The Delaware Superior Court has ruled that Federal Insurance Company must pay a company's defense costs for wrongs committed by a subsidiary under a directors and officers liability policy it issued.

A decision in the case HLTH Corporation and Emdeon Practice Services Inc. v. Federal Insurance Company et. al was delivered earlier this month.

Federal, the court said, must pay defense costs on behalf of HLTH Corporation to the full policy limits against a criminal indictment alleging wrongful acts over an extended period involving a subsidiary acquired after a number of the alleged acts had taken place.

Federal had argued that the defense costs should be allocated proportionately across three different D&O towers which were in force 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 wrongful acts committed within a distinct period of time,' defendants argue that a proper allocation at this time will allocate defense costs to the appropriate tower of coverage based on 'the timing of the wrongful acts alleged in the indictment.'"

The plaintiffs, meanwhile, argued that Federal's policy contained no language regarding such allocation, and contended that Federal could not "unilaterally assert...an allocation scheme which alters the coverage."

William G. Passannante of Anderson Kill & Olick, P.C., lead counsel for HLTH, said, "What this really comes down to is the purpose of D&O insurance, very often, is to pay for defense.

"And the idea that an insurer could wait and make arguments about how some of the events didn't take place during its policy period in order to argue about what percentage of defense expenses it should pay, when meanwhile you have mounting defense costs, kind of contravenes the whole purpose behind D&O liability insurance."

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

The defendants also argued that underlying policies had not been exhausted, and so Federal's excess policy cannot be triggered according to the contract. The defendants pointed to settlements that plaintiffs engaged in with some underlying carriers for less than the policy limits.

The plaintiffs, meanwhile, countered that "an excess policy is triggered once the underlying policy is 'functionally exhausted' by settlement and the loss exceeds the limits of the underlying policy."

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

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

In both cases it was determined that the excess policy was triggered when the underlying policy limit was reached by the total costs incurred by the insured.

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

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

The company did not immediately respond when asked if it would appeal. Mr. Passannante said it is too soon to tell how Federal will react.

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Delaware Court Rules Federal Must Cover Defense Costs

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