ISSUES INVOLVING THE RELATIONSHIP BETWEEN PRIMARY AND EXCESS INSURERS IN ENVIRONMENTAL COVERAGE LITIGATION<

January, 1997

The analysis, interpretations and opinions expressed are the author's alone and do not necessarily reflect the position of Connell Foley LLP its clients, or any other party.

I. INTRODUCTION

In most environmental insurance coverage declaratory judgment actions, the policyholder/insured joins as defendants all of those insurers who provided coverage during the time period of operations from as far back as the insured's insurance program can reach through at least the Absolute Pollution Exclusion years. Factors which force the policyholder to join all known insurers include the size of the monetary liability facing the insured, a particular jurisdiction's caselaw regarding the joinder of parties and claims as well as caselaw regarding allocation and trigger of coverage. When the insured is facing a huge potential environmental liability and believes that all or most of it should be paid for by insurance policies, it is of the utmost importance to be sure that all available insurance is joined in a declaratory judgment action. Typically, the insured will join not only each primary insurer for each year of operation, but all excess insurers, at least up to a certain monetary/policy limit level. What results is a mosaic of insurer-defendants who issued a number of separate policies with separate limits, terms and conditions covering the same risk, and some at the same time.

On paper, the relationship between the insured, a primary insurer and the excess insurer(s) seems simple. In practice, once it is alleged that multiple policies must respond to a given claim, many complicated issues regarding the relationship of numerous insurance policies arise. This is especially true when multiple layers of coverage exist over many years.

There are a number of issues between the primary and excess insurers which must be acknowledged and understood once primary and excess carriers of the same insured find themselves joined as defendants in the same environmental declaratory judgment lawsuit. The purpose of this paper is to address and discuss a number of the issues which arise between primary and excess insurers who are involved in environmental insurance coverage claims. While insurers should try to work together, when possible, to defeat invalid or frivolous claims for environmental coverage, the practical reality of years of coverage litigation demonstrates that issues between primary and excess insurers have the potential to divide them. This is especially true when millions of dollars are at stake, and rulings of law have the effect of determining which insurers will pay and which may not.

This presentation is not limited to a particular jurisdiction. Rather, it presents a general picture of some of the issues, using examples from many jurisdictions throughout the country. Each jurisdiction has its own common law on these legal issues and the practitioner should be guided by the precedential caselaw in the state or court where a particular case is venued, site is located or contract negotiated. Further, many of the reported cases used to illustrate the issues may not involve underlying environmental claims, although the points of law discussed will be applicable to environmental coverage disputes.

II. INITIAL CONCEPTS

A. Primary Insurance: Primary insurance is insurance purchased by a policyholder to be the first in line for defense and indemnity against covered claims. Primary Insurance has been defined as: "property or liability coverage that provides benefit (usually after a deductible has been paid by an insured) up to the limits of a policy, regardless of other insurance policies in effect." Reuben, Harvey W.; Dictionary of Insurance Terms, 3rd Edition (1995).

B. Excess Insurance: Generally, the term "excess insurance" is given to

coverage which attaches after a pre-determined amount of primary coverage has been exhausted. It is usually purchased:

• to provide additional insurance when primary may not be adequate;
• to provide coverage above an insured's self insurance retention; or
• in some cases, to provide first dollar indemnity and defense when primary insurance does not cover a claim covered by the particular excess policy.

There are several types of insurance policies which fall under the terms "excess insurance".

Umbrella Insurance: Umbrella Insurance is insurance which lies above more than one type of primary policy, or may be a policy which provides coverage for risks not insured by an underlying policy. The name "umbrella" suggests that the coverage is broader than the underlying policy or may actually be above more than one type of primary policy. (For example, an umbrella policy may sit above both an automobile policy and a general liability policy.) Some commentators reject the idea that umbrella insurance should be labeled as "excess" because the typical umbrella policy possesses indicia of both primary and excess coverage. "An umbrella policy may provide broader coverage than the underlying insurance. It thus may provide "primary" coverage (with consequential duties to indemnify and defend) for claims not covered under the underlying policy or policies." Aetna Cas. & Sur. Co. v. Centennial Ins. Co., 838 F.2d 346 (9th Cir. 1988) (applying Calif. law).

Following Form Excess Insurance: These policies are true excess policies which, pursuant to their terms must follow the terms of an underlying policy, including exclusions and conditions. A notable exception is that a Following Form Excess Policy usually does not follow an underlying primary policy's defense obligation.

A Following Form Excess Policy may be at any level of a multi layered insurance program. The policy usually follows form to a single underlying policy, and if the particular policy to which it follows form is not designated in the Following Form Excess Policy, one must take care to determine which underlying policy controls. "Following form policies 'are typically written on the same terms and conditions as the coverage provided by the underlying primary coverage. They are generally short, consisting of one or two pages, with an endorsement or provision that incorporates by reference the underlying policy coverages, except for the premium, the liability limits, and the obligation to investigate, defend, or pay costs of defense'." Coca-Cola Bottling Co. v. Columbia Cas. Ins. Co., 11 CA 4th 1176,1182-83, 14 Cal. Rptr. 2d 643, 647 (1992).

A Following Form Excess Policy may also contain its own additional terms, conditions or exclusions some of which may conflict with or override the policy to which it follows form. Normally, when terms are conflicting, the excess policy controls, unless the opposite result is stated in the excess policy. Home Ins. Co. v. American Home Products, 902 F.2d 1111,1113 (2d Cir. 1990). A Following Form insurer is normally not bound by changes made to the underlying policy after issuance of the excess coverage without its consent.

Stand Alone: These policies, as the name states, "stand alone" in that they are self-contained true excess policies which provide excess coverage pursuant to their own terms, conditions and exclusions. These policies are not controlled by any underlying primary or excess policy unless portions of the stand alone excess contract incorporate conditions from a lower policy. Normally, stand alone policies will be subject only to their own contract terms.

C. Maintenance of Underlying Limits: Excess policies provide coverage above and beyond lower level policies. Normally, an excess policy will require the insured to maintain a certain level of underlying coverage throughout the term of the policy. See Fried v. North River Ins. Co., 710 F.2d 1022,1026 (4th Cir. 1983). An excess policy usually contains a "maintenance clause" setting the amount of underlying coverage which must be maintained. Failure to maintain the underlying level of coverage will either force the insured to "pick up the difference" before the excess coverage applies or actually void the excess policy.

III. NATURE OF THE RELATIONSHIP BETWEEN PRIMARY AND

EXCESS INSURANCE

Both primary and excess insurance represent separate contracts between the policyholder and the insurer. With regard to the relationship between the insurer and the insured, there is no difference between excess and primary insurance. Policy construction and interpretation are, for the most part, the same whether a policyholder is looking at primary or excess coverage. The terms of the contract will control. The laws of contract interpretation beyond the terms themselves, if applicable, will apply whether the contract is primary or excess.

Although they most often do not have a contractual relationship with one another, there are a significant number of issues which arise between a primary and the excess insurer who share the same risk. Most of the legal issues which arise between primary and excess insurers focus on the relationship of many insurance policies to one another and the manner and order in which they must respond to an underlying claim. Currently, there is no place where the stakes are higher than in the thousands of environmental insurance coverage declaratory judgment actions pending throughout the country. Issues concerning the relationship between primary and excess insurers which continually arise in environmental coverage litigation include:

1. Duty Issues

• What duty, if any, does the primary carrier owe to the excess insurer?
• What remedy(ies) are available to the excess insurer have if an existing duty is breached?

2. Defense Costs

• Does an excess insurer ever pay defense costs?
• If so, when, and can they be allocated among a number of different layers of insurance?

3. Trigger of Coverage

• How will the various coverage triggers impact the various layers of primary and excess coverage for a particular claim?

4. Prematurity

• When can high level excess insurers stay out of the game?

5. Trial Issues

• How can primary and excess insurers peacefully co-exist at trial?

6. Settlement and Exhaustion issues

• When does the primary insurer have an obligation to protect the excess insurer in settlement activities?
• What determines when primary coverage is "exhausted" thereby exposing excess insurance?

IV. DUTY

A. Duty of Good Faith

Just as the primary insurer and the insured owe each other the duty of good faith and fair dealing, in some jurisdictions, the primary insurer owes the excess insurer a duty of good faith in its dealings with an insured's claims and lawsuits. In the context of primary and excess insurance, it has been noted that "the bulk of the well-reasoned authority . . . supports the existence of a duty owed by a primary to an excess carrier". Continental Casualty Co. v. Reserve Ins. Co., 307 Minn. 5,10 239 N.W. 2d 862,865 (1976). Only a minority of jurisdictions have permitted a direct action by an excess insurer against a primary insurer and only a few states have held that a primary insurer owes a duty of good faith to an excess insurer. Hartford Accident and Indemn. Co. v. Aetna Casualty and Surety Co., 164 Ariz. 286, 792 P.2d 749 (1990). For example, according to New York law, a primary insurer's duty of good faith runs not only to its insured, but also to an excess insurer. General Star National Insurance Company v. Liberty Mutual Insurance Company, 960 F.2d 377 (3rd Cir. 1992). See also St. Paul Fire & Marine Ins. Co. v. USF&G Co., 375 N.E.2d 733 at 734; Hartford Accident and Indemn. Co. v. Michigan Mutual Ins. Co., 93 A.D.2d 337, 462 N.Y.S. 2d 175 (N.Y. App. Div. 1983), aff'd, 61 N.Y.2d 569, 463 N.E.2d 608 (1984). According to the Supreme Court of Arizona in Hartford Accident and Indemn. Co. v. Aetna Casualty and Surety Co., 792 P.2d at 752: ". . . Many states confronted with the issue have allowed an excess insurer to pursue a claim against a primary insurer for breach of good faith". In addition to New York at least, five other states have recognized primary insurers' direct duty to the excess.

New Jersey: Estate of Penn v. Amalgam General Agency, 148 N.J. Super. 419, 372 A.2d 1124 (App. Div. 1977).

Colorado:U.S. Fire Ins. Co. v. Commercial Union, No. 87-2-1161 (D. Colo. 1990).

West Virginia: Vencill v. Continental Ins. Co., 433 F.Supp 1371 (S.D. W. Va. 1977).

Florida: Colonia Ins. Co. v. Assuranceforeningen Skuld, 588 So. 2d 1009 (Fla. Dist. Ct. App. 1991).

Oklahoma: St. Paul Mercury Indemnity Co. v. Martin, 190 F.2d 455 (10th Cir. 1951).

See also Annotation, Liability Insurance: Excess Carrier's Right of Action Against Primary Carrier For improper or Inadequate Defense of Claim, 49 ALR 4th 304 (1986).

The Seventh Circuit Court of Appeals stated:

Direct duty liability to excess insurers is a controversial subject in insurance law. While nearly all states recognize a duty of good faith and fair dealing between primary insurers and insureds, due to the lack of a contractual relationship between the excess insurer and the primary insurer, courts are reluctant to impose on primary insurers an independent direct duty liability to excess insurers. See, also, Puritan, 775 F.2d at 80; American Centennial Ins. Co. v. Canal Ins. Co., 843 S.W.2d 480, 483 (Tex. 1992); Walbrook Ins. Co. v. Unarco Indust., Nos. 90C5111, 9011519, 1992 U.S. Dist. LEXIS 9447 at *9 (N.D. Ill. June 23, 1992); Great Southwest Fire Ins. Co. v. CNA Ins. Cos., 557 So. 2d 966, 969 (La. 1990); Commercial Union Assur. Cos. v. Safeway Stores, Inc., 26 Cal. 3rd 912, 610 P.2d 1038, 1043, 164 Cal. Rptr. 709 (Cal. 1980); Allstate Ins. Co. v. Reserve Ins. Co., 116 N.H. 806, 373 A.2d 339, 340 (N.H. 1976) ('perceiving no relationship between the two insurers which . . . imposed directly upon [the primary insurer] a duty to exercise due care in regard to [the excess insurer]"); The Duty to Settle, 76 VA. L. REV. at 1205 ("Duty-to-settle liability to excess insurers promotes settlement of tort actions against insureds, but its costs include increasingly 'internecine' litigation among the insurance companies that share potential liability for large risks.").

Excess insurers argue that if it was reasonably foreseeable an excess insurer would suffer harm from a primary insurers bad faith, such foreseeability mandates the finding of a direct duty. Most courts which have looked at that issue have rejected the argument. For example, the Federal District Court in Illinois expressly rejected the idea that the Illinois Supreme Court would adopt a direct duty doctrine in Walbrook Ins. Co. v. Unarco Indust., Inc., 1992 U.S. Dist. LEXIS 9447 (N.D. Ill. June 23, 1992):

Foreseeability of harm will not always result in a direct duty of good faith to third parties. In this case, the excess insurers could have contracted with the insured for protection; for example, they could have required the insured to get the excess insurers' approval before settling with the primary insurer. In the absence of a relationship, contractual or otherwise, between the primary and excess insurers, the court does not believe the Illinois Supreme Court would impose a direct duty upon the primary insurer.

B. Equitable Subrogation

While only a minority of courts have found that the primary insurer owes a direct duty of good faith to the excess insurer, most courts have adopted the theory of equitable subrogation. See, Kaste v. Hartford Accident and Indemnity Co., 170 N.Y.S. 2d 614, 753, 5 A.D.2d 203 (1958). Under the theory of equitable subrogation, an excess insurer's claims against the primary insurer are subject to any defenses the primary insurer could assert against the insured, including for example, a refusal to settle or failure to cooperate. American Centennial Ins. Co. v. Canal Ins. Co., 843 S.W.2d 480, 483 (Tex. 1992); Twin City Fire Ins. Co. v. Country Mut. Ins. Co., 23 F.3rd 1175 (7th Cir. 1994); see also, Insurance Co. of North America v. Carnahan, 446 Pa. 48, 284 A.2d 728 (1971); Great American Ins. Co. v. United States, 575 F.2d 1031 (2d Cir. 1978); Williams v. Globe Indem. Co., 507 F.2d 837 (8th Cir. 1974); 8B Appleman, Insurance Law and Practice 4941.

In theory, equitable subrogation is based on the duty of good faith and fair dealing that a primary insurer owes to its insured. By indemnifying the insured, the excess insurer steps into the shoes of the insured in the existing contractual relationship with the primary insurer, giving the excess insurer the right to maintain an action against the primary for any bad faith conduct in the handling of the insured's case. Equitable subrogation is really a legal fiction, but it permits a party to assume the rights and obligations of another when that party is required to pay another's obligation. In Hartford v. Aetna, 792 P.2d at 754 the Supreme Court of Arizona stated:

An excess insurer should not have to pay a judgment if the primary insurer caused the excess judgment by bad faith failure to settle within primary limits. We hold, therefore, that an excess carrier is subrogated to the rights of the insured, and has a cause of action against the primary insurer for bad faith failure to settle within policy limits. The right is derivative of the contract between the insured and the primary carrier.

In Certain Underwriters at Lloyd's v. General Accident Ins. Co. of America, 699 F.Supp. 732,738 (S.D. Ind. 1988) aff'd 909 F.2d 228 (7th Cir. 1990) the United States Court of Appeals suggested that the excess insurers lack of control warranted equitable subrogation:

Equitable subrogation . . . recognizes the essential disparity in coverage and control between primary and excess carriers. By constraining 'overly optimistic' primary carriers to consider the interests of risk-averse excess carriers in the same fashion as they consider the interest of the insured, subrogation prevents primary carriers from inordinately shifting mutual risks and losses to excess carriers.

In Commercial Union Assurance Coss. v. Safeway Stores, 26 Cal. 3rd 912, 610 P.2d 1038 (1980) the court explained its rationale for permitting excess insurers to subrogate to the rights of their insureds:

Since the insured would have been able to recover from the primary carrier for a judgment in excess of policy limits caused by the carrier's wrongful refusal to settle, the excess carrier, who discharged the insured's liability as a result of this tort, stands in the shoes of the insured and should be permitted to assert all claims against the primary carrier which the insured himself could have asserted.

In Patent Scaffolding Co. v. William Simpson Construction Company, 256 Cal. App. 2d 506, 64 Cal. Rptr., 187 (1967) the court listed the elements of an insurer's cause of action based upon equitable subrogation as:

1. The insured has suffered a loss for which the party to be charged is liable, either because the latter is a wrongdoer whose act or omission caused the loss or because he is legally responsible to the insured for the loss caused by the wrongdoer;

2. The insurer, in whole or in part, has compensated the insured for the same loss for which the party to be charged is liable;

3. The insured has an existing, assignable cause of action against the party to be charged, which action the insured could have asserted for his own benefit had he not been compensated for his loss by the insurer;

4. The insurer has suffered damages caused by the act or omission upon which the liability of the party to be charged depends;

5. Justice requires that the loss should be entirely shifted from the insurer to the party to be charged, whose equitable position is inferior to that of the insurer; and

6. The insurer's damages are in a stated sum, usually the amount it has paid to its insured, assuming a payment was not voluntary and was reasonable.

V. WHEN WILL THE EXCESS INSURER ASSERT CLAIMS AGAINST A

PRIMARY?

A. Settlement Issues:

There are thousands of reported cases reporting on disputes between primary and excess insurers regarding settlement of insured's claims. While a review of all of the issues involved in settlement and the primary/excess relationship is beyond the scope of this presentation, the following is a brief review of some of the major issues.

If an primary insurer's refusal to settle an underlying claim within the limits of the primary coverage exposes the insured to liability beyond the primary limits, the excess insurance may be at risk even though it did not have to be. It goes without saying that all courts require the insurer to consider the insured's interests as well as its own when it evaluates the settlement of a claim especially when the claim has the potential to exceed the primary insurance policy limits. When the insurer's refusal to settle within the policy limits arises to a level of fraud, bad faith or even negligence, the primary insurer may be liable for the entire judgment against the insured regardless of the policy limits. See, Coppage v. Fireman's Fund Ins. Co., 379 F.2d 621 (6th Cir. 1967). While a few courts have utilized a negligence standard to impose liability on a primary insurer for failure to settle, most courts apply a bad faith standard to determine whether refusal to settle was actually improper. While there are various definitions and formulations for determining whether refusal to settle was in bad faith, generally speaking the breach of the duty of good faith is defined as a failure to act reasonably on behalf an insured in order to protect its financial assets. (For a thorough look at bad faith actions in the insurance context in New Jersey see Kenny and Lattal New Jersey Insurance Law, Chapter 5.) Although not exclusive, the court in Commercial Union Ins. Co. v. Liberty Mutual Ins., 426 Mich. 127, 393 N.W. 2d 161 (1986) listed 12 factors indicating bad faith conduct on the part of an insurer:

1) failure to keep the insured fully informed of all developments in the claim or suit that could reasonably affect the interests of the insured,

2) failure to inform the insured of all settlement offers that do not fall within the policy limits,

3) failure to solicit a settlement offer or initiate settlement negotiations when warranted under the circumstances,

4) failure to accept a reasonable compromise offer of settlement when the facts of the case or claim indicate obvious liability and serious injury,

5) rejection of a reasonable offer of settlement within the policy limits,

6) undue delay in accepting a reason-able offer to settle a potentially dangerous case within the policy limits where the verdict potential is high,

7) an attempt by the insurer to coerce or obtain an involuntary contribution from the insured in order to settle within the policy limits,

8) failure to make a proper investiga-tion of the claim prior to refusing an offer of settlement within the policy limits,

9) disregarding the advice or recom-mendations of an adjuster or attorney,

10) serious and recurrent negligence by the insurer,

11) refusal to settle a case within the policy limits following an excessive verdict when the chances of reversal on appeal are slight or doubtful, and

12) failure to make an appeal following a verdict in excess of the policy limits where there are reasonable grounds for such a appeal, especially where trial counsel so recommended.

393 N.W.2d at 165-66.

B. Defense Issues

If a primary insurer wrongly refuses to provide a defense to an insured, the primary insurer may be liable for the costs and fees incurred by the insured in defending itself along with consequential damages resulting from the breach of the duty to defend. Kistler v. New Jersey Manufacturers Ins. Co., 172 N.J. Super. 324, 411 A.2d 1175 (App. Div. 1980). If a primary insurer's wrongful refusal to defend causes an excess insurer to defend, settle, or pay more than it would ordinarily have to, that excess insurer may seek redress from the primary based upon the wrongful refusal to defend. An example of this scenario was demonstrated in Fireman's Fund v. Security Ins. Co. of Hartford, 72 N.J. 63 (1976). In that case, the primary insurer under a $50,000 professional liability policy was aware that if there was an adverse verdict in a malpractice action against its insured, the damages would exceed $400,000. Never-theless, it gave only perfunctory, if any, consideration to the recommendations for settlement by those most familiar with the litigation, i.e. the attorney to whom it had assigned the matter. Fireman's Fund wrote excess coverage above Security's primary policy. Although Security chose to ignore advice to negotiate a settlement within the primary limit, Fireman's Fund, with the cooperation of the insured settled the matter and instituted a suit against Security to recover the $50,000 primary coverage plus interest and punitive damages. The Supreme Court indicated that the obligation of the primary carrier was the same to an excess carrier as it is to its insured because the excess carrier, by virtue of its financial responsibility and potential liability, stands in the stead of the insured with a status no different than that of the insured.

Another example of this scenario is reported in F.B. Washburn Candy Corp. v. Fireman's Fund, 373 Pa. Super. 479, 541 A.2d 771 (1988). In that case, Fireman's Fund, a primary insurer to Washburn, refused to defend a claim. Zurich also wrote a policy for the insured which appeared to be excess to the Fireman's Fund coverage. After Zurich defended Washburn it brought a declaratory judgment action against Fireman's Fund for the costs of defense. The court recognized Zurich's rights, under the doctrine of equitable subrogation, to recoup its defense costs:

It is true that there exists no contractual obligation between Fireman's Fund and Zurich. Nonetheless, we are mindful that, while the interests of a primary insurer are virtually unaffected by the existence of excess coverage, the interests of an excess insurer are very much affected by the actions taken by the primary carrier, especially when the latter wrongfully refuses to defend its insured. . . . Zurich was placed in the posture of defending Washburn only after Fireman's Fund wrongfully refused to render a defense. Thus, Zurich's duty to defend was activated under inappropriate circumstances. Moreover, under the doctrine of equitable subrogation, . . . the duty owed to Zurich was identical to that which was owed to Washburn but was refused.

Note also that liability may be created by an excess insurer if it takes charge of and manages the defense of a liability action in the same manner as a primary insurer and fails to do so properly. See, Venetsanos v. Zucker, Facher & Zucker, 271 N.J. Super. 459, 638 A.2d 1333 (App. Div. 1994).

C. Defense Counsel Issues

There are some reported cases where excess insurers allege that primary-retained defense counsel negligently handled a matter so that excess policy limits were unnecessarily reached. Those courts which have held that a primary insurer may be liable for the professional negligence of a defense attorney hired by it do so on principles of agency. See, Pacific Employers Inc. v. P.B. Hoildale Co., Inc., 789 F. Supp. 1117 (D. Kan. 1992); American Centennial ins. Co. v. Canal Ins. Co., 843 S.W. 2d 480 (Tex. 1992). Other courts refuse to foist vicarious liability on a primary insurer for the alleged negligence of its retained defense counsel. See, Continental Casualty Co. v. Pullman, Comley, et al., 929 F.2d 103 (2d. Cir. 1991); Aetna Casualty and Surety Company v. Protective National Ins. Co. of Omaha, 631 So.2d 305 (Fla. App. 3rd Dist. 1993).

D. Litigation Issues

Some courts have stretched the duty of good faith and fair dealing that a primary owes to an excess to include reporting on the litigation. In United States Fire Ins. Co. v. Nationwide Mutual Ins. Co., 735 F. Supp. 1320 (E.D.N.C. 1990), the court held that a primary insurer owed an obligation of good faith to the insured and to the excess insurer and owed a duty to keep the excess insurer informed on the status of the litigation when asked to do so by the excess carrier. To the contrary, some courts have held that an excess insurers failure to monitor may bar an action or reduce the amount recoverable for a breach of the duty. In Insurance Company of North America v. Home Insurance Co., 644 F. Supp. 359 (E.D. La. 1986), the court reduced the amount that an excess insurer could recover from a primary due to the excess insurers negligent failure to monitor the progress of the case which failure the court determined was part of the reason that the excess insurer was damaged.

VI. DEFENSE COSTS

A. More Than One Primary Insurer

The costs of defending underlying environmental claims can be enormous. Many primary insurers spend amounts exceeding the indemnity limits of their policy simply for defense. Thus, those who are responsible for paying defense costs will welcome the opportunity to share in or recoup portions of defense costs.

Many times an underlying insurance claim may trigger more than one primary policy's duty to defend. This is especially true in continuous trigger jurisdictions where the law holds that every primary policy on the risk during the continuum must respond. When multiple primary policies have a duty to defend, a majority of courts hold that primary insurers may obtain contribution from other primary insurers who have the same duty to defend. See, Continental Casualty Co. v. Zurich Ins. Co., 57 Cal. 2d 27, 366 P.2d 455 (1961), where the court stated:

Under general principles of equitable subrogation, as well as pursuant to the rule of prime importance -- that the policy is to be liberally construed to provide coverage to the insured -- it is our view that all obligated carriers who have refused to defend should be required to share in costs of the insured's defense, whether such costs were originally paid by the insured himself or by fewer than all of the carriers. A contrary result would simply provide a premium or offer a possible windfall for the insurer who refuses to defend, and thus, by leaving the insured to his own resources, enjoys a chance that the costs of defense would be provided by some other insurer at no expense to the company which declines to carry out its contractual commitments.

There are a handful of cases where a right of contribution for defense costs against non-defending primary insurers is not recognized. For example, the Supreme Court of Minnesota in Jostens, Inc. v. Mission Ins. Co., 387 N.W. 2d 161 (Minn. 1986), stated:

... where it can be argued, legitimately and in good faith, that either of two insurers has primary coverage for a claim, both insurers have a duty to defend that claim. If either insurer undertakes the defense, it is responsible for its own defense costs and cannot later seek reimbursement from the other...

We believe this rule will encourage two insurers, when tendered at defense, to resolve promptly the duty to defend issue either by some cooperative arrangement between them, or by a declaratory judgment action, or by some other means.

When the court has allowed contribution for defense costs, there are a number of theories used to allocate those costs. The theories are:

1. Pro-Rata

Some courts hold that defense costs should be allocated on a pro-rata basis according to policy limits. See, CNA v. Seaboard Surety Co., 176 Cal. App. 3rd 598, 222 Cal. Rptr. 276 (1986); Federal Ins. Co. v. Cablevision Systems Development Co., 662 F. Supp. 1537, 1540, aff'd, 836 F.2d 54 (2nd Cir. 1987); National Indem. Co. v. St. Paul Ins. Co., 150 Ariz. 492, 724 P.2d 578 (Ariz. App. 1985), approved in part vacated in part, 724 P.2d 544 (1986).

2. Time On The Risk

Some courts allocate defense costs based upon the amount of time a particular insurer was on the risk over the entire period for the defense obligation. See, Gulf Chemical Metallurgical Corp. v. Associated Metals and Minerals Corp., 1 F.3rd 365 (5th Cir. 1993).

3. Per-Capita Defense Costs

Some courts apportion defense costs among primary insurers equally regardless of the amount of a policy limit or time on the risk. See, eg., Argonaut Ins. Co. v. Medical Liability Mutual Ins., 760 F. Supp. 1078 (S.D.N.Y. 1991); Emmons Industries Inc. v. Liberty Mutual Fire Ins. Co., 41 F. Supp. 1022 (S.D.N.Y. 1979); Federal Ins. Co. v. Cablevision System Development Co., 836 F.2d 54 (2nd Cir. 1987).

B. When May An Excess Insurer Be Forced To Defend?

In the normal scenario, the standard indemnity only excess insurer does not have a duty to defend and therefore no obligation to reimburse the primary insurer for the costs of defense. There is an abundance of caselaw which supports the position that a stand alone excess insurer need no pay defense costs as long as the primary insurer must defend or is defending. Molina v. United States Fire Ins. Co., 574 F.2d 1176, 1178 (4th Cir. 1978); Grant v. North River Ins. Co., 453 F. Supp. 1361 (N.D. Ind. 1978); American Concept Ins. Co. v. Certain Underwriters at Lloyd's, 467 N.W. 2d 480 (S.D. 1991).

There are a number of situations where an excess insurer may be called upon to contribute to or actually fund the entire cost of defense themselves:

1. The most notable exception would be with an umbrella policy that contains the obligation to defend claims which are not covered by a primary policy. See, Continental Casualty Co. v. Pacific Indemnity Co., 134 Cal. App. 3rd 389 (1982). A typical umbrella policy may state the following with regard to the defense obligation:

With respect to any occurrence not covered by underlying insurance, but covered by the terms and conditions of this policy, the company shall: (a) defend any suit against the insured alleging such injury or destruction and seeking damages on a count thereof, even if such suit is groundless, false or fraudulent; but the company may make such investigation, negotiation and settlement of any claim or suit as it deems expedient; ...

If underlying insurance is exhausted by any occurrence, the company shall be obligated to assume charge of the settlement or defense of any claim or proceeding against the insured resulting from the same occurrence, but only where this policy applies immediately in excess of such underlying insurance, without the intervention of excess insurance of another carrier.

In American Fidelity Ins. Co. v. Employers Mutual Casualty Co., 3 Kan. App. 2d 245, 593 P.2d 14 (1979) the court enunciated the following principles:

(1) Where the same risk is covered by both primary and secondary insurance, the primary insurer has the primary duty to defend.

(2) Where the claim made is within the limits of the primary policy, and the primary insurer undertakes the defense, the secondary insurer is not required to defend.

(3) Where the claim is over the limits of the primary policy and only one insurer undertakes the defense, the primary insurer and the excess insurer will each be liable for a pro-rata share of the costs of the defense in proportion to the amount of the claim each is required to pay.

This result does not absolve any carrier from a duty to defend, but places the primary burden on the carrier which has issued primary insurance. It also recognizes the equitable subrogation rights of an insurer which has, by fulfilling its own duties to defend, also fulfilled an obligation owed by another.

4. A small minority of courts have recognized that concept of equitable pro-ration of defense costs between primary and excess insurers when the costs of defending underlying claims are so disproportionate to the primary insurance indemnity limits. This is especially true in toxic tort and other latent injury cases. The courts in these cases sometime ignore the fact that an excess policy contains no duty to defend and focuses on the equitable nature of the huge costs of defense in relation to relatively low indemnity limits.

Some courts have required the excess insurer to contribute towards the defense of the insured from the beginning as long as the claim appears to involve more than the primary limits. Other courts have required the excess insurer to contribute to defense costs only after it becomes apparent that the underlying claims will exceed the primary indemnity limits. See, Aetna Casualty and Surety Co. v. Certain Underwriters at Lloyd's, 56 Cal. App. 3rd 791, 192 Cal. Rptr. 47 (1976); Pacific Indemnity Co. v. Fireman's Fund Ins. Co., 175 Cal. App. 3rd 1191, 223 Cal. Rptr. 312 (1985); Columbia Casualty Co. v. USF&G, 870 P.2d 1200 (1994); St. Paul Mercury Ins. Co. v. Huitt, 336 F.2d 37 (6th Cir. 1964).

In Travelers Ins. Co. v. Transport Indemnity Co., 6 Cal. 3rd 514, 99 Cal. Rptr. 627, 492 P.2d 683 (1972) the court held that when two policies affording coverage each have clauses purporting to make their coverage excess, each insurer will be proportionally liable based upon coverage limits for defense costs. In Columbia Casualty Co. v. USF&G, 870 P.2d 1200 (1994) the court held that an apportionment of defense costs between primary and excess based upon liability payments was appropriate. It provided the following rationale:

From the start of this litigation, it was apparent that the primary insurance would be inadequate. This being so, one would expect the insurers to work together to minimize the amount of the settlement and the amount of fees and costs incurred before settlement. Such did not occur. In part that may be because there were economic disincentives to join action. By insisting on the primary insurer undertaking all fees and costs until liability limits were exhausted, Columbia Casualty could minimize its payments for fees and costs. Conversely, USF&G sought to impose all fees and costs on Columbia Casualty by tendering its limits to the excess insurer and asking it to assume the defense. The legal rule to be applied in these circumstances ought to encourage joint action rather than contribute to the hope that one insurer might prosper at the extent of the other. See generally, Hartford Accident and Indemnity Co. v. Aetna Casualty and Surety Co., 164 Ariz. 286, 792 P.2d 749 (1990). Liability for fees and costs based upon proportionate liability payments best serves this purpose. Both primary and excess insurers will know how fees and costs will be paid and will not believe the majority of such costs can be laid off on the other insurer by tactical maneuvering.

VII. TRIGGER AND ALLOCATION ISSUES IN ENVIRONMENTAL COVERAGE CASES

A. Trigger

The stakes are high in the typical large environmental declaratory judgment action. In fact, in all types of progressive injury, property damage or bodily injury cases including asbestos, DES, breast implant, other toxic torts and environmental cases, insureds and insurers face many problems in determining when and how to allocate defense and indemnity payments. When an underlying environmental case involves tens or hundreds of claims stretching over various periods, sometimes decades or more, multiple primary and excess policy periods can be impacted. Because typical general liability policies provide coverage for bodily injury or property damage caused by a "continuous and repeated exposure to conditions which results" in that type of damage, there may be a long period of exposure to the condition followed by some time before the actual damage manifests itself.

It is therefore extremely important for the primary and excess insurers to understand the various theories as to what constitutes an "occurrence", as well as what is necessary for "property damage" or "bodily injury" to take place.

One of four trigger-of-coverage theories is usually applied to cumulative injury or latent damage claims throughout the country. They are:

• The injury-in-fact approach
• The manifestation approach
• The exposure approach
• The continuous trigger approach

1. Injury-in-fact.

The injury-in-fact theory for coverage points to the time when the insured property suffers actual damage. See, Savoy Medical Supply Co. v. F & H Mfg. Corp., 776 F. Supp. 703 (E.D.N.Y. 1991). In practice, the injury-in-fact trigger has been adopted in bodily injury cases many more times than property damage cases. See, eg., Hartford Accident and Indemnity Co. v. Aetna Life and Casualty Ins. Co., 98 N.J. 18 (1984); Diamond Shamrock Chem. Co. v. Aetna Casualty and Surety Co., 258 N.J. Super. 167 (1992); Sandoz Inc. v. Employers Liability Assurance Corp., 554 F. Supp. 257 (D.N.J. 1983).

2. The Manifestation Approach

As the name implies, the triggering event is the time when the property damage becomes manifest or is discovered. The manifestation approach was initially adopted by the 4th Circuit in Mraz v. Canadian Universal Ins. Co., 804 F.2d 1325 (4th Cir. 1986). In that hazardous waste burial case, the court held that the occurrence is judged by the time at which the leakage and damage are first discovered. 804 F.2d at 1328. See also, Pines of LaJolla Homeowners Association v. Industrial Indemnity, 5 Cal. App. 4th 714, 7 Cal. Rptr. 2d 53 (1992); In re Amatex Corp., 107 B.R. 856 (E.D. Pa. 1989).

3. The Exposure Approach

Under the exposure approach, the policies which were on the risk when the injurious exposure to conditions took place are triggered. See, Continental Ins. Co. v. Northeastern Pharmaceutical and Chemical Co., 811 F.2d 1180 (8th Cir. 1987), aff'd on rehearing, 842 F.2d 977 (8th Cir. 1988); Mapco Alaska Pipeline Inc. v. Central National Ins. Co. of Omaha, 784 F. Supp. 1454 (D. Alaska 1991).

4. The Continuous Trigger

The continuous trigger theory is based on the assumption that every policy under risk from the time of the initial expose to the manifestation of damage may be required to respond to a loss. Keene Corp. v. INA, 667 F.2d 1034, 1041 (D.C. Cir. 1981), cert. denied, 455 U.S. 1007 (1982). Under the continuous trigger, where an injury process is not a definite discrete event, the date of occurrence is the entire period from exposure to manifestation.

One of the more notorious continuous trigger cases is Owens-Illinois v. United Ins. Co., 138 N.J. 437, 650 A.2d 974 (1994) where the Supreme Court of New Jersey began to shape that state's caselaw regarding allocation of insurance policies triggered under a continuous trigger. The court held that those insurance policies triggered are not jointly and severally liable, but rather coverage is allocated among them based upon both years on the risk and policy limits. Further, the Court held that during periods where the insured has chosen to be self-insured, the insured shares in the coverage allocation.

While Owens-Illinois dealt exclusively with insurance coverage for asbestos bodily injury and property damage claims, the opinion is widely thought to be the frame work for the resolution of environmental insurance-coverage issues, at least in New Jersey. Under Owens-Illinois, the Court suggested that coverage will exist under all policies from first discharge of waste through "discovery or remediation" of the property damage. By rejecting joint and several liability, the Court allocates among triggered policies based upon years on the risk and policy limits.

Owens-Illinois raises as many questions as it answers. The Court does not address what it means by "manifestation". This issue is certainly an important one in determining how far in years the allocation reaches. The Court does not directly address the question of whether all primary coverage must be exhausted before any excess coverage is reached. That issue was subsequently decided in the unreported Law Division case of Schering Corp. v. Evanston Ins. Co., No. L-97311-88 (N.J. Super., Law Div., 1/24/95) in which the court held that excess coverage would not be triggered until all primary coverage is exhausted. Owens-Illinois also does not provide any detail on the requirement that the insured share in the allocation during periods of self-insurance. The Opinion does not direct how the allocation will work when insured's are unable to find insurance policies or when insurers are bankrupt.

B. Allocation

One of the most controversial questions which follows the trigger of coverage is when a claim triggers multiple years of coverage, how will the coverage available under the policies be allocated. Must all primary policies be exhausted before any excess policy is triggered? (This is sometimes referred to as horizontal exhaustion.) Can an excess policy be triggered upon exhaustion of the immediately underlying primary policy or lower level access policy? (This is referred to as vertical exhaustion.) Case law is slowly developing on this subject. A number of courts have determined that exhaustion by layers, i.e., horizontal exhaustion, is the proper result. See, Continental Casualty Co. v. Armstrong World Industries Inc., 776 F. Supp. 1296, 1301 (N.D. Ill. 1991); Schering Corp. v. Evanston Ins. Co., No. L-97311-88 (N.J. Super., Law Div. 1/24/95); U.S. Gypsum Co. v. Admiral Ins. Co., 268 Ill. App. 3rd 598, 643 N.E. 2d 1226 (1st Dist. 1994), app. denied, 161 Ill. 2d 542, 649 N.E. 2d 426 (1995)("A plain reading of the `other insurance' provision contained in the policies requires Gypsum to exhaust all triggered primary insurance before pursuing coverage under those excess policies. Adopting Gypsum's position permitting `vertical exhaustion' would allow Gypsum to effectively manipulate the source of its recovery, avoiding difficulties encountered as the result of its purchase of fronting insurance and the liquidation of some of its insurers. This would permit Gypsum to pursue coverage from certain excess insurers at the exclusion of others. Such a practice would blur the distinction between primary and excess insurance.")

VIII. EXHAUSTION OF LIMITS

Another area with the potential to divide insurers in environmental coverage litigation is that of policy limit exhaustion. As stated earlier, an excess insurer has no duty to pay unless and until the underlying limits are exhausted. A high level excess insurer need not pay until the underlying primary umbrella and lower level excess policies are first exhausted. There are a number of reported decisions involving excess insurers who have sued primary or lower level carriers based upon improper exhaustion of policy limits.

In Argonaut Ins. Co. v. Hartford Accident and Indemnity Co., 687 F. Supp. 911 (S.D.N.Y. 1988) an excess insurer alleged that the primary had fraudulently misrepresented that its policy limits were exhausted. The court, applying New York law, required the primary insurer to disclose the terms of a settlement agreement to its excess insurer based upon the primary insurer's duty of good faith in dealing with its excess carrier.

Excess insurers have also claimed that primary insurers improperly assign losses to specific policy years in an effort to trigger excess coverage. See, Kaiser Foundation Hospital v. Northstar Reinsurance Corp., 90 Cal. App. 3rd 786, 153 Cal. Rptr. 678 (1979); First State Underwriters Agency of New England Reinsurance Corp. v. Travelers Ins. Co., 803 F.2d 1308 (3rd Cir. 1986); Home Ins. Co. v. Travelers Ins. Co., 156 Misc. 2d 479, 593 N.Y.S. 2d 932 (1993).

IX. HIGHER LEVEL EXCESS INSURERS

Depending upon the terms of a higher level excess insurance policy and the nature and extent of the claims at issue, a higher level excess carrier may decide to rely upon the primary and lower level insurers to take the active role in the litigation and trial of an environmental declaratory judgment action. When an excess policy follows form to a lower level policy and/or when the excess carrier and the lower level insurers are aligned in most of their coverage and exhaustion interpretation issues, the higher level insurer may not see the economic sense in spending the tens, if not, hundreds of thousands of dollars it would take to take an active part in the day-to-day litigation of a large environmental declaratory judgment action. In practice, the high level excess insurers, who face little or no exposure in a case, do tend to rely on the lower lever insurers to do most of the work and simply "monitor" the developments as they occur. Excess insurers sometimes seek dismissal from declaratory judgment cases where it does not appear that the claims at issue will reach their level of coverage. Most courts are reluctant to grant that relief until the proofs of the nature and extent of the underlying claims are well developed. See, Witco Corp. v. Travelers Indemnity Co., 1994 U.S. Dist. Lexis 20781 (D.N.J. April 7, 1994); Shell Oil Co. v. Aetna Casualty and Surety Co., 158 F.R.D. 395, 400-01 (N.D. Ill. 1994).

X. PRIMARY AND EXCESS INSURERS LIVING TOGETHER

Beyond the terms of the policies and the guiding caselaw, there are other mechanisms for guidance on how primary and excess insurers can and should get along. The Guiding Principles for Primary and Excess Insurers first enunciated in 1974 are enumerated suggestions to govern the conduct of primary and excess insurers involved in the same claims. While not binding on anyone, including the signatories, a number of courts have referred to them in reported decisions. In American Centennial Ins. Co. v. Warner-Lambert Company, 293 N.J. Super. 567, 681 A.2d 1241 (Law Div. 1995), the court referred to the Guiding Principles and actually suggested that they could be used to establish the standard of care which a primary insurer must use when settling a claim where an excess insurer may also ultimately be responsible for coverage. 293 N.J. Super. at 577. See also, Pasker v. Harleysville Mutual Ins. Co., 192 N.J. Super. 133,139-40, 469 A.2d 41 (App. Div. 1983) (holding the court should consider the insurance industry promulgated Guiding Principles when fashioning a remedy for a situation described in the Principles).

The Guiding Principles are:

1. The primary insurer must discharge its duty of investigating promptly and diligently even those cases in which it is apparent that its policy limit may be consumed.

2. Liability must be assessed on the basis of all relevant facts which a diligent investigation can develop and in the light of applicable legal principles. The assessment of liability must be reviewed periodically throughout the life of a claim.

3. Evaluation must be realistic and without regard to the policy limit.

4. When from evaluation of all aspects of a claim, settlement is indicated, the primary insurer must proceed promptly to attempt a settlement, up to its policy limit if necessary, negotiating seriously and with an open mind.

5. If at any time, it should reasonably appear that the insured may be exposed beyond the primary limit, the primary insurer shall give prompt written notice to the excess insurer, when known, stating the results of investigation and negotiation, and giving any other information deemed relevant to a determination of the exposure, and inviting the excess insurer to participate in an common effort to dispose of the claim.

6. Where the assessment of damages, considered alone, would reasonably support payment of a demand within the primary policy limit but the primary insurer is unwilling to pay the demand because of its opinion that liability either does not exist or is questionable and the primary insurer recognizes the possibility of a verdict in excess of its policy limit, it shall give notice of its position to the excess insurer when known. It shall make available its file to the excess insurer for examination, if requested.

7. The primary insurer shall never seek a contribution to a settlement within its policy limit from the excess insurer. It may, however, accept contribution to a settlement within its policy limit from the excess insurer when such contribution is voluntarily offered.

8. In the event of a judgment in excess of the primary policy limit the primary insurer shall consult the excess insurer as to further procedure. If the primary insurer undertakes an appeal with the concurrence of the excess insurer, the expense shall be shared by the primary and the excess insurer in such manner as they may agree upon. In the absence of such an agreement, they shall share the expense in the same proportions that their respective shares of the outstanding judgment bear to the total amount of the judgment. If the primary insurer should elect not to appeal, taking appropriate steps to pay or to guarantee payment of its policy limit, it shall not be liable for the expense of the appeal or interest on the judgment from the time it gives notice to the excess insurer of its election not to appeal and tender its policy limit. The excess insurer may then prosecute an appeal at its own expense being liable also for interest accruing on the entire judgment subsequent to the primary insurer's notice of its election not to appeal. If the excess insurer does not agree to an appeal it shall not be liable to share the cost of any appeal prosecuted by the primary insurer.

9. The excess insurer shall refrain from coercive or collusive conduct designed to force a settlement. It shall never make formal demand upon a primary insurer that the latter settle a claim within its policy limit. In any subsequent proceedings between excess insurer and primary insurer the failure of the excess insurer to make formal demand that the claim be settled shall not be considered as having any bearing on the excess insurer's claim against the primary insurer.

It is urgently further recommended by the Council that an attempt be made to reconcile any difference between a primary and an excess insurer by arbitration and the Council outlines rules under which such arbitration should be arranged and carried out.

Excess Liability, 17.16.

Several other courts have sought guidance from or referred to the Guiding Principles including U.S. Fire Ins. Co. v. Nationwide Mutual Ins. Co., 735 F.Supp. 1320,1325 (E.D. N.C. 1990); Monarch Cortland v. Columbia Casualty Co., 626 N.Y.S. 2d 426,430 (165 Mic. 2d 98 (S. Ct. 1995).

In addition to the cases cited, the following sources, among others, were consulted and are suggested as places a practitioner can go for more detailed information about the primary-excess relationship.

1. Magarick & Brownlee, Casualty Insurance Claims (4th Ed. 1995).

2. Kenney & Lattal, New Jersey Insurance Law (1993).

3. Ostrager & Newman, Handbook on Insurance Coverage Disputes (8th Ed. 1995).

4. Lathrop, Insurance Coverage for Environmental Claims (1995).

5. Stempel, Interpretation of Insurance Contracts, Law and Strategy for Insurers and Policyholders (1994).

6. Baldwin & Midkiff, Primary and Excess Relationships: Examining the Evolving Duties (DRI Materials 1995).

7. Baldwin, McPherson & Midkiff, Apportioning Indemnity and Defense Cost: The "Other Insurance" Clause and Other Theories of Allocation(Mealey's Materials 1995).

8. Ballard, Allocation Issues and Intra-Insurer Disputes (Mealey's Materials 1996).

9. Practicing Law Institute, Environmental Insurance Coverage Claims and Litigation, Some Recent Decisions That Impact Relationships Between Primary and Excess Insurers in Environmental and Toxic Tort Claims (1992). 10. California Practice Guide, Insurance Litigation, Chapter 8. Multiple Insurers on Risk (1995).

11. Johnson, Who is Excess? The Nightmare Continues, For The Defense Magazine (February 1996).