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A New York federal bankruptcy court ruled that three excess policies unambiguously required actual payment of underlying policy limits before liability attached.  Rapid-American Corp. v. Travelers Cas. & Sur. Co., 2016 WL 3292355 (Bankr. S.D.N.Y. June 7, 2016).

Rapid-American, the successor to a manufacturer of asbestos-containing products, was sued in thousands of personal injury actions.  Rapid-American settled many claims, but ultimately declared bankruptcy.  Several of Rapid-American’s insurers also became insolvent and were unable to pay the limits of their policies.  Rapid-American filed a declaratory judgment action seeking a ruling as to coverage for certain excess policies.  The excess insurers argued, among other things, that no coverage under their policies was available because Rapid-American had not exhausted underlying insurance.  The court agreed and granted the insurers’ partial summary judgment motion.

The court held that the language in each excess policy required actual payment of the underlying limits.  A policy issued by St. Paul provided that excess coverage does not attach “until the amount of the applicable underlying limit has been paid by or on behalf of the Insured.”  A National Union policy (1977) conditioned payment on exhaustion of underlying limits “by reason of losses paid thereunder.”   Another National Union policy (1984) did not unambiguously require exhaustion, but Rapid-American conceded at oral argument that the policy required exhaustion of underlying limits.  Therefore, the court held that, even assuming that Rapid-American had accrued liabilities that reached excess levels, excess coverage was unavailable because actual payment of underlying limits had not been made.

The court rejected several arguments frequently asserted by policyholders in this context.  First, the court held that Zeig v. Mass. Bonding & Ins. Co., 23 F.2d 665 (2d Cir. 1928), a case commonly cited for the proposition that exhaustion does not require actual payment, was distinguishable because it involved a first-party property policy.  The court further noted that Zeig’s “continuing vitality is open to question” in the wake of recent decisions to the contrary.  See Ali v. Fed. Ins. Co., 719 F.3d 83 (2d Cir. 2013) (discussed in June 2013 Alert); Forest Labs., Inc. v. Arch Ins. Co., 953 N.Y.S.2d 460 (N.Y. Sup. Ct. 2012), aff’d, 984 N.Y.S.2d 361 (N.Y. App. Div. 2014) (discussed in October 2012 Alert).

Second, the court rejected Rapid-American’s argument that a Bankruptcy Clause and corresponding New York statutory law precluded the insurers from relying on the exhaustion requirement.   The court explained that the Bankruptcy Clause precludes insurers from refusing to pay claims on policies of insolvent policyholders but does not excuse compliance with conditions precedent (such as exhaustion) imposed by excess policies.   The court distinguished cases that have excused a policyholder’s payment of a self-insured retention in the case of bankruptcy.  The court explained that in those cases, bankruptcy prevented the policyholder from satisfying the SIR, whereas here the exhaustion requirement could have been satisfied by payment of underlying limits by a party other than Rapid-American.

Finally, the court rejected the contention that a Maintenance Clause precluded the excess insurers from requiring exhaustion or, alternatively, created ambiguity as to the exhaustion requirement.  The court held that the Maintenance Clause, which states that coverage will not “drop down” in the event that the policyholder fails to maintain a lower level policy, was inapplicable because a “settlement with an underlying insurer does not constitute a failure to maintain the underlying policy, and does not excuse the condition precedent imposed by an exhaustion requirement.”