Settling Subrogation Claims and the Dreaded Release

Gary L. Wickert and Lee R. Wickert | Claims Journal

The bane of any subrogation professional’s existence is the dreaded release. It is no coincidence that when Zeus uttered the words, “Release the Kraken!” in the 1981 fantasy adventure film The Clash of the Titans, he chose the word “Release.” The meme itself connotes setting loose utter destruction on one’s enemy—a description which can be woefully accurate to describe the potential aftermath of signing releases which are overbroad and contain terms, conditions, and obligations which a subrogated carrier has no business agreeing to or assuming.

It is said that releases and settlement agreements “use a thousand words when ten would do” and there is a good reason for that. Those drafting the release are often paid by the hour and/or want to pack in the very maximum of future protections, claims released, and indemnity provided by the document. Conversely, those signing the release want to limit the promises made and tailor them to the specific claims and damages made the subject of the release. The concern over limiting the scope and future liability assumed in such broadly worded documents is most-vitally important when the party signing the release is an insurance company settling a simple subrogation claim. The world of insurance is full of horror stories involving publicly-traded insurance companies finding themselves on the hook for liability many times greater than the amount recovered in the subrogation settlement; all because they didn’t take the time and energy to carefully parse the language in the release they signed.

Take, for example, a case in which you have put in considerable work to investigate and develop a potential subrogation claim. You’ve hired investigators and experts, conducted inspections, talked to witnesses, and perhaps even retained an outside “subrogation vendor.” Though settlement negotiations were rough, you won a hard-earned recovery which you believe is reasonable. You start to feel good about all the work you put in when you receive a settlement check and, along with it, a broad, seven-page document entitled “Settlement Agreement, Release of Claims, Indemnity and Hold Harmless Agreement” which purports to be a cross between a release of claims and a mid-sized paperback novel. You flip through the multiple pages and see that it contains lengthy paragraphs referring to indemnity and hold-harmless obligations which rival the Affordable Care Act in length, complexity, and uncertainty. Perhaps you decide to just sign it and find out later what is in it. But that might be the worst move in your career. Knowing what to do and how to even respond can be daunting.

Most insurance defense counsel and liability adjusters cut and paste release language, regurgitating the same settlement agreements over years of handling them. They do this because they feel more is better and because it’s easier for them to include everything rather than actually look at the facts of the case and craft reasonable language specific to each case. They also do it because like you, they don’t understand the import of all the words. And, let’s face it, they’re creatures of habit. Even seasoned lawyers and liability adjusters sometimes have a hard time grasping subrogation concepts in the claims we are pursuing. So, what do you do? Do you sign the release containing the harsh and open-ended indemnity and hold-harmless language in exchange for the immediate gratification of cashing the check? Or do you push back and risk losing your hard-earned settlement? In making that decision it is important that you precisely understand the obligations and future potential liability you are exposing the insurance company to. If you’re not careful, the released party may end up with the last laugh, and you will wish you had never settled the case in the first place.

Let’s review some common release language defense counsel and liability adjusters include in releases and the concepts you want to keep in mind when negotiating the release language.

Recognize The Claims You Own

You should only release the claims that you own – only the ones you are being paid for. In subrogation, the identity of the insurance carrier as the plaintiff should be known and care should be taken as to the caption of the lawsuit. For example, in a worker’s compensation subrogation action, the insurance carrier has made medical benefit payments to medical providers on the claimant’s behalf and indemnity payments to the claimant. In states where workers’ compensation is the exclusive remedy of the injured worker (most states), the worker’s compensation insurance carrier is obligated to pay those medical bills that are related to the covered injury. Where the worker’s compensation claimant is unwilling or uninterested in pursuing a third-party claim, the insurance carrier is often able to pursue subrogation of its indemnity and medical benefit payments. These are the only claims which the insurance carrier possesses and has the obligation to release.

Release vs. Hold Harmless vs. Indemnity

It is important for everyone to understand what they are signing. That importance is tripled when the person signing is signing on behalf of an insurance company with assets in the hundreds of millions or billions. Why? You are an easy target. When you “release” somebody, you voluntarily relinquish a known right to sue that person for the claim or cause of action described in the release or settlement agreement. This is the purpose of a release and you must agree to this – but only insofar as it relates to a carefully-crafted description of the limited cause of action being released. If it’s too broad (e.g., release personal injury claims where only property damage is involved), you could be headed for trouble. A property carrier signing a full release and hold harmless agreement with a tortfeasor paying for repair of water damage may inadvertently be releasing the tortfeasor for future mold and mildew claims which have yet to surface. Look carefully at the definitions contained in the release document. They often contain the details which constitute the devil in the agreement.

Hold-harmless and indemnity clauses are known as “exculpatory clauses” and should be well-understood before they are agreed to. A “hold harmless” agreement, on the other hand, is one party agreeing not to hold the other party responsible for any loss, damage, or legal liability that may arise from the matters made the subject of the agreement. A “hold harmless” or “liability waiver” provision in a contract is an agreement between the parties whereby one or both parties agree not to hold the other party responsible for any loss, damage, or legal liability that may arise under the agreement. In other words, the two parties cannot sue each other for any damage they may suffer due to the negligence of the other party. Hold harmless provisions are often combined with indemnity language.

An “indemnity” agreement means that the party signing the release agrees to “indemnify” the party being released – protecting them against and/or reimbursing them for future damages or liabilities incurred by the released party associated with any threatened or actual civil or criminal proceedings. It is literally the assumption of responsibility and liability that would otherwise belong to someone else, and, for insurance companies, it represents the greatest risk assumed in a settlement agreement. At Matthiesen, Wickert & Lehrer, S.C., we let all parties know from the very beginning of settlement negotiations that our clients will not sign indemnity language. We will release and hold harmless, but will not, under any circumstances, sign releases which require our clients to indemnify anyone. Such a stance makes negotiation transparent and eliminates the potential waste of time which could result if the other side has their heart set on being indemnified.

Avoid General Release Language More Suited To Individual Plaintiff

In a general personal injury release, the defendant will often ask that the injured plaintiff sign a broad release. An injured plaintiff/insured can agree to this broad scope of the release because they own the bodily injury claim. In a subrogation setting, however, the insurance carrier does not own the bodily injury claim and should not agree to this broad scope of release.

The subrogated insurance carrier can only agree to release the claims that it owns. Therefore, broad release and indemnification language should never be agreed to, and you should be able to convince the third-party insurance carrier or defense attorney of the fact that you are not a personal injury plaintiff and that this type of language is inappropriate – perhaps even ineffectual. At a minimum, you should take the time to give him an example of the absurdity that could result if you were to sign on behalf of your insurance company employer. The release often contains broad language requiring you to:

…completely release, discharge and forever hold defendants harmless from any and all claims, demands, suits known or unknown, fixed or contingent, liquidated or unliquidated, whether or not asserted in the referenced case, as of this date, arising from or related to the events and transactions which are the subject matter of this case.

A carrier subrogating only for property damage which agrees to the above language could find a summons and complaint showing up in the mail should the insured later sue the released party for bodily injury damages. It would be hard to explain why you didn’t insist on specifically tailoring the release to property damages.

Following along with our workers’ compensation subrogation scenario, let’s look at some common release language proposed by defense counsel and how it should be modified.

Proposed Language: In consideration of the settlement amount, releasors agree to defend, indemnify, and hold the released parties harmless for any and all claims, demands, judgments, damages, liens, or liability arising out of the incident, including, but not limited to, claims, demands, damages, expenses, actions, liabilities, or other obligations that may be brought against the released parties as to medical liens and wage benefit liens.

Modified Language: In consideration of the settlement amount, releasors agree to defend, indemnify, and hold the released parties harmless, and reimburse for claims, demands, or other obligations that may be brought against the released parties as to medical liens and wage benefit liens and liens payable under the worker’s compensation policy.

As you can see, the modified language limits the liability to only those claims that should appropriately be covered under the workers’ compensation policy. If the proposed language were not modified, the insurance carrier would be opening themselves up to liability where it wasn’t previously contemplated.

Release clauses which need to be carefully reviewed and, if possible, avoided altogether, include:

  • Confidentiality Agreements
  • Indemnity Agreements
  • Hold Harmless Agreements
  • Attorneys’ Fee Clauses
  • Tax Implication Clauses
  • Jury Waivers / Arbitration Clauses
Avoid Extraneous/Unnecessary Clauses In Releases

Once you have successfully convinced the third-party insurance carrier that you can only release those claims which you own, and the release language has been sufficiently modified to reflect that, there are a couple other areas that you should be aware of. The first involves a choice of attorney clause:

In the event of any of the types of claims described in the Agreement are brought against any of the Released Parties, the Released Parties have the right to defend any and all claims with attorneys of their own choosing. Releasors will reimburse the Released Parties for all legal fees incurred in defending any and all lawsuits, claims, suits, demands, actions, and causes of action in connection therewith.

This language is concerning for a couple of reasons. The biggest reason is that, should a medical provider or the like pursue a claim against the third-party carrier, the workers’ compensation carrier has the best information related to this type of claim. Either the medical invoice has been overlooked (for numerous reasons: the medical bill was improperly submitted to the insurance carrier, the medical bill was improperly coded, the medical bill was submitted late, etc.) or the medical bill is not related to the covered injury. In either case, the workers’ compensation carrier has the best information to respond to the claim. Should the third-party insurance carrier be allowed to defend this claim with an attorney of their choosing, there is no control over the defense.

The Business Decision On Releases

Most insurance companies—both large and small—do not have by-laws or corporate rules governing the signing of indemnity. But one errant signature can bind a $50 billion corporation to unlimited liability. While many companies require supervisor or in-house claims counsel approval of release signatures, rules are not always followed, and denying that a claims handling employee did not have apparent authority to bind the corporation to indemnity could be an expensive uphill battle. A release is an agreement between two parties which purportedly consists of the terms that the parties are willing to agree to. Subrogation claims are comprised of specific rights and for specifically stated damages which were paid under the terms of a carefully drafted insurance policy. If a subrogation claim goes to trial and the subrogee wins, there is no indemnity required; no release will need to be signed. Money is simply handed over. Accordingly, if there is a subrogation settlement, the subrogated carrier should not be required or expected to take on an extra duty, responsibility, or liability which expands its potential liability beyond the scope of the policy and the claim it is settling.

An insurance policy pays a claim according to its terms. Any subrogation recovery is posted back to the policy as a subrogation recovery in order to offset the original claim payment. If the settling insurance company is sued on a first-party insurance claim, the defense and ultimate payment under the policy are paid off of the claim file. But if the insurance company is sued based on indemnity or hold harmless language contained in an overbroad release and settlement agreement, the payment is no longer paid on off of the claim file and must be paid directly by the carrier as an errors and omissions claim. This payment comes directly off of the carrier’s bottom line, and the defense of that subsequent suit and any payments made by the carrier in connection with it affects the company’s profits and its shareholders. As such, insurance companies are loathed to accept business risks which are beyond the scope of their policies.

Armed with this knowledge and a keen insight into the inner workings of releases and settlement agreements, you’ll be better able to negotiate harmful release language out of your releases and will be better prepared to protect your company from future liability based on such release language and liability the insurance company should never have assumed. When in doubt, have subrogation counsel (one firm comes to mind) assist you with the review of your settlement agreements and release language. It may save you from headaches and considerable expense and liability in the future. If there was ever a scenario in which a simple one-second signature could change the course of a career—this is it.

Washington Trial Court Narrows Definition of First Party Claimant, Clarifies Available Causes of Action in Commercial Property Loss Context

Kathleen A. Nelson and Jonathan R. Missen | Lewis Brisbois Bisgaard & Smith

The law in the State of Washington, albeit clear on issues regarding first party claimants, was recently challenged in the matter of Eye Associates Northwest, P.C. v. Sedgwick et. al. However, despite this challenge of first impression, the court limited the application of the term “first party claimant” (a term of art akin to “insured”) based upon the wording of a loss payee clause, as well as taking into consideration and harmonizing the wording of the leases, other provisions in the policy regarding tenant improvements, and the simple fact that Eye Associates was not named in the policy whatsoever.

In Eye Associates, the plaintiff leased office space in a high-rise medical office building, insured by three separate insurance companies. A water loss caused damage to the plaintiff’s leased space, and the plaintiff brought suit against the owner of the building, its insurers, the property manager, a third-party administrator (TPA), and two individual adjusters assigned to inspect and adjust the water loss claim.

The plaintiff claimed that it qualified as a “first party claimant/insured,” under the policies issued by the landlord’s insurers because there was coverage under the policies for tenant improvements. The plaintiff alleged that the TPA, through the individual adjusters, hid coverage and misrepresented policy provisions, thereby causing it to incur significant damages and delays to fund its own repair. The plaintiff brought suit for insurance bad faith, fraud, intentional/negligent misrepresentation, and violations of the Washington Insurance Fair Conduct Act (IFCA) and Washington Consumer Protection Act (CPA). The plaintiff further claimed unauthorized practice of law as against the individual adjusters.

After extremely expensive and litigious discovery, both parties moved for summary judgment on liability. The dispute centered on whether tenant improvements, belonging to the tenant, were covered property under the landlord’s policies. The TPA and individual adjusters moved for summary judgment on the basis that the tenant lacked standing to bring claims because its property was not covered and therefore did not qualify as an insured or first party claimant of the landlord’s policies.

To resolve this question, the court looked to the express language of the identical policies and interpreted Merriman v. Am. Guar. & Liab. Ins. Co., 198 Wn. App. 594 (Wash. Ct. App. 2017). In Merriman, the Merrimans’ property was destroyed in a storage warehouse fire. The warehouse policy provided coverage for “personal property of others in the [insured’s] care, custody and control.” The policy further provided: “Our payment for loss of or damage to personal property of others will only be for the account of the owner of that property.” The warehouse insurer concluded that coverage applied to the Merrimans’ personal property.

Under these circumstances, the Merriman court found that the Merrimans were first party claimants because the policy directed the insurer to send claim payment checks to them as owners of the damaged personal property. However, in doing so, the court expressly held that if the policy had included language used in other cases such as “the loss shall be adjusted with the named insured for the account of the owners of the property,” then the Merrimans would not be first party claimants. The Merriman court ultimately concluded that: “A clear lesson…is that no presumption can be made that ‘other owners’ whose property is covered by this type of policy are first party claimants or that they are third party claimants. Policies can be, and are, written both ways.”

In Eye Associates, the loss payee clause stated that “Loss, if any, will be adjusted with and payable to [Named Insured], or as may be directed by [Named Insured]” and that “Any such loss covered by this policy will be adjusted with the Named Insured and any proceeds for such loss shall be made payable to them or as may be directed by them.” The court determined that this language was on par with language at issue in the recent case of Michels v. Farmers Ins. Exch., No. 77919-2-I, (Wash. Ct. App. Apr. 8, 2019). Although unpublished, the court looked to Michels as persuasive authority. There, the loss payee clause stated: “Our payment for loss of or damage to personal property of others will only be for the account of the owners of the property…” The Michels court determined that this language was insufficient to confer first party claimant status because there was no provision providing that property owners would be paid directly. The court in Eye Associates followed the Michels analysis and determined that the plaintiff was not an insured or first party claimant to its landlord’s policies. Because the plaintiff was not a first party claimant, as a matter of law, it lacked standing to assert claims based on coverage under the landlord’s policies.

The decision in Eye Associates sends a clear signal that Washington trial courts are willing to limit the otherwise expansive definition given to “first party claimant” in Washington. Under the plaintiff’s theory, the definition of first party claimant was nearly limitless, encompassing any person or entity with a covered interest of any kind, and any entity claiming any interest under the policy. The trial court in Eye Associates found that definition too broad, ruling that a first party claimant must have defined coverage and/or a payable interest under the policy to assert causes of action as an insured.

Oregon Court of Appeals Addresses Economic Loss Doctrine and Vicarious Liability in Construction Dispute

Blake Robinson | Davis Wright Tremaine

The Oregon Court of Appeals recently issued a decision touching on the economic loss doctrine and vicarious liability in a construction dispute.1 The outcome provides key lessons for manufacturing companies that may maintain principal-agent relationships with distributors or maintenance service companies based on the level of control one party exerts over the other.

Case Background

Quality Plus Services, Inc. was hired to perform welds on piping on an Intel construction project and used a fusion welding machine manufactured by Georg Fischer, LLC to carry out its task. During the course of the work, a service message displayed on the machine’s screen, so Quality Plus contacted Plastic Services Northwest, Inc., a Georg Fischer distributor, to service the machine.

While servicing the welding machine, the Plastic Services technician inadvertently adjusted one of its settings. Quality Plus did not notice the adjustment and continued using the machine to make more than 900 additional welds. Several months later, while Georg Fischer was servicing the machine, it discovered the adjustment and notified Quality Plus. The parties ultimately determined that the adjustment caused all of the more than 900 welds to be non-conforming, and thus had to be replaced at a cost of over $800,000.

Quality Plus asserted a negligence claim, among other things, against Plastic Supply, and sought to hold Georg Fischer vicariously liable for Plastic Supply’s negligence. The Court of Appeals was tasked with determining whether Quality’s Plus’s claims were barred by the economic loss doctrine, as well as whether Georg Fischer was liable for Plastic Supply’s negligence.

The Court’s Ruling

The Court of Appeals held that the economic loss doctrine did not apply. While a party can recover damages for injuries negligently caused to their person or property, a party generally cannot recover if negligence causes a purely “economic loss”—for example, a reduced stock price or lost profits.

Georg Fischer and Plastic Supply argued that Quality Plus had suffered a purely economic loss—costs to provide replacement welds, lease costs for idled equipment, and expenses to remove the defective piping, among other things. Quality Plus countered that it suffered property damage in that the adjustment to the welding machine caused the welds to be manufactured in a way that left them no longer fit for their intended purpose, and thus damaged.

Georg Fischer and Plastic Supply also argued that Quality Plus did not suffer property damage because the piping was actually owned by a different subcontractor. Quality Plus responded by arguing it was sufficient that the piping was in its possession and control. The Court of Appeals agreed with Quality Plus on both arguments and held that the economic loss doctrine did not bar Quality Plus’s negligence claim.

Separately, Georg Fischer argued that it could not be held vicariously liable for Plastic Supply’s negligence because Georg Fischer had no control over Plastic Supply’s work. Generally, one party is only vicariously liable for the negligence of another party if the latter is the agent of the former. Whether a principal-agent relationship exists often depends on whether the purported principal had the right to control the purported agent.

Here, the Court of Appeals held that Georg Fischer was vicariously liable, noting that there was evidence that George Fischer and Plastic Supply’s relationship went beyond that of a typical manufacturer and distributor. The court primarily focused on Georg Fischer’s maintenance and service manual for the welding machine, which included highly specific information about who was permitted to service the machine and the manner in which it must be serviced.


The Court of Appeals’ decision highlights that the economic loss doctrine does not rigidly limit damages in negligence cases—a product not crafted to specification can constitute property damage. Moreover, the plaintiff need not actually own the product, as long as the plaintiff was in possession or control of it. Finally, manufacturing companies should be aware that they could be held liable if another company causes damage by negligently servicing the manufacturer’s construction equipment.


1 JH Kelly, LLC v. Quality Plus Services, Inc., 305 Or App 565, 472 P3d 280 (2020).

State Farm Pilot Uses Sensors to Detect Wiring Defects That Can Cause Fires

Jim Sims | Claims Journal

State Farm is sending sensors that can detect hazards in electric wiring to 40,000 homeowners in California, Arizona and Texas as part of a pilot project that will measure potential savings and customer acceptance.

Mike Fields, a State Farm vice president and leader of the insurer’s Red Labs team, said during an interview Friday that customers who sign up for the project will receive a Ting sensor for free and up to $1,000 for electrical repairs if any problems are detected. The devices, manufactured by Whisker Labs, retail for $349. One Ting plugged into a wall socket can detect loose connections, damaged wires or faulty appliances.

“We know it works in the home,” Fields said. “We want to know the acceptance rate for homeowners.”

State Farm said electrical fires make up 13% of all home fires and cause about $1.3 billion in damages annually in the United States. Electrical fires cause $100,000 in damages, on average.

“No one wants to see those fires,” Fields said.

The Ting software detects tiny electrical arcs, which are precursors to imminent fire risks, Whisker Labs says on its website. If a malfunction is detected, the Ting device sends the homeowner an alert via smart phone.

“The device is simple,” Fields said. “We wanted to wait and make sure that there was an easy and simple way for customers to install it.”

Fields said the Ting device can detect defects not only in wiring inside the home, but also in the transformer outside. That device converts electricity from high-voltage power lines to a lower voltage for household use.

Often transformers are mounted on power poles and can cause wildfires if they shoot off sparks. Investor-owned utilities in California have been ordered to pay billions for damages caused by wildfires ignited by their malfunctioning equipment.

Fields said State Farm chose to market the pilot project to policyholders in areas of California, Arizona and Texas that have a greater wildfire risk specifically to gauge its impact. He said if a Ting device detects a problem with a transformer, it will alert the homeowner, who hopefully willnotify the utility.

Field said State Farm started the project in 2019 by installing 2,000 Ting devices in homes owned by its employees and agents. Since September, the carrier has sent another 11,000 sensors to customers.

He said only about 22 alarms have been set off so far. He said 10 of those alerts were for problems with transformers. The Ting devices also detected an electric heater that was overheating, a sparking outlet, and defective circuit breakers.

State Farm Ventures, the carrier’s investment arm, has an ownership stake in WhiskerLabs, although Fields said that is separate from the partnership for the pilot project. The company, headquartered in Germantown, Md., launched Ting in 2017. The company said that while fundamentally different, the closest market analog to Ting for electrical fire safety applications is the Arc-Fault Circuit Interrupter (AFCI), which was incorporated into the U.S. electrical code in 2010. AFCI’s have a global market of $4 billion, WhiskerLabs said in a press release last year.

Fields said State Farm has also field tested devices that detect water leaks — which are another common cause of property damage claims. He said customers found that it was expensive to install devices that both detected leaks and shut off water to the house, leading to a low “turn-on rate,” except for a small segment of high-income customers. He said devices that detect leaks but can’t shut the water off are easier to install, but most customers wanted devices that shut off the water supply.

Ninth Circuit Adopts General Rule Regarding Circumstances in Which Excess Insurers May Dispute Exhaustion of Underlying Insurance

Alex Silerman | PropertyCasualtyFocus

Addressing an issue of first impression, the Ninth Circuit recently adopted a general rule that will sharply limit the ability of excess insurers to second-guess payment decisions made by lower-level insurers. Subject to limited exceptions, the court concluded that an excess carrier generally cannot challenge decisions underlying insurers made with respect to earlier, unrelated claims, as a basis for arguing that its own layer of coverage has not yet been reached.  AXIS Reinsurance Co. v. Northrop Grumman Corp., No. 19-55135 (9th Cir. Sept. 14, 2020).

The Settlements

The case arises from two underlying lawsuits against Northrop Grumman Corp. for alleged ERISA violations. One was filed by the Department of Labor (DOL) and settled for an undisclosed amount. The other, filed by administrators of a Northrop employee benefits plan, settled for over $16 million (the “Grabek Settlement”). Northrop tendered coverage for both settlements to its insurers, including AXIS. The AXIS policy attached excess of primary and first-layer excess policies, each providing limits of $15 million. AXIS had no payment obligations until the combined $30 million limits of underlying insurance was exhausted in payment of covered loss.

The underlying carriers each determined that the DOL settlement was covered under their policies. As such, the primary carrier contributed its entire limit and the first-layer excess carrier paid the rest, leaving $7 million available for the Grabek Settlement. Having determined the Grabek Settlement also was covered under its policy, the first-layer excess insurer put up the remaining limits of its policy. Northrop then sought the nearly $10 million balance of the settlement from AXIS.

While AXIS did not dispute coverage for the Grabek Settlement, it did take issue with the DOL settlement, which AXIS claimed was uninsurable as a matter of California public policy, and thus should not have been paid by the underlying insurers. AXIS nonetheless paid its share of the Grabek settlement and subsequently filed an action seeking reimbursement of the amount of the DOL settlement from Northrop. AXIS’s theory was that it was forced to prematurely “drop down” and provide coverage for the Grabek Settlement only because the underlying insurers improperly exhausted or otherwise eroded their policy limits in payment of non-covered loss. The district court granted summary judgment to AXIS and Northrop appealed.

The Appeal

The Ninth Circuit framed the issue as follows: “when, if ever, may an excess insurer challenge an underlying insurer’s payment decision as outside the scope of coverage?” Under its “improper erosion” theory, AXIS maintained that insureds bear the risk that excess carriers might withhold payment of otherwise covered claims based on a disagreement as to how the claim was adjusted by underlying insurers in the coverage tower. Northrop disagreed, of course, as did the Ninth Circuit, which concluded that the excess carrier, not the insured, assumes the risk that underlying carriers may handle claims in a manner that implicates upper-layer excess coverage.

Although the Ninth Circuit and California state courts have yet to address the issue, a panel of the Ninth Circuit found Northrop’s position was consistent with the few other cases that have done so. The court relied principally on Costco Whole Sale Corp., 387 F. Supp.3d 1165 (W.D. Wash. 2019), in which a Washington district court found “the weight of authority holds that an excess insurer may not challenge the underlying insurers’ payment decisions in order to argue that their policy limits were not (or should not have been) exhausted … unless there is an indication that the payments were motivated by fraud or bad faith.”

The Ninth Circuit agreed with the Costco approach, and thus adopted it as a general rule. In doing so, the panel emphasized, as did the Costco court, that parties are free to contract around the rule. The court noted that a 2016 Alabama decision involving an excess policy issued by AXIS Surplus Insurance Company did just that. The policy in that case specifically reserved the excess carrier’s right to second-guess payment decisions by underlying insurers, expressly stating that “amounts paid by underlying insurance for losses that would not have been payable under the Axis Excess Policy do not count towards the $10 million” limit of liability, and that, “any amounts that the Primary Policy paid for flood losses do not erode the $10 million threshold.”

In addition, the court rejected the district court’s concern that the Costco rule functionally prohibits excess carriers from challenging their coverage obligations.  In this particular case, AXIS did not dispute that the claim it was asked to cover—the Grabek Settlement—was covered under its policy. It instead sought to reduce its liability for that claim by disputing coverage for a different claim (the DOL settlement), which it was not asked to cover. The Ninth Circuit emphasized that under the Costco rule, excess carriers remain free to dispute coverage for claims tendered to them, even when an underlying insurer determines that the same claim is covered under its own policy. Excess carriers may not, however, second-guess other insurers’ payments of earlier, unrelated claims, without first showing that such payments were motivated by fraud or bad faith, or by pointing to a specific contractual right. Here, AXIS did not allege that Northrop and the underlying carriers engaged in fraud or bad faith, and the court found no contractual basis in the AXIS policy for AXIS’s improper erosion theory. The panel reversed the district court order on this basis alone.

There was an additional issue on appeal as to whether the DOJ settlement called for disgorgement, for which insurance coverage is barred by California public policy. While the court did not reach that issue given its ruling on improper erosion, it did note that the Costco rule would still apply even where underlying limits were paid for earlier, unrelated claims that were arguably uninsurable as a matter of law. In that event, the court explained that the burden would be on the excess insurer to show that the payments made by the lower-level carriers for the earlier claim were motivated by fraud or bad faith, or that the excess carrier had a contractual right to challenge the payments. Since AXIS was never asked to provide coverage for the DOL settlement, the Ninth Circuit seems to indicate that the outcome here would be the same even assuming the DOL settlement did in fact constitute disgorgement.