A controversial issue that Marc has been covering is whether or not insurance companies should have in place written claims guidelines and procedures.  One school of thought is fearful of their use (or abuse) by insureds in coverage actions.  For example, a company employee might mistakenly not follow written guidelines and procedures in the course of handling a claim, and a dispute might arise as a result.  The insured will legitimately be able to argue  that the company’s handling of the claim did not comply with its own guidelines and procedures, and that, accordingly, the company mishandled the claim.  Proponents of this view will say that having claims guidelines and procedures is fine as long as they are merely aspirational and not in writing. 

Others advocate the “damned if you do, damned if you don’t” view.  If a large, professional insurer has no written guidelines and procedures, then the insured’s refrain in a coverage or bad faith action will be that the company is grossly negligent because it lacks the internal or external controls necessary to regulate a very significant portion of its business operations.   But if the company has written claims guidelines and procedures, then surely they will come back to haunt it in the event of litigation.  

Others, including Marc, believe the benefits associated with well-drafted and carefully considered claims guidelines and procedures outweigh the costs associated with formulating and implementing them, and, more importantly, whatever costs might be incurred by the insured’s potential use or abuse of the procedures in the event of a dispute.  Drawing on his experience as a lawyer and a claims executive for two major insurance companies, Marc offers assistance to companies that are interested in implementing written claims guidelines and procedures or improving existing ones. 

Marc recently brought the discussion up to the reinsurance level in his post, “Absence of Procedures to Notify Reinsurance is a Basis for Bad Faith.”   He was kind enough to mention what inspired his thoughtful post — an interesting discussion he and I had about the subject not long ago over a delicious sushi and bento box lunch at Misaki — Manhasset, New York’s best (and only) Japanese restaurant. 

As Marc points out there has been law in the Second Circuit for some time stating that a ceding company’s failure to have in place procedures for notifying reinsurers of claims can constitute bad faith, which may relieve a reinsurer of liability for a late-noticed claim without any showing of prejudice.    That is a pretty good argument for having in place written, ceded-claims handling procedures designed to ensure timely notice to reinsurers.    

In the reinsurance-late-notice context the cost-benefit analysis is probably less challenging than it might be in the direct-insurance-bad-faith context.  If the ceding company does not have in place written guidelines and procedures, and cannot establish by credible and consistent testimony the existence of unwritten guidelines and procedures, then, at least in a case pending in court (as opposed to arbitration), the reinsurer may get a “pass” on a claim based on late notice without any showing of prejudice.  (Prejudice has been defined as “tangible economic injury.”)

On the other hand, if the ceding company has written procedures in place, but they are not followed in a given case, then that, in conjunction with other evidence, may establish that notice was late.  But the reinsurer still has to show prejudice to be relieved of liability.   

So in our hypothetical, counsel for the reinsurer may be able to make some hay at a deposition concerning the cedent’s failure to follow its own guidelines and procedures.  But points scored at depositions can be (and in this case are) ephemeral:  without evidence of prejudice, failure to comply with the guidelines is, for all practical purposes, irrelevant.  

In this day and age of internal controls and corporate responsibility, it seems to us that appropriate written claims guidelines and procedures can benefit insurers, cedents and reinsurers, provided they are carefully drafted, implemented and managed.  We offer the following, very general and non-exclusive list of things companies might consider:   

1.  If written claims procedures are to be adopted and implemented they should be carefully prepared by claims experts and reviewed by experienced counsel.   Poorly drafted and ill-conceived written claims procedures are probably worse than none at all. 

2. Careful thought should be given to privilege issues associated with in-house or outside attorney review of draft guidelines and the involvement of counsel in other aspects of the drafting and implementation process.   The process should be carefully managed and attention should be paid to the company’s document retention policies as respects the maintenance or destruction of drafts.   Remember, in a future litigation or arbitration the insured’s attorneys will likely request prior drafts and depositions of all involved in the preparation and implementation process.  While the insured may or may not be successful in obtaining all the discovery it seeks, it will likely get at least some of it.  

3.  Written claims procedures should be drafted to confer upon claims personnel an appropriate degree of discretion where such discretion is appropriate.   Locking adjusters into particular claims positions without regard to the facts, circumstances and practical realities can cause a myriad of problems. 

4.  To the extent claims procedures provide a certain period of time within which a particular action must be taken, and to the extent that the period is not an inflexible one provided by law or contract, flexibility should be built in to account for minor delays caused by special circumstances or the press of business.   

5.  If written claims guidelines and procedures are to be adopted, the company should ensure claims personnel take them very seriously and do their best to abide by them at all times.   

6.  Written claims procedures should be subject to periodic review by in-house counsel and the claims department to ensure that they comply with current legislation and recent case law developments. 

7.  Outside counsel handling coverage or other, claims-related matters for the company should keep the company’s general counsel apprised of any problems that might be caused or exacerbated by written guidelines and procedures.  

Introduction

In Part I we discussed the controversy surrounding the House of Lords decision in Lexington Insurance Co. v. AGF Insurance Co. [2009] UKHL 40.  The House ruled that two proportional facultative reinsurers were not obligated to indemnify the cedent for their share of the entire amount of a judgment a Washington State court rendered against the cedent in an environmental coverage action.  The judgment, which was based on Pennsylvania law, rendered the cedent liable under the policy jointly and severally for property damage caused by environmental contamination that occurred before, during and after the three-year policy period.  The House ruled that the reinsurers could be held liable only for their respective shares of the loss that occurred during the three-year term of the reinsurance contract (which was concurrent with that of the cedent’s policy), not their shares of the total amount of loss for which the Washington judgment held the cedent liable under the reinsured policy. 

In this Part II we briefly summarize the pertinent background of the case, walk the reader through the House’s reasoning and offer a few parting thoughts.       

Background

The reinsurance contract, which was entered into in 1977, was “back-to-back” – i.e., materially identical to the reinsured policy – save in one respect:  the reinsurance contract was governed by English Law (because it was negotiated and entered into on the London Market) but it was unclear at the time of contracting which U.S. state’s (or states’) law would govern coverage issues in the event of litigation involving the policy.  There was no choice-of-law clause in the policy (though there was a standard, service-of-suit clause), and choice of law would accordingly depend on where the action was brought, the facts, the issues, and applicable choice-of-law rules.  As is typically the case in policies not containing choice-of-law clauses, all of these were imponderables at the time the parties entered into the contract, and would remain so until a coverage action arose concerning the policy, and a court ruled on choice of law.   

Decision of the House

The House explained that whether or not the reinsurer had to pay its proportional share of the entire judgment was informed by some established principles of English reinsurance and insurance law.  First, “a reinsurer cannot be held liable unless the loss falls within the cover of the underlying insurance contract and within the cover created by the reinsurance,” and “what falls within the cover of a contract of reinsurance is a question of construction of that contract.”  Id. at ¶ 59 (Collins, L.J.).  Second, there is a presumption that the coverage of a back-to-back  proportional facultative reinsurance contract is coextensive with that of the cedent’s policy.  Id. at ¶¶ 60-73.   Third, “where an insurance or reinsurance contract provides cover for loss or damage to property on an occurrence basis, the insurer (or reinsurer) is liable to indemnify the insured (or reinsured) in respect of loss and damage which occurs within the period of cover but will not be liable to indemnify the insured (or reinsured) in respect of loss and damage which occurs either before inception or after expiry of the risk.”  Id. at ¶ 74. 

To determine the scope of the reinsurers’ obligation the House had to construe two key contract provisions:  (a) a “Period” clause, which said that the reinsurance contract was in effect for a three-year period running concurrently with the three-year policy period; and (b) a standard “Full Reinsurance Clause,” which contained a follow-the-settlements provision.   The “Full Reinsurance Clause” stated, in pertinent part:    

Being a reinsurance of and warranted same gross rate, terms and conditions as and to follow the settlements of the Company.  .  .  .      

Id. at ¶ 21 (Mance, L.J.). 

As a threshold matter, the Court had to decide whether the general rule that the coverage of the reinsurance contract was coextensive with the insurance contract applied in this case, where each contract was governed by different bodies of law, one determinate, and one indeterminate.  That involved not the application of conflict-of-law rules, but construction of the contract.  See id. at ¶  63 (Collins, L.J.).  The question boiled down to “what law would the parties have expected would be applied by a court in the United States had [the insured] taken advantage of the Service of Suit clause, and in particular would the parties to the reinsurance contract have reasonably had in mind that what losses were recoverable under the insurance contract would be determined ultimately by the law of Pennsylvania?”  Id. at ¶ 95.  Because even though the joint and several liability allocation theory had not been devised by any court back in 1977 — let alone adopted by the Pennsylvania courts — both the insurer  and the reinsurer assumed “the risk of changes in the law.”  Id. at ¶ 110.  And if the parties reasonably expected that Pennsylvania law would apply, then the ordinary rule concerning back-to-back reinsurance would apply, and the reinsurer would be bound to pay its proportional share of the entire judgment, even though English law governed the reinsurance contract, and under English law the reinsurance contract would not ordinarily be interpreted to cover loss occurring outside the term of the contract.

But the Court found that the general rule was not applicable, because, at the time of contracting, there “was no identifiable system of law applicable to the insurance contract which could have provided a basis for construing the contract of reinsurance in a manner different from its ordinary meaning in the London insurance market:” 

I consider that it is fanciful to suppose that in 1977 the hypothetical American lawyer asked to advise on what law governed the contract of insurance, and what law would govern questions of coverage, would have concluded that Pennsylvania law would have applied.  To have reached that conclusion the lawyer would have had to advise or assume that (a) there would be claims based on damage to several sites being litigated together; (b) plaintiffs in the environmental litigation would be most likely to sue in a State which applied the principles in the Restatement Second [of Conflicts of Law]; and (c) the courts of that State would apply those principles to conclude that the law which applied to the issues would be the law of Pennsylvania. 

In my judgment, in complete contrast to Vesta v. Butcher and Groupama  v. Catatumba, [, both of which applied the ordinary, back-to-back rule in situations where another jurisdiction’s law governed the original insurance contract,] in the present case there was in 1977 no identifiable system of law applicable to the insurance contract which could have provided a basis for construing the contract of reinsurance in a manner different from its ordinary meaning in the London insurance market.  In each of those cases, the substance of the foreign law as to the consequences of a non-causitive breach of warranty could be ascertained at the outset, if necessary by recourse to a relevant Norwegian (or Venezuelan) legal source.

Id. at ¶¶ 107-08 (citation omitted).

Accordingly, the Period clause had to be given the meaning that would be ascribed to it in the London insurance market.  Pursuant to that clause, the reinsurance contract “covered ‘All Risks of Physical Loss or damage’ and provided cover in respect of loss and damage occurring between 1 July 1977 and 1 July 1980.  .  .  .,” and was therefore “on the ‘loss occurring’ basis, under which a reinsurer is obliged to pay its share of the loss suffered by the reinsured, if it occurred during the period when the reinsurance contract was in force.”  Id. at ¶ 76.

The Court found “no principled basis for treating the scope of the 3 year reinsurance as the same as the insurance, which has been interpreted under the law of Pennsylvania not to contain any limitation as to time of the physical loss or damage to property.”   Id. at ¶ 110 (citation and quotation omitted): 

If [the cedent] were right, some very uncommercial consequences would flow if the reinsurers had agreed to accept only two years of the risk, rather than the three years of the underlying risk accepted by [the cedent], leaving [the cedent] to reinsure the third year of cover elsewhere; or if the London market had elected to reinsure Lexington by way of three separate one year policies .  .  .  .The periods of cover under the insurance and reinsurances would not be back-to-back.  But [the cedent] would still be maintaining that, in light of the decision of the Washington Supreme Court, if any damage occurred within any relevant policy period, of any duration, the relevant reinsurer would be liable for all of the damage, including damage occurring before inception or after expiry.  That seems to me to be wholly uncommercial and outside any reasonable commercial expectation of either party.    

Id. at ¶ 111. 

The Court also rejected the cedent’s argument that, pursuant to the follow-the-settlements language in the Full Reinsurance Clause, the loss is deemed to fall within the scope of the original insurance policy if “so held by a court of competent jurisdiction, or if it is the subject of a settlement which cannot be impugned”: 

The case for [the cedent] is not assisted by those authorities which decide that the reinsurer cannot go behind a determination of the reinsured’s liability under the contract of insurance to the original insured, whether it is by way of settlement under a follow settlements clause or by the decision of a court of competent jurisdiction.  The reason is that a reinsurer will only be bound to follow its reinsured’s settlement and indemnify the reinsured provided that the claim recognised by them falls within the risks covered by the policy of reinsurance as a matter of law.  This is because the reinsurer cannot be held liable unless the loss falls within the cover created by the reinsurance.  Consequently the question remains the same:  what is the effect of the policy period in the reinsurance? 

Id. at ¶ 112 (citations omitted).   

Finally, the House said that this case illustrated what it expected to be the exception, not the rule in cases involving back-to-back reinsurance:

I would also accept that it would almost invariably be the case that losses for which the insurer has indemnified the original insured would be within the reinsurance even if the losses are payable under a foreign law or a foreign judicial decision which takes a view different from English law of what losses are recoverable.  The presumption that the liability under a proportional facultative reinsurance is co-extensive with the insurance should be a strong one because (as I have said) the essence of the bargain is that the reinsurer takes a proportion of the premium in return for a share of the risk.  But this is an unusual case in which the express (and entirely usual) terms of the reinsurance are clear.  This is not a case where the reinsurers are relying on a technicality to avoid payment.  At the beginning and end of these appeals remains the question whether the provision for the policy period of the reinsurance is to be given the effect it has under English law, or whether the parties must be taken to have meant that the reinsurance was to respond to all claims irrespective of when the damage occurred and irrespective of the period to which the losses related.  There is, in my judgment, no principled basis for a conclusion in the latter sense. 

Id. at ¶ 116. 

Some Parting Thoughts

The judgments in the Lexington case contain some impressive discussions of English law on the nature of reinsurance in general, back-to-back cover, the scope of a period clause, and follow-the-settlements.  As we mentioned in Part I, it is a significant contribution to reinsurance jurisprudence.  Its dissertations on English law concepts may, to some extent,  influence the development of reinsurance law here in the U.S., where courts like the New York Court of Appeals sometimes cite and draw on the teachings of English courts.      

But we do not think the aspect of the rationale on which the case turned will gain wide, if any, acceptance by courts or arbitrators here in the U.S.  And that is the importance the Court accorded to the parties’ lack of knowledge at that time of contracting of what law would likely govern coverage issues arising under the policy.  We believe that both U.S. courts and arbitration panels will probably perceive that aspect of the decision to be overly formalistic, and not reflective of the expectations of the parties to a facultative, back-to-back reinsurance contract.  

Had the parties to the Lexington reinsurance contracts been asked in 1977 whether the reinsurance contract was “back-to-back” with the reinsured policy, we believe the answer would have been a resounding “yes.”  We doubt that the parties would have qualified their answer and pointed out that the reinsurance contract was governed by English, law while the insurance contract was governed by indeterminate U.S. law.  And even had the reinsurer and insurer said that the contract was back-to-back, save in that one respect, we doubt that the insurer and reinsurer would, in turn, conclude that, in the event a U.S. court interpreted the terms of the policy more expansively than an English court might, then the reinsurers would not be required to pay their respective shares of the entire amount of the U.S. judgment.     

The House strongly implied that, had the parties reason to know that Pennsylvania law would govern the interpretation of the policy’s scope of coverage, then the reinsurers would have been responsible for their respective shares of the Washington judgment.  The House said that it would be irrelevant that Pennsylvania had not yet adopted joint and several liability back in 1977, because changes in the governing law are a risk that both the insurer and the reinsurer accept.  So the House presumably would have ruled for the cedent had there been, say, a Pennsylvania choice-of-law clause in the contract, even though neither the reinsurer nor the cedent had, at the time of contracting, any reason to believe that the policy might one day be interpreted to cover loss occurring outside the policy period, and even though in 1977 a Pennsylvania court probably would have interpreted the insurance policy to cover only loss occurring during the policy period.    

A U.S. court or arbitration panel would probably question why the result should be any different simply because neither the insurer nor the reinsurer had knowledge at the time of contracting of what particular state’s law would govern scope of coverage in some future coverage action.  The reinsurer, by agreeing to reinsure a U.S. policy with a service-of-suit clause knew or had reason to know that:  (a) the laws of any number of U.S. jurisdictions might be applied to particular issues arising in a coverage case; (b) those laws might or might not be different than English law concerning the policy’s scope of coverage; (c) those laws might change; and (d) neither the cedent nor the insured could predict with any certainty what law might be applied to the policy, let alone what that law would ultimately provide at the time of some future coverage action.  In other words, the reinsurer’s guess as to what law might be applied to the policy in a future coverage action, and the ensuing result, was as good as the cedent’s and the insured’s. 

Given that all parties were equally in the dark about all of this, we believe many U.S. courts and arbitration panels would consider the risk that the terms of the policy might one day be subject to the laws of a U.S. jurisdiction that construed them differently than English law might to be a risk that a back-to-back, proportional facultative reinsurer accepts when it enters into a back-to-back reinsurance arrangement with a U.S. cedent. 

We also do not believe that many U.S. courts or arbitration panels would be persuaded by the House’s suggestion that a ruling contrary to that in Lexington would render the period clause of the reinsurance contract meaningless.  The House suggested that the cedent’s position would have been the same had the reinsurers entered into three, separate, one-year reinsurance contracts reinsuring the three-year term of the policy.  While that argument has at first blush a logical ring,  it doesn’t fare as well under scrutiny.  First, if there were three, separate one-year reinsurance contracts spanning the term of the policy, then the reinsurance would, by definition, not be back-to-back cover, and there would be no reason to construe the period clauses in the insurance and reinsurance as having the same meaning.  Second, consistent with the parties’ reasonable expectations, the period clause of the policy could reasonably be deemed to have the meaning that the Washington Court accorded it under Pennsylvania law (i.e., as covering loss occurring before, during and after the three-year policy period), and the period clause of each one year reinsurance contract could reasonably be interpreted to cover one-third of the total amount of loss that the Washington Supreme Court deemed covered by the policy.  Since the loss deemed to be covered by the Washington Supreme Court was of a continuous, indivisible nature, it would be reasonable to assume that, under the Washington court’s judgment, one third occurred during the period the first, one-year reinsurance contract was in effect; one third during the term of the second, one-year reinsurance contract; and one third during the term of the third, one-year reinsurance contract.  The terms of the period clause could reasonably be given further meaning by permitting the reinsurers the benefit of a retention each year (absent contract language providing otherwise).

Introduction

Effective October 1, 2009 the House of Lords will be replaced by the Supreme Court of the United Kingdom (more information here).  In what may be among its last official acts, on July 30, 2009 the House decided an important reinsurance case concerning the scope of a reinsurer’s indemnity obligation to a U.S. cedent under English law.  See Lexington Insurance Co. v. AGF Insurance Co. [2009] UKHL 40.  The reinsurance contract was back-to-back with the reinsured policy in all but one respect:  it was governed by English law, while the insurance policy was, in the event of coverage litigation, potentially subject to the laws of any number of U.S. jurisdictions, depending on venue, applicable choice of law rules and other considerations.  Relying on a long-line of English law precedent, and distinguishing other precedent, the House ruled that a proportional facultative reinsurer was not obligated to indemnify the cedent for the reinsurer’s share of the entire amount of a judgment a state court in Washington rendered against the cedent.  The judgment resulted from a Washington Supreme Court decision which, applying Pennsylvania law, ruled that the cedent was jointly and severally liable under its policy for property damage caused by environmental contamination that occurred before, during and after the cedent’s three-year policy period.  The House said that, judgment or no judgment, the reinsurer agreed to reinsure only loss or damage occurring during the coterminus, three-year period of the reinsurance contract, and the reinsurer’s obligation was limited to its share of that loss. 

The House’s decision is likely to be controversial.  In this Part I of a two-part post, we shall discuss the controversy and seek to allay it a bit.  In Part II we’ll walk the reader through that reasoning and offer some parting comments. 

The Controversy

Complex environmental-contamination and asbestos-related claims are anything if not costly.  American insurers have been fighting an expensive, multi-front war with their insureds for many years over the scope and extent of their liability for these claims.  They raise a myriad of issues and are potentially governed by the laws of at least fifty different jurisdictions (some sympathetic to insurers, some not).   These jurisdictions have adopted different approaches to resolving the issues (some favorable to insurers, some not), which means that no matter where may be the venue, complex choice-of-law questions are likely to arise.  And the coverage actions usually involve multiple insurers, sites, claimants, years of coverage, and layers of coverage.  The amount at stake and the concomitant expense can be staggering.  For the most part, these claims and coverage disputes — let alone how some courts might resolve them – could not reasonably have been anticipated at the time when most of the occurrence policies on which they arose were written (generally prior to 1980 and sometimes going back to the 1930s). 

Some U.S. courts, like the Washington Supreme Court in Lexington, have imposed liabilities on insurers that are far in excess of those the U.S. and U.K. insurance  industry thought they were assuming back  when the parties entered into their insurance and reinsurance contracts.  These courts have literally bent over backwards to protect policyholders (most of which are large corporations that may be as sophisticated as, if not more so than, their insurers).  One of the best examples is the one at issue in this case:  the imposition of joint and several liability, under which an insurer can be held jointly and severally liable under a single policy for its share of an environmental or asbestos-related loss that occurred over many years, which triggered many other policies issued by the same or other insurers (solvent or insolvent), and which may have spanned  periods when the policyholder had elected not to purchase insurance.

Since at least the latter part of the 1980s, U.S. cedents have also been fighting with their reinsurers – both international and domestic – over the scope and extent of their reinsurers’ liability for asbestos-related and environmental-contamination claims.  One of the key fights has been over how settlements of these claims are to be allocated.  While insurers have fought hard in the coverage actions to spread their liability among as many other insurers and policies as possible, and to advocate positions on the number of occurrences that limited their overall liability, they have fought equally hard to spread that liability over as few reinsurers and reinsurance contracts as possible, and to advocate positions on number of occurrences that tend to increase the amount of their reinsurance recoveries.  And the reinsurers, in turn, have fought hard to spread that liability over as many reinsurers and contracts as possible, and to advocate positions on the number of occurrences that tend to decrease the amount of their cedents’ reinsurance recoveries.     

These reinsurance allocation disputes must generally be resolved based on an examination of the settlement; the probable number of occurrences; the apportionment of liability to sites or claimants; the terms and conditions of the insurance and reinsurance contracts;  applicable insurance and reinsurance law, custom and practice; and a host of other considerations.  They are quite often the subject of arbitration proceedings, but are sometimes resolved in court.  While they are generally not as factually and legally complex as their coverage-litigation counterparts, they can be fairly expensive to litigate or arbitrate, and the stakes may be high.    

A good number of these reinsurance disputes are between American cedents and their London-based reinsurers, many of which have also been named in U.S. asbestos-related and environmental coverage actions here in the U.S.  Direct and reinsurance asbestos-related and environmental claims are what prompted the U.K. government and insurance industry to form Equitas in 1996 to protect Names that participated in pre-1993 contracts from insolvency, and to enable the London Market to continue writing insurance and reinsurance business.  (For a description of the Equitas restructuring and an explanation of the recent Part VII transfer designed to protect Names from contingent liabilities on pre-1993 contracts, see Re The Names at Lloyd’s for the 1992 and Prior Years of Account, Represented by Equitas Ltd.  [2009] EWHC 1595 (Ch), a copy of which is here.)

From the standpoint of an American reinsurer, a claim based on a judgment imposing joint and several liability would by no means be a happy event.  The reinsurer would no doubt have many questions,  and would need to be sure that the decision to proceed to trial was made in a good faith, business-like manner, and that the loss presented otherwise comported with the terms and conditions of the reinsurance contract.  But given American conceptions of the follow-the-settlements doctrine;  reinsurance custom and practice; the expectations of the parties; and insurance and reinsurance law in general, it is unlikely that most American courts or arbitration panels would reach the same conclusion as the House did on facts like those in Lexington.  More likely than not, the reinsurer would be required to pay its share of the entire judgment, even though that meant that the reinsurer was effectively reinsuring loss outside the period covered by the reinsurance contract (albeit because the judgment of a court of competent jurisdiction so defined the coverage of the reinsured policy).  That does not mean that the House was necessarily wrong or that our hypothetical American court or arbitration panel would necessarily be right.  It simply reflects differing institutional views of how general principles of insurance and reinsurance law, custom and practice ought to be applied; and how best to serve the needs of national and international legal systems and economies.       

Interestingly enough, the English Court of Appeal ruled for the cedent, Lexington.  And in a postscript to his judgment,  Longmore, J. wrote: 

No one can pretend that the decisions of United States courts in relation to asbestosis and pollution claims are remotely satisfactory from the point of view of insurers let alone reinsurers.  Reinsurers’ arguments in the present case had a whiff of an assertion (although they were careful not to say so expressly) that Lexington were an American corporation and had therefore to take unsatisfactory American decisions on the chin, while reinsurers were English (or doing business on the English market) and could not be expected to do so.  That, of course, will not do.  The appellant’s very name is apt to remind one of the opening shots of the War of Independence but that conflict has long since receded into history and must remain there.  The insurance and reinsurance market have been adept over many decades in coming up with solutions to apparently insuperable difficultities.  One such solution has been the evolution of the Bermuda Form in which the parties agree to English or Bermuda arbitration but agree also that the substantive law of the insurance (or reinsurance) is to be that of New York.  This sensible arrangement might avoid some, at least, of the problems thrown up by this difficult case.

Wasa Int’l Insurance. Co. v. Lexington Insurance Co. [2008] EWCA Civ 150, ¶ 42 (Longmore, J.), rev’d, [2009] UKHL 40 (citation omitted). 

Longmore, J.’s thoughtful comment suggests that the result in Lexington may, in part, be a manifestation of frustration on the part of some in the U.K. with a U.S. liability system that they perceive as being out of control, and with the extent to which U.K. companies and Names have been forced to bear what they may believe is a disproportionate share of the loss imposed by those decisions.  England has a long tradition of insurance and reinsurance law and practice, and the notion of joint and several liability is completely at odds with that law and practice.  For many years, English insurers and reinsurers have suffered tremendous losses in U.S. asbestos-related and environmental coverage litigation.  And in recent (and perhaps not so recent) years, a perception appears to have developed that English reinsurers (particularly those in run-off) have not been treated that fairly by U.S. arbitration panels.  It is easy to understand why English reinsurers might perceive asbestos-related and environmental claims to be a problem created by the U.S. legal system, the consequences of which have been unfairly and disproportionately foisted on U.K. insurers and reinsurers, all to the detriment of the U.K. insurance and reinsurance business and the national economy.  The House was apparently more sympathetic than the Court of Appeal to that putative frustration. 

American cedents, of course, are not going to be thrilled by the decision, and that is certainly understandable.  Just as the U.K. has a long tradition of insurance and reinsurance law and practice, so, too, do we.   In some ways it is similar.  And I doubt that the Lexington decision will dramatically change it. 

More to the point, American cedents have certainly taken American decisions “on the chin.”  And it is understandable that they do not want to take it on the chin twice, courtesy of a judicial decision that would deny them a large portion of their expected reinsurance recoveries, especially when no one contends that their direct insurance claims handling was anything but reasonable.  Yet take it on the chin twice is precisely what the House’s decision requires them to do, at least if they must pursue their reinsurance recovery before an English court, and the facts are as they were in Lexington.

But we Americans should resist the temptation to criticize the House of Lords or the English legal system because of the result in Lexington.   It reflects English law and English policy, and frankly the judgments in the case are an an impressive contribution to reinsurance jurisprudence, of which English law decisions are a very important part. The New York Court of Appeals once said that the London Market was “the Mecca of the reinsurance world,” and for good reason.  See Sumitomo Marine & Fire Ins. Co.  v. Cologne Reinsurance Co., 75 N.Y. 2d 295, 302 (1990). 

To work, international dispute resolution requires that participants respect the laws of other nations, even where they may differ from our own.  The House went out of its way not to accord disrespect to our legal system or the judgment of the Washington Supreme Court.  We should do the same. 

Indeed, American courts and arbitration panels may learn from Lexington, and it may contribute (however modestly) to the development of our own law. It, like a lot of other English decisions, illustrates that reinsurance contracts should be treated no differently than ordinary contracts.  And while that may sound like an uncontroversial point, we trust that most readers have seen arbitration awards and court decisions that appear to take a different view.  

Finally, let us not lose sight of economic realities. Whether or not the cedent had prevailed in Lexington, it presumably had the right and obligation to seek contribution from other insurers on the risk.    That is one of the tenets of joint and several liability.  Having lost, the cedent will presumably seek contribution from solvent insurers on the risk and retain those recoveries for its own account, which will mitigate its loss.  Had it won, it would still have had to pursue those recoveries for the benefit of its reinsurers.  And while it may be that it cannot completely offset its loss, it should be able to reduce it, perhaps significantly.   

In Part II we shall take a close look at Lexington and share our parting thoughts.  Read on.  .  .  .

Don Philbin and Randall Kiser explained a theory of mediation based on a combination of brain science, psychology, statistical analysis, and computer graphics, which we thought was as inspiring as it was fascinating.  They discussed the results of empirical studies of decisional errors in litigation, comparing last settlement positions of parties who failed to settle to the ultimate outcome of the proceeding.  They explained who did better, who did worst, and what the cost of the error was.  They also described a technique that can overcome psychological barriers to settlement that uses graphically-depicted outcome-scenarios.  Randall discussed a book he is writing, which will explain and advocate a scientific approach to decision making, and which will delve into the legal malpractice considerations associated with poor decision making.  Randall’s book will hit the shelves this fall.

Once upon a time I thought mediation was, to a significant extent, based on “touch” and “feel,” but Don and Randall have proved me wrong.  To some extent it is certainly an art, but science plays an important role, especially when the mediators are trained to use it properly.  

Katherine Billingham discussed a scientific approach to resolve through mediation complex multi-insurer, multi-layer, multi-year asbestos-related insurance coverage disputes, using excellent graphics.  She explained how these disputes can be mediated in a multi-phase process that takes into account nearly every one of the myriad of variables that must be considered.  Her methodology can also be applied to complex reinsurance disputes, which she also mediates.

All in all, there was much useful information packed into the one-hour presentation, and we view it as a springboard for further research and study.  Kudos to all involved!

On June 18, 2009 the United States Supreme Court ruled 7-2 that an injunction (the “1986 Injunction”)  incorporated into the 1986 Johns-Manville Corp. (“Manville”) bankruptcy reorganization order (the “1986 Order”) barred claims made directly against Manville’s insurer, the Travelers Indemnity Company (“Travelers”), even though those claims were derivative of Travelers’ alleged wrongdoing, as opposed to that of Manville.  See Travelers Indemnity Co. v. Bailey, ___ U.S. ___ (June 18, 2009) (Souter, J.) (copy available here).  The Court held that:  (a) the claims fell within the terms of the 1986 Injunction; and (b) the claimants were barred by res judicata from collaterally attacking the Bankruptcy Court’s subject-matter jurisdiction to enter the 1986 Order containing the 1986 Injunction.  Slip op. at 1-2 & 9-10. 

The decision should bring some degree of finality to Manville’s insurers’ exposure to asbestos-related claims, which has been a moving target for quite some time.  The effect, if any, the decision may have on reinsurance claims and disputes is not yet clear.  That said, now that Travelers’ liabilities presumably can more easily be quantified, cedents, retrocedents, reinsurers and retrocessionaires whose claims and liabilities are derived from Travelers’ and other Manville insurers’ liabilities might be in a better position to attempt to settle or commute those claims and liabilities.  And, in a more general sense, the decision provides some guidance on how bankruptcy-court channeling-injunctions should be interpreted, and the extent to which, if at all, such injunctions may be collaterally attacked for lack of subject-matter jurisdiction. 

Facts

As many readers may know, from the 1920s until the 1970s Manville reputedly was the largest supplier of raw asbestos and manufacturer of asbestos-containing products in the United States.  Travelers insured Manville during much of that period.  Thousands of law suits were filed against Manville as studies demonstrated that asbestos exposure could cause respiratory disease.  Travelers paid Manville’s litigation costs and worked closely with Manville to learn what Manville knew, to assess risks associated with asbestos exposure, and evaluate potential liability for — and defenses to — asbestos claims. 

The Manville Reorganization

In 1982 Manville filed under Chapter 11 of the Bankruptcy Code in the Southern District of New York, and the Bankruptcy Court was charged with devising “a plan of reorganization for [Manville] which would provide for payment to holders of present or known asbestos health-related claims .  .  .  and [to] those persons who had not yet manifested an injury but who would manifest symptoms of asbestos-related illnesses at some future time.”  Slip op. at 2 (quoting Re Johns-Manville Corp., 97 B.R. 174, 176 (S.D.N.Y. Bkrtcy 1989)).   To that end the reorganization plan created the Manville Personal Injury Settlement Trust (the “Trust”) to pay claims, which were channeled to the Trust.  Since inception the Trust has paid $3.2 billion to over 600,000 claimants. 

During the period leading up to the reorganization, Travelers and other insurers litigated with Manville over coverage issues and were sued by third parties seeking to recover under insurance policies issued to Manville.  The insurers entered into a settlement under which they agreed to pay $770 million into the Trust.  Travelers’ contribution was $80 million.  

The quid pro quo for the settlement was the 1986 Injunction, which provided that upon payment of the settlement funds, “all persons are permanently restrained and enjoined from commencing and/or continuing any suit, arbitration, or other proceeding of any type or nature for Policy Claims against any or all members of the Settling Insurer Group.”  The 1986 Injunction also provided that the insurers were “released from any and all Policy Claims,” which were to be channeled to the Trust.  “Policy Claims” were defined as “any and all claims, demands, allegations, duties, liabilities and obligations (whether or not presently known) which have been, or could have been, or might be, asserted by any Person against .  .  .  any or all members of the Settling Insurer Group based upon, arising out of or relating to any or all of the Policies.” 

The 1986 Injunction was incorporated and made part of the 1986 Order, which established a Plan of Reorganization for Manville.  The 1986 Order was affirmed by the District Court, and ultimately, the United States Court of Appeals for the Second Circuit.   

The Independent Direct Action Claims

Lo and behold ten years later, plaintiffs began asserting claims directly against Travelers in various state courts.  These suits (the “Independent Direct Action Claims”) were not derivative of Manville’s wrongdoing or Manville’s rights under the insurance policies, but alleged independent wrongdoing on Travelers’ part.  Some of the suits were brought under state consumer-protection statutes and alleged that Travelers conspired with insurers and asbestos manufacturers to conceal the dangers of asbestos exposure and to assert a “fraudulent” “state of the art” defense (i.e., that asbestos suppliers and asbestos-containing product manufacturers had no duty to warn).  Other suits claimed that Travelers had violated a common law duty to warn the public about the perils of asbestos exposure or had concealed knowledge of those perils.    

The Bankruptcy Court’s Clarifying Order and Subsequent Proceedings

In 2002 Travelers, relying on the 1986 Injunction moved in the Bankruptcy Court to enjoin the Independent Direct Action Claims.  A temporary restraining order was entered and extended multiple times to allow the parties to mediate their disputes.  The mediation led to Travelers agreeing to pay more than $400 million in additional funds into the Trust to compensate plaintiffs for Independent Direct Action Claims, provided that the Bankruptcy Court entered a clarifying order stating that the Independent Direct Action Claims were barred by the 1986 injunction.  After an evidentiary hearing, the Bankruptcy Court concluded that the Independent Direct Action Claims “necessarily ‘arise out of’ and [are] related to’” the insurance policies under which Travelers defended Manville for asbestos-related claims.   The Bankruptcy Court therefore concluded that they were “Policy Claims” that “are — and always have been – permanently barred” by the 1986 Injunction. 

On August 17, 2004 the Bankruptcy Court entered a clarifying order (the “Clarifying Order”), which provided that the 1986 Injunction barred the Independent Direct Action Claims and “[t]he commencement or prosecution of actions and proceedings against Travelers that directly or indirectly are based upon, arise out of or relate to Travelers['] insurance relationship with Manville or Travelers['] knowledge or alleged knowledge concerning the hazards of asbestos,” including indemnification and contribution claims. 

Certain claimants and the Chubb Indemnity Insurance Company objected to the order and appealed.  The District Court affirmed, but the Second Circuit reversed.  The Second Circuit held that the Bankruptcy Court had continuing jurisdiction to interpret and clarify its orders, and that the literal terms of the 1986 Injunction barred the Independent Direct Action Claims.  But the Second Circuit determined that the Bankruptcy Court did not have jurisdiction to enforce the 1986 Injunction because it had no jurisdiction over the Independent Direct Action Claims.  

The Second Circuit held that Bankruptcy Court lacked jurisdiction when it barred “claims brought against a third-party non-debtor solely on the basis of that third-party’s financial contribution to the debtor’s estate,” since “a bankruptcy court only has jurisdiction to enjoin third-party non-debtor claims that directly affect the res of the bankruptcy estate.”    The Second Circuit said that the Independent Direct Action Claims “do not seek to collect on the basis of Manville’s conduct,” but “seek to recover directly from Travelers, a non-debtor insurer, for its own alleged misconduct.” 

The Second Circuit also found that the original Second Circuit decision affirming the 1986 Injunction did not bar the Court from considering the Bankruptcy Court’s subject matter jurisdiction.  According to the Second Circuit the earlier appeal concerned the authority of the Bankruptcy Court to bar a Manville asbestos distributor from collecting out of Manville’s insurance coverage, a claim derivative of Manville’s own alleged wrongdoing, and therefore did not bar a challenge to the Bankruptcy Court’s subject-matter jurisdiction to enjoin claims that were not derivative of Manville’s alleged wrongdoing.  The Supreme Court granted certiorari and reversed. 

United States Supreme Court Decision

The Independent Direct Action Claims Fell Within the Scope of the 1986 Injunction

The Court agreed with the Second Circuit, District and Bankruptcy Courts that the Independent Action Claims fell within the terms of the 1986 Injunction.  The 1986 Injunction defined “Policy Claim” as any claim, allegation, duty, liability, obligation or demand “based upon, arising out of or relating to” Travelers’ coverage of Manville.  This broad language was not limited to claims derivative of Manville’s own alleged wrongdoing or its rights under the policies.  The Court said that the plain terms of the order were controlling and should have been enforced:  

[W]here the plain terms of a court order unambiguously apply, as they do here, they are entitled to their effect.  If it is black-letter law that the terms of an unambiguous private contract must be enforced irrespective of the parties’ subjective intent, it is all the clearer that a court should enforce a court order, a public governmental act, according to its unambiguous terms.  This is all the Bankruptcy Court did. 

Slip op. at 12-13 (citations and parenthetical quotations omitted). 

The Bankruptcy Court Had Subject-Matter Jurisdiction to Enter the Clarifying Order

The Court viewed the subject matter jurisdiction issue as a relatively simple one:  whether the Bankruptcy Court in 2004 had the subject matter jurisdiction to enter the Clarifying Order.  The Court said “[t]he answer here is easy; as the Second Circuit recognized, and respondents do not dispute, the Bankruptcy Court plainly had jurisdiction to interpret and enforce its own prior orders.”  Slip op. at 13 (citation omitted).  And, noted the Court, “when the Bankruptcy Court issued the 1986 Orders it explicitly retained jurisdiction to enforce its injunctions.”  Id. 

The Court said the Second Circuit erred by holding that the Bankruptcy Court lacked subject-matter jurisdiction to enter the 1986 Injunction.  See Slip op. at 13-14.  The issue of the Bankruptcy Court’s jurisdiction was res judicata and simply not open to collateral attack:  “Almost a quarter-centruy after the 1986 Orders were entered, the time to prune them is over.”  Slip op. at 16.  When the Second Circuit first reviewed the 1986 Injunction on direct appeal, “anyone who objected was free to argue that the Bankruptcy Court had exceeded its jurisdiction, and the District Court or the Court of Appeals could have raised such concerns sua sponte.”  Slip op. at 14.  One asbestos distributor challenged the subject matter jurisdiction of the Bankruptcy Court, albeit in the context of a claim derivative of Manville’s own wrongdoing.  But the failure of that person, and others, to object on the ground that the orders might be construed to bar claims that were not derivative of Manville’s alleged wrongdoing, and the failure of the Second Circuit to raise the issue sua sponte, precluded further, collateral attack on the Bankruptcy Court’s subject matter jurisdiction.    

The Court emphasized that its holding was “narrow.”  See Slip op. at 17.  First, the Court said that “[w]e do not resolve whether a bankruptcy court, in 1986 or today, could properly enjoin claims against nondebtor insurers that are not derivative of the debtor’s wrongdoing.”  Id.  The Court noted that a statute enacted in 1994 “authorized bankruptcy courts, in some circumstances, to enjoin actions against a nondebtor ‘alleged to be directly or indirectly liable for the conduct of, claims against, or demands on the debtor to the extent such alleged liability .  .  . arises by reason of .  .  . the third party’s provision of insurance to the debtor or a a related party,’ and to channel those claims to a trust for payments to asbestos claimants.”  Slip op. at 17 (quoting 11 U.S.C. § 524(g)(4) (A)(ii).)  On direct review of a channeling  injunction, said the Court, a reviewing court would have to assess the injunction in light of the requirements of 11 U.S.C. § 524(g)(4)(A)(ii).  But, in view of the procedural posture of the case, the Court did not express any opinion on whether the 1986 Injunction would have satisfied those requirements.  See Slip op. at 17. 

Second, the Court did not decide whether any particular respondent was bound by the 1986 Order.  One of the respondents, Chubb, claimed below that it was not given constitutionally sufficient notice of the 1986 Order (including the 1986 Injunction) and accordingly, due process considerations absolved it from following the Order.  Since the Second Circuit did not reach this argument, the Court said that it could take it up on remand along with any other objections properly preserved by the respondents.  See Slip op. at 17-18. 

Justice Stevens dissented in an opinion joined by Justice Ginsburg.  While a detailed discussion of the dissenting opinion is outside the scope of this post, the dissent’s principal argument was that the 1986 injunction was intended to cover only claims derivative of Manville’s own alleged wrongdoing.