MEALEY S LITIGATION REPORT: Insurance Vol. 22, #10 January 17, 2008

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1 Commentary The Illinois Supreme Court s Decision In Kajima Limits Illinois Targeted Tender Rule And Establishes Illinois As A Pro Rata Allocation Jurisdiction By Scott M. Seaman and Jason R. Schulze [Editor s Note: Scott M. Seaman is a partner in the law fi rm of Meckler Bulger & Tilson LLP and maintains a national litigation practice representing companies, insurers, and reinsurers in a wide-range of commercial, insurance coverage, and reinsurance matters. He is a prolific author and speaker on a variety of insurance and litigation topics. He can be contacted at scott.seaman@ mbtlaw.com or (312) Jason R. Schulze also is partner of Meckler Bulger & Tilson LLP and his practice is focused on insurance coverage and commercial litigation. He can be contacted at jason.schulze@mbtlaw. com or (312) Mr. Seaman and Mr. Schulze co-author a book entitled, Allocation of Losses in Complex Insurance Coverage Claims (2d Ed. Thomson.West Legalworks 2006, 2007 Supp). This article is intended for informational purposes only and nothing herein purports to represent the views of the firm or any of its clients. Copyright 2008 by the authors.] Introduction The Illinois Supreme Court s recent decision in Kajima Construction Services, Inc. v. St. Paul Fire and Marine Ins. Co., No (Ill. Nov. 29, 2007) reprinted in Mealey s Ins. Litig. Rep. Vol. 22, #6 (Dec. 6, 2007) involves the interplay between Illinois targeted tender or selective tender rule and the requirements of horizontal exhaustion. In this single, cogent opinion, the Illinois Supreme Court set proper limits on Illinois targeted tender rule and provided clarity with respect to Illinois law on allocation. The decision makes clear that a targeted tender does not preempt the fundamental requirement of horizontal exhaustion. Further, the decision properly limits the application of the targeted tender rule to circumstances where concurrent primary insurance coverage exists for additional insureds. The decision also has implications with respect to long-tail claims and consecutive policies beyond making clear that the targeted tender rule has no application to such matters. Indeed, the decision further establishes that Illinois is a pro rata or horizontal exhaustion jurisdiction, not an all sums or vertical exhaustion jurisdiction. This is the Illinois Supreme Court s first substantive foray into allocation-related issues since Zurich Ins. Co. v. Raymark Indus. Inc., 118 Ill. 2d 23, 514 N.E.2d 150, 112 Ill. Dec. 684 (Ill. 1987) ( Raymark ) decided over twenty years ago. Notwithstanding substantial decisional authority demonstrating that Illinois is a pro rata jurisdiction, policyholders for years have used the Raymark decision to argue that Illinois is an all sums or vertical spike jurisdiction. The Kajima decision, at a minimum, limits the application of Raymark in the long-tail claim context to primary policies as many decisions applying Illinois law already have recognized and actually establishes that Illinois is a pro rata jurisdiction. We begin with an overview of Illinois targeted tender rule. Next, we examine Illinois jurisprudence on al- 1

2 Vol. 22, #10 January 17, 2008 MEALEY S LITIGATION REPORT: Insurance location spanning from Raymark to Kajima, visiting numerous Illinois appellate and trial court decisions along the way. We then discuss the Kajima decision. Finally, we consider the impact of this decision both on the targeted tender rule and on the broader subject of allocation. The Targeted Tender Or Selective Tender Rule In Illinois There is a line of cases specific to Illinois law that, under certain circumstances, allows a policyholder to tender its defense to one of its primary insurers (but not another) and thereby nullify the defending insurer s rights of equitable contribution as to both defense and indemnity against the non-selected insurer. Simply stated, where applicable, it allows a policyholder covered by multiple primary liability insurance policies to select or target which insurer will defend and indemnify it with regard to a specific claim and to make its selection stick. This targeted tender or selective tender rule originated in Institute of London Underwriters v. Hartford Fire Ins. Co., 234 Ill. App. 3d 70, 599 N.E.2d 1311, 175 Ill. Dec. 297 (Ill. App. 1st Dist. 1992) in the context of concurrent insurance contracts. The case arose out of a construction accident on the premises of an insured property owner. The property owner had coverage available to it both under its own insurance contract (under which it was a named insured) and under a contractor s insurance contract (under which it was an additional insured). The property owner tendered the underlying suit to the contractor s insurer and notified [its own insurer] of the claim but unequivocally stated that [its own insurer] should not respond to the loss, but that the [contractor s insurer] was to provide the defense and indemnification for it under the [contractor s policy]. Id. at 73, 599 N.E.2d at The contractor s insurer defended the property owner in the underlying action. Fourteen months after the underlying action was filed, and against the wishes of the property owner, the contractor s insurer sent a letter requesting that the property owner s insurer contribute to a settlement of the underlying action. The property owner s insurer refused. The contractor s insurer subsequently settled the underlying action on its own and brought an equitable contribution action against the property owner s insurer. Id. at 72-73, 599 N.E.2d at The appellate court held that the doctrine of equitable contribution did not apply on the facts of that case, even though the contractor s insurance and the property owner s insurance were co-primary. The court held that, where two insurance contracts potentially apply to a loss, the policyholder has the right to select which insurer is to defend and indemnify it by tendering its defense to one insurer and not the other, thereby foreclosing the selected insurer s right of contribution from the excused insurer. Id. at 78-79, 599 N.E.2d at The court pointed out that the contractor s insurance contract, unlike the property owner s contract, did not contain an other insurance clause. The court refused to allow the contractor s insurer to claim any benefit from the other insurance clause of the property owner s contract, claiming that to do so would elevate the status of the contractor s insurer to that of a third-party beneficiary under the property owner s insurance contract. Id. at 77, 599 N.E.2d at The appellate court concluded that the property owner s own insurance was never triggered. The property owner never tendered its defense to its own insurer (and, in fact, specifically instructed its insurer not to get involved in the defense or the indemnification of the claim). Further, the letter from the contractor s insurer to the property owner s insurer requesting that the latter contribute to the underlying settlement did not amount to a tender of the defense. As such, the property owner s insurer had no duty to respond to the underlying action in any way. As a result, the contractor s insurer was barred from seeking contribution from the property owner s insurer. The court believed that the property owner s concern that attributing the loss to the policy under which it was the named insured could result in an increase in premiums or cancellation of the policy justified allowing the property owner to have the right to select which policy participated. Id. at 78-79, 599 N.E.2d at Subsequent to the appellate court s decision in Institute of London, the Illinois Supreme Court discussed the targeted tender rule in Cincinnati Cos. v. West American Ins. Co., 183 Ill. 2d 317, 701 N.E.2d 499, 233 Ill. Dec. 649 (Ill. 1998). The issue in that case was whether a primary insurer s duty to defend arose upon receipt of actual notice of the suit against its 2

3 policyholder or upon the policyholder s tender of its defense to the insurer. The Court held that actual notice triggered the duty to defend. In the course of the decision, the Court commented favorably on the targeted tender rule and the policyholder s right to forgo coverage under a policy in order to protect itself against an increase in premiums or policy cancellation. Id. at 326, 701 N.E.2d at 503. The Court also recognized that the targeted tender rule is not a one-way street. In other words, the policyholder may choose to forgo an insurer s involvement in the defense by instructing the insurer not to participate in the litigation. The court stated that the insurer would then be relieved of its obligation to the policyholder with regard to that claim. Id. at 326, 701 N.E.2d at 503. The court did not address whether or not the selected insurer would be precluded from pursuing a claim for equitable contribution against the excused insurer. See also Bituminous Cas. Corp. v. Royal Ins. Co., 301 Ill. App. 3d 720, 704 N.E.2d 74, 234 Ill. Dec. 916 (Ill. App. 3rd Dist. 1998) (applying the targeted tender rule and holding that it is only where its policy is triggered that the insurer becomes liable for the defense and indemnity costs of a claim and it becomes necessary to allocate loss according to the terms of the other insurance clauses of the policies). Targeted tender also was at issue in Alcan United, Inc. v. West Bend Mut. Ins. Co., 303 Ill. App. 3d 72, 707 N.E.2d 687, 236 Ill. Dec. 560 (Ill. App. 1st Dist. 1999). The Alcan case was a declaratory judgment action between two insurers, Reliance National Insurance Company and West Bend Mutual Insurance Company. Alcan United, Inc. was a named insured under the Reliance contract and an additional insured under the West Bend contract. Both the Reliance and West Bend contracts contained other insurance clauses. The Alcan court held that an other insurance clause merely governs apportionment of available insurance and, as such, does not come into play unless other coverage is available (i.e., the policyholder also tenders to another insurer). Id. at 82, 701 N.E.2d at 693, citing Employers Ins. of Wausau v. James McHugh Const. Co., 144 F.3d 1097 (7th Cir. 1998) (applying Illinois law). As such, an other insurance clause does not prevent a policyholder from selectively tendering its defense to only one of its insurers, thereby precluding the selected insurer from obtaining equitable contribution from other insurers that also provide coverage. The Illinois Supreme Court considered whether the presence of an other insurance clause precludes the application of the targeted tender doctrine in John Burns Const. Co. v. Indiana Ins. Co., 189 Ill. 2d 570, 727 N.E.2d 211, 244 Ill. Dec. 912 (2000). Burns, a general contractor, entered into a subcontract with a paving company that required the subcontractor to name Burns as an additional insured under its policy with Indiana Insurance Company. Burns sought to have Indiana defend and indemnify it in a subsequent slip and fall case. Indiana refused and Burns had its own insurer, Royal Insurance Company, defend. Burns and Royal filed an action seeking a declaration that Indiana had the exclusive obligation to defend and indemnify Burns. The trial court held the two insurers must contribute equally to the defense and indemnity of Burns. The appellate court affirmed, holding that Burn s initial tender to Indiana triggered the other insurance clause provision of the Indiana policy, which in turn activated Royal s duty to defend. Id. at 573, 727 N.E.2d at 214. The Illinois Supreme Court, in reversing the appellate court s holding that an other insurance clause provides a selected insurer the right to seek equitable contribution from another insurer, ruled that the presence of an other insurance clause in the insurance contract was irrelevant to the application of the targeted tender rule. The court began its analysis by reaffirming the principle that a policyholder has the right to choose which of its insurers will be required to defend and indemnify it. Addressing Indiana s argument that it could seek equitable contribution from Royal even though the insured had tendered to Indiana alone, the Court stated: Indiana attempts to distinguish Institute [of London] by noting that the policy issued by Institute did not contain an other insurance provision and, therefore, Institute did not have a contractual right to involve Hartford. It was irrelevant that the Institute policy did not contain an other insurance clause, however. As the appellate court noted in Institute [of London], the purpose of an other insurance clause is not to trigger coverage but to provide a method of apportioning coverage that would be triggered otherwise. [Citation omitted]. 3

4 Vol. 22, #10 January 17, 2008 MEALEY S LITIGATION REPORT: Insurance * * * We... conclude that Indiana may not take advantage of the other insurance provision in its policy. The insurance provided by... Royal was not available, in the language of the other insurance provision, for [John Burns] had expressly declined to invoke that coverage. Moreover, we do not believe that the presence of the other insurance provision in the Indiana policy serves by itself to trigger the coverage afforded by Royal s policy. An other insurance provision does not in itself overcome the right of an insured to tender defense of an action to one insurer alone. John Burns, 189 Ill. 2d at , 727 N.E.2d at Holding that Indiana should not benefit as the result of its own refusal to defend Burns, the Illinois Supreme Court also rejected Indiana s argument that Royal s policy was triggered when it took over the defense of Burns after Indiana rejected it. Id. at 578, 727 N.E.2d at 217. Accordingly, after Burns, it was settled law in Illinois that the selective tender doctrine could be applied in that type of concurrent coverage situation regardless of the presence of an other insurance clause in the policy of the selected insurer. A couple of cases allowed a policyholder to deactivate a tender previously made under some circumstances for purposes of invoking exclusive coverage with another carrier. Alcan, 707 N.E.2d at 695. See also Legion Ins. Co. v. Empire Fire and Marine Ins. Co., 354 Ill. App. 3d 699, 822 N.E.2d 1, 290 Ill. Dec. 719 (Ill. App. 1st Dist. 2004), appeal denied, 215 Ill. 2d 598, 833 N.E.2d 3, 295 Ill. Dec. 521 (2005). The issue of the extent to which a policyholder may deactivate a tender or must renounce coverage under other policies likely will be the subject of future decisions. 1 The targeted tender rule generally has been applied in the context of claims involving concurrent primary insurance contracts in which the insured (often a general contractor) has its own policy and is named as an additional insured under policies issued to another (often a subcontractor who names the general contractor as an additional insured pursuant to a contractual obligation). The targeted tender rule has not gained acceptance outside Illinois. In fact, the rule has been subject to considerable criticism as being an improper way to address an issue that could better be addressed as courts in some other states have done by holding that co-insurers other insurance clauses have no impact on their respective rights and obligations when the underlying parties hold harmless and indemnity agreements address how the risk of loss is to be borne. In addition, there has been some concern that policyholders may seek to have the doctrine applied outside its intended scope of concurrent policies under which the policyholder is the additional insured. Illinois Case Law On Allocation Of Losses In 1987, the Illinois Supreme Court issued its decision in Zurich Ins. Co. v. Raymark Industries, Inc., 118 Ill. 2d 23, 514 N.E.2d 150, 112 Ill. Dec. 684 (Ill. 1987). The Court s decision in Raymark primarily was focused on the issue of trigger of coverage in the context of asbestos-related claims under primary commercial general liability policies. The Court ruled that, under the plain language of the policies an insurer must provide coverage for a claim if the claimant sustained bodily injury or sickness or disease during the policy period. In affirming the appellate court, the Illinois Supreme Court applied a triple trigger, holding that the policies were triggered at the initial exposure, when the disease manifested itself, and at any interim time when the claimant manifested some sickness. The Court further noted that, between the time exposure to asbestos ceases and the time an asbestos-related disease becomes diagnosable, there is no continuous injury. The Court stated that sickness may take place in the period before clinical manifestation of the disease and whether and when a claimant suffered sickness must be determined on a case-by-case basis. Id. at 29, 514 N.E.2d at 153. After having fully analyzed the trigger issue and having rejected the application of a continuous (or exposure) trigger used in Insurance Co. of North America v. Forty-Eight Insulations, Inc., 633 F.2d 1212 (6th Cir. 1980), aff d on rehearing, 657 F.2d 814 (1981), cert. denied, 454 U.S. 1109, 70 L.Ed.2d 650, 102 S. Ct. 686 (1981), the court simply held: Having rejected the premise underlying the pro rata allocation approach adopted 4

5 in Forty-Eight Insulations, we conclude that the appellate court did not err insofar as it declined to order the pro rata allocation of defense and indemnity obligations among the triggered policies. Raymark, 118 Ill. 2d at 57, 514 N.E.2d at 166. The above quote constitutes the entirety of the Court s consideration of the issue of allocation. The Illinois Supreme Court simply concluded that the appellate court did not commit reversible error insofar as it declined to order the pro rata allocation of defense and indemnity obligations among the triggered primary insurance policies on the facts of the case before it. The Illinois Supreme Court did not promulgate a rule governing allocation in Illinois and provided no indication whatsoever that it intended its refusal to reverse the lower court s allocation holding in Raymark to apply in any other case or context. 2 Of course, the Raymark decision is 20 years old and predated a wealth of cases in Illinois and across the county specifically analyzing and addressing the important issues of allocation. Post-Raymark Horizontal Exhaustion / Pro Rata Decisions Since Raymark, there have been numerous cases applying Illinois law that have addressed issues regarding allocation of losses. A majority of appellate court decisions in Illinois have recognized the very limited nature of the Raymark decision on the issue of allocation and have concluded that: (1) horizontal rather than vertical exhaustion is required; (2) in the absence of a reliable method to prorate the loss based upon the claim-specific facts, a time-on-the-risk allocation applies; and (3) the policyholder is responsible for periods where it is self-insured or has no available insurance or insufficient insurance available for whatever reason. These cases have recognized that many policies do not contain all sums language and even those policies with such language expressly limit coverage to injuries or damages during the policy period and have considered the requisite equities associated with a fair allocation. See generally, Scott M. Seaman and Jason R. Schulze, Allocation of Losses in Complex Insurance Coverage Claims (2d Edition, Thompson West Legalworks 2006, 2007 Supp.) at 4.2 [b]. In U.S. Gypsum Co. v. Admiral Ins. Co., 268 Ill. App. 3d 598, 643 N.E.2d 1226, 205 Ill. Dec. 619 (Ill. App. 1st Dist. 1994), appeal denied, 161 Ill. 2d 542 (1995), the appellate court addressed the issue of allocation in the context of asbestos property damage claims. The court rejected the policyholder s vertical exhaustion argument because it would blur the distinction between primary and excess insurance and allow the policyholder to effectively manipulate the source of its recovery, avoiding difficulties encountered as the result of its purchase of fronting insurance and the liquidation of some of its insurers. Id. at 654, 643 N.E.2d at The appellate court decision in Outboard Marine Corp. v. Liberty Mut. Ins. Co., 283 Ill. App. 3d 630, 670 N.E.2d 740, 219 Ill. Dec. 62 (Ill. App. 2d Dist. 1996), appeal denied, 167 Ill. 2d 617 (1997) is particularly instructive. The case involved coverage for environmental property damage claims and was authored by the current Chief Justice of the Illinois Supreme Court, Robert Thomas, when he was a justice sitting on the appellate court. 3 Justice Thomas rejected the policyholder s argument that Raymark required vertical exhaustion, noting that the case did not involve a claim for property damage or coverage for excess insurance. The court rejected the policyholder s reliance on the all sums language, noting that such a position ignores the further limitation that the sums the insurer is obligated to pay must be on account of property damage arising out of an occurrence during the policy period. The court followed Gypsum by requiring horizontal exhaustion and allocating damages to the policyholder for the years during which it carried no insurance. Justice Thomas wrote: [t]his is the only fair approach. While the insurers agreed to indemnify OMC for all sums, it had to be for sums incurred during the policy period. Gypsum supports the notion that OMC cannot shift its responsibility for uninsured years to its excess carriers. Id. at 642, 670 N.E.2d at The court saw no justification to impose joint and several liability upon the insurers. Instead, the court applied a pro rata time-on-the-risk allocation with the policyholder being held responsible for uninsured periods. In Missouri Pacifi c R. Co. v. International Ins. Co., 288 Ill. App. 3d 69, 679 N.E.2d 801, 223 Ill. Dec. 350 (Ill. App. 2d Dist. 1997), appeal denied, 174 Ill. 2d 567 (1997), the appellate court ruled on the issue of allocation in the context of noise-induced hearing loss ( NIHL ) and asbestos bodily injury claims. The 5

6 Vol. 22, #10 January 17, 2008 MEALEY S LITIGATION REPORT: Insurance court rejected the policyholder s argument that an all sums ruling was required by Raymark and the policy language, noting: [w]e read nothing in Zurich as precluding the application of the pro rata, time-on-the-risk allocation method announced in Outboard Marine to the case at bar. Zurich s rejection of a pro rata approach was based on the narrow facts of the case before it, namely, that it had rejected the trigger analysis set forth in Forty- Eight Insulations. The court did not adopt a general rule forever precluding the application of a pro rata approach. As we explained in Outboard Marine, such an approach is appropriate where, as here, a single continuous occurrence results in an unallocable loss implicating successive policy periods. Id. at 79, 679 N.E.2d at 808. The court rejected the policyholder s all sums argument, noting it ignored the requirement that such sums must be on account of personal injuries that occur during the policy period. Id. at 77, 679 N.E.2d at 806. The court reversed the grant of summary judgment in favor of the policyholder and ruled that, on remand, the parties should be given the opportunity to present evidence that NIHL and asbestos claims may be measured and allocated, to a reasonable degree of medical and scientific certainty, to particular policy periods. If the injuries cannot be measured and allocated to particular policy periods, the pro rata time-on-the-risk allocation of damages approach used in Outboard Marine would be applied. Id. at 78, 679 N.E.2d at 807. The court held that horizontal exhaustion is required and that the insured is responsible for uninsured periods. Id. at 82, 679 N.E.2d at 810. The appellate court once again rejected the all sums argument and required horizontal exhaustion in AAA Disposal Systems, Inc. v. Aetna Cas. and Surety Co., 355 Ill. App. 3d 275, 821 N.E.2d 1278, 290 Ill. Dec. 704 (Ill. App. 2d Dist. 2005), appeal denied, 213 Ill. 2d 275 (2005). In that case, which involved environmental property damage, the court applied a pro rata time-on-the-risk allocation. Moreover, it held that the period of October 1, 1985 to June 24, 1988 must be included in the allocation notwithstanding the court s acknowledgement that no insurance coverage was available to the insured during that period. In addition, the court determined that the period in which coverage was provided by an insolvent insurer must be included in the allocation period. See also Roman Catholic Diocese v. Interstate Fire Ins. Co., 292 Ill. App. 3d 447, 685 N.E.2d 932, 226 Ill. Dec. 477 (Ill. App. 1st Dist. 1997) (applying a pro rata allocation in a sexual abuse case); Illinois Central Railroad Co. v. Accident and Cas. Co., 317 Ill. App. 3d 737, 739 N.E.2d 1049, 251 Ill. Dec. 116 (Ill. App. 1st Dist. 2000), appeal denied, 193 Ill. 2d 586 (2001) (ruling in favor of the horizontal exhaustion of policies and a pro rata allocation of losses in a case involving employment discrimination that took place over a period of years). 4 As the case histories demonstrate, over the years the Illinois Supreme Court repeatedly has declined to review appellate court decisions providing a pro rata or horizontal approach to allocation and requiring that the policyholder bear responsibility for periods of no insurance. In particular, the Illinois Supreme Court denied review in Outboard Marine, Missouri Pacific, and AAA Disposal Systems, Inc. 5 Post-Raymark All Sums / Vertical Exhaustion Decisions Policyholders argue that a couple of Illinois appellate court decisions have sided with them by looking to the all sums language in some policies in a vacuum and by considering Raymark as requiring an all sums, pick and choose, or vertical spike allocation at least at the primary insurance level. One such decision is Benoy Motor Sales, Inc. v. Universal Underwriters Ins. Co., 287 Ill. App. 3d 942, 679 N.E.2d 414, 223 Ill. Dec. 229 (Ill. App. 1st Dist. 1997). Benoy involved one insurer s obligation to 10 automobile dealerships in connection with various claims asserted by the Illinois Environmental Protection Agency and the United States Environmental Protection Agency at a single polluted site. In Benoy, the appellate court reversed the trial court s ruling that held the insurer was required to pay each dealer only that part of the settlement amount and defense costs that relate to shipments of oil to the site while the policy was in effect and not to shipments made during gaps in coverage. The Benoy decision cites with approval to the Raymark decision and noted that an analogy to the facts of Benoy (which involved environmental contamination) to Raymark was apt. 6

7 The portion of the Raymark decision endorsed by the appellate court in Benoy, however, was the adoption of a triple trigger for asbestos bodily injury claims. Benoy, 287 Ill. App. 3d at 948, 679 N.E.2d at 418. Yet, the appellate court actually applied a continuous trigger and remanded the case for a determination of how much the insurer was obligated to pay on behalf of each policyholder. Id. Accordingly, as another appellate court decision specifically found, Benoy simply did not reach a decision regarding pro rata allocation. AAA Disposal, 355 Ill. App. 3d at 287, 821 N.E.2d at See also John Crane Inc. v. Admiral Ins. Co., 2006 WL , *30 (Cir. Ct., Cook Cty., Ill. April 12, 2006) (noting that Benoy is not applicable because it did not reach a decision regarding pro rata allocation ). In a subsequent opinion authored by Justice Wolfson, the same appellate justice who authored Benoy, the court refused to hold that Illinois law required an all sums allocation. Maremont Corp. v. Continental Cas. Co., 326 Ill. App. 3d 272, 760 N.E.2d 550, 260 Ill. Dec. 133 (Ill. App. 1st Dist. 2001), appeal denied, 198 Ill. 2d 617 (2002). Maremont, like Benoy, was an environmental property damage coverage action. The trial court found the continuing pollution required it to apply a continuous trigger in determining coverage for a single occurrence. Because the policyholder could not prove the amount of damages that occurred during the years that Continental and London insured it, the court allocated damages to the various policies in proportion to the period of time each was on the risk. The trial court further found Maremont was required to horizontally exhaust all primary insurance before it could reach the Continental and London excess policies. Because the pro rated damages did not exceed the liability limits of the primary policies, the trial court ruled Continental and London could not be held liable, and granted their motions for summary judgment. Although the appellate court opinion suggests that Justice Wolfson continues to believe that the during the policy period language does not serve as a limitation on the promise to pay all sums, the court ultimately did not accept the policyholder s argument that Outboard Marine and the other pro rata decisions in Illinois ran contrary to Raymark. The court stated, [w]hether Zurich s no pro rata holding applies to the kind of case before us is an issue that awaits another day. Maremont, 325 Ill. App. 3d at 279, 760 N.E.2d at 556. In fact, the appellate court recognized that Illinois law required horizontal, rather than vertical, exhaustion and affirmed the decision of the trial court. A recent unpublished appellate court order addressed the issue of liability for defense costs associated with asbestos bodily injury claims. Caterpillar, Inc. v. Century Indem. Co., No (Ill. App. 3d Dist. Feb. 2, 2007), reprinted in Mealey s Ins. Litig. Rep. Vol. 21, #14 (Feb. 13, 2007) (unpublished decision), appeal denied 225 Ill. 2d 629, 875 N.E.2d 1110 (2007). The court in Caterpillar rejected the insurer s argument that the during the policy period language limited its obligation to pay a pro rata share of defense costs. The court held there is nothing in the language of [the insurer s] policies that permits a pro rata reduction in its obligation to pay all sums and defend any suit. Id. at 12. In particular, the court found that Raymark is on all fours with the instant case in that both cases involved a primary insurer s obligation to pay defense costs for asbestos bodily injury claims. Id. The Caterpillar court held that the policy language, as well as the precedent set forth in Raymark, direct an all sums allocation of defense costs. Id. at 16. It appears that the factual similarity to Raymark drove the court s decision on defense costs. The Caterpillar decision is of limited utility to policyholders. First, as an unpublished order, it is not precedential and may not be cited by any party except to support contentions of double jeopardy, res judicata, collateral estoppel, or law of the case. See Ill. Sup. Ct. R. 23. Second, the decision was issued prior to Kajima. Third, the holding relates only to primary policies in the context of asbestos claims. Finally, this case only involved policies issued by a single insurance company. In seeking a vertical exhaustion result, policyholders often are relegated to citing the decision of the Massachusetts Appellate Court in Chicago Bridge and Iron Co. v. Certain Underwriters at Lloyd s London, 797 N.E.2d 434 (Mass. App. 2003). The allocation issues in Chicago Bridge involved nine years of successive policies issued by the only insurer defendant in that case. 797 N.E.2d at 436. Thus, because the environmental contamination spanned at least 50 years, the central argument for the allocation issue in Chicago Bridge was whether that insurer, as the lone 7

8 Vol. 22, #10 January 17, 2008 MEALEY S LITIGATION REPORT: Insurance defendant in the action, could limit its obligation to pay defense and indemnity for the environmental losses at multiple sites at issue on a pro rata basis, i.e., 9/50ths of the total loss at issue. The Massachusetts Appellate Court ruled that the insurer was obligated to pay the entire loss on the basis of an all sums allocation methodology. Although purporting to apply Illinois law, the Massachusetts Appellate Court relied mostly upon its own prior allocation ruling under Massachusetts law. Indeed, the Massachusetts Appellate Court specifically noted twice that an all sums ruling was consistent with Massachusetts law under that court s earlier decision in Rubenstein v. Royal Ins. Co. of America, 694 N.E.2d 381 (Mass. App. 1998), aff d in part, 708 N.E.2d 367 (Mass. 1998). Thus, Chicago Bridge appears to be more of a reflection of the court s view of Massachusetts law, than a true reflection of Illinois law. In sum, the weight of pre-kajima authority and certainly the better reasoned decisions support a horizontal exhaustion or pro rata allocation under Illinois law. The Facts In The Kajima Case Kajima, a general contractor, entered into a subcontract with Midwestern Steel Fabricators in connection with a construction project. The subcontract required Midwestern to maintain CGL coverage for Kajima as an additional insured. Midwestern subcontracted a portion of its contract to Up-Rite Steel. Thomas Jones, an employee of Up-Rite, was injured while working on the project and filed a personal injury suit against Kajima and Midwestern. Kajima had its own CGL policy with Tokio Marine and Fire Insurance Company with limits of $1 million per occurrence. Pursuant to the requirements of the subcontract, Kajima also was an additional insured under a $2 million primary policy and $5 million umbrella policy issued to Midwestern by St. Paul. Kajima made a targeted tender to Midwestern and St. Paul to provide the exclusive defense and indemnification with respect to the Jones case. Kajima Construction Services, Inc. v. St. Paul Fire and Marine Ins. Co., No (Ill. Nov. 29, 2007) reprinted in Mealey s Ins. Litig. Rep. Vol. 22, #6 (Dec. 6, 2007). When St. Paul initially did not accept the tender, Kajima requested that Tokio handle the matter and pursue the defense and indemnity owed to Kajima. St. Paul later accepted the tender under a reservation of rights, but it refused Tokio s demand that St. Paul settle the Jones suit by paying $3 million. Ultimately, the Jones case did settle for $3 million, with Tokio paying its primary limits of $1 million and St. Paul paying its primary limits of $2 million. Id. at 2. Kajima and Tokio then filed a declaratory judgment action against St. Paul seeking reimbursement of the $1 million paid by Tokio. On cross-motions for summary judgment, Kajima and Tokio argued that, based upon the targeted tender rule, St. Paul should have contributed an additional $1 million from its umbrella policy because it was solely responsible for the defense and indemnification of Kajima without contribution from Tokio. St. Paul argued it was not required to contribute any of its umbrella limits because Tokio provided primary coverage and Illinois law requires that all primary policies be exhausted prior to an excess policy being implicated (i.e., horizontal exhaustion). The trial court agreed with St. Paul, granting its motion for summary judgment and denying the motion of Tokio/Kajima. Id. at 3. The appellate court affirmed, holding the selective tender rule should be applied to circumstances where concurrent insurance coverage exists for additional insureds. Id. Nonetheless, to the extent defense and indemnity costs exceed the primary limits of the selected insurer, the deselected insurer or insurers primary policies must answer for the loss prior to invoking coverage under an excess policy. Id. The Illinois Supreme Court subsequently allowed the petition of Kajima and Tokio for leave to appeal. The Illinois Supreme Court s Decision In Kajima The unanimous decision authored by Illinois Supreme Court Chief Justice Robert Thomas included a general discussion of horizontal exhaustion and the targeted tender rule. The Court made clear that horizontal exhaustion requires not only that collectable primary insurance must be exhausted before excess insurance is impacted, but that the policyholder must also satisfy its responsibility for periods of fronting insurance, insolvent insurers, and self-insurance. Id. at 4. First, the Court cited to Gypsum and quoted to the following language from Gypsum criticizing vertical exhaustion as allowing the policyholder to: 8

9 Id. [e]ffectively manipulate the source of recovery, avoiding difficulties encountered as the result of its purchase of fronting insurance and the liquidation of some of its insurers. This would permit Gypsum to pursue coverage from certain excess insurers at the exclusion of others. Such a practice would blur the distinction between primary and excess insurance [citations omitted], and would allow certain primary insurers to escape unscathed when they would otherwise bear the initial burden of providing indemnification. Gypsum, 268 Ill. App. 3d at 654. Second, the Court stated that, following Gypsum, the appellate court continued to apply horizontal exhaustion to require an insured to first exhaust all available primary insurance coverage, including self-insured periods, before an excess policy can be reached. Id. (Emphasis added.) 6 The Court noted that its prior decisions addressing targeted tender are not entirely on point as those cases did not involve excess insurance policies. Id. at 9. Although the requirement of horizontal exhaustion originated in cases involving a continuous tort or long-term environmental and hazardous waste claims, the Court ruled that the application of horizontal exhaustion was not limited to those types of claims. Id. at 10. The Court stated [g]iven that the crux of horizontal exhaustion is the difference between primary and excess insurance, we see no reason to depart from horizontal exhaustion in this case. Id. In determining that the targeted tender rule does not prevail over horizontal exhaustion, the Court relied upon the fundamental difference between primary and excess insurance and found Justice Freeman s discussion in Roberts v. Northland Ins. Co., 185 Ill. 2d 262, 705 N.E.2d 762 (Ill. 1998) (Freeman, C.J., concurring in part and dissenting in part, joined by Miller and McMarrow, JJ) (quoting S. Seaman & C. Kittredge, Excess Liability Insurance: Law and Litigation, 32 Tort & Ins. L.J. 653, 656 (1996)) to be particularly instructive. Kajima at In finding that the targeted tender rule does not preempt horizontal exhaustion, the Court stated: [g]iven the clear distinctions between primary and excess insurance coverage, we decline to extend the targeted tender doctrine to require one insurer to vertically exhaust its primary and excess coverage limits before all primary insurance available to the insured has been exhausted. Extending the targeted tender rule to require an excess policy to pay before a primary policy would eviscerate the distinction between primary and excess insurance.... Consequently, we find that the better rule is that set forth by the appellate court that targeted tender can be applied to circumstances where concurrent primary insurance coverage exists for additional insureds, but to the extent that defense and indemnity costs exceed the primary limits of the targeted insurer, the deselected insurer or insurers primary policy must answer for the loss before the insured can seek coverage under an excess policy. This holding preserves the distinction between primary and excess insurance policies. Id. at 12. The Court found that, despite Kajima s targeted tender to St. Paul, Kajima was required to exhaust its primary policies before invoking St. Paul s excess coverage. Id. The Court, therefore, found it unnecessary to address St. Paul s alternative argument that the targeted tender rule does not apply in this case because Kajima did not knowingly forgo coverage from Tokio. Id. at 13. The Impact Of Kajima On Targeted Tender And Allocation Of Losses In Illinois The Kajima decision is significant in the context of concurrent coverage cases because it does not allow a targeted tender to trump the requirement of horizontal exhaustion. Accordingly, all primary coverage must be exhausted before an excess policy is required to respond regardless of whether the policyholder purports to make a targeted tender to implicate excess coverage. The decision also is significant because the Illinois Supreme Court properly limits the application of the targeted tender rule to circumstances where concurrent primary insurance coverage exists for additional insureds. Kajima at 12. Accordingly, a policyholder may not make a targeted tender to select insurers 9

10 Vol. 22, #10 January 17, 2008 MEALEY S LITIGATION REPORT: Insurance in the context of long-tail claims and consecutive policies. Such a limitation is entirely sound and may moot much of the criticism directed toward the targeted tender rule. Essentially, with this proper limitation, the targeted tender rule produces the same result as the law in those states that hold that other insurance clauses have no impact on co-insurers respective rights and obligations where the underlying parties hold harmless and indemnity agreements address how the risk of loss is to be borne. In other words, the properly limited targeted tender rule can be said to effectuate the intent of general contractors and subcontractors (or similar entities) where they agree that the former should be named as an additional insured under the latter s policy in connection with work and materials supplied by the latter under the subject construction contract. Under such circumstances, the naming of a general contractor as an additional insured under the subcontractor s policy is specifically done so that the general contractor may call upon the subcontractor s insurer to respond to a claim arising from the subcontractor s work or acts. Additionally, an insurer may exercise a degree of control of the situation in the underwriting process by agreeing or not agreeing to issue the policy or to restrict who may be named as an additional insured. The insurer also could include specific language in the policy that overrides a targeted tender. Targeted tender simply has no place in the context of excess policies, consecutive coverage, or long-tail claims. The concerns regarding policy cancellation and increase in premiums under policies in force that served as the justification for allowing a targeted tender in the first instance do not exist with respect to historic consecutive policies. The Illinois Supreme Court s decision in Kajima appropriately delineates the limited circumstances to which the targeted tender rule applies some circumstances involving concurrent primary coverage for additional insureds. The decision also has implications with respect to long-tail claims and consecutive policies, in addition to making clear that the targeted tender rule has no application to such matters. The Illinois Supreme Court recognizes that horizontal exhaustion is required under Illinois law in the context of long-tail claims and consecutive policies as well as instances of concurrent coverage. Application of horizontal exhaustion is completely incompatible with an all sums or vertical spike allocation that policyholders have argued is required by Raymark. Allowing a policyholder to vertically spike would eviscerate the distinction between primary and excess insurance in the context of long-tail claims and consecutive policies just as it would in the context of concurrent primary policies. Raymark already has been determined to be limited to its facts and to primary policies by multiple decisions. At a minimum, Kajima supports this limitation. Yet, the Illinois Supreme Court s holding regarding horizontal exhaustion, its citation with approval to decisions such as Gypsum, AAA Disposal, Missouri Pacific, and Outboard Marine, its quotation from Gypsum, and its statement regarding horizontal exhaustion applying to self-insured periods strongly suggest that Illinois law requires a pro rata allocation in all instances involving concurrent coverage, including cases limited to primary policies. Further, the decision supports prior decisions holding that the policyholder is responsible for all periods of self-insurance or periods where insurance is unavailable. Although the court did not discuss the merits of a time-onthe-risk as opposed to a time-on-the-risk and limits pro rata methodology, it did cite cases that employed the time-on-the-risk methodology and that was the methodology employed by Chief Justice Thomas in his appellate court decision in Outboard Marine. Accordingly, in the aftermath of Kajima, Illinois should be viewed as a horizontal exhaustion, pro rata allocation jurisdiction. Endnotes 1. There have been other issues addressed in the context of targeted tender. For example, in Employers Ins. of Wausau v. James McHugh Const. Co., 144 F.3d 1097 (7th Cir. 1998) (applying Illinois law), the United States Court of Appeals for the Seventh Circuit rejected an insurer s argument that a standard cooperation clause required its policyholder to tender its defense to all insurers to protect the defending insurer s rights of contribution against other carriers. The court held that the cooperation clause was inapplicable to the enforcement of a claim against another insurer because the decision in Institute of 10

11 London specifically allows a policyholder to choose one insurance company to provide the whole defense to an underlying action. The Seventh Circuit explained that the cooperation clause did not apply in the McHugh case because, after the policyholder chose to tender only to Wausau instead of its other insurers, Wausau [was] the only insurer who was liable, period. Id. at Thus, Wausau s rights were extinguished by its policyholder s refusal to tender the defense to its other insurers. In American Country Ins. Co. v. Kraemer Bros., Inc., 298 Ill. App. 3d 805, 232 Ill. Dec. 871, 699 N.E.2d 1056 (Ill. App. 1st Dist. 1998), the court upheld an endorsement that was drafted specifically to deal with the doctrine of targeted tender in Illinois. The endorsement required, in pertinent part, the policyholder to [p]romptly tender the defense of any claim made or suit to any other insurer which also has available insurance for a loss which we cover.... Id. at 808, 699 N.E.2d at The court held the provision was enforceable and was not against public policy. It noted that the Illinois Department of Insurance had specifically accepted and approved American Country s cooperation endorsement. 2. The Court also held that the primary policies at issue did not obligate the insurers to assume the costs of defending actions against Raymark after their duty to indemnify has been discharged by the payments of judgments or settlements and they have made an orderly withdrawal from Raymark s defense. 3. Football fans may recognize Chief Justice Thomas from his prior vocation. Prior to beginning a distinguished legal career, Justice Thomas was a place kicker. In college, he kicked the winning field goal to lead the Notre Dame Fighting Irish to a victory over the Alabama Crimson Tide in the 1973 Sugar Bowl and the 1973 National Title. He later played in the National Football League for the Chicago Bears. 4. Various other courts applying Illinois law have found that Illinois law requires a pro rata allocation. See, e.g., Great Lakes Dredge & Dock Co. v. City of Chicago, 260 F.3d 789 (7th Cir. 2001), cert. denied, 535 U.S (2002) (holding that the Supreme Court of Illinois did not establish a principle that transcends the text of the insurance contracts. At least two appellate decisions in Illinois since Zurich Insurance [Raymark] have concluded that the Supreme Court of Illinois does not require joint and several liability independent of policies language. [citations omitted]. Like the intermediate appellate courts in Missouri Pacific and Outboard Marine, we think that, when faced with the question, the Supreme Court of Illinois will follow the better reasoned (and more numerous) decisions that make policies language the benchmark for [the allocation issue]. ); Illinois Central Railroad Co. v. Stonewall Ins. Co., Civil Action No. CV (Cir. Ct., Mobile Cty., Ala., June 2, 2006) (relying upon Missouri Pacific and noting that Illinois courts reject the pick and spike approach because insurers provide coverage for property damage that occurred during the policy period and the insured railroad was not entitled to select one policy period that provides full indemnification); CBS Operations, Inc. v. Admiral Ins. Co., No. L (Super. Ct. Somerset Cty., N.J. Dec. 21, 2006) (holding that the current state of Illinois law is that in environmental property damage cases with a continuous trigger on which coverage is based, such as in this case, Illinois courts are currently applying the pro rata time-on-the-risk allocation methodology. ). 5. Although policyholders may point out that the Illinois Supreme Court also denied review of the Caterpillar decision discussed in the next section, the Court s decision in Kajima was in the pipeline at the time. 6. The Court cited several of the cases discussed previously in this article, including AAA Disposal, Maremont Corp., Missouri Pacific, and Outboard Marine 11