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The interpretation of claims control clauses in reinsurance contracts

In Beazley Underwriting Ltd & Ors v Al Ahleia Insurance Company & Ors [2013] EWHC 677 (Comm), the Commercial Court was asked to determine the scope and effect of a claims control clause in a proportional reinsurance contract. Mr Justice Eder concluded that clauses of this type are to be construed strictly and that the clause in question only applied to settlements or admissions in respect of losses giving rise to a "matching" liability under the reinsurance contract. On the facts, the judge concluded that the defendant reinsureds had not acted in breach of their obligations by settling or admitting a relevant liability.

 

Background

In around January 2005, the defendants entered into an open cover construction all risks and third party liability insurance policy with the Kuwait Oil Company ("KOC") and its contractors for a declaration period of 1 February 2005 to 1 February 2007 ("the Underlying Insurance"). The Underlying Insurance, which was subject to Kuwaiti law, contained a clause which excluded from cover the costs that "would have been incurred if replacement or rectification of the Insured Property had been put in place immediately prior to the said damage" (referred to as "the LEG2 exclusion").

At around the same time, the defendants entered into a reinsurance contract with the claimants and AIG UK Limited ("AIG") as reinsurers ("the Reinsurance Contract") and written on a back-to-back basis. The contract itself was a Lloyd's slip policy governed by English law, covering projects attaching during the same period as the Underlying Insurance. Between them, the defendants retained 10.5% of the risk, ceding the balance to the claimants and AIG. Aon acted as broker in relation to both the Underlying Insurance and the Reinsurance Contract.

The Reinsurance Contract contained the following provisions:

  1. A claims control clause ("the CCC") which, as amended by a subsequent reinsurance declaration, provided as follows:

    "Notwithstanding anything contained in the Reinsurance Agreement and/or the Original Policy Wording to the contrary, it is a condition precedent to any liability under this Reinsurance that:

    a) The Reinsured shall upon knowledge of any loss or losses which may give rise to a claim under this Policy, advise the Reinsurers thereof as soon as reasonably practicable;

    b) The Reinsured shall furnish the Reinsurers with all information available respecting such loss or losses and the Reinsurers shall have the right to appoint adjusters, assessors, surveyors or other experts and to control all negotiations, adjustments, and settlements in connection with such loss or losses;

    c) No settlement and/or compromise shall be made and no liability admitted without the prior approval of Reinsurers.

    In the event of a claim under the Original Policy Wording Reinsurers hereon agree that settlement shall take place at the same time as settlement or advance of funds under the said Original Policy Wording."

  2. A so-called "subscription agreement", the accepted effect of which was that AIG and another of the reinsurers, Beazley Underwriting Limited ("Beazley"), were appointed joint slip leaders; and that the agreement of each of AIG, Beazley and two further reinsurers (together, "the Claims Agreement Parties") would be deemed to amount to the agreement of all reinsurers for the purposes of controlling and agreeing claims. As a result of this agreement, it was also accepted that the prior approval of all of the Claims Agreement Parties was required to any settlement, and that AIG's approval alone was insufficient.

In October 2005, KOC executed an agreement for the construction of a number of crude oil storage tanks. This project was declared to the Underlying Insurance and then notified and agreed under the Reinsurance Contract. In March 2007, one of the tanks was found to be defective and KOC sought an indemnity from the defendants for the costs of repair.

On being notified, the defendants' reinsurers initially denied liability on the basis of the LEG2 exclusion. This was in contrast to the position taken by Al Ahleia Insurance Company ("AIC") on behalf of the defendants, who united with KOC in pressing its reinsurers to pay the claim. In about June 2009, Aon came under pressure from KOC and formed a plan to split off AIG from the other reinsurers. That approach resulted in an agreement between KOC and AIG in October 2009 that AIG would pay its 20% share of an approximately US$19,000,000 loss amount. This sum was considerably higher than the figure first notified to reinsurers. AIG's co-reinsurers were not involved in the discussions leading up to the agreement.

Subsequently, on 2 December 2009, a conversation took place between representatives of AIC and KOC in which the implementation of KOC's agreement with AIG was discussed. Shortly thereafter, AIC produced a memorandum which identified the "partial payment" to be made by AIC in light of the settlement with AIG and recorded (on 6 December 2009) that AIC had no objection to it. In the months which followed, further exchanges took place between all of the parties in which the implications of the agreement with AIG were explored, with the brokers encouraging the balance of the market to settle on the same basis as AIG. However, the claimant reinsurers did not move from their position as regards the application of the LEG2 exclusion and maintained that AIC's conduct was in breach of the CCC. Eventually, KOC brought proceedings against AIC in Kuwait for the payment of a sum equivalent to AIG's proportion.

Issues

Against that background, the claimant reinsurers brought proceedings against their reinsureds in England in order to establish their non-liability under the Reinsurance Contract. It being common ground that compliance with the CCC was a condition precedent to the claimants' liability under the Reinsurance Contract, this question was ordered to be heard as a preliminary issue. The claimants' case was that the defendants had acted in breach of the CCC by:

  1. Failing to allow Beazley or any of the claimants to control the negotiations with KOC and instead in conducting those negotiations behind the backs of reinsurers other than AIG; and

  2. Admitting liability for KOC's claim, and settling/compromising it, without the prior approval of all of the Claims Agreement Parties.

Decision

On the proper approach to the construction of the CCC, Eder J accepted the defendants' submission (citing Royal & Sun Alliance v Dornoch [2005] Lloyd's Rep IR 544 with approval) that the CCC was to be regarded as an exemption clause and therefore to be construed against the claimants being the parties seeking to rely on it. In doing so, the judge rejected an argument by the claimants that the CCC was not in the nature of an exemption clause in that it simply required that the reinsureds must engage with their reinsurers in order to recover under the Reinsurance Contract.

In relation to sub-paragraph (b) of the CCC, Eder J agreed with the claimants that this provision obliged the defendants to give their reinsurers a proper opportunity to control any negotiations as between insurers and insured (not insured and AIG as reinsurer). This obligation was said to have been breached by AIC in commencing negotiations with KOC on 2 December and in concluding a deal with KOC by 6 December without consulting the Claims Agreement Parties. However, in each case, the judge held that there had been no breach of the CCC: first, because the discussions on 2 December 2009 could not be characterised as "negotiations" but as an update on KOC's position and, second, because the subsequent memorandum was an internal document that simply confirmed the previous discussions.

Eder J's findings made it unnecessary for him to decide the reinsured's argument that any "negotiations" were in any event in relation to the AIG "slice" of the loss, rather than the balance of the reinsurance market, such that the CCC was not breached. Eder J did however indicate that he thought the reinsurers would have a strong argument that the negotiations would be "in connection with" the loss as settling AIG's claim would involve negotiations as to the correct figure to use for the 100% loss.

In relation to sub-paragraph (c), it was the claimants' primary case that AIC had acted in breach of this provision by agreeing a settlement on behalf of all of the defendants of the entirety of KOC's claim or by admitting liability in relation to the same. Alternatively, the claimants argued that there had been a breach in any event as a result of the partial settlement or compromise of KOC's claim, namely AIG's share and/or the defendants' share, or an admission in relation to that liability. These arguments gave rise to the following points of construction:

  1. First, whether sub-paragraph (c) prohibited the reinsured from settling/compromising or admitting liability in respect of its own retained share, or in respect of that part of the claim covered just by another reinsurer's share (as the claimants contended on their alternative case). The judge held it did not prohibit such settlements or admissions on the basis that the clause only applied to settlements/compromises or admissions in respect of losses which might give rise to a "matching" liability under the Reinsurance Contract. This was said to flow from the CCC as a whole and to be consistent with business common sense, in that absent clear words to the contrary a reinsured should be able to deal as it so wishes with losses which will not give rise to a claim against a particular reinsurer.

  2. Second, whether in the context of sub-paragraph (c), the word "settlement" covered settlements agreed "without prejudice to liability". Eder J held that the word "settlement" imported a legally binding agreement regardless of whether it was concluded on a without prejudice basis.

  3. Third, whether for sub-paragraph (c) to be triggered, it was necessary for there to be a settlement or compromise and an admission of liability, or whether one or the other of these sufficed. Eder J preferred the latter construction.

  4. Fourth, what constituted an "admission of liability" in the context of this clause. Eder J concluded that an effective admission of liability must be communicated in clear and unequivocal terms. Accordingly, an offer to settle or agreement to pay a sum of money would not per se be sufficient unless it also incorporated an admission of liability. 

On the facts, Eder J concluded that there had been no relevant settlement, compromise or admission of liability amounting to a breach of sub-paragraph (c), both in the period to 6 December 2009 and subsequently.

Comment

As is well known, breach of a condition precedent entitles an insurer (or reinsurer) to decline liability regardless of whether it has suffered any prejudice as a result of a breach. This result, frequently referred to in the authorities (including this) as "draconian", does mean that judges are from time to time inclined to search for bases to avoid a finding of breach. This decision, with its surprising legal and factual findings, perhaps represents a good example of such approach. However, the result of this approach is that the outcome of such cases is not always predictable. Indeed, the Court of Appeal may form a different view (the reinsurers are understood to be seeking leave to appeal).

It is trite law that a reinsurer is not bound by a settlement as between the reinsured and insured (absent a follow the settlements clause). Accordingly, a reinsurer is only prejudiced by a settlement to the extent it produces a loss for which the reinsured then seeks an indemnity and (as in this case) to the extent the settlement sets "the negotiating bar" for subsequent discussions with the insured on the balance of the loss. The judge's construction of the CCC, in looking only at "matching" loss and claim, does not provide protection to the reinsurer in relation to the latter. Further, the judge's conclusion that the CCC operated as an exemption clause on the basis the settlement was prima facie binding must be open to serious doubt.

29 April 2013
London

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