News & Events

Major Victory on Infill and Dropdown Issues from Second Circuit

June 5, 2013
In representing its client, Travelers Company, the firm has achieved a significant victory from the United States Court of Appeals for the Second Circuit. The ruling in Ali v. Federal Insurance Co., (link to ruling) will likely be of substantial precedential value to excess insurers who are faced with underlying insolvent or non-performing coverage layers. Of particular note the court held that “the relevant excess insurance policies requires the ‘payment of losses’—not merely the accrual of liability—in order to reach the relevant attachment points and trigger the excess coverage.” The Court adopted our argument that the mere aggregation of alleged liability cannot trigger an excess liability insurance policy, only actual payment of loss.

In so ruling the Court distinguished its own 1928 ruling in Zeig v. Massachusetts Bonding & Insurance Co., 23 F.2d 665 (2d Cir. 1928) – the first time since Judge Hand wrote Zeig that the Second Circuit has confronted the issue. The Court appears to have limited the holding in Zeig to cases involving insurance for property loss, not third-party liability. In addition to distinguishing Zeig, the Court called into question Zeig’s continued precedential value, saying: “Though not necessary 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. Tompkins, 304 U.S. 64 (1938), overruling Swift v. Tyson, 41 U.S. 1 (1842).”

After the financial collapse of Commodore International Limited (Commodore was the maker of the classic Commodore 64 personal computer), its directors and officers were met with numerous litigations, most of which were successfully defended or settled, with the exception of one action which sought damages well in excess of the total limits of the insurance program. However, four of the coverage layers, below the Travelers’ attachment point, were issued by either Reliance Insurance Company or The Home Insurance of Indiana, both of which are insolvent and in all likelihood will never be exhausted. The directors and officers argued that Travelers’ coverage should fill-in for the insolvent layers or, at the very least, should be available to respond to any settlement demand at its attachment point, regardless of whether the “gap” was ever filled by the directors and officer through actual payment.

The Second Circuit affirmed the September 28, 2011 ruling of Judge Richard J. Sullivan of the United States District Court for the Southern District of New York, issued sub nom a ruling Federal Insurance Company v. The Estate of Irving Gould, et al. and granted our motion for judgment on the pleadings. Judge Sullivan agreed that Travelers, as an excess A/B insurer, has no obligation to drop down in place of unavailable underlying insurance for the former executives. Judge Cabranes, writing for the unanimous Second Circuit panel, reviewed Judge Sullivan’s well-reasoned decision de novo.

He summarized the case as follows: “Each excess liability insurance policy at issue includes an exhaustion clause, which states that the excess insurance coverage attaches only after a certain amount of underlying insurance coverage is exhausted ‘as a result of payment of losses thereunder.’ Based on this language, the insured appellants argue that their liability must reach the attachment point in order to trigger the excess coverage. By contrast, the insurer appellees argue that the excess liability coverage is only triggered when liability payments reach the attachment point.” (Emphasis in original)

The court’s 15-page decision under New York and Pennsylvania law discusses the meaning of the relevant provisions and concludes that Zeig is not controlling. The Second Circuit also adopts Judge Sullivan’s holding in the District Court that excess D&O insurers “have a clear, bargained-for interest in ensuring that the underlying policies are exhausted by actual payment.” And notes that if the Commodore Directors “were able to trigger the Excess Policies simply by virtue of their aggregated [but unpaid] losses, they might be tempted to structure inflated settlements with their adversaries in the Bahamas Litigation that would have the same effect as requiring the Excess Insurers to drop down and assume coverage in place of the insolvent carriers.”

To review the decision, visit this page.

For more information about this decision and its impact on your business, please contact:
James Skarzynski
James Sandnes
Tammy Yuen