Filed Under:Claims, Litigation

The Clash of Insurance Coverage Doctrines Continues

Part Two: Horizontal Exhaustion Makes An Entrance

Thus far, we have seen that although the “targeted tender” doctrine permits an insured to avoid or take an end run around the “other insurance” clause of the commercial general liability (CGL) policy, the insured’s right to make a targeted tender is based upon particular policy language rather than upon public policy considerations. The doctrine can therefore be eliminated by appropriately drafted insurance coverage language.

See Related Article: Clash of Coverage Doctrines, Part One

A second caveat to the application of the targeted tender doctrine is that, according to the Supreme Court discussion in Burns, the right to make a targeted tender is unique to the insured. In other words, if the insured tenders its defense of a claim to its own CGL carrier, then that carrier is not entitled to make a “targeted tender” to another insurance company in order to avoid the application of its own coverage. Those insurance companies responding to targeted tenders are well advised to initially consider who is actually making the tender and to require confirmation from the insured party itself that it is the one making the targeted tender. In at least some instances, one will find that the targeted tender is not actually being made by the insured but rather by the insured’s own CGL insurance carrier, something that is not permitted.

Insurers Must Exercise Caution

Let’s assume, however, that these concerns are not a problem. There is, for example, no policy language prohibiting a targeted tender, and the insured itself actually wants to make a targeted to tender to avoid the application of its own insurance policy. In those circumstances, the insured should nevertheless still be cautious in making a “targeted tender” for several reasons.

First, even though the insured may have the absolute right to make a “targeted tender,” it must consider whether the policy that it is targeting provides sufficient coverage, both in terms of policy limits and scope of coverage, to cover the particular claim or loss at issue.

Frequently, additional insureds are entitled to coverage that is much narrower in scope than would apply to a named insured under the same policy. Although there are numerous additional insured endorsements now in use, many limit the scope of coverage to the additional insured. For example, a commonly used additional insured endorsement [i]contains the following provisions as to the scope of coverage and exclusions:

The insurance provided to additional insureds is limited as follows:

(1) The person or organization is an additional insured but only with respect to your acts or omissions in connection with 'your work' for that additional insured by you or on your behalf at the location designated in the agreement and designated in a Certificate of Insurance issued by our authorized producer.

(2) Additional exclusions.  This insurance does not apply to: (c) ‘Bodily injury’ or ‘property damage’ arising out of any act or omission of the additional insured(s) or any of their employees.”

Thus, a general contractor invoking such coverage should be concerned that the insurance carrier may reserve its rights to deny coverage based upon the narrow scope of the endorsement. In that situation, even though the general contractor has a right to make a “targeted tender” and even though the targeted policy responds, ultimately it may not provide coverage. If the insured has not also tendered to its own CGL carrier and has in effect let its own insurance carrier “off the hook”, at the end of the day it may not have any coverage at all for the loss. Unfortunately, this is something that typically would not be known until after a case goes to verdict, by which time it would be too late for the insured to invoke its own coverage if it had not done so before.

Thus, an insured making a “targeted tender” would be wise to consider whether it is really a good idea in the first instance. While the prospect of not invoking its own coverage and utilizing its own coverage limits has an obvious appeal, it becomes less appealing when one considers the potential perils in doing so. 

The “Horizontal Exhaustion” Doctrine

Now we reach the point that is even more perilous to an insured who is considering making a targeted tender. This is the doctrine of “horizontal exhaustion.” The doctrine of horizontal exhaustion predates the adoption of the targeted tender doctrine. It was first recognized by an Illinois appellate court in United States Gypsum Company v. Admiral Insurance Company, 268 Ill.App.3d 598, 643 N.E.2d 1226 (1st Dist. 1994).

The doctrine of horizontal exhaustion quite simply provides that where an insured has both primary and excess insurance coverage, it must exhaust or use up all of its primary insurance coverage before it can reach any of its excess coverage.

The horizontal exhaustion doctrine does not pose a problem where the insured has multiple primary policies and tenders the defense of a claim to all of those insurance carriers. If the tender has been made to all, then all of those policies have been implicated and the allocation for the loss among the respective primary carriers would be determined by the “other insurance” clauses of the policies.

A different situation, however, is created as a result of the “targeted tender” doctrine. As already seen, in many situations it may seem to the insured that it is in its best interest to avoid tendering the defense of a particular claim or suit to its own CGL insurer if it enjoys other coverage under policies procured by others. This is all well and good as long as the targeted policy is sufficient scope to cover the loss but it is also imperative that the targeted policies be sufficient in terms of coverage limits to cover the “targeted tender.”

For example, if a general contractor is sued by a worker who sustained catastrophic injuries in a construction site accident, making a targeted tender to an insurer that provides additional insured coverage with $1 million limits is not such a great idea because even if the coverage applies, it will probably not be enough to cover the loss if the general contractor is found liable. If that happens, then the insured would need excess coverage to cover the loss and avoid personal liability for the excess portion of any judgment or verdict. It is at this point that the “horizontal exhaustion” doctrine assumes tremendous significance.

Loss of Excess Coverage

Simply put, by having made a “targeted tender” to one primary carrier and thereby deactivating or letting its own primary insurance carrier off the hook, the contractor may have lost all of its excess coverage that would otherwise apply.

Precisely that type of situation was addressed by the Illinois Supreme Court in Kajima Construction Services, Inc. v. St. Paul fire and Marine insurance Company, 227 Ill.App.3d 102, 879 N.E.2d 305 (2007). There, Kajima Construction Company was a general contractor. It entered into a subcontract agreement with Midwestern Steel Fabricators for certain work. The subcontract required that Midwestern name Kajima as an additional insured under its CGL policies. Pursuant to that provision, Kajima was in fact named as an additional insured under a $2 million primary and a $5 million umbrella policy issued bySt. Paul fire and Marine Insurance Company. Kajima also had $1 million of primary coverage through its own CGL carrier, Tokio Marine and Fire Insurance Company.

As result of a construction site accident, Kajima and Midwestern were both sued by an injured worker, Tom Jones. In response to that suit, Kajima made what it designated as a “targeted tender” toSt. Paul. Paul refused to accept that tender and Kajima then requested that its own insurer, Tokio, provide it with a defense, which Tokio did. Subsequently,St. Paulreconsidered and accepted Kajima’s tender of defense. At that point, Kajima was then being defended by two primary carriers, its own carrier, Tokio, andSt. Paul. As the case progressed, Tokio made a pretrial demand uponSt. Paulto settle the case for $3 million, which included St. Paul’s $2 million primary limits and $1 million from its excess coverage.St. Paulrefused to do so. Later, however, the case was settled for a total of $3 million, withSt. Paulpaying $2 million of its primary coverage and Tokio paying the limits of its $1 million primary coverage.

After the case was settled, Kajima and Tokio sued St. Paul, claiming that the “targeted tender” to St. Paul made St. Paul responsible for the entire amount of the $3 million settlement, and St. Paul was therefore required to reimburse Kajima and Tokio for their $1 million contribution to the settlement. The case thus involved a conflict between the targeted tender and horizontal exhaustion doctrines. Kajima and Tokio claimed that the targeted tender doctrine, which was the more recent of those coverage doctrines, applied and that because it had made a “targeted tender” to St. Paul, all of St. Paul’s coverage, both primary and excess, had been invoked. They claimed that the doctrine of horizontal exhaustion did not require that Tokio pay any portion of its primary limits towards the settlement. St. Paul of course argued just the opposite—that its excess coverage could not be reached until Tokio’s primary coverage was exhausted.

Primary vs. Excess Coverage

In resolving this issue, the Illinois Supreme Court concluded that the “horizontal exhaustion” doctrine applied and that the targeted tender doctrine did not apply to excess coverage. Accordingly, Tokio and Kajima were not entitled to recoup any portion of the amounts they paid towards settlement because Tokio was required to contribute its $1 million primary limit before theSt. Paulexcess coverage could be reached.

In a finding that the horizontal exhaustion doctrine preempted the targeted tender doctrine with respect to excess coverage, the Supreme Court relied upon the distinction between primary and excess coverage. It noted, for example, that premiums charged for excess coverage reflect an intent that umbrella policies serve a different function from primary policies, “[e]xcess premiums are lower because excess coverage is, by its very nature, not supposed to be triggered until the underlying policy has been exhausted up to its limits.” The court also stated:

Given the clear distinctions between primary and excess insurance coverage, we decline to extend the “targeted tender” doctrine to require one insurer to vertically exhausted primary and excess coverage limits before all primary insurance available to the insured has been exhausted. Extending the “targeted tender” rules require an access policy to pay before a primary policy would eviscerate the distinction between primary and excess insurance. Kajima, 227 Ill.2d 116.

Based upon the court’s conclusion that the “targeted tender” doctrine did not apply to excess coverage, Kajima and Tokio were on the hook for their $1 million contribution towards settlement. As far as Kajima was concerned, it was nevertheless still covered for the entire loss through its own insurance and that procured for it by Midwestern. However, that proved to be the case only because Kajima had tendered his defense to its own primary insurer, Tokio, after St. Paul initially rejected the “targeted tender."

Stay Tuned...

In the next (and final) installment, we will further discuss the Kajima decision and the distinction between "true" excess coverage and excess coverage that might arise "by coincidence" where multiple primary insurance contracts are at play for the same loss. 

[i] See, American Country Insurance v.  James McHugh Construction Co, 344 Ill.App.3d 960, 801 N.E.2d 103 (1st dist. 2003), for cases discussing the scope and limitations on coverage created by this type of policy endorsement.


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