Reinsuring Clauses 9781843118893

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R E I NSU R I NG C L AUSE S

LLOYD’S INSURANCE LAW LIBRARY

Editor-in-Chief Malcolm Clarke Insurance Law and the Financial Ombudsman Service Dr Judith P Summer (2010) Good Faith and Insurance Contracts Third edition Peter MacDonald Eggers Simon Picken QC Patrick Foss (2010) Reinsurance Practice and the Law Barlow Lyde & Gilbert (2009) The Law of Insurance Contracts Sixth edition Malcolm Clarke (2009) Directors’ and Officers’ Liability Insurance Adolfo Paolini Deepak Nambisan (2009) Compendium of Insurance Law Robert Merkin Johanna Hjalmarsson (2007) Private International Law and Reinsurance and Insurance Raymond Cox, QC, Louise Merrett and Marcus Smith (2006) Insurance Disputes Rt Hon Lord Justice Mance, Iain Goldrein QC and Robert Merkin (2006) Insurance Broking Practice and the law CMS Cameron McKenna (Looseleaf) Reinsurance Practice and the Law Barlow Lyde & Gilbert (Looseleaf) The Law of Insurance Contracts Malcolm Clarke (Looseleaf)

REINSURING CLAUSES BY

ÖZLEM GÜRSES

LONDON

2010

First published 2010 by Lloyd’s List Published 2014 by Informa Law from Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN and by Informa Law from Routledge 711 Third Avenue, New York, NY, 10017, USA Informa Law is an imprint of the Taylor & Francis Group, an informa business Lloyd’s and the Lloyd’s Crest are the registered trademarks of the Society incorporated by the Lloyd’s Act 1871 by the name of Lloyd’s. © Özlem Gürses 2010 All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Whilst every effort has been made to ensure that the information contained in this work is correct, neither the authors nor Informa Law from Routledge can accept any responsibility for any errors or omissions or for any consequences arising therefrom. Product or corporate names may be trademarks or registered trademarks and are used only for identification and explanation without intent to infringe. Lloyd’s is the registered trade mark of the Society incorporated by the Lloyd’s Act 1871 by the name of Lloyd’s.

British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library ISBN 13: 978-1-843-11889-3 (hbk) Text set in 10/12pt Times by Exeter Premedia Services, Chennai, India.

FOR EWOR D

What a welcome book – congratulations to Özlem for producing such an excellent treatise and to Rob Merkin for suggesting she did it! This is a full and learned analysis of reinsuring clauses from a legal viewpoint and of immense value to lawyers and claims personnel, those drafting wordings and, might I dare suggest, underwriters. Özlem has examined carefully cases and referred to a wide selection of authorities – but it is with pleasure that I note that the first authority referred to on page 1 is Reinsurance in Practice by Bob Kiln who was the inspiration for many to consider carefully how reinsurance worked and, in particular, the analysis of reinsuring clauses. I am very pleased to have been invited to write a foreword to this book, not only because of what I have said above, but in that Özlem was one of the first winners of the AIDA Europe Prize for Students to prepare a paper on an insurance or reinsurance topic and then to deliver a summary of the paper at the subsequent AIDA Europe conference in Zurich in 2009. Her topic was Claims Cooperation and Control Clauses which feature in this book. As Chairman of AIDA Europe and the AIDA Reinsurance Working Party I was delighted that Özlem shared her researches at that stage with us and has now gone on to share her work into reinsuring clauses with a much wider audience by the publication of this book. There is much of interest in the book but there are two particular areas which I believe are most valuable. Firstly, Özlem has, which she has identified in her preface, concentrated particularly on “follow the settlements”. She has done much interesting analysis and has some definite views – which could also, in places, be classified as controversial. Here I refer to the recent Wasa case where she has contributed to the debate as to the desirability of this judgment – a debate which no doubt will continue. Secondly, it is of much assistance to those considering wordings to have in one book a comparison of both the American and English decisions and approaches to reinsuring clauses. Özlem herself, again in her preface, identifies the problem with analysing US cases, with which I sympathise, but she has gone a long way to recording these decisions in a coherent and useful summary. English judges, on not infrequent occasions, have in judgments been critical and even caustic with regard to wordings contained in reinsurance contracts – one particular learned judge referring to a contract (which case appears in this book) as “a dog’s breakfast”. This book I am sure will go a long way to contributing to a better understanding of clauses and better drafting of such clauses – and this must be a good thing for the industry. Colin Croly Chairman AIDA Reinsurance Working Party

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PR E FAC E

A survey of decided insurance and reinsurance cases over recent years shows beyond all doubt that most disputes arise because of deficiencies in drafting. The title of this book “Reinsuring Clauses” reflects the fact that many reinsurance disputes arise because the parties’ intentions are not always properly reflected in the words that they have adopted. As the issues mostly turn on “construction” it is not easy to establish settled principles of law and the outcome depends upon the precise words used. Much of the history of the subject consists of the adoption of different forms of words and the subsequent judicial construction of them. Reinsuring clauses and claims settlement clauses are generally found in policies written in the London and US reinsurance markets. Wordings vary from case to case, and in this work an attempt has been made to discuss the most important forms of wording and the leading cases from both jurisdictions on their interpretation. There is a clear distinction between the two jurisdictions. In England there is a growing body of law from which it is possible to determine the approach of the courts to any particular form of wording. In the United States, the position is much more haphazard. Very few of the US states have seen reinsurance disputes coming before their courts, and the decisions are confined to a small number of those courts. Where there are decisions, they have been handed down by an array of federal and state courts operating at different levels within the system, and as a result it is difficult to derive from the cases anything approaching a clear set of principles. Often, the judges are in the hands of the parties, so that the way in which a case is argued will determine the terminology and reasoning of the court. An English judge may, therefore, agonise over the distinction between “follow the settlements” and “follow the fortunes”, whereas a US judge may simply use the terms interchangeably. Indeed, it is common to find the US courts using the phrase “the follow fortunes” doctrine without making clear whether this is a common law principle or one derived from the wording of the policy (which will often refer to “follow the settlements” anyway). That health warning aside, the US cases are discussed at length in this work. This is so because, first, they may provide some insights as to how US courts approach reinsurance disputes and, secondly, because many of the issues discussed in the US cases have not been given detailed consideration in England: allocation, for example, has been the subject of many US decisions but hardly any in England. The potential of this topic was suggested to me by Professor Rob Merkin when I was considering my options for PhD study, and who subsequently became my supervisor. I am grateful to him for his patience and help as supervisor, and subsequently for his comments on the manuscript for this work. . I also would like to thank Associcate Professor Dr EmineYazıcıog˘lu of the Law Faculty at Istanbul University, who has supported me from the very first day of my career in academia. vii

P R E FA C E

I am grateful to the School of Law and the Institute of Maritime Law at the University of Southampton for generously providing the funding for my PhD. My grateful thanks also go to the law firms Butler Rubin Saltarelli & Boyd (Chicago), Chadbourne and Parke LLP (London and Washington DC offices), and Dewey & LeBoeuf (New York) for accommodating me during a research trip to the US. I owe a particular debt to Ellen Woodbury of Chadborne and Parke in Washington, who continues to keep me up to date on US developments and who also made valuable comments on the US chapters. At the final stage of preparing this book for publication, I had the opportunity to use the excellent research environment of the Max Planck Institute for Comparative and International Private Law in Hamburg, and I would like to express my gratitude to the Institute for generously funding my research visit to the Institute. I am also grateful to Dr Ulrich Jürgens and Dr Mary Morrison for their friendship and support during my PhD and since. Finally, I would like to thank my colleague, Johanna Hjalmarsson who read the final version of the book before it was submitted to the publishers. As ever, any errors and omissions are the responsibility of the author. The manuscript was completed at the end of July 2010. Özlem Gürses

2010

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TA BL E OF CON T E N TS

Page v vii xiii xxiii

Foreword Preface Table of Cases Table of Legislation CHAPTER 1: INTRODUCTION TO REINSURANCE CONTRACTS Definition of Reinsurance Forms of reinsurance contracts Proportional reinsurance Non-proportional reinsurance Facultative reinsurance Treaties Definition and types of reinsurance in the United States Definition of reinsurance Purpose of reinsurance Types of reinsurance Wording of reinsurance contracts Treaties Proportional facultative reinsurance

Para 1.01 1.04 1.06 1.07 1.08 1.10 1.16 1.16 1.18 1.20 1.24 1.24 1.25

CHAPTER 2: THE NATURE OF FACULTATIVE REINSURANCE The subject matter of reinsurance Applicable principles Privity of contract Privity – United States General rule: Reinsurers have no obligations towards assureds Intervention in the settlement process by the reinsurer Policy wording Reinsured’s insolvency Cut-through exception Insurable interest Co-insurance/Double insurance The “further insurance” view The “liability” view The principle of back-to-back cover Scope of the principle Vesta v Butcher Groupama Navigation et Transports & Ors v Catatumbo Seguros

ix

2.03 2.04 2.04 2.08 2.10 2.11 2.25 2.34 2.45 2.53 2.65 2.68 2.71 2.82 2.82 2.83 2.93

TA B L E O F C O N T E N T S

Rebutting the presumption Concurrency between insurance and reinsurance policies in the United States Applicable law and back-to-back cover: Wasa v Lexington Facts Decisions Implications of Wasa

2.95 2.102 2.105 2.106 2.111 2.223

CHAPTER 3: INCORPORATION AND THE FULL REINSURANCE CLAUSE The function of “as original” Development of the theory of incorporation Requirements for incorporation HIH v New Hampshire The scope of incorporation Incorporation of unusual terms Incorporation of inconsistent terms Construction of inconsistent terms Inconsistency between reinsurance – insurance contracts Incorporation of claims clauses Incorporation of implied terms Incorporation of arbitration clauses Incorporation from charterparty into bills of lading Incorporation from direct insurance into reinsurance contracts The Arbitration Act 1996 section 6(2) Incorporation of jurisdiction and choice of law clauses

3.01 3.04 3.09 3.10 3.18 3.20 3.25 3.25 3.26 3.35 3.42 3.43 3.43 3.44 3.55 3.56

CHAPTER 4: SPECIFIC ISSUES RELATING TO INCORPORATION Waiver of defences clause in the original insurance Alterations to the original policy Alterations to the original policy and the continuing duty of utmost good faith Leading underwriter clause in the original policy Obligations of the assured under the direct policy Other forms of incorporation wording The presumption of back-to-back cover and incorporation Incorporation in facultative non-proportional reinsurance

4.01 4.05 4.15 4.26 4.29 4.32 4.33 4.42

CHAPTER 5: INCORPORATION IN THE LAW OF THE UNITED STATES Follow the form clauses Follow the form – concurrency between the reinsurance and the original insurance Incorporation of terms Incorporation of arbitration clauses Incorporation of choice of law clauses Follow the form – assignment of the original policy Follow the form – endorsement or modification of the original policy Overriding effect of the follow the form clauses

5.02 5.04 5.18 5.19 5.26 5.27 5.33 5.37

CHAPTER 6: SETTLEMENT CLAUSES English law: Follow the settlements Establishing and quantifying the reinsured’s liability under the direct policy Judgment Arbitration awards

x

6.03 6.03 6.06 6.17

TA B L E O F C O N T E N T S

Settlements Settlement clauses Early formulation of settlement clauses: “To pay as may be paid thereon” Follow the settlements Construction of the follow the settlements clause The Scor case The first limb: Within the scope of the reinsurance agreement The second limb: Acting in a bona fide and businesslike manner in settling the claim Burden of proof Ascertainment of liability in settlements The assured’s fraud Proving liability by the reinsured in stop-loss policies When the reinsurers’ liability arises The necessity of payment to trigger the reinsurer’s liability Follow the leader v follow the settlements Re-opening a settlement United States: Follow the fortunes – follow the settlements Distinguishing follow the fortunes from follow the settlements Implying settlement clauses Functions of settlement clauses Exceptions to the follow the fortunes clauses Fraud or bad faith Validity of the original insurance policy Defences available for reinsurers under the settlement clauses Claim clearly outside the scope of original insurance Claim beyond the reinsurance policy cover Unreinsured losses Losses falling beyond the reinsurance policy limits

6.19 6.22 6.22 6.28 6.32 6.32 6.38 6.60 6.62 6.65 6.70 6.72 6.78 6.81 6.86 6.90 6.104 6.106 6.114 6.131 6.142 6.142 6.147 6.155 6.155 6.177 6.179 6.182

CHAPTER 7: THE SCOPE OF THE FOLLOW THE SETTLEMENTS CLAUSE English law: The reinsured’s costs in defending the assured’s claim “Sue and labour” clauses Partnership and implied term argument United States No follow the settlements clause Does the follow the settlements doctrine extend to defence costs? Cost-inclusive, cost-exclusive and cost supplemental policies Interpretation of the original policy is binding on the reinsurer Wellington Agreement Defence costs that the reinsured agreed to pay beyond the original insurance policy limits Reinsureds’ declaratory judgment costs The relationship with claims provisions Allocation English law The US perspective Inconsistency between pre-settlement and post-settlement allocations Distinguishing settlement from allocation Annualisation Reinsurer’s reservation Summary Interest

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7.01 7.02 7.03 7.08 7.08 7.18 7.18 7.41 7.46 7.63 7.81 7.83 7.99 7.99 7.112 7.113 7.135 7.180 7.200 7.204 7.205

TA B L E O F C O N T E N T S

Extra-contractual liability Commutations Future and unidentified claims

7.208 7.232 7.236

CHAPTER 8: VARIATIONS AND QUALIFICATIONS IN WORDING Variations: Extending cover “Without question” to follow the settlement Liable or not liable Variations-limiting cover: “Without prejudice” settlements Qualified follow the settlements clauses “Within the terms of original insurance” “… as far as applicable hereto”

8.01 8.02 8.05 8.10 8.24 8.24 8.64

CHAPTER 9: CLAIMS PROVISIONS Claims cooperation clauses Notification provisions – time of notification English law United States “Prompt notice,” notice “as soon as practicable,” or “immediate notice” Notice when it “appears likely” that a claim will or “may” involve a policy Claims control clauses Remedy for breach of claims provisions Determining the nature of claims provisions English law Distinguishing warranties from conditions precedent Distinguishing conditions precedent from innominate terms The United States Is terminology determinative? Prejudice California Kansas Massachusetts New Jersey New York North Carolina Pennsylvania Presumption of prejudice Proof of prejudice Exception to the prejudice rule: Reinsured’s bad faith Limits on the reinsurers’ discretion under claims clauses Waiver of right to rely upon breach of claims provisions England United States Implied term: Inspection of records Implications of claims provisions in the US Agency relationship between the reinsured and reinsurer Attorney–client privilege Follow the settlements v claims provisions

9.02 9.06 9.06 9.18 9.27 9.28 9.41 9.52 9.54 9.54 9.65 9.68 9.72 9.73 9.87 9.89 9.93 9.95 9.97 9.103 9.120 9.121 9.122 9.129 9.134 9.138 9.142 9.142 9.151 9.156 9.163 9.163 9.166 9.173 Page

Index

275

xii

TA BL E OF CASE S

A Company No 0013734 of 1991, Re [1992] 2 Lloyd’s Rep 115 ............................................................................6.83 Abrahams v Mediterranean Insurance and Reinsurance Co Ltd [1991] 1 Lloyd’s Rep 216 ....................................2.95 Adamastos Shipping v Anglo-Saxon Petroleum [1959] AC 133 ..............................................................................3.25 Aegis Electrical and Gas International Services Co Ltd v Continental Casualty Co [2008] Lloyd’s Rep IR 17 .................................................................................................2.68, 2.96, 6.58, 8.64, 8.65 Aetna Cas & Sur Co v DR Ins Co 1995 WL 46640 (SDNY Feb 07, 1995) ...............................................6.133, 6.155 Aetna Cas & Sur Co v Home Ins Co, 882 F Supp 1328 (SDNY March 27, 1995).................................................................. 2.102, 2.103, 5.02, 5.03, 5.04, 5.10, 5.15, 5.16, 5.18, 6.116, 6.129, 7.18, 7.58, 7.143 Aetna Cas & Sur Co v Philadelphia Reinsurance Corp 1995 WL 217631 (E.D.Pa. Apr 13, 1995) .........................7.73 Affiliated FM Ins Co v Employers Reinsurance Co 369 F Supp 2d 217 (DRI, May 12, 2005) ........1.21, 6.110, 6.128, 6.177, 7.153, 7.161 Aftab v New Jersey Property-Liability Ins Guar Ass’n 386 NJ Super 41, (NJ Super AD, May 31, 2006) ..............2.17 Agnew v Länsforsäkringsbolagens AB, [2000] Lloyd’s Rep IR 317 ........................................................................1.01 AIG Europe (Ireland) Ltd v Faraday Capital Ltd [2007] 2 CLC 844; [2007] Lloyd’s Rep IR 267; [2008] Lloyd’s Rep IR 454 .......................................6.67, 6.69, 7.235, 9.08, 9.14, 9.16 AIG Europe (UK) Ltd v Anonymous Greek Co of General Insurances, (The Ethniki) [1999] Lloyd’s Rep IR 221; affirmed [2000] Lloyd’s Rep IR 343 ..............................................................3.02, 3.56 AIG Europe SA v QBE International Insurance Ltd [2001] 2 Lloyd’s Rep 268 .............................................3.53, 3.56 Albany Life Assurance Co v De Montfort Insurance Co plc (1995) ......................................................................9.158 Alfred McAlpine Plc v BAI (Run-Off) Ltd [2000] Lloyd’s Rep IR 352; [2000] 1 Lloyd’s Rep 437 ..............4.20, 9.66 Allemannia Fire Ins Co v Fireman’s Ins Co of Baltimore 209 US 326 (US Dist Col Apr 06, 1908) ................................................................................................................2.37, 2.40, 2.41 Allstate Ins Co v American Home Assurance Co 837 NYS 2d 138 (NYAD 1 Dept, Jul 12, 2007) ............7.130, 7.193 American Bankers Ins Co of Florida v Northwestern Nat Ins Co 198 F 3d 1332 (11th Cir ( Fla) Dec 30, 1999) .............................................................................................2.08, 6.142, 6.143, 7.112 American Centennial Insurance Company v Insco Limited [1996] LRLR 407 ..............................................2.82, 4.43 American Employers’ Ins Co v Swiss Reinsurance America Corp 275 F Supp 2d 29 (D Mass, Aug 05, 2003); aff’d 413 F 3d 129 (1st Cir (Mass) Jun 27, 2005) ....................... 2.08, 2.104, 5.16, 6.110, 6.116, 6.133, 7.180, 7.199 American Home Assurance Co et al v American Re-insurance Co et al No:602485/06, NY Sup, New York Co, 24 May 2010 ...........................................................................................6.133, 6.160, 6.181 American Ins Co v North American Co 697 F 2d 79 (2nd Cir (NY) Dec 30, 1982) .............6.173, 6.177, 6.180, 7.215 American International Marine Agency of New York Inc v Dandridge [2005] Lloyd’s Rep IR 643 ................................................................................... 2.82, 2.95, 2.101, 3.09, 4.26, 4.39, American International Speciality Lines Insurance Co v Abbott Laboratories [2003] 1 Lloyd’s Rep 267 ..............3.44 American Marine Ins Group v Neptunia Ins Co 775 F Supp 703 SDNY, Oct 21, 1991; aff’d by 961 F.2d 372 (2nd Cir (NY) Apr 09, 1992) ...........................................................................................6.182 American Motorists Ins Co v American Re-Ins Co, not reported F Supp 2d, 2007 WL 1557848, ND Cal, May 29, 2007 ..................................................................................6.107, 6.126, 6.133 Anders & Kern Ltd v CGU Insurance plc [2008] Lloyd’s Rep IR 460 ..................................................................9.139 Annefield, The [1971] 1 Lloyd’s Rep 1 ....................................................................................................................3.43 Anonymous Greek Co of General Insurances (The Ethniki) v AIG Europe (UK) [2000] Lloyd’s Rep IR 343 ...................................................................................................................................9.61 Argonaut Ins Co v Travelers Ins Co 800 NY S 2d 342 (NY Supp Jan 05, 2005) ........................................6.183, 7.170 ARIG Insurance Co Ltd v SASA Assicurazione Riassicurazione SpA (unreported) ...............................................3.56 Arrow Trucking C v Continental Ins Co 465 So 2d 691 (La Apr 01, 1985) ................................. 2.44, 2.47, 2.49, 2.67 Aspen Insurance UK Ltd v Pectel Ltd [2008] EWHC 2804; [2009] Lloyd’s Rep IR 440 .....................9.59, 9.65, 9.67

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Assicurazioni Generali de Trieste v Empress Assurance Co Ltd [1907] 2 KB 814 ..................................................6.71 Assicurazioni Generali SpA v CGU International Insurance [2003] 2 CLC 852; aff’d [2004] 2 CLC 122; [2004] Lloyd’s Rep IR 457 .............................................6.37, 6.38, 6.44, 6.48, 6.55, 6.58, 6.59, 6.63, 8.02, 8.04, 8.23, 8.62 Assicurazioni Generali SpA v Ege Sigorta AS [2002] Lloyd’s Rep IR 480 .............................................................3.56 Associated Electric & Gas Insurance Services Ltd v European Reinsurance Co of Zurich [2003] 1 All ER (Comm) 253 ...............................................................................................................................6.17 Associated Intern Ins Co v Odyssey Reinsurance Corp 111 F 3d 137 (9th Cir (Cal) Apr 02, 1997) .....................9.129 AT&T v Clarendon Am Ins Co, unreported A.2d, 2008 WL 2583007 Del Super, 2008 ..........................................5.26 Atchison, Topeka & Santa Fe Railway Co v Stonewall Insurance Co 275 Kan 698 (Kan Dist Ct Jul 24, 2000) ....................................................................................................................................9.94 Australian Widows’ Fund Life Assurance Society, Limited v National Mutual Life Association of Australasia, Limited [1914] AC 634 ...............................................................................................3.18, 3.31, 3.32 Axa Re v Ace Global Markets Limited [2006] Lloyd’s Rep IR 683..............................................3.22, 3.50, 3.51, 4.31 AXA Reinsurance (UK) Plc v Field [1996] 2 Lloyd’s Rep 233 ......................................................................2.82, 4.43 Baker v Black Sea & Baltic General Insurance Co Ltd [1995] LRLR 261; [1998] Lloyd’s Rep IR 327 ................................................2.75, 6.42, 6.56, 6.61, 6.62, 6.80, 7.01, 7.03, 7.05, 9.160 Bancroft v Heath (1901) 17 TLR 425 .......................................................................................................................3.01 Bank of Credit and Commerce International SA v Ali and Khan [2002] 1 AC 251 ........................................6.91, 6.92 Bankers Insurance Co Ltd v South [2004] Lloyd’s Rep IR 1 ..........................................................................9.04, 9.66 Barlee Marine Corporation v Trevor Rex Mountain (The Leegas) [1987] 1 Lloyd’s Rep 471........................4.26, 6.86 Barnards v Faber [1893] 1 QB 340 ...........................................................................................................................3.01 Beauchamp v Faber (1898) 3 Com Cas 308 .............................................................................................................3.01 Bell v Hobson (1812) 16 East 240 ............................................................................................................................3.29 Bell v Lever Brothers [1932] AC 161 .......................................................................................................................6.93 Bellefonte Reinsurance Co v Aetna Cas and Sur Co 903 F 2d 910 (2nd Cir (NY) May 19, 1990) ...........................................................6.182, 6.183, 7.12, 7.13, 7.24, 7.63, 7.71, 7.72, 7.77, 7.169, 7.223, 7.231 Black Clawson InternatiolLtd v Papierwerke Waldhof-Aschaffenburg AG [1981] 2 Lloyd’s Rep 446 ...................3.43 Black King Shipping Corporation v Massie (The Litsion Pride) [1985] 1 Lloyd’s Rep 437 ..........................4.16, 4.19 Boden v Hussey [1988] 1 Lloyd’s Rep 423 ..........................................................................................6.90, 6.94, 6.103 Bonner v Cox [2005] Lloyd’s Rep IR 569; affirmed [2006] Lloyd’s Rep IR 385 ........................2.54, 3.42, 4.21, 4.24, 6.63, 9.157, 9.158, 9.159 Bradford v Symondson (1880–81) LR 7 QBD 456 ..................................................................................................2.54 Bradley v Eagle Star Insurance Co [1989] 1 AC 597................................................................................................2.73 Bremer Vulkan Schiffbau und Maschinenfabrik v South India Shipping Corporation Ltd [1981] AC 909 .............3.43 Brennan v Bolt Burdon [2005] QB 303 ....................................................................................................................6.93 British Cash and Parcel Conveyors v Lamson Store Service [1908] 1 KB 1006......................................................2.73 British Dominions General Insurance Co Ltd v Duder [1914] 3 KB 835; [1915] 2 KB 394............................................................................ 2.53, 2.69, 7.02, 7.88, 7.90, 7.91, 7.94 British General Insurance Company Ltd v Mountain (1919) 1 Ll L Rep 605 .................................................3.37, 7.92 British Ins Co of Cayman v Safety Nat Cas 335 F 3d 205 (3rd Cir (NJ) Jul 3, 2003).................9.05, 9.97, 9.94, 9.129 British Intern Ins Co Ltd v Seguros La Republica, SA 342 F 3d 78 (2nd Cir (NY) Aug 26, 2003) .........................7.81 Brown v Brown, 82 Cal Rptr 238, Cal App 5 Dist, Jun 19, 1969 .............................................................................7.98 Calvert Fire Ins Co v Yosemite Ins Co 573 F Supp 27 DCNC, Sep 14, 1983 ........................................................6.186 Carlson Holdings Inc v NAFCO Ins Co 205 F Supp 2d 1069 DMinn, Jan 08 2001 ............................2.08, 2.60, 6.115 Carruthers v Sheddon (1815) 6 Taunt 14 ..................................................................................................................2.54 Cashau v Northwestern Nat Ins Co 5 F Cas 270, CC Wis 1873 .............................................................................. 2.34 Castellain v Preston (1883) 11 QBD 380..................................................................................................................6.71 Centaur Insurance Company v Safety National Casualty Corporation 1993 WL 434056 (ND Ill Oct 22, 1993) ............................................................................................................................................9.29 Central Nat Ins Co of Omaha v Prudential Reinsurance Co 241 Cal Rptr 773 (Cal App 2 Dist Nov 19, 1987) .................................................................................... 2.08, 2.81, 6.177, 9.92, 9.122 Certain Underwriters at Lloyd’s London v Home Ins Co 146 NH 740, N.H. Sep 6, 2001 ....................................9.134 CGU International Insurance v AstraZeneca Insurance Co [2006] Lloyd’s Rep IR 409; [2007] 1 Lloyd’s Rep 142 ........................................................................................................2.53, 2.68, 6.17, 6.112 Charlesworth v Faber (1900) 5 Com Cas 408 .......................................................................3.20, 3.21, 3.22, 3.23, 3.28 Charman v Guardian Royal Exchange Assurance Plc [1992] 2 Lloyd’s Rep 607 ...............2.54, 6.10, 6.56, 6.61, 6.62, 6.64, 8.05, 9.01, 9.160 Charter Reinsurance Company Limited v Fagan [1997] AC 313 .......................................................... 2.44, 2.74, 6.84 Chippendale v Holt (1895) Com Cas 197 .............................................................................6.23, 6.24, 6.28, 6.30, 6.36

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Christiana Gen Ins Corp v Great Am Ins Co, 745 F Supp 150 [SDNY 1990]; aff’d 979 F 2d 268 (2nd Cir (NY) Sep 3,1992) ............................................... 1.18, 1.21, 2.81, 6.114, 6.133, 6.142, 7.143, 9.05, 9.19, 9.30, 9.27, 9.28, 9.91, 9.94, 9.99, 9.102, 9.104, 9.105, 9.110, 9.112, 9.129, 9.134, 9.137 Cigna Life Insurance Co of Europe SA-NV & Ors v Intercaser SA de Seguros y Reaseguros [2001] CLC 1356 ................................................................................................................................3.09, 3.44, 3.55 Citadel Insurance Co v Atlantic Union Insurance Co SA [1982] 2 Lloyd’s Rep 543 .................................................................... 2.82, 2.103, 5.04, 6.133, 6.146, 6.166, 6.177 City Tailors Ltd v Evans (1921) 9 Ll L Rep 394.......................................................................................................3.25 CNA International Reinsurance Co Ltd & Ors v Companhia de Seguros Tranquilidade SA [1999] CLC 140; [1999] Lloyd’s Rep IR 289 ............................2.68, 3.18, 3.40, 3.50, 4.03, 4.31 Colonial American Life Ins Co v CIR 491 US 244, US Jun 15, 1989 ..................................................................... 2.08 Commercial Assur Co v American Cent Ins Co 68 Cal 430, Jan 28, 1886 ............................................................9.165 Commercial Union Assurance Co Plc v NRG Victory Reinsurance Ltd [1998] Lloyd’s Rep IR 439; [1998] 2 Lloyd’s Rep 600 ........................6.06, 6.07, 6.09, 6.10, 6.11, 6.12, 6.19, 6.41, 6.63, 8.37, 8.38 Commercial Union Ins Co v International Flavors & Fragrances, 822 F 2d 267 (2nd Cir (NY) Jun 23, 1987) ...............................................................................................................................9.114 Commercial Union Ins Co v Seven Provinces Ins Co Ltd 9 F Supp 2d 49 (D Mass, Jun 15, 1998); aff’d 217 F 3d 33 (1st Cir (Mass) Jul 6, 2000) ..................1.21, 6.108, 7.136, 7.147, 7.150 Commercial Union Insurance Co v Swiss Reinsurance America Corp 413 F 3d 121 (1st Cir (Mass) Jun 27, 2005) ...................................................................................2.103, 5.13, 6.133, 7.180, 7.199 Commissioner of Ins v Munich American Reinsurance Co 429 Mass 140, Mass, March 05, 1999 ........................2.35 Compania Espanola de Petroleos, SA v Nereus Shipping, SA, 527 F 2d 966 (2d Cir Dec 12, 1975), cert. denied, 426 US 936, 96 S Ct 2650, 49 L Ed 2d 387 (1976) ....................................5.23 Consolidated Real Estate & Fire Ins Co v Cashow 41 Md 59, 1874 ............................................................ 2.34, 6.132 Constitution Reinsurance Corp v Stonewall Ins Co 980 F Supp 124 (SDNY, Sep 17, 1997)........................................................................................1.17, 2.81, 9.73, 9.118, 9.151, 9.155 Container Transport International Inc v Oceanus Mutual Underwriting Association (Bermuda) Ltd [1984] 1 Lloyd’s Rep 476 ........................................................................................4.21 Continental Cas Co v Stronghold Ins Co Ltd 77 F 3d 16 (2nd Cir (NY) Feb 13, 1996) ..........................................1.17 Continental Illinois National Bank of Chicago v Alliance Assurance Co Ltd (The Captain Panagos) [1986] 2 Lloyd’s Rep 470 .....................................................................................................................................4.16 Cox v Bankside Members Agency Ltd [1995] 2 Lloyd’s Rep 437 ...........................................................................2.73 Crowley Maritime Corp v Federal Ins Co 2008 WL 5071118 (ND Cal, Dec 01, 2008); affirmed 373 Fed. Appx. 782 (9th Cir (Cal) Apr 09, 2010) ................................................................................9.178 Crowley v Cohen (1832) 3 B & Ad 478....................................................................................................................2.54 Curiale v DR Ins Co 593 NYS 2d 157 NY Sup, 1992 ............................................................................................7.214 Dalby v India and London Life Assurance Co (1854) 15 Common Bench Reports 365............... 2.54, 2.55, 2.57, 2.58 Daval Aciers D’Usinor et de Sacilor v Armare Srl, The Nerarno [1996] 1 Lloyd’s Rep 1.......................................3.43 Deeny v Gooda Walker Ltd [1994] CLC 1224 .........................................................................................................8.24 Delos, The [2001] 1 Lloyd’s Rep 703 .......................................................................................................................3.43 Delver v Barnes (1807) 1 Taunt 48 ..................................................................................................................2.68, 2.72 Doe & Leicester v Biggs, (1809) 2 Taunt 109 ..........................................................................................................3.25 Donaldson v United Community Ins Co, 740 So 2d 1285 (La May 7, 1999); 741 So 2d 676 (La App 3 Cir Feb 10, 1999) ..................................................................................................... 2.08, 2.45, 2.47, 2.49 Dornoch Ltd v Mauritius Union Assurance Co Ltd [2006] Lloyd’s Rep IR 127; affirmed [2006] Lloyd’s Rep IR 786 ...................................................................................................2.97, 3.56, 4.38 Dornoch Ltd v Royal and Sun Alliance plc [2005] Lloyd’s Rep IR 544 ..............................2.75, 9.07, 9.09, 9.14, 9.16 DR Insurance Co v Seguros America Banamex [1993] 1 Lloyd’s Rep 120 .............................................................2.71 E Hulton & Co v Mountain (1921) 8 Ll L Rep 249 ................................................................................................9.138 Eagle Star Insurance Co Ltd v Cresswell [2004] Lloyd’s Rep IR 537 ...................................................7.04, 9.42, 9.57, 9.58, 9.59, 9.140, 9.141, 9.174, 9.177 Eagle Star Insurance Co Ltd v Spratt [1971] 2 Lloyd’s Rep 116............................................................................. 6.87 Economic v Le Assicurazioni d’Italia, unreported ..................................................................................................9.157 Eddystone Marine Insurance Co ex parte Western Insurance Co, Re [1892] 2 Ch 423 .........................3.04, 6.82, 6.83 Elizabeth H, The [1962] 1 Lloyd’s Rep 172 .............................................................................................................3.43 Ellgass v Brotherhood of RR Trainmen Ins Dep’t, 342 F 2d 1, 3 (9th Cir (Cal.) Feb 4, 1965); cert denied, 381 US 91 (US Cal May 17, 1965) 1965 ........................................................................................9.154 Emanuel v Andrew Weir (1914) 30 TLR 518 .......................................................................................................... 4.11 Employer Reinsurance Corp v Laurier Indemnity Co 2007 WL 1831775 (MD Fla) ...........................1.16, 6.02, 6.126

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Employers Ins Co of Wausau v American Reinsurance Co 256 F Supp 2d 923 WD Wis, March 10, 2003 ...............................................................................................................................7.17, 7.229, 7.230 Employers Reinsurance Corp v American Fidelity & Cas Co 196 F Supp 553, DC Mo, Dec 14, 1959.....................................................................................................2.08, 7.223 Employers Reinsurance Corp v Newcap Ins Co, Ltd 209 F Supp 2d 1184, D Kan, Jul 11, 2002 ..........................7.200 English Insurance Co v National Benefit Assurance Co [1929] AC 114 ........................................................ 2.04, 2.71 Enterprise Oil Ltd v Strand Insurance Co Ltd [2006] EWHC 58 (Comm); [2006] 1 Lloyd’s Rep 500 .................................................................................................................6.67, 6.69, 7.235 Equitas Ltd v R&Q Reinsurance Co (UK) Ltd [2009] EWHC 2787 (Comm) ............6.36, 8.40, 8.41, 8.51, 8.61, 8.62 Equitas Ltd v Wave City Shipping Co Ltd [2006] Lloyd’s Rep IR 577; [2006] Lloyd’s Rep IR 646 .............2.06, 9.50 Excess Ins Co Ltd v Factory Mut Ins 3 NY 3d 577, (NY) Dec 02, 2004 ...............................................................6.183 Excess Insurance Co Ltd & Anor v Mander [1995] CLC 838; [1997] 2 Lloyd’s Rep 119 .................................................................................................3.09, 3.44, 3.53, 3.55, 3.56 Excess Insurance Company Ltd v Mathews (1925) 23 Ll L Rep 71 ...........................................6.29, 6.31, 6.36, 7.205 Faneuil Hall Ins Co v Liverpool & London & Globe In Co 153 Mass 63, Jan 09, 1891..........................................7.10 Faraday Capital Ltd v Copenhagen Reinsurance Co Ltd [2007] 1 Lloyd’s Rep IR 23...........................6.37, 6.90, 8.10 Farmers’ Co-op Ltd v National Benefit Assurance Co (1922) 13 Ll L Rep 530,......................................................3.25 Feasey v Sun Life Assurance Co of Canada [2002] 2 All ER (Comm) 492; [2003] Lloyd’s Rep IR 637 ........................................................... 2.53, 2.54, 2.56, 2.57, 2.58, 2.74, 2.75, 6.79, 6.80 Federal Bulk Carriers Inc v Itoh & Co Ltd [1989] 1 Lloyd’s Rep 103 .....................................................................3.43 Fidelity and Deposit Co of Maryland v Pink 302 US 224 (US NY Dec 06, 1937) .........................................2.40, 2.42 Finagra Ltd v OT Africa Ltd [1998] 2 Lloyd’s Rep 622 ...........................................................................................3.25 Fireman’s Fund Insurance Co v Western Australian Insurance Co (1927) 28 Ll L Rep 243 .........................................................................................2.71, 2.73, 6.25, 6.77, 6.79, 6.177 Firma C-Trade SA v Newcastle Protection and Indemnity Association (The Fanti) [1991] 2 AC 1 ...............6.81, 6.83 First American Ins Co v Commonwealth General Ins Co 954 SW 2d 460 (Mo App WD, Aug 26, 1997) ..............2.43 Fontana v Skandia Life Assurance Ltd 2000 WL 1841575 ..................................................................................... 6.91 Forsikringsaktieselskabet National (of Copenhagen) v Attorney-General [1925] AC 639 ....................2.53, 2.68, 2.70 Forsikringsaktieselskapet Vesta v Butcher [1989] 1 Lloyd’s Rep 331 ........................2.59, 2.71, 2.72, 2.80, 2.83–2.92, 2.93, 2.97, 2.111, 2.113, 2.114, 2.118, 2.119, 2.120, 2.122, 2.123, 2.125, 2.126, 3.02, 3.03, 3.06, 3.29, 3.39, 4.37, 4.38, 4.39, 4.41, 6.39 Fortress Re, Inc v Central Nat Ins Co of Omaha 766 F 2d 163 (4th Cir (NC) Jul 13, 1985) ...........9.120, 9.132, 9.135 Fortress Re, Inc v Jefferson Ins Co of New York 628 F 2d 860 (4th Cir (NC) Aug 14, 1980) ......................9.73, 9.120 Franco Hungarian v Merchants Marine Insurance ................................................................3.20, 3.26, 3.27, 3.28, 3.29 Fraser Shipping Ltd v Colton [1997] 1 Lloyd’s Rep 586..........................................................................................4.25 Friends Provident Life & Pensions Ltd v Sirius International Insurance Corp [2005] 2 Lloyd’s Rep 517 ...............................................................................................4.20, 4.30, 6.82, 9.66, 9.173 Gan Insurance v Tai Ping Insurance (No 1) [1999] Lloyd’s Rep IR 472 .........................................................2.82, 3.59 Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd (No 3) [2002] Lloyd’s Rep IR 612 .....................6.62, 9.64, 9.171 Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd (Nos 2 & 3) [2001] 1 Lloyd’s Rep IR 667 ......................................................................6.04, 6.62, 9.03, 9.70, 9.71, 9.139, 9.141 Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd [2001] Lloyd’s Rep IR 291 ........................................9.138, 9.172 Gantt v American Cent Ins Co 68 Mo 503, October 1878.............................................................................. 2.08, 7.10 Gaughan v Tony McDonagh & Co [2006] Lloyd’s Rep IR 230 ...............................................................................4.25 GE Reinsurance Corp (formerly Kemper Reinsurance Co) v New Hampshire Insurance Co [2004] Lloyd’s Rep IR 404 ................................................................1.05, 2.74, 2.95, 2.97, 4.38, 4.39 General Ins Co v Nutmeg Ins Co, Sup Ct, NY County, 24 July 1987 ....................................................................9.112 General Insurance Co of Trieste Ltd v Corporation of the Royal Exchange (1897) 2 Com Cas 144 ..............3.09, 4.40 Gerling Global Reinsurance Corp v Safety Mut Cas Corp 1981 US Dist LEXIS 13864 .......................................9.162 Gerrard Realty Corp v American States Ins Co 89 Wis 2d 130 (Wis May 01, 1979).............................................9.128 G-I Holdings, Inc v Reliance Ins Co 586 F 3d 247 (3rd Cir (NJ) Oct 26, 2009) ......................................................2.20 Glencore International AG v Ryan (The Beursgracht) (No.1) [2002] Lloyd’s Rep IR 335 ......................................9.66 Goddard & Smith v Frew [1939] 4 All ER 358 ........................................................................................................2.73 Goddard v Gray (1878) LR 6 QB 39 ........................................................................................................................6.08 Goshawk Dedicated Ltd v Tyser & Co Ltd [2007] Lloyd’s Rep IR 224..........................................................3.42, 4.21 Goshawk Syndicate Management Ltd v XL Speciality Insurance Co [2004] Lloyd’s Rep IR 683 .................2.82, 4.44 Gouriet v Union of Post Office Workers [1978] AC 435 ..........................................................................................2.07 Granite State Ins Co v ACE American Reinsurance Co 849 NYS 2d 201, NYAD 1 Dept, Dec 27, 2007 .................................................................................................................................6.133, 6.142, 6.144 Great American Insurance Co v CG Tate Construction Co (Tate I) 303 NC 387 (NC Jul 8, 1981) ............9.120, 9.135 Great Peace Shipping Ltd v Tsavliris Salvage (International) Ltd [2002] 4 All ER 689 ..........................................6.93 Grecoair v Tilling [2005] Lloyd’s Rep IR 151 .................................................................................................2.05, 9.45 Groom v Crocker [1939] 1 KB 194 ........................................................................................................................9.139

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Groupama Insurance Co Ltd v Overseas Partners Re Ltd [2004] 1 CLC 779 ...............................4.25, 4.37, 4.38, 4.39 Groupama Navigation et Transports & Ors v Catatumbo Seguros [2000] 2 Lloyd’s Rep 350 ............2.93–2.94, 2.118, 2.119, 2.120, 2.122, 2.126, 2.127, 3.03, 3.29, 4.33, 4.40, 6.39 Gulf Insurance Co v Transatlantic Reinsurance Co, 788 NYS2d 44 NYAD 1 Dept, 2004 ....................................9.169 Gurney v Grimmer (1932) 44 Ll L Rep 189 ....................................................................................................6.22, 6.28 Hadenfayre Ltd v British National Insurance Society Ltd [1984] 2 Lloyd’s Rep 393..............................................9.04 Halvanon Insurance Co Ltd v Companhia de Seguros do Estado de So Paulo [1995] LRLR 303 ..................2.75, 6.80 Hamilton and Co v Mackie and Sons (1889) 5 TLR 677..........................................................................................3.43 Hanover Ins Co v Carroll, 241 Cal App 2d 558 (Apr 19,1966) ................................................................................9.91 Harbour Assurance Co (UK) Ltd v Kansa General International Insurance Co Ltd [1993] QB 701 .......................3.43 Hartford Acc & Indem v Columbia Cas Co 98 F Supp 2d 251 D Conn, March 31, 2000 ..................................................................................................................6.133, 6.142, 6.143, 7.177 Hartford Fire Ins Co v Lloyd’s Syndicate 1997 US Dist Lexis 10858 (DConn 1997) ...........................................7.214 Hastie v De Peyster 3 Cai R 190, NY Sup 1805 ......................................................2.08, 6.05, 6.15, 6.105, 6.131, 7.08 Hayter v Nelson & Home Insurance Co [1990] 2 Lloyd’s Rep 265 .......................................................................6.111 Heath Lambert Ltd v Sociedad de Corretaje de Seguros [2004] Lloyd’s Rep IR 905 .....................................3.31, 4.38 Henderson v Stevenson LR 2 Sc & Div 470 .............................................................................................................3.20 Heyman v Darwins [1942] AC 356 ...........................................................................................................................3.43 Highlands Ins Co v Employers’ Surplus Lines Ins Co 497 F Supp 169 DC La, Jul 14, 1980 .........................9.75, 9.96 HIH Casualty & General Insurance Ltd v New Hampshire Insurance Co [2001] 1 Lloyd’s Rep 378; [2001] 2 Lloyd’s Rep 161 ...................................2.82, 2.97, 3.09, 3.10–3.17, 3.21, 3.22, 3.24, 3.30, 3.42, 4.01, 4.13, 4.27, 4.28, 4.32, 6.31 Hill v Mercantile & General Reinsurance Co Plc [1995] LRLR 160; [1996] 1 AC 1239; [1996] 3 All ER 865 ...............................................6.03, 6.37, 6.38, 6.39, 6.62, 6.90, 8.25, 8.34, 8.37, 8.38, 8.42, 8.44, 8.61 Hiscox v Outhwaite (No 3) [1991] 2 Lloyd’s Rep 524 ...........................................................................6.39, 6.44, 8.62 HLB Kidsons v Lloyd’s Underwriters [2009] Lloyd’s Rep IR 178 ..........................................................................4.22 Holland v Employers ReIns Corp, 2007 US Dist Lexis 68069 (WD Okla 13 Sept 2007) ...............6.107, 6.125, 6.133 Homan v Employers Reinsurance Corp 345 Mo 650, Nov 03, 1939........................................................................9.44 Home and Overseas Insurance Co Ltd v Mentor Insurance Co (UK) Ltd [1989]1 Lloyd’s Rep 473.......................6.83 Home Insurance Co of New York v Victoria Montreal Fire Insurance Co [1907] AC 59 ..........................................................2.71, 2.73, 2.75, 3.18, 3.35, 4.30, 4.38, 6.78, 9.13 Hong Kong Borneo Services Co Ltd v Pilcher [1992] 2 Lloyd’s Rep 593 ............................................6.19 , 6.22, 6.82 Hongkong Fir Shipping Co Ltd v Kawasaki Kisen Kaisha Ltd [1962] 2 QB 26 ......................................................9.52 Houston Cas Co v Lexington Ins Co, 2006 US Dist Lexis 45027 ..................................1.16, 6.02, 6.110, 6.133, 6.143 Hutton v Warren 150 ER 517 ....................................................................................................................................3.42 Imperial Fire Ins Co of London v Home Ins Co of New Orleans 68 F 698, CA 5 Jun 17, 1895.....................2.60, 5.37 Imperial Marine Insurance Co v The Fire Insurance Corp Ltd (1879) 4 CPD 166 ..................................................3.04 Independence Ins Co v Republic Nat Life Ins Co 447 SW 2d 462 (Tex Civ App, Dallas Oct 24, 1969) ...............6.156 Inland Mut Ins Co v Peerless Ins Co 152 F Supp 506 (SDW Va Jun 26, 1957); aff’d 251 F 2d 696 (4th Cir (W Va) Jan 06, 1958) ..............................2.67, 7.217, 7.222, 7.223, 7.227, 7.229, 7.230 Ins Co of the State of Penn v Associated Int’l Ins Co, 922 F 2d 516, (9th Cir (Cal) Dec 27, 1990) ........................9.94 Insurance Co of Africa v Scor (UK) Reinsurance Co Ltd [1983] 1 Lloyd’s Rep 541; [1985] 1 Lloyd’s Rep 312 ..................................................................................................................1.25, 2.73, 2.96, 6.09, 6.10, 6.12, 6.13, 6.14, 6.28, 6.32–6.33, 6.36, 6.37, 6.38, 6.40, 6.41, 6.46, 6.47, 6.50, 6.51, 6.54, 6.56, 6.58, 6.60, 6.62, 6.71, 6.88, 7.84, 7.85, 7.86, 7.87, 7.94, 7.208, 7.210, 8.04, 8.07, 8.08, 8.34, 8.63, 9.02, 9.68, 9.69, 9.70, 9.71, 9.171, 9.172, 9.173 Insurance Co of New York v Associated Mfg Corp of New York, 70 App Div 69, 74 NYS 1038; aff’d 174 NY 541, (NY Apr 09, 1903)........................................................................................6.152 Insurance Co of North America v US Fire Ins Co 322 NYS 2d 520, NY Sup, Jun 15, 1971; aff’d 348 NYS 2d 122, (NYAD 1 Dept, Oct 04, 1973).......................................................................................6.159 Insurance Co of State of New York v Associated Mfgrs’ Mut Fire Ins Corp 74 NYS 1038; aff’d 174 NY 541, NY Apr 09, 1903 ..................................................................................................................6.142 Insurance Co of State of Pennsylvania v Associated Intern Ins Co 922 F 2d 516 (9th Cir (Cal) Dec 27, 1990) ......................................6.141, 7.236, 9.30, 9.76, 9.89, 9.91, 9.99, 9.102, 9.124, 9.130 Insurance Co of the State of Pennsylvania v Grand Union Insurance Co [1990] 1 Lloyd’s Rep 208 ..........................................................................................................6.36, 6.56, 6.62, 6.64 Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd [1989] QB 433 ...................................3.20, 3.22, 3.24 International Surplus Lines Ins Co v Certain Underwriters and Underwriting Syndicates at Lloyd’s of London (ISLIC) 868 F Supp 917, SD Ohio, Sep 27, 1994 .........................................6.116, 6.129, 6.134 International Surplus Lines Ins Co v Fireman’s Fund Ins Co, 998 F 2d 504 (7th Cir (I11) Jul 08, 1993) .............7.143 Ion, The [1971] 1 Lloyd’s Rep 541 ...........................................................................................................................3.25 IRB Brasil Resseguros SA v CX Reinsurance Company Ltd [2010] EWHC 974 (Comm) ..........................7.105, 8.51

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Jackson v St Paul Fire & Marine Ins Co 99 NY 124, NY 1885...................................................................... 2.08, 2.60 Joyce v Realm Marine Insurance Co Ltd (1871–1872) LR 7 QB 580......................................................................3.29 K.H. Enterprise v Pioneer Container [1994] 2 AC 324 .............................................................................................3.56 K/S Merc-Scandia XXXXII v Lloyd’s Underwriters (The Mercandian Continent) [2001] 2 Lloyd’s Rep 563; [2001] Lloyd’s Rep IR 802 ..................................................4.20, 4.23, 4.25, 9.66, 9.141 Keehn v Excess Ins Co of America 129 F 2d 503 (7th Cir, Jun 17, 1942) .........................................9.75, 9.133, 9.155 King v Brandywine Co (UK) Ltd [2005] 1 Lloyd’s Rep 655 ..........................................................................8.39, 8.40 Kitchen Design & Advice Ltd v Lea Valley Water Co [1989] 2 Lloyd’s Rep 221................................................... 6.91 Kleinwort Benson Ltd v Lincoln City Council [1999] 2 AC 349 .............................................................................6.93 Klockner Stadler Hurter Ltd v Insurance Co of State of PA 785 F Supp 1130, SDNY, Jul 11, 1990 ............ 2.08, 2.50 Korea Foreign Insurance Co v Omne Re Sa [1999] 1 Lloyd’s Rep IR 509 .................................................7.232, 7.233 Korea National Insurance Co v Allianz Global Corporate & Specialty AG [2008] EWCA Civ 1355 ...................9.101 Kosmar Villa Holidays plc v Trustees of Syndicate 1243 [2008] Lloyd’s Rep IR 489.....................9.142, 9.147, 9.149 Kyle Bay Ltd v Underwriters Subscribing to Policy No 019057/08/01 [2007] Lloyd’s Rep IR 460 .......................6.91 Lancashire County Council v Municipal Mutual Insurance Ltd [1997] QB 897 ...................................................7.211 Law Guarantee Trust & Accident Society Ltd, Re [1914] 2 Ch 617 ......................................................2.04, 6.82, 6.83 Lefevre v White [1990] 1 Lloyd’s Rep 569 ..............................................................................................................6.80 Les Affreteurs Reunis SA v Leopold Walford (London) Ltd [1919] AC 801 ...........................................................3.42 Level Export Corp v Wolz, Aiken & Co 305 NY 82, 87, (NY Feb 26, 1953) ..........................................................5.21 Lexington Insurance Co v Multinacional de Seguros SA [2009] Lloyd’s Rep IR 1 ...............................................9.147 Liberty Mutual Insurance Co v Gibbs 773 F 2d 15 (1st Cir (Mass) Sep 23, 1985) .......................9.30, 9.38, 9.94, 9.95 Life and Health Ins Co of America v Federal Ins Co 1993 WL 326404 (ED Pa Aug 25, 1993) .................9.121, 9.129 Limit No 2 Ltd v Axa Versicherung AG [2008] 2 CLC 673; [2008] Lloyd’s Rep IR 330...............................4.25, 9.66 Lincoln National Life Insurance Co v Sun Life Assurance Co of Canada [2005] 1 Lloyd’s Rep 606 .....................6.17 Liquidation of Realex Group, NV, In re 210 AD 2d 91, NYAD 1 Dept., Dec 13, 1994 ...........................................2.43 Lishman v Northern Maritime Insurance Co (1875) LR 10 CP 179.........................................................................4.25 Litho Color Inc v Pacific Employers Ins Co 98 Wash App.286, (Wash App Div 1, Sep 20, 1999) ..........................2.24 Liverpool City Council v Irwin [1977] AC 239 ........................................................................................................3.42 London County Commercial Reinsurance Office Ltd, Re [1922] 2 Ch 67 ............................................6.03, 6.37, 6.69 London Steamship Owners Mutual Insurance Association Ltd v Bombay Trading Co Ltd, The Felicie [190] 2 Lloyd’s Rep 21 ......................................................................................................................6.80 Lower Rhine and Würtemberg Association v Sedgwick [1899] 1 QB 179.............................................4.05, 4.10, 4.11 Lumbermans Mutual Casualty Co v Bovis Lend Lease Ltd [2005] 1 Lloyd’s Rep 494 ..............6.06, 6.66, 6.67, 7.235 Mackenzie v Whitworth (1874–75) LR 10 Ex 142 ..........................................................................................2.54, 2.68 Magee v Pennine Insurance [1969] 2 QB 507 ..........................................................................................................6.93 Manifest Shipping Co Ltd v Uni-Polaris Insurance Co Ltd (The Star Sea) [2001] 1 Lloyd’s Rep 389 ...................................................................................................................4.19, 4.20, 4.21 Mann v Lexington Insurance Co [2001] Lloyd’s Rep IR 179...................................................................................2.82 Manufacturers’ Fire & Marine Ins Co v Western Assur Co, 14 NE 632, Mass. Jan 03, 1888 ................2.60, 5.27, 5.39 Maritime Insurance v Stearns [1901] 2 KB 912 .......................................................................................................3.22 Marten v Steamship (1902) Com Cas 195 .......................................................................................................4.40, 6.24 Marten v The Nippon Sea and Land Insurance Co Ltd (1898) Com Cas 164 ........................................3.20, 3.21, 3.28 Martin Ins Agency, Inc v Prudential Reinsurance Co 910 F.2d 252-53 (5th Cir. 1990) .......................................... 2.49 Meadows Insurance Co Ltd v Insurance Corporation of Ireland Ltd [1989] 2 Lloyd’s Rep 298 .............................2.07 Mentor Ins Co (UK) Ltd v Norges Brannkasse 996 F 2d 506 (2nd Cir (NY) May 24, 1993) ..........6.133, 6.139, 7.143 Merchants’ Marine Insurance Co Ltd v Liverpool Marine & General Insurance Co Ltd (1928) 31 Ll L Rep 45 ....6.23 Metalfer Corporation v Pan Oceanhipping Co Ltd [1998] 2 Lloyd’s Rep 632 .........................................................3.25 Michigan Millers Mut Ins Co v North American Reinsurance Corp 182 Mich App 410, Feb 21, 1990.........................................................................................................................1.17, 6.155, 6.157, 6.177 Michigan Mut Ins Co v Unigard Sec Ins Co 44 F 3d 826 CA 9 (Wash), 1995.......................................................9.162 Michigan Tp Participating Plan v Federal Ins Co 233 Mich App 422 (Mich App Jan 19, 1999) ...................................................................................1.17, 1.18, 6.05, 6.104, 6.125, 6.128 Moe v Transamerica Title Ins Co 21 Cal App 3d 289, 302, Nov 17, 1971 .............................................................9.124 Moorcock, The (1889) LR 14 PD 64 ........................................................................................................................3.42 Morey v Vannucci, 75 Cal Rptr 2d 573 (Cal App 1 Dist Jan 10, 1998) ....................................................................7.13 Municipal Mutual Insurance Ltd v Sea Insurance Co Ltd & Ors [1990] 1 Lloyd’s Rep 208; [1996] CLC 1515; [1998] CLC 957 .................2.71, 2.82, 2.98, 2.131, 3.18, 3.38, 4.30, 4.38, 4.43, 6.60, 7.100 Napier v UNUM Ltd [1996] 2 Lloyd’s Rep 550 .....................................................................................................9.156 National American Ins Co of California v Certain Underwriters at Lloyd’s London 93 F 3d 529 (9th Cir (Cal) Aug 15, 1996)....................................................................6.05, 6.116, 6.124, 7.95, 9.77,

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9.92, 9.123, 9.152 National American v Certain Underwriters, slip op. 91-4021 (CD Cal 1991) ........................................................6.139 National Union Fire Ins Co of Pittsburgh, PA v American Re-Ins Co 441 F, Supp 2d 646, SDNY, Jul 28, 2006..................................................................................................................................6.133, 7.125 Njegos, The [1936] P 90 ...........................................................................................................................................3.43 Nelson v Empress Assurance Corporation [1905] 2 KB 281 ..................................................................2.53, 2.68, 6.23 New York Bowery Fire Ins Co v New York Fire Ins Co 17 Wend 359, NY Sup, 1837 .................................. 2.08, 7.10 New York State Marine Ins Co v Protection Ins Co 18 F Cas 160 (CC Mass 1841) ....................................................................................6.16, 6.105, 6.131, 6.152, 7.08 Newcap Ins Co v Employers Reinsurance Corp 295 F Supp 2d 1229, D Kan Dec 12, 2003 ........................9.93, 9.127 North Atlantic Insurance Co Ltd v Bishopsgate Insurance Ltd [1998] 1 Lloyd’s Rep 459 .............................2.75, 6.80 North River Ins Co v Ace American Reinsurance Co 361 F 3d 134 (2nd Cir (NY) March 15, 2004) ..........................................................1.17, 6.107, 7.114, 7.124, 7.125, 7.151, 7.153 North River Ins Co v CIGNA Reinsurance Co 52 F 3d 1194 (3rd Cir (NJ) Apr 13, 1995) ...................................................... 1.21, 1.23, 2.08, 2.103, 5.04, 5.35, 5.36, 6.15, 6.18, 6.133, 6.134, 6.143, 6.177, 6.179, 7.41, 7.62, 7.143, 7.231 North River Ins Co v CIGNA Reinsurance Co 52 F 3d 1194 (3rd Cir (NJ) Apr 13, 1985) ...........................6.142, 7.77 North River Ins Co v Columbia Cas Co 1995 WL 5792 SDNY, Jan 5, 1995 .........................................................9.168 North River Ins Co v Columbia Ins Co 1995 WL 5792 SDNY, Jan 5, 1995 ..........................................................9.170 North River Ins Co v Employers Reinsurance Corp 197 F Supp 2d 972, SD Ohio, March 11, 2002 .........6.107, 6.129 North River Ins Co v Philadelphia Reinsurance Corp. 797 F Supp 363 DNJ, Apr 6, 1992....................................9.169 North Star Shipping Ltd v Sphere Drake Insurance plc and others (No 2) [2006] 2 Lloyd’s Rep 183 ....................4.11 Norwich Union Fire Insurance Society Ltd v Colonial Mutual Fire Insurance Co Ltd [1922] 2 KB 461 ..........................................................................................................................................4.10, 4.27 Norwich Union Fire Insurance Society Ltd v Price [1934] AC 455 .........................................................................6.93 O’Kane v Jones (The Martin P) [2004] 1 Lloyd’s Rep 389; [2005] Lloyd’s Rep IR 174................................4.25, 6.93 OK Petroleum AB v Vitol Energy SA [1995] 2 Lloyd’s Rep 160 ............................................................................3.44 Ott v All-Star Ins Corp 99 Wis 2d 635, Wis, Jan 6, 1981 ......................1.16, 1.19, 1.20, 2.25, 2.73, 6.02, 7.229, 7.230 Overseas Union Insurance Ltd v Home and Overseas Insurance Co Ltd [2002] 4 SLR 104 .................................7.234 P&O Steam Navigation Co v Youell [1997] 2 Lloyd’s Rep 136 ..............................................................................6.66 Pacific Mut Life Ins Co v Pacific Sur Co 69 Cal App 730, Nov 21, (1924) ...............................................................................................6.05, 6.126, 6.127, 6.128, 6.142, 6.147 Pan Atlantic Insurance Co Ltd v Pine Top Insurance Co Ltd [1994] 2 Lloyd’s Rep 427 .........................................4.19 Penn Re, Inc v Aetna Cas and Sur Co 1987 WL 909519 EDNC, Jun 30, 1987 .....................................................6.189 Penn Re, Inc v Aetna Cas and Sur Co, not reported, F Supp, WL 909519 EDNC, Jun 30, 1987 .................7.78, 7.231 People ex rel. Cont’l Ins Co v Miller, 177 NY 515 (1904) .......................................................................................1.17 Philadelphia Ins Co v Washington Ins Co 23 Pa 250, 1854 ............................................... 2.08, 2.61, 5.17, 5.39, 2.103 Phoenix General Insurance Co of Greece SA v Halvanon Insurance Co Ltd [1985] 2 Lloyd’s Rep 599 .........................................................................2.04, 3.42, 4.21, 6.10, 9.157, 9.158, 9.159 Pine Top Insurance Co Ltd v Unione Italiana Anglo Saxon Reinsurance Co Ltd [1987] 1 Lloyd’s Rep 476 ...............................................................................3.09, 3.18, 3.44, 3.45, 3.55, 4.38, 6.82 Poole Harbour Yacht Club Marina Ltd v Excess Marine Insurance Ltd [2001] Lloyd’s Rep IR 580.....................9.138 Post Office v Norwich Union Fire Insurance Society [1967] 2 QB 363 ...................................................................2.73 Power Auth v Westinghouse Elec Corp, 502 NY S 2d 420 ....................................................................................9.114 Pride Shipping Corp v Chung Hwa Pulp Corp, The Oinoussin Pride [1991] 1 Lloyd’s Rep 126 ............................3.43 Prifti v Musini Sociedad Anonima de Seguros y Reaseguros [2004] Lloyd’s Rep IR 528..............................3.05, 3.56 Progressive Cas Ins Co v CA Reaseguradora Nacional De Venezuela 991 F 2d 42 (2nd Cir (NY) April 06, 1993) ..........................................................................................................1.21, 5.19, 6.122 Property Insurance Company Ltd v National Protector Insurance Company Ltd (1913) Com Cas 119 ....................................................................................................................................4.32, 3.22 Prudential ReinSur Co v Superior Court of Los Angeles County 3 Cal 4th 1118 (Cal, Nov 30, 1992) ..........2.35, 2.42 Quinta Communication SA v Warrington [2000] Lloyd’s Rep IR 81.......................................................................3.25 Reid v Ruffin 503 Pa 458, (Pa Dec 30, 1983) ...................................................................................... 2.10, 2.16, 9.163 Reliance Marine Insurance v Duder [1913] 1 KB 265 .............................................................................................2.82 ReliaStar Life Ins Co v IOA Re, Inc 303 F 3d 874 (8th Cir (Minn) Sep 09, 2002) ..........................6.120, 6.133, 6.143 Rena K, The [1978] 1 Lloyd’s Rep 545 ....................................................................................................................3.43 Rhine and Wurtemberg Insurance Association v Sedgwick [1899] 1 QB 179 .........................................................2.76 Roadworks (1952) Ltd v Charman [1994] 2 Lloyd’s Rep 99 ..........................................................................4.26, 6.86 Roar Marine Ltd v Bimeh Iran Insurance Co (The Daylam) [1998] 1 Lloyd’s Rep 423 .............. 2.66, 6.87, 6.88, 6.89 Ronson International Ltd v Patrick [2006] Lloyd’s Rep IR 194; aff’d [2007] Lloyd’s Rep IR 85 ..................4.20, 9.66

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Royal and Sun Alliance Insurance v Dornoch [2005] Lloyd’s Rep IR 544 ............................................9.08, 9.53, 9.55 Royal Ins Co of Liverpool, England v Caledonian Ins Co of Edinburgh, Scotland 182 Cal 219, Feb 13, 1920 ..............................................................................................................6.05, 6.133, 6.152 Sabah Flour and Feedmills Sdn Bhd v Comfez Ltd [1988] 2 Lloyd’s Rep 18 .........................................................3.25 Salotti v RUWA Polstereimaschinen GmbH (Case 24/76) [1976] ECR 1831 ..........................................................3.56 Scally v Southern Health and Social Services Board [1992] 1 AC 294 ....................................................................3.42 Scott v Copenhagen Re Co (UK) Ltd [2003] Lloyd’s Rep IR 696 ..................................................................8.36, 8.40 Scottish Metropolitan Assurance Co Ltd v Groom (1924) 20 Ll L Rep 44 .....................................................7.02, 7.85 Scottish National Insurance v Poole (1912) Com Cas 9 ...........................................................................................4.11 Security Mut Cas Co v Century Cas Co 531 F 2d 974 (10th Cir (Colo) Mar 12, 1976) ....................9.79, 9.101, 9.114 Security Mut Ins Co v Acker-Fitzsimons Corp 31 NY 2d at 440. (NYAD 1Dep Apr 24, 1972)............................9.114 Shinedean Ltd v Alldown Demolition Ltd [2006] Lloyd’s Rep IR 846...........................................................9.04, 9.65 Siboti K/S v BP France SA [2003] 2 Lloyd’s Rep 364 .............................................................................................3.56 Sir William Garthwaite (Insurance) Ltd v Port of Manchester Insurance Co Ltd (1930) 37 Ll L Rep 194 .............6.31 Sirius International Insurance Co (Publ) v FAI General Insurance Ltd [2005] 1 Lloyd’s Rep 461..........................1.08 Skandia America Reinsurance Corp v Schenck 441 F Supp 715 (SDNY Nov 21, 1977) ........................................2.43 Skips A/S Nordheim v Syrian Petroleum Co and Petrofina SA, The Varenna [1983] 2 Lloyd’s Rep 592 ...............3.43 Skulnick v Roberts Express, Inc, 3 Cal Rptr 2d 597 (Cal App 4 Dist, Jan 15, 1992) ...............................................7.98 Slotkin v Citizens Cas Co of New York 614 F2d 301 (2nd Cir (NY) Aug 29, 1979) ...............................................9.44 Société Anonyme d’Intermediaries Luxembourgeois & Anor v Farex Gie [1994] CLC 1094 ....................9.156, 9.158 Socony Mobil Oil Co Inc v West of England Shipowners Mutual Insurance Association Ltd, The Padre Island (No. 2) [1987] 2 Lloyd’s Rep 529.............................................................................................2.73 South British Fire and Marine Insurance Co v Da Costa [1906] 1 KB 456..............................................................2.71 Southern California Edison v Superior Court, 44 Cal Rptr 2d 227 (1995) ......................................................7.13, 7.14 Southern Foundries (1926) Ltd v Shirlaw [1940] AC 701 ........................................................................................3.42 Southern Pacific Land Company v Westlake Farms, Inc, 233 Cal Rptr 794, 799 (Cal. App 5 Dist. 1987) ..............7.13 Sphere Drake Insurance plc v Basler Versicherungs-Gesellschaft [1998] Lloyd’s Rep IR 35 ........................2.75, 6.80 Squibb-Mathieson I Corp v St Paul Mercury Ins Co 44 Misc 2d 835, Sup Ct Nov 20, 1964 .........................2.08, 2.50 St Paul Fire and Marine Insurance Co v Morice (1906) 22 TLR 449 .......................................................................6.23 Star Steamship Society v Beogradska Plovidba, The Junior K [1988] 2 Lloyd’s Rep 583 ......................................3.22 Statoil ASA v Louis Dreyfus Energy Services LP (The Harriette N) [2008] 2 Lloyd’s Rep 685.............................6.93 Stickel v Excess Ins Co of America 136 Ohio St 49, Ohio 1939 .................................................................... 2.08, 6.84 Stonewall Ins Co v Argonaut Ins Co 75 F Supp 2d 893, ND Ill, Dec 03, 1999...........................................6.110, 6.133 Stott v Gamble [1916] 2 KB 504 at 508–509 ...........................................................................................................9.51 Street v Royal Exchange Assurance (1914) 19 Com Cas 339 ................................................................................. 3.04 Strong v Phoenix Ins Co 62 Mo 289, 1876 ............................................................................................ 2.08, 2.60, 6.15 Stronghold Insurance Co Ltd v Bulstrad Insurance and Reinsurance plc 24 November 2006, unreported ...................................................................................................................3.30, 6.31 Structural Polymer Systems Ltd v Brown [1999] CLC 268 ..........................................................................6.66, 9.139 Stuyvesant Ins Co v United Public Ins Co 139 Ind App 533, Nov 22, 1966 ..........................................................9.133 Sulphite Pulp Co Ltd v Faber (1895–1896) 1 Com Cas 146 ...........................................................................3.01, 4.29 Swiss Re v United India Insurance [2005] Lloyd’s Rep IR 341 ...............................................................................4.23 Thomas & Co Ltd v Portsea SS Co Ltd [1912] AC 1 ...............................................................................................3.43 Thornton v Shoe Lane Parking Ltd [1971] 2 QB 163 ...............................................................................................3.20 Theriot v Colorado Ass’n of Soil Conservation Districts Medical Benefit Plan 38 F Supp 2d 870 (D Colo, Feb 18, 1999) ............................................................................................................2.43 TIG Premier Ins Co v Hartford Acc. & Indem. Co 35 F Supp 2d 348 SDNY, Jan 29, 1999 ....................................7.11 Toomey v Banco Vitalicio De Espana SA de Seguros [2004] Lloyd’s Rep IR 354 ................................2.82, 3.05, 3.06 Toomey v Eagle Star Insurance Co Ltd (No 1) [1994] 1 Lloyd’s Rep 516..................1.13, 2.53, 2.54, 2.68, 6.74, 6.75 Traders & General Insurance Association Ltd v Bankers & General Insurance Co Ltd (1921) 9 Ll L Rep 223 ..........................................................................................................................................6.19 Travelers Cas & Sur Co v Ace American Reinsurance Co 392 F Supp 2d 659 (SDNY, Oct 12, 2005); affirmed 201 Fed Appx 40 (2nd Cir (NY) Oct 18, 2006) ........................ 2.103, 2.104, 5.07 Travelers Cas & Sur Co v Gerling Global Reinsurance Corp of America 419 F 3d 181 (2nd Cir (Conn) Aug 18, 2005) ..................................................................................... 2.08, 5.06, 5.10, 5.18, 6.114, 6.133, 6.143, 7.122, 7.125 Travelers Cas and Sur Co v Certain Underwriters at Lloyd’s of London 96 NY 2d 583 (NY Oct 16, 2001) ....................................................................................................... 1.20, 1.21, 2.08, 6.133, 7.161 Travelers Cas and Sur Co v Constitution Reinsurance Corp 2004 WL 2387313, ED Mich Aug 2, 2004 ..........................................................................................................1.17, 6.115, 6.133, 6.184 Travelers Cas and Sur Co v Insurance Co of North America 609 F. 3d 143 (3rd Cir (Pa) June 9, 2010)......................................................................................... 2.08, 2.103, 5.06, 6.142, 7.186 Travelers Ins Co v Buffalo Reinsurance C, 735 F Supp 492 (SDNY Feb 9, 1990) .....................................9.103, 9.112

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Travelers Ins Co v Central Nat’l Ins Co, 733 F Supp 522 (D Conn 1990) .............................................................9.103 Travellers Casualty & Surety Co of Europe Ltd v Commissioners of Customs and Excise [2006] Lloyd’s Rep IR 63 .....................................................................................................................................1.01 Trustees of the University of Pennsylvania v Lexington Insurance Co (815 F 2d 890 (3rd Cir (Pa) March 31, 1987)) .............................................................................................................................9.40 Trygg Hansa Insurance Co Ltd v Equitas Ltd [1998] 2 Lloyd’s Rep 439........................................................3.55, 3.56 Unigard Sec Ins Co Inc v North River Ins Co 4 F 3d 1049 (2nd Cir (NY) Sep 09, 1993) ................................................... 1.21, 1.22,2.08, 2.09, 2.81, 5.36, 6.172, 6.183, 7.69, 7.231, 9.18, 9.99, 9.102, 9.105, 9.110, 9.131, 9.137 Unigard Sec Ins Co, Inc v North River Ins Co 79 NY 2d 576 (NY May 05, 1992) ....................................... 1.21, 2.08 Unigard Sec Ins Co, Inc v North River Ins Co 4 F 3d 1049 (2nd Cir (NY) Sep 9, 1993) ...................................................................................................7.12, 7.13, 9.134, 9.136 Union LP Gas Systems, Inc v International Surplus Lines Ins Co, 869 F 2d 1109, (8th Cir (Mo.) March 13, 1989 ..................................................................................................6.163 United Fire & Cas Co v Arkwright Mut Ins Co 53 F. Supp. 2d. 632, (SDNY, Jun 30, 1999) .......................5.34, 9.151 Unum Life Insurance Co of America v Israel Phoenix Assurance Co Ltd [2002] Lloyd’s Rep 374 ........................4.26 Uzielli & Co v The Boston Marine Insurance (1884) 15 QBD 11 ...................2.54, 2.68, 6.22, 6.26, 6.36, 7.91, 7.210 Venetsanos v Zucker, Facher & Zucker 271 NJ Super 459 (NJ Super AD Mar 04, 1994) ........................................................2.11, 2.13, 2.18, 2.19, 2.20, 2.21, 2.22, 2.23, 9.44 Versicherungs und Transport A/G Daugava v Henderson (1934) 48 Ll L Rep 54 ....................................................................................2.04, 2.73, 6.77, 6.79, 6.82, 7.02, 7.07 Walker & Sons v Uzielli (1896) Com Cas 452 .........................................................................................................3.01 Wasa International Insurance Co Ltd v Lexington Insurance Co [2007] Lloyd’s Rep IR 604; [2008] Lloyd’s Rep IR 510; [2009] 2 Lloyd’s Rep 508 ............................................................1.09, 1.13, 1.26, 2.53, 2.58, 2.68, 2.69, 2.71, 2.72, 2.73, 2.74, 2.79, 2.95, 2.105–2.131, 3.07, 4.41, 6.03, 6.12, 6.13, 6.14, 6.19, 6.37, 6.39, 6.59, 6.87, 7.05 Welch v Royal Exchange Assurance [1939] 1 KB 294 ...........................................................................................9.156 West Wake Price & Co v Ching [1956] 2 Lloyd’s Rep 618 ......................................................................................2.73 Western Assurance Company of Toronto v Poole [1903] 1 KB 376 ...................................2.71, 6.19, 6.24, 6.30, 6.159 Wurttembergische AG Versicherungs Beteiligungsgesellschaft v Home Insurance Co (No 1) [1997] LRLR 86 ....6.62 Yeatts v Inland .........................................................................................................................................................7.219 Youell v Bland Welch & Co Ltd [1992] 2 Lloyd’s Rep 127 .................................................................................... 2.95 Zenith Ins Co v Employers Ins of Wausau 141 F 3d 300 (7th Cir (Wis) Mar 27, 1998) ...........9.29, 9.94, 9.128, 9.137

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TA BL E OF L EGISLAT ION

Arbitration Act 1996 .................................................3.55 s. 6(2) ....................................................................3.55 69 .......................................................................8.51 72(1)(a) ..............................................................3.51 ss. 67–69 ...............................................................6.17 Brussels Regulation Council Regulation 44/2001 ........................................................6.07, 9.62 art. 5(1)................................................................. 9.62 23.....................................................................3.56 (1) ................................................................3.56 (a)............................................................3.56 (b) ...........................................................3.56 (c)............................................................3.56 (2) ................................................................3.56 (3) ................................................................3.56 (4) ................................................................3.56 (5) ................................................................3.56 arts 13, 17 or 21 ....................................................3.56 Cal. Ins. Code— § 623..................................................................... 2.08 922.2..........................................................2.42, 2.48 (a)..............................................................2.42 (1) .........................................................2.42 (2) .........................................................2.42 (c)..............................................................2.42 922.4...................................................................2.42 922.5...................................................................2.42 Carriage of Goods by Sea Act of the United States 1936 ..........................................3.25 Colorado Revised Statutes s. 10-3-118(3)(b) (1994) .......................................2.43 Contracts (Rights of Third Parties) Act 1999........... 2.04 s. 1(1) ................................................................... 2.04 Financial Services and Markets Act 2000 ....... 1.13, 6.77 Insurance Contracts Act 1984 (Cth) ..........................4.24 s. 9(1)(a) ................................................................4.24 13........................................................................4.24 Judgments Act 1838— s. 17 .....................................................................7.205

Lugano Convention ...................................................6.07 Marine Insurance Act 1745 ..............................2.01, 6.16 s. 4 ............................................2.01, 2.72, 2.111, 3.04 Marine Insurance Act 1906 ..............................4.21, 4.24 s. 9(1) ........................................................... 2.53, 2.54 (2) ................................................................... 2.04 17 ..............................................................4.18, 4.21 33(3) ..................................................................9.53 ss. 18 and 20..........................................................4.21 Marine Insurance Act 1909 (Cth) .............................4.24 Missouri Revised Statutes (1994)— § 375.246.5............................................................2.43 N.Y. Ins. Code— § 1308(a)(2)(B) .....................................................2.48 N.Y. Ins. Law s. 77 (now §1308)..................................................2.43 § 1308....................................................................2.51 Regulation (EC) No 593/2008 of the European Parliament and of the Council of 17 June 2008 .....................................................3.59 Revenue (No 2) Act 1864...............................2.72, 2.111 s. 1 .........................................................................3.04 Rome Convention, Convention on the Law Applicable to Contractual Obligations 19 June 1980 (80/934/EEC) art. 3.1 ...................................................................3.59 Stamp Act 1867 .........................................................2.72 Stamp Act 1891 .........................................................3.28 Supreme Court Act 1981— s. 35A ..................................................................7.205 Tex. Ins. Code— § 493.055...............................................................2.48 Third Parties (Rights against Insurers) Act 1930 ......2.04 Third Parties (Rights against Insurers) Act 2010 ......2.04 Treaty of Peace (Hungary) Act 1921 ..................... 7.205 UNCITRAL Model Law on Arbitration ................ 2.128 art. 28 ................................................................. 2.128

Louisiana Revised Statutes, Title 22 Insurance Code (La.R.S. 22:943) ..........................2.48 22:941(B)(2) .........................................................2.43

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CHAPTER 1

I N T RODUC T ION TO R EI NSU R A NC E CON T R AC TS

DEFINITION OF REINSURANCE

1.01 Various definitions of reinsurance can be found in the reinsurance cases and books. These definitions indicate the same common feature of reinsurance contracts, namely that reinsurance is insurance for insurance companies. For instance in Travellers Casualty & Surety Co of Europe Ltd v Commissioners of Customs and Excise,1 the VAT Tribunal stated that – approving Kiln’s definition2 – reinsurance is insuring insurers.3 The Tribunal also noted that the insurer passes on the risk to another insurer, the reinsurer.4 Reinsurance therefore is regarded as a species of insurance.5 As individuals need to protect themselves against the risks to, say, their property and take out insurance policies, insurance companies also need insurance to maintain solvency, especially against big risks. By sharing the risk, insurance companies also enlarge their capacity to insure. Moreover, in some countries – particularly in jurisdictions in South America and Africa – only local insurers can insure certain types of risk, and in such cases insurance companies often need reinsurance to spread the risk and to be able to insure the whole risk in their country. This form of “fronting” is used in cases where reinsurers take 100%, or close to it, of the risk reinsured. This also enables reinsurers to do business overseas. Consequently, all of these definitions either complement or support each other and meet the common feature that reinsurance is the transfer of risk from an insurer to another party, the reinsurer. 1.02 The assured is the person who has insured his insurable interest in the subject matter insured. The insurer who has accepted the risk is commonly referred to as the direct insurer/ original insurer/reinsured. The insurer who has issued the reinsurance policy is the reinsurer. Reinsurers will also insure their own risk – these transactions are called retrocessions. In a retrocession agreement, the reinsurer becomes the retrocedant and the insurer issuing the retrocession policy is called the retrocessionaire. 1.03 However there is one significant point on which neither the courts nor commentators share a unanimous view: does the reinsurer insure the subject matter of the original policy, or the liability of the reinsured arising from the risk that it reinsured under the direct insurance policy? The point is significant because the latter view has implications for the construction of reinsurance agreements and the extent to which a common construction with the direct policy

1. 2. 3. 4. 5.

[2006] Lloyd’s Rep IR 63. Kiln, RJ/Kiln S, Reinsurance in Practice, Witherby’s, 4th rev edn, 2001. [2006] Lloyd’s Rep IR 63, para. 57. Ibid., at para. 43. Agnew v Länsforsäkringsbolagens AB, [2000] Lloyd’s Rep IR 317, Lord Millet, at 338.

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is called for. According to the view adopted, the reinsurer becomes either liable or discharges from the liability in question. The issue will be discussed in detail in Chapter 2, below. Before moving to the debate on the nature of reinsurance it is necessary to mention briefly the forms of reinsurance and how the reinsurance contracts are worded.

F O R M S O F R E I N S U R A N C E C O N T R AC T S

1.04 The aim of this book is to introduce reinsuring clauses, especially the clause whereby reinsurers agree to be bound by the same terms and conditions of the original insurance and to follow the settlements of their reinsureds. The clause is mostly used in proportional facultative reinsurance contracts, but there are some issues that will be discussed in the following chapters where other forms of reinsurance are involved. Therefore, as well as introducing proportional facultative reinsurance, there is a general introduction to the other types of reinsurance that are available. This will help to make the references to reinsurance cases easier to understand. 1.05 Reinsurance contracts are classified based on the method by which the reinsured and reinsurer share the risk and the premium.6 The first type of categorisation is proportional and non-proportional. Proportional reinsurance contracts may be either facultative or treaty, but non-proportional contracts are mainly written in the form of a treaty. Proportional Reinsurance 1.06 In proportional reinsurance the reinsurer and the reinsured share the risk and the premium on a proportional basis.7 The proportion that the reinsurer takes over depends on the agreement between the parties; it could be any figure between 1% and 100%. It means that the reinsured transfers the premium according to the percentage of the risk that the reinsurer has agreed to take over. The reinsured, however, will generally be permitted a ceding commission consisting of an agreed proportion of the premium payable to the reinsurer. If a loss occurs, the reinsured pays for the loss and claims the amount from the reinsurer according to the reinsurer’s proportion of the risk. Non-Proportional Reinsurance 1.07 Proportional reinsurance operates on a horizontal basis, with the parties sharing the risk. Non-proportional reinsurance, by contrast, is vertical. The reinsured agrees to bear a part of the loss itself, and cedes the excess to the reinsurers. In other words the reinsurer’s liability is triggered when the reinsured’s liability has reached an agreed excess limit. Facultative Reinsurance 1.08 Facultative reinsurance contracts can be placed proportionally or, less commonly, nonproportionally. Under a proportional facultative reinsurance contract a single risk is reinsured on a proportional basis, so that the reinsured insures the risk and transfers it to the reinsurer according to the agreed proportions that the latter has agreed to reinsure. If the reinsurer

6. For instance see GE Rensurance Corp (formerly Kemper Reinsurance Co) v New Hampshire Insurance Co [2004] Lloyd’s Rep IR 404. 7. Merkin, R, (ed), A Guide to Reinsurance Law, Informa 2007, 8.

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1.10

agrees to reinsure 100% of the risk insured this type of contract is called “fronting.” Parties sometimes enter into “fronting” agreements because local regulations only allow local insurers to insure the local risks and insurers may need reinsurance support to cover large risks. Fronting may also be necessary where the assured is not satisfied with the nominated insurer. For example in Sirius International Insurance Co (Publ) v FAI General Insurance Ltd,8 a Lloyd’s syndicate was the insurer and wished to reinsure its liabilities on its onshore energy account by an “A” class reinsurer. FAI offered to reinsure its risks but FAI was not an “A” class reinsurer. Therefore Sirius, an “A” class reinsurer, agreed to act as a front for FAI. It agreed to write the reinsurance policy for the syndicate and retrocede it 100% to FAI. 1.09 Facultative reinsurance contracts are generally in proportional form, so that the reinsured and the reinsurers share any loss in their agreed proportions. This structure makes it clear that the reinsurers and insurers are presumed to provide identical cover because they share the risk and the premium; in other words, it is normally expected that where the reinsured is liable, the reinsurer is liable. This is naturally subject to any specific exclusions of liability which the reinsurers have insisted upon and, as decided cases have shown, it may be affected by the application of different laws to the two contracts. In order to reflect the identical cover between the original insurance and reinsurance policy, the reinsurance slip (usually no formal policy wording is issued) contains the words “subject to the same terms and conditions as original” or only “as original” or “the full reinsurance clause.” The full reinsurance clause which forms a significant part of the subject matter of this book and will be analysed in detail in the following chapters is worded as follows: “Being a reinsurance of and warranted same gross rate, terms and conditions as and to follow the settlements of the company and that said company retains during the currency of this policy at least . . . on the identical subject matter and risk and in identically the same proportion on each separate part thereof, but in the event of the retained line being less than as above, underwriters’ lines to be proportionately reduced.”

The reinsurance policy wording in proportional facultative reinsurance contracts creates various controversial issues. For example what is the purpose of inserting “as original” as a policy wording? Does the phrase “as original” incorporate the direct policy terms into reinsurance or does it simply confirm that original insurance and reinsurance are back-to-back and provide identical cover? This leads to the question of what exactly the reinsured has to prove to make a successful claim against the reinsurer? Will a foreign court judgment be strong enough evidence to prove the reinsured’s liability and where the reinsured is liable according to the judgment will that liability be recognised as binding in England under English law? These questions have been discussed in reinsurance cases since the late nineteenth century and recently most of these issues came before the House of Lords in Wasa International Co Ltd v Lexington Insurance Co.9 Treaties 1.10 A treaty is defined as a mechanism under which risks falling within its scope may be transferred to the reinsurer.10 A treaty is a method for reinsuring a large number of risks either by class or by way of whole account.11 Proportional treaties are either surplus or quota share, where the reinsured transfers to the reinsurer an agreed proportion of all risks accepted. The most common type of non-proportional treaty is excess of loss reinsurance. 8. 9. 10. 11.

[2005] 1 Lloyd’s Rep 461. [2009] 2 Lloyd’s Rep 508. Merkin, R, Colinvaux Law of Insurance, 8th edn, London, Sweet & Maxwell 2006, para. 17.01. Merkin, Colinvaux Law of Insurance, para. 17.01.

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1.11 As noted above proportional treaties are either quota share or surplus. In quota share reinsurance, the reinsurer agrees to automatically reinsure a fixed percentage of each risk subject to a maximum monetary amount per risk.12 For example, if the reinsured retains 30% of each risk and the reinsurer reinsures 70% of it, it is called 70% quota share treaty. Premium is shared pro rata but the reinsured is usually entitled to deduct ceding commission from the premium to be paid to the reinsurers for his efforts in issuing the original policy. 1.12 In surplus treaties where the reinsured underwrites more than it is willing to bear from its own account, the surplus can be transferred to the reinsurer. The amount that the reinsured retains is called its “line” and the maximum value of the treaty will be expressed in terms of the number or lines that the reinsured finds satisfactory for his reinsurance requirements. For example if an insurer retains £5 million of the risk of £55 million and ten reinsurers each reinsure two lines of the risk, the reinsured has reinsurance coverage for £50 million. If losses occur and the reinsured suffers £30 million loss, the reinsured pays £5 million and the reinsurers pick up the balance. 1.13 Excess of loss and stop loss treaties are non-proportional. The former are the most common. By way of example, the reinsurer may agree to indemnify the reinsured up to £20 million in excess of £5 million. This means that if losses occur amounting in the aggregate to only £3 million the reinsurer’s liability is not triggered and the reinsured has to bear the whole sum. However, if the loss is for say £15 million the reinsured bears the first £5 million and the reinsurer pays 15 − 5 = £10 million. Stop loss reinsurance is also known as “aggregate excess of loss reinsurance.”13 Stop loss reinsurance covers aggregate loss in respect of specified class or classes of insurance. The stop loss reinsurers’ liability is triggered where the reinsured’s liability exceeds the premium income. Thus, it becomes clear that stop loss is a framework used to protect reinsureds’ solvency rather than to expand reinsureds’ capacity to insure.14 It is debatable if the most important other form of non-proportional treaty, stop loss reinsurance, should be regarded as reinsurance at all. In Toomey v Eagle Star Insurance Co Ltd (No 1)15 Hobhouse LJ held that stop loss policies are not reinsurance and in Wasa International Insurance Co Ltd v Lexington Insurance Co Lord Mance16 obiter confirmed this view. According to the judges in these cases a stop loss or similar policy taken out by an insurer is not reinsurance and operates as a whole account protection on a different basis. However, it should be remembered that the Financial Services and Markets Act 2000 treats stop loss policies as reinsurance for regulatory purposes. 1.14 A further classification of treaties is obligatory, non-obligatory and facultative obligatory. 1.15 In obligatory treaties there is an obligation on both sides as regarded the ceding of risks: the reinsured is obliged to transfer all risks of a given description and the reinsurer is obliged to accept them. A non-obligatory treaty provides a framework under which individual risks accepted by the reinsured may be declared to the reinsurer and the reinsurer may choose to accept them on an individual basis. An intermediate possibility is the facultative obligatory treaty, under which the reinsured may choose whether or not transfer the risk but if he does so the reinsurer is obliged to accept it.17 12. 13. 14. 15. 16. 17.

A guide to reinsurance law, 15. Butler J and Merkin R, Butler and Merkin’s Reinsurance Law, Sweet & Maxwell (looseleaf), para. A-0037. Ibid. [1994] 1 Lloyd’s Rep 516. [2009] 2 Lloyd’s Rep 508, 518. For more information see Butler and Merkin, Reinsurance Law, para. A-0030 et seq.

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Definition of Reinsurance 1.16 Before starting to add information with regards to reinsurance law in the United States it is necessary to note that most reinsurance disputes in the US are resolved by arbitration18 and there is typically no publicly available written decision explaining the reasons for the decision of the arbitrator panel. There are relatively few judicial decisions involving reinsurance, and state courts, in the absence of a controlling authority by the state’s higher court, often rely on decisions from other state’s courts.19 Only a handful of those the state court decisions on reinsurance issues are decided by the highest state court. Unless the decisions are by the highest state or appellate courts, the court opinions on particular issues are not authoritative or binding, they are merely “persuasive authority” for other courts to consider on the strength of the reasoning. Thus, there is little concerning reinsurance law that is firmly settled in the US by court decision, so the following chapters will for the most part consider case law, but not all of the principles stated can be considered settled law. 1.17 Reinsurance has been defined by many courts in several jurisdictions in the United States. Some definitions are more simply worded than the others but they confirm the same principles. For example, the Michigan Court of Appeals defined reinsurance as “a contract whereby one insurer for a consideration contracts with another to indemnify it against loss or liability by reason of a risk which the latter has assumed under a separate and distinct contract as the insurer of a third person.”20 The US District Court for the Eastern District of Michigan and the US Court of Appeals for the Second Circuit defined reinsurance more simply as “insurance for insurance companies.”21 The US Court of Appeals for the Second Circuit again defined reinsurance in North River Ins Co v Ace American Reinsurance Co22 as “a contract by which one insurer insures the risks of another insurer.” Purpose of Reinsurance 1.18 Reinsurance is particularly important to diversify the risk of loss and to reduce required capital reserves. In Christiania General Ins Corp of New York v Great American Ins Co,23 the Second Circuit defined reserves as reflecting the insurer’s estimation of expected losses and appearing as liabilities on its financial statements. The court noted that the interests of the reinsured and the reinsurer in setting reserves are not always the same. Insurers are required to maintain a certain level of assets relative to their outstanding policies and reinsurance indemnification obligations owed to an insurer may be considered in computing such assets. According to the Second Circuit this was in fact a primary function of reinsurance-enabling the reinsured to reduce the amount of reserves it is required to carry on its books.24 Consequently, 18. Employer Reinsurance Corp v Laurier Indem Co 2007 WL 1831775 (MD Fla); Ott v All-Star Ins Corp 99 Wis.2d 635, (Wis. Jan 06, 1981). 19. Houston Cas Co v Lexington Ins Co, 2006 US Dist, Lexis 45027. It should be also noted that many reinsurance disputes involve several contracts and parties who are domiciled in different states or countries. 20. Michigan Millers Mut. Ins Co v North American Reinsurance Corp, 182 Mich.App. 410, (1990), citing 13A Appleman, Insurance Law & Practice, § 7693, p. 523. Approved in Michigan Tp. Participating Plan v Federal Ins Co 233 Mich.App. 422, (1999). See also Constitution Reinsurance Corp v Stonewall Ins Co, 980 F.Supp. 124, (SDNY, Sep 17, 1997). 21. Travelers Cas and Sur Co v Constitution Reinsurance Corp. 2004 WL 2387313 (ED Mich); Continental Cas Co v Stronghold Ins Co Ltd 77 F.3d 16, (2nd Cir. (NY) Feb 13, 1996). 22. 361 F.3d 134 (2d Cir. (NY) 2004), citing People ex rel. Cont’l Ins Co v Miller, 177 NY 515, (1904). 23. 979 F.2d 268, (2nd Cir. (NY) Sep 03, 1992). 24. See also Michigan Tp. Participating Plan v Federal Ins Co 233 Mich App 422, 1999.

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insurance companies reduce the legal reserve requirement, then possess more capital to invest or to use to insure more risks. 1.19 Similar to the federal court decision stated above in the state of Wisconsin, in Ott v All-Star Ins Corp,25 the Supreme Court of Wisconsin gave a list of purposes that primary insurers may purchase reinsurance for. These purposes were as follows: (a) to reduce their exposure to liability on particular risks and to obtain a greater spread of risk; (b) to protect against accumulations of losses arising out of catastrophes; (c) to reduce total liabilities to a level appropriate to their premium volume and capital; (d) to provide greater capacity to accept new risks and write policies involving larger amounts than could otherwise be written; (e) to help stabilise operating results; and (f) to obtain assistance with new concepts and lines of insurance. Types of Reinsurance 1.20 A similar classification of reinsurance is seen in the US reinsurance market, in that reinsurance is classified either as “pro rata” and “excess” – in other words, proportional and nonproportional or facultative and treaties. The contracts are the same as in English practice, just differently defined. In Ott v All-Star Ins Corp,26 the Supreme Court of Wisconsin clarified that in pro rata types of reinsurance, the reinsurer and the reinsured share the risk and the premium in an agreed fixed proportion; in the excess reinsurance, however, the reinsurer becomes liable on a loss only when the loss exceeds an agreed policy amount. Generally, the premiums for excess of loss reinsurance are lower than those for quota share reinsurance as the risks are not shared proportionately by the reinsured and reinsurer.27 This amount, for which the insurer alone is responsible, is known as the insurer’s “retention.” 1.21 In North River Ins Co v CIGNA Reinsurance Co,28 the United States Court of Appeals for the Third Circuit also touched upon the classification of reinsurance contracts. The Third Circuit defined facultative reinsurance as policy specific, all or a portion of a reinsured’s risk under a specific contract of direct coverage will be indemnified by the reinsurer in the event of loss.29 Under “treaties” reinsurers agree to accept an entire block of business from the reinsured. An insurer who seeks to reduce potential financial losses from policies issued to a class of customers or an industry may purchase treaty reinsurance.30 As treaties cover an “entire block of business”, they evaluate the overall risk pool, but not the individual risk being reinsured. This will include accepting all of the policies under the block of business, including those as yet unwritten. These last two statements are the key factors of treaties that differs them from facultative reinsurance which entails the ceding of a particular risk or policy.31

25. 99 Wis.2d 635, (Wis. Jan 06,1981) (by referring to Nutter, Insurer Insolvencies, Guaranty Funds, and Reinsurance Proceeds, 29 Fed.Ins Counsel Q. 373, 374 (1979)). 26. Ibid. 27. Travelers Cas and Sur Co v Certain Underwriters at Lloyd’s of London 96 NY.2d 583, (NY Oct 16, 2001). 28. 52 F.3d 1194 (3rd Cir. (NJ) April 13, 1995). See also Affiliated FM Ins Co v Employers Reinsurance Co 369 F.Supp.2d 217, (D.R.I., May, 12, 2005). 29. Travelers Cas and Sur Co v Certain Underwriters at Lloyd’s of London 96 NY.2d 583, (NY Oct 16, 2001). 30. Ibid. 31. Christiania General Ins Corp of New York v Great American Ins Co 979 F.2d 268, CA 2 (NY), 1992; See also Unigard Sec Ins Co, Inc v North River Ins Co 79 NY.2d 576, (NY, May 05, 1992); Progressive Cas Ins Co v CA Reaseguradora Nacional De Venezuela 991 F.2d 42 (2nd Cir. (NY) April 06, 1993).

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In facultative reinsurance, where the reinsurer and the reinsured share the risk and the premium,32 the reinsurer assesses the unique characteristics of each policy to determine whether to reinsure the risk and the amount of premium. In Commercial Union Ins Co v Seven Provinces Ins Co Ltd 33 the D. Massachusetts District judge described treaty as a pool defined by the type of risk, not by the identity of the insured of one particular policy as in facultative reinsurance. 1.22 In Unigard Sec Ins Co, Inc v North River Ins Co,34 the court stated that a “typical treaty reinsurance agreement might reinsure losses incurred on all policies issued by the ceding insurer to a particular insured, while facultative reinsurance would be limited to the insured’s losses under a policy or policies specifically identified in the reinsurance agreement.” 1.23 In North River Ins Co v CIGNA Reinsurance Co,35 the Third Circuit gave detailed explanation of primary and excess insurance and their relationship with reinsurance. The court noted that primary insurers, excess insurers, and reinsurers play different roles in the insurance industry. Primary and excess insurers, unlike reinsurers, provide coverage directly to the assured. Primary and excess insurance policies both describe the kinds of liability that will be covered and specify dollar limits. Excess insurers generally replicate the coverage offered by the primary insurer; however, the excess insurer’s liability is not triggered until the primary insurer’s limit is exhausted. Reinsurance, however, is a business between insurance companies in which an insurer, who has provided coverage to its assured, transfers all or part of that risk to other insurance companies (reinsurers) along with a portion of the premiums. In North River,36 the Third Circuit illustrated the relationship between excess insurers and reinsurers with an example of an excess insurer which issued a $100 million policy and retained a certain portion of the risk (eg, the first $10 million of excess liability) and reinsure the balance with other insurance companies: reinsurance here is non-proportional excess of loss reinsurance. The excess insurer will pay the entire excess claim unless a claim exceeds the $10 million retained liability. If a claim exceeds $10 million, that portion of the claim exceeding $10 million will fall on the reinsurer who has accepted the next layer of liability up to the reinsurance policy limit.

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Treaties 1.24 In both treaties and proportional facultative reinsurance, reinsuring clauses delimit the circumstances in which the reinsurer’s liability will arise. As will be seen in the following paragraphs, in proportional facultative reinsurance the wording is not drafted in detailed terms; it is more usual in treaties for reinsuring clauses to be drafted in a more detailed fashion. The reason is that in proportional facultative reinsurance the purpose is to achieve a sharing of a single risk and the premium by providing closely matching or identical cover, so that there is no particular need to repeat what appears in the direct policy. However, treaties have 32. Eg. see Unigard Sec Ins Co, Inc v North River Ins Co 4 F.3d 1049 (2nd Cir. (NY) Sep 09, 1993) where the reinsurer reinsured one-sixth of the risk insured and became entitled to receive one-sixth of the premium paid to North River, less the standard 25% brokerage commission. 33 9 F.Supp.2d 49, (D.Mass. Jun 15, 1998); aff’d by the first circuit, 217 F.3d 33, (1st Cir. (Mass) Jul 06, 2000). 34. The definition that the district court adopted in Unigard, 762 F.Supp. at 572 n. 2, approved by the Second Circuit 4 F.3d 1049 (2nd Cir. (NY) Sep 09, 1993). 35. 52 F.3d 1194 (3rd Cir. (NJ) Apr 13, 1995). 36. Ibid.

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the additional functions of expanding underwriting capacity and protecting the reinsured from insolvency. A treaty covers a series of underlying risks, and sometimes the reinsured’s whole account is reinsured and the reinsurer undertakes to provide an indemnity for the excess losses above an agreed figure during the policy period. In facultative proportional reinsurance, when the assured suffers loss then, subject to any exceptions in the reinsurance contract, where the reinsured is liable, the reinsurer will be liable for the agreed proportion of the direct risk reinsured. However, in treaties, the respective losses faced by reinsured and the reinsurer will deal with other matters, for instance, whether the reinsurer has agreed to cover losses which occurred within the policy period, or which were the subject of claims during the currency of the reinsurance. Furthermore, in the case of excess of loss treaties, the reinsurer will be liable only for losses in excess of the amount retained by the reinsured, so that it is important to define aggregating terms such as “occurrence” and “event,” in order to determine the amount and number of the reinsured’s retentions arising from a series of claims. Reinsurance treaties usually contain inspection clauses which entitle the reinsurer to examine the reinsured’s books and records relating to the business written by the reinsured and within the scope of the reinsurance. As the main purpose of this book to analyse one type of reinsuring clause, the full reinsurance clause, the scope of the various terms used in treaties will not be analysed in detail. Proportional Facultative Reinsurance 1.25 In proportional facultative reinsurance (hereafter, facultative reinsurance) a single risk is reinsured by the reinsurer on a proportional basis: the parties share the risk and the premium: if the risk occurs, the reinsured becomes liable to pay the loss but becomes entitled to claim the relevant proportion of the reinsurer’s contribution. The insurance and reinsurance policies are often drafted to provide identical (back-to-back) or at least closely matching cover. As it is usually the case that the reinsured’s liability to the policyholder will trigger the reinsurer’s liability, in entering into the reinsurance contract, a cover page (reinsurance slip) is appended to the original policy and the cover page usually contains the clause “subject to the same terms and conditions as original and follow the settlements of the reinsured” a clause sometimes expressed to be “the full reinsurance clause”37 and sometimes only “as original and follow the settlements.”38 These phrases are the most important wordings expressing the scope of the reinsurance. Reinsurance slip policies also state the amount of premium to be paid and the reinsurer will in many cases add exclusion or limitation clauses which are not found in the underlying cover. 1.26 It is worth noting that as administrative practice in the London Market, the slip may refer to a choice of forms: J1 or NMA 1779. J1 contains the clause “Being a reinsurance of and warranted same gross rate, terms and conditions as and to follow the settlements of the [reassured].” NMA 1779 does not have a follow settlements clause. However it contains an obligation: “ . . . to pay or to make good to the Reinsured all such Loss as aforesaid as may happen to the subject matter of this Reinsurance, or any part thereof during the continuance of this Policy.” In Wasa International Insurance Co Ltd v Lexington Insurance Co,39 the slip provided for a choice of forms at the option of the broker and also the conditions were stated

37. Insurance Co of Africa v Scor (UK) Reinsurance Co Ltd [1985] 1 Lloyd’s Rep 312. 38. This kind of wording is still permissible under the Contract Certainty Code of Practice so long as the original policy terms are clearly identified by attaching or uniquely describing or referencing. (See Appendix 2: Sample checklist content.) http://www.iua.co.uk/AM/Template.cfm?Section=Contract_Certainty1&CONTENTID=2791&T EMPLATE=/CM/ContentDisplay.cfm (last visited on 27 July 2009). 39. [2009] 2 Lloyd’s Rep 508.

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1.27

as to be “The Full Reinsurance Clause.” One commentator has strongly emphasised that one or other of these forms must have been chosen, as such choice must be made at a time when the reinsurance premium is closed to the market. The commentator was of the opinion that, on the facts of the case, NMA 1779 must have been the chosen form because no further wording was issued.40 However, the House of Lords41 in Wasa found this discussion unhelpful, give that it was common ground between the parties that the wording of the clause adopted was “Being a reinsurance of and warranted same gross rate, terms and conditions as and to the settlements of the Company and that said Company retains during the currency of this Policy at least . . . on the identical subject matter and risk and in identically the same proportion on each separate part thereof, but in the event of the retained line being less than as above, Underwriters’ lines to be proportionately reduced.” 1.27 It should be noted that a standard Full Reinsurance Clause is not seen in US reinsurance policies. The reinsuring clauses used in the United States reinsurance market are varied from one policy to another. Such wordings are analysed on a case by case basis throughout this book.

40. Weir, A, “A Matter of Forms and Substance,” [2009] LMCLQ 210, 217, 235. 41. [2009] 2 Lloyd’s Rep 508.

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CHAPTER 2

T H E NAT U R E OF FACU LTAT I V E R EI NSU R A NC E

2.01 In England marine reinsurance was banned on gambling grounds by the MIA 17451 and the ban lasted until it was finally abandoned more than 100 years later in 1864. After 1864 reinsurance cases gradually came to be seen in the law reports, and those cases show that clauses similar to those expressed above have been in use since the early development of reinsurance business in England. However, there has always been discussion as to the scope of the clauses in question and, also directly related to this issue, the nature of facultative proportional reinsurance contracts. As seen below there are two views on the nature of reinsurance: 1. Reinsurance is a further insurance on the subject matter insured. 2. Reinsurer insures liability of the reinsured’s which arises from the risk that has been insured by the reinsured. 2.02 The significance of this discussion is that it determines what the reinsured has to prove before making a claim against its reinsurer. On either view it is unquestioned that the reinsurance and original insurance contracts are independent of each other. But the issue arises especially where the question is construction of the original insurance and reinsurance contracts where the reinsurance is “as original.” The question in this situation is whether or not the construction of the original policy is binding on the reinsurer. The matter may get more complicated where the insurance and reinsurance contracts are governed by different laws, which is exceedingly common in reinsurance business where local insurance companies reinsure the risks that they undertook in their domestic countries. Therefore before explaining the function of the phrase “as original and follow the settlements” it is necessary to analyse the nature of reinsurance.

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2.03 In facultative reinsurance the reinsured’s liability forms the reinsurer’s liability. In other words, where the reinsured is liable, it is also likely that the reinsurer’s liability will arise subject to any exclusion clauses added into the reinsurance policy different from the direct insurance. But what is the subject matter of the reinsurance contract? For example, if a factory is insured against fire and then reinsured by the reinsurer, does the reinsurer insure the factory building against fire and if the assured suffers loss, pays the proportion

1. MIA 1745 s. 4 “That is shall not be lawful to make reassurance, unless the assurer shall be insolvent, become bankrupt or die; in either or which cases such assurer, his Executors, Administrators or Assignors may make reassurance to the amount of the sum by him assured provided it shall be expressed in the policy to be a Reassurance.”

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of their share to the reinsured, or does the reinsurer insure the reinsured’s liability under the original policy? Before moving to judicial opinion on this issue, it is necessary to analyse these two approaches and to consider how they fit into the current principles of reinsurance law. Applicable Principles Privity of contract 2.04 It is clear that in reinsurance contracts there is no privity between the assured and the reinsurer.2 The test to determine whether a contract is one of reinsurance was expressed by Lord Atkin in English Insurance v National Benefit3 as “whether or not the re-insurers or the alleged re-insurers have assumed a contractual liability to the original assured, for such an original contractual liability is not an incident of re-insurance, and if such an original liability had been assumed then there would have been a contract of insurance . . . .” Moreover, the Marine Insurance Act 1906, section 9(2) states: “unless the policy otherwise provides, the original assured has no right or interest in respect of such reinsurance.” It is the original assured who has the insurable interest on the subject matter insured and who is therefore entitled to take out an insurance policy that is protecting his interest on the subject matter of the insurance contract. The assured cannot make a direct claim against the reinsurer and a reinsurance contract does not contain any undertaking in favour of the assured.4 Therefore the view that reinsurer insures the same subject matter as the original insurance contract does not match with the principle that there is no privity of contract between the assured and the reinsurer.5 2.05 As will be seen below in Chapter 9, reinsurers may want to keep control of the negotiations between the assured and the insurer given that the liability resulting from those negotiations may form their liability as well; therefore reinsurance contracts may contain provisions giving rights the reinsurers to that effect. Under English law, direct contact between a reinsurer and the assured as a result of reinsurers taking over the negotiations from the reinsured does not establish privity between the assured and the reinsurers to the effect of entitling the assured to bring a direct claim against the latter.6

2. Hobhouse J in Phoenix General Insurance Co of Greece SA v Halvanon Insurance Co Ltd [1985] 2 Lloyd’s Rep 599, 614; Re Law Guarantee Trust and Accident Society [1914] 2 Ch 617; Versicherungs und Transport A/G. Daugava v Henderson (1934) 49 Ll L Rep 252, however, controversially Scrutton LJ also declared that the reinsured had insurable interest in the subject matter originally insured. 3. [1929] AC 114, 124. 4. It should be noted that a reinsurance contract may, by virtue of a cut-through clause, provide that the assured can make a direct claim against the reinsurer in the event of the liquidation of the reinsured. However as the clause is provided by the reinsurance contract where the assured has no privity with, the objection as to the enforcement of the clause may appear. The passing of the Contracts (Rights of Third Parties) Act 1999 has removed this objection by allowing a person who is not a party to a contract to enforce its terms if it expressly provides that he may or it identifies him as a beneficiary of the contract (s. 1(1)). A cut-through clause could thus be interpreted as an express clause providing that the third party can make a claim against the reinsurer. See Butler and Merkin, Reinsurance Law, paras. D-0151–D-0177; Merkin, Colinvaux’s Law of Insurance, para. 17-02; A Guide to Reinsurance Law, 259–261. There may, however, be problems under the general pari passu principle applicable to unsecured creditors with enforcing a cut-through clause where the reinsured is insolvent: in fact, cut-through clauses are by their terms only triggered by an insolvency, so their validity remains doubtful. There is also an outstanding question as to whether a cut-through clause is a registrable charge against a company, and thus void against the liquidator if it is not registered. 5. The Third Parties (Rights against Insurers) Act 2010, like its predecessor the Third Parties (Rights against Insurers) Act 1930, does not apply to reinsurance, so that the policyholder of an insolvent insurer has no cause of action against that insurer’s reinsurers. 6. Grecoair v Tilling [2005] Lloyd’s Rep IR 151.

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2.06 Claims provisions may not be in the form of giving the reinsurers the control of the negotiations but the reinsured may be required to seek the reinsurers’ consent before entering into any settlements with the assured. Thus, reinsurers may preclude settlement of a claim by the reinsured by exercising their contractual rights against the reinsured under the reinsurance agreement. The absence of privity is still maintained in such circumstances and the argument that the reinsurers have committed the tort of interfering with the contractual relationship would be unsuccessful as the reinsurers would be using their contractual rights that the parties had agreed at the outset of the contract.7 At this stage it is necessary to leave the issue without discussing it in detail as there will be a comparative analysis of the effect of reinsurers’ control of negotiations with the assured under English law and the law of the United States in Chapter 9 of this work. 2.07 It is also worth noting that reinsurers are entitled to seek a declaration that they are not liable according to the reinsurance policy terms for the payment that the reinsured has made but they cannot seek declaratory relief as to the reinsured’s liability to the assured under the original policy. This was decided in Meadows Insurance Co Ltd v Insurance Corporation of Ireland Ltd 8 where the reinsurer sought declarations to the effect that the reinsured was entitled to avoid, or alternatively was not liable, under the original policy. Following the dicta of Lord Diplock in Gouriet v Union of Post Office Workers9 the Court of Appeal emphasised that the reinsurer was a third party to the relationship between the assured and the reinsured and consequently had no right to seek a declaration with respect to the rights of those parties. Privity – United States 2.08 One of the respects in which that reinsurance being distinct from the original insurance is that the reinsurer is not directly liable to the original assured. From the very early cases10 on reinsurance in the US, it has been generally accepted by the state and federal courts that there is no privity between assureds and reinsurers thus, the reinsurer is not directly liable to the original assured even if the reinsured becomes insolvent.11 The fact 7. Equitas Ltd v Wave City Shipping Co Ltd [2006] Lloyd’s Rep IR 577. 8. [1989] 2 Lloyd’s Rep 298. 9. [1978] AC 435, 501. 10. Hastie v De Peyster 3 Cai. R. 190, N.Y.Sup. 1805. 11. Travelers Cas and Sur Co v Insurance Co of North America 609 F.3d 143 (3rd Cir. (Pa) June 9, 2010) (under New York law); American Employers’ Ins Co v Swiss Reinsurance America Corp 275 F.Supp 2d 29 (D Mass, Aug 05, 2003), aff ’d 413 F.3d 129 (1st Cir. (Mass) Jun 27, 2005); Gantt v American Cent Ins Co 68 Mo 503, 1878; Carlson Holdings, Inc v NAFCO Ins Co 205 F.Supp 2d 1069 D.Minn., Jan 08, 2001; Stickel v Excess Ins Co of America 136 Ohio St. 49, Ohio 1939; New York Bowery Fire Ins Co v New York Fire Ins Co 17 Wend 359, N.Y.Sup., 1837; Philadelphia Ins Co v Washington Ins Co 23 Pa. 250, Pa. 1854; Jackson v St Paul Fire & Marine Ins Co 99 N.Y. 124, NY 1885; Employers Reinsurance Corp v American Fidelity & Cas Co 196 F.Supp 553, D.C.Mo. 1959; Donaldson v United Community Ins Co 741 So 2d 676, La App 3 Cir, Feb 10, 1999; Strong v Phoenix Ins Co 62 Mo 289, 1876; Unigard Sec Ins Co Inc v North River Ins Co 4 F.3d 1049 (2nd Cir. (NY) Sep 09, 1993); Unigard Sec Ins Co, Inc v North River Ins Co 79 N.Y.2d 576, (NY May 05, 1992) (The New York Court of Appeals). Travelers Cas & Sur Co v Gerling Global Reinsurance Corp of America 419 F.3d 181 (2nd Cir. (Conn) Aug 18, 2005); Travelers Cas and Sur Co v Certain Underwriters at Lloyd’s of London 96 NY.2d 583, (NY Oct 16, 2001); North River Ins Co v CIGNA Reinsurance Co 52 F.3d 1194 (3rd Cir. (NJ), Apr 13, 1995); Central Nat Ins Co of Omaha v Prudential Reinsurance Co 241 Cal Rptr 773, (Cal Apr 2 Dist. Nov 19, 1987: it should be noted that the Supreme Court ordered that the opinion not be officially published.); American Bankers Ins Co of Florida v Northwestern Nat Ins Co 198 F.3d 1332, (11th Cir. (Fla) Dec 30, 1999); Klockner Stadler Hurter Ltd v Insurance Co of State of Pa. 785 F.Supp. 1130, (SDNY Jul 11, 1990); Colonial American Life Ins Co v CIR 491 US 244, US Jun 15, 1989. Cal.Ins.Code § 623 states that “[t]he original insured has no interest in a contract of reinsurance.” However, a reinsurer and reinsured may agree to entitle the assured to make direct action against the reinsurer, most often when the reinsured is insolvent. Such a clause is called “cut-through” clause and this can be conceived of an express grant of third-party beneficiary status of the putative non-party direct insured. See Staring, G S, Law Of Reinsurance, 1993, §16:2; New Appleman Insurance Law Practice Guide, LexisNexis, 2007, www.chadbourne. com/files/Publication/b3b45e9d-566d-4433-8198-68078ae54acf/Presentation/PublicationAttachment/441ebf2d7946-4a56-958a-5d6ab2da6c9d/013-60099_60099-ch0040.pdf (last visited on 21 April 2010), 40.01.

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that the assured is aware of the reinsurance policy does not alter the absence of privity,12 It should be noted in the case of reinsured’s insolvency in order to enable the reinsured’s receiver to make a claim against the reinsurer, “insolvency clauses” are used in the United States, this special type of clause is discussed under “Reinsured’s Insolvency” in the following paragraphs. 2.09 In principle, a reinsurer has no contact with the insured; reinsurers generally do not examine direct risks, receive notice of loss from the original insured, or investigate claims.13 In the US, reinsurers often express concerned that contacts with the assured lead to the argument that privity has been established. The following cases illustrate the point. GENERAL RULE: REINSURERS HAVE NO OBLIGATIONS TOWARDS ASSUREDS

2.10 In Reid v Ruffin14 the Supreme Court of Pennsylvania stated that the lack of privity of contract between an assured and a reinsurer is inherent in the nature of the reinsurance contract. The court further clarified that reinsurance is the ceding by one insurance company to another of all or a proportion of its risks for a stipulated proportion of the premium, in which “the liability of the reinsurer is solely to the reinsured, the ceding company, and in which contract the ceding company retains all contact with the original insured, and handles all matters prior to and subsequent to loss.” In Reid v Ruffin15 the assured, Ruffin, negligently caused serious injury to Reid. The reinsured did not settle the claim despite an offer from Reid’s counsel, and at the trial the jury awarded Reid a sum considerably higher than the amount put forward prior to the trial. The reinsured subsequently became insolvent; Reid argued that he was entitled to recover directly from the reinsurers for their own bad faith in refusing to sanction the reinsured to settle, and effectively asked the Court to abandon the privity requirement and to impose a duty of good faith on the reinsurers towards the original insured. The Supreme Court of Pennsylvania noted that an insured is not notified of the reinsurance, has no contact with the reinsuring company, and is generally not a party to the contract. Because the reinsurer has not assumed a contractual duty to represent the original insured, he has no obligation to which the duty of good faith can attach. The reinsurer’s only obligations are toward the reinsured and arise under contract. Therefore the assured was held to have no enforceable rights against the reinsurers. INTERVENTION IN THE SETTLEMENT PROCESS BY THE REINSURER

2.11 In Venetsanos v Zucker, Facher & Zucker16 the Superior Court of New Jersey Appellate Division held that whether or not a reinsurer has a duty to the primary insured depends on the degree of the reinsurer’s percentage of the risk, (ie whether or not the reinsured acted as a front and also the control over the decisions concerning settlement with the third party claimant, assured). Accordingly, where the reinsurer, under the reinsurance contract or otherwise, takes charge of and manages the defence of suits against the original assured, the reinsurer may be held to be “privy” to the action.17 12. Squibb-Mathieson I. Corp. v St Paul Mercury Ins Co 44 Misc.2d 835, 254 N.Y.S.2d 586, (Sup. Ct. Nov 20, 1964). 13. Unigard Sec Ins Co, Inc v North River Ins Co 4 F.3d 1049 (2nd Cir, (NY) Sep 09, 1993). 14. 503 Pa 458, (Pa Dec 30, 1983). 15. 503 Pa 458, (Pa Dec 30, 1983). 16. 271 NJ Super 459, (N.J. Super. A.D. Mar 04, 1994). 17. “Privy to the action” suggests that a person (an insurer/reinsurer) is involved enough in a judicial proceeding that it is reasonable to treat that person as a “party” to the action such that a decision in the action would be binding on the person of the judge could exercise authority over the person in connection with the action.

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2.12 Here, Venetsanos was injured in a boat explosion and brought an action against Manuel Dominguez and other defendants, alleging negligent operation and product defects. 2.13 Following a jury trial of the Venetsanos action, judgment was entered jointly and severally against all defendants in the amount of $960,000, plus pre-judgment interest of $323,425, Dominguez’ share being approximately $315,000. The Mutual Fire, Marine and Inland Insurance Company (Mutual), insured Dominguez under a $100,000 liability policy. Dominguez assigned his rights against Mutual and others to Venetsanos, whose subsequent action against Mutual was dismissed without prejudice because of Mutual’s insolvency petition. Venetsanos then brought an action against Homestead, Mutual’s reinsurers, and asserted in a summary judgment motion that Mutual had been merely “fronting” for Homestead in New Jersey, such that Homestead should be considered the direct insurer on Dominguez’s policy. 2.14 Mutual was a Pennsylvania insurer which was authorised to do business in New Jersey; Homestead, which was the 100% reinsurer of Dominguez’ policy with Mutual, was not so authorised. As Homestead was not licensed to conduct business in New Jersey, Mutual acted as a front for Homestead. It became clear that the broker collected the premium and, after deducting his commission, he sent it to the reinsured; the reinsured took out an agreed percentage as its fronting fee, and sent the rest to the reinsurers. It was undisputed that Homestead faced the entire exposure for liability under the Dominguez policy. 2.15 The Superior Court of New Jersey Appellate Division affirmed the lower court’s judgment that Homestead should be regarded as though it had the obligations of a primary insurer to Dominguez and his assignee, Venetsanos. The court recognised the general rule that an original assured does not have a right of direct action against the reinsurer. However, the special facts in this case demonstrated that the “reinsurance” agreement was one which would subject Homestead to direct action. The reinsurance policy was inexplicably absent from the files of both Mutual and Homestead which precluded an examination of the terms of that agreement; but, in analysing Venetsanos’ action the Appellate Division found the following facts supporting the conclusion: It was not disputed that Homestead was responsible for negotiating and settling the Venetsanos matter on behalf of Mutual through its agent or employee. The court pointed out the direct negotiations between the claimant and the independent contractor appointed by Homestead. Moreover, Homestead was in control of the policy obtained by Dominguez, actually carried out the insurance investigation and had final authority on all settlements. The court stated that: “Where, . . . the reinsuring agreement itself provides, or the conduct of the reinsurer demonstrates, that it takes charge of and manages the defense of suits against the original insured, the reinsurer may be held to be a “privy” to the action. In such cases, judgment creditors of the insured have been allowed to proceed directly against the reinsurer.”

2.16 The court distinguished Reid v Ruffin where, according to the Appellate division, the reinsured had retained most of the risk, reinsuring only 25%, and it controlled the settlement negotiations. 2.17 Venetsanos was later relied on by the claimant in Aftab v New Jersey Property-Liability Ins Guar Ass’n,18 a 2006 proceeding in the Superior Court of New Jersey, Appellate Division. In this case New Jersey attorneys who had been named as defendants in legal malpractice suits in New Jersey brought an action against their professional liability insurer, “American National Lawyers Insurance Reciprocal (Risk Retention) Group” (ANLIR). Because the insurer became

18. 386 N.J.Super. 41, (N.J. Super.A.D., May 31, 2006).

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insolvent the claimants sought indemnification from the New Jersey Property-Liability Insurance Guaranty Association (PLIGA). PLIGA denied coverage because ANLIR was registered in New Jersey solely as a risk retention group whereas PLIGA Act applies only to “direct insurance.” The claimants, however, argued that PLIGA coverage was available because ANLIR’s reinsurer, the Reciprocal of America (ROA), which also became insolvent, was a PLIGA member and exerted controlling influence over ANLIR. Thus, the claimants asserted that the reinsurance veil should be pierced and ANLIR assureds and claimants against them should be entitled to PLIGA coverage because they would be entitled to coverage from ROA. The court rejected these arguments for the reason that an insurer registered in New Jersey solely as a risk retention group was not covered by PLIGA regardless of the status of that insurer in another jurisdiction, and regardless of the status of its reinsurer or its relationship with its reinsurer. 2.18 Alternatively, the claimants argued that ROA stand in the shoes of the direct insurer and therefore as in Venetsanos, ROA was directly responsible for claims against the direct insurer. 2.19 However, the Superior Court of New Jersey Appellate Division distinguished Venetsanos. Here the reinsurance policy was not absent and according to the reinsurance agreement, ANLIR was required to “investigate and settle or defend all claims and losses.” Thus the terms of the reinsurance agreement, which were available for the court’s examination, plainly described a traditional insurer–reinsurer relationship, and provided no basis for direct claims against ROA. Moreover, no contact between the claimants and ROA was established, the evidence did not indicate that ROA took charge of the claims, evaluated them, communicated with assigned counsel, or otherwise controlled the claims. Furthermore, ANLIR did not act as a front for ROA. The court noted that if the claimants could prove a sufficient degree of control they might be able to recover directly from the liquidation estate of ROA but that still does not provide a basis for PLIGA recovery through ROA that did not issue the policies in question. 2.20 Venetsanos was also brought to the attention of the Unites States Court of Appeals of Third Circuit in G-I Holdings, Inc v Reliance Ins Co19 where the law of New Jersey was applied. In this case, G-I bought an insurance policy from Reliance that covered liability arising out of claims made by third parties against G-I’s directors and officers between 1 July 1999 and 1 July 2002. In early 2000, Reliance was in financial trouble; a Pennsylvania state court ordered its liquidation in October 2001. In summer 2000 Hartford acquired renewal and other rights to, and became a reinsurer and servicer of, certain Reliance policies. 2.21 G-I argued that Hartford must cover some or all of the fraudulent conveyance actions because the purchase, servicing, and reinsurance agreements between Hartford and Reliance made Hartford directly liable under the amended Reliance policy and that the reinsurance relationship created brought this case within the ambit of Venetsanos. 2.22 The Third Circuit rejected G-I’s argument. It distinguished Venetsanos based on the fact that Hartford did not have the same level of control over Reliance that Homestead had over Mutual and there was no allegation that Reliance had been fronting for Hartford. 2.23 What these cases demonstrate is that under New Jersey law an assured generally does not have a right of direct action against reinsurers. Nevertheless, it may be necessary to look at the specific facts of the reinsured–reinsurer relationship to determine whether the general rule applies. If the reinsured acted as a front for the reinsurer and if the reinsurer controlled the negotiations and the settlement process with the assured, as Venetsanos indicates, the assured may be able to proceed directly against the reinsurer. However, the cases discussed above emphasised that Venetsanos will be applicable only if the same sort of relationship between the assured and the reinsurer is established. 19. 586 F.3d 247, (3rd Cir. (NJ) Oct 26, 2009).

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2.24 It should also be noted that in Litho Color Inc v Pacific Employers Ins Co,20 the Court of Appeals of Washington held the fact that the reinsurers (HSB) were involved in handling the assured’s claim did not establish privity between the reinsurer and the assured. The evidence demonstrated that HSB was the reinsurer with no actual or intended direct contractual relationship with the assured, Litho. HSB acted pursuant to its reinsurance agreement with the insurer as an agent, not as a principal. Thus the Court of Appeals and Washington approved the lower court’s finding that no privity existed between HSB and Litho. POLICY WORDING

2.25 The policy wording may be interpreted as permitting the assured to bring suit against the reinsurer. In Ott v All-Star Ins. Corp21 the Supreme Court of Wisconsin held that the excessof-policy-coverage clause added to the original reinsurance agreement made the reinsurer a liability insurer of the insurer, allowing the assured to make a direct claim against the reinsurer for the reinsured’s alleged tort of bad faith. In this case Douglas Gould became quadriplegic due to an injury he suffered while diving on the premises of DeNoon Beach, Inc Gould sued DeNoon and its liability insurer, All-Star Insurance Corporation and obtained a judgment against them for a sum in excess of $500,000. The policy limit was $100,000, therefore AllStar’s full payment left DeNoon liable to Gould for the balance of the judgment, which remained unpaid and subsequently made DeNoon insolvent. 2.26 The receiver of DeNoon brought an action against All-Star and North Star who reinsured 85% of the risk that All-Star insured. The claimant’s argument was that All-Star’s failure to settle the claim within the applicable policy limits was in bad faith. The claim was also against North Star because the claimant alleged that Addendum 5 to the originally issued reinsurance policy made North Star the liability insurer of All-Star in respect to its tortious failure to settle within policy limits. 2.27 The original reinsurance agreement between North Star and the All-Star, effective on 15 May 1968, provided: “ . . . (North Star) shall indemnify and reimburse the Company for all losses paid in cash by the Company in excess of (the first $15,000) as respects each accident, subject to a maximum liability of Nine Hundred Seventy Thousand Dollars ($970,000) to the Reinsurer . . . The foregoing reinsurance shall apply only to those claims resulting from any one accident which are covered within the actual limits of liability attaching under policy or policies of the Company provided, however, said limits of liability shall not exceed the following” . . .

2.28 This original agreement, however, was later altered by a number of addenda. One of these, Addendum 5, added the following paragraph: “Notwithstanding the foregoing it is also agreed that should the Company become legally obligated to pay a loss in excess of its policy limits the Reinsurer agrees to assume seventy-five percent (75%) of that part of such loss (plus proportionate loss expense) which is in excess of the policy limit. However, in the event the applicable policy limit is less than the Company’s retention at the time of the loss, the amount hereby assumed by the Reinsurer shall be limited to seventy-five percent (75%) of that part of the loss (plus proportionate loss expense) which is in excess of said retention. In no event, however, shall the liability of the Reinsurer, respecting such loss, exceed the maximum amounts of liability set forth in the Exhibits attached hereto.”

2.29 The trial court dismissed the direct action against the reinsurer on the ground that DeNoon

20. 98 Wash.App. 286, (Wash.App. Div. 1, Sep 20, 1999). 21. 99 Wis.2d 635, (Wis, Jan 06,1981).

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was not in privity of contract with the reinsurer. The Court of Appeals agreed with the trial court. 2.30 The Supreme Court of Wisconsin, however, reversed the judgment. The court pointed out the uncertainty, whether intentional or inadvertent, created by the wording of Addendum 5 as to the true nature of the agreement, the scope of its coverage, and the parties who may and may not invoke its provisions in a legal action. 2.31 According to the Supreme Court, in Addendum 5, the phrase “legally obligated to pay a loss in excess of policy limits” aimed to protect All-Star against liability in tort to one of its assureds for a bad faith or negligent failure to settle a claim within policy limits. 2.32 Moreover, the Addendum covered 75% of loss rather than all amounts (up to policy limits) over $15,000; North Star agreed to cover 75% of the amount above the policy limits of $100,000 when All Star incurred liability in excess of the policy limit. The court pointed out that Addendum 5 did not use the language implying the necessity of All-Star’s actual payment as a prerequisite to North Star’s responsibility; but rather stated that North Star will “assume” 75% of any loss which exceeds policy limits. 2.33 As a consequence the Supreme Court found that Addendum 5 constituted direct liability insurance running from North Star to All-Star against the latter’s liability to its own assured for tortious failure to settle thereby making North Star subject to direct action by Ott, the receiver of DeNoon. REINSURED’S INSOLVENCY

2.34 The principle that the assured has no rights against the reinsurer does not relieve the reinsurer from liability when the reinsured has become insolvent. In Consolidated Real Estate & Fire Ins Co v Cashow22 the Court of Appeals of Maryland held that the original assured has no kind of claim against the reinsurer when the direct insurer is insolvent; the reinsured remains solely liable on the original insurance and alone has a claim against the reinsurer. Hence, if the original insurer becomes insolvent and the assured is paid only a small dividend from his remaining assets, the reinsurer is still liable to pay the whole amount of the reinsurance to the person administering the insolvency of the original insurer without deducting the dividend and the assured has no claim in respect of the money so paid. Similarly, in Cashau v Northwestern Nat Ins Co23 the District Judge of the Circuit Court E D Wisconsin, emphasised that the financial condition of the reinsured is not to be taken into account in the computation of the amount to be paid on the policy of reinsurance. The condition in the reinsurance policy that “in case of loss the company shall pay pro rata at and in the same time and manner as the reinsured” cannot mean that in case of the insolvency of the reinsured the reinsurer can only be obliged to pay the pro rata the dividends of the assets of the reinsured upon the claim of the assured. The condition means that the reinsurer shall pay at and in the same time and manner as the reinsured company shall pay or be bound to pay according to its policy,24 and the reinsurer shall have all the advantages of the time and manner of payment specified in the policy of the reinsured – otherwise the reinsurer’s policy would not be the contract of indemnity intended, and endless litigation might ensue. 2.35 It is necessary to refer briefly to the use of insolvency clauses in the United States. Insolvency clauses operate when the reinsured becomes insolvent, and require the reinsurer to pay the full amount due under reinsurance agreement for the underlying claim to the reinsured’s

22. 41 Md 59, Md, 1874 . 23. 5 F.Cas 270, CC Wis 1873. 24. This is sometimes referred to as a “simultaneous settlements” clause.

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receiver, who then uses reinsurance proceeds and other assets to pay claims of all creditors. Insolvency clauses may be formulated as follows:25 “reinsurance provided by each and every reinsurance agreement heretofore or hereafter entered into by and between the parties hereto shall be payable by the Reinsurer directly to the Company or to its liquidator, receiver, conservator or statutory successor on the basis of the liability of the Company without diminution because of the insolvency of the Company or because the liquidator, receiver, conservator or statutory successor of the Company has failed to pay all or a portion of any claim. . . .”

2.36 In order to facilitate claims against reinsurers upon the reinsured’s insolvency, now most states statutes require reinsurance contracts to contain insolvency clauses. Absent clear language in the reinsurance agreement permitting the reinsured’s receiver to make a claim against the reinsurers, the reinsured would not be able to take credit for the reinsurance in their statutory financial statements. 2.37 The root of the issue goes back to two cases decided by the Supreme Court of the United States in the early twentieth century. In Allemannia Fire Ins Co v Fireman’s Ins Co of Baltimore,26 the clause in question for the court’s construction was: “Upon receiving notice of any loss or claim under any contract hereunder reinsured, the said reinsured company shall promptly advise the said Allemannia Fire Insurance Company, at Pittsburgh, Pennsylvania, of the same, and of the date and probable amount of loss or damage, and after said reinsured company shall have adjusted, accepted proofs of, or paid such loss of damage, it shall forward to the said Allemannia Fire Insurance Company, at Pittsburgh, Pennsylvania, a proof of its loss and claim against this company, upon blanks furnished for that purpose by said Firemen’s Insurance Company, together with a copy of the original proofs and claim under its contract reinsured, and a copy of the original receipt taken upon the payment of such loss; and, upon request, shall exhibit and permit copies to be made of all other papers connected therewith, which may be in its possession.”

2.38 The claimant had originally insured and then reinsured the property which was destroyed by fire in the city of Baltimore. The claimant became liable for the resulting heavy loss, but was unable to pay and became insolvent. The question was whether the loss was recoverable from the reinsurers even though the reinsured did not make any payment. 2.39 The Supreme Court of the United States held that, because of the abovementioned provision, payment of the loss to the original assured was not a prerequisite to recovery by the reinsured on a contract of reinsurance. The clause provided that the reinsured “shall forward to the reinsurer a statement of the date and probable amount of loss or damage, and, after having adjusted, accepted proofs of, or paid, such loss or damage, shall forward the proofs and a copy of the original receipt taken upon the payment of such loss.” 2.40 Allemannia was decided in 1908 and the Supreme Court of the United States discussed a similar issue in 1937 in Fidelity and Deposit Co of Maryland v Pink.27 In Fidelity the contractual language provided: “The Reinsurer’s proportionate share of a loss under the bond, of costs and expenses as hereinafter defined, and of interest, shall be paid to the Reinsured upon proof of the payment of such items by the Reinsured, and upon delivery to the Reinsurer of copies of all essential documents concerned with such loss and costs and the payment thereof. . . .”

25. See Prudential ReinSur Co v Superior Court of Los Angeles County 3 Cal.4th 1118, (Cal., Nov 30, 1992); The Supreme Judicial Court of Massachusetts held that reinsurer of insolvent insurers in liquidation was entitled to offset amounts owed to them against amounts owed by the insurers: see Commissioner of Ins v Munich American Reinsurance Co 429 Mass. 140, Mass., March 05, 1999. 26. 209 U.S. 326, (US Dist Col. Apr 06, 1908). 27. 302 U.S. 224, (US NY Dec 06, 1937) U.S. 1937.

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2.41 Upon an action brought by the assured against the reinsurer the Supreme Court of the United States held that a written contract must be construed according to its terms. The policy language provided that the reinsurers reinsured against loss and that their proportionate share of loss should be paid to the reinsured upon proof of payment and upon delivery of documents concerned with loss and payment thereof. Therefore, payment by the reinsured was a condition precedent to the reinsurer’s liability, and the failure of the reinsured’s liquidator to discharge the liability incurred by the reinsured under a fidelity insurance bond, although the claim based thereon had been allowed, precluded the liquidator from recovering on reinsurance agreement. The reinsurance policy which was incorporated in the reinsurance policy wording in Fidelity was adopted 20 years after Allemannia was decided and the Supreme Court of the United States noted that the use of dissimilar language in the standard form of 1930 might be assumed to have intended to impose liability different from the one found in Allemannia. 2.42 As a result of Fidelity v Pink, many states adopted statutes that prohibit credit for reinsurance unless the reinsurance contract contains an express provision stating that in the event of the insolvency of the reinsured, the reinsurers shall pay reinsurance proceeds to the domiciliary liquidator based on the liability of the reinsured, regardless of whether the liquidator can fully pay such liability.28 For example in California,29 West’s Ann.Cal.Ins.Code § 922.2 provides as follows: “(a) Credit for reinsurance shall be allowed a domestic ceding insurer as either an asset or a deduction from liability in accordance with Sections 922.4 and 922.5 only if the reinsurance contract contains provisions that provide, in substance, as follows: (1) The reinsurer shall indemnify the ceding insurer for the risk it has assumed according to the terms and conditions contained in the reinsurance contract. (2) In the event of insolvency and the appointment of a conservator, liquidator, or statutory successor of the ceding company, the reinsurance shall be payable to the conservator, liquidator, or statutory successor on the basis of claims allowed against the insolvent company by any court of competent jurisdiction or by any conservator, liquidator, or statutory successor of the company having authority to allow such claims, without diminution because of that insolvency, or because the conservator, liquidator, or statutory successor has failed to pay all or a portion of any claims. Payments by the reinsurer as set forth in this subdivision shall be made directly to the ceding insurer or to its conservator, liquidator, or statutory successor, except where the contract of insurance or reinsurance specifically provides another payee of such reinsurance in the event of the insolvency of the ceding insurer. ..... (c) The original insured or policyholder shall not have any rights against the reinsurer which are not specifically set forth in the contract of reinsurance, or in a specific agreement between the reinsurer and the original insured or policyholder.”

2.43 Similar statutory provisions are seen in some other states such as New York,30 Colorado,31 Louisiana,32 and Missouri.33 2.44 The insolvency clause provides a single exception to the general rule where the reinsured becomes insolvent. The clause provides that the reinsurer must pay the liquidator based 28. Hammesfahr, 252; see also Semple, TD and Hall, RM “The Reinsurer’s Liability in the Event of the Insolvency of Ceding Property and Casualty Insurer”, www.robertmhall.com/articles/j.htm#N_15_(last visited 28 July 2010). 29. See Prudential ReinSur Co v Superior Court of Los Angeles County 3 Cal.4th 1118 (Cal, Nov 30, 1992). 30. The New York legislature enacted 1939 N.Y. Laws, c. 882, N.Y. Ins Law s 77 (now §1308); see Skandia America Reinsurance Corp v Schenck, 441 F.Supp. 715, (SDNY Nov 21, 1977); In re Liquidation of Realex Group, N.V.210 A.D.2d 91, N.Y.A.D. 1 Dept., Dec 13, 1994. 31. Colo.Rev.Stat. § 10-3-118(3)(b) (1994); For the case discussing the relevant provision see Theriot v Colorado Ass’n of Soil Conservation Districts Medical Benefit Plan 38 F.Supp.2d 870, (D Colo, Feb 18, 1999). 32. LaRS. 22:941(B)(2). 33. At § 375.246.5, RSMo (1994); See First American Ins Co v Commonwealth General Ins Co 954 S.W.2d 460, (Mo.App. W.D, Aug 26, 1997).

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on an assessment of the reinsured’s liability for the claim rather than loss already sustained by payment to the direct assured. This permits the reinsurance to be taken into account in the computation of the legally prescribed reserve levels, which benefit all the reinsured’s creditors.34 As is discussed in Chapter 6 below, the English courts have reached the conclusion that, in the absence of clear wording to the contrary, reinsurers must pay as soon as the reinsured’s liability has been established and quantified, rather than when payment is made by the reinsured.35 Cut-through Exception 2.45 As stated above, the general principle is that no privity of contract exists between the reinsurer and the assured. However, a contractual liability between the reinsurer and the assured may be created through use of the “cut-through” or “cutoff”36 clauses. These clauses are inserted in reinsurance policies to create an exception to the general rule to the effect that the reinsurers give a guarantee to the reinsured that they will satisfy the reinsured’s obligation to the assured in case the assured brings a direct action against them.37 As such clauses establish a contractual right for the assured to make a direct claim against the reinsurers, it can be conceived of as an express grant of third-party beneficiary status of the putative non-party direct assured.38 Most often “cutthrough” clauses apply only when the direct insurer is insolvent,39 but as will be seen below, some courts recognised the clause without noting the necessity of the insurer’s insolvency. 2.46 The difference between a cut-through clause and insolvency clauses is that in the latter it is provided that in case of the insurer’s insolvency the reinsurers would pay to the liquidator the amount that they would have paid to the reinsured had it not been insolvent. A cut-through clause however is an undertaking by the reinsurers to make payment directly to the assured. Therefore cut-through clauses are regarded not only as the exception to the privity rule, but also an exception to insolvency clauses. 2.47 The intention of the contracting parties as to stipulating such an advantage to the assured has to be clearly expressed in the reinsurance agreement.40 It is normally the case that reinsurance policies mention the original assured’s name to identify the original policy in question. Identification of the original assured in a reinsurance policy without an express provision which gives the assured the right to make a direct claim against the reinsurer or an undertaking by the reinsurer to indemnify the assured directly, is not itself sufficient to accept that such a right has been granted.41 2.48 Many state statutes42 permit reinsurers to enter into cut-through endorsements. For instance the Louisiana Revised Status, Title 22 Insurance Code (La.R.S. 22:943) provides: “Whenever an insurer agrees to assume and carry out directly with the policyholder any of the policy obligations of the ceding insurer under a reinsurance agreement, any claim existing or action or proceeding pending arising out of such policy by or against the ceding insurer with respect to such obligations may be prosecuted to judgment as if such reinsurance agreement had not been made, or the assuming insurer may be substituted in place of the ceding insurer.”

34. Arrow Trucking C v Continental Ins Co, 465 So.2d 691 (La. Apr 01, 1985). 35. Charter Re v Fagan [1997] AC 313. 36. Donaldson v United Community Ins Co, 741 So.2d 676, (La.App. 3 Cir. Feb 10, 1999) the relevant provision was named as a “cutoff” clause by the Court of Appeal of Louisiana, Third Circuit. Writ denied by Donaldson v United Community Ins Co, 740 So.2d 1285, (La. May 07, 1999). 37. Hammesfahr, 256. 38. New Appleman Guide, 40.05[2]. 39. New Appleman Guide, 40.05[2]; Larry P Schiffer, “Cut-Through Provisions in Reinsurance Agreements” www.irmi.com/expert/articles/2001/schiffer03.aspx (last visited 29 July 2010). 40. Donaldson v United Community Ins Co, 741 So.2d 676, (La.App. 3 Cir. Feb 10, 1999) Writ denied by Donaldson v United Community Ins Co, 740 So.2d 1285, (La. May 07, 1999). 41. Arrow Trucking Co v Continental Ins Co, 465 So.2d 691 (La. Apr 01, 1985). 42. Cal. Ins. Code § 922.2; N.Y. Ins. Code § 1308(a)(2)(B); Tex. Ins. Code § 493.055.

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2.49 Thus, where there is language in a reinsurance agreement indicating that the reinsurer is agreeing “to assume and carry out directly with the policyholder any of the policy obligations of the ceding insurer” the assured’s right of direct action against the reinsurers will be recognised.43 2.50 Many courts also recognised giving a third-party beneficiary right to the assured by an express agreement of the reinsurers within the reinsurance policy. For example, in Squibb-Mathieson I Corp v St Paul Mercury Ins Co,44 the Supreme Court of New York State held that–without specifying the clause or giving any examples of that kind – a contract of reinsurance may contain provision whereby the reinsurer agrees to pay to the assured any loss for which the insurer may become liable. The court stated that in such a case the assured may bring a direct claim against the reinsurer. In Klockner Stadler Hurter Ltd v Insurance Co of State of PA,45 the United States District Court for the Southern District of New York cited Squibb with approval in holding that the assured could bring a direct action against the reinsurer of an all-risks insurer where the all risks policy assigned to the assured the right to sue reinsurer directly. 2.51 Where the reinsurance contract contains both an insolvency clause that requires payment by the reinsurer to be made to the liquidator and also a cut-through clause which grants a contractual right to the assured, in case of the reinsured’s insolvency, the question will arise if the reinsurer should be entitled to settle the claim with the original assured. It is necessary to check the statutes of the particular state to see whether or not credit for the third-party beneficiary is permitted. Some state statutes that specifically address credit for reinsurance (eg NY Ins. Law § 1308) appear to allow the ceding insurer to take credit for reinsurance proceeds even where the agreement specifies another payee in the event of insolvency. Other state statutes may not permit the credit. 2.52 It is important to draft a cut-through clause to the effect that the reinsurer does not face duplicate liability; therefore it may be necessary to expressly provide that when the reinsurer makes payments to a third party, it will not be required to make payments to the reinsured or to a statutory receiver.46 Insurable Interest 2.53 The Marine Insurance Act 1906 section 9(1) provides: “The insurer under a contract of marine insurance has an insurable interest in his risk, and may re-insure in respect of it.” Referring to section 9(1), Hobhouse LJ in Toomey v Eagle Star Insurance Co47 expressed the view that the reinsured’s insurable interest has to be identified by reference to the original policy and the reinsurer should be entitled to the benefit of any protection that the reinsured has obtained under the original contract of insurance. Support for this view can be seen in both some of the old and modern cases48 and most recently the House of Lords in Wasa International Insurance Co Ltd v Lexington 43. See Donaldson v United Community Ins Co, 741 So.2d 676, (La.App. 3 Cir. Feb 10, 1999) Writ denied by Donaldson v United Community Ins Co, 740 So.2d 1285, (La. May 7, 1999); Martin Ins Agency, Inc v Prudential Reinsurance Co, 910 F.2d 252-53 (5th Cir. 1990); Arrow Trucking Co v Continental Ins Co, 465 So.2d 691 (La. Apr 01, 1985). 44. 44 Misc.2d 835, Sup. Ct. Nov 20, 1964. 45. 785 F.Supp. 1130, SDNY, Jul 11, 1990. 46. Schiffer, Hammesfahr, 258. 47. [1994] 1 Lloyd’s Rep 516, 522–523. 48. British Dominions General Insurance Co Ltd v Duder [1915] 2 KB 394, 400. See also Mathew LJ in Nelson v Empress Assurance Corporation [1905] 2 KB 281, 285; Forsikringsaktieselskabet National (of Copenhagen) v Attorney-General [1925] AC 639; CGU International Insurance v AstraZeneca Insurance Co [2006] Lloyd’s Rep IR 409; in Feasey v Sun Life Assurance Co of Canada [2002] 2 All ER (Comm) 492 Langley J was also prepared to adopt this view.

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Insurance Co49 adopted the same view; referring to the abovementioned authorities Lord Mance50 stated: “ . . . The insurable interest which entitles the insurer to reinsure in respect of that subject matter is the insurer’s exposure under the original insurance. The principle of indemnity limits any recovery from reinsurers to the amount paid in respect of that insurable interest.” 2.54 The word “risk” within the meaning of section 9(1) of MIA 1906 needs to be clarified. The risk may be interpreted either as the insurer’s financial risk of indemnifying the assured or the loss of the subject matter of the original insurance. In Mackenzie v Whitworth51 Amphlett B stated that “ . . . the fact of the policy being a re-insurance is only a limitation on the liability of the second insurer, and does not make his risk cease to be a risk on goods.” However such early decisions were handed down at a time when reinsurance policies were effected as second insurance against the loss of the subject matter insured by another policy.52 As a result, what must be specified was held to be the subject matter of insurance and not an interest in it,53 therefore it was immaterial for the underwriters to know that the policy was reinsurance.54 Secondly, by reference to Hobhouse LJ’s opinion in Toomey v Eagle Star Insurance Co Ltd,55 it can be argued that there is no need to afford to the reinsurer the reinsured’s protection under the original policy. It should be remembered that the reinsured has no actual legal interest in the property which is the subject matter of the original insurance, and therefore its interest must be confined to the nature and scope of the liability which it has undertaken under the direct insurance.56 To make a claim against the reinsurers, the reinsured has to establish and quantify its loss (ie the existence and amount of its liability to the assured).57 This means liability at law, so that if the reinsured is permitted to rely on an exclusion clause in the original policy but it knowingly fails to do so and makes payment, such payment would be classified as ex-gratia and accordingly outside the cover of the reinsurance.58 Consequently, it appears that the insured risk is a concern of the reinsurers only because it forms the reinsured’s liability and not because it is the subject matter of the original insurance.59 49. [2009] 2 Lloyd’s Rep 508. 50. Ibid., at 518. 51. (1874–75) LR 10 Ex 142, 151. 52. The parties manipulated the word “insurer” as reading “reinsurer” in the standard form of original insurance policies. See Merkin, R, “Incorporation of Terms Into Reinsurance Agreements” The Modern Law of Marine Insurance Vol 2 Rhidian Thomas (ed) Informa Publishing 2002 61; O’Neill, PT/Woloniecki JW, The Law of Insurance in England and Bermuda London: Sweet &Maxwell 2004, paras. 1-27. In Dalby v India (1854) 15 CB 365 the insurers had insured the life of the Duke of Cambridge, and had taken out their own policy which they maintained in force even after the primary insurance had been surrendered. Merkin has argued (“Incorporation of Terms into Reinsurance Agreements”, 61 Butler and Merkin, Reinsurance Law, para. A-0303.) that the second policy was some form of reinsurance but this view was not considered in Feasey v Sun Life Assance Co of Canada [2003] Lloyd’s Rep IR 637. 53. (1875) LR 10 Ex 142, 148; see also Carruthers v Sheddon (1815) 6 Taunt 14; Crowley v Cohen (1832) 3 B & Ad 478 where it was emphasised that the nature of the interest did not need to be properly described. 54. See Merkin, “Incorporation of Terms”, 61. 55. [1994] 1 Lloyd’s Rep 516. 56. Golding, CE/KV Louw, Golding: The Law and Practice of Reinsurance, London Witherby & Co Ltd, 1987, 8. 57. Charman v Guardian Royal Exchange Assurance Plc. [1992] 2 Lloyd’s Rep 607, 613. 58. Similarly, failure to rely upon a right to avoid could render a payment ex gratia, although see the contrary comments of Morison J in Bonner v Cox ([2005] Lloyd’s Rep IR 569, affirmed without comment [2006] Lloyd’s Rep IR 385) where the learned judge held that given the policy is valid until the insurer avoids it for breach of utmost good faith, the reinsurer is bound to follow the settlement of the reinsured if the reinsured chose not to rely on the breach of the duty of utmost good faith defence. The point is touched upon below in Chapter 6 but it is worth noting here as well that it is difficult to conceive why the good faith defence should be treated differently from other defences no matter if the policy is valid until it is avoided. Furthermore, the reinsured who paid by waiving the available defence cannot be said to have settled the claim on the basis of liability. 59. In some early authorities the reinsured’s insurable interest was regarded as loss originating from his contractual liability under the original insurance policy, but they also held that the reinsurance policy was on the subject matter of the original insurance: Brett MR in Uzielli v Boston Marine Insurance Co (1884–85) LR 15 QBD 11, 16-17; Bradford v Symondson (1880–81) LR 7 QBD 456.

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2.55 In Dalby v India and London Life Assurance Co,60 Anchor Life Assurance co-granted to John Wright several policies of insurance of the life of the Duke of Cambridge: two policies for £1,000 and two policies for £500. Anchor agreed to pay £3,000 to John Wright on the death of the Duke. However, Anchor wanted to limit their insurance to £2,000, therefore the excess £1,000 was transferred to the defendants – in the words of the court – by way of “counter-insurance.” Afterwards, Anchor granted an annuity to Wright and his wife in return for the cancellation of the four policies. However, one of the directors of Anchor kept the defendant’s policy on foot by the payment of premiums until the Duke’s death. The court held that Anchor had unquestionably an interest in the continuance of the life of the Duke of Cambridge – and that was to the amount of £1,000, because they had bound themselves to pay a sum of £1,000 to Mr. Wright on that event. The court distinguished life policies from policies of indemnity such as marine risks or fire insurance because life insurance is a contract to pay a certain sum in the event of death which was not prohibited by the Life Assurance Act 1774 and was also valid at common law. The court did not mention whether the policy issued by the defendants was or was not reinsurance, but held that policy was valid and enforceable even though the other policies issued by Anchor were surrendered. 2.56 In a much more recent life insurance case, Feasey v Sun Life Assurance Co of Canada,61 the majority of the Court of Appeal held that the reinsured, Steamship Mutual (SM), had an insurable interest in the lives of employees of its member shipowners, but this decision was based on the express wording of the reinsurance. Although SM had reinsured its liability up until 1994 under ordinary contracts of reinsurance, in that year, due to changes in reserving requirements relating to liability insurance policies at Lloyd’s, new policy wordings were developed and the traditional liability wording was abandoned in favour of the formulation that the subject matter of the insurance was personal injury or death suffered by employees of the reinsured’s member shipowners and others on board their vessels. Therefore the point at issue was SM’s insurable interest in the well-being of employees of its member shipowners. As this was a life policy, the court did not look for any legal or equitable interest in the subject matter insured and the majority of the Court of Appeal concluded that the Club had a pecuniary interest in the personal injury or death of employees and others. Such interest was held to exist at the outset as SM had legal obligations to members which could lead to SM having to pay substantial sums. Consequently Feasey v Sun Life Assurance Coof Canada62 supports the idea that insurers may have insurable interest in the subject matter of the original insurance, but only if the wording of the policy so provides. 2.57 Dalby v India and London Life Assurance Co63 was considered in Feasey; Dyson LJ referred to Parke B’s comment in Dalby where the judge had stated “At the time this policy was subscribed by the defendants, the Anchor Company had unquestionably an insurable interest to the full amount [sc £1,000].” Dyson LJ said:64 “The significance of this statement is clear enough. This ‘counter-insurance’ was on the life of the Duke. It was not a liability insurance. It was not a reassurance of Anchor’s liability to pay. As Parke B stated at p 387, the contract (commonly called life assurance) when properly considered was a ‘mere contract to pay a certain sum of money on the death of a person’. This species of insurance ‘in no way resembles a contract of indemnity’. Accordingly, it was a contract to which the Life Assurance Act 1774 applied. It is difficult to see how Anchor had a legal or equitable interest in the life of the Duke. It had a potential legal liability to pay under the four policies, and that potential liability was sufficient to give it an insurable interest in the life.”

60. 61. 62. 63. 64.

(1854) 15 Common Bench Reports 365. [2003] Lloyd’s Rep IR 637. Ibid. (1854) 15 Common Bench Reports 365. [2003] Lloyd’s Rep IR 637, 663.

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2.58 Merkin has argued65 that in Dalby, the policy the defendants issued was a form of reinsurance. And in Feasey, Dyson LJ questioned how Anchor could have an insurable interest on the life of the Duke. Ultimately, in Dalby and in Feasey, insurable interest was found to exist to support the interest of the insurers’ or the reinsurers’; in Dalby because it was a life insurance which is not a contract of indemnity and without mentioning that the policy was reinsurance; and in Feasey as a result of the particular wording of the reinsurance policy. In Wasa International Insurance Co Ltd v Lexington Insurance Co,66 Lord Mance stated that: “ . . . The insurable interest which entitles the insurer to reinsure in respect of that subject matter is the insurer’s exposure under the original insurance.” It is submitted that in fact “the insurer’s exposure” in this statement indicates that what is reinsured is the insurer’s liability, but not the assured’s interest in the subject matter insured. 2.59 As Lord Griffiths stated in Forsikringsaktieselskapet Vesta v Butcher:67 “The original policy is concerned to define the risk that the insurer is prepared to accept. The contract of reinsurance is concerned with the degree of that risk as defined in the policy that the reinsurer is prepared to accept.” 2.60 In the United States it has been suggested that the insurable interest under a reinsurance contract is the potential liability of the insurer under the original policy.68 The Supreme Court of Missouri and the federal district court of Minnesota in Strong v Phoenix Ins Co69 and Carlson Holdings Inc v NAFCO Ins Co,70 respectively, have held that the direct assured had no interest in the contract of reinsurance. In another early case on reinsurance, Imperial Fire Ins Co of London v Home Ins Co of New Orleans71 the United States Court of Appeals for the Fifth Circuit stated that the cotton – the subject matter of the original insurance between the assured and the reinsured – itself was not the subject of the insurance as between the insurer and reinsurer; the subject matter of the reinsurance contract was the liability of the insurer. Similarly, the New York Court of Appeals72 has stated that the reinsured renders itself liable for any loss that assured may suffer and it acquires an insurable interest in the subject matter to the extent of that liability, but only for the purposes of the risk reinsured. The Supreme Judicial Court of Massachusetts in Manufacturers’ F & M Ins Co v Western Assur Co73 clarified the issue further. In this case the reinsurance policy was drawn on a printed form generally used to insure owners of a property. The policy contained a standard clause making change of title void without the insurer’s consent. The property was sold under a foreclosure and the reinsurers disputed that their consent had not been sought, therefore the reinsurance contract was breached. The question was how far standard terms used in an insurance policy were applicable to a reinsurance contract. The judge drew attention to the material difference in nature of an insurance contract and a reinsurance contract. The former was against damage to the assured’s property, the latter, while in a sense an insurance upon property, was strictly a contract of indemnity against risk under another contract which had been entered into by the assured and the insurer (reinsured). The judge emphasised that the reinsured was not the owner of the property at risk, and had no relation to it, but as an insurer under the original policy it had an insurable interest in it and could enter into any proper contract for the protection of that interest. 65. Merkin, “Incorporation of Terms Into Reinsurance Agreements”, 61; Butler and Merkin, Reinsurance Law, para. A-0303. 66. [2009] 2 Lloyd’s Rep 508, 518. 67. [1989] 1 Lloyd’s Rep 331, 337. 68. Pollack, M, “The Reinsurance Contract” in Reinsurance Contract Wording, 3rd edn, R.W.Strain (ed) 1998, 23. 69. 62 Mo 289, 1876. 70. 205 F.Supp. 2d 1069, (D.Minn., Jan 08, 2001). 71. 68 F. 698, CA 5 June 17, 1895. 72. Jackson v St Paul Fire & Marine Ins Co 99 NY 124, NY 1885. 73. 14 NE 632, Mass. Jan 03, 1888.

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2.61 In one of the earliest US cases on reinsurance, in Philadelphia Ins Co v Washington Ins Co,74 the Supreme Court of Pennsylvania discussed the insurable interest of the reinsured in a context where the original insurance was a time policy and the reinsurance was on a specific voyage. On 15 August 1848 the Washington Insurance Company issued the original insurance on the brig Delaware. The insurance was in the sum of $3,000, on the basis of “lost or not lost” and “at and from 6 June 1848, at noon, for five calendar months, with use of the Globe (Tampico and ports in Texas at all seasons excepted); and if at sea at the expiration of the time, the risk to continue at same rate of premium.” On the same day the Philadelphia Mutual Insurance Company reinsured the risk for $1,500 “at and from Rio de Janeiro to Havana, and at and from thence to Philadelphia.” 2.62 Claims were made as the result of casualties on 30 August on the Delaware’s voyage to Havana and between 9 and 27 January on her voyage from Havana to Philadelphia. 2.63 The reinsurer argued that, because of the difference in the nature of the reinsurance and original insurance policies, the reinsured did not have insurable interest to support the reinsurance policy. 2.64 The court ascertained that the Delaware was at sea on her voyage to Havana at the date of these policies, having sailed from Rio on 15 July 1848. The insurer was bound in respect of any voyage that the Delaware might make or commence within five months from the date indicated, whereas the reinsurers were bound only for the one voyage which was partly performed when they reinsured the risk. That voyage was capable of being finished far short of the five months. The original insurance clearly provided wider coverage than that under the reinsurance policy. If the definition of reinsurance – as the Supreme Court of Pennsylvania affirmed – was “a contract by which, in consideration of a certain premium, the original insurer throws upon another the risk or part of it for which he has made himself responsible to the original assured, to whom, however, he alone remains liable on the original insurance”, the phrase “the risk or part of it” in the definition implied that the insurance and reinsurance agreements had the same subject matter. If the insurance be against perils of the sea, the reinsurance must be against perils of the sea; but whilst it may not be against more, it may be against fewer perils of the sea than the original insurance. The court ruled that the original insurer had no insurable interest in the subject matter insured as such, but he obtained an insurable interest by having rendered himself directly liable to loss from certain perils which might entitle him to be indemnified against these perils. It was obvious in this case that the greater included the lesser and the insurer had an insurable interest in every portion of the risk insured, “which by reinsurance he throw on another.” Co-insurance/Double Insurance 2.65 It has been submitted that reinsurance should be distinguished from double insurance and co-insurance.75 Double insurance arises where the assured takes out more than one policy on the same subject matter, risk and interest.76 Co-insurance arises where there are two or more subscribing insurers to the contract.77 If it is correct to say that reinsurance is a further insurance on the original subject matter, it becomes possible to argue that reinsurance is a form of co-insurance, because both the reinsurer and the reinsured are insuring the same risk. 74. 23 Pa. 250, Pa. 1854. 75. Lowry J/Rawlings, P, Insurance Law: Doctrines and Principles, 2nd edn, Hart Publishing 2005, 390. 76. Colinvaux & Merkin’s Insurance Contract Law (looseleaf) London: Sweet & Maxwell, para. C-0630. 77. The term co-insurance is also commonly used to refer to the situation in which there are two or more assureds insured for their respective rights and interests under a single policy. See Colinvaux & Merkin’s Insurance Contract Law, para. A-600. The term is not used in that sense here.

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However, the assured has no contract with the reinsurer, so the co-insurance argument cannot stand. For the same reason, reinsurance cannot be regarded as double insurance, because the assured cannot be said to have taken out two policies on the same risk: it is simply the case that there are two policies on the same risk, but with different policyholders. 2.66 Particularly in the London Market, risks which cannot be insured directly by reason of local regulatory requirements are brought to the market via fronting arrangements where the local insurer acts as a front by underwriting the risk and reinsuring most or all of it with reinsurers.78 If reinsurance is a further insurance, it is possible to argue that reinsurance should be classified as co-insurance where the reinsured cedes most of the risk or double insurance where it cedes the whole of the risk insured.79 Admittedly, the view that reinsurance is a further insurance assumes that the relevant interest is the reinsured’s interest in the subject-matter insured and this seems to be a feature which distinguishes insurance from reinsurance, but in fact the risk is the reinsured’s financial loss for its undertaking against the assured. Essentially it is only the assured who possesses an insurable interest in the subject matter insured by the original contract of insurance. Another distinguishing feature is that in the context of reinsurance, the insurer handles and is responsible for settling original incoming claims which it then seeks to pass on to his own reinsurer, whereas in co-insurance there is mutuality of interest between insurers.80 In addition to that, lack of privity of contract distinguishes reinsurance from double insurance.81 2.67 Similarly, in the United States it is submitted that reinsurance is not co-insurance, where separate insurers share the same insured risk, nor is it a substitution of one insurer for another.82 Nor it is a partnership between the reinsured and the reinsurer or a separate joint venture between them.83 The “Further Insurance” View 2.68 In the early development of reinsurance, a contract of reinsurance was defined as “a new assurance effected by a new policy on the same risk which was before insured in order to indemnify the underwriters from their previous subscriptions.”84 This analysis has been adopted by subsequent authorities: In British Dominions General Insurance Company v Duder 85 Buckley LJ expressed his view that a reinsurance contract insured the subject matter of the original insurance.86 Later cases have expressly denied that a contract of reinsurance is

78. Merkin, Colinvaux’s Law of Insurance, para. 17-01. 79. It should be pointed out that in Switzerland fronting arrangements are made by means of co-insurance where only the leading co-insurer (licensed in Switzerland) is named in the contract with the direct assured. While the coinsurers share the risk according to their proportion, only the leading co-insurer assumes the risk in full and the direct policyholder has no claim against the other co-insurers. This relationship is regarded as reinsurance. See Merkin, What is Reinsurance? 77. However this is not the form that the London market applies. 80. Roar Marine Ltd v Bimeh Iran Insurance Co [1998] 1 Lloyd’s Rep 423. 81. Legh-Jones, N/Birds J/Owen D, MacGillivray on Insurance Law, Sweet & Maxwell, 11th edn 2008, para. 33-2. 82. Arrow Trucking Co v Continental Ins Co, 465 So.2d 691 (La. 1 Apr 1985) New Appleman Guide, 40.01. 83. New Appleman Guide, 40.01. Cf Inland Mut. Ins Co v Peerless Ins Co 152 F.Supp 506 (S.D.W.Va. Jun 26, 1957), aff’d, 251 F.2d 696, (4th Cir. (WVa) Jan 06, 1958). 84. Mansfield CJ in Delver v Barnes (1807) 1 Taunt 48, 51. 85. [1915] 2 KB 394, 400. See also Mackenzie v Whitworth (1874–75) LR 10 Ex 142; Uzielli & Co v The Boston Marine Insurance (1884) 15 QBD 11; Nelson v Empress Assurance Corporation [1905] 2 KB 281, 285; Forsikringsaktieselskabet National (of Copenhagen) v Attorney-General [1925] AC 639, 642 (here the reinsurance contract was a treaty rather than facultative); CGU International Insurance v AstraZeneca Insurance Co [2006] Lloyd’s Rep IR 409; Simon J in Wasa International Insurance Co Ltd v Lexington Insurance Co [2007] Lloyd’s Rep IR 604. 86. However, in the same case, Bankes LJ stated that as between the reinsurers and the reinsured the value of the subject-matter of the insurance was agreed, and the former had contracted to reinsure a certain proportion of the latter’s liability in respect of that agreed value [1915] 2 KB 394, 411.

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one of liability insurance.87 In CNA International Reinsurance Co Ltd & Ors v Companhia de Seguros Tranquilidade SA,88 where the reinsured affected a policy against the cancellation of a series of concerts by Placido Domingo, Clarke J held that the subject matter of the reinsurance was not the liability of the original insurer to the assured, but rather the non-appearance of the performer. 2.69 In Wasa International Insurance Co Ltd v Lexington Insurance Co,89 Simon J held at first instance that the subject matter of a reinsurance covering the insurance of property belonging to the original assured, Alcoa, was that property; it was not a reinsurance of Lexington’s liability to Alcoa under the insurance contract.90 In the Court of Appeal, Sedley LJ91 adopted the contrary view, but the House of Lords92 reaffirmed Simon J’s ruling. Referring to British Dominions General Insurance CoLtd v Duder93 Lord Philips94 accepted as a well established principle that “ . . .under English law a contract of reinsurance in relation to property is a contract under which the reinsurers insure the property that is the subject of the primary insurance; it is not simply a contract under which the reinsurers agree to indemnify the insurers in relation to any liability that they may incur under the primary insurance.” Lord Mance expressed the same view:95 a reinsurance such as the present is an independent contract, under which the subject matter reinsured is the original subject matter. 2.70 However, because of the principles applicable to reinsurance contracts as explained in the preceding paragraphs, it is submitted that reinsurance is not a further insurance on the subject matter insured because the further insurance view cannot be reconciled with the principles of privity of contract and insurable interest, and how reinsurance could be distinguished from co-insurance or double insurance. In fact the “privity of contract” contradiction was recognised in Forsikringsaktieselskabet National v Attorney-General96 where Viscount Cave LC pointed out that “ . . . the reinsurer does not become directly liable to the original householder who insures against fire, but it does undertake with the ceding office to take over a part of its liability under those policies.” However if reinsurance is a further insurance, it is arguably the assured who could make a claim against the reinsurer for any loss resulting from the occurrence of the insured peril.97 It is also noteworthy that Viscount Cave LC’s comment that “the reinsurer undertakes with the ceding office to take over a part of its liability under those policies” clearly indicates that reinsurance is in essence a liability insurance. The “Liability” View 2.71 Until the House of Lords’ decision in Wasa International Insurance Co Ltd v Lexington Insurance Co,98 despite the weight of authority supporting the proposition that reinsurance is a further insurance on the subject matter insured, there were important suggestions that reinsurance is indeed a contract by the reinsurer to indemnify the reinsured against liability under

87. Toomey v Eagle Star Insurance, per Hobhouse LJ, [1994] 1 Lloyd’s Rep 516, 522. 88. [1999] Lloyd’s Rep IR 289. See also Aegis Electrical and Gas International Services Co Ltd v Continental Casualty Co [2008] Lloyd’s Rep IR 17. 89. [2007] Lloyd’s Rep IR 604. 90. [2007] Lloyd’s Rep IR 604, 613. 91. [2008] Lloyd’s Rep IR 510, para. 49. 92. [2009] 2 Lloyd’s Rep 508. 93. [1915] 2 KB 394, 400. 94. [2009] 2 Lloyd’s Rep 508, 511. 95. Ibid., at 518. 96. [1925] AC 639, 642. 97. Golding, 7. 98. [2009] 2 Lloyd’s Rep 508.

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the original insurance policy.99 For example, in DR Insurance Co v Seguros America Banamex100 Adrian Hamilton QC rejected the idea that reinsurance is a further insurance on the subject matter insured.101 Further, in Home Insurance Company of New York v VictoriaMontreal Fire Insurance Company,102 in explaining the inapplicability of a direct insurance notice term to the reinsurance contract, Lord Macnaghten defined reinsurance as a contract which “against the liability or a portion of the liability undertaken by the original insurer or the insurer covering the original insurer’s direct liability.”103 In Wasa International Insurance Co Ltd v Lexington Insurance Co,104 the Court of Appeal adopted the same view.105 The House of Lords did not agree with the Court of Appeal; however, it is submitted that the Court of Appeal’s view is preferable. 2.72 First of all, it should be remembered that the earlier authorities, such as Delver v Barnes106 were decided at a time when reinsurance contracts were effected by a further insurance on the same subject matter as that of the previous policy and where the parties manipulated the word used to bring that about, (eg “insured” became “re-insured”). Such practice led to the understanding that reinsurance was formed as a further insurance on the subject matter insured.107 Obviously this is not the current practice of the London Market.108 In Delver v Barnes the policy was in question was a marine policy (insurance on the goods on the ship “Ann”) and marine reinsurance was banned by the Marine Insurance Act 1745 section 4109 to prevent gaming and wagering.110 Therefore, as it was defined by the defendants’ council in Delver v Barnes,111 at that time, reinsurance was a contract “where a person receives a high premium for his subscription, and assures again at a lower premium. It is where two policies are effected on the same risk.” 2.73 Secondly, liability insurance is defined as a contract of indemnity which covers the risk of the assured incurring liability to third parties.112 Because such an agreement is a contract of indemnity, the assured cannot recover until loss is sustained and his liability for that loss has

99. Lord Templeman in Forsikringsaktieselskapet Vesta v Butcher [1989] 1 Lloyd’s Rep 331, 334; Western Assurance Company of Toronto v Poole [1903] 1 KB 376, 386; South British Fire and Marine Insurance Co v Da Costa [1906] 1 KB 456; English Insurance Co v National Benefit Assurance Co [1929] AC 114; Merkin, “Incorporation of Terms”, 64; Carter, Reinsurance, 115; Golding, 13. 100. [1993] 1 Lloyd’s Rep 120, 129. 101. See also Fireman’s Fund Insurance Co v Western Australian Insurance Co (1927) 28 Ll L Rep 243, 251. 102. [1907] AC 59, 63. 103. See also Waller J in Municipal Mutual Insurance Ltd v Sea Insurance Co Ltd [1996] CLC 1515 (a point not appealed to the Court of Appeal). 104. [2008] Lloyd’s Rep IR 510. 105. Longmore LJ noted that in accepting either view the result would be the same [2008] Lloyd’s Rep IR 510, 521 but Sedley LJ expressed the view that the purpose of reinsurance was to cover the primary insurer against an agreed proportion of the loss it may incur under its own policy, at 523. 106. (1807) 1 Taunt 48. 107. Sedley LJ’s comment in Wasa International Insurance Co Ltd v Lexington Insurance Co [2008] Lloyd’s Rep IR 510, 522–523. 108. Moreover, Mansfield CJ’s definition in Delver v Barnes implies that the primary insurance is in force before the reinsurance is placed. This is true but it is also often the case in the London Market that the facultative reinsurance policy is subscribed before the underlying insurance has been concluded, (eg Vesta v Butcher) and this indicates that Mansfield CJ’s definition in Delver v Barnes does not meet the modern practice of reinsurance. MacGillivray on Insurance Law, para. 33-3. 109. 19 Geo. 2 c. 37. 110. The ban remained in force until the Revenue (No 2) Act of 1864 which provided that marine reinsurance was lawful, subject to a provision for stamp duty, and the Stamp Act of 1867 repealed the relevant section of the 1745 Act, including “reinsurance” in the expression “sea insurance.” See MacGillivray on Insurance Law, para. 33-6. 111. (1807) 1 Taunt 48, 49. 112. See Fletcher Moulton LJ in British Cash and Parcel Conveyors v Lamson Store Service [1908] 1 KB 1006, 1014; Goddard & Smith v Frew [1939] 4 All ER 358.

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been established and quantified.113 In the same way, it is clear law that in order to make a claim against the reinsurer, the reinsured has to establish and quantify his liability, either by virtue of a judgment or arbitration award against him or a settlement binding on the reinsurer.114 In other words, the reinsured has no cause of action against the reinsurer until his liability to the assured has been ascertained.115 Moreover – as is also explained in the following paragraphs – there is a strong presumption that the risks covered by insurance and facultative proportional reinsurance are likely to be identical as the two policies are generally to be construed back-to-back. This assumption is based on the notion that the reinsured cedes the whole or part of the risk insured to the reinsurer in return for a proportionate part of the premium. The reinsured chooses this method with the object of reducing the amount of its possible loss.116 If reinsurance is a further insurance, in fact, there may be no reason for assuming that the provisions of the two contracts are identical. Furthermore, as is the case with contracts of liability insurance, facultative reinsurance policies may also contain claims cooperation clauses whereby the reinsured undertakes not to admit liability or to settle a claim without first obtaining the reinsurer’s consent. It appears that the only reason for the reinsurer to be concerned about the direct loss is that it will establish his liability. On this analysis it becomes clear that facultative reinsurance contracts cover the liability of the reinsured against its undertaking in the original policy.117 However, this conclusion should not be taken to mean that reinsurance is a form of general liability insurance in favour of the reinsured. That might be possible if the reinsurer was obliged to pay for the reinsured’s extracontractual liability, as where the reinsured has been held liable to pay a sum to the original assured in excess of its contractual obligation to the assured in tort or for breach of contract.118 The reinsurer is under the duty to provide indemnity to the reinsured only within the limits of the reinsured’s contractual liability under the original policy.119 2.74 In Wasa International Insurance Co Ltd v Lexington Insurance Co, Lord Mance120 stated: “Reinsurance slips are underwritten identifying the subject matter insured (here, against the headings “INTEREST” and “SITUATED”) as the original insured’s property, rather than the insurer’s exposure or liability under the original insurance.” That was indeed how the reinsurance slip was worded, but “Interest” and “Situated” in fact defined the risk under the original insurance policy which duly formed the basis of the reinsurance; the purpose of “interest” and “situated” clauses was not to define the subject matter of the reinsurance. Lord Mance’s opinion is supportable insofar as the interest clause relates to the reinsurance itself. However, that was not obviously the case in Wasa, and all the other terms of the reinsurance contract and the surrounding circumstances indicated that the parties intended to achieve back-to-back cover. Plainly there can be reinsurance policies121 where the 113. West Wake Price & Co v Ching [1956] 2 Lloyd’s Rep 618; Post Office v Norwich Union Fire Insurance Society [1967] 2 QB 363; Socony Mobil Oil Co Inc v West of England Shipowners Mutual Insurance Association Ltd, The Padre Island (No. 2) [1987] 2 Lloyd’s Rep 529; Bradley v Eagle Star Insurance Co [1989] 1 AC 597; Cox v Bankside Members Agency Ltd [1995] 2 Lloyd’s Rep 437. 114. Insurance Co of Africa v Scor (UK) Reinsurance Co Ltd [1985] 1 Lloyd’s Rep 312; Fireman’s Fund Insurance Co v Western Australian Insurance Co Ltd (1927) 28 Ll L Rep 243. 115. Per Maugham LJ in Versicherungs und Transport A/G Daugava v Henderson (1934) 49 Ll L Rep 252, 254; Home Insurance Company of New York v Victoria-Montreal Fire Insurance Company [1907] AC 59. 116. Golding, 17. 117. See Sedley LJ in Wasa International Insurance Co Ltd v Lexington Insurance Co [2008] Lloyd’s Rep IR 510, 523; Merkin, “Incorporation of Terms into Reinsurance Agreements”, 66; Carter, 4. 118. See Ott v All-Star Ins Corp 99 Wis.2d 635, (Wis Jan 06, 1981) discussed in Chapter 7 below. 119. See Butler and Merkin, Reinsurance Law, para. C-0137. 120. [2009] 2 Lloyd’s Rep 508, 518. 121. For instance in GE Reinsurance Corporation v New Hampshire Insurance Co [2004] Lloyd’s Rep IR 404 the interest clause of the reinsurance policy was stated: “To indemnify the Reinsured in respect of their obligations under original policy no MCC 1018.”

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interest clause is worded either as covering the reinsured’s liability or as covering the original subject matter, and there are cases such as Feasey, where the latter was adopted and in which it was held – to give effect to that intention – that the reinsurer had an insurable interest on the lives of the employees’ of the assured shipowner. Thus it appears that there is no an absolute rule, but rather a default position which the parties can accept or contract out of at their option. If it is right that the parties are free to agree on the nature of reinsurance, it is necessary to examine the contract as a whole and not just the interest clause. That point is clearly made by Charter Reinsurance Company Limited v Fagan122 where the House of Lords looked to the entirety of the reinsurance in order to conclude that the words “and shall actually have paid” referred to the establishment of liability rather than actual payment. Applying the same analysis to Wasa, the “Interest Clause” should, it is submitted, have been construed as doing no more than identifying the reinsured’s liability which was to form the basis of the reinsurance cover sought. 2.75 Furthermore, it is necessary to point out that in terms of calculating the limitation period in liability insurance, the date of the assured’s loss is the date at which his liability to the third party is established and quantified.123 If reinsurance is further insurance of the original subject matter, both the statutory limitation period and any contractual notice period should run from the same date for both the assured and the reinsured. Nevertheless, as was emphasised in Dornoch Ltd v Royal and Sun Alliance plc.,124 notification clauses are not suitable for use in liability insurance because such clauses assume that there has been actual physical loss whereas in the liability insurance and reinsurance contexts there is no loss until liability has been established and quantified. In Home Insurance Co of New York v Victoria Montreal Fire Insurance Co,125 the Privy Council also stated that the reinsurer could not act until the direct loss was ascertained between parties over whom he had no control, and in proceedings in which he could not intervene. This analysis also strengthens the argument that the reinsurer insures the insurer’s liability.126 In Home Insurance the insured property was damaged by fire, the reinsured127 indemnified the assured 11 months after the loss occurred following a lengthy negotiation. The reinsurers paid it proportionally in month 13 after the fire occurred and the retrocessionaire denied liability by relying on a clause in the original policy under which a claim was to be regarded as time-barred unless brought within 12 months of the occurrence of the risk: the retrocessionaire alleged that the clause was incorporated in to the retrocession. The Privy Council held that the clause was not applicable within the context of retrocession: the clause is reasonable in an original insurance because the assured is the master of the situation and can bring an action immediately. However the reinsurer has to wait until the issue between the assured and the insurer is resolved (ie until the reinsurer’s liability is established). Lord Macnaghten stated: “In a case of re-insurance against liability the insured

122. [1997] AC 313. 123. Sphere Drake Insurance plc v Basler Versicherungs-Gesellschaft [1998] Lloyd’s Rep IR 35; Halvanon Insurance Co Ltd v Companhia de Seguros do Estado de So Paulo [1995] LRLR 303; Baker v Black Sea and Baltic General Insurance Co Ltd [1995] LRLR 261 (the point did not arise in the appeal). The same principle applies to excess of loss reinsurance, in that the date that the excess point is reached triggers the reinsurers’ liability to the reinsured: North Atlantic Insurance Co Ltd v Bishopsgate Insurance Ltd [1998] 1 Lloyd’s Rep 459, 462. However see Feasey v Sun Life of Canada [2003] Lloyd’s Rep IR 637 where the test was varied by express wording that the reinsurer’s duty to provide indemnity arose on the happening of a given event. 124. [2005] Lloyd’s Rep IR 544. 125. [1907] AC 59. 126. See Edelman, C/Burns A/Craig D/Nawbatt A, The Law of Reinsurance, Oxford University Press 2005, para. 4.71. 127. Strictly speaking, this was a retrocession.

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is helpless. He cannot move until the direct loss is ascertained between parties over whom he has no control, and in proceedings in which he cannot intervene. If the respondents are right an honest claim might be defeated in such a case as this without any default or delay on the part of the insured owing to unavoidable difficulties or complications, or possibly in consequence of some dilatory proceeding prompted by the very person in whose favour time is running.” Lord Macnaghten’s comment is consistent with the view that the reinsurer insures the liability of the reinsured under the direct insurance contract. If reinsurance is a further insurance on the subject matter insured, it is not obvious what the reinsurers’ position would be in a case such as that of the question in Home Insurance Co of New York v Victoria Montreal Fire Insurance Co.128 2.76 An example of a further insurance policy can be seen in Rhine and Wurtemberg Insurance Association v Sedgwick.129 A further insurance in Sedgwick was taken out four months after the first policy had been written. The first insurance policy was drafted to provide coverage from 20 February 1896 until 20 February 1897 and the further policy was written for the period from 20 June 1896 until 20 June 1897. The parties were again the same assured as the first policy and the same insurer, the policy was on the same subject matter insured, the ship Collynie, against the same risk, sea perils. Presumably it is likely that the premium of the second insurance policy was assessed between the assured and the insurer separately from the first policy. The amount insured was £350 in the first policy and £850 in the further policy. 2.77 Proportional facultative reinsurance policies are for the most part written so as to provide coverage for the same period as the original insurance; the financial limits of the reinsurance policy are assessed based on the original policy, as the reinsurer shares the risk with the reinsured: in some cases the reinsurers take over 1% of the risk, in some other cases the percentage can reach 100. It is also usually the case that the original insurance and reinsurance coverage start and end at the same time. Moreover, by way of distinction from the further insurance example above, there is no privity between the assured and the reinsurers, the reinsurance policy is a contract between the reinsured and the reinsurer. Furthermore, the premium that the reinsured charges the assured under the original insurance forms, in proportionate terms, the amount of the premium of the reinsurance contract to the effect that the reinsurer and the reinsured share the premium – subject to a deduction that he reinsured is entitled to receive to cover its expenses for taking out the original insurance.130 It is submitted that all of these differences between a typical proportional facultative reinsurance policy and a further insurance policy weaken the argument that reinsurance is a further insurance on the subject matter insured. 2.78 Another matter that needs to be considered is that if reinsurance is a further insurance and if the original policy is cancelled, will the reinsurers still provide coverage to the reinsured? If reinsurance is further insurance on the subject matter insured, the reinsurer is expected to provide coverage unless it is also cancelled. However if reinsurer insures liability of the reinsured the reinsurance policy does not need to be cancelled because the reinsurer would not be liable unless the reinsured’s liability is established. 2.79 Nevertheless, the decision of the House of Lords in Wasa v Lexington adopts a contrary view on almost every point suggested in this chapter. Before analysing the House of Lords’ decision on Wasa together with the principles that have been mentioned up to now, it is useful to explain the principle of the presumption of back-to-back cover in proportional

128. [1907] AC 59. 129. [1899] 1 QB 179. 130. Generally referred to as ceding commission.

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facultative reinsurance contracts. The cases that applied the principle of the back-to-back presumption were also considered by both the Court of Appeal and the House of Lords in Wasa v Lexington. Therefore it is necessary to explain the principles adopted in those cases in order to make the discussion on issues and the decision in Wasa clearer. 2.80 Lord Griffiths said in Forsikringsaktieselskapet Vesta v Butcher131 that the two contracts are dealing with entirely different subject matter. The original policy is concerned to define the risk that the insurer is prepared to accept. The contract of reinsurance is concerned with the degree of that risk as defined in the policy that the reinsurer is prepared to accept. 2.81 It is worth noting that unlike the position in England, the nature of reinsurance has not created controversial issues to date in the US. For example, in Unigard Sec Ins Co Inc v North River Ins Co132 the US Court of Appeals for the Second Circuit stated that: “Reinsurance occurs when one insurer (‘the ceding insurer’ or ‘reinsured’) ‘cedes’ all or part of the risk it underwrites, pursuant to a policy or group of policies, to another insurer.” The court also stated that spreading the risk through the operation of reinsurance aims to prevent a catastrophic loss from falling upon one insurer. Similarly, in Constitution Reinsurance Corp v Stonewall Ins Co,133 the District Court for the South District of New York stated: “The reinsurer indemnifies the ceding insurer for any liability incurred that is covered by the reinsurance.”

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Scope of the Principle 2.82 Under a facultative reinsurance contract, since the reinsurer takes a proportion or all of the risk that the direct insurer has insured, it is to be presumed that in the absence of clear words to the contrary the risks covered by the two contracts are consistent.134 This naturally leads to the result that if the reinsurance and original insurance contain identical terms, for instance where the reinsurance slip contains the clause of “as original” and there are no exclusion clauses which differ from the insurance contract, where the reinsured’s liability is established under the original insurance, it follows naturally that reinsurer’s liability is also established in that the construction of the terms of the original insurance is binding on the

131. [1989] 1 Lloyd’s Rep 331, 337. 132. 4 F.3d 1049 (2nd Cir. (NY) Sep 09, 1993). See also Christiania General Ins Corp of New York v Great American Ins Co 979 F.2d 268, (2nd Cir. (NY) Sep 3, 1992). In Central Nat Ins Co of Omaha v Prudential Reinsurance Co 241 Cal Rptr 773, (Cal. App. 2 Dist. Nov 19, 1987) the California Court of Appeal Second District Court defined reinsurance as a contract whereby one insurer for a consideration contracts with another to indemnify it against a loss by reason of a risk which the latter has assumed under a separate and distinct contract as the insurer of a third party. But it should be noted that the Supreme Court ordered that the opinion be not officially published. 133. 980 F.Supp. 124, (SDNY, Sep 17, 1997). 134. American International Marine Agency of New York Inc v Dandridge [2005] Lloyd’s Rep IR 643; Toomey v Banco Vitalicio De Espana SA de Seguros [2004] Lloyd’s Rep IR 354; HIH Casualty and General Insurance Ltd v New Hampshire Insurance Co [2001] 2 Lloyd’s Rep 161; Mann v Lexington Insurance Co [2001] Lloyd’s Rep IR 179; Reliance Marine Insurance v Duder [1913] 1 KB 265; Citadel Insurance Co v Atlantic Union Insurance Co SA [1982] 2 Lloyd’s Rep 543. The presumption may be inapposite if the risk as presented to reinsurers differs materially from the risk as assumed by the reinsured: Gan Insurance v Tai Ping Insurance (No 1) [1999] Lloyd’s Rep IR 472. Cover is not presumed to be back-to-back in non-proportional reinsurance contracts: AXA Reinsurance (U.K.) Plc. v Field [1996] 2 Lloyd’s Rep 233; American Centennial Insurance Company v Insco Limited [1996] LRLR 407; Municipal Mutual Ins Ltd v Sea Ins Co Ltd [1996] CLC 1515; Goshawk Syndicate Management Ltd v XL Speciality Insurance Co [2004] Lloyd’s Rep IR 683. The existence of such a presumption was doubted and of a very small compass if it exists at all: Weir, 214.

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reinsurer. This may nevertheless be problematic where the original insurance and the reinsurance contracts are governed by different applicable laws. This is not uncommon in reinsurance contracts where local insurers from various countries outside UK take out reinsurance policies in the London Market the policies of which usually are expressly governed by English law whereas the relevant local law will be applicable to the original insurance contracts. Under English law, the construction of the wording of a contract is a matter for its applicable law. Difficulties arise where the two laws provide different meanings for the same words. Vesta v Butcher 2.83 Forsikringsaktieselskapet Vesta v Butcher135 is a case where the original insurance was governed by Norwegian law and the reinsurance contract was subject to English law. It was common ground136 that the insurance and reinsurance policies incorporated a warranty under which a 24-hour watch was to be kept on a fish farm. The warranty was broken by the assured and the issue was whether the insurance and reinsurance warranty to be construed the same way to the effect that the insurance and reinsurance contracts provide identical cover and therefore the reinsured’s liability establishes the reinsurer’s liability. 2.84 In this case a Norwegian insurance company, Vesta, insured a fish farm against loss of living fish from any cause whatsoever and reinsured 90% of its liability under the policy. The reinsurance was placed before the insurance but no importance was attached to the fact that the reinsurance antedated the insurance.137 The contracts of insurance and reinsurance each expressly incorporated identical wording, known as “Aquacultural Wording No V” which contained a warranty that a 24-hour watch would be kept over the site and also the following statement: Failure to comply with any of the warranties outlined hereunder will render this policy null and void. All warranties to be completed at the assured’s expense. 2.85 Having obtained the signatures of the leading underwriters (reinsurance) on the slip, the brokers sent to Vesta a letter enclosing a cover note. In their letter the brokers noted: “We would ask that the assured reads his policy wording carefully in order that there are no misunderstandings.” Having received the cover note, Vesta issued its policy to the assured, with a request to read through the terms and stressing their importance. Mr P, the “alter ego” of the insured, on reading the 24-hour watch clause, informed the local branch of Vesta by telephone that he could not comply with it. Mr. K of Vesta then passed this information to the brokers, but nothing more happened. 2.86 The contract of reinsurance was contained in a slip which incorporated form J1: TYPE Livestock Reinsurance. FORM J.1. ASSURED R/1 Forsikringsaktieselskapet Vesta a/c Fjordlaks, Tafjord A/S. [Then it states the period covered.] INTEREST Rainbow trout and salmon only, the property of Fjordlaks Tafjord A/S only as more fully set forth in the original policy. [Then it gives the sum insured as 90.] CONDITIONS Being a reinsurance of Forsikringsaktieselskapet Vesta who retain 10%. of Full R.I. Clause. PREMIUM [The Kroner deposit premium is stated.] BRKGE 25%. INFN Original policy of Forsikringsaktieselskapet Vesta as attached hereto.

135. [1989] 1 Lloyd’s Rep 331. 136. A contentious concession. 137. Lord Griffiths [1989] 1 Lloyd’s Rep 331, 335.

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2.87 Form J1 provided: “Being a reinsurance of and warranted same gross rate, terms and conditions as and to follow the settlements of the company and that the company retains during the currency of this policy at least the amount stated in the schedule as the retention on the identical subject matter and risk and in identically the same proportion on each separate part thereof but, in the event of the retention being less than that stated in the schedule, the underwriters’ lines to be proportionately reduced.” 2.88 The fish warm was destroyed by a storm and it was common ground that the assured did not keep the 24-hour watch. Under English law a breach of warranty discharges the underwriter from liability regardless of whether or not there is a causal link between the breach and the loss. Under Norwegian law, however, such a causal link is required. The damage to the fish farm would have occurred with or without the maintenance of a watch, and accordingly there was liability under Norwegian law. Consequently, Vesta settled the claim. However, the reinsurers refused reimbursement on the ground that the reinsurance contract was governed by English law and the breach of warranty relieved them from liability even if there was no causal link between the loss and the breach. At first instance, Hobhouse J held that the parties’ intention was that the warranty in the reinsurance contract was to be governed by Norwegian law as the reinsurance policy incorporated the terms of the original insurance.138 More interestingly, he noted that if he had not concluded that, he would have held that both contracts were governed by Norwegian law. The Court of Appeal upheld the former approach, although the judge’s fallback ground was described as “quite unrealistic” by the Court of Appeal and it was ruled on appeal that two contracts were clearly governed by different laws,139 but that Norwegian law should apply to the construction of the reinsurance. 2.89 The House of Lords approached the issue from the presumption of back-to-back cover. Lord Templeman,140 emphasising the clause of the J1 form (as original), stressed that this clause indicated that the two policies were on identical terms, that the risks of the reinsurers and Vesta were identical and that a claim settled under the insurance policy would be a claim payable under the reinsurance policy. Moreover, in the ordinary course of business facultative proportional reinsurance was referred to as “back-to-back” with the insurance, in that the reinsurer agrees that if the insurer is liable under the policy the reinsurer will accept liability to pay whatever percentage of the claim he has agreed to reinsure;141 in other words the reinsurance policy was a contract by the underwriters to indemnify Vesta against liability under the insurance policy. Their Lordships142 concluded that in the absence of any express declaration to the contrary in the reinsurance policy, a warranty must produce the same effect in each policy. Lord Templeman reserved his opinion on the possibility that the reinsurance policy could have provided expressly that the warranties were to have different effects in the two policies or the reinsurance policy could have limited the liability of the underwriters by providing that a breach of warranty by Vesta would absolve the underwriters even if an identical breach of warranty by the fish farmer did not absolve Vesta. However, according to their Lordships any such limitation would be wholly exceptional and would be a departure from the normal understanding of the back-to-back nature of reinsurance: therefore it would be required to be spelt out in clear terms. Lord Templeman,143 however, doubted whether there was any market for such reinsurance. 138. 139. 140. 141. 142. 143.

[1986] 2 All ER 488. [1988] 2 All ER 43. [1989] 1 Lloyd’s Rep 331, 334. Ibid., at 336. Ibid., at 334–335. Ibid., at 336.

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2.90 Lord Griffiths144 reached the same ultimate conclusion, but differed from the other members of the House of Lords145 on the question of the incorporating effect of the J1 form clause. According to Lord Griffiths146 the words “warranted same gross rate terms and conditions” constituted a warranty given by the reinsured that the insurance policy has been or will be written in those terms. 2.91 Lord Lowry147 concentrated on the incorporated clause in the Acquacultural wording, and in particular the word “failure” in the phrase “failure to comply”: According to Lord Lowry once the wording was incorporated from the original policy in the reinsurance contract it meant “relevant failure”, that is “causative failure” because the incorporated contract was governed by Norwegian law. Lord Lowry stated that the parties to the reinsurance contract were deemed to have used the same dictionary namely a Norwegian legal dictionary, to ascertain the meaning of the terms and conditions including the conditions relating to the 24-hour watch and the words “failure to comply.” 2.92 Consequently, the reinsurer was held to be liable: the reinsured was liable under Norwegian law; the reinsurance policy was “as original” and incorporated the original policy terms into the reinsurance contract; the reinsuring clause in J1 form confirmed that the two policies were providing identical cover; the insurance and reinsurance warranties were to be given the same meaning; that failure to comply with the warranty was to be construed as referring to “causative failure” in both the original insurance and the reinsurance; and there was a presumption of back-to-back cover as between the original insurance and the reinsurance. This means that where the reinsured’s liability is established, unless the reinsurance policy contains any limitation on that liability, the reinsurer’s liability is also presumed to be established by reason of the nature of facultative proportional reinsurance contracts. Groupama Navigation et Transports & Ors v Catatumbo Seguros 2.93 The Vesta decision has nothing to say about the effect of an express warranty in the reinsurance contract, although this may be considered as an indication contrary to the presumption of back-to-back cover, and the express warranty in the reinsurance agreement might be thought to be one which is to be given effect according to the law which governs that contract. Nevertheless, the Court of Appeal in Groupama148 confounded this analysis by deciding that even though there was an express warranty in the reinsurance contract, because of the assumption that the reinsurance cover was identical to the direct insurance, the reinsurance cover was to be construed so as to produce the same effect as the underlying warranty. In Groupama a fleet of vessels was insured against hull and machinery losses. The original policy provided a warranty, “Guarantee of maintenance of class. . . .” The reinsurance contract contained the clause “All terms clauses conditions warranties . . . as original and to follow all decisions settlements agreements of same in every respect . . . Warranted existing class maintained.” Two vessels were heavily damaged in a storm and after subsequent investigation it became apparent that the vessels had not been classed during the currency of the policy. The reinsured was liable despite the breach of warranty because, in much the same way as in Vesta, the underlying contract was governed by a foreign law – that of Venezuela – which required a causal link between the breach of warranty and the loss to discharge the insurer from liability. The reinsurers nevertheless argued that the reinsurance warranty was “free standing” and to be 144. 145. 146. 147. 148.

Ibid., at 336. As noted earlier, this point had been conceded and thus did not fall for decision. [1989] 1 Lloyd’s Rep 331, 337. Ibid., at 347. [2000] 2 Lloyd’s Rep 350.

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construed as discharging them from liability without regard to the construction of the original policy warranty, given that the contract was governed by English law. David Steel J and the Court of Appeal placed emphasis on the proportional nature of the reinsurance policy and the presumption of back-to-back cover. The Court of Appeal ultimately held that the presumption governed the case, because the terms of the original insurance were incorporated into the reinsurance by virtue of the “as original” clause. As a consequence of incorporation the Court of Appeal stated that there were two warranties in the reinsurance contract: one was incorporated from the direct policy; and the other was expressly set out in the reinsurance agreement itself. The two warranties were identical except for the fact that the classification society was named in the insurance. Tuckey LJ stated that if the parties intended the two warranties to be construed differently in the two contracts they should have said so. The court was of the opinion that the reinsurers were assumed to have accepted the risk of such interpretation by writing international business.149 Mance LJ emphasised that, had the two contracts contained warranties expressed in different and irreconcilable terms, or had the reinsurance contained a warranty which had no counterpart in the insurance, different considerations could have arisen as it would then have been clear that the two contracts were not and could not to that extent be treated as back-to-back.150 Consequently neither the difference between the applicable laws, nor express warranties of the reinsurance policy was enough to rebut the presumption of back-to-back cover. 2.94 However there are some cases where the presumption of back-to-back cover has been rebutted. These cases are explained below. Rebutting the Presumption 2.95 The presumption of back-to-back cover is simply a rule of construction.151 The presumption is relevant only where the parties are to be taken to have intended that outcome. If identical words are used in the two contracts then the presumption will operate, even though the two contracts are governed by different applicable laws.152 The same conclusion follows if the words are not identical but virtually indistinguishable.153 However, if the words used are quite different, and deliberately so, then the presumption may be rebutted. In Youell v Bland Welch & Co Ltd,154 Beldam LJ did not allow the presumption to be used to modify the meaning of a reinsurance term. In this case, the claimant insurers issued insurance against builders’ risks and other associated risks of three liquefied gas-carrying vessels while under construction in the US. The reinsurance policy, however, contained a clause that limited the scope of reinsurance namely that “The reinsured shall cede to the reinsurers and the reinsurers shall accept by way of reinsurance of the reinsured their proportion of the reinsured’s liability in respect of risks attaching for periods as original (up to but not exceeding 48 months) . . . in respect of vessels . . . whilst under construction . . . and until handed over to and accepted by . . . owners.” When the vessels became constructive total losses as a result of

149. Ibid., at 354. 150. Ibid., at 356. 151. GE Reinsurance Corporation v New Hampshire Insurance Co [2004] Lloyd’s Rep IR 404. In American International Marine Agency v Dandridge [2005] Lloyd’s Rep IR 643 para. 40, it was said that the incorporation issue was dependent on the parties’ intentions objectively ascertained from the surrounding circumstances. 152. But subject to the qualification that the House of Lords in Wasa International Insurance Co Ltd v Lexington Insurance Co [2009] 2 Lloyd’s Rep 508 ruled. See below para. 2.105 et. seq. 153. See the Court of Appeal in Wasa International Insurance Co Ltd v Lexington Insurance Co [2008] Lloyd’s Rep IR 510; but this was overturned by the House of Lords: [2009] 2 Lloyd’s Rep 508. 154. [1992] 2 Lloyd’s Rep 127.

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perils insured against, 48 months had expired after each vessel had come on risk but the original cover was still in force. The reinsureds alleged that the reinsurance cover was still in force because the reinsurance policy should be so construed that the cover provided was co-extensive with the cover contained in the primary policies. Beldam LJ noted that the presumption of back-to-back cover did not apply to this case as the reinsurers accepted the risk on special terms.155 2.96 Again, in Aegis Electrical and Gas International Services CoLtd v Continental Casualty Co156 the original insurance and reinsurance policies contained different definitions of “accident.” Clause 30 of the original policy defined an accident as meaning “a sudden and accidental breakdown of an object or a part thereof and resulting in physical damage that necessitates repair or replacement of the object or part thereof.” Additional clauses attached to the reinsurance policy defined accident as “a sudden and accidental breakdown of an Object or a part thereof, which manifests itself at the time of the occurrence by physical damage that necessitates repair or replacement of the Object or part thereof”, but excluding loss or damage resulting “from explosion other than explosion of the parts of steam boilers, steam turbines, steam engines, steam pipes interconnecting any of the foregoing or gas turbines.” The reinsurance also provided “To follow the terms, clauses, conditions, exceptions and settlements of the original policy wording as far as applicable hereto.” The reinsured argued that the follow the terms provision in the reinsurance slip favoured a match between the terms of the insurance slip and the reinsurance slip, and therefore any mismatch between them should be minimised. It was also argued that any ambiguity was to be resolved contra preferentem against the reinsurers both because they proposed the additional conditions for inclusion in the contract and because they sought to rely upon the exception in the “Additional Conditions.” Andrew Smith J emphasised that every case depended upon the proper construction of the particular reinsurance contract. He held that the reinsurance contract in this case was not back to back because the reinsurers reinsured only some of the risks that fell within the original cover and in that sense the insurance cover and the reinsurance cover were not back to back. Andrew Smith J described the Additional Clauses as modifying the extent of the reinsurance cover; he found no ambiguity in the effect of those Additional Clauses.157 2.97 Moreover, GE Reinsurance Corporation v New Hampshire Insurance Co158 makes it clear that an express warranty in the reinsurance policy can be assessed independently where the original policy does not contain any equivalent clause. In this case investors in a film distribution and production company, Destination, borrowed the sum of US$100 million. This amount had also been secured by the issue of notes to trustees acting for the noteholders. The noteholders approached the broker W to place insurance against the default of the borrower. New Hampshire and Axa insured the risk proportionally as co-insurers, then reinsurance also was taken out but the latter contained a warranty that: “Contracts of employment in respect of Steve Stabler as chief executive officer and Brent Baum as chief operating officer to be maintained for the duration of the policy.” This clause was called “The Stabler Wording” and was not contained in the direct insurance policies. The question was whether or not the reinsurance and insurance policies 155. Ibid., at 138–139. See also Abrahams v Mediterranean Insurance and Reinsurance Co Ltd [1991] 1 Lloyd’s Rep 216 where the Court of Appeal held that the term “subject to original conditions but against total and/or constructive total loss” did not create “all risks” cover. It was held that because the contract was an open cover, all hull covers could be ceded whatever their terms but if such terms were wider than total loss then only the total loss element was ceded. 156. [2008] Lloyd’s Rep IR 17. 157. In Aegis the two contracts were held not to be back-to-back, by reason of the clearly different wording used in the insurance and in the reinsurance, by way of contrast to the position in Insurance Co of Africa v Scor (UK) Reinsurance Co Ltd [1985] 1 Lloyd’s Rep 312. 158. [2004] Lloyd’s Rep IR 404.

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could be construed back-to-back, thereby depriving the Stabler Wording ineffective in the reinsurance in the absence of equivalent direct wording. Langley J, finding for reinsurers, distinguished Vesta as being no more than “an illustration of the general approach to construction which enables a court to resolve ambiguities of wording in a way which it is satisfied the parties objectively intended, in that case both insurance and reinsurance contained the same wording but the potential for inconsistency arose from the different systems of law to which the two policies were subject.” The judge found GE Reinsurance to be very different because the original insurance was wholly silent. Langley J held that neither the presumption of back-to-back cover nor the incorporation wording could be used to oust an express provision in the reinsurance contract if there was no clause in the original policy which regulated the same issue.159 The insurer argued that the Stabler Wording was simply a statement of the content of the Operating Agreement, or at most an obligation imposed upon Destination which should be classified as mere condition. Langley J did not agree and referring to Rix LJ in HIH Casualty and General Insurance v New Hampshire Insurance, held that the term satisfied all of the requirements for classification as a warranty, namely that: it went to the root of the transaction, as Mr Stabler was the key figure within Destination; it bore materially on the risk of loss; and its breach could not adequately be compensated by way of damages. As soon as Mr Stabler’s employment ceased, the risk under the reinsurance came to an end by reason of breach of warranty. 2.98 The case of Municipal Mutual Insurance Ltd v Sea Insurance Co Ltd 160 is also worth mentioning as a further illustration of the presumption of back-to-back cover being ruled inapplicable. In this case Municipal insured the Port of Sunderland for many years under a policy renewed for successive periods. These policies provided coverage for the liability of the Port Authority to third parties for “accidental loss of or damage caused to property not belonging to . . . the insured” which was “caused by negligence by [the insured] or their servants or employees.” A third party, Concorde, brought an action against the Port Authority, claiming damage to the machinery which occurred as a result of vandalism and a succession of individual acts of pilferage over a period of about 18 months carried out by a number of individuals or groups of individuals probably acting independently of one another. In this action Judge Stephenson held that the bulk of the damage occurred between March 1987 and September 1988 and the Port Authority was liable to Concorde. The insurer Municipal indemnified the assured. The defendant reinsurers reinsured Municipal under successive time contracts of 12 months’ duration. Municipal sought recovery from the reinsurers by treating the port’s claim against it as a single claim and by apportioning that claim onesixth, two-thirds and one-sixth between the reinsurance contracts for 1986–1987, 1987–1988 and 1988–1989, in line with the proportion to the lines the reinsurers had written. Waller J161 held that Municipal, having indemnified the port for the compensation paid to Concorde, was entitled to present a single claim to the reinsurers. The learned judge construed the original insurance and reinsurance back to back and held that Municipal was entitled to recover in relation to the 1987– 1988 year when loss and damage was held to have occurred. The judge allowed Municipal to amend to bring its whole claim within the 1987–1988 year, less the deductible of £500,000, and gave judgment for £2,659,401.56. The reinsurers appealed. 2.99 The Court of Appeal162 reversed Waller J’s decision by focusing on the different characters of the original insurance and reinsurance contracts: Each of the reinsuance policies was 159. It was also pointed out that there was no implied term in a reinsurance agreement that the reinsurers would not rely upon a defence not available to the reinsured. See also Dornoch Ltd v Mauritius Union Assurance Co Ltd [2006] Lloyd’s Rep IR 786. 160. [1998] CLC 957. 161. [1996] CLC 1515. 162. [1998] CLC 957.

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for a 12-month period and the percentage of the proportion of the reinsurers reinsured, the terms of the reinsurance contracts and the reinsurers were not always the same. By the original insurance contracts however, Municipal insured the Port of Sunderland in successive years subject to the payment of annual premiums renewing the cover. Because of the distinct independent nature of the reinsurance policies in question, the Court of Appeal found it to be incorrect to treat the insurance and reinsurance contracts as being back-to-back: the right approach would have been to see to what extent the reinsured had established that it was entitled to recover from the relevant reinsurer under each of the three contracts. According to the Court of Appeal, Waller J’s conclusion created the effect that the reinsurance might cover liability in respect of loss or damage which did not occur during the period of the reinsurance and that the same liability might be covered under the reinsurance for different periods. 2.100 In each of the reinsurance contracts, the cover was defined by reference to the year of cover whereas in the original policy the individual years of cover did not seem material to the parties. For example the various changes that the parties made to the terms of the cover were on occasions applied with effect from dates other than the anniversary date. The Court of Appeal found it wrong in principle to distort or disregard the terms of the reinsurance contracts to make them fit with what might have been a different position under the original cover. To recover the assured had to satisfy the court that there had been physical loss or damage which had occurred in the year covered by the relevant contract of reinsurance and which exceeded the excess applicable to that contract. The words “conditions as underlying” could not contradict either the period or limit provisions of the individual reinsurance contracts. The Court of Appeal stressed that when the relevant cover is placed on a time basis, the stated period of time is fundamental and must be given effect. It is for that period of risk that the premium payable is assessed. The difficulty arose from the way in which Municipal chose to operate the original insurance and the way in which it chose to place the reinsurance cover.163 2.101 It is also worth noting that in the case of marine insurance for both total and partial loss, but reinsurance on total loss-only basis, the terms the reinsurance and insurance contracts can be interpreted back-to-back in relation to the total loss cover under both insurance and reinsurance.164 Concurrency Between Insurance and Reinsurance Policies in the United States 2.102 The terminology most often used in the United States to express the match between the reinsurance and the original insurance cover is the word “concurrency.” Reinsurance contracts may contain a “follow the form” clause a typical formulation of which is in the following words: “This Policy is subject to the same warranties, terms and conditions (except as otherwise provided herein) as are contained in or as may be added to the Underlying Coverage prior to the happening of an accident or occurrence, whichever is applicable, for which claim is made hereunder.”165 163. The Court of Appeal found that on the balance of probabilities the loss and damage which occurred prior to 24 June 1987 exceeded in value the sum of £500,000, the deductable of the reinsured. Therefore the claim under the first contract of reinsurance failed. A similar answer was given for the third contract. The Court of Appeal found that the 12-month period for which the second contract provided coverage was the period in which pilferage and vandalism was undoubtedly occurring. It had probably started before the beginning of the period and continued until after the completion of the period. The Court of Appeal was prepared to find that two-thirds in value of the loss and damage probably occurred during this 12-month period. After deduction of the £500,000 excess, the plaintiffs are entitled to recover (in proportion to their lines) from those defendants who subscribed to the reinsurance contract for the second year. This gave the assured a recovery of £1,606,267.68. 164. American International Marine Agency of New York Inc v Dandridge [2005] Lloyd’s Rep IR 643, 654. 165. Aetna Cas and Sur Co v Home Ins Co 882 F.Supp. 1328, (SDNY, March 27, 1995).

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2.103 Both federal and state courts have held that the “follow the form” clause expressed the parties intent to establish concurrency between the original insurance and reinsurance policies unless the reinsurance policy includes a provision that conflicts with the language of the direct policy. In the absence of a conflicting provision, the policy of reinsurance will be construed as offering the same terms, conditions and scope of coverage as exist in the reinsured policy.166 Consequently, if the original insurance policy is triggered, it should follow that the reinsurance policy is also triggered. In Commercial Union Ins Co v Swiss Reinsurance America Corp167 the United States Court of Appeals for the First Circuit clarified that in the retrocession context concurrency operates to the effect that the retrocession contract looked back to the reinsurers’ and the latter’s policies looks back to the original policies with the assured. 2.104 As seen in the above rulings, the presumption of concurrency between the two policies can be overridden where the terms of the reinsurance certificate differ from those in the underlying policy.168 Applicable Law and Back-to-Back Cover: Wasa v Lexington 2.105 Determination of the nature of facultative reinsurance is particularly important where the terms of the reinsurance and the underlying insurance are identical and the reinsured has been held liable in circumstances in which the reinsurer believes itself not to be liable. In such a case, if facultative reinsurance is regarded as an independent insurance of the same risk covered by the direct insurance, it is easier to argue that the reinsurance extends only to those risks which fall within the terms of the reinsurance as construed in accordance with its own applicable law. However, if its purpose is to cover the primary insurer’s loss that may be incurred under the direct policy, then the reinsurer will be obliged to indemnify the reinsured on the ground that the reinsured’s liability to the assured has been established and quantified. Therefore it is significant to determine the nature of reinsurance and what the reinsured must prove to establish its liability under the original insurance and the reinsurer’s liability under the reinsurance policy. The point can be best explained by examining Wasa v Lexington in detail by analysing both the decisions of the Court of Appeal and the House of Lords.169 Facts 2.106 Lexington insured Aluminum Company of America (“Alcoa”) of Pennsylvania and its subsidiary, Northwest Alloys Inc (“NWA”) of Delaware under an American “all risks difference in conditions” (“DIC”) property damage insurance policy issued for the period from 1 July 1977

166. North River Ins Co v CIGNA Reinsurance Co, 52 F.3d 1194, (3rd Cir. (NJ) Apr 13, 1995). City of Renton v Lexington Ins Co (USA), Not Reported in F.Supp.2d, 2007 WL 2751356 (W.D.Wash.); Aetna Cas and Sur C v Home Ins Co 882 F.Supp. 1328, (SDNY, March 27,1995). Travelers Cas & Sur Co v Ace American Reinsurance Co 392 F.Supp.2d 659, (SDNY, Oct 12, 2005); affirmed by the second circuit: 201 Fed.Appx. 40, (2nd Cir. (NY) Oct 18, 2006). Commercial Union Ins Co v Swiss Reinsurance America Corp 413 F.3d. 121, (1st Cir. (Mass) Jun 27, 2005). Philadelphia Ins Co v Washington Ins Co 23 Pa 250, 1854. Travelers Cas and Sur Co v Insurance Co Of North America, (609 F.3d 143 (3rd Cir. (Pa) Jun 9, 2010). 167. 413 F.3d. 121, (1st Cir. (Mass) Jun 27, 2005). 168. Travelers Cas & Sur Co v Ace American Reinsurance Co 392 F.Supp.2d 659, SDNY, Oct 12, 2005.; aff’d by the second circuit: 201 Fed.Appx. 40, (2nd Cir. (NY) Oct 18, 2006). American Employers’ Ins Co v Swiss Reinsurance America Corp 413 F.3d 129, C.A.1 (Mass), 2005. 169. For comments on the House of Lords’ decisions, see Merkin, R, “Wasa International Insurance Co Ltd v Lexington Insurance Co: commercial certainty in the reinsurance market”, LQR 2010, 126(Jan), 24-30; Mecz, A and Bailey, A, “Wasa v Lexington: Buyer Beware”, [2010] JBL, Issue 1, 1–8; Schaff, A, “Wasa v Lexington: The Limits to the “Back to Back” Presumption”, [2010] JBL, Issue 1, 9–23; Gurses O, “The Construction of Terms of Facultative Reinsurance Contracts: Is Wasa v Lexington the Exception or the Rule?” (2010) 73(1) MLR 119–130.

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to 1 July 1980. The limit of liability was US$20 million for loss or damage arising from any one occurrence, subject however to an aggregate limit of US$20 million any one policy year in respect of the peril of flood and surface waters and US$20 million any one policy year in respect of the peril of earthquake. “Occurrence” was defined as “any one loss(es), disaster(s), or casualty(ies) arising out of one event or common cause.” There was a property damage deductible of US$250,000 per occurrence. The “Perils Insured” clause in the original policy provided: “This policy insures against all physical loss of, or damage to, the insured property. . . .” Again, in the original policy there was no express choice of law clause but it contained a standard US service of suit clause which read: In the event of the failure of [Lexington] to pay any amount claimed to be due hereunder, [Lexington] at the request of the Insured, will submit to the jurisdiction of any Court of Competent jurisdiction within the United States and will comply with all requirements necessary to give such Court jurisdiction and all matters arising hereunder shall be determined in accordance with the law and practice of such Court.

2.107 In the early 1990s the US Environmental Protection Agency required Alcoa to clean up pollution and contamination of groundwater, surface water and soil at 58 manufacturing sites in the United States used by Alcoa. The damage arose out of continuing failures on Alcoa’s part in respect of the escape of waste products and the failure of manufacturing units to contain pollutants. The relevant causative acts and omissions of Alcoa first occurred and first began causing damage in 1942 and continued at least until 1986. 2.108 In December 1992 Alcoa began proceedings against a large number of insurers (including Lexington) in the state of Washington in respect of damage involving 35 sites within the US (18 owned by Alcoa or NWA, 17 not so owned) and in May 1996 in respect of damage involving a further 23 owned sites, some outside the US. Alcoa and NWA claimed that their loss related to contamination of the 58 sites by waste products generated and disposed by them over periods going back to the 1940s. The court selected three sites to be the subject of an initial trial. By applying the law of Pennsylvania, the law of the state where Alcoa was incorporated and had its centre of business, the trial judge held that the assured could reasonably expect the insurer to cover the loss which occurred during the policy year and that did not change even if the damage was a continuous process occurring over a number of years and even if it was not discovered until much later. Therefore the assured could not reasonably have expected that the insurer would cover the entire loss, much of which occurred outside the policy period. The best estimate of actual damage in any policy period according to the judge was to be achieved by simply dividing the damage over the time it took to develop. 2.109 Alcoa appealed and the Washington Supreme Court reversed the trial court’s decision. The Washington Supreme Court focused on the heading of “Perils Insured” under the original policy which stated that: “This policy insures against all physical loss of, or damage to, the insured property . . .” Despite the time period clause in the original insurance policy which stated that the insurance was for three years from 1 July 1977 until 1 July 1980, the Washington Supreme Court held that the wording of the Perils Insured clause, by reason of the words “ . . . all physical loss of, or damage to . . .” was so broad to cover the “all loss” occurred during nearly 50 years. Despite the time period clause, the Washington Supreme Court noted that there was no exclusion clause in the original policy limiting the temporal liability of the insured for the loss in question, and the court decided that the perils insured clause had the effect of overriding the three-year coverage clause and making the insurer liable to cover the loss of the assured for the entire period that damage occurred, before, during and after the three-year period. 42

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2.110 Following the decision of the Washington Supreme Court, Lexington settled the assured’s claim and then made a claim against its reinsurers. The reinsurers represented 97.5% of the subscription paid, but Wasa and AGF, who held the remaining 2.5% line on a London market slip reinsuring Lexington for 36 months from 1 July 1977, claimed that they were not liable according to English law which governed their respective reinsurance contracts. Wasa and AGF commenced proceedings in England against Lexington seeking negative declaratory relief. Decisions 2.111 At first instance Simon J170 gave judgment for the reinsurers. The trial judge stated that while the reinsurance contract was (and had been since inception) governed by English law, the insurance contract was (and had been from inception) governed by a system of law that was other than English law. Thus, although in many respects the insurance and reinsurance contracts were back-to-back, they were plainly not in this respect.171 The trial judge was of the view that – agreeing with the submission of the reinsurers – construing the period provision in this reinsurance contracts by reference to the particular interpretation that was subsequently placed upon a similar period provision in the original insurance by a particular US State court would not truly give effect to the intention of the parties; it would lead to a construction whose effect would be back-to-front but not back-to-back.172 Simon J noted that the loss claimed by Lexington was not a loss which fell within the reinsurance contract as a matter of English law; therefore the judge granted the relief for the reinsurers and left open the issue of whether Lexington could make a claim under the reinsurance contract in respect of losses occurring within the three-year period of the reinsurance.173 Lexington was successful on appeal; the Court of Appeal held that the original policy and the reinsurance contracts should be construed in an identical fashion. Longmore LJ174 pointed out that: “Rather than asking whether the reinsurance was intended to be back-to-back or whether the reinsurance was intended only to apply to loss and damage occurring within the policy period (affirmative answers could be given to both questions), it is probably better to ask whether the parties intended that, to the extent that they used the same or equivalent wording in the reinsurance as in the underlying insurance they intended that wording to have the same meaning in both contracts.” Longmore LJ’s answer to this question was positive: Despite the fact that an English court applying English law would focus on the period of cover clause as meaning something different from the interpretation adopted by the Supreme Court of Washington, the policy period had to bear the same construction in both policies.175 Sedley LJ176 noted the historical development of reinsurance in England and pointed out that the Marine Insurance Act 1745, section 4, banned contracts of marine reinsurance until the ban was lifted by the passing of the Revenue (No 2) Act 1864. Because such contracts were regarded as gaming contracts it became useful to ascribe non-marine contracts of reinsurance, which were not expressly forbidden, to the insured risk itself and not to the primary policy. Therefore a contract of reinsurance used to be said to insure the same risk as the primary contract rather than the insurer’s liability under it. Sedley LJ commented on the back-to-back nature of reinsurance contracts and applying Vesta v Butcher, Sedley LJ concluded that the 170. 171. 172. 173. 174. 175. 176.

[2007] Lloyd’s Rep IR 604. Ibid., at 613. Ibid., at 615. Ibid., at 616. [2008] Lloyd’s Rep IR 510, para. 19, Pill LJ agreed para. 60. [2008] Lloyd’s Rep IR 510, paras. 20 and 35. Ibid., at para. 48.

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essential feature of reinsurance is the right on the part of the reinsured to recover in respect of his own liability to the insured.177 Sedley LJ remarked – referring to Volume 25 of the 4th edn of Halsbury’s Laws of England, 774– the back-to-back presumption was adopted precisely because of the problems which arose where the two contracts were governed by different applicable laws.178 It is of interest to note that neither Longmore LJ nor Pill LJ found it necessary to comment on the nature of reinsurance, as they were of the view that the presumption of back to back cover carried the day. 2.112 Before moving to the decision of the House of Lords in Wasa v Lexington, it is useful to look at the reinsurance policies of Wasa and AGF in more detail. The reinsurance policies were “Contributing Facultative Reinsurance” policies, Form was stated to be J1 or NMA 1779 covering All Risks of Physical Loss or Damage excluding Fire and Allied Perils &/or as original, reinsured was named as Lexington Insurance Company, assured was Alcoa Aluminum, the period clause was read “36 months at date 1.7.77 . . . and/or pro rata to expiry of original.” Interest “All property of every kind and Description and/or Business Interruption and OPP &/or as original”, situated: Worldwide and/or as original. Premium was to be calculated at GOR [Gross Original Rate]. The policy also contained “The full reinsurance clause.” 2.113 It is also useful to refer at this stage to the reinsurance policy in Vesta v Butcher in order to see how similar the wording of the reinsurance policies in the two cases actually were. In Vesta the reinsured was Vesta and the original assured was “the fish farmer.” The reinsured’s retention was 10%. The sum reinsured was 90%. of 750,000 Norwegian Kroner, the amount insured by Vesta. The period of reinsurance was expressed to commence and expire at the hour expressed in the original policy. “The perils and interest reinsured hereunder” were expressed to be – “ . . . livestock reinsurance rainbow trout and salmon only, the property of [the fish farmer] only as more fully set forth in the original policy.” 2.114 In Vesta, the reinsurance and original insurance contract were given the same construction but Vesta was distinguished by the House of Lords in Wasa. In Wasa it was common ground that the reference to the full reinsurance clause was to the wording:179 “Being a reinsurance of and warranted same gross rate, terms and conditions as and to follow the settlements of the Company and that said Company retains during the currency of this Policy at least . . . on the identical subject matter and risk and in identically the same proportion on each separate part thereof, but in the event of the retained line being less than as above, Underwriters’ lines to be proportionately reduced.” 2.115 Incorporation of the terms of the original insurance into the reinsurance was not disputed in Wasa and in fact it was also common ground180 that the references in the reinsurance slip to “&/or as original” against the headings “FORM” and “INTEREST” incorporated the relevant insurance provisions relating to the subject matter and risks into the reinsurance. The issue in Wasa was “whether [the] same period of cover should receive the same interpretation in both the original insurance and the reinsurance” or whether “the same or equivalent wording in each of the contracts should . . . be given the same construction”.181 Contrary to the Court of Appeal’s view, the House of Lords unanimously gave a negative answer to this question and each member of the House of Lords gave their own reasons for this decision. 177. 178. 179. 180. 181.

Ibid., at para. 49. [2008] Lloyd’s Rep IR 510, 47. [2009] 2 Lloyd’s Rep 508, Lord Mance, 514. Ibid., at 514. Ibid., Lord Collins, 533.

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2.116 Lord Philips182 stated that the risk is not within the reinsurance cover and the “follow the settlements” clause did not bring the risk within the reinsurance where it was not. According to Lord Phillips the risk was outside the reinsurance cover because it is unlikely that the parties to the reinsurance contract in 1977 can have anticipated that the interpretation of the wording common to the primary insurance and the reinsurance would differ so radically dependent on the law applied to its interpretation. The parties therefore could not be regarded as to have agreed to be bound by the principles applied in construing the original insurance policy which radically differs from English law. Lord Philips183 also expressed that adopting the view that the parties to the reinsurance contracts implicitly agreed that whatever law might be applied to interpretation of the primary cover and whatever result this might produce would apply equally to the reinsurance would treat the contract of reinsurance as one to indemnify the primary insurer in respect of any liability sustained under the primary cover. 2.117 Lord Brown184 expressed his concern as that of that if the terms of the reinsurance and original insurance to be given the same meaning, it would follow that the reinsured would be entitled to recover to the self-same extent as they now claim even had the reinsurance cover extended not for the coincident period of three years but, say, for only three months. 2.118 Vesta and Groupama were regarded as the closest cases to Wasa by Lord Brown185 but his Lordship stated that these two cases do not warrant application in all circumstances, certainly not so as to override so clear a temporal limitation as the reinsurance contracts stipulated here with regard to the risks covered. 2.119 Lord Mance186 also distinguished Vesta and Groupama because in both Vesta and Groupama, it was possible at the time when the insurance and reinsurance were placed to identify the foreign law which would govern the insurance. Lord Mance emphasised Lord Lowry’s opinion that in Vesta by the words “failure” the parties meant the meaning of Norwegian legal dictionary that “causative failure” to interpret the language of the reinsurance. However, in Wasa, Lord Mance187 found no identifiable legal dictionary that the reinsurance and insurance contracts to be construed accordingly. Moreover, the reinsurance has a clear English law meaning. Therefore his Lordship found no basis for interpreting the reinsurance contract as covering any liability which might subsequently be held to arise under the insurance in any State whose law might be applied. Consequently, there was no basis for construing the two contracts as back-to-back in the present situation. 2.120 Another reason that Lord Mance188 distinguished Vesta and Groupama was that both cases were related to warranties which is “an area where English law has long been recognised as unduly stringent and in need of review.” Lord Mance found it commercially and legally unattractive to treat the concept of warranty in the reinsurance as retaining “a stubbornly domestic English significance, trumping any limited significance of such a warranty included in the original and also incorporated by reference into the reinsurance” and expressed the desire of a “harmonious result” which could be achieved relatively easily by treating warranty in the reinsurance as taking its precise meaning and application from any equivalent warranty incorporated in the original. According to their Lordships189 the same construction rules as

182. 183. 184. 185. 186. 187. 188. 189.

[2009] 2 Lloyd’s Rep 508, 511, 512. Ibid., at 512. Ibid., at also Lord Collins, 535. Ibid., at 513. Ibid., at 521. Ibid., at 522. Ibid., at 523. Ibid.

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applied in Vesta and Groupama could be followed in Wasa to some extent for example to construe the reinsurance period (expressed as a unitary period of 36 months at 1 July 1977) would be understood to run back-to-back with the insurance term of 36 months “beginning and ending at noon standard time at location of property involved.” Similarly, the meaning of the sum reinsured of US$20 million in the aggregate in respect of flood and earthquake would be clarified by reference to the original, which makes clear that such aggregate applies to each of these perils separately. However, according to their Lordships, Vesta and Groupama cannot be followed to apply the same construction to the perils insured clause which is identical in the insurance and reinsurance contract. 2.121 In response to the Lexington’s counsel rhetorical question as to what more could Lexington have done to reinsure themselves on a fully back-to-back basis Lord Mance190 clarified that the parties may ensure that insurance and reinsurance are subject to one and the same identifiable or predictable governing law or at least make the insurance subject to an identifiable governing law. 2.122 According to Lord Collins,191 Wasa is an exception to the applicable principles adopted by the precedents. Lord Collins explained that the presumption of back-to-back cover is in the nature of proportional reinsurance as a result of the agreement between the reinsured and the reinsurer as to sharing the risk and premium proportionally; in other words as a result of the bargain that if the insurer is liable under the insurance contract, the reinsurer will be liable to pay the proportion which it has agreed to reinsure. This would lead the comment that in the usual case,192 any loss within the coverage of the insurance will be within the coverage of the reinsurance. In the view of Lord Collins this result reflects the commercial intentions and expectations of the parties and in order to achieve this result it will not be necessary to characterise the reinsurance policy as liability insurance. This was the case because as his Lordship confirmed193 the obvious commercial intention is for the original insurer to reinsure part of its own risk and for the reinsurer to accept that part of the risk, and it is therefore equally obvious that the relevant terms in the reinsurance contract should be construed so as to be consistent with the contract of insurance. Nevertheless, according to Lord Collins Wasa was a highly unusual case and therefore must be distinguished from the general principles applicable to the proportional reinsurance contracts and the reinsurance in Wasa cannot be construed back-to-back with the original insurance because: 1. The Washington Supreme Court decision has to be read in the context of the development of the law in the United States on the liability of successive insurers on policies covering liability for asbestos-related claims and for environmental claims.194 2. In order to apply the principles adopted by Vesta and Groupama (ie in order to construe the reinsurance contract (which is governed by English law) in accordance with the effect of the terms of the original insurance (which is governed by foreign law)) it is necessary that the relevant foreign law could be in reasonable contemplation of the parties when the contracts were entered into.195 However, according to their Lordships this was not the case in Wasa because the effect of the service of suit clause was that litigation could take place anywhere in the United States and the relevant court was then free to apply its own choice of law rules to determine what the applicable law might be. 190. 191. 192. 193. 194. 195.

Ibid. Ibid., at 524. Emphasis added. [2009] 2 Lloyd’s Rep 508, 525–526. Ibid., at 529. Ibid., at 531–532.

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2.126

3. In 1977, when the insurance contract and the reinsurance contract were concluded, there was no identifiable system of law applicable to the insurance contract which could have provided a basis for construing the contract of reinsurance in a manner different from its ordinary meaning in the London insurance market, whereas in Vesta and Groupama the substance of the foreign law as to the consequences of a non-causative breach of warranty could be ascertained at the outset, if necessary by recourse to a relevant Norwegian (or Venezuelan) legal source.196 Implications of Wasa 2.123 In facultative proportional reinsurance contracts, given the principle of back-to-back cover and the “as original” wording, the reinsurer agrees to be bound by the same terms as the original insurer and unless the reinsurance policy indicates any exclusion clause different from the original insurance, the purpose of facultative proportional reinsurance is to share the risk and the premium between the reinsured and the reinsurers. Therefore it is logical to say that subject to any exclusion clauses in the reinsurance contract differing from the original insurance, the purpose is to share the risk and the premium; in other words, where the reinsured is liable the reinsurer is liable in that namely the reinsured’s liability forms the reinsurers’ liability for the proportional amount for which the reinsurer is liable. It is accordingly submitted that Sedley LJ’s comment on the nature of reinsurance contract and the holding of the House of Lords in Vesta are more in conformity with the nature of proportional facultative reinsurance. 2.124 It should be clarified that if the reinsurance contract in Wasa had been for a period any different than 36 months, the reinsurers would not have taken the same proportion of premium and the reinsurance and original insurance contract would not be construed back-toback in this respect and therefore it would have been necessary to prove and calculate the amount of the loss that occurred during the period that the reinsurer agreed to provide coverage by sharing the loss and the premium accordingly. 2.125 The point which has to be emphasised here is that the original insurance also provided a temporal limitation clause together with the peril insured clause but the Washington Supreme Court construed the insurance contract in a manner whereby the perils insured clause overrode the time period clause. As was emphasised in Vesta and by the Court of Appeal and Lord Collins – with whom Lord Philips, Lord Brown and Lord Walker agreed – in Wasa, the nature of reinsurance is to indemnify the reinsured where the reinsured’s liability is established. Therefore the reinsured’s liability is established by the construction of identical terms to the reinsurance contract. Nevertheless, the House of Lords in Wasa construed the reinsurance contract as a further insurance on the subject matter insured which was interpreted under English law, as independent from the reinsured’s liability under the original policy. 2.126 Despite the facts and the contractual wording being very close, the House of Lords neither followed nor overruled Vesta. The question is now when Vesta will be applicable and when Wasa will be followed? In other words is Wasa an exception to the general principles applicable to the proportional reinsurance contracts that arise from the commercial expectations of the parties to reinsurance contracts? Lord Mance distinguished Vesta and Groupama because those cases were on warranties, ie stringent terms that need to have more flexible interpretations. According to his Lordship, relying on warranties would have been unmeritorious and technical because English law on warranties is unduly stringent and in need of review,

196. Ibid., at 534.

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but reliance on a duration provision was legitimate because there was no identifiable legal dictionary available in 1977, when the reinsurance contract was taken out, because the Service of Suit clause made it impossible for the reinsurers to contemplate which legal system would interpret the original insurance contract. Therefore, it is not clear from Lord Mance’s judgment whether Wasa is exceptional or whether Vesta and Groupama are exceptional in that they are confined to warranties. According to Lord Collins – with the agreements of Lord Philips, Lord Walker and Lord Brown – Wasa is the exception because there was no identifiable law to govern the insurance contract at the outset of the reinsurance contract for the Service of Suit Clause allowed the assured to bring an action in any competent jurisdiction in the United States which in fact made the applicable law to the original insurance uncertain. Lord Collins indeed stated that the outcome in Vesta was “almost inevitably” the correct one. 2.127 The result of the House of Lords’ decision is that the applicable law to the original insurance must be clear at the outset of the reinsurance contract where the reinsurers agree to provide back-to-back cover that the reinsurer would know how the original insurance to be interpreted. However, the reasoning of Lord Mance in distinguishing Vesta and Groupama does not make it clear if the presumption of back-to-back cover would apply to cases where the term in question is a warranty, but the applicable law to the original insurance was not predictable by reason of a Service of Suit clause. 2.128 In English law a contract must have a governing law from the outset, and it has been submitted that their Lordships’ reasons as for the unpredictability of applicable law confuses this requirement (which in fact cannot apply to the direct policy because the one law that will not govern it is English law) and the willingness of the reinsurers to accept premium and to issue a policy knowing that the direct insurance does not have an identified applicable law.197 Moreover, it is also worth considering cases where the original insurance contains an arbitration clause without any choice of law. If the dispute is arbitrated in a jurisdiction which has either adopted the UNCITRAL Model Law on Arbitration or under rules containing similar provisions, the choice of the conflict of laws rules to be used to determine the applicable law will be a matter for the arbitrators (Model Law Article 28). In this case could it be said that any decision reached by the arbitrators would not be binding for the reinsurers in terms of proof of the reinsured’s liability because of the unpredictable nature of law applicable to the insurance contract; therefore the reinsurance coverage cannot be construed back to back? Alternatively, if the original insurance contract in Wasa had said that the law of Washington was applicable, would a decision by the Washington court applying its conflict of laws rules and adopting the law of Pennsylvania have produced a result binding on the reinsurers? Those points aside, if their Lordships’ logic is pursued, a direct policy must expressly or by implication have an applicable law at the outset, failing which there is a risk that some (but, it is not clear, which) terms of coverage may be construed in accordance with English law rather than the applicable law ultimately identified for the direct policy by a court of competent jurisdiction.198 2.129 Consequently, the House of Lords has to that extent abandoned commercial certainty in the UK reinsurance market, and has suggested remedial measures which, if adopted, might create even greater uncertainty; the law will have to develop on a case-by-case basis.199 197. Merkin, R, “Commercial Certainty in the Reinsurance Market” (2010) 126 LQR, 27–28. 198. Ibid., at 24, 28. 199. Ibid., at 27. It is necessary to note that their Lordships (Lord Mance reserving his position to some extent) rejected Simon J’s holding that if the rules of the applicable law were unknown at the outset, or had changed between the date of the policy and the date of the judicial ruling on coverage, the reinsurers would not be bound by an unpredictable outcome; uncertainty generated by a change in the law cannot be relevant.

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2.131

2.130 Lord Brown and Lord Collins200 expressed the concern that, in accordance with the reinsured’s contention, the reinsurance contracts would have been construed back-to-back and the reinsurers would have been liable for the loss that occurred in the period for which the reinsured itself faced liability even though the reinsurance period was for a shorter period. Thus, say, if the reinsurance had been only for three months, the outcome would have been the same. That point was conceded by the reinsured in argument in the House of Lords. However, as was mentioned above, in the context of rebutting the presumption of back-to-back cover, that concession appears not to have been correct. If the insurance and reinsurance had been for different periods, they plainly could not have been back-to-back. 2.131 In Municipal Mutual Insurance Ltd v Sea Insurance Co Ltd,201 the original insurance was renewed annually and provided cover for a period of three successive years. By contrast, the three reinsurance contracts covering this period were entirely separate; indeed the identities of the subscribing reinsurers changed in each of the three years and the proportion of risk taken by individual reinsurers varied from year to year. Waller J construed the reinsurance and original insurance contracts as back-to-back. That conclusion was rejected by the Court of Appeal, which held that the phrase “Conditions as underlying” did not require the contracts to be construed back-to-back. In the circumstances it was obvious that liabilities arising in each year of the underlying cover had to be allocated to the corresponding year of reinsurance. Hobhouse LJ emphasised that the relevant reinsurance cover is placed on a time basis which is fundamental and must be given effect because it is for that period of risk that the premium payable is assessed.202 In Wasa, however, the facts were distinguishable from Municipal: the original insurance and reinsurance were both for the same period and the parties shared the premium for the whole three-year period of cover.

200. [2009] 2 Lloyd’s Rep 508, 513 and 535, respectively. 201. [1998] CLC 957. 202. Ibid., at 968.

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CHAPTER 3

I NCOR P OR AT ION A N D T H E F U L L R EI NSU R A NC E C LAUSE

T H E F U N C T I O N O F “A S O R I G I NA L ”

3.01 In the late nineteenth and early twentieth centuries an underwriter who insured risks in which he was not an expert would refer to other policies that had already been taken out on the same subject matter and against the same risk. These contracts contained a typical clause worded as “warranted to be on the same rate, terms and identical interest of . . . Insurance Company.” Such clauses were interpreted by the courts as conditions precedent to the liability of the underwriters that the terms of the later insurance contract were identical to the earlier policy referred to.1 As a result, disparities between the policies such as premium differences,2 or valuation of the policy,3 were held to be breaches of conditions precedent that relieved the insurers from liability.4 3.02 As mentioned above, in the London Market, facultative reinsurance contracts are formed by appending to the direct policy a cover page which states that reinsurance is on the same terms “as original.” There are two views as for the function of these words: The majority is of the view that as original incorporates the terms of the insurance contract into the reinsurance. The minority however argues that these words simply confirm that proportional facultative reinsurance contracts are back-to-back with the original insurance,5 in other words the function of the “as original” wording as ensuring that the substantive or subject-matter terms of the reinsurance, matched the substantive or subject-matter terms of the primary cover.6 According to this view, adopting otherwise could create unnecessary controversies and sometimes superfluous and confusing analysis.7 3.03 It is submitted that the minority view is more supportable and, as Lord Griffiths suggested in Vesta,8 the phrase “warranted the same terms and conditions as original” or similar phrases such as “as original” or “subject to the same terms and conditions as original” is only a warranty by the insurer that the original policy terms have been or will be worded identically 1. Barnards v Faber [1893] 1 QB 340; Bancroft v Heath (1901) 17 TLR 425. However, see: Walker & Sons v Uzielli (1896) Com Cas 452; The Sulphite Pulp Co Ltd v Faber (1895–96) 1 Com Cas 146; Beauchamp v Faber (1898) 3 Com Cas 308. 2. Barnard v Faber [1893] 1 QB 340; Walker & Sons v Uzielli (1896) Com Cas 452. 3. Bancroft v Heath (1901) 17 TLR 425. 4. It should be noted that while classifying such clauses as conditions precedent to the liability of the underwriters, the courts did not give any importance to the word “warranted.” 5. Lord Griffiths, in Forsikringsaktieselskapet Vesta v Butcher [1989] 1 Lloyd’s Rep 331, 338; Nicoll, “HIH Litigation”, (2003) 119 LQR 572, 581. 6. AIG Europe (UK) Ltd v Anonymous Greek Co of General Insurances, The Ethniki [1999] Lloyd’s Rep IR 221, affirmed [2000] Lloyd’s Rep IR 343. 7. Lord Griffiths, in Forsikringsaktieselskapet Vesta v Butcher, [1989] 1 Lloyd’s Rep 331, 338; Nicoll, “HIH Litigation”, (2003) 119 LQR 572, 581. 8. Lord Griffiths, in Forsikringsaktieselskapet Vesta v Butcher [1989] 1 Lloyd’s Rep 331, 338.

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to the terms represented to the reinsurer, or alternatively a confirmation that the insurance contract terms will be identical to the reinsurance policy terms. As has happened in Groupama, adopting the “incorporation” view causes unnecessary complication, while the issues could have been resolved more simply by applying the presumption of back-to-back cover. Nevertheless incorporation is the majority view and it is necessary to analyse requirements and scope of incorporation.

D E V E L O P M E N T O F T H E T H E O RY O F I N C O R P O R AT I O N

3.04 It seems that incorporation was seen as the intended objective from the early development of the reinsurance law.9 In Re Eddystone Marine Insurance Co ex parte Western Insurance Co,10 Joseph Walton QC stated in his address to the court that the policy containing the clause “Being a reinsurance . . . subject to the same terms and conditions as the original policy, and to pay as may be paid thereon” was in the usual form at Lloyd’s. He stated that the original policy may have been effected at various places, and may not perhaps be at hand, or cannot be copied in, so the incorporation of the terms of the original policy was effected by the use of this form.11 3.05 There are also numerous modern authorities supporting this notion. For example, in Toomey v Banco Vitalicio De Espana SA de Seguros12 Andrew Smith J expressly rejected Lord Griffiths’ comment that the full reinsurance clause creates a warranty about the original insurance terms; the learned judge was of the view that the full reinsurance clause is understood by the Market to incorporate the original insurance terms into the reinsurance rather than creating the warranty suggested by Lord Griffiths.13 3.06 In Toomey v Banco, Vitalicio had insured the Spanish football club Atletico de Madrid in respect of losses resulting from the performance of the club in the 1999/2000 season. Atletico made an agreement with Audovisual with regard to broadcasting of Atletico’s games. The insurer agreed to provide coverage for the losses if the club was relegated and therefore lost income from broadcasting rights for their home matches. The claimant reinsurers reinsured 31.54% of the risk that Vitalicio had insured. The reinsurance contract contained the full reinsurance clause: “Being a reinsurance of and warranted same gross rate, terms and conditions as and to follow the settlements of the reassured.” In the original insurance the insurer was stated as “Vitalicio”, the insured and the policy holder was “Atletico” the risk was “To indemnify Audovisual . . . for economic loss which may arise from the fact of Atletico . . . losing its status as member of the first division . . . .” By relying on Lord Griffiths’ comment in Vesta v Butcher the reinsurer argued that by virtue of the full reinsurance clause the reinsured gave a warranty to the reinsurer that the risk insured was Vitalicio’s, but the risk on the original insurance was required to make payment to Audiovisual (the broadcaster); therefore the reinsured was in breach of warranty which discharged the reinsurers from liability. Andrew Smith 9. The Imperial Marine Insurance Co v The Fire Insurance Corp Ltd (1879) 4 CPD 166. In truth, reinsurance appears to be as old as insurance itself. However, reinsurance was declared to be illegal by s. 4 of the Marine Insurance Act 1745 unless the insurer was insolvent, bankrupt or dead, a prohibition which lasted until the Revenue (No.2) Act 1864, s. 1. 10. [1892] 2 Ch 423, 425. 11. Ibid. The common nature of the form was also emphasised by Phillimore LJ in Street v Royal Exchange Assurance (1914) 19 Com Cas 339, 349. 12. [2004] Lloyd’s Rep IR 354. 13. In Prifti v Musini Sociedad Anonima de Seguros y Reaseguros [2004] Lloyd’s Rep IR 528 Andrew Smith J once more rejected the submission that the full reinsurance clause creates such a warranty .

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3.08

J14 approved the insurer’s submission as to the effect of the full reinsurance clause That: “By agreeing to it, the insurer agrees that all the relevant and applicable terms of the original contract of insurance become terms of the reinsurance, and in return the reinsurer agrees to accept and to follow the settlements made by the insured.”15 Andrew Smith J16 did not apply Lord Griffiths’ comment because in Toomey the original insurance was not presented to the reinsurers whereas it had been in Vesta. On appeal to the Court of Appeal17 no view was expressed one way or the other.18 As for the function of the full reinsurance clause or whether or not the judge’s construction was in accordance with the view of the market; their Lordships left the issue for decision in a case in which they actually arise for decision. 3.07 The most recent authority on proportional facultative reinsurance contracts which contain a full reinsurance clause is Wasa International Insurance Co Ltd v Lexington Insurance Co where Simon J19 stated, as a general observation about reinsurance, that the full reinsurance clause incorporates effectively the subject matter of the original risk into the reinsurance contract.20 The Court of Appeal21 did not express any view because they concentrated on the question whether or not the original and reinsurance policy terms were to be given the same meaning. In the House of Lords, Lord Mance22 found it unnecessary to consider whether the full reinsurance clause could incorporate into the reinsurance all the terms of the insurance which could be germane in that context. According to his Lordship the relevant insurance provisions relating to the subject matter and risks into the reinsurance were incorporated by virtue of the reinsurance slip’s references “&/or as original” against the headings “FORM” and “INTEREST.” 3.08 As may be seen, the weight of authority tends to give the phrase “as original” – either stated within the full reinsurance clause or mentioned as a separate clause “as original” – the effect that incorporates the terms of the original insurance into the reinsurance. The incorporation effect is necessary to the view that reinsurance is a further insurance on the subject matter insured. The reinsurer insures the same subject matter as the insurer and, as a consequence, it will be necessary to incorporate the original policy terms into the reinsurance. If the issue is analysed from the point of view that the reinsurer insures the reinsured’s liability against the risk that the reinsured has agreed to cover under the original insurance, incorporation will not be needed as the two contracts are presumed to provide identical cover, the “as original” wording’s effect will be simply confirming the relationship between the reinsured and the reinsurer namely that unless the wording of the reinsurance policy differs from that of the direct policy (eg by the addition of an exclusion clause), where the reinsured’s liability is established under the original policy the reinsurer will be liable for its agreed proportion. This will make resolving the dispute less complicated that resorting to incorporation. Nevertheless, incorporation has been adopted by most of the authorities and it is necessary to explain how incorporation functions in proportional facultative reinsurance contracts.

14. [2004] Lloyd’s Rep IR 354, para. 87. 15. Ibid., at, paras. 86–87. 16. Ibid., at para. 89. 17. [2005] Lloyd’s Rep IR 423. 18. The Court of Appeal dismissed the appeal and also found that the reinsurance policy was voidable for misrepresentation. As the issue as to the full reinsurance clause was raised by the reinsurers as a cross-appeal, Thomas LJ regarded the issue did not arise and did not express any view as to the function of the full reinsurance clause: [2005] Lloyd’s Rep IR 423, 435. 19. [2007] Lloyd’s Rep IR 604. 20. This observation was obiter as the case did not proceed on incorporation. 21. [2008] Lloyd’s Rep IR 510. 22. [2009] 2 Lloyd’s Rep 508, 514.

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Requirements for Incorporation 3.09 Incorporation of a particular clause depends upon the construction of the reinsurance as well as the surrounding circumstances: the underlying question is whether the parties intended the particular clause in question to be incorporated.23 The specific requirements of incorporation of the terms of the original policy into the reinsurance were laid down in HIH Casualty & General Insurance Ltd v New Hampshire Insurance Co24 Before considering these requirements some general principles should be considered. First, in a retrocession context, the wording “as original” refers to the primary insurance and not the reinsurance.25 Secondly, there will be no incorporation if the original insurance contract is itself incomplete at the time the reinsurance is made.26 HIH v New Hampshire27 3.10 This is the leading authority on incorporation, and is discussed further in the following paragraphs. A number of banks and investors invested through Law Debenture Trust (LDT) in the making of a number of films to be co-produced by 7.23 Productions and Flashpoint Ltd (the 7.23 slate) and Rojak Films Inc and Flashpoint Ltd (the Rojak slate). The investment was to be repaid out of the future profits to be earned by the films. HIH issued two film finance insurance policies, pecuniary loss indemnity insurance, to indemnify LDT if at the end of a defined period there was a shortfall between the amount of finance provided and the revenue collected. The “Interest” clauses in the 7.23 policy (the Rojak policy) provided “7.23 productions will produce and make six made-for-TV Films” and “Rojak Films Inc will produce and make 10 made-for-TV films”, respectively. Clause 8.1 was identical in the two insurance policies, and it was in the following terms: “8.1 To the fullest extent permissible by applicable law, the Insurer hereby agrees that it will not seek to or be entitled to avoid or rescind this Policy or reject any claim hereunder or be entitled to seek any remedy or redress on the grounds of invalidity or unenforceability of any of its arrangements with Flashpoint Ltd or any other person (or of any arrangements between Flashpoint Ltd and the Purchaser) or non-disclosure or misrepresentation by any person or any other similar grounds. The Insurer irrevocably agrees not to assert and waives any and all defences and rights of set-off and/or counterclaim (including without limitation any such rights acquired by assignment or otherwise) which it may have against the Assured or which may be available so as to deny payment of any amount due hereunder in accordance with the express terms hereof.”

3.11 HIH acted primarily as a front for three other insurance companies who together participated in 80% quota share reinsurance of HIH. The reinsurance slips defined the reinsured

23. American International Marine Agency v Dandridge [2005] Lloyd’s Rep IR 643, 654. 24. [2001] 2 Lloyd’s Rep 161. 25. Pine Top Insurance Co Ltd v Unione Italiana Anglo Saxon Reinsurance Co Ltd [1987] 1 Lloyd’s Rep 476. However, in an earlier case, General Insurance Co of Trieste Ltd v Corporation of the Royal Exchange (1897) 2 Com Cas 144, both the reinsurance and retrocession contracts were “as original” and Mathew J recognised the incorporation of a term from the reinsurance into the retrocession. 26. For instance in Cigna Life Insurance Co of Europe SA-NV v Intercaser SA de Seguros y Reaseguros [2001]1] CLC 1356 the reinsurance slip provided that the reinsurance conditions followed those in the direct policy, and that other terms and conditions were as per the Intercaser Reinsurance Contract. However there was no such contract as referred to in the slip in existence at the time it had been entered into. See also Excess Insurance Co Ltd & Anor v Mander [1995] CLC 838. 27. HIH Casualty & General Insurance Ltd v New Hampshire Insurance Co [2001] 2 Lloyd’s Rep 161.

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3.16

interest “As Original Policy”, and contained a full reinsurance clause stating that: “This Reinsurance is subject to all terms, clauses and conditions as original and to follow that placement in all respects.” The reinsurance slips also contained variations clauses under which HIH agreed “to consult and obtain Reinsurers’ agreement to all amendments and alterations to the terms, clauses and conditions of the Original Policy.” 3.12 The film productions were not successful at least in part because the specified number of films was not made, and HIH was faced a claim for in excess of US$31 million for the shortfall under the 7.23 and Rojak slates. HIH paid the amount claimed and sought to recover the 80% reinsurance from the reinsurers, who argued that HIH had no liability to LDT under the two direct policies and should not have made payment. The reinsurers also argued that the assured was in breach of warranty so that the reinsurers were not liable according to the reinsurance policy terms. 3.13 David Steel J and the Court of Appeal first discussed whether or not the undertaking to make certain amount of films was a term on the insurance contracts and, if they were, whether or not the relevant terms were warranties. The answers to the two questions were positive: David Steel J and the Court of Appeal were of the view that the policies were against the loss of revenues and in order to obtain revenues the films needed to be made; the fewer the films made, the less the chance of earning enough revenue. This reason was also the basis of holding that the terms relating to the number of films to be made were warranties. David Steel J and the Court of Appeal noted that for a term to be classified as a warranty the word “warranty” does not necessarily have to be used. The most important tests to be applied, as set out in the judgment of Rix LJ, were whether or not the term in question had a material bearing on the risk and whether damages would have been a sufficient remedy. In the present case, the term was held to be a warranty. It followed that the assured was in breach of warranty and therefore there could be no liability under either the insurance or the reinsurance. 3.14 The courts, however, discussed the effect of Condition 8.1 of the direct policies and whether it had been incorporated into the reinsurance. The trial judge was of the view that there had been direct incorporation of that provision by an express term providing “Cancellation Clause as Original Policy.” However, the learned judge also noted that even if that was wrong, there had been incorporation by the general words of the full reinsurance clause. He concluded – and the Court of Appeal agreed – that a term could be incorporated from a direct policy into a reinsurance agreement if the term: (a) (b) (c) (d)

was germane to the reinsurance; made sense, subject to permissible “manipulation”, in the context of the reinsurance; was consistent with the express terms of the reinsurance, and was apposite for inclusion in the reinsurance.

3.15 David Steel J was of the view that the waiver of defence clause was incorporated in its “manipulated” form, changing references to the assured and insurer to the reinsured and reinsurer, with the effect that the reinsurers agreed not to take any defences based, inter alia, on utmost good faith. David Steel J discussed whether or not the clause was so unusual as to prevent incorporation, but concluded – the Court of Appeal agreeing – that the wording was not so uncommon as to preclude the possibility of incorporation from the insurance into the reinsurance. 3.16 However there were two points on which the Court of Appeal disagreed with David Steel J. Rix LJ (delivering the leading judgment) held that the reference to a “cancellation clause” was not a reference to the waiver of rights clause as the latter had nothing to do with cancellation. In fact it was not clear what the cancellation clause in the direct policy was. 55

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Moreover, the Court of Appeal was of the view that the waiver of defences clause was incorporated in an unmanipulated form because incorporation of it in a manipulated form would not be consistent with the reinsurance. Rix LJ pointed out that on purely linguistic grounds, manipulation was impossible, given the reference in the clause to Flashpoint. Furthermore, incorporation in manipulated form would have extended the obligations of the reinsurers to the situation in which the reinsured had been guilty of a distinct breach of duty; thus it did not achieve back to back cover. Additionally, there was no need for manipulation because the clause made perfectly good sense in its unmanipulated form, namely, that reinsurers agreed to indemnify the reinsured in the event that the reinsured was required to make payment despite a breach of the duty of utmost good faith on the part of the assured. Finally, incorporation of the clause in manipulated form would create an issue as to the consistency of the clause with the common law obligation of the insurers to make a fair presentation because any separate breach of duty by the reinsured towards the reinsurers (which had nothing to do with the assured) was waived by reason of the independent operation of the clause as incorporated into the reinsurance. 3.17 Disagreeing with David Steel J, Rix LJ distinguished the fact of incorporation from the effect of incorporation: the effect of incorporation did not necessarily create fresh rights between reinsurers and insurers but merely operated as a recognition of the effect of the clause in the direct policy, and thus operate as no more than a follow settlements provision. Consequently, under the waiver of defence clause the insurer waived any breach by the assured and the liability of the insurers to make payment in such circumstances was recognised in the reinsurance by virtue of the full reinsurance – incorporation – clause.

T H E S C O P E O F I N C O R P O R AT I O N

3.18 It is now settled that the incorporation wording does not encompass all of the provisions of the original insurance contracts: the phrase “all terms and conditions as original” is not to be read as comprising “all” terms of the original policy.28 More explicitly, the terms germane to reinsurance are confined to those provisions defining the period, the geographical limits and the nature of the risk undertaken by the reinsurer.29 Further, the incorporation clause is not to be interpreted as encompassing clauses which are inconsistent with the reinsurance agreement.30 Even if a clause complies with other requirements, incorporation is not allowed to the extent that it contradicts the express provisions of the reinsurance.31 It is also permissible to incorporate a term which refers to eg the “insurer” by manipulating it to read “reinsurer.”32 3.19 The established factors determining which terms may be incorporated are as follows. Incorporation of Unusual Terms 3.20 The position under general contract law is that a clause with an onerous or unusual nature cannot be regarded as incorporated unless the party relying on it proves that he drew the

28. Pine Top Insurance Co Ltd v Unione Italiana Anglo Saxon Reinsurance Co Ltd [1987] 1 Lloyd’s Rep 476; Municipal Mutual Insurance Ltd v Sea Insurance Co Ltd [1996] CLC 1515, 1527. 29. Pine Top Insurance Co Ltd v Unione Italiana Anglo Saxon Reinsurance Co Ltd [1987] 1 Lloyd’s Rep 476. 30. Municipal Mutual Insurance Ltd v Sea Insurance Co Ltd [1996]6] CLC 1515; Home Insurance Company of New York v Victoria – Montreal Fire Insurance Company [1907] AC 59. 31. Australian Widows’ Fund Life Assurance Society, Ltd v National Mutual Life Association of Australasia [1914] AC 634; MacGillivray on Insurance Law, para. 33–54. 32. CNA International Reinsurance Co Ltd v Companhia de Seguros Tranquilidade SA [1999] Lloyd’s Rep IR 289.

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other party’s attention to it.33 In the reinsurance context it has been established that clauses that in common use can be incorporated.34 3.21 A modified approach was adopted in HIH Casualty & General Insurance Ltd v New Hampshire Insurance Co,35 where the reinsured expressly waived its right to rely on breach of duty of disclosure by the assured, and the question was whether this clause was carried into the reinsurance contract. At first instance David Steel J – the Court of Appeal agreed – accepted expert evidence to the effect that such clauses were often requested and “sometimes agreed”; hence were not unconscionable or extortionate.36 This led the trial judge to hold that the waiver of defences clause was not standard or customary, but in no sense unique, and that in all the circumstances it was fair to regard it as incorporated. 3.22 It has been suggested that the effect of an unusual clause might be assessed in terms of good faith.37 If the original policy contains a clause which the reinsurer could not have expected to find, the reinsured would be bound by the rules of disclosure to bring the clause to the reinsurer’s attention as a material fact in pre-contract disclosure, because the reinsurer is entitled to expect the reinsurance to be in usual form.38 Thus, the reinsurer may be entitled to avoid the contract in the absence of disclosure.39 In HIH v New Hampshire40 Rix LJ accepted, obiter, that the appropriate question was not whether there had been incorporation, but whether the reinsured had broken its duty of disclosure in relation to the unusual clause in the original policy. 3.23 Incorporation of unusual terms may also lead to an extension of the reinsurer’s liability beyond its agreed scope. A typical example is the purported incorporation of a held covered clause from the original insurance into a reinsurance policy whose period of cover is expressly limited. Evidence that a held covered clause was commonly used in the particular form of insurance would give a strong argument that the reinsurer could be assumed to have been aware of the existence of the clause, and his liability would be extended beyond the terms of the reinsurance.41 3.24 In the general law of contract, market evidence may be used to determine whether the clause is of a usual nature, in other words whether a reasonable person should expect its

33. Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd [1989] QB 433. See also Henderson v Stevenson LR 2 Sc & Div 470; Thornton v Shoe Lane Parking Ltd [1971] 2 QB 163. 34. Marten v The Nippon Sea and Land Insurance Co Ltd (1898) Com Cas 164; Charlesworth v Faber (1900) 5 Com Cas 408; but see Franco Hungarian v Merchants Marine Insurance, Shipping Gazette, 7 June 1888. 35. [2001] 2 Lloyd’s Rep 161. 36. [2001] 1 Lloyd’s Rep 378, 387. David Steel J (Rix LJ agreed [2001] 2 Lloyd’s Rep 161, para. 207) distinguished Marten v The Nippon Sea and Land Insurance (1898) Com Cas 164 and Charlesworth v Faber (1900) 5 Com Cas 408 because they were only authority for the proposition that reinsurers are bound by usual terms even to the extent of overriding an inconsistency, and that whether general words of incorporation can import an unusual or uncommon term “is quite a different question.” 37. Butler and Merkin, Reinsurance Law, para. B-0124. Also see MacGillivray on Insurance Law, para. 33–53. In contract law, in Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd [1989] QB 433 Bingham LJ gave some indication of his willingness to rely on the civil law good faith principle in formation of contracts. However, see Star Steamship Society v Beogradska Plovidba, The Junior K [1988] 2 Lloyd’s Rep 583. 38. Maritime Insurance v Stearns [1901] 2 KB 912. See Axa v Ace Global Markets [2006] Lloyd’s Rep IR 683 where in approving incorporation of standard market wordings into the reinsurance contract, Gloster J took into consideration that although the wording of EXEL 1.1.90 was not attached to the slip, it was clear from the express terms of the slip that the authors of it clearly had the EXEL 1.1.90 wording in front of them when drafting the slip or alternatively, it was clear that they were extremely familiar with its provisions. 39. See Property Insurance Co v National Protector Insurance Co, (1913) Com Cas 119, 122 where Scrutton J stated that an unusual clause might be a material fact which ought to have been disclosed. 40. [2001] 2 Lloyd’s Rep 161, 199; See Charlesworth v Faber (1900) 5 Com Cas 408 where the reinsurer unsuccessfully relied on the unusual nature of the clause in arguing that he was entitled to avoid the contract. 41. In Charlesworth v Faber (1900) 5 Com Cas 408 Bigham J accepted incorporation of a held covered clause into the reinsurance policy as such a provision was not unusual.

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existence. In Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd,42 the court looked at the rates of ten other firms and found that none of them charged as much as Interfoto. If both parties work in the same business, it is somewhat easier to determine whether a clause could be expected to be found in the contract in question.43 In the same way, in reinsurance cases, other similar contracts may be evidence as to whether the reinsurer should have expected the existence of such a clause in the insurance policy, as in HIH v New Hampshire.44 Incorporation of Inconsistent Terms Construction of Inconsistent Terms 3.25 While the courts’ view was mechanical in the old authorities,45 their attitude has changed and the current position is that conflicting incorporated terms are disregarded if they are incapable of being given a sensible meaning in the context, although the courts will seek to give effect to them if the conflicting clauses can live together.46 The reason for this principle is that in the ordinary course of events the parties may be assumed to have given express consideration to written terms and much less, if any, consideration to the application of the incorporated terms.47 Inconsistency Between Reinsurance – Insurance Contracts 3.26 In some early cases the independence of reinsurance and insurance contracts was recognised, and each was construed in accordance with its own terms. For instance, in FrancoHungarian v Merchants Marine Insurance48 the direct policy contained a held covered clause, whereas the retrocession policy did not, and the reinsurance was “as original.” Day J stressed that incorporated provisions operated only until the retrocession cover ended, according to its own term. 3.27 In Franco-Hungarian the steamship Cochin was insured for a period of 12 months from 1 June 1882. The original insurance provided that if at the expiration of the policy period the ship was at any point or place other than her home port Marseilles, the cover was to be extended until she arrived at that port. Franco-Hungarian reinsured the risk and Merchants Marine retroceded it. All policies provided cover for 12 months from 1 June 1882, therefore the period of cover ended on 1 June 1883. The ship was lost on 8 June 1888. The retrocession was “subject to the same clauses and conditions as the original policy”; therefore the question was whether the extension clause that was granted by the original insurer to the assured was incorporated into the retrocession contract. Day J held that the retrocession was formed as a time policy, therefore the policy period was essential.

42. [1989] QB 433. 43. Per Bingham LJ, in Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd [1989] QB 433, 445. 44. [2001] 1 Lloyd’s Rep 378, 387. 45. See Doe & Leicester v Biggs, (1809) 2 Taunt 109, 113 where Mansfield CJ held stated that “the general rule is, that if there be a repugnancy, the first words in a deed, and the last words in a will, shall prevail.” 46. Finagra Ltd v OT Africa Ltd [1998] 2 Lloyd’s Rep 622; Metalfer Corporation v Pan Oceanhipping Co Ltd [1998] 2 Lloyd’s Rep 632; Sabah Flour and Feedmills Sdn Bhd v Comfez Ltd [1988] 2 Lloyd’s Rep 18. Quinta Communication SA v Warrington [2000] Lloyd’s Rep IR 81. In Adamastos Shipping v Anglo-Saxon Petroleum [1959] AC 133 the charterparty incorporated the US “Paramount Clause.” The clause was worded as “This bill of lading shall have effect subject to . . . the Carriage of Goods by Sea Act of the United States . . . 1936 . . . .” The House of Lords unanimously held that it did not make sense to begin a clause of a charterparty with the words “This bill of lading”; therefore on the true construction of the charterparty the Paramount Clause must be read as if it was “This charterparty shall have effect . . . .” 47. It is much the same principle whereby typed clauses prevail over printed clauses and handwritten clauses will ordinarily prevail over typed clauses. See Farmers’ Co-op Ltd v National Benefit Assurance Co (1922) 13 Ll L Rep 530, 533 per Atkin LJ; City Tailors Ltd v Evans (1921) 9 Ll L Rep 394; The Ion, [1971] 1 Lloyd’s Rep 541. 48. Shipping Gazette, 7 June 1888.

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3.28 Nevertheless, in Marten v The Nippon Sea and Land Insurance49 Bigham J read the full reinsurance clause as extending the reinsurance cover beyond that stated in the reinsurance. In this case the issue was related to the physical limits of cover: the insurance covered the risk from warehouse to warehouse while the reinsurance was stated to be “from loading . . . until . . . safely landed at . . . port.” The goods were damaged in the customs warehouse after being discharged from the ship. Bigham J held that because of the commonplace nature of the clause, it was carried into the reinsurance contract. Similarly, in Charlesworth v Faber50 the issue once again was the unusual character of the held covered clause, but Bigham J ruled that a held covered clause was in common use in connection with that particular kind of time policy on liners. He distinguished Franco-Hungarian v Merchants Marine Insurance51 by asserting that in Franco no evidence appeared to have been given to show that the clause was well known and in common use. It has been submitted that Bigham J’s reason is unconvincing52 because in Franco, Day J did not mention the degree of any use of the relevant clause and his decision was based on the point that incorporation would have extended the reinsurer’s liability beyond that for which he actually contracted. It is unfortunate that the inconsistency between the terms of the insurance and reinsurance contracts was not taken into account by Bigham J and the learned judge did not give any weight to the terms of the reinsurance policy indicating the limited period of the reinsurance cover. It can be deduced from Bigham J’s conclusions that if an inconsistency appears, the original insurance provisions can override the terms of the reinsurance regardless of the independence of these contracts from each other. Consequently, those authorities show that if a term of the original insurance is common in nature, the full reinsurance clause may carry it into the reinsurance, thereby extending the reinsurer’s liability beyond his own contractual terms. 3.29 In Joyce v Realm Marine Insurance Co Ltd,53 the original insurance contained an extension clause providing that “outward cargo to be considered homeward interest twentyfour hours after her arrival at her first port of discharge.” The reinsurance policy which was – according to the court’s assumption – effected after the vessel had arrived in Africa (outward destination) did not mention the extension clause and provided cover “from the loading thereof and thereafter while the cargo was being conveyed between African ports and on its homeward voyage.” The cargo was damaged after the vessel arrived at an African port and at a time when the cargo had remained on its outward journey for more than 24 hours. Blackburn and Lush JJ were of the view that the incorporation wording permitted them to use the original policy terms as evidence to construe the reinsurance provisions to the effect that “from the loading thereof” was meant by the parties covering constructive loading, in line with the original insurance. Blackburn J referred to Bell v Hobson54 where in fact incorporation was not the issue and the concern was construction of marine policy terms which was said to be in continuation of five previous policies: A marine policy on cargo of tobacco was effected on 15 June 1810, “at and from Gottenburgh to any port or ports, place or places, in the Baltic, backwards and forwards, and forwards and backwards . . .” The policy contained the printed words, “beginning the adventure upon the said goods, from the loading thereof on board the said ship” and at the foot of the policy it was stated that the policy was in continuation of five

49. (1898) Com Cas 164. 50. (1900) Com Cas 408, 412. However the case was ultimately decided on the basis that the reinsurance was unenforceable under the Stamp Act 1891 as it was made for a longer period than 12 months. 51. Shipping Gazette, 7 June 1888. 52. Butler and Merkin, Reinsurance Law, para. B-0130. 53. (1871–1872) LR 7 QB 580. 54. (1812) 16 East 240.

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policies which all pre-dated the policy in question. The ships sailed from Virginia, where all the goods were in fact loaded. The intended voyage was described in the former policies, to be “at and from Virginia to her port or ports of discharge in the United Kingdom, or any port or ports, place or places in the Baltic. Te policy also provided the liberty, inter alia, to “take in and discharge goods wheresoever the ship may touch at.” The ship arrived at Gottenburgh, and afterwards proceeded with the same cargo to another port in the Baltic, and was captured. The defendant insurer, who was not an underwriter on any of the former policies, therefore raised the objection that the insurance in question being “at and from Gottenburgh,” and “beginning the adventure on the said goods from the loading thereof on board,” had to be confined to such goods as were loaded on board at Gottenburgh. Lord Ellenborough stated that according to the strict interpretation established by the precedents, where an insurer’s liability in respect of marine cargo is expressed as commencing “from the loading on board”, the phrase is to be confined to the place from where the risk commenced. However, this rule could be made more flexible if there was anything to indicate that a prior loading was contemplated by the parties.55 According to his Lordship, the expression at the foot of the policy as to being in continuation of the former policies indicated that the parties contemplated the taking up the insurance on goods loaded before the ship arrived at Gottenburgh; the fact that the defendant insurer did not write the former policies would not alter the position. Blackburn J adopted Lord Ellenborough’s view but modified it, to the effect that bringing the construction of the terms of the original policy into the reinsurance contract by virtue of the full reinsurance clause which, according to their Lordships, was an indication that the word loading was used in a sense different from the mere putting on board. It may be assumed that if there had been no words of incorporation, the decision in Joyce could have been different.56 Interestingly, Joyce v Realm Marine Insurance Co Ltd 57 pre-dated Franco-Hungarian v Merchants Marine Insurance58 in which the independence of the reinsurance contract was emphasised. However Franco is so poorly reported that it is not clear whether Day J distinguished Joyce.59 3.30 Another case where inconsistency was issue is Stronghold Insurance Co Ltd v Bulstrad Insurance and Reinsurance plc60 where the reinsurance contained the words: “All settlements made by the Company shall be binding on their Reinsurers and the Reinsurers agree to pay to the Company any amounts that may be recoverable under this Agreement within 15 (fifteen) days after the receipt of the necessary papers proving the loss.” The retrocession agreement stated “all clauses terms and conditions as original insofar as applicable and to pay as may be paid thereon.” The reinsurer argued that the effect of the “all clauses terms and conditions as original” wording in the retrocession was to incorporate the “follow the settlements” clause into the retrocession. The latter clause overrode the “pay as may be paid thereon” clause so that, without proving actual liability, the reinsurer could make a claim 55. Ibid., at 243. 56. It is seen in some recent authorities that the full reinsurance clause has been construed in similar understanding to Joyce v Realm Marine Insurance Co Ltd (1871–1872) LR 7 QB 580. For example in Forsikringsaktieselskapet Vesta v Butcher [1989] 1 Lloyd’s Rep 331 the majority of the House of Lords gave the warranty in the reinsurance contract a meaning in the same way as of the original insurance. Furthermore, in Groupama Navigation et Transports & Ors v Catatumbo Seguros [2000] 2 Lloyd’s Rep 350, the Court of Appeal held that the inconsistency should be overcome by construing the reinsurance terms in the same way as of the direct policy. It should nevertheless be noted that in both cases the back to back presumption underlay the decisions. That presumption and these cases are examined in detail below. 57. (1871–1872) LR 7 QB 580. 58. Shipping Gazette, 7 June 1888. 59. Butler and Merkin, Reinsurance Law, para. B-127. The authors also submitted that Joyce did not create a general rule and applies only to the particular facts of the case. 60. Unreported, see Insurance Law Monthly March 2008, 1–4.

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against the retrocessionaire where the reinsurer acted in a bona fide and businesslike manner. HHJ Mackie QC applied the requirements of incorporation laid down in HIH Casualty & General Insurance Ltd v New Hampshire Insurance Co61 and held that “pay as may be paid” and “follow the settlements” clauses produced opposite results so that the two clauses were inconsistent with each other and the latter could not be incorporated into the retrocession agreement. 3.31 It is suggested that, while examining the effect of the incorporation wording in construing inconsistent terms, it is crucial to bear in mind that reinsurance and insurance contracts should be read according to their own terms as they are independent from each other.62 In other words, where the parties to the reinsurance make a specific agreement, this should not be disregarded.63 Obviously, problems are sidestepped if it is accepted that the “as original” wording has no function other than confirming that the terms of reinsurance match the original policy unless the parties agree otherwise. Moreover, even if the incorporation purpose is accepted, the Privy Council’s declaration in Australian Widows Fund Life Assurance Society v National Mutual Life Association of Australasia64 has made it clear that “subject to the same terms and conditions as original” should be construed as if it were prefaced with the words “except as herein otherwise provided.” 3.32 Contradiction between the terms of the original insurance and reinsurance may arise in different ways and Australian Widows’ Fund Life Assurance Society, Limited v National Mutual Life Association of Australasia, Limited65 is another example of this. In this case, by a policy dated 2 January 1908, the insurer (National Mutual Life) issued a policy of life insurance for P Moran for £5,000 with profits. The insurance policy provided that certain written statements made by Moran as to his health should be the basis of the contract, and that the policy should be void if they were untrue. The insurer applied to the reinsurers (Australian Widows’ Fund) for reinsurance cover on the same day. The reinsurance contract provided: “It is understood that in accepting the risk under this re-assurance the Australian Widows’ Fund Life Assurance Society, Limited does so on the same terms and conditions as those on which the National Mutual Life Association of Australasia, Limited have granted a policy and by whom, in the event of claim, the settlement will be made.”

3.33 Moran died in May 1909 and despite the reinsurers informing the insurer that they had reason to believe that some of the statements made by Moran were untrue and warning the insurer that they would not consent to a settlement, the insurer paid £5,000 in settlement of the claim. The insurer then sued the reinsurers. The insurer’s counsel argued the clause in the proposal for reinsurance was incorporated by the recital that the reinsurers had agreed to accept the insurer’s proposal, and effect must be given to the final words of that clause which provided that in the event of a claim the settlement was to be made by the respondents. The insurer argued that it was reasonable to suppose that the intention of the policy of re-insurance was that if the insurer bona fide concluded that it could not successfully resist a claim and accordingly paid, then the reinsurers were to be liable. The jury found that certain of Moran’s statements were untrue and that he had been guilty of concealment and misrepresentation, but the jury also found that the insurer acted reasonably and bona fide in settling the claim. Upon

61. 62. 63. 64. 65.

[2001] 2 Lloyd’s Rep 161. Australian Widows Fund Life Assurance Society v National Mutual Life Association of Australasia [1914] AC 634. Heath Lambert Ltd v Sociedad de Corretaje de Seguros [2004] Lloyd’s Rep IR 905. [1914] AC 634, 642. [1914] AC 634.

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the finding of the jury the Chief Justice of Victoria entered judgment for the reinsurers holding that on the true construction of the policy of reinsurance the liability of the reinsurers was conditional on the truth of the statements which the jury had found to be false, and that the reinsurers were not bound by the settlement effected by the insurer. The insurer appealed, and the Full Court of Victoria by a majority allowed the appeal and the High Court of Australia upheld the Full Court’s decision. The reinsurers appealed to the Privy Council, which overturned the decision of the lower courts. The Privy Council noted the clause in the original insurance which provided that the policy should be avoided if, inter alia, the proposal or any document on the faith of which the policy was granted contained any untrue statement, or if the person making the proposal had with a view of obtaining the policy made any false statement or been guilty of any concealment or misrepresentation. The policy of reinsurance contained a recital that the statements contained in the proposal and declaration were the basis of the contract, and were to be deemed to be part thereof and incorporated therewith. 3.34 The Privy Council held that the clause in the reinsurance policy whereby the reinsurer agreed to be bound by the same terms as the reinsured’s policy, was incorporated, so long as it did not contradict, the express provisions of the reinsurance policy. According to the Privy Council the effect of the insurer’s contention that the reinsurers were bound by the settlement by virtue of the words “by whom in the event of claim the settlement will be made” would bind the reinsurers to the settlement despite the fact that according to the express terms of the reinsurance, no liability had in fact arisen. The Privy Council refused to allow incorporation where it altered the perfectly clear provision of the reinsurance contract. Incorporation of Claims Clauses 3.35 In considering the possibility of incorporation, it is necessary to look at whether the term is potentially applicable in the reinsurance context. For instance, a time bar clause that requires the assured to make a claim in 12-month period running from the date of loss cannot be applied to claims made by the reinsured against the reinsurer, because a reinsurance loss differs from the direct loss. The issue came before the Privy Council in Home Insurance Co of New York v Victoria Montreal Fire Insurance Co.66 In this case the Western Assurance Company of Canada issued a policy for the Canadian Pacific Railway Company covering railway property situated in the United States of America, Canada and Mexico. Home Insurance reinsured the 20% of the risk and the defendant Victoria-Montreal Fire Insurance Company retroceded the Home Insurance reinsurance policy. On 26 April 1900, a good deal of property belonging to the Canadian Pacific Railway Company was destroyed by a fire. After a lengthy inquiry, Western Assurance indemnified the assured on 16 March 1901. The reinsurer then paid their proportion of loss on the following 13 April. The retrocessionaire then denied Home Insurance’s claim against them by relying on the limitation clause contained in the original policy, and alleged by them to be incorporated with and applicable to their policy of retrocession. 3.36 The clause in the original policy that the Victoria-Montreal based their argument provided “No suit or action on this policy for the recovery of any claim shall be sustainable in any court of law or equity until after full compliance by the insured with all the foregoing requirements nor unless commenced within twelve months next after the fire.” The Privy Council expressed their view that a clause as such, namely prescribing legal proceedings after a limited period is a reasonable provision in a policy of insurance against direct loss to specific property where the assured is master of the situation that he can bring his action immediately. In a case 66. [1907] AC 59.

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of reinsurance against liability however the reinsured cannot move until the direct loss is ascertained between parties over whom he has no control, and in proceedings in which he cannot intervene. Applying the same provision within the retrocession context might make an honest claim defeated in a case where there was no default or delay on the part of the reinsured or the reinsurer as the case may be. 3.37 A different approach may be arguably justified for claims co-operation clauses. Under liability policies, and particularly those written on a claims made basis, underwriters specify that they are to be informed of all circumstances that may give rise to claims against them, and also that the assured is not to incur any expense without their assent. Accordingly, in British General Insurance Company Ltd v Mountain the Lord Chancellor stated that the interest of the insurer in being kept closely informed of the making and development of claims was equally applicable to the relationship between reinsurer and reinsured.67 3.38 On the other hand, in Municipal Mutual Insurance Ltd v Sea Insurance Co Ltd,68 the reinsurance policies were worded “Conditions as underlying.” The reinsurers submitted that condition 3 was incorporated to the effect requiring the reinsured to have served notice on the reinsurers, and to allow the reinsurers to take control of the proceedings. Condition 3 of the original policy provided: ‘All injury, loss or damage, all accidents and all claims or legal proceedings arising out of such injury, loss, damage or accidents for which the company may be liable shall be reported to the company immediately and confirmed in writing. Every letter, claim, writ or other correspondence must be sent to the company immediately. No admission of liability waiver of rights or promise of payment shall be made without the company’s written consent. The company may for such period as it thinks proper take upon itself in the name of and on behalf of the Insured the absolute conduct and control of all negotiations and proceedings which may arise in respect of any claim for indemnity or damages and the Insured shall give the company all information and assistance as the company may require.’ 3.39 Referring to Lord Griffiths’ speech in Vesta Waller J recognised inappropriateness of certain terms of the underlying insurance forming terms of the reinsurance, and applied that consideration to condition 3 in this case. According to Waller J the condition should be written into the insurance contract on the basis suggested by the reinsurers. 3.40 The sense of this approach is illustrated by the judgment of Clarke J in CNA International Reinsurance Co Ltd v Companhia de Seguros Tranquilidade SA,69 where something akin to a rewriting of the contract could be discerned, although the decision was based on very clear and careful analysis. In this case a problem arose as to the meaning of a clause incorporated into the direct policy which stated, as translated, “This contract shall be subject to control claim if a claim arises.” Accepting the incorporation of this provision into the reinsurance,70 Clarke J found it appropriate to manipulate the word “insurer” as referring to “reinsurer.” He also described the clause in the direct insurance context as “obscure”; nevertheless the learned judge was convinced that the draftsman of the policy must have intended the claim to be controlled by someone and the only reference in the context was the reinsurer who took over 90% of the risk. Moreover, Clarke J took into account the fact that reinsurance and insurance 67. (1919) 1 Ll L Rep 605. In this case the original insurance contained a clause which required the assured not to incur any expense without consent of the underwriters and the reinsurance policy was subject to the same terms and conditions as original. However, no mention was made of any incorporation or back-to-back point. 68. [1996] CLC 1515. This case went to the Court of Appeal but incorporation of condition 3 did not arise on appeal. 69. [1999] Lloyd’s Rep IR 289. 70. “As original” wording was not the issue, but the reinsurance slip incorporated various wordings and also provided under the heading “interest” that the policy was to indemnify the assured for loss in the event of the cancellation of the concert. Clarke J accepted the argument that the interest clause was a reinsuring provision in its own right which had the effect of incorporating the underlying wording.

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contracts were assumed to provide back-to-back cover; therefore the terms of the reinsurance were to be interpreted in a way to fit the reinsurance although they were originally drafted for the purposes of insurance. 3.41 It should be pointed out that this discussion might have been avoided by accepting that reinsurers reinsure the liability of the reinsured under the original insurance contract. In that case, if the assured is in breach of a claims condition, and assuming that the term is a condition precedent, the insurer would be relieved from liability to the assured; as a result the reinsurer’s liability would not arise either. Accepting the contrary view resulted in a complex and unnecessary discussion. Incorporation of Implied Terms 3.42 At common law, where express terms do not deal with every aspect of performance of the contract,71 the terms may be implied in fact,72 in law,73 or by custom.74 The question is whether an implied term of the original insurance is to be incorporated into the reinsurance policy by means of the full reinsurance clause.75 On one hand the presumption of back-to-back cover seems to make incorporation of implied terms acceptable; on the other, it is possible to contend that the purpose of appending the original slip or policy to the reinsurance contract is to ensure that the reinsurer has seen the terms of the insurance and is aware of the nature of his risk. In HIH v New Hampshire,76 David Steel J expressed the view that implied terms would be incorporated into the contract of reinsurance. However it should be taken into consideration that the reinsurer cannot see the implied term while examining the original policy before signing the slip. As was stated above, onerous or unreasonable terms have been held not to be incorporated unless they had been notified to the reinsurers. Likewise, it would not be fair to compel the reinsurer to be bound by terms that were not apparent at the time the reinsurance contract was made. Incorporation of Arbitration Clauses Incorporation from Charterparty into Bills of Lading 3.43 It is settled law that a general incorporation clause only carries terms which are “germane to . . . the proper subject matter” of the incorporating contract, namely the clauses related to the receipt, carriage, or delivery of the cargo or the payment of freight.77 An arbitration clause governs dispute resolution and is not relevant to the performance of the contract of carriage; it takes effect as a self-contained contract collateral to the substantive agreement.78 As a

71. Unless the parties expressly excluded it. 72. Southern Foundries (1926) Ltd v Shirlaw [1940] AC 701; The Moorcock (1889) LR 14 PD 64 73. Liverpool City Council v Irwin [1977] AC 239; Scally v Southern Health and Social Services Board [1992] 1 AC 294. 74. Hutton v Warren 150 ER 517; Les Affreteurs Reunis SA v Leopold Walford (London) Ltd [1919] AC 801. 75. Recently, a few insurance cases have recognised implied terms: Goshawk Dedicated Ltd v Tyser & Co Ltd [2007] Lloyd’s Rep IR 224. In reinsurance context see Phoenix General Insurance Co of Greece SA v Halvanon Insurance Co Ltd [1985] 2 Lloyd’s Rep 599, but contrast the restrictive view adopted in Bonner v Cox [2006] Lloyd’s Rep IR 385. 76. [2001] 1 Lloyd’s Rep 378. 77. See Wilson, J, Carriage of Goods By Sea, 7th edn, 247–251; See, eg: Skips A/S Nordheim v Syrian Petroleum Co and Petrofina SA, The Varenna [1983] 2 Lloyd’s Rep 592; The Annefield [1971] 1 Lloyd’s Rep 1. 78. Bremer Vulkan Schiffbau und Maschinenfabrik v South India Shipping CorporationLtd [1981] AC 909; Heyman v Darwins [1942] AC 356; Black Clawson InternatiolLtd v Papierwerke Waldhof-Aschaffenburg AG [1981] 2 Lloyd’s Rep 446; Harbour Assurance Co (UK) Ltd v Kansa General International Insurance Co Ltd [1993] QB 701.

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result, because of the ancillary and separable nature of an arbitration clause, unless it is clearly and expressly provided, general words of incorporation do not operate on it.79 Incorporation from Direct Insurance into Reinsurance Contracts 3.44 In Pine Top Insurance Co v Unione Italiana Anglo Saxon Reinsurance Co80 the main purpose for rendering the reinsurance on the same terms as original was explained as being the provision of matching cover. For that reason, only the terms defining the period, geographical limit and the nature of the risk were held to be carried across, and an arbitration clause was held not to have been incorporated. The arbitration clause was classified as ancillary or collateral to the contract of reinsurance. This proposition is now well established.81 3.45 In Pine Top Home and Overseas Insurance issued insurance policies in respect of holiday travel, section 3 of which covered “Medical and other Expenses.” They then reinsured their excess of loss under section 3. “General Conditions” of the reinsurance slip provided: “All terms, clauses and conditions as original. To pay as paid thereon, but subject nevertheless to the terms, clauses and conditions of this reinsurance.” 3.46 The original insurance issued by Home and Overseas contained an arbitration clause for the resolution of disputes between the assured and the insurer. The reinsurance contract between Home and Overseas and the reinsurer also contained an express arbitration clause for the disputes between “the reinsured” and “the reinsurer.” The reinsurer transferred the risk to the retrocessionaire, but the retrocession contract did not contain an express reference to the arbitration clause as it only contained the “as original” wording. 3.47 The retrocessionaire declined to pay under the retrocession agreement and reinsurers sought to refer the dispute to arbitration. The issue was whether the reinsurer could do so by relying on the incorporation of the arbitration clause into the retrocession agreement. 3.48 Gatehouse J held that the word “all” in the general conditions did not mean “all.” Terms, which defined the risk, namely the period, the geographical limits and in this case section 3 could be incorporated but not the arbitration clause. 3.49 Having clarified that “as original” in the retrocession referred to the original contract but not the reinsurance agreement, Gatehouse J stated that the purpose of the as original clause was that the parties to this retrocession agreement were anxious to make sure that identical risks were covered. According to the learned judge, the “as original” wording was a convenient catch-all phrase which the parties to the retrocession contract used without considering whether it was repetitive and, therefore, strictly unnecessary. Applying the settled principles of the bills of lading cases Gatehouse J clarified that in order to incorporate the arbitration clause there should be an express reference to it in the retrocession slip. The judge also noted the wording of the arbitration clause, in that it referred to the disputes between the assured and the reinsured, and the judge

79. Hamilton and Co v Mackie and Sons (1889) 5 TLR 677; Thomas & Co Ltd v Portsea SS Co Ltd [1912] AC 1; The Elizabeth H [1962] 1 Lloyd’s Rep 172; The Njegos [1936] P 90; Federal Bulk Carriers Inc v Itoh & Co Ltd [1989] 1 Lloyd’s Rep 103. For incorporation clauses that expressly referred to the arbitration clause into charterparties: see The Rena K [1978] 1 Lloyd’s Rep 545; Pride Shipping Corp v Chung Hwa Pulp Corp, The Oinoussin Pride [1991] 1 Lloyd’s Rep 126; Daval Aciers D’Usinor et de Sacilor v Armare Srl, The Nerarno [1996] 1 Lloyd’s Rep 1; The Delos [2001] 1 Lloyd’s Rep 703; Merkin, Arbitration Law paras. 5.19–5.33; Todd, “Incorporation of Arbitration Clauses into Bills of Lading” [1997] JBL 331. 80. [1987] 1 Lloyd’s Rep 476. 81. Excess Insurance Co Ltd &Anor v Mander [1995] CLC 838; American International Speciality Lines Insurance Co v Abbott Laboratories [2003] 1 Lloyd’s Rep 267; Cigna Life Insurance Co of Europe SA-NV & Ors v Intercaser SA de Seguros y Reaseguros [2001] CLC 1356; OK Petroleum AB v Vitol Energy SA [1995] 2 Lloyd’s Rep 160.

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did not manipulate the words to the “reinsurer” and “retrocessionaire” because such manipulation would not be appropriate. 3.50 Incorporation of terms from the direct policy should be distinguished from incorporation of terms from other sources, such as standard market wordings.82 In the latter case problems may arise from inconsistency between the standard terms and the express terms of incorporating contract which the court will be required to resolve. For instance in Axa v Ace Global Markets83 the reinsurance was on “Full wording as EXEL 1.1.90.” Gloster J found it possible to reconcile the arbitration clause in standard EXEL wording with the English choice of law and jurisdiction clause in the reinsurance slip by holding that the latter related to supervision of the arbitration and challenges to any award and, accordingly held that the arbitration clause was incorporated with other standard clauses in EXEL 1.1.90. 3.51 In Axa Re v Ace Global Markets Limited, the reinsurer applied for a declaration under section 72(1)(a) of the Arbitration Act 1996 that a reinsurance contract does not, on its true construction, include an arbitration agreement. The reinsurance contract is contained in a reinsurance slip which provided: “Full wording as EXEL 1.1.90 with additional clauses, deletions, endorsements, special condition and warranties (at no additional premium) as follows: … This Contract shall be subject to English Law and Jurisdiction. Clause 15 of EXEL 1.1.90 is an arbitration clause in the following terms: 15.1 The parties agree that prior recourse to courts of law any dispute between them concerning the provisions of this contract shall first be the subject of arbitration. The issue on this application was whether or not, as a matter of construction, the reinsurance slip incorporated the arbitration clause contained in clause 15 of EXEL 1.1.90 into the reinsurance contract, notwithstanding the express incorporation of the English choice of law and jurisdiction clause in the slip.

3.52 Gloster J noted that the reference to EXEL 1.1.90 is a reference to the “Joint Excess Loss Committee excess loss clauses” dated 1 January 1990. EXEL 1.1.90 were in fact a set of standard trade or market terms and conditions. They were, in reality, standard reinsurance contract wordings in common use, the wording was widely available to reinsurance professionals, and could be found on various London Market databases. 3.53 Referring to AIG Europe SA v QBE International Insurance Ltd 84 and Excess Insurance Co Ltd v Mander,85 Gloster J held that the correct approach to be adopted when considering whether or not a jurisdiction clause is incorporated into a contract, is for the court to “construe the language of the contract in the context of its commercial background and ask itself whether a consensus on the subject matter of the jurisdiction clause is clearly and precisely demonstrated.” 3.54 The EXEL 1.1.90 wording was not attached to the slip but the judge found that given the fact that the wording was widely used as standard terms, the drafters of the slip had its provisions well in mind. The fact that the jurisdiction clause was specifically agreed, whereas the arbitration

82. For instance in CNA International Reinsurance Co Ltd & Ors v Companhia de Seguros Tranquilidade SA [1999] CLC 140 Clarke J found that incorporation of terms from standard market wordings was inevitable; otherwise there would be no terms of reinsurance. 83. [2006] Lloyd’s Rep IR 683. 84. [2001] 2 Lloyd’s Rep 268. 85. [1997] 2 Lloyd’s Rep 119.

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clause was incorporated only by reference, led to the conclusion that, if, indeed, there was an irreconcilable conflict between the two provisions, the specifically agreed jurisdiction clause would prevail, as was common ground between the parties. Gloster J nevertheless concluded that the two clauses could be read together in such a way as to avoid both conflict and surplusage, to the effect that the parties envisaged the possibility that the proceedings might take place in court but only after arbitration. Therefore, according to the learned Judge, the parties did not treat arbitration and judicial proceedings as mutually exclusive, but provided arbitration as a step which was to take place before any action in court. As to the reference to English jurisdiction, Gloster J construed it as referring to the supervision of the arbitration, to the law governing the arbitration in relation to matters arising in the course of the arbitration, and as fixing the appropriate court for any appeal proceedings in respect of the award. The Arbitration Act 1996 Section 6(2) 3.55 Pine Top and Excess Insurance Co Ltd & Anor v Mander86 pre-dated the Arbitration Act 1996. Section 6(2) of the Act provides that “the reference in an agreement to a written form of arbitration clause or to a document containing an arbitration clause constitutes an arbitration agreement if the reference is such as to make that clause part of the agreement.” The wording of the section seems to allow the incorporation of an arbitration clause from one document into another via general words of incorporation87. The Departmental Advisory Committee on Arbitration Law (DAC) report paragraph 42 left the issue to the courts to decide, In Trygg Hansa Insurance Co Ltd v Equitas Ltd,88 Raymond Jack QC ruled that this was a field in which the law should be clear, certain and well understood; therefore the Arbitration Act s. 6(2) did not change the settled view. Incorporation of Jurisdiction and Choice of Law Clauses 3.56 Just as in the case of arbitration clauses, jurisdiction clauses are also defined as freestanding provisions because they are related to resolving disputes rather than to the performance of the contract.89 Likewise, they are to be classified as ancillary provisions which the parties to the reinsurance would not normally intend to incorporate.90 Such clauses in direct insurance have nothing to do with defining the risk; thus they are wholly inappropriate to disputes arising between the parties to the reinsurance contract.91 It is settled that a jurisdiction clause is not incorporated unless there is express reference to it in the reinsurance agreement.92 The position at common law has been extended to determination of the validity of jurisdiction

86. [1995] CLC 838. 87. Hunter and Landau, The English Arbitration Act 1996: Text and Notes 1998, fn. 20. 88. [1998] 2 Lloyd’s Rep 439, applied in Cigna Life Insurance Co of Europe SA-NV & Ors v Intercaser SA de Seguros y Reaseguros [2001] CLC 1356. 89. Excess Insurance Co Ltd & Anor v Mander [1995] CLC 838; Trygg Hansa Insurance Co Ltd v Equitas Ltd [1998] 2 Lloyd’s Rep 439. 90. Assicurazioni Generali SpA v Ege Sigorta AS [2002] Lloyd’s Rep IR 480; The expression “all terms whatsoever” does not change the position: Siboti K/S v BP France SA [2003] 2 Lloyd’s Rep 364. 91. AIG Europe (UK) Ltd v Anonymous Greek Co of General Insurances, The Ethniki [1999] Lloyd’s Rep IR 221; Aikens J in Dornoch Ltd v Mauritius Union Assurance Co Ltd [2006] Lloyd’s Rep IR 127, affirmed [2006] Lloyd’s Rep IR 786. 92. AIG Europe (UK) Ltd v Anonymous Greek Co of General Insurances, The Ethniki [1999] Lloyd’s Rep IR 221. See also Hemsworth, “United Kingdom insurance decisions 2000”, [2001] LMCLQ 513; cf In K.H. Enterprise v Pioneer Container [1994] 2 AC 324 (a bill of lading case). See also: Joseph, Jurisdiction and Arbitration Agreements and Their Enforcement, para. 5.02; ARIG Insurance Co Ltd v SASA Assicurazione Riassicurazione SpA (unreported, see Barlow Lyde & Gilbert, Reinsurance Practice and the Law, para. 16–63.

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clauses in EC cases under Art 23 of the Brussels Regulation,93 which requires consensus to be clearly demonstrated.94 In Prifti v Musini Sociedad Anonima de Seguros y Reaseguros,95 Musini issued a direct policy for the Spanish football team Real Sociedad against the risk of players suffering accident or sickness. The direct policy was written for the year 1999–2000 and contained a jurisdiction clause that provided (in translation) that the courts of Spain had exclusive jurisdiction. The policy was renewed for the year 2000–2001 with the same terms. The risk was 98% reinsured in the London market and both 1999–2000 and 2000–2001 reinsurance slips were “as original” and contained a “full reinsurance clause”,96 while the first policy had an express reference to the direct policy wording, in the second reinsurance (for the renewal) there was no reference to the direct wording. 3.57 In April 2003 Real Sociedad commenced proceedings against Musini in San Sebastian for the permanent incapacity of the player Frederic Peiremans. Musini denied liability and also attempted join the reinsurers to the proceedings but this attempt was rejected by the Spanish court. The reinsurers commenced an action in England for a declaration of non-liability. Musini sought to have the English action stayed by relying on the exclusive jurisdiction agreement. 3.58 Andrew Smith J rejected the argument that the full reinsurance clause created a warranty that the original policy terms were the same as the reinsurance policy terms and therefore clear that the reinsurers were promising that reinsurance was subject to the terms of the insurance. The learned judge was of the view that the effect of the full reinsurance clause was to incorporate the terms of the original insurance into the reinsurance, but only those of germane to the subject matter of the insurance, and did not incorporate ancillary provisions.97 3.59 The same considerations have been taken into account in terms of incorporation of choice of law clauses.98 Under Article 3.1 of the Rome Convention,99 a choice of law must be

93. Council Regulation 44/2001. Art 23 provides: 1. If the parties, one or more of whom is domiciled in a Member State, have agreed that a court or the courts of a Member State are to have jurisdiction to settle any disputes which have arisen or which may arise in connection with a particular legal relationship, that court or those courts shall have jurisdiction. Such jurisdiction shall be exclusive unless the parties have agreed otherwise. Such an agreement conferring jurisdiction shall be either: (a) in writing or evidenced in writing; or (b) in a form which accords with practices which the parties have established between themselves; or (c) in international trade or commerce, in a form which accords with a usage of which the parties are or ought to have been aware and which in such trade or commerce is widely known to, and regularly observed by, parties to contracts of the type involved in the particular trade or commerce concerned. 2. Any communication by electronic means which provides a durable record of the agreement shall be equivalent to “writing.” 3. Where such an agreement is concluded by parties, none of whom is domiciled in a Member State, the courts of other Member States shall have no jurisdiction over their disputes unless the court or courts chosen have declined jurisdiction. 4. The court or courts of a Member State on which a trust instrument has conferred jurisdiction shall have exclusive jurisdiction in any proceedings brought against a settlor, trustee or beneficiary, if relations between these persons or their rights or obligations under the trust are involved. 5. Agreements or provisions of a trust instrument conferring jurisdiction shall have no legal force if they are contrary to arts 13, 17 or 21, or if the courts whose jurisdiction they purport to exclude have exclusive jurisdiction by virtue of art 22. 94. AIG Europe SA v QBE International Insurance Ltd [2001] 2 Lloyd’s Rep 268; AIG Europe (UK) Ltd v Anonymous Greek Co of General Insurances, The Ethniki [1999] Lloyd’s Rep IR 221; Salotti v RUWA Polstereimaschinen GmbH (Case 24/76) [1976] ECR 1831. Siboti K/S v BP France SA [2003] 2 Lloyd’s Rep 364. 95. [2004] Lloyd’s Rep IR 528. 96. “Being a reinsurance of and warranted subject to the same terms and conditions (excluding limits and rates) as and to follow the settlements of the reassured.” 97. [2004] Lloyd’s Rep IR 528, 533. 98. Gan Insurance v Tai Ping Insurance (No 1) [1999] Lloyd’s Rep IR 472. 99. Convention on the Law Applicable to Contractual Obligations opened for signature in Rome on 19 June 1980 (80/934/EEC).

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expressed or demonstrated with reasonable certainty, and a general incorporation provision is not to be regarded as having that effect. The position is even more clearly stated under the Rome I Regulation100 which applies to contracts concluded on or after 17 December 2009. Article 3.1101 of the Rome I Regulation requires any choice of law to be expressly or clearly demonstrated, which is by its terms a stricter test than that under the Rome Convention.102

100. Regulation (EC) No 593/2008 of the European Parliament and of the Council of 17 June 2008 on the law applicable to contractual obligations (Rome I). 101. Art 3.1 provides: A contract shall be governed by the law chosen by the parties. The choice shall be made expressly or clearly demonstrated by the terms of the contract or the circumstances of the case. By their choice the parties can select the law applicable to the whole or to part only of the contract. 102. See Merkin, “The Rome I Regulation and Reinsurance”, (2009) 5 JPIL 69.

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CHAPTER 4

SPECI F IC ISSU ES R ELAT I NG TO I NCOR POR AT ION

WA I V E R O F D E F E N C E S C L AU S E I N T H E O R I G I NA L I N S U R A N C E

4.01 It is difficult to see sometimes how a clause which is perfectly appropriate to a direct policy can operate between the parties to the reinsurance contract. An illustration of this is HIH Casualty & General Insurance Ltd v New Hampshire Insurance Co1 which raised the position of a waiver of defences clause by which the direct insurer waived its right of disclosure from the assured and of avoidance in case of misrepresentation. The full facts of this case were given earlier in the discussion of the general criteria for the incorporation into reinsurance of terms from the direct policy,2 but are outlined here for the sake of convenience. Clause 8 of the original policy provided: “8. Disclosure and/or waiver of rights 8.1. To the fullest extent permissible by applicable law, the Insurer hereby agrees that it will not seek to or be entitled to avoid or rescind this Policy or reject any claim hereunder or be entitled to seek any remedy or redress on the grounds of invalidity or unenforceability of any of its arrangements with Flashpoint Ltd or any other person (or of any arrangements between Flashpoint Ltd or the Purchaser) or non-disclosure or misrepresentation by any person or any other similar grounds. The Insurer irrevocably agrees not to assert and waives any and all defences and rights of set-off and/or counterclaim (including without limitation any such rights acquired by assignment or otherwise) which it may have against the Assured or which may be available so as to deny payment of any amount due hereunder in accordance with the express terms hereof.”

4.02 One of the preliminary issues in this case was the construction of clause 8, in particular whether or not the clause was incorporated into the reinsurance contract to the effect that the reinsurers did not have the right to avoid the reinsurance contract on grounds of misrepresentation or non-disclosure. 4.03 At first instance,3 David Steel J followed the analysis of Clarke J in CNA International Reinsurance Co Ltd & Ors v Companhia de Seguros Tranquilidade SA4 and held that the provision in question could be incorporated in its manipulated form, namely the word “insurer” could be read as referring to the “reinsurer.” Accordingly, the term was incorporated into the contract of reinsurance, operating as waiver of defences between the reinsurer and the reinsured. The Court of Appeal5 disagreed with that construction. Rix LJ, delivering the leading

1. 2. 3. 4. 5.

[2001] 2 Lloyd’s Rep 161. See Chapter 3. [2001] 1 Lloyd’s Rep 378. [1999] Lloyd’s Rep IR 289. [2001] 2 Lloyd’s Rep 161.

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judgment held that the judge’s conclusion did not answer the question of what the provision actually achieved as a term in the reinsurance agreement. If the clause was incorporated in its manipulated form, it would mean that any separate breach of duty by the reinsured would be waived by reason of the independent operation of the clause in reinsurance context. Moreover, incorporation in its manipulated form did not achieve back-to-back cover. Rix LJ expressed the view that the clause made perfectly good sense in its unmanipulated form as it operated as a follow the settlements provision. By that provision, reinsurers undertook to follow the reinsured’s settlements so long as they were bona fide and businesslike. When the reinsured, who contractually waived his rights to rely on breach of the duty of utmost good faith, made payment to the assured in circumstances where he would otherwise have had a good faith defence, the reinsurer would be obliged to indemnify the reinsured for the reason that he recognised such payment by the incorporation of the waiver of defences clause. 4.04 The judgment of Rix LJ is significant in distinguishing the fact of incorporation and the effect of incorporation. Accordingly, while incorporation can be achieved by means of the “as original” wording, the incorporated clause may not create new rights between insurers and reinsurers. The function of incorporation can be described as merely recognition of the effect of the clause in the direct policy and the clause may operate as no more than a follow the settlements provision.

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4.05 The original insurance may be replaced with a fresh policy after the reinsurance has been effected. In such a case the question would be whether the new policy terms are covered by the phrase “original policy or policies” in the general words of incorporation. In Lower Rhine and Würtemberg Association v Sedgwick,6 the phrase “the original policy or policies” was held to embrace only the direct policy in existence at the time that the reinsurance contract was made. In this case the underwriter, Mr Sedgwick, issued two insurance policies: The first policy was issued for the ship Collynie against sea perils to provide coverage from 20 February 1896 until 20 February 1897. The second policy was written four months later, against the same risks, to provide coverage from 20 June 1896 until 20 June 1897. The amount insured was £350 in the first policy and £850 in the second policy. The hull and machinery is valued at £5600 – hull at £3,600 and the machinery at £2,000 in both policies. 4.06 The reinsurance policy was written on 27 November 1896 to provide cover from 4 November 1896, to 20 June 1897, to the amount of £250; the hull and machinery being together valued at £5,600. The reinsurance provided: “Being a reinsurance of policy or policies” (here a blank space was left unfilled) “and subject to the same terms, conditions, and clauses as original policy or policies, whether reinsurance or otherwise, and to pay as may be paid thereon.” 4.07 The ship was lost on 3 May 1897, after the first policy underwritten by Mr Sedgwick had expired and after the second policy had been cancelled. 4.08 On 20 February 1897, after the reinsurance policy had been written Mr Sedgwick underwrote a new risk upon the Collynie to cover her from 20 February 1897 to 20 February 1898. This policy valued the hull and machinery of the Collynie at £5,000. The point at stake was as the ship was lost after the first policy was expired and the second policy was cancelled,

6. [1899] 1 QB 179.

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whether or not the reinsurance policy provided coverage for the policy of 20 February 1897, which was issued after the reinsurance policy was underwritten. Resolution of the dispute much depended on the construction of the clause in the reinsurance contract which was left blank after “Being a reinsurance of policy or policies (here a blank space was left unfilled) and subject to the same terms, conditions, and clauses as original policy or policies . . .” Mr Sedgwick submitted that because the space had been left blank, the reinsurers had reinsured any liability Mr Sedgwick might undertake by underwriting any policy or policies upon the ship Collynie subsequent to the reinsurance being effected, if the loss then insured against occurred during the time the reinsurance was running. 4.09 The court did not agree with Mr Sedgwick. The “original policy or policies” mentioned in the clause were held to be the two original policies then in existence.7 Even though it would have been possible to construe the clause as covering policies issued after the reinsurance, the later dated policies had to contain the same terms, conditions, and clauses as the original policy or policies in order to be covered by the reinsurance contract. The policy of 20 February 1897 was materially different8 from the other two policies by valuing the ship at £5,000 but not £5,600. The difference can be illustrated in this way: Suppose that the ship had been damaged and the cost of repairs had been £5,250. In that case the reinsured would have had to pay for a total loss, because the cost of repairs would have exceeded the agreed value. However, the ship would not have been a constructive total loss under the reinsurance policy as the agreed value of the ship was £5,600 and the reinsured would have been entitled to only recover an average loss from his reinsurers. 4.10 In addition to the replacement of the original policy, the same problem arises when the original terms have been modified without making a fresh contract. This was the point at stake in Norwich Union Fire Insurance Society Ltd v Colonial Mutual Fire Insurance Co Ltd 9 where the subject matter of the insured was revalued without issuing a fresh policy. McCardie J rejected the argument that the Sedgwick case should be distinguished, as the original policy under which the reinsurer agreed to provide indemnity remained in force despite the revaluation of the subject matter insured. The learned judge recognised that alteration of the direct policy without the consent of the reinsurer would throw the reinsurer into a position of danger, difficulty and doubt.10 Moreover, “valued as original policy” referred to the valuation in the original policy in respect of which the reinsurance was obtained and it was not to be interpreted “as valued in the original policy as amended from time to time.” Therefore he held that the materially changed policy was not the same as the original policy that the reinsurer had contracted for. 4.11 However, the phrase may cover the replacement policy if its provisions are not materially different from that of the previous agreement.11 This principle was applied in Scottish National Insurance v Poole12 where the loss of the infamous Titanic was in issue. In this case two steamships, the Titanic and the Olympic, were insured in January 1911 while in shipyard for a period of 12 months after delivery. Following the original insurance,

7. [1899] 1 QB 179, 188, 189, 191. 8. Ibid., 187–188. 9. [1922] 2 KB 461. 10. Ibid., at 470. 11. In Lower Rhine and Würtemberg Association v Sedgwick [1899] 1 QB 179, revaluation of the old original policies had been found to be a material change that did not bind the reinsurers. However see North Star Shipping Ltd v Sphere Drake Insurance plc and others (No 2) [2006] 2 Lloyd’s Rep 183 where valuation of the subject matter insured was found an immaterial fact in terms of the assured’s duty of disclosure. Kiln, Reinsurance in Practice, 12. 12. (1912) Com Cas 9.

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reinsurance and retrocession contracts had been effected. The Olympic was delivered in May 1911, but the Titanic was not delivered until April 1912. As it had not been at risk until after the 12-month period ended, another policy was issued in January 1912 upon the same terms as the January 1911 policy. When the Titanic was lost shortly after her delivery in April 1912, the issue was whether the second policy issued in January 1912 cancelled the preceding year’s slip, so that there remained nothing in force to which the reinsurance could attach. Bray J’s answer to this question was in the negative and he emphasised that even if that had been the case, the result would not have changed as the two policies were not materially different from each other.13 4.12 Consequently, it is now settled that a materially modified primary insurance contract, either by issuing a new policy or alteration of the original policy terms only, is not counted as the original policy within the meaning of the full reinsurance clause. 4.13 Such disputes can always be avoided by an express term in the reinsurance contract which requires the reinsured to consult the reinsurers and obtain their consent to all amendments to the terms of the direct policies. In HIH Casualty & General Insurance Ltd v New Hampshire Insurance Co14 the reinsurance policy provided: “The Reinsured hereon agrees to consult and obtain Reinsurers’ agreement to all amendments and alterations to the terms, clauses and conditions of the Original Policy.”

4.14 Having classified this clause as “warranty” David Steel J15 declared that this provision gave contractual substance to the principle established by the abovementioned authorities.

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4.15 It may be asked whether amendments to the original policy without the reinsurer’s consent amount to a breach of the continuing duty of utmost good faith on the part of the reinsured. Two issues need to be considered. The first is whether the duty of utmost good faith can be extended to the period after the contract has been concluded. If so, the second question is determining the proper remedy in the event of breach. 4.16 In the earlier authorities the continuing duty of utmost good faith was applied where the contract expressly required the assured to provide information material to the underwriter.16 In Black King Shipping Corporation v Massie (The Litsion Pride)17 the owners of the 13. (1912) Com Cas 9, 15. Emanuel v Andrew Weir (1914) 30 TLR 518 also based on the same facts, but the parties were different. In this case the reinsurer issued the policy after the Titanic was lost and in order to make the Sedgwick case applicable the reinsurer stated in the policy that the original policy meant the policy initialled in January 1911. The judge applied Scottish National Insurance v Poole (1912) Com Cas 9, and held that when the second slip was initialled in January 1912 a suggestion was made that the insurance on the second slip should be treated so far as the Titanic was concerned, not as a renewal but a confirmation of the original 12 months. However, as opposed to the approach of Bray J, the judge construed the first policy as coming into force on 18 May 1911, when the Olympic came under the risk and he stated that the policy had been in force until 18 May 1912. 14. [2001] 2 Lloyd’s Rep 161. 15. [2001] 1 Lloyd’s Rep 378; approved by Rix LJ, [2001] 2 Lloyd’s Rep 161, 183. 16. Black King Shipping Corporation v Massie (The Litsion Pride) [1985] 1 Lloyd’s Rep 437; Continental Illinois National Bank of Chicago v Alliance Assurance Co Ltd (The Captain Panagos) [1986] 2 Lloyd’s Rep 470. Malcolm Clarke in The Law of Insurance Contracts, 5th edn, Informa, 2006 comments at para. 27-1A1 that: “The duty continues throughout the contractual relationship at a level appropriate to the moment.” 17. [1985] 1 Lloyd’s Rep 437.

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vessel Litsion Pride insured it against war risks. The policy incorporated the War Risk Trading Warranties which provided, inter alia, that: “1 (A) This coverage shall extend worldwide, but in the event of a vessel . . . insured hereunder sailing for . . . or being within the Territorial Waters of any of the Countries or places described in the Current Exclusions . . . additional premium shall be paid at the discretion of Insurers . . . (B) Information of such voyage . . . shall be given to Insurers as soon as practicable and the absence of prior advice shall not affect the cover . . .”

4.17 The vessel sailed to a port in the Persian Gulf, later nominated as Bandar Khomeini which was at the time by far the most dangerous port in the Gulf attracting additional premium at a very substantial rate. The assured alleged that he sent a letter to the insurers on 2 August 1982 informing them about the voyage and asking for the underwriters’ advice accordingly. The brokers did not receive that letter until 12 August. The vessel sank after an attack while sailing towards the Gulf on 9 August 1982. The occurrence of the casualty was notified by telex to the brokers on 11 August 1982. 4.18 The evidence showed that the assured was at the time was insolvent and not able to pay any additional premium. Hirst J found that on the evidence the owners did intend to run the risk of trying to slip in and out of the Gulf in the hope of not being discovered and avoiding the additional premium. The assured alleged that notice was given to the insurers but had been delayed. Hirst J found the assured fraudulent in relation to the letter allegedly sent on 2 August and in relation to the claim. However, Hirst J also alternatively analysed the continuing duty of utmost good faith of the assured. The learned judge commented that the assured is in breach of continuing duty of utmost good faith because there is a contractual requirement for the assured to give the underwriter information which is material. The fact that the assured was required to give notice – entering into a war zone – in this case was material because it would influence the judgment of a prudent underwriter in making a decision under the contract; therefore the assured was under the continuing duty to make full disclosure of all material facts, whether or not he realises their materiality, and not simply to refrain from dishonest, deliberate or culpable concealment. Hirst J also found that section 17 of the Marine Insurance Act 1906, provided that the policy may be avoided, not that it must be avoided and here in the case of post-contract breach it was open to the underwriters simply to defend the claim without avoiding the policy. 4.19 In the Litsion Pride Hirst J was prepared to hold that the duty not to make claims in breach of the duty of utmost good faith is an implied term of the policy. However, this opinion should be approached with care because in Pan Atlantic Insurance Co Ltd v Pine Top Insurance Co Ltd18 the House of Lords stated that the duty of utmost good faith is not based on any implied term and arises ex contractu as a matter of law. Lord Hobhouse’s comment in Manifest Shipping Co Ltd v Uni-Polaris Insurance Co Ltd (The Star Sea)19 is interesting that their Lordships suggested that. “A coherent scheme can be achieved by distinguishing a lack of good faith which is material to the making of the contract itself (or some variation of it) and a lack of good faith during the performance of the contract which may prejudice the other party or cause him loss or destroy the continuing contractual relationship. The former derives from requirements of the law which pre-exist the contract and are not created by it although they only become material because a contract has been entered into. The remedy is the right to elect to avoid the contract. The latter can derive from express or implied terms of the contract; it would be a contractual obligation arising from the contract and the remedies are the contractual 18. [1994] 2 Lloyd’s Rep 427. 19. [2001] 1 Lloyd’s Rep 389, 400.

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remedies provided by the law of contract. This is no doubt why Judges have on a number of occasions been led to attribute the post-contract application of the principle of good faith to an implied term.”

4.20 In The Star Sea,20 the issue was whether alleged false statements made by the assured in the course of legal proceedings on the policy gave the insurers the right to avoid. The House of Lords analysed the issue by addressing whether or not the claim was fraudulent and as the insurer was unable to prove the assured’s fraud, the insurer was held liable. However, the House of Lords also commented on the continuing duty of utmost good faith and expressed their doubt about existence of such duty; however they also noted that even if there is a continuing duty of utmost good faith, it ends when the proceeding before the court begins. Moreover, Lord Hobhouse found that the remedy of avoidance ab initio was disproportionate.21 This opinion on the remedy was also confirmed by the Court of Appeal in K/S Merc-Scandia XXXXII v Lloyd’s Underwriters (The Mercandian Continent)22 where it was held that although the proper remedy for breach of the duty of good faith was avoidance ab initio, that remedy was disproportionate to the post-contractual situation;23 instead, it was appropriate to invoke the remedy of avoidance in a post-contractual context only where the underwriter had the right to treat the entire contract as discharged by reason of the assured’s repudiatory breach.24 4.21 The point at issue here is that there is no specific mention of any continuing duty in the MIA 1906. It was decided by the majority of the Court of Appeal in Container Transport International Inc v Oceanus Mutual Underwriting Association (Bermuda) Ltd25 that although sections 18 and 20 of the MIA 1906 dealt only with pre-contractual disclosure and misrepresentation, those sections were illustrations of the wider duty in section 17. In Phoenix General Insurance Co of Greece SA v Halvanon Insurance Co Ltd 26 Hobhouse J declared that a continuing duty of utmost good faith could be implied into a proportional reinsurance contract, although his decision did not turn on that point and he ultimately decided that the reinsurers were protected by a series of implied terms. A narrower view of the continuing duty was adopted in Bonner v Cox27 where Waller LJ in the Court of Appeal emphasised that good faith was purely a pre-contractual matter and that rights and obligations after placement were governed by the terms of the contract, and he implicitly doubted whether the implied terms suggested by Hobhouse J could be justified. It was also ruled in Bonner v Cox that neither a mere entitlement to cancel the policy by serving a notice of cancellation, nor a mere increase of the

20. [2001] 1 Lloyd’s Rep 389. 21. [2001] 1 Lloyd’s Rep 389, 400. 22. [2001] 2 Lloyd’s Rep 563. 23. Under the pre-contractual duty of utmost good faith, what should be voidable is the decision induced by the failure to disclose material facts and the agreement as to alteration of the original policy should not make the entire policy avoidable as there had been no breach of duty at the stage of formation of contract. See Bennett, The Law of Marine Insurance, (2nd edn, Oxford: Clarendon Press, 2006) para. 4.196. 24. At the time K/S Merc-Scandia XXXXII v Lloyd’s Underwriters (The Mercandian Continent) was decided, Waller LJ in Alfred McAlpine plc v BAI (Run-off) Ltd [2000] Lloyd’s Rep IR 352 had suggested that the insurer had the right to treat the claim as repudiated, leaving the policy itself untouched. However, these comments were rejected by a majority of the Court of Appeal in Friends Provident Life & Pensions Ltd v Sirius International Insurance Corp [2005] 2 Lloyd’s Rep 517, where the existence of the concept of repudiation of a claim was rejected for the reason that insurers were entitled to deny payment to the assured only where they were entitled to repudiate the policy as a whole, and there was no concept of partial repudiation in English law. See also Ronson International Ltd v Patrick [2006] Lloyd’s Rep IR 194, aff’d [2007] Lloyd’s Rep IR 85; Lowry and Rawlings “Innominate Terms in Insurance Contracts” [2006] LMCLQ 135, 139. 25. [1984] 1 Lloyd’s Rep 476. 26. [1985] 2 Lloyd’s Rep 599. 27. [2006] Lloyd’s Rep IR 385.

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risk, would create a continuing duty of utmost good faith.28 The approach of Waller LJ now appears to represent the English law approach. In Goshawk Dedicated Ltd v Tyser & Co Ltd29 Rix LJ held that the duty of utmost good faith was not free-standing, but rather formed the basis for the implication of a term. In Goshawk the assured was held to be subject to an implied term to supply the insurers (through his broker) with placing and claims information which they had previously seen, and also premium information. The implied term was derived from the continuing duty of utmost good faith, but took effect contractually rather than on the free-standing basis that characterises the duty of utmost good faith. 4.22 More recently, in HLB Kidsons v Lloyd’s Underwriters,30 the duty was discussed in relation to a notification of circumstances clause in a claims-made liability policy. Toulson LJ accepted and Rix LJ agreed that under such circumstances “it is impliedly incumbent on the insured to see that any such notification is a fair, if summary, presentation of what the insured knows.” Both accepted that there might be an argument for a continuing duty of good faith in these circumstances. Toulson LJ felt that the appropriate remedy for a breach of the duty was a holding that the notification is invalid; however, their Lordships did not express a firm view on the matter. 4.23 This rather complex debate aside, the continuing duty of utmost good faith seems to have almost no practical significance in the insurance context since it is difficult to think of a situation in which failure to comply with an information clause could be repudiatory.31 In the reinsurance context, irrespective of any clause requiring notification of increase of risk, the better view is that if risk has altered materially, the reinsurers would automatically be discharged from any further liability as a matter of law32 and there is no need to consider breach of contract. However, as was said in K/S Merc-Scandia XXXXII v Lloyd’s Underwriters (The Mercandian Continent)33 breach of such a clause is a breach of contract and does not necessarily amount to a breach of the continuing duty of utmost good faith because obligations regarding the duty of disclosure after placement are governed by the terms of the contract. 4.24 It should be noted that the Australian Law Reform Commission’s Report No. 20 34 suggested that the post-contractual duty should be treated as an implied term of the contract of insurance, and that recommendation was implemented as section 13 of the Insurance Contracts Act 1984 (Cth).35 Consequently, the remedy for breach of duty of utmost good faith is 28. Manifest Shipping Co Ltd v Uni-Polaris Insurance Co Ltd (The Star Sea) [2001] 1 Lloyd’s Rep 389. 29. [2007] Lloyd’s Rep IR 224. 30. [2009] Lloyd’s Rep IR 178. 31. Merkin, Marine Insurance Legislation, 18–19; See also Colinvaux & Merkin’s Insurance Contract Law, para. A-724. 32. Swiss Re v United India Insurance [2005] Lloyd’s Rep IR 341. 33. [2001] 2 Lloyd’s Rep 563 at 576. 34. Insurance Contracts, 1982. This report can be found at: www.austlii.edu.au/au/other/alrc/publications/reports/20/. The same reform was suggested for the Marine Insurance Act 1909 (Cth) but it was not implemented. See ALRC 91 Review of the Marine Insurance Act 1909 (2001). This report can be seen at: www.austlii.edu.au/au/other/ alrc/publications/reports/91/. See Derrington “Marine Insurance Law In Australia: The Australian Law Reform Commission Proposals” [2002] LMCLQ 214–230. 35. Section 13 provides that “A contract of insurance is a contract based on the utmost good faith and there is implied in such a contract a provision requiring each party to it to act towards the other party, in respect of any matter arising under or in relation to it, with the utmost good faith.” A detailed legal and practical analysis on the Australian Law Reform was undertaken by Merkin on behalf of the English and Scottish Law Commissions. The report “Reforming Insurance Law: Is There a Case for Reverse Transportation?” where s. 13 is discussed can be seen on www.lawcom.gov.uk/docs/merkin_report.pdf . In July 2010 the Law Commissions published an Issues Paper on the assured’s post-contractual duty, but this paper is for the most part confined to fraudulent claims (which are probably best regarded as falling outside the continuing duty in any event) and says little about the desirability of a continuing duty. Issues Paper 7: “The Insured’s Post-Contract Duty of Good Faith” can be found at www.lawcom.gov.uk/docs/ issues7_duty-of-good-faith.pdf (last visited on 23 July 2010).

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contractual. This gives rise to a much wider and more appropriate range of remedies than are currently available under the MIA 1906, including damages.36 However in the reinsurance context, the implied term proposal approach should be viewed in the light of the definition of reinsurance as “a business between consenting adults”,37 and it is most unlikely after Bonner v Cox that the courts would imply a term that the parties could have adopted themselves. Furthermore, it is noteworthy that the 1984 Act does not apply to reinsurance.38 4.25 After the making of the contract, if the assured seeks to obtain additional cover and applies to the insurer for the appropriate extension by means of an endorsement, he is required to disclose material facts relating to the application and at this stage duty of disclosure will also be relevant.39 It has been suggested that the preferable approach is that breach of such duty renders voidable only the extension itself and does not vitiate the entire policy.40 This is consistent with K/S Merc-Scandia XXXXII v Lloyd’s Underwriters (The Mercandian Continent),41 where Longmore LJ stated that only the extended cover and not the entire policy would be voidable even though the breach occurred during the currency of the policy. Accordingly, the endorsement would be avoided and the claim would be looked at according to the agreement that was before the endorsement. In reinsurance context, consistently with the principles mentioned above, a materially altered original policy would not be binding on the reinsurers but the reinsured’s claim would be viewed according to the underlying policy terms before the alteration (ie in the form that the reinsured agreed to follow). The reinsurers would simply not be bound by the alteration because the altered original policy would not be the policy within the meaning of “as original.”

L E A D I N G U N D E RW R I T E R C L AU S E I N T H E O R I G I NA L P O L I C Y

4.26 In the London Market it is often the case that in insurance contracts a follow the leader clause confers authority on the leading underwriter to agree certain matters on behalf of the following market. The clause may authorise the leading underwriter to alter the slip42 and this raises the question whether the reinsurer is bound by the alteration of the original policy effected by the leading underwriter. This was the issue in American International Marine Agency v Dandridge43 where the judge held that the leading underwriter clause in the direct policy could not be incorporated into the reinsurance agreement. The claimants participated as following insurers the insurance of the vessel “Avon” for12 months from 30 March 2000 under a hull and machinery (H&M) policy incorporating the Institute Time Clauses (Hulls) CL. 280 dated 1/10/83. The original policy also provided that the vessel was classed with

36. Derrington, “Marine Insurance Law in Australia: The Australian Law Reform Commission Proposals”, 222; Soyer, “Continuing Duty of Utmost Good Faith in Insurance Contracts: Still Alive?” [2003] LMCLQ 39, 75. 37. Reinsurance Practice and the Law, 1-1. 38. 1984 Act, s. 9(1)(a). 39. Lishman v Northern Maritime Insurance Co (1875) LR 10 CP 179; Gaughan v Tony McDonagh & Co [2006] Lloyd’s Rep IR 230; Merkin, Colinvaux’s Law of Insurance para. 6-106. 40. Fraser Shipping Ltd v Colton [1997] 1 Lloyd’s Rep 586; Groupama Insurance Co Ltd v Overseas Partners Re Ltd [2004] 1 CLC 779; O’Kane v Jones [2004] 1 Lloyd’s Rep 389; Limit No 2 Ltd v Axa Versicherung AG [2008] 2 CLC 673; Merkin, Colinvaux’s Law of Insurance, para. 6-106; Bennett, para. 6-106. 41. [2001] 2 Lloyd’s Rep 563, 575. 42. Barlee Marine Corp v Trevor Rex Mountain (The Leegas) [1987] 1 Lloyd’s Rep 471. The leading underwriter may also be authorised to agree the terms of the policy (Unum Life Insurance Co of America v Israel Phoenix Assurance Co Ltd [2002] Lloyd’s Rep 374) or to waive conditions (Roadworks v Charman [1994] 2 Lloyd’s Rep 99). 43. [2005] Lloyd’s Rep IR 643.

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DNV and its existing rating class was maintained. Moreover the policy provided automatic terminations in case of the change of the Classification Society of the Vessel unless the Underwriters agreed to the contrary in writing. The risk was reinsured by the defendant on the terms as “Being a reinsurance and subject to the same clauses and conditions and against the same perils as in the original policy or policies but only against the Risks of Total and/or Constructive Total and/or Arranged Total and/or Compromised Total Loss of vessel.” The original policy contained a leading underwriter clause which provided: “Following French Market Leaders (Axa Global Risks) in all respects, including rates and claims but excluding “ex gratia.” The vessel ran aground on 9 September 2000, and was thereafter declared a total loss. Prior to the casualty Axa agreed “orally” to cover the vessel on the terms that its class had been changed, and its value was reduced from US$2.5 million to US$1.5 million and after the casualty, on 13 September 2000 Axa agreed so in writing, by an endorsement No. 10. The claimants issued an endorsement No. 7 to the Binder in respect of the vessel’s change in class and noted in writing the change in the vessel’s value. The claimants paid US$225,000 in respect of a claim for constructive total loss of the vessel but the reinsurers denied liability. The question was whether or not the follow the leader clause was incorporated into the reinsurance contract by virtue of the reinsuring clause of the reinsurance policy to the effect that Axa’s agreement to change the class and to reduce the value of the vessel binding for the reinsurers. 4.27 Mr Siberry QC held that the clause was not incorporated because it did not meet any of the requirements that were set out by HIH Casualty & General Insurance Ltd v New Hampshire Insurance Co44: first, the clause was neither germane nor apposite to the reinsurance policy. The follow the leader clause concerns the relationship between the leading underwriter and the following market, as well as that between the following market and the assured. Therefore the clause does not make sense in the reinsurance context. According to Mr Siberry QC, there is mutual interests between the leading underwriter and the following market, but the same interest is not found between the leading underwriter and the following market on the one hand, and reinsurers on the other. For example the reduction in insured value agreed by the leading underwriter may be the interests of insurers but such a reduction would have been potentially very prejudicial to the reinsurers’ interests who reinsured for total loss only. The judge also refused to follow the comment of the Court of Appeal in by HIH Casualty & General Insurance Ltd v New Hampshire Insurance Co45 on the effect of incorporation of clause 8.1. Clause 8.1 in HIH, according to Mr Siberry QC, directly related to the relationship between the assured and the reinsured whereas the follow the leader clause is not directly related to the same kind of relationship. Secondly, in its unmanipulated form,46 the clause does not make sense in the reinsurance because Axa were not the leaders of the reinsurers. Mr Siberry QC found that it was obviously not the intention of the parties to the reinsurance that reinsurers should follow Axa in respect of rates, whether in respect of the value of the subjectmatter insured or of any alteration thereto made up their own minds as to the appropriate rates for the total loss only cover they wrote. Thirdly, the follow-the-leader clause would have been inconsistent with the other terms of the reinsurance if it had been incorporated because as it was held in Norwich Union Fire Insurance Society Ltd v Colonial Mutual Fire Insurance Co Ltd47 the interest clause in the reinsurance policy which provided “Valued at

44. [2001] 2 Lloyd’s Rep 161. 45. Ibid. 46. The reinsured did not raise incorporation of the follow the leader clause in its manipulated form, therefore Mr Siberry QC did not discuss the manipulated form of the clause. 47. [1922] 2 KB 461.

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US$2,500,000 or as valued in original policy or policies and/or Interest as original” does not mean “as valued in the original policy as amended from time to time”. But if the follow the leader clause was incorporated, it would, as the reinsured contended, follow that the applicable valuation was that set out in the original policy or “any amendment thereto agreed by Axa.” As a result, the amendments in question were not binding upon the reinsurers and the reinsureds were in breach of classification warranties in the reinsurance with the result that reinsurers were discharged from liability under the reinsurance. 4.28 To a certain extent, Mr Siberry QC’s concerns are explicable, but his reasons are unconvincing.48 The distinction between the fact of incorporation and the effect of incorporation could have been recognised for the incorporation of the follow the leader clause as well. As a matter of fact, the result achieved in HIH was that the function of incorporation could be described as merely recognition of the effect of the clause in the direct policy, and operated as no more than a follow the settlements provision. The effect of the follow the leader clause would be that the reinsured would be bound by alteration agreed to by the leading underwriter and consequently the reinsurer would be forced to accept the amended terms that the reinsured had secured according to the alterations of the policy. If the effect of incorporation was adopted as it had been in the HIH case, neither of the reasons of the trial judge would have been applicable to the case.

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4.29 It has not yet been settled whether the “as original” wording imposes upon the reinsured any duty corresponding to that to which the assured is subject under the original policy. All depends upon the nature of the obligation and the applicability or appropriateness of the clause at the level of reinsurance. For instance, in Sulphite Pulp Co Ltd v Faber 49 the same premises had been insured by various leading fire insurance companies including NBMC. Clause 6(d) of its policy provided: “So long as this insurance remains in force the insured shall notify to the company and have specified in the policy if some other insurance is taken out, or any insurance previously effected ceases.” Later on the assured took out a second fire policy from a Lloyd’s Underwriter which was “subject to the same terms and conditions as a policy or policies of the [NBMC] . . . on identical interest, and in the case of loss it is hereby agreed to settle hereon according to the adjustment adopted by the said company or companies.” Failure to adhere to this clause was to render the policy void. The property insured was destroyed by fire, but before the fire occurred, renewal of all of the earlier policies was declined. This fact was not disclosed to the Lloyd’s underwriter, who sought to determine the second policy for breach of clause 6(d) in the earlier policy. Lord Russell of Killowen CJ held that the clause requiring the assured to notify the insurer if any insurance previously taken out ceased to operate was not inconsistent with the terms of the reinsurance agreement and the obligation was equally applicable to the assured of the later effected insurance policy. Consequently the Lloyd’s policy was held to have incorporated the terms and conditions of the NBMC policy, including clause 6(d), so that the Lloyd’s underwriter was entitled to regard the assured in breach of that condition. 4.30 Similarly, in Home Insurance Co of New York v Victoria Montreal Fire Insurance Co50 the question was the applicability to the retrocession agreement of a time bar clause in the

48. Butler and Merkin, Reinsurance Law, para. B-0149/2. 49. (1895–1896) 1 Com Cas 146. 50. [1907] AC 59.

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original policy. The assured made a claim in the 12-month period allowed by the original policy, but because of lengthy negotiations with the reinsured, the reinsurers could not submit their claim against the retrocessionaire before the 12-month period had expired. The Privy Council considered the applicability of the time bar clause to the retrocession agreement and took account of the fact that a time bar clause made sense in an insurance contract as the assured is the master of the situation, but the reinsurer could not move until the direct loss had been ascertained between the assured and the reinsured. According to their Lordships this rendered the clause inappropriate to the contract between the reinsurer and the retrocessionaire.51 Moreover, in Municipal Mutual Insurance Ltd v Sea Insurance Co Ltd 52 the term requiring the assured to ask written consent of the insurer prior to incurring legal costs was found to be inappropriate to the reinsurance contract. 4.31 Nevertheless, the court may be keen on giving some purpose to incorporation of the reinsurance is not on the same terms as original but incorporates the same standard wording as original as has been seen from the earlier discussion of Axa v Ace Global Markets53 and in CNA International Reinsurance Co Ltd v Companhia de Seguros Tranquilidade SA.54

OT H E R F O R M S O F I N C O R P O R AT I O N W O R D I N G

4.32 The full reinsurance clause may be qualified to overcome the requirements of incorporation set out in HIH Casualty & General Insurance Ltd v New Hampshire Insurance Co.55 For instance, in Property Insurance Company Ltd v National Protector Insurance Company Ltd 56 the retrocession contract was “subject without notice to the same clauses and conditions. . . .” Scrutton J interpreted the phrase “without notice” as a declaration by the retrocessionaire that he would accept the terms of the original policy without notice of what the clauses and conditions were, to the effect that the retrocessionaire waived his right to claim to be informed about the unusual clauses in the policy.57 This case confirms the importance of the nature of the clause that is to be incorporated. As indicated above, in some cases the reasons for accepting incorporation are based on the usual nature of the clause. It can be said that the expression “without notice” can override the obstacle caused by its unusual character. In other words, while in the ordinary case, successful incorporation of an unusual clause is subject to the reinsurer being informed of the existence of that clause, the words “subject without notice the same terms and conditions” overcome the problem and permit incorporation whatever the nature of the clause.

51. In Home Insurance Company of New York v Victoria – Montreal Fire Insurance Company [1907] AC 59 the full reinsurance clause was not the issue, but the reinsurance and retrocession were effected by attaching to a printed form of fire insurance policy a typewritten slip or rider containing the special terms of the so-called reinsurance. The printed form was not amended except by the insertion of the syllable “re” before the word “insure” thus substituting the expression “does re-insure” for “does insure.” Lord MacNaghten interpreted this as incorporation of the original insurance into the reinsurance contract, but he distinguished some provisions that could not be applicable to the reinsurance. 52. [1996] CLC 1515, 1527. Cf Friends Provident Life & Pensions Ltd v Sirius International Insurance Corp [2005] 2 Lloyd’s Rep 517, where the Court of Appeal accepted the incorporation of notice provision into the excess insurance from the primary insurance. 53. [2006] Lloyd’s Rep IR 683.. 54. [1999] Lloyd’s Rep IR 289. 55. [2001] 2 Lloyd’s Rep 161. 56. (1913) Com Cas 119. 57. He also pointed out that the clause was in written form and not printed. This also convinced him as to the parties’ intentions regarding the function of the words “without notice.”

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4.33 In Groupama Navigation et Transports v Catatumbo CA Seguros58, the contract of insurance provided hull and machinery cover to a Venezuelan company in respect of a fleet of vessels including Guasare XI and Guasare XII for the period of one year from 20 June 1996. Clause 3(e) of the policy provided, inter alia: “Guarantee of maintenance of class. . . .” The reinsurers agreed to provide 50 per cent facultative reinsurance cover to the insurer in respect of liability under the insurance contract. The reinsurance contract was in the form of a slip policy which provided, inter alia: “All terms clauses conditions warranties . . . as original and to follow all decisions settlements agreements of same in every respect . . . Warranted existing class maintained.59”

4.34 The two vessels were heavily damaged in a storm. During the course of the investigations it emerged that the vessels, while subject to regular surveys, were not actually classed at the time of the casualty or indeed at any time during the currency of the cover. 4.35 Under Venezuelan Law, any breach of warranty under the underlying insurance would not give defence to the insurer unless it was causative to the loss. Therefore the insurer paid; but the reinsurers sought a declaration that they were discharged from all liability by virtue of the consequent breach of warranty contained in the slip policy. 4.36 David Steel J60 rejected the argument that the warranty in the reinsurance cover was to be regarded as “free standing.” The learned judge was of the view that the warranty in the reinsurance cover was to be construed so as to produce the same effect as the underlying warranty as to class. The Court of Appeal61 disagreed with David Steel J on the point that the warranties were surplusage but they reached the same conclusion that the warranties in the insurance contract and the reinsurance slip should be construed according to Venezuelan law. Their Lordships considered the nature of the reinsurance which was proportional and therefore they noted that in proportional reinsurance contracts there was a presumption that, in the absence of clear words to the contrary, the scope and nature of the cover afforded was the same as the cover afforded by the insurance. The “as original” wording carried through the presumption into the wording of the slip and the presumption and the “as original” wording incorporated the warranties in the insurance into the reinsurance. The Court of Appeal found no significant difference between the warranties in the insurance policy and the slip. Subsequently, the two warranties that the reinsurance slip contained (ie the express warranty and the incorporated warranty) were essentially the same. Therefore the Court of Appeal concluded that the incorporated warranties must have the same effect in both contracts and had to be construed to mean that the reinsurers’ liability would be discharged only where the breach was caused by the loss. The parties’ intention was held not to give different effect to the terms of the slip; if it had been the intention, the parties should have done so clearly. 4.37 In Groupama the facts were to some extent different from Vesta v Butcher62 as in the latter there was no express reinsurance warranty. Therefore it is arguable that the express warranty in the reinsurance slip was a clear intention of the reinsurers to make the warranty to be

58. 59. 60. 61. 62.

[2000] 2 Lloyd’s Rep 350. Emphasis added. [2000] 1 Lloyd’s Rep 266. [2000] 2 Lloyd’s Rep 350. [1989] 1 Lloyd’s Rep 331.

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subject to the English law construction. However, in Groupama, the Court of Appeal did not distinguish Vesta v Butcher and no consideration was given to the parties’ intention in putting an express warranty in the reinsurance policy; the decision rather focused on the presumption and incorporation of warranties which led to the conclusion that the reinsurance slip contained two warranties which in wording were not significantly different to each other. Tuckey LJ expressed the view that although it made it repetitive, having warranties in the reinsurance policy must have a purpose and this purpose was to provide identical interpretation with the original insurance.63 Mance LJ also commented that the reinsurance warranty could be regarded as provisional, designed to be effective only if there was no such warranty in the direct cover. It can thus be seen that where there is a warranty in the original insurance which is not significantly differently worded to the reinsurance slip warranty, the presumption and the incorporation will prevent independent operation of the reinsurance warranty unless the parties to the reinsurance contract clearly state that the reinsurance warranty is subject to a construction independent of applicable to the original insurance warranty. 4.38 With respect, it is submitted that the Court of Appeal’s construction is not consistent with the requirements of incorporation, as incorporation of the original insurance provisions is permitted only if incorporation does not create any inconsistency.64 Obviously, in both Groupama and Vesta, warranties, breach of which requires causative links with the loss, were inappropriate to the reinsurance policies which were governed by English law.65 In both cases the disputes were resolved by virtue of incorporation of the original insurance warranty into reinsurance and the two contracts were construed back to back. However, as distinct from Vesta, in Groupama, the reinsurance contact had its own warranty. Therefore, the effect of the Court of Appeal’s judgment in Groupama is that an incorporated term can override an express term of the reinsurance contract, but perhaps only where there is something equivalent to the reinsurance provision in the direct policy. Although there are authorities indicating that the express terms of the reinsurance dealing with premiums could not be overridden by any incorporated provision,66 Groupama remains good law. On the other hand the principle stated in Groupama seems to be inapplicable to the cases where the insurance and reinsurance contracts contain warranties in different and irreconcilable terms. Moreover GE Reinsurance Corporation v New Hampshire Insurance Co67 makes it clear that an express warranty in the reinsurance policy can be assessed independently where the original policy does not contain any equivalent clause. Langley J held that neither the presumption of back-to-back cover nor the incorporation wording could be used to oust an express provision in the reinsurance contract if there was no clause in the original policy which regulated the same issue.68

63. [2000] 2 Lloyd’s Rep 350, 354. 64. Home Insurance Company of New York v Victoria – Montreal Fire Insurance Company [1907] AC 59; Pine Top Insurance Co Ltd v Unione Italiana Anglo Saxon Reinsurance Co Ltd [1987] 1 Lloyd’s Rep 476. See also Municipal Mutual Insurance Ltd v Sea Insurance Co Ltd & Ors [1996] CLC 1515 where the reinsurance stated “conditions as underlying” but it was found to be wrong in principle to apply the presumption so as to distort or disregard the terms of the reinsurance contracts in order to make them match the direct policy. 65. In Groupama at first instance David Steel J accepted that express warranties in the reinsurance policy precluded incorporation, but the Court of Appeal disagreed. Moreover in Vesta, referring to Home Insurance, Lord Griffiths came close to accepting that a warranty appropriate to the insurance policy but inappropriate to the reinsurance policy could not be incorporated, but he based his decision on the principle that the reinsurance and the insurance contracts were back-to-back and the warranty was to have the same effect in both. 66. Heath Lambert Ltd v Sociedad de Corretaje de Seguros [2004] Lloyd’s Rep IR 905. 67. [2004] Lloyd’s Rep IR 404. 68. It was also pointed out that there was no implied term in a reinsurance agreement that the reinsurers would not rely upon a defence not available to the reinsured. See also Dornoch Ltd v Mauritius Union Assurance Co Ltd [2006] Lloyd’s Rep IR 786.

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4.39 The presumption of back-to-back cover is simply a rule of construction69 and if both Vesta and Groupama had been decided by taking into consideration only the back-to-back nature of the contracts, the same results could have been achieved with less complicated reasoning. For example in Vesta, the reinsurer took over 90% of the liability of the reinsured under the original contract of insurance. There was no contrary indication in the reinsurance contract; therefore it could be presumed that the insurance and reinsurance were back-toback. Hence because the original insurer was liable under Norwegian law, the reinsurer should have been required to reimburse the reinsured regardless of the different laws applicable to those two contracts. Nevertheless adopting the view that the “as original” clause incorporated the direct policy terms into the reinsurance contract led the House of Lords into a long and complicated discussion. Similarly, the incorporation point made the reasoning in Groupama more difficult, because the Court of Appeal first had to decide if the incorporated warranty was in conflict with the reinsurance warranty; it then discussed the construction of the incorporated warranty in the reinsurance contract. Incorporation is problematic because it is now possible to argue that clauses, even though inconsistent with the reinsurance policy, can be incorporated into it. Moreover, the presumption of back-to-back cover is unlikely to be applicable because the presumption operates unless the reinsurance contract contains anything contrary to the original policy terms. However, the Court of Appeal in Groupama did not find any significant difference between the original insurance and the reinsurance warranty and applied the incorporation and the presumption of back-toback cover to construe the reinsurance warranty in line with the original insurance warranty. Therefore only inserting an express warranty would not be sufficient to construe a reinsurance warranty according to English law, the parties are required to make it clear that the reinsurance warranty will be subject to an independent construction to that of the original insurance terms. 4.40 It has been suggested that in fact incorporation adds nothing to the presumption of back-to-back cover as regards insuring clauses70. These two cases aside, many other considerations strengthen the view that the presumption is sufficient on its own to solve the disputes. For instance in Marten v Steamship71 the dispute was simply resolved by applying the principle that the terms of reinsurance and insurance were identical. Even though the reinsurance contract contained no words of incorporation, Bigham J found no impediment to holding that the object of the reinsurance policy was to indemnify the reinsured against the risk of total loss covered by the policy which they themselves had issued.72 Furthermore it has been decided that the presumption of back-to-back cover does not extend to ancillary terms such as claims control, law and jurisdiction and arbitration clauses.73 Consequently it appears that even if there are no incorporating restrictions, the presumption on its own has the same function as that created by the incorporation rules. Accordingly, whether or not the two contracts are back-to-back can be left to be determined by the wording of the agreements themselves and there is no need for incorporation.

69. GE Reinsurance Corporation v New Hampshire Insurance Co [2004] Lloyd’s Rep IR 404. In American International Marine Agency v Dandridge [2005] Lloyd’s Rep IR 64, 3 para. 40, it was said that the incorporation issue was dependent on the parties intentions objectively ascertained from the surrounding circumstances. 70. Merkin, “Incorporation of Terms into Reinsurance Agreements”, 99. 71. (1902) Com Cas 195. 72. Cf General Insurance Co of Trieste Ltd v Corporation of the Royal Exchange (1897) 2 Com Cas 144 where Mathew J accepted that the clause had been incorporated from the reinsurance into the retrocession contract, but could have reached the same result by simply applying the presumption. 73. Per Tuckey LJ in Groupama Navigation et Transports v Catatumbo CA Seguros [2000] 2 Lloyd’s Rep 350 at 354.

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4.41 It should also be noted that Lord Griffiths in Vesta called for urgent consideration of the redrafting of the London Market standard forms of reinsurance policy.74 However redrafting is not the only way of preventing the problems that the incorporation theory has so far created. The solution could be accomplished plainly by recognising that the “as original” wording only affirms that the terms of insurance and reinsurance are identical and that incorporation does not add anything to the presumption which can operate independently of incorporation. Nevertheless, after the House of Lords’ decision in Wasa International Insurance Co Ltd v Lexington Insurance Co75 the applicability of the presumption of back-to-back cover has become more restricted. The decision is not directly related to the relationship between incorporation and the presumption but by not applying the principle of the presumption of back-to-back cover to the case before them, the House of Lords created uncertainty as to the scope and applicability of the presumption.

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4.42 Although it is less commonly the case, facultative reinsurance agreements can be nonproportional, as where the reinsurer reinsures a layer of the liability of the insurer on a single risk.76 The question whether incorporation is inevitable in such contracts that have been worded “as original” has not yet been tested. 4.43 The main arguments, when rejecting the operation of the presumption in non-proportional agreements, are that, in contrast to proportional transactions, the parties cannot be classified as coadventurers since reinsurers assess the merits of writing particular business on different criteria, depending on where they fitted into the insurance chain.77 A direct insurer may issue various policies under which he can fix the deductible and limit of liability according to his knowledge of the policy holders and of the likely size and incidence of the insured risks. On the other hand an underwriter who takes a line on a layer of an excess of loss contract must take a much broader view, as he cannot rate the individual policy holders and individual risks directly. Therefore if the parties intend to give the same effect to their respective contracts, they could write them in the same terms. Accordingly, it becomes arguable that, because the presumption does not operate in non-proportional facultative contracts, general words of incorporation have the significant function of incorporating the provisions of the original insurance into the reinsurance agreement. 4.44 It should nevertheless be borne in mind that there may be cases in which the presumption can operate although the contract is not proportional. For example in Goshawk Syndicate Management Ltd v XL Speciality Insurance Co78 an excess of loss reinsurance was worded “All as per original.” Morison J took into consideration that the reinsurer charged two-thirds of the premium set by the reinsured for the insurance, and held that the cover should match the underlying insurance as far as possible although it was not a classic fronting arrangement. This approach could be open to doubt if this assumption has no factual basis.79 However it appears that the answer much depends on the overall intention of the parties to be back-toback based on the terms and incorporation.

74. [1989] 1 Lloyd’s Rep 331, 338. 75. [2009] 2 Lloyd’s Rep 508. 76. For instance if the reinsurer reinsures 100% of the reinsured’s liability in excess of £200,000 up to £400,000, if the loss is £100,000 the reinsurer pays nothing, whereas if the loss is £400,000 the reinsurer pays £200,000. 77. AXA Reinsurance (UK) Plc v Field [1996] 2 Lloyd’s Rep 233; American Centennial Insurance Company v Insco Limited [1996] LRLR 407; Municipal Mutual Insurance Ltd v Sea Insurance Co Ltd & Ors [1996] CLC 1515. 78. [2004] Lloyd’s Rep IR 683. 79. Merkin, “Reinsurance”, Ins LM, November 2004, 11.

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CHAPTER 5

I NCOR P OR AT ION I N T H E LAW OF T H E U N I T E D STAT E S

5.01 In US reinsurance policies do not have a standard Full Reinsurance Clause. Sometimes – but not often – reinsurance policies contain a “follow the form” clause that is similar in effect to the “as original.” Matters related to the construction of the follow the form clauses that have come before the US courts are discussed below.

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5.02 As stated above, there is no standard full reinsurance clause in use in the US. However, analogous to the phrase “as original” in the “full reinsurance clause” used in England, reinsurance policies may contain a “follow the form” clause. The typical wording is as follows:1 “This Policy is subject to the same warranties, terms and conditions (except as otherwise provided herein) as are contained in or as may be added to the Underlying Coverage prior to the happening of an accident or occurrence, whichever is applicable, for which claim is made hereunder.”

Unlike the London market, it is not necessarily the case in the US that the “follow the form” clauses are used with “follow-the-settlements/fortunes” clauses. 5.03 In Aetna Cas and Sur Co v Home Ins Co2 the District Court for the Southern District of New York clarified that the “follow the form” clause is used to express the match between the reinsurance and insurance coverage. This principle is discussed in the following paragraphs.

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5.04 A reinsurance policy which includes a follow the form provision has been said to “expressly limit the reinsurance to the terms and conditions of the underlying policy and provide that the reinsurance certificate will cover only the kinds of liability covered in the original policy issued to the insured.”3 It should be noted that there are few cases which have discussed the construction of “follow the form” clauses. One of those rare cases where the court touched upon the function of the clause in reinsurance contracts is Aetna Cas and

1. Aetna Cas and Sur Co v Home Ins Co 882 F.Supp. 1328, (SDNY, March 27, 1995). 2. 882 F.Supp. 1328, (SDNY, March 27, 1995). 3. North River Ins Co v CIGNA Reinsurance Co, 52 F.3d 1194, (3rd Cir. (NJ) Apr 13, 1995); City of Renton v Lexington Ins Co (USA), Not Reported in F.Supp.2d, 2007 WL 2751356 (WD Wash.)

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Sur Co v Home Ins Co.4 In this case the issue went back to the 1970s when the assured, AH Robins Company, Inc, introduced the Dalkon Shield intrauterine birth control device. Soon after the initial sales of the product Robins withdrew it from the market due to numerous complaints of physical injuries and other problems related to its use, such as uterine perforations and infections, unwanted pregnancies and spontaneous abortion. As a result of the claims asserted against it from 1973 to 1985 relating to the Dalkon Shield, Robins had to pay approximately US$530 million. With several thousand cases still pending in various courts, Robins became insolvent. 5.05 Aetna Casualty and Surety Company issued primary and excess products liability insurance policies to Robins, and Home Insurance Company reinsured Aetna. Aetna settled Robins’ claims on the basis that Aetna did not apply the loss limitation policy cap to defence costs incurred in defending third-party claims against Robins. The question was whether the reinsurer was liable to indemnify Aetna for the amount of the settlement with Robins, which also included defence costs incurred by Robins. The District Court for the Southern District of New York determined that the resolution of the dispute depended on the interpretation of the Ultimate Net Loss clauses in the original insurance. This issue is discussed in detail in Chapter 7 below, in the context of “Defence costs.” But the point worth noting here is that in order to ascertain the scope of the reinsurance policy the court focused on the follow-the-form clause within the reinsurance agreement and clarified the function of the clause in reinsurance contracts. The Home reinsurance contracts for the 1972, 1973 and 1974 policy years were stated to be “following the terms, conditions and limitations of the Aetna [Excess Insurance Policies].” The 1976 Home policy stated that the policy “is following the terms, conditions, exclusions and limitations of the Aetna [Excess Insurance Policy].” 5.06 The court was of the view that the follow the form clause clarified the type and scope of loss that was reinsured by Home because a “following form” clause in a policy of reinsurance incorporated by reference all the terms and conditions of the reinsured policy, except to the extent that the reinsurance contract by its own terms specifically defined the scope of coverage differently, (eg via an exclusion).5 The District Court stated that the use of a following form clause confirmed the concurrency between the reinsurance and original insurance policies. Thus, where the reinsurer agrees to follow the form of the original insurance, unless the reinsurance policy contains an exclusion or other provision contrary to the direct insurance, the policy of reinsurance will be construed as offering the same terms, conditions and scope of coverage as exist in the reinsured policy. Consequently, if the original insurance policy is triggered, it should follow that the reinsurance policy is also triggered. 5.07 The construction of the follow the form clause came before the US Court of Appeals for the Second Circuit in Travelers Cas & Sur Co v Ace American Reinsurance Co.6 The Second Circuit stated that the presumption that the liability limits of the reinsurance contract applied in a manner concurrent with those of the original insurance policies was not a matter of law, but a matter of simple contract interpretation. In Travelers v Ace, Travelers issued insurance policies between 1971 and 1985 providing coverage excess of umbrella policies issued to Dow Corning Corporation by the Home Insurance Company. The excess of loss 4. 882 F.Supp 1328, (SDNY, March 27, 1995). 5. See also Travelers Cas and Sur Co v Insurance Co of North America, 609 F.3d 143, (3rd Cir. (Pa) Jun 09, 2010). Travelers Cas and Sur Co v Ace American Reinsurance Co 392 F.Supp.2d 659, (SDNY, Oct 12, 2005); aff’d by the second circuit: 201 Fed.Appx. 40, (2nd Cir. (NY) Oct 18, 2006). 6. 201 Fed. Appx. 40, (2nd Cir. (NY) Oct 18, 2006).

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insurance policies issued by Travelers provided annual aggregates. These excess policies included the following terms: Policy period: 6/11/72 to 6/11/75: ‘30% ($4,500,000 Maximum) Quota Share of $15,000,000. Each Occurrence.’ ‘30% ($4,500,000 Maximum) Quota Share of $15,000,000. Annual Aggregate.’

The policies covering the periods from 6/11/75 to 6/11/78 also contained the similar wording that ‘Each Occurrence’ and ‘Annual Aggregate’. ACE reinsured the Travelers policies; the reinsurance certificates, however, were worded slightly differently. They stated: Policy period: 6/11/72 to 6/11/75: ‘$4,500,000 CSL each occ.-agg. part of $15,000,000 CSL each occ. agg. excess of $9,000,000 CSL each occ.-agg. which is excess of underlying insurance.’ Reinsurance Accepted: $1,500,000 CSL each occ.-agg. part of $4,500,000 CSL each occ.-agg..”

Similarly, the ACE reinsurance policies issued for the period 6/11/75 to 6/11/78 had the wording of “. . . each occ.-agg. . . .” Each of the ACE Three-Year Reinsurance Certificates included a follow the form clause with the following wording: “the liability of the Reinsurer . . . shall follow that of the Company and except as otherwise specifically provided herein, shall be subject in all respects to all the terms and conditions of the Company’s policy.”

Travelers subsequently extended the reinsurance provided under two of the three ThreeYear Certificates for two additional years; the renewed certificates were similar to the ACE policies; they contained a follow the form clause and provided: “Reinsurance Accepted: ‘$1,250,000 CSL each occ.-agg. part of $10,000,000 CSL each occ.-agg.’.

5.08 During these policy periods, as a result of its engagement in, inter alia, the business of manufacturing, selling, and distributing silicone breast implants Dow Corning Corporation was exposed to thousands of product liability claims which subsequently led Dow to bring an action against Travelers for coverage. In November 1994, Travelers entered into a settlement agreement with Dow resolving the coverage dispute between them. In June 2004 Travelers made a claim against ACE for $12,070,615.98 for payment on claims settled pursuant to its 1994 settlement with Dow. ACE refused payment. The dispute between the parties was whether the Three-Year Certificates provided coverage up to a single aggregate limit for the three-year period or for three annual aggregate limits. ACE’s exposure would be significantly expanded if the reinsurance certificates were interpreted to provide three annual aggregate limits. 5.09 Travelers argument was that the follow the form clause, which was found in each reinsurance wording, expressed the clear intention of the parties to have the terms of the Three-Year Certificates mirror the terms of the underlying, reinsured excess policies. ACE however focused on the language of the Certificates which included no reference to “annual” aggregate limits. 5.10 The District Court for the Southern District of New York7 interpreted the follow the form clause in conformity with Aetna v Home and held that the clause incorporated the terms of the direct insurance policies into the reinsurance certificates – subject to exclusions or other

7. 392 F.Supp.2d 659, (SDNY, Oct 12, 2005); aff ’d by the Second Circuit: 201 Fed.Appx. 40, (2nd Cir. (NY) Oct 18, 2006).

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provisions in the reinsurance agreements. As for the construction of the reinsurance and direct insurance policy terms the court found that the operative language was unambigous leaving no room for extrinsic evidence. Since the contracts were unambigious, the intent of the parties must be gleaned from within the four corners of the instrument. The court accepted that the abovementioned function of the follow the form clause necessarily expanded the coverage of the reinsurance beyond its literal terms. 5.11 The court noted that the presumption of concurrency between the two policies can be overridden where the liability terms of the certificate differ from those in the underlying policy. This, however, was not applicable to the instant case for the relevant and operative language used in the underlying excess policies and the reinsurance coverage was identical: both used the abbreviation “each occ.-agg.” to describe the relevant coverage period. Accordingly, because the certificates did not explicitly limit the coverage terms of the underlying policy, the presumption of concurrency between the excess policy and the certificates was not overridden. As a result, without considering any extrinsic evidence, the court concluded that the only reasonable interpretation of the phrase “each occ.-agg.” was that each Three-Year Certificate provided coverage for three annual aggregate limits. 5.12 ACE appealed, but the US Court of Appeals for the Second Circuit affirmed the District Court judge’s decision. The Second Circuit pointed out that neither “occurrence” nor “aggregate” was defined in the reinsurance certificates whereas they were defined in the insurance policies and again, under the direct insurance policy terms the “aggregate” applied on an annual basis. According to the Second Circuit, the reinsurance certificates used “agg” to describe the indisputably annualised aggregate limit of the insurance policies. The use of the term “agg,” did not “otherwise specifically provide” that the aggregate liability limits in the reinsurance certificates did not follow the form of the direct insurance policies. Therefore the concurrency between the two contracts remained in place; the reinsurance certificate should be interpreted the same way as the original policy. The only reasonable interpretation of the phrase “each occ.-agg.” in the Certificates was that each Three-Year Certificate provided coverage for three annual aggregate limits. 5.13 Another form of concurrency is seen in Commercial Union Ins Co v Swiss Reinsurance America Corp8 where the reinsurance policy included a follow the form clause. In this case the primary insurance provided coverage to Grace under five successive one-year policies for personal injury and property damage up to $1 million per occurrence. Commercial Union’s excess liability policies provided coverage in the amount of $5 million for each “occurrence.” The Commercial Union policies included follow the form clauses stating that “the terms, conditions and limitations of this policy will not be construed any more restrictive [sic] than the terms, conditions and limitations of Underlying Insurance.” Swiss Re issued three multi-year facultative reinsurance policies to Commercial Union, thereby agreeing to share a specified portion of Commercial Union’s liability to Grace. Swiss Re agreed to take 50% of the first $1 million, so that its cover for any one occurrence giving rise to a claim exceeding $1 million was $500,000. In addition to providing follow the fortunes provisions the Swiss Re certificates contained a follow the form clause which provided that “ – except as ‘otherwise specifically provided’ in the certificate, Swiss Re’s liability would ‘follow’ or ‘be subject’ to the ‘terms and conditions’ of Commercial Union’s policies.” Thus, according to the US Court of Appeals for the First Circuit, through follow the form clauses, Swiss Re’s policies looked back to Commercial Union’s, and the latter’s policies in turn looked back to the primary policies issued to Grace. 8. 413 F.3d 121, (1st Cir. (Mass) Jun 27, 2005).

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5.14 Commercial Union settled Grace’s pollution claims based on an “annualisation approach,” on the unarticulated premise that $5 million per occurrence limit in its multi-year umbrella policies applied separately to each policy year. Swiss Re contested the allocation and argued that the leakage at any one site during the three-year period covered by its certificate comprised a single “occurrence.” If the leakage during the three-year period comprised one occurrence, then Commercial Union’s liability to Grace for a three-year leak would be capped at $5 million and Swiss Re’s liability to Commercial Union would be $500,000 (50% of the first $1 million). 5.15 The First Circuit held that Swiss Re’s argument would have been stronger if the reinsurance contract had not contained a follow the form clause. The court stated that, as the court had held in Aetna Cas and Sur Co v Home Ins Co,9 concurrency between the policy of reinsurance and the reinsured policy is provided where a reinsurance policy contains a follow the form clause and the reinsurance contains no conflicting provisions to the original insurance. Under Swiss Re’s follow the settlements clause it was bound to accept this pro-annualisation reading of the Commercial Union policy to establish Commercial Union’s liability to Grace. According to the First Circuit, Swiss Re’s follow the form clause was deemed to extend this reading into the parallel language in Swiss Re’s own certificates subject only to any clear limitation to the contrary in the Swiss Re policies which defined single occurrence as including a “continuous or repeated exposure to conditions” and did not include additional language “within a single year.” 5.16 Aetna was also cited with approval by the First Circuit in American Employers’ Ins Co v Swiss Reinsurance America Corp10 where the follow the form clause was worded as: “The liability of [Swiss Re] specified in Item 4 of this Certificate shall follow that of [American], and except as otherwise specifically provided herein, shall be subject in all respects to the terms and conditions of [American’s] policy.”

The First Circuit stated that such clauses were designed to provide conformity between the terms of coverage under reinsurance and underlying insurance policies.11 5.17 In Philadelphia Ins Co v Washington Ins Co12 the issue was whether the reinsurance and original policies were co-extensive despite the fact that the reinsurance was a voyage policy and the original insurance was a time policy. On 15 August 1848 the Washington Insurance Company issued the original insurance on the brig Delaware. The insurance was for the sum of $3,000, on the basis of lost or not lost and “at and from June 6th, 1848, at noon, for five calendar months, with use of the Globe (Tampico and ports in Texas at all seasons excepted); and if at sea at the expiration of the time, the risk to continue at same rate of premium.” On the same day the Philadelphia Mutual Insurance Company reinsured the risk for $1,500 on the terms that “at and from Rio de Janeiro to Havana, and at and from thence to Philadelphia.” The issue arose out of the loss that occurred as a result of the casualties on 30 August on her voyage to Havana and between 9 January and 27 January on her voyage from Havana to Philadelphia. The reinsurer argued that because of the different nature of the reinsurance and original insurance policies, the reinsured did not have insurable interest to take out the reinsurance policy. The preliminary issue, therefore, was actually the reinsured’s insurable interest, but the court nevertheless referred to the coextensive nature of the reinsurance and original insurance policies. The Supreme Court of Pennsylvania determined that the original insurance 9. 10. 11. 12.

882 F.Supp. 1328, (SDNY, March 27, 1995). 413 F.3d 129, (1st Cir. (Mass) Jun 27, 2005). Citing Aetna Cas & Sur Co v Home Ins Co, 882 F.Supp. 1328, 1337 (SDNY March 27, 1995). 23 Pa 250, 1854.

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was for five months and the insurer insured any risk that might occur during that period. The reinsurer’s risk was on a specific voyage, therefore lesser, and included within that of the reinsured. The insurance was against perils of the sea, so the reinsurance had to be against perils of the sea; but whilst it could not be against more, it might be against fewer perils of the sea than the original insurance. To the extent that the reinsurance and original insurance provided identical cover with respect to the voyage reinsured, the two policies were coextensive.

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5.18 As stated above, it is accepted under New York law that a follow the form clause in a policy of reinsurance incorporates by reference all the terms and conditions of the reinsured policy, except to the extent that the reinsurance contract by its own terms specifically defines the scope of coverage differently.13 Unlike English law, however, incorporation of terms has not caused controversy, nor has there been much dispute regarding the terms that can be incorporated. There are, however, a few cases in which the courts have questioned the incorporation of dispute resolution provisions. These are discussed below. Incorporation of Arbitration Clauses 5.19 In Progressive Cas Ins Co v CA Reaseguradora Nacional De Venezuela14 (RNV) incorporation of an arbitration clause from the reinsurance into the retrocession agreement was at issue. In this case a group of Venezuelan insurance companies issued insurance to a subsidiary of Petroleos de Venezuela, SA, an oil and gas exploration and development company owned by the Venezuelan government. The Venezuelan insurers reinsured $10 million of the risk with RNV. RNV in turn retroceded this risk through Sedgwick Marine & Cargo Ltd, a London-based broker who placed 90% of the retroceded risk with London-based reinsurers and placed the remaining 10% with New York Marine Managers, Inc (NYMM), the underwriting agent for a group of reinsurers in the US (which will be called collectively “the American Reinsurers”).15 The policy that NYMM signed was stated to be “Subject to Facultative Reinsurance Agreement” and the Facultative Reinsurance Agreement (FRA) in question contained an arbitration clause in the following terms: “Any question or dispute arising between the contracting parties concerning the interpretation of this Reinsurance Agreement, which cannot be otherwise arranged shall be settled by arbitration in London, England.”

5.20 Two claims were brought by RNV which were rejected by the American Reinsurers. The American Reinsurers brought a declaratory judgment action seeking a declaration that RNV’s claims were not covered by the policy. RNV argued that this action should be stayed on the ground that the parties agreed to bring any dispute to an arbitration proceeding. The question therefore was whether the arbitration clause in the FRA was incorporated into the reinsurance agreement signed by NYMM, the American Reinsurers’ underwriting agent.

13. Aetna Cas and Sur Co v Home Ins Co 882 F.Supp. 1328, (SDNY, March 27, 1995); Travelers Cas and Sur Co v Ace American Reinsurance Co 392 F.Supp.2d 659, SDNY, Oct 12, 2005.; aff’d by the Second Circuit: 201 Fed. Appx. 40, (2nd Cir. (NY) Oct 18, 2006). 14. 991 F.2d. 42, (2nd Cir. (NY) Apr 6, 1993). 15. The American Reinsurers were Progressive Casualty Insurance Co, The Reinsurance Corporation of New York, Christiania General Insurance Corporation of New York, Worcester Insurance Company, Pennsylvania Lumbermens Mutual Insurance Company, Colonia Insurance Company, United Reinsurance Corporation of New York and United Fire and Casualty Company

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5.21 The US Court of Appeals for the Second Circuit accepted RNV’s position. The court noted that under New York law, in the absence of fraud or other wrongful conduct, a party who signed a written contract was bound by its terms as he was conclusively presumed to know the contents of the document and thus assented to them.16 The court also found no sign that RNV or its broker misrepresented or concealed the terms of the policy; the term referring to the FRA plainly appeared in the document signed by NYMM. As a result, the American Reinsurers were bound by the all-policy terms, including the term referring to the FRA and its arbitration provision. 5.22 The District Court17 had ruled that a trial was necessary to determine whether the policy identified the FRA with sufficient specificity to incorporate it by reference into the policy. The Second Circuit disagreed: The FRA was directly and specifically identified by name and that any reasonable person would understand that the capitalised letters in the phrase “Subject to Facultative Reinsurance Agreement” indicated that a specific document was being referenced. Furthermore, according to the Second Circuit, if the American Reinsurers’ underwriting agent was unfamiliar with the FRA, it should either have asked the London brokers, or objected to the provision before signing the policy. NYMM did not do either of these and therefore NYMM, which was described by the Second Circuit as a very sophisticated party, was assumed as a matter of law to have understood and agreed to all aspects of the policy. 5.23 Moreover, the Second Circuit referred to the position it had adopted in disputes over incorporation of charterparty terms into bills of lading: “a broadly-worded arbitration clause which is not restricted to the immediate parties may be effectively incorporated by reference into another agreement.” Specifically, in the charterparty cases the court had ruled that a clause in a charterparty which provided for arbitration of “any and all differences and disputes of whatsoever nature arising out of this Charter” was binding on parties to a bill of lading which incorporated the charterparty by reference.18 5.24 Similarly, the Second Circuit found the FRA’s arbitration clause was worded broadly enough to allow its effective incorporation by reference into other contracts. Moreover, the FRA’s clause used the phrase “the contracting parties” and thus did not restrictively refer to the immediate parties to that contract by name. 5.25 The American Reinsurers pointed out that the FRA’s arbitration clause referred to disputes “concerning the interpretation of this Reinsurance Agreement” which applied only to disputes concerning the FRA even where the clause had been incorporated into another agreement. The Second Circuit however rejected this challenge on the basis that it was inconsistent with prior case law in which the court had applied arbitration clauses using similar language to disputes arising out of other agreements into which they have been incorporated by reference. Furthermore, according to the Second Circuit, adopting the American Reinsurers’ position would make almost impossible to incorporate any arbitration clause into a second agreement.19 Incorporation of Choice of Law Clauses 5.26 The issue of incorporating by reference choice of law clauses has arisen in the US, not in the reinsurance context but in an excess of loss reinsurance dispute. In AT&T v Clarendon Am

16. Referring to Level Export Corp v Wolz, Aiken & Co, 305 NY 82, 87, (NY Feb 26, 1953). 17. 802 F.Supp 1069 (SDNY Sep 30, 1992). 18. Citing Compania Espanola de Petroleos, SA v Nereus Shipping, SA, 527 F.2d 966, 973 (2d Cir. Dec 12, 1975), cert. denied, 426 US 936, 96 S Ct 2650, 49 L.Ed.2d 387 (1976). 19. This is the position in England.

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Ins Co20 the Superior court of Delaware accepted the argument for incorporation of a choice of law clause in the fourth-level excess policy into the fifth-level excess of loss policy by virtue of the follow the form clause. The clause provided that the fifth level excess policy followed form to “the policy of the Primary Insurer, together with all the . . . terms . . . contained in . . . any Underlying Excess Policy(ies).”) The fourth-level policy was one of the “Underlying Excess Policy(ies).”) The court also noted that the parties to the dispute were sophisticated parties who understood the meaning and effect of including the New York choice of law provision in the fourth-level excess policy and the ramifications it would have on the excess policies that “follow form.” While the fourth-level excess policy provided that New York law should govern the contract, the primary policy was silent on the governing law. Thus, the policies did not contain any inconsistent provisions which would otherwise preclude incorporation.

F O L L OW T H E F O R M – A S S I G N M E N T O F T H E O R I G I NA L P O L I C Y

5.27 In one of the early cases on reinsurance, the Supreme Judicial Court of Massachusetts touched upon the effect of the assignment of the original policy on the reinsurance policy which contained a follow the form clause. In Manufacturers’ F & M Ins Co v Western Assur Co,21 the reinsurance policy was drawn on a standard policy form used for direct insurance policies insuring against loss upon property by the owners of it. The standard printed blank page contained stipulations making the policy void if, “without the written consent of the company, the subject of the insurance should be sold or transferred, or any change should take place in title or possession, or the policy should be assigned before loss; and these stipulations appear in the policy declared on.”

5.28 The property was sold under a foreclosure and the reinsured consented to the change of title. The reinsurers contended that the foreclosure sale was a breach of the proviso contained in their policy, and thereby their liability was ended. 5.29 The judge of the Supreme Judicial Court of Massachusetts emphasised that such a stipulation was prepared for original insurance policies and it is doubtful how far provisions relating to the conduct of an assured person as general owner of property that was the subject of a direct policy should be given effect in a reinsurance policy in which the property insured did not belong to the reinsured. According to the judge the use of a printed blank page was careless and the policy in this case contained many provisions which were originally intended to regulate the conduct of an owner in relation to his property before and after a possible fire. The use of the printed blank page caused difficulties as to the applicability of these provisions to the reinsurance. However, the reinsurance policy also contained a follow the form clause and the judge found guidance in it as to the interpretation of the reinsurance policy terms to ascertain what the reinsurers agreed and did not agree to be bound: “This policy to be subject to the same risks, conditions, valuations, endorsements, privileges, assignments, and mode of settlement, as are or may be assumed or adopted by the Manufacturers’ Insurance Company; and the loss, if any, and expense of adjustment, payable, pro rata, at the same time and in the same manner, as by said company. Other insurance permitted.”

5.30 This language was interpreted by the judge as binding the reinsurers by what had been, and by what might be, assumed and adopted by the reinsured, properly pertaining to the 20. Unreported in A.2d, 2008 WL 2583007 Del.Super., 2008. 21. 14 NE 632, Mass. Jan 03, 1888.

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risk which it was reinsuring. The reinsurers were assumed to have knowledge of all the terms and conditions of the reinsured’s policy, and the language of the clause implied that the reinsured might properly “assume or adapt” “risks, conditions, valuations, endorsements, privileges assignments, and modes of settlement,” without materially changing the nature of the liability created by the original policy. The court held, however, that the language of the clause did not authorised the reinsured to charge the reinsurer by the assumption of a new risk of a different character, or to materially enlarge the existing one. 5.31 The judge found that the property was sold under a foreclosure, and the reinsured gave its assent to this change and to an assignment of the policy to continue the insurance. The purchaser of the property held the policy in the same interest as the mortgagee to whom it was at first made payable had done. The judge noted that the only change was a technical transfer of the legal estate. As the reinsured consented to the change, the validity of the policy was preserved. The reinsurer, by the follow the form clause, expressly agreed that its policy should be subject to “endorsements” and “assignments” upon the reinsured’s policy, to be afterwards “assumed or adopted” by the reinsured. The judge construed this language as covering what the reinsured had done and found that the reinsured acted in the same way as an insurance company in its position would have acted in accordance with the general usage of such companies in the proper performance of their duty for the continuation of the same risk. Thus, the interpretation of the follow the form clause revealed that the reinsurers were not relieved from liability on the ground that a change in ownership which did not affect the risk was assented to by the reinsured to prevent a forfeiture. 5.32 The judge noted that this conclusion was reached not only based on a proper construction of the follow the form clause, but was also consistent with the manifest purpose and spirit of the reinsurance contract where the reinsurer agreed to take over half the risk reinsured upon the buildings and machinery insured and the reinsured retained at its own risk an equal amount under its own policy.

F O L L OW T H E F O R M – E N D O R S E M E N T O R M O D I F I C AT I O N O F T H E O R I G I NA L P O L I C Y

5.33 Once the reinsurance policy is signed and the reinsurer agrees to follow the form of the original policy, if the reinsured then extends the original policy cover, a question will arise as to whether or not the reinsurer is also automatically bound by the endorsement because of the follow the form clause. 5.34 Under New York law it has been held that an extended period of endorsement provision in business interruption policy was neither a “term” nor a “condition” of policy, but rather was a separate and distinct endorsement to policy and thus was not covered by follow the form clauses of reinsurance contracts providing that the reinsurers’ liability would follow terms and conditions of underlying policy. The issue came to the District Court for the Southern District of New York in United Fire & Cas Co v Arkwright Mut Ins Co22 where the insurer, Arkwright, issued to Warnaco a first-party property damage and business interruption insurance policy covering Warnaco’s property throughout the US and Mexico. Arkwright’s standard policy form provided basic business interruption coverage. The extended period of endorsement (EPI) lengthened the period of interruption in the Warnaco Policy for an additional 270 consecutive days beyond the time afforded by the basic business 22. 53 F.Supp. 2d. 632, (SDNY, Jun 30, 1999).

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interruption coverage. An earthquake occurred on 17 January 1994 which damaged Warnaco’s property. The business interruption loss sustained by Warnaco was $12,644,243 between the date of the earthquake and the time that the property was ready to be reoccupied (July 1994). The loss paid under the EPI endorsement was $5,726,998 which represented the amount of business interruption loss sustained by Warnaco in the 270 days subsequent to July 1994, ending in April 199523 and resulted primarily from the difficulty in re-categorising stock and the consequent inability to fill orders, which resulted in a loss of market share. The reinsurer argued that the endorsement contained in the Arkwright policy of insurance issued to Warnaco was not reinsured and that the reinsurers were not liable under their Certificates of Facultative Reinsurance. Balis, a reinsurance intermediary, placed facultative reinsurance for the Warnaco Policy with Western Re and Axa Re. Both reinsurance certificates included a “follow the form” clause to the effect that the liability of the reinsurer shall follow the terms and conditions of the reinsured’s policy furnished to the reinsurer at the effective date of the reinsurance certificate, unless otherwise specifically provided herein by endorsement made a party of the certificate. Taking into consideration that facultative certificates do not necessarily constitute the entire agreement among the parties to a reinsurance transaction, the District Court looked to the communications exchanged between the parties to determine the nature of the actual agreement between them. The court saw that from 1989 through to 1993 none of the documents exchanged between the parties, the submissions, requests, binders, facultative notes and certificates contained any reference to EPI. The court pointed out that the reinsurers agreed to reinsure the peril of earthquake and consequential business interruption, and they followed all of the Warnaco Policy’s terms and conditions with respect to the business interruption coverage pursuant to the “follow the form” clauses. However, EPI was not a term or condition of the business interruption coverage contained within the Warnaco Policy, but rather a separate and distinct endorsement to that policy. 5.35 A similar issue arose in connection with the Wellington Agreement,24 reached in the US between thousands of asbestos injury claimants and the asbestos manufacturers as a result of numerous asbestos injury claims filed against asbestos producers between 1980 and 1985. It established a non-profit claims handling centre that coordinated claim payments on behalf of the asbestos producers. It also contained provisions that aimed to avoid coverage disputes between producers and their insurers and established arbitration procedures to adjudicate claims the participants could not settle. The question was whether this altered the reinsurance policies and whether the follow the form doctrine bound reinsurers to cover an agreement entered into after reinsurance was issued. In North River Ins Co v CIGNA Reinsurance Co25 the United States Court of Appeals for the Third Circuit stated that the Wellington Agreement did not rewrite existing policies between producers and their insurers, but founded the Asbestos Claims Facility which aimed to encourage settlements in place of costly litigation and to reduce asbestos litigation awards while lowering the associated costs; the Agreement aimed to avoid coverage disputes by applying insurance arrangements “in a consistent manner.” In North River v CIGNA, the reinsurance policy contained

23. In the decision the date was given as April 1994, but that is clearly a mistake as 270 days after July 1994, would be April 1995, not April 1994. 24. Named after Professor Harry Wellington of the Yale Law School. The Wellington Agreement represented an innovative effort by asbestos producers and their insurers to solve the asbestos litigation crisis. See also Chapter 7. 25. 52 F.3d 1194 (3rd Cir. (NJ) Apr 13, 1995).

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a follow the form clause, but the dispute with regards to the reinsurers’ liability for the defence costs incurred by the assured and indemnified by the reinsured was resolved by application of the follow the fortunes clause and the Third Circuit did not make any comments on the effect of the follow the form clause on the Wellington Agreement. 5.36 In Unigard Sec Ins Co, Inc v North River Ins Co,26 however, the US Court of Appeals for the Second Circuit pointed out that under the Wellington Agreement the Asbestos Claims Facility would be the “sole agent” and have “exclusive authority and discretion to administer, evaluate, settle, pay or defend all asbestos-related claims.” The signing of the Wellington Agreement thus materially altered the terms of the reinsurance contract by which prompt notice and right to associate clauses gave the reinsurers the right to associate in the defence and settlement of claims. According to the Second Circuit, reinsurers should have been notified of such a material change. (North River v CIGNA and Unigard v North River are discussed in detail below at paragraph 7.41 et seq).

OV E R R I D I N G E F F E C T O F T H E F O L L OW T H E F O R M C L AU S E S

5.37 Reinsurers may sometimes seem to be exposed to liability beyond the cover that they originally agreed. In Imperial Fire Ins Co of London v Home Ins Co of New Orleans,27 in November and December, 1891, Imperial and Royal issued treaty reinsurance policies for Home Insurance under which Home was allowed to accept future risks which would then be declared to the treaty. Home warranted to retain $25,000 and the subject matter was “cotton subject to coinsurance clause.” The reinsurance policies, which were subject to a retention, also contained the following clause: “This policy to be subject to the same risks, conditions, valuations, endorsements, and modes of settlement as are or may be assumed and adopted by the reinsured, and the loss, if any, payable pro rata at the same time and in the same manner as by said company.”

5.38 During the currency of these policies a large amount of the cotton was destroyed by fire. The policies written by Home with the coinsurance clause were to the amount of $97,700, and policies without the coinsurance clause were to the amount of $25,000. The loss on the cotton covered by the policies with the coinsurance clause was $38,707.58, and the remaining loss exceeded the coverage of the other policies. Some of the policies issued by Home did not contain the coinsurance clause, so Home was liable for greater sums than would otherwise have been the case, which adversely affected the reinsurers. The reinsurers thus argued that they were not liable for the losses paid under those polices that did not contain the coinsurance clause. 5.39 The majority of the US Court of Appeals for the Fifth Circuit ruled for the reinsured, pointing out the concurrency between the reinsurance and insurance policies and stating that the contract of reinsurance must apply to risks of the same kind as those specified in the original policy: if the original policy was a contract of insurance against loss by fire, the reinsurance must be against loss by fire, and not against loss by storms on land or at sea. The specific risk in the policy of reinsurance need not be identical with that in the original policy,28 so that an original insurance may be effected on a vessel for six months, whereas the reinsurance

26. 4 F.3d 1049 (2nd Cir. (NY) Sep 09, 1993). 27. 68 F 698, CA 5 Jun 17, 1895. 28. Referring to Philadelphia Ins Co v Washington Ins Co 23 Pa.St. 250, 1854.

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may be for a single voyage within the bounds not prohibited, and for a lesser amount. The follow the form clause in this context was construed by the majority to mean that the reinsurer had agreed to cover any risk which the insurer might be willing to take. Subsequently, where the reinsurance was subject to the same risks, conditions, valuations and endorsements, reinsurance was to cover any of the fire risks insured by the original insurer and the limit that the Fifth Circuit put on this was that “original insurance on cotton in Shipper’s Press, yard 1 (where the cotton was located).” The follow the form clause in the policy, according to the court, gave to the original insurer the privilege of taking such risks on cotton in the designated place as it may choose because the reinsurer in this case in fact declared that: “I will reinsure whatever contract you make, and, to protect me from any imprudence on your part, you must retain at least $25,000 on the same risk.”29 5.40 Moreover, the majority compared the purposes of the coinsurance clause in the original insurance and the retention clause in the reinsurance policies. Accordingly, in the insurance policy the object of the coinsurance clause was to make the assured, the owner of the property, carry a part of the risk and thus to compel him to take out policies to the full value of his property. In the reinsurance policies, however, the retention clause was designed to discourage full reinsurance. Because of the retention clause, the original insurer would not effect reinsurance to the extent of his entire liability, but would carry himself a part of that liability which was fixed at not less than $25,000. Thus, it became clear that the retention clause sought to achieve an aim totally different from the object intended to be secured by the coinsurance clause in the original insurance policy. The majority stated that the coinsurance clause did not describe the risk as between the reinsurer and the reinsured “because the risk which the reinsurer takes is the risk described in the original policy, whatever that may be, unless some clause can be found in the reinsurance contract which expressly varies that description.” 5.41 The reinsurers urged the difference of the premium rate between the reinsurance policies with a coinsurance clause and those which did not contain it. They contended that they expressly asked for reinsurance subject to coinsurance for the reason that at the time when the contracts of reinsurance in this case were entered into, the market rate charged in the city of New Orleans upon policies on cotton, which contained the coinsurance clause, was 1%, whilst policies not containing such a clause upon the same product demanded a premium of 1½%. Thus, it cost 50% more to obtain insurance without the coinsurance clause than with it. The majority, however, disagreed and found that failure to disclose that some policies did not contain the coinsurance clause was not a material fact. The fact that some of the policies did not have the coinsurance clause cannot therefore be relied on as a concealment. According to the majority’s assessment, the assured had $60,000 worth of cotton of which they lost $30,000. They had $25,000 of insurance without the coinsurance clause, for which they paid a 1½% premium, amounting to $375, and got $25,000 on their policies. The indemnity received was five-sixths of the loss. To have received a like amount under coinsurance policies, they must have had policies written nominally for five-sixths of the value of the property insured; that is to say, to the amount of $50,000, which at 1% on the amount nominally written would have cost them $500 instead of $375 which was not materially different comparing to what the assured obtained and how much premium he paid for it. 5.42 One judge however dissented, finding that in a reinsurance policy the description of the risk reinsured was just as material as was the description of the property insured in an

29. Referring to Manufacturers’ Fire & Marine Ins Co v Western Assur Co, 14 N.E. 632, Mass. Jan 03, 1888.

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ordinary policy. The judge took into consideration the fact that the reinsurers had asked and therefore intended for reinsurance only upon risks of Home under policies which contained the coinsurance clause. If Home had applied for reinsurance upon policies upon the same property, but not containing the coinsurance clause, and that had been accepted, the premium would have been 1½%. The judge found the majority reason unsound as it permitted the Home Insurance Company to recover from the Royal Insurance Company reinsurance for which the Home Insurance Company never asked, for which it never paid, and upon risks never insured by the Royal Insurance Company, and which the Home agreed that the Royal should not insure. 5.43 The majority view was that reinsurance was a contract of liability insurance, and that the liability was unaffected by a failure by the reinsured to insert a coinsurance clause. But it may be thought obvious that the object of the coinsurance clause was to reduce the reinsured’s liability. A coinsurance clause is one which provides that if the assured is not insured for the full value of the subject matter then the assured and insurers share the loss proportionately. For example if the cotton is worth $100,000 and is insured for only $50,000 and if cotton to the value of $10,000 is destroyed, the insurer and the assured share the loss $5,000 each because they are co-insurers. If there is no coinsurance clause then the insurers will pay the full $10,000, and indeed they will pay the full amount of any loss up to policy limit of $50,000 – it is only where the loss exceeds the policy limit of $50,000 that the assured has to bear any part of the loss himself. Thus, it is submitted that the dissenting judge rightly stated that the majority decision permitted Home to recover sums which in fact were not reinsured by the reinsurers.

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CHAPTER 6

SET T L E M E N T C L AUSE S

6.01 As was discussed earlier, facultative reinsurance contracts subscribed in the London Market usually consist of a cover page that typically provides only the full reinsurance1 clause by which the reinsurer undertakes to follow the settlements of the reinsured. The clause is widely used and has an important application in reinsurance practice. It has been a long process for the market to establish the practice of the follow the settlements clause, but there remain further issues to explore. In this part of the present work the historical development of the clause will be examined, followed by various issues that the English usage of the clause has established to date. 6.02 Settlement clauses are also widely used in the US reinsurance market. It is accepted that in the absence of a follow the settlements clause the reinsured would have to deal with the proof of the loss and the amount of it twice, at the insurance and reinsurance level. Therefore it has been found necessary to use settlement clauses to prevent unnecessary procedures and delays for reinsured’s claims.2 As noted earlier in this work, there are relatively few US judicial authorites, given that most cases are resolved in arbitration,3 and that some of those cases are from lower level courts and thus of persuasive authority only. Consequently, it is necessary to look at law overall in the US without making any limitations to any State’s law.4

E N G L I S H L AW: F O L L OW T H E S E T T L E M E N T S

Establishing and Quantifying the Reinsured’s Liability under the Direct Policy 6.03 The principle of indemnity is said to be an essential part of reinsurance contracts.5 In addition reinsurance responds only to legal liability and not to ex gratia payments. Accordingly, the reinsured must face liability to the assured under the direct policy. What the reinsured is required to prove in order to establish its liability to the assured can be divided into two situations: (a) Where the reinsurance contract contains a “follow the settlements” clause; and (b) Where there is no “follow the settlements” clause in the reinsurance. In the absence of a settlements clause, the rule established by Re London County Commercial Reinsurance

1. Leaving aside premium, duration and claims provisions. 2. See Chaffetz and Moss, “Follow the Fortunes and Allocation: An Update” (2009) 16 Journal of Reinsurance 55, 57. 3. Employer Reinsurance Corp v Laurier Indem Co 2007 WL 1831775 (MD Fla); Ott v All-Star Ins Corp 99 Wis.2d 635, Wis, Jan 6, 1981. 4. Houston Cas Co v Lexington Ins Co 2006 US Dist, LEXIS 45027. 5. Golding, 11.

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Office Ltd6 is that a reinsured who wishes to make a claim against the reinsurer must prove his loss in the same manner as the original assured must have proved it against him. Further, even if the reinsured himself did not rely on them, the reinsurers can raise all defences which were open to the reinsured against the original assured. Lord Mustill has emphasised the same principle, by holding that the loss must fall both within the scope of the original insurance and the reinsurance contract.7 Consequently, it is now an established principle that, in the absence of a follow the settlements clause, the reinsurer is not obliged to indemnify the reinsured if the reinsured chose to make payment to the assured where in fact the original policy did not cover the loss in question.8 6.04 The reinsured can generally establish its liability to the assured by an adverse judgment or arbitration award.9 However, the assured’s claim is not always contested by insurers, and the vast majority of claims are settled. If the insurer is in good faith convinced that he is liable to the assured and settles the claim on that basis, requiring the reinsured to prove its liability in the same manner as the assured might be inconvenient, time consuming, expensive and indeed repetitive. Therefore the market has developed the settlement clauses whereby the reinsurers in principle agree to follow any settlement by the reinsured which was a genuine and businesslike attempt to settle what was arguably a valid claim. 6.05 The same principle has been applied by the US courts. In Michigan Tp Participating Plan v Federal Ins Co10 for instance, the Court of Appeals of Michigan stated that in the absence of specific contract language requiring the reinsurers to indemnify the reinsured on the basis of its good faith settlement of a claim, the reinsured had to prove that it was bound to indemnify the assured under the original insurance. Proof of payment to the assured would not suffice to discharge such burden but the reinsured had to prove the loss as if it was the assured.11 Moreover in National American Ins Co of California v Certain Underwriters at Lloyd’s London12 the US Court of Appeals for the Ninth Circuit agreed that this “accurately portrays the common law rule in California.”13 Judgment 6.06 In principle, the reinsured’s liability is accepted to have been proved where it is established by a judgment in favour of the assured.14 However it is often the case that the reinsured and the reinsurer are not in the same jurisdiction. Therefore, the reinsured may make its claim against the reinsurer by relying on a judgment given by a competent court in a jurisdiction which is not that of the reinsurer. In that case, the rule that a person is not bound by a judgment in proceedings to which he is not party takes on even more force, at least from the reinsurer’s

6. [1922] 2 Ch 67, 80, PO Lawrence J. 7. Hill v Mercantile & General Reinsurance Co Plc [1996] 3 All ER 865. 8. [1922] 2 Ch 67, 80 PO Lawrence J. This was doubted by Lord Mance in Wasa; the issue is dealt with in the following paragraphs. 9. Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd (Nos 2 & 3) [2001] 1 Lloyd’s Rep IR 667, 691. 10. Michigan Tp. Participating Plan v Federal Ins Co 233 Mich.App. 422, (Mich. App. Jan 19, 1999). 11. See also Hastie v De Peyster 3 Cai R 190, NY Sup 1805; Royal Ins Co of Liverpool, England v Caledonian Ins Co of Edinburgh, Scotland 182 Cal 219, Feb 13, 1920 (dictum); Pacific Mut Life Ins Co v Pacific Sur Co, 69 Cal App. 730, 734, Nov 21, (1924) (dictum). 12. 93 F.3d. 529, (9th Cir. (Cal) Aug 15, 1996). 13. However the court noted that they did not accept the reinsurers’ contention that this rule precludes evidence of custom and usage to the contrary to the effect that a settlement clause may be implied into reinsurance contracts if custom and usage permits to do so. The Ninth Circuit noted that where, as here, the law derives from the common law but not statute, the rule that custom or usage cannot overcome a rule of law applies with less force. See below, implication of follow the fortunes clause. 14. Lumbermans Mutual Casualty Co v Bovis Lend Lease Ltd [2005] 1 Lloyd’s Rep 494.

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point of view. Nevertheless, there is authority, albeit obiter, for the proposition that there is an implied term that, unless the contract contains any provisions to the contrary, the reinsurer agrees to be bound by a judgment, including that of a foreign court, for the purpose of establishing the reinsured’s liability to the assured.15 This principle is subject to four requirements set out by Potter LJ in Commercial Union Assurance Co Plc v NRG Victory Reinsurance Ltd.16 1. The foreign court is of competent jurisdiction in the eyes of the English Court, 2. That judgment has not been obtained in the foreign court in breach of an exclusive jurisdiction clause or other clause by which the original insured was contractually excluded from proceeding in that court (eg, an arbitration clause), 3. The reinsured took all proper defences, 4. The judgment is not manifestly perverse. 6.07 It seems that while the first three conditions are consistent with general principles of law for the recognition and enforcement of foreign judgments,17 the operation of the last requirement is a novel concept. The meaning of perverse is not clear. In Commercial Union Assurance Co Plc v NRG Victory Reinsurance Ltd.18 Potter LJ did not find it necessary to clarify the situation in which a plea of perversity might successfully be raised in respect of the decision of a foreign court, because on the facts before him the point did not arise.19 6.08 If “perverse” means very wrong, determination of a decision as perverse would require the English court to analyse the facts and the issues in the proceedings brought by the reinsured against the reinsurer. However this would mean making another decision on the same issue, an approach which is contrary to the usual rule that judgments of foreign courts must be recognised and enforced in England without regard to their substance. In principle a foreign judgment cannot be challenged in the English courts, so that findings of fact must be accepted and errors of law must be ignored.20 In terms of enforcing of a foreign court decision, there are limited objections available (eg that the judgment has been obtained by fraud or its enforcement or recognition would be contrary to public policy).21 There is little authority on the meaning of public policy in this context and it has yet to be determined in England whether the enforcement of a foreign judgment which is for exemplary, punitive, or manifestly excessive damages should be refused on grounds of public policy.22 However it should be noted that the binding effect of a judgment on reinsurers is a quite separate question to whether a foreign judgment is enforceable in England. If the assured has been awarded punitive damages in the US against an insurer, the English courts may refuse to enforce that award on public policy grounds. However the question in reinsurance is not public enforcement, it is whether as a 15. Commercial Union Assurance Co Plc v NRG Victory Reinsurance Ltd [1998] 2 Lloyd’s Rep 600; see Sir Lawrence Collins, Briggs A, Harris J, McLean JD, McLachlan C, Morse CGJ, Dicey, Morris and Collins on the Conflict of Laws, Sweet & Maxwell; London, 14th edn, 2006, para. 14-033. 16. [1998] 2 Lloyd’s Rep 600. 17. This is a common law principle, but is now established by various international agreements incorporated into English law, most importantly the Brussels Regulation and the Lugano Convention as regards European Judgments. There are only limited defences that can be raised in proceedings to enforce a foreign judgment in England. See Colinvaux & Merkin’s Insurance Contract Law para. D-0866; Dicey, Morris and Collins on the Conflict of Laws, Chapter 14. 18. [1998] 2 Lloyd’s Rep 600. 19. Ibid., at 611. 20. The principle arises from the old case Goddard v Gray (1878) LR 6 QB 39. See also Dicey, Morris and Collins, para. 14-110; Colinvaux and Merkin’s Insurance Contract Law, para. D-0866. 21. See Dicey, Morris and Collins, Chapter 14; Colinvaux and Merkin’s Insurance Contract Law, para. D0866–D-0872. 22. Dicey, Morris and Collins, para. 14-146.

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matter of contract reinsurers have agreed to be bound by a punitive damages award, and in practice they will not. Consequently, although the meaning of perverse is not clear, and it may be explained as very wrong, an English court would almost certainly refuse to make a determination on the correctness or otherwise of a foreign decision as to its substance. Therefore the requirement of not being manifestly perverse does not seem to be very useful or in practice, applicable. 6.09 It has been suggested that the implication of a term in reinsurance contracts to the effect that the reinsurer is assumed to have agreed to be bound by a foreign judgment with regard to the proof of the reinsured’s liability is inappropriate.23 This opinion seems to suggest that such a term could only be implied where there is a follow the settlements clause, and where the parties have chosen not to insert the clause in a reinsurance contract; this would also indicate that they have expressed an intention contrary to the effect of the implied term. Moreover it is claimed that implying such a term would bind the reinsurers to a judgment when they had not been involved in the proceedings. Besides that, implication would be inconsistent with the approach adopted by the Court of Appeal in Insurance Co of Africa v Scor (UK) Reinsurance Co Ltd24 that in the absence of a follow the settlements clause the reinsured would not have been bound by the Liberian Court’s decision as to the coverage of the original policy. Therefore it is suggested that the better view would be the decision of a foreign court should be taken as no more than evidence of liability that to be determined by the court which will also decide on the reinsurer’s liability towards the reinsured.25 6.10 However counter-arguments can be brought against this suggestion. Where a reinsurance contract contains a follow the settlements clause the reinsurer will be bound by the reinsured’s bona fide and businesslike settlement even though the reinsurer was not involved in the settlement process.26 Moreover it was held in Insurance Co of Africa v Scor (UK) Reinsurance Co Ltd27 that where the reinsurer agrees to follow the reinsured’s settlement, subject to the reinsured having acted bona fide and businesslike manner in assessing the assured’s loss, the reinsurer should follow the settlement of the reinsured if the loss also falls within the reinsurance policy. If a settlement that was entered into by the assured and the reinsured could be binding on the reinsurer, a decision that was given by a competent foreign jurisdiction with regard to the reinsured’s liability should also be accepted as evidence of the reinsured’s liability under the original policy. Therefore it seems reasonable to imply a term into a reinsurance contract that the reinsurer is bound by a foreign court judgment with regard to the reinsured’s liability. Moreover, as noted above, foreign judgments are in most circumstances recognised by the English courts and by so doing such decisions become binding on the parties. Additionally, it is not the case that in Scor the Court of Appeal held that in the absence of the follow the settlements clause the Liberian court decision was not binding. In Scor the reinsurer denied liability for the reason that they believed that the assured was fraudulent in that the fire which destroyed the subject matter insured was deliberately set. The Liberian court held that the claim was not fraudulent and the reinsured was liable. The reinsurer tried in England to 23. O’Neill and Woloniecki, para. 5-29. 24. [1985] 1 Lloyd’s Rep 312. For the Scor case see para. 6.32 et seq. below, Heading no 6.1. 25. O’Neill and Woloinecki, para. 5-29. It should be noted that in Commercial Union Assurance Co Plc v NRG Victory Reinsurance Ltd Potter LJ rejected the argument that the decision of a foreign Court could be no more than evidence of the reinsured’s liability: [1998] 2 Lloyd’s Rep 600 at 611. 26. However this would be the case only where the contract does not contain a claims co-operation or claims condition clause or where there was no right for the reinsurer to be involved the settlement process. See: Charman v Guardian Royal Exchange Assurance [1992] 2 Lloyd’s Rep 607; Phoenix General Insurance Co of Greece SA v Halvanon Insurance Co Ltd [1985] 2 Lloyd’s Rep 599. 27. [1985] 1 Lloyd’s Rep 312.

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challenge the reinsured’s liability despite the Liberian court decision. Leggatt J and the Court of Appeal in Scor held that in the absence of evidence that the reinsured was a party to any fraud, the reinsurers were not entitled to go behind the Liberian judgment. Given that the reinsured’s settlement after the Liberian court decision was in good faith; the reinsurers were bound to follow the settlement constituted by the decision of the court in the Liberian proceedings.28 In this case a decision of the Liberian court established that the reinsured was liable for the loss under the original policy; therefore the Court of Appeal did not need to discuss if the settlement was binding on the reinsurer and held that the reinsured, and therefore the reinsurer, was liable. This in fact shows that, contrary to the abovementioned argument, by recognising the Liberian court judgment in proving the reinsured’s liability to the assured without mentioning the function of the follow the settlements clause, the Court of Appeal in Scor also reached a decision that is consistent with the later ruling in Commercial Union v NRG. 6.11 It is also worth noting that in Commercial Union v NRG the Court of Appeal implied the term for all reinsurance contracts irrespective of any follow the settlements clause. 6.12 It has not been decided yet whether or not the foreign decision must be from the last appeal court to amount an evidence to prove the reinsured’s liability. In Scor the reinsured appealed the decision in Liberia but then abandoned the appeal because there was no evidence of fraud, for which the reinsured lost at first instance and the reinsured was advised that in the absence of any proof of fraud there was no point in appealing. The Court of Appeal did not discuss whether or not the Liberian court decision should have been appealed. The Court of Appeal instead focused on the settlement clause and according to the facts they held that the reinsured’s settlements was bona fide and businesslike, the reinsured settled the loss which was constituted by the Liberian court decision, and the loss fell within the reinsurance cover. Accordingly the reinsurers were liable. These cases thus support the proposition that the judgment of a foreign court is binding on the reinsurers. However, certain comments of Lord Mance in Wasa International Insurance Co Ltd v Lexington Insurance Co29 have raised a doubt as to whether a foreign decision is binding on the reinsurers for the purposes of establishing and quantifying the reinsured’s liability to the assured. In Wasa v Lexington the decision on which the reinsured, Lexington, based its settlement was that of the final appeal court in the state of Washington, the Washington Supreme Court. According to the Washington Supreme Court’s construction the insurer/reinsured was liable for the assured’s loss. The original insurance was subscribed for three years from 1977 until 1980 but the Washington Supreme Court found the reinsured liable for the loss which occurred in the period from 1942 until about 1986. This was so because the Washington Supreme Court, according to the construction of the original policy in accordance with its applicable law,30 was of the view that the insuring clause of the insurance policy was drafted in a manner covering the whole period of loss as long as any part of that loss fell within the duration clause. The reinsurance policy wording was identical to that of the original insurance: the reinsurance contracts were as original and the period was stated to be 36 months from 1 July 1977. The House of Lords, however, construed the reinsurance policy according to English law and found the reinsurers not liable. The House of Lords did not state that the Washington Supreme Court decision was perverse, and indeed the reinsurers deliberately refrained from suggesting that it had been perverse and not binding: the case turned on the question whether English law should be applied to the reinsurance contract, which was held to be so. The House of Lords’ reason for

28. [1985] 1 Lloyd’s Rep 312, 323; emphasis added. 29. [2009] 2 Lloyd’s Rep 508. 30. Held to be the law of Pennsylvania.

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this conclusion was that the Service of Suit clause, in the original policy, which entitled the assured to bring an action in any competent jurisdiction within the US, meant that the parties to the reinsurance contract could not have contemplated at the beginning of the contract which law would govern the original insurance policy. In such circumstances the reinsurers were entitled to rely upon an English law construction of fundamental reinsurance terms rather than be bound by a judgment of a court whose identity could not be predicted. Therefore the Washington Supreme Court decision was not enough to prove the reinsured’s liability and the House of Lords construed the reinsurance policy terms according to English court interpretation. Counsel for the reinsured supported the view that, because of the ruling of Commercial Union Assurance Co v NRG Victory Insurance Ltd,31 even without the follow the settlements clause, reinsurers would, as a matter of contractual implication, have been bound by the Washington Supreme Court’s interpretation of the scope and application of the original cover. Lord Mance32 however did not agree with this submission. His Lordship put the matter in the following way: “It is unnecessary to decide upon the correctness or otherwise of the Court of Appeal’s obiter observations (Commercial Union v NRG) on the effect under reinsurance of a judgment against the insurer. I note only that there was no suggestion in the Scor case, where there was such a judgment, that this judgment could be binding in the absence of a follow the settlements clause; and that the basis for such a contractual implication has been questioned by a powerfully constituted Bermudian arbitration panel in an interim award dated 12 December 2000 in Gold Medal Insurance Co v Hopewell International Insurance Ltd, as well as by specialist writers: O’Neill and Woloniecki, The Law of Reinsurance in England and Bermuda, Sweet & Maxwell, 2nd Edition, 2004, pages 191 to 193. Here, there is a follow the settlements clause, and any issue which might have arisen regarding the actual settlement (see para 30 above) was not canvassed below or before the House. The only issue raised by reinsurers is whether the loss arising from Lexington’s settlement with Alcoa falls within the terms of the indemnity provided by the reinsurance slip.”

6.13 These comments were pure dicta. The dispute in Wasa related to the entirely separate question of whether the loss fell within the scope of the reinsurance agreement and not whether the underlying settlement was bona fide and businesslike or whether the judgment of the Washington Supreme Court provided an effective basis for the subsequent settlement. In Scor, as Lord Mance pointed out, there was a foreign judgment which held the reinsured liable to the assured. The Court of Appeal did not discuss whether or not the loss was within the reinsurance cover but they discussed whether or not the settlement was bona fide and businesslike and it was held that the settlement which was entered into after Liberian court decision, which was constituted by the decision, was bona fide and businesslike and the reinsurer was bound by the settlement. Stephenson LJ33 stated: “In this case ICA have been held liable to pay ATC.s claim by the Liberian Court, and Scor are bound to pay ICA unless in paying they can be seen not to have acted in good faith or to have acted in collusion with ATC or not to have taken all proper and businesslike steps to have the amount of the loss fairly and carefully ascertained.”

6.14 The House of Lords did not follow the same route as the Court of Appeal in Scor but rather focused on whether or not the loss was within the reinsurance cover and even though the reinsurance wording was as original, since the parties were not able to contemplate which jurisdiction the dispute would be brought and which law would be applicable to interpret the

31. [1998] Lloyd’s Rep IR 439. 32. [2009] 2 Lloyd’s Rep 508, 519. 33. [1985] 1 Loyd’s Rep 312, 322.

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original insurance, the reinsurers were not bound by the interpretation of the Washington Supreme Court with regard to the reinsured’s liability which would form the reinsurers’ liability under the identical terms of the original insurance and reinsurance contracts. Consequently, Lord Mance’s comments in Wasa have created uncertainty as to proof of reinsured’s loss where there is a foreign decision holding the reinsured liable to the assured. 6.15 In the US, the Supreme Court of Missouri has stated that where a reinsured’s liability was established by a judgment reinsurers were bound by such a decision so long as this risk was also within the reinsurance policy cover.34 Moreover, in North River Ins Co v CIGNA Reinsurance Co35 the US Court of Appeals for the Third Circuit noted that the courts were normally reluctant to recognise or enforce a judgment against a person who was not party to the dispute but a judgment in an action between an assured and reinsured should be regarded as an exception to the rule that a judgment did not bind a non-party, given the interest of reinsurers in the outcome. An illustration of this principle is seen from the very early cases on reinsurance in the United States. In Hastie v De Peyster,36 Hastie and Patrick issued a hull insurance to cover the vessel Sally for $1,000 dollars on a voyage from Malaga to New York. In the course of her voyage the vessel was captured and taken to Santa Domingo. The assured sought to abandon the vessel to the insurers on the ground that there had been constructive total loss, but the insurers refused to accept the abandonment. However, it was later agreed between the assured and the insurers that when the vessel reached New York the assured was entitled to sell the vessel and dispose of her on the most favourable possible terms, and that he would still be entitled to make his claim for constructive total loss against the underwriters and if he succeeded he could claim the policy moneys but deduct from the policy moneys the amount he received from the sale. All of this happened. The assured sold the vessel, and then successfully made a claim against the insurers. As a result of the action brought by the assured the insurers were found to be liable for $832.35 under the policy and that sum – minus the amount received by the assured for the sale of the vessel – was paid to the assured. The reinsurers denied liability for the reason that no notice of abandonment was given to them. 6.16 The Supreme Court of New York first looked for assistance from English law but, as reinsurance was rendered unlawful in England by the Marine Insurance Act 1745, no such assistance was available. However, the court noted that reinsurance was lawful in France and the French authorities indicated that as a general principle reinsurance and original insurance are independent of each other and the reinsurer had no responsibilities to the assured. Therefore, it was clear, under French law, that in the absence of a clause where a reinsurer agrees to be bound by the reinsured’s settlement, the original insurers must, in a suit brought against the reinsurers, establish the same facts, as would entitle the assured to recover upon the original policy.37 This, however, did not mean that when the assured gave a notice of abandonment, the reinsured had to give the same sort of notice to the reinsurer. The reinsurer would be bound to indemnify the reinsured – not the assured – when the reinsured established his liability under the original policy. The notice of abandonment to the reinsurers was not necessary due to the nature of reinsurance contracts.38 As a result, the reinsurers were held to be liable to the reinsured for the latter established its liability by the judgment obtained by the assured against him. 34. Strong v Phoenix Ins Co 62 Mo 289, 1876. 35. 52 F.3d. 1194, (3rd Cir. (NJ) Apr 13, 1995). 36. 3 Cai R 190, NY Sup 1805. 37. The same principle was repeated by approval by the Circuit Court, D. Massachusetts in New York State Marine Ins Co v Protection Ins 18 F.Cas 160 (CC Mass 1841). 38. The reinsurers were thus held to be liable: (a) the sums paid by the insurers; (b) the assured’s legal costs of $108.53; and (c) the insurers’ legal costs of $30.56. The ratio for holding the reinsurers liable for defence costs will be mentioned below under the relevant heading.

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Arbitration Awards 6.17 It is extremely common to find arbitration clauses in various types of contracts, providing that any disputes arising from those contracts should be resolved by arbitrators. Unless the award is appealed,39 it is conclusive between the parties to the dispute, so that the award establishes the reinsured’s liability to the assured. The difficulty here is that there is much authority for the proposition that an arbitration award is binding only on the parties to it and indeed that its contents are confidential.40 However, it has been accepted that where the original insurance contract contains an arbitration clause, it is implicit in reinsurance contracts that the reinsurer agrees to be bound by the arbitration award even if the award is not fully consistent with strict law, subject to the reinsured having argued its case properly in the arbitration and exhausted all rights of appeal.41 6.18 In North River Ins Co v CIGNA Reinsurance Co42 the US Court of Appeals, Third Circuit noted that it found no difference in terms of a binding effect of a judgment or an arbitration award on reinsurers’ liability. Settlements 6.19 Assureds’ claims do not always lead to legal proceedings between assureds and insurers. In most cases the parties reach agreement as to the claim and settle the amount, and insurers make payment accordingly. In the absence of a follow the settlements clause, in order to make a claim against the reinsurer the reinsured is required to establish that the loss falls within the terms of the original policy and the reinsurance policy. If there is an arbitration award or a judgment against the reinsured – subject to the exception in Wasa International Insurance Co Ltd v Lexington Insurance Co43 stated above – the reinsured’s burden of proof becomes easier. However, if the reinsured settles the claim without the reinsurers having agreed to follow the settlements, the reinsured may be required to prove that it was liable as a matter of law.44 In other words, where a reinsured reaches a settlement with the assured this settlement will be binding on the reinsurer if the reinsured proves that the loss was proximately caused by the insured peril and it had no defences to the claim.45 6.20 Where a reinsured makes a claim against the reinsurer by relying on the settlement, being obliged to prove its liability and quantum may not always be appropriate to the commercial relationship between the parties. For example, where the reinsurer accepts 100%, or most of the proportion of the risk, requiring the reinsured to prove its loss may cause unnecessary formality and delay in the reinsured’s recovery. The Market has accordingly formulated clauses that entitle the reinsured to an indemnity where it acted in good faith in assessing the original loss, in other words, that it settled the assured’s claim honestly believing that the loss was genuine. 6.21 In the late nineteenth century the formulation that was widely used was “to pay as may be paid thereon.” Nevertheless as will be seen below the clause was not interpreted in the way 39. Only in exceptional circumstances can an arbitration award can be appealed; see the Arbitration Act 1996, ss. 67–69. 40. Associated Electric & Gas Insurance Services Ltd v European Reinsurance Co of Zurich [2003] 1 All ER (Comm) 253; Lincoln National Life Insurance Co v Sun Life Assurance Co of Canada [2005] 1 Lloyd’s Rep 606. 41. Butler and Merkin, Reinsurance Law, para. C-0007. See also CGU International Insurance v AstraZeneca Insurance Co [2007] 1 Lloyd’s Rep 142. 42. 52 F.3d 1194, (3rd Cir. (NJ) Apr 13, 1995). 43. [2009] 2 Lloyd’s Rep 508. 44. Commercial Union Assurance Co Plc v NRG Victory Reinsurance Ltd [1998] 2 Lloyd’s Rep 600. 45. In this case if the reinsured can establish that the loss arose from insured perils and the settlement was reasonable, the reinsurer would not be able to challenge quantum: Traders & General Insurance Association Ltd v Bankers & General Insurance Co Ltd (1921) 9 Ll L Rep 223. The position is the same where the reinsurance policy provides “to pay as may be paid thereon” clause: Western Assurance Co of Toronto v Poole [1903] 1 KB 376, 386. See also Hong Kong Borneo Services Co v Pilcher [1992] 2 Lloyd’s Rep 593, 598.

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that it was apparently desired by the parties, and subsequently the Market developed the “follow the settlements” clause. Settlement Clauses Early Formulation of Settlement Clauses: “To pay as may be paid thereon” 6.22 The use of the “to pay as may be paid thereon” clause goes back at least to the late nineteenth century.46 It is believed that the clause was adopted to provide the opportunity to the reinsured to make a claim against the reinsurer where it settled the claim genuinely believing that it was liable to the assured. Hence the proof of actual loss would not be required so long as the reinsured could convince the reinsurer of its honesty and good faith.47 6.23 The leading authority on the construction of the clause is Chippendale v Holt48 where the insured ship was stranded and the insurer paid on the basis that the ship was a constructive total loss. However the reinsurer denied liability by alleging that the reinsured had not proved that constructive total loss had occurred. Therefore the issue was whether the reinsured had to prove its legal liability to the assured before making a claim against its reinsurer. By relying on the “to pay as may be paid thereon”49 clause counsel for the claimant argued that the clause should be construed literally, and that the sole condition of the defendant’s liability was that the claimant had been satisfied that it was liable and had made the payment in good faith. Mathew J rejected this argument and held that a contract requiring the reinsurer to pay the insurer if he chose to pay whether liable or not would be a wager and not reinsurance. He said that he saw no ground for supposing that the form of the clause was meant to create a liability outside the limits of the original policy. According to Mathew J’s interpretation the words “to pay as may be paid thereon” would seem to assume the existence of liability, proved or admitted, in respect of the loss reinsured.50 6.24 The suggestion in the Chippendale ruling that the clause required mere payment, subject to good faith, has been described as quite sensible, in that the clause in that case made no reference to liability.51 Nevertheless, following Chippendale v Holt it was once more emphasised in Marten v Steamship52 that the words “to pay as may be paid thereon” meant only to pay as the reinsured may have been compellable to pay; only having chosen in good faith to pay the assured’s claim was not enough to trigger the clause. In this case the original policy was against total or partial loss (all risks), whereas the reinsurance was only against total or constructive total 46. For example see Uzielli v Boston Marine Insurance (1884) 15 QBD 11. Clauses providing that the reinsurer would indemnify the reinsured upon mere proof of payment were used in French reinsurance practice from the early eighteenth century. See Hoffman, “Common Law of Reinsurance Loss Settlement Clauses: A Comparative Analysis of the Judicial Rule Enforcing the Reinsurer’s Contractual Obligation to Indemnify the Reinsured for Settlements” [1994] LMCLQ 52. 47. Gurney v Grimmer (1932) 44 Ll L Rep 189, 193, per Scrutton LJ; Hong Kong Borneo Services Co Ltd v Pilcher [1992] 2 Lloyd’s Rep 593, 597, per Evans J. 48. (1895) Com Cas 197. 49. The retrocession policy provided: “Being a reinsurance subject to the same clauses and conditions as the original policy and/or policies, and to pay as may be paid thereon, but against the risk of total and/or constructive total loss only.” 50. See also Nelson v Empress Assurance Corporation [1905] 2 KB 281; Merchants’ Marine Insurance Co Ltd v Liverpool Marine & General Insurance Co Ltd (1928) 31 Ll L Rep 45. In St Paul Fire and Marine Insurance Co v Morice (1906) 22 TLR 449, the “pay to be paid” clause did not feature as a part of the reasoning. However, referring to Chippendale v Holt (1895) Com Cas 197, Kennedy J commented that the reinsurers were under no liability to pay unless the claimants could prove not merely that they were legally liable to the original assured under the original policy, but also that they were entitled to recover from the reinsurers under the terms and conditions and subject to the warranties contained in the policy of reinsurance. 51. Hoffman, 60 fn. 53. 52. (1902) Com Cas 195.

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loss (CTL). According to the facts Bigham J found that the reinsured made payment for a large partial loss, therefore, the reinsurer was not liable. He was of the view that even if the reinsured classified that payment as CTL, the reinsured cannot claim payment by relying on “to pay as may be paid thereon” clause because in fact they were not liable for CTL.53 6.25 Moreover, in Fireman’s Fund Insurance Co v Western Australian Insurance Co54 Bateson J pointed out that a contract of reinsurance properly understood was a contract to indemnify against losses which the original underwriter had suffered, but not against gifts that the reinsured might choose to make to his assured. In this case the reinsured paid the assured even though the ship was unseaworthy and therefore the loss was not covered by the original insurance policy. Bateson J found that the reinsured made payment before investigating the claim properly and with little information as to what had happened. Having emphasised that the reinsurance policy was a policy covering the liability of the original insurer,55 the learned Judge pointed out that if there was no liability on the original underwriter there could not be any liability on the reinsurer. Subsequently, it was held that a “to pay as may be paid thereon” clause did not render the reinsurer bound by the reinsured’s settlement only because the original underwriter paid the assured’s claim by waiving its rights to rely on the unseaworthiness defence.56 6.26 It is noteworthy that it was held in Uzielli & Co v Boston Marine Insurance Co57 the “to pay as may be paid thereon” clause did not make the reinsurer liable for more than the amount reinsured; nevertheless Lindley LJ indicated that the clause may have caused a result that would not have otherwise been reached. In this case the interpretation of the clause was not the issue, but comments were made as to its function. The reinsurance and retrocession policies contained suing and labouring clauses, and the retrocession contract also provided “to pay as may be paid thereon.” The ship was lost and the original settlement was reached between the assured and the insurer for 88% of the loss. A direct claim on a vessel was settled for 88% of its insured value of £1,500, although the insurer’s liability for salvage costs resulted in an overall payment of 112%. The vessel was reinsured for £1,000, and the insurers sought to recover 112% (ie £1,120). The Court of Appeal held that the reinsured could recover only 100%; therefore the retrocessionaire was held liable to pay £1,000, the whole amount retroceded. The reasoning of Brett MR and Cotton LJ is not clear as to why the retrocessionaire was obliged to pay 100% of the insured amount but not 88% or 112%. Nevertheless, it is seen from Lindley LJ’s judgment that the additional 12% recovery resulted from the “to pay as may be paid thereon” clause. However this case has not been cited as authority on the construction of the clause in later cases. 6.27 As a result of these decisions it became settled law that either as regards liability or its amount the “pay as may be paid thereon” clause added nothing to what would have been the parties’ position in its absence. FOLLOW THE SETTLEMENTS

6.28 Given that the “pay as may be paid thereon” clause was not construed by the courts in accordance with the likely intention of the draftsman,58 the Market looked for alternative 53. A similar view was applied by Bigham J in Western Assurance Co of Toronto v Poole [1903] 1 KB 376. 54. (1927) 28 Ll L Rep 243, 251. 55. Ibid., at 250. 56. Moreover Bateson J rejected the argument that the payment was morally obligatory because no reputable underwriter would rely on the unseaworthiness defence where the claim was small. 57. (1884) 15 QBD 11. 58. The Market’s unhappiness as to the ruling in Chippendale v Holt (1895) Com Cas 197 was expressed in various proceedings. See for example: Gurney v Grimmer (1932) 44 Ll L Rep 189; Robert Goff LJ in Insurance Co of Africa v Scor (UK) Reinsurance Co Ltd [1985] 1 Lloyd’s Rep 312, 330.

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formulations to bind the reinsurers by the reinsured’s settlements entered into by the reinsured in the belief that it was genuinely liable to the assured. 6.29 An example of such an alternative clause was first seen in Excess Insurance Co Ltd v Mathews59 where the reinsurer agreed “to pay as may be paid thereon and follow the settlements of the reinsured.” It was held that this formulation carried the “pay to be paid clause” a step further and bound the reinsurers to a compromise on the question of liability, as they were already bound by a compromise on the question of amount. In this case the claimant, an English company, took out a licence under the law of Austria-Hungary to trade in that country. The claimant then insured against damage and loss by fire the profits of a steam corn mill at Budapest owned by a local company with a limit of £32,000. The same day the risk was reinsured at Lloyd’s. After the First World War broke out, the mill in question was destroyed by fire. A claim for £28,000 was made and settled by the claimant insurer by the payment of £27,486. The clause in the reinsurance policy was as follows: “. . . and to pay as may be paid thereon and to follow their settlements.” The reinsured argued that these words bind the reinsurers by any compromise as well on the question of liability upon the original policy as on any question of amount arising upon an admitted liability. The reinsurer on the other hand contended that this clause did add nothing to the meaning of the reinsurance policy, which only made the reinsurers liable for what the reinsured was legally liable to pay. 6.30 Branson J mentioned the ruling on Chippendale v Holt60 and Western Insurance Co of Toronto v Poole,61 but approved the claimant’s contention that the words “and to follow their settlements” were to be construed so as to carry the matter a step further that to bind the reinsurers to a compromise of the question of liability as they were already bound by a compromise of the question of amount. According to the learned judge the follow the settlement clause must mean more than “to pay as may be paid or settled thereon”, the settlement here was not dishonest and the reinsurers were liable whether or not the reinsured was legally liable to the assured under the original policy. 6.31 Nevertheless in a later case, Sir William Garthwaite (Insurance) Ltd v Port of Manchester Insurance Co Ltd,62 Scrutton LJ expressed an opinion contrary to that of Branson J. In this case the reinsurance policy provided: “. . . to follow settlement of the original underwriters subject to the same clauses and conditions as original policy or policies and to pay as may be paid thereon.” Scrutton LJ, who was undoubtedly familiar with Branson J’s view in Excess v Mathews, nevertheless treated the two phrases in the same way and held that “to pay as may be paid thereon” was no different from “to pay as may be settled thereon”63. Consequently, it is evident that the “pay to be paid clause” or “pay to be paid and follow the settlements” clauses were not construed by the courts in a manner that allowing the reinsured

59. (1925) 23 Ll L Rep 71. In this case the judge found that the original insurers were legally liable to pay their insured, so that his comments on the clause were obiter. 60. (1895) Com.Cas 197. 61. [1903] 1 KB 376. 62. (1930) 37 Ll L Rep 194. 63. Nevertheless the inconsistency between the two different types of clause came before HHJ Mackie QC in an incorporation context. In Stronghold Insurance Co Ltd v Bulstrad Insurance and Reinsurance plc 24 November 2006, unreported, discussed in Insurance Law Monthly March 2008, 1-4, the reinsurer agreed to follow the reinsured’s settlements whereas the retrocession agreement was worded “all clauses terms and conditions as original insofar as applicable and to pay as may be paid thereon.” The reinsurer contended that the clause was incorporated to the effect that the “follow the settlements” clause overrode the “pay as may be paid thereon” clause so that the reinsurer could make a claim against the retrocessionaire by proving that it acted bona fide and businesslike manner without need to show actual liability. HHJ Mackie QC held that the two clauses produced opposite results and therefore they were inconsistent with each other; consequently they did not meet the requirements of incorporation that were set out in HIH Casualty and General Insurance Ltd v New Hampshire Insurance Co [2001] 2 Lloyd’s Rep 161.

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to make a claim against its reinsurer by proving an honest settlement. However, the reinsurance cases decided after 1985 disclose that the custom is now the use of the follow the settlements clause without the words of “pay to be paid” and in the following chapters the construction of the modern settlement clauses will be analysed.

C O N S T RU C T I O N O F T H E F O L L OW T H E S E T T L E M E N T S C L AU S E

The Scor Case 6.32 It appears to be the case that between the 1920s and 1984 almost all reinsurance disputes were referred to arbitration. It was as late as 1985 that the follow the settlements clause first came to be analysed by the courts in Insurance Co of Africa v SCOR (UK) Reinsurance Co Ltd64; the comments of the Court of Appeal in construing the follow the settlements clause have been taken as definitive ever since. 6.33 The facts of Scor are briefly as follows: In Monrovia, a warehouse, called the Old Customs Building, was in possession of Africa Trading Co (ATC) for the storage of its goods under a 15-year lease from the Liberian government. It was insured by the Insurance Co of Africa (ICA) by a standard fire insurance policy for $500,000 for the buildings and $3 million for the contents. Some 98.6% of the risk was reinsured in the London market; Scor (UK) Insurance Co Ltd. (Scor) was the leading underwriter with an 11.53% share of 98.6% 6.34 On 7 February 1982 a fire totally destroyed a warehouse and its contents. On 8 February, ATC gave notice in writing to the insurer of the fire and the damage caused by it and the reinsurers were advised of the loss. The insurer instructed the local loss adjuster to carry out a preliminary investigation, and an overseas adjuster was also engaged. They both took the view that the stock loss and the cost of rebuilding would exceed the policy limit. 6.35 On 15 April the reinsurers stated that they had received certain information in connection with the loss, that that information was being investigated and that pending completion of these enquiries the London market reinsurers were not prepared to make any payment in respect of the claim. The information that the reinsurers received was alleging that ATC deliberately set fire to the warehouse. Pursuant to that investigation, the reinsurers sent their representatives to Monrovia to investigate the information contained in the anonymous letters. The insurer, however, failed to cooperate with the investigators and the reinsurers refused to approve the proposed settlement of the claim. Following the reinsurers consent to a settlement ICA rejected ATC’s claim and upon the denial of the claim by ICA, ATC brought an action in Liberia and ATC was awarded $3.5 million for the loss, together with general damages of $600,000 and costs amounting to $58,000. The reinsurers refused to make a payment because the claim was fraudulent as the fire was deliberately set by the assured. In England, before Mr Justice Leggatt, Scor failed to prove arson and fraud. On appeal they applied for a new trial but the Court of Appeal rejected the claim and discussed the construction of the reinsurance wording. The reinsurance contract provided the full reinsurance clause that “Being a Reinsurance of and warranted same . . . terms and conditions as and to follow the settlements of the Insurance Company of Africa …” 6.36 In construing the follow the settlements clause the Court of Appeal carefully analysed the cases from Uzielli & Co v The Boston Marine Insurance65 to Excess Insurance Co Ltd v

64. [1985] 1 Lloyd’s Rep 312. 65. (1884) 15 QBD 11.

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Mathews66 and put emphasis on two issues: the unhappiness of the market in terms of the construction of the pay as may be paid clause by the courts and the fact that in Scor, in contrast to Excess Insurance Co Ltd v Mathews67 the words “to pay as may be paid thereon” were not attached to the reinsuring clause. According to the Court of Appeal this was significant because without the use of “to pay as may be paid thereon,” the clause follow the settlements is a new different wording which should have a different construction. After pointing out the market’s unhappiness about the construction of the “pay as may be paid thereon” clause by Mathew J in Chippendale v Holt,68 their Lordships emphasised that the full reinsurance clauses had developed from indemnities allowing reinsurers to dispute the amount of a claim into indemnities which permitted them to question the honesty or competence of the reinsured.69 Recognising the market’s unhappiness as for the construction of the “to pay as may be paid thereon” clause, the Court of Appeal noted the difference between this clause and the wording of the “follow the settlements.” Their Lordships were of the view that the clause in Scor was not to be construed in the same way as the “pay as may be paid” clause because the absence of any reference to that clause showed that the parties wished to move away from the outcome in Chippendale v Holt.70 The Court of Appeal clarified that where the policy contains only a follow the settlements clause the reinsurers agree to indemnify the insurers in the event that they settle a claim by their assured if the claim so recognised by them falls within the risks covered by the policy of reinsurance as a matter of law, and provided also that in settling the claim the insurers have acted honestly and have taken all proper and businesslike steps in making the settlement.71 In other words, the reinsured does not need to establish that the claim fell within the risks covered by the (underlying) contract of insurance as a matter of law.72 The Court of Appeal in Scor was of the view that where the reinsurer agreed to follow the settlement, it was not appropriate to impose any higher duty on the reinsured.73 6.37 Scor established that the standard form of the clause relieved the reinsured of the obligation to prove that he was legally liable to pay to the assured. This aspect of the follow the settlements clause was also approved in Hill v Mercantile & General Reinsurance Co Plc74 where Lord Mustill expressed that the reinsurer cannot be held liable unless the loss falls within the cover of the policy reinsured and within the cover created by the reinsurance. However it was also pointed out in this case that the parties are free to agree on ways of proving whether these requirements are satisfied. The follow the settlements clause is an example of such an agreement.75 The First Limb: Within the Scope of the Reinsurance Agreement 6.38 In the reinsurance context the Market has tried to find a workable balance between conflicting practical demands, namely the wish to avoid investigating the same issues twice and the need to ensure that the integrity of the reinsurer’s bargain is not eroded by an agreement over which 66. (1925) 23 Ll L Rep 71. 67. (1925) 23 Ll L Rep 71. 68. (1895) Com Cas 197. 69. Lord Justice Stephenson and Robert Goff LJ, [1985] 1 Lloyd’s Rep 312, at 326 and 330, respectively. 70. [1985] 1 Lloyd’s Rep 312, 330, Mortimer J; Insurance Co of the State of Pennsylvania v Grand Union Insurance Co [1990] 1 Lloyd’s Rep 208. 71. [1985] 1 Lloyd’s Rep 312, 330. 72. Equitas Ltd v R&Q Reinsurance Co (UK) Ltd [2009] EWHC 2787 (Comm), para. 49. 73. [1985] 1 Lloyd’s Rep 312, 330. 74. [1996] 3 All ER 865; Re London County Commercial Reinsurance Office Ltd [1922] 2 Ch 67. 75. See also Assicurazioni Generali SpA v CGU International Insurance plc [2004] 2 CLC 122, 126 Tuckey LJ; Morrison J, Faraday Capital Ltd v Copenhagen Reinsurance Co Ltd [2007] 1 Lloyd’s Rep IR 23, 30; Simon J, Wasa International Insurance Co Ltd v Lexington Insurance Co [2007] Lloyd’s Rep IR 604; O’Neill and Woloniecki, 5–11.

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he has no control76. Therefore while on the one hand the reinsured is given the right to make a claim against the reinsurer as long as it has acted in a bona fide and businesslike fashion in settling the claim, on the other hand it is necessary that the loss should be proved to fall within the reinsurance coverage. What the reinsured is required to prove is not that the original loss falls within the cover created by the reinsurance but rather that the claim so recognised by the reinsured falls within the risks covered by the policy of reinsurance as a matter of law.77 It is generally assumed that this condition is equally applicable where the two contracts provide co-extensive cover. Therefore the first limb of Scor is not automatically satisfied unless the reinsured can show that the claim so recognised by it fell within the scope of the reinsurance even though the contracts are back-to-back and the reinsurer is bound by the settlement under the second limb of Scor. However, taking into consideration the principle of back-to-back cover together with the operation of the full reinsurance clause, this proposition seems to be doubtful. 6.39 As was explained in Chapter 2 of this work, facultative reinsurance contracts by their nature assume that the cover of the insurance and the reinsurance are identical. This principle necessitates interpreting the two contracts in the same way.78 As Lord Mustill stated in Hill v Mercantile & General Reinsurance Co79 a follow the settlements clause operates in facultative reinsurance contracts where the terms of the two contracts are identical and where the parties share the risk and the premium, in order to avoid the investigation of the same issues twice. In this case the interests of the direct insurer and the reinsurer are broadly the same and it seems reasonable to hold the reinsurer to be bound by the reinsured’s settlements. However the question here will be whether the presumption of back-to-back cover or the incorporation clause will deprive the reinsurer of its own policy defences where the reinsured acted bona fide and businesslike in a commercial sense but was not liable as a matter of strict law. This was the issue in Hiscox v Outhwaite80 where the assureds were exposed to a massive number of asbestos-related personal injury claims. Taking into consideration the potential quantum of liability in terms of both the number of parties involved and the amount claimed, in order to simplify the procedure for handling such claims, in 1984, a number of asbestos producers and their insurers – including the reinsured in this case – entered into the Wellington Agreement. From then until 1988 the Wellington Facility acted as a clearing house for all parties to the Agreement to the effect that the amounts paid in settlement of such claims to individual sufferers were shared rateably among all subscribing producers. Subsequently the reinsured made payment to the producers irrespective of whether that producer had been named as a defendant by a claimant and irrespective of whether that producer could have been legally liable to the claimant. Therefore the reinsured was in the position of arguing that it was acting in a bona fide and businesslike manner in a commercial sense, but had made payments under the Wellington Agreement which it might not have been legally liable to make. The syndicate’s whole stop loss reinsurance account was on terms which were agreed to be the equivalent of a follow the settlements clause81 and the reinsured 76. Hill v Mercantile & General Reinsurance Co Plc [1996] 3 All ER 865. 77. Assicurazioni Generali SpA v CGU International Insurance plc [2003] 2 CLC 852, 870 (Gavin Kealey QC) aff’d [2004] 2 CLC 122, 127. 78. Forsikringsaktieselskapet Vesta v Butcher [1989] 1 Lloyd’s Rep 331; Groupama Navigation et Transports v Catatumbo CA Seguros [2000] 2 Lloyd’s Rep 350; Court of Appeal in Wasa International Insurance Co Ltd v Lexington Insurance Co [2008] Lloyd’s Rep IR 510. 79. [1996] 3 All ER 865. 80. [1991] 2 Lloyd’s Rep 524. 81. Article 6: “The protection afforded by this Agreement shall as far as applicable be subject to the identical periods, terms, clauses, conditions and warranties as contained in the original policies of Insurance or Reinsurance and/or contracts of Insurance or Reinsurance and in all things falling within the scope of this Agreement the Reinsurers shall share to the extent of their interest the fortunes of the reassured.” Article 7: “The reassured shall exercise due diligence in dealing with all matters relating to this Agreement it being understood that all loss settlements made by the reassured whether by way of compromise, ex gratia or otherwise shall in every respect be unconditionally binding upon the Reinsurers.”

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argued that the reinsurers were precluded from requiring the syndicate to prove which Wellington Agreement payments represented payments that would have been made in any event to discharge liabilities to insured producers under their policies of insurance. Evans J rejected the argument and held that the existence of the follow the settlements clause and the presumption of a back-to-back principle did not prevent the reinsurers from raising the defences provided by the reinsurance contract itself. The judge expressed the view that this was the only protection for the reinsurers if they were called upon to indemnify the reinsured for bona fide and businesslike settlements but it was shown that the reinsured was not obliged to pay as a matter of law. Evans J pointed out that the disputed claims in this case were of the kind that no liability would have existed without the Wellington Agreement, as the claims were asserted against non-insured producers only, who by definition were not within the scope of the reinsurance contract. They did not become insured, and therefore reinsured, claims merely because the Syndicate agreed to treat them as if they were. For these reasons, Evans J found that payments made in respect of claims asserted against non-insured producers were outside the scope of the reinsurance contract. 6.40 It follows from this reasoning that, even if the original policy and the reinsurance are back-to-back the reinsurers can still argue that they are not liable for the claim paid by the reinsured without legal liability under the original policy. However, the difficulty with this analysis is that, taken on its face, it undermines the follow the settlements clause. The reinsurers have agreed to follow bona fide and businesslike settlements on the basis that such a settlement establishes and quantifies the reinsured’s own liability for the purposes of limb 2 in Scor, but at the same time they reserve the right to refuse to follow the selfsame settlement based on the identical words in the reinsurance agreement, by relying upon limb 1 in Scor. 6.41 It is suggested that Evans J’s decision is correct but his reasoning is open to question. It is the case that bona fide in commercial sense does not equate to bona fide in legal sense.82 Wellington payments could not fall within the second limb of Scor (ie acting bona fide and businesslike) because even though the reinsured’s liability might be reduced in some respects by reason of the sharing of losses, the reinsured knew that under the Wellington Facility it would have to make payments which it was not legally liable to make. Consequently the payments were not within the original policy and therefore did not fall within the reinsurance. Where the contracts are back-to-back, if the loss falls within the original contract, it is also assumed that it falls within the reinsurance policy terms given that the contracts provide identical cover. If the reinsurance policy contains anything contrary to the original policy or any additional clauses, the contracts are not back-to-back in those respects and naturally the reinsurers can rely on their own policy defences. If the settlement is not bona fide and businesslike, it will be outside the second limb of Scor and automatically outside the reinsurance policy terms (ie the second limb of Scor). 6.42 On the other hand, if the loss in fact did not fall within the original policy but the reinsured acted bona fide and in a businesslike manner in assessing the original loss, the reinsurers would be obliged to pay even though it could be subsequently established that the reinsured was not genuinely liable.83 This is the case because the reinsurers have agreed to follow the settlements of the reinsured and the construction of the follow the settlements clause entitles the reinsured to be indemnified in such cases. Therefore, where the contracts provide identical cover and the reinsured has acted bona fide and in a businesslike manner, contending that the reinsured was not genuinely liable thereby enabling the reinsurer to rely on its own policy defences would be tantamount to undermining the construction of the follow the settlements clause. 82. Commercial Union Assurance Co Plc v NRG Victory Reinsurance Ltd [1998] 2 Lloyd’s Rep 600. 83. Potter J Baker v Black Sea & Baltic General Insurance Co Ltd (1995) LRLR 261.

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6.43 The dilemma raised by this approach is therefore to find a means of reconciling the follow the settlements clause with the principle that reinsurers can rely upon their own contract in a manner which gives meaning to both principles. 6.44 In Assicurazioni Generali SpA v CGU International Insurance84 the Court of Appeal adopted the principle laid down in Hiscox v Outhwaite, but in a way which in practical terms gives primacy to the follow the settlements clause. In Assicurazioni a Canadian company which was acting as a front for Generali provided the original cover against contractors’ risks for the installation and maintenance of power cables to be laid under the St Lawrence river. About a year after they had been laid one of the cables suffered a loss of power which was later found to be caused by abrasion of the cable on the riverbed. The cable had to be replaced after a repair attempt. After lengthy negotiations Generali settled the claim for $4 million. 6.45 Some 80% of the original risk was reinsured at Lloyd’s by a number of syndicates. The reinsurance was stated to be: “As original: Anything herein to the contrary notwithstanding, this Reinsurance is declared and agreed to be subject to the same terms, clauses and conditions, special or otherwise, as the original policy or policies and is to pay as may be paid thereon and to follow without question the settlements of the Reassured except ex gratia and/or without prejudice settlements.”

6.46 Some of the participant reinsurers at Lloyd’s market paid their share of Generali’s claim on the reinsurance but the defendant reinsurers refused to pay their shares. The reinsurers’ defence was based on the second proviso to Scor, namely that the claim recognised by Generali did not fall within the risks covered by the policy of reinsurance as a matter of law. Thus, the point at stake in this case was – as Tuckey LJ described: “to what extent does the first proviso preclude reinsurers from raising coverage issues [under the second proviso] relating to terms which are the same in both the insurance and the reinsurance contracts?”

6.47 Generali sought summary judgment on its claim. It became apparent at the first instance hearing that summary judgment could not be given on the facts, but both the High Court and Court of Appeal expressed their views on the operation of Scor where the terms of the insurance and reinsurance were identical and the reinsurance contained a follow the settlements clause. 6.48 At first instance,85 Deputy High Court Judge Gavin Kealey QC drew a distinction between (a) proving that an original loss falls within the cover provided by a contract of insurance and by a contract of reinsurance; and (b) proving that a claim that has been recognised by the reinsued as falling within the cover provided by a contract of insurance also falls within the cover provided by a contract of reinsurance. According to Mr Kealey QC in the first case it is necessary to examine “what in fact happened and whether, on the basis of what actually happened, the insurers are liable to indemnify the assured under the contract of insurance and the reinsurers are liable to indemnify the insurers under the contract of reinsurance, according to their respective terms.” The second case, however, required an examination of whether the claim as recognised by the reinsured by the settlement with the assured by admission or compromise falls within the reinsurance cover as a matter of law. 6.49 Mr Kealey QC was also convinced that the presumption of back-to-back cover together with the reinsurers’ agreement to follow the reinsured’s settlement did not amount to an obligation on the reinsurers to follow every single bona fide and businesslike settlements as binding on the reinsurers. 84. [2004] 2 CLC 122. 85. [2003] 2 CLC 852.

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6.50 Mr Kealey QC gave examples of situations where the claim as recognised by insurers may not fall within the reinsurance cover. The first hypothetical case was where the insurance and reinsurance contracts contained identical exclusion clauses or warranties relating to the subject matter of the insurance and additionally, the reinsurance contract contained a follow the settlements clause. In such a case, if the assured is in breach of the terms of the insurance contract and if the reinsured waives its policy defences and settles the claim in a businesslike fashion, the claim as recognised by the reinsured would not fall either within the original insurance or reinsurance coverage. But it must be questioned here whether such a settlement would indeed be bona fide and businesslike within the meaning of Scor, and whether the example is no more than illusory. 6.51 Another illustration given by Mr Kealey QC related to the exclusion of losses characterised as fair wear and tear. If in such a case the reinsured settled a claim for loss on the basis that it was fair wear and tear, that basis, assuming it was valid, would fall outside the risks covered by a back to back contract of reinsurance as a matter of law. However, once again, it can scarcely be said that settling a claim on a basis known to be outside the terms of the insurance amounts to a bona fide and businesslike settlement within the meaning of Scor. 6.52 It is noteworthy that Mr Kealey QC also considered the situation in which the reinsured considered the application of an exclusion clause and determined both on the facts and on the law that it did not apply or arguably did not apply to exclude the loss. Accordingly, if the reinsured settled the claim on the basis of an admission or compromise of liability under the terms and conditions of the insurance, the claim so recognised would fall within the risks covered by the contract of reinsurance as a matter of law. It might be thought that this strengthens the argument that the wording of the reinsurance has no independent effect on the reinsured’s rights where the wording is back to back and the claim is settled on a bona fide and businesslike basis. 6.53 The Court of Appeal upheld the first instance judgment. Tuckey LJ, delivering the only reasoned judgment, recognised Gavin Kealey QC’s efforts – which, both judges called “somewhat academic” – to give hypothetical examples to illustrate his conclusions, but Tuckey LJ preferred not to embark on such an “ambitious exercise” as it would not be wise to enter into controversy about the application of principle to hypothetical facts. 6.54 Tuckey LJ accepted that Scor established that the standard form of the follow the settlements clause relieved reinsureds of the obligation to prove that the loss fell within the original cover, both as to liability and amount. Nevertheless, his Lordship noted that such relief did not include the reinsured’s obligation to prove that the loss fell within the cover created by the reinsurance. Tuckey LJ approved the first instance ruling that while the reinsured did not have to prove that the original loss fell within the risks covered by the reinsurance, it remained necessary for the reinsured to prove that the claim so recognised by the reinsured fell within the risks covered by the policy of reinsurance as a matter of law. 6.55 It is noteworthy that on appeal the reinsured’s counsel invited the court to consider the philosophy behind follow the settlements clauses, which was to avoid multiple claims enquiries and to reduce the possibility of disputes between insurers and reinsurers. Tuckey LJ recognised the philosophy but also noted that it did not compel any particular solution.86 The reinsured also argued that, because the reinsurers were bound to accept any settlement made between the reinsured and his assured, where the terms of the two contracts were back-to-back

86. As is seen in various parts of this work that in the US most of the judgments of the “follow the fortunes” doctrine have relied on the philosophy that the reinsureds’ counsel in Assicuracioni v Generali unsuccessfully brought to the Court of Appeal’s attention.

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and the reinsured had acted honestly and taken all proper and businesslike steps in settling the claim, the reinsurers were bound. Tuckey LJ, having described this submission as a bold one rejected it. Tuckey LJ held that the reinsured did not have to prove that if the original claim was fully argued it would in fact have succeeded. No investigation as to whether it was arguably within the terms of the original policy was required. The reinsured was required to prove that the basis on which he settled it was one which fell within the terms of the reinsurance as a matter of law or arguably did so. This and the need for the reinsured to have acted honestly and taken all reasonable and proper steps in settling the claim, according to Tuckey LJ, provided adequate protection for the reinsurer. 6.56 Tuckey LJ, in so deciding, referred to number of cases: In Charman v Guardian Royal Exchange Assurance plc87 and Baker v Black Sea and Baltic General Insurance Co Ltd 88 it had been held that “the reinsurer is not liable if the claim settled does not fall within the risks covered by the policy of reinsurance as a matter of law” where the contracts were assumed to be back-to-back. In Insurance Co of the State of Pennsylvania v Grand Union Insurance Co, Mortimer J accepted that, with regard to the second proviso of Scor, Robert Goff LJ had referred to the reinsurance policy’s terms but not those of the original insurance which had been incorporated into the reinsurance, and stated that allowing the reinsurers to rely upon the incorporated terms would undermine the conclusion that Robert Goff LJ had reached in Scor. Tuckey LJ’s conclusion was that the correct approach was that reinsureds “do not have to show that the claim they have settled in fact fell within the risks covered by the reinsurance, but that the claim which they recognised did or arguably did.” 6.57 It should be noted that Mr Kealey QC at first instance refused to decide whether or not Generali’s settlement was ex gratia, given that the claim before him was for summary judgment and the issue of whether the settlement was ex gratia should be the subject of proper disclosure and ultimately, if necessary, oral evidence at trial. Mr Kealey QC nevertheless defined ex gratia settlements as those of made on the basis of no liability to indemnify. Thus, if the claim recognised by the reinsured in settling the claim, admitted or compromised, was at least arguably within the terms of the original insurance, the settlement would not be ex gratia. 6.58 In summary, therefore, as long as the reinsured has treated the claim as one falling within the scope of the direct policy, the reinsurers cannot go behind that decision. The difficulty with the ruling in Generali that the reinsurers are entitled to rely upon the words of the reinsurance is that, where the reinsured’s settlement is bona fide and businesslike, it is difficult to conceive of a case in which the settlement could be said arguably not to fall within the original insurance cover. If the settlement is bona fide and businesslike in this sense, the reinsurers will be obliged to follow that settlement where the reinsurance is in identical terms to the original policy. Similarly, if a settlement is not bona fide and businesslike, as Mr Kealey QC and the Court of Appeal emphasised, for instance because the reinsured consciously chose not to rely on original policy defences available to him, it will not be necessary to consider whether the loss fell within the reinsurance policy coverage. Thus, while the Assicurazioni Generali may be regarded as a compromise approach, attempting to give independent effect to the first limb of the Scor test where there is a follow the settlements clause, while at the same time seeking not to undermine the effect of the follow the settlements clause, it is difficult to see how the compromise can ever work in favour of the reinsurers. The outcome is that the reinsured will fail to satisfy the first limb of Scor only where the claim is not recognised 87. [1992] 2 Lloyd’s Rep 607. 88. (1995) LRLR 261.

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by the reinsured as falling within the scope of the reinsurance. This was the situation in Aegis Electrical and Gas International Services Co Ltd v Continental Casualty Co 89 where a claim was paid without regard to whether or not it fell within the terms of the direct policy, and accordingly the reinsured could not assert that it had recognised the claim on any sort of basis at all. 6.59 Assicurazioni Generali SpA v CGU International Insurance90 was accepted as correct by the House of Lords in Wasa International Insurance Co Ltd v Lexington Insurance Co.91 However, the situation in Wasa was quite different to that in Assucurazioni Generali because the argument in Wasa was that the two contracts were not to be construed back-to-back, so there was no issue of the reinsurers being unable to rely upon their own policy wording. In Wasa, having decided that the contruction of the terms of the original insurance by the Washington Supreme Court by applying the law of Pennslyvania was not binding for the reinsurers whose contracts were subject to English law, their Lordships92 noted that the follow the settlements clauses did not have the effect of bringing within the cover of a policy of reinsurance risks that, on the true interpretation of the policy, would not otherwise be covered by it. The House of Lords also93 found that the authorities which decided that under the follow the settlements clause the reinsurer is bound by the reinsured’s settlement which was entered in good faith or following a decision of a court of competent jurisdiction cannot assist the reinsured in Wasa because a reinsurer will only be bound to follow its reinsured’s settlement provided that the claim recognised by them falls within the risks covered by the policy of reinsurance as a matter of law. This is because the reinsurer cannot be held liable unless the loss falls within the cover created by the reinsurance. With respect, it is submitted that where the original insurance and the reinsurance contract terms are identical and where the reinsurer and the reinsured agreed to share the premium and the risk proportionally, a construction to this effect undermines the nature of the proportional facultative reinsurance. But, as commented above, that was not the issue in Wasa. THE SECOND LIMB: ACTING IN BONA FIDE AND BUSINESSLIKE MANNER IN SETTLING THE CLAIM

6.60 The result of Scor is that where the reinsurance contract provides a follow the settlements clause the reinsured is relieved from the obligation of proving the actual loss. All that is necessary is that the reinsured takes proper and businesslike steps in determining whether there was a serious possibility that the policy covers the assured’s claim and there is no defence available against it.94 6.61 One of the key elements in determining whether the reinsured has acted in bona fide and businesslike fashion is whether the reinsured has appointed a competent loss adjuster and adequately supervised its conduct and questioned its findings. Reinsureds are to be identified with the conduct of their loss adjusters and any other agents they employ for the purpose of making the settlement.95 Therefore reinsureds will be responsible for a failure of the loss adjusters to act with good faith or in a businesslike manner.96 This means that the reinsured’s conduct will not be regarded businesslike if it simply slavishly follows the loss adjuster’s report. When any report is 89. [2008] Lloyd’s Rep IR 17. 90. [2004] 2 CLC 122. 91. [2009] 2 Lloyd’s Rep 508. 92. Ibid. at 512. 93. Ibid. at 534. 94. Municipal Mutual Insurance Ltd v Sea Insurance Co Ltd [1996] CLC 1515. [1990] 1 Lloyd’s Rep 208. 95. Charman v Guardian Royal Exchange Assurance [1992] 2 Lloyd’s Rep 607, 612. 96. Potter J in Baker v Black Sea and Baltic General Insurance Co Ltd [1995] LRLR 261.

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produced by the loss adjuster the reinsured is under a duty to take appropriate steps to put matters right where it is obvious or should be obvious to the reinsured that the report has been prepared inadequately, perhaps because the loss adjuster has assumed something which the reinsured knows to be incorrect or where the report appears to be defective for any other reason.97 Consequently, a reinsurer may defeat the application of a loss settlement clause on the ground that the reinsured’s loss adjuster failed properly and carefully to investigate and ascertain the loss.98 The burden of proof that the loss adjuster or any other agent of the reinsured did not act in a businesslike manner will, as stated above, be on the reinsurer. Burden of Proof 6.62 As to the evidentiary effect of the clause, it was stated that the reinsured is entitled to call upon the reinsurer to follow his settlement upon proof that the reinsured has paid his original insured and that the claim against the reinsurer falls within the reinsurance policy.99 In the absence of any express wording imposing further duties on the reinsured the reinsured’s burden of proof is discharged by providing the reinsurers with information and documents which show, but not necessarily in detail, how the claim arose and dealt with; in other words it needs to demonstrate only that the claim and its records were in proper form.100 Subsequently, if an issue arises either as to good faith or as to the fact that the settlement was not made in a business-like fashion, the burden must lie upon the reinsurer.101 The reinsurer must prove either that the compromise was dishonestly arrived at, or that the reinsured has failed to take all the proper and businesslike steps to have the amount of the loss fairly and carefully ascertained.102 6.63 The most obvious situation in which it may be argued that the reinsured did not act bona fide and businesslike is where it disregarded defences available under the original policy terms. It was held in Commercial Union Assurance Co Plc v NRG Victory Reinsurance Ltd,103 in the context of a judgment rather than a settlement, that if the reinsured failed to take proper steps to defend the claim in the proceeding the judgment might not be binding on reinsurers. For instance if the reinsured had defences against the assured’s claim, such as breach of warranty or duty of utmost good faith but waived the right to rely upon such defences and chose to pay the claim, the follow the settlements clause does not automatically bind the reinsurer by the settlement that was entered into by the reinsured.104 Nevertheless where the assured is in

97. A Guide to Reinsurance Law, 239–240. 98. Hoffman, 83. 99. Charman v Guardian Royal Exchange Assurance [1992] 2 Lloyd’s Rep 607, 613; See also Hill v Mercantile & General Reinsurance Co Plc [1996] 3 All ER 865 where it was held that if the reinsured cannot prove how he settled the claim with adequate evidence, the reinsurer may not be liable. 100. Charman v Guardian Royal Exchange Assurance [1992] 2 Lloyd’s Rep 607; Webster J also stated that imposing any further duty to give detailed report and convincing the reinsurer that the settlement was bona fide and businesslike would actually entitle the reinsurer to require his reinsured to prove liability (at 614). See also Wurttembergische AG Versicherungs Beteiligungsgesellschaft v Home Insurance Co (No 1) [1997] LRLR 86. The reinsured may also be required to make appropriate investigations and conduct to local lawyers as to the meaning of the original policy Gan Insurance v Tai Ping Insurance (No 3) [2002] Lloyd’s Rep IR 612. 101. Insurance Co of the State of Pennsylvania v Grand Union Insurance Co [1990] 1 Lloyd’s Rep 208; Charman v Guardian Royal Exchange Assurance [1992] 2 Lloyd’s Rep 607; Andrew Smith J in Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd [2001] Lloyd’s Rep IR 667; Potter J in Baker v Black Sea and Baltic General Insurance Co Ltd [1995] LRLR 261. 102. Per Leggatt J in Insurance Co of Africa v Scor (UK) Reinsurance Co Ltd [1983] 1 Lloyd’s Rep 541, 555 approved by Stephenson LJ, [1985] 1 Lloyd’s Rep 312, 322. The reinsurer must bring expert evidence on the matter in order to prove its allegation: Insurance Co of the State of Pennsylvania v Grand Union Insurance Co [1990] 1 Lloyd’s Rep 208, 217. 103. [1998] 2 Lloyd’s Rep 600. 104. Per Gavin Kealey QC in Assicurazioni Generali SpA v CGU International Insurance [2003] 2 CLC 852.

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breach of duty of utmost good faith, Morison J in Bonner v Cox105 held that, given the policy is valid until the insurer avoids it for breach of utmost good faith, the reinsurer is bound to follow the settlement of the reinsured if the reinsured chose not to rely on the breach of the duty of utmost good faith defence. This view is not supportable for two reasons.106 First, it is difficult to conceive why the good faith defence should be treated differently from other defences no matter if the policy is valid until it is avoided. Secondly the reinsured who paid by waiving the available defence cannot be said settled the claim on the basis of liability. 6.64 The rule that imposing the reinsurer the burden of proof that the reinsured did not act in a bona fide and businesslike manner is justifiable because obliging the reinsured to prove that it was not negligent in settling the claim would be in fact requiring it to prove its genuine liability.107 Moreover, essentially, by a follow the settlements clause the reinsurer puts his trust in the reinsured; therefore, obliging the latter to prove that reliance is justified would be quite inconsistent with the existence of any such trust.108 Ascertainment of Liability in Settlements 6.65 Where more than one claim has arisen under an insurance agreement,109 the parties usually enter into a global settlement agreement which encompasses all of those claims. However, if the settlement does not indicate the method as to the calculation of figures under the agreement is the reinsurer entitled to assert that the settlement is not one which can be regarded as establishing and quantifying the reinsured’s liability? 6.66 In the liability insurance context it is generally accepted that a global settlement is binding as long as the assured’s liability is established and the settled amount is reasonable in that it does not exceed the amount for which the assured would have been liable had it been sued to judgment.110 The point is not, however, entirely free from doubt. In Lumbermans Mutual Casualty Co v Bovis Lend Lease Ltd,111 a case involving a direct liability policy, Colman J held that such a settlement was not binding. In this case the assured and the third party entered into a settlement for $15 million but the settlement did not contain any indication as to the method by which the parties calculated that amount. Colman J looked for any identifiable loss in respect of any identifiable insured eventuality and the absence of that possibility led him to conclude that a global settlement agreement of the nature of that found in the present case did not satisfy the requirement of ascertainment of loss. Moreover, the judge took into consideration that the settlement also covered various counterclaims that made identifying the figures more significant.112 6.67 Nevertheless, in a later case, Enterprise Oil Ltd v Strand Insurance Co Ltd,113 Aikens J stated that there was no precondition that specific claims should be allocated in the settlement itself, so that the assured could recover under the global settlement of insured and uninsured losses as long as it proves the liability. According to the learned judge if an allocation was required in settlements, it should equally be applied to judgments or awards; consequently, a judgment which also did not meet the requirement would be rendered invalid. He emphasised 105. [2005] Lloyd’s Rep IR 569, affirmed without comment [2006] Lloyd’s Rep IR 385. 106. Butler and Merkin, Reinsurance Law, para. C-0008, fn. 3. 107. Charman v Guardian Royal Exchange Assurance [1992] 2 Lloyd’s Rep 607, 613. 108. Ibid.; Insurance Co of the State of Pennsylvania v Grand Union Insurance Co [1990] 1 Lloyd’s Rep 208, 224. 109. This is particularly the case with treaties, although treaties typically do not contain follow the settlement provisions. 110. Structural Polymer Systems Ltd v Brown [1999] CLC 268. See also P&O Steam Navigation Co v Youell [1997] 2 Lloyd’s Rep 136. 111. [2005] 1 Lloyd’s Rep 494. 112. It is worth noting that Colman J rejected extrinsic evidence as proof of that liability. 113. [2006] 1 Lloyd’s Rep 500.

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that judgments rarely descend to the level of particularity which Colman J appeared to suggest therefore, his ruling would cause commercial inconvenience.114 6.68 Colman J’s decision is not appropriate to commercial practice because the parties usually settle multiple and cross-claims in a global agreement where they do not make any admission of liability or attempt to allocate sums to the various claims. Therefore it was said in the later cases that Colman J’s ruling is likely to militate against the global agreements between the parties. It was also described as “technical” for the reason that if the failure to allocate each sum prevents the assured from making a claim, it also deprives him from the ability to prove liability. This view suggests that Colman J’s ruling could be applicable where the settlement covers both insured and uninsured losses, so that the mere fact of settling counterclaims would not affect the binding feature of the settlement.115 6.69 It should be noted that these two authorities were not reinsurance cases116 and in fact Aikens J reserved his position as to whether his analysis would be applicable to reinsurance, given that it is not certain if reinsurance is liability insurance.117 However, it is submitted that these rules are equally applicable to the settlements entered into by reinsureds because the logic of the reasoning is that a settlement that not allocate the each claim does or does not establish and quantify the reinsured’s loss.118 It should also be remembered that in Re London County Commercial Reinsurance Office Ltd119 it was held that the reinsured must prove the liability in the same way as the assured had to do. Therefore there seems to be no reason why these principles should not be applicable to reinsureds’ settlements. Because Enterprise Oil Ltd v Strand Insurance Co Ltd 120 is a High Court decision, it cannot be said that Colman J’s view was overruled. On the other hand it should be borne in mind that it has been rejected by trial judges on two separate occasions.121 The Assured’s Fraud 6.70 In terms of establishing and quantifying its liability to the assured it is necessary only for the reinsured to have acted honestly and professionally in determining that there was a serious possibility that the loss fell within the original insurance coverage. Subsequently, if the assured’s claim is shown to have been fraudulent, that should not in principle affect the reinsured’s rights against the reinsurer under the follow the settlements clause because matters have to be judged at the date of the settlement. As long as the reinsured acted in a bona fide and businesslike manner in settling the claim, even if subsequently it was demonstrated that the assured acted fraudulently, this should not cause the reinsured to lose its rights. 6.71 The issue came before the Court of Appeal in Insurance Co of Africa v Scor (UK) Reinsurance Co Ltd 122 where the insured warehouse in Liberia was destroyed with its contents 114. See AIG Europe (Ireland) v Faraday Capital Ltd [2007] Lloyd’s Rep IR 267, 282: it was not necessary to decide the point but Morison J nevertheless stated that Lumbermans Mutual Casualty Co v Bovis Lend Lease Ltd [2005] 1 Lloyd’s Rep 494 was unlikely to be right and had he been forced to state an opinion he would have followed Enterprise Oil Ltd v Strand Insurance Co Ltd [2006] 1 Lloyd’s Rep 500 “which produces a commercially sensible conclusion.” 115. Butler and Merkin, Reinsurance Law, para. C-0009/2. 116. It should be noted that in Enterprise Oil Ltd v Strand Insurance Co Ltd [2006] 1 Lloyd’s Rep 500 the insurer was a captive, and pursuant to an agreement with the reinsurers, the defence to the claim was effectively conducted in the insurer’s name by reinsurers. 117. [2006] 1 Lloyd’s Rep 500 para. 163. See the discussion above, Chapter 2. 118. Butler and Merkin, Reinsurance Law, para. C-0009/2. 119. [1922] 2 Ch 67, 80 PO Lawrence J. 120. [2006] 1 Lloyd’s Rep 500. 121. See AIG Europe (Ireland) v Faraday Capital Ltd [2007] Lloyd’s Rep IR 267 (Morrison J’s judgement was overturned by the Court of Appeal without making any comment on this issue [2008] Lloyd’s Rep IR 454) and Enterprise Oil Ltd v Strand Insurance Co Ltd [2006] 1 Lloyd’s Rep 500. Obviously a Court of Appeal decision is needed to solve the issue conclusively. See Reinsurance Law and Practice, para. 15.2.7.4. 122. [1985] 1 Lloyd’s Rep 312.

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by fire. While the reinsured was investigating the loss through a local loss adjuster, the reinsurer received anonymous letters from Liberia alleging that the fire was set deliberately by the assured. The reinsurers sent their representatives to Monrovia to investigate. The reinsured however failed to cooperate with the investigators and the reinsurers refused to approve the proposed settlement of the claim. The reinsured was obliged to contest the claim and the assured brought an action against the reinsured in Liberia. The Liberian court decided for the assured because the reinsured was unable to submit any evidence proving that the fire was deliberately set by the assured and that the claim was fraudulent. Following the decision the reinsured settled the claim with the assured but the reinsurers denied liability for the same reason – that the claim was fraudulent. The reinsured brought an action in England to make good its claim against the reinsurers. In addition to setting out the rules for the construction of the follow the settlements clause, the Court of Appeal also expressed the view as to the effect of the clause on fraudulent claims. Their Lordships stated that as long as the reinsured had settled the claim acting honestly and in a proper and businesslike manner, the reinsurers were not entitled to reject to follow the settlement even if it is later proved that the claim of the assured was fraudulent.123 The Court of Appeal suggested that reinsurers may have recourse to their rights of subrogation124 arising upon payment of the claim under the policy of reinsurance, to seek to rescind the settlement with the assured and to recover the money paid by the insurers under that settlement.125 Proving Liability by the Reinsured in Stop-Loss Policies 6.72 It has not been settled yet whether stop-loss policies are reinsurance but the cases have nevertheless considered the operation of the follow the settlements clause in stop-loss contracts. 6.73 In this kind of agreement the reinsurers accept liability for aggregate ultimate net losses in excess of a fixed monetary amount per annum, subject to an upper limit.126 In other words, the reinsurer protects the reinsured against the risk of a series of losses occurring during one year in excess of the reinsured’s retention up to an agreed limit.127 They are normally written on the basis that all losses above a given figure will be picked up by reinsurers. Hence stop-loss reinsurance is not intended to provide protection against individual claims.128 The reinsurer will be liable after the loss ratio for the year reaches an agreed percentage of the premiums until its limit of liability is reached.129 6.74 Toomey v Eagle Star Insurance Co Ltd130 was a case where the policy was in stoploss form and referred itself as “this reinsurance contract.” Eagle Star, the reinsurer to close,131 agreed to pay all claims and other outgoings in respect of the run-off of the 123. [1985] 1 Lloyd’s Rep 312, 330. 124. In Assicurazioni Generali de Trieste v Empress Assurance Co Ltd [1907] 2 KB 814, (there was no “follow the settlements” or “pay as may be paid thereon” clause) the reinsured sued the brokers on the grounds that their employee had fraudulently misrepresented to the insurer that the ships in question came within the scope of the open cover. Pickford J applied Castellain v Preston (1883) 11 QBD 380 and held that the reinsurers were entitled to recover the amount of the claim that they had paid, less “the costs” reasonably and properly incurred in pursuing the claim against the brokers. For subrogation, see O’Neill and Woloniecki, para. 5.95 et seq. 125. [1985] 1 Lloyd’s Rep 312, 330. 126. Carter, 686. 127. Carter, 641; Kiln, 303. 128. It is possible, but extremely unlikely, that a single claim would exceed policy limits, but if it did the maximum limit can in principle be applied to payments arising from one single claim: Carter, 686. 129. Golding, 194. 130. [1994] 1 Lloyd’s Rep 516. 131. Lloyds is organised into syndicates of Names each of whom accepts a liability for a proportion of the syndicate’s underwriting account. The accounts of the syndicate are prepared on an annual basis and are kept open and not closed until the third year after the year of account. When the accounts for a given year are closed, provision is made to meet outstanding liabilities and credits by reinsuring into the next open year, by means of “reinsurance to close.”

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syndicates’ 1965 underwriting year of account including all previous years of account reinsured by that year. The contract provided that settlements were to be made monthly on receipt of debit notes to be rendered by the syndicate to Eagle Star. For a long time the agreement operated without difficulty, until a huge increase in claims, mostly arising from personal injuries as a result of asbestosis, had been made against the syndicates in respect of 1965 and prior years. The issue was whether Eagle Star was under an obligation to reimburse the syndicates for claims and other relevant payments regardless of the claimants’ proof of liability to the assured. 6.75 The contract provided that claims negotiations should be handled by the reinsured, that settlements should be made monthly on receipt of debit notes from the reinsured, that the reinsured should provide Eagle Star with brief details of any new losses or increased losses which come to their attention and that Eagle Star should be entitled to inspect the records of the reinsured at any reasonable time. Hobhouse LJ found that this contract did not require the claimants to prove liability as would be the case in a true reinsurance or liability insurance contract.132 His alternative solution for Eagle Star was that they could deny liability either by relying on good faith defence or by exercising their contractual right to be kept informed. 6.76 Furthermore Hobhouse LJ said that because of the “pay as may be paid clause” in some reinsurance contracts, establishing liability was required but in this case there was no such clause and liability did not need to be proved. 6.77 It is in fact not clear why the court found it unnecessary to prove liability and whether it was because of the absence of a “pay as may be paid” clause, as was said by Hobhouse LJ in distinguishing this case from Versicherungs und Transport A/G Daugava v Henderson133 and Fireman’s Fund Insurance Co v Western Australian Insurance Co Ltd,134 or whether because stop-loss was not reinsurance. However, it is suggested that his reasoning is incorrect either way. Stop-loss policies cover all losses incurred by the reinsured and are a variation of excess of loss non-proportional cover. Stop-loss does look more like an agreement to pay debts once they reach a certain level, rather than reinsurance, but it is accepted as reinsurance by the market135 and by the regulator.136 As a matter of reinsurance law, there is no inconsistency between the idea of reinsurance and nil retention by the reinsured.137 Moreover reinsurance operates in the same way as liability insurance and, regardless of any discussion of the nature of reinsurance, it is established that in the absence of a follow the settlements provision the reinsured must prove liability. When the Reinsurers’ Liability Arises 6.78 Two different contractual relationships are affected when the risk insured against by a direct policy has occurred. In facultative reinsurance contracts the assured’s loss forms the reinsured’s claim against the reinsured. Under this mechanism the reinsured cannot claim until its liability to the assured has been established and quantified.138 However this may give rise to disputes as to, for example, the relevant exchange rate for the claim against the reinsurers and also the applicable limitation period. 132. 133. 134. 135. 136. 137. 138.

[1994] 1 Lloyd’s Rep 516, 524. (1934) 49 Ll L Rep 252. (1927) 28 Ll L Rep 243. Edelman, para. 1–19. Financial Services Authority, under the Financial Services and Markets Act 2000. Edelman, para. 1–19. Home Insurance Company of New York v Victoria – Montreal Fire Insurance Company [1907] AC 59.

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6.79 The exchange rate was the issue in Versicherungs und Transport A/G Daugava v Henderson139 where an English underwriter reinsured a Latvian insurance company against liability under a fire insurance policy on buildings in Riga. A fire occurred and, as a result of legal proceedings commenced by the assured, judgment was given against the reinsured by the Latvian courts, assessed in the local currency, Lats. The amount was paid to the assured within a month. The issue was, with regard to the reinsurer’s liability, whether the sum was to be converted into sterling at the exchange rate on the day of the fire, or at the date of the settlement of the insurer’s liability.140 At first instance Roche J emphasised the follow the settlements clause and stated that the exchange must be calculated as to the exchange rate at the judgment date, January 1932, because the reinsurer was not under any liability at all until there was a settlement to follow, and that did not occur until January 1932.141 In the Court of Appeal Scrutton LJ reached the same conclusion but for different reasons. He found it unnecessary to decide if Roche J’s reason was correct and expressed the opinion that the reinsurer could not be liable to pay an amount until it had been fixed between the insurer and the assured.142 He also added that if the rate of exchange has been fixed at a date before the insurer’s liability to pay is quantified and satisfied, the insurer may recover more than it is actually entitled to, which would be contrary to all principles of insurance indemnity.143 6.80 In terms of the limitation period in liability insurance, that period starts running from the date when the assured’s liability to the third party is established and quantified by virtue of judgment, arbitration award or settlement.144 The same principle applies to reinsurance.145 That amount will form the measure of the reinsured’s indemnity146 and this indeed lends further support to the proposition that reinsurance is a form of liability insurance. The Necessity of Payment to Trigger the Reinsurer’s Liability 6.81 The fact that the reinsured must establish and quantify its liability as a condition of payment does not mean that this suffices: the further question is whether payment by the reinsured is also precondition to payment by the reinsurers. Some policies may deal with the matter expressly, as in the case of a “simultaneous settlements” clause whereby the reinsurers are required to make payment as soon as the reinsured has done so. If the policy does not deal with the point specifically,

139. (1934) 49 Ll L Rep 252. 140. The fire occurred on 11 April 1930 and the insurance payment was made in January 1932. 141. (1934) 48 Ll L Rep 54, 60. 142. (1934) 49 Ll L Rep 252, 253. The parties can expressly agree when the reinsurer’s liability arises. In Feasey v Sun Life Assurance Co of Canada [2003] Lloyd’s Rep IR 637 the reinsurance agreement was drafted on the basis that the reinsurer’s liability to make payment arose when the insured contingency happened rather than on which the reinsured’s own liability was established. However, Feasey turned on a contract specifically drafted to achieve that end. 143. (1934) 49 Ll L Rep 252, 253. In Fireman’s Fund Insurance Co v Western Australian Insurance Co (1927) 28 Ll L Rep 243 Bateson J stated that “. . . a contract of reinsurance is a contract to indemnify against a liability and a payment. There must be both liability and payment, and the precise liability must be covered in each case.” After Versicherungs und Transport A/G Daugava v Henderson (1934) 49 Ll L Rep 252 this dictum arguably cannot stand: Butler and Merkin, Reinsurance Law, para. C–0003. 144. London Steamship Owners Mutual Insurance Association Ltd v Bombay Trading Co Ltd, The Felicie [190] 2 Lloyd’s Rep 21; Lefevre v White [1990] 1 Lloyd’s Rep 569. 145. Sphere Drake Insurance plc v Basler Versicherungs-Gesellschaft [1998] Lloyd’s Rep IR 35; Halvanon Insurance Co Ltd v Companhia de Seguros do Estado de So Paulo [1995] LRLR 303; Potter J Baker v Black Sea and Baltic General Insurance Co Ltd [1995] LRLR 261 (The point did not arise on appeal). The same principle applies in excess of loss reinsurance: the date on which the excess point is reached establishes the reinsured’s liability to pay: North Atlantic Insurance Co Ltd v Bishopsgate Insurance Ltd [1998] 1 Lloyd’s Rep 459, 462. However see Feasey v Sun Life Assurance Co of Canada [2003] Lloyd’s Rep IR 637 where the test was varied by the express statement that the reinsurer’s duty to provide indemnity arose on the happening of the insured peril. 146. Potter J Baker v Black Sea and Baltic General Insurance Co Ltd [1995] LRLR 261.

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there is room for an argument that prepayment is required.147 This argument may seem to be strong especially where the contract contains “to pay as may be paid thereon” clause. 6.82 The issue first came before the court in Re Eddystone Marine Insurance Company, Ex p Western Insurance Company148 where both the reinsurer and the reinsured were in liquidation and the marine reinsurance policy was expressed to be “. . . subject to the same terms and conditions as the original policy, and to pay as may be paid thereon.” Stirling J expressed the view that the words “to pay as may be paid thereon” did not have a strict grammatical connection with those words which immediately preceded it. The effect of the clause was nevertheless to impose an obligation as to payment on the reinsurers and this obligation should not depend upon to make payment by the reinsured, which would in any event be impossible if the reinsured was insolvent.149 Stirling J also added that in order to construe the clause as rendering payment by the reinsured as a condition precedent the clause should clearly so state.150 6.83 The matter has more recently come before the courts in the construction of ultimate net loss clauses in excess of loss treaties. Those clauses typically provide that the reinsurers’ liability is triggered when the reinsured “shall actually have paid” the assured. For example in Home and Overseas Insurance Co Ltd v Mentor Insurance Co (UK) Ltd151 the reinsurance policy was drafted as “. . . only to pay the Excess of an ultimate net loss to the reinsured . . . ” and the policy defined ultimate net loss as “the sum actually paid by the reinsured in settlement of losses. . . .” The reinsured went into voluntary liquidation and made claims against the reinsurer. The latter denied liability and applied for summary judgment declaring that “the amount paid being given by the reinsured,” “only to pay . . .” and “. . . the sum actually paid by the reinsured in settlement . . .” required the actual payment by the reinsured to make a claim against them. Referring to Stirling J’s comments in Re Eddystone Marine Insurance Co ex parte Western Insurance Co152 and also Re Law Guarantee Trust & Accident Society Ltd,153 Hirst J expressed that it would be “unjust” and “discordant” with commercial good sense if the reinsurer should be discharged from liability just because the reinsured went into liquidation and not be able to make any payment to the assured, especially in a situation where the reinsurer would unquestionably have been liable had the reinsured remained solvent.154 Moreover

147. It is in fact the case in P & I. See Firma C-Trade SA v Newcastle Protection and Indemnity Association (The Fanti) [1991] 2 AC 1 where the relevant club rules provided: “Protect and indemnify members in respect of losses which they as owners of the entered vessel shall have become liable to pay and shall have in fact paid.” The House of Lords held that “shall have in fact paid” imposed actual payment by the member/assured as condition precedent to the insurer’s liability. 148. [1892] 2 Ch 423. This case was also mentioned with approval by Scrutton LJ in Versicherungs und Transport A/G Daugava v Henderson (1934) 49 Ll L Rep 252, 254, and by Evans J, obiter, in Hong Kong Borneo Services Co Ltd v Pilcher [1992] 2 Lloyd’s Rep 593. 149. The reinsurer will also be liable for the full amount of the assured’s loss. Re Law Guarantee Trust & Accident Society Ltd [1914] 2 Ch 617. 150. Stirling J’s decision is consistent with the modern approach: in Friends Provident Life & Pensions Ltd v Sirius International Insurance Corp [2005] 2 Lloyd’s Rep 517 the Court of Appeal emphasised that in order to be classified as a condition precedent, the clause must expressly so state. Nevertheless, in Pine Top Insurance Co Ltd v Unione Italiana Anglo Saxon Reinsurance Co Ltd [1987] 1 Lloyd’s Rep 476, 478. Gatehouse J noted the general rule that the reinsurer is obliged to pay as soon as the reinsured’s liability is, or is capable of being assessed, even though the reinsured has not yet made payment. However the learned judge construed the “to pay as paid thereon” clause as altering the general rule, obliging the reinsurer to indemnify the reinsured on payment of claims by the reinsured. 151. [1989]1 Lloyd’s Rep 473. 152. [1892] 2 Ch 423. 153. [1914] 2 Ch 617. 154. 1988 WL 624156. On appeal, the Court of Appeal declined to comment on this point. Parker LJ however, distinguished the case from Firma C-Trade SA v Newcastle Protection and Indemnity Association (The Fanti) [1991] 2 AC 1 as in Home and Overseas Insurance Co Ltd v Mentor Insurance Co (UK) Ltd [1989]1 Lloyd’s Rep 473 the contract did not contain any provision which covered the position in liquidation: [1989] 1 Lloyd’s Rep 473, 485.

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the word “paid” in the definition of ultimate net loss clause has been construed as “liable to pay” where the reinsured went into liquidation, holding otherwise being contrary to common sense in that it would unduly prolong the reinsured’s liquidation.155 6.84 In Charter Reinsurance Company Limited v Fagan156 the House of Lords drew particular attention to the nature of excess of loss reinsurance, and held that within this context the phrase “actually paid” should not be given its ordinary meaning. Their Lordships preferred to read the word “actually” as “in the event when finally ascertained,” and “paid” as “exposed to liability as a result of the loss insured under clause 1.” Lord Hoffmann emphasised that words may have different meanings in different contexts and in order to explain that in this policy the words “shall have actually paid” should not be construed in their literal meaning, gave an example of a typical conversation between a husband and wife. He took the word “pay” as an example and said that “A wife comes home with a new dress and her husband says ‘What did you pay for it?’ She would not understand his question in its natural meaning if she answered’ Nothing, because the shop gave me 30 days’ credit’”.157 Lord Hoffmann said that there was an ambiguity of meaning of “pay” here because his question was about the amount of money that has changed hands whereas her answer was about the liability that was incurred, but had not at the time been discharged. Consequently the House of Lords held that the phrase was not designed to introduce a temporal pre-condition to recovery in the form of disbursement or other satisfaction of the precise net commitment between the assured and the reinsured, but was there “for the purpose of measurement.”158 6.85 Obliging the reinsured to have made payment where it is insolvent would clearly be tantamount to releasing the reinsurer from liability just because the reinsured faced financial difficulties. This unjust result was correctly pointed out by the courts and the rule has been settled. The issue in fact does not create real problems where the reinsured is capable of paying the assured’s claim, but is more significant where the reinsured has gone into liquidation. Follow the Leader v Follow the Settlements 6.86 In insurance contracts many slips contain a “leading underwriter” clause, conferring on the leader the right to negotiate changes and to settle claims on behalf of all subscribing syndicates. The scope of authority conferred by a leading underwriter clause in the slip will depend upon its wording. For instance in Barlee Marine Corporation v Mountain, The Leegas159 the leading underwriter was given the authority to alter the slip;160 in Roadworks (1952) Ltd v Charman161 the following underwriters agreed to be bound by “All alterations, additions, deletions, extensions, agreements, rates and changes in conditions to be agreed by the leading Lloyd’s underwriter.”

155. Re A Company No 0013734 of 1991 [1992] 2 Lloyd’s Rep 115. 156. [1997] AC 313. See also the discussion of the Insolvency Clause used in the US, in Chapter 2 above. As may be seen, the outcome is the same in both jurisdictions. 157. [1997] AC 313, 391. 158. However, the Supreme Court of Ohio held in Stickel v Excess Ins Co of America 136 Ohio St. 49, Ohio 1939 that the phrase “the sum actually paid in cash” in an “ultimate net loss” clause was held to mean that actual payment in cash of a loss by the reinsured for which it is liable was a condition precedent to the duty of the reinsurer to pay. 159. [1987] 1 Lloyd’s Rep 471. 160. “Any amendments additions deletions including new and or managed and or chartered notice of assignment ratings and alterations of any description to be agreed by Leading Underwriter and to be binding on all others hereon.” 161. [1994] 2 Lloyd’s Rep 99.

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6.87 If there are a number of subscribing underwriters on a risk, a major claim can be settled in one of three ways. 1. 2. 3.

Each underwriter makes his own decision, some may pay and some may not.162 All of the underwriters may agree to follow the leader, so if he decides to settle then unless he has acted in bad faith all the others will act accordingly.163 The underwriters may try to agree what to do. In that case they will form a steering committee which will represent all of them, and that committee will make a decision on payment which will be binding on all the underwriters.164

6.88 The question may arise whether the Scor provisos are also applicable to (2), where the policy contains a follow the leader clause. The issue came before Mance J in Roar Marine Ltd v Bimeh Iran Insurance Co (The Daylam)165 where the insurance policy provided “It is agreed with or without previous notice to follow leading British underwriters in regard to . . . settlements in respect of claims. . . .” The insurers submitted that a proviso was implied into the “follow the leader” clause that the settlement must have been concluded in a proper and businesslike way by the leader. 6.89 Mance J recognised the difference between insurance and reinsurance. In the reinsurance context, the insurer handles and is responsible for settlement of original incoming claims on which he then seeks to rely against his own reinsurer; whereas in the insurance context, there is mutuality of interest between insurers. Following insurers agree with the insured to be bound by settlements handled and made by their leading coinsurer. The insured does not control the way in which the leading underwriters handle or settle the claim; for better or for worse following insurers trust and follow their leader. Following underwriters accept both the advantages and any risks of the leading underwriters’ handling of settlements and of other matters affecting them. The leading underwriter clause was, in Roar Marine Ltd v Bimeh Iran Insurance Co (The Daylam),166 limited by the presence of two express exceptions to the following market’s duty to follow settlements, namely exgratia and without prejudice settlements. Mance J found no basis for further qualifying the operation of the follow the leader clause as between the following market and the insured in the manner suggested by the defendants. The qualification would in reality undermine its purpose and operation. Re-Opening a Settlement 6.90 The word “settlement” indicates a concluded binding agreement between the assured and the original insurer, and it does not mean something that can be reconsidered at a later stage by the parties.167 Therefore a settlement that is provisional168 or subject to being 162. See Wasa International Insurance Co Ltd v Lexington Insurance Co [2008] Lloyd’s Rep IR 510. 163. Roar Marine Ltd v Bimeh Iran Insurance Co (The Daylam) [1998] 1 Lloyd’s Rep 423. 164. Eagle Star Insurance Co Ltd v Spratt [1971] 2 Lloyd’s Rep 116 decides that if a steering committee is appointed and all agree to be bound by its decision, then they must honour that decision. 165. [1998] 1 Lloyd’s Rep 423. 166. [1998] 1 Lloyd’s Rep 423. 167. Faraday Capital v Copenhagen Reinsurance [2007] Lloyd’s Rep IR 23, 30. 168. Provisional payments that are subject to future changes are not absolute and can be challenged later on. However in Boden v Hussey [1988] 1 Lloyd’s Rep 423 the retrocessionaire was held liable for a claim settled on the basis of provisional liability subject to adjustment in the event that the reinsured’s liability was either reduced or not proved. In this case an aircraft was lost in an explosion whose cause was not established, so it was unclear whether the loss fell within the scope of the original aviation policy. The reinsurance contract required the reinsurer to make provisional payment, and the reinsurer sought an indemnity from its retrocessionaire under an agreement which indemnified the reinsurer for “losses which may be sustained howsoever” and stated “follow the reinsurer’s settlements.” The Court of Appeal construed the word “losses” as covering payments made both under an established liability and also provisional payments. However, the decision was based on one particular form of retrocession wording and does not establish a general principle: Butler and Merkin, Reinsurance Law, para. C-0004. See para 6.34 et seq.

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reopened cannot be defined as “settlement” for the purposes of a follow the settlements clause.169 6.91 In practice most settlements are expressed to be “full and final” and cover “all claims whether known and unknown,” hence subsequent changes in the law render them immune from being reopened.170 For example, if it is discovered after the settlement that the assured has suffered some consequential loss he will not thereby be entitled to overturn the settlement.171 In the same way, if after having reached a settlement it appears that the amount of the insured loss is greater or lesser than the settled amount, this should not lead to the settlement being re-opened.172 However it should be borne in mind that there may be some circumstances that the parties could not have contemplated at the time of the settlement. For instance in Bank of Credit and Commerce International SA v Ali and Khan,173 the House of Lords decided by a majority to re-open a settlement between a bank and dismissed employees by reason of the fact that at the date of the settlement the law had not recognised damages for the manner of dismissal, a head of loss subsequently recognised by the courts, thereby rendering the settlement one tainted by error of law. 6.92 This decision will be somewhat disappointing to those who rely upon the certainty of settlements and commutations, although it should be taken into account that Bank of Credit and Commerce International SA v Ali and Khan174 is an employment case and of a different nature from insurance cases where the assured’s heads of loss are generally ascertainable from the outset.175 Therefore it cannot be treated as an authority on the re-opening of reinsurance settlements. But in any event it is sensible to draft the settlement as covering all claims “known and unknown” to take steps to protect it against possible re-opening,176 and this is indeed the market practice. 6.93 Nevertheless, it should be remembered that at common law, settlements can be overturned if either party can prove that there was a fundamental mistake which undermined what had been agreed.177 Therefore the validity of an insurance settlement can be challenged if the contract that the settlement was based upon did not exist in the first place. For example if a reinsurer proves a fundamental mistake in assessing the loss that made them believe that the loss fell within the reinsurance cover whereas it did not,178 this mistake may be interpreted as rendering the settlement void because there was in truth no intention to contract.179 It is also 169. Rix J in Hill v Mercantile & General Reinsurance Co Plc [1995] LRLR 160 (approved by the House of Lords [1996] 3 All ER 865), commented that there must be a proven settlement and not some other form of acceptance of liability. 170. The validity and amount of the payment can be challenged if the insurer simply asks the insured to sign a receipt without requiring the insured to sign an acceptance declaring that the settlement is full and final: Butler and Merkin, Reinsurance Law, para. C–0161. 171. Kitchen Design & Advice Ltd v Lea Valley Water Co [1989] 2 Lloyd’s Rep 221; Fontana v Skandia Life Assurance Ltd 2000 WL 1841575. 172. Kyle Bay Ltd v Underwriters Subscribing to Policy No 019057/08/01 [2007] Lloyd’s Rep IR 460. 173. [2002] 1 AC 251. 174. Ibid. 175. Butler and Merkin, Reinsurance Law, para. C-0153. 176. Ibid., at para. C-0153. 177. Bell v Lever Brothers [1932] AC 161. However this common law principle should be considered together with the principle that a contract is void (not voidable) when the subject matter of the contract is not in existence, therefore mistake in quality is not enough to render it void: Great Peace Shipping Ltd v Tsavliris Salvage (International) Ltd [2002] 4 All ER 689; O’Kane v Jones (The Martin P) [2005] Lloyd’s Rep IR 174; Brennan v Bolt Burdon [2005] QB 303; Statoil ASA v Louis Dreyfus Energy Services LP (The Harriette N) [2008] 2 Lloyd’s Rep 685. 178. See Norwich Union Fire Insurance Society Ltd v Price [1934] AC 455 where the insurers made payment on the basis of a mistaken belief that the loss arose from perils insured against. The Privy Council found the mistake “vital” and reopened the settlement. 179. Bell v Lever Brothers [1932] AC 161.

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worth noting that in Kleinwort Benson Ltd v Lincoln City Council,180 the House of Lords abolished the distinction between mistake of law and fact and ruled that the two types of mistake should be analysed in the same way. As a result if the insurer makes payment and subsequently establishes his right to avoid the policy or to rely upon the breach of warranty, that payment may, subject to the defences available to restitutionary claims,181 be recoverable.182 6.94 Provisional payments that are made subject to future changes are not absolute and can be reviewed in the light of later events. Accordingly they cannot be regarded as binding settlements for the purposes of reinsurance claims. Nevertheless, it should be noted that the particular form of a reinsurance or retrocession policy wording may also lead to the possible construction that a provisional settlements is indeed a “loss” within the policies. An example of this particular construction can be seen in Boden v Hussey183 where the Court of Appeal noted that the answer to the fundamental question of “what is the liability against which the reinsurer has by the policy of reinsurance agreed to indemnify the insurer?” depended on the true construction of the policy of reinsurance, rather than on any overriding principle of law. In this case on 23 June 1985, a Boeing 747 Jumbo jet operated by Air India became a total loss as a result of the crash into the sea off the west coast of Ireland. The insurer, General Insurance Corporation of India (GIC), settled Air India’s claims; it did not matter whether the claim was an all risks or a war risks claim because Air India had a combined all risks and war risks cover with GIC. 6.95 GIC was reinsured on the London market as to 74.15% in respect of its all risks exposure, and as to 79.7% in respect of its war risks exposure. Some of the reinsurer covered only war risks, some other covered all risks as well as war risks. The reinsurance slip policies provided: “Subject to all other Policy terms and conditions, in the event of loss or damage to aircraft insured hereunder, the circumstances of which give rise to reasonable doubt as to under which of the Hull “All Risks” and Hull “War Risks” policies the claim should fall and where such doubt cannot be resolved by the respective Leading Underwriters within fifteen days of such loss or damage it is agreed to provisionally fund such claims by means of a loan on the basis of 50%/50% or as mutually agreed between the respective Leading Underwriters.”

6.96 GIC and most, but not all, of the all risks and war risks reinsurers made an agreement (the “September Agreement”) which provided: “. . . the official investigation into the accident has not been concluded and no cause or causes of the accident have been officially recorded or other definitive evidence emerged [and that] in the circumstances it cannot yet be determined which of the said slip policies of reinsurance will finally have to respond [to GIC]. The All Risks Reinsurers will pay to the General Insurance Corporation of India the sum of US $35,221,250 being 50% of their 74.15% order of US $95,000,000 and the War Risks Reinsurers will also pay to the General Insurance Corporation of India the sum of US $37,857,500 being 50% of their 79.70% order of US $95,000,000 (the Settlement).”

6.97 The reinsurer made claim against the retrocessionaire. The retrocessionaire challenged the agreement between the reinsurers and GIC for being provisional but not establishing the reinsurers’ liability. The Court of Appeal disagreed with this argument. Their Lordships referred to four separate clauses in the retrocession. These clauses were: 180. [1999] 2 AC 349. 181. Most importantly, change of position. 182. The point is not free from doubt. It was held in Magee v Pennine Insurance [1969] 2 QB 507 it was held that a settlement could be overturned where it was based on claim under a policy subsequently avoided. However, the result in Magee was doubted in The Great Peace [2004] 4 All ER 689. 183. [1988] 1 Lloyd’s Rep 423.

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“Article I, Interest Clause: This Agreement is to cover the liability of the Reassured for losses which may be sustained howsoever and wheresoever arising anywhere in the world under policies and/or contracts of insurance and/or reinsurance covering War . . . Risks. Article II, Reinsuring Clause: In consideration of the Reassured paying premium as hereinafter defined and complying with all the terms and conditions of this Agreement, the Reinsurers agree to indemnify the Reassured whenever the Reassured has paid on interest falling within the scope of this Agreement an amount exceeding £20,000 . . . in respect of each and every loss and/or series of losses arising out of one event. The Reinsurers shall thereupon be liable for the excess thereof. This liability was expressed to be subject to a stated limit in respect of each and every loss and/or series of losses arising out of one event. Article IV Ultimate Nett Loss Clause The term ‘Ultimate Nett Loss’ shall mean the sum actually paid by the Reassured in settlement of losses or liability after making deductions for all recoveries, all salvages and all claims upon other reinsurances, and shall include all adjustment expenses arising from the settlement of claims other than the salaries of employees and the office expenses of the Reassured. All salvages, recoveries or payments recovered or received subsequent to a loss settlement under this Agreement shall be applied as if recovered or received prior to the aforesaid settlement and all necessary adjustments shall be made by the parties hereto. Any interest received by the Reassured in respect of such salvages, recoveries or payments shall be shared between the Reassured and the Reinsurers in the proportion that the recovery is apportioned. Nothing in this Article shall be construed to mean that losses under this Agreement are not recoverable until the Reassured’s Ultimate Nett Loss has been ascertained. Article VII, Losses clause: . . . All loss settlements made by the Reassured shall be binding upon the Reinsurers provided that such settlements are within the terms and conditions of the original policies and within the terms and conditions of this Agreement, and the Reinsurers shall pay the amounts due from them upon exhibition of payment receipts by the Reassured or certified copies thereof, and of such other evidence as may reasonably be required.”

6.98 The retrocessionaire’s argument was that it has not yet been ascertained whether there had been any loss under the war risks reinsurances of GIC or, conversely, any loss under the all other risks reinsurances of GIC. A payment in accordance with the obligation in the 50%/50% clause to “advance” an agreed percentage of the interested underwriters’ liability could not constitute a “loss” within the meaning of Article I. 6.99 The Court of Appeal noted that classic insurance principles require that a loss must be proved before any question of an indemnity can arise. However their Lordships noted that the fundamental question was: “What is the liability against which the reinsurer has by the policy of reinsurance agreed to indemnify the insurer?” According to their Lordships, the answer to this question must depend on the true construction of the policy of reinsurance, rather than on any overriding principle of law. 6.100 The Court of Appeal therefore focused on the construction of the terms of the reinsurance and retrocession contracts. According to the Court of Appeal Article IV indicated that the retrocessionaire could be liable to make a payment to the reinsurers under the indemnity in Article II before the Ultimate Nett Loss had been ascertained, if reinsurers had made the corresponding payment within the terms and conditions of their policy with GIC. A payment made before ascertainment of the Ultimate Nett Loss could be followed by a readjustment and 131

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repayment to the retrocessionaire as a result of the subsequent realisation of salvage or as a result of subsequent recoupment from a third party. 6.101 The retrocessionaire’s contention was, as was noted above, that these were all instances where there had been a loss accepted and established, albeit not finally quantified, under the reinsurance policy between the reinsurers and GIC against war risks or against all other risks, and there had been no loss accepted or established under either of those policies. 6.102 The Court of Appeal however defined the key obligation as that of the retrocessionaire under Article II to indemnify the reinsurers whenever the reinsurers have paid an amount falling within the scope of the agreement. The reference to interest falling within the scope of the agreement referred back to Article I where the agreement was said to cover liability of the reassured “for losses” which may be sustained howsoever and wheresoever arising, under certain policies which include a reinsurance of GIC. Therefore, the contribution of the reinsurers to the provisional funding under the 50%/50% arrangement was a liability of the reinsurers which was presently enforceable, and it was a liability under a policy which was within the scope of Article I. This was a liability “for losses” because the claim of GIC against its war risk reinsurers had been met under the terms of the policy, albeit only provisionally. This was underlined by the guidance on the meaning of the word “loss”, in Article IV and in particular the distinction there drawn between “loss or liability” and “the Ultimate Nett Loss.” 6.103 It should be however borne in mind that Boden v Hussey184 is a decision based on one particular form of retrocession wording. Therefore it should not be regarded as having established a general principle.185

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6.104 As a general principle, reinsurers are not obliged to make any payments to reinsured where the reinsured had no liability to the assured under the original policy, that is, where the reinsured has made a payment that was not legally bound to make. Thus, as discussed above, the English cases have established that the reinsured has to prove the loss in the same way as the assured has to do. However, the parties may specify in the reinsurance contract that a settlement or other adjustment of loss between the assured and the reinsured is to be binding on the reinsurers. By so doing the reinsurer’s obligation to indemnify the reinsured becomes dependent on the reinsurance policy terms, and not on the question of whether the insured suffered a loss as a matter of law under the original policy.186 It is seen that the same principles apply in the United States. 6.105 In Hastie v De Peyster187 and New York State Marine Ins Co v Protection Ins Co188 the courts pointed out the inconvenience caused by the rule regarding the reinsured has to prove the loss in the same way as the assured is required to do and noted that in the French policies of reinsurance it was usual to see a clause allowing and authorising the original insurers to make a voluntary bona fide settlement and adjustment of the loss, which is binding upon the reinsurers. In such a policy the only obligation of the reinsured is to act in good faith. In the absence of such an agreement, however, the reinsured had to prove the existence and 184. 185. 186. 187. 188.

[1988] 1 Lloyd’s Rep 423. Butler and Merkin, Reinsurance Law, para. C–0004. Michigan Tp Participating Plan v Federal Ins Co, 233 Mich App 422, (Mich. App. Jan 19, 1999). 3 Cai R. 190, NY Sup. 1805. 18 F.Cas 160 (CC Mass 1841).

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extent of a covered loss. Today such clauses have two forms in the United States: “follow the settlements” or “follow the fortunes.” Distinguishing Follow the Fortunes from Follow the Settlements 6.106 There appears to be no standard form of settlement clauses in the US and, as will be seen in the following paragraphs, clauses are drafted individually in every case. The common feature of the settlements clauses is that they contain the expression “All claims involving this reinsurance, when settled by the company, shall be binding on the reinsurer ….” 6.107 Provisions that contain such an expression is sometimes referred to as a follow the settlements clause, and sometimes as a follow the fortunes clause. As stated below, the modern authorities have noted that these two clauses are used interchangeably but some authorities suggest that the follow the fortunes doctrine is broader than that of the “follow the settlements.” In North River Ins Co v Ace American Reinsurance Co189 the Second Circuit stated that follow the settlements is narrower than follow the fortunes190 and essentially describes the follow the fortunes doctrine in the settlement context. Similarly, in North River Ins Co v Employers Reinsurance Corp,191 having noted that these terms are frequently used interchangeably, the US District Court, Southern District of Ohio stated that follow the fortunes more accurately describes the reinsurer’s obligation to follow the reinsured’s underwriting fortunes, whereas follow the settlements refers to the duty to follow the actions of the reinsured in adjusting and settling claims. 6.108 One commentator has stated that follow the fortunes is implied into every reinsurance contract, whereas follow the settlements is not.192 While the former more properly relates to the obligation of a reinsurer to follow developments affecting the reinsured’s business that are outside its control, the latter refers to the claims handling function of the reinsured, namely that the clause prevents a reinsurer from second-guessing bona fide claim settlements that are made in good faith. Follow the fortunes has also been defined as requiring reinsurers to accept a reinsured’s good faith decision that a particular loss is covered by the terms of the underlying policy, while the follow the settlements doctrine requires reinsurers to abide by a reinsured’s good faith decision to settle, rather than litigate, claims on that policy.193 6.109 It has been stated that, during the early history of reinsurance underwriters agreed to contribute to profits or losses of traders as they conducted their business around the world.194 This seems to be the source of the follow the fortunes clause, given that such an agreement required the reinsurer to contribute to the reinsured’s bad or good fortunes.195 In the modern context, if the clause is to be distinguished from the follow the settlements clause, it may be said that the word “fortunes” is more suited to treaties than to facultative reinsurance. In treaties, reinsurers allow the reinsured to exercise a large measure of discretion and therefore 189. 361 F.3d. 134, (2nd Cir. (NY) March 15, 2004). 190. In American Motorists Ins Co v American Re-Ins Co Not Reported in F.Supp.2d, 2007 WL 1557848, ND Cal, May 29, 2007 the US District Court, ND California stated “. . . Included in the “follow the fortunes doctrine” is the “‘follow the settlements’ doctrine ….” See also Holland v Employers ReIns Corp, 2007 US Dist Lexis 68069 (WD Okla). 191. 197 F.Supp 2d 972,. (SD Ohio, March 11, 2002). 192. Blatt, Hammesfahr and Eaton The Law of Reinsurance Claims 1997 Supplement (supplement by Robert W Hammesfahr, Scott W Wright), 64. 193. Commercial Union Ins Co v Seven Provinces Ins Co 9 F.Supp. 2d 49, (D Mass, Jun 15, 1998); aff’d 217 F.3d 33 (1st Cir. (Mass) Jul 6, 2000). 194. Langen, J F, “Special Clauses and Endorsements,” Reinsurance Contract Wording, 3rd edn, RW Strain (ed.) 1998, 582. 195. Langen, 582.

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“fortunes,” in the sense of “course of good or bad luck . . . in some undertaking” can be seen to refer to the obligation of reinsurers to that of the reinsured.196 The insurer may be required to make claims payments, subject to the terms and limitations of the reinsurance agreement, in connection with a policy although he is not obliged to do so in objective terms (eg in cases of fraudulent action on the part of the insured which cannot be proved). The follow the fortunes clause is therefore designed to protect the reinsured against circumstances that are beyond its control.197 On the other hand, the phrase follow the settlements pertains to the obligations of the reinsured for particular amounts voluntarily paid out in settlement of specific claims on behalf of the underlying insured.198 6.110 Despite the conflicting analyses, it is clear from modern precedent that the word “fortune” in fact is used not to follow the reinsured’s fortune where there was no settlement clause but rather it is now interchangeably used with the follow the settlements clause.199 In American Employers’ Ins Co v Swiss Reinsurance America Corp200 the US Court of Appeals for the First Circuit stated that “follow-the-fortunes” provisions were often described as follow the settlements provisions. 6.111 In England, a follow the fortunes clause came before the High Court in Hayter v Nelson & Home Insurance Co.201 In this case the retrocession treaty expressly incorporated the reinsurance treaty and provided that the reinsurer should in all circumstances follow the fortunes of the reinsured in respect of the reinsurance treaty. The reinsurers’ argument was that the retrocessionaire was bound by judgments given or an award made against the reinsured by virtue of the follow the fortunes clause. In expressing his unwillingness to interpret the relevant provision to the effect contended by the reinsurers, Saville J noted the difficulties as twofold: (1) Although the use of such clauses is commonplace in the business of reinsurance and retrocession, there was no authority on the meaning of a follow the fortunes clause of this or indeed any other kind. (2) It was clear from the textbooks202 that there appeared to be very considerable uncertainty as to what is intended to be meant and agreed by the use of the phrase “follow the fortunes.” Subsequently, the learned judge declined to give a summary judgment to the effect that a reinsurer is bound by judgments given or award made against the reinsured by virtue of a follow the fortunes clause. 6.112 A follow the fortunes clause also came before Creswell J in CGU International Insurance v AstraZeneca Insurance Co,203 where in the reinsurance slip the title follow the

196. Staring, para. 18:1. 197. Gerathewohl, K, Reinsurance Principles and Practice, Vol I, 1980, 711, 712; Holmes, E M, Sutin, A S (Original edition by Appleman, J A) Holmes and Appleman on Insurance 2D (as modified by the Cumulative Supplement, 2007), Vol. 14, Law of Reinsurance, LexisNexis Publishing 2000 §106.2. 198. Holmes and Appleman § 106.2. 199. Affiliated F.M. Ins Co v Employers Reinsurance Co 369 F.Supp. 2d 217 DRI, May 12, 2005; Houston Cas Co v Lexington Ins Co, 2006 US Dist LEXIS 45027; Stonewall Ins Co v Argonaut Ins Co 75 F.Supp. 2d 893, N.D.Ill., Dec 03, 1999 (applying California law). Vitkowsky, VJ, “The Central Arena: Follow the Fortunes vs Utmost Good Faith,” Mealey’s Litigation Report: Reinsurance, 22 May 1996, Vol 7, No 2, 30; Cuff, J, “Follow the Fortunes:Industry Customs And Practices,” Mealey’s Litigation Report: Reinsurance, 15 June 2000, Vol 11 No 3, 31; Neppl, D J, “Reinsurance Coverage for “Annualized” Loss Presentations under Multi-Year Policies: “Follow the Fortunes” or Bellefonte?,” Coverage (Published by LexisNexis), Vol 16, No 3, May/June 2006. 200. 413 F.3d 129, (1st Cir. (Mass) Jun 27, 2005). 201. [1990] 2 Lloyd’s Rep 265. 202. Citing Kiln, Reinsurance Law in Practice 32–35; Golding, The Law and Practice of Reinsurance (1965) at 65 and Butler & Merkin Reinsurance Law, chapters 1.1 and 1.4. 203. [2006] Lloyd’s Rep IR 409; Creswell J’s judgment was appealed but on appeal the issue as to the meaning of the follow the fortunes clause did not arise.

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fortunes was crossed out and was substituted by the wording “Assistance and Co-operation.” The relevant part of the wording read: “The Reinsurer agrees to follow in all respects the fortunes of the Reinsured. Reinsurers hereunder will, however, have the right to and shall be given the opportunity to associate with the Reinsured in the defence and control of any claim, suit or proceedings relative to any loss where the claim or suit involves or appears relatively likely to involve Reinsurers hereunder.”

6.113 Creswell J noted that there was no clear meaning to the follow the fortunes clause. The learned judge stated that neither party suggested that the follow the fortunes clause had the same effect as a follow the settlements clause: indeed, the parties appeared to agree that the follow the fortunes clause imposed a lesser obligation on the reinsurers than follow the settlements. Thus, without deciding what the wording meant and whether the parties had been right in their concession, the judge treated the policy as if there was no follow the settlements clause. Implying Settlement Clauses 6.114 Reinsurance contracts are construed according to the rules of construction applicable to contracts generally.204 As regards New York law, it has been stated that when a reinsurance contract is clear and unambiguous on its face, the intent of the parties must be gleaned from “within the four corners of the instrument, and not from extrinsic evidence.”205 However, when the terms of the contract are ambiguous, reference to extrinsic evidence may provide guidance to the parties’ intent.206 Extrinsic evidence becomes especially important in cases which include industry custom and practice. Subsequently, a question that arises becomes: “are the follow the settlements or fortunes clauses implied in every reinsurance agreement by virtue of industry custom and practice?” 6.115 The rationale of settlement clauses is accepted to be to meet the goal of maximising coverage, reducing relitigation by simplifying the reimbursement process and preventing a reinsurer from continually challenging the propriety of a reinsured’s settlement decisions.207 The latter consideration in particular has led the courts to consider implying a follow the fortunes clause into all reinsurance contracts where the wording itself is silent. 6.116 It is accepted by a minority of the US decisions that it is commonly understood that reinsurers must follow the fortunes of their reinsured; therefore, even if this is not expressed in the reinsurance agreement, the doctrine is nevertheless applicable.208 In National American Ins Co of California v Certain Underwriters at Lloyd’s London209 the US Court of Appeals for the Ninth Circuit stated that the necessity for reinsured to establish the loss in the same way as the assured in order to recover upon the original policy, derives from the common law rather 204. Christiania General Ins Corp of New York v Great American Ins Co 979 F.2d 268, (2nd Cir. (NY) Sep 03, 1992); Travelers Cas and Sur Co v Ace American Reinsurance Co 392 F.Supp.2d 659, SDNY, Oct 12, 2005.; affirmed by the second circuit: 201 Fed.Appx. 40, (2nd Cir. (NY) Oct 18, 2006). 205. Travelers Cas and Sur Co v Ace American Reinsurance Co 392 F.Supp.2d 659, SDNY, Oct 12 2005; aff’d by the second circuit: 201 Fed.Appx. 40, (2nd Cir. (NY) Oct 18, 2006). 206. Christiania General Ins Corp of New York v Great American Ins Co 979 F.2d 268, (2nd Cir. (NY) Sep 03, 1992). 207. Travelers Cas and Sur Co v Constitution Reinsurance Corp 2004 WL 2387313, ED Mich., Apr 02, 2004; Carlson Holdings Inc v NAFCO Ins Co 205 F.Supp 2d 1069 DMinn, Jan 08 2001 (applying Minnesota law). 208. International Surplus Lines Ins Co v Certain Underwriters and Underwriting Syndicates at Lloyd’s of London 868 F.Supp 917 SD Ohio, Sep 27, 1994; Aetna Cas and Sur Co v Home Ins Co 882 F.Supp 1328, SDNY, March 27, 1995; American Employers’ Ins Co v Swiss Reinsurance America Corp 275 F.Supp 2d 29 D.Mass., 2003, aff’d 413 F.3d 129 (1st Cir. (Mass) Jun 27, 2005). 209. 93 F.3d 529 (9th Cir. (Cal) Aug 15, 1996).

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than statute and under circumstances such that the rule that “custom or usage cannot overcome rule of law” is applied with less force. In this case the insurer Stuyvesant issued liability insurance policies for Hughes for the years of 1962, 1963 and 1964. In all three years, Hughes purchased $1 million in liability coverage. As originally structured, the first $500,000 of each year’s coverage was under a primary policy from Stuyvesant and the additional $500,000 in coverage was provided by an excess insurance policy issued by the brokers on behalf of the Underwriters. The policies however were amended as effective from 1 January 1963, that Stuyvesant’s primary coverage of Hughes was increased to the full $1 million, and in response the brokers converted the Underwriters’ $500,000 excess policy covering Hughes into a $500,000 reinsurance policy covering Stuyvesant. Moreover, Stuyvesant purchased another $150,000 of reinsurance coverage from the Underwriters for 1964 in excess of $350,000 for that year. 6.117 Hughes operated a manufacturing plant near Tucson International Airport from 1951 until the mid-1970s during which it had disposed of considerable amounts of toxic waste. In 1985, residents living near the Tucson airport brought a class action against Hughes (the “Valenzuela litigation”) which was ultimately settled with the claimants and the liability insurers of Hughes for about $84 million. The insurers agreed to pay approximately $72 million of this. National’s share (the successor in interest of the Stuyvesant Insurance Company) was $2.5 million. 6.118 At the time the Valenzuela litigation commenced, National was unaware of the reinsurance policies, but they found out about them through the brokers on 22 May 1989 – several years after National had undertaken its role in Hughes’ defence, but long before any settlement was ultimately reached. Despite the fact that National notified the brokers within nine days after it received the reinsurance certificates of a possible claim against the reinsurance policies and, after the settlement, again notified them about the terms of the settlement agreement, neither the brokers nor the reinsurers responded until National brought an action under the reinsurers. National paid the full $2.5 million to Hughes and then claimed $1.15 million against the reinsurers under the 1963 and 1964 policies. Additionally it sought coverage for the reinsurers’ share of the associated costs. 6.119 The reinsurers challenged National’s settlement by emphasising the rule that in the absence of a settlement clause in a reinsurance policy the reinsured has to prove its liability as if he was the assured, in other words it has to prove the loss and the amount of it in the same way as required of the assured. The US Court of Appeals for the Ninth Circuit accepted that this rule accurately portrayed the common law rule in California but the court also noted that such a rule did not preclude a further contention as to submitting evidence of custom and usage demonstrating to the contrary. In other words, the Ninth Circuit accepted the possibility that the follow the settlements clause could be implied in reinsurance policies if custom and usage recognised such an implication. The Ninth Circuit relied on two points: first, that the reinsurers did not show any case law to the effect precluding evidence of custom and usage contrary to common law; and, secondly the principle that custom or usage cannot overcome a rule of law applies with less force when, as in the instant case, the law derives not from statute, but from the common law. Moreover, the court noted that even if the rule that custom or usage cannot overcome a contrary law was subject to an important qualification that “law that applies only in the absence of an agreement to the contrary,” that did not preclude evidence of custom or usage. The evidence of custom and usage was a question of fact and the Ninth Circuit was convinced that there was an unresolved factual question in this case as to whether there existed within the facultative reinsurance industry prior to the 1970s a custom or usage to follow the settlements which made a trial necessary on this issue. 136

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6.120 In ReliaStar Life Ins Co v IOA Re, Inc 210 the question was whether a term requiring strict proof of liability was a part of the retrocession agreements and, if so, whether it precluded the application of follow the fortunes doctrine so that it amounted to an “anti-followthe-fortunes” clause. The facts of the case, briefly, were that by a quota share agreement ReliaStar reinsured 75% of the risk that the Canada Life Assurance Company had insured on a product, commonly called “snowbird” insurance. ReliaStar then retroceded two-thirds of its exposure under the reinsurance to IOA Re and Swiss Re, one-third of the risk to each company. After ReliaStar had submitted its first bill to the retrocessionaires’ the latter notified ReliaStar that the policy was being cancelled for non-payment of premium. ReliaStar sought summary judgment against the retrocessionaries for breach of contract, and the retrocessionaires contended that they were not liable and they were not obliged to follow ReliaStar’s settlements because their retrocession contracts with ReliaStar expressly denied the application of the “follow the fortunes” doctrine. The reinsurance contract between Canada Life and ReliaStar referred to the ETFS Travel Health Medical Reinsurance Agreement, which required strict proof of coverage for the claim reinsured. The retrocession placement slips stated: “Conditions: See attached ETFS Travel Health Medical Reinsurance Agreement.” Therefore IOA and Swiss Re contended that their retrocessional contracts contained the same terms as the reinsurance agreements between ReliaStar and Canada Life to the effect of requiring strict proof of the claims paid by ReliaStar which precluded the application of the follow the fortunes doctrine. In other words, it was IOA and Swiss Re’s case that the clause requiring strict proof of coverage was an “anti-follow the fortunes” provision which precluded implying and application of the follow-the-fortunes doctrine to their retrocessional coverage of ReliaStar’s risk. 6.121 The US District Court for the District of Minnesota rejected the argument that the retrocessional agreements incorporated any limiting language that might be found in the Canada Life/Reliastar reinsurance agreement. The court concluded that the retrocessionaires, IOA Re and Swiss Re failed to introduce any evidence “indicating that ReliaStar consented to adopting the limitations included in the reinsurance contract between Canada Life and ReliaStar.” The court explained that the retrocessional placement slips merely identified the “pertinent insurance contract.” 6.122 IOA Re and Swiss Re unsuccessfully appealed to the US Court of Appeals for the Eighth Circuit, by relying on language in the retrocession placement slips which stated “Conditions: See attached ETFS Travel Health Medical Reinsurance Agreement” for their contention that the retrocession contracts incorporated the loss notice and settlement procedures agreed to between Canada Life and ReliaStar. According to the Eighth Circuit, the plain purpose of these slips was to define the parties to the retrocession agreement, the period of coverage, and the coverage that the retrocessionaire was to provide, as well as other details which included identifying the portion of the insured risk that was being ceded to the retrocessionaire. The Eighth Circuit refused to construe the language of the slips as incorporating a set of specific procedures agreed to between Canada Life and ReliaStar in a separate agreement to which neither of the retrocessionaires were a party; for such incorporation, the language of the slips would be required to be clearer as to indicating the intention of incorporation of those specific terms.211 210. 303 F.3d 874 (8th Cir. (Minn) Sep 09, 2002). 211. The Eighth Circuit conferred with the Second Circuit’s decision on Progressive Cas Ins Co v CA Reaseguradora Nacional De Venezuela, 991 F.2d 42, 46 (2nd Cir. (NY) Apr 6, 1993). where the clause “Subject to Facultative Reinsurance Agreement [FRA]” was found sufficient to incorporate FRA arbitration clause into reinsurance policy. For Progressive see Chapter 5.

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6.123 The retrocessionaires further challenged the District Court’s application of the “follow the fortunes” doctrine to this case by contending that the existence of an industry custom requiring the implication of a follow the fortunes obligation was a question of fact that should be left to a jury and not resolved by the judge. The Eighth Circuit, however, noted that the experts’ statements that both parties had submitted in this case were consistent in agreeing on the customary usage of the follow the fortunes clauses into every reinsurance contracts: the retrocessionaires’ expert admitted that the “follow the fortunes” obligation was “customary with reinsurance contracts” and further explained that this custom applied unless “the reinsured has not dealt with the reinsurer or retrocessionaire in the ‘utmost good faith’ [or] . . . the reinsured fails to prove reinsured losses.” ReliaStar’s expert agreed that “follow the fortunes” was a “key principle” of the reinsurance business, and means “when the ceding company has paid claims in good faith, the reinsurer may not second-guess such payment but must fulfill its own payment obligations.” Thus, the Eighth Circuit found no dispute between the parties as to the customary usage of the clause, but the real dispute according to the court was whether the language of the parties’ contracts rendered this industry custom inapplicable to their insurance arrangement. Having concluded that the contracts did not contain “anti-follow the fortunes” provisions, the Eighth Circuit found that the District Court had correctly applied the customary “follow the fortunes” doctrine to the present dispute. 6.124 Some commentators suggest that decisions such as National American come into play where the reinsurance contract does not require the reinsured to seek the reinsurer’s approval in settling the claim and the claim is not excluded by the terms of the reinsurance contract.212 6.125 Although the minority view is that follow the fortunes clauses are to be implied into all reinsurance contracts, a majority of cases take the line that the parties to a reinsurance contract are sophisticated enough to write their own policy wordings to protect their respective interests by negotiation of the terms of the reinsurance agreement.213 In Michigan Tp Participating Plan v Federal Ins Co,214 the Court of Appeals of Michigan gave an answer in negative to the question that “[D]oes Michigan law impose a Follow-the-Fortunes doctrine when there is no express provision in the contract adopting such[?]” for imposing liability on the reinsurer for a settlement contribution absent such an agreement would be to write a new contract for the parties. In this case an old schoolhouse owned by the Village of Thompsonville was destroyed by a fire in March 1991. An insurance policy was issued to protect the village against fire loss, with respect to particular buildings up to $181,500 for the structure, and $10,000 for the contents of the schoolhouse. The insurer then entered into two reinsurance contracts under which American Commercial Liability Insurance Company (ACLIC) took over the first $100,000 of risk, and FIC agreed to cover risk in excess of $100,000 but limited to $5 million. After the fire the insurer settled with Thompsonville for $191,500 and sought reimbursement. The Court of Appeals of Michigan, however, found for the reinsurers in this case as the reinsured was not able to prove that it was liable under the original policy. The court took into consideration that an express follow the fortunes clause was not agreed by the parties when drafting the reinsurance contract. In the absence of specific contract language requiring the reinsurers to indemnify the reinsured on the basis of its good faith settlement the reinsured was required to prove the loss in the same way as the assured has to prove which could not be discharged by the proof of payment to the assured only. 212. Lasley, L M, “Follow the Settlements: Reasonable, Not ‘Deviant’ ,” Mealey’s Litigation Report: Reinsurance, 27 September 1995, Vol 6 No 10, 16. 213. Holland v Employers ReIns Corp, 2007 US Dist Lexis 68069 (WD Okla 13 Sept 2007). 214. 233 Mich.App. 422, (Mich. App. Jan 19, 1999).

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6.126 In Employer Reins Corp v Laurier Indemnity Co 215 the reinsured argued that the contract’s silence as to follow the fortunes created an ambiguity; therefore the court should allow custom to imply the clause into the reinsurance contract. Accepting that there were certainly benefits and numerous public policy considerations supporting enforcement of the follow the fortunes doctrine in the world of reinsurance, the US District Court, MD Florida nevertheless rejected the reinsured’s argument, for the reason that the parties were both sophisticated entities dealing at arm’s length, and familiar with drafting contracts who could agree on a follow the fortunes clause at the outset. The same view was adopted in American Motorists Ins Co v American Reins Co216 where, relying on Pacific Mut Life Ins Co v Pacific Sur Co,217 the reinsured argued that even though the reinsurance agreement did not provide express follow the settlements provision, the other language in the policy was sufficient to constitute an agreement to “follow the settlements.”218 The clause in Pacific Mutual read: “The ‘Pacific Mutual’ alone shall settle all claims, and such settlements shall be binding on the ‘Reinsurance Company’ in proportion to its participation, whether the settlement be in full or in compromise. The claim papers and other evidence and vouchers accepted as sufficient by the ‘Pacific Mutual’ shall likewise be taken by the ‘Reinsurance Company’ and copies of all such papers duly certified by an officer of the ‘Pacific Mutual’ shall be furnished to the ‘Reinsurance Company’ accompanying their claim under the reinsurance.” 6.127 The reinsured contended that Pacific Mutual provided that where a reinsurer agreed to “(1) follow the same terms of the reinsured’s contract; (2) give the reinsured the right to settle the claim; and (3) then agree to pay the settlement made by the reinsured, a “follow the settlements” agreement should be found. 6.128 The District Court of Appeal, (First District, Division 1), California found that the reinsured mischaracterised the case Pacific Mutual. In that case the clause was itself an express “follow the settlements” provision. The reinsured was also unsuccessful in its contention that the follow the settlements clause should be implied by reason of “custom and practice,” for the court stated that the reinsured did not present any evidence of “custom and practice” as to the implication of the clause in the reinsurance industry. It was also stated that if the follow the settlements doctrine was so widely accepted as an inherent part of every reinsurance contract that the doctrine may be read into every certificate as a matter of law, there would be no need to include such clauses in reinsurance contracts to hold otherwise would be to write a new contract for the parties, which the court had no right to do.219 6.129 As for other issues regarding the doctrine, while a State court may refer to other jurisdictions, in North River Ins Co v Employers Reinsurance Corp,220 the US District Court SD Ohio (Eastern Division) refused to apply the precedents cited by the reinsured which applied a state law different to that which governed the instant contract. In North River v Employers the reinsured had relied on International Surplus Lines Ins Co v Certain Underwriters and Underwriting Syndicates at Lloyd’s of London (ISLIC)221 and Aetna Cas and Sur Co v Home Ins Co,222 to persuade the district court that the follow the settlements clause is 215. 2007 WL 1831775 (MD Fla). 216. Not Reported in F.Supp 2d, 2007 WL 1557848, ND Cal, May 29, 2007. 217. 69 Cal App 730, Nov 21, (1924). 218. However the claimant did not refer to any specific clause in the reinsurance May 12, agreement. 219. Affiliated FM Ins Co v Employers Reinsurance Co 369 F.Supp 2d 217 DRI, 2005; Michigan Tp Participating Plan v Federal Ins Co 233 Mich App 422, (Mich. App. Jan 19, 1999). 220. 197 F.Supp 2d 972 SD Ohio, March 11, 2002 (applying New Jersey law). 221. 868 F.Supp 917, SD Ohio, Sep 27, 1994. The district judge in North River v Employers noted that although Ohio law was applicable in ISLIC, there was no discussion of whether Ohio courts had addressed this question. 222. 882 F.Supp. 1328, SDNY, March 27, 1995, New York law applied.

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implicit in all reinsurance contracts. In both cases cited by the reinsured it had been held that it is commonly understood that reinsurers must follow the fortunes of the reinsured even though the reinsurance agreement does not expressly provide such a provision. Moreover, as with North River v Employers, the ISLIC case was also decided by the Eastern Division of the US District Court of SD Ohio. However the district court in North River v Employers held that whether the follow the fortunes doctrine was to be implied into a contract by reason of custom or policy will vary depending on which state’s laws apply to the contract dispute. In the instant case the issue was to be resolved under New Jersey law which did not apply in either ISLIC or Aetna. The court further confirmed that the rule requiring the analysis of the implication of follow the settlements clause into all reinsurance contracts in each state according to its own state law strongly militated against the contention that the practice of implying a follow the settlements clause in every reinsurance contract was so widespread and accepted in the industry as to be beyond all factual and legal dispute. 6.130 As previously stated, in the US, reinsurance disputes are mostly arbitrated. It was suggested that even though courts have recognised limits on the scope of the follow the fortunes doctrines, the reinsurance industry largely measures mutual relationships as if a particular contract included a broad follow the settlements clause.223 It should be noted that most arbitration panels pay attention to provisions in reinsurance contracts directing them to consider reinsurance agreements as “honorable engagements.”224 Functions of Settlement Clauses 6.131 In Hastie v De Peyster 225 and New York State Marine Ins Co v Protection Ins Co226 the Supreme Court of New York and Circuit Court, D. Massachusetts stated that in principle, no voluntary payment by the original insurers would be binding or obligatory upon the reinsurers and the reinsurers were entitled to resist the claim until the proper proof of loss from the assured in a regular suit against reinsured was provided. In order to avoid this inconvenience and delay, however, the courts also noted that the French policies of reinsurance usually contain a clause allowing and authorising the original insurers to make, bona fide, a voluntary settlement and adjustment of the loss, which shall be binding upon the reinsurers. Such a provision, according to the courts, put the whole matter within the exercise of the sound discretion of the reinsured whose only obligation would be to act in good faith to determine whether to contest or to admit the claim of its assured. 6.132 In one of the earliest cases, Consolidated Real Estate & Fire Ins Co v Cashow,227 the Court of Appeals of Maryland held that the condition that the reinsured is obliged to prove a loss under the reinsurance agreement in the same way as the assured must prove a loss under the direct policy would be unnecessary where the reinsurance policy contained a clause that the reinsurance was “. . . subject to the same risks, valuations, conditions and mode of settlement as are or may be adopted or assumed by said company.” 6.133 The follow the settlements doctrine requires payment where the reinsured’s good faith settlement is at least arguably or reasonably within the scope of the insurance coverage

223. New Appleman Guide, 40.19. 224. New Appleman Guide, 40.19, 40.24: An honourable engagement clause instruct arbitrators to interpret the contract “as an honourable engagement and not merely as a legal obligation” and relieves arbitrators from following the strict rules of law. 225. 3 Cai R. 190, NY Sup 1805. 226. 18 F.Cas 160 (CC Mass 1841). 227. 41 Md 59, 1874.

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that was reinsured even if technically not covered by it.228 In other words, where a reinsurer agrees to follow the fortunes of the reinsured, the question is not whether the underlying claim was covered by the reinsured’s policy, but whether there is any reasonable basis to conclude there was such coverage.229 Therefore, reinsurers are not entitled to second-guess the reinsured’s good faith judgments for settling the claim with the assured, or the reinsured’s good faith decision to waive defences to which it may be entitled.230 The Court of Appeals of New York231 stated that the rationale behind this doctrine was two-fold: (a) it would meet the goal of maximising coverage and settlement; and (b) it would streamline the reimbursement process and reduce litigation by preventing a reinsurer from continually challenging the propriety of a reinsured’s settlement decision. 6.134 In International Surplus Lines Ins Co v Certain Underwriters and Underwriting Syndicates at Lloyd’s of London232 the Eastern Division of the US District Court, SD Ohio stated that this standard was purposefully low for the reason that if reinsurers are entitled to interfere with the reinsured’s decision-making process, the foundation of the reinsured– reinsurer relationship would be damaged233 because a reinsured faced with de novo review of its claims determinations would ultimately feel the need to litigate every coverage issue rather than settling the claim. In this case, Owens-Corning purchased several layers of liability insurance from 1979 through 1 September 1983. The first layer, an umbrella policy, provided coverage in each of the four years in the amount of $25 million for each “occurrence” which was defined in similar wording in the umbrella policies that: “[A]n accident, event or happening including continuous or repeated exposure to conditions which results, during the policy period, in personal injury. . . . All such personal injury . . . caused by one event or by continuous or repeated exposure to substantially the same conditions shall be deemed to result from one occurrence.”

6.135 One endorsement found in those policies provided that the policy limits were subject to a $1 million deductible, payable by Owens-Corning for “each and every occurrence.” 6.136 ISLIC issued 16 excess policies covering each of the four years insured by the umbrella policies. ISLIC’s excess policies incorporated by reference the definition of occurrence set forth in the umbrella policies. ISLIC then purchased reinsurance from various 228. Christiania General Ins Corp of New York v Great American Ins Co 979 F.2d 268, (2nd Cir. (NY) Sep 03, 1992); Travelers Cas and Sur Co v Ace American Reinsurance Co 392 F.Supp.2d 659, SDNY, Oct 12, 2005.; aff’d by the second circuit: 201 Fed. Appx. 40, (2nd Cir. (NY) Oct 18, 2006); American Employers’ Ins Co v Swiss Reinsurance America Corp 275 F.Supp 2d 29 D Mass, 2003, aff’d 413 F.3d 129, (1st Cir. (Mass) Jun 27, 2005); Granite State Ins Co v ACE American Reinsurance Co 849 NYS 2d 201, NYAD 1 Dept, Dec 27, 2007; Commercial Union Ins Co v Swiss Reinsurance America Corp 413 F.3d 121 (1st Cir. (Mass) Jun 27, 2005); Aetna Cas & Sur Co v DR Ins Co 1995 WL 46640 (SDNY Feb 07, 1995); National Union Fire Ins Co of Pittsburgh, PA v American Re-Ins Co 441 F, Supp 2d 646, SDNY, Jul 28, 2006; Travelers Cas and Sur Co v Certain Underwriters at Lloyd’s of London 96 NY.2d 583, NY, Oct 16, 2001; American Motorists Ins Co v American Re-Ins Co Not Reported in F.Supp.2d, 2007 WL 1557848, ND Cal, May 29, 2007; American Home Assurance Co et al v American Re-insurance Co et al No:602485/06, NY Sup., New York Co, 24 May 2010. 229. North River Ins Co v CIGNA Reinsurance Co 52 F.3d 1194, (3rd Cir. (NJ) Apr 13, 1995). 230. City of Renton v Lexington Ins Co (USA), Not Reported in F.Supp.2d, Sep 19, 2007 WL 2751356 (WD Wash); Holland v Employers ReIns Corp, 2007 US Dist Lexis 68069 (WD Okla); Houston Cas Co v Lexington Ins Co 2006 US Dist Lexis 45027; Hartford Acc & Indem v Columbia Cas Co 98 F.Supp 2d 251 D Conn, March 31, 2000; ReliaStar Life Ins Co v IOA Re, Inc. 303 F.3d 874 (8th Cir. (Minn) Sep 09, 2002); Stonewall Ins Co v Argonaut Ins Co 75 F.Supp 2d 893, N.D.Ill., Dec 03, 1999 (applying California law); Travelers Cas and Sur Co v Constitution Reinsurance Corp 2004 WL 2387313, ED Mich Aug 2, 2004; Mentor Ins Co (UK) Ltd v Brannkasse 996 F.2d 506 (2nd Cir. (NY) May 24, 1993); Royal Ins Co of Liverpool, England v Caledonian Ins Co of Edinburgh, Scotland 182 Cal 219, Feb 13, 1920. 231. Travelers Cas and Sur Co v Certain Underwriters at Lloyd’s of London 760 N.E.2d 319, N.Y., 2001. 232. 868 F.Supp 917, SD Ohio, Sep 27, 1994. 233. This statement was approved by the third circuit in North River Ins Co v CIGNA Reinsurance Co, 52 F.3d 1194, (3rd Cir. (NJ) Apr 13, 1995).

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reinsurers. The reinsurers provided $255 million of coverage which was a little more than half of ISLIC’s $410 million excess liability limit. 6.137 The assured, Owens-Corning, was in the business of manufacturing, distributing, and selling insulation products containing asbestos. Having confronted thousands of personal injury claims, Owens began making claims against ISLIC in February 1992 by taking the position that the asbestos claims against it arose from one occurrence – the decision to manufacture and sell products containing asbestos. ISLIC accepted Owens-Corning’s position and in making payment it applied only a single $1 million “per occurrence” deductible in each of the four annual policy periods. 6.138 The reinsurers challenged ISLIC’s subsequent claim against them by asserting that each asbestos claim by each individual claimant must be treated as a separate occurrence, subject to a separate $1 million deductible. The reinsurers contended that the umbrella policies serving as a basis for ISLIC’s excess coverage contemplated “multiple occurrences,” rather than single occurrences. They further pointed out that Owens-Corning was a signatory to the Wellington Agreement, thus ISLIC might have unreasonably committed itself to the single occurrence position set forth in that agreement. ISLIC then filed the instant motion for summary judgment. 6.139 The Eastern Division of the US District Court of SD Ohio accepted that it was commonly understood that reinsurers must follow the fortunes of their insured; thus, even if a reinsurance contract did not contain a follow the fortunes provision, the doctrine still applied to all reinsurance contracts.234 The court also stated that the doctrine required reinsurers to reimburse the reinsured for payment of the settled claims as long as the payments were made reasonably and in good faith. Consequently, it was necessary for the court to determine whether ISLIC acted reasonably and in good faith when it accepted Owens-Corning’s position that the asbestos claims arose from a single occurrence. Accepting that this standard was purposefully low; the court noted that otherwise the court would have to conduct a de novo review of ISLIC’s decision-making process which would damage forever the foundation of the reinsured–reinsurer relationship. Reinsureds faced with de novo review of their claims determinations would ultimately litigate every coverage issue before making any attempt at settlement and this would give way to a proliferation of litigation. 6.140 After having examined the state of the law concerning the number of occurrences, the court found that the focus had to be on “the underlying circumstances which resulted in the claim for damages” rather than on the number of persons injured or the items damaged. Moreover, the language used in the umbrella policies referred to a per-occurrence basis rather than a per-claim basis. Therefore the assured’s and, in turn the reinsured’s, settlement was reasonable under Ohio law. The court recognised that the application of multiple deductibles would create virtually no coverage and any interpretation of the term “occurrence” as a per-claim term would render the umbrella policies meaningless. The court found that Owens-Corning’s position was influenced by this fact, and it was not unreasonable for ISLIC to accept that the term referred to a single “occurrence.” Finally, the court rejected the reinsurers’ argument with regards to the Wellington Agreement for the reinsurers had not pointed to any provision that addressed the number of occurrences issue. 6.141 Encouraging settlements has also been stated to be a matter of public policy. In Insurance Co of State of Pennsylvania v Associated Intern Ins Co235 the settlement agreement 234. Citing Mentor Ins Co v Norges Brannkasse, 996 F.2d 506, 516, (2nd Cir. (NY) May 24, 1993); National American v Certain Underwriters, slip op. 91-4021 (CD Cal.1991); Henry T. Kramer, “The Nature of Reinsurance,” in Reinsurance (1980) RW Strain (ed.) 11–12. 235. 922 F.2d 516 (9th Cir. (Cal) Dec 27, 1990).

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between the insurers, ICP, and the assured, Fibreboard, called for the payment of “future unidentified claims.” The reinsurers asserted that they were liable only for payments which were “actually expended to injured claimants by way of settlement or judgment.” The US Court of Appeals for the Ninth Circuit stated that the settlement agreement required ICP to pay asbestos claims “as and if such claims arise.” Pursuant to the reinsurance contract, Associated’s liability “shall follow that of [ICP] and shall be subject in all respects to all the terms and conditions of the [ICP-Fibreboard] policy. . . .” Under the ICP-Fibreboard policy, ICP was required “to indemnify [Fibreboard] for all sums which [Fibreboard] shall be obligated to pay by reason of the liability. . . .” Therefore, since the asbestos claims represented a liability against Fibreboard which it was obliged to pay, ICP had to indemnify Fibreboard and, pursuant to the reinsurance contract, Associated was required to indemnify ICP. The Ninth Circuit found that accepting the reinsurers’ argument would be contrary to the policy in question and would frustrate the public policy of encouraging settlement.

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Fraud or Bad Faith 6.142 It is undisputed that the reinsurers may not object to the reinsured’s settlement of a claim unless the settlement was fraudulent, collusive or made in bad faith.236 6.143 The burden of showing bad faith is on the reinsurers237 and it is not easily discharged: the standard is not mere negligence – the reinsurer must show that the reinsured had been guilty of deliberate deception, gross negligence or recklessness, or that the settlement was not even arguably within the scope of the reinsurance coverage.238 To equate bad faith with simple negligence would lead to virtually every decision by the reinsured being second-guessed and litigated under a simple negligence standard which would eventually vitiate all of the policy reasons that gave rise to the follow the fortunes doctrine.239 Accordingly, the question is not whether the reinsured was ultimately correct or incorrect, but whether it acted in good faith at the time.240 6.144 In Granite State Ins Co v ACE American Reinsurance Co 241ACE American Reinsurance Company agreed to reinsure excess umbrella liability policies issued by the subsidiaries of American International Group (collectively known AIG). ACE reinsured only one of the policies issued by AIG to Granite State in 1979. Castle & Cooke (C&C), the assured, was

236. Travelers Cas and Sur Co v Insurance Co of North America, 609 F.3d 143 (3rd Cir. (Pa) Jun 09, 2010); Christiania General Ins Corp of New York v Great American Ins Co 979 F.2d 268, (2nd Cir. (NY) Sep 03, 1992); Hartford Acc. & Indem. v Columbia Cas Co 98 F.Supp. 2d 251, D Conn, March 31, 2000; North River Ins Co v CIGNA Reinsurance Co 52 F.3d. 1194, (3rd Cir. (NJ) April 13, 1985); American Bankers Ins Co of Florida v Northwestern Nat Ins Co 198 F.3d 1332 (11th Cir. ( Fla) Dec 30, 1999) ; Granite State Ins Co v ACE American Reinsurance Co 849 NYS 2d 201, NYAD 1 Dept, Dec 27, 2007; Pacific Mut Life Ins Co v Pacific Sur Co, 69 Cal App 730, 734, Nov 21, (1924); Insurance Co of State of New York v Associated Mfgrs’ Mut Fire Ins Corp 74 NYS 1038, aff’d 174 NY 541, N.Y. Apr 09, 1903. 237. Houston Cas Co v Lexington Ins Co, 2006 US Dist LEXIS 45027. 238. North River Ins Co v CIGNA Reinsurance Co 52 F.3d 1194, (3rd Cir. (NJ) Apr 13, 1995); Hartford Acc & Indem v Columbia Cas Co 98 F.Supp. 2d 251 D Conn, March 31, 2000; Travelers Cas & Sur Co v Gerling Global Reinsurance Corp of America 419 F.3d 181 (2nd Cir. (Conn) Aug 18, 2005). In ReliaStar Life Ins Co v IOA Re, Inc 303 F.3d 874 CA 8 (Minn), 2002, where Minnesota law applied, the Eighth Circuit expressly agreed with the formulation of “bad faith” adopted by other circuits (The Third Circuit: North River v CIGNA and the Eleventh Circuit: American Bankers v Northwestern) and adopted the same standard as their own. 239. American Bankers Ins Co of Florida v Northwestern Nat Ins Co 198 F.3d 1332 (11th Cir. (Fla) Dec 30, 1999). 240. Ibid. 241. 849 NYS 2d 201, NYAD 1 Dept, Dec 27, 2007.

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exposed to thousands of claims by field workers who claimed injuries as a result of being exposed to the pesticide dibromochloropropane (DBCP). After having consulted with its counsel AIG argued that the GS policy did not provide coverage for C&C’s claim. C&C then entered into a future-cost agreement with certain AIG companies as to which policies would provide defence and indemnity on the C&C claims on an ongoing basis. AIG realised that it had paid more than the available limits with respect to defence expense and indemnity on one of its National Union policies issued to C&C which was not reinsured by ACE. Then AIG and C&C added an addendum to the future-cost agreement that AIG had exhausted the applicable limits of its National Union policy and “to the extent and any sums remain unpaid, they shall become the responsibility of Granite State.” AIG made a claim against the reinsurer by alleging that C&C faced 26,000 lawsuits in many states and foreign countries and, once the National Union policy was exhausted, the future-cost agreement was amended by endorsement to replace the policy with the Granite State policy. However, AIG did not clarify how it moved around its losses to charge ACE to the Granite State policy. 6.145 The New York Supreme Court Appellate Division took into consideration that the Granite State policy excluded DBCP claims, the future-cost agreement did not mention Granite State in the parties stated on the list and AIG allocated the loss within the Granite State policy after discovering that it made payments under the National Union policy. Noting that where there is concurrency of coverage between the original insurance and reinsurance policy, the follow the fortunes doctrine imposes a contractual obligation upon the reinsurer to indemnify the reinsured for payments it makes pursuant to a loss settlement under its own policy, the reinsurer was held not to be obliged to follow settlements that were made in bad faith or with the knowledge that the payment was outside the original policy. The court concluded that AIG’s claim fell within the exception of bad faith and ex gratia payments to the follow the fortunes doctrine. 6.146 Another example of a finding that the reinsured had acted in bad faith is City of Renton v Lexington Ins Co (USA )242 where the reinsured paid a claim without further notice to, or consultation with, the reinsurers, knowing that the reinsurers had already declined cover for the claim under the “inherent vice” exclusion. Validity of the Original Insurance Policy 6.147 In Pacific Mut Life Ins Co v Pacific Sur Co243 the District Court of Appeal, First District, Division 1, California approved the rule that where a reinsurance policy contains a follow the settlements clause the reinsurers’ will not be able to challenge the reinsured’s settlement with the assured unless it is established that the reinsured acted in bad faith or was fraudulent in settling the assured’s claim. However, the reinsurers’ challenge in this case was with regard to the validity of the original insurance, and the district court held that “. . . while a reinsuring company operating under a contract containing an adjustment clause such as the one above quoted may not avail itself of defenses based upon matters arising on or after the occurrence of the disaster which created the liability, it may attack the settlement for fraud or collusion, or it may deny its liability entirely upon the ground that a valid contract of insurance was not in existence between the insured and reinsured at the time the alleged liability thereunder occurred. In other words, before the reinsured may recover from the reinsurer, it must show that the settlement made by it was grounded upon a contract of insurance valid in law up to and at the time of the disaster out of which such liability arose.” 242. Not Reported in F.Supp 2d, 2007 WL 2751356 W D Wash, Sep 19, 2007. 243. 69 Cal App 730, Nov 21, (1924).

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6.148 In this case the insurer Pacific Mutual’s agency issued an accident policy for the assured in the sum of $10,000 in April 1914, subsequent to the date of the execution of the reinsurance contract. On 5 June 1914, a second policy was issued by Pacific Mutual’s agency to the same assured for a like amount. The assured was murdered in July 1914. Four days later the beneficiary named in the underlying policies claimed that both policies were in force and demanded against the reinsured for the payment of $30,000. Pacific Mutual initially refused payment but as a result of the suit brought by the beneficiary the claim was settled for $17,000. 6.149 The reinsurance contract provided the following provisions: “2. The ‘Pacific Mutual’ alone shall settle all claims, and such settlements shall be binding on the ‘Reinsurance Company’ in proportion to its participation, whether the settlement be in full or in compromise. The claim papers and other evidence and vouchers accepted as sufficient by the ‘Pacific Mutual’ shall likewise be taken by the ‘Reinsurance Company’ and copies of all such papers duly certified by an officer of the ‘Pacific Mutual’ shall be furnished to the ‘Reinsurance Company’ accompanying their claim under the reinsurance.” “All liability of the ‘Reinsurance Company’ shall cease when the risk terminates under the respective policy or renewal.”

6.150 The reinsurers denied payment of the settlement on the ground that neither of the underlying policies that the settlement was based on came within the terms of the reinsurance contract because the second underlying policy had been issued in lieu of the first policy. 6.151 In an action brought by Pacific Mutual against its reinsurers the question was that to what extent the reinsurers could object to the settlement under the abovementioned clause in the reinsurance policy. The reinsurers argued that all defences that were available to Pacific Mutual against the assured’s claim on the original policies were equally available to them in this action. In this respect they contended that the original policies were not in force at the time of the death of the assured for the reason that the second policy was issued in lieu of the first one. Moreover, the assured was in breach of warranty as he gave false answers to the questions set forth in said warranties. 6.152 Having noted the rule established by the precedent cases244 that in the absence of a clause such as that of quoted above, the reinsurers were entitled, against the reinsured, to make the same defences which might be asserted by the reinsured against the assured. Thus, no voluntary payment by the reinsured would be binding for the reinsurer. Nevertheless, where the reinsurance provided a clause such as that of the abovementioned, in the absence of fraud or bad faith on the part of the reinsured, the reinsurer was not in a position to be entitled to object to the reinsured’s settlement; which put the whole matter within the exercise of the sound discretion of the reinsured whether to contest or admit the claim of the assured. 6.153 As a result, the court found that because of the abovementioned provision the reinsurers were not entitled to urge in their defence related to any matters occurring at the time of or subsequent to the date of death of the assured, such as the original insurer might have invoked against the validity of the beneficiary’s claim. Nevertheless, this did not deprived the reinsurers of requiring the reinsured to establish that the underlying policies which based on the settlement were “valid up to the time of the occurrence of the disaster out of which the claim for liability on the part of both arose”, or that such fact had been previously adjudicated by a court of competent jurisdiction.

244. Citing Royal Insurance Co v Caledonian Ins Co 182 Cal. 219, Feb 13, 1920; New York State Marine Ins Co v Protection Ins Co, 18 Fed Cas 160, (CC Mass 1841), Insurance Co of New York v Associated Mfg Corp of New York, 70 App Div 69, 74 NYS 1038, aff’d in 174 NY 541, (NY Apr 09, 1903).

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6.154 In analysing the evidence, the court found that it was not sufficiently established that both contract of insurance were in force so as to render the reinsurance contract operative. Defences Available for Reinsurers under the Settlement Clauses Claim Clearly Outside the Scope of Original Insurance 6.155 A reinsurer is not obliged to indemnify the reinsured where the latter’s claim is clearly beyond the scope of the original policy.245 In other words, if it appears that no liability has attached against the reinsured under the original contract, the fact that the original insurer has paid a claim does not establish that it is entitled to indemnity from the reinsurer.246 6.156 In Independence Ins Co v Republic Nat Life Ins Co247 a life insurance policy lapsed before the assured died by reason of unpaid monthly instalment of premiums. Nevertheless the reinsured paid under the policy and claimed to be indemnified by the reinsurers. The Court of Civil Appeals of Texas held that a contract of reinsurance did not either enlarge the rights of the assured under the original policy or renew rights already lost. If the reinsured was not liable under the terms of the original contract of insurance issued by it to the assured then, by the same token, the reinsurers could not be liable. The court also stated that, by a follow the fortunes clause, the reinsurer submitted itself to any settlement or adjustment of liability on the original policy which the reinsured might adopt or assume in good faith, but such authorisation did not mean the reinsured could impose liability on the reinsurer by settlement or adjustment of a claim for which no liability existed as a matter of law. 6.157 A similar issue also came before the Court of Appeals of Michigan in Michigan Millers Mut Ins Co v North American Reinsurance Corp248 the claimant reinsured insured Transcriptions Ltd with a $1 million umbrella policy in which Transcriptions was required to maintain $300,000 of underlying coverage. The defendant reinsurers reinsured 95% of the reinsured’s liability under the umbrella policy issued to Transcriptions. After the assured was sued for personal injury claims it was discovered that its underlying policy with its primary insurer, Insurance Company of North America (INA), provided for only $100,000 of primary coverage and it was unclear who was responsible for the $200,000 gap in coverage. The underlying action against Transcriptions was settled for $240,000. INA, as the primary insurer, contributed its policy limit of $100,000; Utica Mutual, another errors and omissions insurer contributed $100,000; Transcriptions contributed $15,000 from its own funds; and the claimant reinsured contributed the final $25,000. The reinsurer however argued that the reinsured’s payment was outside the original insurance and therefore no liability ever has arisen either under the original or the reinsurance policies. 6.158 The reinsurance contract provided that: “The liability of the Reinsurer shall follow the terms and conditions of the Company’s policy [umbrella policy] furnished to the Reinsurer at the effective date of this Reinsurance Certificate. . . .”

This clause, according to the Court of Appeals of Michigan, made the reinsurers’ liable based on the reinsured’s liability to Transcriptions under the umbrella policy. Thus, if the

245. 246. 247. 248.

Aetna Cas & Sur Co v DR Ins Co, not reported in F.Supp, 1995 WL 46640 SDNY, Feb 07, 1995. Michigan Millers Mut Ins Co v North American Reinsurance Corp 182 Mich.App. 410, 1990. 447 SW 2d 462 (Tex Civ App, Dallas Oct 24, 1969). 182 Mich App 410, Feb 21, 1990.

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reinsured has no liability under the umbrella policy, then it is not entitled to indemnity from its reinsurers even though it may have made a payment. The umbrella policy provided that: “In the event that the limits of liability of the underlying insurance listed in the Schedule of Underlying Insurance Policies are exhausted by an occurrence, the Company shall be obligated to assume charge of the settlement or defense of any claim or proceeding against the insured resulting from the same occurrence, but only where this policy applies and is immediately in excess of such listed underlying insurance without intervening excess insurance with another insurer.”

Hence, the umbrella policy clearly did not cover losses below $300,000, and therefore, the reinsurers were not required to reimburse the reinsured. 6.159 Similarly, in Insurance Co of North America v US Fire Ins Co 249 goods which were insured while in transit from US gulf ports to the United Kingdom were destroyed by hurricane while undergoing bagging operations at Gulfport. The reinsurance policy provided “. . . to pay as may be paid by the Reassured, liable or not liable.” The reinsured paid the assured and, relying in particular on the phrase “liable or not liable” in the reinsurance contact, contended that the reinsurer was liable whenever the reinsured decided, unilaterally, to pay its assured. The Supreme Court, New York County250 rejected this argument and held that the reinsured’s construction would be an unwarranted and indeed tortured construction of that clause, in that it held a reinsurer bound, for example, to pay if the primary insurer paid monies to its insured on a claim completely without the scope of the policy and not in good faith. Referring to an English case Western Assurance Co of Toronto v Poole 251 the court stated that the follow the fortunes clause was certainly a broad one, but that it was clear that the reinsurer was liable only for “a loss of the kind reinsured.” To determine what type of loss was reinsured, the court turned to the original insurance contract. Subsequent to the issuance of the reinsurance policy, the reinsured issued two binders to the assured, for an additional premium, providing coverage for inland transport “from Int. U.S. to Gulfport, Miss., and while at risk there at State Authority Warehouse, Gulfport, Miss. during bagging operations and thence until laden on board overseas vessel.” The court found that issuance of the two binders indicated the reinsured’s intention that the original insurance contract was not intended to cover the losses occurring during bagging. The stoppage and bagging of the cargo at Gulfport was an interruption in the transit of the goods and created a shore risk not insured and the reinsurers had never consented to reinsure a loss not covered in the original insurance policy. 6.160 More recently, in American Home Assurance Co et al. v American Re-insurance Co et al.,252 the Supreme Court of the State of New York once again found that the reinsurers were not obliged to follow the reinsured’s settlement which included the coverage of the assured’s claim for punitive damages which was expressly excluded by the original policies. In this case AIG insured Monsanto, a manufacturer of chemical and agricultural products, under approximately 60 excess liability insurance policies, to provide coverage from 1967 through 1985 involving many layers of coverage, up to the excess layer of $250 million. AIG then entered into facultative reinsurance agreement with the various reinsurers, including the defendants, Everest and American Re, to reinsure three of these excess general liability policies from 1975 until 1978.

249. 250. 251. 252.

322 NYS 2d 520, NY Sup, Jun 15, 1971, aff’d by 348 NYS 2d 122, (N.Y.A.D 1 Dept, Oct 04, 1973). Aff’d by the Supreme Court, Appellate Division, First Department, New York. [1903] 1 KB 376. No:602485/06, NY Sup., New York Co, 24 May 2010.

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6.161 As a result of its activities of using, generating and storing certain materials that contaminated the environment and caused personal injury and property damage, Monsanto faced claims by the Environmental Protection Agency, state regulatory authorities and third parties. In 1988 Monsanto made a claim against its insurers including AIG, in connection with these claims, and AIG and Monsanto settled the actions on 31 August 1993 in order to “avoid the expense and disruption of further litigation.” As a result of the settlement, Monsanto agreed to release the insurers for coverage for “clean-up costs” for the sum of $7,375,000. Additionally, AIG agreed to indemnify Monsanto with respect to Third Party Claims that AIG would pay up to 50% of Monsanto’s expenses and liability, up to $150 million per site, without any allocation of spreading as to underlying coverage. In September 2001 Monsanto informed AIG that it had exhausted $80 million per site deductible and sought reimbursement for Third Party Claims under the 1993 settlement. In 2004 AIG agreed to pay Monsanto $140,566,79.82 of the $150 million per site limit for Third Party Claims. 6.162 The reinsurance certificates contained a standard clause providing that all claims covered by the certificates were binding on the reinsurers when settled. AIG claimed that the reinsurers should follow its settlements reached in 2004 with the assured. 6.163 The judge of the Supreme Court of the State of New York pointed out that the excess insurance policies contained exclusions for bodily injury or property damage caused by pollution unless the contamination was sudden and accidental. Additionally, the policies expressly provided that: “This Insurance does not cover any liability for . . . punitive or exemplary damages.” Beside the express exclusions in the excess policies, under applicable Missouri law, an excess policy that covers bodily injury and property damage would not cover punitive damages unless the policy expressly provides for payment of punitive damages.253 6.164 The payment made to Monsanto under the 1993 settlement and 2004 Agreement provided coverage regardless of whether the losses fell into any of the exclusions. Moreover, the evidence demonstrated that the fear of the amount of the jury awards for punitive damages (which could reach $900 million) might have played a significant role in Montano’s decision to settle. 6.165 The judge found that the considerable portion of the $140 million paid to Monsanto under the 2004 Agreement, and subsequently was sought from the reinsurers was designed to reimburse Monsanto for a potential punitive damages award and for injury and property caused by traditional environmental pollution which was not sudden and accidental. The judge was convinced that AIG failed to raise a triable issue that it conducted a reasonable claims investigation to determine whether it was legally liable for the assured’s claim prior the settlement in 2004. Therefore the reinsurers were successful in their arguments that the payment pursuant to the 2004 settlement was not made within the scope of the excess insurance policies, and also the reinsured failed to conduct a reasonable investigation as to coverage. Consequently, the reinsurers were not obliged to follow the reinsured’s settlement of 2004. The judge also touched upon the allocation and stressed that “with respect to allocation, a reinsurer cannot be held accountable for any loss that the reinsurance policy does not cover.” 6.166 The point at stake in a dispute before the US District Court, WD Washington, at Seattle City of Renton v Lexington Ins Co (USA)254 was again similar. In this case the Monster Road Bridge, located in the City of Renton, was insured by WCIA and reinsured by Lexington. Inspections had found cracks at the bridge; eventually, these worsened to the point that the bridge required extensive repairs to maintain operational safety. 253. Citing Union LP Gas Systems, Inc v International Surplus Lines Ins Co, 869 F.2d 1109, (8th Cir. (Mo) March 13, 1989. 254. Not reported in F.Supp 2d, 2007 WL 2751356 WD Wash, Sep 19, 2007.

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6.172

6.167 The WCIA policy was against “all risk of direct physical loss including fire and lightning, extended coverage, all other perils, flood and earthquake providing coverage for all real and personal property . . . as more fully defined in the forms attached thereto.” 6.168 The policy excluded: “A) Loss or damage caused by or resulting from moths, vermin, termites, or other insects, inherent vice, latent defect, wear, tear or gradual deterioration, contamination, rust, wet or dry rot, mould, unless caused by a peril not excluded, or loss or damage by normal settling, shrinkage or expansion in building or foundation.” 6.169 The reinsurance policy was: “… subject to all terms, clauses and conditions as original except as provided herein, and to follow the settlements or other payments of whatsoever nature made by the Original Underwriters arising out of and in connection with the original insurance and to bear its proportion of any expenses incurred whether legal or otherwise in the investigation and defense of any claim hereunder.”

6.170 The reinsurer argued that the design error was an inherent vice which was specifically excluded from coverage; therefore, despite the payment made by WCIA, they were not under any obligations to indemnify the reinsured for the payment for claim which was outside the original insurance and therefore the reinsurance cover. 6.171 The US District Court, WD Washington, at Seattle noted that experts evaluating the condition of the bridge had concluded that bridge cracks were not attributable to external events such as rain, wind, earthquake, etc but the structural integrity of the bridge had been deficient from the outset. For this reason, the design defect which caused the City’s loss did not fall within the insuring provision of the WCIA policy, which insured against “all risk of direct physical loss or damage”, but was an inherent vice. The court noted that it was inherent, not in the nature of bridges in general, but of this particular bridge as it was designed and delivered to the City. 6.172 The court emphasised the principle that the reinsurance relationship depends on the reinsurer and the reinsured observing high levels of good faith.255 Moreover, the reinsurer is liable only for a loss of the kind reinsured and this principle is not rebutted by the follow the settlements or “follow the terms and conditions of the policy” clauses. According to the District court the following forms provision expressly limits the reinsurance to the terms and conditions of the underlying policy and provides that the reinsurance certificate will cover only the kinds of liability covered in the original policy issued to the insured and a follow the fortunes clause limited a reinsurer’s defences. However, the court also noted that these clauses did not make a reinsurer liable for risks beyond what was agreed upon in the reinsurance certificate. In other words, the notion of follow the fortunes cannot create reinsurance where none exists. To this extent, the court stated, the reinsurer retained the right to question whether the reinsured’s liability stemmed from an unreinsured loss. The court clarified that a loss was unreinsured if it was not contemplated by the original insurance policy or was expressly excluded by terms of the reinsurance policy. According to the District court this distinction between insured and uninsured risks was particularly important where the reinsurance was facultative because the reinsurer accepted only specific risks, as set forth in the underlying policy. Therefore, the question was whether the error in design of the bridge was a risk covered by the WCIA policy. The policy wording made it clear that the answer to this question was in the negative and subsequently the reinsurer was not bound to pay where the primary insurer paid on a claim that was completely outside the scope of the policy, and not in good faith. The court found that the reinsured did not pay the assured’s claim in good faith, because

255. Citing Unigard Sec Ins Co v North River Ins Co, 4 F.3d 1049, (2nd Cir. (NY) Sep 09, 1993).

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WCIA paid the claim late in this action, after discovery had closed, and without further notice to or consultation with defendants, knowing that defendants had already declined to cover the claim under the “inherent vice” exclusion. 6.173 The same principles were applied at the federal level by the US Court of Appeals for the Second Circuit in American Ins Co v North American Co for Property and Cas Inc.256 In this case, again, the point at stake was the reinsurers’ obligation to indemnify the reinsured for the punitive damages award against the assured. The reinsured, American Insurance Company (AIC), insured Dow Chemical Company during the 1970s for all damages that Dow became legally obliged to pay. North American Company for Property and Casualty Insurance (NACPAC) agreed to reinsure part of AIC’s risk, for a layer of liability between $250,000 and $500,000 per damage award. In July 1977 a Minnesota state court jury found Dow liable to pay $146,970 of compensatory damages and $750,000 of punitive damages caused by a fire in a building insulated with Styrofoam, a Dow product. While the Minnesota award was on appeal, AIC settled a number of the Styrofoam cases for $1.2 million, of which $500,000 was allocated to the Minnesota case. AIC then submitted its claim to NACPAC for $250,000 of the Minnesota award which NACPAC refused to pay. NACPAC asserted that the Minnesota jury had awarded punitive damages against Dow for deliberate corporate misbehaviour, and consequently most of AIC’s Minnesota settlement had compensated Dow for damages excluded from the insurance and reinsurance policies. NACPAC further contended that the part of the settlement attributable to compensatory damages, which was the only part covered by NACPAC’s policy, was less than $250,000; therefore, they had no duty to reimburse AIC for any portion of the settlement. 6.174 The Second Circuit confined its analysis to the terms of the AIC-Dow policy and found no ambiguity in the phrase of the policy’s definition of “occurrence,” referring to “damage not intended from the standpoint of the insured.” The court further held that the parties agreed that the Dow Policy be interpreted according to the terms of the Memorandum dated 15 December 1971 which made that coverage for punitive damages would be provided where the assured was “vicariously assessed with punitive damages but did not itself direct or ratify the offending act.” The Memorandum also made it clear that punitive damages would not be indemnified if such coverage was prohibited by local public policy or such an award was given as a result of the assured’s own performance or directing or ratification of the offending act. Subsequently the Second Circuit agreed with the District Court’s finding that the punitive damages assessed by the Minnesota jury fell within the category of punitive damages for which the AIC-Dow policy did not provide coverage. 6.175 AIC argued that even if the original policy excluded the Minnesota punitive damages award, because of the follow the fortunes clause in the reinsurance policy NACPAC was obliged to reimburse AIC for its settlement on behalf of Dow. NACPAC however contended that “follow the fortune” clauses did not bind reinsurers for ex gratia payments. The follow the fortunes clause in the policy provided: “All claims involving this reinsurance, when settled by the company, shall be binding on the reinsurer …”

6.176 The Second Circuit stated that if there was genuine ambiguity as to what a settlement covered, a follow the fortunes clause might oblige a reinsurer to contribute to a settlement even if the settlement might encompass excluded items. However, according to the Second Circuit, there was no ambiguity in the AIC-Dow policy.

256. 697 F.2d 79, 12 (2nd Cir. (NY) Dec 30, 1982).

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Claim Beyond the Reinsurance Policy Cover 6.177 The reinsurance and original insurance contracts are independent of each other and clearly, the extent of the liability of the reinsurer is determined by the language of the reinsurance contract, and the reinsurer cannot be held liable beyond the terms of its contract merely because the original insurer has sustained a loss.257 While a follow the fortunes clause limits a reinsurer’s defences, it does not change this principle and make a reinsurer liable for risks beyond those agreed in the reinsurance certificate.258 In other words, the clause does not create reinsurance cover where none otherwise existed,259 at least in circumstances where the direct policy and the reinsurance are written in different terms. In Michigan Millers Mut Ins Co v North American Reinsurance Corp260 the reinsured issued an umbrella policy for $1 million in excess of the assured’s retention of $300,000 The reinsured contributed to a settlement which fell within the scope of the assured’s retention, and sought to recover from the reinsurers on the basis of the following clause: “F. LOSS PAYABLE. All insurance policy claims involving this reinsurance, when settled by the company, shall be binding upon the reinsurer, which shall be bound to pay its proportion of such settlements promptly following receipt of proof of loss in the following manner . . . .”

6.178 The Michigan Court of Appeals emphasised the wording “Claims involving this reinsurance” and stated that this language made it clear that only the settlement of claims involving the reinsurance contract could be binding on the reinsurers. The Michigan Court of Appeals also noted that a finding that that the reinsured was liable under the umbrella policy for a loss below the $300,000 limit, merely because its own assured failed to secure adequate primary layer coverage, would effectively have required the court to rewrite the policy. Furthermore, the reinsured contended that although it had contributed to a settlement that was less than the assured’s retention, it agreed to do so to avoid exposure to a potentially larger jury verdict and excessive litigation costs. However the court stated that interpreting the contract in this way would expose the reinsurers to greater risk than contracted for, and it rejected the reinsured’s public policy argument. UNREINSURED LOSSES

6.179 In North River Ins Co v CIGNA Reinsurance Co261 the US Court of Appeals for the Third Circuit once more confirmed that the “follow the fortunes” clauses limit a reinsurer’s defences because the clause prevents reinsurers from second guessing good-faith settlements and obtaining de novo review of judgments of the reinsured’s liability to its assured; but the court also noted that such limitation does not operate to make the reinsurers liable for risks beyond those agreed upon in the reinsurance contract. In other words, the reinsurer still retains the right to question whether the reinsured’s claim is based on an unreinsured loss. The court further clarified that a loss would be unreinsured if it “was not contemplated by the original insurance policy or if it was expressly excluded by terms of the certificate of reinsurance.” 257. Michigan Millers Mut Ins Co v North American Reinsurance Corp 182 Mich.App. 410, Feb 21, 1990. 258. North River Ins Co v CIGNA Reinsurance Co 52 F.3d 1194, (3rd Cir. (NJ) Apr 13, 1995); City of Renton v Lexington Ins Co (USA) Not Reported in F.Supp 2d, 2007 WL 2751356 WD Wash, Sep 19, 2007; American Ins Co v North American Co 697 F.2d 79, (2nd Cir. (NY) Dec 30, 1982); Fireman’s Fund Insurance Company v Aachen & Munich Fire Insurance Company 2 Cal App 690, Jan 20, 1906; Central Nat Ins Co of Omaha v Prudential Reinsurance Co 241 Cal Rptr 773, Nov 19, 1987. The Supreme Court ordered that the opinion be not officially published. 259. Affiliated FM Ins Co v Employers Reinsurance Co 369 F.Supp 2d 217 DRI, May 12, 2005. North River Ins Co v CIGNA Reinsurance Co 52 F.3d 1194 (3rd Cir. (NY) Apr 13, 1995); City of Renton v Lexington Ins Co (USA) not reported in F.Supp 2d, 2007 WL 2751356 WD Wash, Sep 19, 2007. 260. 182 Mich App 410, Feb 21, 1990. 261. 52 F.3d 1194, (3rd Cir. (NJ) Apr 13, 1995).

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6.180 A dispute relating to a unreinsured loss came before the US Court of Appeals for the Second Circuit in American Ins Co v North American Co for Property and Cas Inc,262 the facts of which were stated above, where AIC asserted that the reinsurers were obliged to follow its settlements – which encompassed the cover punitive damages falling outside the original insurance policy – because it acted in a businesslike manner as it entered into a settlement not because of the Minnesota jury’s award of punitive damages, but for a variety of valid business reasons, including a fear that the compensatory damage award might be increased as a result of the appeal. The Second Circuit however found that AIC’s settlement was primarily designed to compensate Dow for a punitive damages award that was excluded from the reinsurance policy. The settlement did not compensate Dow for insured risks in an amount greater than $250,000. Under these circumstances, it would be unfair to NACPAC to hold it liable for damages beyond the scope of its policy. 6.181 In American Home Assurance Co et al. v American Re-insurance Co et al.,263 the facts which were stated above, after concluding that the reinsured’s payment included uninsured losses, with respect to such payment’s allocation to the reinsurance the judge noted that “. . . a reinsurer cannot be held accountable for any loss that the reinsurance policy does not cover.” LOSSES FALLING BEYOND THE REINSURANCE POLICY LIMITS

6.182 In addition to unreinsured losses, reinsurers also plainly do not have to pay any amount beyond the limits of liability stated in the reinsurance policy.264 In Bellefonte Reinsurance Co v Aetna Cas and Sur Co,265 the reinsured settled a claim with the assured, including the assured’s defence expenses even though the aggregate payment was in excess of the cap stated in the policies. The reinsurance agreement provided. “All claims involving this reinsurance, when settled by the Company, shall be binding on the Reinsurer, which shall be bound to pay its proportion of such settlements, and in addition thereto, in the ratio that the Reinsurer’s loss payment bears to the Company’s gross loss payment, its proportion of expenses . . . incurred by the Company in the investigation and settlement of claims or suits . . . .”

6.183 The reinsured claimed the settled amount from the reinsurers by contending that the follow the fortunes clause obliged the reinsurer to follow its settlement. The Second Circuit declined to read the follow the fortunes clause as negating the phrase “the reinsurer does hereby reinsure Aetna . . . subject to the . . . amount of liability set forth herein.” This was so because such an interpretation would strip the limitation clause and other conditions of all meaning; the reinsurer would be obliged to reimburse the insurer for any and all funds paid. The court stated that the follow the fortunes clause “coexist [s]with, rather than supplant,[s] the liability cap.” The phrase “in addition thereto” was also challenged by Aetna, but the court stated that the function of the phrase in the clause was merely to differentiate the obligations for losses and for expenses; it was not designed to exempt defence costs from the overall monetary limitation in the certificate.266 Rather, the court held that defence costs were “subject to”

262. 697 F.2d 79, (2nd Cir. (NY) Dec 30, 1982). 263. No:602485/06, NY Sup., New York Co, May 24, 2010. 264. American Marine Ins Group v Neptunia Ins Co 775 F.Supp 703 SDNY, Oct 21, 1991, aff’d by 961 F.2d 372 (2nd Cir. (NY) Apr 09, 1992) 265. 903 F.2d 910 (2nd Cir. (NY) May 19, 1990). 266. It was suggested that the limit of liability set forth in the certificate’s declaration page should clearly mention whether that limit includes or excludes expenses. “Determining How to ‘Follow the Fortunes’,” Presented by Clifford H. Schoenberg (Miller, Singer, Raives & Brandes, PC) at Safeguarding Your Rights in Reinsurance Agreements, New York, 1991.

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the express cap on liability in each certificate. Accordingly, this monetary limitation was a cap on all payments under the certificate. It did not indicate that either component was not within the overall limitation.267 6.184 The same approach was followed by the Michigan District Court in Travelers Cas and Sur Co v Constitution Reinsurance Corp.268 Travelers’ policy provided coverage to Dow for the period 1975 to 1978. CRC reinsured Travelers under three reinsurance certificates for the same time period for: “$1,000,000 each occurrence and in the aggregate where applicab[l]e part of $4,000,000 part of $8,000,000 part of $15,000,000 which in turn is excess of $24,000,000.”

6.185 The reinsured settled the assured’s claim and then argued that the $1 million per occurrence limits in the three reinsurance certificates should be annualised, so that the reinsured could obtain reinsurance coverage up to $3 million for each certificate. The Michigan District Court noted that the “Reinsurance Accepted” for the 1975–1978 reinsurance certificate was $1 million for “each occurrence and in the aggregate where applicab[l]e part of” $8 million. There was nothing in the express language of the certificates stating that the $1 million limited apply “annually” or “each year” or “for each annual period.” Rather, they unambiguously granted coverage up to $1 million (not $3 million) for each occurrence during the period of reinsurance coverage. Interpreting “each occurrence” to mean “each occurrence, each year” would require reading in a contract term that was not there. The court also refused to read the follow the form clause as disregarding the reinsurer’s liability limit under the reinsurance policy.269 The policy issued to Dow provided coverage for $4.5 million part of $15 million, but reinsurance was only provided for $1 million part of $4.5 million. The court stressed that if Travelers were allowed to recover its full liability to Dow simply because it held some amount of reinsurance, the negotiated coverage limits of the reinsurance certificates would be rendered meaningless. 6.186 In Calvert Fire Ins Co v Yosemite Ins Co270 it can be seen that the rule applicable to reinsurance policy defences is strictly interpreted. Yosemite issued liability insurance policy to Yellow Cab Co of California (Yellow Cab) against the liability imposed upon it by law arising out of the operation of its taxi cabs, subject to a self-insured retention or deductible of $25,000. Calvert reinsured Yosemite for 50% of each loss in excess of $25,000 up to a limit of $300,000. The problem here arose when Yellow Cab went into bankruptcy and Yosemite became liable under its policy to pay claims within Yellow Cab’s self-insured retention of $25,000. Yosemite thereupon made a demand that its reinsurers, Calvert, paid claims of less than $25,000 which had been made against Yosemite.

267. Bellefonte was followed by Unigard Sec Ins Co, Inc v North River Ins Co 4 F.3d (2nd Cir. (NY) Sep 09, 1993). In Excess Ins Co Ltd v Factory Mut Ins 3 NY.3d 577, (NY) Dec 02, 2004 the reinsured’s claim for its litigation expenses against the assured was above the reinsurance policy limit. It was held that holding otherwise would make the reinsurer subject to limitless liability, it was particularly unfair where because of the “follow the settlements” clause the reinsurer has no control over the handling with an unsuccessful litigation against the assured. See also Argonaut Ins Co v Travelers Ins Co 800 N.Y. S.2d 342 (NY) Supp. Jan 05, 2005). where it was held that the follow-thesettlements clause does not alter or override the other terms of a reinsurance contract, or obligate a reinsurer to indemnify a reinsured for payments in excess of the reinsurer’s agreed-to exposure. 268. 2004 WL 2387313, ED Mich, Apr 02, 2004 (applying Michigan law). 269. The district court expressed that the clause expressly limits the reinsurance to the terms and conditions of the underlying policy and provides that the reinsurance certificate will cover only the kinds of liability covered in the original policy issued to the insured. 270. 573 F.Supp 27 DCNC, Sep 14, 1983 (applying North Carolina law).

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6.187 The first provision of the reinsurance contract provided: “ ... liability of [Calvert] specified in Item 4 shall follow that of the Company, except as otherwise specifically provided herein, and shall be subject in all respects to all the terms and conditions of [Yosemite’s] policy.”

Under item 4 of the reinsurance contract Calvert reinsured Yosemite for the first $50,000 of its exposure over Yellow Cab’s retention for each person injured; $150,000 for all bodily injuries in any one accident; and $25,000 for property damage in any one accident. 6.188 The court found that item 4 was not ambiguous and the first provision of the reinsurance contract had to be construed as meaning that the reinsurer’s liability followed that of the reinsured within the limits specified in Item 4. To construe the clause otherwise would effectively have eliminated the provision in Item 4 that the reinsurer’s liability began after the selfinsured retention had been exhausted. 6.189 It was also ruled that, unless reinsurers expressly agreed otherwise, they were not liable for the increase of the original insurance limit which was agreed after the reinsurance policy had incepted. In Penn Re, Inc v Aetna Cas and Sur Co271 the District Court of ED North Carolina noted that the “follow-the-fortunes” doctrine did not support the proposition that Aetna could unilaterally increase the reinsurers’ liability by agreeing with the assured to do so. In this case the reinsurers were held to be obligated to pay – in addition to the reinsurance policy limits – expenses incurred by the assured in defending the actions brought against him but it was because of the contractual language of the particular clause that the reinsurers had agreed to be bound but not because the follow the fortunes doctrine obliged the reinsurers to do so. Applying the rules of contractual construction of North Carolina, the court held that the follow the fortunes doctrine did not impose such additional liability upon the reinsurers and they could only be bound if they expressly assented to it.

271. 1987 WL 909519 EDNC, Jun 30, 1987.

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T H E SCOPE OF T H E FOLLOW T H E SET T L E M E N TS C L AUSE

E N G L I S H L AW: T H E R E I N S U R E D ’ S C O S T S I N D E F E N D I N G T H E ASSURED’S CLAIM

7.01 The reinsured is under a duty to take all proper and businesslike steps to ascertain that there is a serious possibility that the loss fell within the contract of insurance. However if there are arguable defences available against the assured, the reinsured might have to incur expense in defending the assured’s claim. If the reinsured’s defence is successful, this would necessarily be to the reinsurer’s benefit and therefore one may argue that the reinsurer should share the relevant costs with the reinsured. This may be on the basis of relying on a sue and labour clause or alternatively, especially in proportional reinsurance contracts, the suggestion that the reinsurer and the reinsured are in a partnership relationship and they should share the costs of defending the assureds claim as well as sharing the risk and the premium.1 These propositions are analysed below. “Sue and labour” Clauses 7.02 In the past there have been cases in which the reinsured has based its claim to recover costs on “sue and labour” clauses. In Scottish Metropolitan Assurance Co Ltd v Groom2 the reinsurance policy did not contain any follow the settlements or to pay as may be paid thereon clause, but provided that “. . . in case of any loss or misfortune it shall be lawful to the assured . . . to sue, labour and travel for, in and about the defence, safeguard, and recovery of the said goods and merchandises and ship, & c., or any part thereof, without prejudice to this insurance.” The insurer incurred considerable expenses in successfully defending an action by the assured on the ground that the vessel had been deliberately cast away and that the loss was not covered by the policy for that reason. By relying on the sue and labour clause, the reinsured then claimed the cost of defending the assured’s action. The reinsured alternatively contended that a term should be implied into reinsurance which required the reinsurer to contribute the expenses incurred by the reinsured in defending the assured’s claim. However the Court of Appeal rejected the reinsured’s arguments. The court looked closely at the wording of the sue and labour clause and held that it was inapposite to cover such claims as it did not contain any provision for payment of costs. As for the implied term argument it was suggested that the term was to be implied from the conduct and action of 1. Baker v Black Sea & Baltic General Insurance Co Ltd [1998] Lloyd’s Rep IR 327. 2. (1924) 20 Ll L Rep 44; cf British Dominions General Insurance Co Ltd v Duder [1915] 2 KB 394. Scottish Metropolitan Assurance Co Ltd. v Groom was applied by Roche J in Versicherungs und Transport A/G Daugava v Henderson (1934) 48 Ll L Rep 54, 60. It should be noted that the reinsurer in this case agreed to follow the settlements of the reinsured but Roche J did not express any view as to the effect of the follow the settlements clause on claiming costs.

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the defendant or possibly from a practice at Lloyd’s. Nevertheless no sufficient evidence was produced to establish any practice by which the defendant would be bound by implied contract to pay these costs. It can be inferred from the Court of Appeal’s comments on the “sue and labour” clause that the reinsurer may be held liable for the costs but all will depend on the wording of the clause. Partnership and Implied Term Argument 7.03 The partnership argument was the issue in Baker v Black Sea & Baltic General Insurance Co Ltd3 where the reinsurance policy contained the “Full Reinsurance Clause,” and the reinsured Lloyd’s syndicate emphasised the relationship between the reinsured and the reinsurer and asserted that the reinsurance was an extension of the underlying insurance so that the parties should share the costs as well as the benefits of the contract. The reinsured further asserted that the reinsurer was profiting from the defence of these coverage actions and accordingly should contribute to the cost because the proportional nature of reinsurance requires sharing proportionately all aspects of the contract, including defence costs. 7.04 The Court of Appeal4 distinguished a partnership relationship from reinsurance, pointing out that, in the former, costs and expenses incurred by one partner in the course of the partnership business are incurred for and on behalf of the partnership. Nevertheless in the reinsurance context the legal costs and expenses incurred by the syndicate in investigating claims were incurred by it as principal and on its own account in the course of its own business. Consequently the syndicate had no right to recover any part of such costs from the reinsurer unless the reinsurance contract expressly so provided.5 7.05 In the House of Lords6 the reinsured continued to rely on its assertions that a term to such effect must be implied in order to give the contract business efficacy, or because it was trade practice in the London insurance market.7 7.06 The House of Lords rejected the reinsured’s implied term argument, entirely agreeing with the Court of Appeal. As to market practice, the House of Lords pointed out that there would have to be evidence of a universal and acknowledged practice of the market for reinsurers to pay such costs and no such evidence had been produced. The case was remitted to the High Court to see if such evidence existed, but the reinsured did not press its case. There has been no subsequent attempt to argue that there is a market custom to the effect that costs are recoverable on this basis. 7.07 As a result of these authorities, it is now settled that unless the policy expressly imposes an obligation on the reinsurers, the reinsured is not entitled to claim the costs that it incurred in investigating the loss or defending the assured’s claim and the follow the settlements 3. [1998] Lloyd’s Rep IR 327. 4. [1996] LRLR 353. 5. For an express term in a reinsurance policy that entitling the reinsured to claim for costs see Eagle Star Insurance Co Ltd v Cresswell [2004] Lloyd’s Rep IR 537: “In the event of a loss arising to which the underwriters hereon may be liable to contribute, no legal costs shall be incurred on their behalf without their consent being first obtained and if they so consent they shall contribute to the said costs in the proportion that their share of the loss as finally settled bears to the total sum payable. If, however, a settlement of the loss be practicable prior to taking the case into court whether by compromise or otherwise for a sum not exceeding the limits stated in the Schedule hereto, no legal costs shall be payable by the underwriters hereon.” 6. [1998] Lloyd’s Rep IR 327. 7. See Wasa International Insurance Co Ltd v Lexington Insurance Co [2007] Lloyd’s Rep IR 604, where Simon J rejected a claim for defence costs by relying on Baker v Black Sea & Baltic General Insurance Co Ltd [1998] Lloyd’s Rep IR 327 and holding that the reinsurance contract contained no express provision for such coverage and that the reinsured had not attempted to prove a universal practice in the London market in 1977. The point was not appealed.

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clause does not include to follow the reinsured’s such expenses because unless the parties agree otherwise the expenses of dealing with a loss are no part of the loss itself.8

U N I T E D S TAT E S

No Follow the Settlements Clause 7.08 In the early cases on reinsurance the courts were of the view that upon notification of the assured’s claim, if the reinsurer declined to indemnify the reinsured, thereby forcing the reinsured to incur costs to defend the assured’s claim, it was perfectly reasonable to hold the reinsurer liable for the defence costs incurred by the reinsured, on the basis that the reinsurers could have prevented the reinsured from incurring those costs by affirming the claim. In Hastie v De Peyster9 the assured sued the insurer in New York, seeking recovery on the basis that the insured vessel had become a constructive total loss. The vessel had been sold by the assured under an agreement with the insurer. The insurer notified the action to the reinsurers who denied payment for the reason that the notice of abandonment had not been given to them. In the proceedings brought by the assured the insurer was found to be liable, and the insurer sought to cover its defence costs from the reinsurers. The reinsurance contract did not contain a follow the settlements/fortunes clause, although the Supreme Court accepted that the reinsured had established its liability to the assured by virtue of a judgment given by the courts of New York. The Supreme Court of New York decided that the reinsurers were bound to pay the costs that the reinsured had incurred in defending the claim brought by the assured. The Supreme Court of New York was of the view that upon notification of the assured’s action against the reinsured the reinsurers might have come forward and prevented the action by payment of the sum claimed. The cost was necessarily incurred as a result of suit brought by the assured against its insurer which resulted in the insurer’s liability under the insurance policy. This reasoning was applied in New York State Marine Ins Co v Protection Ins Co10 where the Circuit Court, D Massachusetts set out the qualification for claiming the costs incurred by the reinsured in defending the assured’s claim. The facts of this case were briefly as follows. The claimant insured the vessel Evelina on a “lost or not lost” basis for $4,000 at and from her port or place of loading in Massachusetts to Amsterdam and at and from thence to New York. On her way from Massachusetts to Amsterdam the vessel sustained damage by perils of the seas and put into St Thomas in distress. She was there repaired with funds procured on bottomry and proceeded to Amsterdam, where she was attached and sold by the holders of the bottomry bond. The owners made a claim against the insurer for total loss of Evelina and upon the refusal by the insurer they brought an action in New York in which they recovered only a partial loss. The insurer then made a claim against its reinsurers for the loss under the policy together with the expenses of costs and counsel fees incurred by it in defending the assured’s suit. The Circuit Court, D Massachusetts was of the view that where the insurer established its liability to its assured by a judgment given in favour of the assured, the insurer was entitled to recover a full indemnity for the entire loss sustained by him together with the costs and expenses that he had reasonably and necessarily incurred in defending the assured’s suit

8. Roche J, Versicherungs und Transport A/G Daugava v Henderson (1934) 48 Ll L Rep 54. Costs were not in issue on appeal. 9. 3 Cai. R 190, NY Sup 1805. 10. 18 F.Cas 160 (CC Mass 1841).

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against him. The court however noted that this would be subject to appropriate qualifications that: (a) (b) (c) (d)

the reinsured’s challenge of the assured’s claim must be just and reasonable; the expenses must be fairly and reasonably incurred; the reinsured must act in a bona fide manner; the reinsured must exercise a sound discretion.

7.09 Hence, the reinsurers will not be liable for expenses and costs “wantonly and unnecessarily” incurred by the reinsured in a case of loss where there was clearly no reasonable ground of defence. 7.10 The court emphasised that notice of the assured’s suit was crucial because upon notification of the assured’s claim the reinsurers have a fair opportunity to exercise an election, whether to contest, or to admit the claim. The court described it as the reinsurers’ duty to act within a reasonable time upon such notice. Thus, if the reinsurers had not used the opportunity to contest that claim or to authorise the reinsured to compromise or settle the claim, the reinsurers would be deemed to have consented to the defence of the claim and thereby impliedly to have agreed to indemnify the reinsured against the costs and expenses necessarily and reasonably incurred in defending the suit.11 According to the court, reinsurers who refused to interfere with the process of defending the assured’s claim or who stayed silent upon notification, have no right afterwards to maintain that the costs and expenses of the suit ought not to be borne by them. In such circumstances the costs in question would be incurred exclusively for the benefit of the reinsurers, and were indispensable for the protection of the reinsured. Consequently, the court found that the reinsured’s claim not only satisfied the abovementioned qualifications but also the reinsured had informed the reinsurers that they would be looked to for reimbursement of the costs and expenses of the assured’s action and the reinsurers neither made any objection nor interposed an offer of payment. Thus, the court found appropriate to hold that the reinsurers must be taken to have approved the reinsured’s contestation of the claim against it and to have authorised the defence to be made. The reinsurers were held to be liable to pay their proportion of the costs and expenses, including the fees of the attorneys and counsel employed in the defence. 7.11 Extrinsic evidence as to these requirements was accepted in TIG Premier Ins Co v Hartford Acc. & Indem. Co12 where the reinsurance policy was governed by California law. In TIG, the assured, Dow, was faced with hundreds of claims by women for injuries allegedly caused by breast implant products manufactured by Dow. Dow sought indemnity from its various insurers, including Hartford Accident and Indemnity Company. TIG Premier Insurance Co reinsured Hartford by a facultative reinsurance policy. Having settled the claim with Dow, Hartford sought coverage from TIG for both the liability damages and proportionate share of Hartford’s reimbursement to Dow of Dow’s expenses in defending the suits by third parties and also the proportionate share of Hartford’s own litigation costs in its coverage disputes with Dow. The standard reinsurance policy contained a box entitled “Reinsurance Accepted” in the following language: “$150,000 each occurrence/NIL aggregate, being 20% P/O $750,000 each occurrence/NIL aggregate, excess item 5.”

11. See Faneuil Hall Ins Co v Liverpool & London & Globe In Co 153 Mass 63, Jan 09, 1891, where in an action upon a policy of reinsurance to recover, besides the insurance money, the expense of an unsuccessful defence of a suit, of which the reinsurer had notice, and of the successful defence of another suit, of which the reinsurer had no notice, the former alone was held recoverable. See also Gantt v American Cent Ins Co 68 Mo 503, October 1878; New York Bowery Fire Ins Co v New York Fire Ins Co 17 Wend 359, 1837. 12. 35 F.Supp 2d 348 SDNY, Jan 29, 1999 (applying California law).

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7.12 By relying on Bellefonte Reinsurance Co v Aetna Cas. and Surety Co.13 and Unigard Security Ins Co v North River Ins Co,14 where the Court of Appeals held that the reinsurers were not liable for the reinsured’s defence costs which were beyond the reinsurance policy limits, TIG argued that they were not liable for the defence costs claimed by Hartford. 7.13 The case was brought before the US District Court, Southern New York, but the conflict of law rules of New York indicated that TIG’s reinsurance contract was governed by the law of California. Therefore the court refused to apply Bellefonte and Unigard, where the law of New York was applicable, and instead heard extrinsic evidence produced by Hartford. The district court judge stated that California courts repeatedly ruled that “[e]ven if a contract appears unambiguous on its face, a latent ambiguity may be exposed by extrinsic evidence which reveals more than one possible meaning to which the language of the contract is yet reasonably susceptible.”15 7.14 Hartford’s contention was that the “Reinsurance Accepted” box was a kind of industry shorthand that meant that TIG’s reinsurance coverage extended to 20% of all of the risks insured under the original insurance policy with Dow. One of the pieces of evidence submitted by Hartford was that in 1994, TIG, in paying a claim under a nearly identical reinsurance policy with Hartford, reimbursed Hartford for legal expenses in addition to the dollar amount set forth in the “Reinsurance Accepted” box. Moreover, TIG’s internal documents concerning the very policy here at issue stated that “[e]xpenses are in addition to limits” and “TIG can anticipate that the 150,000 max loss amount will be used up. Further expenses will no doubt be very large,” and that “[t]he policy limits under such policies are not eroded by defense expenses.” The district court found all of the evidence were acceptable under California law because in California it was ruled that “‘[t]he practical interpretation of the contract by one party, evidenced by his words or acts, can be used against him on behalf of the other party, even though that other party had no knowledge of those words or acts when they occurred . . .”16 7.15 In addition, two experts, who worked in the reinsurance industry in the 1970s, the period when this policy was entered into, also stated that it was “standard practice within the industry” for reinsurers to pay their pro rata share of the primary insurer’s payments of the underlying insured’s liability damages and also the same percentage of the primary insured’s reimbursement of the underlying insured’s defence costs. 7.16 The court found that the evidence was more than sufficient to prove that the “Reinsurance Accepted” meant that “TIG’s coverage included not only 20% of Hartford’s obligations to Dow on the $750,000 reinsured liability risk but also 20% of the related defence costs incurred or covered by Hartford under its primary policy with Dow.” The court recognised that such a construction was not apparent from the plain words of the contract but that the extrinsic evidence revealed the latent ambiguity with the wording of the clause and made it perfectly plausible the specialised meaning these terms convey in the context of the reinsurance industry. The court also noted that a New York court might not interpret the clause this way, but that a California court would recognise this interpretation of the clause in the light of extrinsic evidence.

13. 903 F.2d 910, 911, (2nd Cir. (NY) May 19, 1990). 14. 4 F.3d 1049, 1071, (2nd Cir. (NY) Sep 09, 1993). 15. Citing Morey v Vannucci, 75 Cal Rptr 2d 573, 578. (Cal. App. 1 Dist. Jan 10, 1998); accord Southern Pacific Land Company v Westlake Farms, Inc, 233 Cal Rptr 794, 799 (Cal. App 5 Dist. 1987); Southern California Edison v Superior Court, 44 Cal Rptr 2d 227, 232 (1995). 16. Citing Southern California Edison v Superior Court, 44 Cal Rptr 2d at 234.

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7.17 In the US, reinsurance policies usually contain a clause regarding the reinsurer’s liability for expenses incurred by the reinsured. For example in Employers Ins Co of Wausau v American Reinsurance Co17 the court found that the clause “all expenses incurred in the investigation and settlement of claims or suits” covered expenses incurred in declaratory judgment actions where the reinsured contested the assured’s claim.18 Does the Follow the Settlements Doctrine Extend to Defence Costs? Cost-inclusive, Cost-exclusive and Cost Supplemental Policies 7.18 It may be argued that where a reinsured has, in the course of settling a claim brought against it by the assured, paid the assured’s defence costs in an amount which, together with the amount of the assured’s liability, exceeds the original policy limits, the reinsurers are liable to indemnify the reinsured for the defence costs even though they are in excess of the reinsurers’ own limit of liability. The assertion is based on the argument that such excess liability arose because the reinsured entered into a businesslike settlement in good faith with the assured, grounded upon the reasonable judgment of the reinsured that if the issue had gone to trial the reinsured’s prospects of winning would have been slight. In Aetna Cas and Sur Co v Home Ins Co19 Aetna put forward this contention. In this case AH Robins Company was the manufacturer of the Dalkon Shield intrauterine birth control device. Soon after the product had been introduced in early 1970s, Robins received complaints with regards to physical injuries related to the use of the product, such as uterine perforations and infections. There were also unwanted pregnancies and spontaneous abortion. As a result of the complaints Robins was faced with thousands of claims, and subsequently became insolvent. 7.19 Aetna issued primary and excess liability insurance policies for Robins. After Robins started receiving the complaints, in 1977, Aetna and Robins made an Interim agreement which stated : “IT IS THEREFORE NOW UNDERSTOOD AND AGREED BY AND BETWEEN AETNA AND ROBINS: 1. That Aetna will continue to defend the aforesaid Dalkon Shield cases and all similar cases filed in the future which come within the coverage of the Policies as they may be modified by this Agreement (hereinafter referred to as ‘said cases’). The terms ‘Policies’, as used in this agreement, means all contracts or policies of liability or indemnity insurance ever issued, both as of the date of this agreement and in the future, by Aetna and insuring Robins. 2. That both parties hereby agree henceforth to be bound by the terms and conditions of the Policies when read in conjunction with this agreement; further, this agreement is hereby issued as an endorsement by Aetna which forms a part of the Policies.”

7.20 The court noted that, on the proper construction of the primary and excess policies issued by Aetna, before the interim agreement was concluded between Aetna and Robins, there was no duty on Aetna to defend Robins against claims by third parties; however, the interim agreement created a new duty on the part of Aetna to defend Robins against any pending and future claims. 7.21 However, despite the interim agreement, in assessing Robins’ claims, Aetna allocated Robins’ defence costs to the limit of liability under the excess policies. Subsequently, Robins

17. 256 F.Supp 2d 923 WD Wis, March 10, 2003. 18. For a comment on the case see Kendall W Harrison, “Recent Developments Concerning a Reinsurer’s Obligation to Pay Its Reinsured’s Declaratory Judgment Expenses”, Mealey’s Litigation Report, Vol.14, No 5, 3 July 2003, 24. 19. 882 F.Supp 1328, SDNY, March 27, 1995.

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brought an action against Aetna to enforce the interim agreement, seeking an order to the effect that defence costs were to be excluded from the limit of indemnity under the policies. Aetna eventually settled Robins’ claim and agreed with Robins’ interpretation that the policy cap to third-party claims only, and defence costs should not be capped by the policy coverage limits. 7.22 Home Insurance Company reinsured Aetna on a facultative basis. Home had given their consent to the interim agreement and other endorsements to the original policies. Aetna argued that Home should indemnify Aetna without applying the reinsurance liability cap to the defence costs that Aetna agreed to pay to Robins again outside the original insurance loss limitation cap. 7.23 The District Court for the Southern District of New York had a careful look at the original insurance and reinsurance policy wordings. The court noted that in general terms coverage may be limited to the payment of indemnity, (ie amounts recovered by third-party claimants against the assured in the form of damages) or it may also include allocated claim expenses. In order to determine the limitation of liability under the Aetna’s policies the District Court’s starting point was to see whether claims expenses were within the scope of coverage at all. If the answer was in the affirmative, the next question would be whether those expenses were included within the policies’ definition of ultimate net loss which operated as the cap for Aetna’s limit of liability. The result would be that if expenses were covered by the policies, and if the duty to pay such expenses was not encompassed within the definition of ultimate net loss, the insurer’s liability for expenses was in excess of whatever sums it had to pay for ultimate net loss, and such excess liability for those expenses would simply be unlimited. 7.24 The Aetna policies at issue here contained “loss” limitations (ie dollar limitations on the liability of the insurer for ultimate net loss).20 According to the court’s interpretation, loss limitations were different from “policy” limitations. The latter were a cap on all payments which the insurer might be required to make by way of indemnification of the assured. However, by reason of the loss limitation, the limit could only be for the losses which were listed in the ultimate net loss clauses. 7.25 The Court gave the definitions of three different types of policies which were classified on the basis of including or excluding defence costs as follows: 1. Cost-exclusive policies: Policies that “include no duty to defend the insured and no provision for the payment of defence costs by the insurer.” 2. Cost-inclusive policies: Policies that “provide for a duty to defend subject to an overall limit of liability.” 3. Cost-supplemental policies: Policies that “place in the insurer a duty to defend the insurer but does not by its terms include those costs within the limit of liability.” 7.26 In a cost-exclusive policy the assured must bear the costs of investigating and defending claims by third parties, with the insurer being bound to indemnify the assured for damages which it had to pay to claimants. In a cost-inclusive policy the maximum liability of the insurer to its assured is capped by the limit of liability expressed in the policy. Thus indemnity

20. At this point the court distinguished the reinsurance policies in Bellefonte. The Aetna excess policies here at issue, as well as the Home reinsurance policies, contain “loss” limitations (ie dollar limitations on the liability of the insurer/reinsurer for ultimate net loss). The facultative reinsurance policies in Bellefonte contained “policy” limitations which cap on all payments which a reinsurer may be required to make by way of indemnification of the ceding company. Thus, in the Bellefonte case, Aetna was unable to claim defence costs from the reinsurers.

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payments for third-party claimants and the costs of defending against such claims will be charged against the limit of liability. Once the cap is reached, the insurer will bear no further liability under the policy. 7.27 In examining the Aetna policies the court determined that the limit of liability capped ultimate net loss, and the definition of ultimate net loss in each of the policy years provided that ultimate net loss referred to damages; in other words, payments made by the insurer to indemnify the assured for liability to third-party claimants. As a result, if it was concluded that Aetna undertook by its policy terms to bear the costs of defending the third party claims against Robins, those costs would be outside ultimate net loss and would not be capped by the limit of liability in the Aetna policies. Therefore the next step was to examine the ultimate net loss clauses. 7.28 The definition of ultimate net loss in each of the Aetna policies differed from year to year: In the 1972 policy ultimate net loss was defined as “. . . the sum actually paid or payable in cash in the settlement or satisfaction of any claim or suit for which the insured is liable either by adjudication or settlement with the written consent of the company, after making proper deduction for all recoveries and salvages collectible, but excludes all loss expenses and legal expenses (including attorney’s fees, court costs and interest on any judgment or award) and all salaries of employees and office expenses of the insured, the company or any underlying insurer so incurred.”

7.29 In the 1973 policy limits of liability applicable to each claim was “the total limit of the Company’s liability or all Damages and for all expenses incurred under the Supplementary Payments Provisions (other than salaries of the Company’s employees) because of Bodily Injury or Property Damage to any one person.” In the 1973 policy “excess of loss” defined as “. . .The total of all sums which the INSURED becomes legally obligated to pay or has paid, as damages on account of any one accident or occurrence, and which would be covered by the terms of the Controlling Underwriting Insurance, if written without any limit of liability, less realized recoveries and salvages, which is excess of any self-insured retention and the total of the applicable limits of liability of all policies described in Section 3, Schedule of Underlying Insurance; whether or not such policies are in force” (the following sentence was deleted from the clause): “Loss shall not include any costs or expense in connection with the investigation or defense of claims or suits, or interest on any judgment which accrues after entry of the judgment.”

7.30 The definition in the 1974 policy was as follows: “ “EXCESS NET LOSS” means that part of The total of all sums which the insured becomes legally obligated to pay or has paid, as damages on account of any one accident or occurrence and which would be covered by the terms of the Controlling Underwriting Insurance, if written without any limit of liability, less realized recoveries and salvages, which is excess of any self-insured retention and the total of the applicable limits of liability of all policies described in Section 3, Schedule of Underlying Insurance; whether or not such policies are in force.”

7.31 As may be seen, in 1974, in the Aetna excess policy the definition of loss did not clearly exclude claims expenses. In 1976, however, the policy excluded “any costs or expenses in connection with the investigation or defence of claims or suits.” The clause provided: “EXCESS NET LOSS” means that part of the total of all sums which the INSURED becomes legally obligated to pay or has paid, as damages on account of any one accident or occurrence, and which would be covered by the terms of the Controlling Underlying Insurance, if written without any limit of liability, less realized recoveries and salvages, which is excess of any self-insured retention and the total of the applicable limits of liability of all policies described in Section 3, Schedule of Underlying Insurance; whether or not such policies are in force. Loss shall not include any costs or expenses in connection with the investigation or defense of claims or suits, or interest on any judgment which accrues after entry of the judgment. (emphasis added).

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7.32 As a result, the 1972 and 1976 Aetna policies explicitly excluded claims expenses from the definition of ultimate (or excess) net loss; the 1973 and 1974 policies did not contain the same exclusions but they did not list claims expenses with damages as items contained within the definition of loss. The 1973 and 1974 policies also did not provide that claims expenses were capped by any limit of liability. Each of the excess policies was reinsured. 7.33 Aetna’s counsel examined the chances of success against Robins’ claims for defence costs. The Vice President and Claim Counsel for Aetna found that the chance was for the 1971 and 1972 policy was 10%, for the 1973 and 1974 policies was 60% (because exclusion of claims expenses had been deleted by a modification that intended to achieve a cost-inclusive definition). For the 1975, 1976 and 1977 years, which did not carry the language found in the 1973 and 1974 policies, the chance of success was estimated as 20%. As a result Aetna was advised to settle with Robins. The settlement agreement was based on the following formula: ($Limit × .26) − % chance of successful defence = Net Contribution above Limit 7.34 Upon denial of liability for the claims expenses that Aetna agreed to pay to Robins, Aetna brought the present action against Home. The District Court ascertained that resolving the dispute depended on the question of “who has the right to make the controlling interpretation of the Aetna excess policies generally, and of the liability for defence costs in particular.” The court further confirmed that Aetna’s excess policies were cost-exclusive as originally written, but that Aetna amended its 1973 and 1974 policies and Home also amended the relevant reinsurance policies accordingly. Therefore the court found that it was the intention of the parties that both the Aetna excess policies and the related reinsurance policies were costinclusive. Further, Aetna billed Home with respect to the related reinsurance contracts on a cost-inclusive basis. Home therefore argued that the modification in 1973 (deleting the exclusion of costs from the definition of ultimate net loss) and the subsequent cost-inclusive billing signified an intent to include defence costs within the policy limits. It should be noted that after the 1984 settlement agreement, Aetna billed Home on a cost-supplemental basis, reflecting its conclusion that, due to the settlement, it was bound to pay defence costs as a benefit supplemental to the loss limitations. Aetna asserted that the reinsurance policies were concurrent with the original insurance policies and, because Aetna reasonably concluded that the scope of coverage at least arguably provided for the payment of defence costs in addition to the stated limits of liability, the reinsurer had to follow Aetna’s good faith settlement. 7.35 The court found that its first task was to determine the type and scope of the loss reinsured by Home. Referring to the following form clauses in the reinsurance policies the court found that all the terms and conditions of the reinsured policy were incorporated into the reinsurance policy, and the two contracts provided concurrent coverage unless the reinsurance contract by its own terms provided an exclusion clause that defined the coverage differently. For instance, if the Aetna policies provided for the payment of defence costs outside ultimate net loss, the reinsurers were obligated to reimburse Aetna for such payments unless the reinsurance policy explicitly provided otherwise (eg by expressly including such costs within the definition of loss or by expressly stating that costs were capped by an overall policy limit even if such costs were not part of the loss limitations). The court noted that no such restriction could be found in Home’s policies. The effect of the follow the form clause according to the court was “whatever coverage the Aetna policies provided to Robins, the Home policies provided the same coverage by way of indemnity to Aetna, absent a contrary provision in the Home contract.” However the court added that the Aetna policies did not plainly establish how defence costs were to be paid. Significantly, the court stated that, as the Aetna policies did not plainly establish how defence costs were to be paid, Aetna’s payment for defence costs was a 163

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supplemental benefit and hence Aetna could not bind the reinsurers to that settlement simply because the reinsurance contracts were following form with regard to the excess contracts. Under the follow the form clause, it still had to be established that the claim was unambiguously within the scope of coverage provided by the reinsured policy which was incorporated by reference into the reinsurance policy. For this reason, the court went on to decide the case by referring to the follow the fortunes and follow the settlements principles even though the reinsurance contracts in this case did not contain a standard follow the settlements or fortunes clause. Thus, having rejected Aetna’s first submission that the follow the form clauses had the same effect as the follow the settlements clause (ie that the reinsurer was obliged to follow the settlements that the reinsured entered into on bona fide and businesslike assessment of the assured’s claim) the court accepted Aetna’s alternative submission that a follow the settlements or fortunes clause was to be implied into the Home reinsurance policies by operation of long standing custom and business practice even in the absence of an express loss settlement clause. Therefore the final question was to determine whether or not Aetna’s settlement was bona fide and businesslike. 7.36 The District Court noted that the follow the settlements clause did not have the effect of binding the reinsurers to follow all of the settlements of the reinsured. For example, if the reinsured had paid a loss that was categorically outside the scope of coverage, it would not trigger a duty on the part of the reinsurers even though such a settlement might make good business sense. The reinsurers were bound to follow the settlement only where the reinsured’s interpretation of the original policy was based on a reasonable judgment of the reinsured that the assured’s interpretation of the scope of coverage was meritorious. Consequently, where the original insurance and reinsurance policies are concurrent, if the settlement agreement between the assured and the reinsured is grounded on a reasonable interpretation of the reinsured policy, the reinsurers may not raise policy defences and objections that would have been available to the reinsured in defending the assured’s claim. Thus, the court’s inquiry would be limited to asking the question whether or not the reinsured’s interpretation was reasonable and bona fide, and not one manifestly outside the scope of the original insurance. 7.37 The court further ruled that: • The definition of ultimate net loss in each of the Aetna policies for the relevant policy years, read literally, unambiguously excluded the defence costs that had been accepted by Aetna in the 1977 Interim Agreement. • As regards the 1972 and 1976 policy years in particular, Aetna found that Robins interpretation was supported by the policy language. • As to the 1973 and 1974 policies, the dispute was considered by Aetna to be open to debate, for the reason that the exclusion of defence costs had been deleted from the definition in the ultimate net loss clause, but Aetna also took into consideration that such costs were not expressly included within the loss limitations. • As a result, Robins’ claim was of a supplementary nature, outside the loss limitation, but Robins had a meritorious, albeit debatable, claim. 7.38 The District Court found that Aetna’s determination was reasonable. The court recognised that Aetna’s settlement was based on the advice given by its claims counsel and Aetna did not have the benefit of 20/20 hindsight that a full trial on the merits would have afforded. Nevertheless, the court took into consideration that the specific purpose of an ultimate net loss clause in an insurance contract was to determine whether claims expenses were to be allocated pro rata according to the reinsurer’s share of loss, or whether such expenses were to be included within the ultimate net loss clause and, therefore, the loss limitations. Aetna 164

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reasonably determined that for the 1972 and 1976 policies, due to the language of the policies, those policies were cost-supplemental. As far as the 1973 and 1974 policies were concerned, although there was no evidence that the policies were cost-inclusive following the deletion of defence costs from the original definition of ultimate net loss, the policies did not on its face include expenses within the loss limitations but continued to define ultimate net loss as those sums payable as damages. 7.39 The court stated that “The reasoning that undergirds the ‘follow the settlements’ doctrine does not require that a ceding company pursue every defense in litigation against the insured, however close a call the particular policy defense might be. Quite the contrary: subject to the ceding company’s duty of utmost good faith, and the requirement that investigations such as the one conducted by Shea be reasonable and businesslike, the doctrine leaves it to the ceding company to make the settlement decision in the first instance, which settlement is then binding upon the reinsurers. Although this court has ultimately found that all policies were intended to be cost-inclusive, at least as of 1973, that finding does not change the result here; rather, it is the reasonableness of Aetna’s interpretation of the scope of coverage at the time of the settlement that is dispositive of the reinsurers’ obligation to the reinsured.”

7.40 It was clearly the case that the 1977 Interim Agreement to which Home gave consent, imposed a duty on Aetna duty to defend third-party claims against Robins. Thus, Aetna’s policies were clearly not “cost-exclusive.” The further question was, therefore, whether they were cost-supplemental or cost-inclusive. If they were cost-inclusive, payment for defence costs would be outside the limit of the original policy loss limitations and also the reinsurance polices by reason of the concurrency provided by the following form clause. In order to calculate the cap that the Aetna policies provided it was necessary to examine the ultimate or excess net loss clauses. The 1972 policy excluded the defence costs from the loss limitation: in other words, any payment for defence costs would be supplemental to the limit for indemnification provided for the third-party damages. The 1973 policy clearly deleted the exclusion, therefore it was cost-inclusive. Similarly, the 1974 policy did not clearly exclude defence costs, and it was therefore cost-inclusive. The 1976 policy contained the same exclusion as had been in the 1972 policy: therefore it was also cost-supplemental. As a result, counsel ascertained the chance of success for Aetna against Robins for its claim for defence costs was higher in 1973 and 1974 policies than under the 1972 and 1976 policies. It is not clear from the case why counsel determined that the chance for the 1973 and 1974 policies was no higher than 60%. However, the court found that assessment to be reasonable, and therefore that it fell within the reinsurance coverage by virtue of the concurrency provided by the follow the form clause as well as by reason of the duty imposed on the reinsurer by the operation of the “implied” follow the settlements clause. INTERPRETATION OF THE ORIGINAL POLICY IS BINDING ON THE REINSURER

7.41 In North River Ins Co v CIGNA Reinsurance Co21 the reinsurers were held to be liable for the defence costs that the assured had incurred and the reinsured had paid after an arbitration award which held the reinsured liable in this respect both under the Wellington Agreement and also under the interpretation of the original insurance independently of the Wellington Agreement. It is noteworthy that the absence of an express exclusion of defence costs in the reinsurance contract was one of the grounds for the holding that the reinsurers were liable for such costs.

21. 52 F.3d 1194 (3rd Cir. (NJ) Apr 13, 1995).

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7.42 North River Insurance Company was the excess insurer of Owens-Corning Fiberglas between 1974 and 1978 for various amounts of loss in excess of $26 million. The policies did not include a duty to defend clause, but gave North River the option to participate in “the control, defense and/or trial of any claims, suits or proceedings.” 7.43 CIGNA was the facultative reinsurer of North River. The reinsurance contracts contained “following forms” language, a follow the fortunes clause, and a consent clause requiring North River to obtain CIGNA Re’s prior approval for any changes made to the policies. The reinsurance policies did not expressly exclude coverage for defence costs. 7.44 Owens was an asbestos manufacturer. Like all asbestos producers, it incurred significant costs in defending-and paying out-asbestos injury claims which lead the exhaustion of its primary insurance by March 1987. Owens then sought coverage from its excess insurer, North River. North River refused to cover defence costs. Because North River and Owens-Corning had signed the Wellington Agreement, a global settlement agreement providing for arbitration of asbestos coverage disputes, the dispute went to binding arbitration. The arbitrator found that under the terms of the policy itself, and according to the provisions of the Wellington Agreement, North River was obligated to cover Owens-Corning’s defence costs. After CIGNA Re refused to cover its share of these defence costs, North River brought an action against the reinsurer in federal district court seeking to compel its reinsurer to “follow” North River’s fortunes. The district court granted summary judgment to the reinsurer, CIGNA Re. 7.45 The US Court of Appeals for the Third Circuit ruled for the reinsured. The court found the arbitrator’s decision supportable and reasonable. Before moving into the detailed analysis of the case at this stage it is necessary to say a little more about the Wellington Agreement which played an important role on the payment made by the reinsured to Owens-Corning. WELLINGTON AGREEMENT

7.46 As a result of tens of thousands of asbestos injury claims filed against asbestos producers, between 1980 and 1985 manufacturers and their insurers had paid out an estimated $1 billion on asbestos injury claims-with roughly half going for costs alone. In 1985, several insurers and asbestos producers entered into the Agreement Concerning Asbestos-Related Claims. This is known as the Wellington Agreement because of the mediation of then-Yale Law School Dean Harry Wellington. The Agreement established a non-profit claims handling centre that co-ordinated claim payments on behalf of the asbestos producers. Wellington did not rewrite existing policies between producers and their insurers but founded the Asbestos Claims Facility which aimed to encourage settlements in place of costly litigation and to reduce asbestos litigation awards while lowering the associated costs. 7.47 Appendix D of the Wellington Agreement required the signatory insurers and policy holders to “schedule” their policies to clarify particular features of coverage. Appendix D set out nine “schedules” or generic categories of coverage, from A through I. The insurer and the insured were supposed to agree on which category applied to their policy. The significant differences lie among categories “G”, paying defence costs or “allocated expenses” beyond policy limits, “H”, paying allocated expenses within the policy limits, and “I”, not paying allocated expenses at all. Appendix D did not require insurers to provide coverage for defence costs; parties could agree to schedule their policies expressly to exclude defence costs but in the absence of any designation, Wellington set up a presumption that defence costs would be covered. 7.48 North River and Owens-Corning signed the agreement; CIGNA Re, North River’s reinsurer, did not. 7.49 Owens-Corning scheduled its policies with North River as “G.” North River did not agree to Owens-Corning’s scheduling, but instead of registering its disagreement on the 166

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scheduling form, wrote letters to Owens-Corning detailing what it did and did not agree to cover. Subsequently, North River paid the liability claims but denied coverage for defence costs. Owens-Corning and North River submitted their dispute to arbitration in accordance with the Wellington Agreement. The arbitrator found that North River’s objection to Owen’s scheduling should have been made according to the procedures provided by the Wellington Agreement which North River did not follow. The letter response did not satisfy Wellington’s scheduling requirements. Therefore North River was deemed to have assented to OwensCorning’s “G” designation and was liable for defence costs. Moreover, according to the Wellington agreement, unless expressly excluded, it was presumed that all policies provided coverage for allocated costs. 7.50 The arbitrator also examined the original policy language; the policy wording did not expressly exclude payment of defence costs and the policy provided for payment of costs upon consent of the insurer. He held North River was responsible for Owens-Corning’s defence costs because it had not met its burden of showing that those costs were excluded from the policy coverage. North River initially appealed the arbitrator’s ruling but later dropped the appeal. 7.51 CIGNA Re indemnified North River for liability under the policies but denied coverage for defence costs. The district court granted summary judgment to CIGNA. On appeal, the Third Circuit found the reinsurers liable for the defence costs according to the original policy interpretation and the follow the fortunes doctrine. The Third Circuit applied New York law to interpret the reinsurance contract and Ohio law to interpret the underlying insurance contract. The reinsurance contract contained a “follow the form”22 and a follow the fortunes clause which read as follows: “[T]he liability of [CIGNA Re] . . . shall follow that of [North River] and except as otherwise specifically provided herein, shall be subject in all respects to all the terms and conditions of [North River’s] policy except such as may purport to create a direct obligation of [CIGNA Re] to [Owens-Corning].” “All claims involving this reinsurance, when settled by [North River], shall be binding on [CIGNA Re], which, shall be bound to pay its proportion of such settlements, and in addition thereto, . . . its proportion of expenses . . . incurred by [North River] in the investigation and settlement of claims or suits and, with the prior consent of the Reinsurer to trial court proceedings, its proportion of court costs and interest on any judgment or award.”

7.52 As to the function of the follow the fortunes clause, the Third Circuit noted that the follow the fortunes doctrine creates an exception to the general rule that contract interpretation is subject to de novo review. The court emphasised three points: 1. By a follow the fortunes clause a reinsurer is bound to follow its reinsured’s fortunes in settling claims unless the reinsurer can show that the reinsured did not act in good faith or after conducting a reasonable investigation. 2. Thus, the question would be not whether the underlying claim was covered by the reinsured’s policy, but whether there is any reasonable basis to conclude there was such coverage. 3. Only if the reinsured pays a claim that is clearly outside the scope of its policy, that would be a sustainable challenge. 7.53 Therefore, according to the Third Circuit, reinsurers were limited to two inquiries: first, they may ask whether an insurer engaged in fraud or collusion in the payment of a claim, 22. As the Third Circuit found the reinsurer obliged to follow the fortunes of the reinsured it did not examine the effect of the follow the form clause to the reinsurers’ liability.

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and second, whether the claim arose from a risk clearly outside the policy as reinsured. The court noted that once those questions were answered in the negative, the reinsurer could not second-guess the resolution of a particular dispute over coverage. 7.54 As stated above, the arbitrator found North River responsible for defence costs incurred by the assured for two reasons: (1) by virtue of the Wellington Agreement; and (2) independently of the Wellington Agreement, under the original policy issued by North River which provided coverage for defence costs. 7.55 The Third Circuit noted that the follow the fortunes doctrine did not require the reinsurer to cover risks undertaken after the reinsurance contract was concluded. Given the fact that the Wellington Agreement were entered into after the risk was reinsured, the Third Circuit focused on the interpretation of the original policy without the intervening Wellington Agreement. 7.56 As the issue was not a settlement between North River and Owens-Corning, and because North River was obliged to indemnify Owens-Corning for defence costs by virtue of an arbitrator ruling, the first issue that the court examined was that whether or not the follow the fortunes doctrine was applicable to arbitrator rulings as well as settlements. The Third Circuit stated that the follow the fortunes doctrine was applicable to settlements as well as being applicable generally to all outcomes of coverage disputes, whether in the form of settlements or judgments. The court found no difference between the effects of court judgments and arbitration decisions for follow the fortunes purposes. 7.57 Secondly, the Third Circuit focused on the principle that “the reinsurer is liable only for ‘a loss of the kind reinsured’.” The reinsurers contended that because the defence costs were not covered by the original insurance policy, they were not liable for the defence costs either. Hence, in order to determine what type of loss was reinsured, it was necessary to examine the original policy wording. As the parties had stipulated that Ohio law governed the interpretation of the underlying insurance policy, the court examined the policy language under Ohio law. 7.58 Unlike Aetna Cas and Sur Co v Home Ins Co23 the North River policy did not include a duty to defend clause; Owens-Corning was “solely responsible for the investigation, settlement, defense and final disposition of any claim made or suit brought or proceeding instituted against the Insured. . . .” North River however “. . . shall have the right and shall be given the opportunity to associate with [Owens-Corning] or its underlying insurer or insurers, or both, in the control, defense and/or trial of any claims, suits or proceedings which, in the opinion of [North River], involves or appears reasonably likely to involve [North River].” Moreover, the “ultimate net loss” was defined as “the sums paid in settlement of losses for which the Insured is liable . . . and shall exclude all ‘Costs’.” “Costs” were “interest on judgments, investigation, adjustment and legal expenses.” Nevertheless, the policy also provided that costs incurred by Owens-Corning “with the written consent of [North River]” would be apportioned and elsewhere in the policy North River’s “obligation to pay any ultimate net loss and costs” when underlying limits have been paid was referred to. 7.59 The court read the policy as a whole. According to the principles that were taken into consideration in reading the policy, a special provision was to override a general provision only where the two cannot stand together. If reasonable effect can be given to both, each was to be retained. As a result, the court agreed with the arbitrator that the policy provided a limited exclusion for costs. It was the case because on the one hand the policy wording stated that North River was to indemnify Owens-Corning against “ultimate 23. 882 F.Supp 1328, SDNY, March 27, 1995.

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net loss” which in definition excluded “costs,” and on the other hand, it stated that North River’s obligation was to pay both ultimate net loss and costs. It is nevertheless noteworthy that North River agreed that the defence costs could be apportioned “with the written consent of the Company.” But the court found that such a literal reading of this last phrase would be inconsistent with other clause in the policy, especially with the clause which provided that North River’s obligation to pay costs would not attach until the underlying limits had been paid. If written consent by North River was required, Owens-Corning would be required to obtain written consent from its excess insurer before it could permit its primary insurer to engage in litigation or settlement on its behalf-even though the excess insurer would not be responsible for the resulting liability unless the primary insurer’s limits were exhausted. Consequently, the court found that compliance with both paragraphs was practically infeasible to the effect that strict construction of both provisions would yield an unreasonable effect. 7.60 The arbitrator did not touch upon the issue that the North River policy did not impose any duty on the insurer to defend third-party claims against Owens-Corning. The Third Circuit was of the opinion that an excess insurer and its assured would have good reason to omit a duty to defend clause from an excess policy that in most instances the primary insurer already would have accepted the duty to defend the assured. Thus, it was not unreasonable to interpret this policy without linking the obligation to pay defence costs to a duty to defend. Accordingly, the Third Circuit found that the reinsurers had failed to establish that Ohio law would not support the arbitrator’s construction of the insurance policy provision as requiring North River to pay defence costs. As the reinsurance policy provided a follow the fortunes clause, which obliged reinsurers to follow reinsureds’ fortune in the absence of the latter’s bad faith in defending the claim (or settling it), CIGNA Re was to reimburse North River for the defence costs paid. 7.61 Significantly, the Third Circuit pointed out that – as stated above – CIGNA Re could have expressly excluded coverage for defence costs and such an exclusion would prevent the follow the fortunes doctrine to apply to the reinsurance contract in this respect but CIGNA Re’s policies did not contain such an exclusion. 7.62 North River Ins Co v CIGNA Reinsurance Co24 is a case where the Third Circuit’s reasoning focused on the application of the follow the fortunes doctrine, to the effect that unless the reinsurance contract contains any exclusion clauses or the reinsurer establishes that the reinsured acted in bad faith in defending or settling the claim the reinsurer is bound by the reinsured’s settlement. The Third Circuit did not examine the effect of the follow the form clause to the dispute. However, it might be useful to mention that the original insurance and reinsurance policies were concurrent and the follow the form clause confirmed the concurrency. The Third Circuit nevertheless pointed out that CIGNA’s reinsurance policy did not provide any exclusion clauses for defence costs and this statement actually lead the same result without specifically mentioning the follow the form clause and its function of providing the concurrency between the reinsurance and the direct insurance policies. Defence Costs that the Reinsured Agreed to Pay Beyond the Original Insurance Policy Limits 7.63 Bellefonte Reinsurance Co v Aetna Cas and Sur Co25 was another case which arose out of the explosion of litigation over the Dalkon Shield intrauterine device. By primary and excess policies from 1968 through 1977 Aetna insured Robins against liability for personal 24. 52 F.3d 1194, (3rd Cir. (NJ) Apr 13, 1995). 25. 903 F.2d 910, (2nd Cir. (NY) May 19, 1990).

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injury claims arising from use of Robin’s products. By facultative reinsurance, Aetna transferred specified proportions of the excess insurance policies to its reinsurers. The relevant reinsurance contracts provisions were as follows: Provision 1: “[Reinsurer] . . . [d]oes hereby reinsure Aetna . . . (herein called the Company) in respect of the Company’s contract hereinafter described, in consideration of the payment of the premium and subject to the terms, conditions and amount of liability set forth herein, as follows. . . .” Provision 2: “Reinsurance Accepted $500,000 part of $5,000,000 excess of $10,000,000 excess of underlying limits . . .” Provision 3: “The Company warrants to retain for its own account . . . the amount of liability specified . . . above, and the liability of the Reinsurer specified . . . above [i.e., amount of reinsurance accepted] shall follow that of the Company. . . .” Provision 4: “All claims involving this reinsurance, when settled by the Company, shall be binding on the Reinsurer, which shall be bound to pay its proportion of such settlements, and in addition thereto, in the ratio that the Reinsurer’s loss payment bears to the Company’s gross loss payment, its proportion of expenses . . . incurred by the Company in the investigation and settlement of claims or suits. . . .” 7.64 Robins was faced with number of product liability actions brought by third parties who had used the Dalkon Shield intrauterine device. As a result, in making its claims against Aetna, Robins included not only the amount paid to the third parties for their claim, but also the expenses incurred in defending the actions against Robins. Initially, Aetna refused to indemnify Robins for those defence costs that exceeded the limitations of liability stated in the excess insurance policies, but the parties settled the dispute in an action brought by Robins before the judgment was given. Under the settlement with Robins Aetna agreed to pay an amount substantially in excess of the cap provided by the policies. It is worth noting that the reinsurers neither participated in these settlement negotiations nor signed the agreement. 7.65 When Aetna made claim against its reinsurers it included a portion of the excess in its claim: Aetna sought a sum totalling more than $5 million – from all of the reinsurers combined – in excess of the liability caps. The reinsurers did not dispute that they had to follow Aetna’s fortunes with respect to the Robins settlement but they denied any obligation to make payment exceeding the reinsurance policies liability cap. Aetna, however, contended that the reinsurers were liable beyond the stated limits because the excess was for “reasonable” defence costs expended on settlement in “good faith” of a dispute arising from the underlying policy. 7.66 The US Court of Appeals for the Second Circuit described Aetna’s suggestion as allowing the follow the fortunes clause to override the limitation on liability. The court did not approve such a reading for it would be contrary to the parties’ express agreement and to the settled law of contract interpretation. The court adopted the view in terms of the interpretation of the follow the fortunes clause that first, the follow the fortunes clauses in the reinsurance contracts “coexisted with, rather than supplanted, the liability cap.” To construe the certificates otherwise would have effectively eliminated the limitation on the reinsurers’ liability to the amount that the parties agreed to cap the liability. Secondly, the limitation was set to cap all payments26 by the reinsurer. In other words, the follow the fortunes doctrine did not allow Aetna to recover defence costs beyond the express cap stated in the certificates. 26. Emphasis added.

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7.67 Aetna also contended that, because Provision 4 used the phrase “in addition thereto,” the monetary limitation on liability set forth in the first two provisions of the certificates were to be applicable to the reinsurers’ liability for the underlying losses only but not the reinsurers’ liability for defence expenses and costs. The Second Circuit disagreed and expressed the view that the phrase did not exempt defence costs from the overall monetary limitation in the reinsurance certificates. Liability for defence costs was separate from Robins’ direct liability to the Dalkon Shield claimants. The phrase “in addition thereto” merely differentiated the obligations for losses and for expenses. The monetary limitation was to cap all payments under the reinsurance agreements. Hence, all other contractual language had to be construed in light of that cap. 7.68 The court further ruled that, whatever the form of the demand by the reinsured, ie for additional expenses, for additional settlement contributions, or that the reinsurers were obliged to follow the liability of Aetna, it was ultimately the case that the reinsurers’ full obligation was quantitatively limited by the dollar amount the reinsurers had agreed to reinsure. For this reason, except for paying up to the certificate limits, the reinsurers had no additional liability to Aetna for defence expenses or settlement contributions. Any other construction of the reinsurance certificates would negate the phrase “the reinsurer does hereby reinsure Aetna . . . subject to the . . . amount of liability set forth herein.” 7.69 In Unigard Sec Ins Co Inc v North River Ins Co27 the Second Circuit applied the same principle where the reinsured was obligated to pay the assured’s defence costs in excess of the policy limits by an arbitration award and claimed that defence costs from its reinsurers, again, in excess of the reinsurance policy limits. This was another case where the asbestos claims against Owens-Corning gave rise to the dispute. North River insured Owens-Corning and Unigard agreed to reinsure North River’s policies. The reinsurance policy contained a follow the form, follow the settlements and notice of loss and claims association28 clauses. North River signed the Wellington Agreement but did not give sufficient notification to its reinsurers with regards to it. The Second Circuit agreed with the reinsurers that the facility which was established by the Wellington Agreement and which was the sole agent to resolve the disputes between the asbestos manufacturers and the claimants was contrary to the terms of the reinsurance policy which entitled Unigard to associate with North River in the defence and control of any claim, suit or proceeding which might involve the reinsurance with the full cooperation of North River. Therefore the Second Circuit held that North River was required to notify the reinsurers of the singing of the Wellington Agreement. As North River did not give a sufficient notification it was in breach of the terms of the reinsurance agreement. However, the Second Circuit also looked for any prejudice that the reinsurers had suffered or whether North River acted in bad faith in failing to comply with the reinsurance notification provision. As both inquiries were in the negative, the reinsurers were held to be liable to North River. 7.70 The next question was whether Unigard was liable – in excess of the reinsurance policy limits – for the defence costs for which North River was compelled by an arbitration award to indemnify Owens Corning. 7.71 The Second Circuit referred to its decision in Bellefonte Reinsurance Co v Aetna Cas & Surety Co,29 where it held that the follow the fortunes clause did not “override the limitation on liability” and that therefore the reinsurer was not liable for expenses in excess of the liability limit. North River, however, pointed out that the “follow the form clause” was not considered in Bellefonte and that it required Unigard to pay expenses in excess of the policy

27. 4 F.3d 1049 (2nd Cir. (NY) Sep 09, 1993). 28. For “notice of loss” and “claims association” clauses see Chapter 9. 29. 903 F.2d 910 (2nd Cir. (NY) May 19, 1990).

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limit. North River also asserted that in Bellefonte the reinsurer paid expenses in excess of the policy limits pursuant to a settlement agreement but in the instant case a binding arbitration ordered North River to pay expenses to its insured. Thus, the reinsurers were liable for the defence costs which exceeded the policy limit. 7.72 The Second Circuit disagreed. First, the follow the form clause stated that the liability of the reinsurers, “except as otherwise provided by this Certificate, shall be subject in all respects to all the terms and conditions of [XS-3672]” and the reinsurance policy otherwise provided by the policy limits. Secondly, similarly to Bellefonte, Provision 1 of the reinsurance Certificate provided that Unigard agreed to reinsure North River “in consideration of the payment of the reinsurance premium and subject to the terms, conditions, limits of liability, and Certificate provisions set forth herein.” It was ruled in Bellefonte that “the limitation on liability provision capped the reinsurers’ liability under the [Certificate]. All other contractual language must be construed in light of that cap.” As a result, the court once more concluded that the fact that North River was compelled by arbitration to pay the disputed expenses did not alter the terms of the agreement and Unigard was not liable for expenses that exceed the reinsurance policy limits. 7.73 The same principles apply under Pennsylvania law: In Aetna Cas & Sur Co v Philadelphia Reinsurance Corp30 it was held that the reinsurers were not liable for the defence costs that the reinsured claimed if those expenses were beyond the reinsurance policy limits. In this case dispute arose, once again, from insurance provided by Aetna for Owens-Corning. Aetna issued insurance policies for Owens-Corning Fiberglass from the early 1930s to cover claims arising from asbestos injuries, and then purchased reinsurance from a number of reinsurers, including Phil Re, who agreed to reinsure portions of the policies up to $7.5 million providing cover from October 1964 to October 1970. 7.74 The reinsurance contract contained a “following form” clause in the following terms:31 “[T]he liability of the Reinsurer specified . . . above shall follow that of the Company and except as otherwise specifically provided herein, shall be subject in all respects to all the terms and conditions of the Company’s contract.”

7.75 There was also a follow the fortunes clause: “All claims involving this reinsurance, when settled by the Company, shall be binding on the Reinsurer, which shall be bound to pay its proportion of such settlements, and in addition thereto, in the ratio that the Reinsurer’s loss payment bears to the Company’s gross loss payment, its proportion of expenses, other than Company salaries and office expenses, incurred by the Company in the investigation and settlement of claims or suits. . . .”

7.76 Aetna alleged that the follow the fortunes clause rendered Phil Re liable for a pro rata share of Aetna’s expenses (lawyer’s fees) in defending Owens Corning under asbestos policies even though those expenses were beyond the base liability limit of $7.5 million. In other words, Aetna argued that the reinsurance certificates were “cost supplemental,” while Phil Re contended that the certificates were “cost-inclusive.” 7.77 As well as the follow the form and follow the fortunes clauses, the District Court, ED Pennsylvania took into consideration that the first clause of the reinsurance policy stated “[Phil Re] [d]oes hereby reinsure Aetna . . . subject to the terms, conditions and amount of

30. 1995 WL 217631 (E.D.Pa. Apr 13, 1995) (applying Pennsylvania law). 31. The certificates at issue and all copies have been destroyed or lost. However, the parties agreed that the language of the certificates was identical to other certificates between them.

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liability set forth herein, as follows.” Applying Bellefonte32 the district court judge held that the reinsurer’s entire obligation was quantitatively limited by the dollar amount the reinsurers agreed to reinsure. Once the reinsurers had paid up to the certificate limits, they had no additional liability to Aetna for defence expenses or settlement contributions. Any other construction of the reinsurance certificates would negate the first clause stated above.33 7.78 In North Carolina, applying the North Carolina rules of construction of contracts, the courts have refused to apply the follow the fortunes doctrine to claims for the assured’s defence costs in excess of the policy limits that the reinsured had agreed to pay. Penn Re, Inc v Aetna Cas and Sur Co34 was another dispute which arose from the claims made against the assured Robins for the Dalkon Shield products and where the reinsurers, Penn Re, refused to pay for expenses – in excess of the reinsurance policy limits – incurred by the assured in defending the suits against him. In this case, from 1975 Robins was faced with massive number of claims brought by women who used the Dalkon Shield products. Robins made claim against Aetna and, while a dispute between them was still being litigated, Aetna settled Robins claim on the basis that Aetna agreed to pay – as well as damages claims falling within the scope of the policy – expenses incurred in defending the Dalkon Shield cases over and above the aggregate limits of the excess policies. As a result, Aetna made substantial payments for the purposes of investigation, defence or settlement costs including attorneys’ fees, experts’ fees, and costs incurred in the defence of the Dalkon Shield cases and claims exclusive of damages payments. 7.79 The two reinsurance policies issued for 1975 and 1976 provide that (Provision 3): “All claims involving this reinsurance, when settled by the Company, shall be binding on the Reinsurer, which shall be bound to pay its proportion of such settlements, and in addition thereto, in the ratio that the Reinsurer’s loss payment bears to the company’s gross less [loss?] payment, with respect to business accepted on an excess of loss basis and in the ratio that the Reinsurer’s limit of liability bears to the Company’s gross limit of liability with respect to business accepted on a pro rata basis, its proportion of expenses, other than Company salaries and office expenses, incurred by the Company in the investigation and settlement of claims or suits and, with the prior consent of the Reinsurer to trial court proceedings, its proportion of court costs and interest on any judgment or award.”

7.80 The District Court of ED North Carolina interpreted this clause to the effect that the settlement of claims by Aetna was binding on the reinsurers and they were thereby obliged to pay their proportion of such settlements. Furthermore, the court addressed the reinsurers’ obligation for “costs” incurred in settling claims brought by a third party alleging injury caused by the assured’s products as covered by the reinsurance certificate. According to the district judge, the contractual language of Provision 3 obligated Penn Re to pay their proportion of settlements involving insured risks and it further obligated them to pay their proportion of suit costs and expenses in addition to such settlement amounts. The court also noted that in

32. 903 F.2d 910 (2nd Cir. (NY) May 19, 1990). 33. One day after the court granted the summary judgment for the reinsurer, the Third Circuit decided North River Ins Co v CIGNA Reinsurance Co 52 F.3d 1194 (3rd Cir. (NJ) Apr 13, 1985). and Aetna applied for reconsideration of the Pennsylvania District Court decision in favour of the reinsurer for the reason that North River v CIGNA effected a change in the law mandating a denial of Phil Re’s motion. Aetna argued that it was held in North River that whether the underlying insurance policies are cost-inclusive or cost-supplemental was the dispositive factor in interpreting a follow the fortunes clause. The District Court stated that in Bellefonte Reinsurance Co v Aetna Cas and Sur Co 903 F.2d 910 CA 2 (2nd Cir. (NY) May 19, 1990) the reinsurance policy was cost-inclusive. Moreover, the issue in North River v CIGNA was whether the certificates covered costs at all, ie whether they were cost-exclusive, not whether they were cost-inclusive or cost-supplemental. North River did not reach the issue decided here and in Bellefonte, it did not affect a change in the law warranting denial of Phil Re’s summary judgment motion. Aetna’s motion for reconsideration was denied. 34. Not reported in F.Supp, WL 909519 EDNC, Jun 30, 1987.

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settling with Robins, Aetna amended the limits of its excess policies upwards and the follow the fortunes doctrine could not make the reinsurers liable for the newly increased limits unless the reinsurers had agreed to be so bound. The reinsurers were held to be liable for the settlements including defence costs because of the abovementioned clause, not because of the follow the fortunes doctrine. Reinsureds’ Declaratory Judgment Costs 7.81 Regardless of whether the policies are cost-inclusive or not, it is accepted that a reinsured’s declaratory judgment expenses are not a “risk” that is reinsured by the reinsurer. In British Intern Ins Co Ltd v Seguros La Republica, SA35 the reinsurance policy provided: “. . . subject to the same risks, valuations, conditions, endorsements (except changes of location), assignments and adjustments as are or may be assumed, made or adopted by the reinsured, and loss, if any, hereunder is payable pro rata with the reinsured and at the same time and place. . . .” BIIC, the reinsured, argued that the then-prevailing custom in the industry required the reinsurer to pay a pro rata share of the reinsured’s expenses in resisting coverage; and that such payment was compelled by the reinsurance doctrine requiring the reinsurer to follow the fortunes of the reinsured. The Second Circuit rejected this argument for the reason that the follow the fortunes doctrine simply required payment where the reinsured’s good faith payment to its insured was at least arguably within the scope of the insurance coverage that was reinsured. According to the court, BIIC’s contention required proof that its own declaratory judgment expenses in litigating against its policyholders were potentially within the coverage of the underlying policies. However, the court was of the view that this could not be done because the policyholders obtained no benefit from the mounting of coverage litigation against their own claims; such an initiative could be conceived as any part of the policyholders’ coverage; on the whole, any policyholder would prefer the insurer to forego the contest. The reinsurers did not by their contract agree to cover the claims-handling expenses that an insurance company incurred in the conduct of its own operations. 7.82 The Second Circuit also noted that the trade usage must establish either that the party alleged to be bound was aware of the custom, or that the custom’s existence was “so notorious” that that party should have been aware of it. Moreover the trade usage must have been “so well settled, so uniformly acted upon, and so long continued as to raise a fair presumption that it was known to both contracting parties and that they contracted in reference thereto.” Thus, a reinsured has to prove that the reinsurer either actually knew of the alleged custom, or that the practice of reinsurers’ paying declaratory judgment expenses was so notorious in the industry that the reinsurers must have been aware of it.36

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7.83 In reinsurance policies it is sometimes the case that reinsureds are required to seek reinsurers’ consent prior to any settlements with the assureds. Alternatively, the reinsurers may take over the defence of the assured’s claim in a proceeding brought by the latter. In either case breach of a clause requiring the reinsured to cooperate with the reinsurer, if it is a condition precedent, would deprive the reinsured of the right to make claim against the reinsurer even if

35. 342 F.3d 78 (2nd Cir. (NY) Aug 26, 2003). 36. According to the Second Circuit, the practice of one company would not be sufficient to establish a trade usage.

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the claim itself is covered by both the insurance and the reinsurance. Where the reinsurance contract contains a claims cooperation clause which requires the reinsured to seek the reinsurer’s consent before any settlement with the assured, if the reinsurer does not give consent to the settlement the reinsured is in effect required to refuse the assured’s claim even though it is convinced that the assured has established the loss and the claim. As the reinsurer has forced the reinsured to challenge the assured’s claim, it may be arguable that, in such a case, a term should be implied into the contract that the cost of defending the claim would be on reinsurers, at least to the extent of their proportion of the risk. 7.84 This issue was discussed in Insurance Co of Africa v Scor (UK) Reinsurance Co Ltd37 where the reinsurance policy contained a follow the settlements and a claims co-operation clause that: “It is a condition precedent to liability under this Insurance that all claims be notified immediately to the Underwriters subscribing to this Policy and the Reassured hereby undertake in arriving at the settlement of any claim, that they will co-operate with the Reassured Underwriters and that no settlement shall be made without the approval of the Underwriters subscribing to this Policy. Being a Reinsurance of and warranted same . . . terms and conditions as and to follow the settlements of the Insurance Company of Africa. . . .”

7.85 The assured was in possession of a warehouse under a 15-year lease agreement and it was using the warehouse to store its goods. The warehouse, together with the goods stored inside was destroyed by fire. The report that the loss adjuster issued stated that the reinsured was liable for the loss. However, the reinsurers received some anonymous letters alleging that the fire was set by the assured deliberately. Subsequently, they notified the reinsured that they would not pay if the reinsured chose to pay the assured’s claim because they suspected that the claim was fraudulent. Upon the reinsurers’ refusal to approve the settlement of the claim with the assured, the reinsured had to deny liability to the original assured even though it did not posses any evidence of fraud. The assured brought an action against the reinsured and the jury found in favour of the assured and awarded the assured $58,000 by way of the costs of the proceeding.38 In addition, the Liberian court awarded the assured the sum of $600,000 by way of what was classified by the court as “general damages.” The reinsured sought to recover each of these additional sums from the reinsurers. Leggatt J39 held that under the contract wording and the facts of this case the reinsured should bear the defence costs of the assured at least to the extent of their proportion of the risk.40According to the learned judge this was the case because the reinsurers withheld approval of a settlement between the assured and the reinsured by exercising their contractual right to do so, and the reinsurers’ act obliged41 the reinsured to resist the claim against the assured. In such a case, according to Leggatt J, it could not have been the intention of the parties to the reinsurance policy that the reinsured should be required to bear the cost of doing so. Leggatt J

37. [1985] 1 Lloyd’s Rep 312. 38. The jury also awarded $600,000 for general damages, apparently penal in character. Exactly what that figure included is not entirely clear. The reinsured’s claim was for $658,000 in addition to the amount paid for the subject matter insured. The Court of Appeal discussed the reinsurers’ liability for the sum of $658,000 without making any separation between the general damages ($600,000) and the costs ($58,000) but held the ruling together for both claims for $658,000. The reason is applicable to both claims for defence costs and general damages, in the text above the issue will be mentioned in terms for defence costs only. 39. [1983] 1 Lloyd’s Rep 541. 40. Emphasis added. 41. This is different from Scottish Metropolitan Assurance Co Ltd v Groom (1924) 20 Ll L Rep 44 because in Scottish v Groom the reinsured voluntarily incurred the expenses.

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also held, on the same ground, that the general damages were recoverable from the reinsurers.42 Liability was based on an implied term of the reinsurance contract that the reinsurers would indemnify the reinsured against costs expenses and liabilities incurred by the reinsured at the request of the reinsurers. 7.86 On appeal to the Court of Appeal, one of the preliminary questions was whether implication of such a term is necessary in a business sense to give efficacy to the contract. Stephenson LJ’s response was in positive. Stephenson LJ confirmed that, as Leggatt J had emphasised, the source of the loss suffered by ICA was the reinsurers’ refusal to give approval of the settlement that the reinsured wished to enter into with the assured. Upon this refusal the reinsured was obliged to deny the claim and thus to face legal proceedings from the assured which caused the reinsured to incur expenses to defend the case. Stephenson LJ43 stated that a contract of reinsurance is a contract of indemnity and the indemnity must cover any payments made by the reinsured which are the reasonably foreseeable result, in arriving at a settlement of the insured’s claim, of any request or requirement, expressed or implied, by the reinsurer to the reinsured. The reinsurer’s failure to approve the settlement which ICA wished to make on the basis of its loss adjuster’s reports was to leave ICA with no alternative but to fight ATC’s claim to judgment. ICA was not merely asked to do so but was compelled to challenge the assured’s claim. 7.87 This, however, was a minority view. The majority of the Court of Appeal, Robert Goff and Fox LJJ, did not agree that the reinsurers should be liable for defence costs or indeed the general damages. The majority defined the reinsurers’ refusal as one which did not oblige the reinsured to reject the claim and subsequently to defend the action. Their Lordships stated that instead of requiring the reinsured to reject and subsequently to defend the claim, the reinsurers left it to the reinsured to decide what to do. The reinsured could have chosen to pay the full amount of the ATC claim and then, if the reinsurers refused to pay on the reinsurance policy, it could have sought to prove that it was in fact liable to pay the claim and, therefore, entitled to recover under the reinsurance policy.44 Moreover, their Lordships said that Leggatt J had not sufficiently defined the implied term which he had been prepared to accept.45 In order to make the reinsurers liable for such costs, a request in law by the reinsurers, express or implied, to incur the relevant expense or liability, or so to act as to expose themselves to it, would have been necessary. If this condition is met, then an obligation upon the reinsurers to indemnify the reinsureds would arise by virtue of the request, not as an implied term of the policy. Their Lordships agreed that the attitude of the reinsurers put the reinsureds in very considerable difficulty; however Goff LJ46 emphasised that, by so doing, the reinsurers left to the reinsured to decide what course of action the latter should take, and this did not amount to a request to defend the claim of the assured. Therefore the majority of the Court of Appeal found it unnecessary to imply the suggested provision for indemnity to give business efficacy to the contract; the contract could work effectively without such an implication in this case. Robert Goff LJ stated that had this implied term been proposed by the officious bystander at the time of the contract, it could not have been predicated that the reinsurers would have assented to it. It is implicit in this reasoning that the reinsured cannot rely on the follow the settlements clause to seek 42. The issue of “general damages” is discussed below, paras. 7.208 et seq. 43. [1985] 1 Lloyd’s Rep 312, 324. 44. Ibid., at 335. 45. In fact he did, by saying that if the reinsurer compelled the reinsured to deny the claim, then the latter should bear the cost of defending it proportionate to his liability under the reinsurance contract. 46. [1985] 1 Lloyd’s Rep 312, 331.

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reimbursement of defence costs and general damages, nor can it seek to rely upon any implied term to that effect. 7.88 It seems that there is only one case where the Court of Appeal has expressed willingness to award defence costs, but this case turns on its facts. In British Dominions General Insurance Co Ltd v Duder,47 the claimant insured the hull and machinery of the vessel Katina under a time policy, valued at £20,500, to the extent of £1500 against total and/or constructive total loss only. The defendant reinsured the ship, valued as in the original policy, for £1,500 against total and/or constructive total loss only. The reinsurance policy did not contain the clause “to pay as may be paid thereon.” The owner gave notice of abandonment following the vessel becoming stranded. The insurers other than the claimant agreed to pay 66% of the owner’s claim for a constructive total loss of the vessel. The claimant asked the reinsurers to agree to this compromise, but the reinsurers refused to do so on the ground that the vessel was not a constructive total loss. Upon the reinsurers’ refusal, the claimant declined to join the other insurers in the compromise and the owner brought an action against the claimant which was later settled on the terms of the claimant paying 66% of the claim and the owner’s cost. 7.89 In an action by the reinsured against the reinsurers it was proved that there was in fact a constructive total loss. The question was, however, whether the claimant was entitled to 100% or 66% against the reinsurers. The reinsured claimed 100% of the loss against the reinsurer by contending that the reinsurer should not have benefited from their wrongful rejection of the claim. 7.90 Bailhache J48 held that the vessel was a constructive total loss and the reinsured was entitled to the full amount insured. The reinsurers appealed by contending that they were liable only for the amount which the reinsured, as a result of the compromise, actually paid to the original assured. 7.91 The Court of Appeal put emphasis on the nature of reinsurance, and because reinsurance is a contract of indemnity it was concluded that the reinsured could not recover more than it paid.49 Buckley LJ50 and Pickford LJ51 held that the reinsurers were entitled to the benefit of the compromise even though they had nothing to do with it, so that the sum recoverable was 66% rather than 100%. However, it was further held that the reinsured’s entitlement to an indemnity was not necessarily confined to the 66%; the costs of obtaining the compromise at 66% should be added to the sum recoverable. On the facts, the reinsured had failed to demonstrate exactly what costs had been incurred by it in reaching the settlement, so that, in the absence of agreement, the court would direct an inquiry into the sums recoverable by way of costs. 7.92 This case aside, which is out of line with the other authorities, it is accepted that the reinsured will be entitled to claim defence costs against the reinsurer only if there is some agreement to that effect, either at the outset52 or after the claim has arisen.

47. [1915] 2 KB 394. 48. [1914] 3 KB 835. 49. The court also discussed the applicability of Uzielli v Boston Marine Insurance (1884) 15 OBD 11, doubts were expressed as to what Uzielli actually decided: the case was not regarded as authority for the proposition that the reinsured can recover more than it paid. 50. [1915] 2 KB 394, 403. 51. Ibid., at 407–408. 52. It is suggested that a clause such as “The ceding company have the sole right to settle claims either by way of compromise, ‘ex gratia’ payments, or otherwise, and all settlements are binding on the reinsurers. The reinsurers should be liable for their share of any costs incurred in resisting or defending any claim” would be an example of an express clause as for costs. See Carter, 135.

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Otherwise the reinsured’s claim for costs will fail irrespective of the other terms of the reinsurance.53 7.93 The rule seems reasonable because if there is any defence available to the reinsured it has to be asserted, failing which it cannot be said that the reinsured has acted in bona fide and businesslike manner, and if the assured has sued the reinsured as a result of rejection of its claim, the reinsured has to defend itself. If the reinsured chooses not to plead the defence then it would not be able to establish its liability for the purposes of an outwards reinsurance claim. The point is that the incurring of defence costs is in many cases a necessary prerequisite of the reinsured’s ability to make a claim against its reinsurers. 7.94 It is not clear from British Dominions General Insurance Co Ltd v Duder54 whether the Court of Appeal would have been willing to hold the reinsurer liable for the costs had the reinsured paid 100% of the loss plus costs. In Insurance Co of Africa v Scor (UK) Reinsurance Co Ltd55 the sum paid plus expenses exceeded the amount reinsured. Therefore it is possible to say that Scor left open the possibility of the implication of a term to the effect that the reinsurer might be liable for the reinsured’s defence costs so long as it is up to the maximum of the reinsurer’s potential contractual liability where the reinsured’s claim itself does not reach the reinsurance policy maximum figure.56 7.95 An illustration of a situation in which a claims provision affected the reinsurers’ liability for defence costs can be seen in a case decided by the US Court Appeals for the Ninth Circuit. In National American Ins Co of California v Certain Underwriters at Lloyd’s London,57 the reinsured was successful in claiming its costs in investigating and settling claim because of the reinsurers’ silence for more than two years to the reinsured’s attempts to inform them with regards to the assured’s claim and the settlement process followed by it. In this case the reinsurance policy provided: 2. APPORTIONMENT OF COSTS. Costs incurred with the written consent of the Underwriters shall be apportioned as follows:(a) Should any claim or claims become adjustable prior to the commencement of trial for not more than the Primary Limit(s), then no Costs shall be payable by the Underwriters. (b) Should, however, the amount for which the said claim or claims may be so adjustable exceed the Primary Limit(s), then the Underwriters, if they consent to the proceedings continuing, shall contribute to the Costs in the ratio that their proportion of the ultimate net loss as finally adjusted bears to the whole amount of such ultimate net loss.

7.96 The assured took out liability insurance for $1 million in total ($500,000 primary and $500,000 excess insurance) for the years 1962, 1963 and 1964. The policies issued for the years 1963 and 1964 were, however, amended to the effect that the reinsured took the whole

53. In fact the reinsurance of a liability policy will normally cover the reinsured’s obligations to indemnify the assured both for any liability to the third party and for any defence costs incurred by the assured insofar as they relate to an insured peril although such recovery may be conditional on the reinsured seeking the consent of the reinsurers for the defence of the claim against the assured. For instance in British General Insurance Co Ltd v Mountain (1919) 1 Ll L Rep 605 the reinsured issued a liability policy in the sum of £1,000. The reinsured took out a reinsurance policy for £750, with an excess of £250. The direct policy imposed liability on the reinsured for the assured’s defence costs. The reinsurers were also liable to indemnify the reinsured for the assured’s defence costs, although if the claim against the assured was likely to exceed the reinsured’s £250 retention then the reinsurers were only liable for those defence costs if they had given consent for them to be incurred. A claim was made against the assured likely to exceed £250, but the reinsured did not seek the reinsurers’ consent to defend the claim. It followed, therefore, that the reinsurers were not liable to indemnify the reinsured for its liability for the assured’s defence costs. 54. [1915] 2 KB 394. 55. [1985] 1 Lloyd’s Rep 312. 56. Butler and Merkin, Reinsurance Law, para. C–0128. 57. 93 F.3d. 529, (9th Cir. (Cal) Aug 15, 1996).

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risk for $1 million by retaining the first $500,000 and reinsuring the other $500,000 (policy number LC 58392). Moreover, by a separate policy, the reinsured purchased another $150,000 of reinsurance coverage from the reinsurers for 1964 in excess of $350,000 for that year (policy number LC 103204). 7.97 The two reinsurance policies both provided notifications clauses in the following words: (Policy no: 58392): “Upon knowledge by the named Assured’s insurance manager, or by another person designated by the named Assured to give notification of claims, of any occurrence likely to give rise to a claim hereunder, written notice thereof shall be given to Underwriters as soon as practicable.” (Policy no: LC 103204): “The Company upon knowledge of any occurrence likely to give rise to a claim hereunder shall give immediate written advice thereof to the person(s) or firm named for the purpose in the schedule.”

7.98 The reinsured, National, was the successor of Stuyvesant who had purchased the reinsurance policies initially. The assured brought an action against its insurers as a result of the class action brought by residents living near Tucson airport where the assured had operated a manufacturing plant and had disposed of considerable amounts of toxic waste. At the time National took part in defending the claim against the assured it was unaware of the reinsurance policies. However, after making inquiry via its brokers, National discovered the existence of the reinsurance policies and nine days later it notified the reinsurers of the assured’s claim. National also notified the reinsurers’ of the settlement agreement with the claimants in the suit brought against the assured. The reinsurers however were silent for more than two years to the reinsured’s letters until it brought an action against them in California. In its suit against the reinsurers National sought $1.15 million in liability coverage under two reinsurance policies issued for the years of 1963 and 1964 together with an additional amount as the reinsurers’ share of the associated costs, and the Ninth Circuit gave a judgment for the reinsured. The court emphasised the fact that in the letter that National sent to the brokers to notify the assured’s claim it also advised them that it was incurring costs related to the assured’s suit. The court found that the reinsurers’ refusal to respond to the repeated attempts by National to inform them of the ongoing settlement negotiations estopped them from claiming as a defence National’s failure to obtain written consent for incurring the costs.58

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English Law 7.99 Allocation relates to whether and in what manner the reinsurance contract covers a claim by a reinsured.59 Allocation of loss is particularly important when long-tail toxic and environmental claims are in question. When reinsurance comes into play in such claims, inevitably complications arise as to allocating the loss among reinsurance policies. Reinsureds may settle

58. The Ninth Circuit approved the definition of estoppels by the Court of Appeal, Fourth District, Division 1, California (Skulnick v Roberts Express, Inc, 3 Cal Rptr 2d 597, (Cal. App. 4 Dist., Jan 15, 1992) (quoting Brown v Brown, 82 Cal Rptr 238, Cal. App. 5 Dist., Jun 19, 1969) that the object of equitable estoppel was to “prevent a person from asserting a right which has come into existence by contract, statute or other rule of law where, because of his conduct, silence or omission, it would be unconscionable to allow him to do so.” 59. Robert M Hall and Matthew T Wulf, “Allocation To Reinsurers And Follow The Settlements,” Mealey’s Litigation Report: Reinsurance, Vol.13, No. 19, 6 February 2003, 30.

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insured and uninsured claims in a global settlement agreement or there may be more than one reinsurer who has reinsured long-tail risks and which losses will fall upon which reinsurers makes the problem more complicated. The English cases have not turned on the meaning of follow the settlements provisions but rather on the question of whether the reinsured has been able to prove that losses fell within a particular policy year. Accordingly, there is no English authority on the question whether a follow the settlements clause allows the reinsured to rely upon a settlement which incorporates an allocation made in a bona fide and businesslike fashion. In principle there seems to be no reason why a follow the settlements clause should not apply in that situation. 7.100 The issue came before the Court of Appeal in Municipal Mutual Insurance Ltd v Sea Insurance Co Ltd60 where Municipal insured the Port of Sunderland under a policy renewed annually and provided cover for a period of three successive years, from 1986 to 1989. The original policies provided coverage for liability of the Port Authority to third parties for “accidental loss of or damage caused to property not belonging to . . . the insured” which was” caused by negligence by [the insured] or their servants or employees.” In May 1985 two partly dismantled dragline excavators arrived at the Port of Sunderland to be kept at the port until their then owners found buyer for them, to whom they would then be delivered. They were placed at some four locations within the port area. They remained at their location for a few years and it was later discovered that most but not quite all of the electric motors had been taken and many other parts had been removed or damaged. In an action brought by the owner of the machinery against the Port of Sunderland, Judge Stephenson found that the huge bulk of the damage must have in all probability occurred between March 1987 and September 1988 and the port authority was held liable for the loss as it had been the bailee of these goods and it appeared that it did not take any steps to exercise due diligence to take care of the good as required by its duty as bailee. Municipal paid out £3,159,401.56 in damages and interest, expenses and the port’s and the owner’s costs. Since the original policy contemplated that it would be renewed annually and since there was no annual limit on the liability of the insurers under the policy, the date when a liability was incurred was not significant. 7.101 Municipal had purchased reinsurance from several reinsurers. The reinsurance policies, however, unlike the direct insurance, were distinct. They were three separate policies each for 12 months’ duration. The original insurance policies were renewed annually between the same insured and the assured, whereas three reinsurance contracts covering the period from 1986 to 1989 were entirely separate, and the identities of the subscribing reinsurers changed in each of the three years. Moreover, the proportions of risk taken by individual reinsurers varied from year to year. Each year of reinsurance provided for a deductible of £500,000 in the aggregate. 7.102 Municipal sought recovery from the reinsurers by treating the port’s claim against it as a single claim. Municipal adopted – as Hobhouse LJ called it – a straight-line approach that the loss and damage was spread evenly over the 18-month period involved. Accordingly, in making claim under the reinsurance policies Municipal assumed that one-sixth of the loss and damage to the goods was suffered in 1986–1987, two-thirds in the period of 1987–1988 and one-sixth in 1988–1989. Hobhouse LJ in the Court of Appeal emphasised that the relevant reinsurance cover was placed on a time basis which was fundamental and must be given effect to because it was for that period of risk that the premium payable was assessed.61

60. [1998] CLC 957. 61. Ibid., at 968.

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7.103 Their Lordships focused on the different characters of the original insurance and reinsurance contracts. The right approach would be to ascertain to what extent the reinsured had established that it was entitled to recover from the relevant reinsurer under each of the three contracts. Accordingly, their Lordships held that liabilities arising in each year of the underlying cover had to be allocated to the corresponding year of reinsurance. A contrary solution, according to the Court of Appeal, would create the effect that the reinsurance might cover liability in respect of loss or damage which did not occur during the period of the reinsurance and that the same liability might be covered under the reinsurance for different periods. The reinsurance contracts provided a temporal limit to the cover and did not provide cover outside that period. Accordingly, the Court of Appeal concluded that for the contract for the first year the reinsured must satisfy the court on the balance of probabilities that there was loss and damage which occurred during the three months between 23 March 1987 and 23 June 1987 which exceeded in the aggregate £500,000. For the second contract they must prove that on the balance of probabilities loss or damage exceeding £500,000 occurred during the 12-month period from 24 June 1987 to 23 June 1988. For the third contract the claimants must prove on the balance of probabilities that loss or damage occurred which exceeded £1.5 million during the three months between 24 June 1988 and 25 September 1988. 7.104 The evidence indicated that the loss and damage had already started before 24 June 1987 and that it was a continuing sequence of occurrences extending through the rest of 1987 and into September 1988. The Court of Appeal found that on the balance of probabilities the loss and damage which occurred prior to 24 June 1987 did not exceed in value the sum of £500,000; thus, the claim under the first contract of reinsurance failed. The claim under the third contract also failed for similar reasons. The second contract covered a 12-month period within which pilferage and vandalism was undoubtedly occurring. The Court of Appeal found that it had probably started before the beginning of the period and continued until after the completion of the period. The assessment of how much occurred during this period – which was in fact a jury question – Hobhouse LJ was prepared to find that two-thirds in value of the loss and damage probably occurred during this 12-month period. After deduction of the £500,000 excess, the reinsured were held to be entitled to recover (in proportion to their lines) from the reinsurers who subscribed to the reinsurance contract for the second year. This gave the reinsured a recovery of £1,606,267.68. 7.105 Recently, in IRB Brasil Resseguros SA v CX Reinsurance Company Ltd,62 Burton J affirmed the view of the arbitrators that losses which arose from product liability claims were to be allocated to insurance and reinsurance policy years on the basis that the losses followed a regular pattern. The reinsurance did contain a follow the settlements clause, but this required the reinsured to prove its loss under both the insurance and the reinsurance, so the case turned not so much on the interpretation of this clause but rather on the question of whether the reinsured had proved its loss on the balance of probabilities. In practice, as the case illustrates, there may be little difference between the two situations, because proof of reasonable behaviour on the part of the reinsured will normally be enough for the reinsured to prove its loss on the balance of probabilities. In this case the class actions brought against the policyholders were settled by the reinsureds. The reinsureds claimed $1.6 million in total under 25 relevant reinsurance contracts. The reinsurance was subject to a “Period” clause, which stated: This reinsurance covers all losses as herein defined occurring during the period commencing with . . . and ending with . . . , both days inclusive, local standard time at the place where the loss occurs. 62. [2010] EWHC 974 (Comm).

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7.106 The reinsurance was in excess of loss form, so that the reinsurers were liable for all losses exceeding the reinsured’s ultimate net loss. As is usual in this form of insurance, there was an aggregate limit per each and every loss in any one year, a concept defined in the “Each and Every Loss” clause, as follows: “For the purpose of this reinsurance, the term ‘each and every loss’ shall be understood to mean each and every loss and/or occurrence and/or catastrophe and/or disaster and/or calamity and/or series of losses and/or occurrences and/or catastrophes and/or disasters and/or calamities arising out of one event.”

7.107 Relying on these provisions the reinsurers challenged the reinsureds’ allocation and denied payment. The dispute was referred to three arbitrators and they decided in favour of reinsureds. The reinsurers appealed, but again Burton J found that on the balance of probabilities the losses fell within the reinsurance and the reinsureds’ allocation was reasonable. The analysis of the arbitrators and the Burton J were as follows. 7.108 The assured, Stauffer, faced environmental pollution claims with respect to chemical and agricultural products which it produced. The claims were from about 100 sites which they owned, or had owned in the past. On one site in California clean-up costs were likely to be huge. Stauffer owned that site between 1967 and 1976. 7.109 The claims were settled with the leading London Underwriters in the sum of $46.5 million which included $1.85 million in defence costs. The reinsured then made its claim from IRB for the policy years of 1976 to 1978, but IRB challenged the allocation on the grounds that the allocation over the policy years was artificial. The arbitrators accepted that spreading it equally over all the relevant years was artificial; nonetheless, it would have been even more artificial to assign a larger portion of the loss to one year rather than another. Consequently, the arbitrators and Burton J found that on the terms by which it was settled, the claim fell within the terms of the insurance and the reinsurance and the settlement was reasonable and businesslike. 7.110 The losses with regard to the AHS and three million claims were related to the liability of manufacturers of silicon breast implants. With respect to the AHS claims the insurance policies covering products liabilities over a period of many years and therefore the question was if the assured was held liable for bodily injury claims caused by its products, which of the insurance policies would pay the claims. The claim was settled between the assured and its insurers on a “coverage in place” (CIP) basis. On the basis of CIP, from 1974 to 1986 the insurers covered 63.5% of the losses but settled the claim by agreeing to pay 70% of the policies issued for that period. IRB contended that the additional 6.5% was an ex gratia payment. The arbitrators however found that there was no evidence that it was unreasonable paying 70% of the overall loss and therefore the assured’s proven liabilities was reasonable and businesslike. On appeal Burton J put emphasis on the “triple-trigger theory” applicable in the US courts, by which, “once the defect (in this case a breast implant) was identified, liability could be found on (at least) three different occasions, and thus within three different periods of cover.” Burton J took into consideration that the 1987 to 1991 insurers, whose cover was provided on a “claims made” basis, would not be liable at all; thus, there must have been the corresponding risk that, by virtue of the triple-trigger theory, the insurers covering the period from 1974 to 1986 could be found liable for 100% of the loss. That meant that the reinsured potentially faced 100% liability, so a 70% settlement was perfectly reasonable. Similarly, the arbitrators were convinced that had the 3M cases been litigated and 3M been found liable to pay damages, they would have produced valid claims against 3M’s product liability insurers. Burton J took the nature of the claims into consideration which was related to a “long-tail liability.” Such nature would allow the application of the triple trigger theory which might 182

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again demonstrated that any “future claims” would be likely to be treated as falling within the cover of the policy the subject of the Policy Buy Back. 7.111 Other claims whose allocation gave rise to challenge were those against Owens Corning, an asbestos manufacturer in the US. As a result of its manufacturing and installing many products containing asbestos for many years, back as far as the 1950s, Owens faced massive number of claim (318,000 by 1998). The claims were settled for $335 million, CX Re agreed to pay $5.1 million and for the years 1978 and 1979 CX Re claimed $56,546 against IRB. Burton J noted that the class actions against Owens by the claimants alleging that it was Corning’s operation which caused the exposure, and hence the infiltration of the employees, occurred throughout the 20-year period. CX’s cover was for two years, 1978 and 1979, thus 10% of that period. The settlement was on the basis was that a fair conclusion was that a similar proportion of the losses over the 20-year period had occurred in that two-year period: consequently that the $56,546 was properly allocated to the two policy years, 1978 and 1979, and was thus within the cover. Therefore, the allocation was found to be reasonable. The US Perspective 7.112 Disputes relating to reinsureds’ allocation in England are relatively new. However the US courts have been dealing with more diverse issues with regard to allocation for many years. The reason may be that in the US, reinsureds sometimes use different loss allocation methods in settling the claim with the assured and making claims against their reinsurers, which inevitably lead to challenge by the reinsurers. It will be seen below that the approach adopted by the US courts is similar to that of the English courts in the cases just discussed, in that that the courts look to whether the settlement is grossly negligent, recklessly done or if the reinsured has acted fraudulently.63 If the answer is in the negative, the reinsurers are unlikely to be able to question the allocation. The various issues regarding reinsured’s allocation in the US will be analysed below as each issue under different subheadings. Inconsistency Between Pre-Settlement and Post-Settlement Allocations 7.113 In order to serve the goals of the follow the settlements doctrine, which are to encourage maximum coverage and settlement and to prevent courts from undermining the foundation of the reinsured-reinsurer relationship, as long as the allocation meets the typical follow the settlements requirements, reinsurers have been held to be obliged to follow the reinsured’s post-settlement allocation even though there is inconsistency between the pre-settlement and post-settlement allocations. 7.114 A mismatch between a reinsured’s pre-settlement and post-settlement allocations came before the US Court of Appeals for the Second Circuit in North River Ins Co v Ace American Reinsurance Co.64 North River insured portions of the second, third, fourth and fifth excess layers of Owens-Corning Fiberglass Corporation’s coverage for the years from 1974 to 1983. The total per occurrence limits of North River’s second layer policies for the ten-year period between 1974 and 1983 was $345 million; the third, fourth and fifth excess layers of coverage, insuring per-occurrence losses ranging, in certain years, were from $76 million to $251 million. 7.115 ACE reinsured portions of the second excess layer policies and also $125,000 of coverage in the third excess layer of the 1978 to 1980 policies. The facultative reinsurance 63. American Bankers Ins Co of Florida v Northwestern Nat Ins Co. 198 F.3d 1332, (11th Cir. (Fla) Dec 30, 1999). 64. 361 F.3d 134, (2nd Cir. (NY) March 15, 2004).

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contracts between ACE and North River each contained a follow-the-fortunes provision, providing that the “liability of the Reinsurer . . . shall follow that of the Company.” 7.116 Owens-Corning faced over 447,000 claims due to its manufacture, sale, and installation of asbestos-containing insulation in the years 1953 to 1973. The product liability coverage Owens-Corning had purchased exhausted by 1994. Owens-Corning then characterised many of its asbestos-related claims as “non-product” as it was seeking to obtain additional coverage under its policies; then it argued that it was entitled to a new set of policy limits for those claims classified non-product. In June 1999, Owens-Corning initiated an alternative dispute resolution proceeding under the Wellington Agreement but before the proceeding was concluded North River and Owens-Corning settled for $335 million. Under the settlement agreement North River obtained a full release of liability under all of its policies with Owens-Corning for not only asbestos-related claims, but also for any future, non-asbestos-related claims. North River also insisted on a buyback of all its policies with Owens-Corning.65 7.117 After settling with Owens-Corning, North River allocated 1% of the cost of the settlement to the “buyback” of North River’s policies with Owens-Corning. It then used the “rising bathtub” approach to allocate the remaining 99% of the cost of the settlement. The ‘rising bathtub’ allocation method – as the Second Circuit explained in the case – is “a phrase used to describe a provision of the Wellington Agreement that deals with how asbestos bodily injury losses would be allocated to insurers. That provision calls for asbestos payments to be allocated on the basis of horizontal exhaustion, which means losses are allocated to the lowest layer of coverage first and, like a bathtub, fill from the bottom layer up. Under that approach, a given layer of coverage is not implicated until the layer beneath it is completely exhausted.”

7.118 As noted above, the total per occurrence limits of North River’s second layer policies for the ten-year period between 1974 and 1983 was $345 million. The portion of the settlement allocated to pay non-product claims was $332 million which did not exceed the $345 million per occurrence limits within the North River second layer of excess coverage. North River sought from ACE $49 million; it sought this amount only from the second excess layer of coverage and did not seek indemnification for any portion of the settlement attributed to non-product asbestos claims from its reinsurers of the third, fourth, and fifth excess layers of coverage. 7.119 ACE disputed North River’s post-settlement allocation and contended that North River had assigned its entire settlement to the second layer while its pre-settlement analysis of possible litigation outcomes identified risk of loss in higher layers.66 ACE did not question the reasonableness of North River’s settlement with Owens-Corning, or the good faith of North River in deciding to settle or at what amount, nor did it question that the losses were of a type within the coverage of the underlying insurance contract. ACE only disputed North River’s decision to allocate the settlement to a layer of reinsurance no higher than the second, even though that settlement eliminated risk to upper layers that had been identified and quantified by North River’s pre-settlement analysis. ACE’s argument was that mutuality of interest was a fundamental premise of the follow the settlements doctrine, whereas North River’s interests in allocating the loss to it were in conflict with those of ACE; therefore, they were not liable to follow North River’s settlement. 7.120 There were number of reasons that the court found that the reinsurers were obliged to follow the reinsured’s settlements. The main rationale for the follow the settlements doctrine 65. Having paid $1 billion for products losses, and then $335 million to resolve the non-product losses, North River “never wanted to hear from Owens-Corning again.” 66. ACE however paid $24 million to North River which was best estimate of the uncontested amount it owed.

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as explained by the Second Circuit was to foster the “goals of maximum coverage and settlement” and to prevent courts, through “de novo review of [the cedent’s] decision-making process,” from undermining “the foundation of the cedent-reinsurer relationship” and these goals were achieved by upholding North River’s allocation here. The Second Circuit was of the view that requiring post-settlement allocation to match pre-settlement analyses would permit a reinsurer, and require the courts, to scrutinise the specific factual information regarding settlement negotiations. The court classified ACE’s appeal falling within that category. Thus, allowing ACE’s appeal would permit the kind of intrusive factual inquiry into the settlement process which the follow the settlements doctrine was designed to prevent and subsequently, the certainty that the general application of the doctrine to settlement decisions created would be undermined. The court took into consideration that in reaching its decision to settle, North River conducted an analysis of possible outcomes and their likelihood if it were to litigate its dispute with Owens-Corning. North River used a computer model which demonstrated how a given level of Owens-Corning’s “non-product” asbestos damage would impact North River’s policies under particular coverage parameters. The analysis also included the consideration of coverage parameters and various potential defences to Owens-Corning’s claims. The computer model then applied probability weights to obtain different damage scenarios. 7.121 The Second Circuit further pointed out that applying the follow the settlements doctrine to post-settlement allocation decisions did not leave a reinsurer without protection: Reinsureds must make good-faith allocations, and reinsurers also could not be held accountable for any loss not covered by the reinsurance policy. Therefore, irrespective of whether an inquiry would reveal an inconsistency between the post-settlement and pre-settlement allocation decisions, the Second Circuit extended the follow the settlements doctrine to the reinsured’s postsettlement allocations as long as the settlements were in good faith, reasonable and within the applicable policies. 7.122 Another case arising from the dispute between the reinsured and its reinsures with regards to the allocation of claims against Owens-Corning as a result of its activities between 1953 and 1972 of manufacturing and distributing Kaylo, an insulation product containing asbestos, was Travelers Cas & Sur Co v Gerling Global Reinsurance Corp of America.67 From 1952 until 1979, Travelers issued a series of annual policies to insure Owens-Corning for bodily injury and property damage. The primary policies distinguished between “products” and “non-products” claims with respect to bodily injury claims. The difference was that products coverage were provided to protect Owens-Corning from claims for asbestosrelated injuries that occurred either after asbestos products were placed into the stream of commerce, or after an asbestos-related operation was completed. Non-products coverage were set to protect Owens-Corning from claims for asbestos-related injuries resulting from asbestos exposure on its premises or during its business operations, in particular, injuries occurring during the installation or removal of asbestos products. Each primary policy had a $1 million “per occurrence” limit of liability; policies for products coverage also had a $1 million “aggregate” limit of liability. Thus, if claims arising from multiple occurrences triggered products coverage, the most that Travelers had to pay under any single policy was $1 million. Travelers also issued to Owens-Corning a number of excess policies covering the same period. Each excess policy included a $25 million “per occurrence” limit on liability. The combined “per occurrence” limit of all of the Owens-Travelers’ policies-both primary and excess-was $273.5 million.

67. 419 F.3d 181, (2nd Cir. (Conn) Aug 18, 2005).

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7.123 Travelers purchased five facultative reinsurances from Gerling on its excess policies for the period 1975 to 1977. Gerling agreed to be bound by any loss settlements entered into by Travelers with the underlying insured, so long as they fell within the terms and conditions of the original policy and of the certificate. Upon facing hundreds of thousands of claims against it, Owens-Corning categorised its asbestos-related claims as falling within the products and single occurrence category until the early 1990s. But the products coverage exhausted by the early 1990s and Owens-Corning thus began to submit its asbestos claims as non-products claims. Travelers refused payment and the dispute was referred to an arbitration proceeding. However, before the arbitrators determine on the issue the parties settled upon which Travelers agreed to pay roughly $273.5 million, which was approximately one additional occurrence limit. The settlement agreement did not clarify any particular theory of coverage or whether the claims arose from a single occurrence or multiple occurrences. In making its claim against Gerling, Travelers used the “rising bathtub” methodology and allocated the settlement amount evenly among policy years. As each year’s primary policy had a $1 million per occurrence limit, the primary polices were quickly exhausted. The remaining amount was then spread among the excess policies, including those reinsured by Gerling. Gerling unsurprisingly argued that the allocation should have been made on a multiple-occurrence basis. 7.124 As the Second Circuit noted, the issue in this case was almost identical to that of in North River v ACE68 stated above: (a) Gerling challenged that allocation methodology, which resulted in higher liability for them than would have resulted from an alternative methodology; (b) Travelers used the “rising bathtub” methodology; and (c) Gerling’s challenge was based upon the fact that the ultimate allocation differed from an earlier position allegedly taken by the reinsured. 7.125 The Second Circuit was convinced that the rationale applied in North River v ACE, that a reinsured’s post-settlement allocation was subject to “follow the fortunes,” was applicable to the cases regardless of any pre-settlement position taken by the reinsured, whether that position was articulated in a pre-settlement risk analysis, or implicit in the settlement with the underlying insured. Moreover, comparing the reinsurers’ position in the two cases the court noted that here, Gerling’s position was even weaker than ACE’s against North River. In the latter case it was clear from the evidence that North River had considered a different position against the assured, but in the instant case, Gerling’s argument was based on an assumption; it was not clear whether Travelers ever accepted a multiple-occurrence position. The only indication that could be obtained from the settlement agreement was that it was for “roughly” one occurrence limit, but the settlement agreement “explicitly disclaimed any particular theory of coverage.” The court therefore concluded that in such a case it was less appropriate than it was in North River v ACE to argue that the pre- and postsettlement allocations were inconsistent. According to the Second Circuit, where settlements were made in cases involving multiple policies and multiple insurers and reinsurers, numerous good faith methods of allocation would be available and under consideration. The reinsured would ultimately have to choose an allocation methodology among those available and to allow reinsurers to second-guess that allocation would be to make settlement impossible and reinsurance itself problematic. As a result, if the settlement itself was in good faith, reasonable and within the terms of the policies, the court declined to allow a challenge to the reinsureds’ post-settlement allocation.69 68. 361 F.3d 134 (2nd Cir. (NY) March 15, 2004). 69. Travelers Cas & Sur Co v Gerling Global Reinsurance Corp of America was applied in National Union Fire Ins Co of Pittsburgh, PA v American Re-Ins Co 441 F.Supp 2d 646 (SDNY, Jul 28, 2006) to provide the certainty that the general application of the doctrine to settlement decisions creates.

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7.126 Gerling’s alternative argument was that Travelers acted in bad faith for two reasons: (a) The allocation of all non-products claims to a single occurrence was inconsistent with the definition of “occurrence” in the underlying policies; and (b) Travelers had not reinsured its primary policies. In order to maximise its reinsurance recovery it sought to shift its settlement loss from the primary insurance policies to the excess policies. 7.127 The court described the first argument as that of the kind that the follow the fortunes doctrine aimed to prevent as it required to make a de novo review on the reinsured’s construction of the original insurance. Moreover, the court did not find that this argument constituted an evidence of dishonesty or disingenuousness. 7.128 The Second Circuit found, as regards the second contention, that an allocation that increased reinsurance recovery as a result of a choice from multiple possible allocation where the settlement was in good faith and reasonable, and was not of itself evidence of bad faith. 7.129 Thus, it becomes clear that the English and US authorities share the same view that if the settlement is in good faith and reasonable it is unlikely that reinsurers would be able to succeed in their challenge of a post-settlement allocation unless the reinsurers prove that the reinsured in fact had settled the claim with its assured on a different allocation basis to that presented to its reinsurers. In other words, merely demonstrating that, during the settlement negotiations, the reinsured in fact had predicated some other methodology or the assumption that the reinsured had tried to settle the assured’s claim on a different basis than in fact it was ultimately settled on, will not be sufficient to prove the reinsured’s bad faith even though the allocation against the reinsurers indicates that the reinsured aimed to maximise the reinsurance coverage. However, actual proof of the difference between the reinsured’s allocation in the settlement with the assured and with the reinsurers will likely succeed in demonstrating the reinsured’s bad faith and to this extent the application of the follow the fortunes rationale of maximising the coverage is not limitless. 7.130 This qualification was laid down by the Supreme Court, Appellate Division, First Department, in New York in Allstate Ins Co v American Home Assur Co.70 In this case the original insurance was in the form of a property insurance issued by a member of American International Group (AIG) for United Technologies Corporation (UTC) for the period 1975 to1978 and 1978 to1981. The liability limit for any “one loss, disaster, or casualty”, was $6 million under the 1975 policy and $10 million under the 1978 policy; in both policies UTC’s retention was $200,000 for “any one occurrence.” 7.131 The insurer purchased reinsurance for the 1975 and 1978 policies. The reinsurer reinsured 22% of the $5 million excess of a $1 million primary layer and 25% of the $5 million excess of a $1 million primary layer. The reinsurance policies were stated to be subject to the terms and conditions of the UCT policies, and the reinsurers’ liability follows that of the insurer under the UTC policies. 7.132 In April 1992, UTC commenced an action against the insurer in the United States District Court for the District of Connecticut for indemnification under the UTC policies for physical loss and damage allegedly sustained due to environmental pollution at various sites, including plants in West Palm Beach, Florida, Stratford and Windsor Locks, Connecticut, and Santa Clara County, California. During this litigation both UTC and its insurer argued that there were multiple occurrences at each of these sites, the key issue being the $200,000-per-occurrence deductible under the UTC policies. Clearly, more deductibles meant less coverage under the insurance policies as the number of occurrences dictated the number

70. 837 NYS.2d 138, (NYAD 1 Dept, Jul 12, 2007).

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of deductibles that would be applied. After trial, a jury found that there were seven different areas at the Windsor Locks site during the period covered by the 1975 and 1978 policies at which damage or loss occurred. In a suit for summary judgment that the parties sought after the verdict on the number of occurrences involved the District court found seven occurrences of damage or loss took place at Windsor Locks site as consistent with the jury verdict. Meanwhile, the UTC litigation continued on the coverage question with respect to the 16 sites, including the West Palm Beach, Stratford and Coyote sites, but before the trial regarding these sites the insurer settled with UTC agreeing to pay a lump sum of $112 million for all of the sites at issue. In the settlement negotiations the insurer took the position that it had a “verdict in hand” for Windsor Locks and that there should be no discount in settlement for that site. 7.133 It should be noted that no single occurrence at the sites would have exceeded the $1 million retention and thus the reinsurers’ liability would not have been triggered under the 1975 or 1978 certificates. The insurers’ counsel, however, treated each site as one occurrence in preparing an allocation of an environmental coverage dispute settlement for reinsurance purposes. Consequently, by treating each site as one occurrence the loss was allocated per year in excess of $1 million the reinsurers’ obligations under the 1975 and 1978 policies were triggered according to the reinsured’s post-settlement allocation. 7.134 In an action where the reinsurers sought negative declaratory relief, the court found that the reinsured treating its assured’s claim on a per-occurrence loss basis at each site and then allocating the loss to its reinsurer on a single-occurrence-per-site basis was the very antithesis of the follow the fortunes doctrine. The court recognised that the reinsured applied the occurrence deductible at the assured’s level to minimise the amount of the reinsured’s exposure and loss, whereas at the reinsurance level, in the same loss setting, the occurrence deductible was used as sparingly as possible to maximise the reinsured’s recovery against the reinsurer; the court defined such an allocation as neither reasonable nor reflective of good faith but disingenuous. Moreover, the follow the fortunes doctrine was not intended to allow an insurer to use a different set of rules at each level. The court defined the reinsured’s allegation as a manifest manipulation in total disregard of its obligation to act in good faith. The court confirmed the rule that despite an inconsistency between pre-and post-settlement allocations the reinsurer may be obliged to follow the settlements as long as the allocation meets the typical follow the settlements requirements. Here the settlement was unreasonable because the one-occurrence-per-site allocation of the Windsor Locks site directly contradicted the district court ruling as to the number of occurrences at that site. As a result, the court stated that the follow the fortunes doctrine did not require that courts turn a blind eye to such manifest manipulation of the allocation process in total disregard of the reinsured’s obligation to act in good faith. The court also touched upon the abovementioned cases where the reinsured’s postsettlement allocations were approved, but the difference in the present case to those that follow the settlements doctrine was extended to the post-settlement allocations where “an inconsistency between that allocation and the [reinsured’s] pre-settlement assessments of risk as long as the allocation meets the typical follow-the-settlements requirements ie, is in good faith, reasonable, and within the applicable policies.” In the instant case however – as the court ascertained – the inconsistency was between the reinsured’s pre-settlement allocation of loss with its insured (UTC) and its post-settlement allocation with its reinsurer but not between defendant’s post-settlement allocation and its pre-settlement assessments of the risk. Distinguishing Settlement from Allocation 7.135 It may be argued that the parties to a reinsurance agreement are sophisticated enough to look after their own business relationship; therefore, adopting the rationale that the follow the 188

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fortunes doctrine aims “to nurture the relationship” between reinsureds and reinsurers, the notion that it is permissible “to maximise reinsureds’ coverage” is inappropriate71 and therefore a settlement should be distinguished from allocation and they can be challenged separately. On the other hand in practice an allocation cannot easily be separated from the underlying settlement, and if no objection can be taken to the settlement then it is difficult to object to the allocation. If the settlement is in good faith, then in the absence of exceptional circumstances, the allocation is also to be assumed to have been made in good faith. Challenging the allocation would involve challenging the settlement itself, requiring a de novo review of the type which is intended to be precluded by follow the settlement clauses. In the following authorities mentioned it is seen that the US authorities do not permit reinsurers to challenge the allocation unless reinsured’s allocation is made clearly in bad faith or if the challenge requires to determine whether or not the loss as a matter of law fall within the original insurance or reinsurance policy. 7.136 It may thus be seen that the US courts have not accepted any distinction between a reinsured’s settlement from its post-settlement allocation and have held that allocation is binding so long as the settlement has been made in good faith. In Commercial Union Ins Co v Seven Provinces Ins Co, Ltd 72 the reinsurers challenged the reinsured’s good faith in the “allocation” rather than in the “settlement.” The district court judge found – and the US Court of Appeals for the First Circuit agreed – this to be “a distinction without a difference” because there it could be seen no difference between determining which of several policies covered which particular loss among many and the more general decision that the losses were covered by the policies. 7.137 In this case a California manufacturing company, Teledyne, Inc, purchased several insurance policies from Employers’ Surplus Lines Insurance Company (ESLIC). Seven Provinces reinsured ESLIC for a portion of the Teledyne risk on the “semiconductor site” where Teledyne had carried on manufacturing activity since 1962. The reinsurance was for the same period as the underlying policy, from 1 July 1963 to 1 July 1 1964, and on the same risks. Seven Provinces’ facultative reinsurance provided that if Teledyne claimed against ESLIC for up to $450,000 in excess of the first $50,000 of loss, Seven Provinces would reimburse ESLIC for half of the covered amount, up to $225,000. 7.138 Having discovered environmental contamination at several of its plants, Teledyne made claims against its insurers in 1982 to cover the resulting liability. In 1993, ESLIC’s successor in interest, Commercial Union, settled its share of these claims for $2.2 million. Under the settlement, one site in particular was the focus of negotiations, namely, the “semiconductor site” for which clean-up costs were estimated to be $20.93 million. Commercial Union ascertained that $843,000 of the $2.2 million settlement pertained to environmental contamination at the “semiconductor site” and claimed from Seven Provinces $225,000 as its half of the first $450,000 of the loss in excess of $50,000. Commercial Union claimed the remaining $225,000 of the $450,000 portion of the loss from its quota share treaty reinsurers. 7.139 Seven Provinces denied liability. They asserted that the reinsured had taken out a reinsurance treaty from another reinsurer under which, according to the net retention provision in the Seven Provinces policy, the reinsured was expected to reduce Seven Provinces’ policy exposure. The “net retention” provision was in the following terms:

71. Grais D J, “Follow-The-Settlements And Its Rationale In American Law,” Mealey’s Litigation Report: Reinsurance, 5 October 2007, Vol. 18, No. 11, 13. 72. 9 F.Supp.2d 49, D Mass, Jun 15, 1998; aff’d by the first circuit, 217 F.3d 33, (1st Cir. (Mass) Jul 06, 2000). 73. The district court judge noted that as one of the experts stated during trial this was a British spelling of “net” which means “net of commission paid to an agent or broker.”

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“Being a reinsurance of and warranted same NETT73 rate, terms and conditions as and to follow the settlements of the EMPLOYERS’ SURPLUS LINES INSURANCE COMPANY and that the local office of the said Company retains during the currency of this insurance at least $225,000.00 BEING 50% OF $450,000.00 EXCESS $50,000.00 COMBINED SINGLE LIMIT (subject to reduction by any general excess loss or excess catastrophe reinsurance whether effected by the head office or local office of the Company) on the identical subject matter and risk and in identically the same proportion on each separate part thereof, but in the event of the retained line being less than as above, [ESLIC’s] lines to be proportionally reduced.”

7.140 Both the district court and the First Circuit agreed that the meaning of the net retention provision in the facultative reinsurance was ambiguous. After hearing the expert evidence the judge found – and the First Circuit affirmed – that although the policy called for Seven Provinces’ liability to be “proportionally reduced” to the extent that Commercial Union’s “local office” retained less than “$225,000.00 [of risk] BEING 50% OF $450,000.00 EXCESS $50,000.00 COMBINED SINGLE LIMIT,” the wording of the clause still permitted Commercial Union to obtain “general excess loss or excess catastrophe reinsurance whether effected by the head office or local office of the Company” without violating the net retention requirement. Thus, while the policy restricted Commercial Union’s use of some forms of reinsurance to cover its residual share of the risk of loss, other forms of additional reinsurance were permissible and the phrase “general excess loss or excess catastrophe reinsurance” attempted to define the types of additional reinsurance that Commercial Union could procure without violating the net retention provision. Consequently, it was held that the facultative certificate provided for Seven Provinces’ portion of the Teledyne risk to be reduced only if ESLIC obtained facultative reinsurance on its portion of the risk; otherwise, it allowed the reinsured to purchase treaty reinsurance that would cover its portion of the Teledyne risk. 7.141 Seven Provinces also challenged the allocation accepted by Commercial Union; they asserted that allocation could have been “more reasonable” by applying alternative allocation methods that they suggested. Moreover, they argued that Commercial Union should not have paid Teledyne its environmental liability because such losses were excluded from coverage by the underlying Teledyne-ESLIC policy’s “owned property exclusion.” 7.142 The district court judge expressed the view that two separate but related doctrines governed the legal effect of Seven Provinces’ challenges to the reinsured’s allocation of the Teledyne settlement. 1. The follow the fortunes doctrine required reinsurers to accept a reinsured’s good faith decision that a particular loss was covered by the terms of the underlying policy. 2. The follow the settlements doctrine required reinsurers to abide by a reinsured’s good faith decision to settle, rather than litigate, claims on that policy. The judge approved the expert testimony view as to the latter, so that the reinsurer “must go along with however the insurer settles the claim.” 7.143 Having noted that the reinsurance policy contained a follow the settlements clause, the judge focused on the interpretation of that doctrine. By citing a number of precedents74 from different US jurisdictions, the judge stated that the purpose of the follow the settlements doctrine was to prevent the reinsurer from second-guessing the good faith settlement decisions of the reinsured. The reinsured’s settlement could, however, be challenged if the reinsurer 74. Aetna Casualty & Sur Co v Home Ins Co, 882 F.Supp. 1328, 1346 (SDNY March 27, 1995); North River Ins Co v CIGNA Reinsurance Co, 52 F.3d 1194, (3rd Cir. (NJ) Apr 13, 1995); Mentor Ins Co (UK) v Norges Brannkasse, 996 F.2d 506, (2nd Cir. (NY) May 24, 1993); Christiania Gen Ins Corp v Great Am Ins Co, 979 F.2d 268, 280, (2nd Cir. (NY) Sep 3, 1992); International Surplus Lines Ins Co v Fireman’s Fund Ins Co, 998 F.2d 504, (7th Cir. (I11) Jul 08, 1993).

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proved that the reinsured was fraudulent, collusive, or acted in bad faith. In order to discharge the burden of proof the reinsurer had to show “gross negligence or recklessness” or that the settlement was not even “arguably” within the scope of the reinsurance coverage. Consequently, the reinsurer could not dispute a good faith determination that a risk was covered by the underlying insurance policy, or a good faith interpretation of policy terms. The judge also clarified that reasonableness of the reinsured’s judgment was to be determined as of the time of settlement. 7.144 As a result, after hearing the expert evidence and analysing the reinsured’s allocations of the loss, the judge found no evidence indicating that Commercial Union allocated the settlement amongst policies so as to maximise its reinsurance recovery, or that its allocation was in any other way affected by the existence of reinsurance. The settlement was not for an ex gratia payment made in exchange for the environmental release, nor there was any evidence of bad faith or unreasonableness in the allocation of settlement monies between the insurance policies with Teledyne. 7.145 According to the district court judge, in terms of applying the follow the settlements doctrine, distinguishing settlement from allocation would undermine the entire follow the settlements doctrine. Furthermore, the court found the question of which of the several policies covered any particular loss among many did not require a very different analysis from the more general question of whether the losses were covered by the policies. The reinsured was allowed to make judgments on these two issues for the sake of encouraging settlement. Thus, any attempt to challenge either type of decision had an equal likelihood of undermining a settlement and fostering litigation. 7.146 The judge further drew attention to the nature of the assured’s claims that they were complex environmental claims. Such claims necessarily involved a number of sites, a range of years in which the exposure could have occurred. This characteristic, according to the district court, justified its holding because; (a) if a reinsured could be forced into litigation over its good faith judgment as to which policies covered which losses, it would be impossible for it to come to any settlement of such complex claims; and (b) when several reinsurers were involved, there would be a risk of successive rounds of litigation, in which each reinsurer offered an alternative allocation model that would reduce its own liability. 7.147 The First Circuit75 affirmed the district court’s view as to extending the doctrine of follow the settlements to the reinsured’s post-settlement allocations where the settlement itself was reasonable and made in good faith. 7.148 The First Circuit noted that Commercial Union’s payment to Teledyne, and the fact that at least a portion of the settlement covered losses under the semiconductor policy, were sufficient to prove that Commercial Union had suffered a loss within the scope of its reinsurance coverage. Seven Provinces therefore had to raise a valid defence to coverage such as an exclusion in the reinsurance agreement indicated that Commercial Union had failed to fulfil a condition precedent to its recovery under the terms of the policy. Neither the district court judge nor the First Circuit accepted Seven Provinces’ challenges to the allocation and held that these could be disputed only on grounds of bad faith or unreasonableness. 7.149 Seven Province’s additional argument that coverage for the underlying hazardous waste claim was barred by the “owned property” exclusion in the Teledyne policy was not successful, given the fact that this argument was plainly prohibited by the follow the settlements doctrine.

75. 217 F.3d 33, (1st Cir. (Mass) Jul 06, 2000).

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7.150 The ratio that the courts relied on in Seven Provinces has been criticised as exaggerated,76 for the reason that in fact only a few cases involving follow the settlement clauses give rise to allocation disputes, and the court failed to explain why all the reinsurers affected should not be parties in the allocation dispute in order not to increase the number of reinsurance disputes. 7.151 In North River Ins Co v Ace American Reinsurance Co77 – as stated above – the insurer’s policies covered portions of the second, third, fourth, and fifth excess layers of assured’s coverage. With the exception of $125,000 of coverage in the third excess layer of the 1978 to 1980 policies, ACE reinsured only portions of the second excess layer policies. After its products liability coverage was exhausted, the assured settled the claim with the insurer, releasing the insurer from liability under all of its policies with the assured for not only asbestos-related claims but also for any future, non-asbestos-related claims. North River allocated 99% of the costs of the settlement to non-product asbestos claims among its reinsurers using the “rising bathtub”78 approach, consistent with its view of the policies and the Wellington Agreement. ACE disputed the settlement allocation because North River’s pre-settlement analysis of possible litigation outcomes identified risk of loss in higher layers but North River assigned its entire settlement to ACE’s layer of reinsurance (the second layer). ACE did not question the reasonableness of North River’s settlement with Owens-Corning, or the good faith of North River in deciding to settle or at what amount, nor did it question that the losses were of a type within the coverage of the underlying insurance contract. ACE only disputed North River’s decision to allocate the settlement to a layer of reinsurance no higher than the second, even though that settlement eliminated risk to upper layers that had been identified and quantified by North River’s pre-settlement analysis. 7.152 The Second Circuit refused to distinguish the settlement from the reinsured’s postsettlement allocation and emphasised that requiring post-settlement allocation to match presettlement analyses would permit a reinsurer, and require the courts, to scrutinise the specific factual information regarding settlement negotiations. This would undermine the certainty that the general application of the doctrine to settlement decisions created. 7.153 In Affiliated FM Ins Co v Employers Reinsurance Co79 the US District Court, D Rhode Island clarified that what had not been permitted in North River v Ace was that “questioning allocation of covered loss.” According to the district court, this was quite different to “looking behind the settlement to determine whether the loss claimed is covered by the reinsurance contract,” which was in fact permitted to do so according to the principles governed the follow the fortunes doctrine. In Affiliated, Affiliated FM Insurance Company issued a $5 million umbrella excess liability insurance policy to Elt, Incorporated, and Baltimore Paint & Chemical Co in 1975. The policy covered the period from 31 December 1975, to 31 December 1976 and as a result of the policy limit increase to $10 million on 7 October 1976, Affiliated took out a “Facultative Reinsurance Certificate” with Employers Reinsurance Corporation (ERC) to cover the newly acquired $5 million in liability. The Reinsurance coverage was agreed to be from 7 October 1976, to 31 December 1976, and ERC agreed to indemnify Affiliated for “Nil% of $5,000,000 and 100% of 5,000,000 excess of $5,000,000.” 7.154 Beginning in the late 1970s a wave of asbestos-related actions began to be brought against the assured. After the assured notified Affiliated of the exhaustion of the primary insurance coverage, Affiliated entered into an “Interim Indemnity and Defense Cost Sharing 76. Graydon S Staring “Following Settlements and Following Allocations,” Lexis Nexis Mealey’s Litigation Report: Reinsurance, Vol. 15, No. 15, 2 December 2004, 27. 77. 361 F.3d 134 (2nd Cir. (NY) March 15, 2004). 78 For definition of the “rising bathtub” approach see para 7.117 above. 79. 369 F.Supp 2d 217, DRI, May 12 2005.

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Agreement” with the other excess liability insurers in which the insurers agreed to share costs and pursuant to this agreement Affiliated paid out $2,210,028.40 in indemnity, as well as $865,582.74 in defence costs, over a period of approximately four years. Moreover, on 3 July 2001, Affiliated entered into a “Settlement Agreement and Release” for the amount of $6 million in return for which Affiliated was released from all future liability. 7.155 In deduction of $5 million from the total amount it paid out, Affiliated claimed the amount of $4,179,611.14 from ERC. The main objection that ERC raised was that: “Affiliated FM has allocated $4,179,611.14, the entire amount of [its] payments excess of $5,000,000, to the ERC Certificate, although ERC only reinsured Affiliated FM for a period of less than 3 months (85 days), whereas the Affiliated FM policy was in effect for the entire year.” 7.156 The reinsurance policy did not contain a follow the fortunes clause; however Affiliated asserted that the doctrine was applicable regardless or having an express clause in the reinsurance policy. The court recognised the authorities in favour of Affiliated’s argument but refused to resolve the dispute at that point because in the district judge’s view Affiliated’s arguments in the case would have failed even if the court were to assume that a follow the settlements clause was implicit in the Reinsurance Certificate. 7.157 The district court emphasised that – even if it was to apply – the follow the fortunes doctrine did not create reinsurance coverage where none exists under the terms of the reinsurance contract. ERC’s reinsurance certificate explicitly excluded defence costs from the definition of “loss.” However, Affiliated’s argument focused on the construction of the follow the fortunes doctrine to the effect – arguably by Affiliated – that it might be reimbursed for payments made to extinguish future liability for defence costs as long as the settlement was entered into in good faith. The court recognised that such an argument might be supported for the reasons to encourage settlements but that would also mean to impose whatever settlement decisions Affiliated makes on the reinsurers. 7.158 As the follow the fortunes doctrine does not make a reinsurer liable for risks beyond those agreed upon in the reinsurance contract, the court held that the reinsurer retained the right to question whether the reinsured’s liability stemmed from an unreinsured loss, (ie a loss which was not contemplated by the original insurance policy or if it was expressly excluded by terms of the reinsurance policy). 7.159 ERC therefore was held to have a right to question the settlement in this respect. Notably, the court stated that the issue here was not the type of risk of loss assessments that Affiliated was permitted to make in regards to a settlement without risking second-guessing, but the point at stake was looking behind the settlement to ascertain whether the loss claimed was covered by the reinsurance contract. The court commented that this was permitted under the follow the fortunes doctrine. What was not permitted, as distinct from questioning whether the loss fell within the reinsurance, was questioning the allocation of covered loss. ERC was not seeking to challenge the allocation but the settlement, and the evidence indicated that Affiliated was trying to improperly submit amounts it paid to extinguish its own liability for defence costs as covered loss under the reinsurance certificate. 7.160 As a result, the court denied the reinsured’s claim for summary judgment, as it had become clear to the court that an allocation of the settlement amount was required to determine whether it was covered by the reinsurance contract. As the proper allocation was a question of fact, the judge held that ERC was entitled to further discovery on this point. 7.161 As in Affiliated, disputes coming before the New York State courts also exemplified circumstances where a reinsured’s post-settlement allocation may be distinguished from the settlement and therefore can be challenged by reinsurers. For example in Travelers Cas and 193

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Sur Co v Certain Underwriters at Lloyd’s of London80 the NY Court of Appeals refused to extend the follow the fortunes doctrine to the reinsured’s post-settlement allocation for the reason that the allocation was inconsistent with the terms of the reinsurance contract. Travelers settled two separate pollution coverage disputes, the Koppers and the Dupont litigations, with two different assureds. The Koppers Litigation was related to primary, excess and umbrella general liability insurance, issued by Travelers, for the Koppers Company from 1960 to 1981. Koppers was a chemical manufacturer that has operated in locations throughout the US since the early 1900s. The primary policies limits were to be per occurrence and beginning in 1971, the primary policies contained “sudden and accidental” pollution exclusion clauses. 7.162 Travelers purchased various types of reinsurance, in particular it purchased facultative reinsurance for 50% of the limits of its excess liability policies issued to Koppers from 1 January 1966 to 1 March 1972. For the years 1960 to 1970 it also obtained a catastrophic excess of loss reinsurance from the defendant reinsurers. The excess of loss reinsurers agreed to pay Travelers for “each and every loss” incurred by Travelers that exceeds the retentions established under the treaties. “Each and every loss” was defined in treaties as: “all loss arising out of any one disaster and/or casualty under coverage of any or all insureds of the Companies, or all loss under the products liability coverage of any one insured, or all loss arising out of the occupational disease hazard under Workmen’s Compensation and Employers’ Liability coverage of any one insured.”

7.163 The definition of “disaster and/or casualty” was described as: “each and every accident, occurrence and/or causative incident, it being further understood that all loss resulting from a series of accidents, occurrences and/or causative incidents having a common origin and/ or being traceable to the same act, omission, error and/or mistake shall be considered as having resulted from a single accident, occurrence and/or causative incident.”

7.164 The treaties also contained a follow the fortunes clause which read: “Any and all payments made by [Travelers] in settlement of loss or losses under [its] policies, whether in satisfaction of a judgment in any Court against the Insured or [Travelers] or made voluntarily by [Travelers] before judgment, in full settlement or as a compromise, shall be unconditionally binding upon the [Reinsurers] and amounts falling to the share of the [Reinsurers] shall be immediately payable to [Travelers] by [the Reinsurers] upon reasonable evidence of the amount paid by [Travelers] being presented” “The [Reinsurers] agree to abide by the loss settlements of [Travelers], such settlements to be considered as satisfactory proofs of loss.”

7.165 In the early 1980s federal, state and local governments and a number of private parties commenced environmental actions against Koppers with regards to Koppers’ 150 plant and disposal sites throughout the country, many of which had been in operation for over 60 years. Koppers’ claim against Travelers was settled between them for approximately $140 million, resolving Travelers’ alleged liability to provide insurance coverage for pollution liability claims arising at more than 160 separate known sites throughout the United States, as well as at an undetermined number of unknown sites. In making its claim against the reinsurers Travelers allocated the $140 million settled amount among the underlying direct insurance policies by treating each Koppers site as a separate occurrence. Subsequently, Travelers claimed approximately $61.5 million of this settlement from its facultative reinsurance

80. 96 NY.2d 583, N.Y. Oct 16, 2001. This case was said to have proved that old saying that “hard cases make bad law.” P Jay Wilker, “Travellers v Lloyd’s – Has New York’s Highest Court Made It Harder For Cedents to Settle with Their Insureds?,” Mealeys’s Litigation Report: Reinsurance, Vol. 12, No. 13, 1 November. 2001, 26.

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policies. In determining how much of the settlement to allocate to the reinsurers under the applicable reinsurance treaties, Travelers treated the entire settlement as a single “disaster and/ or casualty” and appropriated the settlement monies correspondingly among the implicated treaties and claimed $13 million of the primary insured’s claim from its excess of loss reinsurers. Travelers’ contended that the Koppers loss resulted from a “common origin” and/or was “traceable to the same act, omission, error and/or mistake,” namely, “Koppers’ company-wide waste disposal practice.” 7.166 In addition to the Koppers’ policies, Travelers purchased reinsurance in treaty form from 1967 to 1985 from the defendant for the excess and umbrella liability insurance policies issued for EI Dupont, the largest chemical company in the world. The relevant provisions in those treaties – including the definitions of “each and every loss,” “disaster and/or casualty” and the follow the fortunes clause – were identical to the Koppers treaties. 7.167 Travelers also settled Dupont’s claim by agreeing to pay $72.5 million for insurance claims arising from pollution liabilities at Dupont’s sites, and then apportioned this settlement between two direct insurance policies with DuPont. Relevant to this appeal, $69 million was attributed to a 1967 to 1970 umbrella policy, with 25 different sites identified as separate occurrences for allocation purposes. 7.168 Travelers then allocated $34 million of the settlement to certain facultative reinsurance policies and claimed $7.4 million from its treaty reinsurers. Similarly to the Koppers’ claims, Travelers calculated this amount by treating the environmental contamination at the DuPont sites as a single loss and asserted that the polluted sites shared a “common origin,” namely, a managerial failure by DuPont in the implementation and enforcement of its company-wide environmental policy. 7.169 The dispute before the NY Court of Appeals was whether Travelers’ single allocations of its losses were encompassed by the term “disaster and/or casualty,” which included “all loss resulting from a series of accidents, occurrences and/or causative incidents having a common origin and/or being traceable to the same act, omission, error and/or mistake.” The answer given by the court was in the negative. The NY Court of Appeals emphasised the fact that the reinsurers here were not contesting Travelers’ settlement decisions based on the underlying policies; rather, the challenge was to Travelers’ allocation of those settlements based on the contractual language in the reinsurance treaties. To this extent, the court distinguished the cases that established the follow the fortunes doctrine. Moreover, it was clear that (as Travelers also admitted) if each site was to be treated as a separate “disaster and/or casualty,” the retention level of reinsurance would not be penetrated. Travelers, however, asserted that the reinsurers were obliged to follow its fortunes as the allocation was made in a reasonable and good faith manner. Agreeing with the Second Circuit’s ruling in Bellefonte Re Ins Co v Aetna Cas & Sur Co81 the NY Court of Appeals held that while a follow the fortunes clause in most reinsurance agreements left reinsurers little room to dispute the reinsured’s conduct of the case, it did not alter the terms or override the language of reinsurance policies. The court noted that a follow the fortunes clause did not supersede specific language in a reinsurance contract. The practical result of holding that the follow the fortunes clause supplanted the definition of “disaster and/or casualty” in the reinsurance treaties and allow Travelers to recover under its single allocation theory would have been that a reinsurance contract governed by New York law and which contained a follow the fortunes clause would bind a reinsurer to indemnify a reinsured whenever it paid a claim, regardless of the contractual language defining the insured peril or the loss.

81. 903 F.2d 910 (2nd Cir. (NY) May 19, 1990).

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7.170 A few years later a similar issue came before the Supreme Court of New York County in Argonaut Ins Co v Travelers Ins Co82 where the court once again distinguished the reinsured’s post-settlement allocation from its settlement in respect to application of the follow the settlements clause because the allocation was inconsistent with the reinsurance policy wording. In this case Travelers Insurance Company insured Witco for the period from 1 January 1962 through 1 April 1973 (the Primary Policies), and also issued umbrella excess policies for the period from 11 July 1964 through to 1 April 1973. Travelers then purchased reinsurance covering a portion of its obligations under the Excess Policies, for the period from 21 July 1964 through 1 April 1973. When Witco faced claims for damages arising from environmental pollution at approximately 140 separate sites located throughout the United States, initially the disputes arose between Witco and Travelers with regards to the coverage provided by the primary and excess policies but the parties ultimately reached a settlement agreement in 1995 pursuant to which Traveler agreed to pay Witco $50 million. By the settlement agreement Travelers was released from all liability under the Primary and Excess Policies. 7.171 In making its claim against its reinsurers Travelers allocated the $50 million settlement amount to the Excess Policies and the Reinsurance Certificates on the basis that the environmental pollution claims against Witco constituted a “single occurrence.” 7.172 The reinsurers asserted that Witco’s environmental coverage claims constituted “multiple occurrences” rather than a “single occurrence” and Travelers allocation was unreasonable and made in bad faith. Travelers asserted that all of the environmental pollution claims relating to all of Witco’s sites arose from a “common cause” or “common origin” which was the failure of Witco’s management to implement company-wide procedures to assure that operations and waste disposal were conducted in an environmentally sound manner. 7.173 Pointing out the policy definition of occurrence, the court refused Traveler’s argument. “Occurrence” was defined by the excess policies – which also governed the reinsurance definitions- as meaning: “. . . as respects property damage, (1) an accident, or (2) continuous or repeated exposure to conditions which results in injury to or destruction of tangible property, including consequential loss resulting therefrom, during the policy period. All damages arising out of such exposure to substantially the same general conditions shall be considered as arising out of one occurrence.”

7.174 The court held that the damages which arose from environmental pollution at Witco’s approximately 140 sites throughout the US could not properly be aggregated into one occurrence because the damage arising at each site resulted from exposure to the particular conditions existing at that site, and not from “general conditions” that were “substantially the same” at all of the different sites. Travelers’ goal in negotiating the Settlement Agreement was concededly to obtain a “global” settlement, which released it from liability in connection with environmental claims relating to all Witco sites. As Travelers made clear in making its claim against its reinsurers, by the global settlement agreement “[a]ll Environmental Pollution Claims, known or unknown, [were] resolved”; and “[a]ll existing environmental coverage litigation [would] be dismissed with prejudice.” 7.175 The reinsurance policy contained a follow the settlements provision which provided: “[a]ll claims involving this reinsurance, when settled by [Travelers], shall be binding on the Reinsurers, who shall be bound to pay their proportion of such settlements. . . .” The court however did not apply the follow the settlements doctrine to the instant case because here, the

82. 800 N.Y.S.2d 342 (NY Sup. Jan 05, 2005).

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reinsurers were contesting Travelers’ allocation of the Witco settlement on a single rather than multiple-occurrence basis, and not challenging the settlement. According to the court in such circumstances the follow-the-settlements clause did not bar the reinsurers’ present challenge. 7.176 The decision was not greeted with sympathy. It has been argued that the court substantially departed from the way in which the other courts analysed the application of follow the settlements to post-settlement allocations.83 Instead, the court should have looked only at the question whether the settlement was in good faith; the factual inquiry that the court did in-depth was described as “de novo” review of the reinsured’s decision in settling the assured’s claim which was in fact the follow the fortunes doctrine aimed to prevent.84 The commentator noted, however, that if the court had analysed if the allocation was made in good faith, rather than analysing the facts in depth, the same result would probably have followed.85 7.177 As will be clearly seen from the authorities on the issue of “annualisation in allocations,” in principle, allocating the loss settlement to the reinsurance recovery favourable to the reinsureds own interest or in other words aiming to maximise the recovery from reinsurance is not itself sufficient to prove the reinsured’s bad faith. In other words, the reinsured is not under any positive duty to minimise the coverage but the reinsured still has to prove that the allocation was reasonable, in that at least the allocation was one of the options that on reasonable basis that he could choose among others. Hartford Acc & Indem v Columbia Cas. Co86 is another example where the District Court of D Connecticut found no factual or technical justification for the reinsured’s allocation of its settlement with the assured. In this case Hartford Accident & Indemnity Company was the comprehensive general liability insurer of Reichold Chemicals, Inc from 1972 until 1985. Hartford had issued annual comprehensive general liability insurance policies which provided a $1 million indemnity limit for each occurrence and covered Reichold’s legal expenses for defending any claim covered by the policy. In October 1988, Reichold brought an action against Hartford seeking coverage of its environmental contamination liabilities arising at more than 50 of its manufacturing sites around the US. Although there was uncertainty about the contamination at the Newsom site the parties settled the coverage claim in 1995 in return of which Hartford was released from liability for all Reichold’s sites. As a result of the settlement agreement, Hartford paid $3,201,213 as an underlying expense and $7,798,787 as indemnity. 7.178 In 1977 and 1978 Columbia Casualty Company reinsured Hartford’s loss in excess of $500,000 per occurrence up to a limit of $500,000 per occurrence as well as expenses. The parties also agreed that: “All claims covered by this reinsurance when settled by the company shall be binding on the Reinsurers, who shall be bound to pay their proportion of such settlements.” Under these policies Hartford claimed from Columbia approximately $3.2 million. Hartford settled Reichold’s claim covering over 50 sites but allocated the settlement to solely to one site, the Newsom Site, solely to one short period of years, 1977 to 1984, and significantly based on only one event, the 1977 fire. 7.179 Hartford sought summary judgment, contending that Columbia was obliged as a matter of law to follow Hartford’s settlements as there were no genuine disputes of material fact showing Hartford’s settlement with Reichold was not reasonable and in good

83. Rubenstein, A M “ ‘Follow the Settlements’ and Allocation: A Review of Recent Developments” Mealey’s Litigation Report: Reinsurance, 5 November 2007, Vol. 18 No. 13, 29. 84. Rubenstein, 29. 85. Ibid., at 30. 86. 98 F.Supp. 2d 251, D. Conn, March 31, 2000.

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faith. Denying Hartford’s claim the District Court focused on the suggestions of unreasonableness of Hartford’s allocation of the entire Reichold settlement to the Newsom Site. This allocation, arguably, enabled Hartford to maximise the amount that it could recover by way of reinsurance from Columbia. Moreover, the court noted that the original policy between Reichold and Hartford provided: “[t]he full premium is not charged at the time the policy is written. It’s predicated upon either incurred or paid reserves and/or indemnity, and it’s collected at a later date.” This provision made it arguable that – as the reinsurers contended – Hartford’s retrospective premium adjustments would have been triggered if the allocation had been made on a multiple occurrence basis, but in classifying the settlement as a single occurrence Hartford’s motivation appeared to be to minimise the amount Hartford might be eligible to recover from Reichold and maximising the amount it could collect from its reinsurers given that Hartford not need exhaust its $500,000 deductible per multiple occurrence. Annualisation 7.180 In policies insuring or reinsuring a long-tail liability for damage to property or personal injury claims policies may be multi-year and may also contain a per occurrence limit. In such a case the question will be, in calculating the insurers’/reinsurers’ liability, whether the peroccurrence policy limit is to be applied once for the whole policy period or to each year separately within the multi-year policy cover. As seen above, in Commercial Union Ins Co v Swiss Reinsurance America Corp.87 the United States Court of Appeals for the First Circuit approved the reinsured’s settlement which based on an “annualisation approach” due to the policy wording which permitted such construction.88 On the day that Commercial Union v Swiss Reinsurance was decided there was a companion case before the First Circuit in which the same reinsurer, Swiss Re, involved with another reinsured, American Employers’ Insurance Co and the issue was again on the annualisation matter in assessing the reinsurers’ liability. In American Employers’ Ins Co v Swiss Reinsurance America Corp.89 American was the excess insurer of Pennsalt Chemical Company (later became Elf) under three multiple-year umbrella insurance policies – the “A-15 policies” – covering the periods 1 January 1964 to 1 January 1967; 1 January 1967 to 1 August 1968; and 1 August 1968 to 1 January 1971. The policies covered liability for bodily injury and property damage that might be incurred by the assured over and above coverage provided by a primary insurer. 7.181 Under the first two American policies the insurer’s liability to Pennsalt was subject to the limits of $2 million for “each occurrence.” The limit was $5 million per occurrence under the third policy. All three policies, with minor variations, defined “occurrence” to mean: “(a) an accident, or (b) an event, or continuous or repeated exposure to conditions, which unexpectedly results in personal injury, property damage, or advertising liability . . . during the policy period . . . [A]ll personal injury and property damage . . . arising out of one event or continuous or repeated exposure to substantially the same general conditions existing at or emanating from one premises location shall be deemed to be one occurrence.” 87. 413 F.3d 121, (1st Cir. (Mass) Jun 27, 2005). 88. In the policy definition occurrence was including a “continuous or repeated exposure to conditions” and did not include additional language “within a single year.” 89. 413 F.3d 129, (1st Cir. (Mass) Jun 27, 2005); Either New York or Massachusetts law would be applicable to construe the reinsurance contracts. As the application of either Massachusetts or New York law yielded the same result, the court found unnecessary to make a formal choice of law decision.

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7.182 Swiss Re reinsured American by three multi-year reinsurance certificates each of which contained a follow the form and follow the fortunes clauses in the following terms: “The liability of [Swiss Re] specified in Item 4 of this Certificate shall follow that of [American], and except as otherwise specifically provided herein, shall be subject in all respects to the terms and conditions of [American’s] policy.” “All claims involving this reinsurance, when settled by [American], shall be binding on [Swiss Re], which shall be bound to pay its proportion of such settlements promptly following receipt of proof of loss.” By the first two policies Swiss Re agreed to indemnify 50% of American’s liability and by the third certificate Swiss Re’s liability was: “$2,000,000 each occurrence which is 40% quota share part of $5,000,000 which in turn is excess of underlying limits.”

7.183 American settled Elf’s claims with regard to hazardous waste losses involving property damage and bodily injury caused by pollution at various sites. There was no indication that the settlement agreement was based on “annualisation” but when making the claim against the reinsurer, the reinsured calculated the claim on an annualised basis that applied peroccurrence limit separately to each policy year. The reinsurer argued that they would be less liable if the allocation was done “site-by-site . . . once per-policy basis.” 7.184 The First Circuit found that the definition of “occurrence” was arguably ambiguous as to whether per-occurrence limits should be annualised; however, the court also noted that the definition could be construed in favour of Swiss Re because the definition stated “repeated exposures” at a site constituted one occurrence and that exposures comprising “the same general conditions” (conceivably, even different pollutants from the same manufacturing operation) were also “one occurrence.” The First Circuit, however, noted that American did not focus on the policy definitions, but rather insisted that the settlement with the assured was in good faith and reasonable and Swiss Re thus was obliged to follow its settlements with Elf. According to the court, American’s characterisation of the settlement was supportable: if the case had been litigated the New Jersey courts might choose to apply New Jersey law which was arguably pro-annualisation. American calculated its ultimate obligation using annualisation and the settlement roughly matched this figure. Thus, this was not a post-hoc characterisation or a unilateral post-settlement allocation without good grounds in the settlement process itself. The First Circuit however refused American’s contention that reinsurers were bound by the post-settlement allocation of the reinsured regardless of what the settlement embodied. As the First Circuit did not agree with the district court, which found no basis for the annualisation, the First Circuit vacated the judgment, remitted the decision for a follow the fortunes analysis and noted that reinsurers were free to challenge the reasonableness and good faith of reinsurer’s decision to settle such as arguing that the chances were very small in an Elf-American litigation American would be held liable based on annualised limitations which would weaken the reasonableness of paying out funds based on that ground. 7.185 Swiss Re also argued that whatever American’s liability to Elf, its own liability to American was limited by its certificates. But the First Circuit found no clear-cut antiannualisation language in the Swiss Re certificates. The policies used only the phrase “per occurrence” which, standing alone, according to the court neither adopted nor disproved annualisation. Additionally, the court noted that certainly American could have settled only as to the 10 sites, but this would simply have left the risks of greater liability and litigation costs as to the 27 sites for the future.

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7.186 Annualisation recently came before the US Court of Appeals for the Third Circuit in Travelers Cas and Sur Co v Insurance Co of North America90 where the original insurance was governed by Michigan law and the reinsurance contracts were subject to New York law. In this case, the assured, Acme,91 was seeking coverage under insurance policies issued by Aetna (later acquired by Travelers) in the 1970s and 1980s. Acme faced two sets of claims being brought against it: (a) breast implant claims, relating to safety testing of silicone breast implants that Acme had performed; and (b) chemical products claims, relating to chemical products manufactured by Acme, including the pesticide commonly known as “DBCP.” 7.187 The insurance policies consisted of three distinct layers: primary policies (bearing the designator AL), buffer policies (bearing the designator XS), and excess policies (bearing the designator XN). 7.188 The primary policies (AL) were issued between April 1976 and April 1987 and provided coverage for all non-products claims brought against Acme, as well as products claims brought against it outside the United States. Each of the AL policies had a per-occurrence coverage limit, but only the policies issued between April 1985 and April 1987 had aggregate coverage limits. 7.189 In addition, the primary (AL) policies were subject to captive reinsurance, that is, reinsurance provided by an Acme subsidiary. Each AL policy was reinsured for 95% of all losses above the loss limit. By the policy wording the primary insurers were also agreed to cover defence expenses in addition to an obligation to indemnify Acme for liability it incurred. The buffer (XS) policies covered the period between April 1976 and April 1982. The XS policies were also subject to captive reinsurance for 95 or 100%. The XN policies provided the final layer of coverage. These policies covered both products and non-products claims, and were in excess of all Acme’s insurance coverage. The XN layer was reinsured by INA through facultative reinsurance certificates, a portion of nine of the XN policies. Each certificate issued by INA contained both a follow-the-form provision and a follow-the-fortunes provision. 7.190 Acme initially sought coverage for the tens of thousands of breast implant claims brought against it under the AL policies, and sought coverage for the chemical products claims under both the XS policies and the XN policies. Initially the parties focused on reaching a “coverage-in-place” deal under which Travelers would agree to pay a fixed sum to cover Acme’s past and future losses. The parties would work out a formula for matching the specific claims against Acme to the specific insurance policies. However by the time the settlement was finalised Acme proposed, and Travelers accepted, another approach so that rather than a coverage in place deal Travelers would simply pay Acme a lump sum foregoing both retrospective premiums and captive reinsurance and in return, Travelers would be released all of Acme’s future claims under the policies. The settlement was finalised on this latter proposal and Travelers paid $137 million, $80 million of which would be allocated to the breast implant claims, $20 million would be dedicated to the chemical products claims.92 In addition, the parties agreed that the breast implant claims would be treated as nonproducts, single occurrence claims, while the chemical products claims would be treated as products claims. The parties however did not deal with any further allocations as to the specific policies potentially implicated.

90. 609 F.3d 143 (3rd Cir. (Pa) Jun 09, 2010). 91. The actual name of the insured was subject to a confidentiality agreement with Travelers. Out of respect for that agreement, the third circuit referred to it here by a pseudonym, Acme Corporation, which stands for “A Company that Makes Everything.” 92. The remaining $37 million would go to claims that are not at issue in this case.

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7.191 The settlement agreement expressly provided that: “[n]o payments . . . shall be allocated to any [AL] Primary Policies with a policy period commencing on or after April 1, 1982, or to any . . . XS Policies because the payments of the Settlement Amount are net payments and such Policies have been exhausted by virtue of the settlement.” “[w]ith the exception of the agreements explicitly set forth in . . . this Agreement, Acme and Travelers each reserve to themselves the right to allocate any or all of the Settlement Amount to any Policy; Acme will not be deemed to concur in any such allocation by Travelers, and Travelers will not be deemed to concur in any such allocation by Acme.”

7.192 Travelers allocated the $80 million to the breast implant claims by using “fill the bathtub” (rising bathtub)93 method; with regard to the AL coverage, confining itself to the preApril 1982 policies, Travelers allocated losses to the lowest layer of coverage first and, like a bathtub, fill[ed] from the bottom layer up. Thus, a given layer of coverage was not implicated until the layer beneath it was completely exhausted and in total Travelers allocated $24 million to the AL policies. The remaining $56 million of the $80 million then was allocated to the XN policies in accordance with the “fill the bathtub” method. Two of the XN policies implicated by Travelers’ allocation of the breast implant claims settlement had three-year policy periods, which were reinsured by INA. Within these multi-year policies Travelers applied their per-occurrence limits separately to each policy year with the effect tripling the amount that could be allocated to them. 7.193 INA contested Travelers’ allocation method. The Third Circuit approved the view that in principle the application of the follow the fortunes doctrine was extended to reinsured’s post-settlement allocation but also reserved the point that those allocations must still have been in “good faith” to be binding on the reinsurer. The court specified the reinsured’s duty as that of not to take advantage of the reinsurers’ dependence on the decisions made by the reinsured. Again, in conformity with Allstate Ins Co v American Home Assurance Co,94 the court further explained that the reinsured, whose allocation was primarily based on the purpose of increasing its reinsurance recovery, would be in breach of its duty. However, in the First Circuit’s view, the reinsured’s negative duty not to make allocation decisions primarily in order to increase reinsurance recovery did not translate into a positive duty on the reinsured to minimise its reinsurance recovery. In other words, if a reinsured has multiple possible allocations and if it chooses a particular allocation decision which increases its access to reinsurance, would rarely demonstrate bad faith in and of itself. In order to succeed, the reinsurer must prove either that the reinsured was motivated primarily by reinsurance considerations, or must establish that the after-the-fact rationales offered by the reinsured are not credible. 7.194 Turning to the facts the Third Circuit found both allocation of the $24 million out of $80 to the breast implant claims and also the allocation of the chemical products claims reasonable for the reason that Travelers was under no duty to minimise its reinsurance recovery. The evidence regarding the parties pre-settlement negotiations which indicating that before finalising the settlement the parties initially had considered alternative methods was not sufficient to prove that the reinsured acted in bad faith or it did not impose a duty on the reinsured to minimise the reinsurance recovery. 7.195 However, Travelers’ allocation of the settlement with regard to XN policies was problematic. As noted above, each facultative certificate issued by INA contained a “follow the forms” clause which aimed to provide concurrency between the policies of underlying insurance and reinsurance. As the Third Circuit accepted, in the absence of express language 93. For the definition of the “rising bathtub” approach see para 7.117 above. 94. 837 NYS 2d 138, NYAD 1 Dept, June 12, 2007.

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in the policy of reinsurance to the contrary, it is presumed that a policy of reinsurance will be construed as offering the same terms, conditions and scope of coverage as exist in the reinsured policy. This follows that the question was, and the reinsurer had to prove that, whether a reasonable interpretation of the underlying policy language, under Michigan law, unambiguously provided that the per-occurrence limits were not to apply separately to each policy year. 7.196 As stated above, the two XN policies at issue here were three- year policies. The policies were subject to two separate limits: an aggregate limit and a per-occurrence limit. The policy wording provided: “EACH OCCURRENCE: 53% ($8,000,000.MAXIMUM) QUOTE SHARE OF $15,000,000. ANNUAL AGGREGATE.”

7.197 The Third Circuit pointed out that the aggregate limit was modified by the word “annual,” while the “each occurrence” limit was not. In other words, the policy wording strongly indicated that the aggregate limit was meant to operate annually, while the peroccurrence limit was not. Moreover, the XN policies provided that “[Travelers] will indemnify the INSURED against EXCESS NET LOSS arising out of an accident or occurrence during the policy period.” The incorporated XN policies also provided: “The term occurrence wherever used herein shall mean an accident, or a happening, or event, or a continuous or repeated exposure to conditions which unexpectedly and unintentionally results in personal injury, property damage or advertising liability during the policy period. All such exposure to substantially the same general conditions existing at or emanating from one premise’s location shall be deemed one occurrence.”

7.198 The Third Circuit found in these policy wordings a clear implication that the term “accident or occurrence” was linked with the entire policy period (ie three years, rather than being linked separately to each policy year). Thus, the court approved the district court’s ruling that the three-year XN policies clearly and unambiguously had a single per-occurrence limit for the entire policy period. 7.199 It is noteworthy that the Third Circuit distinguished Commercial Union Insurance Co v Swiss Reinsurance America Corp95 and American Employers’ Insurance Co v Swiss Reinsurance America Corp96 in that, in both cases, unlike Travelers in the present case, the reinsureds were able to prove the existence of some reasonable basis for their annualisation decision. A further point here was that the $80 million settled amount for the breast implied claims was more than enough coverage available even without annualising the limit, so that Acme would not have had any reason to insist that Travelers annualise the per-occurrence limits of the XN policies. Reinsurers’ reservation 7.200 It should be noted that where the settlement is silent as to allocation, and if the reinsurers reserve their rights for judicial determination when making payment, the reinsurers may be able to challenge the allocation. In Employers Reinsurance Corp v Newcap Ins Co Ltd,97 the assured, Providence Hospital, obtained both primary and excess insurance coverage: its primary coverage was provided by a corporation formerly known as the Daughters of Charity National Health Systems (DCNHS) through the “Amended and Restated” Self-Insurance Trust Plan Document. The Trust Plan included both Commercial 95. 413 F.3d. 121, (1st Cir. (Mass) Jun 27, 2005). 96. Ibid. 97. 209 F.Supp 2d 1184, D Kan, Jul 11, 2002.

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Liability Insurance (CGL) and Hospital Professional Liability (HPL) coverage. DCNHS was the parent corporation of NewCap who provided excess liability coverage to DCNHS’s member hospitals, including Providence, through an Umbrella Liability Policy. As the Umbrella Policy covered only excess liability, it did not apply until the limits of the Trust Plan were exhausted. 7.201 ERC agreed to reinsure 100% of the Umbrella Policy up to a maximum of $35 million. The Trust Plan provided $10 million of HPL coverage; thus, ERC’s coverage for HPL claims did not attach until a claim exceeded $10 million. The primary cover limit with regards to the CGL was however lower, that it was either $1 million or $5 million.98 Following a claim by a patient, Providence entered into a settlement for $7.6 million. Providence’s insurance companies then made an interim funding agreement to fund the settlement, under which ERC contributed $6.6 million; the insurance company providing Providence’s primary coverage contributed $1 million. The underlying dispute arose between ERC and NewCap on the question of allocation (ie whether the CGL or the HPL provided coverage). This was significant because, as stated above, the CGL and HPL provisions had different policy limits, and the Umbrella policy for which ERC provided reinsurance was an excess policy that did not attach until the policy limits of the underlying coverage were exhausted. Thus, the allocation of the $7.6 million settlement between the parties depended on which provision of the underlying insurance plan provided coverage. For instance if the claim fell in HPL policy the loss would fall within $10 million primary coverage limit, therefore, the excess umbrella policy for which ERC provided reinsurance would not attach. 7.202 The settlement agreement between Providence and the third-party patient was silent on the question of allocation. The interim funding agreement between NewCap, DCNHS and ERC was, however, not silent with regards to the allocation. It stated that although ERC’s opinion was that the claim was covered under the HPL policy, because DCNHS “is a long-standing and valued client of [ERC] and both parties wish to work together in a cooperative spirit to facilitate settlement of the Underlying Action”, ERC would contribute $6.6 million toward the settlement. The agreement also made it clear that the contribution was “without prejudice to any right [ERC] may have to reimbursement of such funds in the event of judicial determination that [ERC] has paid more than required under the terms of the [DCNHS] policy.” 7.203 The reinsured argued that the claim fell within CGL policy and that ERC was obliged to follow its settlement because it was a good faith and reasonable settlement and the doctrine extended to decisions of how to allocate a settlement between different policies. The US District Court, D Kansas did not apply the follow the settlement doctrine to the case and allowed the reinsurers to challenge the reinsured’s settlement allocation, for the reason that the settlement between the third party and the Hospital was silent as to the policy within which the claim fell and the reinsurers had expressly reserved their rights to challenge the allocation while entering into the interim agreement with DCNHS and NewCap, Providence’s insurance companies. The district court also distinguished other cases that established and also applied the follow the settlement doctrine, in that here the reinsurers contributed the majority of the money that settled the case and in that, unlike the cases which

98. The parties disagreed on when ERC’s coverage attached with regards to the CGL policies that the reinsurance agreement provided that the attachment point was $1 million, whereas the Trust Plan originally provided $5 million. The court however did not address the issue as it was not relevant.

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applied the follow the settlements doctrine, in the present case the reinsurers and reinsured’s interests were directly opposed. In other words, while the interests of the primary insurer and the reinsured were aligned against the reinsurers, NewCap and DCNHS had different objectives in trying to settle the third-party patient than they did have in this coverage dispute. Summary 7.204 The principles that may be taken out from the abovementioned cases may be summarised as follows: • Under English law on the balance of probabilities if the settlement is reasonable and the amount allocated to the reinsurance is reasonable the reinsurers are not permitted to challenge their reinsured’s settlement. • In the US, the issue has come before courts at both the federal and states levels and in more diverse forms than the English courts have dealt with up to now. • In the US “questioning allocation of covered loss” is not permitted under the follow the fortunes doctrine but “looking behind the settlement to determine whether the loss claimed is covered by the reinsurance contract” is still permissible. In other words, where the reinsurers agreed to follow the fortunes of the reinsured, the courts refuse to allow a challenge to the reinsured’s settlement decisions based on the underlying policies but the reinsurers are entitled to raise defences based on the reinsurance contract and thus they may challenge the reinsured’s allocation of the settlements based on the contractual language of the reinsurance. • The reinsured is not under any positive duty to minimise the coverage but the reinsured still has to prove that the allocation was reasonable, or at least the allocation was one of the options that on a reasonable basis that he could choose among others. • Allocating the loss settlement to the reinsurance recovery favourable to the reinsureds own interest or in other words aiming to maximise the recovery from reinsurance is not itself sufficient to prove the reinsured’s bad faith. • If evidence indicates that the reinsured had in fact considered alternative allocation methods before settling the claim with the assured but then in finalising the settlement decided to apply a different allocation method, that is not sufficient to prove the bad faith in respect of the reinsured’s allocation. • The follow the fortunes rationale of maximising the coverage is not limitless. If the reinsurers prove that the reinsured in fact had settled the claim with its assured on a different allocation basis to that used against its reinsurers, it is likely that the reinsurers may succeed in their challenge. Therefore, where the settlement agreement between the assured and the reinsured itself expressly clarifies the allocation of the loss, or if the ground of the allocation is determined by a judgment and if the allocation to the reinsurance policies is clearly different, the reinsurers may be able to prove the reinsured’s bad faith in allocating the settlement amount and the follow the fortunes doctrine would not apply to the reinsured’s post-settlement allocation. • If it is clear from the facts that in its allocation the reinsured was motivated by the existence of reinsurance, this may ease the reinsurers’ position with regard to proving the reinsured’s bad faith. • If the reinsurers reserve their right to challenge the allocation while making the payment to the reinsured, and if the settlement based on the reinsured’s allocation is itself silent as for the grounds for the settlement allocation, the reinsurers may succeed in challenging the allocation. 204

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7.205 If a reinsured fails to settle the claim quickly and it is ultimately held liable to the assured it may have to pay a considerable amount of interest99 and the matter to be discussed is whether the interest should be counted as part of the loss in respect of which the reinsurers undertakes to indemnify the reinsured. The answer was held to be positive in Excess Insurance Company Ltd v Mathews100 but this case should be read in the light of its particular circumstances. In Excess Insurance Company Ltd v Mathews101 the claimant insured a mill in Budapest against fire and reinsured the risk at Lloyd’s. On 14 August 1914, war was declared between Britain and Austria-Hungary. The mill was destroyed by fire in September 1914. Under clause 12 of the conditions endorsed upon the policy the reinsureds were not bound to pay any loss until the fire companies interested in the property had settled and paid the fire losses. This had in fact been done by 20 February. On 8 March 1915, a “Loss Calculation Protocol” was signed between the agent of the reinsured and one Armin, providing that the agreed sum shall carry interest at 5% from 20 February 1915 until payment and that payment should be made within three months of the conclusion of peace or earlier if the wartime restrictions on payment by British to Hungarian subjects were removed, or if the claimants’ assets in Hungary became available. On 4 June 1920 the Treaty of Trianon with Hungary was signed, which by virtue of the Treaty of Peace (Hungary) Act, 1921, obliged the reinsured to pay to the assured with 5% interest to run from the date of commencement of hostilities (or, if the sum of money to be recovered fell due during the war, from the date at which it fell due) until the sum was credited to the Clearing Office of the creditor. 7.206 In this case, even though the risk occurred during the currency of the original policy, the insurers were legally prevented from paying such loss due to the First World War. After the War a protocol between Hungary and Britain made the insurers legally compellable to pay the loss but with interest at a specified rate of exchange at a date after the conclusion of the war. Therefore it was inevitable that the reinsured and the reinsurers were liable for the interest. However Branson J’s comments in this case can be interpreted as meaning that the follow the settlements clause should entitle the reinsured to claim interest from the reinsurer. The learned judge stated that subject to the point on the words “and to follow their settlements” the reinsurers could not be made liable to pay interest merely because the claimants chose to agree to do so or because the claimants became compellable to do so by any act or default of their own other than an express agreement in the original policy. However even though the learned judge put a reservation on the effect of the follow the settlements clause it was not the basis of the decision. 7.207 It should also be remembered that the settlement process might be prolonged because the insurers might have refused to give consent to the reinsured’s settlement. Even in this situation it is unlikely that reinsurers are to be held liable for the surplus interest because the insurers took the risk under a “claims cooperation”102 clause that reinsurers may refuse consent. E X T R A - C O N T R AC T UA L L I A B I L I T Y

7.208 A reinsured may be obliged to make payment to the assured in excess of its contractual liability. The reinsured may be exposed to this situation because it failed to settle the claim 99. Section 35A of the Supreme Court Act 1981 authorises the English courts to award interest on the sum due, and s. 17 of the Judgments Act 1838 provides that interest runs from the date of judgment to the date of actual payment. 100. (1925) 23 Ll L Rep 71. 101. Ibid. 102. For claims cooperation clauses see Chapter 9 below.

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promptly, thereby rendering itself liable for damages for its negligent act.103 This may arise because the reinsured is obliged to make payment within a certain time limit but did not do so in breach of express terms of the contract, as in Insurance Co of Africa v Scor (UK) Reinsurance Co Ltd,104 where the reinsured was obliged to settle the claim in 60-day period. In Scor, the claim for extra-contractual liability was rejected because it was in conflict with the “claims cooperation” clause. After the subject matter insured was destroyed by fire, the reinsured investigated the claim and the loss adjuster report was prepared, the reinsured believed that it was liable, but the reinsurers notified the reinsured that they would not indemnify the reinsured in case the latter settled the claim with the assured. The reinsurers received some anonymous letters which alleged that the fire was set deliberately by the assured; so the reinsurers suspected that the original claim was fraudulent. The reinsurance policy contained a full reinsurance clause as well as a claims cooperation clause. The latter provided “It is a condition precedent to liability under this insurance that all claims be notified immediately to the Underwriters subscribing to this policy and the reassured hereby undertake in arriving at the settlement of any claim, that they will co-operate with the Reassured Underwriters and that no settlement shall be made without the approval of the Underwriters subscribing to this Policy.” 7.209 The reinsured, upon the refusal by the reinsurers to approve the settlement, had to deny liability and the assured brought an action against the reinsured in Liberia. The reinsured was not able to prove that the claim was fraudulent because there was no evidence of fraud and the jury awarded $3.5 million for the assured loss, as well as $600,000 for general damages, apparently penal in character.105 Additionally, the reinsured paid $58,000 for the cost of defending the assured’s claim. One of the preliminary issues before the Court of Appeal was whether or not the reinsurers were obliged to indemnify the reinsured for the general damages and costs as well as the sum for the insured property. Neither Leggatt J nor the Court of Appeal distinguished the reinsured’s claim for general damages from its claim for costs,106 but discussed the reinsurers’ liability for $658,000 as a whole. Stephenson LJ agreed with the first instance decision and held that the reinsurers’ refusal obliged the reinsured to deny the assured’s claim, subsequently the reinsured was sued by the assured which led the judgment for additional amount of $658,000 as well as liability for the loss of the insured property. Leggatt J and Stephenson LJ were of the opinion that the reinsurers were liable for $658,000 even though it would exceed the amount reinsured, at least to the extent of their proportion of the risk. However the majority of the Court of Appeal was of the view that by refusing to give approval of the settlement, the reinsurers merely used their contractual rights and they, albeit leaving the reinsured in a very difficult position, had not obliged the reinsured to deny the claim but left it to the reinsured to decide what to do; the reinsured could have settled the claim and if the reinsurers did not indemnify upon the settlement, the reinsured could have sought to prove that it was in fact liable to pay the claim and therefore entitled to recover under the reinsurance policy. Therefore, the majority of the Court of Appeal found it unnecessary to imply a term into the reinsurance contract to the effect that the amount awarded for general damages and the cost should fall on the reinsurers. Implying such a term could have been possible if the reinsurers had requested the reinsured to conduct the legal proceedings which resulted the incurring the liability to the general damages and costs but the reinsurers did not

103. It is unclear whether such liability is imposed by English law: Butler and Merkin, Reinsurance Law, paras. C-0135, C-0136. 104. [1985] 1 Lloyd’s Rep 312. 105. Ibid., at 324, per Lord Justice Stephenson. 106. As to costs, see the discussion on para 7.01, et seq.

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so request and had only refused to give approval of the settlement, which is not the same as compelling the reinsured to conduct the legal proceedings. 7.210 It should be added that in Scor the Court of Appeal107 focused on the effect of the “claims cooperation” clause and not the follow the settlements clause; therefore it is not certain what would the position would have been if the policy contained only the settlements clause without any claims provisions.108 Moreover in Scor the extra-contractual liability was in excess of the reinsurance policy’s limit so it is not clear what the position would have been if the aggregate sum had remained within the reinsurance policy limit.109 7.211 Another possibility is that the reinsured might be obliged to pay exemplary damages representing a penalty for settling the claim late. There is no direct authority on reinsurance110 in English law, but it is arguable that this would be a personal punishment of the reinsured and the award should be borne by the reinsured only.111 7.212 As the phrase itself suggests “extra-contractual liability” is not within the coverage of the reinsurance contract itself: such liability is outside the original policy because it is not damage to or loss of the subject matter insured. Therefore, it is submitted, that it would not be justifiable to hold the reinsurers liable for such amount unless the policy expressly provides otherwise. Furthermore, imposing liability would also be inconsistent with the nature of reinsurance now presently recognised, as it would turn out to be a general liability insurance of the reinsured.112 An implied term which allows the reinsured to claim punitive damages awarded against it would in addition potentially expose the reinsurers to open-ended liability unless any such term was to be confined to payment up to policy limits. All of that aside, if a penalty is imposed on public policy grounds, there may be public policy objections to the obligee being indemnified for it. 7.213 Extra Contractual Obligations (ECO) are defined in the US as: “damages awarded by a court against an insurer or reinsurer that are outside the provisions of the insurance policy, due to the insurer’s bad faith, fraud, or gross negligence in the handling of a claim.”113 7.214 The question of whether or not a follow the fortunes clause applies to punitive damages awarded against an assured or a reinsured has come before the courts on a number of occasions. The opinions are not unanimous and turn on the facts of the case and the policy wording. In principle, unless the parties expressly agree,114 a follow the settlements clause does not apply punitive damages because the clause applies to the claims at least arguably within the original policy cover whereas ECO, by definition, arise outside the reinsurance policy.115 7.215 In American Ins Co v North American Co for Property and Cas Inc116 the parties to the insurance contract agreed that coverage for punitive damages would be provided, unless prohibited by local public policy, only when the assured was “vicariously assessed with 107. [1985] 1 Lloyd’s Rep 312. 108. Butler and Merkin, Reinsurance Law, para. C-0138. 109. According to Uzielli v Boston Marine Insurance (1884) 15 OBD 11 it could be said that if it is within the policy limit the reinsurer may be held liable for such losses. 110. See Lancashire County Council v Municipal Mutual Insurance Ltd [1997] QB 897 where it was held that public policy for a liability policy would cover both compensatory awards and exemplary damages. 111. Butler and Merkin, Reinsurance Law, para C-0144. 112. Ibid., para C-0137. 113. Glossary of Insurance and Risk Management Terms, 11th edn, IRMI Book Collection, 2007, 104. 114. Hartford Fire Ins Co v Lloyd’s Syndicate 1997 US Dist Lexis 10858 (DConn 1997) it was accepted that the clause “those liabilities . . . which arise from the handling of any claim [including] but not limited to . . . alleged or actual negligence, fraud or bad faith . . . .” included ECO. 115. Curiale v DR Ins Co 593 NYS 2d 157 NY Sup, 1992. Schoenberg (conference paper); Staring, §18:7. 116. 697 F.2d 79, (2nd Cir. (NY) Dec 30, 1982).

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punitive damages but did not itself direct or ratify the offending act” and would not be available for punitive damages assessed because the assured “has itself performed, directed or ratified the offending act.” A Minnesota state court jury found the assured liable to pay $146,970 of compensatory damages and $750,000 of punitive damages caused by a fire in a building insulated with a product that the assured produced. The reinsured settled the claim, but the reinsurers denied liability for the reason that the punitive damages award was for the assured’s deliberate corporate misbehaviour which was not covered by the original insurance and therefore the reinsurance policies. The reinsured however asserted that even if the punitive damages award was outside the original insurance, the reinsurers agreed to follow its businesslike settlements. 7.216 The reinsured’s claim was rejected. The Second Circuit found the claim clearly outside the original insurance policy according to the policy wording, in which the court found no ambiguity. In response to the reinsured’s contention that the reinsurers were obliged to follow its settlement, the Second Circuit noted that the settlement was primarily designed to compensate the reinsured for a punitive damages award that was excluded from the reinsurance policy. 7.217 However, as will be seen below, the cases suggest that agreeing to follow the fortunes of the reinsured may include an obligation to follow the fortunes for extra-contractual obligations.117 For instance, in Inland Mut Ins Co v Peerless Ins Co118 the reinsurers were held to be liable for the reinsured’s share of extra-contractual obligations in the absence of any express clause. Inland issued a vehicle liability policy under which Inland agreed to indemnify the assured against liability for personal injuries arising out of the operation of the insured’s vehicles to the extent of $15,000 for injuries arising to one person in any one accident. Pursuant to the reinsurance treaty, Inland retained $5,000 of this coverage and transferred to Peerless the excess, forwarding to Peerless the appropriate proportion of the premium paid by the assured. 7.218 The assured was involved in an accident where a third party made a claim against him. The reinsured and reinsurers were notified the claim. During the litigation the claimant’s advocate offered a settlement of $20,000 but the advocate representing the assured and appointed by the reinsured without objection by the reinsurers found the amount too high and was of the opinion that they should not settle for more than $7,500. The claimant rejected this offer, and after a trial the jury awarded $75,000, Inland paid the assured $15,000, and Peerless paid Inland $10,000. Then, the assured brought an action against Inland for its negligence and bad faith in failing to settle the third-party litigation for $17,500. The parties reached a settlement where Inland paid the assured $27,500, and the assured paid the third party this $27,500 together with an additional $30,000 (the face amount of the policy together with $15,000 contributed by the assured), or a total of $57,500, for the release of the third party judgment of $75,000. Afterward the reinsured initially claimed the full $27,500 which later was reduced to two-thirds of that amount. Inland also claimed from Peerless its “proportionate share” of the expenses of investigating and defending the Arms-Yeatts (third party – assured) suit and the Yeatts-Inland (assured–reinsured) suit. 7.219 The court put emphasis on the fact that Inland kept Peerless fully and adequately informed of the significant developments in the case of Arms v Yeatts. Peerless expressed no objection to the nature or quality of the defence provided by Inland. The court119 noted that 117. Hollenbach, M, “Surplus Share,” Reinsurance Contract Wording, 3rd edn, R W Strain (ed.) 1998, 201. 118. 152 F.Supp 506, (S.D.W Va Jun 26, 1957) aff’d, 251 F.2d 696, (4th Cir. (W Va) Jan 06, 1958). 119. There is no previous authority on the matter, so the court has to decide the question for itself without the benefit of earlier judicial guidance. Therefore the court stated that the question that whether Peerless is liable under the facts in this suit is one of first impression.

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under the original policy the obligation of Inland was to defend any suit against Yeatts, and it had the right to investigate, negotiate and settle any claim or suit, and as the liability of Peerless followed that of Inland in every case, upon actual payment of loss by Inland, the question was whether or not the payment by Inland of $27,500 and expenses in the Yeatts v Inland suit, was a loss or expense of Inland under its policy insuring Yeatts. 7.220 The court also found that law firm defending the third-party claim was selected by Inland, but Peerless never at any time objected, nor did seek to exercise its rights to be associated with the company in the defence or control of any claim or suit or proceeding by appointment of its own counsel.120 7.221 Peerless therefore was held to know as much about the Arms case as did Inland, Peerless was freely and frankly consulted by Inland and Peerless left the decision in Inland’s hands. Accordingly, that decision became the decision of Peerless as well as Inland; Peerless was thus bound along with Inland by that decision whether sound or unsound, favourable or unfavourable; and that because the liability of Peerless “shall follow that of” Inland, Peerless was liable for two-thirds of the cost to Inland of a concededly proper settlement of the YeattsInland litigation. Notably, the court accepted in this case that claims cooperation created a joint enterprise: in other words, in defending the action against Yeatts, the companies were unquestionably engaged in a joint enterprise, the losses arising from which were be borne in accordance with their respective interests in the enterprise. 7.222 It has been suggested that the interpretation of the contract language and defining the parties as joint venturers was wrong:121 the court ignored the fact that the reinsurer agreed to follow the reinsured’s liability under the original policy, not outside it. Once the reinsured’s liability under the original policy was exhausted, no further liability could be imposed on the reinsurer. It has also been said that it was the reinsured who could make the ultimate decision despite the reinsurer’s involvement in investigating and defending the claim.122 The reinsurer did not have control of the handling of the underlying claim and should not be penalised by that.123 The argument here runs that in Peerless the insurer was penalised by the court for having analysed both the original claim and the nature of the reinsurance relationship accurately.124 It should be noted that Peerless did not rule on what the position might be where the reinsurers are not fully appraised of all developments regarding the claim or were not consulted about the settlement procedure within the policy limits or where the reinsurers refused to settle the claim after the consultation. 7.223 Peerless has since been regarded as a case that is confined to its facts125 and was distinguished in Employers Reinsurance Corp v American Fidelity & Cas Co126 where the extracontractual liability of the reinsured concerned an excess of loss reinsurance which did not contain a follow the fortunes clause. In this case, American was the excess insurer of LC Jones Trucking Company, with coverage up to $25,000. American then purchased a reinsurance treaty from Employers’ Reinsurance Corporation for retaining for itself $10,000 of the liability loss exposure. Employers’ maximum reinsurance coverage under the treaty was $90,000 measured

120. In fact, Peerless appointed its Assistant Secretary (an attorney) who extensively involved in the handling of the claim. 121. Schoenberg, C H, “Follow the Fortunes and Extra-Contractual Obligations (“ECOs”),” Mealey’s Litigation Report: Reinsurance, 8 July 1992, Vol. 3 No. 5, p. 24. 122. Schoenberg, 25. 123. Ibid. 124. Ibid. 125. See Bellefonte Reinsurance Co v Aetna Cas and Sur Co 903 F.2d 910 (2nd Cir. (NY) May 19, 1990). 126. 196 F.Supp 553, DC Mo, Dec 14, 1959.

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by the ‘Definition of Loss and Claim Expenses’. “Loss” was defined by the treaty to “mean only such amounts, within applicable policy limits, as are actually paid in cash by the reinsured to claimants in settlement of claims or in satisfaction of judgment; but the word ‘loss’ shall not include claim expenses.” “Claim Expenses” included “court costs, interest upon judgments, insurance afforded for first aid medical expense, and allocation, investigation and legal expense, paid by the reinsured.” The treaty also contained a clause regulating the reinsurers’ contribution to expenses with regards to the appeal taken by the reinsured from a verdict or judgment which was in excess of the reinsured’s retention, if ‘the amount of such appeal or judgment in excess of the reinsured’s Retention bears to the total amount of such verdict or judgment, excluding from such computation such part of such verdict or judgment as may be in excess of the limits provided by the policy.’ The reinsurance treaty did not contain a follow the fortunes provision. 7.224 There were two disputes related to this action, one brought against the assured by third parties in Florida and the other brought by third parties in Oklahoma. In both cases the assured was found to be liable to indemnify the claimants and American, the reinsured, did not settle the claim while the actions were in proceeding. In the meantime the reinsured kept informing the reinsurers, Employers, with regards to the proceedings. In both cases the amount that American was held to be liable was exceeding American’s retention and Employers’ indemnified American accordingly. The dispute between American and Employers’ nevertheless arose from the actions brought by the assured against American for American’s bad faith in refusing to settle the third party claims against the assured within the policy limits. As for the litigation in Oklahoma, a verdict was returned in favour of the assured for $7,133.49, and $28,988 had been returned against American for “bad faith” in refusing to settle the claims within policy limits in the Florida litigation. 7.225 American asserted that it was a recent trend in insurance law that an insurer may be held liable for amounts in excess of its policy limits when the insurer negligently, or in bad faith, refused to accept a settlement offer within policy limits. American contended that under such circumstances the reinsurers should be required to follow the reinsured’s fortunes to the effect that Employers’ reinsurance treaty should be held to cover excess judgments obtained against the reinsured. 7.226 The US District Court, WD Missouri, (Western Division) disagreed with American’s contention. The court stated that contractually, the reinsurance treaties were silent with regards to the factual situation whereby liability was imposed upon Employers for American’s “bad faith” or negligent failure to settle a liability claim within the ambit of American’s primary policy coverage when American had a reasonable opportunity to do so. The ground for the liability that caused American to pay to its assureds in the Oklahoma and Florida cases sums in excess of its policy coverage was one imposed by the law of tort and not strictly by breach of contract. The court noted that the relationship between assured and insurer was different in nature to that between a reinsured and its reinsurers, that in the former a duty was imposed upon the insurer to act honestly and in good faith toward the assured and a number of courts recognised insurers’ liability for their bad faith failure to accept a reasonable compromise and for negligence in rejecting such an offer. The court put emphasis on the fact that “bad faith” in such circumstances arose in tort as independent of the contract obligation. The court defined American’s action here for that of seeking to impose liability on Employers for its own adjudicated “bad faith” merely because of the contractual relationship between the parties and American argued that Employers liability as a reinsurer ‘follows that of (American) in every case,’ as a matter of law. 7.227 It is worth noting that the court distinguished Peerless and held that Employers’ reinsurance treaty and factual situation giving rise to the excess claims made it clear that the 210

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Peerless case was not authority in support of American’s position. The obvious difference between the two cases was that in Peerless the reinsurance treaty specifically provided that “the liability of the reinsurer (Peerless) shall follow that of the Company (Inland) in every case” whereas Employers reinsurance policy did not include a follow the fortunes clause. The contractual language of the Employers policy clearly stated that the reinsurance contract was that of “indemnity” to the reinsured against “loss” within specified limits set forth in the reinsurance contract and the court refused to construe such a contract as providing indemnity against liability to American or to the assured. The court also emphasised that there was no privity created between the original assured and the reinsurers under the type of reinsurance contract here considered. According to the district court the result in Peerless was in favour of the reinsured, first, because of the follow the fortunes clause, and secondly, because the excess liability claim resulted from the particular dealings between the parties in Peerless. The court defined Peerless as a case where the conclusion was reached by a limited view that the reinsurers were obliged to follow the fortunes of the reinsured, and the court in Peerless had not taken into consideration to what extent the fortunes of the reinsurers should follow those of the reinsured. Employers’ reinsurance treaty was to indemnify American after American discharged its liability to the assured primary insured and that being so, in the absence of a charge of “specific bad faith” on the part of Employers in respect to a duty owed to American, there was no legal basis for the claims American had made in this action. 7.228 The district court recognised the possibility of making such a claim against Employers only if Employers and American were engaged in a joint enterprise in respect to the liability imposed on American for the latter’s “bad faith” failure to compromise its primary claims. Alternatively, the court also accepted that there could be liability if Employers joined with American in its tortious breach of the latter’s policy obligations to its assureds. However, the court found no factual basis to support any of these alternative suggestions: Employers policy was not a joint adventure but a policy where Employers undertook to indemnify American for loss actually paid by it. Moreover, if American and Employers were joint tortfeasors in respect to the liability imposed by law on American, and if American sought for indemnity against Employers on that basis, then American would have no right of contribution against Employers. 7.229 The Peerless and Employers cases were distinguished in Ott v All-Star Ins Corp,127 where the Supreme Court of Wisconsin held that the “excess of policy coverage” clause added to the original reinsurance agreement made the reinsurer the liability insurer of the insurer, allowing the assured to make a direct claim against the reinsurer for the reinsured’s alleged tort of bad faith. In Ott v All-Star the addendum to the reinsurance agreement between North Star and the All-Star provided: “Notwithstanding the foregoing it is also agreed that should the Company become legally obligated to pay a loss in excess of its policy limits the Reinsurer agrees to assume seventy-five percent (75%) of that part of such loss (plus proportionate loss expense) which is in excess of the policy limit. However, in the event the applicable policy limit is less than the Company’s retention at the time of the loss, the amount hereby assumed by the Reinsurer shall be limited to seventy-five percent (75%) of that part of the loss (plus proportionate loss expense) which is in excess of said retention. In no event, however, shall the liability of the Reinsurer, respecting such loss, exceed the maximum amounts of liability set forth in the Exhibits attached hereto.”

127. 99 Wis.2d 635, Wis, Jan 6, 1981.

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7.230 The Supreme Court of Wisconsin stated that, despite the similarities between the reinsurance policies in Peerless and Ott v All-Star, in neither Peerless, nor Employers did the reinsurance policies provide “excess of policy limits” coverage in the form of the addendum in Ott. Furthermore, in Employers, the reinsurance policy did not contain a follow the fortunes clause, and the court focused on the contractual terms of the reinsurance agreement. The court emphasised in Employers that the reinsurance contract did not provide liability insurance to the reinsured or to the assured. According to the Supreme Court of Wisconsin, the main distinguishing element which led to a different contractual relationship between the reinsured and the reinsurers in Ott v All-Star to that in Peerless or Employers, was the Addendum which made North Star the liability insurer of All-Star to the effect of providing coverage for All-Star’s torts in connection with All-Star’s relations with its own assureds. 7.231 A commentator has suggested that ECO are to be distinguished from Excess of Loss Policy Limits (XPL) which relate to covered losses that are in excess of the policy limits.128 Similar to the view adopted in North River v CIGNA129 as for the defence costs above, it is contended that where a reinsurance agreement contains a follow the fortunes clause, so long as the reinsured acted in good faith in settling the claim, the strict ECO rules should not be applicable and the reinsurers should be bound by the settlement unless the reinsurance policy expressly provides to the contrary.130 The author justifies this approach by arguing that holding otherwise might cause claims decisions to be distorted, thereby ultimately increasing the losses claimed from reinsurers.131 It is not clear what the author means by saying “unless specifically agreed otherwise” but this is referring to the situation in which XPL is not expressly excluded then what is being said is effectively that as long as the reinsured has acted in good faith in settling the claim, the reinsurers should follow its settlement irrespective of the maximum sum reinsured. In Bellefonte,132 which was decided two years before the article was published, it had been decided that the follow the fortunes clause could not be interpreted so as to disregard the reinsurance policy limits. There is no reason why the reinsurers should be obliged to pay more than the policy limit simply to prevent a reinsured distorting the claim.133 And in fact as the Second Circuit noted in Unigard134 a reinsurance policy provides otherwise simply by imposing policy limits. C O M M U TAT I O N S

7.232 As a means of simplifying accounting issues reinsurers and reinsureds may enter into commutation agreements that release the parties from accrued and future liabilities, known and unknown, in relation to the payment of agreed sums.135 Since liability under the reinsurance 128. Maneval, A, “‘Follow the Fortunes’ and Excess of Policy Limit Obligations,” Mealey’s Litigation Report: Reinsurance, 9 September 1992, Vol. 3 No. 9, 15. 129. 52 F.3d 1194, (3rd Cir. (NJ) Apr 13, 1995). 130. Maneval, 18. 131. Ibid., 17. 132. 903 F.2d 910 (2nd Cir. (NY) May 18, 1990. 133. That is true that in Penn Re, Inc v Aetna Cas and Sur Co Not Reported in F.Supp, WL 909519 EDNC, Jun 30, 1987 the reinsurer was held liable beyond the policy limit but the ratio of the case did not base on the “follow the fortunes” doctrine but a particular clause that the court relied on. 134. 4 F.3d 1049 (2nd Cir. (NY) Sep 09, 1993). 135. Merkin, Colinvaux’s Law of Insurance para. 17-22; Evans LJ in Korea Foreign Insurance Co v Omne Re Sa [1999] 1 Lloyd’s Rep IR 509, 514 particularly in relation to old accounts or when one party is in run-off. MacGillivray on Insurance Law, para. 33-70; O’Neill/Woloniecki, para. 5–54. For an example of a commutation agreement, see A Guide to Reinsurance Law, 303–306. The sum in question is calculated by taking into account the claims history, what claims are likely to be made in the future and the likely cost of those claims and what payments are likely to be made in respect of existing claims.

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agreements is replaced by a fresh contract the question here becomes whether the remedy for breach of the commutation agreement is enforcement of that agreement, or disregard of that agreement and reversion to the rights set out in the reinsurance agreement. 7.233 According to general contract law principles, if one party is in repudiatory breach of contract the other party has a right to elect whether or not to perform the contract or to treat it as wholly discharged. On the other hand commutation agreements, unless the contrary is provided, release the parties from their obligations arising from the underlying contract and any claim can be brought only for breach of the commutation agreement. However an express term can provide options for the parties. For instance in Korea Foreign Insurance Co v Omne Re Sa136 the commutation agreement was subject to a condition precedent that “in the event the Omne Re makes default in payments of USD 100,000.00 upon execution of this Agreement and/or any of the instalments within 5 to 10 bank working days from [any] reason whatsoever, this Commutation and Release Agreement shall be wholly null and void, and KFIC shall be entitled to reserve its full rights without prejudice to its rights under the Reinsurance Agreements and the claims recoveries.” The agreement was also stated to be in “full and final settlement of the outstanding claims under the reinsurance contracts.” The Court of Appeal was of the opinion that the clause was not to be construed as meaning that the commutation agreement was null and void in case of any default in making payment because such a construction would be contrary to business commonsense and to the commercial purpose of the contract: that approach would enable the reinsurers to render the agreement null and void at any time simply by not making payment during the performance of the agreement. Therefore, the effect of the clause was held to be that a default during the interim period gave the reinsured a right to elect whether or not to affirm the compromise agreement and to insist upon performance of its terms or to disregard the agreement and rely upon the underlying reinsurance contracts.137 7.234 Another question may be whether or not a commutation agreement is a settlement within the meaning of the follow the settlements clause. A similar issue came before the High Court of Singapore in Overseas Union Insurance Ltd v Home and Overseas Insurance Co Ltd138 where OUI entered into ten reinsurance contracts with the reinsured then made a claim against its retrocessionaires. The reinsurance agreement provided “all loss settlements made by the reinsured, including compromise settlements, shall be unconditionally binding upon reinsurers.” Woo Bih Li J held that the follow the settlements clause did not make the commutation recoverable from the retrocessionaires. A commutation agreement was not a settlement within the meaning of the follow the settlements clause: it was a separate agreement over and above a reinsurance contract. 7.235 This decision seems justifiable as the learned judge correctly stated that a commutation agreement includes the settlement of losses but the reasons for settlement are quite different to a normal settlement because the reinsurer has another priority besides merely settling the individual losses. The agreement will cover various claims and counterclaims that have been accrued and also future liabilities. Therefore by its nature a commutation is usually entered into within the context of treaty rather than facultative reinsurance, but even if it is made in the latter context, so long as the reinsured loss has not been ascertained, it may be the case that the reinsurers are not obliged to follow the commutation agreement.139 136. [1999] 1 Lloyd’s Rep IR 509. 137. The words “void ab initio,” were disregarded by the Court of Appeal because the phrase had not been used accurately. 138. [2002] 4 SLR 104. 139. Lumbermans Mutual Casualty Co v Bovis Lend Lease Ltd [2005] 1 Lloyd’s Rep 494. This case has, however, been doubted insofar as it decides that the mere fact that various losses are contained in the same settlement does not mean that the settlement cannot be used as the basis for a claim against reinsurers: Enterprise Oil Ltd v Strand Insurance Co Ltd [2006] EWHC 58 (Comm); AIG Europe (Ireland) Ltd v Faraday Capital Ltd [2008] Lloyd’s Rep IR 454.

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FUTURE AND UNIDENTIFIED CLAIMS

7.236 In Insurance Co of State of Pennsylvania v Associated Intern Ins Co140 Associated, the reinsurer, challenged the reinsured’s settlement which called for the payment of “future, unidentified claims.” Associated asserted that the reinsurers agreed to cover payments which are “required only for funds actually expended to injured claimants by way of settlement or judgment.” According to Associated, ICP (reinsured)’s settlement was beyond the scope of the reinsurance because ICP entered into the settlement in order to free itself from a bad faith actions by its own assured. The US Court of Appeals for the Ninth Circuit took into consideration that it was common ground that “the funds paid in settlement . . . would be used for payment by Fibreboard of actual asbestos claims made against Fibreboard.” The court found the operative language of the settlement agreement, the reinsurance contract and the insurance policy was clear and unambiguous: The ICP-Fibreboard settlement agreement required ICP to pay asbestos claims “as and if such claims arise.” The reinsurance contract provided that Associated’s liability “shall follow that of [ICP] and shall be subject in all respects to all the terms and conditions of the [ICP-Fibreboard] policy . . . .” Turning to the ICP-Fibreboard policy, ICP was required “to indemnify [Fibreboard] for all sums which [Fibreboard] shall be obligated to pay by reason of the liability . . .” The court concluded that the asbestos claims represented a liability against Fibreboard which it was obligated to pay; accordingly, ICP was bound to indemnify Fibreboard, and, pursuant to the reinsurance contract, Associated was required to indemnify ICP. The Ninth Circuit further recognised that to hold settlements between an assured and insurer which addressed future claims were not reimbursable under the reinsurance would defeat the parties’ contractual purpose. The court noted that judicial policy in California was against implying provisions into insurance contracts which would defeat the contractual purpose. The Ninth Circuit’s final comment on the settlement dispute is noteworthy: to decide in favour of Associated “would frustrate the public policy which encourages settlement.”

140. 922 F.2d 516, (9th Cir. (Cal) Dec 27, 1990).

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8.01 The follow the settlements clause is not always worded in its usual form and some variations may be found. In such cases the question is whether or not the variations release the reinsured from the obligation of acting in bona fide and businesslike manner in settling the assured’s claim. On the London reinsurance market variations in the wording of the follow the settlements clause may be seen as follows: “Without Question” to Follow the Settlement 8.02 This was the issue in Assicurazioni Generali SpA v CGU International Insurance plc.1 where the reinsurance was: “As original: Anything herein to the contrary notwithstanding, this Reinsurance is declared and agreed to be subject to the same terms, clauses and conditions, special or otherwise, as the original policy or policies and is to pay as may be paid thereon and to follow without question the settlements of the Reassured except ex gratia and/or without prejudice settlements.”

8.03 Generali’s primary construction was that the effect of the provision was that the reinsurers were obliged to indemnify Generali in respect of any settlement entered into by Generali under the underlying policy other than an ex gratia or without prejudice settlement or a settlement made in bad faith. Generali submitted that the words “without question” precluded the reinsurers from challenging whether Generali had taken all proper and businesslike steps in making the settlement. 8.04 At first instance Gavin Kealey QC2 rejected the argument that the words “without question” qualified the follow the settlements clause. The function of the words “without question” was to describe the manner in which the reinsurers were required to follow those settlements but they did not mean that the reinsurers agreed to relieve Generali of its important implied obligation in relation to any compromise of liability or amount to take all proper and businesslike steps in making the settlement. Gavin Kealey QC accepted the possibility to exclude the obligation to take reasonable and businesslike steps to enter into a good faith settlement with the assured, but in order to do so far clearer and more explicit words would be required. The Court of Appeal3 agreed with the first instance decision and noted that the words “without question” were not sufficiently clear to exclude the second proviso of Scor. 1. [2004] 2 CLC 122. 2. [2003] 2 CLC 852, 878–879. 3. Tuckey LJ, [2004] 2 CLC 122, 131 (Sir Martin Nourse and Gibson LJ agreed).

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Liable or not Liable 8.05 In Charman v Guardian Royal Exchange Assurance4 the claimant’s syndicate at Lloyd’s insured an oil refining company for the period of 24 months from 1 September 1989. The insurers took out a facultative reinsurance policy which provided: “Subject to the same terms, conditions, definitions, warranties as Sections ii(a), ii(b), ii(c), ii(d) and iii of the original policy and to follow such sections insofar as applicable, including loss settlements, liable or not liable.”

8.06 On 16 September 1989 Hurricane Hugo approached the refinery; it passed over the refinery on 17 September as a result of which the assured suffered various losses and made various claims against its insurers. As a result of the loss adjusters’ report, which was prepared with accountants, engineers and salvors, the insurers paid the assured’s claim. The reinsurers however rejected the reinsured’s claim. The reinsured submitted that the added words to the follow the settlements clause that “liable or not liable” removed the proviso that the reinsured must have effected his settlement in compliance with the businesslike obligation. 8.07 Webster J5 found the settlement in this case was reasonable and businesslike and therefore, applying the Scor test, held that reinsurers were liable. The learned judge nevertheless commented on the effect of the additional words “liable or not liable”: Referring to Scor, Webster J6 once again emphasised that by virtue of a follow the settlements clause the reinsurers trust not merely the honesty, but also the professionalism of insurers, and the standard of care imposed on the insurer was that of acting both honestly and in a proper and businesslike manner, but no higher than this. 8.08 According to Webster J, Scor underlined the difference between an obligation to take care to ascertain the loss and the less onerous obligation to take proper steps to have it ascertained. The judge accepted that the clause in the present case differed in some respects from a typical “follow settlements” clause, but the judge found no material difference for the purposes of this case.7 8.09 Webster J noted that the only possible qualification by the added words to the obligation to act in a bona fide and businesslike fashion would be that the reinsured would be entitled to pass on to his reinsurers a claim which he settled when he knew that there was no liability under the claim either because there was no prima facie liability or because he had an arguable defence to it which he waived. However, as the learned judge pointed out, in most circumstances, that settlement would probably not have been made in good faith or in a businesslike manner; but, theoretically, there may be instances where a claim could be settled in those circumstances both in good faith and in a businesslike manner. However, as the judge found the settlement in this case bona fide and businesslike, he did not decide if this theoretical qualification was applicable to the settlement in front of him.

VA R I AT I O N S - L I M I T I N G C OV E R : “ W I T H O U T P R E J U D I C E ” S E T T L E M E N T S

8.10 In Faraday Capital Ltd v Copenhagen Reinsurance Co Ltd8 Aikens J discussed the types of settlement falling within the ambit of a follow the settlements clause which excluded 4. 5. 6. 7. 8.

[1992] 2 Lloyd’s Rep 607. Ibid., at 612. Ibid., at 611. Ibid. [2007] 1 Lloyd’s Rep IR 23.

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8.15

“without prejudice settlements.”9 Lexington issued the primary layer of insurance for Nevada Power, an electricity company that conducts business in the US and operates a number of electricity generating stations, for losses up to US$5 million. The dispute concerned an excess layer policy which insured Nevada Power in respect of real and personal property situated within the US. The policy provided coverage against all risks of direct physical loss or damage for a period of 36 months from 15 June 1998 up to a limit of US$345 million per occurrence for each location in excess of $5 million per occurrence for each location in excess of specified deductibles. Faraday underwrote some 9.778% of this excess layer original policy. 8.11 Copenhagen Reinsurance reinsured Faraday in respect of its proportion of the original policy up to a limit of $95 million per occurrence in excess of $5 million per occurrence in excess of underlying deductibles for the period of 24 months from 15 June 1999. 8.12 The Reinsurance Contract contained a follow the settlements provision; its terms were as follows: “This Reinsurance is subject to all terms, clauses and conditions as original except as provided for herein, and to follow in all respects the settlements or other payments of whatsoever nature excluding Without Prejudice and Ex-Gratia Settlements made by the Original Underwriters arising out of and in connection with the Original Insurance.”

8.13 In May 2000 two of the generating units at the Clark Generating Station, Nevada suffered a failure and the Station tripped off-line. The failure caused two types of loss (ie repair costs and the costs of replacement power). The loss with regard to generating unit No 7 was over US$11 million, generating unit No 8 was over $10 million. After it was repaired, unit No 8 again suffered a loss totalling over US$9 million. 8.14 Nevada Power presented a claim under the primary layer insurance and original policy in respect of all of these costs and expenses. Faraday, along with the primary insurers, settled Nevada Power’s claims in respect of generating unit No 7; Faraday’s proportion of this settled sum was $504,531.60. 8.15 No payment was made in respect of unit No 8; Nevada Power brought an action against the primary and excess insurers in the US by claiming that the three abovementioned failures amounted to one occurrence, not two or three. On the advice of lawyers in the United States, Nevada Power’s claim was eventually settled. The settlement agreement had a long preamble which stated, inter alia, that: (a) That “although the London Market Insurers made certain payments towards the Claims, they denied liability for some aspects of the Claims”; (b) That “in an effort to obtain further payments towards the Claims . . . Nevada Power filed an action [in the US District Court for the Southern District of Nevada] . . .”; (c) That “. . . the London Market Insurers have denied and continue to deny all substantive allegations asserted against them in the action”; and (d) That “. . . by this Agreement, the Parties intend to adopt, by way of compromise and without prejudice to or waiver to their respective positions, without further trial or adjudication of any issues of fact or law, and without the London Market Insurers admitting liability, either under the Subject Insurance Policies or under any other theory, a full and final settlement that releases and terminates all rights, obligations and liabilities of the London Market Insurers to NPC with respect to the Claims under Subject Insurance

9. “This Reinsurance is subject to all terms, clauses and conditions as original except as provided for herein, and to follow in all respects the settlements or other payments of whatsoever nature excluding Without Prejudice and Ex-Gratia Settlements made by the Original Underwriters arising out of and in connection with the Original Insurance.”

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Policies, including but not limited to, all rights, obligations and liabilities arising from the Claims on a contractual, extra-contractual, tortuous, fiduciary or any other basis.” 8.16 Nevada Power also agreed to release the insurers from any causes of action whether presently known or unknown, with respect to any and all past, present or future claims of any type whatsoever in connection with the claims under the subject insurance policies. 8.17 Moreover, clause 7 of the settlement agreement expressly stated that this agreement was a compromise between the parties and shall not be construed as an admission of coverage under the insurance policies. Furthermore, the settlement agreement would not be treated as “. . . a waiver, modification, or retraction of the positions of the Parties with respect to the interpretation and application of the Subject Insurance Policies that are the subject of the Action.” 8.18 The preliminary issue before English courts was the nature of the settlement agreement; was this agreement to be excluded from the follow the settlements clause in the Reinsurance Contract by the words “excluding Without Prejudice and Ex-Gratia settlements”? 8.19 Aikens J described the clause in the policy in the case as a variation on a standard follow the settlements clause because the current clause contains the wording: “. . . and to follow in all respects the settlements or other payments of whatsoever nature excluding Without Prejudice and Ex Gratia Settlements made by the original underwriters.”

8.20 Faraday submitted two alternative arguments with regard to the construction of the clause: First, the phrase “without prejudice settlements” in the reinsurance policy meant a settlement which was not full and final; therefore it had to be one liable to be re-opened; Secondly, the clause applied only where the paying party settled even though it did not consider itself liable or likely to be liable. Faraday’s counsel argued that “a without prejudice settlement” meant a settlement that was without detriment to existing legal rights. However, he distinguished the settlement in this case as one which terminated the existing rights and obligations of the two sides and replaced them with rights and obligations under the settlement agreement. 8.21 The reinsurers submitted that the phrase “Without Prejudice Settlement” meant any settlement where the liability of the underwriters was not admitted even where such liability actually existed: such a settlement would “without prejudice” to the question of whether the underwriters would have been liable to the insured. 8.22 Aikens J defined a “settlement” as a concluded agreement between the reinsured and its assured which was binding and could not be reconsidered at a later stage by the parties. The learned judge found this meaning to be inherent in the word “settlement.” The judge also noted that the settlement in this case was elaborate and formal. 8.23 Aikens J approved Gavin Kealey QC’s definition of “without prejudice” settlements in Assicurazioni Generali SpA v CGU International Insurance10 as: “. . . those where the basis on which they were made was that there was no admission of the existence of any liability under the terms and conditions of the original policy to indemnify.” The learned judge emphasised that a “without prejudice” settlement was one made by the reinsured with no admission of the existence of any liability to indemnify the assured under the terms and conditions of the original policy. The learned judge distinguished an “ex gratia” settlement as one whereby the insurer made a payment knowing that there was no liability under the policy to indemnify the assured. Consequently, the judge rejected the reinsured’s submissions on the correct construction of the phrase “without prejudice settlement” in the follow the settlements clause. Aikens J noted that the reinsurers might be prepared to follow the settlements “in all respects” and to follow “other payments of whatsoever 10. [2003] 2 CLC 852.

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nature” while remaining entitled to insist that if the reinsured was not prepared to admit liability under the original policy then the reinsured must prove that there was, in fact, a liability under the original policy. Therefore, Aikens J ruled that the addition of the words “without prejudice and ex gratia settlements” was an encouragement to the reinsured to give proper and businesslike consideration to its liability to its assured and to act honestly in settling the claim. Applying this general rule of construction to the reinsurance contracts and variations of the follow the settlements clause, the judge found that the settlement agreement between the assured and the reinsured was that of a “without prejudice” settlement within the meaning of the clause in the reinsurance contract. The settlement was no doubt a binding agreement but it was also clear from clause 7 that the reinsured entered into the settlement agreement on the basis that there was no admission of the existence of any liability to indemnify the assured under the terms and conditions of the original policy. According to the learned judge, the words in the settlement agreement that it “. . . shall not be construed as an admission of coverage under the Subject Insurance Policies” clearly indicated that this was a “without prejudice settlement” excluded from the clause. Q UA L I F I E D F O L L OW T H E S E T T L E M E N T S C L AU S E S

“Within the Terms of Original Insurance” 8.24 The qualified follow the settlements clause where the reinsurers agree to follow the reinsured’s settlement if it is “within the terms and conditions and the original policy and reinsurance policy” has been discussed in a number of cases. Some of these cases were closely related to each other because they were reinsured by virtue of the same type of policies. The cases go back some 20 years to events in Alaska and the Middle East. (1) In 1989, the tanker, the “Exxon Valdez” ran aground in Prince William Sound in Alaska, resulting in a major spillage of oil, in turn leading to an extensive clean-up operation. (2) In 1990, Iraq invaded Kuwait and took control of Kuwait International Airport and all the aircraft there on the ground. These included 15 aircraft owned by Kuwait Airways Corporation (KAC) and a British Airways aircraft. The KAC aircraft were flown to Iraq, Jordan and Iran, while the BA aircraft remained at the airport where it was destroyed in the course of the liberation of Kuwait by coalition forces in February 1991. Various risks were insured, reinsured, retroceded and then further retroceded numerous times in the London Market, by means of the London Market Excess Spiral (LMX Spiral). The LMX Spiral has been defined as a complex structure of excess of loss reinsurance and retrocession.11 Both incidents gave rise to catastrophic losses which first entered the LMX Spiral in the early 1990s. 11. Deeny v Gooda Walker Ltd [1994] CLC 1224 Philips J also clarified LMX spiral further that: “. . . Many syndicates which wrote XL cover took out XL cover themselves. Those who reinsured them were thus writing XL on XL. They, in turn, frequently took out their own XL cover. There thus developed among the syndicates and companies which wrote LMX business a smaller group that was largely responsible for creating a complex intertwining network of mutual reinsurance, which has been described as the spiral. When a catastrophe led to claims being made by primary insurers on their excess of loss covers, this started a process whereby syndicates passed on their liabilities, in excess of their own retentions, under their own excess of loss covers from one to the next, rather like a multiple game of pass the parcel. Those left holding the liability parcels were those who first exhausted their layers of excess of loss reinsurance protection. . . . claims were repeatedly made in respect of the same loss as it circulated in the spiral . . . As the loss passed through the spiral, however, it impacted repeatedly on successive layers of reinsurance cover and ultimately concentrated on those reinsurers who found their cover exhausted. There were at least two significant ways in which spiral business was written: (1) XL on XL: this described the grant of excess of loss cover in respect of an excess of loss account; (2) whole account: an underwriter who took out, without exclusion, excess of loss cover in respect of his whole account would thereby obtain excess of loss cover in respect of that part of his whole account which itself comprised excess of loss business. . . . the higher the level of the layer of excess of loss protection, the lower the risk that it would be impacted . . . Another effect was to transfer from the insurers to the brokers a very substantial part of the overall premiums in respect of a risk, for on each excess of loss reinsurance, brokerage fell to be paid at a rate of ten per cent of the premium.”

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8.25 The first case that should be mentioned with regard to the loss of the aircraft belonged to KAC and British Airways is Hill v Mercantile & General Reinsurance Co Plc,12 which involved four contracts made within the LMX Spiral. 8.26 The first contract was between KAC and a number of Kuwaiti insurance companies insuring KAC against loss or damage to 15 aircraft for the period between 1 July 1990 and 30 June 1991 caused by “War, invasion, acts of foreign enemies, hostilities . . . seizure, restraint, detention, appropriation, requisition for title or use by or under the order of any Government. . . .” The policy provided that: “the Maximum Sum Insured in respect of Ground Risks is US$300,000,000 any one occurrence.” 8.27 The second contract was the contract by which syndicates in the London market reinsured the Kuwaiti insurers on the same terms as the original insurance. 8.28 Thirdly, there were chains of excess of loss reinsurances (Lord Mustill classified them as the intermediate reinsurances) which were again written on terms identical to the original insurance. 8.29 Fourthly, there were further excess of loss reinsurances (retrocessions) which were again identical to the other contracts referred to above. 8.30 The reinsurance contract between the Kuwaiti insurers and the London reinsurers contained a follow the settlements clause which provided – as divided into lettered paragraphs by Lord Mustill – as follows: “[a] All loss settlements by the Reassured including compromise settlements and the establishment of funds for the settlement of losses shall be binding upon the Reinsurers, [b] providing such settlements are within the terms and conditions of the original policies and/or contracts [c] and within the terms and conditions of this Reinsurance.”

8.31 While the original insurance and reinsurance contracts were for 12 months ending 30 June 1991, the fourth category of reinsurance contracts stated above was to provide cover for the period between 1 January and 31 December 1990. 8.32 On 2 August 1990 Iraqi invading forces seized control of the 15 aircraft on the ground at Kuwait airport. During January 1991 six of the aircraft were removed to Iran, and one to Jordan. Of the aircraft remaining in Iraq, seven were destroyed on the ground by allied attacks during January and February 1991. The eight surviving aircraft were later recovered and returned to KAC. 8.33 Therefore, it may be seen that the losses occurred whilst the aircraft were on-risk under the direct contracts. It was also arguable that the cause of the ultimate destruction was the invasion of Kuwait and the removal of the aircraft, which constituted “any one occurrence” for the purposes of the aggregate limit of the direct insurance and reinsurance. But there was the question of whether the loss was covered by the retrocession, which was taken out for a period different to that of the original policy, namely from 1 January until 31 December 1990. The retrocessionaires therefore denied payment by taking the view that no loss had occurred in 1990 and nothing was payable under the 1990 cover. Summary judgment was sought against the retrocessionaires. 8.34 Lord Mustill stated that the follow the settlements clause in Hill v Mercantile was different to the clause in Scor.13 The crucial words were “within the terms and conditions” of the original policies and of the reinsurance. Their Lordships found that the purpose of this wording was to ensure that the reinsurers’ original assessment and rating of the risks assumed were not

12. [1996] 3 All ER 865. 13. [1985] 1 Lloyd’s Rep 312.

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falsified by a settlement outside the terms of the cover albeit one which was reached in good faith. Lord Mustill emphasised that the reinsurers undertake to protect the reinsured against risks which they have written, not risks which they have not written. There was clearly no question that the loss was covered by the original insurance which was issued by the Kuwaiti insurers, but that was not necessarily the case under the reinsurances which provided coverage for a different period of time. The reinsurers rated the policy by reference to such variables as time and place, type of casualty, boundaries of the insured layer, and the bargain between the reinsured and the reinsurers was founded by those variables on the basis of which the premium and other terms were set. Therefore, the loss had to fall in fact and in law both within the reinsurance and retrocession cover. The aim of the provisos was to prevent the reinsurers to make claim for an honest and conscientious appraisal of the legal implications of the facts embodied in an agreement between parties but in fact outside the reinsurance or retrocession agreement. Lord Mustill did not agree with the argument that such a construction would decrease the effect of the use of the follow the settlements clauses. If the clause was intended to have the same effect as it had in Scor, the clause could have been drafted accordingly. In the case before their Lordships, the wording of the clause clearly pointed to the construction that was adopted by their Lordships. It followed that there was a dispute as to the coverage of the retrocession so that the case was not a suitable one for summary judgment. The Hill case laid down for the first time the meaning of the qualified follow the settlements clause. That decision subsequently came to have major implications for the Kuwaiti and Exxon Valdez claims subsequently presented to the London market. 8.35 Turning first to the Kuwaiti claims, the KAC and BA losses were presented to and paid by insurers and reinsurers within the LMX Spiral on the basis that they arose out of one event with a date of loss of 2 August, 1990, namely, the Iraqi invasion of Kuwait. As again stated above, on 2 August 1990 Iraq invaded Kuwait and took control of the Kuwait International Airport together with 15 aircraft belonged to KAC and one belonged to BA. During January 1991 six of the aircraft were removed to Iran and one to Jordan. Of the eight aircraft remaining in Iraq, seven were destroyed on the ground by allied attacks during January and February 1991. The eight surviving aircraft were later recovered and returned to KAC. The BA aircraft, which was on the ground at the time of the invasion, was left untouched by the invaders, but was nevertheless subsequently destroyed on the ground in February 1991 in the course of the operation to liberate Kuwait, “Desert Storm.” 8.36 All these losses were claimed and paid on an aggregated basis; no differentiation was made between the KAC and BA losses, which were given a single “Cat 90V” market coding. However, In Scott v Copenhagen Re Co (UK) Ltd14 the Court of Appeal held that the KAC and BA losses ought not to have been aggregated as they did not arise out of the same event because the loss of the KAC fleet occurred as a result of the invasion and capture of the airport, however the same could not be said in respect of the loss of the BA aircraft. That led to the market ceasing to pay any further claims. 8.37 As far as the Exxon Valdez losses was concerned, after the decision in Hill v Mercantile, Commercial Union Assurance Co Plc v NRG Victory Reinsurance Ltd15 came before the Court of Appeal of England. The reinsurance policies in respect of the Exxon Valdez provided: “All loss settlements by the Re-assured including compromise settlements . . . shall be binding upon the Reinsurers, providing such settlements are within the terms and conditions of the original policies and/ or contracts . . . and within the terms and conditions of this Reinsurance.” 14. [2003] Lloyd’s Rep IR 696. 15. [1998] 2 Lloyd’s Rep 600.

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8.38 The assured applied for summary judgment against the reinsured in the Texas Courts under a policy governed by English law, but then the reinsured settled the claim before trial. The reason was a local lawyer’s advice that the reinsured would be unlikely to succeed. According to the lawyer, Mr Reasoner, the case involved a complex construction of terms. But the judge was not experienced and the Texas jury was likely to take a pro-assured approach. Relying on Mr Reasoner’s view, the reinsured settled the claim but the reinsurer denied payment on the ground that the reinsured had a clear defence in that the policy covered only “debris” and not oil pollution. Clarke J decided in favour of the reinsured, but the Court of Appeal reversed the judgment. Both Clarke J and the Court of Appeal agreed that the reinsured must prove his liability in the same manner as the original assured. However while Clarke J was convinced that the reinsured had shown that he would have been liable to the assured if the issue had gone to trial, the Court of Appeal disagreed. Potter LJ found that Clarke J fell into error in his approach to the question of whether or not the liability of the claimants to the assured was proved. Potter LJ said that in the absence of a binding foreign judgment, it was the judge’s duty to form his own view as to whether an arguable defence had been shown by the reinsurers that the reinsured was not liable to the assured according to the applicable law and rules of construction.16 Potter LJ stated that the settlement was no doubt reasonable and businesslike, but he pointed out that the follow the settlements clause in this case was worded in a similar way to that of Hill v Mercantile & General Reinsurance Co Plc17 and under such a qualified clause establishing that the settlement was businesslike in commercial sense was not enough to make the reinsurer liable.18 Potter LJ was of the view that any court should be reluctant to make predictions as to a decision in another court. Moreover, Mr Reasoner’s prediction was not based on the principles of law and was no more than a prediction of human behaviour based on the jury’s consideration of different matters in another trial. Furthermore it could not be ignored that it was the reinsured’s decision to settle the claim which prevented the jury having the opportunity to consider the case. 8.39 Subsequently, in King v Brandywine Co (UK) Ltd19 the trial of the substantive issues arising under the retrocession cover came before the English courts. The Court of Appeal, upholding the decision of Colman J at first instance, held that oil pollution did not fall within the definition of “debris,” so that there was no cover for certain of the losses incurred by the assured and thus no liability for those losses under the retrocession. Once again, retrocessionaires ceased paying claims. 8.40 The position reached in each of these cases was, therefore, that claims which had been fed into the LMX Spiral and which had been paid, were rejected by retrocessionaires, even though it was undisputed that substantial parts of those claims were indeed valid and that only a small part of the loss had been ruled out by the decisions in Scott v Cophenhagen Re and King v Brandywine. This caused deadlock in the market, and an attempt to break that deadlock was made before Gross J in Equitas Ltd v R&Q Reinsurance Co (UK) Ltd.20 Gross J gave a crucial judgment as to the obligation of retrocessionaires within the LMX Spiral to accept claims which had been incorrectly aggregated and therefore would have encompassed uninsured losses at a lower level in the chain of placements. In Equitas v R&Q the claimant, Equitas, was the assignee of the rights of Lloyd’s Syndicates under various

16. 17. 18. 19. 20.

Ibid., at 611. [1996] 3 All ER 865. [1998] 2 Lloyd’s Rep 600, 612. [2005] 1 Lloyd’s Rep 655. [2009] EWHC 2787 (Comm).

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contracts of retrocessional excess of loss reinsurance written by the defendants, R&Q within the LMX Spiral. The claim made by Equitas was concerned with the questions that whether the LMX market wrongly (1) aggregated certain losses; and (2) included irrecoverable losses which precluded Equitas from recovering under the reinsurance contracts for otherwise potentially recoverable losses. 8.41 In Equitas there were 26 sample reinsurance contracts involved, 14 of which were related to the KAC/BA aggregation and 12 to the initial market allowance of irrecoverable Exxon losses. The contracts were all excess of loss covers, attaching when ultimate net loss flowing from any one event reached an attachment point. Some simply provided cover for losses in excess of underlying aggregate limits, others were written on a “top and drop” basis whereby they provided both excess cover and also back-up or drop-down cover once underlying cover had been exhausted. All reinsurance contracts were retrocessional level XL contracts with limits of cover excess of a stipulated amount on an “each and every loss” basis. 8.42 All the reinsurance contracts incorporated the Joint Excess Loss Committee Excess Loss Clauses (the JELC clauses), those at stake in Hill, which provided as follows: “1.3 It is a condition precedent to liability under this contract that settlement by the reassured shall be in accordance with the terms and conditions of the original policies or contracts. 3.1 ‘Loss’ under this contract means loss, damage, liability or expense arising from any one event . . .”

8.43 Many of the reinsurance contracts incorporated the following “settlements clause”: “All loss settlements by the Reassured including compromise settlements and the establishment of Funds for the settlement of losses shall be binding upon the Reinsurers, providing such settlements are within the terms and conditions of the original policies and/or contracts . . . and within the terms and conditions of this Reinsurance.”

8.44 The threshold question was whether the ruling in Hill v Mercantile constituted authority for the proposition that the test “providing such settlements are within the terms and conditions of the original policies and/or contracts” could only be satisfied if Equitas could represent correctly aggregated losses upwards through the LMX Spiral. If that was the case, then if any part of the claims was demonstrably incorrect – and it was common ground that at least 80% of the losses were covered by the retrocession – then the retrocessionaires could face no liability whatsoever. This argument required Gross J to analyse the effect of the House of Lords’ decision in Hill v Mercantile, and concluded that the threshold question had to be answered against the retrocessionaires. The learned judge held that there was a key distinction lay between questions of law on the one hand and questions of fact or evidence on the other. In other words the question was whether Equitas could establish on a balance of probabilities that the claim was either properly within the scope of the cover and/or the underlying limits had been exhausted. The notion that “there could be no liability whatsoever” was one which Gross J was plainly not prepared to countenance, and his ultimate conclusion that loss could be recovered to the extent that it could be proved. The learned judge found that Lord Mustill’s reference to the “original policies and/or contracts” in Hill was to the inward contracts between the inward reinsured and the syndicates not the contracts between the KAC and the direct insurers/reinsurers. Gross J therefore stated that in Equitas’ case the reference in clause 1.3 of the JELC clauses to the “original policies or contracts” must relate to the inwards policies or contracts and was not to be taken as referring to the intermediate or underlying contracts. Consequently, the focus in the present case should be on the position of the reinsurers against the retrocessionaires, rather than upon those at the “bottom” or at intermediate levels of the 223

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spiral. The question was mostly related to the burden on Equitas which Equitas had to satisfy to prove its claims. 8.45 According to Gross J, a settlement clause, albeit qualified, was still designed to avoid the need to investigate the same issues twice so long as provisos [b] and [c] were satisfied. The settlement clauses and thus provisos [b] and [c] dealt with the legal extent of the contracts in question but they did not affect the facts which generated the claims or the quantum of any proper and businesslike settlement. In other words, the settlement clauses say nothing as to how the reinsured must discharge the burden of proof, say nothing as to the evidence required for the reinsured to discharge the legal burden resting upon it. Gross J noted that, depending on the facts of the case, such evidence would necessarily vary. This reasoning led to the conclusion that the reinsured’s liability against the reinsurer or the reinsurers’ against the retrocessionaire would be established once it could be demonstrated that the reinsured’s/reinsurer’s claim on the balance of probabilities fell within the cover of the policy of reinsurance/retrocession. This would leave only one unresolved issue, namely, the quantum of the loss, but that was a question of fact to be established by evidence. Thus, Gross J crucially clarified that the reinsured is not bound in all cases to prove a loss at each underlying level in the chain within the LMX Spiral, and it was conceded that that exercise would have been simply impossible. 8.46 Subsequently, Gross J analysed the way that Equitas tried to prove its loss. As Equitas was unable to reproduce the LMX Spiral, it did the next best thing and submitted actuarial statistical models for the KAC and Exxon Valdez losses which, so far as possible, sought to replicate the LMX Spiral. Those models showed that recoverable losses had reached the relevant attachment point under the excess of loss covers. R&Q as retrocessionaires did not put forward their own models – and indeed they were not obliged to do so, as the burden of proof of loss was on Equitas – but contended that the models presented by Equitas were not a reasonable approximation of reality and therefore failed to show that the attachment point had been reached. As explained in the following paragraph, Gross J found the models sufficiently established Equitas’ loss (albeit by reference to the least favourable results found from the various runnings of the models) and that the sums indicated by the models were recoverable. 8.47 The statistical models submitted by Equitas were based on actual data relating to the inwards and outwards payments by the syndicates. The models assumed a number of participants who were direct insurers and to whom losses were allocated. Then representative reinsurance programmes were generated, allowing for “leakage” to reinsurance outside the Lloyd’s market and for retentions. This led the development of two scenarios: The first was Scenario A where both recoverable and irrecoverable losses were fed into the LMX Spiral, and reproduced the proportion of a participant’s ultimate net loss paid in relation to those losses. The second was Scenario B which involved two models of recoverable and irrecoverable losses giving rise to a proportion of recoverable and irrecoverable losses. Equitas was held to be able to rely on the use of the models as suitable to discharge its burden of proof, and it was irrelevant that the models did not exactly recreate the LMX Spiral. Gross J was satisfied that there was a relationship between the model participants and reality and that the reinsurance programmes produced by the model were reasonably typical of those found in the LMX Spiral, so that the models produced a minimum figure for recoverable losses for each syndicate. The further test was to determine the proportions of recoverable loss that the models produced. As a result of applying Scenario A, 90% for KAC and 79.5% for Exxon Valdez was recoverable, whereas, according to Scenario B, 86.5% for KAC and 75% for Exxon Valdez was produced as recoverable loss. Scenario A was based on the assumption that inwards and outwards claims were in the same proportion, whereas 224

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Scenario B sought to predict what would have happened if irrecoverable losses had not entered the Spiral at all. Gross J emphasised the need for caution and held that the Scenario B figures represented the minimum losses incurred by the syndicates. 8.48 One further element that needs to be emphasised is that the United Nations Compensation Commission provided compensation to insurers and reinsurers in relation to the loss of the KAC and the BA aircraft. Some of the syndicates had received refunds and others had not, mainly because of the market being in “lockdown” pending the determination of the present proceedings. Gross J held an undertaking by Equitas to introduce the refunds into the model would resolve the dispute that the refunds might cause. 8.49 Equitas therefore was held to be able to make claim against its retrocessionaires even though the losses in question were wrongly aggregated or irrecoverable within the lower level in the chain. Although it was required by law for Equitas to show that the loss fell within the terms and conditions of the original policy, it was not a requirement of law that Equitas could only do so by proving a loss at each underlying level of the LMX Spiral. 8.50 As the parties settled after the first instant judgment the decision was not appealed. The outcome, therefore, is a rather curious one which imposed an obligation of reinsurers and retrocessionaires to accept claims which had been incorrectly aggregated and which otherwise encompassed uninsured losses at a lower level in the chain of placements. This was plainly a pro-reinsured approach which is not obviously consistent with the follow the settlements clauses. However, the alternative would have been no recovery at all even though there were plainly substantial insured losses. 8.51 Subsequently, the question of the interpretation of the same type of loss settlements clause came before Burton J in IRB Brasil Resseguros SA v CX Reinsurance Company Ltd21 and the court adopted the reasoning in Equitas. In this case IRB Brasil were participants in an excess of loss reinsurance programme which protected the CX’s worldwide casualty book of business for the period 1976 to 1983. Class actions had been brought against policyholders, and these had been settled by the reinsured. There were 25 relevant reinsurance contracts, under which the reinsurers claimed $1.6 million in total. The reinsurers denied payment and the dispute was referred to three arbitrators. It was agreed that the arbitrators would determine claims relating to eight losses which comprised the bulk of the claims, and the outcome was an award in favour of the reinsured in the sum of US$665,055.51. The reinsurers applied to the court for permission to appeal against the award under section 69 of the Arbitration Act 1996 on the ground of error of law. The application was related to six of the losses totalling US$ 489,958.73 million. 8.52 These six cases which were related to various liability insurance claims in the US were as follows: (a) Two claims in respect of the liability of manufacturers of silicon breast implants (AHS and 3M); (b) Two claims in relation to liability of producers of products derived from blood contaminated by HIV or Aids (Baxter Travenol and Revlon); (c) One claim in respect of the liability of a company engaged in a business involving the use of asbestos (Owens Corning); and (d) One claim in respect of environmental pollution claims against a manufacturer of chemical and agricultural products (Stauffer).

21. [2010] EWHC 974 (Comm).

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8.53 The implant claims were brought by many women in the US against Baxter and other implant manufacturers with the complaints of various problems such as rupture and allergic reactions caused by silicon breast implants. The class action was settled wherein the agreement provided the setting up of a fund by the manufacturers, each contributing according to their market share; individual claimants were paid on an agreed scale of compensation. Accordingly, Baxter’s share was determined to be 20%. It may be necessary here to point out that the arbitrators recognised that most of class actions involved a compromise settlement of claims for damages for bodily injury and/or property damage caused to a third party. In such a compromise settlement it was all but impossible for the assured to prove absolutely that he was, in fact, liable for all of the claims: it was inevitable that some claims would be valid, some would be invalid, some would be overvalued and some would be undervalued. The arbitrators put the point as follows: “In a class action with hundreds or thousands of plaintiffs there is likely to be a very wide variation of degree of bodily injury: the object is to include as many people with a complaint, or who might have a complaint, as possible. It may well be that certain individual plaintiffs receive an award which they do not deserve or more than they deserve, but that is the price to be paid for dealing with the problem on this inclusive basis. The commercial advantages for the defendant company and their insurers (and their reinsurers) are (usually) substantial. . . .”

8.54 Claims related to blood contaminated by HIV or Aids were also brought in a class action which was settled where the four producers agreed to be responsible for payments under the global settlement in proportion to their market share. Baxter’s share of the “pool” was 20%. 8.55 With regards to the implant claims the arbitrators emphasised that Baxter believed that their share of the liabilities would be roughly equivalent to their market share of implants supplied and as to the HIV claims the arbitrators found that – on the balance of probabilities – had the patients’ claims been pursued to a judgment in court, damages would be awarded on the insurance policies. For this reason the arbitrators accepted that Baxter’s liability was established under the insurance and reinsurance policy terms. 8.56 Similarly, as to the Owens Corning claims, the arbitrators found in favour of the reinsured. Owens Corning, as an asbestos manufacturer, was faced a substantial number of claims as a result of their operations (318,000 by 1998, many unresolved). Up to 1998 the claims against Corning were considered as products liability claims. From 1998 onwards, however, the claims against Corning would be subject to “any one event” limit and Corning therefore maintained that there was a single event being “the determination of the company to engage in the insulation business and to install Kaylo insulation products over a twenty year period.” Corning’s insurers in the US disputed Corning’s claim but later they settled it for $335 million. CX’s share in London as a reinsurer was $5.1 million. CX Re’s total claim against IRB was $56,546 over two policy years, 1978 and 1979. 8.57 The arbitrators emphasised that the insurance claim, which was in respect of many individual original claims over a long period of time, was settled by the payment of $335 million and this was a reasonable and businesslike compromise with suitable legal advice in settlement of what were – on the balance of probabilities – valid claims under the policies. 8.58 The reinsurers obtained permission to appeal against the arbitrators’ ruling on the ground of error of law. The question before Burton J was “With respect to the IRB’s obligation to follow the settlements what standard of proof is it necessary for a reinsured to prove his case under the follow the settlements clause.”

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8.59 The issue was significant in terms of the reinsured’s burden of proof under the follow the settlements clause because, as Burton J described, the clause in IRB policies was a “double proviso” follow settlements clause which was in the following terms: “All loss settlements made by the Reinsured, including compromise settlements, shall be unconditionally binding upon Reinsurers provided such settlements are within the conditions of the original policies and/ or contracts and within the terms of this reinsurance, and amounts falling to the share of the Reinsurers shall be payable by them upon reasonable evidence of the amount paid being given by the Reinsured.”

8.60 This clause contained a double proviso because: (a) the first proviso required that settlements of losses by the insurer must be within the terms and conditions of the original policies; and (b) the second proviso entailed that settlements must be within the terms and conditions of the reinsurance. 8.61 Having recognised that this clause was identical to that of discussed in Hill v Mercantile & General Reinsurance Co plc22 and Equitas v R & Q,23 Burton J also noted that the issue with regards to the interpretation of the settlement clause in this case was to ascertain how a reinsured could satisfy the first requirement. This was a matter not addressed by Lord Mustill in Hill where His Lordship had merely commented that “the parties are free to agree on ways of proving whether these requirements are satisfied.” 8.62 To answer this question Burton J found guidance from what he called the “single proviso” cases such as Hiscox v Outhwaite (No 3)24 and Assicurazioni Generali SpA v CGU International Insurance plc25 where it was stressed that what was required was to prove that the assured’s claim was arguably within the original insurance cover. Burton J also took into consideration that a follow the settlements clause was designed to avoid the need to investigate the same issues twice. Moreover, the learned judge pointed out that in Equitas Ltd v R & Q Reinsurance Co (UK) Ltd26 Gross J had held that compliance with both provisos had to be proved on the balance of probabilities. Taking these three cases together, the learned judge determined that as far as the first proviso was concerned, the cases of Generali, Hill and Equitas clarified that the proof on the balance of probabilities was that the original arguable claim which was compromised by the reinsured fell within the terms of the insurance. As a result, Burton J agreed with the arbitrators that on the balance of probabilities each settlements including compromise settlements fell within the both provisos in the follow the settlements (or loss settlements) clause in IRB policies. 8.63 It is submitted that this interpretation can lead the argument that for all practical purposes the reinsured has to prove the same thing whether the “follow the settlements” clause is qualified or unqualified. As Burton J pointed out the primary aim of the insertion of a follow the settlements clause in a reinsurance policy is to avoid the need to investigate the same issues twice. Thus, the clause is related to the proof of the reinsured’s liability under the original policy. Under an unqualified follow the settlements clause, as the Court of Appeal ruled in Scor, the reinsured is only required to prove that the settlement was in bona fide and businesslike and the proof of actual loss is not necessitated. Holding that under a qualified follow the 22. 23. 24. 25. 26.

[1996] 1 AC 1239. [2009] EWHC 2787. [1991] 2 Lloyd’s Rep 524. Court of Appeal, [2004] Lloyd’s Rep IR 457. [2009] EWHC 2787.

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settlements clause the reinsured satisfies the burden of proof by establishing that on the balance of probabilities the claim fell within the original insurance, and thus reasonable, again, did not entail the proof of actual loss. However, it should be borne in mind that this could only arise under a treaty. In a facultative contract the reinsured would have to prove its loss as a matter of law, but under a treaty that is not possible. In a treaty the reinsured can only show that on the balance of probabilities the amount of the settlement was no greater than the amount of potential liability. In Equitas the reinsured had actuarial modelling to do that, but in IRB the reinsured could do no more than prove that it had settled reasonably and that was enough for the court to decide for the reinsured. “. . . as far as applicable hereto” 8.64 In Aegis Electrical and Gas International Services Co Ltd v Continental Casualty Co27 the provision under which the reinsurers agreed “To follow the terms, clauses, conditions, exceptions and settlements of the original policy wording as far as applicable hereto” was described as a qualified follow the settlements clause which required analysis of whether or not a loss fell within the both the original insurance and reinsurance contracts separately. 8.65 Aegis was a case where the subject matter insured was an oil refinery which was built in the 1920s on the Caribbean Island of Aruba. The dispute related to two incidents which occurred at the refinery on 9 April 2001 and on 6 November 2001, affecting the Visbreaker Unit and the DIA reactor respectively. The insurer paid the assured’s loss with respect to these incidents but the reinsurers argued that these incidents were not covered under the terms of the reinsurance contracts, which defined “accident” and “object” more narrowly than the the original policy. 8.66 The reinsurers’ argument was based on an Additional Conditions document attached by them to the reinsurance slip while initialling it. The document contained the definitions of the terms “accident” and “object” as follows: “Accident means ‘a sudden and accidental breakdown of an Object or a part thereof, which manifests itself at the time of the occurrence by physical damage that necessitates repair or replacement of the Object or part thereof’. Accident ‘shall not mean or include loss or damage resulting from specified events or of specified kind, including (f) from explosion other than: (1) explosion of the parts of steam boilers, steam turbines, steam engines, steam pipes interconnecting any of the foregoing or gas turbines; or (2) moving or rotating machinery or parts of same when such loss is caused by centrifugal force or mechanical breakdown . . . (p) caused by or resulting from a peril insured elsewhere in the reinsured policy’. Object means ‘any boiler, fired or unfired pressure vessel, refrigerating or air conditioning system, piping and its accessory equipment, and any mechanical or electrical machine or apparatus used for the generation, transmission or utilization of mechanical or electrical power’.”

8.67 The original insurance covered all risks of physical loss or damage to onshore property. Clause 30 of the policy provided: “Accident shall mean a sudden and accidental breakdown of an object or a part thereof and resulting in physical damage that necessitates repair or replacement of the object or part thereof.”

8.68 The term “object” was defined as: “any boiler, fired or unfired pressure vessel, refrigerating or air conditioning system, piping and its accessory equipment, and any mechanical or electrical machine or apparatus for the generation, transmission

27. [2008] Lloyd’s Rep IR 17.

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8.71

or utilization of mechanical or electrical power including any electronic computer or electronic data processing equipment and its associated media.”

8.69 The reinsurers argued that their own definitions in the attached pages should be given priority; whereas the reinsured argued that the definitions of “accident” and “object” should be construed consistently with those in the original policy. 8.70 Andrew Smith J found that the effect of the Additional Conditions document was to modify the extent of the reinsurance cover, by creating a mismatch between the terms of the original insurance and reinsurance policies. Such a mismatch also had the effect of precluding the reinsurance from being construed as providing an identical or back-to-back cover. 8.71 The court also ruled that the follow the settlements clause did not alter this conclusion by requiring the reinsurers to follow the reinsured’s settlements with respect to the assured’s losses. Andrew Smith J noted that it was not clear whether the adjectival phrase “as far as applicable hereto” in the follow the settlements clause qualified as a matter of grammar the word “settlements” or “original policy wording,” but on either approach in his view the phrase reflected that the reinsurance cover was not fully back-to-back with the direct cover. The effect of the qualified clause was to restrict the application of the follow the settlements obligation to settlements to which the reinsurance cover was applicable. Due to its qualified nature in this case, the reinsurance cover was to be determined by analysing independently of its own policy terms but not looking back to the original insurance construction which contained different definitions to that of the reinsurance policies.

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CHAPTER 9

CLA I MS PROV ISIONS

9.01 In the absence of an express provision in a reinsurance contract, the reinsured is not under any duty to notify the claim to the reinsurer or to seek the reinsurer’s consent to settle the claim, and the reinsurer has no right to interfere with the manner in which the reinsured handles it.1 However, claims provisions provide such opportunity to reinsurers. On the London Market there are two types of claims provisions found in facultative contracts: claims cooperation clauses; and claims control clauses.

C L A I M S C O O P E R AT I O N C L AU S E S

9.02 Claims cooperation clauses give reinsurers the right to be involved in the investigation and settlement of the loss.2 The reinsured retains the responsibility for the settlement but its authority will be subject to compliance with any obligations imposed by the contract. Such obligations could be advising the reinsurer within a certain time limit about any circumstances that may give rise to a claim or cooperation with reinsurers in investigating and assessing the claim or contesting the reinsurers consent before reaching a settlement with the assured. For example, in Insurance Co of Africa v Scor (UK) Reinsurance Co Ltd3 the claims cooperation clause provides as follows: “It is a condition precedent to liability under this Insurance that all claims be notified immediately to the Underwriters subscribing to this Policy and the Reassured hereby undertake in arriving at the settlement of any claim, that they will co-operate with the Reassured Underwriters and that no settlement shall be made without the approval of the Underwriters subscribing to this Policy.”

9.03 Another form of a claims cooperation clause was in question in Gan Insurance Co Ltd v Tai Ping Co Ltd (Nos 2 & 3)4 where the clause was in the following terms: “Notwithstanding anything contained in the reinsurance agreement and/or policy wording to the contrary, it is a condition precedent to any liability under this policy that: (a) The reinsured shall, upon knowledge of any circumstances which may give rise to a claim against them, advise the reinsurers immediately, and in any event not later than 30 days. (b) The reinsured shall co-operate with reinsurers and/or their appointed representatives subscribing to this policy in the investigation and assessment of any loss and/or circumstances giving rise to a loss.

1. Charman v Guardian Royal Exchange Assurance Plc. [1992] 2 Lloyd’s Rep 607; O’Neill and Woloniecki, para. 5–105; Butler and Merkin, Reinsurance Law, para. C-0053. 2. Edelman, para. 5.07; Merkin, Colinvaux’s Law of Insurance, para. 17–24. 3. [1985] 1 Lloyd’s Rep 312. 4. [2001] 1 Lloyd’s Rep IR 667.

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(c) No settlement and/or compromise shall be made and liability admitted without the prior approval of reinsurers. All other terms and criticisms of this policy remain unchanged.”

9.04 Claims cooperation clauses usually specify a time limit to comply with the clause however if the clause does not provide any specified time limit the insured (and reinsured) should comply with the clause within a reasonable time. What is reasonable depends on the facts of each case.5 9.05 Claims provisions are used in the US reinsurance market as well. However, the terminology is not the same as that of the London market. For example, a provision that giving the reinsurer the right “to consult with and advise the reinsured in its handling of the claim,”6 is called a “right to associate” clause. Claims cooperation clauses are also seen in the form of “Prompt notice” provisions. The two types of clause were described “fairly typical of reinsurance contracts”7 in the US. Association is a discretionary right,8 not a duty, although there is a corresponding duty on the part of the reinsured to make full and prompt disclosure of the information the reinsurers need in order to decide whether to associate.9

N OT I F I C AT I O N P ROV I S I O N S – T I M E O F N OT I F I C AT I O N

English Law 9.06 A claims cooperation provision is generally in two parts: an obligation to notify losses; and thereafter an obligation to keep the reinsurers informed of the progress of the settlements. 9.07 Turning first to notification, in reinsurance policies where the reinsured has insured the liability of the assured, both the insurance and reinsurance policies are likely to contain a claims notification10 provision which states something like; “Notwithstanding anything herein contained to the contrary, it is a condition precedent to any liability under this policy that the reinsured shall upon knowledge of any loss or losses which may give rise to claim under this policy, advise the underwriters thereof within . . . hours.” Whilst such clauses make commercial sense in property insurance policies, problems may arise where policy is one on liability, because the concept of a “loss” is not appropriate to that form of cover.11 Facultative reinsurance operates similarly to liability insurance, whether or not it is right to classify it as such, and in this context to construe such clauses it is necessary to determine the meaning of the word “loss” and the sort of knowledge that the reinsured is required to posses in order to trigger the running of time under the clause.

5. See (in insurance context) Hadenfayre Ltd v British National Insurance Society Ltd [1984] 2 Lloyd’s Rep 393, 402; per Lloyd J. See Bankers Ins v South [2004] Lloyd’s Rep IR 1; Lowry and Rawlings, 251–252; Shinedean Ltd v Alldown Demolition Ltd [2006] Lloyd’s Rep IR 846. 6. British Ins Co of Cayman v Safety Nat Cas. 335 F.3d 205 (3rd Cir. (NJ) Jul 3, 2003). 7. Christiania General Ins Corp. of New York v Great American Ins Co 979 F.2d 268 (2nd Cir. (NY) Sep 3, 1992). 8. New Appleman Guide, 40.11. The discretionary nature is particularly noteworthy because reinsurers’ biggest concern in taking part in any negotiations between the assured and the reinsured or defending the assured’s claim in a litigation may lead the assured to succeed in a direct action against the reinsurers as such an association may persuade the court that a privity was established between the assured and the reinsurers. For authorities see below “claims control clauses.” 9. Wollan, E, Handbook of Reinsurance Law, Aspen Law & Business, 2002. Para. 4.07. 10. Or, in the case of a claims made liability policy, a “circumstances” notification provision. 11. Dornoch Ltd v Royal and Sun Alliance plc. [2005] Lloyd’s Rep IR 544, 549–550.

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9.12

9.08 These were the issues in Royal and Sun Alliance Insurance v Dornoch12 and AIG Europe (Ireland) Ltd v Faraday Capital Ltd.13 The facts were slightly different in the two cases, as was reflected in their outcomes. 9.09 In Dornoch Coca-Cola and its directors and officers were insured under a Master Subscription Policy (the MSP) with a consortium which included Royal and Sun Alliance Insurance plc (RSA). The insurance policy provided coverage for “any securities claims” made against Coca-Cola or directors or officers of the company. It was also a condition precedent that the assured should give notice in writing of any claim “as soon as practicable.” The defendants reinsured RSA, the reinsurance slip policies contained a “Full Reinsurance clause” and “Claims Control clause” which read as follows: Full Reinsurance clause Being a reinsurance of and warranted same gross rate, terms and conditions as the original policy, so far as they may be applicable hereto and shall pay as may be paid thereon, but subject nevertheless to the terms, clauses and conditions of this reinsurance. Claims Control clauses Notwithstanding anything herein contained to the contrary, it is a condition precedent to any liability under this policy that: (a) The reinsured shall upon knowledge of any loss or losses which may give rise to claim under this policy, advise the Underwriters thereof by cable within 72 hours; (b) The reinsured shall furnish the Underwriters with all information available respecting such loss or losses and the Underwriters shall have the right to appoint adjusters, assessors and/or surveyors and to control all negotiations, adjustments and settlements in connection with such loss or losses.

9.10 Coca-Cola were alleged to have made false statements about their affairs and caused investors to buy their shares at artificially inflated prices. On 27 October and 9 November 2000 two different class actions were filed against Coca-Cola and named directors in the US, seeking damages for loss sustained by the complainants as a result of the alleged false statements. RSA knew of the existence of the complaints by at latest 12 December 2000. They received copies of them on 30 December 2000. The reinsurers argued that within 72 hours of 15 December 2000, they should, pursuant to the claims control clause have been advised of the potential losses accruing to Coca-Cola and RSA. RSA did not, however, pass on their awareness of the complaints until 19 January 2001. 9.11 There were two preliminary issues that Longmore LJ, who gave the only reasoned judgment at the Court of Appeal, discussed: the construction of the 72-hour notification clause; and the meaning of the phrase “. . . upon knowledge of any loss or losses” in subparagraph (b). The second issue was whether the loss that the reinsured which the assured was required to know and notify was that of the investors who bought shares at artificially inflated prices or the loss of Coca-Cola in being required to compensate the claimants for their loss. 9.12 Longmore LJ pointed out the complete mismatch between the original insurance and the reinsurance: the direct insurance was on a “claims made” basis and required notification to insurers of “claims,” and the reinsurance policy which contained a claims control clause that required “knowledge” of “loss” on the part of RSA. His Lordship found the use of such a clause “ill-chosen” because it was not apt for the type of reinsurance that was in question in this case. According to

12. [2005] Lloyd’s Rep IR 544. 13. [2007] 2 CLC 844.

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Longmore LJ, in a property insurance, for example, it might be practicable to inform reinsurers within 72 hours if a fire has recently taken place as the sooner an adjuster or surveyor arrives, the more likely it is that he will discover the true cause of the loss. However, in a policy where a reinsurer has reinsured a policy against directors’ and officers’ liability the need for notification of loss within 72 hours is less obvious. That was nevertheless how the parties had drafted the claims cooperation clause and Longmore LJ recognised that it had to be given its true effect. On the other hand, he chose to adopt the construction most favourable to the reinsured, because a condition precedent was to be regarded as an exemption to the reinsurers’ liability in circumstances where the reinsured had otherwise proved its liability to the assured. Such an exemption could, however, be relied on if the clause was clearly worded. Longmore LJ in the result found the subparagraph not sufficiently clear to exempt the reinsurer from liability for breach of the relevant obligation. 9.13 As for the meaning of the subparagraph (b) Longmore LJ was of the view that the loss of which the reinsured had to have “knowledge” was that of Coca-Cola’s investors. Until the class actions had been settled, it was not known by anyone that the American claimants had suffered the loss which they claimed or, indeed, any loss because the question whether the claimants had suffered any loss was up to that point disputed. The loss should have been proved in order to describe it as an “actual loss” which might give rise to an insurance claim.14 Accordingly, there was no breach of the clause. 9.14 It is noteworthy that Longmore LJ reserved his position on what the outcome would have been where the claim had been that, as a result of something done by the directors of Coca-Cola the value of the stock had obviously fallen; particularly if the stock had been rendered valueless. Then it might have been clear that there had been a loss at the outset, and once the reinsured were notified of a claim for that loss, it could be said that they then had knowledge15 of a loss which might give rise to a claim under the reinsurance policy.16 In fact, shortly afterwards, the Court of Appeal, again including Longmore LJ, heard AIG Europe (Ireland) Ltd v Faraday Capital Ltd17 and found that the situation in AIG fitted the reservation in Dornoch. In AIG the notification clause which was in the form of combination of (ii) and (iii) above was in question. In this case Smartforce, the assured, was an Irish company which ran e-learning and other training courses for the IT industry and AIG had provided liability insurance cover to Smartforce under a directors’ and officers’ policy governed by Irish law. The amount AIG insured was 75% of any loss in excess of US$5 million up to an overall limit of US$15 million. AIG then retained the first US$5 million, and reinsured 50% of the remaining US$10 million equally with Faraday and Brit, the remaining 50% being taken by Swiss Re. The Faraday policy contained a claims cooperation clause in the following terms: “Notwithstanding anything contained herein to the contrary, it is a condition precedent to any liability under this Policy that: (a) The Reinsured shall upon knowledge of any loss or losses which may give rise to a claim, advise the Reinsurers thereof as soon as is reasonably practicable and in any event within 30 days. (b) The Reinsured shall furnish the Reinsurers with all information available respecting such loss or losses, and shall cooperate with the Reinsurers in the adjustment and settlement thereof.”

14. See Home Insurance Company of New York v Victoria-Montreal Fire Insurance Company [1907] AC 59 where there was no claims control clause and the Privy Council emphasised that the reinsured could not be expected to notify the claim unless it had been established that it was liable to the assured. 15. It is noteworthy that Longmore LJ recommended avoiding the use of the word “knowledge” as it can be an elusive concept because in any given case a party to a contract may have difficulty in showing what another party “knows.” 16. [2005] Lloyd’s Rep IR 544, 551. 17. [2008] Lloyd’s Rep IR 454.

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9.19

9.15 Smartforce was listed on the NASDAQ exchange. It merged with a US corporation, Skillsoft, on 6 September 2002. AIG’s policy was converted into a run-off policy covering risks arising out of claims made during an increased policy period of six years in respect of wrongful acts before the date of the merger. The management of the new merged enterprise announced on 19 November 2002 that they intended to restate the financial statements of Smartforce for the years of 1999, 2000 and 2001 and for the first two quarters of 2002. As a result of the announcement the listed value of Smartforce’s shares fell and subsequently, the shareholders brought class actions against Smartforce and its directors by alleging that they had bought their shares at an artificially inflated value which the November disclosures then exposed and they had lost money as a result. The shareholders’ claims were settled following a court-ordered mediation in March 2004 which led AIG to pay the full policy limit of US$15 million to Smartforce on 2 June 2005. Upon AIG’s claim, all reinsurers paid, but Faraday denied liability for breach of the claims notification provision in the reinsurance agreement. 9.16 The decision was for the reinsurers. Longmore LJ noted that in the Dornoch case it was held that there could be no “loss” unless it was established that the shares had been bought originally for an artificially high price; however, the facts of AIG were different: In Dornoch there was no event – apart from such artificial inflation – which could trigger any loss; the fall in that occurred in the share value could have arisen as a result of normal market fluctuation or market perceptions of the normal kind. In AIG however there was a positive event happened on 19 November 2002 that covered a substantial drop in the share price after the announcement on that day of the intention to restate the company’s account. The reinsured had to know “any loss or losses which may give rise to a claim.” Consequently, AIG knew about the claim when Smartforce notified them in late December 2002; therefore AIG should have notified reinsurers within 30 days of that date. 9.17 As may be seen, therefore, there is fixed rule as to the loss which triggers the running of the notification period. All turns on the facts of each case and the wording of the clause in question. United States 9.18 Under New York18 law it is accepted that prompt notice provisions in reinsurance were designed to: (a) apprise the reinsurer of potential liabilities to enable it to set reserves; (b) enable the reinsurer to associate in the defence and control of underlying claims; and (c) assist the reinsurer in determining whether and at what price to renew reinsurance coverage. 9.19 Therefore, the time when the notification duty arises is usually determined by taking such purposes in consideration. One of the cases decided by the Second Circuit, Christiania General Ins Corp of New York v Great American Ins Co,19 illustrates the point. In this case, Great American was the third level provider of product liability excess insurance to Honda for the policy years 1980 to 1983 responsible for losses in excess of $15, $15, $17 and $18 million for each policy year, for amounts up to $10, $10, $10 and $7 million, respectively. Christiania

18. Unigard Sec Ins Co Inc v North River Ins Co 4 F.3d 1049 (2nd Cir. (NY) Sep 9, 1993). 19. 979 F.2d 268, (2nd Cir. (NY) Sep 3, 1992).

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General Insurance Corporation of New York issued facultative reinsurance certificates to reinsure Great American’s portion of Honda excess insurance policy. Each of the facultative certificates entered into between Great American and Christiania contained a “prompt notice” and “right to associate” clause in the following words: “Prompt notice shall be given by [Great American] to [Christiania] of any occurrence or accident which appears likely to involve this reinsurance and . . . [Christiania] shall . . . have the right and be given the opportunity to associate with [Great American] . . . in the defense and control of any claim, suit or proceeding which may involve this reinsurance . . .”

9.20 Honda distributed products of ATVs. The significant potential exposure stemming from ATV use was first suggested in 1985 when the Consumer Products Safety Commission issued a proposed rule as a result of the increasing number of serious injuries associated with them. Moreover, a TV programme displayed a report detailing the risks posed by ATVs. 9.21 In April 1985 Honda’s insurance broker notified Great American of “the possibility that your policy for each of [the 1979 and 1980] policy years may become involved” and in October 1985 the broker warned Great American that (for the 1979 and 1980 policy years) “it is certainly possible [the] liability coverage [of the Insurance Company of North America (INA), the excess insurance carrier for the layer immediately below Great American] for each of the policy periods . . . may be exhausted. Therefore your coverage would come into operation to protect the interests of [Honda].” The broker sent the similar notification concerning a particular claim involving the 1982 policy year. 9.22 Great American had a meeting with its reinsurers on 27 August 1987 and before the meeting, in the spring of 1987, Great American undertook an audit of the Honda account which indicated that it should establish reserves for at least the 1983 policy year. At the meeting in August 1987 Great American provided its reinsurers with the detailed information concerning the Honda account and particular claims garnered from the audit. 9.23 Christiania rejected Great American’s claim for the reason that it did not comply with the prompt notice requirement. One of the preliminary issues before the Second Circuit was therefore whether Great American had given prompt notice as required by the reinsurance certificate. 9.24 It should be noted that in this case the Second Circuit did not determine whether or not Great American was in breach of the “prompt notice” clause; the court ruled that that was a matter for the jury to decide, and directed the case to the district court to proceed to trial on the question of whether Great American satisfied its contractual obligation and, if not, whether Christiania suffered prejudice as a result.20 The Second Circuit however clarified the purpose of notification clauses in reinsurance agreements under New York Law. In New York, insurance and reinsurance companies are required to set their reserves to cover the potential claims insured and reinsured. When an insurer sets its reserve, its reinsurance policies can be included in its assets. Therefore ceding some proportions of the risk to a reinsurer is favourable for insurance companies. For reinsurers, a “prompt notice” clause may be particularly important because it primarily serves the purpose of enabling them to set proper reserves covering anticipated losses which would lead to the decision whether the reinsurers wish to exercise their right to participate in the defence of a particular claim. Additionally, it enables the reinsurers to establish premiums that accurately reflect past loss experience. 9.25 Great American contended that it was necessary to wait until the meeting on 27 August because it was not possible for it to give the type of detailed information it provided to its

20. For the significance of “prejudice”, see below, para. 9.87.

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reinsurers until it completed an audit. Moreover, it would have been overly burdensome and wasteful for it to have had to undertake such an audit far in advance of its layer being pierced on a paid basis. Great American further alleged that earlier notice would not have been helpful to Christiania in deciding whether to exercise its right to associate because the necessary details as to the specific claims that Great American would be called upon the defend were neither known nor knowable prior to the audit being completed. 9.26 The Second Circuit dismissed this argument for the reason that it overlooked the purposes of prompt notice clauses, one of which was to enable reinsurers to set reserves for the future claims. The court found that late notice of claims to reinsurers made proper reserving difficult. The court also noted that whenever the total incurred loss threatened to penetrate the excess layer, the excess insurer and the reinsurers were required to consider the appropriate reserves to be established. Therefore the Second Circuit described Great American’s contention as “nothing more than a sleight-of-hand trick that equates a notice clause with a right to associate clause.” “Prompt notice,” notice “as soon as practicable,” or “immediate notice” 9.27 The Second Circuit21 confirmed that such clauses require notice within a reasonable time after the duty to give notice has arisen. Reasonableness requires an objective evaluation of the facts known to the assured. Thus, a mere speculation, rumour, or a remote contingency far removed from particular policy in question is not enough to trigger the objective reasonableness standard. The duty to notice arises where by investigating potential claims with due diligence, when a prudent assured would believe that its policy may be involved. Notice when it “appears likely” that a claim will or “may” involve a policy 9.28 This does not require a probability that the policy at issue will be involved but a “reasonable possibility” of such a happening based on objective assessment of information available will be required.22 9.29 Under Wisconsin law23 and also the law of ND Illionis,24 the courts have agreed with the analysis that where a provision of reinsurance contract requiring reinsured to give reinsurer “prompt notice” of potential claim, the test to determine when the reinsured’s duty to provide such notice commences is an objective assessment of reasonableness. 9.30 In conformity with the Second Circuit in Christiania, the First Circuit held in Liberty Mutual Insurance Co v Gibbs25 that “losses which ‘may’ give rise to a claim” required showing “a reasonable possibility” and not a reasonable likelihood. In this case Liberty issued a general liability policy to Boston Edison and Lloyd’s reinsured 80% of all payments Liberty became obliged to make in excess of $250,000. Boston Edison was sued for personal injury loss but its attorney, who took over the defence, did not notify the reinsurer until after the jury returned a verdict for the claimants. The First Circuit decided that the controlling date that the reinsured should have given notice was not the date of jury’s verdict; Liberty’s duty to notify the reinsurer arose soon after it started defending the claim. 21. Christiania General Ins Corp of New York v Great American Ins Co 979 F.2d 268 (2nd Cir. (NY) Sep 3, 1992). 22. Ibid. 23. Zenith Ins Co v Employers Ins of Wausau 141 F.3d 300 (7th Cir. (Wis) March 27, 1998). 24. Centaur Insurance Company v Safety National Casualty Corporation 1993 WL 434056 (ND Ill Oct 22, 1993.) (United States District Court, ND Illinois, Eastern Division). 25. 773 F.2d 15 (1st Cir. (Mass) Sep 23, 1985).

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Liberty Mutual v Gibbs was applied by the Ninth Circuit in Insurance Co. of State of Pennsylvania v Associated Intern. Ins. Co.26 In this case ICP issued an excess umbrella liability insurance policy providing $20 million coverage to Louisiana-Pacific Corporation. Associated agreed to reinsure the ICP-Louisiana-Pacific policy up to $2.25 million. The reinsurance agreement provided ICP: “To notify [Associated] promptly of any occurrence which in [ICP]’s estimate of the value of injuries or damages sought, without regard to liability, might result in judgment in an amount sufficient to involve this certificate of reinsurance.”

The reinsurance contract further required ICP: “to notify [Associated] promptly . . . when notice of claim is received by [ICP].”

Moreover, the reinsurance contract specified that Associated had: “the right and shall be given the opportunity, with the full cooperation of [ICP], to associate counsel at its own expense and to join with [ICP] and its representatives in the defense and control of any claim, suit or proceeding involving this certificate of reinsurance.”

9.31 The dispute arose as a result of Associated’s refusal of ICP’s claim under the reinsurance policy by asserting that ICP was in breach of the notification provision. 9.32 The facts were as follows. In 1978, Louisiana-Pacific acquired the stock of Fibreboard Corporation, a company which, prior to 1972, manufactured products containing asbestos. Upon the acquisition, Fibreboard automatically became insured under the ICPLouisiana-Pacific policy. Subsequently, Louisiana-Pacific’s premiums were increased by 10%. Shortly thereafter, Associated received a document from ICP indicating the additional premium collected; however, no mention was made of Louisiana-Pacific’s acquisition of Fibreboard. 9.33 During the late 1970s thousands of personal injury claims arising from exposure to asbestos were brought against Fibreboard. As a result, three letters were sent to ICP from Louisiana-Pacific’s insurance brokers informing ICP of the outstanding claims and warning ICP of “an increasing possibility of eventual potential claims against policies issued by excess underwriters.” The first letter was sent in February 1979, the second was sent in October 1980 and a third letter was dated 18 December 1980. The last letter explained to ICP that “due to the sheer number of claims involved, we believe and expect that your excess policies will be penetrated.” ICP did not communicate this information to Associated. 9.34 In May 1979, the Fireman’s Fund Insurance Company, one of Fibreboard’s primary insurers, brought an action in the California state courts seeking declaratory relief against Fibreboard and several of Fibreboard’s insurers to resolve a coverage dispute as to the asbestos claims. Fibreboard responded by a cross-claim seeking declaratory relief and compensatory and punitive damages for breach of contract, breach of the insurer’s duty of good faith and fair dealing, and deceptive and unfair acts and practices against all of its insurers, including ICP. Specifically, the cross-complaint alleged “that the potential liability of Fibreboard in the underlying action exceeds Fibreboard’s underlying primary and other insurance coverage.” None of these developments were transmitted to Associated. 9.35 Following Fibreboard’s notification of the forthcoming exhaustion of the layers of insurance below its excess policies for certain year and request for payment in late July 1986 ICP and other insurers started negotiations with Fibreboard to settle the claim and the settlement agreement was reached in May 1987. 26. 922 F.2d 516 (9th Cir. (Cal) Dec 27, 1990).

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9.36 ICP formally informed Associated of asbestos claims in April 1987 by a document entitled “First Notice of Loss.” In June 1987 Associated rejected ICP’s claim as it was in breach of its reinsurance contract due to the late notice of asbestos claims. 9.37 Before analysing the facts in the light of the applicable law, the US Court of Appeals for the Ninth Circuit first noted that in the absence of a decision by the state’s highest court it looked to decisions by intermediate appellate state courts for guidance. The court also noted that “wellreasoned decisions from other jurisdictions” may also be considered. It became clear that no California Supreme Court case that had addressed the specific question of a notice provision in a reinsurance contract. Thus, the Ninth Circuit stated that it should use its “own best judgment in predicting” how the Supreme Court of California would interpret this reinsurance contract. 9.38 According to the Ninth Circuit, the clause in the Associated policy was analogous to that found in Liberty Mut Ins Co v Gibbs.27 In Liberty the notice clause specified that the insured was required “to reasonably inform [Reinsurer] of ‘any loss or losses which may give rise to a claim’ under the reinsurance policy.” Applying Massachusetts law, the First Circuit stated that the language “refer [s]to any losses that presented a ‘reasonable possibility’ of resulting in a claim under the reinsurance policy.” Thus, in the instant case, the Ninth Circuit similarly found that the cross-claim brought by Fibreboard against ICP was an occurrence “that presented a ‘reasonable possibility’ of resulting in a claim under the reinsurance policy.” Had ICP complied with the “care, skill . . . and faithfulness” required under California law, it would have realised that the cross-claim “might result in judgment in an amount sufficient to involve this certificate of reinsurance.” As a result, ICP’s failure to act with “reasonable expedience,” was a breach of the reinsurance notification clause. 9.39 Moreover, the Ninth Circuit pointed out the word “claim” was used in two occasions in the notice provision, which stated that ICP was required to notify Associated “when notice of claim is received” and the contract stated that Associated may join “in the defense . . . of any claim, suit or proceeding involving this certificate of reinsurance.” The court stated that the word “claim” was used in a more general sense, encompassed the more specific terms “claim, suit or proceeding” in the provision allowing Associated to join in the defence. 9.40 Furthermore, the court put emphasis on the fact that breach of notification requirement in the reinsurance contract would have curtailed Associated’s right to join in the defence sharply if Associated had only been entitled to notice upon ICP’s “subjective determination that the reinsurance certificate would be impacted.” Thus, the Ninth Circuit found that under California law, Fibreboard’s cross-claim against ICP was a “claim” within the ICP-Associated reinsurance contract. As a result, ICP’s failure to notify Associated of the “claim,” also constituted a breach of the notice clause.28

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9.41 These clauses provide even more authority to the reinsurer, in that the reinsured is obliged to pass to reinsurers the control of any negotiations with the direct assured. The reinsured may be required to inform the reinsurer of all developments that may affect the cost of 27. 773 F.2d 15 (1st Cir. (Mass) Sep 23, 1985). 28. The court also referred to a Third Circuit case Trustees of the University of Pennsylvania v Lexington Insurance Co (815 F.2d 890, (3rd Cir. (Pa.) March 31, 1987)) where a clause “the policy required notice whenever the Insured had information from which it might ‘reasonably conclude’ that an occurrence was ‘likely to involve’ the policy” was interpreted that under Pennsylvania law the insured had the obligation to notify whenever reasonable judgment, based on the information available to insured, suggested that the claim was likely to involve insurer.

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claims.29 They become particularly important where the reinsurance contract is in fronting form.30 9.42 An example of a claims control clause is seen in Eagle Star Insurance Co Ltd v Cresswell31 where the clause the reinsured agreed (a) To notify all claims or occurrences likely to involve the underwriters within seven days from the time that such claims or occurrences become known to them. (b) The underwriters hereon shall control the negotiations and settlements of any claims under this policy. In this event the underwriters hereon will not be liable to pay any claim not controlled as set out above. (c) Omission however by the company to notify any claim or occurrence which at the outset did not appear to be serious but which at a later date threatened to involve the company shall not prejudice their right of recovery hereunder. As may be seen, claims control clauses aim to give reinsurers more power than claims cooperation clauses. 9.43 Unlike right to associate clauses, in the US, terminology does not differ and to express provisions which make the reinsurer by agreement in control of claims handling and disposition.32 It has been submitted that claims control clauses are wider than right to associate clauses because the former give the reinsurers control over claims settlements.33 9.44 On the other hand, reinsurers’ biggest concern in using their right given by the claims provisions in terms of handling of claims is that they may run the risk of being held directly liable to policyholders or third parties.34 For instance in Homan v Employers Reinsurance Corp35 an excess of loss reinsurance contracts provided that it was “subject to” all of the general and special terms and conditions of the policies and endorsements reinsured thereunder. The reinsured became insolvent and the assured made a claim against the reinsurer by relying on a judgment that was against the reinsured, the reinsurer having been involved in the defence of the assured’s claim. The Supreme Court of Missouri held that being subject to all of the general and special terms and conditions of the contract made the reinsurer liable to the assured but only to the extent of the coverage limit of the reinsurance policy. Moreover, the court found that, because the reinsurer took charge of and managed the defence of the assured’s action, this established a privy between the reinsurers and the assured. Consequently, even though the court recognised the general rule that there is no privy between the assured and the reinsurers, the abovementioned facts meant that the court distinguished this case from the general principle. 9.45 Under English law, however, it is unlikely that direct contact between the assured and the reinsurers in the negotiations settling the assured’s claim after the loss occurred, even the reinsurance is in fronting form, is of itself enough to create a contract between them under which the assured may sue the reinsurers directly. This point was raised by the assured in

29. Carter, 358. 30. Merkin, Colinvaux’s Law of Insurance, para. 17–24. 31. [2004] Lloyd’s Rep IR 537. 32. Wollan, para. 4.07 33. In order to obligate the reinsured to confer with and secure the agreement of the reinsurer to settle claims of certain types or amounts in order to be indemnified claims control clauses sometimes are worded “counsel and concurrence” or “concur and consent” clauses. New Appleman Guide, 40.11 34. See Venetsanos v Zucker, Facher & Zucker 271 NJ Super 459, (N.J. Super. A.D. Mar 04, 1994) above under the “Privity of Contract” heading. Slotkin v Citizens Cas Co of New York 614 F.2d 301 (2nd Cir. (NY) Aug 29, 1979). 35. 345 Mo 650, Nov 03, 1939.

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Grecoair v Tilling.36 In this case, an aircraft, which was owned by Grecoair and dry leased to Angola Air Charter Ltd (AAC) was insured against Hull and Liability All Risks for the periods 1 March 1994 to 31 March 1995 and 1 April 1995 to 29 February 1996 by the National Insurance Company of Angola (ENSA). In the insurance policies the assured was stated to be AAC, and Grecoair was named as an additional assured. ENSA entered into excess of loss reinsurance agreements with several reinsurers. 9.46 In the reinsurance policies it was stated that the assured was AAC “and/or as original.” The reinsured was ENSA, the sum insured for the 1995–1996 policy was 98.50% in the case of Hull Risks, and 99.80% for Liability Risks. The “conditions” included “The Claims Control Clause ‘Aviation 41’ ”; Aviation or AVN 41 provided (in part) that it is a condition precedent to the liability under the reinsurance that: “(a) no amendment to the terms or conditions or additions to or deletions from the original policy shall be binding upon Reinsurers hereon unless prior agreement has been obtained from the said Reinsurers; (b) the Reinsured shall upon knowledge of any loss . . . advise the Reinsurers within 72 hours; (c) the Reinsured shall furnish the Reinsurers with all information available respecting such loss . . . and the Reinsurers shall have the sole right to appoint adjusters, assessors, surveyors and/or lawyers and to control all negotiations, adjustments and settlements in connection with such loss . . .”

9.47 The reinsurance also contained the following provision: “This Policy to follow all the terms and conditions of the Aircraft Hull All Risks Policy.

It was Grecoair’s case that during its lease to AAC and within the period that it was insured by ENSA the aircraft sustained two accidents, and Grecoair demanded indemnity from its insurer. 9.48 The reinsurers were involved in the negotiations. A series of meetings was held between the assured, the insurer and the reinsurers with regard to the damage suffered by the aircraft. Grecoair claimed directly against the reinsurers, asserting that in the course of the negotiations a representation had been made by the reinsurers that they were “happy to have the aircraft repaired.” The assured also asserted that the reinsurance contract terms37 established privity between the assured and the reinsurers. 9.49 After a detailed analysis of the negotiations that took place between the assured and the reinsurers, Langley J rejected the assured’s claim. According to the learned judge, there was no evidence to support the contention that the reinsurers accepted a claim directly from the assured at the meeting held between them, and indeed the evidence showed that the parties in fact reached no agreement at the end of that meeting. Moreover, Langley J found no indication within the reinsurance contract terms establishing a direct contractual relationship between the assured and the reinsurers. The learned judge stated that the contractual terms in question were all in line with ordinary reinsurance practice that ENSA was the reinsured under the reinsurance agreements and ENSA had its own insurance agreement with Grecoair. The judge found no evidence that ENSA acted as an agent for Grecoair in agreeing the

36. [2005] Lloyd’s Rep IR 151. 37. The term in question was “information” clause the relevant part of which read: “Original Policy . . . with: 7. In respect of [the aircraft] agree include provisions of dry lease agreement with Grecoair (as expiry) and in this respect include . . . AVN 67A. . . . Grecoair are held harmless in respect of any/all losses of or damage to the aircraft for the duration of the lease. . . .” There were 18 numbered items of “Information” altogether. Langley J described them as plainly the introductory words quoted and the colon show, information about the terms of the “Original” or underlying policy whereby ENSA insured AAC and, as an additional insured, Grecoair. According to the learned judge, they were matters disclosed to reinsurers as material underwriting information.

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reinsurances or that reinsurers were in some way estopped from rejecting a direct exposure to Grecoair. Langley J further ruled that the “information” provision under which the reinsurance was stated to “. . . follow all the terms and conditions of the Aircraft Hull All Risks Policy” had the effect that reinsurers consented to the stated terms being included in the ENSA policies and could refuse cover to ENSA in the event that ENSA paid claims to Grecoair on the basis of those terms; but it did not establish privity between the assured, Grecoair, and the reinsurers. Moreover, the learned judge was not persuaded that the privity was established by reason of the fronting nature of the reinsurance; the reinsurers had used their contractual rights given by AVN41 wording in handling the claims. 9.50 As was seen under the paragraphs discussing “claims cooperation clauses” above, contract terms may require the reinsured to seek the reinsurers’ consent before entering into any settlements with the assured. Thus, reinsurers may preclude settlement of a claim by the reinsured by exercising their contractual rights to refuse to agree to a settlement. In such a case, the reinsurers cannot face liability to the assured, as there is no basis for the imposition of any contractual duty on the reinsurers towards the assured.38 Nor the assured will be able to assert successfully that the reinsurers have committed the tort of interfering with the contractual relations between the assured and the reinsured. As was pointed out in Equitas Ltd v Wave City Shipping Co Ltd,39 of the tort of interfering with the contractual relations would require proof that the reinsurers intended to interfere with the contract, rather than simply to pursue their own interests in a manner which subsequently happened to affect the rights of the assured. To illustrate the point, the further facts of Equitas Ltd v Wave City Shipping Co Ltd are instructive. In this case the Demetra Beauty, which was owned by Wave, sank in January 1991 in the Gulf of Oman. She was insured against war risks with the Hellenic War Risks Mutual Association (Bermuda) Ltd. In March 1991 Wave made its claim against Hellenic, contending that the vessel had sunk after striking a mine. However, the investigation that Hellenic carried out disclosed that there was insufficient evidence that the Demetra Beauty had struck a mine; thus, Hellenic denied payment. Hellenic was reinsured by ERL and ERL’s liability was retroceded to Equitas. Wave brought several actions in Greece against Hellenic and the reinsurers, most of which were unsuccessful. In the present English proceedings, the assured alleged that the reinsurers and Hellenic had made profit commission arrangements under which the reinsurers agreed to give their reinsured a share of any profit that they might earn in respect of the relevant underwriting year. The assured alleged that such an agreement was tortious in that the reinsurers thereby induced Hellenic to refuse to pay valid claims and, in particular, the claim in respect of the Demetra Beauty. 9.51 Clarke J found that any argument that the inclusion of an arrangement for a profit commission in any reinsurance of Hellenic gave rise to a tort of any kind was without foundation. The only relevant tort could be that of inducing or procuring a breach of contract. On the facts there was no evidence that a profit commission agreement between Hellenic and the reinsurers had been reached. However, Clarke J noted that such arrangements were extremely common, and it was necessarily the case that the reinsurance would be more profitable if a claim was rejected than it would be if it was accepted. But, according to the learned judge, that did not necessarily mean that the clause “induces the insurer to break his contract with the assured.” Clarke J noted that there was no evidence that the reinsurers in this case ever intended to bring about a breach of the contract of insurance, much less that they “knowingly” induced any breach. In order to establish a tort it would be necessary to show an intention on the part of the reinsurers to interfere with the insurance contract; mere proof that that breach was the natural consequence 38. Merkin, Colinvaux Law of Insurance, para. 17.02. 39. [2006] Lloyd’s Rep IR 646.

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of the alleged tortfeasor’s act would not be sufficient.40 Consequently, in order to be able to succeed in its argument, according to the learned judge, the assured needed to establish that Hellenic was in breach of contract in not paying under the insurance and that Hellenic’s decision was in reliance on a profit commission provisions. Neither could be shown on the facts.

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9.52 It is necessary to determine the nature of claims provisions because the remedy for the breach of these clauses will depend on their classification. In ordinary contract law terms are classified as conditions, warranties or innominate. Breach of a condition entitles the innocent party to terminate the contract and claim damages. The innocent party does not have to terminate, however: he may choose to affirm the contract and this does not deprive him of claiming damages if he suffered any actual loss as a result of the breach of contract. The effect of breach of warranty in the general law is that the innocent party can claim damages only and that such breach does not give the innocent party the right to terminate the contract. The third category is innominate terms, (ie a term which cannot be classified as a condition or warranty from the outset) so that the remedy for breach depending on the seriousness of the consequences of that breach: if the breach is so serious that goes to the root of the contract, in other words, deprives the innocent party from the benefit that he was expecting to gain by entering into the contract, he can terminate the contract and also claim damages. However, if the breach is not so serious, breach of an innominate term only entitles the innocent party to claim damages.41 9.53 In the insurance and reinsurance context these terms are construed differently. Breach of warranty discharges the insurer/reinsurer from liability as at the date of the breach.42 Conditions may be classified either mere conditions, breach of which, as with innominate terms in general contract law, entitles the innocent party to claim damages or if the breach goes to the root of the contract, repudiate the contract as a whole.43 In the insurance and reinsurance context conditions may also be in the form of “condition precedent” breach of which gives right the insurer/reinsurer to reject the claim merely on proof of breach. In Royal and Sun Alliance Insurance v Dornoch44 Longmore LJ defined condition precedent in the following words: “A reinsurer of a reinsured’s liability to a third party is prima facie liable to the extent of his subscription once it is ascertained that the reinsured is liable to that third party. A condition precedent to the liability of the reinsurer operates as an exemption to that prima facie liability.”

D E T E R M I N I N G T H E NAT U R E O F C L A I M S P ROV I S I O N S

English Law 9.54 English law has taken the view that a claims provision is to be treated either as a condition precedent or an innominate term, depending upon how it is drafted. If the clause is a

40. 41. 42. 43. 44.

Referring to Stott v Gamble [1916] 2 KB 504 at 508–509 and Clerk & Lindsell, Torts at para. 24–16. Hongkong Fir Shipping Co Ltd v Kawasaki Kisen Kaisha Ltd [1962] 2 QB 26. Marine Insurance Act 1906, s. 33(3). Edelman, para. 6–52. [2005] Lloyd’s Rep IR 544, at 550.

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condition precedent, breach prevents the claim from being pursued irrespective of prejudice to the reinsurers. If the clause is not a condition precedent, but is merely innominate, the reinsurers have the right to refuse to pay only where the reinsured has repudiated the policy as a whole by his breach, and for that purpose the fact that the reinsurers have suffered prejudice in relation to the claim is irrelevant; in the absence of such repudiation the reinsurers are held to damages. Given that a late claim is unlikely to be repudiatory, the reality is that breach of a claims condition which is not a condition precedent will have little or no consequence for the reinsured. The distinction is thus crucial. 9.55 Whether or not the clause is a condition precedent is a question of construction of the clause. The use of the words is not always conclusive. For example in Royal and Sun Alliance Insurance v Dornoch45 a claims notification clause was worded as follows: “Notwithstanding anything herein contained to the contrary, it is a condition precedent to any liability under this policy that: (a) the reassured shall upon knowledge of any loss or losses which may give rise to claim under this policy, advise the Underwriters thereof by cable within 72 hours, . . .”

9.56 Despite the express use of “condition precedent,” the 72-hour notification clause was held not to have been sufficiently clearly drafted to have the effect of exempting the reinsurer from liability in case of its breach. 9.57 Another case that indicates that the use of the words “condition precedent” is not conclusive in determining the nature of the clause is Eagle Star Insurance Co Ltd v Cresswell46 where the clause in fact was not expressly stated to be a “condition precedent.” In this case “the reinsured agreed: (a) To notify all claims or occurrences likely to involve the underwriters within seven days from the time that such claims or occurrences become known to them. (b) The underwriters hereon shall control the negotiations and settlements of any claims under this policy. In this event the underwriters hereon will not be liable to pay any claim not controlled as set out above.47 Omission however by the company to notify any claim or occurrence which at the outset did not appear to be serious but which at a later date threatened to involve the company shall not prejudice their right of recovery hereunder.”48 9.58 The Court of Appeal found that using the words “condition precedent” was not essential and that other clear words could be used to express the consequences of breach.49 According

45. [2005] Lloyd’s Rep IR 544, at 550. 46. [2004] Lloyd’s Rep IR 537. The policy also contained a typical full reinsurance clause. 47. The reinsured argued that sub-paragraph (b) conferred an option on reinsurers whereby they could, if they wished, opt to control the negotiation and settlement of claims. That option was triggered by Eagle Star giving notice of claims under sub-paragraph (a) which requires the reinsured to notify all claims or occurrences likely to involve the underwriters within seven days from the time that such claims or occurrences become known to them but the reinsurers did not so opt, so sub-paragraph (b) had no application. The Court of Appeal disagreed with the reinsured and read the word “shall” as not imposing any obligation on the reinsurer to control negotiations with the original assured but conferred upon them the right to do so. In other words the clause was construed to be an allocation not an option, namely the reinsurer was entitled to be informed when negotiations began so that the reinsurer could decide at that point how the negotiations should be conducted. 48. The Court of Appeal commented that this clause was in the nature of a claims control clause. However nothing turned on that classification. 49. In its original form of the Claims Cooperation Clause in the Lloyd’s and Companies Market Policies was expressed as a condition precedent to the liability of reinsurers.

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to their Lordships the words “reinsurers will not be liable to pay any claim not controlled by them” were clear enough to create the equivalent remedy to a breach of a condition precedent. Additionally, the words “will not be liable to pay any claim” were described as strong words,50 if not the language of condition precedent, at any rate the language of exclusion.51 Furthermore, in the second sentence, the phrase “in this event” dealt with the situation where there were negotiations in respect of a claim. Therefore the clause was held to mean that “whenever negotiations or settlement have taken place which have not been controlled by the reinsurers, reinsurers will not be liable to pay the relevant claim” unless some reason was shown for excusing the agreed fact that the reinsurers did not control the negotiations or settlement of the assured’s claim.52 As a result the Court of Appeal was convinced that the clause was to be construed as condition precedent which deprived the reinsured of the right to make a claim against the reinsurers even if the reinsured could establish that it was in fact and in law liable to indemnify the assured. 9.59 More recently, in Aspen Insurance UK Ltd v Pectel Ltd,53 Teare J applied the Eagle Star principle. In Aspen the policy was a direct insurance providing for the assured, an experienced expert in the removal of asbestos from commercial and government property, a combined liability insurance cover in respect of employers’ liability, public liability and products liability. The insurer argued that the assured was in breach of claims notification clause which was found in clause 4(a) of the policy requiring the assured to give the insurer “immediate written notice with full particulars of any occurrence which may give rise to indemnity under this insurance.” The construction of clause 4(a) was the question before Teare J as the insurer argued that the clause was a condition precedent to the insurer’s liability. Teare J accepted the insurer’s argument that condition 13, which provided that the “liability of Underwriters shall be conditional on the assured paying in full the premium demanded and observing the terms and conditions of this insurance,” when read together with condition 4(a), created a conditional link between the assured’s obligation to comply with condition 4(a) and the underwriters’ obligation to pay the claim in question. The judge further noted that the commercial purpose of condition 4(a) was to enable the underwriters to investigate the potential claim at the earliest opportunity and such purpose was sufficient to justify compliance with condition 4(a) being a condition precedent to liability. 9.60 Thus, what is more significant than the actual terminology used is the outcome that the parties have attached to the breach of the condition in question. 9.61 This, however, does not mean that is possible to disregard the policy language which designates the relevant provision a condition precedent. Anonymous Greek Co of General Insurances “The Ethniki” v AIG Europe (UK)54 is a case in which the notice provision was expressly stated to be a condition precedent. In “The Ethniki” a Greek insurance company, Ethniki, insured factory buildings and machinery in Greece owned by Hellenic against risks including earthquakes. AIG reinsured a percentage of that risk in the London market. One of Hellenic’s factories was damaged by an earthquake in 1995. Hellenic claimed against the insurers and in 1997 brought proceedings. Ethniki in turn issued third-party proceedings against AIG, AIG sought in England a declaration of non-liability under the reinsurance on

50. 51. 52. 53. 54.

Emphasis added. [2004] Lloyd’s Rep IR 537, 548. Ibid., at 549. [2009] Lloyd’s Rep IR 440. [2000] Lloyd’s Rep IR 343.

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grounds that Ethniki was in breach of the claims control clause in the reinsurance, which was designated as a condition precedent by the following words: “Notwithstanding anything herein contained to the contrary, it is a condition precedent to any liability under this policy that: (a) the Reassured shall, upon any knowledge of loss or losses which may give rise to a claim under this policy, advise the Underwriters thereof by cable within 72 hours; (b) the Reassured shall furnish the Underwriters with all information available respecting such loss or losses, and the Underwriters shall have the right to appoint adjusters, assessors and/or surveyors and to control all negotiations, adjustments and settlements in connection with such loss or losses.”

9.62 AIG argued that Ethniki’s obligations under the claims control clause to give prompt notice of claim and to provide information were to be performed in London and that the English court therefore had jurisdiction by virtue of Article 5(1) of the Brussels Convention.55 9.63 The Court of Appeal agreed with Colman J that the reinsurers’ claim for a declaration of non-liability was based principally on the reinsured’s failure to inform AIG promptly of the claim received in Athens. England was the place of performance of that obligation. If the reinsured had complied with the notice provision a London adjuster could have been appointed and AIG’s need for reliance on the reinsured for information and for investigating and responding to the claim would have been greatly reduced or might have been extinguished altogether. The Court of Appeal found that the policy language describing the obligation as to giving notice to the reinsurers within the period indicated by the relevant provision as a condition precedent to the reinsurers’ liability was fundamental and the reinsured’s breach was the “real ground of complaint.” 9.64 Finally it should be noted that the burden of proof that the reinsured is in breach of claims provisions is borne by the reinsurers.56 Distinguishing warranties from conditions precedent 9.65 It is important to distinguish warranties from conditions precedent. Where the assured is in breach of condition precedent, it does not amount to breach of contract which gives rise to liability in damages, but the breach prevents the assured from making a claim regardless of whether or not the insurer/reinsurer is prejudiced by the breach.57 The breach cannot affect the assured’s/reinsured’s right to pursue a separate claim the conditions relating to which have been complied with: as a result, for example if a condition precedent which requires a claim to be made within a specified period is breached, that claim is lost but other claims are unaffected.58 Consequently it appears that breach of condition precedent will cause the assured/ reinsured to lose their claim but the policy and the risk itself will remain unaffected,59 whereas in case a breach of warranty, the risk terminates as of the date of breach and there can be no

55. Now the Brussels Regulation, Council Regulation 44/2001, although there is no significant difference in the wording. The Brussels Convention art. 5.1 provides: “A person domiciled in a Contracting State may, in another Contracting State, be sued: 1. in matters relating to a contract, in the courts for the place of performance of the obligation in question; . . . .” There are special jurisdiction rules relating to insurance in the Brussels Regulation, but they do not apply to reinsurance. 56. Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd (No.3) [2002] Lloyd’s Rep IR 612. 57. Shinedean Ltd v Alldown Demolition Ltd [2006] Lloyd’s Rep IR 846. 58. Colinvaux and Merkin Insurance Contract Law, para. B-0086. 59. Aspen Insurance UK Ltd v Pectel Ltd [2008] EWHC 2804.

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future liability under the policy. In other words the breach of a condition precedent affects the claim, whereas a breach of warranty affects the risk as a whole.60 9.66 The concept of repudiation of claim was discussed in terms of breach of claims notification clauses in an insurance context in Alfred McAlpine Plc v BAI (Run-Off) Ltd.61 It was there suggested by Waller LJ that breach of claims notification clause entitled the insurer to reject the claim if the breach was serious but not sufficiently serious to repudiate the policy. This interpretation was adopted in a number of subsequent decisions.62 However in Friends Provident Life & Pensions Ltd v Sirius International Insurance Corp63 the majority of the Court of Appeal rejected the principle of repudiation of a claim and held that English law did not recognise the concept of partial repudiation. If there was a serious breach of contract then the entire policy was repudiated: if the breach was minor, then the only remedy was damages. Accordingly, given that claims conditions are to be construed as innominate terms only, and given that it is all but inconceivable that breach of a claims condition could ever amount to a repudiation of the policy as a whole, unless the term is drafted as condition precedent at the outset, the only remedy available to insurers is to claim damages.64 9.67 This ruling has recently been confirmed by Teare J in Aspen Insurance UK Ltd v Pectel Ltd65 where the learned judge rejected the submission that breach of the notice clause which was a condition precedent relieved the insurer of all liability under the policy. There were basically three reasons for the judge’s conclusion. First, Teare J accepted that a literal reading of clause 4(a) which required the assured to give insurer “immediate written notice with full particulars of any occurrence which may give rise to indemnity under this insurance” together with condition 13 which provided that the “liability of Underwriters shall be conditional on the assured paying in full the premium demanded and observing the terms and conditions of this insurance” may seem to have such an effect as the insurer submitted. However, the learned judge added that that was not the objective purpose of condition 13. The objective purpose was to ensure that the underwriters have the opportunity to investigate the occurrence promptly and to take such action as is required to minimise the extent of any required indemnity. This purpose did not extend to enable the insurer who has not received written notice of one occurrence which may give rise to an indemnity to deny liability to indemnify the assured in relation to any other occurrence which may give rise to a claim. Secondly, relieving the insurer of all liability under the policy for breach of clause 4(a) would be so draconian that very clear words would be required to achieve it; such clear wording however were absent from condition 13. Thirdly, the judge actually did draft a clause which would reflect the objective purpose of condition 13 together with clause 4(a) that: “The liability of the underwriters to indemnify the assured in respect of a claim for an indemnity shall be conditional upon the assured observing the terms and conditions of the policy with regard to that claim.”

60. Colinvaux and Merkin’s Insurance Contract Law, para. B-141. 61. [2000] 1 Lloyd’s Rep 437. 62. K/S Merc-Scandia XXXXII v Lloyd’s Underwriters (The Mercandian Continent) [2001] Lloyd’s Rep IR 802 and Glencore International AG v Ryan (The Beursgracht) (No.1), [2002] Lloyd’s Rep IR 335; Bankers Insurance Co Ltd v South [2004] Lloyd’s Rep IR 1. 63. [2005] 2 Lloyd’s Rep 517. 64. See also Ronson International Ltd v Patrick [2006] Lloyd’s Rep IR 194; Limit (No 2) v Axa Versericherung AG [2008] Lloyd’s Rep IR 330 (Repudiation by failing to make declarations in time was dealt with at length by the trial judge in Limit No(2) but it was not raised on appeal). 65. [2009] Lloyd’s Rep IR 440.

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DISTINGUISHING CONDITIONS PRECEDENT F RO M I N N O M I NAT E T E R M S

9.68 The key distinction, as noted above, is nevertheless between innominate terms and conditions precedent. For instance in Insurance Co of Africa v Scor (UK) Reinsurance Co Ltd66 the reinsurance slip contained a claims cooperation clause which provided: “It is a condition precedent to liability under this insurance that all claims be notified immediately to the Underwriters subscribing to this policy and the Reassured hereby undertake in arriving at the settlement of any claim, that they will co-operate with the Reassured Underwriters and that no settlement shall be made without the approval of the Underwriters subscribing to this Policy.”

9.69 Leggatt J divided the clause into two and held that only the first part which related to notification of loss was a condition precedent.67 The court interpreted the rest of the clause as constituting a two-fold undertaking by the reassured in arriving at the settlement of the claim: first, that they will cooperate with the reinsurers, and secondly, that they will not make any settlement without the reinsurers’ approval. In the Court of Appeal the reinsurer was held to be liable despite the breach of the claims cooperation clause, because the reinsured had proved its loss. However in Scor the reinsured had proved its loss by a judgment against it. The case does not deal with the situation in which the reinsured has entered into a settlement falling within the scope of the follow the settlements clause. It is unclear whether the Court of Appeal’s comment that the reinsured has to prove its loss means that a reinsured in breach of the claims cooperation clause is automatically denied the right to rely upon a bona fide and businesslike settlement or whether the Court of Appeal was simply referring to the fact before it. This point is discussed below. 9.70 The clause in Gan Insurance Co Ltd v Tai Ping Co Ltd (Nos 2 & 3)68 was worded differently from that of Scor. The parties agreed: “Notwithstanding anything contained in the reinsurance agreement and/or policy wording to the contrary, it is a condition precedent to any liability under this policy that (a) The reinsured shall, upon knowledge of any circumstances which may give rise to a claim against them, advise the reinsurers immediately, and in any event not later than 30 days. (b) The reinsured shall co-operate with reinsurers and/or their appointed representatives subscribing to this policy in the investigation and assessment of any loss and/or circumstances giving rise to a loss. (c) No settlement and/or compromise shall be made and liability admitted without the prior approval of reinsurers. All other terms and criticisms of this policy remain unchanged.69

9.71 Comparing this clause to the claims cooperation clause in Scor, Mance LJ found that this was more stringent and the draftsmen had separated out the three parts of the clause and had resolved to make each into a condition precedent.70 Therefore while in Scor the breach of the claims cooperation clause which was not a condition precedent left it open to the reinsured to prove actual liability against the assured, in Gan the clause was classified as condition

66. [1985] 1 Lloyd’s Rep 312 67. No breach of notification clause was alleged in Scor. 68. [2001] 1 Lloyd’s Rep IR 667. 69. It was held that the reinsured would be in breach of the claims cooperation clause by settling, compromising the claim or admitting liability; in other words, any breach in these regards would entitle the reinsurer to reject the claim. 70. [2001]1 Lloyd’s Rep IR 667, 687.

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precedent, breach having the effect that the reinsured could not recover even by proving that he was in fact and in law liable to the assured.71 The United States 9.72 The remedy for a breach of claims notification provision depends on the nature of the clause. As will be seen in the following paragraphs, in some states, if the clause is a condition precedent, the reinsurers are discharged from liability without any requirement of proof of any prejudice resulting from the breach. It should nevertheless be noted that this is not a generally accepted rule and some decisions still look for prejudice even though the notification clause is classified as a condition precedent. However, if the clause is not a condition precedent, reinsurers may be discharged if there is proof of prejudice. The latter proposition contrasts with the English approach to conditions which are not conditions precedent: as stated above, in English law breach of such a clause will not defeat a claim irrespective of prejudice. To that extent English law is more generous to the reinsured than the law of the US.

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9.73 Sometimes reinsurance policies clearly state that a claims notification clause is a condition precedent.72 However, in some states, using such terminology is not essential to determine the nature of claims notification clauses. For example in Fortress Re, Inc v Jefferson Ins Co of New York73 the reinsurance policy contained a notice provision which provided: “Prompt notice shall be given to the Reinsurer by the Company of any occurrence or accident which appears likely to involve this reinsurance. . . .”

9.74 Applying the law of North Carolina the US Court of Appeals for the Fourth Circuit granted summary judgment for the reinsurers, who claimed that they were not liable to the reinsured following the breach of the claims notification clause even though the clause did not use the words “condition precedent.” 9.75 Similarly, in Keehn v Excess Ins Co of America,74 the United States Court of Appeals for the Seventh Circuit held that under Illinois law, failure of a third party automobile public liability insurer to give notice to the reinsurer of any accident in which reinsurance may probably be involved in compliance with provisions of reinsurance contract would bar recovery by original insurer upon the reinsurance contract, notwithstanding that the contract did not designate provision requiring notice as a condition precedent or contain a declaration of forfeiture for non-compliance.75 9.76 However, in some states courts have put emphasis on terminology. For instance, in Insurance Co of State of Pennsylvania v Associated Intern Ins Co76 in holding that the relevant provisions were not condition precedent under California law, the US Court of Appeals for the Ninth Circuit took into consideration that contractual provisions were not deemed to be conditions precedent unless the parties show their intention to give them such nature in “conspicuous, unambiguous, and unequivocal” language. 71. 72. 73. 74. 75. 76.

Ibid., at 688. Constitution Reinsurance Corp v Stonewall Ins Co 980 F.Supp 124 (SDNY, Sep 17, 1997). 628 F.2d 860, (4th Cir. (NC) Aug 14, 1980). 129 F.2d 503 (7th Cir. Jun 17, 1942). See also Highlands Ins Co v Employers’ Surplus Lines Ins Co 497 F.Supp 169 DC La, Jul 14, 1980. 922 F.2d 516, (9th Cir. (Cal) Dec 27, 1990).

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9.77 The Ninth Circuit applied the same principle in National American Ins Co of California v Certain Underwriters at Lloyd’s London77 In this case there were two reinsurance policies containing claims notification clauses in the following words: (Policy no 58392): “Upon knowledge by the named Assured’s insurance manager, or by another person designated by the named Assured to give notification of claims, of any occurrence likely to give rise to a claim hereunder, written notice thereof shall be given to Underwriters as soon as pradcticable.” (Policy no: LC 103204): “The Company upon knowledge of any occurrence likely to give rise to a claim hereunder shall give immediate written advice thereof to the person(s) or firm named for the purpose in the schedule.”

9.78 The Ninth Circuit rejected the reinsurers’ contention that proof of prejudice was not required because the notification clauses were conditions precedent. The court stated that the wording of the abovementioned clauses was not a “clear and unambiguous expression by the parties . . . that they intended the notice provision to be a condition precedent. . . .” 9.79 The omission of the words “condition precedent” was also found to be significant in Security Mut Cas Co v Century Cas Co.78 However, not only the terminology but also the nature of reinsurance and the particular wording of the whole policy, were also taken into consideration in the decision. In this case, Security Mutual Casualty Company agreed to reinsure a specified portion of Century Casualty Company’s losses under its primary insurance. The reinsurance was in treaty form and, during 1969, Century Casualty insured Anderson Aviation whose business was the leasing aircraft to the public. As a result of a plane crash on 3 September 1969, the pilot and five passengers were killed and the plane was destroyed. Various actions were brought in the state of Arizona on behalf of the passengers against Anderson Aviation in which the defendant was held liable in negligence and the judgment was given against it in the amount of $385,000 plus costs and interests. 9.80 There was no dispute as to liability for the payment for the damage to the aircraft. For the death claims however, it became apparent that even though the suit was filed on 12 September 1970, Security Mutual received no notice of the deaths or the lawsuits until 27 April 1971, after the verdict had been returned against the assured and the post-trial motions had been denied. 9.81 The relevant provision of the Security Mutual – Century Casualty reinsurance treaty provided: “The Company (Century) shall immediately give notice to the Reinsurer (Security) on all claims reserved in excess of the Company’ (sic) retention and also shall give prompt notice to the Reinsurer on claims which, in the judgment of the Company could develop into losses involving reinsurance hereunder. Further, as respects bodily injuries, the Company shall report to the Reinsurer all claims involving fatalities, . . . regardless of liability, where the policy limits (or Workmen’s Compensation Benefits) applicable to such losses exceed the retention of the Company. . . .”

9.82 Thus the reinsurers argued that Century was in breach of notification provision. The issue was whether such breach discharged the reinsurers from liability for the claims in question. The US Court of Appeals for the Tenth Circuit held that the answer depended on the nature of the provision, and that if it was a condition precedent the holding should be for the reinsurers. 9.83 In analysing the nature of notification provision the court drew attention to the language that was used in the policy as a whole. The abovementioned provision clearly did not 77. 93 F.3d 529 (9th Cir. (Cal) Aug 15, 1996). 78. 531 F.2d 974 (10th Cir. (Colo) Mar 12, 1976).

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indicate that it was a condition precedent. However, the Tenth Circuit noted that in the same contract the arbitration clause stated: “(A)s a condition precedent to any right of action hereunder, the parties to this agreement shall submit the matter in dispute to arbitration.”

9.84 Having emphasised that a provision for notice of loss was not to be construed as a condition precedent to reinsurers’ liability unless that intention was clearly and unequivocally stated in the contract, the Tenth Circuit found the omission of similar language in the notice provision was significant, and that provision was not to be considered a condition precedent. 9.85 The Tenth Circuit further clarified that Colorado law did not favour construing ambiguous terms as conditions precedent. The Tenth Circuit preferred to treat the clause as a “covenant” (ie an auxiliary term which did not go to the root of the contract and breach of which did not entitle the innocent party to bring the contract to an end). This construction was desirable because it avoided forfeiture of a claim for a trivial breach. The Tenth Circuit was reinforced in this conclusion by the general principle that any ambiguity in a reinsurance contract was to be resolved against the reinsurers unless the language was that of the reinsured or its brokers. This is akin to the English approach, which treats claims provisions not designated as conditions precedent merely as bare conditions which do not go to the root of the contract, the only remedy for reinsurers being damages to the extent that they can prove any loss. 9.86 The Tenth Circuit was also convinced that its construction was consistent with the main purposes of the contract. In the insurance context the purpose of notice clauses was to provide the insurer an opportunity to investigate and estimate the claim while witnesses and facts were available. This would be also helpful to prevent fraud. In the reinsurance context, which is, according to the Tenth Circuit, a contract for insurance, but not a contract of insurance, reinsurers leave the investigation of the claim to primary insurers. Even though reinsurers might reserve their rights to associate in the defence of the claim, for reinsurers, the Tenth Circuit did not find such rights as essential as for primary insurers. Furthermore, the court found little danger of fraud in a relationship between insurers and reinsurers as Century had as much reason as Security to see that the death claims in the Anderson Aviation litigation were properly investigated and defended. Additionally, the Tenth Circuit suggested that had Security shown any pecuniary injury from Century’s failure to give them notice, damages would have been an adequate remedy. Prejudice 9.87 The classification of a claims notification clause is important because most courts find that if the clause is a condition precedent which has been broken by he reinsured, the reinsurers do not need to prove prejudice in order to be relieved from liability. 9.88 This is not, however, a unanimous view. Variations may be found from state to state and indeed even within individual states. The jurisdictions that dispute that prejudice is required are mentioned in the following paragraphs. CALIFORNIA

9.89 In Insurance Co of State of Pennsylvania v Associated Intern Ins Co79 the reinsurance policy contained a notice provision requiring ICP to: “notify [Associated] promptly of any occurrence which in [ICP]‘s estimate of the value of injuries or damages sought, without regard to liability, might result in judgment in an amount sufficient to involve this certificate of reinsurance.” 79. 922 F.2d 516, (9th Cir. (Cal) Dec 27, 1990).

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9.90 ICP was also required to notify Associated promptly when it received a notice of claim. Associated was also given “the right and shall be given the opportunity, with the full cooperation of [ICP], to associate counsel at its own expense and to join with [ICP] and its representatives in the defense and control of any claim, suit or proceeding involving this certificate of reinsurance.” 9.91 As stated above in the paragraphs where the effect of the terminology has been discussed, the Ninth Circuit held that the notification provision was not a condition precedent in this case as the intention of the parties to draft it in that nature was not indicated in the language of the provision “conspicuously, unambiguously, and unequivocally.” Thus, it became necessary to discuss whether the settled rule in the insurance context that an insurer, in order to avoid liability on the basis of a breach of the notice clause, had to establish actual and substantial prejudice, applied to a reinsurer. The reason behind this rule was to “protect the insurance company from being placed in a substantially less favourable position than it would have been if timely notice had been provided.” The Ninth Circuit found that the rationale underlying the notice-prejudice rule in contracts of direct insurance was equally applicable in the context of reinsurance contracts and that prejudice had to be shown.80 The Ninth Circuit also noted that California courts81 have held that, in the insurance context, even if the notice provision had been made a condition precedent to the liability of the insurer, the insurer must still prove prejudice in order to avoid liability based upon the insured’s breach of the notice requirement. As a result, the court concluded that the notice provision should be interpreted in accordance with its purpose and the notice-prejudice rule was to be applicable to contracts of reinsurance. 9.92 Likewise, in National American Ins Co of California v Certain Underwriters At Lloyd’s London82 – as stated in the above paragraphs – the Ninth Circuit found that the relevant provision was not condition precedent because the policy language did not clearly and unambiguously provide that it was a condition precedent and subsequently, the court looked for proof of “substantial prejudice” from the late notice.83 KANSAS

9.93 In Kansas, it is necessary for insurers to prove prejudice flowing from the assured’s breach of a notification provision of an insurance policy if the relevant provision is not a condition precedent. In Newcap Ins Co v Employers Reinsurance Corp84 the District Court, D Kansas extended this rule to reinsurance where the relevant provision of the reinsurance contract provided: “[NewCap] agrees . . . that it will give prompt notice to [ERC] of any claim which, in [NewCap]‘s opinion is likely to involve [ERC] hereunder.”

80. The ninth circuit referred to a New York case Christiana Gen. Ins Corp v Great Am Ins Co where the second circuit (979 F.2d 268 (2nd Cir. (NY) Sep 3,1992)) aff’d the US District Court for the Southern District of New York 745 F.Supp. 150 (SDNY 1990) ruling with regards to proof of prejudice that under New York law, a reinsurer must show prejudice from the late notice in order to avoid liability under a reinsurance contract. Pennsylvania v Associated came before after the District Court’s but before the second circuit’s judgment in Christiania; therefore in Pennsylvania v Associated the Ninth Circuit referred to the District Court’s ruling which was later approved by the Second Circuit. It is noteworthy that the Ninth Circuit confirmed that in deciding over the dispute, in the absence of a decision by the state’s highest court “well-reasoned decisions from other jurisdictions” may also be considered as well as decisions by intermediate appellate state courts for guidance. 81. Referring to Hanover Ins Co v Carroll, 241 Cal. App. 2d 558, (Apr 19,1966). 82. 93 F.3d 529 CA 9 (9th Cir. (Cal) Aug 15, 1996). 83. Court of Appeal, (Second District, Division 7), California held expressed the same view in Central Nat Ins Co of Omaha v Prudential Reinsurance Co 241 Cal Rptr 773 1987. However, the case was ordered de-published by the California Supreme Court, and cannot be relied on as precedent. 84. 295 F.Supp 2d 1229, D Kan Dec 12, 2003.

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9.94 Although the Kansas Supreme Court had not specifically addressed the issue, the district court found adequate guidance from the case of Atchison, Topeka & Santa Fe Railway Co v Stonewall Insurance Co,85 where the Kansas Supreme Court extended the rule to the relationships between the parties in an excess insurance contract. Therefore, the district court was convinced that the Kansas Supreme Court would adhere to its general rule that an insurer, including a reinsurer, must demonstrate that it was prejudiced by the lack of notice in order to be relieved of its obligation to provide coverage. It is necessary to clarify that as for the nature of the notice provision the court did not make any express holding whether it was a condition precedent or not, but rejected the reinsurers’ contention as to applying Liberty Mutual Insurance Co v Gibbs86 by noting that Employers Reinsurance Corporation, the reinsurers, did not argue that the reinsurance agreement contained any such express condition precedent language. MASSACHUSETTS

9.95 The US Court of Appeals for the First Circuit confirmed in Liberty Mutual Insurance Co v Gibbs87 that under Massachusets common law, where a notification clause is worded expressly as a condition precedent, lack of prejudice to the reinsurers resulting from reinsured’s failure to give timely notice of loss under reinsurance contract is not relevant. In this case the reinsurance policy provided: “It is a condition precedent to any liability under this policy that [Liberty] shall upon knowledge of any loss or losses which may give rise to a claim under this policy advise [Lloyd’s] thereof as soon as reasonably possible.”

9.96 The First Circuit held that there was a breach of the clause in that Liberty, as an experienced underwriter did not notify Lloyd’s of the accident until several weeks after the jury had returned a verdict.88 Proof of prejudice flowing from the breach was, however, not necessary. NEW JERSEY

9.97 As was noted by the US Court of Appeals for the Third Circuit in British Ins Co of Cayman v Safety Nat Cas89 the rule requiring proof of prejudice in order to relieve insurer from liability as a result of assured’s breach of a late notice provision was well-settled and the question before the Third Circuit was, once again, whether or not to extend this principle to the reinsurance context. The relevant reinsurance provision provided: “The Company shall advise Reinsurer promptly of any claim and any subsequent developments pertaining thereto which, in the opinion of the Company, may involve the reinsurance hereunder . . .”

9.98 Having extended the prejudice rule to the reinsurance cases the Third Circuit recognised that reinsurance contract were clearly agreements between two sophisticated insurance

85. 275 Kan. 698, (Kan. Dist. Ct. Jul 24, 2000). It is also seen in the judgment that the court was also persuaded as to the accuracy of this prediction because of the other decisions from various jurisdictions such as British Ins Co of Cayman v Safety National Cas, 335 F.3d 205, 207-15, (3rd Cir. (NJ) Jul 3, 2003); Zenith Ins Co v Employers Ins of Wausau 141 F.3d 300 (7th Cir. (Wis) Mar 27, 1998); Christiania Gen Ins Corp v Great Am Ins Co , 979 F.2d 268, 274, (2nd Cir. (NY) Sep 3, 1992); Ins Co of the State of Penn v Associated Int’l Ins Co, 922 F.2d 516, 523, (9th Cir. (Cal) Dec 27, 1990). 86. 773 F.2d 15 (1st Cir. (Mass) Sep 23, 1985). For Liberty see below where the position in Massachusetts is analysed. 87. 773 F.2d 15 (1st Cir. (Mass) Sep 23, 1985). 88. See also Highlands Ins Co v Employers’ Surplus Lines Ins Co 497 F.Supp 169 DC La, 1980. 89. 335 F.3d 205 (3rd Cir. (NJ) Jul 3, 2003).

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companies but in the court’s view, such nature did not preclude construing reinsurance contracts by the rules of contract construction.90 9.99 The reinsurance policy also provided: “The Company, when so requested, will afford the Reinsurer an opportunity to be associated with the Company, at the expense of the Reinsurer, in the defense or control of any claim, suit or proceeding involving this reinsurance, and the Company and the Reinsurer shall cooperate in every respect in the defense and control of such claim, suit or proceeding.”

9.100 The Third Circuit was of the opinion that even if it is assumed that a reinsurer’s right to associate can be impaired by a late notice from the reinsured, that risk of impairment is not sufficiently serious to justify the prediction that the New Jersey Supreme Court would abandon the prejudice rule. 9.101 It is not clear from this case whether prejudice has to be shown in condition precedent cases as well as non-condition precedent cases. However, it is understood that the clause in this case was not held to be a condition precedent. The indications were that the Third Circuit applied Security Mut Cas Co v Century Cas Co91 in which the omission of the use of words “condition precedent” was found to be significant and led to the holding that the clause was not drafted by the parties as a condition precedent, and in which also the differences in the contractual undertakings of primary insurers and reinsurers were emphasised. In Security, as was noted above, it was found that notice provisions were significantly less important to the reinsurer than to a primary insurer. Additionally, the Tenth Circuit pointed out that it was more significant for insurers to be able to investigate the claims soon after the loss occurred, whilst reinsurers tended to leave such investigations to insurers given the absence of danger of fraud by the reinsured against the reinsurers.92 9.102 The Third Circuit also found that Insurance Co of State of Pennsylvania v Associated Intern Ins Co,93 Christiania General Ins Corp of New York v Great American Ins Co,94and Unigard Sec Ins Co Inc v North River Ins Co95 – for the last two mentioned cases see below the New York law – were consistent with its ruling where it was unanimously held that if the provision is not a condition precedent proof of prejudice was required. NEW YORK

9.103 Under New York law the courts discussed the issue of prejudice especially in the 1990s. For example, in Travelers Ins Co v Buffalo Reinsurance Co96 the District Court of SD New York held that the reinsurers did not have to establish prejudice in order to relieve of their liability to indemnify the reinsured by relying on the reinsured’s failure to give timely notice of claim.97 The notice provision in this case was not expressly stated to be a condition

90. The issue was yet to be considered by the NJ Supreme Court. Thus, the third circuit was required to predict what the NJ Supreme Court would hold on the issue. The third circuit referred to Christiania, Unigard and Pennsylvania v Associated by noting that although none of these decisions involved the application of NJ law, they were consistent with the view that the third circuit adopted in this case. 91. 531 F.2d 974 (10th Cir. (Colo) Mar 12, 1976). 92. There may nevertheless be a danger. See the allegations in Korea National Insurance Co v Allianz Global Corporate & Specialty AG [2008] EWCA Civ 1355. 93. 922 F.2d 516, (9th Cir. (Cal) Dec 27, 1990). 94. 979 F.2d 268, (2nd Cir. (NY) Sep 3, 1992). 95. 4 F.3d 1049 (2nd Cir. (NY) Sep 9, 1993). 96. 739 F.Supp. 209, SDNY, Jun 22, 1990. 97. The reinsured relied on Travelers Ins Co v Central Nat’l Ins Co, 733 F.Supp. 522 (D.Conn.1990) where the proof prejudice was required but the district court distinguished it as Connecticut law was applicable in Travelers v Central and it contrasted with New York law did not impose such a burden on the reinsurer.

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precedent and the district court did not make any comments on the nature of the relevant clauses.98 9.104 Two years later, in Christiania General Ins Corp of New York v Great American Ins Co,99 the US Court of Appeals for the Second Circuit put emphasis on the nature of prompt notice clause that where prompt notice provision in reinsurance contract is not drafted as a condition precedent to reinsurers’ liability under the reinsurance policy, reinsured’s breach of a prompt notice clause does not relieve reinsurers of their contractual duty to indemnify reinsured unless they can prove that they were prejudiced as a result of the breach. 9.105 Soon after Christiania, a similar issue again came before the Second Circuit in Unigard Sec Ins Co, Inc v North River Ins Co100 where the reinsurer brought an action seeking declaratory judgment relieving it of any obligation to indemnify third layer excess insurer, for losses paid by insurer on asbestos claims pursuant to asbestos claims facility agreement. 9.106 In this case, North River, a New Jersey corporation and was a subsidiary of Crum & Forster, Inc, issued two excess insurance policies to Owens-Corning Fiberglass Corporation in July 1974. The two excess policies provided coverage for, inter alia, claims for asbestosrelated bodily injuries. One of the policies, the policy of XS-3672, was to provide coverage of $30 million, payable if losses exceeded the $76 million in underlying excess and primary coverage for the policy periods of: (A) 9 July 1974 to 22 October 1974; (B) 22 October 1974 to 22 October 1975. One-sixth of the risk of XS-3672 was reinsured by Unigard. 9.107 The relevant terms of the coverage under the reinsurance were as follows: [Follow the Form Clause] A. . . . [T]he liability of [Unigard] shall follow that of [North River] and, except as otherwise provided by this Certificate, shall be subject in all respects to all the terms and conditions of [North River’s] policy except such as may purport to create a direct obligation of [Unigard] to the original insured or anyone other than [North River]. [Notice of Loss Clause and Claims Association Clause] C. Prompt notice shall be given by [North River] to the Underwriting Managers on behalf of [Unigard] of any occurrence or accident which appears likely to involve this reinsurance and while the Underwriting Managers or [Unigard] do not undertake to investigate or defend claims or suits, the Underwriting Managers, directly or through its representatives and/or counsel, shall nevertheless have the right and be given the opportunity to associate with [North River] and its representatives at [Unigard’s] expense in the defense and control of any claim, suit or proceeding which may involve this reinsurance with the full cooperation of [North River]. [Follow the Fortunes Clause] D. All claims covered by this reinsurance when settled by [North River] shall be binding on [Unigard], who shall be bound to pay their proportion of such settlements. In addition thereto, [Unigard] shall be bound to pay (1) their proportion of expenses, other than [North River’s] salaries and office expenses, incurred by [North River] in the investigation and settlement of claims or suits, and (2) their proportion of court costs, interest on any judgment or award and litigation expenses (provided their prior consent to legal proceedings has been obtained from the Underwriting Managers) as follows: (a) with respect to reinsurance provided on an excess of loss basis, in the ratio that [Unigard’s] loss payment bears to [North River’s] gross loss payment. . . . 98. In this case two different forms of facultative reinsurance policies were in question. These two policies provided that the reinsured “will notify [the] Reinsurer promptly of any event or development which the Company [Travelers] reasonably believes might result in a claim against [the] Reinsurer” and “shall advise the Underwriter(s) promptly of any claim and any subsequent developments pertaining thereto which, in the opinion of the Company [Travelers], may involve the reinsurance hereunder.” 99. 979 F.2d 268, (2nd Cir. (NY) Sep 3, 1992). 100. 4 F.3d 1049 (2nd Cir. (NY) Sep 9, 1993).

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9.108 The reinsured singed on the Wellington Agreement which applied the producer- and insurance-allocation formulae to a vast amount of claims. That meant, as the Second Circuit clarified, multiplying the 40,000 claims pending against the Facility, which was established by the Wellington Agreement to arrange the payments to the claimants, at the time of the signing of the Agreement in 1985. Owens-Corning’s historical average settlement per claim was of approximately $10,000. Multiplying 40,000 claims by $10,000 would have yielded an estimated exposure to Owens-Corning of $400 million. Nevertheless, in 1985, there was only $337 million in coverage remaining below XS-3672. Consequently, based on the insurance allocation formula, the signing of the Wellington Agreement meant that North River would pay some claims for which it was not liable and would pay amounts not proportional to its contracted liabilities on others. Furthermore, these figures did not cover the impact of future unreported claims. As a result, the Second Circuit found that the Facility that the Wellington Agreement demanded had increased the likelihood of reasonable possibility of that the reinsurance coverage would be reached. 9.109 Another effect of the Wellington Agreement was that given that the Facility would be the “sole agent” and have “exclusive authority and discretion to administer, evaluate, settle, pay or defend all asbestos-related claims,” Unigard was deprived of using its contractual right to associate in the defence and settlement of claims. In this respect the court emphasised the necessity of notification also based on the principle of duty of utmost good faith. Imposing the duty of utmost good faith here was necessary because without doing so reinsurers would have to duplicate actuarial and claims-handling efforts of reinsureds and reinsurance would become unavailable. 9.110 Moving from the wording of the clause North River’s contention was that the signing of the Wellington Agreement was not an “occurrence or accident,” therefore, no notice was required. Referring to its holding in Christiania,101 the Second Circuit firstly stated that a provision that required notice when it “appears likely to involve the reinsurance” necessitated – based on an objective assessment of the information available – “reasonable possibility” that the policy at issue will be involved. Secondly, the court noted that the “occurrence [s]” and “accident[s]” were the exposures to asbestos. The signing of the Wellington Agreement was an event increasing the likelihood to a “reasonable possibility” that the reinsurance would be involved in compensating claims based on such exposures or “occurrences.” Hence, the court had no doubt that the reinsurers should have been notified. 9.111 Nevertheless, the Second Circuit held that this did not discharge the reinsurers from liability for the reinsurers did neither prove that they had been prejudiced by the breach or the reinsured acted in bad faith in failing to notify the sighing on the Wellington Agreement.102 9.112 It should be stated that in order to clarify the position under New York law as to the prejudice rule, the Second Circuit asked the New York Court of Appeals103 whether a reinsurer

101. The Second Circuit noted that notification clause in the reinsurance policy in Unigard was identical to that of found in Christiania. 102. Emphasis added. 103. The Second Circuit asked the New York Court of Appeal’s opinion because: (1) that the only New York decision on the issue of whether a reinsurer is required to demonstrate prejudice is an unpublished opinion (General Ins Co v Nutmeg Ins Co, Sup.Ct., NY County, 24 July 1987, Shainswit, J); and (2) that there is a split of authority on the issue within the Southern District of New York (Christiana Ge Ins Corp v Great Am Ins Co, 745 F.Supp. 150 (SDNY 1990) (holding that reinsurer must demonstrate prejudice to prevail on late-notice defence), appeal pending 979 F.2d 268 (2nd Cir., 1992), with Travelers Ins Co v Buffalo Reinsurance C, 735 F.Supp 492 (SDNY Feb 9, 1990) (reinsurer need not prove prejudice), vacated in part 739 F.Supp 209 (SDNY Jun 22, 1990]).

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must prove prejudice before it can successfully invoke the defence of late notice of loss by the reinsured. The Court of Appeals’ answered to that question was in the affirmative.104 9.113 The New York Court of Appeals stated that the “no prejudice” rule was a limited exception to two established rules of contract law: 1. that in ordinary circumstances the party who seeks to escape the obligation to perform under a contract must demonstrate a material breach or prejudice 2. that absent clear language showing that the parties intended to make it a condition, a contractual duty normally will not be construed as a condition precedent. 9.114 Moreover, the Court of Appeal noted that the cases had established that for primary insurers the exception was applicable because: (a) the insurer must have an opportunity to protect itself;105 (b) without timely notice, an insurer may be deprived of the opportunity to investigate a claim and is rendered vulnerable to fraud,106 whereas prompt notice permits the primary insurer to make an early estimate of potential exposure, to investigate the claim while witnesses and facts are available, and to take steps to prevent fraud;107 (c) late notification may prevent the insurer from providing a sufficient reserve fund;108 (d) early notice enables the insurer, inter alia, to exercise early control over the claim and enhances the possibility of settlement.109 9.115 In its opinion to the Second Circuit, the New York Court of Appeals emphasised that the specific prompt notice provision in the Unigard did not expressly indicate the parties intended to operate the clause as a condition precedent. Moreover, according to the court, one of the important consequences of the lack of privity between the assured and the reinsurer is that the assured has no right to make a direct claim from the reinsurer; the investigation and defence of claims are the sole responsibility of the primary insurer and a reinsurer is not responsible for providing a defence, for investigating the claim or for attempting to get control of the claim in order to effect an early settlement. Thus, a reinsurer may not be held liable to the assured for a breach of these duties. Consequently, it became clear to the court that failure to give the required prompt notice was of substantially less significance for a reinsurer than for a primary insurer. 9.116 Furthermore, the court compared the interests of a reinsurer, reinsured and the assured. Between the reinsured and the assured, the interests of the parties may often be adverse. It is mostly the case that a dispute arises over coverage or the assured’s cooperation to deal with third-party claims. On the other hand the interests of a reinsurer and the reinsured with respect to a pending claim are generally identical. The Court of Appeals found it vital for a reinsured/original insurer to be promptly notified of the claim and to cooperate to investigate the claim; whereas, in reinsurance the application of such considerations is greatly diminished. The court also touched upon the fact the reinsurers were deprived of using their contractual right to associate in defending the assured’s claim, but comparing to the primary insurer’s interest in investigating the claim and the reinsurers’ interest in right to associate, the New York

104. 105. 106. 107. 108. 109.

79 NY.2d 576, 1992. Security Mut Ins Co v Acker-Fitzsimons Corp., 31 NY.2d at 440. (N.Y.A.D. 1Dep. Apr 24, 1972). Power Auth v Westinghouse Elec Corp, 502 NY S.2d 420. Security Mut Cas Co v Century Cas Co, 531 F.2d 974, 978. (10th Cir. (Colo) Mar 12, 1976). Power Auth. v Westinghouse Elec Corp, 502 NY S.2d 420. Commercial Union Ins Co v International Flavors & Fragrances, 822 F.2d 267, 271, (2nd Cir. (NY) Jun 23, 1987).

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Court of Appeals did not find this impairment was sufficiently grave to warrant applying a presumption of prejudice. As a result, the conclusion the court reached was that there was no sound reason to depart from the general contract law principle that a breach will excuse performance only if it is material or demonstrably prejudicial. 9.117 Agreeing with the New York Court of Appeals, the Second Circuit held that Unigard had to demonstrate more than the loss of the right to associate to meet the prejudice standard. The Second Circuit was required to show a tangible economic injury suffered as a result of the breach. The court also noted that given the reinsurer’s and reinsured’s interests were essentially the same as to liability, good faith coverage decisions generally did not constitute prejudice. The Wellington Agreement provided radical automatic formulae to replace individualised determinations as to the liability of assureds and their insurers but the alterations of coverage and liability might counterbalance each other and the total payouts by particular insurers might remain roughly the same. 9.118 The issue once again came before the District Court of SD New York in Constitution Reinsurance Corp v Stonewall Ins Co110 where the relevant provision was in the following forms: “As a condition precedent, the Company [Stonewall] shall promptly provide the Reinsurer [Constitution] with a definitive statement of loss on any claim or occurrence reported to the Company and brought under this Certificate which involves a death, serious injury or lawsuit.”

9.119 The assured sued the reinsured after the latter denied coverage but then the reinsured paid $3.25 million in exchange for the assured dropping its suit. The reinsured became aware of the potential claim under the policy as of 6 June 1990 but did not notify the reinsurer until 20 November 1992. The court held that under New York law the notice was not promptly given and the breach of condition precedent operated as a complete bar111 against Stonewall’s recovering under the reinsurance policy without proving prejudice. NORTH CAROLINA

9.120 In North Carolina prejudice is required even though the clause is a condition precedent.112 Fortress Re, Inc v Central Nat Ins Co of Omaha113 traces the development of the law in North Carolina where the US Court of Appeals for the Fourth Circuit stated that claims notification clauses had long been regarded as conditions precedent where prejudice was irrelevant and the bar on recovery was absolute. However, referring to Great American Insurance Co v CG Tate Construction Co (Tate I)114 where it was held that the failure to give timely notice to the insurer did not relieve the insurer of its obligations unless the delay materially prejudiced the insurer’s ability to investigate and defend, the Fourth Circuit recognised that the rule in North Carolina has changed in a way that the designation “condition precedent” no longer has this effect and that reinsurers have to prove either: (a) that they have suffered prejudice; or (b) that the reinsured acted in bad faith in failing to comply with the clause. The Fourth Circuit applied Tate I even though it was an insurance case. By defining reinsurance as an insurance contract where “one having an insurance company as a policyholder” the court stated that it could see no reason why 110. 980 F.Supp 124 SDNY, Sep 17, 1997. 111. Emphasis added. 112. The reinsurance certificate provided that “[p]rompt notice shall be given to the Reinsurer by the Company of any occurrence or accident which appears likely to involve this reinsurance. . . .” Thus, the provision was not worded as a condition precedent but the Fourth Circuit obiter stated that proof of prejudice was required even if the clause was a condition precedent. 113. 766 F.2d 163 (4th Cir. (NC) Jul 03, 1985). 114. 303 NC 387, (NC Jul 8, 1981).

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a different rule should be applied to reinsurance contracts. The Fourth Circuit also noted that in Tate I the Supreme Court of North Carolina overruled the two state cases on which Fortress Re, Inc v Jefferson Ins Co of New York115 had been based. Thus, in Fortress v Omaha the Fourth Circuit refused to follow Fortress v Jefferson where the same court had decided that the notification clause was a condition precedent even though the clause did not use the words “conditions precedent” and the reinsurers were held not liable without requiring proof of any prejudice. PENNSYLVANIA

9.121 Similarly, in Life and Health Ins Co of America v Federal Ins Co116 the District Court of Pennsylvania applied the settled rule in the insurance context in this jurisdiction to the reinsurance case before him that an (re)insurer cannot refuse to pay on an otherwise valid claim solely because the (re)insured’s notice was out of time, or because the (re)insured breached a notice provision of the (re)insurance contract. The (re)insurers bear the burden of showing that the notice was late, and that they were unduly prejudiced by the lateness. In Life and Health v Federal Ins the reinsurance policy expressly provided for standard notice provisions, requiring that the reinsured notify the reinsurers “as soon as practicably possible” in the event that a legal action is initiated against the reinsured for which the reinsurers could ultimately be liable under the terms of the (re)insurance. The district court did not clarify whether or not the relevant provision should be drafted as a condition precedent before reaching this conclusion. PRESUMPTION OF PREJUDICE

9.122 It was expressed under California law that, because both parties are experienced insurance companies, who bargained at arm’s length, and the reinsured acquired all of the claims information that the reinsurer lacked, it would be just and equitable to place the burden of proving compliance with the notice clause upon the reinsured.117 If the reinsured was unsuccessful in meeting its burden, a rebuttable presumption of prejudice arose.118 The reinsured could rebut the presumption by showing lack of prejudice to the reinsurer.119 9.123 A contrary presumption in favour of reinsured was noted in National American Ins Co of California v Certain Underwriters at Lloyd’s London120 where the US Court of Appeals for the Ninth Circuit stated that numerous California cases hold that where an (re)insurer denies coverage, a strong presumption arises that it has not suffered prejudice from late notice; so that if an (re)insurer takes the position that it is not liable under the policy, as the reinsurers did in the instance case, then it experiences no prejudice by late notice – it merely denies coverage at a later date. In order to overcome this presumption the reinsurers must show a substantial likelihood that, with timely notice, and notwithstanding a denial of coverage or reservation of rights, they would have settled the claim for less or taken steps that would have reduced or eliminated the reinsured’s liability. 9.124 However, in Insurance Co of State of Pennsylvania v Associated Intern Ins Co121 the Ninth Circuit rejected the presumption of prejudice; the (re)insurer has the burden of proving actual and substantial prejudice, and a “mere possibility” of prejudice would not suffice.122 115. 628 F.2d 860, CA 4 (NC), 1980. 116. 1993 WL 326404 (ED Pa. Aug 25, 1993). 117. Central Nat. Ins Co of Omaha v Prudential Reinsurance Co 241 Cal Rptr 773 1987. However, the case was ordered de-published by the California Supreme Court, and cannot be relied on as precedent. 118. Central v Prudential 241 Cal Rptr 773 1987. 119. Central v Prudential 241 Cal Rptr 773 1987. 120. 93 F.3d 529, (9th Cir. (Cal) Aug 15, 1996). 121. 922 F.2d 516, (9th Cir. (Cal) Dec 27, 1990). 122. Citing Moe v Transamerica Title Ins Co, 21 Cal.App.3d 289, 302, Nov 17, 1971.

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9.125 In this case the reinsurers asserted that it was prejudiced in three ways: First, Associated argued that the late notice deprived it of the opportunity to investigate the Fibreboard cross-claim and participate in the settlement negotiations. Secondly, it was unable “to establish a reserve earlier and thereby obtain a tax deduction” under earlier tax laws. And thirdly, Associated was unable to assert a claim for its own reinsurance, because its reinsurer, Mission Insurance Company, went bankrupt in 1985. 9.126 The court found that because of the late notice the reinsurer merely is prevented from “contemporaneously investigat[ing] the claim,” or from the mere “denial of the opportunity to make an early settlement of the claim” would not suffice proof of prejudice. Furthermore, it would not be sufficient for the reinsurer simply to “display[ ] end results; the probability that such results could or would have been avoided absent the claimed default or error must also be explored.” The reinsurer has to prove actual prejudice that there was a substantial likelihood that it could have either defeated the underlying claim against the reinsured, or settled the case for a smaller sum than that for which the reinsured ultimately settled the claim. The Ninth Circuit further emphasised the fact that Associated had cited no case, and the court itself found none, to support the proposition that such collateral matters may constitute prejudice so as to relieve a reinsurer from its liability under a reinsurance contract. Moreover, there was no factual basis for concluding that Associated suffered the alleged collateral losses or it was not clearly demonstrated that had such collateral losses been sustained, they would have resulted from the delayed notice. Consequently, Associated was held not to have proved that it suffered actual prejudice as a result of the reinsured’s breach of reinsurance notification provision. 9.127 Similarly, the District Court, D Kansas held that prejudice was not presumed and the burden of proof that it was substantially prejudiced by the lack of notice was on the (re)insurer.123 9.128 In Zenith Ins Co v Employers Ins of Wausau124 the reinsurance policy required the reinsured to give prompt notice to the reinsurer and also gave right the reinsurer the right to associate to defend the assured’s claim. Wausau handled matters on its own and did not notify Zenith the existence of the claim until after the jury had returned a massive verdict against the assured. The US Court of Appeals for the Seventh Circuit noted that according to Wis Stat § 631.81,125 where late notices arrive within a year of the time required by the policy, the claim will not be invalidated unless two criteria are met: the insurer was prejudiced by the late notice, and it was “reasonably possible” to give timely notice. The statute, however, does not address situations where notice is given more than one year after the time in which notice is required by the policy. The Seventh Circuit noted that, where notice is given more than one year after time required by policy, there is a rebuttable presumption of prejudice and the burden of proof shifts to the assured to prove that the insurer was not prejudiced by the late notice.126 Consequently, the Seventh Circuit commented that Wisconsin, therefore, requires some kind of showing of prejudice in all cases where (re)insured is in breach of notification clause. The court clarified that in which (re)insurer receives late notice. The court further clarified Wis Stat § 631.81 simply shifts the burden of proof from the (re)insurer to the re(insured) when the notice is more than a year after the time required by the policy.

123. Newcap Ins Co v Employers Reinsurance Corp 295 F.Supp.2d 1229, D Kan 2003. 124. 141 F.3d 300 (7th Cir. (Wis) Mar 27, 1998). 125. Wis Stat § 631.81 provides: (1) Timeliness of notice. Provided notice or proof of loss is furnished as soon as reasonably possible and within one year after the time it was required by the policy, failure to furnish such notice or proof within the time required by the policy does not invalidate or reduce a claim unless the insurer is prejudiced thereby and it was reasonably possible to meet the time limit. 126. Gerrard Realty Corp v American States Ins Co 89 Wis.2d 130, (Wis. May 01, 1979).

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PROOF OF PREJUDICE

9.129 Proof of prejudice is a question of fact for the jury.127 The burden of proof is on the reinsurer128 – unless prejudice is presumed in the relevant jurisdiction. Prejudice to the reinsurer depends upon whether the reinsurer would have been in a more favourable position had it received earlier notice.129 It was clarified in Associated Intern Ins Co v Odyssey Reinsurance Corp.130 that the reinsurer will have to prove that “with timely notice, and notwithstanding a denial of coverage or reservation of rights, it would have settled the claim or taken steps that would have reduced or eliminated” the reinsured’s liability. 9.130 As stated in the paragraphs above, it is clearly the position in California that a mere possibility of prejudice will not suffice. Likewise, being deprived of the opportunity to join and control the underlying claim or being unable to take “evasive action” to protect the reinsurer against the loss is not enough to prove prejudice. For example being unable to claim a tax deduction may amount to a prejudice but it was necessary to prove what prejudice had actually been caused.131 9.131 Similarly, in Unigard Sec Ins Co, Inc v North River Ins Co132 the Second Circuit held that loss of contractual right to associate itself is not enough to prove prejudice without showing economic loss (tangible economic injury). 9.132 The Fourth Circuit was of the same opinion in Fortress Re, Inc v Central Nat Ins Co of Omaha133 that mere proof of having deprived of using the contractual right to associate defending the assured’s claim did not suffice proof of prejudice. The court recognised that a reinsurance contract differs from a primary insurance contract with respect to the investigation and defence of claims and this is clearer especially when the reinsurer does not reserve its right to undertake to investigate or defend suits. However, the court noted that even where the reinsurer reserves such right by the reinsurance contract terms, in the case of breach of the relevant provision the question still remains as to whether the breach caused any prejudice to the reinsurer; in other words, if the right would have been exercised, would the reinsurer’s association with the reinsured have resulted in a more favourable disposition of the claim? 9.133 On the other hand, unlike all other abovementioned opinions, it was held in Keehn v Excess Ins Co of America134 where the Seventh Circuit applied Illinois law, and in Stuyvesant Ins Co v United Public Ins Co135 where the Appellate Court of Indiana did specify the applicable law that if the reinsurance policy gives the reinsurer right to associate it is likely that failure to give notice will deprive the reinsurer of the ability to use its contractual right and opportunity to associate with the reinsured in defence of the third party claim against the assured and this deprivation may be held to highly constitute prejudice without any actual proof that the results of the litigation would have been different. EXCEPTION TO THE PREJUDICE RULE: REINSURED’S BAD FAITH

9.134 It was ruled that, where a reinsurer cannot prove prejudice but he proved its reinsured’s bad faith in failing to comply with the notification clause, the reinsurer would be discharged 127. Christiania General Ins Corp of New York v Great American Ins Co 979 F.2d 268, (2nd Cir. (NY) Sep 3, 1992) Life and Health v Federal 1993 WL 326404 ED Pa. 128. British Ins Co of Cayman v Safety Nat Cas. 335 F.3d 205 (3rd Cir. (NJ) Jul 13, 2003). 129. Life and Health v Federal 1993 WL 326404 ED Pa; British Ins Co of Cayman v Safety Nat Cas. 335 F.3d 205 (3rd Cir. (NJ) Jul 3, 2003). 130. 111 F.3d 137 (9th Cir. (Cal) Apr 02, 1997). 131. Insurance Co of State of Pennsylvania v Associated Intern. Ins Co 922 F.2d 516 (9th Cir. (Cal) Dec 27, 1990). 132. 4 F.3d 1049 (2nd Cir. (NY) Sep 9, 1993). 133. 766 F.2d 163 (4th Cir. (NC) Jul 13, 1985). 134. 129 F.2d 503 (7th Cir. Jun 17, 1942). 135. 139 Ind App 533, Nov 22, 1966. It was not clearly stated in the report if the court applied Indiana law.

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from liability without need for proof of prejudice.136 Whether or not an insurance company has acted in bad faith is a question of fact.137 9.135 Bad faith is not to be judged by reference to the conduct of a reasonable person. In Fortress Re, Inc v Central Nat Ins Co of Omaha,138 following Great American Insurance Co v CG Tate Construction Co (Tate I),139 the test of good faith was stated to be a subjective one, namely that “Anyone who knows that he may be at fault or that others have claimed he is at fault and who purposefully and knowingly fails to notify ought not to recover even if no prejudice results.” In other words, bad faith is to be measured by a subjective standard, based upon actual knowledge, and an intentional (ie purposeful and knowing failure to notify by the insured). 9.136 The minimum standard for bad faith was stated to be gross negligence or recklessness.140 In Unigard, the Second Circuit refused to regard simple negligence in not disclosing a material fact as bad faith. The court found that if a reinsured deliberately deceives a reinsurer, that deception would amount to bad faith. Gross negligence was explained in Unigard as meaning that if a reinsured had implemented routine practices and controls to ensure notification to reinsurers but inadvertence caused a lapse, the reinsured has not acted in bad faith; but if a reinsured did not implement such practices and controls, then it had wilfully disregarded the risk to reinsurers and was guilty of gross negligence. The Second Circuit justified this exception that a reinsurer who was dependent on its reinsured for information, should be able to expect at least this level of protection and in the case of bad faith of the reinsured the reinsurer’s late notice of loss defence should succeed without necessarily proving a tangible ecomonic loss as a result of the breach. 9.137 It is noteworthy that in Zenith Ins Co v Employers Ins of Wausau141 the district court also believed that prejudice did not matter if the insured acted in bad faith. On appeal however the Seventh Circuit noted that the district court referred to the cases decided under New York law such as Unigard142 and Christiania.143 Nevertheless, the court was of the opinion that it would not be appropriate to apply New York law in Wisconsin as there was no analogue to that New York rule in Wisconsin law. Thus, it was held that either Zenith must show prejudice or Wausau must show the lack of it, depending on how late Wausau’s notice was.

L I M I T S O N T H E R E I N S U R E R S ’ D I S C R E T I O N U N D E R C L A I M S C L AU S E S

9.138 As was stated above, claims cooperation clauses may require the reinsured to seek the reinsurer’s consent before entering into any settlements with the assured. It might be thought that in such circumstances there should be an implied term that reinsurers could not withhold approval of a settlement unless there were reasonable grounds for that.144 In Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd,145 at first instance Longmore J found it necessary to imply

136. Christiania General Ins Corp of New York v Great American Ins Co 979 F.2d 268, CA 2 (NY), 1992; Unigard Sec. Ins Co Inc v North River Ins Co 4 F.3d 1049 CA 2 (NY), 1993; Certain Underwriters at Lloyd’s London v Home Ins Co 146 NH 740, NH Sep 6, 2001. 137. Certain Underwriters at Lloyd’s London v Home Ins Co 146 NH 740, N.H. Sep 06, 2001. 138. 766 F.2d 163 (4th Cir. (NC) Jul 13, 1985). 139. 303 NC 387, 1981. 140. Unigard Sec. Ins Co, Inc v North River Ins Co 4 F.3d 1049 (2nd Cir. (NY) Sep 9, 1993). 141. 141 F.3d 300 (7th Cir. (Wis) Mar 27, 1998). 142. 4 F.3d 1049 (2nd Cir. (NY) Sep 9, 1993). 143. 979 F.2d 268 (2nd Cir. (NY) Sep 3, 1992). 144. Reasonableness is required in the insurance context; see E Hulton & Co v Mountain (1921) 8 Ll L Rep 249; Poole Harbour Yacht Club Marina Ltd v Excess Marine Insurance Ltd [2001] Lloyd’s Rep IR 580.

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that obligation, to give business efficacy to the contract for the reason that arbitrarily refusing approval of a settlement would defeat the purpose of the reinsurance contract, which was to indemnify the reinsured in respect of his actual liability to his assured.146 9.139 However in the Court of Appeal Mance LJ expressed his concerns as to the difficulties of identifying criteria by which to determine whether a reinsurer acted on reasonable grounds in withholding approval.147 Mance LJ stated that if it had been the case that the reinsured agreed that the reinsurer should have absolute conduct and control of all or any proceedings against the assured,148 it would make sense to imply a reasonableness requirement. However the clause in Gan did not give the reinsurer the power to act on behalf of or to bind the reinsured.149 As a general qualification Mance LJ declared that the reinsurer should act in good faith in withholding approval by taking into consideration that the facts giving rise to the particular claim and not with reference to extraneous considerations that not connected with the merits of the claim.150 It should also be noted that such good faith is not an extension of the duty of utmost good faith which is special to insurance law, but arises from the nature and purpose of the relevant contractual provisions. The case thus draws a distinction between reasonableness (which was rejected) and rationality (which was accepted).151 9.140 The matter becomes more significant where the claims cooperation clause is a condition precedent breach of which provides defence for reinsurers even if reinsureds establish their liability to assureds. In Eagle Star Insurance Co Ltd v Cresswell152 in order to get around the problem Rix LJ suggested the reinsurer’s rejection could amount a waiver, so that in appropriate circumstances a refusal to participate by reinsurers could be construed as a willingness to follow the reinsured’s settlements. According to their Lordships waiver could be an issue where the reinsurers chose not to intervene the negotiations. However this suggestion should be read with care because it will be appreciated that waiver may not readily be made out by a simple refusal to join the negotiations. Moreover Rix LJ’s second suggestion will be open to doubt where the clause gives the right to the reinsurers to intervene at any time. 9.141 It should be emphasised that Mance LJ’s test in Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd (Nos 2&3)153 is not a reasonableness test but an implied term whereby reinsurers could not exercise their discretion under a claims provision in bad faith, capriciously or arbitrarily but should use its discretion in a rational fashion by disregarding considerations other than those relating to the claim itself. Moreover in Eagle Star Insurance Co Ltd v Cresswell154 Rix LJ took the matter slightly further, and indicated that the duty to act in this

145. [2001] Lloyd’s Rep IR 291. 146. The judge did not find it useful to answer the question of implication of a term obliging the reinsurer to respond to the reinsured’s request for approval of a settlement with reasonable promptness. Longmore J found that an unanswered request would be tantamount to a refusal and it was therefore, difficult to foresee circumstances when it actually mattered that a reinsurer did not respond with reasonable promptness: [2001] Lloyd’s Rep IR 291, 308. 147. [2001] 1 Lloyd’s Rep IR 667, 691. 148. As in Groom v Crocker [1939] 1 KB 194. 149. [2001] 1 Lloyd’s Rep IR 667, 693. 150. Ibid., at 697. For example, if a reinsurer withholds approval to harm an insurer as a competitor in respect of other business. Cf Structural Polymer Systems Ltd v Brown [1999] CLC 268 where it was held that where the criteria for liability had been met it was irrelevant that the settlement had been motivated at least in part by commercial considerations. 151. See also Anders & Kern Ltd v CGU Insurance plc [2008] Lloyd’s Rep IR 460 where the distinction was noted but not developed. 152. [2004] Lloyd’s Rep IR 537. 153. [2001] 1 Lloyd’s Rep IR 667. 154. [2004] Lloyd’s Rep IR 537.

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way was “as a matter of law in the very essence of the reinsurers” mutual obligation155 of good faith as it was suggested by Longmore LJ in K/S Merc-Scandia XXXXII v Lloyd’s Underwriters (The Mercandian Continent).156 As a result it became apparent that the reinsurers’ discretion in handling claims is not unlimited whatever the wording of the policy may be.157

WA I V E R O F R I G H T T O R E LY U P O N B R E AC H O F C L A I M S P ROV I S I O N S

England 9.142 The significance of the nature of claims provisions under English law is seen not only in terms of remedies but also with regards to analysing reinsurers’ waiver of their right to rely upon breach of such clauses. In Kosmar Villa Holidays plc v Trustees of Syndicate 1243158 the assured was a specialist tour operator with a particular focus on destinations in Greece. A young man who had booked a holiday with Kosmar at the Marina Beach Apartments in Corfu, dived into the shallow end of a swimming pool and was badly injured. This happened on 22 August 2002 but it was not until 4 September 2003 that Kosmar first gave notice to the insurer of the occurrence. Clause 7 of the insurance policy provided: “7. It is a condition precedent to insurers’ liability under this insurance that: (1) The Insured shall immediately after the occurrence of any Injury or Damage give notice in writing with full particulars thereof to insurers. Every letter, claim, writ, summons or process shall be notified or forwarded to insurers immediately on receipt. Notice shall also be given in writing to insurers immediately the Insured shall have knowledge of any impending prosecution or inquest in connection with any accident for which there may be liability under this insurance. So far as is reasonably practicable no alteration or repair shall without the consent of the insurers be made to any works, machinery, plant, commodities or goods which are directly or indirectly connected with the occurrence until insurers shall have had the opportunity of examining the same. . . .”

9.143 The assured therefore failed to comply with a condition precedent of the policy which required it to give notice in writing to the insurers immediately after the occurrence of any injury. 9.144 The issue however was whether the communications between the assured and the insurer waived the insurer’s right to rely on the breach of condition precedent. The Court of Appeal discussed the difference between waiver by election and waiver by estoppel and it was held that where the clause is a condition precedent, breach of the clause cannot be waived by election. Rix LJ noted that waiver by election applies when one party becomes entitled to exercise a right and has to choose whether to exercise the right or not. Such an election has generally to be an informed choice, made with facts giving rise to the right and it is not dependent upon reliance on it by the other party. Their Lordships distinguished equitable estoppels from election as in the former an unequivocal representation by one party that he will not insist upon his legal rights against the other party is required. The representees reliance on this representation will render it inequitable for the representor to go back on his representation. In other words, the party making his election is communicating his choice whether or not to exercise a right which has become available to him. However, in an equitable estoppel the representor promises that he will not in future enforce his legal rights.

155. 156. 157. 158.

Ibid., at 550. [2001] Lloyd’s Rep IR 802. Merkin, “Follow the Settlements and Claims Cooperation,” Insurance Law Monthly, Sept 2004, 6, 10. [2008] Lloyd’s Rep IR 489.

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9.145 From the above definitions it became clear that election is the exercise of a right to choose between inconsistent remedies. Clearly, the party electing should have the knowledge of the facts giving rise to the choice and the other party should know that the choice having been made. One further point is that as the election is the choice of the party electing, it is his conduct which is decisive. Once made the election is final and irrevocable. However, the estoppel may not be irrevocable, but may be suspensory only. 9.146 The Court of Appeal concluded that breach of a procedural condition precedent automatically discharged the insurer from liability, thus leaving no scope for a choice between inconsistent remedies and the doctrine of waiver. However, the court mentioned about the possibility that if, having been automatically discharged from liability, insurers represented unequivocally to the assured, by words or conduct, that they did not intend to rely upon the breach, and the assured relied on that representation to its detriment, insurers could be estopped from relying on the breach of the claims condition. 9.147 The Kosmar case was applied by Chirstopher Clarke J in Lexington Insurance Co v Multinacional de Seguros SA159 where Multinacional, one of Venezuela’s largest insurers, acted as a front insurer for the reinsurers by insuring several companies under a property and business interruption policy for the period of 12 months from 1 July 1997. There were seven reinsurance slips and Lexington subscribed four of them. On 16 April 1998 an event occurred at the assured’s property which gave rise to a claim by the assured against Multinacional for property damage and business interruption loss. 9.148 The reinsurance contract taken contained a claims settlements clause in the following terms: “Notwithstanding anything contained in the reinsurance agreement and/or the policy wording to the contrary, it is a condition precedent to any liability under this policy that: (a) Upon the reinsured being advised of any circumstances which may give rise to a claim against this policy, the reinsured will advise reinsurers of such notification as soon as is reasonably practicable; (b) The reinsured shall furnish the reinsurers with all information in respect of such circumstances and shall co-operate with the reinsurers in the adjustment and settlement of the claim.”

9.149 The reinsured failed to cooperate with the reinsurer in investigating the claim. Following that, the reinsurer sent a letter to the reinsured declaring that because of the breach of claims cooperation clause the reinsurers were treating themselves as discharged from liability. After this letter further negotiation took place between the assured and the reinsured, the effect of which was a waiver by the reinsured of the assured’s failure to rely upon a time-bar defence open to it in respect of the third-party claim. Christopher Clarke J held that the reinsured was in breach of the claims condition clause by this action. At the trial the reinsured argued that, by virtue of the first letter in which liability had been denied, the reinsurers had waived their right to rely upon any future failure by the reinsured to co-operate. Applying the decision in Kosmar, Christopher Clarke J held that where the reinsured was automatically discharged from liability for breach of condition precedent, waiver of the right to rely on the breach by election was not a possibility because there was nothing to elect to waive. 9.150 Consequently the only form of waiver open to the reinsured was waiver by estoppel. In other words the reinsured had to prove both that there was an unequivocal representation by

159. [2009] Lloyd’s Rep IR 1.

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the reinsurers that they accepted liability and that the reinsured relied on such representation to its detriment. United States 9.151 Under New York law waiver is defined as “the intentional relinquishment of a known right.”160 Therefore it is necessary to show that the reinsurer possessed sufficient knowledge, actual or constructive, of the circumstances with regards to the unasserted defence, and also to produce direct or indirect evidence that the reinsurer intended to discard it.161 Waiver can be express, or it can be implied where it can clearly be inferred from the circumstances.162 9.152 Applying California law, in National American Ins Co of California v Certain Underwriters at Lloyd’s London163 the Ninth Circuit agreed with the district court that the reinsurers’ delay constituted a waiver of any late notice defence they may have had. 9.153 In this case the assured operated a manufacturing plant near Tucson International Airport from 1951 until the mid-1970s and disposed of considerable amounts of toxic waste. As a result in 1985, residents living near the Tucson airport brought a class action against the assured. The reinsured, who took part in defending the claim against the assured but at the time the litigation commenced was unaware of the reinsurance policies, later discovered the existence of the reinsurance policies via its brokers and on 31 May 1989, before any settlement was reached with the claimants, sent the reinsurers a letter giving them preliminary notice of a possible claim against the policies. The reinsurers did not respond and the reinsurers settled the claims and on 9 January 1991 it informed the reinsurers of the terms of the settlement agreement but the reinsurers maintained their silence until July 1991, when National brought an action against the reinsurers. 9.154 In response to the reinsured’s action the reinsurers asserted that the reinsured was in breach of the notification clauses in the reinsurance policies. The Ninth Circuit stated that under California law, a reinsurer may invoke the defence of late notice so long as it immediately objected to the late notice, and suffered “actual and substantial prejudice” (West’s Ann Cal Ins Code § 554). Despite receiving notice of the claim on 31 May 1989, the reinsurers did not object to the late notice until after suit was brought in July1991. While “promptly” is not specifically defined in Cal Ins Code § 554, the Ninth Circuit noted that a case164 where an insurance company who delayed 20 months before objecting to a claim was “a clear case of waiver.” Here, the reinsurers delay (between May 1989 and July 1991) was more than two years, which was not a prompt objection by any definition. 9.155 An example of a note which was held to have reserved the reinsurers’ right to contest the reinsured’s claim unequivocally is seen in Constitution Reinsurance Corp v Stonewall Ins Co,165 where the reinsurers wrote in their letter that “we question the late nature of your initial notice and subsequent report.” In Stonewall it was also held that due to unequivocal reservations of rights, under New York law, the reinsurers’ partial payment on multimillion dollar claim did not constitute waiver of right to rely on late notice defence. In Keehn v Excess Ins Co of America166 the reinsured argued that the telegram that was sent by the 160. United Fire & Ca. Co v Arkwright Mut. Ins Co 53 F.Supp 2d 632 SDNY, 1999. 161. Constitution Reinsurance Corp v Stonewall Ins Co 980 F.Supp. 124, SDNY, Sep 17, 1997. 162. Constitution Reinsurance Corp v Stonewall Ins Co, 980 F.Supp. 124, SDNY, Sep 17, 1997. 163. 93 F.3d 529, (9th Cir. (Cal) Aug 15, 1996). 164. Ellgass v Brotherhood of RR Trainmen Ins Dep’t, 342 F.2d 1, 3 (9th Cir. (Cal) Feb 4, 1965) cert. denied, 381 US 91, (U.S. Cal. May 17, 1965) 1965. 165. 980 F.Supp. 124, SDNY, Sep 17, 1997. 166. 129 F.2d 503 (7th Cir. Jun 17, 1942).

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reinsurer saying “Sorry but our records do not confirm Snow-Hartliep ever reported; please give us complete information.” constituted waiver. The Seventh Circuit noted that an insurer must have knowledge of all the material facts before its conduct could constitute a waiver; the telegram indicated that the reinsurer had had no notice of the Snow accident and was requesting information. Without knowledge of material facts the court held that there could not be waiver.

IMPLIED TERM: INSPECTION OF RECORDS

9.156 Inspection clauses are in fact more typical of reinsurance treaties than of facultative contracts, although the latter may also contain clauses requiring the reinsured to keep records to demonstrate that negotiations were carried out in bona fide and businesslike manner.167 The effect of breach of such clauses is no different from that of other claims provisions, namely the English courts will not allow the reinsurer to repudiate the claim itself unless the clause was drafted as a condition precedent.168 9.157 Nevertheless reinsurance contracts do not always contain inspection of records clauses and the question that has arisen is whether a term providing a right to inspection should be implied into the contracts. Such an implication has been found appropriate in facultative obligatory treaties. In Phoenix General Insurance Co of Greece SA v Halvanon Insurance Co Ltd169 Hobhouse J expressed the view that the necessity to imply a duty to investigate claims properly arose from the undertaking by the reinsurer to follow the settlements of the reinsured.170 Consequently, the duty should apply to all reinsurance contracts that contain a settlement clause.171 9.158 However it should be taken into consideration that Hobhouse J’s implication was based on the facultative/obligatory nature of the contract in question. It is especially noteworthy that in these types of contract no restrictions are imposed on the reinsured as to its right to choose whether or not to cede the risk insured. On the other hand the reinsurer does not have any equivalent right and is obliged to accept all risks that has been ceded by the reinsured. For these reasons, in this type of reinsurance, the judge found it appropriate to imply the duty on the reinsured “to conduct the business involved in the cession prudently, reasonably carefully and in accordance with the ordinary practice of the market.” However such an implication may not be appropriate in non-proportional reinsurance. Having recognised the nature of the contract in Phoenix, the Court of Appeal in Bonner v Cox172 expressed

167. Exercising the right to inspect is subject to a reasonableness requirement: Welch v Royal Exchange Assurance [1939] 1 KB 294; Napier v UNUM Ltd [1996] 2 Lloyd’s Rep 550. It should not be exercised in bad faith and in an excessive or “fishing” fashion: Société Anonyme d’Intermediaries Luxembourgeois & Anor v Farex Gie [1994] CLC 1094. 168. In fact inspection clauses are not really appropriately drafted as conditions precedent, as in treaties the reinsurer is entitled to examine the reinsured’s books and records whether or not there has been a loss: Merkin, Colinvaux’s Law of Insurance, para. 17–15. 169. [1985] 2 Lloyd’s Rep 599. According to the learned judge the reinsured is obliged to, inter alia, “keep full, proper and accurate accounts showing at all times the amounts due and payable by the plaintiffs to the defendants and by the defendants to the plaintiffs under the contract.” The case was applied in Economic v Le Assicurazioni d’Italia unreported: see Bonner v Cox [2006] Lloyd’s Rep IR 385. 170. [1985] 2 Lloyd’s Rep 599, 614. 171. Edelman, para. 3.45. 172. [2006] Lloyd’s Rep IR 385.

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that Hobhouse J could not possibly have intended to say that the implied terms applied to all forms of reinsurance,173 although the implied term under consideration in Bonner was not an inspection clause, but rather a term whereby the reinsured undertook to write business with reasonable care. 9.159 In Bonner v Cox the Court of Appeal did not make clear whether they overruled Hobhouse J’s decision with regard to proportional contracts. However looking into detail of the two decisions it seems that implied term theory is not supportable. For instance in Phoenix it was held that the relevant obligations must be regarded as continuing ones, just as is the obligation of the utmost good faith whereas, in Bonner v Cox, the Court of Appeal emphasised that the duty of utmost good faith was only pre-contractual. Moreover, according to Hobhouse J the relevant terms have to be implied so as to require the reinsured to conduct his business in a proper and business-like fashion and the reinsurer may also be able to find out what his rights are. On the other hand the Court of Appeal in Bonner v Cox were of the opinion that the reinsurers could protect themselves by way of using other defences rather than implying terms into the contract. The reinsurers are entitled to agree on the policy terms at the outset that could provide enough protection for them. The Court of Appeal found it inappropriate to make reinsured responsible for the reinsurers’ failure to take such steps. More importantly Hobhouse J ruled that the implied terms were to be innominate and therefore the remedy for breach of them must depend on the nature and gravity of the relevant breach. Nevertheless in Bonner v Cox the Court of Appeal put emphasis on the difficulties in determining whether damages would always cancel out the claim entirely or whether the defence of contributory negligence would be taken into account. 9.160 It should be noted that even if implied terms are found justifiable, they will not be classified as conditions precedent174 and the breach of record-keeping and inspection obligations will not deprive the reinsured of a claim against the reinsurers and the reinsured can still rely on the follow the settlements clause. However it could avail the reinsurers to claim for damages if they prove that they suffered loss as a result of the breach.175 Nevertheless such remedy should be considered with the effect of the reinsurers’ right to rely on a defence regarding the inspection clauses and the clause itself would remove the prospect of separate loss for the breach of such clauses.176 9.161 In the US, provisions entitling the reinsurer the “Inspection of Records” or simply “Audit”.177 An example of a formulation of an access to records clause is: “The reinsurer or its designated representatives shall have free access to the books and records of the Company on matters relating to this reinsurance at all reasonable times for the purpose of obtaining information concerning this Contract or the subject matter hereof.”178 9.162 Similar to Hobhouse J’s view stated above, in the US, the approach is that access to records is of importance for reinsurers, especially in determining if the reinsured acted reasonably and in good faith in handling and settling the underlying claims.179 On the other hand, a 173. In Albany Life Assurance Co v De Montfort Insurance Co plc (1995) unreported see Butler and Merkin, Reinsurance Law, para. C-0578) it was found to be inappropriate to imply a term that required the assured to co-operate with the insurer in the investigation of any claim and to make available the claim file for insurers’ inspection. See also Société Anonyme d’Intermediaries Luxembourgeois v Farex Gie [1994] CLC 1094. 174. Baker v Black Sea & Baltic General Insurance Co Ltd [1995] LRLR 261. 175. Charman v Guardian Royal Exchange Assurance Plc [1992] 2 Lloyd’s Rep 607, 616. 176. Butler and Merkin, Reinsurance Law, para. C-0656. 177. New Appleman Guide, 40.10[1]. 178. New Appleman Guide, 40.39. 179. The Law of Reinsurance Claims 1997 Supplement, 85; New Appleman Guide, 40.10[1]. A reinsured is still obligated to provide the information reasonably requested by its reinsurer in the absence of a clause as such failing of which may cause denial of the reinsured’s claim: Michigan Mut Ins Co v Unigard Sec Ins Co 44 F.3d 826 CA 9 (Wash), 1995.

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reinsurers’ failure to exercise the right of inspection may be interpreted in favour of reinsureds. In Gerling Global Reinsurance Corp v Safety Mut Cas Corp.,180 such a failure by the reinsurers was held to defeat a fraudulent concealment allegation in the absence of any indication that the reinsured failed to honour the access to records provision. It should also be noted that reinsurers’ request to access to records must be at “reasonable times.”181 Nevertheless, it was pointed out that in drafting an access to records clause it should provide that: there is a right to inspect all books and documents relating to business transferred to the reinsurer; the right of inspection survives contract termination; the inspection right vests in the reinsurer or in any of its authorised representatives; and access for inspection will be allowed at all reasonable times.182

I M P L I C AT I O N S O F C L A I M S P ROV I S I O N S I N T H E U S

Agency Relationship between the Reinsured and Reinsurer 9.163 Agency is described as a “manifestation of consent of one person to another that the other shall act on his behalf and subject to his control, and consent by the other so to act.” In Reid v Ruffin,183 where the court put forward this definition, the reinsured agreed not to settle the assured’s claims falling within the reinsurance without the consent of the reinsurer, except in those instances where an immediate decision was necessary and it was impracticable to obtain the consent of the reinsurer (Article 8). The assured, Ruffin, was involved in an accident which caused serious injury to Reid. Reid brought an action against Ruffin, but prior to trial offered to settle the case for the policy amount, $10,000, an offer to which the reinsured did not respond or inform the reinsurers. Later, the reinsured tried to settle but Reid refused. The matter went to trial and the jury awarded Reid a verdict of $80,000. The court construed Article 8 as meaning that it did not require all decisions regarding settlement matters involving reinsurance to be approved by the reinsurers. The reinsurers were given no control over decisions by the reinsured not to settle a claim and, the reinsurers could not direct the reinsured to accept an offer of settlement if for some reason the reinsured was unwilling to do so. 9.164 The court saw no general agency relationship, and made it clear that Article 8 authorised the reinsured to act on behalf of the reinsurer only “in those instances where an immediate decision is necessary and it is impracticable to obtain the consent of the Reinsurer.” Otherwise, a settlement was not to be made without the reinsurer’s consent. Thus, if the reinsured can be said to be the agent of the reinsurers, it is only to the limited situation in which an immediate decision to settle was necessary. Therefore a finding of bad faith was the reinsured’s decision not to settle, a decision over which the reinsurers had no control; the bad faith of the insurer could not be imputed to the reinsurer. 9.165 However if the clause clearly so states, the reinsured might be regarded as acting as an agent of the reinsurer in defending the claim. In Commercial Assur Co v American Cent Ins Co,184 where there was no follow the fortunes clause, upon the notification of the loss the reinsurer and the reinsured refused to pay. The assured then brought an action against the original

180. 181. 182. 183. 184.

1981 US Dist LEXIS 13864. The Law of Reinsurance Claims 1997 Supplement, 85. New Appleman Guide, 40.10[1]. 503 Pa 458, 1983. 68 Cal 430, Jan 28, 1886.

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insurer to recover the loss and the two companies again agreed that the action should be resisted and contested, and that the original insurer, as defendant in the action, should have the conduct, management, and control of the contest for itself and as agent of the reinsuring company. However the reinsured abandoned the defence and compromised and settled the claim with the assured. The Supreme Court of California held that such an authorisation required the reinsured to defend the action until the question of liability was adjudicated. Under the authority it had been given by the agreement with the reinsurer, the reinsured had no power to compromise and settle the claim to bind the reinsurer unless the latter had knowledge of the compromise, and consented to it or approved of it. Attorney–Client Privilege 9.166 In commercial disputes it is permitted in the US for the parties to request from each other documents to help them prove their respective cases.185 However, if a document is subject to the attorney–client privilege it will be immune from discovery.186 9.167 The documents that are subject to the privilege are stated to be:187 (a) claims counsel reports regarding the defence of the assured’s claim; (b) expert reports or analyses of a claim by the insurer’s or insured’s personnel concerning the defence of a claim; (c) coverage analyses by the reinsured’s in-house or outside counsel; and (d) draft arguments and communications with counsel regarding those pleadings. 9.168 If the parties have a common interest on a particular issue, disclosure of documents is not to be restricted on the basis of the attorney–client privilege.188 In that situation, communications made to the shared attorney to establish a defence strategy remain privileged as against the rest of the world. However, it is accepted that reinsurers and reinsureds do not share a common interest. The issue arose in North River Ins Co v Columbia Cas Co189 where the arbitrator decided that North River was obliged to pay the assured’s attorney’s fees in defending third-party asbestosis claims. North River then claimed those fees from the reinsurers, Columbia. The reinsurers requested sight of the documents between North River and their attorney in respect of defending the assured’s own claim for defence costs. North River argued that those documents were protected by attorney-client privilege. The court clarified that the common interest doctrine applies when multiple persons were represented by the same attorney and therefore rejected the reinsurers’ contention that the doctrine was applicable to the reinsurance relationship. For example if an insurer actually retained counsel to provide a defence for the insured, there was a common legal interest between them. Therefore, the mere fact that the parties had a reinsurer, reinsured relationship was insufficient to find that they shared a common interest. The court also noted that North River and Columbia were not represented by the same counsel, and Columbia did not contribute to North River’s legal expenses nor exercise any control over its conduct of the proceedings. Nor was there any evidence that the two parties coordinated litigation strategy in any way. While their commercial interests

185. 186. 187. 188. 189.

Hammesfahr 94, 136. Hammesfahr 2004, 269. New Appleman Guide, 40.10[3][a]. However, privilege against a third party is still applicable: New Appleman Guide, 40.10[2]. 1995 WL 5792 SDNY, Jan 5, 1995.

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coincided to some extent, their legal interests sometimes diverged, as demonstrated by the instant litigation. 9.169 A cooperation clause does not waive attorney–client privilege.190 In North River Ins Co v Philadelphia Reinsurance Corp.191 the cooperation clause in the reinsurance contract provided: “The company [North River] shall furnish the Reinsurer with a copy of its policy and all endorsements thereto which in any manner affect this certificate, and shall make available for inspection and place at the disposal of the Reinsurer at reasonable times any of its records relating to this reinsurance or claims in connection therewith.” The court recognised that a reinsured may contractually be bound to provide its reinsurer with all documents or information in its possession that may be relevant to the underlying claim adjustment and coverage determination. However, according to the judge, more explicit language was required to achieve that result. A cooperation clause did not mean that the reinsured waived wholesale its right to preserve the confidentiality of any consultation it might have with its attorney concerning the underlying claim and determination of its coverage. The court also stated that under a cooperation clause a reinsurer is not entitled to be appraised of legal advice obtained by a reinsured with a “reasonable expectation of confidentiality.” It was enough to satisfy its obligations under the cooperation clause to make available to the reinsurer all factual knowledge or documentation in its possession relevant to the underlying claim or the handling of that claim. 9.170 However it should be noted that if a reinsured discloses the documents in any other litigation with other parties, such disclosure amounts to a waiver of privilege. In North River Ins Co v Columbia Ins Co192 it was mentioned that North River disclosed documents in litigation against CIGNA in circumstances where North River and CIGNA had no common legal interest. Therefore North River was held to have waived the attorneyclient privilege with respect to the documents that it had disclosed in the litigation against CIGNA, and Columbia was held to be entitled to see those documents without any attorney-client privilege restriction.

F O L L OW T H E S E T T L E M E N T S V C L A I M S P ROV I S I O N S

9.171 The interpretation of the follow the settlements clause indicates that the reinsurer trusts the honesty and professionalism of the reinsured. On the other hand reinsurers may want to control the negotiations or the process of dealing with the assured’s claim by the insurer, particularly where the reinsurers have accepted a significant proportion of the risk and therefore the reinsurance policy may contain claims provisions as well as a follow the settlements clause. Claims provisions impose restrictions on the reinsured’s rights recognised by the common law.193 Therefore it is necessary to clarify how to resolve the inconsistency that may arise in a policy which contains both clauses.

190. Nor a standard access to records clause. In Gulf Insurance Co v Transatlantic Reinsurance Co, 788 NYS.2d 44 NYAD 1 Dept, 2004, the reinsurance contract provided that “the Reinsurers . . . will have the right to inspect . . . all records of the Company [ie plaintiff] that pertain in any way to this Agreement.” The Supreme Court of New York Appellate Division held that a standard access to records clause in a contract did not waive any claim of privilege with respect to those documents. 191. 797 F.Supp 363 DNJ, Apr 6, 1992. 192. 1995 WL 5792 SDNY, Jan 5, 1995. 193. Per Robert Goff LJ Insurance Co of Africa v Scor (UK) Reinsurance Co Ltd [1985] 1 Lloyd’s Rep 312, 331. Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd (No.3) [2002] Lloyd’s Rep IR 612.

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9.172 Insurance Co of Africa v Scor (UK) Reinsurance Co Ltd194 is an example of such a case. The reinsurance slip contained a full reinsurance clause and a claims cooperation clause which stated inter alia: “It is a condition precedent to liability under this Insurance that all claims be notified immediately to the Underwriters subscribing to this Policy and the Reassured hereby undertake in arriving at the settlement of any claim, that they will co-operate with the Reassured Underwriters and that no settlement shall be made without the approval of the Underwriters subscribing to this Policy. Being a Reinsurance of and warranted same . . . terms and conditions as and to follow the settlements of the Insurance Company of Africa . . .”

Leggatt J195 at first instance found that there was no reason to construe the claims provisions as weakening the effect of the follow the settlements clause. So long as the settlement is bona fide and businesslike and the loss falls within the reinsurance cover the reinsurer is obliged to follow the reinsured’s settlement. The Court of Appeal196 disagreed. Although the members of the Court of Appeal recognised the conflict between the follow the settlements and the claims cooperation clauses, they were of the view that the two different kinds of clauses should be read together to the effect that the follow settlements clause will be applicable only to such settlements as are approved by the reinsurers.197 Indeed, non-compliance with the clause would remove the right of the reinsured to recover even in respect of an established liability in the form of a judgment or award against it. The Court of Appeal admitted that such construction would remove the value of the follow settlements clause;198 nevertheless their Lordships were convinced that this was what the parties to a policy in this form had agreed and this construction would do least violence to the language.199 9.173 However, it may be thought that there is in fact no necessary connection between a follow the settlements and a claims clause, so the mere fact that the reinsured is in breach of claims clause which is not expressed to be a condition precedent should not deprive the reinsured of its right to insist that its settlement is followed.200 In Scor itself, the reinsured was held to be in breach of the latter part of the clause, requiring cooperation, but because that part of the clause was not expressed to be a condition precedent, the reinsured was held to be entitled to recover, its liability having been established by a judgment against it. While it is inevitable that, where the claims provisions are conditions precedent breach of which entitle the reinsurer to reject the claim, the reinsured will not have any right to rely on the follow the settlements clause, but where the clause is not a condition precedent it is open to doubt why the reinsured should not have the rights conferred by the follow the settlements clause.201 It should also be remembered that Friends Provident Life & Pensions Ltd v Sirius International Insurance Corp202 accepted that a clause which is not a condition precedent is of no significance as regards the claim. Therefore so long as the reinsured has acted in a bona fide and businesslike manner in settling the claim, not seeking the reinsurer’s consent should not deprive the reinsured of its right to rely on the follow the settlements clause where the claims provision is not a condition precedent. 194. [1985] 1 Lloyd’s Rep 312. 195. [1983] 1 Lloyd’s Rep 541. 196. [1985] 1 Lloyd’s Rep 312. 197. Naturally, reinsurers may, if they wish, waive that requirement. 198. See also Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd, per Longmore J, [2001] Lloyd’s Rep IR 291, 307. 199. Fox LJ, [1985] 1 Lloyd’s Rep 312, 334. 200. Butler and Merkin, Reinsurance Law, para. C-0584. O’Neill/Woloniecki, para. 5–26 state that Leggatt J’s view in Insurance Co of Africa v Scor (UK) Reinsurance Co Ltd [1983] 1 Lloyd’s Rep 541 is more supportable because there is no logical inconsistency between the follow the settlements and claims cooperation clauses. 201. Butler and Merkin, Reinsurance Law, para. C-0584. 202. [2005] 2 Lloyd’s Rep 517.

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9.178

9.174 In Eagle Star Insurance Co Ltd v Cresswell203 a typed no settlement without consent clause was found to cut away the printed follow the settlements clause in so far as the two clauses were inconsistent. However, the ratio did not focus on reading a follow the settlements and a claims cooperation clause together but it was based on reading a printed clause along with a typed clause which are inconsistent each other in the same contract. In the reinsurance policy which Eagle Star was reinsured the claims cooperation clause204 provided:205 “The company agree: (a) To notify all claims or occurrences likely to involve the Underwriters within 7 days from the time that such claims or occurrences become known to them. (b) The Underwriters hereon shall control the negotiations and settlements of any claims under this Policy. In this event the Underwriters hereon will not be liable to pay any claim not controlled as set out above.”

Omission however by the Company to notify any claim or occurrence which at the outset did not appear to be serious but which at a later date threatened to involve the Company shall not prejudice their right of recovery hereunder. 9.175 This clause was a typewritten clause and is one of a collection of clauses under the heading “Attaching to and forming part of Policy Number 69/12966/4”. Policy 69/12966/4 dated was a Lloyd’s Reinsurance Policy in J1 form and in its printed wording described itself as: “Being a Reinsurance of and warranted same gross rate, terms and conditions as and to follow the settlements of the Company.”

9.176 One of the other typed clauses attached to the policy preceded the original claims cooperation clause, the fifth paragraph provided: “. . . No settlement of a loss by agreement shall be effected by the Company for a sum in excess of the limits stated in the Schedule hereto, without the consent of the Underwriters.”

9.177 Longmore LJ206 recognised that this fifth paragraph was inconsistent with the reinsurers’ agreement in the printed words of the policy “to follow the settlements” of the reinsured because the fifth paragraph provided that any settlement in excess of the deductible has to be with the consent of underwriters. The Court of Appeal held that in accordance with normal principles of interpretation, the typed words, unless for some reason they are inapplicable, would prevail over inconsistent printed words in the contract. 9.178 In the US, clauses requiring reinsurers’ consent for settlement are found in apparent conflict (or at least tension) with a follow the settlements clause if the reinsurance contract contains one.207 No reinsurance case has in fact turned on this issue, but in the insurance context, in Crowley Maritime Corp v Federal Ins Co,208 the insurer was held not to be liable to follow the assured’s settlements entered into without the insurer’s consent contrary to a policy term whereby the assured agreed not to settle any claim without the insurer’s written consent. 203. [2004] Lloyd’s Rep IR 537. 204. Longmore LJ noted that a clause in this form would normally be called a claims control clause rather than a claims cooperation clause but nothing turns on the terminology. [2004] Lloyd’s Rep IR 537, 540. 205. In its original form the clause was expressed in terms which made it a condition precedent to the liability of reinsurers under the reinsurance policies (1) that the reinsured should advise the reinsurers within seven days of acquiring knowledge of any losses which might give rise to a claim and (2) that the reinsured should furnish the reinsurers with available information and cooperate with them in the adjustment and settlement of claims. The parties, however, cancelled this clause by stamping ‘This clause void’ across it and substituted for the clause mentioned in the text above. 206. [2004] Lloyd’s Rep IR 537, 542. 207. New Appleman Guide, 40.11; Staring §17:3 208. 2008 WL 5071118 (ND Cal, Dec 01, 2008) affirmed by the Ninth Circuit 373 Fed. Appx. 782 (9th Cir. (Cal) Apr 09, 2010).

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I N DE X

Aggregate excess of loss reinsurance generally, 1.13 Allocation of loss ‘follow the fortunes’ clauses, and annualisation, 7.180–7.199 distinguishing settlement from allocation, 7.135–7.179 inconsistency between pre-settlement and post-settlement allocations, 7.113–7.134 introduction, 7.112 reinsurers’ reservation, 7.200–7.203 summary, 7.204 ‘follow the settlements’ clauses, and, 7.99–7.111 Alterations to original policy continuing duty of utmost good faith, and, 4.15–4.25 generally, 4.05–4.14 Annualisation ‘follow the fortunes’ clauses, and, 7.180–7.199 Arbitration awards ‘follow the settlements’ clauses, and, 6.17–6.18 Arbitration clauses charterparty into bills of lading, from, 3.43 direct insurance into reinsurance contracts, from, 3.44–3.54 ‘follow the form’ clauses, and, 5.19–5.25 s 6(2) Arbitration Act 1996, and, 3.55 ‘As far as applicable hereto’ qualifications in wording of ‘follow the settlements’ clauses, and, 8.64–8.71 ‘As original’ See also Incorporation function, 3.01–3.03 nature of facultative reinsurance, and, 2.02 wording of reinsurance contracts, and, 1.25 Assignment of original policy ‘follow the form’ clauses, and, 5.27–5.32 Assured’s obligations under direct policy incorporation, and, 4.29–4.31

Back-to-back cover principle—cont. scope—cont. Vesta v Butcher, 2.83–2.92 Wasa v Lexington decisions, 2.111–2.122 facts, 2.106–2.110 implications, 2.123–2.131 introduction, 2.105 wording of reinsurance contracts, and, 1.25 Bad faith ‘follow the fortunes’ clauses, and, 6.142–6.146 Bona fide settling claim ‘follow the settlements’ clauses, and 6.60–6.61 Burden of proof ‘follow the settlements’ clauses, and ascertainment of liability in settlements, 6.65–6.69 fraud of assured, 6.70–6.71 generally, 6.62–6.64 stop-loss policies, 6.72–6.77 Businesslike manner in settling claim ‘follow the settlements’ clauses, and, 6.60–6.61 Choice of law clauses ‘follow the form’ clauses, and, 5.26 generally, 3.56–3.59 Claim beyond reinsurance policy cover generally, 6.177–6.178 losses falling beyond reinsurance policy limits, 6.182–6.189 unreinsured losses, 6.179–6.180 Claim outside scope of original insurance ‘follow the fortunes’ clauses, and, 6.155–6.176 Claims provisions ‘appears likely’, 9.28–9.40 ‘as soon as practicable’, 9.27 breach remedy, 9.52–9.53 waiver of right to rely upon, 9.142–9.155 claims control clauses, 9.41–9.51 claims cooperation clauses, 9.02–9.05 conditions precedent distinguishing from innominate terms, 9.68–9.71 distinguishing from warranties, 9.65–9.67 generally, 9.54–9.64 ‘follow the settlements’ clauses, and, 7.83–7.98, 9.171–9.178 ‘immediate notice’, 9.27

Back-to-back cover principle applicable law, 2.105–2.131 concurrency between policies in US, 2.102–2.104 forms of reinsurance contracts, and, 1.09 incorporation, and, 4.33–4.41 rebutting the presumption, 2.95–2.101 scope generally, 2.82 Groupama Navigation v Catatumbo Seguros, 2.93–2.94

275

INDEX

Claims provisions—cont. implications in US agency relationship between reinsured and reinsurer, 9.163–9.165 attorney-client privilege, 9.166–9.170 implied term, 9.156–9.162 incorporation, and, 3.35–3.41 innominate terms, and, 9.68–9.71 inspection of records, 9.156–9.162 introduction, 9.01 limits on reinsurers’ discretion, 9.138–9.141 nature (UK law) distinguishing from innominate terms, 9.68–9.71 distinguishing from warranties, 9.65–9.67 generally, 9.54–9.64 nature (US law) determinative terminology, 9.73–9.86 generally, 9.72 prejudice, 9.87–9.137 notification English law, 9.06–9.17 US law, 9.18–9.40 prejudice requirement (US) California, 9.89–9.92 exception to rule, 9.134–9.137 generally, 9.87–9.88 introduction, 9.73–9.86 Kansas, 9.93–9.94 Massachusetts, 9.95–9.96 New Jersey, 9.97–9.102 New York, 9.103–9.119 North Carolina, 9.120 Pennsylvania, 9.121 presumption, 9.122–9.128 proof, 9.129–9.133 reinsured’s bad faith, 9.134–9.137 ‘prompt notice’, 9.27 remedy for breach, 9.52–9.53 time of notification English law, 9.06–9.17 US law, 9.18–9.40 US, in agency relationship, 9.163–9.165 attorney-client privilege, 9.166–9.170 implications, 9.163–9.170 nature, 9.72–9.137 time of notification, 9.18–9.40 waiver of right to rely upon breach, 9.151–9.155 waiver of right to rely upon breach English law, 9.142–9.150 US law, 9.151–9.155 warranties, and, 9.65–9.67 Co-insurance subject matter of facultative reinsurance, and, 2.65–2.67 Commutations ‘settlements’ clauses, and, 7.232–7.235 Cut-through exception subject matter of facultative reinsurance, and, 2.45–2.52 Declaratory judgment costs ‘follow the fortunes’ clauses, and, 7.81–7.82

Defence costs ‘follow the fortunes’ clauses, and agreed by reinsured to be paid beyond original insurance policy limits, 7.63–7.80 costs-exclusive, 7.18–7.40 costs-inclusive, 7.18–7.40 costs-supplemental policies, 7.18–7.40 interpretation of original policy binding on reinsurer, 7.41–7.45 Wellington Agreement, 7.46–7.62 Definition of ‘reinsurance’ generally, 1.01–1.03 US, in, 1.16 Double insurance subject matter of facultative reinsurance, and, 2.65–2.67 Endorsement of original policy ‘follow the form’ clauses, and, 5.33–5.36 Excess of loss reinsurance generally, 1.13 Extension of cover ‘liable or not liable’, 8.05–8.09 ‘without question’, 8.02–8.04 Extra-contractual liability ‘follow the fortunes’ clauses, and, 7.213–7.231 ‘follow the settlements’ clauses, and, 7.208–7.212 Facultative obligatory treaty reinsurance generally, 1.15 Facultative reinsurance See also Proportional reinsurance co-insurance, 2.65–2.67 cut-through exception, 2.45–2.52 double insurance, 2.65–2.67 follow the settlements clauses See also Follow the settlements clauses allocation of loss, 7.99–7.111 commutations, 7.232–7.235 construction, 6.32–6.103 early formulation, 6.22–6.31 establishing reinsured’s liability under direct policy, 6.03–6.21 extra-contractual liability, 7.208–7.212 future claims, 7.236 interest, 7.205–7.207 introduction, 6.01–6.03 qualifications in wording, 8.24–8.71 quantifying reinsured’s liability under direct policy, 6.03–6.21 relationship with claims provisions, 7.83–7.98 scope, 7.01–7.07 unidentified claims, 7.236 US, in, 6.104–6.189 variations in wording, 8.01–8.23 ‘further insurance’ view, 2.68–2.70 generally, 1.08–1.09 incorporation See also Incorporation development of theory, 3.04–3.17 function of ‘as original’, 3.01–3.03 scope, 3.18–3.59 specific issues, 4.01–4.44 US, in, 5.01–5.43

276

INDEX

Facultative reinsurance—cont. insurable interest, 2.53–2.64 ‘liability’ view, 2.71–2.81 nature introduction, 2.01–2.02 principle of back-to-back cover, 2.82–2.131 subject matter, 2.03–2.82 obligatory treaty reinsurance, 1.15 principle of back-to-back cover applicable law, 2.105–2.131 concurrency between policies in US, 2.102–2.104 rebutting the presumption, 2.95–2.101 scope, 2.82–2.94 privity of contract generally, 2.04–2.07 US, in, 2.08–2.44 subject matter insured applicable principles, 2.04–2.67 co-insurance, 2.65–2.67 cut-through exception, 2.45–2.52 double insurance, 2.65–2.67 ‘further insurance’ view, 2.68–2.70 insurable interest, 2.53–2.64 introduction, 2.03 ‘liability’ view, 2.71–2.81 privity of contract, 2.04–2.44 US, in, 1.20 wording, 1.25–1.27 ‘Follow the form’ clauses arbitration clauses, 5.19–5.25 assignment of original policy, 5.27–5.32 choice of law clauses, 5.26 concurrency between reinsurance and original insurance, 5.04–5.17 endorsement of original policy, 5.33–5.36 generally, 5.02–5.03 incorporation, and arbitration clauses, 5.19–5.25 choice of law clauses, 5.26 introduction, 5.18 introduction, 5.01 modification of original policy, 5.33–5.36 overriding effect, 5.37–5.43 ‘Follow the fortunes’ clauses allocation of loss annualisation, 7.180–7.199 distinguishing settlement from allocation, 7.135–7.179 inconsistency between pre-settlement and post-settlement allocations, 7.113–7.134 introduction, 7.112 reinsurers’ reservation, 7.200–7.203 summary, 7.204 bad faith, 6.142–6.146 claim beyond reinsurance policy cover generally, 6.177–6.178 losses falling beyond reinsurance policy limits, 6.182–6.189 unreinsured losses, 6.179–6.180 claim clearly outside scope of original insurance, 6.155–6.176 declaratory judgment costs, 7.81–7.82

‘Follow the fortunes’ clauses—cont. defence costs agreed by reinsured to be paid beyond original insurance policy limits, 7.63–7.80 costs-exclusive, 7.18–7.40 costs-inclusive, 7.18–7.40 costs-supplemental policies, 7.18–7.40 interpretation of original policy binding on reinsurer, 7.41–7.45 Wellington Agreement, 7.46–7.62 defences for reinsurers claim beyond reinsurance policy cover, 6.177–6.189 claim clearly outside scope of original insurance, 6.155–6.176 distinguishing from ‘follow the settlements’ clauses, 6.106–6.113 exceptions bad faith, 6.142–6.146 claim beyond reinsurance policy cover, 6.177– 6.189 claim clearly outside scope of original insurance, 6.155–6.176 defences for reinsurers, 6.155–6.189 fraud, 6.142–6.146 losses falling beyond reinsurance policy limits, 6.182–6.189 unreinsured losses, 6.179–6.180 validity of original insurance policy, 6.147–6.154 extra-contractual liability, 7.213–7.231 fraud, 6.142–6.146 functions, 6.131–6.141 future claims, 7.236 generally, 6.104–6.105 implication, 6.114–6.130 introduction, 6.01–6.03 losses falling beyond reinsurance policy limits, 6.182–6.189 reinsureds’ declaratory judgment costs, 7.81–7.82 relationship with claims provisions, 7.95–7.98 scope defence costs, 7.18–7.80 generally, 7.08–7.17 reinsureds’ declaratory judgment costs, 7.81–7.82 unidentified claims, 7.236 unreinsured losses, 6.179–6.180 validity of original insurance policy, 6.147–6.154 Wellington Agreement, 7.46–7.62 ‘Follow the leader’ ‘follow the settlements’ clauses, and, 6.86–6.89 ‘Follow the settlements’ clauses allocation of loss, 7.99–7.111 arbitration awards, 6.17–6.18 ‘as far as applicable hereto’, 8.64–8.71 ascertainment of liability in settlements, 6.65–6.69 bona fide settling claim, 6.60–6.61 burden of proof ascertainment of liability in settlements, 6.65–6.69 fraud of assured, 6.70–6.71 generally, 6.62–6.64 stop-loss policies, 6.72–6.77 businesslike manner in settling claim, 6.60–6.61 claims provisions, and, 7.83–7.98, 9.171–9.178 commutations, 7.232–7.235

277

INDEX

‘Follow the settlements’ clauses—cont. construction burden of proof, 6.62–6.77 leading underwriter clauses, 6.86–6.89 necessity of payment to trigger reinsurer’s liability, 6.81–6.85 re-opening a settlement, 6.90–6.103 Scor case, 6.32–6.61 when reinsurer’s liability arises, 6.78–6.80 distinguishing from ‘follow the fortunes’ clauses, 6.106–6.113 early formulation, 6.22–6.31 establishing reinsured’s liability under direct policy arbitration awards, 6.17–6.18 generally, 6.03–6.05 judgment, 6.06–6.16 settlements, 6.19–6.21 extension of cover ‘liable or not liable’, 8.05–8.09 ‘without question’, 8.02–8.04 extra-contractual liability, 7.208–7.212 ‘follow the leader’, and, 6.86–6.89 fraud of assured, 6.70–6.71 future claims, 7.236 interest, 7.205–7.207 introduction, 6.01–6.03 judgments, 6.06–6.16 leading underwriter clauses, 6.86–6.89 ‘liable or not liable’, 8.05–8.09 nature of facultative reinsurance, and, 2.02 ‘pay as may be paid thereon’, 6.22–6.31 qualifications in wording ‘as far as applicable hereto’, 8.64–8.71 ‘within the terms of original insurance’, 8.24–8.63 quantifying reinsured’s liability under direct policy arbitration awards, 6.17–6.18 generally, 6.03–6.05 judgment, 6.06–6.16 settlements, 6.19–6.21 reinsurer’s liability necessity of payment to trigger, 6.81–6.85 when arises, 6.78–6.80 relationship with claims provisions, 7.83–7.98 re-opening a settlement, 6.90–6.103 scope implied term argument, 7.03–7.07 introduction, 7.01 partnership argument, 7.03–7.07 ‘sue and labour’ clauses, 7.02 Scor case acting in bona fide and businesslike manner in settling claim, 6.60–6.61 first limb, 6.38–6.59 generally, 6.32–6.37 scope of reinsurance agreement, 6.38–6.59 second limb, 6.60–6.61 settlements, 6.19–6.21 stop-loss policies, 6.72–6.77 ‘sue and labour’ clauses, 7.02 ‘to pay as may be paid thereon’, 6.22–6.31 unidentified claims, 7.236 US, in See also Follow the fortunes clauses allocation of loss, 7.112–7.204

‘Follow the settlements’ clauses—cont. US, in—cont. distinguishing follow the fortunes, 6.106–6.113 exceptions, 6.142–6.189 extra-contractual liability, 7.213–7.231 functions, 6.131–6.141 generally, 6.104–6.105 implication, 6.114–6.130 introduction, 6.01–6.03 relationship with claims provisions, 7.95–7.98 scope, 7.08–7.82 variations in wording extension of cover, 8.01–8.09 limitation of cover, 8.10–8.23 ‘within the terms of original insurance’, 8.24–8.63 ‘without prejudice’ settlements, 8.10–8.23 ‘without question’, 8.02–8.04 wording of reinsurance contracts, and, 1.25 Fraud ‘follow the fortunes’ clauses, and, 6.142–6.146 ‘follow the settlements’ clauses, and, 6.70–6.71 ‘Full reinsurance clause’ generally, 1.25–1.27 ‘Further insurance’ view subject matter of facultative reinsurance, and, 2.68–2.70 Future claims ‘settlements’ clauses, and, 7.236 Identical cover principle applicable law, 2.105–2.131 concurrency between policies in US, 2.102–2.104 forms of reinsurance contracts, and, 1.09 incorporation, and, 4.33–4.41 rebutting the presumption, 2.95–2.101 scope generally, 2.82 Groupama Navigation v Catatumbo Seguros, 2.93–2.94 Vesta v Butcher, 2.83–2.92 Wasa v Lexington decisions, 2.111–2.122 facts, 2.106–2.110 implications, 2.123–2.131 introduction, 2.105 wording of reinsurance contracts, and, 1.25 Implied terms incorporation, and, 3.42 Inconsistent terms construction, 3.25 insurance – reinsurance contracts, 3.26–3.34 Incorporation alterations to original policy continuing duty of utmost good faith, and, 4.15–4.25 generally, 4.05–4.14 arbitration clauses, of charterparty into bills of lading, from, 3.43 direct insurance into reinsurance contracts, from, 3.44–3.54 s 6(2) Arbitration Act 1996, and, 3.55 assured’s obligations under direct policy, 4.29–4.31 back-to-back cover, and, 4.33–4.41 choice of law clauses, of, 3.56–3.59

278

INDEX

Incorporation—cont. claims clauses, of, 3.35–3.41 development of theory, 3.04–3.17 facultative non-proportional reinsurance, in, 4.42–4.44 follow the form clauses, and arbitration clauses, 5.19–5.25 choice of law clauses, 5.26 introduction, 5.18 function of ‘as original’, 3.01–3.03 implied terms, of, 3.42 inconsistent terms, of construction, 3.25 insurance – reinsurance contracts, 3.26–3.34 jurisdiction clauses, of, 3.56–3.59 leading underwriter clause in original policy, 4.26–4.28 obligations of assured under direct policy, 4.29–4.31 other forms of wording, 4.32 presumption of back-to-back cover, and, 4.33–4.41 requirements HIH v New Hampshire, 3.10–3.17 introduction, 3.09 scope arbitration clauses, 3.43–3.55 choice of law clauses, 3.56–3.59 claims clauses, 3.35–3.41 implied terms, 3.42 inconsistent terms, 3.25–3.34 introduction, 3.18 jurisdiction clauses, 3.56–3.59 unusual terms, 3.20–3.24 specific issues alterations to original policy, 4.05–4.25 back-to-back cover, 4.33–4.41 facultative non-proportional reinsurance, 4.42–4.44 leading underwriter clause, 4.26–4.28 obligations of assured, 4.29–4.31 other forms of wording, 4.32 waiver of defences clause, 4.01–4.04 unusual terms, of, 3.20–3.24 US, in assignment of original policy, 5.27–5.32 concurrency between reinsurance and original insurance, 5.04–5.17 endorsement of original policy, 5.33–5.36 generally, 5.02–5.03 incorporation of terms, 5.18–5.26 introduction, 5.01 modification of original policy, 5.33–5.36 overriding effect of clauses, 5.37–5.43 waiver of defences clause in original policy, 4.01–4.04 Insurable interest subject matter of facultative reinsurance, and, 2.53–2.64 Interest ‘follow the settlements’ clauses, and, 7.205–7.207 Judgments ‘follow the settlements’ clauses, and, 6.06–6.16 Jurisdiction clauses incorporation, and, 3.56–3.59

Leading underwriter clause ‘follow the settlements’ clauses, and, 6.86–6.89 incorporation, and, 4.26–4.28 ‘Liability’ view subject matter of facultative reinsurance, and, 2.71–2.81 ‘Liable or not liable’ variation of wording of ‘follow the settlements’ clauses, and, 8.05–8.09 Limitation of cover variation of wording of ‘follow the settlements’ clauses, and, 8.10–8.23 Losses falling beyond reinsurance policy limits ‘follow the fortunes’ clauses, and, 6.182–6.189 Modification of original policy ‘follow the form’ clauses, and, 5.33–5.36 Non-obligatory treaty reinsurance generally, 1.15 Non-proportional reinsurance facultative reinsurance, 1.08 generally, 1.07 incorporation, and, 4.42–4.44 treaty reinsurance, 1.10 US, in, 1.20 Obligatory treaty reinsurance generally, 1.15 ‘Pay as may be paid thereon’ ‘follow the settlements’ clauses, and, 6.22–6.31 Principle of back-to-back cover applicable law, 2.105–2.131 concurrency between policies in US, 2.102–2.104 forms of reinsurance contracts, and, 1.09 incorporation, and, 4.33–4.41 rebutting the presumption, 2.95–2.101 scope generally, 2.82 Groupama Navigation v Catatumbo Seguros, 2.93–2.94 Vesta v Butcher, 2.83–2.92 Wasa v Lexington decisions, 2.111–2.122 facts, 2.106–2.110 implications, 2.123–2.131 introduction, 2.105 wording of reinsurance contracts, and, 1.25 Privity of contract generally, 2.04–2.07 US, in general rule, 2.10 intervention in settlement process by reinsurer, 2.11–2.24 introduction, 2.08–2.09 policy wording, 2.25–2.33 reinsured’s insolvency, 2.34–2.44 reinsurers have no obligations towards assureds, 2.10 Proportional reinsurance facultative reinsurance See also Facultative reinsurance generally, 1.08–1.09

279

INDEX

Proportional reinsurance—cont. generally, 1.06 treaty reinsurance, 1.10–1.15 US, in, 1.20 wording, 1.25–1.27 Qualifications in wording ‘as far as applicable hereto’, 8.64–8.71 ‘within the terms of original insurance’, 8.24–8.63 Quota share reinsurance generally, 1.11 ‘Reinsurance’ generally, 1.01–1.03 US, in, 1.16 Reinsurance contracts aggregate excess of loss reinsurance, 1.13 classification, 1.05 definition of ‘reinsurance’ generally, 1.01–1.03 US, in, 1.16 excess of loss reinsurance, 1.13 facultative obligatory treaty reinsurance, 1.15 facultative reinsurance, 1.08–1.09 forms facultative reinsurance, 1.08–1.09 introduction, 1.04–1.05 non-proportional reinsurance, 1.07 proportional reinsurance, 1.06 treaty reinsurance, 1.10–1.15 US, in, 1.20–1.23 ‘full reinsurance clause’, 1.25–1.27 method of share of risk and premium, 1.05 nature introduction, 2.01–2.02 principle of back-to-back cover, 2.82–2.131 subject matter, 2.03–2.82 non-obligatory treaty reinsurance, 1.15 non-proportional reinsurance facultative reinsurance, 1.08 generally, 1.07 treaty reinsurance, 1.10 US, in, 1.20 obligatory treaty reinsurance, 1.15 proportional reinsurance facultative reinsurance, 1.08–1.09 generally, 1.06 treaty reinsurance, 1.10–1.15 US, in, 1.20 wording, 1.25–1.27 quota share reinsurance, 1.11 ‘reinsurance’ generally, 1.01–1.03 US, in, 1.16 stop loss reinsurance, 1.13 surplus reinsurance, 1.12 treaty reinsurance aggregate excess of loss reinsurance, 1.13 excess of loss reinsurance, 1.13 facultative obligatory, 1.15 introduction, 1.10 non-obligatory, 1.15 non-proportional reinsurance, 1.13 obligatory, 1.15

Reinsurance contracts—cont. treaty reinsurance—cont. proportional reinsurance, 1.11–1.12 quota share reinsurance, 1.11 stop loss reinsurance, 1.13 surplus reinsurance, 1.12 US, in, 1.20 wording, 1.24 US, in ‘full reinsurance clause’, and, 1.27 purpose, 1.18–1.19 ‘reinsurance’, 1.16–1.17 types, 1.20–1.23 wording proportional reinsurance, 1.25–1.27 treaty reinsurance, 1.24 Re-opening a settlement ‘follow the settlements’ clauses, and, 6.90–6.103 Settlements clauses follow the settlements clauses See also Follow the settlements clauses allocation of loss, 7.99–7.111 commutations, 7.232–7.235 construction, 6.32–6.103 early formulation, 6.22–6.31 establishing reinsured’s liability under direct policy, 6.03–6.21 extra-contractual liability, 7.208–7.212 future claims, 7.236 interest, 7.205–7.207 introduction, 6.01–6.03 qualifications in wording, 8.24–8.71 quantifying reinsured’s liability under direct policy, 6.03–6.21 relationship with claims provisions, 7.83–7.98 scope, 7.01–7.07 unidentified claims, 7.236 US, in, 6.104–6.189 variations in wording, 8.01–8.23 follow the fortunes clauses See also Follow the fortunes clauses allocation of loss, 7.112–7.204 distinguishing follow the fortunes, 6.106–6.113 exceptions, 6.142–6.189 extra-contractual liability, 7.213–7.231 functions, 6.131–6.141 future claims, 7.236 generally, 6.104–6.105 implication, 6.114–6.130 introduction, 6.01–6.03 relationship with claims provisions, 7.95–7.98 scope, 7.08–7.82 unidentified claims, 7.236 Stop-loss policies ‘follow the settlements’ clauses, and, 6.72–6.77 Stop loss reinsurance generally, 1.13 Subject matter of facultative reinsurance applicable principles, 2.04–2.67 co-insurance, 2.65–2.67 cut-through exception, 2.45–2.52 double insurance, 2.65–2.67 ‘further insurance’ view, 2.68–2.70

280

INDEX

Subject matter of facultative reinsurance—cont. insurable interest, 2.53–2.64 introduction, 2.03 ‘liability’ view, 2.71–2.81 privity of contract, 2.04–2.44 ‘Sue and labour’ clauses ‘follow the settlements’ clauses, and, 7.02 Surplus reinsurance generally, 1.12 ‘To pay as may be paid thereon’ ‘follow the settlements’ clauses, and, 6.22–6.31 Treaty reinsurance aggregate excess of loss, 1.13 excess of loss, 1.13 facultative obligatory, 1.15 introduction, 1.10 non-obligatory, 1.15 non-proportional, 1.13 obligatory, 1.15 proportional, 1.11–1.12 quota share, 1.11 stop loss, 1.13 surplus, 1.12 US, in, 1.20 wording, 1.24 Unidentified claims ‘settlements’ clauses, and, 7.236 United States claims provisions, and agency relationship, 9.163–9.165 attorney-client privilege, 9.166–9.170 implications, 9.163–9.170 nature, 9.72–9.137 time of notification, 9.18–9.40 waiver of right to rely upon breach, 9.151–9.155 definition of ‘reinsurance’, 1.16–1.17 follow the form clauses, and assignment of original policy, 5.27–5.32 concurrency between reinsurance and original insurance, 5.04–5.17 endorsement of original policy, 5.33–5.36 generally, 5.02–5.03 incorporation of terms, 5.18–5.26 introduction, 5.01 modification of original policy, 5.33–5.36 overriding effect, 5.37–5.43 follow the fortunes clauses See also Follow the fortunes clauses allocation of loss, 7.112–7.204 distinguishing follow the fortunes, 6.106–6.113

United States—cont. follow the fortunes clauses—cont. exceptions, 6.142–6.189 extra-contractual liability, 7.213–7.231 functions, 6.131–6.141 future claims, 7.236 generally, 6.104–6.105 implication, 6.114–6.130 introduction, 6.01–6.03 relationship with claims provisions, 7.95–7.98 scope, 7.08–7.82 unidentified claims, 7.236 ‘full reinsurance clause’, and, 1.27 privity of contract, and general rule, 2.10 intervention in settlement process by reinsurer, 2.11–2.24 introduction, 2.08–2.09 policy wording, 2.25–2.33 reinsured’s insolvency, 2.34–2.44 reinsurers have no obligations towards assureds, 2.10 purpose of reinsurance, 1.18–1.19 ‘reinsurance’, 1.16–1.17 types of reinsurance, 1.20–1.23 Unreinsured losses ‘follow the fortunes’ clauses, and, 6.179–6.180 Unusual terms incorporation, and, 3.20–3.24 Validity of original insurance policy ‘follow the fortunes’ clauses, and, 6.147–6.154 Variations in wording extension of cover ‘liable or not liable’, 8.05–8.09 ‘without question’, 8.02–8.04 limitation of cover, 8.10–8.23 Waiver of defences clause incorporation, and, 4.01–4.04 qualifications in wording ‘Within the terms of original insurance’ qualifications in wording of ‘follow the settlements’ clauses, and, 8.24–8.63 ‘Without question’ variation of wording of ‘follow the settlements’ clauses, and, 8.02–8.04 ‘Without prejudice’ settlements variation of wording of ‘follow the settlements’ clauses, and, 8.10–8.23

281