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March 2014 Washington Court Holds That Unambiguous Exhaustion Language Bars Coverage

Photo---ILIA---Diane-Polscer--crop-dlp-picBy Diane Polscer

Washington’s Court of Appeals recently held that the exhaustion provisions in two excess policies are unambiguous and, therefore, barred coverage because the underlying carrier had not paid its policy limits.  QuellosGrp. LLC v. Fed.Ins. Co., ---P.3d ---, 2013 WL 5989370 (Wash. Ct. App. Nov. 12, 2013) (published).  In Quellos, the insured sought to recover from several insurers $35 million in settlements and $45 million in defense costs paid in connection with a fraudulent tax shelter developed by the insured.  Id. at *4.  One insurer issued a claims-made policy during the relevant policy period with $10 million liability limit.  Id. at *2.  The other two insurers issued first-tier and second-tier excess policies above this limit.  Id.  The underlying insurer agreed to pay the insured $5 million, and the insured agreed to pay the gap between this amount and the primary insurer’s $10 million limit in an effort to trigger the excess policies.  Id. at *5.

One of the excess policies stated that coverage “shall attach only after the insurers of the Underlying Insurance shall have paid in legal currency the full amount of the Underlying Limit.” Id. at *1.  The other excess policy stated that coverage “will attach only after all of the Underlying Insurance has been exhausted by the actual payment of loss by the applicable insurers thereunder.” Id.  Washington’s Court of Appeals found these provisions to be “clear and unambiguous,” requiring the underlying insurer “to pay the full amount of its limits of liability before excess coverage is triggered.”  Id. at **11-12.  Because the underlying insurer only paid approximately one-half of its policy limits, and disputed any further coverage, the Court of Appeals affirmed the summary judgment dismissal of the insured’s claims against the excess carriers.  Id

In so holding, the Court of Appeals rejected several arguments asserted by the insured.  First, the insured argued that exhaustion is a condition, and the insurer must establish either material breach or prejudice to defeat coverage.  Id. at *7.  However, the Court distinguished the exhaustion language from cooperation or no-settlement clauses, which “designate the manner in which claims covered by the policy are to be handled once a claim has been made.”  Id. at *10.  Second, the insured argued that the application of the exhaustion clauses “contravenes public policy in favor of settlements,” but the Court was not persuaded that “public policy should override the unambiguous exhaustion language.”  Id. at *11.

Of note, in finding the exhaustion clauses unambiguous, the Court distinguished cases cited by the insured on the basis that they involved “either an ambiguity in the definition of ‘exhaustion’ or a lack of specificity in the policy language as to how to exhaust primary insurance.”  Id. at *11.  The Court observed that one of these cases involved a policy that “was silent about whether the underlying policy needed to be collected or actually paid out before the excess was triggered.”  Id.  In contrast to this policy, the excess policies in Quellos specified that the underlying insurer must pay its limits.  Id.  Thus, while Quellos supports the application of unambiguous exhaustion language, this decision may not support the application of all exhaustion provisions.