BatesCarey LLP successfully defended an insurer when an Illinois appellate court ruled in favor of the insurer in interpreting exhaustion provisions in excess D&O policies.  The court held that an underlying insurer’s “pledge” of its remaining policy limit did not constitute proper exhaustion, where the excess policies required exhaustion “solely as a result of actual payment in legal currency.” Ritchie v. Arch Specialty Ins. Co., 2017 IL App (1st) 160413-U. 

In the underlying matter, an investor made two separate investments in a hedge fund operated by the policyholder. The policyholder’s fund collapsed in October 2006, causing the investor to suffer losses.  The investor then sued the policyholder, seeking, among other things, rescission and a return of its investments. The court entered judgment in favor of the investor and against the policyholder in the amount of approximately $9.2 million.  The policyholder appealed the judgment. 

The policyholder had a $20 million tower of D&O insurance, consisting of a $5 million primary policy and three $5 million excess policies.  After the primary carrier paid its $5 million limit in defense costs, the first excess carrier began paying defense costs.  The first excess carrier agreed to advance the policyholder’s defense costs as to the appeal from the judgment and to file its policy with the court in lieu of an appeal bond to stay execution of the judgment.  However, the remaining limit of the first excess policy did not cover the full amount of the security necessary to stay the $9.2 million judgment. 

Next in line in the tower was the second excess carrier whose policy contained an exhaustion providing that its policy applied only after exhaustion of the underlying limit “solely as a result of actual payment in legal currency.”  The third excess carrier’s policy contained a similar exhaustion provision.  Nevertheless, the policyholder asked the second and third excess carriers (collectively, the “Excess Carriers”) to fund the collateral for the appeal bond in the underlying lawsuit.  The Excess Carriers declined to do so because:  (1) the policy limit of the underlying excess insurer had not been exhausted; (2) the definition of “Defense Expenses” in the primary policy provided that the insurers had “no obligation to procure or furnish any bond” for the appeal; and (3) a monetary award for rescission was uninsurable under Illinois law. 

The policyholder sued the Excess Carriers and moved for judgment on the pleadings, seeking a declaration that the Excess Carriers were obligated under their policies to provide collateral to secure the appeal bond.  The trial court granted the policyholder’s motion even though $2.4 million remained on the first excess policy.  While the trial court conceded that a “strict reading” of the Excess Carriers’ policies “would require [the first excess carrier] to completely pay out its $5 million policy limit in legal currency before the [second excess carriers’ policy] would become effective,” the court found that the first excess carrier’s “pledge” of its policy as collateral for the appeal bond was good enough to satisfy the exhaustion provision in the second excess policy, requiring the Excess Carriers to pay the premium and post collateral for an appeal bond.  The trial court also found that the exhaustion provisions contradicted the primary policy’s definition of “Defense Expenses,” which included “reasonable legal fees and expenses incurred by or on behalf of any Insured in the defense or appeal of any Claim, including costs of appeal, attachment or similar bonds, provided that the Underwriter shall have no obligation to procure or furnish any bond.”  According to the trial court, this “contradiction” rendered the Excess Carriers’ exhaustion provisions ambiguous.  

The Excess Carriers appealed the trial court’s rulings, asserting that their policies had yet to be triggered because the first excess policy had not been exhausted.  The Excess Carriers contended, among other things:  (1) that the first excess carrier’s “pledge” of the $2.4 million remaining on its policy as collateral for the appeal bond did not constitute “actual payment, in legal currency,” as required to trigger the excess policies; (2) that the primary policy’s definition of “Defense Expenses” did not include coverage for appeal bond collateral; and (3) that the judgment in the underlying case was uninsurable (the trial court declined to consider this third argument because it related to the issue of indemnification rather than payment of defense expenses). 

The appellate court reversed the trial court’s decision, siding with the Excess Carriers.  First, the appellate court found that the exhaustion language at issue was not ambiguous.  The second excess policy stated that exhaustion of the underlying policy occurred “solely as a result of actual payment in legal currency.”  The third excess policy similarly required exhaustion “solely as the result of actual payment of losses thereunder by the applicable insurers.”  The appellate court held that “the plain, ordinary, and popular meaning of these provisions unambiguously requires actual payment of losses in order to exhaust the underlying policies and trigger excess coverage.”  In so holding, the appellate court stated that the trial court “identified an ambiguity where none existed.”  According to the appellate court, the trial court “prematurely interpreted the primary and excess policies as a whole and found an ambiguity between the ‘Defense Expenses’ provision in the primary policy and the exhaustion provisions in the excess policies before determining the threshold issue of whether the exhaustion provisions triggered coverage.”  The appellate court found that the first excess carrier agreed to advance defense costs as to the appeal in the underlying case and file its insurance policy as collateral.  However, the first excess carrier did not exhaust its policy limit by “actual payment in legal currency,” and, thus, the underlying limit below the second excess policy had not been exhausted.  Accordingly, “the excess policies had not been triggered, precluding coverage for the cost of collateral or security for an appeal bond.”  Notably, the appellate court rejected the policyholder’s argument that “notice” to an excess insurer that a primary insurer “agreed to pay” its limits for an ongoing suit constituted primary policy exhaustion sufficient to trigger excess insurer defense cost obligations. 

At bottom, the appellate court found that “the excess insurance policies clearly defined exhaustion.” According to the court, the Excess Carriers and the policyholder “entered into a clear, bargained-for exhaustion provision that the underlying policies must be exhausted by actual payment.”  The court opined that, “[i]f the [policyholder] desired coverage for an anticipated event requiring future payment, i.e., to cover the costs of an appeal bond, [it] could have included language in their tower of insurance coverage to that effect.”  Instead, as the court noted, the second excess policy specifically stated, "[t]he risk of any gaps in coverage or uncollectibility for any reason is expressly retained by the Insured, and is not assumed or insured by the Excess Insurer.”  The appellate court enforced the unambiguous terms of the Excess Carriers’ exhaustion provisions as written, precluding coverage for the costs of the appeal bond in the underlying appeal until actual payment in legal currency of the full amount of the underlying limit of the first excess policy.  As this issue was dispositive, the appellate court did not address the remaining issues raised by the Excess Carriers.   

Robert J. Bates, Jr., Ommid C. Farashahi, and Mike T. Skoklund represented the client in the matter.