Exhaustion Is Not Blanket Rule for Excess-Insurer Lawsuits

Tuesday, July 28, 2026

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California Supreme Court:

Exhaustion Is Not Blanket Rule for Excess-Insurer Lawsuits

Opinion Says Allegation That Coverage Limits on All Underlying Policies Have Been Fully Paid Out Not Required for Viable Claims for Declaratory Relief, Bad Faith Against Higher-Tier Provider

By Kimber Cooley, associate editor

The California Supreme Court held yesterday that a failure to plead that coverage limits on underlying insurance policies have been fully paid out is not fatal to a party’s claims for declaratory relief and breach of the implied covenant of good faith and fair dealing against higher-tiered excess insurers.

Chief Justice Patricia Guerrero authored the opinion for the unanimous court, saying:

“In this case, we consider whether claims for declaratory relief and breach of the implied covenant of good faith and fair dealing brought by alleged insureds…against excess insurers are susceptible to demurrer on the ground that the insureds could not allege prior exhaustion of all of the insurance coverage underlying the excess insurers’ policies. We conclude that the absence of exhaustion is not fatal to these claims.”

She acknowledged that a “cause of action seeking declaratory relief regarding coverage or liability” would be “typically unjustified” where “the complaint alleges that an insured’s covered losses are fully known, or that is the only reasonable inference one can draw from the factual allegations in the complaint, and these losses do not reach an excess policy’s attachment point.”

However, she rejected “a blanket exhaustion prerequisite” for the “recognition of an actual controversy,” as required for declaratory relief under Code of Civil Procedure §1060, opining that it is sufficient for a party to plead that it would be reasonably likely that the threshold for liability will be met.

Case Law Disapproved

Noting the existence of case law “that could be read as endorsing a pleading rule contrary to the principles we have articulated,” she declared that the high court disapproves of the 2005 decision by the Sixth District in Lockheed Martin Corporation v. Continental Insurance Company as well as that court’s 2000 opinion in Ludgate Insurance Company v. Lockheed Martin Corporation.

She also pointed out that, to the extent language in the 1994 Ninth U.S. Circuit Court of Appeals decision in Iolab Corporation v. Seaboard Surety Company “has been perceived as asserting another seemingly conflicting rule regarding the availability of declaratory relief, it too must be read in context.”

As to bad-faith claims, Guerrero added:

“[I]t would ask too much, too soon, from insureds to require them to plead the prior exhaustion of all underlying insurance before they may pursue a bad faith claim. The proper focus at the pleading stage is not on whether coverage under a particular excess policy has already attached….Rather,…an insured in plaintiffs’ position needs only to allege facts that, taken as true, are sufficient to show that coverage under a defendant insurer’s excess policy will attach—or that it would attach, if not for the excess insurer’s bad-faith conduct—and that the insurer’s misconduct has impaired the insured’s recovery of benefits owed to it under the policy.”

Years of Litigation

The question arose after a dispute between co-founders Saul Fox and Dexter Paine of the Silicon Valley-area investment firm Fox Paine & Company (“FPC”) had a falling out that led to years of litigation over allegations that Paine had poached employees to launch a competitor. Fox-controlled entities asserted claims against Paine, the competing company, and additionally named FPC as a defendant even though Paine had exited the company.

FPC and related entities held a liability insurance tower with $50 million in total protection, with each of five policies having a $10 million limit. Houston Casualty Company (“HCC”) agreed to cover the first $10 million in exposure while Twin City Fire Insurance stood as the first-and-third-excess insurer and St. Paul Mercury Insurance and Liberty Mutual Insurance company covered the second and fourth tiers of liability.

Each policy conditioned coverage on exhaustion of underlying insurance or by those lower-tier providers being held liable to pay. After Fox and Paine settled their years-long dispute in 2012, FPC purportedly learned that HCC paid out the full $10 million to parties affiliated with Paine and that Twin City and St. Paul also paid out an aggregate of $9 million to the same entities in alleged settlement indemnity payments.

Fox-related entities then sued the excess insurers for breach of contract, declaratory relief, and breach of the implied covenant of good faith and fair dealing in 2017.

They asserted $43 million in losses “and recoverable interest” relating to the litigation with the Paine parties.

Allegations in Complaint

After then-San Francisco Superior Court Judge Andrew Y.S. Chang (now deceased) sustained a demurrer to the operative complaint (except for claims asserted against Twin City as to its first-excess-layer policy) in 2023, Div. Two of the First District affirmed in 2024, finding that the relevant policies had not yet “attached” upon exhaustion of all underlying insurance and that the plaintiffs had not adequately alleged and “actual controversy” for declaratory relief.

Guerrero pointed out that “[a] trial court’s discretion not to entertain a claim seeking declaratory relief” under Code of Civil Procedure §1060 is not unlimited. As to the defendants’ view that the plaintiffs were required to allege that all of the insurance coverage underlying their claims had been exhausted in order to satisfy the “actual controversy” requirement, she wrote:

“If that were the rule, insureds seeking recovery against multiple excess insurers would have to engage in piecemeal litigation, scaling the tower of excess insurance policy-by-policy by securing a favorable judgment against each excess insurer, executing upon it, filing a new lawsuit against the next insurer in the queue, and repeating this process until they reached the summit. Such onerous, time-consuming, and expensive proceedings would pose a serious risk of deterring insureds from ever pursuing their rights against excess insurers and compromise the ability of insureds to vindicate these rights.”

Presence of Contingencies

She continued:

“An actual controversy over insurance coverage may exist even when coverage depends on the satisfaction of a future contingency or contingencies….While at some point these contingencies may become so great that no actual controversy will be found to exist…, the mere fact ‘[t]hat…liability may be contingent does not necessarily defeat jurisdiction of a declaratory judgment action....’ ”

The jurist recognized that “there is some risk that allowing claims for declaratory relief against excess insurers to proceed while litigation against lower-layer insurers remains pending will require the former to remain enmeshed in litigation that might prove unnecessary as to them” but remarked:

“Requiring individual actions to be brought against individual insurers at different times and, potentially, in different jurisdictions poses a heightened risk of conflicting rulings that could make the parties’ rights and responsibilities under insurance policies more difficult to ascertain and act upon.”

As to the plaintiffs’ claims the jurist declared:

“We remand this cause to the Court of Appeal to reevaluate the adequacy of plaintiffs’ allegations as they bear upon the existence of an actual controversy. That court shall address whether plaintiffs must allege a covered loss that reaches an excess policy’s attachment point in order to state an actual controversy involving that policy, or whether additional considerations justify application of the reasonable likelihood approach here. Once the appropriate standard has been identified that court shall determine whether it has been met.”

Amount Alleged

She agreed with the Court of Appeal that the plaintiffs’ allegation of $43 million is “flawed” because it “commingles covered loss with recoverable interest” but commented:

“[W]hen a representation that a loss is ‘covered’ is supported by other allegations in a complaint that describe what the loss involves and the policy provisions that allegedly provide coverage—both of which appear in plaintiffs’ complaint—it has enough of a factual basis to be credited at the pleading stage and inform a court’s assessment of whether the insured’s losses will reach, or are reasonably likely to reach, an excess policy.”

However, she said:

“We leave it to the Court of Appeal to determine in the first instance whether to parse plaintiffs’ allegation of over $43 million in covered loss and recoverable interest into separate components and, if so, what amount of covered loss can reasonably be inferred from this allegation.”

Addressing the plaintiffs’ allegations that the insurers acted in bad faith, she concluded:

“The Court of Appeal…erred by treating plaintiffs’ failure to allege exhaustion as dispositive of their bad faith claims. We reverse its judgment and remand for further proceedings for that court to apply the proper standard….As with plaintiffs’ claims seeking declaratory relief, if the Court of Appeal concludes that plaintiffs’ allegations of bad faith are inadequate as to one or both defendants but that deficiency is capable of being cured through amendment, plaintiffs should be granted leave to amend.”

The case is Fox Paine & Company LLC v. Twin City Fire Insurance Company, 2026 S.O.S. 2190.