PROVIDENCE, R.I.—A ruling that says that, under Rhode Island law, individuals seeking to recover damages from a bankrupt company cannot directly collect from excess insurers if the company has not exhausted its self-insured retention likely will be significant nationally, said an attorney in the case.

According to Monday's decision in Henry Rosciti et al. vs. Liberty Mutual Insurance Co. et al., Rhode Island's “direct action” statute allows tort victims to recover damages directly from the liability insurers of a bankrupt firm.

Henry and Donna Rosciti and Henry Rosciti Jr. had sued a unit of New York-based American International Group Inc., Insurance Co. of the State of Pennsylvania, alleging that the bankrupt Coburg, Ore.-based Monaco Coach Corp., sold them a defective mobile home and then failed to repair it, which caused one of them to become ill from toxic mold.

ICSOP had provided Monaco with excess insurance policies covering claims above a self-insured retention of $500,000, up to limits ranging from $1.5 million to $2.5 million, depending on the policy. The parties agreed Monaco would not pay the self-insured retention because of its bankruptcy status.

The plaintiffs argued that the state's direct-action statute nullified insurance policy provisions requiring exhausting the retention before ICSOP became liable. However, ICSOP said it was not liable for the coverage because Monaco had failed to pay the retained limit and sought dismissal of the case, according to the opinion.

U.S. District Court Judge William E. Smith agreed with the insurer. “Monaco must completely expend its retained limit before ICSOP can be liable to plaintiffs. Since Monaco has not done so, and will not be able to, the contracts do not allow plaintiffs to recover from ICSOP,” he ruled.

“Ultimately, while the court empathizes with plaintiffs, it cannot see how the (direct action) statute might effectively void the exhaustion clause in the contract.” The Rhode Island law “does not mention policy terms that deal with exhaustion or retained limits,” Judge Smith ruled in dismissing the case.

“If excess insurers knew they faced the possibility of dropping down in the context of bankruptcy, they would charge higher premiums for bearing that risk. So if the court held that an exhaustion clause violates (the direct-action statue) where a bankrupt policyholder is self-insured for the retained limit, the net effect would be to reverse the existing contractual allocation of risk,” said Judge Smith, who issued a final order in the case Tuesday. “Plaintiffs' contention thus strains the language of (the statute) too much.”

Stephen Prignano, a partner with law firm Edwards Angell Palmer & Dodge L.L.P. in Providence, who represented the insurer, said although the Rhode Island law is several years old, this is the first significant ruling in the state to deal with this issue. Furthermore, although about 20 other states have similar statutes, “there aren't many (decisions) out here that have addressed this precise issue.”

In future cases involving excess insurers, plaintiffs “will not be able to argue that the direct-action statute trumps their insurance policy, ultimately,” Mr. Prignano said. “They're going to need to show there's coverage” under the policy and that any retention has been exhausted, he said.

The Rosciti's attorney, Robert D. Fine, a partner with Chace Ruttenberg & Freedman L.L.P. in Providence, declined comment.

Boston-based Liberty Mutual was removed earlier as a defendant on the case.