Kajima: Illinois Supreme Court Holds Horizontal Exhaustion Prevails Over Targeted Tender

Providing uniformity to the myriad Illinois appellate decisions addressing allocation in Illinois, the Illinois Supreme Court holds that all primary policies must be exhausted prior to reaching excess policies in Kajima Const. Services, Inc. v. St. Paul Fire & Marine Ins. Co., 2007 WL 4200949 (Ill. Nov. 20, 2007).

The appellate decision and facts of Kajima, 368 Ill.App.3d 665, were previously discussed in an earlier CM Report, and they will be briefly summarized here.  The case is premised on CGL policies issued to a general contractor and its subcontractor for a construction project.  Pursuant to contract, the subcontractor was required to maintain insurance coverage for the general contractor as an additional insured.  The subcontractor provided the general contractor with $2 million in general liability coverage and $5 million in umbrella coverage.  The general contractor also maintained its own primary coverage with limits of $1 million per occurrence.

After an employee was injured on the site, both the general contractor and the subcontractor were sued for injuries sustained.  The general contractor made a "targeted tender" to the subcontractor’s carrier for its defense and indemnity of the bodily injury lawsuit.  Under the targeted-tender rule, an insured covered by multiple concurrent policies has the right to choose which insurer will defend and indemnify it for a particular loss.  However, here the subcontractor's insurer did not accept the tender.  Subsequently, the general contractor requested that its own insurer handle the matter.  Eventually the subcontractor’s carrier accepted the tender under a reservation of rights.  The general contractor's insurer requested that the subcontractor's insurer settle the lawsuit for $3 million from its primary and umbrella insurance policies.  The subcontractor's insurer refused to do so.  Instead, the subcontractor's insurer paid its $2 million in primary coverage and the general contractor's insurer contributed its $1 million in primary coverage.  The general contractor's insurer filed a declaratory judgment action in Cook County, Illinois requesting reimbursement of its $1 million of primary coverage that it contributed toward the settlement.

The Supreme Court affirmed the decision of the Illinois Appellate Court, First District, which had affirmed the trial court’s entry of summary judgment in favor of the subcontractor's insurer, finding that under Illinois law, the subcontractor was not required to pay its $1 million in umbrella coverage before the general contractor paid its $1 million in primary coverage.  

In reaching its decision, the Supreme Court analyzed both Illinois' "targeted tender" rule and Illinois' adoption of horizontal allocation.  While confirming that Kajima has the right to tender its defense and indemnification to one of several insurers that potentially cover the same risk under the targeted-tender rule, the Court concluded that tender does not supersede Illinois law requiring that all primary policies be exhausted before reaching a true excess policy, i.e. "horizontal exhaustion."

In finding that the subcontractor's umbrella policy at issue was a "true" excess policy which is not triggered until the underlying policy has been exhausted, the Court reaffirmed the distinction between primary and excess insurance.  Based upon the distinction between excess and primary coverage, the Supreme Court declined to extend the targeted tender doctrine to require one insurer to vertically exhaust its primary and excess coverage limits before all primary insurance available to the insured has been exhausted.  The Court stated that "extending the targeted tender rule to require an excess policy to pay before a primary policy would eviscerate the distinction between primary and excess insurance."

This is the first Illinois Supreme Court decision specifically addressing and embracing horizontal exhaustion.  Notably, the Court said the horizontal exhaustion doctrine is not limited to cases involving a continuous tort or long-term environmental and hazardous waste claims.  The Court instead applied the doctrine to an ordinary personal injury claim arising from a single accident, declaring that where multiple primary and excess policies potentially afford coverage for a given claim, horizontal exhaustion trumps the targeted tender rule -- requiring the insured to exhaust all primary policies before looking to any excess policies for coverage.