David Simantob

Just when you thought California insurance law could not get worse for insurers, on July 27, 2026, the California Supreme Court issued a unanimous opinion in Fox Paine & Co., LLC v. Twin City Fire Ins. Co., 20 Cal. 5th 188 (2026), which fundamentally reshapes the landscape for excess insurers in California. The Supreme Court reversed the Court of Appeal’s insurer-friendly decision and held that an insured need not allege exhaustion of the underlying insurance to pursue claims for declaratory relief or bad faith against an excess insurer. This decision significantly expands the circumstances under which excess insurers may face litigation well before their policies have formally attached.

Background and Procedural History
The case arose from a dispute after a falling out between Saul Fox and Dexter Paine, co-founders of Fox Paine & Company, LLC (FPC), a private equity management firm established in 1996. After their relationship deteriorated in 2006, the parties became embroiled in extensive litigation across multiple jurisdictions, including proceedings in Delaware, New York, and California.

FPC maintained a $50 million insurance tower comprising of a $10 million primary policy and four successive $10 million excess layers. Each excess policy was a “follow form” policy conditioning coverage on exhaustion of all underlying insurance. During the underlying litigation, without notifying the insureds, the $10 million primary limits were paid to the plaintiffs and two excess insurers settled the claims for approximately $9 million. When the insureds learned of these payments, they sued the three excess insurers in San Francisco Superior Court in 2017, asserting claims for breach of contract, declaratory relief, bad faith, and aiding and abetting breaches of fiduciary duty. The trial court sustained the demurrers of two excess insurers in the tower, finding that the insureds failed to allege exhaustion of the underlying policies. 

In September 2024, the Court of Appeal (First District, Division Two) in Fox Paine & Co., LLC v. Liberty Mut. Ins. Co., 104 Cal. App. 5th 1034 (2024) affirmed the judgments in favor of the excess insurers. The decision was strongly favorable to excess insurers on multiple grounds, including that there was no “actual controversy” sufficient to support declaratory relief without underlying exhaustion and that an insured could not pursue bad faith absent allegations of exhaustion as, “without coverage there can be no liability for bad faith.” The Court of Appeal articulated strong policy justifications, stating that “[a] strict exhaustion requirement brings stability and predictability to the excess insurance system” and that “burdening the excess insurers with prematurely litigating coverage issues before exhaustion upsets insurers’ settled expectations.”

The California Supreme Court’s Ruling
The Supreme Court reversed the decision, departing from the Court of Appeal on both the declaratory relief and bad faith theories. 

First, the Court held that “an insured may state a viable cause of action for declaratory relief regarding coverage and liability under an excess insurance policy even if all of the underlying insurance coverage has not yet been exhausted.” The Court rejected a blanket exhaustion prerequisite, reasoning that such a rule would “place too much emphasis on the fact that a contingency exists, and too little on the likelihood it will occur.” Instead, the Court adopted a “reasonable likelihood” standard: where an insured’s covered losses are uncertain, a declaratory relief claim is ripe if it is “practically or reasonably likely that the insured’s potential liability will reach into the excess coverage.” Where an insured’s covered losses are fully known and fall short of the attachment point, the claim is properly rejected.

The Court further held that bad faith claims could be pursued without alleging exhaustion—although noting that coverage must still be established for bad faith liability. Drawing on Schwartz v. State Farm Fire & Cas. Co., 88 Cal. App. 4th 1329 (2001), the Court emphasized that “an excess insurer’s implied covenant not to injure an insured’s right to receive the benefits of the insurance contract exists from the inception of the agreement.” The Court recognized that an insurer may breach the implied covenant “while remaining in technical compliance with the express terms of its policy” and that, “in some instances it may be the insurer’s bad faith itself that prevents an insured from fulfilling all of the conditions of coverage.” At the pleading stage, though, an insured needs only allege facts showing that coverage under the excess policy will attach, or that it would attach but for the insurer’s bad-faith conduct and that the insurer’s misconduct has impaired the insured’s recovery of policy benefits.

Key Implications for Excess Insurers
The immediate implications of this decision against excess insurers are clear. The decision will impact the ability of excess insurers to avoid participation in coverage litigation before their policies attach. Excess insurers can no longer rely on the absence of exhaustion as a categorical bar to declaratory relief and bad faith claims. Insureds may now bring these claims as soon as a “reasonable likelihood” of coverage attachment can be alleged.

In addition, the ruling that the implied covenant exists from policy inception and can be alleged before coverage attaches creates significant new expense in defending bad faith claims. Excess insurers’ conduct during the pendency of underlying claims may now be scrutinized under a bad faith standard even when the excess layer has not yet been triggered. What is not clear by this decision is what kind of conduct can be bad faith in the absence of exhaustion. We anticipate there will be a lot of litigation trying to figure out what the California Supreme Court meant by this part of the ruling.

Here are some areas for insurer consideration in light of this decision:

1. Claims-Handling Protocols. The insurers can review internal procedures for proactive engagement with insureds upon tender of an excess claim, including timely acknowledgment of notices, communication regarding coverage positions, and documentation of claims-handling activities.

2. Litigation Strategy. Demurrers and motions to dismiss premised solely on lack of exhaustion are unlikely to succeed under the new California Supreme Court framework. Defense strategies can instead focus on the sufficiency of the insured’s allegations regarding covered losses and the reasonable likelihood of attachment.

3. Policy Language Enhancements. Excess insurers can review policy language to ensure that exhaustion provisions, conditions precedent, and other protective terms are as clear and enforceable as possible in light of the Court’s analysis.