Court Opinion

ID: 2641925
Source: CourtListenerOpinion
Date Created: 2013-11-12 21:10:30.60455+00
Date Added: 2024-06-11T09:17:43.358233
License: Public Domain

20\3HOV 12 ^9;Sl

          IN THE COURT OF APPEALS OF THE STATE OF WASHINGTON

QUELLOS GROUP LLC,                               No. 68478-7-1

        Appellant/Cross Respondent,              DIVISION ONE

                  v.

FEDERAL INSURANCE COMPANY;
INDIAN HARBOR INSURANCE
COMPANY,                                         PUBLISHED OPINION

        Respondents/Cross Appellants,

STEADFAST INSURANCE COMPANY;
AND NUTMEG INSURANCE
COMPANY,

        Defendants.                              FILED: November 12, 2013

       Schindler, J. —An excess insurance policy provides coverage only after

underlying insurance coverage is exhausted. Quellos Group LLC appeals summary

judgment dismissal of the lawsuit against excess insurance carriers Federal Insurance

Company and Indian Harbor Insurance Company for failure to exhaust the underlying

insurance coverage. The Federal policy states coverage "shall attach only after the

insurers of the Underlying Insurance shall have paid in legal currency the full amount of

the Underlying Limit." The Indian Harbor policy states coverage "will attach only after all

of the Underlying Insurance has been exhausted by the actual payment of loss by the

applicable insurers thereunder." Because the plain and unambiguous language of the
No. 68478-7-1/2

excess insurance policies require exhaustion ofthe underlying liability limits by actual
payment by the insurer before excess coverage is triggered, and there is no dispute that
the underlying insurers did not pay policy limits, we affirm.

                                          FACTS

       Quellos Group LLC was a Seattle-based investment management company.
Beginning in 1999, former Chief Executive Officer (CEO) Jeffrey Greenstein and

Quellos Director and attorney Charles Wilk, together with other Quellos employees,

developed a new tax shelter strategy, the "Personally Optimized INvestment

Transaction" (POINT). The POINT tax shelter gave wealthy clients the opportunity to

offset large capital gains by acquiring securities with built-in losses. Quellos used two

offshore shell corporations and a "paper portfolio of over $9 billion in U.S. high tech

stocks" to create "fake" capital losses for the POINT transactions. The fee Quellos

charged clients was based on the amount of the POINT transaction tax loss.

       Using circular transactions and offsetting payments that cancelled each
       other out, these offshore corporations created a paper portfolio of over $9
       billion in U.S. high tech stocks that appeared to suffer price drops and
       generated the fake capital losses used in the POINT transactions. The
      fees charged by Quellos depended upon the amount of tax loss generated
       in each transaction for the taxpayer who bought the shelter; the more
       money the taxpayer "lost" from the transaction, the more Quellos charged
      for the scheme.

Quellos recognized the importance of obtaining legal opinions from well regarded law

firms on the tax consequences of the POINT tax shelter. Quellos provided false

information and documentation to the law firms on the POINT tax shelter in order to

obtain favorable legal opinions that supported the POINT strategy.

       Between 2000 and 2002, six Quellos clients agreed to use the POINT tax shelter.

The first three POINT client transactions took place between April and September 2000.
No. 68478-7-1/3

In September 2000, Quellos purchased layers of insurance coverage for investment
management claims against its directors and officers.

       Quellos purchased a claims-made insurance policy from American International

Specialty Lines Insurance Company (AISLIC), an "Investment Management Insurance
Policy," for the period of September 21, 2000 through September 21, 2002, with a

liability limit of $20 million. Quellos purchased excess insurance coverage for the period

of September 21, 2000 to September 21, 2004 from AISLIC and other carriers.

       The next three POINT client transactions occurred in late 2000 and 2001. In

total, the POINT transactions protected approximately $2 billion in capital gains from

federal taxes and generated approximately $65 million in fees to Quellos.

       In 2004, AISLIC issued a claims-made Investment Management Insurance Policy

to Quellos with a $10 million liability limit for the period of September 21, 2004 to

September 21, 2005. The policy was subject to a $2.5 million self-insured retention.

Under the terms of the policy, there is no duty to defend. The AISLIC policy provides

coverage to the past, present, or future officers, directors, and employees of Quellos for

damages, including defense costs resulting from claims first made during the "Policy

Period ... for any Wrongful Act" in rendering services as an investment adviser and for

other professional services.1

       1The AISLIC policy provides, in pertinent part:
       With respect to any such Wrongful Act for which insurance is afforded by this policy
       under Insuring Agreement I Coverages A, B, C or D above, the Company shall, as part of
       and subject to the limit of liability set forth in Item 3 of the Declarations, pay the Insured's
       Defense Costs as they are incurred.
       "Defense Costs" are defined as
       reasonable and necessary fees, costs and expenses . . . incurred by the Company or by
       the Insured with the written consent of the Company, and resulting solely from the
       investigation, adjustment, defense and appeal of any claim against the Insured.
No. 68478-7-1/4

       Quellos obtained excess coverage from Federal Insurance Company and second-
tier excess coverage from Indian Harbor Insurance Company for the policy period of

September 21, 2004 to September 21, 2005. The first-tier Federal policy provided a $10

million liability limit after exhaustion of the AISLIC policy limits. The second-tier Indian

Harbor policy provided excess coverage of $20 million after exhaustion of AISLIC and

Federal coverage policy limits. The Federal and Indian Harbor policies are subject to

and incorporate the terms of the AISLIC primary policy, and do not provide coverage for

claims excluded from coverage under the AISLIC policy.

       The AISLIC policy provides, in pertinent part:

       1.     INSURING AGREEMENTS

              COVERAGE A: INVESTMENT ADVISER PROFESSIONAL
                  LIABILITY — AND CORPORATE REIMBURSEMENT
              This policy shall, subject to the limit of liability set forth in Item 3 of
              the Declarations, pay on behalf of the Insured all sums which the
              Insured shall become legally obligated to pay as damages resulting
              from any claim or claims first made against the Insured and
              reported in writing to the Company during the Policy Period or the
              Extended Reporting Period (if applicable) for any Wrongful Act of
              the Insured or of any person for whose Wrongful Act the Insured is
              legally responsible, but only if such Wrongful Act occurs prior to the
              end of the Policy Period and solely in rendering or failing to render
              Investment Advisory Services for others for compensation in the
              course of the Entity Insured's business as an Investment Adviser;
              and with respect to the Entity Insured including amounts which the
              Entity Insured is permitted or required to pay as indemnification for
              such liability of the Individual Insured.

              COVERAGE C: DIRECTORS AND OFFICERS LIABILITY AND
                     CORPORATE REIMBURSEMENT
              This policy shall, subject to the limit of liability set forth in Item 3 of
              the Declarations, pay on behalf of the Executive Insured all sums
              which the Executive Insured shall become legally obligated to pay
              as damages resulting from any claim or claims first made against
              the Executive Insured and reported in writing to the Company
              during the Policy Period or the Extended Reporting Period (if
              applicable) for any Wrongful Act of the Executive Insured or of any
No. 68478-7-1/5

              other person for whose Wrongful Act the Executive Insured is
              legally responsible, but not Wrongful Acts to which Coverage A or
              Coverage D applies or would apply if it had been effected under
              this policy, and only ifsuch Wrongful Act occurs prior to the end of
              the Policy Period; and with respect to the Entity Insured including
              amounts which the Entity Insured is permitted or required to pay as
              indemnification for such liability of the Executive Insured. This
              Coverage C shall not apply to Executive Insureds of the Funds for
              any Wrongful Act in their capacity as such.[2]

       The AISLIC policy defines "Wrongful Acts" as "any breach of duty, neglect, error,

misstatement, misleading statement, omission or other act wrongfully done or attempted

by the Insured." The AISLIC policy expressly excludes from coverage "any claim arising

out of, based upon or attributable to the committing in fact of any criminal or deliberate

fraudulent act by any Insured, or any knowing or willful violation of any statute by any

Insured." The policy also excludes "any actual or alleged Wrongful Act committed with

knowledge that is was a Wrongful Act" and "any actual or alleged Wrongful Act

occurring prior to the Continuity Date specified in Item 6 of the Declarations, if on or

before such Continuity Date any Insured knew of such Wrongful Act or could have

reasonably foreseen that such Wrongful Act could lead to a claim."3
       The Internal Revenue Service (IRS) audited the tax returns of the six Quellos

clients who used the POINT tax shelter. In February 2005, the IRS subpoenaed POINT

transaction documents from Quellos. The IRS denied the tax benefits claimed by the

Quellos clients.

       In June 2005, one of the POINT tax shelter clients notified Quellos of the intent to

file a lawsuit. In March 2006, Quellos entered into a settlement with the client, and the

client agreed to release all claims against Quellos and its directors and officers. In

       2(Emphasis in original.)
       3The"Continuity Date" is September 20, 2000.
No. 68478-7-1/6

March 2006, another POINT client threatened legal action. In November 2007, Quellos

entered into a settlement agreement, and the client released all claims against Quellos

and its directors and officers.

       In September 2005, the United States Senate Permanent Subcommittee on

Investigations of the Committee on Homeland Security and Governmental Affairs

(Senate Subcommittee) initiated an investigation and subpoenaed information from

Quellos about the POINT tax shelter strategy. Former Quellos CEO Jeffrey Greenstein

testified before the Senate Subcommittee.

       On August 1, 2006, the Senate Subcommittee issued a report on Tax Haven

Abuses: The Enablers. the Tools and Secrecy. 109th Cong. 1. The report describes

the Quellos POINT tax shelter as a complex securities transaction "aimed at sheltering

over $2 billion in capital gains from U.S. taxes, relying in part on offshore secrecy to

shield its workings from U.S. law enforcement." Tax Haven Abuses, at 3.

       In July 2007 and June 2008, the United States Attorney's Office for the Western

District of Washington issued subpoenas to Quellos to obtain information and

documents related to the POINT transactions, and convened a grand jury.

       In 2008, the State of California Franchise Tax Board (Board) audited the tax

return of a Quellos client who used the POINT tax shelter. The Board concluded the

POINT tax shelter was fraudulent and assessed approximately $1 million in penalties

against Quellos.

       In December 2009, the United States Attorney filed an indictment charging

Greenstein and Wilk with conspiracy to defraud the IRS, tax evasion, counseling false

tax returns, wire fraud, and conspiracy to launder monetary instruments. In the 42-page
No. 68478-7-1/7

indictment, the United States Attorney alleges that from 1999 to 2001, Greenstein, Wilk,
and others designed, marketed, and implemented POINT as a "pre-ordained series of

sham transactions ... for the sole purpose of providing a means for wealthy individuals
to reduce and/or defer the payment of taxes on capital gains income."

      On September 10, 2010, Greenstein and Wilk pleaded guilty to conspiracy to
defraud the IRS of $240 million in taxes. Greenstein and Wilk admitted that they

conspired with others to defraud the IRS by designing and promoting the fraudulent

POINT tax shelter. Greenstein and Wilk admitted, in pertinent part:

             Beginning in 1999 and continuing through 2005, Jeffrey Greenstein,
      together with Charles Wilk, and others conspired and agreed to defraud
      the Internal Revenue Service by designing, promoting, and implementing
      a fraudulent tax shelter, which they referred to by the acronym, POINT,
      and by directly and indirectly deceiving and lying to the IRS during
      examinations of returns that taxpayers filed in reliance upon POINT. To
      accomplish the objective of this conspiracy, Jeffrey Greenstein and
      Charles Wilk worked with individuals at European American Investment
      Group (EURAM) to create fictitious losses through the purported purchase
      and sale of "synthetic" stock with a paper value exceeding $9.6 Billion
      between two Special Purpose Vehicles (SPV's), Isle of Man businesses,
      Jackstones, Ltd., and Barnville, Ltd, which had no assets. In truth there
      was no actual stock; no purchase and sale of actual stock; no payment for
      actual stock, and no basis in stock. These fictitious losses were used in
      POINT to offset approximately equal dollar amounts of real capital gains,
      thereby deferring substantial capital gains taxes.
            As part of the conspiracy and in furtherance of it, Jeffrey Greenstein
      and Charles Wilk told wealthy individuals and their advisors with
      substantial capital gains that they could defer taxes on such capital gains
      by participating in POINT. The defendants then provided and caused to
      be provided to these willing taxpayers, information and documentation for
      POINT that they knew were false. They also provided these taxpayers
      with legal opinions, based upon the same false information and
      documentation, that attested to the probable legitimacy of POINT.
      Defendants knew these opinions relied on false information and
      documentation.
              The taxpayers, in reliance upon the losses generated by POINT,
      filed individual and partnership returns in which they claimed huge losses
      as a means of offsetting real capital gains, thereby deferring taxes of
      approximately $240 Million. When these returns came under audit, the
No. 68478-7-1/8

        defendants gave the taxpayers and their advisors the same false
        information and documentation and the defendants knew that the
        taxpayers and their advisors would use the false information and
        documentation in responding to the IRS. The false information and
        documentation purportedly explained the genesis and business purpose of
        the POINT strategy.

        Quellos sought reimbursement from AISLIC, Federal, and Indian Harbor for the

policy period of September 21, 2004 to September 21, 2005 for the POINT transaction

settlements and costs related to the government investigations.4 In addition to seeking
approximately $35 million for the settlements with the individual investors, Quellos

sought approximately $45 million in defense costs and other costs incurred in

connection with the investigation of the IRS, the Senate Subcommittee, and the United

States Attorney.

        AISLIC determined that Quellos was entitled to coverage under the 2004-2005

policy for $4,982,974 of the $10 million policy limit. Federal and Indian Harbor refused

to pay under a reservation of rights and on the grounds that the underlying insurance

limits had not been exhausted.

        In December 2010, Quellos filed a breach of contract and declaratory judgment

action against AISLIC and excess insurance carriers Federal, Indian Harbor, Steadfast

Insurance Company, and Nutmeg Insurance Company. Quellos alleged the insurance

carriers breached the terms of the insurance policies issued from 2000 through 2006 by

denying coverage for defense and other costs related to the investigations and POINT

transactions.5

        4Quellos did not seek coverage underthe 2000-2004 policies for its claims related to the POINT
transactions.
        5
         Quellos purchased additional excess coverage from September 21, 2000 to September 21,
2004 from AISLIC, Steadfast, and Nutmeg that is not relevant to this appeal.

                                                   8
No. 68478-7-1/9

      AISLIC, Federal, and Indian Harbor denied Quellos was entitled to coverage for

defense and other costs under the terms of the policies. In addition to asserting the

claims were barred by the AISLIC policy exclusions, including the exclusion for "any

actual or alleged Wrongful Act committed with knowledge that it was a Wrongful Act,"

the excess carriers asserted coverage was not triggered until after Quellos exhausted

underlying coverage and policy limits.

       In June 2011, Quellos entered into a global settlement agreement with AISLIC.

In the "Confidential Settlement and Release Agreement" dated June 27, 2011, AISLIC

agreed to pay $5 million under the excess policy that AISLIC issued in 2000 for

contingent deferred swap transactions, and $10 million under the 2006 AISLIC primary

policy in connection with a Texas lawsuit. AISLIC did not agree to pay any additional

amounts under the 2004-2005 policy. In an effort to trigger the excess insurance

coverage for the 2004-2005 policy period, Quellos agreed to pay the gap between the

$10 million liability limit and the approximately $5 million AISLIC had previously agreed

to pay under the 2004-2005 policy.

      The excess carriers filed a motion for summary judgment dismissal of the breach

of contract and coverage claims on the grounds that the Wrongful Act and other

exclusions in the AISLIC policy barred coverage for defense and other costs related to

the fraudulent POINT tax shelter. Federal and Indian Harbor also filed a separate

motion for summary judgment dismissal on the grounds that under the express terms of

the policies, the failure to exhaust primary coverage was an absolute bar to excess

insurance coverage.
No. 68478-7-1/10

         Quellos filed a cross motion for "Partial Summary Judgment Regarding
Exhaustion of Underlying Limits of Insurance." Quellos conceded the settlement

agreement with AISLIC released AISLIC from any further liability under the 2004-2005

policy, that AISLIC paid only approximately one-half of the policy limits for the 2004-

2005 policy period, and the settlement agreement did not allocate any additional

payments for the 2004-2005 policy period. Quellos argued that a literal interpretation of

the exhaustion requirement violated the policy of promoting settlements. In the

alternative, Quellos argued that because the exhaustion requirements function as "a

condition to coverage," the excess carriers waived the right to invoke the condition and

could not establish breach of the exhaustion requirement was either material or

prejudicial.

        The court granted in part and denied in part the motion for summary judgment on

the exclusions. The court ruled, in pertinent part: "Each of the Exclusions apply to

Quellos's claims, but there are genuine issues of material fact as to which amounts

sought by Quellos in this action are covered, if any, and which are not."

        The court granted the excess carriers' motion for summary judgment for failure to

exhaust the underlying coverage and policy limits. The court ruled that under the plain

and unambiguous language of the policies, Quellos did not exhaust the underlying limits

of liability.

                And in this particular case the court finds that neither the Federal
        Insurance Company policy nor the Indian Harbor Insurance Company
        policy language are ambiguous, and if they're not ambiguous, the court
        will give effect to the policy language that the parties entered into and
        therefore the cases, virtually all of the cases that the plaintiff cites to the
        court on this particular issue, are not applicable and are fully
        distinguishable.

                                                10
No. 68478-7-1/11

               [T]he Washington cases do not actually construe condition as - the
        term condition as broadly as the policy holder here would ask us to do and
        simply there is a substantial difference between a grant of coverage and
        conditions to that coverage itself.

                And in this particular case, the attachment point or underlying limit
        or however you want to characterize it, that particular issue is the essential
        characteristic of an excess insurance. I mean, that is, essentially, what
        distinguishes it from anything else. It follows form, essentially, to the
        primary insurance and the only difference is the attachment point. I mean,
        that is the one distinguishing factor.
                ... It is that factor which basically is the defining aspect of excess
        insurance policy itself. So it is not a mere condition to coverage that is
        susceptible to the prejudice analysis, but rather, it is the defining
        characteristic of an excess insurance policy.

        The court entered a final judgment under CR 54(b). The "Corrected CR 54(B)

Stipulation Re Final Judgment" states, in pertinent part:

        Since Quellos' claims against Federal and Indian Harbor arise from the
        POINT Claims and are unrelated to Quellos' claims against Nutmeg,
        which arise out of. . . separate and distinct. . . Transactions, there is no
        just reason for delay of entry of a final and appealable judgment as to the
        summary judgment orders dismissing Quellos' claims against Federal and
        Indian Harbor. There is no reason to delay the process towards resolving
        the disputes between Quellos and Federal/Indian Harbor.

                                               ANALYSIS

        Quellos contends the court erred by dismissing the lawsuit against excess

carriers Federal and Indian Harbor for failure to exhaust the underlying policy limits.6 In
an effort to avoid the exhaustion requirement and shift the burden to the excess

carriers, Quellos argues exhaustion is a condition and the excess carriers did not

establish either material breach or prejudice. The excess carriers assert exhaustion of

        6Federal and Indian Harbor filed a cross appeal challenging denial of the motion for summary
judgment on the policy exclusions. A denial of summary judgment is not an appealable order. RAP
2.2(a)(1); In re Estate of Jones. 170 Wn. App 594, 605, 287 P.3d 610 (2012) ("denial of a summary
judgment motion is not a final order that can be appealed"). While the corrected CR 54(b) final judgment
lists the order granting in part and denying in part the motion for summary judgment regarding policy
exclusions, the order expressly finds that the final and appealable judgment relates only to dismissing the
claims against Federal and Indian Harbor.

                                                    11
No. 68478-7-1/12

the primary policy limits is the critical and defining feature of excess policy coverage and

under the plain and unambiguous language of the excess insurance policies, the court

did not err in granting summary judgment dismissal. We agree with the excess carriers.

       We review summary judgment de novo. Smith v. Safeco Ins. Co., 150Wn.2d

478, 483, 78 P.3d 1274 (2003). Interpretation of an insurance contract is a question of

law that we also review de novo. Overton v. Consol. Ins. Co., 145 Wash. 2d 417, 424, 38
P.3d 322 (2002); McDonald v. State Farm Fire & Cas. Co.. 119 Wash. 2d 724, 730-31, 837
P.2d 1000 (1992). We construe an insurance policy in the same manner as a contract.

Quadrant Corp. v. Am. States Ins. Co.. 154Wn.2d 165, 171, 110 P.3d 733 (2005). The

policy should be read as a whole and given a fair, reasonable, and sensible construction

as would be given to the contract by the average person purchasing insurance. Am.

Nat'l Fire Ins. Co. v. B&L Trucking & Constr. Co.. 134 Wash. 2d 413, 427-28, 951 P.2d 250

(1998). The insured has the burden of establishing coverage. McDonald. 119Wn.2dat

731.

       When interpreting an insurance contract, our primary goal is to determine the

intent of the parties and view the contract as a whole; a phrase cannot be interpreted in

isolation. Allstate Ins. Co. v. Peaslev. 131 Wash. 2d 420, 424, 932 P.2d 1244 (1997). "[A]

court must construe the entire contract together so as to give force and effect to each

clause." Pub. Util. Dist. No. 1 of Klickitat County v. Int'l Ins. Co.. 124 Wash. 2d 789, 797,

881 P.2d 1020 (1994). "[T]he expectations of the insured cannot override the plain

language of the contract." Quadrant. 154 Wash. 2d at 172. A provision is ambiguous only

if on its face, it is fairly susceptible to more than one reasonable interpretation.

Quadrant, 154Wn.2d at 171. If the policy language is clear and unambiguous, we must

                                              12
No. 68478-7-1/13

enforce it as written and not modify the insurance contract or create ambiguity where
noneexists. Quadrant. 154 Wash. 2d at 171.

      An excess insurance policy provides coverage "over and above that available

through an underlying policy." Christal v. Farmers Ins. Co. of Wash.. 133 Wash. App. 186,

195, 135 P.3d 479 (2006). The critical and distinctive feature of an excess insurance

policy is that it provides coverage "only after the primary coverage is exhausted." Diaz

v. Nat'l Car Rental Svs.. Inc.. 143 Wash. 2d 57, 62, 17 P.3d 603 (2001).

       Federal issued a first-tier excess insurance policy for the policy period of

September 21, 2004 to September 21, 2005 with a liability limit of $10 million. The

excess coverage is subject to the terms and conditions of the primary AISLIC policy,

and attaches only after AISLIC pays "in legal currency the full amount of the Underlying

Limit." The Federal excess policy states, in pertinent part:

                            In consideration of the payment of the premium and
                            subject to the Declarations, limitations, conditions,
                            provisions and other terms of this policy, the
                            Company agrees as follows:

       Insuring Clause      1.     The Company shall provide the Insureds with
                                   insurance during the Policy Period excess of
                                   the Underlying Limit. Coverage hereunder
                                   shall attach only after the insurers of the
                                   Underlying Insurance shall have paid in legal
                                   currency the full amount of the Underlying Limit
                                   for such Policy Period. Coverage hereunder
                                   shall then apply in conformance with the terms
                                   and conditions of the Primary Policy as
                                   amended by any more restrictive terms and
                                   conditions of any other policy designated in
                                   Item 4(B) of the Declarations, except as
                                   otherwise provided herein.[7]

       7{Second emphasis added.)
                                             13
No. 68478-7-1/14

The Federal policy defines the "Underlying Limit" to mean "the amount equal to the

aggregate of all limits of liability as set forth in Item 4 of the Declarations for all

Underlying Insurance, . . . plus the applicable uninsured retention, if any, under the

Primary Policy." The Federal policy declarations identify the "Underlying Insurance" as

the "Primary Policy" issued by AISLIC.

       Other sections of the Federal policy reiterate the requirement to exhaust

underlying limits through payment by the underlying insurer. The "Maintenance of

Underlying Insurance" section states:

       All Underlying Insurance shall be maintained in full effect during the Policy
       Period and shall afford the same coverage provided by all Underlying
       Insurance in effect upon inception of this Policy Period, except for any
       depletion or exhaustion of the Underlying Limit solely by reason of
       payment of losses thereunder.®
       The "Depletion of Underlying Limits" section of the Federal policy states:

       Only in the event of exhaustion of the Underlying Limit by reason of the
       Insurers of the Underlying Insurance, or the Insureds in the event of
       financial impairment or insolvency of an insurer of the Underlying
       Insurance, paving in legal currency loss which, except for the amount
       thereof, would have been covered hereunder, this policy shall continue in
       force as primary insurance, subject to its terms and conditions and any
       retention applicable to the Primary Policy, which retention shall be applied
       to any subsequent loss in the same manner as specified in the Primary
       Policy.
             The risk of uncollectability of any Underlying Insurance, whether
       because of financial impairment of insolvency of an underlying insurer or
       any other reason, is expressly retained by the Insureds and is not in any
       way insured or assumed by the Company.[9]
       Indian Harbor issued a second-tier excess insurance policy for the policy period

of September 21, 2004 to September 21, 2005 with a liability limit of $20 million. The

Indian Harbor policy is subject to the terms and conditions of the AISLIC primary policy

       8 (Emphasis added.)
       9(Emphasis added.)
                                                14
No. 68478-7-1/15

and the terms and conditions of the Federal excess policy. The Indian Harbor policy
does not provide coverage until all of the underlying insurance has been exhausted "by
the actual payment of loss by the applicable insurers."

       The "Insuring Agreement" of the Indian Harbor policystates, in pertinent part:

       The coverage hereunder will attach only after all of the Underlying
       Insurance has been exhausted by the actual payment of loss by the
       applicable insurers thereunder and in no event will the coverage under this
       Policy be broader than the coverage under any Underlying Insurance.[10]
The Indian Harbor policy defines "Underlying Insurance" as the AISLIC primary policy

and the first-layer Federal excess policy.

       The Indian Harbor policy reiterates the requirement of exhaustion of all

underlying insurance by actual payment of loss by the insurer in the "Depletion of

Underlying Limits of Liability" and "Maintenance of Underlying Insurance" provisions.

The Depletion of Underlying Limits of Liability provision states:

       (A)    This policy, subject to the terms, conditions, limitations and
              endorsements of this Policy and the Underlying Insurance, will
              continue to apply to loss as excess insurance remaining under such
              Underlying Insurance, in the event of the reduction or exhaustion of
              the limits of liability of the Underlying Insurance solely as the result
              of the actual payment of loss by the applicable insurer thereunder.
       (B)    This Policy, subject to the terms, conditions, limitations and
              endorsements of this Policy and the Underlying Insurance, will
              continue for subseguent claims or loss as primary insurance in the
              event of the exhaustion of all of the limits of liability of such
              Underlying insurance solely as the result of the actual payment of
              loss by the applicable insurer thereunder.
       (C)    Any risk of uncollectibility with respect to the Underlying Insurance
              will be expressly retained by the Insured and will not be assumed
              by the Insurer.

              This Policy, subject to all its terms, conditions and endorsements,
              will not drop down for any reason including, but not limited to
              uncollectibility (in whole or in part) whether because of financial
              impairment or insolvency of the Underlying Insurance or for any

       10 (Emphasis added.;
                                             15
No. 68478-7-1/16

              other reason except for the actual payment of loss by the applicable
              Insurer thereunder.[11]

      The Maintenance of Underlying Insurance provision states, in pertinent part:

      The limit(s) of liability of the Underlying Insurance designated in ITEM 4 of
      the Declarations shall be maintained during the Policy Period in full effect
      except for any reduction or exhaustion of the aggregate limits of liability
      available under the Underlying Insurance solely by reason of actual
       payment of loss thereunder.[1^
       In interpreting the provisions of the excess insurance contracts as a whole, the

plain and unambiguous language compels the conclusion that excess coverage was not

triggered by the agreement of Quellos to pay the policy limits of approximately $5 million

that AISLIC refused to pay. Under the Federal and Indian Harbor policies, the excess

carriers agreed to provide coverage only after exhaustion by payment of the insurer of

the underlying policy limits. The Federal policy requires payment by primary insurer

AISLIC "in legal currency" for the full amount of the underlying insurance. The Indian

Harbor policy states that coverage does not attach unless the underlying insurance

coverage is exhausted by the "actual payment" of the claim by underlying insurers

AISLIC and Federal.

       Use of the language "only after" in the insuring clause in the policies does not

mean that the requirement that the insurer must pay the full amount of the underlying

policy limits before the excess insurer is obliged to provide coverage is a condition. The

language "only after" reflects the distinguishing characteristic and function of an excess

insurance policy.

      The terms of an insurance agreement establish whether the function of the
      policy is to attach coverage immediately upon the happening of an
      accident (in which case the policy is primary), or whether the function of

       11 (Emphasis added.]
       12 {Emphasis added.]
                                            16
No. 68478-7-1/17

       the policy is to provide coverage only after the primary coverage is
       exhausted (in which case it is excess).

Diaz. 143Wn.2dat62.13

       We also reject the argument that the exhaustion requirement should be treated in

the same manner as a cooperation or notice requirement. In contrast to a cooperation

or no-settlement clause, the requirement that the underlying insurer must first pay the

full amount of the underlying policy limits in order to trigger excess insurance coverage

does not "designate the manner in which claims covered by the policy are to be handled

once a claim has been made." Klickitat County. 124 Wash. 2d at 803; Or. Auto. Ins. Co. v.

Salzberg. 85 Wash. 2d 372, 377, 535 P.2d 816 (1975).14 Rather, the policies
unambiguously state how the underlying insurance is exhausted. See also Goodyear

Tire & Rubber Co. v. Nat'l Union Fire Ins. Co. of Pittsburgh. Pa.. 694 F.3d 781, 783 (6th

Cir. 2012) ("[T]his case does not concern a mere notice or cooperation requirement

Rather, the provision at issue here is where the rubber hits the road: the agreement's

Insuring Clause, under whose terms [the insurer] undisputedly did not agree to provide

the coverage that [the insured] now seeks.").

        In the alternative, Quellos asserts that a literal interpretation of the standardized

language in the excess policies to preclude Quellos from paying the approximately $5

million gap contravenes the public policy in favor of settlements, and produces an

absurd result.15

        13 (Emphasis added.)
        14 Quellos cites and relies on a number of unpublished cases that are neither precedential nor
persuasive.
        15 Quellos also claims that the excess carriers waived the right to demand compliance with the
exhaustion requirement. But the record shows that AISLIC consistently denied liability for the policy limits
under the terms of the 2004-2005 policy. The excess carriers also consistently identified the exhaustion
requirement.

                                                    17
No. 68478-7-1/18

       The record does not support the assertion that the exhaustion provision in the

Federal and Indian Harbor policies is standardized language. Unlike the language in

the Federal and Indian Harbor policies, the excess insurance policy issued by AISLIC

for 2000 to 2002 allowed Quellos to pay underlying policy limits in order to trigger

excess insurance coverage. The AISLIC excess policy provided, in pertinent part:

              It is expressly agreed that liability for any covered Loss with respect
       to Claims first made against the Insureds during the Policy Period and the
       Discovery Period (if applicable) and reported in writing to the Insurer
       pursuant to the terms of this policy shall attach to the Insurer only after the
       Underlying Insurers and/or the Insureds or the Company shall have paid
       the full amount of the Total Underlying Limits, and the Company or the
       Insureds shall have paid the full amount of the applicable Retention
       amount under any Underlying Policy. In the event, and only in the event,
       of exhaustion of the Total Underlying Limits by reason of the Underlying
       Insurers and/or the Insured or the Company paying Loss covered
       thereunder, this policy shall: (i) in the event of reduction, pay excess of
       the reduced Total Underlying Limits, and (ii) in the event of exhaustion,
       continue in force as primary insurance.1161
The record also shows that an amendment was available from Indian Harbor that

allowed the insured as well as the underlying insurer to pay the full amount of the

underlying policy limits to trigger excess coverage.17
       Neither the Washington Supreme Court's decision in Seafirst Center Limited

Partnership v. Erickson. 127 Wash. 2d 355, 898 P.2d 299 (1995), nor Zeig v.

Massachusetts Bonding & Insurance Co.. 23 F.2d 665 (2d Cir. 1928), support the

       16 (Emphasis added.)
       17 In consideration of the premium charged, Section III Depletion of Underlying Limits of
       Liability (C) of the Policy is amended to read in its entirety as follows:
       (C)       Any risk of uncollectibility with respect to the Underlying Insurance will be
                 expressly retained by the Insured and will not be assumed by the Insurer.
       This Policy, subject to its terms, conditions and endorsements, will not drop down for any
       reason including, but not limited to uncollectibility (in whole or in part) whether because of
       financial impairment or insolvency of the Underlying Insurance or for any other reason
       except for the actual payment of loss by the applicable Insurer thereunder or the Insured.
(Emphasis added) (internal quotation marks omitted).

                                                     18
No. 68478-7-1/19

argument that public policy should override the unambiguous exhaustion language in

the Federal and Indian Harbor policies.

       In Seafirst. the court did not rewrite the plain and unambiguous terms of the

contract. The court abrogated the common law rule of discharge for settlements that

involve joint contractual obligations. Seafirst. 127 Wash. 2d at 364. In Zeig and the other

cases Quellos cites that follow Zeig. there was either an ambiguity in the definition of

"exhaustion" or a lack of specificity in the policy language as to how to exhaust primary

insurance. See Zeig. 23 F.2d at 666; see also Stargatt v. Fid. & Cas. Co. of N.Y.. 67
F.R.D. 689 (D. Del. 1975) (policy did not define "exhaustion"); Reliance Ins. Co. v.

Transamerica Ins. Co.. 826 So. 2d 998 (Fla. Dist. Ct. App. 2001) ("exhaustion" not

defined).

       In Zeig. the excess insurance policy required exhaustion of the underlying policy,

but was silent about whether the full amount of the underlying policy needed to be

collected or actually paid out before the excess policy was triggered. The Second

Circuit held the underlying policy was exhausted by a settlement agreement and public

policy favoring settlement supported that conclusion. Zeig. 23 F.2d at 666.

               The defendant argues that it was necessary for the plaintiff actually
       to collect the full amount of the policies for $15,000, in order to "exhaust"
       that insurance. Such a construction of the policy sued on seems
       unnecessarily stringent. It is doubtless true that the parties could impose
       such a condition precedent to liability upon the policy, ifthey chose to do
       so. But the defendant had no rational interest in whether the insured
       collected the full amount of the primary policies, so long as it was only
       called upon to pay such portion of the loss as was in excess of the limits of
       those policies. To require an absolute collection of the primary insurance
       to its full limit would in many, if not most, cases involve delay, promote
       litigation, and prevent an adjustment of disputes which is both convenient
       and commendable. A result harmful to the insured, and of no rational

                                             19
No. 68478-7-1/20

       advantage to the insurer, ought only to be reached when the terms of the
       contract demand it.

Zeig. 23F.2dat666.

       Here, unlike in Zeig. the plain and unambiguous language of the excess

insurance policies unambiguously states how the underlying insurance is exhausted.

The policies require the underlying insurer to pay the full amount of its limits of liability

before excess coverage is triggered. AISLIC paid only approximately one-half of the

$10 million policy limits and continued to dispute whether Quellos was entitled to

coverage under the 2004-2005 policy for defense and other costs related to the

investigations into the fraudulent POINT tax shelter scheme. See also Citigroup. Inc. v.

Fed. Ins. Co.. 649 F.3d 367, 372 (5th Cir. 2011) ("the plain language of the [excess

insurance] policies dictate that the primary insurer pays the full amount of its limits of

liability before excess coverage is triggered"); Qualcomm, Inc. v. Certain Underwriters at

Lloyd's. London. 73 Cal. Rptr. 3d 770, 785 (Cal. Ct. App. 4 2008) (because the

exhaustion language in the excess policy unambiguously precluded coverage, the court

rejected argument that the public policy promoting settlement contravened the policy

language).

       Because the exhaustion language in the Federal and Indian Harbor excess

insurance policies is clear and unambiguous, we must enforce it as written, and affirm

summary judgment dismissal of the lawsuit against Federal and Indian Harbor.

However, because the order to seal "Exhibit G," "Plaintiff Quellos Group LLC's

Responses and Objections to Defendant Indian Harbor Insurance Company's First Set

of Interrogatories to Plaintiff," does not comply with GR 15 or Seattle Times Co. v.

                                              20
No. 68478-7-1/21

Ishikawa, 97 Wash. 2d 30, 640 P.2d 716 (1982), we remand to consider whether to seal

Exhibit G.18

                                                       SgiO* ,vtQQ
WE CONCUR:

                                                          T^ec^og;

          18 On appeal, the parties submitted a "Stipulated Motion to Seal Exhibit Previously Sealed in the
Trial Court and Regarding Continued Protection of Confidential Information," Exhibit G to the "Declaration
of Gary P. Seligman in Support of Defendant Federal Insurance Company's Motion for Summary
Judgment." Because the trial court order does not comply with GR 15 and the record does not indicate
that the court addressed Ishikawa, we deny the stipulated motion to seal the unredacted Exhibit G, and
remand.

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