Premature Exhaustion Leaves Insured Feeling Unsatisfied


[authors: Aaron Mandel and Stevi Raab]

In JP Morgan Chase v. Indian Harbor Insurance Company, No. 603766/08, 2012 N.Y. Slip Op. 04702 (June 12, 2012), the First Department of New York’s Appellate Division recently held that, under Illinois law, an excess insurer is not obligated to provide coverage when an insured settles with an underlying insurer for less than the underlying insurer’s policy limits.

In 2002, JP Morgan Chase & Co., JP Morgan Chase Bank N.A., and J.P. Morgan Securities Inc.'s (collectively, “JP Morgan”) predecessor and its affiliates (collectively, “Bank One”) were sued by numerous parties for their roles as indenture trustees of notes issued by NPF XII Inc. and NPF VI Inc.  While those lawsuits were pending, Bank One merged with JP Morgan.  Between 2006 and 2008, JP Morgan paid $718 million to settle six of the lawsuits.  JP Morgan sought coverage for those settlements under a $175 million tower of claims-made professional liability policies consisting of a primary layer and seven excess layers (the “Bank One Tower”).

JP Morgan’s primary, first-layer excess insurer, and second-layer excess insurer apparently paid out their limits of liability.  JP Morgan also settled with two of its excess insurers, third-layer excess insurer Zurich American Insurance Company (“Zurich”) and sixth-layer excess insurer Federal Insurance Company (“Federal”), for $17 million each.  Notably, JP Morgan’s settlement with Zurich resolved JP Morgan’s claim under both Zurich’s $15 million share of the Bank One Tower, and an insurance policy issued by one of Zurich’s affiliate insurers, Steadfast Insurance Company (“Steadfast”) that provided $13.4 million in coverage.  Similarly, JP Morgan’s settlement with Federal resolved JP Morgan’s claim under both Federal’s $10 million share of the Bank One Tower, and an insurance policy issued by Federal’s affiliate, Executive Risk Indemnity Inc. (“Executive Risk”).

JP Morgan sued its remaining excess insurers – i.e., fourth-layer excess insurer Twin City Fire Insurance Company (“Twin City”); fifth-layer excess insurers Lumbermens Mutual Insurance Company (“Lumbermens”), St. Paul Mercury Insurance Company (“St. Paul”), and Arch Insurance Company (“Arch”); and seventh-layer excess insurer Swiss Re International SE (“Swiss Re”) (collectively, the “Insurers”) – seeking coverage for the settlements.  Twin City’s policy contained an attachment provision stating that coverage under its policy attached “only after the Primary and Underlying Excess Insurers shall have duty admitted liability and shall have paid the full amount of their respective liability.”  The attachment provisions in Lumbermens’, St. Paul’s, Arch’s, and Swiss Re’s policies generally stated that coverage under those policies did not apply until the underlying insurers paid or were held liable to pay the full amount of their limits of liability.  Based on these attachment provisions, the Insurers moved for and were granted summary judgment on the ground that JP Morgan’s settlements with Zurich/Steadfast and Federal/Executive Risk made it unable to determine whether either Zurich’s or Federal’s policy limits had been exhausted.  JP Morgan appealed.

First, addressing the Twin City policy, the First Department concluded that the plain language of the policy’s attachment provision imposed two conditions precedent: (1) the underlying insurers must have admitted liability; and (2) the underlying insurers must have paid the full amount of their policies’ limits of liability.  The First Department found that the first condition had not been met because Zurich did not admit liability in the settlement between JP Morgan and Zurich/Steadfast.  The First Department also concluded that there was no way to determine if Zurich paid the full amount of its policy limits because the settlement between JP Morgan and Zurich/Steadfast did not allocate the settlement payment between Zurich and Steadfast.

Turning to the attachment provisions in the other Insurers’ policies, the First Department concluded, based on Great American Insurance Co. v. Bally Total Fitness Holding Corp., No. 06 C 4554, 2010 WL 2542191 (N.D. Ill. June 22, 2010) and Citigroup Inc. v. Federal Insurance Co., 649 F.3d 367 (5th Cir. 2011), that those provisions unambiguously required JP Morgan to collect the full limits of the underlying policies before their policies applied, and that that a “settlement for less than the underlying insurer's limits of liability does not exhaust the underlying policy.”  Because it was unclear whether the settlement agreements between JP Morgan and Zurich/Steadfast and Federal/Executive Risk exhausted Zurich’s and Federal’s respective shares of the Bank One Tower, the First Department affirmed summary judgment in favor of the Insurers.

Lastly, the First Department rejected JP Morgan’s reliance on Zeig v. Massachusetts Bonding & Insurance Co., 23 F.2d 665 (2d Cir. 1928), in support of its argument that a settlement with a primary carrier for less than its limits of liability can nevertheless obtain coverage from its excess carriers for amounts greater than the primary carrier’s limits of liability.  In Zeig, the Second Circuit determined that an attachment provision in an excess policy stating that its coverage only applied in excess over insurance “exhausted in the payment of claims to the full amount of expressed limits of such other insurance” was ambiguous because the term “payment” could mean “the satisfaction of a claim by compromise, or in other ways” in addition to “payment in cash.”  Citing to the California Court of Appeal’s decision in Qualcomm, Inc. v. Certain Underwriters at Lloyd's, London, 161 Cal. App. 4th 184 (2008), the First Department wrote:

"we reject the notion that “when an insured settles with its primary insurer for an amount below the primary policy limits but absorbs the resulting gap between the settlement amount and the primary policy limit, primary coverage should be deemed exhausted and excess coverage triggered, obligating the excess insurer to provide coverage under its policy[.]”

The First Department’s decision is consistent with recent case law addressing the issue of whether an excess insurer must pay when the primary settles for less than policy limits in the wake of Qualcomm.  One consequence of the First Department’s decision is that excess carriers with attachment provisions specifying that their coverage does not attach until underlying limits are exhausted now have a stronger argument (at least in jurisdictions that have adopted the Qualcomm court’s reasoning) that they are not required to pay until the underlying insurers pay the full limits of the underlying policies.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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