Over the past decade, excess D&O insurers have become increasingly aggressive in denying coverage when a policyholder settles with one or more underlying insurers for less than full policy limits. These denials are generally based on a line of cases holding that exhaustion language found in many excess D&O policies requires payment of full limits by each underlying insurer before an excess policy is triggered.
Policyholders typically respond that these cases are wrongly decided (especially where a policyholder itself has paid losses that reach the excess insurer’s layer) because they misconstrue the relevant exhaustion language, conflict with general rules of insurance contract interpretation, and create bad public policy that prohibits compromise between policyholders and underlying insurers. Despite the seminal Zeig decision and other favorable rulings, litigating this issue entails substantial risk for policyholders, as many courts around the country have found the Qualcomm line of cases persuasive.
However, policyholders incorporated in Delaware have a simple — but rarely utilized — way to alleviate this risk: litigate this issue in a Delaware court, where (1) Delaware law should apply to D&O policies issued to Delaware corporations (regardless of their principal place of business), and (2) established Delaware law follows Zeig and should not preclude coverage under excess policies due to below-limits settlements with underlying insurers. This suggested strategy, which empowers Delaware corporations to litigate this issue on a very favorable footing, stems from the Delaware decisions summarized below.
First, although policyholders often assume that choice-of-law decisions in insurance coverage disputes will center on the state of their headquarters, Delaware courts have held that the focus of a choice-of-law analysis under D&O policies should be the policyholder’s state of incorporation. These courts, applying the “most significant relationship test set forth in Restatement (Second) of Conflict of Laws Section 188,” explained that “when the ‘risk is the directors’ and officers’ honesty and fidelity to the corporation, and the choice of law is between the headquarters or the state of incorporation, the state of incorporation has the most significant relationship.’” Put differently “the point is that [the insurer] insured [the policyholder’s] directors and officers under Delaware law” and “[t]hose directors and officers caused a Delaware corporation to defraud its investors, which made the corporation liable and triggered the corporation’s D & O policy,” in which case “what difference does headquarters’ location make to the company or the people involved?” These courts have applied Delaware law to Delaware corporations’ claims for D&O coverage in connection with both derivative claims and securities fraud claims. Although choice-of-law rulings are highly fact-specific, a Delaware corporation should expect a Delaware court to apply Delaware law to its D&O policies.
Second, Delaware courts applying Delaware law have repeatedly “decline[d] to accept the reasoning set forth in Qualcomm … as … contrary to … Zeig and … the established case law of … Delaware,” and permitted policyholders to recover from excess insurers despite below-limits settlements with underlying carriers and detailed exhaustion language in the relevant excess policies. For instance, in Massachusetts Mutual, the court held that full payment from each underlying insurer was not necessary even though the relevant excess policy required that “the Underlying Insurance has been exhausted by the actual payment of losses.” The court in Mills reached the same conclusion under an excess policy that “only provides coverage when the Underlying Limit of Liability is exhausted by reason of the insurers of the Underlying Policies paying or being held liable to pay in legal currency the full amount of the Underlying Limit of Liability as loss.”
In consistently reaching this conclusion, Delaware courts applying Delaware law focused on the rationale, first articulated in Zeig, that an excess insurer has “no rational interest in whether the insured collected the full amount of the primary policies” and that such a requirement would “involve delay, promote litigation, and prevent an adjustment of disputes which is both convenient and commendable.” While every coverage dispute requires a detailed analysis of the pertinent policy wording and other key facts, a Delaware corporation should expect a Delaware court following these precedents to reject an excess carrier’s attempt to escape coverage based on settlements for less than policy limits between the corporation and underlying carriers.
Because excess D&O insurers routinely rely on Qualcomm and its progeny to deny any coverage obligation whatsoever, the ultimate resolution of this exhaustion issue can be the difference for a policyholder between a substantial recovery and no recovery at all under an excess D&O policy. For this reason, Delaware corporations facing such a coverage denial would be well-advised to consult experienced coverage counsel regarding the potential advantages, under their specific facts and policy wording, to litigating a D&O coverage dispute regarding alleged exhaustion issues in Delaware. Although exhaustion disputes with excess D&O insurers can be quite challenging, Delaware-incorporated policyholders confronting this issue should be aware that they have an underutilized strategy available that may be of great assistance.
 See, e.g., Qualcomm, Inc. v. Certain Underwriters at Lloyd’s, London, 161 Cal. App. 4th 184 (2008); Comerica, Inc. v. Zurich Am. Ins. Co., 498 F. Supp. 2d 1019 (E.D. Mich. 2007).
 See, e.g., Zeig v. Mass. Bonding & Ins. Co., 23 F.2d 665 (2nd Cir. 1928); Massachusetts Mut. Life Ins. Co. v. Certain Underwriters at Lloyd’s of London Subscribing to Bond Nos. B0391/FD020720G & B0391/FD020730G, No. CVN10C-11-219FSSCCLD, 2014 WL 3707989 (Del. Super. Ct. June 6, 2014).
 See Arch Insurance Co. v. Murdock, No. CVN16C01104EMDCCLD, 2018 WL 1129110 (Del. Super. Ct. Mar. 1, 2018); Mills Ltd. Partnership v. Liberty Mut. Ins. Co., C.A. No. 09C-11-174 FSS, 2010 WL 8250837 (Del. Super. Nov. 5, 2010).
 Murdock, 2018 WL 1129110, at *9 (quoting Mills, 2010 WL 8250837, at *6).
 Mills, 2010 WL 8250837, at *6.
 See id.; Murdock, 2018 WL 1129110, at *9.
 Insurers often argue that the Second Circuit overturned Zeig when it issued Ali v. Federal Insurance Co., 719 F.3d 83 (2d Cir. 2013), but Delaware courts applying Delaware law have rejected this argument and continued to follow Zeig on this issue even after Ali was issued. See Massachusetts Mut., 2014 WL 3707989, at *6–7.
 2014 WL 3707989, at *10.
 2010 WL 8250837, at *9.
 23 F.2d at 666; see also Massachusetts Mut., 2014 WL 3707989, at *8 (“viewing the exhaustion clause less dogmatically and more practically works to everyone’s advantage, insured and insurer alike”); Mills, 2010 WL 8250837, at *9 (“Most importantly, echoing Zeig, there is no business reason offered to explain why it should make a difference to [the insurer] if [the policyholder] settled with the underlying carriers, so long as the . . . policy was going to be reached.”); HLTH, 2008 WL 3413327, at *15 (“Settlements avoid costly and needless delays and are desirable alternatives to litigation where both parties can agree to payment and leave other separately underwritten risks unchanged. The Court sees unfairness in allowing the excess insurance companies in the instant case to avoid payment on an otherwise undisputedly legitimate claim.”).
Daniel I. Wolf is an associate at Gilbert LLP.
The opinions expressed are those of the author and do not necessarily reflect the views of the firm, its clients, or Portfolio Media, Inc., or any of its or their respective affiliates. This article is for general informational purposes and is not intended to be and should not be taken as legal advice.
Originally published on Law360, reprinted with permission.