Actual Controversy Without Actual Exhaustion: California Supreme Court Allows Declaratory Relief and Bad Faith Claims Against Excess Insurers

California courts were previously split on the issue of whether an insured may bring declaratory relief claims against excess insurers prior to the exhaustion of underlying insurance. Some California courts held that the actual exhaustion of underlying insurance was necessary, whereas other courts allowed for these types of claims to proceed.[1]

Recently, the California Supreme Court addressed this split of authority and, in doing so, handed down a significant win for policyholders. In Fox Paine & Company, LLC, et al. v. Twin City Fire Insurance Company et al., the Court held that insureds may proceed with bringing forth viable declaratory relief and bad faith claims against excess insurers prior to the exhaustion of underlying insurance.[2] A summary of the Court’s opinion is provided below.

I. Background

The dispute concerned a $50 million insurance tower that consisted of a primary policy and four excess policies. Following extensive underlying litigation, the primary policy was exhausted, and contributions were made by the first and second layer excess insurers. After additional amounts were submitted for reimbursement under the excess policies and denied, the insureds initiated coverage litigation against the excess insurers alleging, inter alia, causes of action for declaratory judgement and bad faith.

On demurrer, the trial court concluded that only the first layer excess insurer could remain in the case because only the primary policy’s limit had been exhausted. The Court of Appeal affirmed, and the California Supreme Court reversed and remanded.

II. Claims for Declaratory Relief Must be Supported by Allegations of Covered Loss Reaching, or Reasonably Likely to Reach, Excess Coverage

The Court rejected a bright-line exhaustion requirement, explaining that an “actual controversy” under Code of Civil Procedure, section 1060 may exist even where attachment of an excess policy depends on future contingencies. The Court noted, however, that it is the insured who bears the burden of “pleading a covered loss sufficient to create an actual controversy regarding each excess policy in light of its attachment point.” To meet this burden, the Court discussed two instances: (1) where the amount of the covered loss is reasonably known; and (2) where the amount of the covered loss is unknown.

A. The Amount of the Covered Loss is Reasonably Known

Where the amount of the covered loss is reasonably known, the Court explained that the insured “may be reasonably expected to plead this amount and what the covered losses consist of” which, in turn, can then “be compared with the attachment point of the excess policy for which a judicial declaration is sought.” Absent there being other grounds, the Court noted that “when the amount of allegedly covered losses is sufficient to reach that [excess] policy, it is certain enough for pleading purposes that the contingency of meeting the excess policy’s attachment point will come to pass.”

B. The Amount of the Covered Loss is Unknown

Where the amount of the allegedly covered loss is unknown, the Court adopted the “reasonable likelihood” analysis, which has no precise formula and is case-specific. Yet, under this approach, the Court explained that a lower court may use a “worst case or highest estimate of damages” to ascertain whether an “actual controversy” exists, look to allegations pertaining to other claimants whose claims may exhaust the underlying insurance, as well as “other facts and circumstances that may affect whether an insured’s losses or liabilities will reach an excess policy . . ..” Additionally, the Court cautioned against placing undue weight on potential coverage defenses that would prevent the exhaustion of underlying insurance if proven successful in future proceedings.

With the above in mind, the Court remanded the case, instructing the Court of Appeal to reevaluate whether the insured’s allegations were sufficient to create an actual controversy concerning the higher-layer excess policies. That is, whether the insured had alleged covered loss reaching the higher-layer excess policies’ attachment points, or whether additional considerations justified application of the “reasonable likelihood” analysis.

III. Bad Faith Claims May Also Proceed Against Excess Insurers Prior to the Exhaustion of Underlying Insurance

The Court similarly rejected the position that a bad faith claim cannot be maintained against an excess insurer until the underlying insurance has been exhausted. At the pleading state, the Court explained an insured need “only to allege facts that, taken as true, are sufficient to show that coverage under a defendant insurer’s excess policy will attach – or that it would attach, if not for the excess insurer’s bad-faith conduct – and that the insurer’s misconduct has impaired the insured’s recovery of benefits owed to it under the policy.”

IV. Conclusion

In summary, the Court’s opinion expands policyholders’ ability to pursue claims against excess insurers prior to the actual exhaustion of underlying insurance. However, the opinion does not eliminate the minimal pleading requirements and sets forth several guiding principles for the same.

If you have questions regarding excess insurance claims, then the attorneys at Saxe Doernberger & Vita, P.C. are available to assist.

*This case alert was researched and contributed to by Summer Associate Henry Austin.