K&LNGAlert FEBRUARY 2006 Insurance Coverage Sovereign Marine and WFUM Announce Plan to Propose Bar Date Via Combined Insolvent and Solvent Scheme of Arrangement By Gregory S. Wright 1 INTRODUCTION In May 2005, certain policyholders successfully blocked the attempt of a solvent London insurer (British Aviation Insurance Company) to adopt a so-called Solvent Scheme of Arrangement, which included a bar date for all claims against the insurer. In the wake of the High Court s Order rejecting British Aviation s proposed Solvent Scheme (which British Aviation elected not to appeal), several other solvent London insurers withdrew proposed Schemes or placed their plans on hold. 2 Certain solvent insurers, however, have persisted in their efforts to wind up their affairs via Solvent Schemes. 3 The next major battle concerning Solvent Schemes may relate to an unprecedented Scheme that (if approved) would govern claims against both insolvent and solvent insurers. Specifically, in a letter to creditors dated January 20, 2006 ( January 2006 Letter ), PRO Insurance Solutions ( PRO ) elaborated on its plans to propose a Scheme that would govern claims against (1) Sovereign Marine & General Insurance Company Limited ( Sovereign ), which is an insolvent London insurer, and (2) a group of sixteen solvent London insurers that participated in the so-called WFUM pool ( WFUM Insurers ) ( Sovereign/WFUM Scheme or Scheme ). PRO intends to seek approval of the Scheme at a Creditor s Meeting, which it anticipates will be held in May 2006. If approved, the Scheme would establish a bar date in late 2006 for all claims, including contingent and IBNR claims. Policyholders would lose the ability to seek coverage for claims that arose after the bar date. Given the potential controversy related to this proposed Scheme, policyholders should take steps now to evaluate and protect their interests. Initially, policyholders should determine the participation of Sovereign and the WFUM Insurers in their London programs. As discussed below, given the nature of the WFUM pool, this initial step will be more complex and will require more time than is typically required. To the extent there is material participation, policyholders should evaluate whether they wish to support the Scheme, oppose the Scheme, or propose changes to key terms in the Scheme. Regardless of their position on the Scheme, policyholders also should file claim information at the earliest possible time, rather than waiting for the bar date, to maximize their ability to influence whether the Scheme is approved and to take full advantage of certain settlement opportunities. 1 Gregory S. Wright is a partner in the Washington, D.C. office of the law firm of Kirkpatrick & Lockhart Nicholson Graham LLP ( K&LNG ), where he regularly advises policyholders with respect to a wide variety of insurance coverage claims, including claims against insolvent London insurers. The views expressed in this article are not necessarily those of K&LNG or of its clients. This article is for informational purposes only and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting with a lawyer. 2 For example, Gordian Run-Off Ltd., Lion City, and Scottish Lion have withdrawn proposed Solvent Schemes or indefinitely delayed proposing such Schemes. 3 For example, the Dutch Aviation Pool and Scottish Eagle have proceeded with Solvent Schemes. Additional solvent London insurers have announced their intention to seek approval of Solvent Schemes in 2006 (e.g., NRG and European Reinsurance Company of Zurich). Kirkpatrick & Lockhart Nicholson Graham LLP
THE PROPOSED SCHEME In its January 2006 Letter, PRO the WFUM pool run-off manager and proposed Scheme Manager discusses the proposed Sovereign/WFUM Scheme. Sovereign is an insolvent insurer that has been operating under a so-called reserving Scheme of Arrangement for many years. The proposal at issue would convert Sovereign s existing Scheme to a socalled closing Scheme, which imposes a bar date and requires the Scheme Administrator to estimate the value of contingent and IBNR claims. In recent years, several other insolvent London insurers (e.g., KWELM, Andrew Weir, etc.) have secured creditor approval to amend their Schemes to impose bar dates, in lieu of continuing in liquidation for decades. The proposed Sovereign/WFUM Scheme, however, seeks not only to convert the existing Sovereign Scheme, but also to add the solvent WFUM insurers. 4 This attempt to combine solvent and insolvent insurers in one Scheme is unprecedented. PRO has argued that the collective scheme is justified because Sovereign and the WFUM Insurers share common reinsurance claims. Specifically, PRO has stated that given the fragmentation of the WFUM pool which would occur if Sovereign and its solvent subsidiaries were to close in isolation, and the associated complexity for policyholders, one of the aims of the Pool Scheme is to enable the closure of the pool business to be carried out for the Scheme Companies and their policyholders in a unified and efficient manner. 5 Procedurally, Sovereign and the WFUM Insurers are seeking to schedule a hearing with the High Court of Justice in London to seek permission to propose the Scheme to their creditors. The hearing will be held no earlier than 21 February 2006. 6 According to PRO, as of February 10, 2006, the court hearing has not been scheduled. Assuming the High Court grants permission, PRO intends to schedule the Creditors Meeting to vote on the proposed Sovereign/WFUM Scheme in May 2006. Given that the proposed Scheme relates to a pool of insurers, it raises various logistical issues. To illustrate, PRO s January 2006 Letter identifies sixteen (16) Scheme Companies, but states that the above are the current names of the WFUM pool participants and as such are not necessarily the names that were in existence at the time that the business was written. PRO s January 2006 Letter then refers creditors to the WFUM web site (www.wfumpools.com), which identifies dozens of additional insurers (e.g., former names or predecessor companies) that are potentially impacted by the Scheme. To complicate matters, though, the Scheme appears to impact the identified insurers only to the extent that they participated in one of the hundreds of stamps identified in a 120-page PDF.file linked to the web site. Given the complex nature of the pool, policyholders should allow for sufficient time to determine the relevant participation of the Scheme Companies. As a starting point, policyholders should request from PRO their unique login identification and password, which will permit policyholders or their counsel to access a web site containing participation information prepared by PRO. In many cases in the past, however, participation information posted by insurers on web sites has been inaccurate or incomplete. As such, policyholders should also review their own policies to confirm the relevant participation. ISSUES RELATED TO SOLVENT SCHEMES As noted above, Solvent Schemes have generated considerable controversy in the policyholder community in recent years. Since the early 1990s, insolvent London insurers routinely have adopted Schemes as an alternative to statutory liquidations. 7 In the past few years, numerous solvent London insurers in run-off (generally, solvent insurers that no longer issue new policies) also have proposed or announced their intention to propose Solvent Schemes that impose bar dates. Although solvent London insurers by definition are in a position to pay claims on a going-forward basis, insurers frequently have touted various perceived advantages of such Schemes. For example, insurers have asserted that policyholders may benefit by obtaining early payments for estimated claims, rather than waiting years for the claims to mature. 4 Technically, the Pool Scheme consists of a separate scheme of arrangement for each of the Scheme Companies, although the terms of the Pool Scheme are the same for each Scheme Company [with certain exceptions]. See PRO s January 2006 Letter, at 3. 5 Id. at 2. 6 Id. at 2. 7 A Scheme of Arrangement is basically a binding contract among the insurer and all of its creditors that dictates how claims are handled and paid. Schemes generally must be approved by a super-majority of the insurer s creditors and then sanctioned by an English court. 2
While Solvent Schemes may benefit certain policyholders (particularly those that are in a position to support contingent claims with actuarial data), their impact on other policyholders remains unclear. For example, under a Solvent Scheme, policyholders would not be able to file claims after the bar date, even if they were unaware of the claims before the bar date. Additionally, it is unclear how Scheme Administrators will value IBNR claims, particularly for policyholders that may have just recently become involved in lawsuits related to asbestos or other longtail liabilities. The uncertainty extends to whether the Solvent Scheme s actuaries will limit their analysis to projections based on existing claims data or whether they will consider other factors. It is also unclear whether Scheme Administrators will handle claims fairly, given that policyholders arguably lose the threat of suing the insurer if a settlement is not reached or the insurer acts in bad faith. Lastly, it is unclear whether Scheme Adjudicators will handle disputes fairly. In any event, after English courts approved several Solvent Schemes (e.g., Ludgate Insurance Company and Sphere Drake Insurance Company), certain policyholders became skeptical and started to oppose Solvent Schemes. Specifically, in May 2005, in response to objections filed by a group of policyholders based in the United States, the English High Court of Justice rejected a Solvent Scheme proposed by British Aviation. 8 In sum, the Court denied British Aviation s application on the grounds that it did not have jurisdiction to hear the petition because British Aviation had failed to identify and secure the approval of all classes of creditors in a correct manner. Specifically, the Court held that policyholders with accrued claims and policyholders with IBNR claims should have been treated as separate classes, reasoning as follows: Unlike the policyholder with an accrued claim, who knows the extent of his exposure to that claim, the policyholder with an IBNR claim does not. The essence of the scheme is that it retransfers the risk from the insurer (who had contracted to bear it) to the policyholder (who did not). Thus the rights of a policyholder with an IBNR claim are fundamentally different under the scheme from the rights that he would have in the absence of the scheme. 9 Given these conflicts among the creditors, the Court held that the single scheme meeting was not properly constituted. It follows, therefore, that I must hold that I have no jurisdiction to sanction the scheme. 10 Although the Court based its decision on jurisdictional grounds, the Court in dicta also expressed reservations about the overall fairness of the proposed Scheme and the conduct of the Creditors meeting, including reservations whether votes were properly considered at the Creditors meeting and whether the Estimation Methodology in the Scheme provided a clear basis for treating all Creditors alike. 11 For example, certain policyholders had objected on the grounds that British Aviation had greatly discounted the IBNR claims of certain policyholders that voted against the Scheme, while recognizing multimillion dollar IBNR claims of policyholders that voted in favor of the Scheme. 12 While not reaching any definitive conclusions, the Court stated that I have a very uneasy feeling that these IBNR claims were simply brushed aside The real problem is that the votes of the policyholders with IBNR claims have to be estimated using sophisticated and controversial actuarial techniques. In such a case it seems to me that the court must be especially wary of simply waving through a vote in which so many of the dissentients have had a nominal value placed on their claims. 13 In conclusion, the Court stated that the most powerful consideration was that it is unfair to require the manufacturers who have bought insurance policies designed to cast the risk of 8 In re British Aviation Insurance Company Ltd., No. 165 of 2005, English High Court of Justice, Chanc. Div. (July 21, 2005) ( Order ). 9 Id. at 83. 10 Id. at 97. 11 Id. at 142. 12 Id. at 103 and 104. 13 Id. at 109-110. 3
exposure to asbestos claims on insurers to have that risk compulsorily retransferred to them. [British Aviation] is in the risk business; [the policyholders] are not. 14 The proposed Sovereign/WFUM Scheme appears to raise many of the same issues addressed by the British Aviation Order. It should be noted that PRO s January 2006 Letter recognizes that if the rights of creditors are so different or would be affected so differently by a scheme of arrangement as to make it impossible for them to consult together in their common interest, they must be divided into classes and vote at separate class meetings. 15 PRO, however, intends to propose calling a single class meeting of Scheme Creditors [for each Scheme Company] for the purpose of considering and, if thought appropriate, approving the Past Scheme for that Scheme Company. 16 Notwithstanding the reasons articulated in the British Aviation Order why creditors with IBNR claims should be treated as a separate class, PRO states that the Scheme Companies are of the view that there is no sound basis for concluding that [all Scheme Creditors] cannot consult together. 17 Thus, it appears that PRO intends to challenge directly the reasoning of the British Aviation Order. CONCLUSION Given the likely controversy surrounding the Scheme, policyholders should take steps now to protect their rights with respect to the proposed Sovereign/WFUM Scheme. Gregory S. Wright gwright@klng.com 202.778.9250 14 Id. at 143. 15 See PRO s January 2006 Letter, at 3. 16 Id. at 4. 17 Id. at 4. 4
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