In a case involving multiple ghosts of long lost companies, a judge in federal court in Manhattan has held that excess D&O insurers do not have a duty to “drop down” to fill the gaps in coverage caused by the insolvency of underlying insurers. The court also held, based on the language of the excess policies at issue, that the excess insurers’ coverage obligations were not triggered merely because the insureds’ losses exceeded the amount of the underlying insurance, where the underlying insurance has not been exhausted by actual payment.
This insurance coverage case arises out of the bankruptcy of Commodore International Limited (the manufacturer of the classic Commodore 64 personal computer, pictured above). In connection with the bankruptcy proceedings, numerous lawsuits were filed against the company’s former directors and officers. Most of these actions have been resolved, save only one proceeding remaining in the Bahamas where the claimants seek to recover $100 million. The defendants have so far incurred a total of $14 million in losses as a result of the various actions.
At the time of the bankruptcy, Commodore carried a total of $51 million of D&O insurance arranged in eight layers and involving six insurers. Unfortunately for the company’s former directors and officers, the first and fourth excess layers were provided by Reliance Insurance Company, and the third and sixth level excess insurance was provided by The Home Insurance Company. In 2001, Reliance went into a regulatory liquidation, and in 2003 so did The Home.
The primary layer of 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 layer of insurance. The individuals then turned to the solvent upper level excess insurers, seeking to have them provide coverage for the individuals’ continuing defense fees and other losses. The solvent excess insurer that provided the second and fifth level excess insurance agreed to advance defense fees pursuant to an interim funding agreement and later filed an action (in which the other solvent excess insurers joined) seeking a judicial declaration that there was no coverage under its excess policies as a result of the insolvent underlying insurers’ unpaid gaps. The individual directors and officers sought to establish that there was coverage under the solvent excess insurers’ policies, claiming that the excess insurers’ payment obligations had been triggered because osses exceeded the amount of the underlying insurance.
The policies of the solvent excess insurers all contained a similar provision essentially providing that “the Underlying Policies shall be maintained during the Policy Period ….Failure to comply with the foregoing will not invalidate this policy but the [excess insurance carrier] shall not be liable to a greater extent that if this condition had been complied with.” In addition, the excess policies all have provisions essentially providing that their policies are 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 September 28 Opinion
In his September 28 opinion, Judge Sullivan agreed with the excess insurers that they had no obligation to “drop down” to fill the insolvent insurers’ gaps, and he also concluded that the excess insurers’ obligations under their policies had not been triggered merely because the individuals’ losses exceeded the amount of the underlying insurance.
Judge Sullivan found that the laws of New York and Pennsylvania “clearly provide” that “an excess insurer is not required to fill gaps in coverage created by the insolvency of the underlying insurer.” He went on to note that
The Insurance Contracts themselves make no mention whatsoever of such an obligation. To the contrary, the policies expressly state that, in the event that Defendants fail to maintain underlying insurance, the insurers “shall not be liable to a greater extent than if this condition had been complied with.” This language expressly demonstrates that the coverage provided by the Excess Insurers will not be enlarged to compensate for gaps in underlying coverage.
In rejecting the individuals’ argument that the excess insurers’ payment obligations were triggered because the amount of the individuals’ losses exceeded the amount of underlying insurance, Judge Sullivan found that the “express language” in the excess insurers’ policies requiring exhaustion of the underlying limits by actual payment of loss in order to trigger coverage “establishes a clear condition precedent to the attachment of the Excess Policies,” and therefore it is “clear from 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.”
In reaching this latter conclusoin, Judge Sullivan rejected the applicability of the 1928 Zeig v. Massachusetts Bonding & Insuance Co. casae, and similar cases. Judge Sullivan said these cases "provide not guidance because they involved circumstances where the insured had accepted partial insurance from the underlying carriers while making up the shorfall themselves. In this case and unike in Zeig, the carriers "have a clear bargained for interest in assuring that the underlying policies are exhausted by actual payment."
This case provides a sharp reminder that though insurance carriers fail infrequently, when they do it is a real mess. This reminder highlights the all-too-often overlooked importance of carrier solvency – and not just when coverage is bound but also at the time when a claim must be paid.
The mess created by the carriers’ insolvency, compounded by the excess carriers’ ability to avoid dropping down to fill the gap, leaves these individuals uninsured for their continuing expenses and exposures. Which in turn provides a vivid illustration of the value of a so-called Excess Side A/DIC policy, which by its terms would drop down and provide coverage in the event of the insolvency of an underlying carrier.
Excess Side A/DIC policies were available at the time that Commodore procured its D&O insurance, but they were not nearly as pervasive as they are now. (The policies that were available at that time were somewhat more restrictive than those available today.) 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 notwithstanding the gaps caused by the insurers’ insolvency
Judge Sullivan’s holding that the excess insurers’ payment obligations were not triggered even though the individuals’ losses exceed the amount of the underlying insurance is consistent with other recent decisions in which the 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 and here).
This case may also represent the first occasion on which a court applying New York law expressly declined to follow Zeig. However, the court never conclusively stated whether it was applying New York law; rather, Judge Sullivan said only that the outcome was the same whether New York or Pennsylvania law applied. He also distinguished Zeig rather than overtly declining to follow it.
It is worth noting that in the current D&O insurance marketplace excess insurance policies are available with trigger language that allows the amount of the underlying limits of liability to be paid either by the insurer or the insured, in order for the excess insurer’s payment obligation to be triggered. How this language would have affected the outcome of this case is not entirely clear, because it does not appear from the record whether or not the individuals have actually funded the shortfall themselves. (My impression is they did not.)
It is astonishing to note that ten full years after Reliance failed, problems from its failure continue to arise. It somehow seems appropriate that all of these ghosts from an earlier era have all gathered in this one locale, presided over by the specter of the late lamented Commodore 64. Clearly, the former directors and officers continue to be haunted by their former company’s remarkably unlucky choice of carriers. (This company doubled down on its bad luck, by managing to slot both of the eventually insolvent carriers in two different layers each in Commodore’s insurance program.)
One final note. Commodore’s primary insurance carrier has a name that would have been completely unknown to all concerned at the time Commodore procured its coverage. The primary insurer is a company now known as “Chartis” – a company that in that bygone era was known by a different name altogether.
Yes, there are all kinds of ghosts roaming around on the set of this production.
Special thanks to a loyal reader for providing me with a copy of Judge Sullivan’s opinion.
“As of Now, I am in Control”: There is at least one more ghost to mention here. Among Commodore’s former directors and officers was the late Alexander Haig, Jr. who among other things served as Secretary of State under Ronald Regan. Haig had a distinguished career of public service, but he will be most remembered for his unfortunate statements shortly after Reagan had been shot: “Constitutionally gentlemen, you have the president, the vice president and the secretary of state, in that order, and should the president decide he wants to transfer the helm to the vice president, he will do so. As for now, I’m in control here, in the White House, pending the return of the vice president and in close touch with him. If something came up, I would check with him, of course.”
Unfortunate News for Former Directors and Officers in Failed Bank Litigation: There’s some bad news for former directors and officers of failed banks defending themselves in FDIC litigation. On September 27, 2011, in the case the FDIC filed in the Central District of California against four former officers of IndyMac bank (in what was the first lawsuit the FDIC filed in the current round of bank failures, as discussed here), Judge Dale Fischer granted in part the FDIC’s motion for judgment on the pleadings as to certain of the defendants’ affirmative defenses. A copy of Judge Fischer’s opinion can be found here.
Judge Fischer held that because the FDIC as receiver stands in the shoes of the failed bank, the defendants could not assert defenses based on the FDIC’s pre-receivership actions or omissions. Accordingly, she granted the FDIC’s motion for judgment on the pleadings as to the individual defendants’ defenses of unclean hands, failure to mitigate and ratification. She did deny the FDIC’s motion as to other affirmative defenses, including the business judgment rule.
Special thanks to a loyal reader for sending me a copy of Judge Fischer’s opinion.