In virtually all construction settings, the general contractor or other higher level contractors maintain their own general liability insurance and are also named as additional insureds on subcontractors’ policies. This creates a situation where a defendant in an action brought by a third party may be insured by two or more carriers who may be obligated to respond to the loss. Illinois courts have adopted the selective, or “target,” tender rule, which allows an entity insured under two or more policies to select which carrier it wishes to respond to the loss. John Burns Construction Co. v. Indiana Ins. Co., 189 Ill.2d 570, 727 N.E.2d 211 (2000).
The Illinois First District Court of Appeals recently decided two cases addressing issues of first impression with respect to application of the selective tender rule. In Kajima Construction Services, Inc. v. St. Paul Fire and Marine Ins. Co., 856 N.E.2d 452 (1st Dist. 2006), the appellate court held that a general contractor’s selective tender did not extend to excess insurance provided by the subcontractor’s carrier, finding that the general contractor’s own primary insurance must first be exhausted under the doctrine of horizontal exhaustion. In The North River Ins. Co. v. Grinnell Mutual Reinsurance Co., 2006 Ill. App. LEXIS 1128 (Ill. App. 1st Dist. December 8, 2006), the appellate court addressed a situation where all concurrent primary policies had been exhausted. In that case, the court held that an insured may “target tender” an excess carrier.
A. The Selective Tender Rule Does Not Supersede the Horizontal Exhaustion Doctrine
Kajima Construction Services, Inc. v. St. Paul Fire and Marine Ins. Co., 856 N.E.2d 452 (1st Dist. 2006).
Kajima Construction Services, Inc. (“Kajima”) entered into a subcontract with Midwestern Steel Fabricators, Inc. (“Midwestern”) requiring that Midwestern obtain general liability coverage with $1 million primary coverage and $5 million umbrella coverage. The subcontract also required that Midwestern name Kajima as an additional insured on Midwestern’s insurance policies. In accordance with the subcontract, Midwestern obtained a $2 million primary policy and a $5 million umbrella policy from St. Paul Fire and Marine Ins. Co. (“St. Paul”). Kajima maintained its own general liability coverage with Tokio Marine and Fire Ins. Co. (“Tokio”).
During the construction project, an employee of Midwestern’s subcontractor was seriously injured. The employee subsequently filed a personal injury lawsuit against Kajima and Midwestern, alleging that his injuries were caused by their negligence. Following receipt of the lawsuit, Kajima made a “targeted tender” to Midwestern and St. Paul, requesting a defense and indemnity to the personal injury lawsuit. St. Paul agreed to defend Kajima under a reservation of rights. During the trial of the personal injury action, the parties settled the case for $3 million, with St. Paul paying its primary limit of $2 million and Tokio paying its primary limit of $1 million. St. Paul had previously refused Kajima’s request that it pay the entire $3 million settlement.
Kajima and Tokio subsequently filed a declaratory judgment action against St. Paul seeking reimbursement of Tokio’s contribution to the settlement. Kajima and Tokio asserted that that Tokio was not obligated to contribute any amounts to the settlement because of Kajima’s targeted tender to St. Paul. In response, St. Paul argued that Illinois law required that all primary policies be exhausted prior to reaching any excess policies. The circuit court agreed with St. Paul and entered summary judgment in its favor. Kajima and Tokio appealed.
On appeal, Kajima and Tokio contended that the selective tender rule supersedes the “horizontal exhaustion” doctrine argument advanced by St. Paul. Under this doctrine, an insured covered under multiple primary and excess policies is required to exhaust all primary policies (including uninsured and self insured periods) before invoking any excess policies. Illinois Emcasco Ins. Co. v. Continental Casualty Co., 139 Ill.App.3d 130, 487 N.E.2d 110 (1st Dist. 1985). In contrast, vertical exhaustion allows an insured to seek coverage from an excess carrier so long as any primary policies immediately beneath the excess policies have been exhausted, regardless of whether other primary policies may apply. United States Gypsum Co. v. Admiral Ins. Co., 268 Ill.App.3d 598, 643 N.E.2d 1226 (1994). Vertical exhaustion is not favored by Illinois courts.
Kajima asserted that it exercised its right to selectively tender the defense and indemnity to St. Paul. Accordingly, Kajima and Tokio argued that St. Paul alone must respond to the claim and exhaust both its primary and excess policies before Tokio’s primary policy was implicated (vertical exhaustion). In contrast, St. Paul contended that, while the selective tender rule is recognized by Illinois courts, it applies only to concurrent primary policies, and not to successive primary or excess policies where additional primary coverage is available (horizontal exhaustion).
In its analysis, the appellate court noted that Kajima and Tokio cited no authority to support their assertion that an excess policy could be activated by a selective tender prior to exhausting all primary coverage. In addition, the court emphasized the difference between primary and excess policies (intentions of the contracting parties, premiums paid, conditions to coverage), noting that the general rule in Illinois is that, with certain exceptions, excess coverage cannot be activated until all underlying primary coverage is exhausted. The court declined to apply vertical exhaustion in this case, finding that the selective tender rule should be applied only to circumstances where concurrent coverage exists for additional insureds. Accordingly, to the extent that defense or indemnity costs exceed the primary limits of the selected insurer, the deselected insurer or insurers’ primary policies must respond to the loss before invoking coverage under an excess policy. (On January 24, 2007, the Illinois Supreme Court granted a petition for leave to appeal this case).
B. An Insured May Use Selective Tender Rule and Direct Excess Insurer To Pay Indemnity So Long As All Underlying Primary Insurance Exhausted
The North River Ins. Co. v. Grinnell Mutual Reinsurance Co., 2006 Ill. App. LEXIS 1128 (Ill.App. 1st Dist. December 8, 2006).
In this case, Kajima, the general contractor, entered into a subcontract with Shelco Steel Works, Inc. (“Shelco”) for a construction project. Shelco, in turn, subcontracted with American Miscellaneous Steel, Inc. (“AMS”). During the project, one of AMS’ employees sustained injuries when he was hit by an iron bar joist. The employee filed suit against Kajima, Shelco and others, alleging his injuries resulted from their negligence.
Kajima maintained a $1 million in primary and $2 million excess coverage with Tokio. Shelco was covered by a $ 1 million primary policy issued by North River Insurance Company (“North River”) and a $2 million excess policy issued by United States Fire Insurance Company (“U.S. Fire”). AMS was covered by a $1 million primary policy and $2 million umbrella policy issued by Grinnell Mutual Reinsurance Company (“Grinnell”). Kajima was an additional insured on the Shelco and AMS policies.
After receipt of notice of the personal injury lawsuit, Kajima tendered its defense and indemnity to North River and Grinnell. Both ultimately accepted the tender and shared the costs of Kajima’s defense. As the lawsuit proceeded, it became apparent that the lawsuit would exceed the combined limits of the primary policies issued by North River and Grinnell. Consequently, North River asked Tokio to contribute $500,000 towards a settlement package. Tokio refused. The lawsuit settled for $4 million during trial, with North River and Grinnell contributing their $1 million primary policies, and U.S. Fire contributing $2 million from Shelco’s excess policy. Tokio did not contribute to the settlement.
U.S. Fire subsequently sought declaratory relief against Tokio alleging that Tokio was obligated to exhaust its primary policy before U.S. Fire was obligated to contribute on Kajima’s behalf. In response, Tokio argued that it was not obligated to contribute to the settlement because its policy was not “available,” given Kajima’s selective tender to Shelco, AMS and their respective insurers, including U.S. Fire. Like St. Paul in Kajima Construction Services, Inc. v. St. Paul Fire and Marine Ins. Co., 856 N.E.2d 452 (1st Dist. 2006), U.S. Fire contended that it was not obligated to contribute until all primary policies had been exhausted. U.S. Fire also argued that Kajima and AMS’s excess insurers were also obligated to equally contribute to the loss at an excess level due to the policies’ mutually repugnant “other insurance” clauses.
The trial court granted summary judgment in favor of U.S. Fire and against Tokio with respect to U.S. Fire’s claim that the horizontal exhaustion doctrine exempts the selective tender rule. The trial court also ruled that the selective tender rule applies to multiple excess policies, and because Kajima selectively tendered its defense and indemnity to its subcontractors’ insurers, Tokio’s excess policy was not available for indemnity until the targeted insurers exhausted their policy limits. Tokio appealed and U.S. Fire cross-appealed the judgment of the trial court.
Based on its ruling in the Kajima case discussed above, the appellate court reiterated that the selective tender rule does not entitle an insured to vertically exhaust consecutive insurance policies. Deselected primary insurers must answer for a loss before an excess insurance policy is activated. Thus, the appellate court found that Tokio should have contributed its primary policy towards the settlement before any excess policy.
The appellate court addressed the issue of whether the selective tender rule applies to excess insurers, assuming all underlying insurance is exhausted, in U.S. Fire’s cross-appeal. U.S. Fire sought equitable contribution from Grinnell and Tokio’s excess policies in its declaratory judgment action (Grinnell settled with U.S. Fire for $500,000, which was paid out of the excess policy). The appellate court held that once and insured has exhausted it concurrent primary insurance coverage, it may selectively tender its indemnity to concurrent excess carriers.
In reviewing the extensive body of case law discussing the insured’s “right” to select one insurer, to the exclusion of all other insurers, the appellate court noted that nothing in those cases limited the right only to primary carriers. Central to the appellate court’s reasoning, is the fact that the selective tender rule may be applied only to concurrent, and not consecutive, policies. Accordingly, the appellate court maintained the distinction between primary and excess policies, which was of paramount concern in the Kajima opinion. Similarly, the appellate court found that the fact that an excess policy contained an “other insurance” clause did not preempt the selective tender rule. The appellate court explained that the purpose of an “other insurance” clause is to apportion liability between properly triggered concurrent policies. The appellate court noted that whether the excess policies contained “other insurance” clause was irrelevant because the deselected policy was never “triggered.” Thus, U.S. Fire could not seek contribution from Tokio’s excess layer.
Scott D. Braun is special counsel with Sedgwick, Detert, Moran & Arnold, LLP, in Chicago, Illinois and a member of DRI. Mr. Braun’s insurance coverage practice includes the nationwide management and oversight of professional liability lawsuits. In addition, Mr. Braun has successfully defended contractors and manufacturers in complex construction and products liability cases involving catastrophically injured plaintiffs. Mr. Braun has also represented general contractors, owners and architects in claims arising out of the construction process.