February 27, 2018 Practice Points

When and How an Insured—and Its Insurer—Become “Legally Obligated to Pay”

This decision holds particular value for corporate policyholders and their counsel deciding how best to structure a settlement agreement and any associated funding mechanism

by Christopher Kuleba

The U.S. District Court for the Southern District of Florida, applying New York law, recently clarified the circumstances under which an insured—and thus its insurer—becomes “legally obligated to pay” an underlying settlement. In Sun Capital Partners, Inc. v. Twin City Fire Insurance Company, Case No. 9:12-CV-81397-KAM (S.D. Fla. January 16, 2018), the insured and several of its 43 co-defendants settled an underlying lawsuit for $166 million, agreeing to internally allocate the settlement sum in accordance with their relative exposure. To facilitate the orderly consolidation of settlement funds from multiple sources—including assets temporarily held by third party entities partially owned by the insured—the insured and its co-defendants created an LLC to act as a paying agent on behalf of the settling defendants. The settlement funds were consolidated from various sources into the paying agent and, upon closing, the paying agent issued payment to the plaintiffs.

The carrier sought to disclaim all responsibility under its $10 million excess directors and officers (D&O) liability policy on the basis that the insured was not legally obligated to pay the settlement sums at issue. The carrier argued that since the settlement agreement obligated entities other than the insured—including the paying agent—to issue payment on the insured’s behalf, the insured never paid or became legally obligated to pay. The insured argued that the issue of whether it actually paid was irrelevant under a liability policy obligating the insurer to pay when the insured becomes “legally obligated to pay,” as distinguished from an indemnity policy under which the insurer is only obligated to reimburse the insured for amounts paid out of pocket. As evidence that it incurred the requisite legal obligation to pay, the insured pointed to the language of the settlement agreement rendering the insured jointly and severally liable for the settlement payment, even though the agreement directed the defendants’ paying agent to make the actual payment.

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