Ninth Circuit Holds that Excess Carrier May Challenge Allocation of Primary Carrier’s Settlement that Resolves Both the Underlying Claim and a Coverage Dispute

Applying California law, the Ninth Circuit held that an excess insurer may challenge the allocation of an underlying settlement that resolves both an underlying claim against an insured and the insured’s coverage dispute with the primary insurer. Scottsdale Ins. Co. v. Certain Underwriters at Lloyds., 2020 WL 7419261 (9th Cir. Dec. 18, 2020). The court further held that a primary insurer is not entitled to equitable contribution from an excess carrier if the excess carrier was not notified of the underlying claim until after the primary insurer denied coverage.

In the underlying matter, the primary carrier had reached a settlement with the insured law firm of both the underlying malpractice claim against the insured and the insured’s bad faith and failure to defend claims against the primary insurer. The settlement agreement did not allocate the settlement amount between amounts paid to resolve the underlying and amounts paid to resolve the coverage dispute. However, the primary carrier did allocate, and agreed that some amounts of the settlement would be paid out of the primary policy; some out of the excess policy; and some would be paid by the primary insurer as extra-contractual liability. The excess carrier filed a declaratory judgment action against the primary insurer, contesting the allocation of the underlying settlement. The primary insurer counterclaimed and sought equitable contribution for the settlement from the excess carrier.

First, the Ninth Circuit held that an excess insurer is allowed to challenge the allocation of an underlying settlement where the settlement resolves a coverage dispute asserted by the insured against the primary insurer. In that regard, the court distinguished this case from another recent decision, AXIS Reinsurance Co. v. Northrop Grumman Corp.—where an excess insurer was not permitted to challenge a primary carrier’s payment decision for an insured’s loss that might not be covered. Here, by contrast, the court concluded that the excess carrier should be entitled to challenge the allocation to ensure that the policy proceeds were not used to resolve the insured’s claim against the insurer. The court noted that allowing such a challenge would “protect the insurers’ reasonable expectations of the policy.”

The Ninth Circuit also affirmed the district court’s holding that the primary carrier was not entitled to equitable contribution from the excess carrier for the underlying settlement. The court reasoned that, because the excess carrier had not been notified of the underlying claim until after the primary insurer denied coverage, the excess carrier was “subjected to the financial burden of the claim, but it could not ‘enjoy any of the concomitant benefits,’ such as investigating the matter or participating in the defense.” The court also observed that the “collusive nature of the allocation” supported denying equitable contribution.

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