The California Supreme Court recently confirmed that policyholders need not exhaust all underlying insurance before bringing declaratory relief or bad-faith claims against excess insurers. It is enough to allege a covered loss reasonably likely to reach the excess policy’s attachment point. The decision rejects a strict exhaustion pleading bar, clarifies conflicting prior case law and gives California policyholders a clear path to bring an entire insurance tower into a single lawsuit.
A Coverage Fight Years in the Making
Companies that carry layered, or “excess,” insurance programs in California just got a significant boost from the state’s highest court. On July 27, 2026, the California Supreme Court decided Fox Paine & Company, LLC v. Twin City Fire Insurance Company, No. S287404, resolving a question that has quietly divided California courts for years: must a policyholder wait until every dollar of underlying insurance is paid out before it can sue a higher-layer excess insurer? The court said no.
The case grew out of a bitter falling out between Saul Fox and Dexter Paine, co-founders of the private equity firm Fox Paine & Company, LLC (FPC). After Paine launched a new fund on his own in 2006 without Fox’s support, the relationship collapsed into a 2007 lawsuit in Delaware, followed by years of related litigation the parties called the “Continuing Paine Claims.” To fund the defense and prosecution of these disputes, FPC and its affiliates turned to a $50 million layered insurance program: a $10 million primary policy from Houston Casualty Company (HCC), and four $10 million excess layers sitting above it, issued by Twin City Fire Insurance Company (first and third layers), St. Paul Mercury Insurance Company (second layer), and Liberty Mutual Insurance Company (fourth layer). Each excess policy “followed form” to HCC’s terms and, by its own language, only attached once all underlying insurance was exhausted.
According to FPC’s complaint, the excess insurers did not handle the claims cleanly. HCC allegedly paid its full $10 million primary limit to Fox’s rivals, the “Paine Parties,” without telling FPC. Twin City and St. Paul then allegedly settled with the Paine Parties for a combined $9 million – again, without notifying FPC, which claims it only learned of the settlement years later through a third-party docket alert. FPC says it submitted virtually all of its own reimbursement invoices, totaling more than $43 million in covered loss and interest, and received nothing. When FPC sued, the trial court let claims proceed against Twin City’s first excess layer, where the underlying $10 million primary had been paid out, but dismissed FPC’s claims against St. Paul, Liberty Mutual and Twin City’s third layer, because those higher layers had not yet been exhausted. The Court of Appeal affirmed, and the California Supreme Court took up the case to resolve whether that outcome was correct.
Reconciling a Split in the Case Law
Before this decision, California case law sent mixed signals. In Qualcomm, Inc. v. Certain Underwriters at Lloyd’s, London (2008) 161 Cal.App.4th 184, the Court of Appeal affirmed dismissal of a declaratory relief claim because the insured had settled with its primary insurer for less than the primary limits – meaning exhaustion, and therefore excess coverage, could never occur as a matter of law. By contrast, Ludgate Ins. Co. v. Lockheed Martin Corp. (2000) 82 Cal.App.4th 592, and the later Lockheed Martin Corp. v. Continental Ins. Co. (2005) 134 Cal.App.4th 187, contained broad language suggesting that exhaustion is “merely an issue of proof and entitlement to recovery, not of pleading,” and that an insured need not even show a reasonable probability of exhaustion to sue an excess insurer. Insurers read Qualcomm as requiring exhaustion up front; policyholders read Ludgate as requiring nothing more than a bare allegation of a dispute.
The Supreme Court reconciled these decisions rather than picking a side. It held that Qualcomm was correctly decided because it involved a fully known loss amount that, even taken as true, could never reach the excess layer – a scenario where declaratory relief is properly rejected at the pleading stage. Ludgate and Lockheed Martin reached the opposite result because, on their own facts, the insured had alleged both sufficient exhaustion of underlying limits and anticipated liabilities well in excess of the primary policy’s coverage – allegations the Supreme Court found were, in substance, enough to satisfy a “reasonable likelihood” standard. The court adopted that reasonable likelihood standard going forward: an insured must allege that it is “practically or reasonably likely” that its losses will reach the excess layer’s attachment point, but need not prove actual exhaustion has already occurred. Because broader language in Ludgate and Lockheed Martin could be read as excusing insureds from alleging any covered loss at all, the court disapproved both decisions to that limited extent, while leaving their actual outcomes intact.
The Court’s Ruling
Applying this framework, the court held that FPC’s inability to allege full exhaustion of the St. Paul and Liberty Mutual policies did not, by itself, defeat its declaratory relief claims. An “actual controversy” under the California Code of Civil Procedure Section 1060 can exist even though coverage depends on a future contingency, so long as the insured pleads a covered loss reasonably likely to reach that policy’s attachment point. The court found FPC’s own $43 million allegation flawed, however, because it improperly combined covered loss (which counts toward exhaustion) with prejudgment interest (which does not), and it remanded for the Court of Appeal to sort out how much of that figure reflects covered loss alone.
The court reached the same conclusion for FPC’s bad-faith claims. A policyholder does not need to plead prior exhaustion of all underlying insurance to state a claim for breach of the implied covenant of good faith and fair dealing against an excess insurer. It is enough to allege that coverage will attach – or would attach but for the insurer’s own bad-faith conduct – and that the insurer’s misconduct impaired the policyholder’s recovery. The court distinguished its earlier decision in Waller v. Truck Ins. Exchange, Inc. (1995) 11 Cal.4th 1, explaining that Waller addressed situations where there was never any potential for coverage at all, not the timing of exhaustion under a still-viable excess policy. The court reversed the Court of Appeal’s judgment and remanded the case for further proceedings consistent with these holdings.
Why This Matters for Policyholders with California Risk
This decision removes a major procedural obstacle for any organization carrying a layered insurance program with California exposure. Policyholders no longer need to sue their way up the tower one layer at a time, waiting years for each lower policy to pay out before the next insurer can be brought into the case. That single change can meaningfully shorten the path to recovery, reduce litigation costs and avoid the risk of inconsistent rulings when multiple “follow form” policies interpreting identical language end up before different courts at different times.
The ruling also raises the stakes for excess insurers’ claims handling. Because a bad-faith claim no longer requires proof of prior exhaustion, an excess insurer that mishandles a claim, delays communication or takes steps that make exhaustion harder to reach may face tort exposure well before its policy would otherwise attach. Policyholders should take note of this leverage, and insurers should revisit how early and how transparently they engage with claims in a tower
The decision is not a blank check, however. Policyholders still must plead specific facts – not conclusions – showing that a covered loss is reasonably likely to reach each excess layer’s attachment point, and must be careful to separate covered loss from interest or other non-covered amounts when quantifying their claims. Getting that pleading right will determine whether a policyholder can bring its whole tower into one case or gets knocked out at the demurrer stage.
If you have questions about structuring a coverage action involving layered or excess insurance, contact Bradley Dlatt or Nancy Sher Cohen, or your regular Lathrop GPM attorney.