In General Star National Insurance Company v. Universal Fabricators, Inc., 2009 WL 3645683 (2d Cir. Nov. 5, 2009), the Second Circuit held that a primary insurer’s settlement of an underlying action did not bind a non-participating excess insurer.

The decision arises out of a rather complex factual background. The insured, Universal Fabricators, Inc. (“UFI”), entered into a contract with the City of New York and International Terminal Operating Company (“ITO”) to perform repair work on the New York City passenger ship terminal. The contract between ITO and UFI required UFI to procure general liability insurance in the amount of $5 million per occurrence, naming ITO and the City as additional insureds, and to indemnify and defend ITO and the City from claims relating to the repair work. UFI purchased a primary general liability insurance policy in the amount of $1 million from Mutual Marine and a secondary excess policy in the amount of $4 million from General Star.

On February 26, 1999, Ronald Ernish, a UFI employee performing repair work at the terminal, was seriously injured when a scaffold collapsed. Ernish brought suit against ITO and the City. ITO and the City then filed a third-party complaint against UFI seeking indemnification.

Mutual Marine and General Star received notification of the third-party action against UFI. Because General Star concluded that UFI’s liability exposure would not exceed Mutual Marine’s policy limits, General Star authorized Mutual Marine to defend UFI in the third-party action. General Star instructed Mutual Marine that “should future developments lead you to believe otherwise, please notify us immediately.” 2009 WL 3645683, at *2.

Ultimately, Mutual Marine arrived at a settlement agreement with ITO and the City, settling the third-party claim that ITO and the City had asserted against UFI (“First Agreement”). The First Agreement provided that ITO and the City would pay 25% and UFI would pay 75% of whatever amount was ultimately awarded to Ernish against ITO and the City in the Ernish lawsuit. Mutual Marine neither informed General Star of the First Agreement nor did Mutual Marine obtain UFI’s consent.

The state trial court directed a verdict in the Ernish lawsuit in favor of Ernish against ITO and the City pursuant to the New York Scaffolding law. Thereafter, a jury returned an award of $3 million against ITO and the City. On appeal to the New York Appellate Division, the judgment was reduced $2,175,000. The amount of the verdict exceeded the parties’and insurers’ initial expectations.

ITO and the City were insured by National Union Fire Insurance Company of Louisiana (“National Union”). National Union paid Ernish 25% of the judgment to satisfy the obligation of ITO and the City under the First Agreement. Mutual Marine, in turn, paid its policy limits in partial satisfaction of UFI’s 75% share of the judgment against ITO and the City and the First Agreement. Thus, $650,584.19 of UFI’s portion of the judgment under the First Agreement remained unpaid. General Star, however, refused to pay that amount, contending that it was not bound by the First Agreement.

National Union paid the remainder of the judgment and then commenced a declaratory judgment action against UFI, Mutual Marine, and General Star. Thereafter, Mutual Marine, UFI, and National Union entered into two additional settlement agreements. Mutual Marine and UFI entered into a settlement agreement (“Second Agreement”) pursuant to which Mutual Marine agreed to indemnify and defend UFI in National Union’s declaratory judgment action. In consideration, UFI agreed that to the extent that Mutual Marine pays any judgment against UFI, Mutual Marine shall be subrogated to the rights of UFI, including the right to pursue claims against General Star.

In turn, Mutual Marine and National Union entered into a settlement agreement (“Third Agreement”), pursuant to which Mutual Marine paid National Union $700,000, the amount National Union had paid to satisfy UFI’s obligation to ITO and the City under the First Agreement. National Union correspondingly dismissed its suit against UFI and Mutual Marine, assigning to Mutual Marine the rights it had asserted against General Star.

Mutual Marine then asserted a claim against General Star seeking the excess amount over its policy limits that it had paid to National Union under the terms of the Third Agreement. The district court entered summary judgment for Mutual Marine. The Second Circuit reversed that decision and remanded the case to the district court.

The General Star policy provided that General Star would pay for “ultimate net loss in excess of the retained limit because of bodily injury or property damage to which the policy applies.” The policy further provided that “ultimate net loss means the total amount of damages for which the Insured is legally liable. Ultimate net loss may be established by adjudication, arbitration or a compromise settlement to which [General Star] has previously agreed in writing.”

The Court concluded that there remained for determination the issue of whether General Star was obligated to reimburse Mutual Marine because liability had in some manner been established against UFI by means other than the judgment against ITO and the City. 2009 WL 3645683, at *5.

The Court concluded that the district court was correct in deciding that General Star was not directly obligated to reimburse Mutual Marine under the First Agreement because General Star was not a party to that agreement.

“The harder question is whether General Star is bound by the terms of its policy with UFI to reimburse Mutual Marine.” 2009 WL 3645683, at *6. The Court observed that under the General Star policy “it is the amount of damages for which the insured is legally liable that ‘may be established by adjudication, arbitration or a compromise settlement to which [General Star] has previously agreed in writing,’ not the legal liability itself.” Id. That is, the “establishment of liability is the predicate to the applicability of the provision rather than being governed by it.” Id. (emphasis in original).

The Court concluded that General Star was not necessarily contractually obligated to reimburse Mutual Marine based on the judgment against ITO and the City in the Ernish lawsuit. 2009 WL 3645683, at *7. “Mutual Marine is not pursuing any rights that may or may not have belonged to ITO and the City (or their insurers) based on their status as additional insureds.” 2009 WL 3645683, at *8. On that basis, the Court concluded that it was immaterial “whether General Star has ever owed ITO and the City anything as additional named insureds under the GenStar Policy.” Id. “Since Mutual Marine does not assert rights in the place of ITO and the City against General Star, General Star is not liable to Mutual Marine on the basis of any direct obligation General Star may have had to ITO and the City arising out of the adjudication in the Ernish lawsuit against them.” 2009 WL 3645683, at *8.

The Court determined that “the Ernish adjudication was not tantamount to an adjudication of ‘legal liability’ on the part of the relevant ‘insured’ in this case, UFI.” 2009 WL 3645683, at *9. “And without an establishment of legal liability, ‘ultimate net loss’ could not be established either.” Id.

Nonetheless, the Court concluded that the First Agreement may well have established the legal liability of UFI for Ernish’s judgment. “If it was properly executed by Mutual Marine on behalf of UFI and rendered UFI liable for three-quarters of the judgment against ITO and the City, then the Ernish adjudication would have determined not liability, but the amount for which UFI was legally liable, thereby constituting an ‘ultimate net loss’ for which General Star was liable under its policy.” Id.

The Court acknowledged that “using the First Agreement to establish the legal liability of UFI would appear to violate the condition in the GenStar Policy that ‘no insured will, except at their own cost, voluntarily make a payment, assume any obligation, or incur any expense without our consent.’” Nonetheless, General Star had not “issued a disclaimer to that effect, as it was required to do under New York insurance law.” Id. The Court rejected General Star’s argument that it was not required to disclaim coverage because a disclaimer is unnecessary where a claim falls outside the scope of the policy’s coverage. Rather, the Court observed that General Star’s defense to coverage was a “‘policy condition’ that is plainly in nature of an exclusion, for which disclaimer is required, and is not part of the ‘coverage portion’ of the GenStar Policy.” 2009 WL 3645683, at *10.

On these findings, the Court concluded that “the GenStar Policy does not foreclose the possibility that the First Agreement established UFI’s liability and thereby, in conjunction with the Ernish litigation, obligated General Star to reimburse Mutual Marine for the excess Mutual Marine paid over its policy limit to cover UFI’s share of the judgment.” Id.

The Court recognized that “if UFI was never bound by the First Agreement, that agreement could establish no legal liability on the part of UFI for which General Star would be liable under the GenStar Policy.” 2009 WL 3645683, at *11. Finally, the Court rejected General Star’s argument that Mutual Marine acted as a volunteer in entering into the Third Agreement: “Although the Ernish adjudication in itself did not establish an ‘ultimate net loss’ with respect to UFI such that UFI had a claim against General Star that it could assign to Mutual Marine, it may have done so if the legal liability of UFI was established under the First Agreement or otherwise.” 2009 WL 3645683, at *11. The Court remanded to the district court the resolution of the factual question of whether Mutual Marine was acting as a volunteer when it paid an amount in excess of the policy limit. Id.