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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.

The court agreed with the insured, holding that, as a matter of law, the insured incurred a legal obligation to pay under the settlement agreement, thereby triggering the coverage grant of the D&O officers liability policy. Importantly, the court rejected the notion that an insured’s decision to fund its settlement obligation through a paying agent or other indirect mechanism eliminated its “legal obligation to pay” for purposes of coverage under the subject liability insurance policy:

[T]he fact that the Settlement Agreement identifies the sources of payment that satisfy Sun’s liability does not mean that the Settlement Agreement does not create Sun’s obligation to pay, even assuming arguendo for purposes of this Order only, that none of the payment sources enumerated in the agreement required direct payment from Sun. There is nothing in the Policy that requires Sun to pay the liability or suffer out-of-pocket loss as a condition to coverage. Rather, coverage applies under this liability Policy “as soon as the insured incurs liability for the loss.” Moreover, although the Settlement Agreement establishes three sources of payment, the Settlement Agreement specifically provides that Sun is jointly and severally liable for those payments and there is nothing in the Settlement Agreement that purports to release Sun from its liability absent full satisfaction of the settlement amount.

This decision affects individual and corporate policyholders alike, but holds particular value for corporate policyholders and their counsel deciding how best to structure a settlement agreement and any associated funding mechanism. The Sun Capital decision was driven by the language of the subject settlement agreement and the specific (though relatively common) language of the subject D&O liability policy. Insureds and their counsel should always be sure to review the language of the particular insurance policy at issue and the state law under which that policy will likely be construed when confronting similar issues.

Disclosure: The author, Christopher Kuleba, and his firm, Ver Ploeg & Lumpkin, P.A., represent Sun Capital Partners, Inc. in the matter discussed herein.


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