Is Exhaustion Required to Seek Declaratory Relief From an Excess Insurer?

Post 4578

Posted on November 9, 2026 by Barry Zalma

In Fox Paine & Company, LLC, et al. v. Twin City Fire Insurance Company et al., S287404, 593 P.3d 832, 593 P.3d 838, 346 Cal.Rptr.3d 541, Supreme Court of California, (July 27, 2026) the Supreme Court noted that Insurance is sometimes procured in a series of layers, with an insured acquiring a primary insurance policy that provides an initial layer of coverage for loss or liability and an excess insurance policy or policies that provide additional coverage in the event the underlying coverage is exhausted. Usually, the first layer of coverage must be exhausted before the excess layers are available to the insured.
Exhaustion

Fox and Paine’s investment-firm dispute generated extensive litigation and competing insurance claims. Their insurance tower consisted of a $10 million primary policy and four $10 million excess layers.

The Fox Parties alleged that insurers paid their rivals, withheld information, failed to investigate their claims, and impaired their access to policy benefits. They claimed more than $43 million in covered loss and interest.

The lower courts dismissed claims against higher-layer excess insurers because the underlying policies had not been exhausted.
LAW

Declaratory relief:

Code of Civil Procedure section 1060 permits declarations concerning an actual controversy before a contractual obligation is breached. An excess policy’s exhaustion requirement governs when its payment obligation attaches; it does not automatically determine whether a coverage dispute is justiciable.

Bad faith:

The implied covenant exists from the policy’s inception and protects the insured’s right to receive contractual benefits. Misconduct may violate that covenant before payment becomes due.

DISCUSSION

The actual exhaustion as a categorical prerequisite to declaratory relief. Requiring insureds to litigate against each insurer sequentially would increase expense, delay, and the risk of inconsistent coverage rulings.

Nevertheless, insureds must plead covered losses implicating the particular excess layer:

1. When losses are fully known, the allegations must show they reach that policy’s attachment point.
2. When material uncertainties remain, a practical or reasonable likelihood of reaching the layer may suffice.

BAD FAITH

For bad faith, the insured must allege facts showing coverage will attach — or would attach but for the insurer’s misconduct — and that the misconduct impaired recovery of policy benefits.

ANALYSIS

An exhaustion clause may postpone payment without insulating an excess insurer from all pre-attachment misconduct. The decision does not eliminate exhaustion requirements or establish liability.

Declaratory relief and bad faith also retain distinct pleading standards: reasonable likelihood may support declaratory relief in uncertain-loss cases, while the articulated bad faith standard requires allegations demonstrating eventual attachment or attachment prevented by misconduct.

CONCLUSION

St. Paul’s argument that exhaustion is required before there is a ripe dispute also implicates the hardship component of the actual controversy inquiry. Treating a lack of exhaustion as sufficient on its own to defeat a claim for declaratory relief would impose a significant hardship on insureds such as plaintiffs, require unnecessary and wasteful proceedings, and lead to potentially inconsistent outcomes.

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

A rule requiring seriatim proceedings when excess insurance is involved might impose more than an inconvenience on insureds and insurers alike. Requiring individual actions to be brought against individual insurers at different times and, potentially, in different jurisdictions poses a heightened risk of conflicting rulings that could make the parties’ rights and responsibilities under insurance policies more difficult to ascertain and act upon.

The supreme court reversed and remanded for reconsideration under the proper standards, with leave to amend if deficiencies could be cured. It did not order payment or find the insurers liable for bad faith.
ZALMA OPINION

California’s Supreme Court that invented the tort of Bad Faith has expanded its presence claiming to avoid invitations to mischief by requiring multiple courts, at multiple times, to litigate the coverage issues starting with the primary insurer and then individual declaratory relief actions with each layer of coverage inviting different decisions from different courts as each layer faces exhaustion. In this case the issues could be presented to five different courts who could reach five different, and impossible to reconcile decisions.

(c) 2026, Barry Zalma

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