The Sixth Circuit recently addressed the question of whether an excess insurer must provide a defense when the primary insurer fails to do so.  In IMG Worldwide v. Westchester Fire Insurance Company, No. 3836 (6th Cir. July 15, 2014), the court reversed the decision of a trial court and ordered an excess insurer to pay nearly $8 million in defense costs.  In reaching this conclusion, the court not only misconstrued the plain language of the excess policy, but it also misapprehended the nature and purpose of excess insurance.

IMG Worldwide was a consultant to a failed real estate development project in Orlando, Florida.  Investors sued IMG and others, alleging the defendants engaged in fraud when they sold properties with the promise that the properties would be developed into high-end condominiums.  In addition to fraud, the plaintiffs asserted claims for conversion, theft, and violations of Florida’s Deceptive and Unfair Trade Practices Act.

IMG sought coverage from its primary insurer as well as its excess insurer, Westchester Fire Insurance Company.  Both carriers denied coverage because IMG’s alleged conduct was intentional rather than accidental, among other reasons.  IMG incurred more than $8 million in defense costs but ultimately settled the underlying lawsuit for nearly $5 million.

After IMG reached a settlement with the plaintiffs, IMG reached a settlement with its primary insurer for $1,250,000.  This represented the primary policy limit for one policy year of $1 million plus $250,000 toward defense costs.  As part of the settlement, IMG released the primary insurer from further liability. 

IMG later filed a declaratory judgment action against Westchester, which continued to deny coverage, and the matter proceeded to a jury trial.  The jury found that the claims in the underlying matter were covered under the excess policy and that Westchester therefore was obligated to reimburse IMG for the settlement amount in excess of the funds it received from the primary carrier.  The court retained the question of whether Westchester was obligated to defend IMG and thus liable for defense costs.  The trial court concluded there was no duty to defend under these circumstances and found in favor of Westchester.  The Sixth Circuit reversed.

The duty to defend was set forth in the excess policy in pertinent part as follows:

[Westchester] will have the right and duty to defend the insured against any “suit” seeking damages for . . . “property damage”when the “underlying insurance” does not provide coverage or the limits of the “underlying insurance” have been exhausted. . . . However, [Westchester] will have no duty to defend [IMG] against any “suit” seeking damages for . . . “property damage” to which this insurance does not apply.(emphasis added).  According to the Sixth Circuit, Westchester’s duty to defend under this provision depended on what it means to “provide” coverage.  More specifically, the court examined whether the duty arises where the underlying insurance provides coverage but the primary insurer “nevertheless improperly denies coverage.”

The Sixth Circuit concluded that the term “provides” was susceptible to two meanings: it could mean “provide for” or it could mean “undertakes to deliver.”  Under the latter reading, according to the court, Westchester would have become responsible for defending IMG once the primary insurer wrongfully denied coverage.  Concluding that the language was ambiguous, the court construed it against Westchester.  Because the primary insurer “did not undertake to deliver coverage,” the court determined that Westchester had a duty to defend IMG after the primary insurer declined to provide IMG with a defense.

In reaching this conclusion, the Sixth Circuit overlooked not only the plain language of the policy but also the nature and purpose of excess insurance.

The policy provided that Westchester’s duty arises “when the ‘underlying insurance’ does not provide coverage . . . .”  Viewing this clause as a whole, rather than examining the word “provides” in isolation, it becomes clear that the clause refers to a situation where the underlying policy does not cover the loss rather than where the underlying policy does cover the loss but the insurer erroneously denies coverage.  In other words, there is a distinction between insurance that does not provide coverage for a loss and an insurerthat does not provide coverage despite an obligation to do so.  Contrary to the Sixth Circuit’s conclusion, there was nothing ambiguous about the duty to defend provision.

Moreover, the court failed to appreciate the nature of excess insurance, which generally falls into two categories: follow-form and umbrella coverage.  Follow-form provides coverage above the primary limits under the same terms and conditions as the primary policy, while umbrella coverage fills gaps in the primary coverage. 

The duty to defend provision in the Westchester policy contained both elements of excess coverage.  The duty arises not only where the underlying insurance does not provide coverage, but also where the primary insurer provides a defense but terminates the defense upon exhaustion of the primary limits.  Excess coverage, however, is not and should not be treated as a replacement for primary coverage, particularly where it becomes clear that the underlying suit was within the scope of the primary carrier’s coverage.