Appeals Court Defines Drop-Down Duty For Umbrella Insurers

The 5th District Appellate Court recently held that, to trigger the duty of an umbrella insurer to “drop down” and defend the insured, the insurer must have actual evidence of the exhaustion of the aggregate limits of the underlying insurance policy.

The umbrella insurer in Sinclair Oil Corp. v. Allianz Underwriters Insurance Co., 2015 IL App (5th) 140069 (April 7, 2015) was represented by DeFranco & Bradley P.C. of Fairview Heights and BatesCarey LLP. Cook, Ysursa, Bartholomew, Brauer & Shelvin Ltd. of Belleville represented the insured, Sinclair Oil.

Sinclair owned and operated an oil pipeline near downstate Hartford blamed for leakages in the early 1980s. The resulting contamination prompted lawsuits for both property damage and bodily injury beginning in 2003 along with federal and state regulatory remediation efforts.

Allianz Underwriters issued a commercial general liability umbrella policy to Sinclair for a one-year period in 1981-82. The policy identified a primary policy issued by Home Insurance as underlying.

The Allianz policy stated that upon the “exhaustion of the aggregate limits of liability applicable” to the Home policy, the Allianz policy would “continue in force as underlying insurance.”

The Home policy, in turn, contained general language stating that the coverage limits for bodily injury were $500,000 per occurrence and $500,000 in the aggregate and for property damage at the same levels. These limits were subject to all the other policy terms.

The Home policy further broke down the bodily injury and property damage coverage. For bodily injury coverage, the policy indicated that the completed operations and products hazards were, together, subject to the aggregate limit. For the property damage coverage, the policy said the aggregate limit would apply “separately” depending on various circumstances, such as whether the work was by an independent contractor.

Prior to the lawsuits regarding the Hartford-area leakages, Sinclair notified Allianz of claims arising from lawsuits in Wyoming.

In those suits Home paid substantially for settlement, including some $500,000 that was allocated for property damage during the Allianz policy period.

Sinclair subsequently notified Allianz of the litigation involving the Hartford leakages. After the litigation was underway, Sinclair took the position that the Allianz policy had been triggered because Home’s policy was exhausted by payments made in the Wyoming litigation.

In 2008, Sinclair initiated the current declaratory litigation against Allianz in Madison County Circuit Court.

Following Allianz’s motion for summary judgment, the trial court found that Allianz had a duty to either provide a defense under reservation or file a declaratory action when it received notice of the litigation; that it failed to do either; and that it therefore breached its duty to defend Sinclair. Allianz took this appeal.

Aggregate Limits

In an opinion by Justice James R. Moore, the 5th District affirmed in part and reversed in part. He initially examined the Allianz policy language requiring that policy to “continue in force as underlying insurance.”

That language, he found, required Allianz to provide a defense for Sinclair upon exhaustion of the Home policy.

Moore then examined the question of policy exhaustion and what exactly would trigger Allianz’s duty to drop down and defend. After reviewing the Home policy, he found that “only certain types of claims are subject to an aggregate limit.”

He thus rejected Sinclair’s position that all the claims against it were subject to the $500,000 primary aggregate limits.

With respect to bodily injury and despite general language otherwise, Moore interpreted the Home policy as applying an aggregate limit only to claims based on the completed operations and products hazards. All other claims, he said, were subject only to an occurrence limit.

In contrast, he found that all property damage claims were subject to an aggregate limit, although separate aggregates might apply to different claims.

Evidence Of Exhaustion

Applying this analysis to Allianz and Sinclair, Moore initially observed that the requirement that an insurer either defend under a reservation or file a declaratory action, at the peril of being estopped from raising policy defenses, until now has been applied only to primary insurers. For umbrella insurers, an additional standard should be considered before imposing the same requirement on them.

The additional standard, according to Moore, is whether the umbrella carrier has “actual notice” that the underlying policy’s aggregate limits are exhausted. Moreover, the umbrella insurer is entitled to more than an insured’s mere allegation of exhaustion.

Moore said the umbrella insurer should receive evidence of actual payments that meet or exceed the applicable aggregate limits. Only upon receipt of such evidence does the duty to defend under reservation or to file the declaratory action arise.

In this case, Moore found that the record was insufficient to establish that Allianz had sufficient evidence of the exhaustion of the Home policy’s aggregate limits for bodily injury claims.

The evidence was, however, sufficient to show that Allianz had sufficient evidence of exhaustion of at least one of the categories of property damage claims to which the aggregate limit applied.

The court therefore concluded that Allianz breached its duty to defend Sinclair with respect to property damage claims and is liable for defense costs from the time Allianz received notice. The trial court’s decision to that extent was affirmed. The court reversed and remanded with respect to Allianz’s duty to defend Sinclair on the bodily injury claims.

Key Point

An umbrella insurer with a potential duty to drop down and defend the insured cannot be said to have breached its duty to defend at least until it sees evidence of actual payments exhausting the relevant limits of the underlying primary policy.