Excess Policies Required Actual Payment of Underlying Limits Before Coverage Was Triggered, N.Y. Bankruptcy Court Rules

A federal bankruptcy court in New York, overseeing the case of a debtor facing approximately 275,000 asbestos-related personal injury claims, has ruled that the debtor’s underlying insurance policies must be exhausted by actual payment before its excess insurance policies are triggered. The bankruptcy court’s decision, in In re Rapid-American Corp., Case No. 13-10687 (SMB), Adv. Proc. No. 15-01095 (SMB) (Bankr. S.D.N.Y. June 7, 2016), reaffirms the general insurance law principle requiring actual exhaustion of underlying coverage limits before excess policies can be reached – even when the insured seeks bankruptcy protection.

Background

When Rapid-American Corporation, the successor to the liabilities of The Philip Carey Manufacturing Company, which manufactured and distributed products containing asbestos, entered Chapter 11 on March 8, 2013, after years of litigating asbestos-related personal injury actions, there were approximately 275,000 asbestos-related personal injury claims still pending against it.

At the time of its bankruptcy filing, Rapid had reached agreements with nearly all of its primary and excess liability insurance carriers.  In addition, certain of the insurers that issued policies to Rapid had become insolvent and unable to pay the full limits of their policies.  However, neither Rapid nor any other entity had actually paid – through settlement, judgment, or otherwise – an amount sufficient to reach the level of excess coverage provided under the excess policies in issue.

Nevertheless, Rapid, the Official Committee of Unsecured Creditors, and the Future Claimants’ Representative (collectively, the “Plaintiffs”) filed an adversary proceeding in the bankruptcy court alleging that Rapid had spent, made, or committed to make at least $701,782,193.49 in indemnity payments and defense costs relating to asbestos claims. The Plaintiffs also asserted that, in addition to the tens of thousands of asbestos claims against Rapid that remained pending, numerous others likely would be filed in the future.

The Plaintiffs argued that four excess insurance policies (collectively, the “Insurance Policies”) sold by St. Paul Fire and Marine Insurance Company and Travelers Casualty and Surety Company, f/k/a The Aetna Casualty and Surety Company (collectively, “Travelers”) and National Union Fire Insurance Company of Pittsburgh, Pa. (“National Union” and, collectively with Travelers, the “Insurers”) provided total limits of $64 million.  However, the Insurers denied that they were liable under the Insurance Policies.

The Plaintiffs sought a declaratory judgment that coverage under the Insurance Policies had attached or would attach upon the lifting of the automatic stay that took effect under Bankruptcy Code Section 362 immediately upon Rapid’s bankruptcy filing.

The Plaintiffs made three basic arguments. First, they argued that Zeig v. Mass. Bonding & Ins. Co., 23 F.2d 665 (2d Cir. 1928), mandated that the exhaustion language in the Insurance Policies not be read literally but, rather, that the exhaustion language was satisfied where the insured settled with and released the underlying insurers, even if those insurers did not pay the full policy limits in cash.

Second, the Plaintiffs contended that the Insurers could not rely on the Insurance Policies’ exhaustion language because the bankruptcy filing rendered Rapid unable to fill any gap by paying up to the underlying limits, a condition to the Insurers’ coverage liability.

Third, they asserted that the “maintenance clauses” in three of the policies precluded the Insurers from requiring exhaustion of the underlying insurance. (A “maintenance clause” is designed to protect an excess insurer by establishing that its coverage will not “drop down” in the event that the insured failed to maintain a lower level policy or the lower level policy was invalidated.)

Travelers and National Union argued that Zeig did not govern the interpretation of the exhaustion requirement in light of the Second Circuit’s more recent decision in Ali v. Fed. Ins. Co., 719 F.3d 83 (2d Cir. 2013), and in light of the New York appellate court’s decision in Forest Labs., Inc. v. Arch Ins. Co., 116 A.D.3d 628 (N.Y. 1st Dep’t 2014).

The Insurers also contended that the Plaintiffs could not ignore the policies’ unambiguous exhaustion requirement.

They also asserted that they were not relying on Rapid’s bankruptcy filing or insolvency to deny coverage but that the policies expressly required exhaustion of Rapid’s underlying insurance and that Rapid’s bankruptcy filing did not negate those provisions.

Finally, the Insurers argued that the “maintenance clauses” were intended to require the insured to maintain underlying insurance and to prevent insurers from having to “drop down” to cover gaps in coverage and that these clauses had to be enforced.

The insurers moved for summary judgment with respect to three of the excess policies on the question of exhaustion. (Travelers agreed that one of the excess policies did not require exhaustion.)

The Bankruptcy Court’s Decision

The bankruptcy court ruled in favor of the Insurers on the exhaustion question based on the “unambiguous exhaustion language” in the excess policies. The bankruptcy court was not persuaded by any of the arguments put forth by the Plaintiffs.

First, the bankruptcy court decided that the “continuing vitality” of Zeig was open to question following the Second Circuit’s decision in Ali. It observed that, in Ali, the circuit court had explained that excess insurance coverage did not attach until the underlying insurance had been exhausted, and that “the very nature of excess insurance coverage” was such that “a predetermined amount of underlying primary coverage must be paid before the excess coverage is activated.” The bankruptcy court also noted that the Second Circuit in Ali had rejected the argument that coverage was triggered when the “obligations” reached the attachment point, explaining that the policies required “payment,” and that “obligations” and “payment” were not the same thing.

In addition, the bankruptcy court agreed that the appellate court’s ruling in Forest Labs., where the state court decided that underlying coverage had to be exhausted through actual payment of the policy’s limit before an excess carrier could be required to pay, supported the Insurers’ argument that Rapid had to exhaust the underlying insurance through payment before coverage attached under the excess policies.

The bankruptcy court then found that the maintenance clauses in the policies did not conflict with the exhaustion clause or create an ambiguity given that settlements with Rapid’s underlying insurers did not constitute a “failure to maintain” the underlying policies. The maintenance clauses did not excuse the condition precedent imposed by an exhaustion requirement, according to the bankruptcy court.

Next, the bankruptcy court ruled that the policies’ bankruptcy clauses – providing that the insured’s insolvency did not release the insurers from the payment of damages for injury sustained or loss occasioned during the life of and within the coverage of the policies – also did not eliminate the exhaustion requirement.

It explained that the bankruptcy clause provided an injured claimant a cause of action against an insurer for the same relief that would be due to a solvent principal seeking indemnity and reimbursement after the judgment had been satisfied, and that the cause of action was “no less” but also “no greater” than it was before the debtor’s bankruptcy filing. The bankruptcy court acknowledged that some courts have relieved a bankruptcy debtor of the duty to pay the amount of a self-insured retention (“SIR”) before an insurer’s liability attached. It distinguished those decisions, however, by explaining that bankruptcy filing prevented the insureds from satisfying their prepetition SIR obligations while the exhaustion language in the Insurance Policies only required that the amounts be paid by or on behalf of Rapid. Thus, it pointed out, the Insurance Policies permitted some party other than Rapid to satisfy the exhaustion requirements and trigger coverage.

Finally, the bankruptcy court decided that Bankruptcy Code Section 365, which details the rights and obligations relating to treatment of a debtor’s executory contracts and unexpired leases in bankruptcy, could not be used to invalidate or modify provisions of the Insurance Policies because the policies were not executory contracts.

Conclusion

The bankruptcy court’s decision reaffirms the general principle under New York insurance law that requires exhaustion of underlying limits by actual payment before excess insurance policies can be triggered – as well as the rule that the bankruptcy of the insured does not alter that result. Policyholders and their creditors may assert a variety of arguments in an attempt to persuade a bankruptcy court to reach a different conclusion but, as the Rapid-American ruling makes clear, such a result is not permitted under well-established insurance and bankruptcy law doctrines.

Reprinted with permission from FC&S Legal.  All rights reserved.