Fox Paine & Co., LLC. v. Twin City Fire Insurance Co.

(Failure to Allege Exhaustion Of Underlying Policy Limits Merited Dismissal of Lawsuit Against Excess Insurers, Including Claim of Declaratory Relief)

(October 2024) - In Fox Paine & Company, LLC, et al. v. Twin City Fire Ins. Co., et al. 104 Cal.App.5th 1034 (September 5, 2024), the California First District Court of Appeal affirmed the trial court's order sustaining the demurrers of defendants St. Paul Mercury Insurance Company ("St. Paul") and Liberty Mutual Insurance Company ("Liberty Mutual") and dismissing without leave to amend a Third Amended Complaint ("TAC") filed by Fox Paine & Company ("FPC") against Liberty Mutual and St. Paul for declaratory relief, breach of contract and bad faith arising out Liberty Mutual's and St. Paul's refusal to pay or reimburse defense costs incurred in connection with the defense of an underlying counter-claim filed by business entities consisting of the Paine's Family Trust, Fox Paine Management III, LLC (FPM III) and FPC (the "Paine Parties") against FPC, Saul Fox, individually, and derivatively on behalf of FPC and two Fox related entities (the "Fox parties").

The Paine Parties and Fox parties had been engaged in an underlying business dispute involving the filing of, and settlement of, several underlying lawsuits spanning five years. The first underlying lawsuit was filed in August 2007. St. Paul and Liberty Mutual refused to pay any costs or expenses because the first layer excess policy (Twin City Fire Insurance Company) had not exhausted its limits. Because the TAC failed to allege exhaustion of such limits, the TAC did not allege claims for breach of contract and declaratory relief against St. Paul and Liberty Mutual.

In December 2006, FPC obtained a Private Equity Professional Liability Policy from Houston Casualty Company for the period of December 30, 2006 to December 30, 2007, later extended to January 2, 2008. The policy covered Insured Organizations and their directors and officers on claims-made basis. FPC also purchased excess coverage from Twin City Fire Insurance Company ("Twin City"), St. Paul and Liberty Mutual. The coverage provided $40 million in four layers excess of the Houston Casualty Company primary policy limits of $10 million. The tower of insurance looked like the following:

While the Houston policy ultimately exhausted its limits in connection with the underlying litigation between the Paine Parties and Fox parties, the Twin City policy had not paid its limits in connection with the underlying litigation. Hence, St. Paul and Liberty Mutual refused to pay any of the amounts demanded by FPC in connection with the defense of the underlying litigation. As a result, FPC filed its lawsuit against St. Paul and Liberty Mutual.

In affirming the trial court's order dismissing FPC's lawsuit, the Court of Appeal stated as follows in connection with FPC's breach of contract cause of action:

No Breach of Contract

Plaintiffs' first cause of action is breach of contract. As plaintiffs describe it in their brief, the excess insurers "breached their obligations to Plaintiffs by, among other things: (i) failing to provide consent to defense costs arising from covered claims; (ii) failing to pay or reimburse Plaintiffs' defense costs for covered claims; (iii) refusing to communicate with Plaintiffs, their insureds ... ; (iv) failing to properly investigate tendered claims; (v) communicating improperly with FPC's litigation opponents, and non-insureds, regarding coverage and proceeds ... ; (vi) failing to disclose communications to third parties regarding the Excess Policies; and (vii) improperly disbursing policy proceeds from the FPC Policies to uninsured parties who were litigating against the Plaintiffs ... . (E.g., 6AA1113–1114 [TAC ¶ 86–90]; see generally Ins. Code, § 790.03, subdivision (h).)"

We begin by noting that, except for the claim, however imprecisely expressed, that the excess insurers failed to pay covered claims, the other "failures" alleged by plaintiffs cannot be breaches of contract, as the alleged wrongs are not within the coverage of the policies. In other words, neither policy requires that the insurer do—or not do—any of the things alleged, and thus cannot support a breach of contract. (Archdale v. American Internat. Specialty Lines Ins. Co. (2007) 154 Cal.App.4th 449, 466 [64 Cal. Rptr. 3d 632] breach of contract cause of action "necessarily relates only to the express promises made by [an insurer] in its policy"]; see also Levy v. State Farm Mutual Automobile Ins. Co. (2007) 150 Cal.App.4th 1, 6 [58 Cal.Rptr.3d 54] [demurrer properly sustained where plaintiff offered mere allegation of breach without facts demonstrating "a link" between the alleged violations "and the insurance contract[]"].)

And as to the allegation as to what might be a breach of contract, i.e., the failure to pay covered claims, it fails as well, as the policies are excess policies, described this way by the late Justice Croskey in his leading commentary:

"'Excess' insurance: Excess insurance 'refers to indemnity coverage that attaches upon the exhaustion of underlying insurance coverage for a claim.' (Montrose Chemical Corp. of Calif. v. Superior Court (Canadian Universal Ins. Co., Inc.) (Montrose III) (2020) 9 Cal.5th 215, 222 [260 Cal. Rptr. 3d 822, 460 P.3d 1201] (internal quotes omitted); Powerine Oil Co., Inc. v. Superior Court (Central Nat'l Ins. Co. of Omaha) (Powerine II) (2005) 37 Cal.4th 377 [33 Cal. Rptr. 3d 562, 118 P.3d 589] (citing text).)

"In other words, excess insurance 'provides coverage after other identified insurance is no longer on the risk.' (North American Capacity Ins. Co. v. Claremont Liability Ins. Co. (2009) 177 Cal.App.4th 272, 291 [99 Cal. Rptr. 3d 225].)

"An excess insurer's coverage obligation begins once a certain level of loss or liability is reached; that level is generally referred to as the 'attachment point' of the excess policy. [Citations.]" (Croskey et al., Cal. Practice Guide: Insurance Litigation (The Rutter Group 2023) ¶ 8:177.)

In Reserve Insurance Co. v. Pisciotta (1982) 30 Cal.3d 800 [180 Cal. Rptr. 628, 640 P.2d 764]—there addressing the issue of insolvency of an underlying insurer—our Supreme Court held that we must look to the excess policy's express language to determine whether an excess insurer is obligated on its policy. (Id. at p. 814.) We do that, and easily conclude that plaintiffs show no such "obligation." The policies have not, in Justice Croskey's words, "attached."

The St. Paul policy provides that St. Paul "shall only be liable ... after the total amount of all Underlying Limits of Liability has been paid in legal currency by the Issuers of all Underlying Insurance as covered loss thereunder."

The Liberty Mutual policy "only provides coverage when the underlying limit of liability is exhausted by reason of the insurers of the underlying policies paying or being held liable to pay in legal currency the full amount of the underlying limit of liability as loss." And "underlying limit of liability" is defined as "the combined limits of liability of the underlying policies, less any reduction or exhaustion of limits of liability due to payment of loss under those policies." And "underlying policies" are defined as the Houston Casualty policy in the first-, second-, and third-layer excess policies issued by Twin City and St. Paul.

. . .

The St. Paul policy is triggered only if the "total amount of" underlying limits "has been paid." And Liberty Mutual's policy "only provides coverage" when the underlying limit of liability "is exhausted" by the underlying insurers "paying or being held liable to pay." Such language demonstrates that the St. Paul and Liberty Mutual policies did not "attach"—and no obligations arose. (See Qualcomm, Inc. v. Certain Underwriters at Lloyd's, London (2008) 161 Cal.App.4th 184, 196 [73 Cal. Rptr. 3d 770] (Qualcomm) [insurer's obligations did not arise "until [the underlying insurer] actually paid the full ... amount of its underlying limit"]; Wells Fargo Bank v. California Ins. Guarantee Assn. (1995) 38 Cal.App.4th 936, 945 [45 Cal. Rptr. 2d 537]; Span, Inc. v. Associated Internat. Ins. Co. (1991) 227 Cal.App.3d 463, 476 [277 Cal. Rptr. 828].) As the Ninth Circuit put it in applying California law, "ntil the legal obligations of the primary insurers ha[ve] been determined and the excess policies had been triggered," an insured "[can]not ... sue[] the excess insurers for breach of contract." (Iolab Corp. v. Seaboard Surety Co. (9th Cir. 1994) 15 F.3d 1500, 1504 (Iolab).)

As respects FPC's cause of action for declaratory relief, the Court of Appeal rejected such cause of action because it was derivative of plaintiff's breach of contract cause of action (which was dismissed based on the failure to allege exhaustion) and the fact that the outcome of the lawsuit filed by FPC against first-layer excess insurer Twin City is unknown. Absent exhaustion of the Twin City policy, there could be no controversy between FPC, St. Paul and Liberty Mutual meriting a claim for declaratory relief.

In addition, the Court of Appeal rejected FPC's argument that St. Paul had waived its right to contest the issue of exhaustion based on its settlement with the Paine Parties in a companion lawsuit for $3 million. The Court of Appeal reasoned as follows:

Plaintiffs' argument is hard to comprehend. St. Paul is, as noted, an excess insurer whose duties under its policy do not arise until exhaustion of the underlying coverage. The TAC acknowledges that in 2012 the Paine parties were in litigation demanding payment from St. Paul under the policy because they were the insureds who had suffered covered "Loss." And St. Paul's decision to settle with the Paine parties was in the context of resolving that litigation. That is, while St. Paul denied coverage to the Paine parties, it simply decided in favor of resolution with the Paine parties over contentious litigation. The settlement does not imply that St. Paul would not "insist on exhaustion" as to plaintiffs, and certainly does not demonstrate that St. Paul "inten[ded] to give up such right" as to plaintiffs. (Utility Audit Co., Inc. v. City of Los Angeles (2003) 112 Cal.App.4th 950, 959 [5 Cal. Rptr. 3d 520].) In sum and in short, there is no support—not in the TAC, not in the record as a whole—for the claim that St. Paul's settlement constituted a known relinquishment of the right to insist on exhaustion of the remainder of the Twin City policy limits.

In addition to all that, plaintiffs' theory is foreclosed by the public policy favoring settlements. (See, e.g., Western Steamship Lines, Inc. v. San Pedro Peninsula Hospital (1994) 8 Cal.4th 100, 110 [32 Cal. Rptr. 2d 263, 876 P.2d 1062].) As our Supreme Court earlier put it, "'[A] man is allowed to negotiate for the purchase of his peace without prejudice to his rights.'" (Potter v. Pacific Coast Lumber Co. (1951) 37 Cal.2d 592, 600 [234 P.2d 16].) So, too, an excess insurer.

The Court of Appeal also found that FPC could not maintain a cause of action for bad faith against St. Paul and Liberty Mutual absent a breach of contract.

Lastly, the Court of Appeal rejected FPC's claim of aiding and abetting against St. Paul and Liberty Mutual based on the absence of any allegation that the insurers had intentionally aided FPC's broker in breaching alleged fiduciary duties owed to FPC.

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