The Delaware Superior Court has ruled that Federal InsuranceCompany must pay a company's defense costs for wrongs committed bya subsidiary under a directors and officers liability policy itissued.

A decision in the case HLTH Corporation and Emdeon PracticeServices Inc. v. Federal Insurance Company et. al was deliveredearlier this month.

Federal, the court said, must pay defense costs on behalf ofHLTH Corporation to the full policy limits against a criminalindictment alleging wrongful acts over an extended period involvinga subsidiary acquired after a number of the alleged acts had takenplace.

Federal had argued that the defense costs should be allocatedproportionately across three different D&O towers which were inforce at various times during the alleged wrongdoing.

Summing up Federal's argument, the decision of the court states,"As [the three towers] of coverage all 'expressly cover wrongfulacts committed within a distinct period of time,' defendants arguethat a proper allocation at this time will allocate defense coststo the appropriate tower of coverage based on 'the timing of thewrongful acts alleged in the indictment.'"

The plaintiffs, meanwhile, argued that Federal's policycontained no language regarding such allocation, and contended thatFederal could not "unilaterally assert...an allocation scheme whichalters the coverage."

William G. Passannante of Anderson Kill & Olick, P.C., leadcounsel for HLTH, said, "What this really comes down to is thepurpose of D&O insurance, very often, is to pay fordefense.

"And the idea that an insurer could wait and make argumentsabout how some of the events didn't take place during its policyperiod in order to argue about what percentage of defense expensesit should pay, when meanwhile you have mounting defense costs, kindof contravenes the whole purpose behind D&O liabilityinsurance."

The court rejected the defendants' allocation scheme and ruledthat it is "unfair to plaintiffs, especially considering theinability of defendants to direct the court to any contractprovision or case that would specifically require it."

The defendants also argued that underlying policies had not beenexhausted, and so Federal's excess policy cannot be triggeredaccording to the contract. The defendants pointed to settlementsthat plaintiffs engaged in with some underlying carriers for lessthan the policy limits.

The plaintiffs, meanwhile, countered that "an excess policy istriggered once the underlying policy is 'functionally exhausted' bysettlement and the loss exceeds the limits of the underlyingpolicy."

Defendants cited two cases where this argument was decided infavor of excess carriers: Qualcomm Inc. v. Certain Underwriters atLloyd's, London, which was decided in California; and Comerica Inc.v. Zurich American Insurance Co., which was decided inMichigan.

The Delaware court, though, chose to reference Stargatt v.Fidelity and Casualty Company of New York, which was heard in theUnited States District Court for the District of Delaware; andWestinghouse Electric Corporation v. American Home AssuranceCompany, which was heard in New Jersey.

In both cases it was determined that the excess policy wastriggered when the underlying policy limit was reached by the totalcosts incurred by the insured.

"The court sees unfairness in allowing excess insurancecompanies in the instant case to avoid payment on an otherwiseundisputedly legitimate claim," wrote Judge Richard R. Cooch.

Noting the divergence of opinions among the cases cited by thedefendants and those cited by the court, Mr. Passannante said thathe believes the Qualcomm and Comerica cases diverged from thecurrent majority rule, but he noted that "now that you have thisissue in [Michigan and California] we're probably going to see morelitigation on [this matter]."

The company did not immediately respond when asked if it wouldappeal. Mr. Passannante said it is too soon to tell how Federalwill react.