California Court of Appeal Addresses Horizontal Exhaustion Applied to Excess Coverage
On August 31, 2017, the California Court of Appeal, Second Appellate District, issued its long awaited decision in Montrose Chemical Corp. of California v. Superior Court (Canadian Universal), Case No. B272387. The issue before the Court concerned the sequence in which an insured may access its excess liability policies to respond to long tail environmental liabilities.
Montrose sought declaratory judgment that it may “electively stack” excess policies—i.e., that it may choose any excess policy issued in any policy year so long as the lower-lying policies for the same policy year have been exhausted. The excess insurers sought a ruling that no insurer had a duty to pay a covered claim until the insured had “horizontally exhausted” the lower level excess policies in all triggered years.
For example, assume a hypothetical coverage portfolio and $100 million of liability resulting from continuous property damage over five years. According to the excess insurers, Montrose must exhaust its first and second layer excess policies (each layer representing $10 million of coverage) in each policy year before accessing any of its third layer excess policies as depicted below:
| Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | |
$50 mil
Layer 5 | |||||
$40 mil
Layer 4 | |||||
$30 mil
Layer 3 | |||||
$20 mil
Layer 2 |  | | | | |
$10 mil
Layer 1 | | | | | |
However, as depicted below, Montrose asserted it could choose coverage from the first through third excess insurance layers for policy years two and three, and the first through fourth excess insurance layers for policy year four, without accessing any excess coverage for policy years one and five.
| Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
$50 mil
Layer 5 | ||||
$40 mil
Layer 4 | | |||
$30 mil
Layer 3 | | | | |
$20 mil
Layer 2 | | | | |
$10 mil
Layer 1 | | | |
The trial court, affirmatively rejected Montrose’s “elective stacking” position, and instead found that “horizontal exhaustion,” applied and ruled on summary judgment that that higher-level excess policies could not be accessed until lower-level excess policies had been exhausted for all policy years.
The Court of Appeal agreed with the trial court that “elective stacking” is inconsistent with the policy language in at least some of the more than 115 excess policies at issue and is not compelled by California authorities such as the California Supreme Court’s decision in State of California v. Continental Ins. Co. (2012) 55 Cal.4th 186. However, the Court of Appeal also rejected the insurers’ argument for horizontal exhaustion at each coverage level and for each year before higher-level policies may be accessed. Instead, the Court concluded that the sequence in which excess policies may be accessed must be decided on a policy-by-policy basis, taking into account the relevant provisions of each policy.
As an example of a policy language that does not stack (and thus required horizontal exhaustion) , the Court cited to some of the polices’ retained limit provisions which provided, “‘[T]he company’s liability shall be only for the ultimate net loss in excess of the insured’s retained limit defined as the greater of . . . the total of the applicable limits of the underlying policies listed in [the declarations] hereof, and the applicable limits of any other underlying insurance collectible by the insured.’ ” The Court also relied certain policies’ definition of ultimate net loss which provided “the sums paid as damages in settlement of a claim or in satisfaction of a judgment for which the insured is legally liable, after making deductions for all recoveries, salvages and other insurances (whether recoverable or not) other than the underlying insurance and excess insurance purchased specifically to be in excess of this policy.’ ” Finally, the Court looked to a number of policies “other insurance clauses” for its conclusion that in certain instances “horizontal exhaustion,” is the proper allocation method for excess exhaustion over “elective stacking.”
In the end, the Court of Appeal concluded that there is no blanket approach to excess allocation and instead the sequence in which policies may be accessed must be decided on a policy-by-policy basis, taking into account the relevant provisions of each policy.
We expect that this is not the end of the road for this decision. We will keep you updated.