Axis Reinsurance Company v. Northrop Grumman Corporation ( 2020 )

FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
AXIS REINSURANCE COMPANY, a No. 19-55135
corporation,
Plaintiff-Appellee, D.C. No.
2:17-cv-08660-
v. AB-JC
NORTHROP GRUMMAN
CORPORATION, a corporation, OPINION
Defendant-Appellant.
Appeal from the United States District Court
for the Central District of California
André Birotte, Jr., District Judge, Presiding
Argued and Submitted March 30, 2020
Pasadena, California
Filed September 14, 2020
Before: Richard A. Paez, Consuelo M. Callahan, and
Patrick J. Bumatay, Circuit Judges.
Opinion by Judge Callahan
2 AXIS REINSURANCE V. NORTHRUP GRUMMAN
SUMMARY *
Diversity/Insurance
The panel reversed the district court’s summary
judgment in favor of plaintiff, AXIS Reinsurance, and
remanded, in AXIS’s action seeking reimbursement of an
insurance payment that it made, as a secondary excess
insurer, to Northrop Grumman Corporation.
AXIS argued that Northrop’s underlying insurers paid an
uncovered claim arising from Northrop’s settlement of
alleged ERISA violations, thereby “improperly eroding”
their policies’ liability limits and prematurely triggering
AXIS’s excess coverage. The district court agreed and held
that AXIS was entitled to seek reimbursement of the
payment amount from Northrop against a later, valid claim.
The panel held that, consistent with the limited caselaw
and secondary sources that have addressed excess insurer
claims of “improper erosion,” “improper exhaustion,”
“wrongful exhaustion,” and similar challenges to the
payment decisions of underlying insurers, an excess insurer
may not challenge those decisions in order to argue that the
underlying liability limits were not (or should not have been)
exhausted absent a showing of fraud or bad faith, or the
specific reservation of such a right in its contract with the
insured.
*
This summary constitutes no part of the opinion of the court. It
has been prepared by court staff for the convenience of the reader.
AXIS REINSURANCE V. NORTHRUP GRUMMAN 3
The panel concluded that no reasonable insured in
Northrop’s position would understand that it might have to
justify its underlying insurers’ payment decisions as a
prerequisite to obtaining excess coverage from AXIS.
Therefore, consistent with the general rule favoring the
objectively reasonable expectations of the insured, the panel
reversed the district court’s summary judgment order and
remanded for further proceedings consistent with its
opinion.
COUNSEL
Kevin M. Fong (argued), Shaw Pittman LLP, San Francisco,
California; Barry J. Fleishma, Shaw Pittman LLP,
Washington, D.C.; for Defendant-Appellant.
Kim W. West (argued) and Alec H. Boyd, Clyde & Co. US
LLP, San Francisco, California, for Plaintiff-Appellee.
OPINION
CALLAHAN, Circuit Judge:
This case raises an issue of first impression in our circuit:
when, if ever, may an excess insurer challenge an underlying
insurer’s payment decision as outside the scope of coverage?
AXIS Reinsurance Company (“AXIS”), a secondary excess
insurer to Northrop Grumman Corporation (“Northrop”),
argues that underlying insurers paid an uncovered claim
arising from Northrop’s settlement of alleged ERISA
violations, thereby “improperly eroding” their policies’
liability limits and prematurely triggering AXIS’s excess
coverage. The district court agreed and held that AXIS was
4 AXIS REINSURANCE V. NORTHRUP GRUMMAN
entitled to seek reimbursement of the payment amount from
Northrop against a later, valid claim. We find that no
authority supports AXIS’s theory of “improper erosion.”
Nor did AXIS clearly reserve its right to challenge the
underlying insurers’ coverage decision. Therefore,
consistent with the general rule favoring the objectively
reasonable expectations of the insured, we reverse.
I
Two separate lawsuits were brought against Northrop
alleging violations of the Employee Retirement Income
Security Act of 1974 (“ERISA”), 29 U.S.C. § 1001 et seq.
Northrop settled both lawsuits out of court, in each case
referring its settlement payment to its insurers for coverage.
The first lawsuit was brought by the Department of
Labor (“DOL”) following a broad investigation into the
administration of the Northrop Grumman Savings Plan
(“Plan”) and several related employee savings and pension
plans. The DOL investigation resulted in assertions of
wrongful activity by a number of Northrop-related entities
and individuals. In December 2016, Northrop settled the
alleged violations, consenting to pay certain amounts 1 to the
Plan and to the DOL in exchange for a full release from
further liability (“DOL Settlement”). Although Northrop
agreed to the payments, it did not admit or deny the DOL’s
allegations. Because the parties settled out of court, there
were no judicial findings or factual stipulations regarding the
1
The specific settlement amounts are confidential and remain in the
sealed portions of the record.
AXIS REINSURANCE V. NORTHRUP GRUMMAN 5
proportion of the settlement payments, if any, that
constituted disgorgement. 2
The second lawsuit was brought on behalf of the Plan
and another Northrop savings program. Northrop settled this
second lawsuit in June 2017 for the sum of $16,750,000
(“Grabek Settlement”).
At the time, Northrop carried a multi-layered program of
Employee Benefit Plan Fiduciary Liability Insurance,
including (1) a $15 million primary insurance policy with
National Union Fire Insurance Company of Pittsburgh, PA
(“National Union”); (2) a $15 million excess insurance
policy with Continental Casualty Company (“CNA”); and
(3) a $15 million secondary excess insurance policy with
AXIS. As the secondary excess insurer, AXIS was required
to “drop down” to provide coverage only when the combined
$30 million liability limit of the underlying insurance
policies was exhausted for “covered loss” under those
policies.
National Union determined that the DOL Settlement fell
under its primary insurance policy, which covered loss
resulting from actual or alleged wrongful acts by Northrop
or its employees, including violations of ERISA. The policy
defined “loss” to include damages, judgments, settlements,
and defense costs, but not “matters which may be deemed
uninsurable under [applicable state] law” or “civil or
criminal fines or penalties imposed by law, except . . . the
20 percent or less penalty imposed upon an Insured under
Section 502(1) of ERISA, with respect to covered
2
“Disgorgement” refers to “[t]he act of giving up something (such
as profits illegally obtained) on demand or by legal compulsion.”
Disgorgement, Black’s Law Dictionary (11th ed. 2019).
6 AXIS REINSURANCE V. NORTHRUP GRUMMAN
settlements or judgments.” 3 National Union paid a portion
of the DOL Settlement amount, exhausting its $15 million
liability limit. CNA agreed that the DOL Settlement fell
within the scope of coverage and dropped down to pay the
remainder of the settlement amount. Because CNA’s partial
payment did not fully exhaust its $15 million liability limit,
AXIS was not required to cover any portion of the DOL
Settlement.
Because the DOL Settlement exhausted National
Union’s primary coverage, CNA covered the subsequent
Grabek Settlement as primary insurer. CNA determined that
this settlement, like the DOL Settlement, fell within its scope
of coverage and it contributed $7,043,762.08 of the total
settlement cost, exhausting the remainder of its $15 million
liability limit. AXIS was then called upon to pay the
remainder of the settlement, $9,706,237.92. AXIS did not
contest the validity of the Grabek Settlement under the terms
of its excess policy and covered its portion of the settlement.
However, it notified Northrop that it intended to seek
reimbursement of the DOL Settlement amount on the ground
that this earlier payment by National Union and CNA was
“not for covered loss.” AXIS argued that the underlying
insurers’ improper payment of the DOL Settlement
prematurely triggered AXIS’s excess liability once the
Grabek Settlement was filed.
3
The National Union policy also excluded from coverage claims
arising out of, based upon, or attributable to (1) the gaining of any profit
or advantage without legal entitlement, or (2) the knowing or willful
violation of any statute, rule, or law—including ERISA—but only in
cases where, unlike here, the illegal profit or violation of law was
established by a judgment, final adjudication, or a binding arbitration
adverse to Northrop.
AXIS REINSURANCE V. NORTHRUP GRUMMAN 7
AXIS accordingly filed a complaint for declaratory relief
and damages against Northrop, alleging that “the collective
payment of [the DOL Settlement] by National Union and
[CNA] . . . was not for covered loss and therefore resulted in
improper erosion of the Limits of Liability of” the
underlying policies, which “caus[ed] AXIS to ‘drop down’
by [the settlement amount,] . . . unjustly enriching Northrop
by the same amount.” Specifically, AXIS argued that the
DOL Settlement payment constituted disgorgement,
rendering it “uninsurable under [California] law” and,
therefore, an “uncovered loss” under the terms of the
primary and excess policies. The district court agreed and
granted AXIS’s motion for summary judgment. It held that,
“[a]s a matter of law, AXIS’s payment of . . . the DOL
Settlement [amount] was not covered by its excess coverage
policy” and therefore “AXIS is entitled to reimbursement of
[the settlement amount] for its excess coverage.”
Northrop timely appealed. We have jurisdiction under
28 U.S.C. § 1291.
II
We review de novo a district court’s grant of summary
judgment. Fresno Motors, LLC v. Mercedes Benz USA,
LLC, 771 F.3d 1119, 1125 (9th Cir. 2014). Summary
judgment is appropriate where there is no genuine dispute as
to any material fact and the movant is entitled to judgment
as a matter of law. Id. (citing Fed. R. Civ. P. 56(a)). In
making this determination, we view the evidence in the light
most favorable to the non-moving party, drawing all
justifiable inferences in that party’s favor. Id.
8 AXIS REINSURANCE V. NORTHRUP GRUMMAN
III
We begin our analysis by noting that no circuit precedent
adopts the “improper erosion” theory of recovery asserted by
AXIS and relied upon by the district court in its summary
judgment order. Under that theory, when an entity purchases
multiple layers of insurance, the insured entity (in this case,
Northrop) bears the risk that an excess insurer might
disagree with payment decisions made by underlying
insurers, and might withhold payment of valid claims it
would otherwise cover to compensate itself for the exposure
caused by those allegedly improper payments. Northrop
argues that this theory is unsupported and wrong, and that
AXIS, not Northrop, assumed the risk that Northrop’s
primary and first level excess insurers might adjust claims in
a manner that would trigger AXIS’s secondary excess
coverage.
We agree with Northrop’s perspective, which is
consistent with the limited caselaw that has addressed this
issue. Those decisions hold that excess insurers generally
may not avoid or reduce their own liability by contesting
payments made at prior levels of insurance, unless there is
an indication that the payments were motivated by fraud or
bad faith. Of course, excess insurers may contract around
this general rule by including specific language in their
policies reserving a right to challenge prior payments (so
long as the provision is not prohibited by applicable law). 4
4
Cf. AXIS Surplus Ins. Co. v. Innisfree Hotels, Inc., No. CIV.A. 05-
0527-WS-C, 2006 WL 2882373, at *9 n.22 (S.D. Ala. Oct. 6, 2006)
(noting that “the Axis Excess Policy . . . states that amounts paid by
underlying insurance for losses that would not have been payable under
the Axis Excess Policy do not count towards the $10 million” liability
limit, and that, “[a]s a result, any amounts that the Primary Policy paid
for flood losses do not erode the $10 million threshold, creating a
AXIS REINSURANCE V. NORTHRUP GRUMMAN 9
Here, however, there is no indication that Northrop and
AXIS mutually agreed that the “covered loss” provision in
the AXIS policy would have this effect.
A
In adopting AXIS’s theory of improper erosion and
applying it to the DOL Settlement, the district court relied
on Shy v. Insurance Company of the State of Pennsylvania,
528 F. App’x 752 (9th Cir. 2013). That unpublished
decision affirmed a district court’s grant of summary
judgment to an excess insurer that denied coverage despite
the primary insurer’s payment of the claim up to its liability
limit. Id. at 753–54. In Shy, however, a single claim was
referred to two different insurers, who took differing views
of whether the claim fell within the underlying policy’s
coverage provisions. Id. In that distinct scenario, we
concluded that the excess insurer was “bound by the terms
of [the primary] policy but not [the primary insurer’s]
coverage decision.” Id. at 754; accord Allmerica Fin. Corp.
v. Certain Underwriters at Lloyd’s, London, 449 Mass. 621,
633 (2007). In other words, the excess insurer could
challenge the portion of the single claim that the insured
asked it to pay, despite the primary insurer’s decision not to
challenge its own portion of the claim.
The facts of this case are closer to those at issue in a
recent district court case, Costco Wholesale Corp. v.
Arrowood Indem. Co., 387 F. Supp. 3d 1165 (W.D. Wash.
2019) (“Costco”). There, a third layer excess insurer argued
that “its policy should never have been triggered because the
underlying insurers should have refused to pay some or all
possibility of a gap in coverage between layers for which [the insured]
itself would be responsible” (emphasis added)).
10 AXIS REINSURANCE V. NORTHRUP GRUMMAN
of the invoices submitted to them” in relation to an
$8 million class action settlement between Costco and its
employees with over $30 million in attorney’s fees and costs.
Id. at 1173. The excess insurer argued that its excess policy,
which contained similar language to the “covered loss”
provision in the AXIS policy, 5 required Costco to defend the
underlying insurers’ coverage decisions. Id. at 1173–74. In
essence, the insurer argued that “each excess insurer in an
insurance tower can force the insured to prove that every
payment made by the underlying insurers fit the definition
of ‘Loss,’ that no exceptions or limitations on coverage were
overlooked, and generally that there had been no
overpayments at the lower levels of coverage.” Id. at 1174.
The Costco court rejected this argument, observing that
an excess insurer generally “may not . . . second-guess the
coverage determinations of the underlying insurers” absent
a “contractual right to interfere in their adjustment
processes.” Id. at 1173. Instead, while an excess insurer is
not bound by the underlying insurers’ policy interpretations,
the weight of authority holds that an excess
insurer may not challenge the underlying
insurers’ payment decisions in order to argue
that their policy limits were not (or should not
have been) exhausted . . . unless there is an
indication that the payments were motivated
by fraud or bad faith.
5
The policy provided that Costco’s third layer excess insurer would
drop down to provide coverage “only in the event of the reduction or
exhaustion of the Underlying [$35 million] Limit by reasons of the
insurers of the Underlying Policies paying in legal currency Loss.”
387 F. Supp. 3d at 1174.
AXIS REINSURANCE V. NORTHRUP GRUMMAN 11
Id. at 1173–74 (citations omitted). The Costco court went
on to note that the policy provision at issue was “ambiguous
in the context presented . . . and in light of other policy
language,” and that it therefore “must be construed against
the insurer and in favor of the insured” under applicable state
law. Id. at 1174 (citing Holden v. Farmers Ins. Co. of Wash.,
169 Wash. 2d 750, 756 (2010)).
We adopt the general rule set out in Costco, which the
weight of authority clearly supports. 6 We agree with
6
See Allan D. Windt, Insurance Claims and Disputes, § 6:45A (6th
ed. 2018) (“[A]t least absent fraud/bad faith, an excess insurer is bound
by the fact that the primary insurer has paid, and cannot contest (a) that
such payment reduces the primary insurer’s applicable aggregate, or
(b) that the excess insurer must provide policy benefits when the
aggregate in any relevant primary policy has been exhausted.”); Edward
E. Gillen Co. v. Ins. Co. of the State of Pa., No. 10-C-564, 2011 WL
1694431, at *4 (E.D. Wis. May 3, 2011) (holding that an excess liability
insurer “is free . . . to contest coverage under its own policy [but] cannot
avoid or reduce liability under its own policy by challenging a separate
insurer’s decision to settle or pay out claims at a prior layer of
insurance”); ARM Props. Mgmt. Grp. v. RSUI Indem. Co., A-07-CA-
718-SS, 2008 WL 5973220, at *5–7 (W.D. Tex. Aug. 25, 2008)
(rejecting excess insurer’s argument that the underlying policy limits had
not been exhausted because the underlying insurers had made payments
outside the scope of coverage, had failed to apply exceptions to coverage,
or had otherwise overpaid); Ins. Co. of N. Am. v. Kayser-Roth Corp.,
770 A.2d 403, 416-17 (R.I. 2001) (“[A]bsent fraud between the insured
and the primary carrier, ‘the insured does not carry the burden of proving
the soundness of the primary carrier’s decision to pay . . . [I]t is for the
excess carrier to seek redress from the underlying carrier should the
excess carrier believe that the underlying carrier has exposed it to
liability or caused it harm by mishandling the claim in some respect.”);
UNR Indus., Inc. v. Cont’l Ins. Co., No. 83 A 2523, 1988 WL 121574,
at *16–17 (N.D. Ill. Nov. 9, 1988), amended, No. 85 C 3532, 1989 WL
265493 (N.D. Ill. Jan. 11, 1989) (rejecting excess insurer’s unsupported
theory that it could “proceed against its insured because of the primary
insurer’s alleged ‘improper exhaustion’ of primary coverage or
12 AXIS REINSURANCE V. NORTHRUP GRUMMAN
Northrop that the district court’s alternative rule—that
excess insurers generally may contest the soundness of
underlying insurers’ payment decisions—“would undermine
the confidence of both insureds and insurers in the
dependability of settlements,” eliminating one of the primary
incentives for obtaining insurance in the first place.
Furthermore, such a rule would introduce a host of
inefficiencies into the insurance industry, with no obvious
countervailing benefits to insurers or policyholders.
The district court was concerned that adoption of the
Costco rule “would render the terms of excess insurer
policies useless,” because “[w]ere AXIS required to pay,
without any opportunity to dispute the validity of its
payment, any excess insurer could be liable to cover
payments totally outside the scope of its excess coverage
policy.” We do not share the district court’s concern, which
ignores that AXIS never disputed the validity of the claim
that Northrop asked it to cover—the Grabek Settlement.
Instead, AXIS sought to reduce its liability for that
concededly valid claim by disputing the validity of a
different claim, the DOL Settlement, which it was never
asked to cover. Under the Costco approach, which we adopt,
an excess insurer remains free to contest claims submitted to
it during the claims adjustment process, even when an
underlying insurer has already determined that the same
claim falls within the scope of coverage. But, absent a
specific contractual provision, it may not second-guess other
‘negligent handling’ of a defense” where the excess insurer “alleged no
bad faith conduct by” the primary insurer); see also Amerisure Mut. Ins.
Co. v. Arch Specialty Ins. Co., 784 F.3d 270, 275 (5th Cir. 2015)
(expressing skepticism about, although not reaching, an excess insurer’s
“wrongful exhaustion” claim against an underlying insurer, where the
excess insurer was arguing on behalf of a common insured).
AXIS REINSURANCE V. NORTHRUP GRUMMAN 13
insurers’ payments of earlier claims without first showing
that those payments were motivated by fraud or bad faith.
The district court’s perspective presumes that underlying
insurers are motivated to pay uncovered claims even in the
absence of fraud or bad faith. While such a possibility may
exist, we do not think that there are many instances where an
insurance company will pay out claims—let alone its
policy’s limit—when it is not obligated to do so (at least in
cases not involving fraud or bad faith). But even if AXIS
were correct that insurers sometimes choose to settle claims
that fall outside their scope of coverage “for what they
perceive[] as legitimate business reasons,” nothing prevents
AXIS or any other excess insurer from raising and
leveraging this concern during contractual negotiations with
their policyholders. For example, the excess insurer could
request higher premiums to account for this contingency, or
it could insert specific policy language reserving its right to
contest “improper erosion” by the underlying insurers under
certain conditions—so long as the provision does not
conflict with applicable law or public policy. 7
Therefore, consistent with the limited caselaw and
secondary sources that have addressed excess insurer claims
of “improper erosion,” “improper exhaustion,” “wrongful
exhaustion,” and similar challenges to the payment decisions
of underlying insurers, we hold that an excess insurer may
not challenge those decisions in order to argue that the
underlying liability limits were not (or should not have been)
7
We note that Northrop argued only that the inclusion of “improper
erosion” clauses in excess policies would be impractical and unwise, not
that they would be per se illegal. Neither party has pointed to any public
policy or provision of the California Insurance Code prohibiting such
clauses as a matter of law, nor are we aware of any.
14 AXIS REINSURANCE V. NORTHRUP GRUMMAN
exhausted absent a showing of fraud or bad faith, or the
specific reservation of such a right in its contract with the
insured.
B
Here, AXIS has not alleged fraud or bad faith. Thus, the
only question is whether the terms of its excess policy with
Northrop entitled it to assert improper erosion—that is, to
challenge the soundness of National Union’s and CNA’s
decision to cover the DOL Settlement and to demand
reimbursement from Northrop of the settlement amount
against a later, unrelated claim.
To answer this question, we look to California law,
which both parties agree applies here. Under California law,
interpretation of an insurance policy is a question of law,
subject to the ordinary rules of contractual interpretation.
See Bank of the West v. Superior Court, 2 Cal. 4th 1254,
1264 (1992); Waller v. Truck Ins. Exch., Inc., 11 Cal. 4th 1,
18 (1995); AIU Ins. Co. v. Superior Court, 51 Cal. 3d 807,
818 (1990). Policy language must be interpreted “in context,
with regard to its intended function in the policy,” keeping
in mind that “[t]he fundamental goal of contractual
interpretation is to give effect to the mutual intention of the
parties.” Bank of the West, 2 Cal. 4th at 1264–65 (citing Cal.
Civ. Code § 1636). “If contractual language is clear and
explicit, it governs.” Id. at 1264 (citing Cal. Civ. Code
§ 1638). If there is ambiguity, however, it is generally
resolved against the insurer and in favor of coverage. Id.;
see AIU Ins., 51 Cal. 3d at 822 (“[W]e generally interpret the
coverage clauses of insurance policies broadly, protecting
the objectively reasonable expectations of the insured.”). A
policy provision is ambiguous when it is capable of two or
more constructions, both of which are reasonable. Waller,
11 Cal. 4th at 18.
AXIS REINSURANCE V. NORTHRUP GRUMMAN 15
The AXIS policy requires, as a prerequisite to excess
coverage, exhaustion of the underlying insurance liability
limits “for covered loss” under those policies. But the policy
contains no language expressly providing AXIS with the
right to challenge the propriety of the underlying insurers’
payment decisions under this provision. It does not state that
AXIS may challenge those prior payments on grounds of
“improper erosion” or “improper exhaustion,” or that AXIS
may seek reimbursement of those payments against
unrelated, valid claims by asserting that the prior payments
were for “uncovered loss.” As AXIS conceded at oral
argument, the “covered loss” provision “is silent on the
ability to challenge,” and AXIS has pointed to no other
policy provision as a basis for its purported right to seek
reimbursement of the prior payment on grounds of
“improper erosion.”
In short, the AXIS excess policy does not clearly and
unambiguously reserve for AXIS a right to challenge
National Union’s and CNA’s payment of the DOL
Settlement. Because the policy language as a whole
indicates that Northrop and AXIS did not mutually intend
for AXIS to have the right to second-guess the coverage
decisions of underlying insurers, we resolve whatever
ambiguity exists in the policy against the insurer, AXIS, and
in favor of Northrop’s objectively reasonable expectations
of coverage. See Bank of the West, 2 Cal. 4th at 1264–65;
AIU Ins., 51 Cal. 3d at 822.
C
Because we hold that there is no general rule supporting
AXIS’s claim of improper erosion and AXIS did not
contractually reserve its right to assert this claim, we do not
reach the question of whether the DOL Settlement violated
California’s public policy against paying insurance benefits
16 AXIS REINSURANCE V. NORTHRUP GRUMMAN
to compensate an insured for disgorgement. See Bank of the
West, 2 Cal. 4th at 1266, 1269. We do note, however, that
the statute that barred insurance coverage for disgorgement
in Bank of the West, California Insurance Code § 533.5,
applies only to civil actions brought by the state attorney
general, a district attorney, or a city prosecutor—not to
actions, like the DOL lawsuit, brought by the federal
government. See Bodell v. Walbrook Ins. Co., 119 F.3d
1411, 1417 (9th Cir. 1997); Mt. Hawley Ins. Co. v. Lopez,
215 Cal. App. 4th 1385, 1390 (2013). Furthermore, Bank of
the West held that “one may not insure against the risk of
being ordered to return money or property that has been
wrongfully acquired.” 2 Cal. 4th at 1266 (emphasis added).
That public policy rule may not be applicable where, as here,
there was no final adjudication of Northrop’s alleged ERISA
violations, Northrop made no admissions of guilt, and the
DOL asserted multiple theories of recovery besides
disgorgement. See, e.g., U.S. Bank Nat. Ass’n v. Indian
Harbor Ins. Co., 68 F. Supp. 3d 1044, 1050 (D. Minn. 2014)
(“When an underlying action alleging ill-gotten gains and
seeking disgorgement of those gains settles before trial, there
is no final adjudication in that action determining that the
gains were ill-gotten and ordering the return of those
gains.”).
But even accepting that the DOL Settlement required
disgorgement and was, therefore, uninsurable as a matter of
California state law, AXIS is the wrong insurer to raise that
issue here. National Union and CNA could have raised this
defense and preserved it for appeal by denying coverage on
state law grounds when Northrop referred the DOL
Settlement to them for claim adjustment. These underlying
insurers’ failure to challenge the DOL Settlement under
Bank of the West at that time does not entitle AXIS, as the
secondary excess insurer, to raise the “uninsurable
AXIS REINSURANCE V. NORTHRUP GRUMMAN 17
disgorgement” issue now in relation to a separate insurance
claim that AXIS concedes falls within its scope of coverage.
Thus, our holding that excess insurers generally may not
second-guess the payment decisions of underlying insurers
applies even in cases where, as here, those prior payments
arguably were for loss that is uninsurable as a matter of state
public policy. In such cases, as in all others, the burden is
on the excess insurer to show that the underlying insurers’
payments were motivated by fraud or bad faith, or that it has
a clear contractual right to challenge those payments—as
contrary to law or otherwise—in the context of unrelated
claims.
IV
We conclude that no reasonable insured in Northrop’s
position would understand that it might have to justify its
underlying insurers’ payment decisions as a prerequisite to
obtaining excess coverage from AXIS. In reaching the
opposite conclusion, the district court misapplied our
unpublished decision in Shy, ignored the weight of authority
rejecting “improper erosion” as a valid basis for denying
coverage, and misconstrued the “covered loss” provision in
AXIS’s excess policy as a reservation of the right to second-
guess other insurers’ payments. Accordingly, we reverse the
district court’s summary judgment order and remand for
further proceedings consistent with this opinion.
REVERSED and REMANDED.