A case involving an excess insurer’s obligation to drop down wouldn’t seem to be the stuff of one of the year’s ten most significant. In general, drop down provisions in excess or umbrella policies are often-times unique and the decisions dictated by such language. So no matter how seemingly important a drop down decision, that it was tied to possibly unique policy language would likely diminish its ability to influence cases to come. It is for this reason that drop down decisions rarely even make it into a regular issue of Coverage Opinions -- let alone the annual insurance coverage Best Of.

But the Sixth Circuit’s decision in IMG Worldwide, Inc. v. Westchester Fire Insurance Company is an exception. Its holding is significant, it involves a recurring claim scenario and the drop down language at issue, far from being unique, is what’s contained in ISO’s standard Commercial Liability Umbrella form (CU 00 01 12 07). This combination landed the decision here. Given that IMG Worldwide involves policy language contained in a standard ISO coverage form, it is also an ISO-take-note decision. [Curiously, a Law360 article about the decision stated that, “according to attorneys,” the opinion dealt with unusual policy language. I can’t see how that can be when the relevant language appears in ISO’s CU 00 01 12 07.]

IMG Worldwide has a lot going on. There is more to the case than just the drop down issue. But to keep things as simple as possible I will endeavor to focus solely on the drop down aspect.

The case had its start with a real estate deal that went bad. A suit was filed in Florida state court against IMG and real estate developers seeking over $300 million in damages stemming from the failure of a real estate development project in Orlando. The plaintiffs were 270 persons who had invested in the project and alleged that the developer had sold them undeveloped properties with the promise that they would be upgraded and developed into high-end condominiums. IMG’s involvement with the project was as a consultant and not a developer.

IMG sought coverage for the suit from its primary insurer, Great Divide Insurance Company, and its excess insurer, Westchester Fire Insurance Company. The primary policy provided a $1 million occurrence limit and the excess policy contained a $25 million limit above that. IMG sought coverage from Great Divide and Westchester. Both insurers denied a defense. IMG ultimately settled the suit for nearly $5 million (Galstaldi settlement) and incurred over $8 million in defense costs.

IMG and Great Divide reached a settlement of their dispute. Great Divide paid $1 million, exhausting its occurrence limit, and $250,000 toward defense costs. Westchester refused to settle and suit was filed by IMG. The case proceeded to a jury trial. “[T]he jury returned a special verdict form, finding: (1) IMG had proven by a preponderance of the evidence that Westchester breached its contract with IMG by not paying on the Policy; (2) IMG proved by a preponderance of the evidence that there was an ‘occurrence;’ (3) there was ‘property damage;’ and, (4) Westchester had not proven by the requisite burden of proof that the ‘expected or intended injury’ exclusion applied.”

“Accordingly, the jury returned a verdict in favor of IMG, finding that Westchester was liable for breaching its duty to indemnify IMG, and awarding damages to IMG in the amount of $3,900,000 for the Galstaldi settlement. The court retained the question of whether Westchester is also liable for reimbursement of IMG’s defense costs over and above the $250,000 contributed by Great Divide in its settlement with IMG.” The trial court ultimately concluded that Westchester was not liable for IMG’s defense costs.

The case went to the Sixth Circuit. Putting aside some detail that is not directly relevant to the drop down issue, the federal appeals court affirmed the jury’s decision that IMG’s liability in the underlying Florida suit satisfied the “occurrence” and “property damage” aspects of the Westchester policy.

Next the court turned to IMG’s appeal of the duty to defend -- where the lower court held that Westchester did not have an obligation. The appeals court first noted that it was not being guided by labels. The parties were apparently making arguments using such terms as “true” excess insurer or “coincidental” excess insurer or whether Westchester was obligated to provide “drop down” coverage. The court, however, called these issues “red herrings” and stated that “[t]o determine whether Westchester had a duty to defend IMG in the Galstaldi suit, we look to the language of the Policy.”

The Westchester “policy provides that Westchester has a ‘duty to defend the insured against any ‘suit’ seeking damages for ... ‘property damage’ when the ‘underlying insurance’ [Great Divide] does not provide coverage ....’” [The court set out the full text of this policy language, which reveals that it is the same as that which is contained in the insuring agreement of ISO’s standard Commercial Liability Umbrella form (CU 00 01 12 07).]

The IMG court described the issue this way: “Westchester’s obligations under this provision turn on what it means to ‘provide coverage’—and, more specifically, whether an underlying insurance that provides for coverage, but nevertheless improperly denies coverage, ‘provides coverage,’ under the terms of the Policy.” The court concluded that “[t]he term ‘provides’ could reasonably mean either ‘provide for’ or ‘undertakes to deliver.’ Under the latter reading, Westchester would have become responsible for defending IMG in the Galstaldi suit when Great Divide wrongfully denied coverage. Since the language in this Policy is susceptible to more than one meaning, it is ambiguous.” The court held that “[b]ecause the Galstaldi suit was a ‘suit’ seeking damages for ‘property damage,’ and Great Divide did not undertake to deliver coverage, we find that Westchester had a duty to defend IMG after Great Divide wrongfully denied coverage.”

The court also found support for its decision in a Westchester policy condition: “A second, separate provision of the Policy also independently supports the finding that Westchester owed a duty to cover IMG’s defense costs when Great Divide wrongly denied coverage: ‘If no other insurer defends, [Westchester] will undertake to do so, but [Westchester] will be entitled to the insured’s rights against all those other insurers.’ At the time IMG requested that Westchester defend it in the Galstaldi suit, after Great Divide had refused to do so, ‘no other insurer’ had defended IMG. At that time, Westchester had a duty to defend IMG, since, as discussed above, the Galstaldi suit was a ‘suit’ for ‘property damage.’” [Here too this policy language appears in ISO Umbrella form CU 00 01 12 07.]

The court held that Westchester was obligated to pay IMG just about $8 million for its defense costs plus pre-judgment interest.

The court also examined whether its decision should be impacted by the fact that Westchester did not have a subrogation right against Great Divide – on account of the settlement between IMG and Great Divide. The answer was no: “We also disagree with the district court’s finding that Westchester’s promise to undertake defense ‘is dependent on the fulfillment of [the] condition [ ] ... that Westchester maintains subrogation rights against the primary insurer.’ Other than the fact that this provision as a whole happens to be included in a section of the contract under the umbrella heading, ‘Conditions,’ nothing in this provision makes Westchester’s duty to defend contingent on a right of subrogation against the primary insurer. Indeed, the only conditional language in the provision is ‘if no other insurer steps in to defend,’ and it is undisputed that that happened in this case: Great Divide denied coverage, i.e., did not defend. Under a plain reading of this clause, obtaining or preserving subrogation rights was not a condition precedent to Westchester’s duty. Accordingly, under the terms of the Policy, Westchester was obligated to defend IMG when Great Divide improperly refused to do so. Westchester breached the Policy when it refused to provide a defense to IMG after no other insurer did so, despite IMG's specific demand.”

[The court did note that Westchester could still seek reimbursement from Great Divide under various equitable principles including equitable contribution and subrogation.]

The court’s decision in IMG Worldwide turned on its conclusion that when a primary policy improperly denies coverage, it fails to “provide coverage” under the terms of the policy. As noted above, the court held that “provides” could reasonably mean either “provide for” or “undertakes to deliver.” Thus, the court saw the language as ambiguous and held that “[b]ecause the Galstaldi suit was a ‘suit’ seeking damages for ‘property damage,’ and Great Divide did not undertake to deliver coverage,” it did not provide coverage.

The IMG Worldwide court’s decision is simply wrong. Under the court’s rationale, an excess insurer not only insures its policyholder’s risks of causing injury or damage – it bargained for that -- but also the risk of its policyholder’s primary insurer improperly disclaiming coverage. For that risk the excess insurer did not bargain. A primary insurer can now disclaim coverage, and, even if blatantly wrong, shift the defense obligation to the excess insurer. And what if the claim has no realistic chance of reaching the excess layer? Here too the excess insurer would be obligated to defend. There is something wrong with the picture of an excess insurer, that attaches at $5 million, being required to defend a soft tissue slip and fall action because the primary insurer disclaimed coverage. While the excess insurer would have a right of subrogation, the time and expense of handling the defense, as well as enforcing that subrogation right, places an unfair burden on the insurer. Not to mention placing a burden on the excess insurer to ensure that the primary insurer does not reach any sort of settlement that prejudices the excess insurer’s subrogation right.

Even if “provides” could reasonably mean either “provide for” or “undertakes to deliver,” the term is not ambiguous when interpreted in its rightful context – the relationship between a primary insurer (which receives extra premium because of its defense obligation) and an excess insurer. That’s not to say that there are never situations where an excess insurer has a duty to defend, but this is not intended to be one of them.

As I said, given that IMG Worldwide involves critical policy language contained in a standard ISO coverage form, it is an ISO-take-note decision.