The opinion of the court was delivered by: Robert L. Carter, District Judge.
Plaintiffs Reliance Insurance Company, ("Reliance"), Continental
Insurance Company, ("Continental"), and Royal Insurance Company,
("Royal"), (collectively "plaintiffs" or "insurers"), seek a judgment
declaring that they are not required under the provisions of a marine
multi-liability excess insurance policy ("bumbershoot policy") to
indemnify the defendants: Keystone Shipping Company, ("Keystone"), and
Intercoastal Bulk Carriers, ("IBC"), (collectively "defendants" or
"assureds"), for costs defendants incurred during the arbitration and
settlement of a claim brought by New England Power Company ("NEP")
seeking costs for a damaged ship defendants sold to NEP under a charter
agreement. Alternatively, plaintiffs argue that if defendants' claim is
covered under the bumbershoot policy, third party defendant, James
Sedgwick of Pennsylvania, Inc., ("Sedgwick"), is required to indemnify
them for any costs paid to the defendants.
A. The Charter Agreement Dispute
In 1980, defendants formed an agreement with NEP to build the "Energy
Independence," a self-unloading coal transport vessel ("the vessel"),
that would be used for transporting NEP coal supplies. (Jt. Or. at 52,
¶ 13).*fn1 The Energy Independence is a "bulk carrier": it spans the
length of two football fields, is approximately six stories high, and has
five cargo holds composed of bare uncoated, unlined and unpainted steel.
(Id. at 53, ¶ 14). The vessel was completed and launched in 1983.
(Id. at 52, ¶ 13). From that time forward, it was exclusively engaged
in transporting coal from various United States's ports to NEP's New
England coal burning plants. (Tr. at 476).
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.
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).
Morency testified at trial that he reviewed the application and, based
on Gallagher's responses, agreed that Reliance would issue defendants
bumbershoot coverage from May 11, 1995, to May 1, 1996. (Tr. at 55-56).
Morency also testified that, since he assumed that defendants had
unlimited P & I coverage for the charter agreement, he calculated
their premium for the bumbershoot policy using a percentage of the
standard premiums for Terminal Operators, Contingent Marine Liability,
Comprehensive General Liability and Automobile policies. (Id. at 57-58).
Sedgwick was responsible for preparing the final policy, which was a
series of boilerplate excess multi-liability insurance forms with
standard bumbershoot clauses. (Tr. at 20-21). The parties had no further
communication about the bumbershoot policy's scope until April 1996, when
plaintiffs received a letter from Sedgwick indicating that defendants
would seek indemnification under the bumbershoot policy for the costs of
repairing the vessel's damage and other costs from the settlement with
NEP. (Pl. Ex. 20).
At the start of the dispute with NEP about the vessel's damage,
defendants assigned Achuff to investigate which of their insurance
policies would indemnify them for the potential liability arising from
this matter. Achuff had Sedgwick employees send letters to several of
defendants' insurers which summarized NEP's allegations that defendants'
deficient maintenance had severely damaged the vessel during the charter
term. (See, e.g., Pl.Ex. 21) ("Sedgwick claim letters"). Before sending
out the claim letters, Achuff discussed NEP's allegations with Ralph
Hill, Keystone's general counsel, and other Keystone officials. Although
the parties considered several causes for the vessel's wastage, no one
indicated, as later alleged, that microbes had damaged the ship.
In response to a Sedgwick claim letter, American Club sent Sedgwick a
letter, dated May 30, 1996, denying defendants coverage under defendants'
primary P & I policy. (Jt. Ex. 243). American Club indicated that the
dispute about the vessel's damage concerned wear and tear damage to the
assureds' own property, and therefore was not covered under the terms of
their P & I policy. (Id).
American Hull Insurance Syndicate ("AHIS"), the underwriter of
defendants' primary hull policy, also responded to the Sedgwick claim
letter by denying defendants coverage. AHIS explained that the costs from
the dispute about the vessel's damage "did not arise from losses
sustained as the owner of the vessel, but rather [were being made] on the
basis of [defendants'] contractual indemnity to NEP," and therefore
look to their third party liability policies to cover these losses. (Jt.
Plaintiffs also responded to the Sedgwick claim letter by denying
defendants coverage. In a letter, dated July 23, 1996, plaintiffs
indicated that the dispute about the vessel's damage was not covered
under the bumbershoot policy because: (1) the damage to the vessel was a
result of ordinary wear and tear, and therefore was not an "occurrence"
covered by P & I insurance, and (2) the damage to the vessel occurred
while defendants still owned the vessel, and therefore did not constitute
third party liability. (Jt. Ex. 240). Achuff discussed with Keystone
officials the various letters from defendants' insurers denying
defendants coverage. Although Keystone officials mentioned several
possible causes for the vessel's damage, again, no one suggested that
microbes had caused the damage. (Tr. at 354).
On August 12, 1996, Sedgwick and Reliance representatives convened to
discuss whether Reliance, as lead underwriter, would extend coverage
under the bumbershoot policy for the dispute about the vessel's damage.
During the meeting, Reliance and Sedgwick representatives discussed the
damage to the vessel as though it had resulted from ordinary wear and
tear; no mention was made of damage-causing microbes. (Tr. at 114-16,
After the meeting Sedgwick crafted a response to Reliance's denial of
defendants' claim. In a letter, dated August 13, 1996, Sedgwick explained
that the vessel's damage was caused by repeated exposure to environmental
conditions which triggered oxidation and corrosion of the vessel's steel
holds. (Pl.Ex. 39). Achuff reviewed this letter with Keystone's general
counsel and other Keystone and IBC officers, and the letter was
approved. (Tr. at 365-66). None of these officers indicated at this time
that the vessel's damage was caused by microbes.
Reliance again indicated to defendants that it did not believe that the
bumbershoot policy offered coverage for the vessel's damage or the NEP
settlement; defendants continued to assert that the policy did cover
these costs. Reliance ultimately convened with the other underwriters who
had subscribed to the bumbershoot policy and with counsel, and as a group
denied defendants coverage under the policy. (Tr. at 31-32).
Additionally, the underwriters brought the instant claim under
28 U.S.C. § 1333 and § 2201 for a declaratory ...