THE FIFTH CIRCUIT PROVIDES GUIDANCE ON “ERODING LIMITS” LIABILITY POLICIES AND THE DUTY OF A PRIMARY INSURER TO DEFEND
On April 21st, the Fifth Circuit Court of Appeals in New Orleans examined whether defense costs and attorney’s fees were “expenses” and whether an endorsement transforms the policy into an “eroding limits” liability policy. In Amerisure Mut. Ins. Co. v. Arch Specialty Ins. Co. 2015 WL 1811843 ((5th Cir. April 21, 2015), Arch Specialty Insurance Company appealed an adverse summary judgment in favor of Amerisure Mutual Insurance Company in an insurance policy dispute. Amerisure cross-appealed. In 2006, Amerisure issued a Texas Commercial Package Policy to Admiral Glass & Mirror Co. The policy afforded coverage in excess of any coverage afforded by a controlled insurance program policy. Arch issued an Owner Controlled Insurance Program (“OCIP”) policy to Endeavor Highrise, LP and its contractors and subcontractors for bodily injury and property damage arising out of construction of the Endeavor Highrise. Admiral was a subcontractor insured under the policy. The policy had combined bodily injury and property damage limits of $2,000,000 per occurrence, a general aggregate limit of $2,000,000, and a products-completed operations aggregate limit of $2,000,000. The OCIP policy contained a Supplementary Payments provision which provided that Arch will pay “[a]ll expenses we incur” in connection with any covered claim, and that “[t]hese payments will not reduce the limits of insurance.” Endorsement 16 to the OCIP policy expressly deleted and replaced the statement quoted above with: “[supplementary payments] will reduce the limits of insurance.” The OCIP policy also provided that Arch's duty to defend ends “when we have used up the applicable limit of insurance in the payment of judgments or settlements.”
Prior to the claim giving rise to this lawsuit, Arch settled three claims under the OCIP policy: a wrongful death suit arising from a worker's fatal fall (settled for $1,555,000.00; attorneys' fees and defense costs of $159,543.160); a toilet leak claim in one of the apartment units (settled for $60,000; attorneys' fees and defense costs of $62,620.18 incurred); and a fire sprinkler leak claim (settled for $880,000; attorneys' fees and defense costs of $31,671.87 incurred).
On June 7, 2010, Endeavor sued Admiral and others for faulty work. Amerisure tendered the lawsuit to Arch as the primary insurer. Prior to Arch accepting the defense, Amerisure incurred $23,879 in defense fees. In April 2012, Arch withdrew from defense of the lawsuit asserting that attorneys' fees, defense costs, and settlements of $2,000,000 from defending Admiral and other subcontractor defendants exhausted policy limits. Amerisure took over the defense and incurred additional fees and costs of $114,957 before settling the claims. In total, Arch paid a settlement of $1,555,000 and defense costs of $159,543 under the general coverage limit of the OCIP, and paid settlements totaling $1,472,032 and defense costs of $527,967 under the products-completed operations coverage of the OCIP policy.
Amerisure sued Arch in Texas state court for breach of contract, contending Arch wrongfully refused to defend and indemnify Admiral. Arch removed the case to federal court based on diversity jurisdiction. Amerisure filed a motion for partial summary judgment seeking a declaration that: (1) Arch had not exhausted the policy because defense costs did not erode the policy limits; or (2) Arch had a continuing duty to defend after the policy was exhausted. Arch filed a cross-motion for partial summary judgment on the same issues and a second motion for partial summary judgment seeking a declaration on a third issue: that it had not “wrongfully exhausted” the policy by paying uncovered claims. The magistrate judge determined (1) defense costs and attorneys' fees were “expenses” under the Supplementary Payments provision and therefore eroded the policy limits; (2) though subject to the same policy limits, the duty to defend ended only when the policy limits were exhausted by judgments and settlements alone (i.e., not by defense costs); and (3) coverage existed for the toilet and sprinkler leaks and therefore Arch did not “wrongfully exhaust” the policy limits with payments on uncovered claims. The district court adopted the magistrate's recommendation over both parties' objections and held that Arch did not breach its duty to indemnify, but did breach its duty to defend Admiral.
Arch appealed the finding that it had a duty to defend Admiral that had been breached. Amerisure cross-appealed the part of the judgment holding that Arch had no duty to indemnify Admiral. Turning first to the meaning of the term “expenses,” the court noted: “given it its ordinary meaning, when an insurer pays costs of defense, including attorneys' fees, that is an “expense” to the insurer. Absent some indication that a different meaning is intended, we see no reason to deviate from this ordinary meaning of the term.” Turning then to the question of whether “supplementary payments” erode the limits, the court concluded the endorsement transforms the policy into an “eroding limits” policy. The court further found the district court’s finding that there are two separate policy limits for indemnity and defense essentially “reads the endorsement out of the policy.” Finally, the court turned to the argument that Arch wrongfully exhausted the policy by paying claims that should have been excluded under the “products-completed” coverage. The court questioned whether Amerisure had the authority to argue that amounts were “wrongfully paid” and whether such a claim even exists and found that even if assuming arguendo that such a claim did exist, it did not apply here. The court affirmed the district court's judgment regarding the duty to indemnify, reversed the district court's judgment regarding the duty to defend, and rendered judgment for Arch.