Horizontal and Vertical Exhaustion in the Additional Insured Context
Date Posted
Construction project owners and general contractors (“upstream parties”) usually require that their subcontractors (“downstream parties”) procure certain minimum limits of Commercial General Liability insurance on a primary/non-contributory basis that names the upstream parties as additional insureds. Parties may assume that the contract language dictates the priority of insurance coverage available to them – i.e. that the downstream parties’ primary and excess policies will react first when the upstream party seeks coverage as an additional insured for damages arising out of the downstream party’s work. However, disputes arise when a downstream party’s primary CGL policy is insufficient to cover the loss. Although the parties may assume that the downstream party’s excess policy responds before the upstream parties’ primary policies, some courts have held otherwise.
Courts have recognized two legal theories on assigning priority of insurance coverage: “vertical” and “horizontal” exhaustion. Vertical exhaustion is the theory that primary and excess policies purchased by the downstream parties must pay before any policies purchased by the upstream parties. Typically, vertical exhaustion reflects the intent of the parties seeking to transfer risk to the downstream party. By contrast, horizontal exhaustion is the theory that the downstream party’s excess policy is not triggered unless all applicable primary policies have been exhausted, including the upstream parties’ own primary CGL insurance.
Illustrative Example
General Contractor enters into a subcontract with Subcontractor. Subcontractor is required to procure $2 million of primary CGL coverage and $5 million dollars of excess coverage on a primary and non-contributory basis, naming General Contractor as an additional insured. General Contractor also has its own insurance consisting of $2 million dollars of primary CGL coverage and $5 million dollars of excess coverage.
An injury occurs on the construction project arising out of Subcontractor’s work. Judgment is entered against Contractor and Subcontractor in the amount of $8 million dollars. The order of payment amongst Subcontractor’s and General Contractor’s insurance policies depends on whether vertical or horizontal exhaustion is applied: