No Exhaustion, No Problem? California Supreme Court Gives Policyholders a Path to Bring Bad Faith Claims Against Excess Insurers

Policyholders pursuing coverage under large insurance towers often encounter the same argument from excess insurers: no exhaustion, no claim. In July 2026, however, the California Supreme Court rejected a broad version of that argument, holding that policyholders are not categorically barred from pursuing declaratory relief and bad-faith claims against excess insurers simply because underlying coverage has not yet been exhausted.

The dispute arose from a multi-layer insurance program and allegations that excess insurers took positions that impaired the insureds’ ability to obtain policy benefits. In particular, the insureds alleged that the insurers failed to pay them policy benefits in connection with underlying litigation, and allowed insurance proceeds to be disbursed to the opposing party in the litigation, in violation of the duty of good faith and fair dealing. The insurers argued that any claims against them were premature because their policies had not yet attached. The court disagreed.

The court held that a policyholder may seek declaratory relief regarding an excess insurer’s obligations before exhaustion occurs where a present controversy exists. It further concluded that bad-faith claims are not automatically foreclosed at the pleading stage merely because underlying limits remain unexhausted. Instead, where an insured plausibly alleges that an excess insurer’s conduct has impaired or threatened its ability to obtain policy benefits, dismissal is not required solely on exhaustion grounds.

The decision is significant because it limits a common early defense used by excess insurers and recognizes that an excess carrier’s conduct can affect a policyholder long before its coverage layer is triggered. While policyholders must still prove coverage and bad faith, the decision confirms that exhaustion is not always a gateway requirement to getting into court.

The decision is Fox Paine & Co., LLC v. Twin City Fire Ins. Co., No. S287404, 2026 Cal. LEXIS 3943 (Cal. Jul. 27, 2026)