In an insurance coverage lawsuit brought by 3M Co. and certain of 3M’s wholly owned subsidiaries, including Aearo LLC, the Delaware Superior Court recently ruled that 3M’s payment of litigation costs on Aearo’s behalf do not count toward Aearo’s $250,000 Self-Insured Retention (SIR) contained in several of its legacy policies. This ruling is significant because 3M and Aearo seek, among other things, more than $370 million in defense fees for nearly 300,000 product liability lawsuits consolidated in a multidistrict litigation in the US District Court for the Northern District of Florida and state court in Minnesota. Parent companies, and those looking to acquire, should be aware of legacy policy provisions like those expressly prohibiting satisfaction of an SIR by anyone except the named insured.

Not all policies contain an express prohibition that clearly requires the insured to pay the SIR from its own funds and courts typically hold that an insured can satisfy the SIR using other insurance policies or third-party payments. So, just how precise does the insurer’s policy language need to be? Court’s typically require very strong, explicit language. In Aearo’s case, the relevant policies provided that the SIR “shall not be reduced by . . . any payment made on your behalf by another.”

While the meaning of SIR varies based on state law and specific policy language, it typically refers to a dollar amount stated in a liability policy that must be satisfied by the insured before the insurer will pay any defense or indemnity costs on a claim. Insurers frequently argue that SIRs are intended to make sure the insured has “skin in the game” to justify the requirement that the named insured contribute the full retention amount. Policyholders, on the other hand, typically argue that SIRs are intended to be a buffer layer for more frequent, less severe loss that is retained by the insured and not transferred to the insurer; thus, the source funding the SIR is irrelevant because the insurer still does not have to pay until the loss payments exceed a certain amount. In this vein, 3M argued that it is a “pointless formality” requiring 3M’s funds to be “transferred to Aearo and then, in the next moment, paid out in satisfaction of invoices for attorneys’ fees and other defense costs.” But the Delaware court disagreed that this requirement is a “pointless formality” and disallowed Aearo’s attempt to “credit to itself those defense costs paid for by 3M, a non-policy holder who is not bound by the Policies’ restrictions and requirements.”

The Delaware Superior Court’s ruling serves as a good reminder of the importance of carefully reviewing policy language, including provisions governing self-insured retentions and deductibles, early and often whenever there is a claim. Parent companies should also be mindful of specific requirements contained in its subsidiary’s insurance policies that may not reflect the relationships or corporate structures of affiliated companies that share or consolidate finances. As always, consulting experienced coverage counsel during the claim process and the due diligence phase of acquisition can ensure compliance with specific policy requirements and maximize recoveries.