The “old days” of London Market contracts based on a “gentleman’s agreement” no longer exist - and in a commercial world, parties should express the nature of their obligations to each other in the contract document, claim Anthony Lennox and Kelly Evans of Berwin Leighton Paisner LLP.

Anecdotally, there was a time when parties to London Market reinsurance contracts operated in a “gentlemanly” fashion and in accordance with the “intention” of a contract rather than applying a literal interpretation of the words of the contract for their own advantage. Allegedly, in such halcyon days, the reinsured could rely upon its reinsurer to meet all claims or settlements which fell within the spirit of the reinsurance treaty.

This may be a state of affairs which never existed or is one which is recalled with the benefit of hindsight seen through rosetinted spectacles. However, if the anecdote is to be believed, then a great deal has changed in the London Market. Insurers argue, with some justification, that they are caught between a rock and a hard place, with pressures to settle inwards claims and reinsurers who will not pay unless the claim falls squarely within the outwards treaty. It may be said that such arguments were once raised only by those who did not have ongoing commercial relationships (for example those in run-off), but that is no longer the case and many reinsurers in the “live” market will raise such issues.

On the other hand, the reinsurers, quite correctly, say that their relationship is a contractual one governed by the words of the contract that the parties chose to enter.

Heads they win…

On one side of the coin, insurers are under increasing pressure to resolve inwards liabilities prior to a legal determination and may, in any event, want to do so for their own and their reinsurers’ benefit. In the case of a London Market insurer providing cover for US risks, the insurer may find itself on the wrong end of litigation in a State with a reputation for making large punitive damages awards against insurers. In such circumstances, it is often the case that the insurer will be advised to settle or risk the prospect of an adverse finding with a substantial punitive award.

…Tails you lose

Under English law, there are significant disincentives for an insurer in settling such claims because of difficulties it may face in collecting from its reinsurers. Each situation will depend upon the basis of settlement as applied to the reinsurance contract. However, there has been a line of English cases which suggest that, under many forms of reinsurance contract, unless there is a finding of liability against the insurer, the insurer will not be able to recover from its reinsurers.

In 1998 there was the oft-quoted Court of Appeal decision in Commercial Union Assurance –v- NRG Victory Reinsurance. This case arose out of the grounding of the Exxon Valdez in 1989. Insurers settled proceedings following advice from Texas lawyers which predicted that insurers would lose if the case proceeded to trial, on the basis that Texas juries “were often unfavourable to insurers and biased against them”. Insurers then claimed from their reinsurers. The reinsurance policies did not contain effective “follow settlement” wording and insurers were, therefore, required to prove that they were liable under the insurance policy.

The Court of Appeal held that if a foreign Court decides against insurers on liability, then that decision is binding on an English Court in determining reinsurers’ liability provided that certain criteria are complied with (for example, that the Court is of competent jurisdiction). However, there had been no ruling. An advice that there was a likelihood of an adverse jury verdict award was not sufficient. The Court of Appeal considered that, on the evidence provided, reinsurers did have an arguable defence at law that they were not liable to insurers (and in King –v- Brandywine, the Court of Appeal upheld reinsurers’ position on the facts of the case).

This was followed in 2004 by the controversial decision in Lumbermans Mutual Casualty Co –v- Bovis Lend Lease. This is a construction case, but has an impact on reinsurance settlements. It concerned a settlement that involved both the insured’s claim and a counterclaim against the insured. The settlement figure was not apportioned between claim and counterclaim. The insured sought to recover the estimated value of the counterclaim from insurers. Insurers refused to pay. The Court held that insurers were not liable as the settlement agreement had failed to identify the cost of discharging liability for the counterclaim and that extrinsic evidence could not be used to ascertain that loss.

The case of Enterprise Oil Limited -v -Strand Insurance Company (this year) has cast some doubt on Lumbermans. It concerned a settlement agreement reached, following two awards against the insured, one in English Court proceedings and one by a mock Texas jury. The Court held that the insured could only recover from insurers if it could demonstrate that it would have actually been liable as opposed to arguably liable in the Texas proceedings. The Court held that where a foreign Court had not determined liability, it was up to the English Court to decide the issue in accordance with the relevant laws, not by determining the likely outcome before a particular jury. On the facts, the Court held the insured would not have been liable in the Texas proceedings, but also considered, hypothetically, what the situation would be, had the Court decided there was liability under Texas law. It held that a settlement agreement that did not specifically allocate liability to particular aspects of a claim did not stop an insured from claiming under its liability policy. The Court held, contrary to Lumbermans, that it was open to the insured to provide extrinsic evidence to prove liability. The Court stated that the decision in Lumbermans would lead to “…great commercial inconvenience and to artificial statements in judgments, awards and settlement agreements”. However, this case has not overruled Lumbermans.

Faraday Capital Ltd -v -Copenhagen Reinsurance Co Ltd was decided in early May this year. Here a reinsurance contract contained a follow the settlements clause which excluded “without prejudice and ex gratia” settlements. Claims made under an insurance policy were settled by way of an agreement, which was expressed to be “without prejudice to or waiver of” the parties’ positions. Following settlement, the reinsured sought to recover from its reinsurers. Reinsurers argued that the settlement fell outside the follow settlements clause.

The reinsured argued that the agreement was not without prejudice, as it was full and final and could not be re-opened. Alternatively, the reinsured argued that it had settled in the belief it was liable. The Court held that the settlement agreement was a “without prejudice” agreement for the purposes of the follow the settlements clause and it was not appropriate to look behind the terms of the agreement. The Court also stated that it is for the parties to agree (in the contract) what needs to be proved in order to establish that the reinsurer must pay.

Therefore, in many cases, there is scope for a reinsurer to argue that it is not liable to meet claims on it, where the underlying (potential) liability has been settled. Much will, however, depend upon the form of the settlement and the outwards wording.

Solutions?

The result of these cases could be that insurers would never settle for fear of not being able to recover, preferring instead to fight and run the risk of greater liability. For the London Market as a whole, that cannot make commercial sense and there is force in the comment that the law is at odds with what is best for the market.

Importantly, in both Lumbermans and Faraday, it appears likely that the result may have been different had settlement been different. If, for example, in Faraday, the settlement had not been entered on a without prejudice basis, then presumably the finding may have been different. The first consideration, therefore, for an insurer when settling with its insured is to take care as to the terms of the settlement and to the basis of settlement.

It is also often said that an insurer should seek the consent of its reinsurer before entering into any settlement. That has many difficulties in practice, because, invariably, the reinsurer will answer that the reinsured should act as a prudent unreinsured. Further, it adds delay to the process.

Also, the reinsurer should be able to rely upon the contract wording which is, after all, the basis of the bargain between insurer and it. The “old days” no longer exist and in a commercial world, the parties should express the nature of their obligations to each other in the contract document. If the parties want to restrict or broaden the ability of a reinsured to collect settlements from its reinsurer, then that should be included in the contract. That, of course, is of limited comfort to those dealing with claims on contracts which already exist.

This Special item appeared in issue 106 of JTW News - June 2006

Author: Anthony Lennox | Kelly Evans - Berwin Leighton Paisner LLP.