In his commentary, "Settlements With Underlying Layers Satisfy Exhaustion Conditions in Excess Policies," Michael T. Sharkey of Perkins Coie LLP analyzes the recent decision of Quellos Group LLC v. Federal Insurance Co., No. 68478-7-1, 2013 Wash. App. LEXIS 2626 (Nov. 12, 2013) [enhanced version available to lexis.com subscribers]. There, the Court of Appeals of Washington allowed excess insurance companies to escape any coverage for a loss reaching their layers on the grounds that a policyholder had not properly exhausted underlying coverage when it entered into a negotiated settlement at less than full limits with a lower layer policy (even though the policyholder would make up out of its own pocket any gap caused by the settlement discount). The commentary points out that other courts have recognized that a rule in which a policyholder forfeits all its excess coverage if it settles a dispute with a lower level insurance company flies in the face of the public policy favoring settlements and makes the resolution of insurance coverage disputes much more difficult. Nevertheless, the Quellos court and others in that line hold that this result is required by the plain policy language and the traditional rules of contract construction, which they conclude cannot be overridden by public policy concerns.
The commentary opines that contrary to these decisions, however, well settled contract law principles do not support forfeiture of excess coverage as a result of an underlying settlement. At best for the excess insurance companies, the exhaustion provisions are conditions to coverage. Conditions are strictly construed and will not be enforced to cause a disproportionate forfeiture, particularly when there has been no prejudice or increase in risk to the insurance company. In addition, an excess insurance company cannot take advantage of a condition requiring full payment by an underlying insurance company, if, as is often the case, it has assisted in hindering that event from taking place. These traditional contract law principles support the same result as the public policy favoring settlements — an excess insurance company that is not asked to respond to a loss before its express underlying limit is reached should not be permitted to escape its obligations for an otherwise covered loss on the grounds that the policyholder settled a disputed claim under a lower level policy.
The commentary concludes that lawyers representing policyholders should be prepared to counter exhaustion arguments by demonstrating that such forfeiture is not supported by traditional contract law principles. Policyholders also should seek to head off such disputes before they arise, by reviewing the excess policies they purchase, and insisting on exhaustion language that recognizes the possibility of settlement of underlying policies without a windfall to the excess insurance companies.
Michael T. Sharkey is a partner in the insurance coverage practice of Perkins Coie LLP, where he represents policyholders in insurance coverage disputes nationwide. The opinions expressed in this commentary are those of the author and not necessarily those of any of his clients. He can be reached at MSharkey@PerkinsCoie.com.
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