Connecticut Appellate Court Breaks New Ground on Policy Exhaustion
By: Eric B. Hermanson and Austin D. Moody
The Connecticut Appellate Court recently issued a wide-ranging opinion, Continental Casualty Co. v. Rohr, Inc., which significantly extended the current restrictive view on when a general liability policy can be considered exhausted so as to trigger overlying excess coverage. The case marks a further step away from Judge Augustus Hand’s almost-century-old ruling in Zeig v. Massachusetts Bonding & Ins. Co., which held that an underlying policy could be “exhausted” by a below-limits settlement as long as the insured was willing to “fill the gap” between the settlement amount and the limits of the policy.
In recent years, courts in California and elsewhere have increasingly walked back Zeig’s broad ruling – holding in Qualcomm v. Certain Underwriters, for example, that an insured’s below-limits settlement with primary carriers does not exhaust the limits of primary coverage, or allow the insured to access overlying excess coverage.
However, these insurer-friendly decisions typically involved excess policy language that differed from Zeig: specifically, language in which excess insurers explicitly required an underlying insurer to pay its full limits before the underlying policy is deemed “exhausted.”
Rohr takes Qualcomm a step further – holding that even without explicit policy language, a policy can be “exhausted” only when the underlying insurer pays its full limits.
Rohr also makes a number of other important rulings as to policyholders’ ability to access excess coverage – holding, for example, that horizontal (not vertical) exhaustion of primary policies is required before excess policies are triggered under California law.
The plaintiff in Rohr was an aerospace manufacturing company, which purchased various policies of general liability insurance. Beginning in the 1940s, and for a period of several decades, it operated at various plants in California and elsewhere. Environmental contamination was discovered at these plants, leading to cleanup orders.
Rohr sought coverage for these cleanup costs under a series of multi-year primary policies issued by Royal Indemnity Company (Royal) during the period from 1959 to 1971. The Royal policies had per-occurrence limits of $2 million, but the policies did not clearly state if the limits were annualized, i.e., if the limits applied once per policy period, or separately for each year the policy was in effect.
Sitting over Royal’s primary coverage were a number of excess policies issued by Twin City Fire Insurance Company (Twin City), Continental Casualty Company (Continental), Federal Insurance Co. (Federal) and Century Indemnity Co. (Century). All parties agreed that this coverage was governed by California law.
Eventually, Rohr and Royal reached a settlement in which they agreed to compromise the question of annualization. Royal paid an amount that was greater than the combined single limits of the policies, but less than the full limits of the Royal policies would have been if annualized.
Rohr and Twin City also reached a settlement. Compromising Rohr’s claim, Twin City paid an amount that was more than it believed it owed, but less than the full limits of the Twin City policies.
Finally, Rohr turned its attention to the other excess carriers, sitting over Royal and Twin City. Those carriers denied coverage. Among other things, these carriers invoked Qualcomm, and argued Rohr’s settlements with Royal and Twin City did not exhaust the underlying policies because the full limits of those policies had not been paid. The carriers argued, further, that Royal’s failure to pay full limits should end any right to excess coverage, based on a theory of horizontal exhaustion.
No Annualization of Primary Limits
The Connecticut Appellate Court first addressed the Royal policies. It found Royal’s initial position had been correct: the policies did not provide for annual limits. As a result, Rohr’s settlement with Royal – in which Royal compromised its dispute by paying a sum beyond the policies’ combined single limits – exceeded the limits of these policies, correctly calculated on a non-annualized basis.
In effect, the court found that Royal, settling the dispute, had overpaid its correctly calculated, non-annualized legal liability. Thus, the court held, all of the Royal policies were exhausted, and Rohr could seek excess coverage, notwithstanding the court’s ruling that horizontal exhaustion applied.
Qualcomm Extended To Policies That Do Not Explicitly Refer To “Payment”
As to Twin City, the Appellate Court accepted Federal’s argument: namely, that the Twin City policies could not be “constructively exhausted” by a settlement in which Twin City did not pay its full policy limits. Because the Twin City policies were not exhausted by the settlement, the overlying Federal policies were not triggered, and had no obligation to respond.
On its face, this part of the Appellate Court’s ruling would seem to be a straightforward application of Qualcomm. But in fact Rohr goes further than Qualcomm. The excess policies in Qualcomm said the excess insurers in that case would “be liable only after the insurers under each of the underlying policies have paid or have been held liable to pay the full amount of the Underlying Limit of Liability.” The Qualcomm court relied heavily on this language: exploring in detail the case law as to the meaning of the term “payment,” and concluding that “the phrase ‘have paid . . . the full amount of [$20 million],’ particularly when read in the context of the entire excess policy and its function as arising upon exhaustion of primary insurance, cannot have any other reasonable meaning than actual payment of no less than the $20 million underlying limit.”
By contrast, the Federal excess policies at issue in Rohr did not have the same language. They contained no specific reference to exhaustion by “payment” of the underlying carrier’s limits. They only said that Federal’s excess coverage would “apply … in excess of and after all underlying insurance… has been exhausted.”
In finding full payment to be necessary, even under this less explicit policy language, the Appellate Court essentially rejected the view that the concept of exhaustion allows for “constructive” exhaustion, i.e., a settlement that in which the insurer pays less than full limits and the insured or third parties “fill the gap.” The Appellate Court held, in other words, that full payment by an underlying carrier is required to exhaust the underlying carrier’s policies, and access excess coverage, even if the excess carrier’s policies do not explicitly require or refer to such “payment.”
Rohr marks the next step in the retreat from Zeig and its progeny. It rejects the public policy concerns that motivated the Zeig court almost a hundred years ago, and finds full payment of limits is required to “exhaust” an underlying policy, even if the overlying excess policy does not require such payment explicitly.
As courts continue to grapple with the issue of underlying exhaustion, it will be interesting to observe whether Rohr is seen as an outlier, or the first in a new wave of decisions, pushing off from Zeig in new directions.
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 Nos. AC 41537, AC 41538, AC 42613, 2020 Conn. App. LEXIS 366 (App. Ct. Dec. 1, 2020).
 23 F.2d 665 (2d Cir. 1928).
 The Zeig decision was largely based on a public policy favoring settlements, and on a widely-criticized judicial assumption that excess carriers had no particular interest in whether underlying policies paid a claim – in whole or in part – so long as the excess carrier maintained its own attachment point and was not obligated to “drop down.” See Zeig, 23 F.32d at 666: “[T]o require an absolute collection of the primary insurance to its full limit would in many, if not most, cases involve delay, promote litigation, and prevent an adjustment of disputes which is both convenient and commendable.”
 73 Cal. Rptr. 3d 770 (Ct. App. 2008).
 For other cases to the same effect, see e.g., Mehdi Ali v. Federal Ins. Co., 719 F.3d 83 (2d Cir. 2013); Comerica Inc. v. Zurich Am. Ins. Co., 489 F.Supp.2d 1019 (S.D. Mich. 2007); Citigroup Inc. v. Fed. Ins. Co., 649 F.3d 367, 373 (5th Cir. 2011); Intel Corp. v. American Guarantee & Liability Ins. Co., 2012 Del. LEXIS 480 (Del. 2012).
 The excess policy language in Qualcomm said, for example, that the excess carriers were to be “liable only after the insurers under each of the Underlying Policies have paid or have been held liable to pay the full amount of the Underlying Limit of Liability.” Qualcomm, 161 Cal. App. 4th at 189.
 Horizontal exhaustion refers to an exhaustion method in which all of an insured’s primary insurance, across all policy periods, must be exhausted before any excess coverage can be accessed in any of these policy periods. Vertical exhaustion refers to an exhaustion method in which the insured may access excess coverage, in a particular policy period. In finding that horizontal exhaustion was required, under California law, the Appellate Court surprised many observers. Just a few months earlier, in Montrose Chem. Corp. of Cal. v. Superior Court, 9 Cal. 5th 215, 260 Cal. Rptr. 3d 822, 460 P.3d 1201 (2020), the California Supreme Court held “vertical exhaustion” – not horizontal exhaustion – should apply to excess policies with different attachment points issued over multiple years. But the Connecticut Appellate Court distinguished Montrose, on grounds that Montrose involved a scenario where all primary coverage had been exhausted, and overlying excess policies had different attachment points in different policy years. According to the Appellate Court, Montrose did not address the issue of “when or whether an insured may access excess policies before all primary insurance covering all relevant policy periods has been exhausted.” Instead, the Court found, this issue was governed by earlier California law, which it said favored horizontal exhaustion.
 In February 2021, at the request of the parties, the court acknowledged that it had slightly overstepped the scope of the interlocutory appeal. The parties agreed that “the issue in this interlocutory appeal was limited to whether the settlement payment made under the Royal primary policies was capable of exhausting the policies’ per occurrence limits. The question of whether, in fact, the policies had been exhausted with respect to any one occurrence, was reserved for determination on remand to the trial court.” The court corrected its opinion to state that “in summary, because [Royal], has paid Rohr more than the per occurrence limits of its 1959 to 1971 policies, the obligations of the Continental plaintiffs may arise if it is determined on remand that [Royal’s] payment satisfies the exhaustion requirement of those policies with respect to any one occurrence.”