In HLTH Corp. v. Agricultural Excess & Surplus Insurance Co., No. 07C-09-102-RRC, 2008 Del. Super. LEXIS 280 (Del. Super. Ct. July 31, 2008), the insurance companies that sold HTLH Corp. multiple directors and officers insurance policies tried to limit their obligation to pay defense costs by asking the Delaware Superior Court to apply a pro rata allocation of defense costs. The excess insurers tried to avoid paying at all, asserting that because there were settlements of the lower layers of coverage for less than the full policy limits, the excess insurers did not have to pay at all. The court correctly rejected both arguments.

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The court decided properly that the insurers could not rely on a pro rata allocation of defense costs.

The corporate entity insureds under the directors and officers insurance policies in question went through various corporate transactions, including name changes and acquisitions, and there were multiple towers of coverage at issue in HLTH Corp. See 2008 Del. Super. LEXIS 280, at *5-*9. The underlying actions at issue were indictments against certain former directors and officers, with allegations of improper inflation of the earnings of the corporate insured entities. See generally id. at *10-*12. The plaintiff corporate insured entity HLTH Corp. (HLTH) indemnified the former directors and officers for the defense costs that they incurred in defending the underlying actions. See id. At *9-*10 HTLH “assert[ed] claims for coverage only” under two out of the three triggered towers of coverage; the third tower contained a $10 million deductible, and HTLH did not seek coverage under that tower. Id. at *13. Of those two towers under which HTLH asserted claims for coverage, “[t]he limits of the policies” in one of the two towers “[we]re no longer available as a result of” multiple coverage settlements. Id.

As they have sought to do in other cases involving general liability policies, the insurers asked the court to invent a pro rata allocation scheme that was found nowhere in the policies. See id. at *21-*22; see also, e.g., Rich Scislowski, Allocating Losses under a 1973 CGL, Int’l Risk Mgmt. Inst., Inc., Sept. 2007, http://www.irmi.com/expert/Articles /2007/Scislowski09.aspx (“pro rata allocation is a theory that ‘was invented out of whole cloth by the federal courts as a mere judicial convenience.’”); cf. Consol. Edison Co. of N.Y., Inc. v. Allstate Ins. Co., 774 N.E.2d 687, 695 (N.Y. 2002) (admitting that courts have created various methods to implement the insurers’ pro rata theory). The insurers sought to allocate 77 percent of the defense costs to the towers that were unavailable because of settlement and had a large deductible, suggesting that they had reached the percentages by considering “the alleged dates of their occurrences as set forth in the indictment” and assigning them “to each tower’s coverage period and then dividing by the total.” HLTH Corp., 2008 Del. Super. LEXIS 280, at *31-*32.

The court explained that, although the insurers had conceded that each of the three towers of coverage was obligated to pay defense costs independently, the insurers nonetheless argued that each policy’s promise to pay should be limited because the insured had settled some coverage and had a high deductible for other coverage. See id. at *29-*34. The court rejected the insurers’ requests, looking to Delaware and New Jersey law. See id. at *32-*35. The court explained that the proposed pro rata allocation was not found in “any contract provision or case that would specifically require it.” Id. at *32. The court explained further that had the insurers wished to limit their obligations, they “could have explicitly included an allocation requirement in their contracts that would require the very allocation that they now ask this Court to order, but they did not.” It is a well-accepted concept in insurance coverage law that if an insurer could have included restrictive language in a policy, but did not, it cannot then enforce this restriction in litigation. Id. at *37-*38; see, e.g., Hercules, Inc. v. AIU Ins. Co., 784 A.2d 481, 491 n.28 (Del. 2001) (Refusing to grant insurers’ requests for pro rata limitation of CGL because “the policies could have contained proration provisions, but did not.”) In addition to the strict construction reason for rejecting the insurers’ arguments, the court noted that the insurers’ requests to limit artificially their coverage obligations would be “unfair to” the insureds. HLTH Corp., 2008 Del. Super. LEXIS 280, at *32.

The court decided properly that the lower layers of coverage were exhausted as a matter of law.

The insurers also raised a “supplementary argument” that, because the insureds could not demonstrate “exhaustion of the underlying policies,” due to their decisions to settle lower layers of coverage for less than the full policy limits, the remaining insurers would never be obligated to pay under their policies. Id. at *42-*43. The insurers relied on the following clause to support their argument:

Only in the event of exhaustion of the Underlying Limit by reason of the insurers of the Underlying Insurance, or the insureds in the event of financial impairment or insolvency of an insurer of the Underlying Insurance, paying in legal currency, loss which, except for the amount thereof, would have been covered hereunder, this policy shall continue in force as primary insurance, subject to its terms and conditions and any retention applicable to the Primary Policy, which retention shall be applied to any subsequent loss in the same manner as specified in the Primary Policy. The risk of uncollectability of any Underlying Insurance, whether because of financial impairment of insolvency of art [sic] underlying insurer [sic] other reason, is expressly retained by the Insureds and is not in any way insured or assumed by the Company.

Id. at *43.

The court held that under New Jersey and Delaware law, the excess layer policies are responsible for covered amounts in excess of the lower layer policy limits. See id. at *44. It was irrelevant whether the insured collected the full amount of the lower layers’ coverage limits; as long as the underlying liability reached the upper layers’ attachment point, the upper layers were obligated to respond. See id. at *45. The court explained it rejected the argument that the upper layers would not attach if the insured had settled the lower layers of coverage for less than their policy limits, because “the excess insurance company could not possibly claim to have a stake in whether the insured actually received all of the underlying insurance limits.” Id. In so ruling, the court rejected Qualcomm, Inc. v. Certain Underwriters at Lloyd’s, London, 161 Cal. App. 4th 184; 73 Cal. Rptr. 3d 770 (2008), review denied, 2008 Cal. LEXIS 6969 (Cal. June 11, 2008) and Comerica Inc. v. Zurich American Insurance Co., 498 F. Supp. 2d 1019 (E.D. Mich. 2007), two decisions on which the insurers relied on to support their argument that the lower layer settlements would vitiate the upper layers’ coverage obligations. See id. at *46. The court explained that those decisions are “contrary to the established case law of New Jersey and Delaware.” Id. The court concluded by holding that “to the extent that [the insureds’] defense costs exceed any loss they may have imposed on themselves by accepting settlements with underlying insurers for less than the policy limit, . . . those underlying policies have been exhausted as a matter of law.” Id. at *47.

Conclusion

The HLTH Corp. decision correctly rejected the insurers’ attempt to create a pro rata allocation of defense costs that is not supported by policy language, case law, or fairness, thereby ensuring that the insureds could recover their full defense costs. The decision also correctly rejected the insurers’ attempts to use the insureds’ decisions to settle its lower layer coverages as a sword against the insureds, and ruled that the lower layers of coverage were exhausted as a matter of law.

Scott Godes [formerly] is counsel in Dickstein Shapiro’s Insurance Coverage Practice. Mr. Godes focuses on representing corporate policyholders in insurance coverage disputes. He is an experienced litigator who has an extensive background trying complex insurance coverage disputes, including class actions, in state, federal, bankruptcy, and appellate courts, as well as in commercial arbitrations.

This was posted originally at Lexis’ Insurance Law Center.

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