Market News > Addleshaw Goddard E-Alert-Court of Appeal Decision
Court of Appeal rejects fundamental nature of an English law reinsurance Period Clause.
WASA International Insurance Company Ltd v Lexington Insurance Company and ors (Court of Appeal, 29 February 2008)
In a decision that may have significant consequences for the London reinsurance market, the Court of Appeal ("CA") has overturned the judgment of the Commercial Court concerning the interpretation of a 3-year period clause in an English facultative reinsurance contract, in finding for US cedent, Lexington, and permitting the recovery of US pollution losses which had occurred over a 40-year or so period. Addleshaw Goddard acted for WASA International Insurance Company Ltd ("WASA"), the successor to the original London market reinsurer. To see our summary of the first instance decision, click here [add link].
The first instance decision had re-affirmed the principle that as a matter of English law, a period clause is fundamental to a reinsurance contract, and that a "follow the settlements" clause, even in a facultative back-to-back scenario, does not bind reinsurers to provide coverage for losses that fall outside the period clause of the reinsurance. The CA, however, has taken a very different view.
The Contracts
The dispute arose out of the reinsurance (the "Reinsurance") by WASA of Lexington's exposure to the Aluminium Company of America ("Alcoa") under an insurance contract covering loss or damage to property (the "Insurance"). The Insurance provided cover to Alcoa and its worldwide subsidiaries for a period of three years from 1977 to 1980, subject to a limit of US$20 million loss or damage per occurrence. There was no jurisdiction or choice of law clause in the Insurance. The Reinsurance contained the same provisions in terms of the limit and period of cover, was expressed to be "as original" and also contained a "Full R/I Clause" follow the settlements wording.
Background
Alcoa incurred very substantial costs in cleaning up environmental damage sustained at a number of its US sites. The damage was found by a US jury to have occurred between 1942 to at least 1986, and the clean-up costs ran to hundreds of millions of dollars. In 1992, Alcoa issued proceedings in the US against its property insurers, including Lexington. The Supreme Court of Washington State found Lexington liable to indemnify Alcoa for the full costs of remediation at certain test-case sites, regardless of when the pollution had occurred, provided only that some damage had occurred at the relevant site during the 3-year Insurance period. Subsequently, Lexington negotiated a settlement of Alcoa's losses for US$103 million, and then looked to its reinsurers, including WASA, for a recovery.
First instance decision
At first instance, WASA succeeded in establishing that it was not liable to indemnify Lexington for any loss that occurred before or after the period clause of the Reinsurance. Critically, the Commercial Court held that the Reinsurance could not be construed, as a matter of English law, as if it provided cover for the cost of remedying damage that occurred outside the policy period, because a period clause in a reinsurance contract is of fundamental importance.
The Court also took the view that in 1977 there was no relevant US law interpretation of the period clause in the Insurance, as US law was not uniform on the question of allocation of liability across coverage years, and it had not been clear in 1977 that the insurance dispute would be determined by the courts of Washington State in accordance with Pennsylvanian law (as, in the event, it was), with the result that Lexington would be held liable for losses occurring outside of the temporal limits of the Insurance cover. The Court considered that the process of construing the period clause in the Reinsurance by reference to an interpretation given by a US court, which happened to be seized of an underlying insurance dispute 20 years later, was not so much back-to-back, as "back-to-front".
The CA decision
The CA took a very different approach to the issue of the Reinsurance policy period, and found that WASA was bound to follow the Alcoa settlement, which meant that it was liable to pay for losses occurring outside the period clause of the reinsurance contract. The CA reached this conclusion on the following grounds:
1. The Insurance and Reinsurance used equivalent wording to define the policy period. Hence it must have been the intention of the parties that the wording should have the same meaning in both contracts.
2. The CA was not convinced by the "back-to-front" analysis of the Commercial Court. In its view, the meaning of the period clause in the Insurance could always have been ascertained by applying the law most probable to apply, i.e. the law of Pennsylvania, where Alcoa was incorporated and had its centre of business. Moreover, WASA had to take the risk of US law changing over time since they had agreed to reinsure a US insurance company.
3. The CA also expressed doubts concerning the previously considered, established principle that a reinsurance contract covers the primary risk and not the insurer's liability.
Comment
Lord Mustill in Hill v M&G Re emphasised the fact that reinsurers are entitled to rate a policy by reference to its chronological extent. However, in this case, the CA doubted whether the underwriter would have done so. In deciding that WASA were liable for losses occurring outside the 3-year reinsurance contract, any such rating issue was rendered an irrelevance in any event. However, although the reinsurance underwriter may have agreed to go back-to-back on the dates of insurance's inception and expiry, did he or she really intend for the English law reinsurance to respond to US law implications of the property damage insurance cover, which was held to have no express exclusion for damage which occurred prior to inception? Is that how the London market would have rated the 3-year reinsurance risk?
The CA has effectively ruled that it is not enough for a London market facultative reinsurance contract to be governed by English law: where there is "follow the settlement" language in a back-to-back scenario, reinsurers will be taken to have agreed that the meaning of the reinsurance contract will be determined in accordance with the law or laws governing the meaning of the underlying insurance contract. The additional CA comments that reinsurance is in reality no more than liability insurance of the cedent appears further to emasculate the independence of the reinsurance contract. WASA is considering petitioning the House of Lords.
