In a matter of first impression, the Delaware Superior Court has adopted the “larger settlement rule” to govern allocation of settlement amounts where (i) a settlement resolves, at least in part, insured claims; (ii) the parties cannot agree as to the allocation of amounts attributable to covered versus non-covered claims; and (iii) the policy’s allocation provision does not prescribe a specific allocation method.  Arch Ins. Co. v. Murdock, No. N16C-01-104 (Del. Super. Ct. Jan. 17, 2020).

Six excess insurers sought a declaratory judgment disclaiming coverage for two settlements due to alleged breaches of D&O policies by an insured corporation and insured director.  The Delaware Superior Court issued an initial decision, finding that both settlements constituted “Loss” under the policies, but leaving open issues relating to subrogation, allocation, and exhaustion.  The Delaware Superior Court later heard argument on the allocation issue – in particular, on what allocation standard applies to the policies.

The director argued that the court should adopt the so-called “larger settlement rule” when determining how any indemnifiable loss encompassed by the settlements should be allocated between covered and uncovered loss.  Under the larger settlement rule, the director argued, the entire amount of both settlements would be recoverable unless the insurers could establish that some uncovered liability increased the amount of the settlements.

The insurers argued that the larger settlement rule did not apply because the allocation provision in the primary policy expressly required an allocation between covered and uncovered loss.  The allocation provision provided, in relevant part, that if insureds who are afforded coverage for the claim incur loss jointly with others who are not afforded coverage for the claim, or incur amounts both covered and uncovered under the policy, “then the Insureds and the Insurer agree to use their best efforts to determine a fair and proper allocation of covered Loss.”

The court ultimately determined that the allocation provision was “unhelpful,” as it spoke only to situations where the insurer and insured work together using “best efforts” to arrive at “a fair and proper allocation of covered Loss.”  The court held that the situation at hand – where the parties failed to agree on an allocation – requires the application of the larger settlement rule, which the court opined directed that “allocation is appropriate only if, and only to the extent that, the defense or settlement costs of the litigation were, by virtue of the wrongful acts of the uninsured parties, higher than they would have been had only the insured parties been defended or settled.”

The court concluded that any type of pro rata or relative exposure allocation would be contrary to the policies’ language, which affords coverage for all Loss that the insureds become legally obligated to pay, and thus implies complete indemnity for Loss regardless of who else might be at fault for similar actions.  The court further found that the allocation provision’s directive to “take into account the relative legal and financial exposures of the insureds in connection with the defense and/or settlement of the Claim” supported the economic rationale of the larger settlement rule to protect the expectations of an insured when it purchases coverage under an insurance policy.  The court thus adopted the larger settlement rule and deferred resolution of factual issues and the burden of proof regarding allocation for a future conference.