CURRENT ISSUES IN MARINE INSURANCE
AND REINSURANCE LAW
YEDITEPE UNIVERSITY
22-23 February 2005
Professor Rob Merkin
Southampton University; Barlow Lyde & Gilbert
A: THE ASSURED’S DUTY OF UTMOST GOOD FAITH
The pre-contractual duty
The most significant development here is the “rise of inducement”.
The basic rule that the assured must avoid material false statements and disclose material facts is
contained in sections 18 and 20 of the Marine Insurance Act 1906. A fact is material if it “would
influence the judgment of a prudent insurer” in calculating the premium or in his decision to accept or
reject the risk. In Pan Atlantic Insurance v Pine Top Insurance [1994] 3 All ER 581 the House of
Lords held that the test of materiality is a generous, one, namely, whether a fact would be of interest to
a prudent underwriter and not whether it would have had any form of influence on his decision.
The key element in Pan Atlantic was the superimposition onto the statutory materiality test of a
secondary test, that the actual underwriter must have been induced to enter into the contract. Lord
Mustill, vigorously opposed by Lord Lloyd, held that there was a “presumption of inducement”, so that
proof of objective materiality raises a presumption that the actual underwriter was induced. After initial
acceptance of Lord Mustill’s approach, it is now clear that it is the exception rather than the rule. The
position was established by the Court of Appeal in Assicurazioni Generali v Arab Insurance Group
[2003] Lloyd’s Rep IR 131. The question was whether retrocessionaires could avoid their subscription
to a retrocession agreement on the basis that there had been a misrepresentation that Munich Re would
be a party to the reinsurance: in fact, Munich Re was party to only one element of the reinsurance. The
Court of Appeal held that, even if the statement was false, there had been no inducement. For there to
be inducement, a false statement had to be an, although not necessarily the, effective cause of the
particular insurer or reinsurer entering into the contract. If it could be shown that the insurer would
have entered into the contract on the same terms in any event, the representation or non-disclosure
would not, however material, be an effective cause of the making of the contract and the insurer or
reinsurer would not be entitled to avoid the contract. The principles relating to inducement were
summarised as follows:
1. In order to be entitled to avoid a contract of insurance or reinsurance, an insurer or reinsurer
must prove on the balance of probabilities that he was induced to enter into the contract by a
material
non-disclosure
or
by
a
material
misrepresentation.
2. There is no presumption of law that an insurer or reinsurer is induced to enter in the
contract
by
a
material
non-disclosure
or
misrepresentation.
3. The facts may, however, be such that it is to be inferred that the particular insurer or
reinsurer was so induced even in the absence from evidence from him.
4. In order to prove inducement the insurer or reinsurer must show that the non-disclosure or
misrepresentation was an effective cause of his entering into the contract on the terms on
which he did. He must therefore show at least that, but for the relevant non-disclosure or
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misrepresentation, he would not have entered into the contract on those terms. On the other
hand, he does not have to show that it was the sole effective cause of his doing so.
The effect of the cases is that the underwriter is required to show that he was induced, so that he can be
cross-examined (although not on his previous indiscretions (Marc Rich & Co AG v Portman [1996] 1
Lloyd’s Rep 430). If he can give evidence he must do so, and if he fails to do so then inducement will
not be made out. It is only when evidence cannot be given that the presumption of inducement comes
into operation, and the only situation in which it has been held to be operative is in the case of a market
subscription where one or more of the underwriters has not been available but the others have been
(see: St Paul Fire & Marine Co (UK) Ltd v McConnell Dowell Constructors Ltd [1995] 2 Lloyd's Rep
116; Toomey (of Syndicate 2021) v Banco Vitalicio de Espana SA de Seguros y Reasseguros [2004]
Lloyd’s Rep IR 354).
Inducement involves not just looking at the impact of a material fact, but also at the likely
consequences of a failure to disclose. If it can be shown that disclosure would have led to other
consequences and they would in turn have resulted in no change to the underwriters’ decision then the
fact withheld is not material. This was the crucial holding in Drake Insurance plc v Provident
Insurance plc [2004] Lloyd’s Rep IR 277 (for more detail, see below). It was there held by Rix and
Clarke LJJ (Pill LJ dissenting) that it was legitimate to consider what would have happened had there
been full disclosure. A similar issue, albeit in very different circumstances, arose in Bonner v Cox
[2004] EWHC 2963 (Comm), where it was held that reinsurers could not claim to have been induced
not to withdraw a partly-subscribed reinsurance slip as a result of the reinsureds’ brokers failure to
inform the reinsurers of a loss.
The post-contractual duty
The significant issue here has been the virtual elimination of the notion that the assured owes any postcontractual duty to the insurers to disclose material facts.
The legal basis for such a duty is section 17 of the Marine Insurance Act 1906, which is general in its
terms. The modern starting point is Black King Shipping v Massie, The Litsion Pride [1985] 1 Lloyd’s
Rep 473, where it was held that an assured who falsely stated the circumstances giving rise to a loss
was in breach of the continuing duty of good faith and the policy could be avoided ab initio. Hirst J
based his decision on a number of principles:
(a)
(b)
(c)
s 17 of the Marine Insurance Act 1906 was not confined to pre-contractual matters;
there were various cases in which the courts had, after a loss, ordered a marine
assured to provide the insurers with the ships’ papers (China Traders Insurance Co v
Royal Exchange Assurance Corpn [1898] 2 QB 187; Leon v Casey [1932] 2 KB 576)
– Hirst J classified this duty as being based on utmost good faith;
there were cases in which an assured had sought to exercise his rights under a held
covered clause, and to obtain extended coverage on offer under the contract by giving
notice to the insurers and paying any additional premium required (Overseas
Commodities v Style [1958] 1 Lloyd’s Rep 546; Liberian Insurance Agency v Mosse
[1977] 2 Lloyd’s Rep 560).
None of these grounds is particularly convincing. Ground (a) overlooks the fact that the part of the
Marine Insurance Act 1906 in which ss 17-20 appear is headed “Disclosure and Representations,” so
that it is arguable that nothing more than pre-contractual matters were under discussion, and indeed
there is no pre-1906 Act case which could have justified a codification of the law along the lines
suggested by Hirst J. Ground (b) appears to be merely a point of procedure rather than any application
of a principle of good faith, and was so treated by the House of Lords in Manifest Shipping Co Ltd v
Uni-Polaris Shipping Co Ltd, The Star Sea [2001] Lloyd’s Rep IR 247 (but note the recent reenactment of the ships papers rule in CPR r 62 with effect from March 2002). Ground (c) is
reconcilable with principle, in that the held covered clauses in question required a decision on the part
of the insurer to extend cover, and in that respect they can be regarded as fresh insurances to which the
ordinary pre-contractual duty would apply. In short, there is no solid basis for a continuing duty.
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It should also be said that the legal basis for the continuing duty – an implied term in the insurance
contract – cannot stand, as it has long been clear (a point emphasised by the House of Lords in Pan
Atlantic v Pine Top), that the duty of utmost good faith is not based on any implied term and arises ex
contractu as a matter of law. In The Star Sea the House of Lords, almost inevitably, overruled The
Litsion Pride. As a matter of law, it decoupled the obligation of good faith both from s.17 and the
remedy of avoidance and from the contractual principles which would apply to a breach of contract. In
so far as it was based upon the principle of the irrecoverability of fraudulent claims, the decision was
questionable upon the facts since the actual claim made was a valid claim for a loss which had occurred
and had been caused by a peril insured against when the vessel was covered by a held covered. Lord
Hobhouse was nevertheless of the view that the result might have been supportable on other grounds,
but he did not elaborate.
In The Star Sea itself the House of Lords was faced with the very narrow issue of 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 held that the issue had to be addressed as if it were a fraudulent
claim, and decided that as fraud had not been established the insurers had no defence. Beyond that, the
decision is perplexing. Lord Hobhouse came close to denying the existence of any continuing duty,
and in any event limited its ambit to: (a) fraud; and (b) statements made prior to the commencement of
litigation. He ruled out virtually every situation in which there could be a continuing duty, and treated
the remedy of avoidance ab initio as “disproportionate”. Lord Scott’s comments came to much the
same thing.
Matters have been clarified by subsequent Court of Appeal decisions. In K/S Merc-Skandia XXXXII v
Certain Lloyd’s Underwriters [2001] Lloyd’s Rep IR 802 the Court of Appeal was faced with a
fraudulent statement by the assured, designed to assist liability insurers in defending a claim brought by
a third party. Longmore LJ, speaking for the Court of Appeal, held that in the post-contract situation,
the rights of the parties were governed primarily by their contract and not by rules of law and
accordingly, it was necessary to determine the position under the contract. Longmore LJ also
confirmed that the law relating to fraudulent claims did not form a part of the continuing duty of utmost
good faith. He ruled that the assured’s continuing duty of utmost good faith arose only where the
insurers had a contractual right to receive information and that term had been broken in a fashion which
repudiated the assured’s rights under the policy. In short, the continuing duty of utmost good faith was
simply an alternative to the right of insurers to treat a contract as having been repudiated for breach of
an express information provision. As that is almost certain not to be the case (demonstrated by the facts
of K/S itself), the continuing duty has all but been abolished.
Subsequently, in Agapitos v Agnew [2002] Lloyd’s Rep IR 573 emphasised that a fraudulent claim was
governed by contract or public policy, and not by the continuing duty of good faith.
B: THE INSURERS’ DUTY OF UTMOST GOOD FAITH
Section 17 of the Marine Insurance Act 1906 states that the duty of utmost good faith is mutual, but
there is nothing in the rest of the Act which develops the scope of the insurers’ duty. There is very little
scope for an extensive pre-contractual duty, given that the only remedy is avoidance and this will rarely
be in the assured’s interests. Possible illustrations are where the assured has been misled into believing
that the policy covers risks which it does not cover, or where the risk insured against is to the
knowledge of the insurers non-existent.
However, in a series of recent cases the English courts have begun to develop a duty of utmost good
faith imposed on insurers, the remedy being not avoidance but a prohibition on denying liability. It is
likely that there will soon be recognised a duty to act in good faith in claims-handling, although –
unlike the US – breach of the duty cannot give rise to damages. The root of the present cases is
recognition that, in handling a claim for the assured, a liability insurer is required to act in the interests
of both itself and the assured (eg, not settling for a sum grossly in excess of policy limits): this was so
stated in Groom v Crocker [1939] 1 KB 194.
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In K/S Merc-Skandia XXXXII v Certain Lloyd’s Underwriters [2001] Lloyd’s Rep IR 802 Longmore LJ
commented, relying on Groom, that insurers were under a duty of utmost good faith to take into
account the interests of the assured
In Gan Insurance Company Ltd v. Tai Ping Insurance Company Ltd (Nos 2 and 3) [2001] Lloyd’s Rep
IR 667 a reinsurance agreement contained a claims control clause under which the insurers had the
right to decide whether or not to consent to any settlement. It was accepted at first instance that this
power had to be exercised reasonably (98% of reinsurers had confirmed the settlement, 2% had refused
to do so). This was reversed on appeal, but the majority view (Sir Christopher Staughton dissenting)
was that reinsurers were required to act for the right reasons and without arbitrariness, and not to refuse
to accept a settlement for any reason other than one based on the merits of the settlement itself. The
Court of Appeal classified this as an implied term, but the outcome is much the same.
In Strive Shipping Corporation v Hellenic Mutual War Risks Association [2003] Lloyd’s Rep IR 669
the assured’s vessel was lost in mysterious circumstances. The insurers denied liability on the basis that
the vessel had been scuttled, and they also avoided the policy for non-disclosure of the fact that the
assured had suffered four previous losses none of which had been satisfactorily explained. At the trial
the insurers failed on the fraud point, but maintained their utmost good faith defence. The assured was
permitted by Colman J. to introduce evidence as to the circumstances of the four earlier losses for the
purpose of demonstrating that nothing untoward had occurred. In the event, the assured persuaded the
court after consideration of voluminous evidence that the earlier losses were not suspicious. Colman J.
proceeded to hold that, while the circumstances of the earlier losses might have been material facts
when the policy was obtained, the assured’s proof of his innocence prevented the insurers from
avoiding their liability in reliance on those material facts. Colman J. gave two separate grounds for his
conclusion. The first was that a purported avoidance for breach of the duty of utmost good faith could
be overturned by the court if it was found not to be justified in the light of hindsight. The second was
that insurers would be in breach of their own duty of utmost good faith in attempting to rely upon those
allegations if it were proved at the trial that the allegations were unfounded. This decision therefore
supports the proposition that there is an equitable barrier, preventing an insurer from relying upon facts
which appeared to be material and true when the policy incepted but which have been proved not to be
true at the trial or by the time the insurer seeks to rely upon them. This is likely to apply only to
intelligence received by the assured, criminal charges and suspicions of dishonesty. The point being
made was that the facts were material and had to be disclosed a proposition not doubted by Colman J.
but that as they had been disproved they could be relied upon to justify avoidance. Each of the two
possible constraints suggested by Colman J has been considered in subsequent decisions.
Colman J’s suggestion that a court of equity could overturn a valid avoidance was rejected by the Court
of Appeal in in Brotherton v Aseguradora Colseguros SA [2003] Lloyd’s Rep IR 758. In this case the
defendants were the fidelity insurers of a Colombian bank. Reinsurance had been placed in London
with the claimant reinsurers for a period running from December 7, 1997 to (after extension) January
31, 1999. After the reinsurance had expired the reinsurers discovered that there had during 1997 been
various media reports relating to the president of the bank: there had initially been a report that the
bank had made payments to a company controlled by the president of the bank, and these had been
followed by reports that the president of the bank and four colleagues were under suspicion of fraud
and that he had been suspended from office. The reinsurers avoided the policy, and commenced
proceedings seeking a declaration of non-liability. The insurers sought to defend the proceedings by
introducing evidence to the effect that, whatever the strength and materiality of the reports, they had in
fact proved to be false. The Court of Appeal refused to admit evidence of the innocence of the
president of the bank, as the only issue was whether the reports true or false were material facts at the
dates of the placement and extension. The Court of Appeal confirmed the principle that the materiality
of a given fact and its inducement on the underwriter in question had to be tested at the time of the
placing of the risk. The Court of Appeal went on to give detailed consideration to the question of
whether an avoidance by insurers could be overturned by the court at trial on the basis that the material
facts relied on by the insurers had been shown at the trial and in the light of hindsight to be irrelevant in
terms of materiality and inducement. The Court of Appeal here held that avoidance is a self-help
remedy that does not require the assistance or sanction of the court. Thus, once the reinsurers had
purported to avoid the policy, their avoidance took effect and could not be overturned by the court. The
Court of Appeal was also of the view that, even if there had been no purported avoidance before the
trial and the insurers chose to avoid at the trial, it was not open to the court to challenge the avoidance
by admitting evidence to show that the material facts relied upon had proved with hindsight not to be
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material. The refusal of the Court of Appeal to countenance intervention where there had been a valid
avoidance was justified by Mance LJ, giving the leading judgment, on the ground that were it
otherwise it would be necessary to conduct a trial within a trial in order to determine whether the
material facts relied upon by the insurers had later been shown to be material. Mance LJ further pointed
out that it was by no means obvious which party should pay the costs of the trial within the trial: while
at first sight it appeared that payment should be made by the insurers if the assured could establish that
there was in hindsight no basis for avoidance, the reality of the position would be that insurers would
be liable to pay the costs of a mini-trial even though the information in question had not been disclosed
at the placement of the risk and was at that time material.
However, very soon after Brotherton, a differently constituted Court of Appeal held in Drake
Insurance Co v Provident Insurance Co [2004] Lloyd’s Rep IR 277 concluded that an avoidance would
be invalid if carried out in bad faith. This case involved a claim for contribution as between two motor
insurers, each of whom had issued a policy which covered the liability of the driver for personal
injuries inflicted on a third party. The defendants avoided the renewal of the policy on the ground that
their assured, the driver’s husband, had failed to disclose on renewal a speeding conviction obtained by
the assured: on the underwriting criteria adopted by the defendants, the points allocated to this incident,
coupled with the points allocated to an earlier accident in which the assured’s wife had been involved,
took the assured’s points total to a level at which the defendants would have charged a higher premium
on renewal. Following avoidance, it became clear that the accident involving the assured’s wife had not
been her fault and that it ought not to have been regarded as attracting any points: the insurers would
not, therefore, have charged a higher premium on renewal. The claimants, who had satisfied the claim,
thus argued, relying on Strive Shipping, that the court ought not to permit an avoidance when it was
clear from facts proved at trial that the facts relied upon were immaterial. Rix and Clarke LJJ held that
the insurers had no right to avoid, for the reason that there had been no inducement: had the conviction
been disclosed, the insurers would have attempted to charge a higher premium and at that point it
would have become apparent that the accident had not been the assured’s fault, so that ultimately the
same premium would have been charged. However, the majority expressed the view that the insurers
were under a continuing duty of utmost good faith, and that duty bound them not to avoid if at the time
of the avoidance they were either actually aware that they were relying upon disproved facts or at least
that they turned a blind eye to the possibility that the facts had been disproved. The majority accepted
the factual finding of Moore-Bick J that the insurers had not at the time of avoidance possessed either
actual or “blind eye” knowledge of the true position relating to the accident and accordingly that they
were not in breach of their continuing duty. Pill LJ, dissenting, held that the insurers’ continuing duty
was not confined to actual or blind eye knowledge, and that good faith extended to making reasonable
inquiry of the assured prior to avoidance: had this been done in Drake v Provident, then Pill LJ’s view
was that the true position relating to the accident would have come to light and that the avoidance
would have been seen to have been unjustified. The result of Drake v Provident is that the proposition
that materiality and inducement have to be tested as at the date of the placement remains good, but that
the right of the insurers to effect an avoidance at a time they are or ought to be in possession of
knowledge that the fact was not material or had not induced them can render their avoidance in breach
of their continuing duty of good faith. This point is considered further, below, in the context of the
insurers’ continuing duty.
In Eagle Star Insurance Co Ltd v Cresswell [2004] EWCA Civ 602 the terms of a reinsurance
agreement provided that the reinsurers would follow the settlements of the reinsured, but that it was a
condition precedent to any liability under the policy that the claimant would (a) give notice to the
reinsurers within seven days of the occurrence of any loss, and (b) co-operate with the reinsurers in the
adjustment and settlement of claims. Subsequently the printed form was amended: the claims cooperation clause was struck out, and was replaced with a series of typed clauses. Those clauses stated
that the consent of the reinsurers was required before any settlement was binding on them. There was
also a claims control clause in the following words.
(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.
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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.
The issue was whether (b) was a condition precedent to the reinsurers’ liability, the argument being that
if the reinsurers chose not to exercise their rights of control then they were not laible to pay It was
common ground that (a) was not a condition precedent, and Morison J held at first instance that (b) was
not a condition precedent either, for a number of reasons: (1) there was no reason to suppose that the
parties intended that the two limbs of the same clause would operate differently; (2) clear wording was
needed; (3) the deleted insolvency clause made the position clear, but the parties had moved away from
that; (4) no obligations were actually imposed on the reinsured, so that if the reinsurers were right it
gave them a discretion not to pay by not exercising control rights – the only sensible way of reading the
clause was to imply an obligation on the reinsured not to obstruct the reinsurers. On appeal the Court of
Appeal disagreed. The initial point was that the typed clauses prevailed over the printed clauses, this being a
general principle of construction. The Court of Appeal accepted that, but for the claims control clause, the
clause which required the reinsurers’ consent to any settlement would not have precluded recovery by the
reinsured if it had been able to prove its loss: that clause was not a condition precedent and (just as in the
Scor case) its only effect would have been to prevent reliance on the follow the settlements clause. Turning
to para (b) of the claims control clause, the Court of Appeal analysed its two sentences separately. The
Court of Appeal was unanimous that the first sentence – “The Underwriters hereon shall control the
negotiations and settlements of any claims under this Policy” – did not impose any obligation on the
reinsurers to take over the control of the settlements, but rather conferred upon them the right to do so.
There was at this point a dispute as to the time at which the reinsurers were entitled to take control. The
reinsured argued the clause was in the nature of an option which had to be exercised on notification of
the loss under paragraph (a) (or at least within a reasonable time), and that thereafter the right to control
was lost and the reinsurers were obliged to follow the reinsured’s settlements. The Court of Appeal
preferred the reinsurers’ interpretation that the reinsurers were entitled to be informed by the reinsured
when negotiations began so that the reinsurers could at that point decide how the negotiations should
be conducted, so that the clause was an allocation rather than an option. The reinsured’s construction
would make it almost impossible for the reinsurers to make an informed choice, as at the date of the
notification it was possible that full information would not be available. Longmore LJ’s only
reservation was to express doubt – without deciding the point – that the clause enabled the reinsurers to
dictate that negotiations should begin earlier than the reinsured thought to be right or sensible.
The next issue concerned the second sentence of paragraph (b), “In this event the Underwriters hereon
will not be liable to pay any claim not controlled as set out above.” The Court of Appeal held that,
consistently with the first sentence of the paragraph, the words “In this event” did not mean in the event
that the reinsurers opted to control the proceedings, but rather in the event that there were negotiations
in respect of a claim. Once that meaning was given to the words, the following words – “the
Underwriters … will not be liable to pay any claim not controlled …” inevitably constituted a
condition precedent to the reinsurers’ liability as that was what the clause said. The absence of the
phrase “condition precedent” was not regarded by the Court of Appeal as fatal to this conclusion, as the
meaning was otherwise clear. Putting the matter another way, once there were negotiations in respect
of a claim, if the reinsurers did not control those negotiations then the reinsured was simply unable to
recover: it was not a case of the reinsured being required to notify the reinsurers of settlement
negotiations (by means of some implied term) but rather there was an absolute bar to recovery if the
reinsurers were not involved.
The Court of Appeal also addressed one further matter, namely, how would a claims co-operation
clause expressed in this fashion operate where the reinsurers simply refused to exercise control? If the
wording does give rise to a condition precedent, and the reinsurers simply decline to participate, the
reinsured is lost because any settlement made by the reinsured will by definition not be binding on the
reinsurers. Looked at in this way, if the reinsurers’ rights are unlimited, the reinsurers in effect have an
absolute discretion to refuse to honour the reinsurance agreement. Rix LJ suggested two possible ways
round this problem. The first was waiver, so that in appropriate circumstances a refusal to participate
by reinsurers could be construed as a willingness to follow the reinsured’s settlements. This point was
not amplified, and it will be appreciated that waiver may not readily be made out by a simple refusal to
join the negotiations. The second solution built upon the suggestion by the majority of the Court of
Appeal in Gan v Tai Ping (Nos 2 and 3) (vehemently rejected by Sir Christopher Staughton) that there
was an implied term whereby reinsurers would not exercise their discretion under a claims provision
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(in Gan, to give their consent to a settlement) in bad faith, capriciously or arbitrarily. As was
emphasised in Gan, this is not a reasonableness test (the suggestion made at first instance in Gan and
rejected by the Court of Appeal) but a test which focuses on the reinsurers’ taking into account
considerations other than the merits of the claim. Rix LJ took the matter slightly further, and indictaed
the duty to act in this way was “as a matter of law in the very essence of the reinsurers' mutual
obligation of good faith”, a suggestion made by Longmore LJ in K/S Merc-Skandia XXXXII v Lloyd’s
Underwriters [2001] Lloyd’s Rep IR 802. One way or another, therefore, the reinsurers’ discretion in
handling claims is not unlimited whatever the wording of the policy may be.
In WISE Underwriting Agency Ltd v Grupo Nacional Provincial SA [2004] EWCA Civ 962 a policy
covered quantities of goods in transit for delivery to a retailer in Cancun, Mexico, a resort known as
catering for tourists with expensive tastes. The proposal as presented to reinsurers in London, and
translated from Spanish, stated that the goods included “clocks”, an apparent mistranslation of a term
intended to cover both clocks and watches. In fact a large quantity of valuable Rolex watches were
consigned to the assured and the entire consignment was stolen. The reinsurers purported to avoid the
reinsurance for the non-disclosure of the inclusion of Rolex watches. Simon J held at first instance that
the fact was material and that there had been inducement of the reinsurers: the materiality point was not
appealed, and the Court of Appeal upheld the finding on inducement. In the event the Court of Appeal
held by a majority that the reinsurers had affirmed the policy after having become aware of a right to
avoid it, but chose also to give extended consideration to a further point which in the event proved
irrelevant to the outcome, namely whether the reinsurers had waived disclosure of the presence in the
cargo of Rolex watches. The argument for the reinsured was that the disclosure which had been made
of the inclusion of clocks ought to have put the reinsurers on notice of the possibility that watches
would also be involved and that the failure of the reinsurers to make further inquiries amounted to
waiver. The Court of Appeal by a majority rejected the waiver argument, but the discussion of the point
gave rise to an important disagreement of principle.
The majority view, that of Longmore and Peter Gibson LJJ, was that the reinsurers were entitled to rely
on what they had been told and that they were not under any duty to go behind the reinsured’s
presentation of the risk in the absence of a clear indication that further facts existed. Longmore LJ’s
approach was that a two step investigation was required: (a) was there an unfair presentation of the
risk; and (b) if so, were the reinsurers “put on inquiry by the disclosure of facts which would raise in
the mind of the reasonable [re]insurer at least the suspicion that there were other circumstances which
would or might vitiate the presentation?” Longmore LJ’s view was that if there was by definition a
potentially unfair presentation at the outset, there could be waiver only where the matters withheld
were “ordinary incidents of the particular contract being insured” and thus the insurers were under no
duty to ask further questions unless they were “put on enquiry by the disclosure of facts which would
raise in the mind of a reasonable insurer at least a suspicion that there were other circumstances which
would or might vitiate the presentation made to him”.
Peter Gibson LJ concurred, stating that
the court should not subvert the duty of the assured to make a fair presentation of the risk by
finding that the reinsurers were put on inquiry and failed to discover for themselves the
material information save in a clear case.
On the facts there was held to be nothing in the mention of clocks which would have put a prudent
underwriter on notice of the possible shipment of Rolex watches, so that waiver could not be made out,
and similarly the mere fact that Cancun was a high-class tourist resort was not of itself enough to cause
a prudent underwriter to investigate further.
Rix LJ, dissenting on analysis and on the outcome, emphasised two separate points. First, he held that it
was not possible to treat the concepts of fair presentation and waiver separately. After a lengthy review
of the authorities, Rix LJ concluded that the duty of the assured was to make a fair presentation,
including the disclosure of unusual or special facts. Rix LJ rejected the majority’s two-step approach
and preferred the view that the question whether there was an unfair presentation of the risk itself
encompassed the further question of whether there remained undisclosed facts which were unusual or
special and which distorted the presentation of the risk. Rix LJ summarised his reasoning as follows:
the question is: Has the insurer been put fairly on inquiry about the existence of other material
facts, which such inquiry would necessarily have revealed? The test has to be applied by
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reference to a reasonably careful insurer rather than the actual insurer, and not merely by
reference to what such an insurer is told in the assured’s actual presentation but also by
reference to what he knows or ought to know, ie his section 18(3)(b) knowledge. The
reasonably careful underwriter is neither a detective on the one hand nor lacking in commonsense on the other hand. Mere possibilities will not put him on inquiry, and very little if
anything can make up for non-disclosure of the unusual or special. Overriding all, however, is
the notion of fairness, and that applies mutually to both parties, even if the presentation starts
with the would-be assured.
Rix LJ was heavily influenced by the mutual duty of utmost good faith which, in the present context,
imposed a duty on the underwriters to act fairly when purporting to avoid. The relevant principle here
was that:
the question is ultimately not whether an “unfair” presentation has been waived, but whether,
taking both sides of the matter into consideration, the presentation is unfair or alternatively it
would be unfair of the insurer to seek to avoid on a ground on which he was put on inquiry
and should have satisfied himself.
Applying these tests, Rix L.J. was not satisfied that unusual or exceptional facts had been withheld.
There was nothing unusual about a person in the assured’s position selling valuable watches, and
indeed it was to be expected. A single simple question would have resolved the problem, and the
reinsurers, having failed to take that step, could not avoid the policy.
C: THE CHANGING ROLE OF INTERMEDIARIES
Brokers occupy an anomalous position in English law. Accepted propositions are that:
(a)
(b)
the broker is the agent of the assured and not the agent of the insurers, and
accordingly does not owe a duty of care to the insurers, even if acting as cover
holder;
the broker is remunerated by the insurers, the right to be paid being earned by the
placing of business.
In recent times each of these propositions has been put under scrutiny.
Agency of brokers
The broker is the agent of the assured, so that information or money passed to the broker is not deemed
to have been passed to the insurers (although note the exception in section 53 of the Marine Insurance
Act 1906 that the broker has to pay the premium – see Heath Lambert Ltd v Sociedad de Corretaje de
Seguros [2004] Lloyd’s Rep IR 905). However, it is gradually being accepted that: (1) a broker can be
the agent of the insurers if there is no conflict of interest involved or if the assured gives full and
informed consent; and (2) that in certain circumstances a broker can be regarded as a dual (“common”)
agent, acting for both parties (or independently): see J A Chapman & Co Ltd v Kadirga Denizcilik Ve
Ticaret [1998] Lloyd’s Rep IR 377, comments adopted in Heath Lambert, in the context of the
payment of the premium. It may be that there is now simply a presumption that the broker is the agent
of the assured, but that this can be rebutted on the facts in any given situation.
The agency of brokers is now under attack. The rule was criticised by the Court of Appeal in Roberts v
Plaisted [1989] 2 Lloyd’s Rep 341. The extended role of a broker in “market-making” as opposed to
placing business was recognised by the House of Lords in Forsakrings Vesta v Butcher [1989] 1 All
ER 402.
In Aneco Reinsurance Underwriting Ltd v Johnson & Higgins Ltd [2002] Lloyd’s Rep IR 91 the House
of Lords recognised that a broker who was employed to place a reinsurance cover for a Lloyd’s
8
Syndicate owed a duty of care to the reinsurers in respect of the retrocession to be arranged by the
broker, on the basis that the broker had assumed the responsibilities of an adviser to the reinsurers. This
is a contentious decision as regards the imposition of a duty of care on the facts, but the principle is
undoubted
In HIH Casualty and General Insurance Co v Chase Manhattan Bank [2003] Lloyd’s Rep IR 230 the
House of Lords confirmed that a broker placing business for an assured owed an independent duty of
utmost good faith to insurers and could face liability in damages for negligent or fraudulent
misrepresentation. Section 19 of the MIA 1906 Act 1906 provides that an agent must disclose to the
insurer:
(a)
(b)
every material circumstance which is known to himself, and an agent to insure is
deemed to know every circumstance which in the ordinary course of business ought
to have been known by, or to have been communicated to, him; and
every material circumstance which the assured is bound to disclose, unless it comes
to his knowledge too late, to communicate it to the agent.
Their Lordships concluded that section 19 imposed a duty of utmost good faith entirely distinct from
that of the assured. The significance of the point in HIH was that a clause which excluded any
obligation on the assured to disclose material facts did not extend to the assured’s broker, whose duty
was independent and did not fall within the terms of the exclusion. The House of Lords accepted that a
broker’s duty of disclosure could be waived even if the broker had been negligent. Lord Scott was
prepared to go further and to hold that a clause protecting the assured from the consequences of
misrepresentation or non-disclosure could extend to the fraud of the broker, although this suggestion
was rejected by Lord Hobhouse. The former view all but recognises that the broker is in many cases an
independent agent and that there is no reason why responsibility for the broker’s fraud should not be
allocated between the parties between whom he is mediating. The latter view reverts to the traditional
notion that the broker is the agent of the assured and that while in certain circumstances the broker may
owed duties to the insurer it is not possible to undermine the fundamental rule that the broker is the
agent of the assured. It might be suggested that in the modern context, where brokers do in practice
fulfil functions for both parties and in some circumstances act in a way which defies classification as
agency, that the view of Lord Scott conforms with commercial reality.
In Sphere Drake Insurance Ltd v Euro International Underwriting Ltd [2003] Lloyd’s Rep IR 525
liability was imposed by Thomas J upon a broker who placed business with the insurer’s underwriting
agent in a fashion which amounted to providing knowing assistance to the underwriting agency in
breaking its fiduciary duties to the insurer. It was accepted that the broker did not owe a duty of care to
the insurers. This was followed by Morison J in Bonner v Cox Dedicated Corporate Member Ltd
[2004] EWHC 2963 (Comm).
Commission
The traditional rule that the broker is paid by the insurers was thrown into doubt in Carvill America Inc
v Camperdown UK Ltd, September 2004, unreported. US insurers, XL, appointed Carvill America to
place reinsurance business. The letter of appointment stated that remuneration earned by Cargill would
be paid entirely by the reinsurers in accordance with the custom in the industry. The cover, in the form
of two reinsurance treaties, was placed in London with 13 European reinsurers by Carvill UK, with
effect from July 1999 and was renewed until the end of 2003. The treaties contained arbitration clauses
Gross premiums were paid to Carvill, which deducted brokerage and passed on the net premiums to the
reinsurers. Disputes arose as to the level of commission, and XL terminated the agreement with Carvill
with effect from 13 August 2003. After that date premiums were not paid to Carvill and Carvill did not
receive any brokerage. Carvill commenced proceedings in England seeking brokerage of some US$4.7
million from the European reinsurers, most of which related to 2003. Carvill relied upon the letter of
appointment with XL which made the reinsurers liable for the premium, and also on custom and
practice of the London market whereby brokerage was paid by reinsurers. Soon afterwards XL
commenced proceedings in Connecticut, seeking amongst other things a declaration that it was not
liable for the brokerage. Carvill America for its part started its own action in Connecticut against XL
for unpaid brokerage relating to US business: there was no claim for the brokerage sought in the
English action. Subsequently Carvill obtained permission to join XL to the proceedings, on the basis
9
that if the reinsurers did not face liability for the European brokerage then it was arguable that XL was
bound to pay. XL contested its joinder and sought to have the permission set aside. HHJ HavelockAllan QC refused to set aside the proceedings against XL.There was a serious question to be tried as to
XL’s liability to Carvill. The appointment contract was arguably ambiguous in casting the burden of
paying premium on the reinsurers, and in any event that contract was governed by the law of
Connecticut and there would need to be evidence as to how it would be construed in Connecticut.
Further, it was far from clear that there was an established custom in the reinsurance market that
reinsurers were liable for the premium: there was an apparent custom in the insurance market to that
effect but there was no authority on the position in reinsurance, and in any event there was no authority
for the proposition that insurers or reinsurers were under a legal obligation to pay the brokerage.
D: THE REINSURERS’ LIABILITY FOR LOSSES
Reinsurance losses
The term loss is for reinsurance purposes presumed to be met on the date on which the reinsured’s
liability is established, and not at the later date when the reinsured has paid its own assured. It is
unclear whether the standard excess of loss wording of ultimate nett loss clauses – ‘and shall actually
have paid’ – affects this position. In two first instance decisions, Home v Mentor [1989] 1 Lloyd’s Rep
473, and Re A Company No 0013734 of 1991 [1992] 2 Lloyd’s Rep 413, there was a marked
reluctance to give the words their prima facie meaning, as this gives reinsurers a windfall in the event
of their reinsureds’ insolvency. The House of Lords in Charter Re v Fagan [1996] 3 All ER 46,
affirming the views of Mance J and the Court of Appeal (2:1) held that these words did not alter the
prima facie rule that establishing liability is enough. The position is not the same in all jurisdictions. In
Cleaver and Bodden v Delta American Reinsurance Co [2002] Lloyd’s Rep IR 167 a reinsurance
contract governed by New York law contained an insolvency provision under which, in event of the
retrocedant’s insolvency, the retrocessionaires were to pay the retrocedants “on the basis of the liability
of” the retrocedant. The Privy Council accepted evidence that under New York law the
retrocessionaires were liable to make payment only when the retrocedant had itself indemnified its own
policy holders, but went on to hold that the effect of the insolvency clause was to alter the payment rule
and to render the retrocessionaires liable to make payment where the retrocedant proved its own
liability to policy holders. That meant that the retrocessionaires were liable to make payments in
respect of losses incurred but not reported (IBNR) which formed a part of the retrocedant’s proof of
debt even though it was no more than an estimate of future claims: that was the case even though the
retrocedant might not be called upon to make payments forming part of the IBNR for some time to
come, if ever.
The reinsured’s rights at common law
The relevant principles were laid down by Lord Mustill in Hill v. Mercantile and General Reinsurance
Co plc [1996] 3 All ER 865. That particular decision was concerned with the proper construction of
express follow the settlements wording, but Lord Mustill set out the basic rule that a reinsurer is liable
to indemnify the reinsured only if (a) the loss falls within the wording of the direct policy, and (b) the
loss falls within the cover created by the reinsurance. Requirement (b) is a matter of law. Requirement
(a), by contrast, while also a matter of law, can be satisfied in such manner as the parties may agree,
and in practice this is done by means of a follow the settlements/fortunes clause. The reinsured’s
liability to the direct policyholder may arise in one of three ways: by judgment; by arbitration award;
and by binding settlement.
As far as judgments are concerned, in Commercial Union Assurance Co v. NRG Victory Reinsurance
Ltd [1998] 2 Lloyd’s Rep 600 the Court of Appeal was required to consider whether a settlement
reached by a reinsured with its policyholder during the course of foreign litigation was binding on the
reinsurer. The Court of Appeal held that the reinsurer was not bound. As a preliminary aspect of its
reasoning, the Court of Appeal gave consideration to the circumstances in which a foreign judgment
establishing and quantifying the reinsured’s liability should be recognised in a subsequent reinsurance
10
dispute. It was put to the Court of Appeal that a foreign judgment is no more than evidence of the
reinsured’s liability to the original assured, and, in particular, that where the insurance contract is
governed by English law the English court possessed the jurisdiction to rule on the reinsured’s liability
under English law. Potter LJ held that this view was too extreme:
In my view, the matter is better treated as a question of implication into the reinsurance
contract, the implied term being that, absent any provision to contrary effect, the insurer will
treat the decision of a foreign court of competent jurisdiction as to the liability of the reinsured
to his original insured as binding, subject only to reversal on appeal and the [above] limits.
Four specific conditions for the operation of the implied term in the reinsurance agreement were laid
down by the Court of Appeal.
(1)
(2)
(3)
(4)
The foreign court must, in the eyes of the English court, be a court of competent
jurisdiction, and it is not necessarily enough that the foreign court has ruled that it
possesses the necessary jurisdiction under its own domestic jurisdiction rules. While
it is the case that only exceptionally would an English court refuse to recognise such
a ruling, there are circumstances where this might be the case.
The judgment has not been obtained in the foreign court in breach of an exclusive
jurisdiction clause or other clause by which the original assured was contractually
excluded from proceeding in that court, e.g. an arbitration clause. The English courts
are required to refuse to afford recognition to a foreign judgment in these
circumstances, under the Civil Jurisdiction and Judgments Act 1982, s.32.
The reinsured has taken all proper defences. Plainly, if the reinsured has allowed a
default judgment to be entered against it, or has disregarded potential defences, the
reinsured cannot be said to have proved its loss.
The judgment is not manifestly perverse. Quite what this might mean was not
amplified by the Court of Appeal, although in the case of an insurance contract
governed by English law there would plainly be some temptation for the court to
reopen the issues resolved in the foreign proceedings where there is a manifest error
of law.
As far as arbitration awards are concerned, it is settled law that material presented to arbitrators and the
ultimate award are confidential between the parties to the arbitration, and the award itself has no effect
upon the legal rights of third parties. However, an arbitration award is not devoid of all legal effect as
regards third parties, and it has generally been assumed — without actually being tested — that if a
reinsured has properly defended arbitration proceedings brought against it by its assured, and has been
found liable by the arbitrators, the award is conclusive evidence of the reinsured’s liability and the
reinsurer is itself obliged to indemnify the reinsured in respect of the award. If the position were
otherwise, the reinsured would be in an impossible position should the reinsurer demand that the award
be reopened for reinsurance purposes, given that, as far as the insurance claim against the reinsured is
concerned, the arbitrators have the final say on questions of fact and their decisions of law can be
appealed against only in exceptional circumstances. One method of overcoming any problem here, and
which is doubtless consistent with commercial practice, would be to regard it as implicit in a
reinsurance agreement in respect of an insurance contract containing an arbitration clause that the
reinsurer has agreed to be bound by the arbitrator’s award. In support of an implied term, it might be
argued that the reinsurer must be taken to have agreed to run the risk of arbitrators reaching a result
which might not be fully consistent with strict law.
As far as a settlement is concerned, it is clear that while such a settlement may be binding on the
reinsured vis à vis the direct policyholder, it has no effect on the reinsurer and it remains necessary for
the reinsured to demonstrate in judicial or arbitral proceedings or in some other way acceptable to the
reinsurer that the reinsured was under a legal liability to make payment to the direct policyholder. If,
therefore, the reinsured cannot demonstrate that: (1) there was a loss suffered by the policyholder; (2)
the loss was proximately caused by an insured peril; (3) the reinsured had no defences to the
policyholder’s claim; and (4) the amount of the settlement was no greater than the reinsured’s legal
liability, he cannot recover. The reinsurer is, therefore, plainly not liable for ex gratia payments, and
even where the reinsurer admits liability or the reinsured demonstrates that it faced legal liability, the
reinsurer retains the ability to challenge quantum. The requirement that the reinsured is to prove its
legal liability to justify a settlement is a strict one, as is demonstrated by the Court of Appeal’s decision
11
in Commercial Union Assurance Co v. NRG Victory Reinsurance Ltd. In this case, the claimant
reinsured was one of a number of liability insurers of the vessel Exxon Valdez. The vessel ran aground
in 1989, resulting in a notoriously damaging oil spill. As a result, the insured owners faced massive
liabilities, particularly for clean-up costs. The liability cover was arranged under a corporate global
excess policy which was assumed to be governed by English law. Proceedings were commenced
against the reinsured by the owners in the courts of Texas, the place in which the owners’ business was
centred. The matter was due to come before a judge, who was not trained in insurance matters, sitting
with a jury. The reinsured, following the advice of local lawyers, decided that it would be sensible to
settle the claim and not to permit it to come before the court. While the reinsured accepted that the
wording of the policy would have given it a strongly arguable defence had the matter come before the
English Commercial Court, it was strongly advised that local juries on the whole sympathised with
policyholders rather than insurers, particularly where an insurer was perceived to be relying upon
technical wording defences. The reinsured had indeed experienced this, as in a later action arising out
of the same incident and involving the owners and the reinsured, the jury had disregarded a defence
which the reinsured had regarded as powerful, and had found for the owners. For these reasons, the
reinsured reached a settlement with the owners in the sum of US$300 million: this was substantially
less than the claim, and avoided any possible liability for costs and also for exemplary damages being
awarded against the reinsured by the jury. The issue was whether the defendant excess of loss
reinsurers were bound by the settlement. The reinsurance did not contain a follow settlements
provision, so that the question was not whether the reinsured had settled in a bona fide and businesslike
fashion but rather whether, as a matter of law, the reinsured had proved its loss.
The reinsured argued that it had proved its loss by reliance on an affidavit of Mr Reasoner, a local US
lawyer. That affidavit expressed the lawyer’s strong view that the jury was unlikely to be friendly to an
insurer relying on technicalities of policy wording to avoid liability. Clarke J, at first instance, held that
this was sufficient, in that it was necessary to consider the question of the reinsured’s liability not as a
matter of strict English law as it might be applied in the Commercial Court in England, but rather in the
manner that it was likely to be applied before a non-specialist judge and a jury in Texas. This reasoning
was rejected by the Court of Appeal, which ruled that the reinsured had not proved its loss. Potter LJ,
with whose judgment Lord Woolf and May LJ agreed, accepted that it was necessary for the reinsured
to prove its loss as a matter of law, and denied that a reinsurer is bound by bona fide and reasonable
settlements. As it was to be presumed that English law principles governed the direct policy, it was
necessary to apply English law strictly and to disregard the mere ‘predictions’ of a local lawyer. The
affidavit ‘did not bite on the question of whether the evidence demonstrated actual legal liability under
the insurance contract’ even though its conclusions had not been contested by the reinsurers. The result
of the decision is that, in the absence of a follow the settlements or equivalent clause, a bona fide and
businesslike settlement by the reinsured is not binding on the reinsurer even though it is demonstrated
that the settlement removed the risk of a far greater liability being imposed upon the reinsurer. This is
not at first sight an attractive outcome, but two considerations should be borne in mind: the absence of
a follow the settlements clause, which gives rise to this result, is presumably a deliberate decision by
the parties; and the ruling is consistent with the general rule of English law that a non-marine insurer is
not obliged to indemnify an assured for expenditure incurred by him in avoiding or mitigating a loss
even if the assured’s efforts operate to the insurer’s advantage.
Subsequently, in King v Brandywine Reinsurance Co (UK) Ltd [2004] EWHC 1033 (Comm), [2005]
Lloyd’s Rep IR (forthcoming) the reinsured unsuccessfully sought to show that there had been liability
under the direct policy, so that the claim against the reinsurers was dismissed.
Follow the settlements
The earliest attempt to modify the common law position was by the use of the phrase “pay as may be
paid thereon”. This was considered in a number of cases. In the earliest, Chippendale v. Holt (1895) 65
LJQB 104, Mathew J held that the reinsurer was legally liable to indemnify the reinsured only if the
reinsured was itself legally liable to its original assured; any defence open to the reinsured is, therefore,
open to the reinsurer as against the reinsured, and this is so irrespective of any independent defences
that the reinsurer may have under its agreement with the reinsured. Further, the fact that the reinsured
genuinely believed that it was liable to pay when this was not the fact in law could not make the
reinsurer liable. This approach was confirmed by the Court of Appeal in Merchants’ Marine Insurance
Co Ltd v. Liverpool Marine and General Insurance Co Ltd (1928) 31 Ll LR 45. In later cases a
12
distinction was drawn between liability and quantum. Bigham J in Western Assurance Co of Toronto v.
Poole [1903] 1 KB 376 held that “So long as liability exists, the mere fact of some honest mistake
having occurred in fixing the exact amount of it will afford no excuse for not paying. He has promised
‘to pay as may be paid thereon’.” That analysis was doubted by Scrutton LJ in Gurney v. Grimmer
(1932) 44 Ll LR 189 who stated that he did not know where Bigham J had ‘got that from’ although
more recently it has been approved in Hong Kong Borneo Services Ltd v. Pilcher [1992] 2 Lloyd’s Rep
593.
These cases led to the introduction of a new formulation, “follow the settlements”. The decision on the
‘follow the settlements’ formulation is Excess Liability Insurance Co Ltd v. Mathews (1925) 31 Com
Cas 43. The claimant reinsured had insured the profits of a mill in Hungary against any loss following
fire, and reinsurance was obtained from the defendant Lloyd’s underwriters. In August 1914, a state of
war was declared between Britain and Hungary, and the following month the mill was burnt down. In
1920, a treaty agreed between Britain and Hungary preserved the validity of commercial contracts
made between persons domiciled in those countries, the insurance agreement falling within this
category. Thereafter a claim by the mill owners under the policy was initially rejected by the reinsured,
but a settlement of 65% was eventually reached. A claim was then made by the claimant reinsured
against the Lloyd’s underwriters under the reinsurance contract, which obliged the latter ‘to pay as may
be paid thereon and to follow their settlements’. Branson J ruled that the reinsured’s payment had been
founded upon a legal liability to pay, so that the only question for discussion was whether the new
formulation permitted the reinsured to recover for settlements. In deciding that the reinsurer was indeed
bound to indemnify the reinsured. The court ruled that a settlement based on legal liability will bind the
reinsurer if made without fraud on the reinsured’s part, and if the reinsured has taken all proper and
businesslike steps to have the amount of the loss fairly and carefully ascertained.
Despite some early doubts, this view was confirmed by the Court of Appeal in Insurance Co of Africa
v. Scor (UK) Reinsurance Co Ltd [1985] 1 Lloyd’s Rep 312. The original insurance in Scor was on a
warehouse, known as the Old Customs Building, situated in Monrovia, the assured being the African
Trading Co (Liberia) Ltd (ATC) which had leased the building from the Liberian government. The
sums insured were $3,000,000 for its contents, in consideration of a premium of 1%. The insurer, ICA,
reinsured 98.6% of its liability in the London market, with Scor acting as the leading reinsurer. By the
terms of the reinsurance slip, Scor undertook to ‘follow the settlements’ of ICA. On 7th February 1982
the warehouse was destroyed by fire, the authorities being hampered by a series of misfortunes from
putting it out, and the entire building was subsequently levelled by the army as being in a dangerous
condition. A loss adjuster present in Liberia at the time prepared a report on the fire, and concluded that
ATC could not be blamed for the fire, and that ATC’s losses under both limbs of its insurance policy
exceeded the policy limits. These views were concurred with by a second loss adjuster sent to
Monrovia by ICA’s parent company in the United States. Consequently, by the beginning of April
1982, ICA was preparing to pay for a total loss under both parts of the policy, as by this time other
insurers had paid over sums to ATC and, in any event, the agreement between ATC and ICA obliged
ICA to pay any loss within sixty days of a claim.
At this stage, Scor received a series of three anonymous letters sent from Liberia alleging, inter alia,
that the effective controller of ATC had set fire to the warehouse with the co-operation of a senior army
officer, that ICA’s senior executive in Liberia had received a substantial bribe to keep quiet about this,
and that the original loss adjuster stood to receive up to 10% of the insurance monies for his part in the
fraud. Armed with this information, Scor refused to grant permission to ICA to pay the claim, and sent
its own investigators to Liberia. Scor also refused to give any reasons to ICA for its conduct, nor for
subsequent investigations into the ICA officer who had been accused of conspiracy by the anonymous
letters. As a result, ICA’s parent company instructed ICA not to co-operate with Scor’s investigators.
Subsequently, Scor made it clear to ICA that it would not indemnify ICA in respect of any payments
made by it to ATC, although the precise reasons for this were never fully disclosed to ICA, other than
that fraud was suspected. By this time, ATC had commenced proceedings in Liberia against ICA under
the original policy. ICA was unable to defend the claim by alleging fraud, as it was not party to any of
the evidence possessed by Scor, and judgment was given against ICA for the sums of $3,500,000 on
the claim itself, $600,000 for general damages (in English terms, punitive damages for delay) and
$58,000 in legal costs. It was for these sums that indemnity was sought by ICA from Scor in the
English courts. It should perhaps be noted, before the application of the law to these facts is considered,
that Leggatt J found as a matter of fact that there had been no fraud involved in the destruction of the
Old Customs Building, a finding with which the Court of Appeal did not seek to interfere.
13
As Scor had at no time authorised any payment to be made to ATC, the preliminary question which
arose in Scor was whether the ‘follow the settlements’ clause obliged Scor to indemnify ICA. The
Court of Appeal was unanimous that it did, The leading judgment of Stephenson LJ undertook a
detailed analysis of the old authorities on ‘to pay as may be paid thereon’ and concluded with the
following statement of the law and its application to the instant case:
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 ACT or not to have taken all proper and businesslike steps to have the
amount of the loss fairly and carefully ascertained. I adhere to the exact words unmodified of
Bigham J’s formulation in the Poole case, which has not been disapproved. I am in complete
agreement with the judge’s conclusion from the authorities as to the effect of the follow the
settlements clause.
Robert Goff LJ, with whose judgment on this point Fox LJ expressed his agreement, similarly analysed
the earlier authorities, and rejected the argument that Excess Liability Insurance Co v. Mathews was not
authoritative in the circumstances of the present case, for there the agreement had contained both the
‘to pay as may be paid thereon’ and the ‘follow the settlements’ formulations, whereas in Scor the
words ‘follow the settlements’ appeared alone in the relevant clause. Robert Goff LJ described that
argument as ‘unrealistic’, and held that the use of the words ‘follow the settlements’ alone was
intended and understood by the reinsurance market to have the desired effect of overturning
Chippendale v. Holt. Robert Goff LJ’s overall views, and the justification for them, were expressed in
the following way:
In my judgment, the effect of a clause binding reinsurers to follow settlements of the insurers,
is that the reinsurers agree to indemnify insurers in the event that they settle a claim by their
assured, i.e. when they dispose, or bind themselves to dispose, of a claim, whether by reason
of admission or compromise, provided that 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 their settlement. This construction seems to me to be consistent with the approach of
Branson J in Excess Liability Insurance Co v. Mathews. In particular, I do not read the clause
as inhibiting reinsurers from contesting that the claim settled by insurers does not, as a matter
of law, fall within the risks covered by the reinsurance policy; but, in agreement with Bigham
J, I do consider that the clause presupposes that reinsurers are entitled to rely not merely on
the honesty, but also the professionalism of insurers, and so is susceptible of an implication
that the insurers must have acted both honestly and in a proper and businesslike manner. I do
not, however, consider it possible to imply any stronger term, imposing a higher duty of care
on insurers.
The effect of the judgment of Robert Goff in Scor is that there are two conditions which have to be met
before the reinsured can seek indemnification for a settlement reached with the assured. The first is that
in settling the claim the reinsured has acted in a businesslike fashion. The second is that, as a matter of
law, the claim falls within the risks covered by the reinsurance agreement.
Limb I: proper and businesslike steps
There has been little discussion in the cases as to exactly what steps must be taken by the reinsured to
satisfy the Scor requirement that any settlement must be reached bona fide and in a businesslike
fashion. In many cases, the reinsurance agreement will contain a claims co-operation or claims control
provision, the effect of which will be to confer upon the reinsurer to a greater or lesser extent the right
to dictate how the reinsured must act, but even if such a provision exists the assured is otherwise
required to act in a bona fide in businesslike fashion. There are, essentially, two aspects to the
reinsured’s consideration of his position: the wording of the direct policy under which liability arises;
and the determination of the facts in order to apply the wording of the direct policy to them and to
assess the amount of the loss.
14
As to the first of these matters, the reinsured is justified, by a standard follow the settlements provision,
in taking a reasonable view of the policy (Municipal Mutual Insurance Ltd v. Sea Insurance Co Ltd
[1996] LRLR 265) although in some situations this may require taking legal advice from local lawyers.
The determination of facts is a rather more subjective matter. In Charman v. Guardian Royal Exchange
Assurance plc [1992] 2 Lloyd’s Rep 607 the reinsureds, Lloyd’s underwriters, appointed a loss adjuster
to investigate the assured’s loss, and were content to accept his report that the assured had sustained a
loss of $99.5 million. Webster J held that, in order to satisfy the Scor test, the underwriters were
obliged:
(a)
(b)
(c)
when appointing a loss adjuster, to act in a businesslike fashion in determining who
is to be appointed, and in particular to ensure that the appointee is reasonably
competent;
before accepting the adjustment, to ensure that it had been made in a businesslike
fashion;
having received the report, to negotiate with the assured in a businesslike fashion in
the light of the report.
The reinsureds were held by Webster J to have met each of these requirements on the facts of the case.
The amount of the loss was also in issue in Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd (No 3)
[2002] Lloyd’s Rep IR 612. The case concerned a fire at a computer wafer-chip factory in Taiwan. The
defendant reinsured, a local company, reached a settlement with the assured and claimed against the
reinsurers, all of whom other than the present claimant accepted liability. The claimant asserted various
breaches of claims co-operation obligations, but also argued that the defendant had given in to
commercial pressure too early and could have settled for less, an assertion supported by the fact that
the settlement figure was above the carefully considered maximum adopted by the other reinsurers. The
Court of Appeal was not called upon to come to a final decision on this point, as the only issue was
whether the claimant had an arguable case on the point which ought to be tried, and in confirming that
this was the case Mance LJ accepted that the difference between the level of settlement accepted by
other reinsurers and the level of settlement reached by the defendant was an important consideration. It
would also seem from the judgment that if the reinsured’s motivation to settle at a higher figure was
not based on the merits of the claim but rather on external considerations, eg, government pressure to
settle or the desire to maintain a relationship with the original assured, then it could not be said that the
reinsured had acted in a bona fide and businesslike fashion as regards that claim.
Limb II: loss within terms of reinsurance
Robert Goff LJ, in Scor, laid down a second requirement for recovery under a follow the settlements
clause, namely, that the loss had ‘as a matter of law, [to] fall within the risks covered by the
reinsurance policy’. It will, therefore, be necessary to consider as a separate question the meaning of
the reinsurance agreement. If the reinsurance is not written in the same terms as the direct policy, and
there is no reason to construe the two contracts in a consistent fashion, it is clear that the second limb of
the Scor test requires an independent analysis of the meaning of the reinsurance agreement to see
whether the reinsured’s loss falls within its terms. However, more usually, the reinsurance contract and
the direct policy will mean the same thing. It is readily apparent that the use of more or less identical
language in the two contracts will lead to a consistency of interpretation. Nevertheless, even if different
wording has been used, in many situations there is a presumption of ‘back-to-back’ cover which will
give the same result. The presumption of back-to-back cover will apply, as decided by the House of
Lords in Axa Reinsurance (UK) Ltd v. Field, in proportional reinsurance, where the reinsurer is more or
less sharing the risks accepted by the reinsured, although it has little or no role in non-proportional
reinsurance as there is no necessary connection between the risks accepted by the reinsured and the
reinsurer and thus there is no necessary connection between the terms of the direct policy and the terms
of the reinsurance. On that basis the House of Lords ruled in Axa that the aggregating terms ‘event’ in
an excess of loss reinsurance agreement, and ‘originating cause’ in the direct policy, could not be
assumed to bear the same meaning.
In many cases, the same risks will be covered by the two contracts and it follows that any acceptance of
liability by the reinsured which is outside the terms of the cover granted to the assured is automatically
taken outside the terms of the reinsurance agreement. It also follows that, if the reinsured’s liability to
15
the assured has been established by a judgment, the reinsurer’s liability under the policy of reinsurance
is of itself automatically established. The difficult situation is that in which the reinsured’s liability has
not been established as a matter of law, but the reinsured is justified taking the view that there is
liability to the assured, with the consequence that the reinsurer is liable to the reinsured as a matter of
law: this may occur where there has been an arbitration award in the assured’s favour, or where the
reinsured has obtained convincing legal advice that the wording of the contracts gives rise to liability.
Scor does not in terms deal with this question, and it was first addressed by Evans J in Hiscox v.
Outhwaite (No 3) [1991] 2 Lloyd’s Rep 524. This case arose from the ‘Wellington Agreement’ reached
in 1985 between insurers and assureds following a series of decisions by the US courts in which the
assureds were held liable for asbestos-related illnesses allegedly caused by their products. Under the
Wellington Agreement, insurers accepted liability towards the assureds, and agreed between
themselves not to pursue contribution claims against each other. Reinsurers were notified of the
Wellington Agreement, and disputes subsequently arose between insurers and reinsurers as to whether
the reinsurers had agreed to vary reinsurance agreements to provide indemnity for payments made
under the Wellington Agreement. A further issue was whether the reinsurance agreements in their
original form covered Wellington Agreement payments, which had explicitly been made on the basis
that those payments encompassed situations in which there was liability as a matter of law and
situations in which there was no liability as a matter of law. The reinsuring clause, cl.7, was in the
following terms:
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.
The case proceeded on the basis that this wording took effect as a ‘follow the settlements’ clause. An
additional feature present in Hiscox was that the insurance and reinsurance were in common terms by
virtue of an incorporation clause in the reinsurance agreement.
The rival contentions were as follows. The insurers argued that any claim compromised by them in a
reasonable and businesslike manner was binding on the reinsurers whatever the precise position in law
might have been. The reinsurers claimed that any payment made by the insurers other than on strict
legal liability was not covered by the reinsurance. Evans J held that the true position was an
intermediate one: the reinsurers were liable for reasonable compromises involving disputed questions
of law and fact, but were not in general liable for any payment which the insurers chose to make even if
bona fide, reasonable and businesslike, if it was made irrespective of the consideration whether the loss
fell within the scope of the direct policy. Evans J summarised the effect of Scor in this way:
In my judgment, the reinsurer is always entitled to raise issues as to the scope of the
reinsurance contract, and where the risks are co-extensive with those of the underlying
insurance he is not precluded from raising such issues, even where there is a ‘follow the
settlement’ term of the reinsurance contract. Ultimately, this is the only sure protection which
the reinsurer has against being called upon to indemnify the reinsured against payments which
were not legally due from him to the original insured, however reasonable and business-like
these payments may have been. But this is subject to one proviso . . . The reinsurer may well
be bound to follow the insurer’s settlement of a claim which arguably, as a matter of law, is
within the scope of the original insurance, regardless of whether the Court might hold, if the
issue was fully argued before it, that as a matter of law the claim would have failed.
Applying this principle to the facts before him, Evans J upheld the view of the arbitrator that the
reinsurers were not liable to indemnify the insurers for payments made to uninsured persons under the
Wellington Agreements.
The reasoning of Evans J in Hiscox seeks to compromise between the needs of the parties: the
reinsured is entitled to settle, having taken sensible steps to establish his liability under the contract as a
matter of law, and the reinsurer is bound under the reinsurance contract as a matter of law providing
that the reinsured’s settlement was one which was based on assumed liability. What is clear from this
formulation is that the second limb of Scor is not eliminated simply because the reinsurance agreement
and the direct policy are, or are to be construed as being in identical terms, as it remains open to the
reinsurers to prove that the reinsured settled on the basis that it might or might not have been liable to
16
make the payments and therefore that there was as a matter of law no cover under the reinsurance
agreement.
It might be thought that the real effect of the Hiscox reasoning is to negative the second limb in Scor,
for if the reinsured has settled irrespective of actual liability then it has not acted in a bona fide and
businesslike fashion or it has acted ex gratia. However, if this is the case then the claim fails under the
follow the settlements clause itself and there is no need to rely upon the wording of the reinsurance.
This analysis is supported by the decision of the House of Lords in Hill v. Mercantile and General
Reinsurance Co plc. Hill involved fifteen aircraft operated by Kuwait Airways on the ground at Kuwait
airport at the time of the Iraqi invasion in August 1990 and one belonging to British Airways. The
aircraft were seized by Iraq and flown out of Kuwait to Iraq in the days that followed, but eight were
later recovered. The remaining aircraft were destroyed in February 1991 in the course of the Gulf War.
The aircraft were insured during 1990 by a local insurer, KI, which had reinsured through a series of
transactions in the ‘LMX spiral’, at Lloyd’s with a group represented by the claimant. The claimant had
in turn retroceded liability to the defendant retrocessionnaires. The retrocession agreement bound the
defendant to follow settlements provided that they were ‘within the terms and conditions of the original
policies . . . and within the terms and conditions of this reinsurance’. KI, under the direction of the
reinsurers by virtue of a claims control clause, accepted liability on a provisional basis for up to $300
million to Kuwait Airways on the basis that there had been one loss which occurred in 1990 and that all
the losses formed part of one occurrence. The defendants denied liability, asserting that the six Kuwaiti
aircraft and the BA aircraft were lost in 1991 rather than 1990 and that the loss of each insured aircraft
constituted a single ‘event’ within the terms of the retrocession, thereby preventing the losses being
aggregated into a single claim. The claimant responded by seeking summary declaratory judgment
against the defendant. The question was whether the defendants had an arguable defence.
At the initial hearing in Hill, Rix J, adopting the two-limb approach of Scor, held that the reinsurers had
arguable defences as a matter of law, affecting the scope and meaning of the retrocession agreement.
These related to the period covered by the retrocession and to the meaning of the word ‘event’ as an
aggregating factor. Rix J further held that the follow the settlements clause used in the retrocession was
not unqualified but was subject to two provisos requiring losses to be within the terms of both contracts
— and that it was arguable that those provisos took the case outside the ordinary application of Scor. In
the light of arguable defences, Rix J refused summary judgment. It might be added that Rix J found a
further arguable defence in the fact that the follow the settlements clause referred to settlements,
whereas Rix J took the view that the provisional acceptance of liability by KAC’s direct insurers did
not amount to a settlement as such but merely a step in the acceptance of liability. This point was
ultimately dismissed by the House of Lords in Hill, as the settlement referred to in the follow the
settlements clause was held to be that between the claimant retrocedant and its reinsureds, but the point
made by Rix J — that there must be a proven settlement and not some other form of acceptance of
liability — was confirmed, and indeed ambiguity as to the basis of the plaintiff’s acceptance of liability
to his policyholders was held by the House of Lords to preclude the operation of the follow the
settlements clause.
The Court of Appeal overturned the decision of Rix J and held that summary judgment could be given
in favour of the claimant. The Court of Appeal held that where a claim on its face fell within the cover
granted by the reinsurance the reinsurer is not permitted to challenge a bona fide and business-like
decision by the reinsured to settle the claim. This reasoning in effect disposed of the second limb in
Scor, and allowed a reinsured under a follow the settlements clause to determine both the facts giving
rise to the claim and the proper construction of the reinsurance cover. The Court of Appeal further held
that the express wording of the treaty — restricting the defendants’ liability to follow only those
settlements ‘within the terms and conditions of the original policies . . . and within the terms and
conditions of this reinsurance’ — merely codified Scor and required the reinsurers to accept bona fide
and businesslike judgments by the reinsured both as to the facts giving rise to the claim and the proper
construction of the policy under which the claim arises.
It will be seen that the analysis of the Court of Appeal in Hill effectively disposes of the second limb of
Scor where the reinsurance and the insurance are in the same terms: all that matters on this approach is
that the reinsured has settled with the assured in a bona fide and businesslike fashion. The approach has
been applied in other cases. In Axa Reinsurance (UK) Ltd v. Field, the Court of Appeal agreed with the
leading judgment of Hirst LJ in Hill, although in Axa the point did not arise as such. Again, in Baker v.
Black Sea and Baltic General Insurance Co [1995] LRLR 261 Potter J held that the reinsurer was
17
bound to follow the reinsured’s settlements to the effect that liability for the use of ‘Agent Orange’ was
not excluded from the underlying insurance under a war risks clause. The settlements were based on
detailed legal advice from US lawyers and Potter J held that, as the settlements had been reached in a
bona fide and businesslike fashion and, as the reinsurance incorporated the terms of the direct policy,
the reinsured’s acceptance of liability was binding on the reinsurer and again the second limb of Scor
had no independent effect.
The appeal in Hill to the House of Lords, which it was hoped would provide definitive guidelines on
the meaning of the second limb in Scor, proved to be disappointingly inconclusive. The House of Lords
overturned the Court of Appeal’s summary judgment, and held that there were arguable defences open
to the defendants which could be resolved only by a full trial; and it was uncertain whether there had
been a settlement within the follow the settlements clause as between the plaintiff and its reinsureds as
there was inadequate evidence of the manner in which the claimant had accepted liability. These
findings would have been enough to dispose of the matter, but the House of Lords — in a speech
delivered by Lord Mustill with which the remainder of their Lordships agreed — chose to make some
general observations on the principles which underlie the construction of a follow the settlements
clause.
Lord Mustill’s initial proposition was that there were no real issues of principle involved, and that two
obvious rules applied.
(1)
(2)
‘The reinsurer cannot be held liable unless the loss falls within the cover of the policy
reinsured and then within the cover created by the reinsurance’.
‘The parties are free to agree on ways of proving whether these requirements are
satisfied’. In every case it was a matter of construing the words of the follow the
settlements clause to determine how the parties had chosen to compromise their
respective interests, namely, that of the reinsured in avoiding a second investigation
by the reinsurer of the circumstances of the loss; and that of the reinsurer in ensuring
that the integrity of the reinsurance agreement is not overriden by a settlement over
which the reinsurer has no control.
Lord Mustill pointed out that the problems arose out of the efforts of the market to strike a balance
between the conflicting practical demands which were inherent in the different forms of reinsurance. In
this connection Lord Mustill drew a distinction between reinsurance, whereby the reinsured and
reinsurer are what he termed ‘co-adventurers’, and other forms of reinsurance. Into the category of ‘coadventure’ Lord Mustill placed ‘participatory’ (presumably, proportional) reinsurance, and facultative
reinsurance where the reinsured bears a large retention: in these cases it would appear that a settlement
reached in a bona fide and businesslike fashion by the reinsured binds the reinsurer both as regards the
factual basis of the settlement and as regards the meaning of a reinsurance agreement where the
reinsurance is on the same terms as the direct contract.
Lord Mustill instanced two other situations which gave rise to greater problems.
(1)
(2)
Cases in which the terms of the successive policies are not the same, as here there are
deliberate differences in the terms of cover and the parties must be assumed to have
intended that the determination of issues under the direct policy is to have no
necessary impact on the issues to be resolved under the reinsurance.
Cases in which retrocession is involved, so that there is at least one interposing
transaction between the retrocessionaire and the direct assured which would, in the
case of an unqualified follow the settlements clause, result in the retrocessionaire’s
liabilities being entrusted to a stranger.
An attempt to rationalise the various authorities on the scope of the second limb in Scor when the
insurance and reinsurance are back to back was made in Assicurazioni Generali SpA v CGU General
Insurance plc [2004] Lloyd’s Rep IR 457. The claimant was the 100 per cent reinsurer under a quota
share agreement of a Canadian fronting company, CIC, which had insured Pirelli against the loss of or
damage to three single armoured high density submarine power cables. The claimant retroceded 80 per
cent of its liability to the defendants under an open cover, on the following terms:
18
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.
Including deviation and/or change of voyage and/or extension of the original policy, as
original.
One of the cables suffered a loss and Pirelli’s claim was settled, in effect directly by the claimant. The
defendants refused an indemnity, arguing that CIC had various defences under the policy against Pirelli
which had not been raised, including the number of losses, failure to apply adequate safety design
criteria and bad workmanship. The claimant brought the present action for summary judgment. The
claimant put forward three possible constructions of the reinsuring clause, in descending order of
generosity to the claimant:
(1)
(2)
(3)
the defendants were obliged to provide an indemnity for any settlement entered into
by the claimant other than an ex gratia or without prejudice settlement or a settlement
made in bad faith, so that the matching insuring terms of the retrocession were
automatically satisfied;
the defendants were bound to all settlements made by the claimant, other than ex
gratia and without prejudice settlements, so long as the claim “as recognised” by the
claimant prima facie fell within the risks covered by the reinsurance as a matter of
law and so long as the settlement was made other than in bad faith – under this
formulation, as opposed to formulation (1), it was incumbent on the claimant to
demonstrate the basis on which the claim had been settled;
the defendants were bound to follow to all settlements made by the claimant so long
as: (a) the basis on which the claim was recognised by the claimant fell within the
risks covered by the reinsurance as a matter of law; and (b) in settling the claim, the
claimant acted honestly and took all proper and businesslike steps in making the
settlement.
The defendants’ asserted construction of the clause was that they could not be liable unless: (a) the
losses fell within the direct cover as a matter of law and the defendant acted in a bona fide and
businesslike fashion in reaching a settlement; and (b) the losses fell within the terms of the retrocession
as a matter of law. This argument sought to treat the follow the settlements clause as one which under
the first limb of Scor bound the defendants to follow the claimant’s factual findings if they were
reached in a bona fide and businesslike fashion, thereby leaving it open to the defendants to rely upon
the proper interpretation of the policy and other legal defences under the second limb of Scor.
The trial judge held, following the judgment of Evans J in Hiscox v Outhwaite (No 3), that the correct
approach was the third alternative put forward by the claimant and that the claimant was entitled to
summary judgment. Possibility (1) was rejected as it would deprive the defendants of their right to
require the claimant to establish that the claim was settled within the terms of the direct cover and to
require the claimant to settle in a bona fide and businesslike fashion. Possibility (2) similarly did away
with the protection given to the defendants that the claimant had acted in a bona fide and businesslike
fashion. The defendants’ submission was inconsistent with Scor as it required the claimant to show
actual liability to the original assured. Possibility (3) was, therefore, the correct approach.
The judge proceeded to analyse how possibility (3) operated. The first limb in Scor was satisfied as
long as the reinsured had acted in a bona fide and businesslike fashion in treating the claim as falling
within the scope of the direct policy and had not settled either ex gratia or without prejudice. The
second limb in Scor was automatically satisfied where the basis on which the reinsured had settled the
claim was within the coverage of the direct policy. It was not, for this reason, open to the defendants to
reopen, under the second limb of Scor, the correct construction of the policy or the existence of any
possible defences which may have been open to the claimant under the direct cover. The key question
was, therefore, ascertaining the legal basis on which the claim had been settled by the claimant. The
court noted that this did not necessarily equate to the basis upon which the original assured had
submitted a claim, and that what was required instead was for the claimant to show that “the
identification of the loss, the circumstances in which it came to occur, the causes of it, whether and
how particular terms of the contract of insurance which could impact upon its recoverability” had all
formed a part of the decision-making process leading to the claimant’s conclusion that the loss was
19
covered by the direct policy. If this was the case, then the loss as presented to the claimant was within
the scope of the direct policy and thus was also within the scope of the reinsurance or retrocession.
The judge accepted that this interpretation compromised the independence of the retrocession where
the retrocession and the reinsurance were back to back, as the coverage of the retrocession was as a
matter of law determined by the manner in which the reinsurer settled the claim. However, there were
circumstances in which the defendants in the present case would be entitled to rely upon their own
wording even though there had been a bona fide and businesslike fashion. This would arise, for
example, where the claimant had waived valid contractual or extra-contractual defences, or where – as
in Hiscox v Outhwaite (No 3) – the reinsured had chosen to treat payments as falling within the direct
cover even though they were not covered as a matter of law. However, as long as the claimant had
acted in a bona fide and businesslike fashion, and not ex gratia, in treating the claim as one which was
covered by the direct policy, then the defendants were unable to rely upon the wording of the
retrocession to reopen the basis on which the claim had been settled. Gavin Kealey QC supported this
interpretation by commenting that that if the defendants were able to reopen the same issues of
coverage as a matter of law under the retrocession as had been resolved by the claimant, the principle
of back to back cover and the unqualified obligation to follow settlements would be undermined
The Court of Appeal upheld the first instance judgment but its analysis was somewhat briefer. Tuckey
L.J., delivering the leading judgment more or less adopted the analysis of Evans J in Hiscox v
Outhwaite (No 3) and confirmed that it was always open to the reinsurer to raise issues as to the scope
of the reinsurance contract whether or not the terms of the direct policy and the reinsurance were the
same. The second limb of the Scor test was nevertheless satisfied where the claim as recognised by the
reinsured actually or arguably fell within the scope of the reinsurance: this analysis precluded the
reinsurer from demanding proof that the assured’s claim fell within the scope of the direct policy (as it
was the duty of the reinsured only to act in a bona fide and businesslike fashion in that regard) but
nevertheless gave substance to the second limb in Scor.
Qualified follow the settlements clauses
The settlements clause in Hill was qualified by two distinct provisos. The defendants were obliged to
follow the claimant’s settlements provided that such settlements were:
(a)
(b)
‘within the terms and conditions of the original policies’; and
‘within the terms and conditions of this reinsurance’.
Rix J at first instance in Hill held that these provisos raised difficult questions of law as to the scope of
the follow the settlements clause. In particular, Rix J held that the first proviso might arguably have the
effect of requiring the claimant to demonstrate that any settlement with his reinsureds as a matter of
law fell within the wording of the original policies. Rix J recognised that this interpretation might have
the effect of emasculating the basic tenet of the follow the settlements clause, but further held that such
an interpretation could not be dismissed out of hand. It was also commented above that the Court of
Appeal rejected Rix J’s approach, and held that the provisos were merely declaratory of the follow the
settlements clause and did not impose any qualifications on it.
Lord Mustill noted that each of the provisos commenced with the words ‘within the terms and
conditions of’ and was of the view that this phrase drew a distinction between, on one hand, the facts
giving rise to the claims, and, on the other hand, the proper construction of the contracts, and that the
provisos referred only to the latter. Thus, even if the claims against the plaintiff were ‘soundly based on
the facts’ (i.e. genuine losses not tainted by fraud), the provisos prevented the plaintiff from treating
those losses as falling within the insurance or reinsurance unless those contracts on their proper
construction covered the losses. In Lord Mustill’s words:
To allow even an honest and conscientious appraisal of the legal implications of the facts
embodied in an agreement between the parties down the chain to impose on the reinsurers
risks beyond those which they have undertaken and those which the reinsured have
undertaken would effectively rewrite the [contracts]: and it is this, in my opinion, which the
provisos are designed to forestall.
20
Lord Mustill, unlike Rix J, felt that this interpretation did not mean that the provisos emasculated the
follow the settlements clause, as that clause was still effective to require the defendants to follow the
plaintiff’s settlements insofar as they were within the two contracts. Lord Mustill did nevertheless
recognise that this construction would give rise to great inconvenience and uncertainty in the context of
the LMX spiral, given that the contracts under dispute were at the head of the spiral, but his response
was that this was the natural result of the wording used.
Other forms of wording
The inclusion of additional wording may give rise to complications. In Charman v Guardian Royal
Exchange Assurance plc [1992] 2 Lloyd’s Rep. 607 Lloyd’s underwriters represented by C had
provided direct business interruption cover to an American oil refinery company, and had reinsured
with GRE under a facultative agreement. The slip policy provided that GRE would “follow the
settlements” of the underwriters “whether liable or not liable”. A settlement was agreed between the
underwriters and the assured, which GRE disputed on the ground that it had not been reached bona fide
and in a businesslike fashion. Webster J. rejected GRE’s argu ment on this matter, and held that the
underwriters were entitled to recover. One point raised in the proceedings was whether the words
“whether liable or not liable” made any difference to GRE’s obligation to follow settle ments. The
underwriters claimed that the additional words removed any possible defence which GRE might have,
and that their intention was to confer absolute liability upon GRE whatever the nature of the underwri
ters’ settlement with the assured. Webster J. held that this was not the case and that the words “whether
liable or not liable” were simply declaratory of the position established by Scor. The same approach
was adopted by Evans J in Hiscox v Outhwaite (No 3) [1991] 2 Lloyd's Rep 524 in which the clause
rendered settlements “in every respect . . . unconditionally binding”, but this was held not to affect the
operation of the Scor test in the usual way.
In Assicurazioni Generali SpA v CGU General Insurance plc [2003] Lloyd’s Rep IR 737 the obligation
on retrocessionaires was “to follow without question the settlements of the [reinsured] except ex-gratia
and/or without prejudice settlements.” It was argued by the claimant retrocedant that the words
“without question” removed from the retrocedant the obligation to act in a bona fide and businesslike
fashion and bound the retrocessionaires to follow any settle ment which was presented to them. Deputy
High Court Judge Gavin Kealey Q.C. disagreed, and held that words were devoid of any effect.
“The words without question’ do not describe or qualify what the Defendants have agreed to
follow, namely Generali’s settlements, but rather how or the manner in which they are
required to follow those settlements . . . I do not consider that the words “without question”
mean that the Defendants have agreed to relieve Generali of its important implied obligation
in relation to any compromise of liab ility or amount to take all proper and businesslike steps
in making the settlement. On the contrary, in circumstances where, as I find, the Defendants
have so significantly entrusted their interests to Generali, the implied obligation assumes an
even greater significance than it might otherwise possess. If the Defendants were to be
deprived of the protection that it offers, far clearer and more explicit words would be required.
It seems to me that those words were used on the assumption that all such proper and
businesslike steps would be taken.”
The Court of Appeal on appeal upheld the ruling of the trial judge that the words “without question”
added nothing to the clause, and served only to clarify it rather than to alter the rights of the reinsured.
Tuckey LJ did nevertheless accept that clear wording could have the effect of varying the second limb
of Scor so as to impose an obligation on the reinsurers to follow settlements irrespective of the wording
of the reinsurance.
Settlements involving cross-claims
The settlement figure agreed between the reinsured and the assured is often a global one, encompassing
all of the claims by the reinsured against the assured and any claims that the reinsured may have
against the assured, eg, by way of unpaid premium. The question which this scenario may give rise to
is whether the reinsurers are entitled to insist upon some form of allocation of the settlement figure to
21
the various losses and cross-claims. Where a global settlement in respect of all outstanding claims is
reached between the assured and the reinsured – reflecting some losses which are the subject of
reinsurance and others which are not – then the reinsured is entitled to recover on proof that the
settlement was a reasonable one in that did not exceed the reinsured’s liability under the direct policies.
It might be thought that the same principle would apply to the situation in which the settlement is a
compromise of various claims and cross-claims. However, in Lumberman’s Mutual Casualty Co v
Bovis Lend Lease Ltd [2004] EWHC 2197 (Comm) Colman J decided that this is only the case if the
settlement agreement contains a money allocation of the claims and cross-claims. In Lumberman’s,
which involved a liability policy, the assured contractor made a claim against the employer for amounts
owing to it under the contract, totalling just under £38,000,000. The employer counterclaimed for
damages for breach of contract, initially for an amount in excess of £100,000,000 and in the alternative
for about £75,000,000. The parties reached a settlement under which the assured was paid £15,000,000
in full and final settlement. The compromise did not specify how this figure had been reached. The
assured made a claim against its liability insurers for just under £20,000,000, the basis of the claim
being that this figure represented the amount of its liability to the employer (minus the per claim
deductible in the policy). The policy did not contain any follow settlements provision, and the insurers
refused an indemnity. Coverage issues aside, the question for Colman J was whether the assured had
established and quantified its liability to the employer. It was common ground that the settlement was
not of itself binding on the insurers, and that it was necessary – in accordance with the general principle
applicable to liability policies and to reinsurance – for the assured to establish and quantify its loss.
Where the parties differed was that the assured argued that once the settlement had been reached it was
open to the assured to prove its liability at law, whereas the insurers’ argued that a settlement which did
not attempt to quantify the assured’s liability was not a sufficient trigger of potential liability under a
liability policy. Colman J agreed with the insurers. In his view the settlement had not established and
quantified the assured’s liability at all, but merely identified the overall price which the assured had
paid as consideration for a contract which settled the outstanding dispute between the parties. Colman J
envisaged a two-stage process: (a) the establishment and quantification of the assured’s liability by
judgment, arbitration award or settlement; and (b) proof of the insurers’ liability, which was automatic
in the case of a judgment or award but required eveidence of liability at law in the case of a settlement.
In the present case Colman J’s view was that the assured failed at step (a), and that a settlement which
did not specify the amount of the assured’s liability was not one which could be said to establish or
quantify liability. Accordingly, it was simply not open to the assured to proceed to step (b) and to show
that there was as a matter of law liability to the employer in any given amount.
It might be argued that this approach is both uncommercial and technical. Where there are cross-claims
between the parties, it is usual for a global settlement to be reached without any admission of liability
on either side and without any attempt to allocate sums to the various claims which have been
compromised. Requiring an assured to identify in the settlement the amounts for which liability has
been accepted is likely to militate against a settlement being reached in the first place and is contrary to
commercial practice. Further, it seems strange that the assured’s failure to take the technical step of
seeking to have sums written into the settlement should have the draconian consequence of preventing
the assured from even attempting to prove its loss as a matter of law. Any figure would have to be
justified as a matter of law, so it is difficult to see why the absence of such a figure should have any
major significance. Although the decision is one based on direct insurance, it is plainly very relevant to
reinsurance as well, and creates a serious difficulty for a reinsured. This is obviously so where the
reinsurance does not contain a follow the settlements clause, but may be equally problematic where the
contract does contain such a clause, as the logic of the reasoning is that a settlement of this type does
not amount to the establishment and quantification of the reinsured’s loss. Accordingly, there is
nothing upon which the follow the settlements clause can bite. There is authority for the proposition
that an assured who makes a payment in order to prevent a dispute from arising cannot seek
indemnification from his liability insurers (see Corbin v Payne 1990, unreported) but it could be argued
that the situation in Lumberman’s is quite different, in that there is a claim against the assured but it has
simply been settled for an undetermined amount.
E: INSURABLE INTEREST AND P&I CLUBS
Insurable interest in general
22
The requirement for a contract of insurance to be supported by insurable interest has been a feature of
English law since the eighteenth century, and was originally devised primarily to limit the use of
insurance policies as a form of wagering on property or lives and to remove the danger that persons
holding policies would attempt the deliberate destruction of the insured subject matter. The earliest
legislation was the Marine Insurance Act 1745 which banned the making of marine insurance policies
unless the assured had an interest in the subject matter, and the prohibition was extended to life and
related policies by the Life Assurance Act 1774.
The modern law on insurable interest is found in a complex combination of common law and statutory
principles, which may be outlined in the following way.
Life policies are governed by the Life Assurance Act 1774. This legislation, as construed by
the courts, provides that
(a)
(b)
(c)
the assured must have an insurable interest in the life of the insured person at the date
the policy is taken out, failing which the policy is illegal (section 1), although there is
no need for the assured to possess an insurable interest at the date of the death of the
insured person as the contract is not one of indemnity but rather is in the form of an
investment;
the assured can recover under the policy only the amount of his interest as measured
at the inception of the policy (section 3);
the names of all persons interested in the policy must be inserted at the outset
(section 2), although this requirement was relaxed by section 50 of the Insurance
Companies Act 1973, which deems this requirement to be satisfied where a
beneficiary belongs to a class of persons identified in the policy.
Marine policies are governed by the Marine Insurance Act 1906. This provides that
(a)
(b)
the assured must have either an actual insurable interest, or the reasonable
expectation of obtaining an insurable interest, when the policy is taken out, failing
which the policy is deemed to be made by way of gaming or wagering and is void
(section 4);
the assured must be interested in the subject matter insured at the time of the
occurrence of the insured peril (section 6) – if he has no interest at the date of the
loss, then the common law principle of indemnity reflected in section 6 means that he
has no right of recovery.
Other policies, including property and liability covers are not governed by any specific
statute, but the principles are much as for marine insurance
(a)
(b)
section 18 of the Gaming Act 1845 renders unenforceable contracts made by way of
gaming or wagering, and an insurance policy taken out by a person who has no actual
insurable interest and no reasonable expectation of obtaining such an interest will
contravene this legislation;
the assured must be interest in the subject matter insured at the time of the occurrence
of the insured peril, as the common law principle of indemnity permits the assured to
recover only the amount of his actual loss.
Definition of insurable interest
Section 5(2) of the Marine Insurance Act 1906, which is based on the judgment of Lawrence J in
Lucena v Craufurd (1806) 2 Bos & PNR 269, defines insurable interest as
any legal or equitable relation to … any insurable property at risk … in consequence of which
[the assured] may benefit by the safety or due arrival of the insurable property, or may be
prejudiced by its loss, or by damage thereto, or by the detention thereof, or may incur liability
in respect thereof.
23
The most recent authorities have recognised that modern market developments in the forms of
insurance agreements have required a wider approach to the definition of insurable interest than was at
one time thought necessary. The modern approach is set out by the Court of Appeal in Feasey v Sun
Life Insurance of Canada [2003] Lloyd’s Rep IR 637, where it was emphasised that if the parties have
entered into a commercial arrangement there is every reason to seek to support that arrangement and
not to strike it down on technical grounds. The judgment of Waller LJ in Feasey indicates that three
questions have to be asked where an insurable interest issue is raised:
(1)
(2)
(3)
What is the subject matter of the insurance policy. This question involves interpreting
the policy to see exactly what has been insured.
What is the interest of the assured in the subject matter of the policy. This question is
a matter of law, and involves the court considering the range of possible interests that
the assured may have in the insured subject matter.
Does the policy encompass the assured’s insurable interest. This question again
involves the proper construction of the policy, the issue being whether the policy by
its terms actually covers the insurable interest of the assured in the insured subject
matter or whether it refers to some other interest.
There are numerous illustrations of insurable interest in the cases. The mere fact that that the assured is
not wagering is not determinative of the question, although it is an important consideration in
determining the existence of insurable interest.
As far as property is concerned, any interest in that property will give rise to an insurable interest. Such
interests may include ownership, possession or security. A person who has agreed to purchase property
also has an insurable interest in that property. It follows, therefore, that a limited interest is insurable,
and that there may be a variety of different interests in the same property. Feasey itself recognised that
a person may have insurable interest in property if he stands to suffer a loss in the event that the
property is destroyed (eg, where the assured is a contractor who has been engaged to carry out work on
that property). A person who faces liability in the event that property is lost or damaged as a result of
his negligence plainly has an insurable interest for the purposes of a liability policy, and he may also
have sufficient insurable interest to support a policy on the property itself, although under the third
principle in Feasey it is a matter of a construction of the policy to determine whether it covers liability
for property.
As far as lives are concerned, it is presumed that a person has an unlimited insurable interest in his or
her own life and that of his or her spouse, although other family relationships and friendships do not
give rise to an insurable interest unless the policy holder can demonstrate some actual financial interest
in the life of the person insured. Commercial relationships can give rise to insurable interest in lives,
eg, a creditor has an insurable interest in the life of his debtor, an employee has an interest in the life of
his employer and an employer has an insurable interest in the life of his employee. A person who faces
liability for the death or personal injury of an individual can insure his liability under an ordinary
liability policy, but in some circumstances it may be possible for that person to insure the life of the
individual in question: this matter was considered in the Feasey case, discussed in detail in the next
section.
Where different interests are insured under a single policy, that policy is regarded as composite with
the result that each assured has a separate contract with the insurers in respect of his own interest. The
separability of interests means that in the event of a loss, each assured has a separate claim against the
insurers. The separability principle means that insurers may have defences against some assureds (eg,
for breach of policy terms) but not others.
Insurable interest under reinsurance contracts
Reinsurance agreements are contracts of indemnity, and it follows that the reinsured must have an
insurable interest to support the reinsurance. In the vast majority of cases the reinsured’s insurable
interest will be in the liability which the reinsured faces to its direct assureds under the contracts issued
to them. This appears to be the effect of section 9(1) of the Marine Insurance Act 1906:
24
The insurer under a contract of marine insurance has an insurable interest in his risk, and my
reinsure in respect of it.
Reinsurance contracts are, therefore, typically drafted in terms of cover in respect of the liability of the
reinsured. Some reinsurance agreements require the reinsured to have made payment to the assured
before any claim can be made against the reinsurers, but even where this is the case the essential point
remains that it is the potential liability of the reinsured to make payment in the event of a claim by the
assured which gives the reinsured its insurable interest.
Although it is usual for reinsurance agreements to be expressed in terms of liability to pay, there is in
principle no reason why a reinsurance agreement should not be framed as a contract for payment on the
occurrence of an event which causes the loss of or damage to the subject matter insured under the
direct policy. This proposition has indirect support from the construction cases in which the courts
have held that a contractor has, under a property policy on the building works, an insurable interest in
the works by reason of his potential liability for the works in the event that his negligence causes loss
or alternatively, an insurable interest in his own personal loss in the event that he is no longer able to
perform his contract following loss of or damage to the works (National Oilwell (UK) Ltd v Davy
Offshore Ltd [1993] 2 Lloyd’s Rep 582; Deepak Fertilisers v ICI Chemicals [1999] 1 Lloyd's Rep
387). The Court of Appeal confirmed this analysis in the Feasey case.
In Feasey v Sun Life Insurance of Canada [2003] Lloyd’s Rep IR 637, in 1994 Syndicate 957 at
Lloyd’s had reinsured a P&I Club, Steamship Mutual, against exposure to its shipowner members for
their liability for personal injury or death in relation to vessels entered with Steamship. In September
1994 Lloyd’s announced changes to its risk codes for the 1995 year of account, the effect of which was
that, for the purposes of reinsurance, bodily injury and illness-related elements in liability policies
could no longer be classified as personal accident insurance but were classified as long-tail liability
cover for which substantial reserves were to be held. Personal accident cover was to be treated as
short-tail only if payments were on a fixed benefit basis, the amount payable was dependent only upon
the degree of injury or illness sustained and the amount could be assessed within a reasonable time.
This change in the risk codes prompted Syndicate 957 and brokers acting for Steamship to devise a
personal accident reinsurance scheme, under which Syndicate would pay fixed benefits within 30 days
of the Steamship producing documentary evidence of the death of, or injury to, any employee or person
on board a shipowner’s vessel: proof of Steamship’s liability to indemnify the shipowner was not
required. This structure enabled the business to be classified as personal accident cover for the
purposes of Lloyd’s risk codes. Although the reinsurance was not expressed to be in terms of
Steamship’s liability to its members, the payments were calculated in a manner which meant that, over
a period of time the sums paid out by Steamship would be more or less equal to the sums received by
Steamship from the Syndicate. In the event, there was a shortfall and Steamship obtained top up
reinsurance from another source. The Syndicate retroceded its liability to the defendant insurers.
Disputes arose, and the defendants denied liability to the Syndicate. One of the arguments raised by the
defendants was that the reinsurance issued by the Syndicate to the Steamship was a personal accident
policy on the life or lives of employees of Steamship’s members, and thus caught by the Life
Assurance Act 1774, but that Steamship had no insurable interest in the lives of those individuals. It
was not disputed that, had the reinsurance been in traditional liability form, Steamship would clearly
have had an insurable interest in its own liability.
The Court of Appeal (Waller and Dyson LJJ, Ward LJ dissenting), held that that the Syndicate had the
necessary insurable interest and that the insurable interest was covered by the reinsurance.
(1) It was unattractive for a court to refuse to give effect to a commercial contract.
(2) The policy fell within the Life Assurance Act 1774 as it was a policy whose subject matter
was lives. While it was clear that Steamship was not wagering, that was not of itself enough to
satisfy the Life Assurance Act 1774: it remained necessary to show that Steamship possessed
an insurable interest.
(3) Steamship had an insurable interest in its liability to its members. However, the existence
of that class of insurable interest did not preclude other forms of insurable interest. While it
was arguably the case that an insurer might not for reinsurance purposes have insurable
interest in the life of a specific individual insured by the insurer, the position was different
where the policy dealt with many lives and over a substantial period, and this was a pecuniary
interest in lives which satisfied the 1774 Act. The necessary insurable interest to support the
25
reinsurance was thus in place independently of any insurable interest that Steamship had in its
own liability.
(4) The fact that Steamship might have reinsured under an ordinary liability policy did not
mean that reinsurance in a different form was not legitimate. The object of the policy was to
cover Steamship for the losses it would suffer as insurer of its members under its rules, and it
could not be said that the subject matter of the reinsurance was so specific as to preclude
Steamship from reinsuring its pecuniary interest in lives
(5) The reinsurance was not defeated by section 3 of the 1774 Act, which holds an assured to
recovering the amount of its interest measured at the date of the policy. It was clear that the
sums which Steamship might have to pay were in excess of the amount of the reinsurance, and
thus it could not be said that Steamship was seeking to recover an amount in excess of its own
actual payments to its members.
The Feasey case shows that, while the insurable interest of a reinsured is generally to be regarded as its
potential liability to its direct policy holders, it is perfectly possible to draft a reinsurance as a further
policy on the original subject matter. If this is the case, the reinsured must possess an insurable interest
which complies with the rules applicable to the insured subject matter. This point is also apparent from
Re London County Commercial Reinsurance Office [1922] 2 Ch 67. This case concerned the
admissibility of claims in the winding up of a reinsurance company. The reinsurer had, to match the
direct cover, issued a reinsurance contract on a marine insurance form to provide payment to the
reinsured “in the event of peace not being declared between Great Britain and Germany on or before 31
March, 1918.” The policy was stated to be an honour policy and that the insurers would pay on the
basis of policy proof of interest (ppi), so that payment was to be made interest or no interest. The issue
was whether the reinsurance was valid under the insurable interest rules. Lawrence J held that the
reinsurance was unlawful and that proof of a claim under it was not to be admitted.
(1) Although the direct policy was stated to be a marine policy, it was not an insurance on a
marine adventure as required by section 1 of the Marine Insurance Act 1906 and thus was not
governed by that legislation.
(2) The direct policy was one on events and thus fell within section 1 of the Life Assurance
Act 1774.
(3) The direct policy was illegal under the 1774 Act as the original assured had no insurable
interest in a declaration of peace. The fact that the policy was an honour policy did not affect
the position under the 1774 Act, as the assured either had an interest or he did not have an
interest.
(4) As it had been established that the original insurance was illegal, it followed that the
reinsurance was tainted with the same illegality and was itself illegal and void.
F: THIRD PARTY CLAIMS AGAINST P&I CLUBS
Third Parties (Rights against Insurers) Act 1930: background
The Third Parties (Rights against Insurers) Act 1930 was originally passed to supplement the
introduction of compulsory motor insurance by the Road Traffic Act 1930, and confers on a third party
a right of action against the liability insurers of an assured who is unable to satisfy a judgment in favour
of the third party. The intended scheme in 1930 was that the victim of a negligent driver could obtain a
judgment against the motorist and then enforce it against the insurers following the driver’s insolvency.
This measure was found to be necessary following two first instance decisions, Hood’s Trustees v
Southern Union General Insurance Co of Australasia [1928] Ch 793 and Re Harrington Motor Co
[1928] Ch 105, in each of which it was held that the proceeds of an insurance policy payable to an
insolvent assured in respect liability to a third party formed a part of the assured’s general assets for
distribution to all unsecured creditors and not just to the third party. The Road Traffic Act 1934
subsequently conferred a direct cause of action in favour of the third party against the motor insurers of
a negligent driver whether or not the driver was insolvent (this still exists, in section 151 of the Road
Traffic Act 1988, discussed above), and the Third Parties (Rights against Insurers) Act 1930 ceased to
26
be relevant to motor claims. That Act was not, however, repealed, and is now widely used in all forms
of liability insurance as a method of enforcing a judgment against an assured who does not have the
assets to meet the judgment himself.
Section 1 of the 1930 Act (as amended) provides as follows.
(1) Where under any contract of insurance a person (hereinafter referred to as the insured) is
insured against liabilities to third parties which he may incur, then-(a)
in the event of the insured becoming bankrupt or making a composition or
arrangement with his creditors; or
(b)
in the case of the insured being a company, in the event of a winding-up
order being made, or a resolution for a voluntary winding-up being passed,
with respect to the company, or of the company entering administration, or
of a receiver or manager of the company's business or undertaking being
duly appointed, or of possession being taken, by or on behalf of the holders
of any debentures secured by a floating charge, of any property comprised
in or subject to the charge or of a voluntary arrangement proposed for the
purposes of Part I of the Insolvency Act 1986 being approved under that
Part;
if, either before or after that event, any such liability as aforesaid is incurred by the insured,
his rights against the insurer under the contract in respect of the liability shall, notwithstanding
anything in any Act or rule of law to the contrary, be transferred to and vest in the third party
to whom the liability was so incurred.
(2) Where the estate of any person falls to be administered in accordance with an order
under section 421 of the Insolvency Act 1986 , then, if any debt provable in bankruptcy (in
Scotland, any claim accepted in the sequestration) is owing by the deceased in respect of a
liability against which he was insured under a contract of insurance as being a liability to a
third party, the deceased debtor's rights against the insurer under the contract in respect of that
liability shall, notwithstanding anything in any such order, be transferred to and vest in the
person to whom the debt is owing.
(3) In so far as any contract of insurance made after the commencement of this Act in
respect of any liability of the insured to third parties purports, whether directly or indirectly, to
avoid the contract or to alter the rights of the parties thereunder upon the happening to the
insured of any of the events specified in paragraph (a) or paragraph (b) of subsection (1) of
this section or upon the estate of any person falling to be administered in accordance with an
order under section 421 of the Insolvency Act 1986 making of an order under section one
hundred and thirty of the Bankruptcy Act 1914, in respect of his estate, the contract shall be of
no effect.
(4) Upon a transfer under subsection (1) or subsection (2) of this section, the insurer shall,
subject to the provisions of section three of this Act, be under the same liability to the third
party as he would have been under to the insured, but—
(a)
if the liability of the insurer to the insured exceeds the liability of the insured
to the third party, nothing in this Act shall affect the rights of the insured
against the insurer in respect of the excess; and
(b)
if the liability of the insurer to the insured is less than the liability of the
insured to the third party, nothing in this Act shall affect the rights of the
third party against the insured in respect of the balance.
(5) For the purposes of this Act, the expression "liabilities to third parties," in relation to a
person insured under any contract of insurance, shall not include any liability of that person in
the capacity of insurer under some other contract of insurance.
(6) This Act shall not apply—
(a)
where a company is wound up voluntarily merely for the purposes of
reconstruction or of amalgamation with another company; or
(b)
to any case to which subsections (1) and (2) of section seven of the
Workmen's Compensation Act 1925, applies.
The Act is silent on its territorial scope, and it is unclear whether its application is based on the contract
of insurance being governed by English law or on the fact that the insolvency proceedings against the
assured were initiated in England: the latter is probably the better view, as the 1930 Act is designed to
form a part of insolvency law.
27
Scope of the 1930 Act
The 1930 Act confers a direct action on the third party against the assured’s insurers where the
following conditions are met.
First, the contract of insurance must be one under which the assured is insured against liabilities,
although subsection 1(5) expressly excludes reinsurance contracts. Accordingly the 1930 Act cannot be
used by an assured to sue the reinsurers of an insolvent insurance company. A policy which covers
negligence liabilities is plainly covered. In Tarbuck v Avon Insurance Co [2002] Lloyd’s Rep IR 393 it
was held that the Act did not apply to a policy covering a liability to pay a contractual debt: in that case
the assured incurred liability to a solicitor for his costs, and it was ruled that the solicitor could not
recover those costs from the assured’s legal expenses insurers. In T&N Ltd v Royal and Sun Alliance
plc [2004] Lloyd’s Rep IR 144 it was held that the Act did not extend to a liability voluntarily
undertaken under contract, in that case the liability of the assured to repay to employers’ liability
insurers a part of the insurance proceeds in the event of a claim made against the assured which was
paid by the insurers (a device which overcame the prohibition on policy excesses in employers’
liability cases, discussed above). These cases were, however, overruled by the Court of Appeal in Re
OT Computers [2004] EWCA Civ 653. Here, the assured was a supplier of computers which offered
extended warranty protection to its customers. A finance company which provided the finance for
consumers to purchase computers was jointly and severally liable to honour the extended warranties.
The supplier became insolvent, and claims were met by the finance company, which thereby became
subrogated to the customers’ claims against the supplier. The finance company sought, invoking the
1930 Act, to recover its payments from the supplier’s liability insurers. The Court of Appeal ruled that
the Act applied to the insurance even though it was designed to protect against contractual obligations
rather than obligations in tort, and the Court of Appeal laid down the principle that the Act covered all
forms of liability, including liabilities voluntarily incurred by the assured under contract, whether by
way of damages or debt.
Secondly, there must have been a relevant insolvency event involving the assured, as set out in section
1(1). That section is extended to limited liability partnerships by section 3A of the 1930 Act, which
provides that references to a resolution for a voluntary winding-up being passed are references to a
determination for a voluntary winding-up being made. The 1930 Act may be used if the assured has
become insolvent before the third party has obtained a judgment against the assured, or if a previously
solvent assured has failed to pay the judgment debt and insolvency proceedings have been taken
against him by the third party
Thirdly, the third party must have established and quantified the assured’s liability by means of
judgment, arbitration award or binding settlement. In the period between the assured’s insolvency and
the establishment and quantification of the assured’s liability, the third party is regarded as having
contingent rights against the insurers. Thus, even though a claim may not be made against the insurers
in this period, the third party is not devoid of rights. In particular, in this period: (a) the third party may
seek a declaration that the policy covers the loss; (b) the third party may seek insurance information
from the assured and from the insurers (see below); and (c) the insurers cannot seek to alter the rights
of the assured under the policy, as this prejudices the contingent rights of the third party (this was so
held in Centre Reinsurance International Co and another v Curzon Insurance Ltd [2004] EWHC 200
(Ch). The right of the third party to make a claim against the insurers does not, however, accrue until
the liability of the assured has been established and quantified. In Post Office v Norwich Union Fire
Insurance Society [1967] 1 All ER 577 employees of the assured negligently damaged the claimant’s
property. The claimant brought immediate proceedings against the assured’s liability insurers for
indemnification. The Court of Appeal held that the action was premature, and that it could not be
brought until the liability of the assured had been established and quantified by the claimant. The Post
Office principle means that it is necessary to sue the assured. In the case of an assured company which
has been removed from the register of companies and which has therefore ceased to have a legal
existence, it will be necessary for the third party to apply to the court under section 651 of the
Companies Act 1985 for the company to be restored to the register of companies so that proceedings
can be brought against it, and the court will reinstate the company unless it is shown that any action
against it is time-barred under the Limitation Act 1980. Section 651 was amended with retrospective
effect by the Companies Act 1989 to modify the then rule in section 651 that a company may be
28
restored only within two years of its dissolution: under the section as amended there is now no time
limit for restoration in the case of personal injury claims, although the two year period remains
applicable in other cases. The amendments to section 651 were the result of the decision of the House
of Lords in Bradley v Eagle Star Insurance Co [1989] 2 WLR 568, in which it was held that a
dissolved company could not be sued and that unless it could be restored to the register the third party
could not establish and quantify its liability so as to facilitate a claim under the 1930 Act against the
company’s liability insurers.
The principle that a claim may be made against the insurers under the 1930 Act as soon as the assured’s
liability is established and quantified is also relevant to the prioritising of claims under the 1930 Act
where there are number of competing claims which are in the aggregate greater than the sums available
under the policy. In Cox v Bankside Members Agency Ltd [1995] 2 Lloyd’s Rep 437 Phillips J held that
the correct approach to prioritisation was “first past the post”, so that the first person to obtain a
quantified judgment against the assured had the first claim on the insurance proceeds under the 1930
Act. Phillips J recognised the arbitrary nature of “first past the post”, but he rejected the alternative
approach based on apportionment which he regarded as both contrary to the principles of the 1930 Act
and likely to give rise to serious delays as no sums could be paid out until all of the claims against the
assured had been processed and resolved. In the event of a shortfall, section 1(4) preserves the right of
the third parties to pursue the assured in the relevant insolvency procedure.
Rights of the third party
Section 1(1) of the 1930 Act states that once the third party has satisfied the requirements of the 1930
Act the rights of the assured 2against the insurer under the contract in respect of the liability shall,
notwithstanding anything in any Act or rule of law to the contrary, be transferred to and vest in the
third party to whom the liability was so incurred.” The effect of the legislation is place the third party
in the shoes of the assured, a process variously described as assignment or subrogation.
The key point is that the third party is to be treated as the assured for the purposes of the insurance
claim. Any defences that the insurers have against the assured will, therefore, be available against the
third party, including in particular: the right to avoid for breach of the duty of utmost good faith; the
right to refuse to pay a claim for breach of policy conditions; and the right to demand payment of the
premium from the third party if it has not been paid by the assured. It also follows that if the insurers
have a valid defence to a claim and indicate to a potential third party claimant that they do not intend to
take the defence against the assured, then there can be no waiver as far as the assured is concerned as
the insurers’ conduct was not addressed to the assured. This was so held in Spriggs v Wessington Court
School Ltd [2004] Lloyd’s Rep IR (forthcoming). The most that the third party can argue is that the
insurers are estopped from denying liability to him, but for this to occur there would have to be reliance
by
the
third
party
on
the
insurers’
conduct.
The extent of this principle can be seen by the decision of the House of Lords in The Fanti and the
Padre Island [1990] 2 All ER 705. This case concerned a “pay to be paid” clause, under which it was a
precondition to the insurers’ liability to indemnify the assured that the assured had made payment to
the third party. Plainly, this type of clause operates to negative the 1930 Act: if the assured has paid,
then there is no need for the third party to use the 1930 Act, but if the assured has not paid then the
third party is precluded from using it. The House of Lords nevertheless maintained the principle that
the third party cannot be in any better position than the assured and that the third party could not rely
on the 1930 Act. It would seem that this type of clause is only used in marine liability policies issued
by P&I Clubs, and in any event is not relied upon in practice in respect of personal injury liability
claims but only in respect of cargo liability claims.
The only possible modification of the insurers’ rights arises where the assured has incurred liability in a
manner which precludes recovery under the rules of public policy, eg, because the assured’s act was
deliberate or because the claim can only be made out by reliance on criminality. It was suggested by
Mance Jin Total Graphics Ltd v AGF Insurance Ltd [1997] 1 Lloyd’s Rep 599 that a public policy
defence is merely a personal bar to recovery on the part of the assured, and that the third party can still
avail himself of the 1930 Act as long as he is not a party to the deliberate or illegal act.
29
In bringing proceedings against the insurers, the third party is subject to the same limitation period as
that applicable to claims by the assured, eg, six years from the date on which the assured’s liability has
been established and quantified. Time does not run from the date of the assured’s insolvency even
though that date is the trigger for the actual or potential application of the 1930 Act. The main danger
faced by the third party is that, having established and quantified the assured’s liability, he awaits the
outcome of proceedings on the policy brought by the assured against the insurers. In the event that
those proceedings drag on without conclusion for longer than six years after the judgment against the
assured, and the assured then becomes insolvent, it will no longer be possible for the third party to
make a claim against the insurers: the six-year time limit will have expired, and the third party is not
entitled to take over the existing action brought by the assured against the insurers as he is not a party
to it. This was so held in Lefevre v White [1990] 1 Lloyd’s Rep 569. This type of problem does not
arise if the assured has become insolvent before or soon after his liability has been established and
quantified, as the third party then has plenty of time to bring an action against the insurers. The solution
for the third party is, having obtained his judgment, to seek to enforce it and to initiate immediate
bankruptcy proceedings against the assured in the event that it is not satisfied, thereby triggering his
right to sue the insurers under the 1930 Act.
It is not possible for the insurers to rely upon policy terms which, in the words of section 1(3) purport
“whether directly or indirectly, to avoid the contract or to alter the rights of the parties” on the
happening of an insolvency event. The prohibition applies only where the legal rights of the assured
have been altered by reason of his insolvency: a policy term which applies whether or not the assured
has become insolvent, but only has practical consequences in the event of insolvency, is not outlawed
by section 1(3). In The Fanti and the Padre Island [1990] 2 All ER 705 a “pay to be paid clause” was
held not to contravene section 1(3), because under the clause the assured was required to make
payment to the third party as a condition of being indemnified in all cases: the fact that the clause was
only of practical significance where the assured was insolvent and could not afford to pay the third
party, so that he would lose his indemnity, was regarded not as a variation of his contractual rights. Not
every term which applies only on insolvency can be regarded as producing a variation in the assured’s
rights. In Centre Reinsurance International Co and another v Curzon Insurance Ltd [2004] EWHC 200
(Ch) an employers’ liability policy contained a claims control clause which stated that on the assured’s
insolvency the insurers were to have the absolute right to control any claims against the assured. This
was held by Blackburne J not to be a term falling within section 1(3), because the right of the third
party to make a claim against the assured could not be said to have been prejudiced by the transfer of
control.
In much the same way, there are restrictions on the ability of the assured and the insurers to enter into
an agreement which prejudices the third party’s rights. Section 3 provides as follows:
Where the insured has become bankrupt or where in the case of the insured being a
company, a winding-up order or an administration order has been made or a resolution for a
voluntary winding-up has been passed, with respect to the company, no agreement made
between the insurer and the insured after liability has been incurred to a third party and after
the commencement of the bankruptcy or winding-up or the day of the making of the
administration order, as the case may be, nor any waiver, assignment, or other disposition
made by, or payment made to the insured after the commencement or day aforesaid shall be
effective to defeat or affect the rights transferred to the third party under this Act, but those
rights shall be the same as if no such agreement, waiver, assignment, disposition or payment
had been made.
Section 3 applies only to an agreement made after the assured’s insolvency: a settlement between the
assured and the insurers prior to insolvency is not precluded (so held in Normid Housing Association
Ltd v Ralphs [1989] 1 Lloyd’s Rep 265 even though it may have serious adverse consequences for the
third party’s ultimate right to enforce any judgment obtained against the assured.
Provision of information
Section 2 of the 1930 Act confers upon the third party the right to obtain information as to the assured’s
insurance position. Armed with that information, the third party can make a decision as to whether or
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not it is likely that any judgment which may be obtained against the assured will be covered by a
liability policy. Section 2 in its amended form is as follows:
(1) In the event of any person becoming bankrupt or making a composition or arrangement
with his creditors, or in the event of the estate of any person falling to be administered in
accordance with an order under section 421 of the Insolvency Act 1986, or in the event of a
winding-up order being made, or a resolution for a voluntary winding-up being passed, with
respect to any company or of the company entering administration or of a receiver or manager
of the company's business or undertaking being duly appointed or of possession being taken
by or on behalf of the holders of any debentures secured by a floating charge of any property
comprised in or subject to the charge it shall be the duty of the bankrupt, debtor, personal
representative of the deceased debtor or company, and, as the case may be, of the trustee in
bankruptcy, trustee, liquidator, administrator, receiver, or manager, or person in possession of
the property to give at the request of any person claiming that the bankrupt, debtor, deceased
debtor, or company is under a liability to him such information as may reasonably be required
by him for the purpose of ascertaining whether any rights have been transferred to and vested
in him by this Act and for the purpose of enforcing such rights, if any, and any contract of
insurance, in so far as it purports, whether directly or indirectly, to avoid the contract or to
alter the rights of the parties thereunder upon the giving of any such information in the events
aforesaid or otherwise to prohibit or prevent the giving thereof in the said events shall be of no
effect.
(1A) The reference in subsection (1) of this section to a trustee includes a reference to the
supervisor of a voluntary arrangement proposed for the purposes of, and approved under, Part
I or Part VIII of the Insolvency Act 1986
(2) If the information given to any person in pursuance of subsection (1) of this section
discloses reasonable ground for supposing that there have or may have been transferred to him
under this Act rights against any particular insurer, that insurer shall be subject to the same
duty as is imposed by the said subsection on the persons therein mentioned.
(3) The duty to give information imposed by this section shall include a duty to allow all
contracts of insurance, receipts for premiums, and other relevant documents in the possession
or power of the person on whom the duty is so imposed to be inspected and copies thereof to
be taken.
The statutory scheme is that the third party may first request information from the assured or the person
in charge of the insolvency procedure to which the assured is subject (subsection (1)). Thereafter, under
subsection (2), the third party can approach the insurers themselves. The information which must be
provided is sufficient to allow the third party to determine whether there is a policy, whether there is
likely to be a defence open to the insurers and whether premiums have been paid. The first two cases
to interpret section 2, Nigel Upchurch Associates v. Aldridge Estates Investment Co. Ltd [1993] 1
Lloyd’s Rep 535 and Woolwich Building Society v. Taylor [1995] 1 BCLC 132, rendered the section all
but ineffective. In each of them, albeit for different reasons, it was held that section 2 could only be
used after the third party had obtained a judgment against the assured. These cases were overruled by
the Court of Appeal in Re OT Computers [2004] EWCA Civ 653, [2004] Lloyd’s Rep IR
(forthcoming). The Court of Appeal ruled that the third party’s rights under section 2 arose on the
assured’s insolvency, as that was the point at which the third party obtained contingent rights under
section 1 of the Act. The Court of Appeal recognised that any other interpretation would render legal
proceedings against an insolvent defendant a complete lottery.
Reform of the 1930 Act
In July 2001 the Law Commission published proposals for reform of the 1930 Act, along with a draft
bill. There is no sign of the bill being implemented in the near future, and some of the
recommendations in the bill have been overtaken by subsequent decisions of the Courts which have
construed the 1930 Act in a manner consistent with the Law Commission’s proposals. The most
important aspects of the draft bill are as follows:

The list of situations in which the Act applies will be expanded, including winding up
for the purpose of reconstruction, individual voluntary arrangements under the
Insolvency Act 1986 and the appointment of a provisional liquidator.
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






The Act should be extended to policies covering voluntarily incurred liabilities
(achieved by the decision in Re OT Computers, discussed above).
The two-stage process whereby it is necessary for the third party to sue the assured in
order to establish his liability and quantify the loss, and then to sue the insurers under
the policy, will be abolished. Instead, the third party will proceed against the insurers,
and it is for them to raise the issues of the liability of the assured and of the coverage
of the policy. By this means policy disputes can be resolved as preliminary issues,
thereby removing the need for a potentially lengthy trial on liability beforehand, and
one side effect will be that a company which has been struck off the register of
companies will no longer have to be restored to the register so that its liability can be
established and quantified in preliminary proceedings. Limitation problems of the
type encountered in Lefevre v White (discussed above) are also removed, as the only
relevant limitation period is that governing the third party’s action against the
assured.
The third party will be able to obtain insurance information from the assured and
from the insurers when proceedings are about to be commenced (in any event
achieved by the decision in Re OT Computers, discussed above).
Policy terms which have to be complied with as a condition precedent to the liability
of the insurers, eg, the making of a claim, will be able to be satisfied by the third
party, and pay to be paid clauses are not to be permitted other than in the case of
maritime claims not involving death or personal injury.
In the event that there are multiple claims against a limited insurance fund, the first
past the post solution should be retained.
Once the assured has become insolvent it will no longer be possible for the assured to
enter into an agreement with the insurers compromising the amount of the insurers’
liability.
The legislation will be applicable where the insolvency of the assured is conducted
under a English insolvency procedure: the law applicable to the insurance policy is of
no consequence in determining the applicability of the Act.
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