The Allocated Share Set-Off Rule: New York Enters the Debate

As explained above, the allocated share set-off rule has a number of beneficial effects: it precludes double recovery, avoids the need for messy contribution actions, and moots the potential effect of collusive settlements. Based on these and other considerations, a number of courts have adopted the rule in the insurance context. See, e.g., Emhart Inds. Inc. v. Home Ins. Co., 515 F. Supp. 2d 228, 256-57 (D.R.I. 2007), aff'd sub nom, Emhart Inds. Inc. v. Century Indem. Co., 559 F. 3d 57, 73-74 (1st Cir. 2009) (agreeing that non-settling insurer is entitled to set off for amount allocable to policies it proves have been settled); GenCorp, Inc. v. AIU Ins. Co., 297 F. Supp. 2d 995, 1007 (N.D. Ohio 2003) (same). Not all jurisdictions have fully embraced the rule, however. See, e.g., Eli Lilly & Co. v. Aetna Cas. & Sur. Co., Cause No. 49D12 0102 CP 000243 (Ind. Super. Ct. Jul. 15, 2002) (holding that set off is limited to amount actually paid by settling insurer, not amount allocable to settling insurers' policies); Fireman's Fund Ins. Co. v. Maryland Cas. Co., 65 Cal. App. 4th 1279, 1308 (Cal. Ct. App. 1998) (same); Weyerhaeuser Co. v. Commercial Union Ins. Co., 15 P. 3d 115, 126 (Wash. 2000) (finding that insurer did not prove settlements with other insurers were limited to the liability at issue and, therefore, insurer could not claim any credit for those settlements).

The Alfa Laval Case

Until recently, New York courts ' the venue for much of the seminal insurance law developed in the United States ' had not directly weighed in on the allocated share set-off rule. Last month, however, a New York trial judge issued a partial summary judgment decision that expressly adopted the rule in the context of long-tail asbestos claims. In Travelers Casualty Ins. Co., et al. v. Alfa Laval, Inc., Index No. 650667/2009, Judge Debra James of the Supreme Court of the State of New York in Manhattan was asked to decide whether Travelers and several other insurers had a duty to defend Alfa Laval with respect to two “exemplar” asbestos bodily injury claims. Through its summary judgment motion, Travelers argued that its defense cost liability to Alfa Laval was “limited to a pro rata percentage based upon its 'time on the risk.'” Nov. 22, 2011, Slip Op. at 3. Judge James disagreed, finding that the unique factual circumstances of the case made it “highly impractical to allocate the insurers' liability for defending Alfa in the plethora of suits pending against it.” Id. at 5. Deciding that pro rata allocation would not be appropriate under these circumstances, the court advised Travelers that it could recover an appropriate share of its defense cost payments from Alfa Laval's other triggered insurers. Id.

While the court's refusal to apply pro rata allocation will no doubt be the subject of further litigation, the aspect of Judge James' decision relevant to this article is the manner by which the New York court has allowed Travelers to avoid being saddled with an unfair share of Alfa Laval's liability, including its defense costs. Specifically, the court declared that “double recovery will be avoided by reducing Travelers' liability for Alfa's defense by the amounts obtained by Alfa from the other insurers.” Id. at 6-7. Thus, to the extent an insured governed by New York law has received, or is receiving, defense cost payments from any of its insurers, no other insurer may be required to pay for the entire defense effort. Per Judge James' ruling, the obligation to pay defense costs is automatically reduced to the extent of all defense payments received or to be received from others.

More important to the development of New York insurance law, however, is Judge James' finding that if an insured has settled one or more of its triggered policies, the non-settling insurers also have the right to “offset” any defense expenses they would be “entitled to recoup from” the settled insurers. Id. at 10. This right of offset, as distinct from the less valuable right to recoup, is critical because it necessarily brings the insured back into the defense participation picture at the outset of the underlying claim, before the insurer has paid anything. Moreover, unlike an offset for amounts actually received by the insured, the right to offset defense expenses allocable to settled policy years is not diminished if a settled insurer made a less-than-pro-rata contribution toward the past or continuing defense of claims.

An Unusual Path

The path the court took to arrive at this rule is somewhat unusual and warrants some explanation. When Travelers filed its pro rata allocation motion, TIG Insurance Company, one of Alfa Laval's other insurers, filed a companion motion asking the court to declare that TIG, as a settled insurer, was not obligated to contribute to Alfa Laval's defense beyond its confidential settlement-related obligations. TIG also asked the court to compel production of the confidential settlement agreement with the hope that publication of the agreement's defense payment provisions would demonstrate why TIG should be excused from contributing further. But the court found that there was no need to require production of the TIG settlement agreement because, under New York law, “an unsettled insurer cannot be liable for more than its pro rata share and, therefore, contribution claims against settled insurers are extinguished.” Id. at 9. The court noted that “the fact of settlement in itself is sufficient to warrant dismissal” of Travelers' contribution claims against TIG, and thus, there was no need to disclose the contents of the settlement agreement. Id. at 9-10. Adopting the allocated share set-off rule, Judge James explained why dismissal of the contribution claims against TIG without revelation of its settlement agreement was fair to Alfa Laval's other insurers:

In practical terms, Travelers and the other insurers shall not be impacted by the dismissal of their claims against TIG, since when contribution calculations are made TIG will be included in the allocation of risk, and any amounts which Travelers or the other co-insurers are entitled to recoup from TIG in contribution would just be offset against the amount they are obligated to pay to Alfa. Id. at 10.

Thus, the allocated share set off rule has now entered New York long-tail insurance jurisprudence.

'Purely Conceptual' Rulings

While the rule has arrived in New York, most insurance coverage practitioners know that the devil is always in the rule's details. To her credit, Judge James appears to agree. She cautioned that her rulings “are purely conceptual” and that “the parties themselves shall work out the specifics of each case in which the primary insurer disclaims liability for Alfa's defense in accordance with this decision.” Id. at 11. What this means is that for purposes of defense payments governed by New York law, an insured, standing in the shoes of the insurers with which it has settled, must now engage with non-settled insurers at the outset of the claims process to allocate defense costs whenever it has convinced the court to adopt a “joint and several” allocation approach. And where the claims involve injury that spans a lengthy period of time and implicate the varying terms of multiple insurers' policies (settled and non-settled), the insured and its non-settling insurers must consensually hammer out ' or litigate ' an upfront resolution that respects the non-settled insurers' judicially confirmed right of offset. The need to respect set-off rights is one of the reasons the “joint and several” allocation approach, which usually promotes self-serving conduct and spawns messy side litigation, can be far more trouble than the “pro rata” approach. This is particularly true in high-stakes, multi-claim, multi-policy insurance coverage cases where settlements are likely to have occurred and the remaining parties necessarily find themselves engaged in pro rata-based negotiations to quantify the appropriate set off amounts. In such cases, the benefits of pro rata allocation may warrant adopting that approach from the outset.

Harry Lee, a member of this newsletter's Board of Editors, is a partner in the Washington, DC, office of Steptoe & Johnson LLP, an international law firm. He was recently appointed to serve as chair of the firm's global Insurance and Reinsurance practice, which includes more than 50 attorneys who provide litigation, regulatory and claims-related legal services to casualty, property and life insurers and reinsurers in the United States, Europe, and Asia. The observations and views expressed in this article are those of Lee, not necessarily those of his firm or the firm's clients.

Long-tail environmental and toxic tort claims have spawned decades of hard-fought insurance coverage litigation. As the litigation has matured, judges have been forced to fashion rules that allow the courts and litigants to navigate between the desire for coverage, the reality of insurance contract terms, the dictates of public policy, respect for precedent, and the requirement that judicial solutions be practical.

The “allocated share set-off rule” is an excellent example of the judiciary working through these conflicting goals. Stated generally, the rule provides that where numerous liability insurance policies are triggered by a “long-tail” loss or losses, and the insured settles with some, but not all, of its insurers, the non-settling insurers may set off any portion of the overall liability properly allocable to the settled insurers' policies. Critically, this right applies pre-payment, i.e., the non-settling insurers need not make payment and then attempt to recoup the amounts allocable to settled policies; instead, they may exercise their set-off right prior to any payment.

In Koppers Co., Inc. v. Aetna Cas. & Sur. Co. , 98 F.3d 1440 (3rd Cir. 1996), the U.S. Court of Appeals for the Third Circuit explained the rule in the context of long-tail environmental losses. The court first predicted that “the Pennsylvania Supreme Court would hold that each non-settling insurer whose policy was triggered to cover an indivisible loss is jointly and severally liable, up to the limits of its policy, for the full amount of the judgment, less the settling insurers' apportioned share.” 98 F.3d at 1453 (emphasis in original). The Koppers court's prediction that Pennsylvania would permit upfront subtraction of any settling insurers' apportioned share rested in part on the “fundamental principle of insurance law [that] prohibits insurance contracts from conferring a benefit greater than the insured's loss (i.e., a 'double recovery').” Id. at 1452. Thus, the court rejected the notion that “an insured, having recovered part of its loss from one insurer, can recover an amount equal to its entire loss from another.” Id. The Koppers court also reasoned that “the apportioned share set-off rule is superior to a rule permitting (or requiring) suits for contribution and indemnity because the former rule promotes both judicial economy and settlement ' while also avoiding collusive settlement by placing the burden of a low settlement on the [insured].” Id. at 1453 n. 15 (citing McDermott, Inc. v. AmClyde , 114 S. Ct. 1461, 1467-68 (1994)).

As explained above, the allocated share set-off rule has a number of beneficial effects: it precludes double recovery, avoids the need for messy contribution actions, and moots the potential effect of collusive settlements. Based on these and other considerations, a number of courts have adopted the rule in the insurance context. See, e.g., Emhart Inds. Inc. v. Home Ins. Co. , 515 F. Supp. 2d 228, 256-57 (D.R.I. 2007), aff'd sub nom , Emhart Inds. Inc. v. Century Indem. Co. , 559 F. 3d 57, 73-74 (1st Cir. 2009) (agreeing that non-settling insurer is entitled to set off for amount allocable to policies it proves have been settled); GenCorp, Inc. v. AIU Ins. Co. , 297 F. Supp. 2d 995, 1007 (N.D. Ohio 2003) (same). Not all jurisdictions have fully embraced the rule, however. See, e.g., Eli Lilly & Co. v. Aetna Cas. & Sur. Co. , Cause No. 49D12 0102 CP 000243 (Ind. Super. Ct. Jul. 15, 2002) (holding that set off is limited to amount actually paid by settling insurer, not amount allocable to settling insurers' policies); Fireman's Fund Ins. Co. v. Maryland Cas. Co. , 65 Cal. App. 4th 1279, 1308 (Cal. Ct. App. 1998) (same); Weyerhaeuser Co. v. Commercial Union Ins. Co. , 15 P. 3d 115, 126 (Wash. 2000) (finding that insurer did not prove settlements with other insurers were limited to the liability at issue and, therefore, insurer could not claim any credit for those settlements).

The Alfa Laval Case

Until recently, New York courts ' the venue for much of the seminal insurance law developed in the United States ' had not directly weighed in on the allocated share set-off rule. Last month, however, a New York trial judge issued a partial summary judgment decision that expressly adopted the rule in the context of long-tail asbestos claims. In Travelers Casualty Ins. Co., et al. v. Alfa Laval, Inc., Index No. 650667/2009, Judge Debra James of the Supreme Court of the State of New York in Manhattan was asked to decide whether Travelers and several other insurers had a duty to defend Alfa Laval with respect to two “exemplar” asbestos bodily injury claims. Through its summary judgment motion, Travelers argued that its defense cost liability to Alfa Laval was “limited to a pro rata percentage based upon its 'time on the risk.'” Nov. 22, 2011, Slip Op. at 3. Judge James disagreed, finding that the unique factual circumstances of the case made it “highly impractical to allocate the insurers' liability for defending Alfa in the plethora of suits pending against it.” Id. at 5. Deciding that pro rata allocation would not be appropriate under these circumstances, the court advised Travelers that it could recover an appropriate share of its defense cost payments from Alfa Laval's other triggered insurers. Id.

While the court's refusal to apply pro rata allocation will no doubt be the subject of further litigation, the aspect of Judge James' decision relevant to this article is the manner by which the New York court has allowed Travelers to avoid being saddled with an unfair share of Alfa Laval's liability, including its defense costs. Specifically, the court declared that “double recovery will be avoided by reducing Travelers' liability for Alfa's defense by the amounts obtained by Alfa from the other insurers.” Id. at 6-7. Thus, to the extent an insured governed by New York law has received, or is receiving, defense cost payments from any of its insurers, no other insurer may be required to pay for the entire defense effort. Per Judge James' ruling, the obligation to pay defense costs is automatically reduced to the extent of all defense payments received or to be received from others.

More important to the development of New York insurance law, however, is Judge James' finding that if an insured has settled one or more of its triggered policies, the non-settling insurers also have the right to “offset” any defense expenses they would be “entitled to recoup from” the settled insurers. Id. at 10. This right of offset, as distinct from the less valuable right to recoup, is critical because it necessarily brings the insured back into the defense participation picture at the outset of the underlying claim, before the insurer has paid anything. Moreover, unlike an offset for amounts actually received by the insured, the right to offset defense expenses allocable to settled policy years is not diminished if a settled insurer made a less-than-pro-rata contribution toward the past or continuing defense of claims.

An Unusual Path

The path the court took to arrive at this rule is somewhat unusual and warrants some explanation. When Travelers filed its pro rata allocation motion, TIG Insurance Company, one of Alfa Laval's other insurers, filed a companion motion asking the court to declare that TIG, as a settled insurer, was not obligated to contribute to Alfa Laval's defense beyond its confidential settlement-related obligations. TIG also asked the court to compel production of the confidential settlement agreement with the hope that publication of the agreement's defense payment provisions would demonstrate why TIG should be excused from contributing further. But the court found that there was no need to require production of the TIG settlement agreement because, under New York law, “an unsettled insurer cannot be liable for more than its pro rata share and, therefore, contribution claims against settled insurers are extinguished.” Id. at 9. The court noted that “the fact of settlement in itself is sufficient to warrant dismissal” of Travelers' contribution claims against TIG, and thus, there was no need to disclose the contents of the settlement agreement. Id. at 9-10. Adopting the allocated share set-off rule, Judge James explained why dismissal of the contribution claims against TIG without revelation of its settlement agreement was fair to Alfa Laval's other insurers:

In practical terms, Travelers and the other insurers shall not be impacted by the dismissal of their claims against TIG, since when contribution calculations are made TIG will be included in the allocation of risk, and any amounts which Travelers or the other co-insurers are entitled to recoup from TIG in contribution would just be offset against the amount they are obligated to pay to Alfa. Id. at 10.

Thus, the allocated share set off rule has now entered New York long-tail insurance jurisprudence.

'Purely Conceptual' Rulings

While the rule has arrived in New York, most insurance coverage practitioners know that the devil is always in the rule's details. To her credit, Judge James appears to agree. She cautioned that her rulings “are purely conceptual” and that “the parties themselves shall work out the specifics of each case in which the primary insurer disclaims liability for Alfa's defense in accordance with this decision.” Id. at 11. What this means is that for purposes of defense payments governed by New York law, an insured, standing in the shoes of the insurers with which it has settled, must now engage with non-settled insurers at the outset of the claims process to allocate defense costs whenever it has convinced the court to adopt a “joint and several” allocation approach. And where the claims involve injury that spans a lengthy period of time and implicate the varying terms of multiple insurers' policies (settled and non-settled), the insured and its non-settling insurers must consensually hammer out ' or litigate ' an upfront resolution that respects the non-settled insurers' judicially confirmed right of offset. The need to respect set-off rights is one of the reasons the “joint and several” allocation approach, which usually promotes self-serving conduct and spawns messy side litigation, can be far more trouble than the “pro rata” approach. This is particularly true in high-stakes, multi-claim, multi-policy insurance coverage cases where settlements are likely to have occurred and the remaining parties necessarily find themselves engaged in pro rata-based negotiations to quantify the appropriate set off amounts. In such cases, the benefits of pro rata allocation may warrant adopting that approach from the outset.

Harry Lee, a member of this newsletter's Board of Editors, is a partner in the Washington, DC, office of Steptoe & Johnson LLP, an international law firm. He was recently appointed to serve as chair of the firm's global Insurance and Reinsurance practice, which includes more than 50 attorneys who provide litigation, regulatory and claims-related legal services to casualty, property and life insurers and reinsurers in the United States, Europe, and Asia. The observations and views expressed in this article are those of Lee, not necessarily those of his firm or the firm's clients.