Two cases: avoidance and cooperation

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1 JULY 2004 INSURANCE AND REINSURANCE Inside: We discuss recent United Kingdom reinsurance decisions Two cases: avoidance and cooperation Partner John Edmond, Lawyer Matthew Ireland and Law Graduate Brigg Baxter examine two UK reinsurance decisions handed down over the past 12 months. The fi rst case deals with reinsurers seeking to avoid reinsurance contracts on the grounds of nondisclosure and the second looks at the construction of a claims co-operation clause. Case 1 Your publication: If you would prefer to receive our publications in electronic format, please publications@aar.com.au VISIT OUR WEB SITE TO READ ALL FOCUS EDITIONS Brotherton & 4 Ors v Aseguradora Colseguros SA & Anor [2003] EWHC 1741 Facts The plaintiffs in this case were a group of reinsurers seeking a declaration that they had validly avoided reinsurance contracts in favour of the defendant reinsureds, who were the insurers of Caja de Credito Agraria Industrial y Minero, a state-owned bank in Colombia (Caja). The reinsurance contracts were Bankers Blanket Bond and Professional Indemnity reinsurance covers, covering risks of losses incurred by Caja due to robberies of rural branches and certain losses caused by employee fraud. In the year leading up to the placement of the reinsurance contracts in the London market through English placing brokers, there had been several news reports in Colombia covering allegations of misconduct and related investigations involving Caja s president, Señor Benjamin Medina and his running of the Caja business. Three weeks prior to the placement, Caja suspended Señor Medina for misconduct and, shortly after the placement, he was arrested. Approximately nine months before the reinsurance contracts were extended at the end of their fi rst year, there were further news reports of the investigations centred around Señor Medina and Caja, including news reports relating to Señor Medina s arrest and the arrest of other Caja employees. 1

2 JULY 2004 During Señor Medina s suspension, but prior to his arrest, offi cers from the reinsureds and Caja attended a pre-placement meeting in London with the lead reinsurer s underwriter, Mr Satterford. When Mr Satterford enquired about Señor Medina s absence, he was told that Señor Medina was in Colombia attending to Caja s affairs. Claims The reinsurers claimed that they were entitled to avoid the reinsurance contracts and the extensions on the basis that the reinsureds knew or ought to have known of the news reports and the investigations to which they related, and that they were material to be disclosed: as circumstances likely to give rise to claims under the reinsurance contracts; or as suggesting moral hazard. Further, the lead reinsurer claimed that it was entitled to avoid its reinsurance contract on the basis of the misrepresentation made to Mr Satterford regarding Señor Medina s absence from the pre-placement meeting. The issues to be considered in determining whether the non-disclosure/misrepresentation entitled the reinsurers to avoid the reinsurance contracts can be summarised as: whether the non-disclosure/misrepresentation was material; and whether it induced the reinsurer to accept the risk. Defences Each of the reinsurance contracts contained a standard notifi cation of circumstances clause (which the judge referred to as a standard discovery limitation clause) stating that: There shall be no liability in respect of any claim:... b. arising out of or in connection with any circumstances or occurrences known to the insured prior to the inception hereof and that have not been informed to insurers at time of inception. The reinsureds argued that this clause did not permit reinsurers to avoid the policy for failure to disclose information material to a claim arising out of circumstances known to the reinsureds prior to inception of the reinsurance contract; rather it only permitted reinsurers to deny indemnity for any claim arising from those circumstances not disclosed. The non-disclosure or misrepresentation must be an effective cause of the reinsurer accepting the risk but need not be the sole cause. The reinsureds also claimed that they were not obliged to disclose their knowledge of the news reports because section 18(3) of the Marine Insurance Act 1906 (UK) applied. Section 18(3) states that, in the absence of inquiry, any circumstance that is known or presumed to be known to an insurer need not be disclosed. The section goes on to state that insurers are deemed to know matters of common notoriety or knowledge and matters that an insurer in the ordinary course of business, as such, ought to know. Materiality The judge found that allegations made in news reports, both prior to the placement and to the extension, were material in that they were matters that would or might affect the mind of an underwriter. His Honour dismissed the reinsureds claims that the news reports were idle rumours or gossip on the basis that they were stories of specifi c allegations made against identifi ed persons, giving reasons for the allegations and mentioning the involvement of the authorities. Section 18(3)(b) Marine Insurance Act 1906 (UK) The reinsureds claims that non-disclosure of the news reports and the misrepresentation to Mr Satterford were excused by s18(3) were dismissed, as the judge found that Mr Satterford s inquiry as to Señor Medina s whereabouts at the pre-placement meeting was suffi cient inquiry to displace the operation of that section in this case. Deemed knowledge Further, his Honour found that, in any event, Mr Satterford did not know of the news reports and the allegations contained therein and dismissed the reinsureds argument that the following facts should operate to mean that Mr Satterford was presumed to have known of them: 2

3 Mr Satterford s specialty as an underwriter of risk associated with Latin American fi nancial institutions; the fact that the reinsureds retained no part of the risk (which the reinsureds claimed meant that Mr Satterford should be treated as a direct underwriter. His Honour also dismissed this proposition); the fact that Mr Satterford had engaged the persons responsible for auditing the Caja s security systems (His Honour noted that the limitations of the auditor s brief were such that even if they had inadvertently discovered the allegations, the reinsureds would not have been relieved from their disclosure obligations in respect of them); and Mr Satterford s subscription to press material from Latin America (His Honour did note that Mr Satterford s news service had not carried any of the news reports while he had been a subscriber). The judge found that allegations made in news reports... were material in that they were matters that would or might affect the mind of an underwriter. The discovery limitation clause The judge found that this clause did not relieve the reinsureds of their disclosure obligation for the news reports. His Honour stated that the fact that a claim has been made against a reinsured, which the reinsured is confi dent can be successfully resisted because of a particular clause in the insurance policy between it and the insured, does not mean that the reinsured is thereby excused from his or her duty of disclosure to its reinsurer for that claim. Inducement In relation to inducement, his Honour noted authority stating that the non-disclosure or misrepresentation must be an effective cause of the reinsurer accepting the risk but need not be the sole cause. His Honour also noted that if, however, the reinsurer would have accepted the risk on the same terms in any event then the representation or non-disclosure will not, regardless of its materiality, be an effective inducement and the reinsurer will not be entitled to avoid the reinsurance contract. His Honour accepted that the non-disclosure/ misrepresentation had induced Mr Satterford to initially accept the risk on behalf of the lead reinsurer in that if he had known of the news reports it was unlikely that he would have done so. His Honour also found that if disclosure had been made of the post-placement news reports, Mr Satterford would not have extended the reinsurance contracts beyond their fi rst year. The following market Some of the following market had required separate presentations from offi cers of the reinsureds and Caja prior to accepting the reinsurance risk, but neither Señor Medina s suspension nor the reasons for it were disclosed at those presentations. His Honour found that this was material non-disclosure and that those reinsurers were entitled to avoid their reinsurance contracts. In relation to the following market that did not receive separate presentations, his Honour noted that Mr Satterford s position as a known and respected leader in this type of risk and his acceptance of this risk for his own syndicate were material to the decision of the following market to write the risk, and that they had done so on the basis that there had been a fair presentation to Mr Satterford. His Honour found that, in these circumstances, if a lead underwriter is entitled to avoid a reinsurance contract then the following market must be equally entitled to avoid their own. Conclusion The judge in this case took a strict view on the disclosure obligations of two reinsureds about allegations of corruption and embezzlement against the president of an insured bank. Also worth noting was the judge s fi nding that a misrepresentation made to the lead reinsurer s underwriter allowed the following market to avoid the policy as well. It can be seen from this decision that the duty rests squarely with the reinsured to disclose all facts that may be material to the reinsurer or run the risk of having the entire reinsurance contract voided rather than simply having cover denied for a claim arising out of the undisclosed facts. 3

4 Case 2 Eagle Star Insurance Company Limited v J.N. Cresswell & Others [2003] EWCA Civ 602 Facts Eagle Star (the reinsured) had issued a general liability excess of loss policy to Varian (the insured), and reinsured the policy with various underwriters (the reinsurers). The reinsurance contract was a standard Lloyd s Reinsurance Policy (standard policy) with additional clauses attached (attachment). The reinsured retained 40 per cent of claims made by the insured, with the reinsurers taking the remaining 60 per cent. A number of environmental pollution claims were made against the insured, who then invoked their insurance policy against the reinsured. Initially, the reinsured denied coverage but ended up settling the claim for US$1 million. The reinsured then sought indemnity from the reinsurers; however, the reinsurers denied coverage. Proceedings were commenced. Lord Justice Longmore also stated that it did not matter that the clause did not include the words condition precedent, as other clear words can be used (to convey that intent). Two relevant paragraphs in the attachment to the reinsurance contract were: 1. Claims Co-Operation Clause: The Company [defi ned to mean the Reinsured] agree: a. To notify all claims or occurrences likely to involve the [Reinsurers] within 7 days from the time that such claims or occurrences become known to them. b. The [Reinsurers] hereon shall control the negotiations and settlements of any claims under this Policy. In this event the [Reinsurers] hereon will not be liable to pay any claim not controlled as set out above. 2. Paragraph 5 under the heading Apportionment of Costs : 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. Also relevant to this case was that, under the standard policy, the main insuring obligation clause required the reinsurers to follow the settlements of the reinsured. Paragraph 7 of the attachment contained a clause under the heading Insolvency that, while very similar to the main insuring obligation in the standard policy, did not include any reference to follow the settlements. There were two main issues for the court to determine: Was it a condition precedent to liability on the part of the reinsurers that the reinsured comply with paragraph (b) of the Claims Co-Operation Clause? Were the reinsurers bound to comply with the follow the settlements clause regardless of whether the reinsured complies with paragraph (b) of the Claims Co-Operation Clause? First instance decision Justice Morrison held that the reinsured and the reinsurers were co-adventurers and that it was not a condition precedent to settlement that the reinsurers control and negotiate the settlement. In any event, the reinsurers were liable under the follow the settlements clause. In reinsurance contracts that include a claims co-operation clause, the reinsured must ensure that the reinsurers are properly informed of any negotiations or settlement activities of an underlying insured s claim. The appeal The Court of Appeal unanimously overturned the fi rst instance decision and held in favour of the reinsurers. The Claims Co-operation Clause was found to operate either as a condition precedent to liability or 4

5 an exclusion to liability for the reinsured s claim. Lord Justice Rix s comments are instructive: The fi rst sentence of paragraph (b) does not use the language of condition precedent. Neither does the second sentence, at any rate in the sense that there is no express reference to condition precedent in it. However it does provide that in the circumstances there contemplated the Reinsurers will not be liable to pay any claim. Those are strong words, if not the language of condition precedent, at any rate the language of exclusion. Lord Justice Longmore also stated that it did not matter that the clause did not include the words condition precedent, as other clear words can be used (to convey that intent). The English Court of Appeal held that a Claims Co-operation Clause was, in effect, a claims control clause, that amounted to a condition precedent to, or an exclusion of, the reinsurers liability. The Claims Co-operation Clause allocated a controlling role to the reinsurers over negotiation and settlement of any claims made against the reinsured, so that the failure of the reinsured to afford the reinsurers the opportunity to take control of negotiations or settlement, entitled the reinsurers to deny liability: per Lord Justice Longmore. The reinsurers were not bound to follow the reinsured s settlement. The follow the settlements clause was held not to apply. Lord Justice Chadwick acknowledged that paragraph 7, while similar to the main insuring clause in the standard policy, did not include the words follow the settlements and instead, in their place, referred to a limitation of liability and the saving words except as otherwise provided herein. Lord Justice Chadwick asserted that the attachment superseded or restricted the standard policy to the extent of any inconsistency. Lord Justice Longmore analysed the reasoning of the trial judge and rejected his view that the fi fth and seventh paragraph of the attachment only related to questions of apportionment and insolvency, asserting that these paragraphs were dealing with the settlement of claims as a whole and had a wide application requiring the reinsurers to control the negotiation and settlement process of the insured s claim. Conclusion The English Court of Appeal held that a Claims Co-operation Clause was, in effect, a claims control clause, that amounted to a condition precedent to, or an exclusion of, the reinsurers liability. The reinsurers did not have to follow the reinsured s settlement of the claim as the reinsurers had not controlled its negotiation and agreement. The Claims Co- Operation Clause took precedence over any follow the settlements clause. In this case, the court found an intention, in spite of drafting ambiguities, that reinsurers are entitled to control negotiations or settlement between the reinsured and the underlying insured. In reinsurance contracts that include a claims co-operation clause, the reinsured must ensure that the reinsurers are properly informed of any negotiations or settlement activities of an underlying insured s claim. The ambiguities in the reinsurance contract in this case demonstrate the ongoing need for careful drafting in order to ensure both clarity of terms and consistency between clauses in the reinsurance contract. 5

6 JULY 2004 For further information, please contact: Oscar Shub Partner, Sydney Ph: Oscar.Shub@aar.com.au Louise Jenkins Partner, Melbourne Ph: Louise.Jenkins@aar.com.au Andrew Buchanan Partner, Brisbane Ph: Andrew.Buchanan@aar.com.au Sydney Melbourne Brisbane Perth Port Moresby Singapore Hong Kong Jakarta Shanghai Bangkok Phnom Penh 8541 Jenny Thornton Partner, Perth Ph: Jenny.Thornton@aar.com.au Simon McConnell Partner, Hong Kong Ph: Simon.McConnell@aar.com.au Have your details changed? If your details have changed or you would like to subscribe or unsubscribe to this publication or others, please go to or contact Barbara Leis on or Barbara.Leis@aar.com.au 6