Washington Appellate Court Enforces Strict Exhaustion Language in Excess Directors and Officers Liability Policies

Washington Appellate Court Enforces Strict Exhaustion Language in Excess Directors and Officers Liability Policies

By Leslie S. Ahari and Gabriela A. Richeimer

The State of Washington has joined the growing list of jurisdictions that have enforced strict exhaustion language in an excess policy’s insuring agreement in favor of the excess carrier in situations where the insured has settled with the underlying insurance carriers for less than the policy limit and then “fills the gap” between the below-limits settlement and the attachment point of the excess policy. On November 12, 2013, the Court of Appeals of Washington, Division One, issued a reported opinion in Quellos Group, LLC v. Federal Insurance Company [enhanced version available to lexis.com subscribers], holding that two excess insurance policies were not triggered where the insured had settled its claims against the primary carrier without requiring full payment of the primary policy limit. As the court explained: “Because the plain and unambiguous language of the excess insurance policies require exhaustion of the underlying liability limits by actual payment by the insurer before excess coverage is triggered, and there is no dispute that the underlying insurers did not pay policy limits, we affirm” the summary judgment granted to the excess carriers by court below.

The Quellos coverage case involved claims arising from an off-shore tax avoidance strategy developed by the insured called “POINT” - a strategy that federal authorities eventually found to be fraudulent and in violation of United States tax laws. Quellos paid tens of millions of dollars in POINT-related legal fees and settlements for claims asserted against the company and its former officers and directors, including two officers who admitted (and pled guilty to) a conspiracy to defraud the IRS “by designing and promoting the fraudulent POINT tax shelter.” Before these guilty pleas were entered, the primary carrier had paid $4,982,974 of its $10 million policy limit to Quellos for POINT-related losses; however, Quellos and the primary carrier later entered into a global settlement encompassing multiple claims and policy periods without the primary carrier paying any additional amounts for POINT.

After the primary carrier and the insured entered into this below-limits settlement, the two excess carriers, Federal Insurance Company and Indian Harbor Insurance Company, moved for summary judgment on a number of grounds, including exhaustion. Each of the excess policies specified in the insuring agreement (and elsewhere) that the excess coverage was triggered only after the underlying insurers actually paid their full limits. The trial court granted the insurers’ motion for summary judgment that the excess policies were not and could not be triggered once the insured settled with the primary carrier for less than the primary policy limit.

Quellos appealed, and the Court of Appeals agreed with the excess insurers that “exhaustion of the primary policy limits is the critical and defining feature of the excess policy coverage.” The Court of Appeals’ rejected the Quellos’ argument that excess insurers’ use of the phrase “only after” in the insuring agreement relegated the exhaustion provision to a mere condition, which would shift the burden of proof to the insurers to show material and substantial prejudice in order to deny coverage. As the court explained, under Washington law: “[u]se of the language ‘only after’ in the insuring clause in the policies does not mean that the requirement that the insurer must pay the full amount of the underlying policy limits before the excess insurer is obliged to provide coverage. The language ‘only after’ reflects the distinguishing characteristic and function of an excess insurance policy.”

The Court of Appeals also disagreed with Quellos that the exhaustion requirement in the excess policies should be treated like a notice, cooperation or so-settlement clause. On this point, the court cited and quoted from the Sixth Circuit’s recent decision in Goodyear Tire & Rubber Co. v. Nat’l Union Fire Ins. Co. of Pittsburgh [enhanced version available to lexis.com subscribers]: " the provision at issue here is where the rubber hits the road: the agreement’s Insuring Clause, under whose terms [the insurer] undisputedly did not agree to provide the coverage that [the insured] now seeks.’”

Finally, the Court of Appeals looked to the factual record to dispel Quellos’ argument that literal enforcement of the so-called “standardized language in the excess policies” would produce absurd results and would violate the public policy of the State of Washington. In fact, Quellos had obtained excess coverage from another insurer in a previous policy period that specifically allowed the insured to settle with an underlying carrier and then fill the gap with the insureds’ own payment of losses. Furthermore, Indian Harbor, one of the excess carriers produced an endorsement available in the time frame of the Quellos coverage that would have amended the policy form to allow the insured to fill the gap and thereby trigger the excess policy. Here, however, because Federal and Indian Harbor had made exhaustion a plain and unambiguous defining feature in the insuring agreement, this language rightly should be enforced under Washington law. For this reason, the court distinguished the often quoted Second Circuit decision in Zeig v. Massachusetts Bonding & Insurance Co. [enhanced version available to lexis.com subscribers], and its progeny, where the excess policies at issue (unlike the policies in Quellos) did not define exhaustion.

Troutman Sanders represented Indian Harbor and argued the exhaustion issue in both the trial court and Court of Appeals.

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