California Supreme Court Confirms Policyholders May Sue Excess Insurers for Declaratory Relief and Bad Faith Prior to Exhaustion of Underlying Policies

Declaratory Relief. The Court confirmed that an insured may state a viable cause of action for declaratory relief regarding coverage and liability under an excess insurance policy “even if all of the underlying insurance coverage has not yet been exhausted.” This is because an actual controversy may exist “even when coverage depends on the satisfaction of a future contingency or contingencies.” Thus, “for a declaratory judgment coverage action involving an excess policy to be ripe, it must be practically or reasonably likely that the insured’s potential liability will reach into the excess coverage; absolute proof that the policies will be triggered is not required.”

The Court recognized that “the maintenance of a single action that includes claims for declaratory relief has significant advantages relative to the alternative of piecemeal litigation involving serial lawsuits against the excess insurers.” The Court also determined that declaratory relief was neither unnecessary nor improper under the circumstances and rejected the excess insurers’ arguments that the declaratory relief claim was duplicative of other claims, improper due to Twin City’s assertion of defenses in the pending parallel action, or an undue hardship on excess insurers.

Insurer Bad Faith. The Court held “an insured suing an excess insurer for tortious breach of the implied covenant of good faith and fair dealing does not have to allege the prior exhaustion of all underlying insurance.” Instead, the Court held, “[i]t is sufficient to allege facts that, taken as true, show that coverage under an excess policy will attach, and that the insurer’s misconduct has impaired the insured’s recovery of benefits owed to it under the policy.” The Court confirmed that:

• insurers owe insureds the duty to act with good faith from the inception of the contract;
• an insurer may breach the implied covenant of good faith and fair dealing while remaining in technical compliance with the express terms of the policy; and
• a breach of the implied covenant can occur before coverage is due and prior to the breach of any obligation to pay benefits under the policy.

The Court left open the question of whether a bad faith claim might lie in what it termed the “unusual circumstances” of a bad faith claim absent coverage where the insured suffers consequential harm from the insurer’s conduct.

The decision allows insureds to resolve declaratory relief and bad faith claims against excess insurers in a single action rather than through piecemeal litigation and confirmed that an insurer’s duty of good faith arises at contract formation and may be breached even before any obligation to pay benefits has matured.

Pillsbury’s Anne Voigts, leader of the firm’s appellate practice, and Pauleen Truong are counsel in this proceeding. Pillsbury Winthrop Shaw Pittman LLP, Reed Smith, and King & Spalding represented Petitioners in the California Supreme Court. Sterlington PLLC served as consulting attorneys on the briefs.