Must a policyholder wait until it exhausts its underlying insurance limits before it can sue a higher-layer excess insurer? The Supreme Court of California recently said no, reconciling a split in California case law. Fox Paine & Co., LLC v. Twin City Fire Ins. Co., No. S287404, 2026 WL 2148053 (Cal. July 27, 2026).

Insured Fox Paine & Co (FPC) turned to its $50 million in layered insurance to defend and prosecute various underlying lawsuits. FPC had a $10 million primary policy from Houston Casualty Company (HCC), and four $10 million excess policies above its primary coverage: two policies 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.

In the underlying lawsuit, HCC settled with the adverse parties in the lawsuit for the entire $10 million without notifying FPC. Twin City and St. Paul then settled with the adverse parties for an additional $9 million between them, again without notifying FPC. FPC paid approximately $43 million defending the underlying lawsuit. FPC sued Twin City, St. Paul, and Liberty Mutual, requesting declaratory judgment declaring the underlying lawsuits were covered by the excess policies and alleging bad faith against its insurers.

The Supreme Court of California acknowledged a split in case law:  In Qualcomm, Inc. v. Certain Underwriters at Lloyd’s, London, 161 Cal. App. 4th 184 (2008), the Court of Appeal affirmed a dismissal of a declaratory relief claim because the insured had settled with its primary insurer for less than the primary limits. As a result, the court determined the excess policy’s exhaustion clause precluded liability and excess coverage would not be would not be reached and thus was not triggered. Id. at 198. However, Courts of Appeal in Ludgate Ins. Co. v. Lockheed Martin Corp., 82 Cal. App. 4th 592 (2000) and Lockheed Martin Corp. v. Continental Ins. Co., 134 Cal. App. 4th 187 (2005) suggested 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 create an actual controversy to sue an excess insurer. Ludgate Ins. Co., 82 Cal. App. 4th at 606.

Confronted by this seeming contradiction, California’s high court decided that both were correct. The Supreme Court of California decided that Qualcomm was correctly decided because “it is appropriate to reject a declaratory relief claim due to the absence of an actual controversy when an insured alleges a fully known loss or liability that is insufficient to reach an excess policy’s attachment point.” Fox Paine & Co., at *14.

In cases where the amount of the loss is unknown or has not yet been ascertained, the Court refined the approach used in Ludgate Ins. Co. and Lockheed Martin Corp. and decided on a “reasonable likelihood” standard. In determining whether an excess insurer can be sued in a declaratory judgment coverage action, “it must be practically or reasonably likely that the insured’s potential liability will reach into the excess coverage; absolute proof that the policies will be triggered is not required.” Fox Paine & Co., at *12. In practice, an insured must allege that it is “practically or reasonably likely” that its losses will reach the excess policy’s attachment point, but the insured does not have to prove that the underlying policy has already been exhausted. Id.

Applying this framework to FPC’s claims, the Court found that FPC’s inability to allege full exhaustion did not defeat its declaratory relief claims. Id. at *10. The same was true for FPC’s bad faith claims: the insured does not have to plead exhaustion of the underlying policies to allege bad faith against an excess insurer. At the pleading stage, an insured “needs only to allege facts that, taken as true, are sufficient to show that coverage under a defendant insurer’s excess policy will attach — or that it would attach, if not for the excess insurer’s bad-faith conduct — and that the insurer’s misconduct has impaired the insured’s recovery of benefits owed to it under the policy.” Id. at *21.

This decision removes a major procedural obstacle for an insured with layered insurance policies in California. Insureds need not sue one insurer at a time, waiting for a payout at the lower level before bringing its excess carrier into a lawsuit. This change could shorten the path to resolution and avoid the risk of inconsistent rulings when multiple policies interpreting identical language end up before different courts at different times. However, insureds still must show that a covered loss is reasonably likely to reach each excess layer’s attachment point.