhausted” the insurer’s limits under both towers (even though the insurer paid less than its limits of liability under both towers).
Another excess insurer that issued the policy directly excess of the settling layer in the BPL tower, contended that liability did not attach to its policy by reason of the settlement. That excess policy stated liability attaches only if the underlying insurers “shall have duly admitted liability and shall have paid the full amount of their respective liability.” The insured argued that the settling insurer’s $17 million payment more than exhausted its $15 million excess policy in the BPL tower. After reviewing law from jurisdictions across the country (including Zeig and its progeny), the court determined that the non-settling excess policy unambiguously required the underlying carriers to have admitted liability and paid the full amount of their respective policy limits before coverage under the excess policy would attach. Because that did not occur, the non-settling excess insurer was not liable.
3. Goodyear Tire & Rubber Co. v. National Union Fire Ins. Co.
In Goodyear Tire & Rubber Co. v. National Union Fire Ins. Co., 211 U.S. Dist. LEXIS 121866 (N.D. Oh, Sept. 19, 2011), the court likewise held that liability does not attach to an excess D&O policy where the underlying insurer pays less than its full limit of liability. In that case, the insured tendered to the D&O insurers approximately $28 million in fees and expenses incurred in responding to an SEC investigation and an internal investigation. The D&O insurers denied coverage for the investigation costs, and the insured company filed a coverage lawsuit against the insurers. Two years into that coverage litigation, the insureds and the primary insurer reached a settlement pursuant to which the primary insurer paid $10 million of its $15 million limit of liability. The excess insurer then argued that it was not liable because the excess policy stated that coverage “shall attach only after the insurers of the Underlying Insurance shall have paid in legal currency the full amount of the Underlying Limit.”
The court granted the excess insurer’s motion for summary judgment, rejecting the insureds’ argument that public policy favors settlements and that the insureds should be allowed to “fill the gap” between the amount paid by the primary insurer and the primary policy’s full limit of liability. The court ruled that the attachment language in the excess policy unambiguously required the underlying insurer to pay the underlying limit and that public policy does not trump unambiguous language in the excess policy.
The court also rejected the insureds’ argument that the excess insurer must prove prejudice from the failure to exhaust the underlying limit. The court held that the excess carrier did not need to prove prejudice, but nonetheless noted that the excess insurer would suffer prejudice if it could not rely on its attachment language since the excess insurer “based the premium it charged…on that expectation, not some lesser amount.” The court also noted that the excess insurer suffered prejudice because it had been forced to litigate the coverage issues for over two years based on the insureds’ insistence that the excess limit was implicated. Finally, the court noted that as a sophisticated insured with the capacity to hire counsel to advise it in placing and bargaining for coverage, the insured company could have sought excess coverage with different attachment language.
4. Federal Ins. Co. v. Estate of Irving Gould
Federal Ins. Co. v. Estate of Irving Gould, 2011 U.S. Dist. LEXIS 114000 (S.D.N.Y. Sept. 28, 2011) addressed whether excess D&O insurers must drop down when an underlying insurer does not pay covered loss due to its insolvency. In that case, the first and fourth excess layers in the company’s $51 million D&O insurance tower were issued by Reliance Insurance Company and the third and sixth layers were provided by The Home Insurance Company. Both Reliance and Home were insolvent at the time the insureds sought coverage for losses under the insurance program. The court ruled that the insurer which issued the second excess layer (directly above the Reliance first excess layer) was not obligated to drop down and pay losses within the insolvent Reliance layer based on both the “maintenance of underlying insurance” clause and the attachment language in the excess policy.
The excess policy’s “maintenance of underlying insurance” clause stated that “the Underlying Policies shall be maintained during the Policy Period…. Failure to comply with the foregoing will not invalidate this policy but the insurer shall not be liable to a greater extent than if this condition had been complied with.” The court ruled that this language was enforceable and defeated the Insured’s argument that the excess policy should drop down into the insolvent underlying layer of coverage.
The court likewise ruled that the excess insurer was not obligated to drop down into the underlying Reliance layer based upon the attachment language in the excess policy, which stated that coverage under the excess policy was triggered “only in the event of exhaustion of all of the limit(s) of liability of such Underlying Insurance solely as a result of payment of losses thereunder.” The court found that language to be unambiguous and to clearly require payment of the underlying losses before liability attaches to the excess policy. Unlike the other cases summarized above, the insured company here was in bankruptcy, and therefore the insured directors and officers were arguing that liability attached to the excess policy even though no insured paid the full amount of the underlying limit. In rejecting that argument, the court noted that if the directors and officers “were able to trigger the Excess Policies simply by virtue of their aggregated losses, they might be tempted to structure inflated settlements with their adversaries…that would have the same effect as requiring the Excess Insurers to drop down and assume coverage in place of the insolvent insurers.”
Importance of Integrated D&O Insurance Program
To avoid the coverage gap which existed in these cases, Insureds need to focus on two elements of their D&O insurance program. First, the attachment language in the excess follow-form policies should state that the underlying limit is eroded not only by the underlying insurers paying covered loss, but also by the Insureds or a Side A Excess DIC Policy paying covered loss. These cases demonstrate a clear judicial trend toward enforcing the attachment language in excess D&O policies as written without regard to whether that language may create a gap in coverage between excess policies. Therefore, it is more important than ever that the attachment language be drafted properly.
Historically, the attachment language in many excess follow-form D&O policies required the underlying insurer to pay the full amount of the underlying limit. More recently, excess D&O policies routinely state that liability attaches to the excess policy if either the underlying insurers or the Insureds pay covered loss equal to the underlying limit. This broader attachment language would have eliminated the attachment dispute in the CitiGroup, the JPMorgan Chase and the Goodyear cases and would have required the excess insurer to pay the covered loss within the excess insurer’s layer of coverage if the insured rather than the underlying insurer paid the losses within the underlying limit. This new attachment language provides important flexibility for corporate insureds under Side B and Side C of a D&O insurance policy. However, broader attachment language does not protect directors and officers under Side A of a D&O insurance policy since directors and officers are typically unwilling and perhaps unable to personally pay a portion of a loss in order to access a higher layer excess policy within the D&O insurance tower. For example, if an underlying insurer is insolvent (like in the Estate of Irving Gould case summarized above), liability would not attach to the higher level solvent excess follow-form insurers even if those higher level excess policies contained the broader attachment language described above and even if a Side A Excess DIC Policy dropped down to pay the losses within the insolvent layer of coverage. In that case, the underlying limit for those higher level excess policies would not be paid by the underlying insurers or by the insureds, so liability would not attach to those higher level excess policies.
For that reason, the revised attachment language in excess follow-form policies should state that the underlying limit is also eroded by a Side A Excess Policy’s drop down payment into an underlying layer of coverage. With that additional language, directors and officers would avoid losing large amounts of follow-form coverage because a Side A Excess DIC Policy makes a modest drop down payment.
Second, high quality Side A Excess DIC Policies with broad drop-down language should be purchased. Such policies will fill gaps in the underlying follow-form program created by the underlying insurers failing or refusing to pay their full limit of liability due to coverage defenses, their insolvency or any other reason.
To achieve this important drop down protection, three features of the Side A DIC policy are particularly critical. Firstly, the Side A DIC policy should have very broad DIC language which is triggered if the underlying insurers fail or refuse for any reason to pay loss covered under the Side A policy. Secondly, the Side A policy should be purchased from an insurer with unquestionable financial strength so that the Side A insurer can survive financial challenges which cause the insolvency of an underlying insurer.
Thirdly, the Side A policy should contain ultra-protective coverage terms which afford broader coverage than afforded by the underlying policies. For example, some of the extraordinary coverage features in the benchmark CODA Premier Side A DIC policy form include:
- Narrow “conduct” exclusions:
- not applicable to Defense Costs;
- not applicable if majority of disinterested directors waive the exclusion;
- not applicable to Independent Directors.
Narrow “bodily injury/property damage” exclusion:
not applicable to pollution claims;
not applicable if majority of disinterested directors waives the exclusion;
not applicable to Independent Directors.
Narrow “entity v. insured” exclusion:
applies only if the Claim is (1) by or on behalf of the Company, and (2) at least two current senior executive officers of the Company approve or assist in prosecuting the Claim;
not applicable to Claim by Insured Person;
not applicable after Parent Company has change of control;
not applicable if majority of disinterested directors waives the exclusion;
not applicable if independent legal counsel opines that the fiduciary duties of the Company’s directors and officers require them to bring the Claim.
No presumptive indemnification (i.e., coverage applies if the Company is permitted but fails to indemnify).
Broad definition of Claim (includes circumstances that could give rise to a Claim and requests to provide evidence as a fact witness).
Optional additional limit of liability for only Independent Directors and for only officers.
Insurability issues determined under broad UK law.
Now more than ever it is important that a company maintain a fully integrated D&O insurance program in which each policy properly interrelates with the other policies in the program. The primary policy should contain the many coverage enhancements available in today’s “soft” insurance market. The excess follow-form policies should contain broad attachment language which allows the underlying limit to be eroded by payments by the Insureds, by excess Side A DIC policies and perhaps by other sources. The Side A Excess DIC policies should afford extraordinarily broad coverage and should require drop-down if the underlying insurers fail or refuse to pay loss for any reason. The excess follow-form and Side A Excess DIC policies issued by ACE Bermuda/CODA routinely contain those important features.
Equally important, especially the Side A Excess DIC policies should be purchased from insurers which have unquestionable financial strength, a proven record of outstanding claims practices, deep experience in the many unique issues which arise under a Side A policy, and a long-term commitment to the Side A insurance product. For example, ACE Bermuda’s CODA Side A Excess DIC policies have been offering personal asset protection to directors and officers for 25 years, more than twice as long as any other insurer. As a result our underwriters have in-depth knowledge and extensive experience in handling Side A claims. For more information about ACE Bermuda’s insurance products please contact your Bermuda based broker or visit our website at www.acebermuda.com.
This is not an offering of insurance. ACE Bermuda’s products are only available through non US-based brokers.
Although prepared by professionals, this publication should not be utilized as a substitute for legal counseling in specific situations. Readers should not act upon the information contained herein without professional guidance.