On June 4, 2013, the Second Circuit, in an insurance
coverage action involving the defunct Commodore International computer company,
affirmed that excess D&O insurance is not triggered even if losses exceed the
amount of the underlying insurance, where the underlying amounts have not been
paid due to the insolvency of underlying insurers. The Second Circuit's June 4,
2013 opinion can be found here
[an enhanced version of this opinion is available to lexis.com
The Second Circuit's opinion is important because it
represents the first time the Circuit has revisited its venerable and
influential 1928 opinion in the Zeig v. Massachusetts Bonding &
Insurance Co [enhanced version].
As I noted in my discussion of the district court's
this is a tale haunted by the ghosts of several long-lost companies - not only
the ghost of Commodore itself (the manufacturer of the classic Commodore 64 computer),
but also the ghosts of Reliance Insurance Company, which went into regulatory
liquidation in 2001, and of The Home Insurance Company, which went into
liquidation in 2003. This case not only analyzes the requirements to trigger
the obligations of excess insurers, but it also serves as an important reminder
of the chaos that can follow when carriers become insolvent.
Commodore filed for bankruptcy in 1994. In the bankruptcy
proceeding, various claims were asserted against the company's former
directors. The individuals sought insurance protection for these claims from
Commodore's D&O insurers. Commodore had a D&O insurance program with
total limits of $51 million, arranged in nine layers, consisting of a primary
layer of $10 million and eight excess layers in varying amounts. Unfortunately
for Commodore's former directors, the first and fourth level excess layers were
provided by Reliance and the third and sixth level excess layers were provided
by The Home.
The primary D&O insurance was exhausted by payment of
losses. However, due to Reliance's insolvency, the individuals were unable to
obtain insurance for losses that went into the next layers of insurance. The
individuals sought to have the solvent excess insurers that provided the
insurance layers above the insolvent carriers pay their defense expenses and
other loss costs. These "next level" excess insurers filed an action
seeking a judicial declaration that they had no obligation to "drop down" to
fill the gaps created by the insolvent insurers, and also seeking a declaration
that their excess insurance obligations had not been triggered because the
underlying layers had not been exhausted by payment of loss. The individual directors
contended that the excess insurers' payment obligation had been triggered
because their liabilities exceeded the amount of the underlying insurance.
The solvent excess insurers' policies all contained a
similar provision essentially providing that the payment obligation under the
policies is 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
As discussed here,
on September 28, 2011, Southern District of New York Judge Richard Sullivan
granted the insurers' motion for summary judgment. He ruled that the "next
level" excess insurers had no obligation to drop down to fill the gaps caused
by the insolvency of Reliance and of The Home. (Judge Sullivan's ruling on the
"drop down" issue was not appealed and was not before the Second Circuit).
Judge Sullivan also concluded that the "next level" excess insurers obligations
had not been triggered merely because the individuals' liabilities exceeded the
amount of the underlying insurance.
Judge Sullivan found that the "express language" in the
excess insurers' policies required exhaustion of the underlying limits by
actual payment of loss in order to trigger coverage. He said that it is "clear
from the plain language of the Excess Policies ... that the excess coverage will
not be triggered solely by the aggregation of Defendants' covered losses.
Rather the Excess Policies expressly state that coverage does not attach until
there is payment of the underlying losses."
Following further proceedings in the District Court, the
individual directors appealed Judge Sullivan's summary judgment ruling.
The June 4 Opinion
In June 4, 2013 Opinion written by Judge José Cabranes for
a unanimous three-judge panel, the Second Circuit affirmed Judge Sullivan's
ruling. The appellate court said that "the plain language of the insurance
policies supports the view of the insurer appellees."
The individual directors had argued that the excess
insurers' payment obligation attached when defense or indemnity obligations
reached the excess insurers' respective attachment points. The Second Circuit
said that "'obligations' are not synonymous with 'payments' on those
obligations," adding that "to hold otherwise would make the 'payment of'
language in these excess liability contracts superfluous." The appellate court
added that "because the plain language of the contracts specifies that the
coverage obligation is not triggered until payments reach the respective
attachment points, the District Court properly denied the Directors' request
for a declaration that coverage obligations are triggered once the Directors'
defense and indemnity obligations reach the relevant attachment point."
Interestingly, the Second Circuit noted that the District
Court had never actually said that the underlying insurers must make the
payments before the excess insurers' obligations were triggered. The appellate
court noted that the District Court, echoing the excess policies' themselves,
"described the requirements in the passive voice and did not specify which
party was obligated to make the requisite payments." The District Court, the
appellate court noted, "did not err in doing so," as denying the directors'
request "did not require ruling on whether the underlying insurers, in particular,
were required to made the payments; the Directors simply sought a declaration
that the excess policies' coverages are triggered once the respective
attachment points were reached."
The Second Circuit also rejected the individual directors
attempt to rely on the Second Circuit's 1928 Zeig opinion. (Zeig had
held that an insured under a property insurance program could obtain the
benefits of an excess policy where the insured's loss exceeded the amount of
the underlying insurance.) The appellate court did not overrule Zeig; rather,
the Second Circuit distinguished Zeig.
First, the Second Circuit differentiated between the
"context" in Zeig, in which the prior Court had been interpreting a first-party
property policy, and the context in this this case, in which the Court was
interpreting a third-party excess liability policy. The relevance of the
question whether or not the amount of loss exceeded the amount of underlying
insurance is clearly different in the context of a property policy than in the
context of a third-party liability policy. The Second Circuit noted, quoting
with approval from the Judge Sullivan's opinion, that a third party liability
insurer was within its right to require actual payment of the underlying
amounts, so as to protect against collusive settlements.
Though the Second Circuit did not overrule Zeig, it did
comment in a footnote that "though not relevant to our decision, it bears
recalling that the freestanding federal common law that Zeig interpreted
and applied no longer exists. See Erie R.R. Co. v. Tomkins, 304
U.S. 64 (1938) [enhanced version], overruling Swift v. Tyson,
41 U.S. 1 (1842) [enhanced version]."
If nothing else, this case serves as a reminder of the
critical importance of carrier solvency. Carriers do not become insolvent
frequently, but when they do, it is a mess. Here we are fully twelve years
after Reliance went into liquidation (and nearly twenty years after Commodore
went into bankruptcy) fighting about the problems caused when the carriers went
bust. Unfortunately for the former Commodore directors, their insurance
program had doubled down on the carriers that went insolvent; its insurance
program included two layers of excess insurance each for both Reliance and The
The Second Circuit's holding that the excess insurers'
payment obligations were not triggered even though the individuals' losses
exceeded the amount of the underlying insurance is consistent with other recent
decisions in which courts have interpreted the excess insurer's trigger
language to require exhaustion of the underlying insurance by the actual
payment of loss (refer for example here
Though the Second Circuit's decision is consistent with
other recent decisions on this topic, there are still a number of interesting
things about this opinion. First of all, as noted above, this case apparently
represents the first occasion on which the Second Circuit has revisited its
venerable Zeig decision, a case on which policyholders have relied for
years to try to compel their excess insurers to pay losses that exceeded the
excess insurers' layers.
The Second Circuit did not overturn Zeig, it
merely distinguished the case. (For that matter, the Second Circuit didn't even
make clear which state's law it was applying; in a footnote, the appellate
court noted that the parties disputed whether Pennsylvania law or New York law
applied, observing that "because there is no conflict between the relevant
substantive law in these states however, we dispense with any choice of law
Just the same, I question whether or not Zeig
remains good law after this decision in the Commodore case. As I noted above,
the Second Circuit expressly noted that that "freestanding common law" that Zeig
interpreted "no longer exists." In light of this statement, I doubt whether Zeig
represents reliable authority that could be cited and relied upon for the
propositions it otherwise represents.
It is worth noting that for several years now, the
D&O insurance marketplace has featured the availability of excess insurance
policies with trigger language that allows the amount of the underlying limits
of liability to be paid either by the insurer or the insured for the excess
insurer's payment obligation to be triggered. However, even if the policies of
the solvent excess carriers in this case had included this modern language, the
excess carriers' payment obligations might not have been triggered; the clear
suggestion of the Second Circuit's analysis of the "payment of" language is
that the underlying amounts had not been paid here, either by the insolvent
insurers or by the insured persons -- which serves as a reminder that even the
modern language does not solve every excess trigger problem.
It was interesting in the Second Circuit's opinion that
the appellate court expressly did not reach the question of whether the
individual directors' payment of the losses would have been sufficient to
satisfy the "payment of" triggers of the excess policy. The Second Circuit's
commentary on this issue, and its analysis of the passive voice "payment of"
language in the excess policy's trigger, will give policyholders in coverage
cases involving excess policies that lack the modern trigger a basis on which
to argue for coverage. The policyholders could argue, if they have in fact
themselves paid the underlying loss, that their payment of the loss satisfies
the "payment of" trigger where the excess policy uses the passive voice and
does not specify who must make the payment in order for the excess
coverage to be triggered.
Owing to the insolvency of Reliance and The Home, the
individual directors here are left to face the underlying claims without the
benefit of insurance. This dire circumstance provides a vivid illustration of
the value of Excess Side A/DIC insurance, which by its terms would drop down
and provide coverage in the event of the insolvency of an underlying insurer.
Excess Side A/ DIC policies were available at the time that Commodore procured
its D&O insurance, but the inclusion of these types of policies in a
program of D&O insurance was not as common then as now. (The policies
available then were more restrictive than those available today, as well.) If
Commodore's insurance program had included an Excess Side A/DIC policy, the
individual defendants might have been able to rely on that policy to defend
themselves despite the gaps caused by the insurers' insolvency.
In any event, the time has finally come to draw a curtain
on this production. At this point in a Shakespearean play, the stage directions
would say: Exeunt stage left. And off into the night would troop the spirits of
Commodore, Reliance and The Home - followed by the spirits of the several
individual directors who have passed away while this seemingly interminable
drama has dragged on. Among them would be the departing spirit of the late
Alexander Haig, who during his mortal span of years was a Commodore director
and who also served as Secretary of State under Ronald Reagan. He was not in
fact "in control" during the tense hours after Reagan's attempted assassination
any more than he is now.
Special thanks to a loyal reader for sending me a copy of
the Second Circuit's opinion.
Read other items of interest from the world
of directors & officers liability, with occasional commentary, at the D&O Diary, a blog by
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