In 1989, Keystone and NEP entered a new agreement controlling the use
and disposal of the vessel ("charter agreement"). The charter agreement
outlined the terms of NEP's continuing charter of the vessel ("charter
provisions"); it also granted NEP the right to purchase the vessel during
the charter term ("buy-out provisions"). Specifically, the charter
provisions designated IBC, an affiliate of Keystone, as the vessel's
"owner"; designated NEP as the vessel's "charterer"; and named Keystone
as the vessel's "operator". (Jt. Ex. 115). The charter provisions also
required IBC, as "Owner [of the vessel, to] . . . maintain the vessel in
class throughout the period of the Charter," and to "exercise due
diligence . . . to make the Vessel tight, staunch, strong, seaworthy and
in good order and condition." (Jt. Ex. 115) (Charter Agreement, clauses 3
The buy-out provisions in the charter agreement set the purchase price
for the vessel at an amount sufficient to pay off the vessel's remaining
financing costs, and to provide defendants with approximately 5 to 10
million dollars in profit. (Tr. at 429-31). The precise purchase amount
for the vessel was computed under calculations in "appendix five" of the
charter agreement. (Jt. Ex. 115). During the negotiations of the buy-out
provisions, Philip Fisher, the Chief Financial Officer and Vice President
of Keystone and the President of IBC, asked Keystone's insurance broker
and in-house risk manager, Sedgwick, whether the charter agreement's
buy-out provisions could be insured. (Tr. at 348). Charles Achuff,
Sedgwick's Vice President, advised Fisher that the buy-out provisions
could not be insured under any type of insurance policy. (Id.). The
buy-out provisions were then drafted to provide that the vessel was to be
sold "as is where is." (Tr. at 338).
In November, 1994, NEP exercised its buy-out option, and defendants
opposed the purchase of the vessel. (Jt. Or. at 53, ¶ 20; Tr. at
446-47). The parties submitted their dispute for arbitration, and the
arbitration panel ultimately held that NEP had properly exercised its
buy-out rights and could terminate the charter and buy the vessel. (Jt.
Ex. 116 at 2). The parties then entered a settlement, dated September
10, 1995, which provided that the vessel would be sold to NEP for the
purchase price set by appendix five of the charter agreement. (Tr. at
447; Jt. Ex. 166). On September, 28, 1995, defendants delivered the
vessel to NEP. (Tr. at 447).
In October, 1995, NEP put the vessel in drydock at Bethlehem Steel in
Sparrows Point, Maryland, and conducted surveys to assess the vessel's
condition. (Pl. Ex. 11 at 2). The surveys revealed that the vessel's
holds were severely wasted, in addition to needing numerous other
repairs. (Id.). NEP arranged to have the vessel repaired and, in a letter
dated April 22, 1996, informed defendants that the vessel was damaged and
that NEP would file a claim against them for $11,173,732.00 in damages.
(Pl.Ex. 21). Only part of NEP's damage claim was directly attributable to
the cost of repairing the vessel. For example, only approximately 8
million dollars of NEP's damage claim was for the costs NEP incurred in
arranging for steel renewals to the vessel.*fn2 (Id.).
NEP brought its damage claims before the same arbitration panel that
had handled the parties' prior dispute. At this hearing, NEP argued that
defendants had breached clauses 3 and 6 of the charter agreement,
requiring defendants to perform diligent maintenance on the vessel, and
to keep the vessel "in class" and "in good repair" during the period of
the charter. (Jt. Or. at 54; Jt. Ex. 232). The arbitration hearing was
held over twenty-six days, and the panel ultimately decided that
defendants could be held liable for the damage to the vessel under
clauses 3 and 6
of the charter agreement.*fn3 (Jt. Or. at 54, ¶¶ 21-24). Defendants
and NEP then entered a settlement agreement, dated August 29, 1997, in
which defendants agreed to settle all of NEP's remaining damage claims
for $3,250,000.00 (Jt. Ex. 248).
Sedgwick subsequently notified plaintiffs that defendants intended to
file a claim to cover the costs of its settlement with NEP for the
vessel's damages under a bumbershoot policy plaintiffs had issued to
defendants for the period May 11, 1995, to May 1, 1996. Specifically,
defendants requested indemnification for: $3,250,000.00 in damages and
$2,000,000.00 in punitive damages paid to NEP in the settlement;
$350,120.00 NEP collected as interest on the settlement; $1,891,800.92 in
lawyers' fees incurred while opposing NEP's claims; $479,174.64 in costs
and expenses incurred in the arbitration; and interest at prime rate plus
3% on the claim settled with NEP as of the date the settlement was made.
B. The Policy
The bumbershoot policy at issue is a standard marine umbrella insurance
policy; it provides both excess insurance coverage and "drop down"
coverage.*fn4 (Tr. at 18, 27). The excess insurance provisions provide
insurance coverage over and above the limits of the assureds' enumerated
primary insurance policies, and only respond when the limits of the
primary policies have been exhausted. See Raymond P. Hayden & Sanford
E. Balick, Marine Insurance: Varieties, Combinations and Coverages, 66
Tul.L.Rev. 311, 353 (1991) ("Marine Insurance"). The "drop down"
provisions of the policy fill in gaps in coverage left by the primary
insurances. See id. at 361; (Tr. at 27). The dispute in this case
concerns the scope of the bumbershoot policy's drop down provisions.
Defendants purchased their bumbershoot policy through Sedgwick.
Negotiations on the policy began when Joseph Morency, the Assistant Vice
President and Marine Underwriters Liability Manager for Reliance, advised
Sedgwick Assistant Vice President Elizabeth Gallagher, that defendants'
current bumbershoot policy was about to expire. Morency indicated that
Reliance was interested in participating in a joint subscription with
other insurers for defendants' bumbershoot coverage for the year
1995-1996, contingent upon its approval of defendants' insurance renewal
application ("application") (Tr. at 52-53).
Gallagher prepared the application, which required detailed information
regarding defendants' potential liabilities, and their primary insurance
coverage for the 1995-1996 calendar year. On page 00006 of the
application, in response to the question "Describe contractual coverage in
primary policy[s]," Gallagher indicated:
"Lease agreements covered by primary
CGL.*fn5 Charter Parties/Labor Agreements/Operating
Agreements covered by P & I policy.
Storage/Transfer Agreements covered by Terminal
Operators Liability Policy." (Jt. Ex. 223 emphasis
The P & I policy Gallagher referred to in the application was a
protection and indemnity ("P & I") policy that another insurer,
American Club, had issued to Keystone. Gallagher also indicated in the
application that the American Club P & I policy offered defendants
unlimited P & I coverage, except for a $500,000,000 pollution
limitation. (Id.; Tr. at 55). Gallagher testified that she was at
Keystone's offices when she prepared the application and could have
examined the American Club P & I policy and the charter agreement,
but she failed to do so. (Tr. at 48485). Gallagher further testified that
her statement in the application, that defendants' charter agreement
liability was covered under the American Club P & I policy, was only
intended to indicate that this insurance would cover some charter
agreement liabilities. (Tr. at 483).