In Isilon Systems, Inc. v. Twin City Fire Ins. Co., Case No. C10-1392 (W.D. Wash. April 10, 2012) [see here], the Court handed down what some may view as a surprising ruling upon the defendant excess insurer’s Motion for Partial Summary Judgment.

The underlying facts are rather straightforward. The excess insurer attached with a policy limit of $5 million excess of $20 million underlying limits.[1] The claim at issue was one brought by the SEC against a former CFO of the insured company. It was resolved with an award of injunctive relief, but with the incurrence of significant defense expenses estimated at about $5 million in excess of the $20 million underlying limits. The company paid these defense expenses by way of its indemnification obligations to the former CFO and sought reimbursement from the insurer before the underlying limits were fully exhausted.

The insurer denied coverage on the basis that the CFO had knowledge or information that could lead to a claim at the time the application for the policy was completed. It based its coverage determination upon documents provided by the company to the SEC. The company then brought the instant litigation against the insurer challenging its denial of coverage. A few months later, the insurer withdrew its denial and stated that it would pay its $5 million limit as soon as it received proof of exhaustion of the underlying limits. The insurer in fact paid the $5 million after receiving proof of the exhaustion of the underlying policy.

End of story and all lived happily ever after?

Noooooo!

Among the company’s claims in its lawsuit against the insurer were ones based on the following.

• Violation of Washington’s Consumer Protection Act (“CPA”)
• Breach of the insurance contract
• Breach of an implied covenant of good faith and fair dealing (the bad faith claim)
• Violation of Washington’s Insurance Fair Conduct Act (“ICFA”)

First, the court granted summary judgment to the insurer on the CPA claim because the company could not establish an injury once the insurer performed under the contract by paying its limits at the time it was first obligated to do so. Likewise, the insurer was also granted summary judgment on the breach of contract claim for essentially the same reasons.

So far, so good, at least from the insurer’s perspective. But, here is where it gets interesting.

The Court declined to grant summary judgment on the bad faith claim. Applying Washington law, the Court held that there remained an issue of whether, at the time of the application, the former CFO had subjective knowledge of facts that might give rise to a claim. The Court found that the insurer did not establish its good faith because, at the time of the denial, it was open to question, at least on an objective basis, whether the former CFO had in fact violated the prior knowledge warranty question on the application.[2] The Court also declined to grant summary judgment on the statutory ICFA claim based on the same reasoning.

Dependent upon what may transpire in continuing litigation at the trial level or upon any appeal that might be taken, this case stands for the proposition that an insurer may still have a bad faith exposure grounded in its initial denial of coverage, even after it pays its full policy limits when first contractually obligated to do so.

[1] It appears that the policy may have been an excess Side A DIC, but whether it was of that variety or a follow form excess is of no moment to the Court’s decision and reasoning.

[2] The Court’s Opinion does not indicate whether it was this former CFO who signed the application.