Over a year ago we ran a Reinsurance Nuts & Bolts feature entitled “Aggregate Extension Clauses”  (here).  To our considerable surprise, that article was, and remains, one of our more popular ones. 

At the close of the article we said (tongue in cheek):  “If you, the reader, have gotten this far, then perhaps you would like to delve into a discussion of ‘Aggregate Extraction Clauses.’  But these clauses – which conjure up some of the more frightening scenes from Marathon Man (1976) – are better left for another day.  .  .  . ”  Brace yourselves, for we fear that day has arrived.  .  .  .        

B.   What is an Aggregate Extraction Clause? 

To put aggregate extraction clauses in context a very brief review of aggregate cover and aggregate extension clauses is in order.  As discussed in our aggregate extension clause feature (here), policies covering on an aggregate basis are designed to insure principally against the risk that the frequency of relatively small (i.e., low severity) losses will exceed an expected level during a given period.  That’s why products liability risks are frequently written on an aggregate basis – i.e., to protect against the high-frequency, low-severity “Coca-Cola-type”  losses discussed by the English Court of Appeal in Yasuda Fire & Marine Co. of Europe Ltd v. Lloyd’s Underwriting Syndicates No. 209, 356 & Ors., [1998] Lloyd’s Rep. LR. 343 (C.A.). 

The existence and amount of aggregate coverage is determined by aggregating together all losses occurring within a specified period, irrespective of their severity.  That aggregate amount is subject to an aggregate deductible and frequently an aggregate limit.   

Reinsuring aggregate cover on an excess of loss basis presents problems because the amount of each loss or occurrence is generally not high enough to exceed the retention of the excess of loss treaty.  Over a period, however, the accumulated loss covered by the policy might well exceed the retention of the excess of loss treaty were it deemed to arise from a single occurrence.   

We explained in our prior article (here) that the aggregate extension clause effectively extends the aggregate cover of the underlying policy into the excess of loss treaty.   Instead of subjecting each individual loss or occurrence to a separate retention and limit, it allows the aggregation of losses or occurrences when the original policy is written on an aggregate basis.   

The aggregate extraction clause deals with the special problems that may arise when losses covered on an aggregate basis arise out of a single occurrence that has also caused loss under one or more policies that were not written on an aggregate basis.  If – as is sometimes the case — the loss arising out of a single occurrence is of relatively high severity, then it is not the type of loss that either the aggregate policy or the aggregate extension clause was principally designed to cover.   And when the relatively severe loss is lumped into the aggregate cover provided by the reinsurance contract, it eats up capacity that was designed principally to accommodate high frequency, low severity losses. 

At the same time, the cedent is deprived of the ability to accumulate the single-occurrence aggregate-loss with non-aggregate losses on other reinsured policies arising out of the same occurrence.   Thus, while the cedent may get the benefit of clash cover protection on single-occurrence, non-aggregate losses arising out of multiple, non-aggregate policies, it loses that benefit in situations where a portion of the loss arising out of the occurrence is covered on an aggregate basis.   (An excess of loss contract provides clash cover when a single occurrence under the treaty is subject to a single retention and limit, irrespective of the number of original policies that respond to the occurrence.  This type of cover reinsures against the accumulation of net retained liability under multiple, original policies arising from the same occurrence.)   

The aggregate extraction clause addresses both of these problems.   It allows the cedent to extract from aggregate reinsurance coverage a single-occurrence-based loss on policies written on an aggregate basis and combine it with other losses on non-aggregate policies that arise out of the same occurrence.  Brokers and Reinsurance Markets Association (“BRMA”) clause 4A is an example of an aggregate extraction clause: 

As regards liability incurred by the Company for losses on a policy or policies covering on an aggregate basis, the Company shall be permitted to extract from such aggregate policy or policies the amount of loss sustained by it arising from one loss occurrence in order that such loss can be added to the Company’s losses from the same occurrence on [an]other policy or policies, if any.

For the purposes of this Article, the amount of loss from one occurrence on an aggregate policy shall be deemed to be that percentage of the aggregate loss to the Company that the total loss from the particular occurrence bears to the total aggregate losses to the insured or company on the business protected by such aggregate policy. 

To operate the clause requires the following: 

1.  There must be liability incurred by the Company for losses under a policy covering on an aggregate basis;  

2.  Some of that loss (in 1., above) must arise out of a single occurrence for the purposes of the reinsurance contract;

3.  The cedent must have also incurred liability for loss or losses under one or more other original policies that do not provide cover on an aggregate basis; and

4.  Those losses (referred to in 3., above) must arise out of the same occurrence as the aggregate loss referred to in 2., above.  

When all these requirements are met, the cedent may remove from aggregate coverage the loss referred to in 2., above, and combine it with the losses referred to in 3., above. 

Typically, the loss extracted from aggregate reinsurance coverage will be of relatively high severity compared to the other losses falling under the reinsurance contract’s aggregate coverage.   Otherwise there would likely be little reason for the cedent to exercise the aggregate extraction option. 

The second paragraph of the clause provides a formula for determining the amount of aggregate loss deemed to arise out of the single occurrence.  To calculate that amount, our hypothetical ceded-claims person would divide the total amount of loss arising from the occurrence under all reinsured policies by the “total aggregate losses to the insured or company on the business protected by such aggregate policy,” multiply the result by 100, and multiply the resulting percentage figure by the total amount of aggregate loss on the aggregate policy.  The product would equal the amount of loss under that aggregate policy deemed to arise out of the single occurrence and therefore subject to aggregate extraction.  

And that, in a nutshell, is what an aggregate extraction clause is and does.  .  .  .

In Part I of this two-part post (here) we discussed the background and procedural history of Gulf/Transatlantic and how New York’s Appellate Division, First Department resolved the issues of:  (a) the amount of reinsurance accepted by Gerling; and (b) whether the trial court should have granted Gerling’s motion for summary judgment on Gulf’s reformation claim.  This Part II covers the remaining three issues whether:  (a) the 1998 First Union Policy “attached” to the 1999 Treaty; (b) Gerling reinsured the policies Gulf issued to a subsidiary of the General Electric Company; and (c) Gerling established a question of material fact concerning whether it was entitled to rescind the 1999 Treaty.    

Discussion

A.     Did a three-month stub period of the 1998 First Union Corporation Policy “attach” to the 1999 Treaty? 

Gerling sought a declaration that the policy issued to First Union Corporation (the “First Union Policy”) was not covered by the 1999 Treaty, and Gulf sought a declaration that Gerling was “obligated to indemnify Gulf under the 1999 treaty for Gerling’s share of [a settlement Gulf entered into with First Union and for which it sought partial reimbursement under].  .  .  the 1999…Treaty.”  Slip op. at 13.  Both parties moved for partial summary judgment on this claim, and the trial court granted partial summary judgment in favor of Gerling and denied partial summary judgment in favor of Gulf.  The Court held that the trial court should have denied both parties’ summary judgment motions on this claim because neither party met its burden on its motion. 

Effective January 1, 1996 Gulf issued a twelve-month policy to First Union (the “1996 First Union Policy”).  Gulf issued two subsequent policies effective January 1, 1997 (the “1997 First Union Policy”), and January 1, 1998 (the “1998 First Union Policy”).  Gulf and First Union reached an agreement to extend coverage for three months into 1999 under the same terms of the 1998 First Union Policy pending negotiations, but neither Gulf nor Gerling presented any evidence whether the agreement was oral or written, or cited “any evidence bearing on the question of whether the agreement, as opposed to the coverage, was effective as of a date in 1998, as of.  .  .  January 1, 1999 or as of a later time and date in 1999.”  Slip op. at 13.   

The 1999 Treaty was “’[e]ffective January 1, 1999 at 12:01 a.m., Eastern Standard Time, to January 1, 2000 at 12:01 a.m. Eastern Standard Time, as respects losses occurring on policies attaching during the term’“  Slip op. at 12 (emphasis in original; quoting 1999 Treaty).  The “Business Covered” article said that Gulf ceded to its reinsurers a “’quota share participation of the net retained insurance liability of [Gulf] on each risk insured under new and renewal policies becoming effective at and after 12:01 a.m., Eastern Standard Time, January 1, 1999, as respects losses occurring at and after said date covering business classified by [Gulf] as Automobile Residual Value Insurance’”  Slip op. at 12. (emphasis in original; quoting 1999 Treaty).  “Policies” were defined as “’[Gulf's] binders, policies and contracts providing insurance and reinsurance on the business covered under this Agreement.’” Slip op. at 12 (emphasis in original; quoting 1999 Treaty).  The Treaty’s choice-of-law clause provided that “’[t]his Agreement shall be governed by and construed according to the laws of the State of New York.’”  Slip op. at 12 (emphasis in original; quoting 1999 Treaty).

While the Treaty did not define the verb “attaching,” the Court said that “[i]ts meaning.  .  .  seems clear from the above-quoted language of Article I of the treaty, and the parties appear to be in agreement that a policy, be it a “new” or a “renewal” policy, “attach[es]” during the term of the treaty if it becomes effective during the treaty’s term.”  Slip op. at 12.  Thus, concluded the Court, “[r]egardless of whether the agreement is characterized as an ‘extension,’ a ‘new’ or a ‘renewal’ policy, the decisive question is whether that policy attached — i.e., became effective — during the term of the [T]reaty.”  Slip op. at 15-16.  And the resolution of that question turned on whether First Union and Gulf intended “that the agreement become effective on a date during the term of the” Treaty.  Slip op. at 16. 

The problem for both Gerling and Gulf was that neither came forward with any evidence as to what First Union’s and Gulf’s intent was as respects when the parties intended the agreement to extend the term of the policy to be effective:

[I]f Gulf and First Union agreed in 1998 to extend the 1998 policy and intended their agreement to be effective in 1998, Gerling would be entitled to summary judgment.  But if Gulf and First Union agreed in 1999 to extend the 1998 policy, or agreed in 1998 to such an extension but intended their agreement to be effective in 1999, Gulf would be entitled to summary judgment (putting aside, of course, Gerling’s claim that it is entitled to rescission of the 1999 treaty [See Section C., below]).  As neither party alerts us to any evidence presented to Supreme Court bearing on when the agreement was reached or when it was intended to be effective, neither party met its burden and each party’s motion for partial summary judgment should have been denied.

Slip op. at 16.  

B.      Did Gerling agree to reinsure Gulf’s Section B coverage in 1998? 

The Treaties contained two separate coverage types:  Section A, which consisted of RVI policies Gulf issued to various insureds; and Section B, which consisted solely of the RVI policies Gulf issued to a subsidiary of the General Electric Company.  The issues we have discussed thus far have applied to both coverage sections, so we have not yet had occasion to distinguish between the two. 

But Gulf contended that there was an oral agreement between Gerling and Gulf under which Gerling agreed to reinsure Gulf’s section B coverage during the period August 1, 1998 until and including December 31, 1998.  Gulf contended this was a separate agreement from the 1999 Treaty, and therefore proof of its existence was not barred by the integration clause in the 1999 Treaty.  Gerling moved for partial summary judgment on Gulf’s claim, which the trial court granted, and which the Court affirmed. 

The Court did not have to address Gulf’s claim that the agreement was separate from the 1999 Treaty, because it found that Gulf failed to meet its burden to establish the existence of a material issue of fact warranting the denial of summary judgment.  See Slip op. at 17-18.   

Under New York law, said the Court, “’[t]o create a binding contract, there must be a manifestation of mutual assent sufficiently definite to assure that the parties are truly in agreement with respect to all material terms.’”  Slip op. at 17  (quoting Re  Express Indus. & Term. Corp. v New York State Dept. of Transp., 93 N.Y.2d 584, 589 (1999) (here)).   And to defeat summary judgment on a claim predicated on the existence of an oral agreement, the party opposing summary judgment must “’set forth such necessary evidentiary details as when, where or by whom the alleged oral agreement was made or the substance of the conversations.’”  Slip op. at 17 (quoting Apache-Beals Corp. v Intl. Adjusters, Ltd., 59 A.D.2d 1032, 1033 (4^th Dep’t 1977), aff’d, 46 N.Y.2d 888 (1979) (here)). 

Gulf’s evidentiary submissions did not meet this burden, and the Court affirmed the trial court’s grant of partial summary judgment.  Gulf relied on a March 29, 1999 fax from the broker to Gerling’s underwriter which purported to “confirm,’ among other things, coverage under Section B  effective August 1, 1998,” but the fax did not “identify when, where or by whom Gerling agreed to such coverage,” and the underwriter “did not respond to the fax or to a subsequent letter” from the Broker “enclosing for [the underwriter’s] signature an I & L contract for Section B coverage only for the period from August 1, 1998 through December 31, 1998.”  Slip op. at 17 (quotations omitted).  Gerling also relied on other facts, “including Gerling’s receipt of a premium from Gulf consistent with participation by Gerling on Section B coverage for the last five months of 1998.”  Slip op. at 17-18.  While those facts might have established an implied contract, Gulf’s claim was based on an oral contract, and they  did not establish the existence of such a contract.  See slip op. at 17-18.

C.     Did Gerling establish that there was a question of material fact as to whether it was entitled to rescind the 1999 Treaty?     

Rescission was one of the grounds on which Gerling opposed Gulf’s motion for summary judgment concerning Gerling’s indemnification obligations under the 1999 Treaty.  The trial court ruled there was a material question of fact as to whether Gerling was entitled to rescind the 1999 Treaty.  The Court affirmed, albeit on different grounds. 

For the benefit of readers not already familiar with the law governing rescission of reinsurance contracts, a reinsurer need not prove actual – or even constructive – fraud or mutual mistake to rescind a reinsurance contract.  What sets reinsurance contracts apart is the duty of utmost good faith (uberrimae fidei):   To establish a prima facie case for rescission, a reinsurer need only show that pre-contract the cedent failed to disclose material facts concerning the original risk of loss.  Even an innocent nondisclosure may suffice.  See, e.g., Union Indemnity Ins. Co. v. American Centennial Ins. Co., 89 N.Y.2d 94, 106-07 (1996) (copy here).   For a more thorough recitation of the applicable legal principles, and cites to other key cases, see slip op. at 18. 

Gerling’s rescission defense concerned events surrounding the First Union policy, which was discussed in Section A., above.  As discussed, there is a question of fact as to whether that policy was ceded to the 1999 Treaty in the first place.  But Gerling’s rescission defense is predicated on different facts. 

Gerling adduced evidence that, when Gulf solicited Gerling’s participation in the 1999 Treaty, Gulf failed to disclose that L&M – Gulf’s managing general agent (“MGA”) – “was seeking a 360% increase in the premium rate on.  .  .  the First Union policy, even though, in response to inquiries from.  .  .  Gerling’s underwriter, Gulf stated that it was too early in the program to seek premium adjustments from its insureds.”  Slip op. at 18-19.  It was undisputed that:  (a) the First Union Policy – due to expire on December 31, 1998 – accounted for approximately one-half the premium reported under the reinsured RVI program; (b) “L&M was seeking … a substantial premium increase;” and (c) Gerling was not informed of the request prior to agreeing to participate in the 1999 Treaty.  Slip op. at 19. 

The crux of Gulf’s position was that there was no evidence that Gulf knew, at the time of placement, that L&M was requesting a substantial increase in premium for the First Union policy, and that L&M’s knowledge cannot be imputed to Gulf because L&M was acting not as an agent, but as an independent contractor of Gulf.  In support Gulf cited the agency agreement between L&M and Gulf, which expressly recited that L&M acted as an independent contractor,  not an employee of Gulf. 

The Court held that L&M’s knowledge could be imputed to Gulf.  It recited New York’s common-law definition of an agency relationship – one that “results from a manifestation of consent by one person to another that the other shall act on his behalf and subject to his control, and the consent by the other to act.”  Slip op. at 19 (quotations and citations omitted).  While it did not discuss the terms of the Gulf/L&M agency agreement, it said that “a review” of it “makes clear” that “the true relationship between Gulf and L&M with respect to Gulf’s RVI program is that of principal and agent.”  Slip op. at 19.  The Court also rejected Gulf’s fallback argument that there can be no imputation of knowledge from agent to principal for the purposes of a reinsurance nondisclosure claim, noting that “[n]o case cited by Gulf purports so to hold or even to suggest that the common-law rule imputing the knowledge of an agent to the principal is not applicable in the reinsurance context,” and that Gulf provided no “justification for such an exception” or any attempt to “reconcile it with the duty of utmost good faith owed by reinsureds.”  Slip op. at 19-20.   

The Court held that Gerling satisfied its burden to defeat Gulf’s motion for summary judgment, and that the materiality of the nondisclosure presented a question of fact for trial.  Slip op. at 20.

Today we look at a reinsurance case recently decided by the New York Supreme Court, Appellate Division, First Department, New York’s intermediate appellate court for cases originating in New York County (Manhattan) and certain other counties in the New York metropolitan area.  We would not characterize Gulf Ins. Co. v Transatlantic Reins. Co., ___ A.D.3d ___,  2009 NY Slip Op. 06788 (1^st Dep’t Oct. 1, 2009) (copy here), as a ground-breaker, but it involves a number of interesting  issues, including the interpretation and construction of a quota share treaty, course of performance, reformation and rescission. 

Substantive reinsurance cases are a relatively rare breed to begin with (especially in recent years), and cases that discuss a broad range of issues in some depth are rarer still.  That makes Gulf/Transatlantic worthy of some attention, especially to those interested in learning a few reinsurance law basics.  Hat tip to my friend and former colleague James P. Tenney for bringing the case to our attention.

 A few caveats are in order.  First, one of the reasons we do not see that many substantive reinsurance cases arising out of reinsurance treaties (as opposed to facultative certificates) is because arbitration clauses have historically been the norm in the treaty context.  Disputes like those in Gulf/Transatlantic are therefore more commonly resolved in arbitration.  That may change in the future as attitudes about the desirability of arbitration as a method to resolve reinsurance disputes appear to be in flux (let’s hold that thought for another day). 

Second, as most reinsurance lawyers know (or quickly learn), courts usually decide reinsurance cases according to the strict rules of law, while arbitration panels generally do not, particularly when there is an honorable engagement clause in the contract.  (See our discussion of honorable engagement clauses, here.)   Never assume that the outcome of a reinsurance case in arbitration is going to mirror one a court would reach, although courts and arbitrators may occasionally reach the same or similar conclusions based on the same set of facts.          

Third, given the number of issues raised in the case, and their somewhat technical nature, we thought it best simply to discuss what they were, how they arose and how the Court ruled on them, rather than engaging in a critical analysis or providing our thoughts on how a typical arbitration panel might have decided them.  We simply attempt to make the opinion a little easier for reinsurance professionals and others interested in the subject to digest.   

Part I of this two-part post sets forth the background, and deals with two issues, both of which relate to the amount of reinsurance accepted by the reinsurer.  One involves contract interpretation, the other, reformation.  Part II of this post will tackle three issues:  one involving whether a stub period of a policy was reinsured by one of the treaties, one concerning whether the reinsurer agreed to reinsure both coverage types specified in parts A and B of the treaty, and another concerning whether the reinsurer’s rescission claim raised a question of fact sufficient to defeat summary judgment.  

Background

Beginning in 1996 Gulf Insurance Company (“Gulf”) wrote automobile residual value insurance (“RVI”) policies.   Gulf obtained reinsurance for these policies, including a series of quota share treaties in which various reinsurers participated.  As is frequently the case, each treaty was evidenced by a treaty wording, and an interest & liabilities agreement (“I & L”), which set forth each reinsurers’ participation in the treaty.  Gerling Global Reinsurance Corporation of America (“Gerling”) (n/k/a “GLOBAL Reinsurance Corporation of America”) participated only in the treaties effective 1999, 2000, and 2001. 

In March 2000 a Gulf policyholder, First Union Corporation (“First Union”), commenced a coverage action against Gulf, claiming $418 million was due it under its RVI policy.  In 2003 Gulf and First Union settled the coverage action for $266 million and Gulf billed its 1996, 1997 and 1998 reinsurers for what it claimed were their respective shares of the settlement.  Gerling was not billed because it did not participate in any of those treaty years.  The reinsurers refused to pay and Gulf commenced an action in Supreme Court, New York County (New York County’s trial court of general jurisdiction) to collect the disputed reinsurance balances.

In March 2004 Gulf billed a portion of the settlement to reinsurers participating in treaties in later years, including the treaty effective 1999 in which Gerling participated.  Gerling refused to pay and Gulf commenced an action against it in Supreme Court, New York County.  Gerling, in turn, commenced a separate action in the same court seeking rescission of the treaties effective 1999, 2000 and 2001, and, in the alternative, certain declaratory relief.  Pretrial proceedings in these two actions were consolidated. 

After discovery, the parties filed cross-motions for summary judgment.  The issues raised by the motions for summary judgment, and their resolution by the trial and appellate courts, are discussed in detail in this two-part post (in the order in which they were addressed by the Court).      

Discussion

A.  What Amount of Reinsurance did Gerling Accept? 

A key issue informing the resolution of the summary judgment motions was whether Gerling’s percentage participation in the 1999 and 2000 Treaties, as stated in the I & Ls, was intended to be a percentage participation of a 45% quota share of Gulf’s gross liability under the applicable RVI policies, or simply a percentage participation of Gulf’s gross liability under those policies.  The Court held that Gerling accepted 6.5% of 45% of Gulf’s gross liability under the policies reinsured by the Treaties, not 6.5% of 100% of that gross liability. 

Most versed in reinsurance law and practice would correctly observe that this holding was uncontroversial.  But there was nevertheless some support for Gulf’s position based on the maxim “loss follows premium.” 

 Let’s take a look at what the Treaties and I & Ls provided as respects Gerling’s participation.  As the 1999 and 2000 Treaties were identical, we need only consider the 1999 Treaty wording and I & L (collectively, “the Treaty”).  The applicable “Business Covered” section of the Treaty wording said that “[t]he Company [Gulf] shall cede to the Reinsurer [defined to include all participating reinsurers collectively] and the Reinsurer shall accept from the Company a 45% quota share participation of the net retained insurance liability of the Company on each risk insured.”  “Net retained insurance liability” was defined as “the remaining portion of the Company’s gross liability on each risk reinsured under this Agreement after deducting recoveries from all reinsurance, other than the reinsurance provided hereunder and the reinsurance provided in the Company Retention Article.”  The “Company Retention Article” said that “[t]he Company will maintain for its net account a 55% participation in the business reinsured hereunder.  However, at its discretion, the Company may purchase facultative reinsurance.”

Let’s pause briefly here to deal with a wrinkle in the contract language that did not affect the outcome, but which might otherwise cause confusion.   The definition of “net retained insurance liability” set forth above suffered from what presumably was a scrivener’s error.  It provided for the deduction of “recoveries from all reinsurance, other than the reinsurance provided hereunder and the reinsurance provided by the Company Retention Article.”   Slip op. at 4 (emphasis added).  Where, as here, Gulf’s retention was expressed on a pro-rata basis (55%), not deducting inuring facultative reinsurance for the purposes of calculating net retained insurance liability would result in Gulf effectively receiving additional quota share reinsurance on loss that was already reinsured 100% by inuring facultative reinsurance.  The parties therefore agreed that “net retained insurance liability” simply meant “the remaining portion of the Company’s gross liability.  .  .  after deducting recoveries from all reinsurance, other than the reinsurance provided hereunder.”     

Turning back to the rest of the contract, the I & L stated that “[Gerling] shall have a 6.50% participation … in the Interests and Liabilities of the Reinsurer as set forth in the Agreement attached hereto entitled Quota Share Reinsurance Agreement.”  The Treaty wording said “Gulf shall cede to the Reinsurer and the Reinsurer shall accept from [Gulf] a 45% quota share participation of [Gulf's] net retained insurance liability … on each risk insured.”  These two documents, taken together, showed that Gerling accepted a 6.5% participation in the 45% quota share of Gulf’s net retained insurance liability.  The Court said that whether or not Gulf had inuring reinsurance, “[t]he crucial and unambiguous fact is that Gerling has a 6.5% participation in the 45% quota share and that quota share cannot be equal to 100% of Gulf’s net retained insurance liability.”  Slip op. at 7.  

The premium provisions of the I & L buttressed this conclusion.  They stated that “[Gulf] shall pay [Gerling] 6.50% of all premiums due … the Reinsurer in accordance with the provisions of the Agreement [the Treaty] attached.”  (emphasis added)  The Treaty wording, in turn, stated that “[Gulf] shall pay to the Reinsurer 45% of [Gulf's] original gross net written premium … in respect to its net retained insurance liability.”  And the Treaty defined “original gross net written premium” as “gross written premium less returns, cancellations, inuring excess of loss reinsurance and facultative reinsurance, if any.” 

So putting aside for the moment any extrinsic evidence, the I & L and Treaty wording provided that Gerling was entitled to a 6.5% share of 45% of the “original gross net written premium.”  That, in turn, meant that Gerling accepted a 6.5% share of “a 45% quota share participation of the net retained insurance liability of the Company on each risk insured.”  Slip op. at 6-7.  

But the extrinsic evidence arguably cast matters in a different light.  First, Gulf had not procured any inuring reinsurance.  Second, Gulf paid Gerling – and Gerling accepted without objection — 6.5% of 100% of the “original gross net written premium.”  Third, as Gulf pointed out, “when all of the reinsurers’ individual participations under their I & L contracts were added up (TRC 12.5%; XL 11.25%; Odyssey 11.25%; and Gerling 10%), they total the 45% share of Gulf’s gross liabilities that the .  .  . reinsurers agreed collectively to accept under the [Treaty].”  Slip op. at 5.  

Gerling explained “’that its acceptance of the [higher amounts of premium] was based upon its mistaken acceptance of the broker’s representations to its bookkeeping department that the amounts were correct.’”  Slip op. at 6 (quoting trial court).  Gerling also pointed out that “because the premium was received after — not contemporaneously with — execution of the contract documents, its receipt and related documents of its bookkeepers ‘do not reflect any interpretation of treaty wordings.’”  Slip op. at 6 (quoting trial court) (emphasis added). 

While Gulf’s extrinsic evidence was consistent with Gulf’s position that Gerling accepted a 6.5% participation of Gulf’s gross liability under the reinsured RVI policies, it contradicted what the Court found to be the clear and unambiguous provisions of the I & L and Treaty wording.  New York law does not permit consideration of extrinsic evidence to vary the terms of clear and unambiguous contract language.  Because the I & L and Treaty provisions were unambiguous, the Court found that the conflicting extrinsic evidence was irrelevant.  Slip op. at 7 (citation omitted).  Accordingly, the Court held that the trial court “correctly concluded that the relevant provisions of the 1999 and 2000 treaties and I & L contracts unambiguously state Gerling’s percentage participation as a percentage of all risk assumed by the reinsurers.”  Slip op. at 8.  

 B.  Did the Trial Court Properly Grant Summary Judgment on Gulf’s Reformation Claim?

In the event it lost on the amount of reinsurance accepted issue, Gulf sought, in the alternative, reformation of the Treaties to provide that Gerling accepted a 6.5% share of Gulf’s gross liability under the reinsured policies.  The predicate for reformation was mutual mistake.  The trial court granted Gerling’s motion for summary judgment, but the Court reversed, finding that Gulf had adequately established its burden to show that there was a material issue of fact precluding summary judgment.  Slip op. at 12.  

Given its finding that the Treaties clearly and unambiguously provided that Gerling accepted a 6.5% share of 45% of Gulf’s gross liability, the Court had to square this case with two prior New York Court of Appeals decisions holding that a party resisting summary judgment of a claim for reformation of a clear and unambiguous contract between sophisticated parties must come forward with “unequivocal and persuasive evidence of mutual mistake”  Slip op. at 8, 8-10; see Chimart Assoc. v Paul, 66 N.Y. 2d 570 (1986) (here);  Backer Mgt. Corp.v Acme Quilting Co, 46 N.Y. 2d 211 (1978). 

Gulf was required to show that the mutual mistake existed at the time the contract was executed.  But the Court found that, while “[h]ow the parties perform a contract necessarily is manifested after execution of the contract…,” “their [subsequent] performance is highly probative of their state of mind at the time the contract was signed.”  Slip op. at 10.   The Court acknowledged that “neither Gulf’s course-of-performance evidence nor the Gerling ‘Account Instructions’ conclusively establish mutual mistake.”  Slip op. at 11.  And if Gerling’s version of the events was “accepted, Gulf’s course-of-performance evidence could be viewed as equivocal,” because “the interpretation of a contract manifested by a party’s performance ‘must be the conscious action of a responsible agent of the party against whom the interpretation is urged[.]’”  Slip op. at 11 (quoting Jansen v United States, 344 F.2d 363, 369 (Ct. Cl. 1965)): 

 Gerling countered Gulf’s evidence with an affidavit from Alice Belkin, an assistant secretary and account analyst in Gerling’s accounting department who was involved in reviewing and booking premiums and losses reported to Gerling by Gulf through its broker, Guy Carpenter. According to Ms. Belkin, she recorded in Gerling’s books premium and loss experience relating to the reinsurance agreements with Gulf in accordance with assurances she received from Guy Carpenter, not on the basis either of any review by her of the terms of the treaties and I & L contracts or of discussions with Gerling underwriters knowledgeable about those terms. Referring to Ms. Belkin’s affidavit, and apparently accepting the truth of its factual assertions, Supreme Court wrote that “Gerling explains that its acceptance of the [higher amounts of premium] was based on its mistaken acceptance of the broker’s representations to its bookkeeping department that the amounts were correct.”

Slip op. at 11.  

But, for the purposes of summary judgment, the trial court should have taken Gulf’s version of the facts as true, and not effectively have ruled that Gerling’s evidence was more credible than Gulf’s: 

The trier of fact might have a favorable impression of Ms. Belkin’s credibility.  But it also might regard testimony in accordance with those factual assertions as a deus ex machina, appearing too suddenly and conveniently after Gulf ceded the First Union claim to its reinsurers. Gulf contends, and we agree, that from all the evidence it submitted, a fact finder reasonably could conclude that a multibillion dollar reinsurance company does not collect the premium and pay losses for more than three years without any internal controls whatsoever to ensure that the substantial amounts it receives and pays are consistent with the terms of the underlying contracts.  As a panel of the Third Department stated in a similar context, “we think it cannot be said on this record that a reasonable person could by no rational process find the evidence of mutual mistake to be clear, positive and convincing.  Summary judgment on affidavits should not be granted where there is any doubt as to the existence of triable issues of fact.

Slip op. at 11-12 (citations omitted). 

Accordingly, the Court reversed the trial court’s grant of summary judgment, holding that “Gulf was not required to come forward with incontrovertible proof of mutual mistake. It met the heavy burden it was required to shoulder of coming forward with ‘unequivocal evidence of mutual mistake’ in evidentiary form.”  Slip op. at 12. 

In Part II we discussed the remaining three issues considered by the Court, so stay tuned.  .  .  .

I remember when I first heard the term “aggregate extension clause.”  I was a couple of years out of law school and just getting my feet wet in reinsurance law and practice.  Naturally, I had no idea of what an aggregate extension clause was or, for that matter, why someone would want to call something an “aggregate extension clause” in the first place, unless the principal objective was to confuse the reader.  I envisioned some densely worded, obtuse, complex and hopelessly confusing provision designed to accomplish some obscure yet important purpose, the relevance of which was surely beyond my ken.  I decided  that I could read up on the clause, or ask a colleague about it, but I feared that the explanation – written or oral – would be at least as difficult to decipher as the clause itself, and probably more so.  So I did my best to avoid even having to think about aggregate extension clauses — let alone deal with them — for as long as possible.  

Eventually, of course, I had to face my fears and grapple with the seemingly elusive concept of “aggregate extension.”  I quickly learned that my initial assessment was only partly correct:  aggregate extension clauses are indeed densely worded, but the purpose of the clause is far more straightforward than I once assumed.  Once I learned a little bit about the clause, I realized (or at least thought) that I could impress – or perhaps awe – my less experienced colleagues with it, and might even be able to use it to show my more experienced colleagues that I knew something about reinsurance.   While I can’t say I obtained as much mileage out of my newfound knowledge as I expected,  I am nevertheless glad that I invested a little time into learning about aggregate extension clauses.    

In this Reinsurance Nuts & Bolts post we briefly discuss in very simple and basic terms what an aggregate extension clause is, and what it does.  We also provide the reader with an example of some of the operative wording of an aggregate extension clause.  Our discussion is not intended to be comprehensive; if anything, it is oversimplified.  But it should give the reader a basic understanding of the topic.   

Extending the Concept of Aggregate Cover into the Excess of Loss Treaty

Excess of loss reinsurance agreements typically provide cover on an each and every loss or each and every occurrence basis.  They provide reinsurance for each loss or occurrence in an amount in excess of a specified retention per loss or occurrence up to a specified limit per loss or occurrence.  Excess of loss treaties often cover a wide range of the cedent’s underlying policies, and their retentions and limits are frequently set to respond to losses of moderate to high severity (of course, some are specifically designed to address catastrophic losses or low severity losses).  Losses or occurrences that do not meet the retention (sometimes referred to as the attachment point) are not covered. 

All of this works quite well when the underlying insurance contract provides insurance on an each and every loss or each and every occurrence basis for losses of moderate to high severity.  But it does not work well when the underlying insurance is written on an aggregate basis. 

Aggregate cover is generally designed to insure against the risk that there will be a higher frequency of low severity losses than the insured expects.  The dollar amount of an individual loss or occurrence does not determine whether the contract provides cover or the dollar amount of the cover.  The existence and amount of cover is determined by aggregating together all losses occurring within a specified period, irrespective of their severity.  The aggregate amount is subject to an aggregate deductible and frequently an aggregate limit.  The risk insured is that the frequency of relatively small losses will exceed an expected level during the period, although larger losses may also fall within the scope of the cover.   

Reinsuring aggregate cover on an excess of loss basis presents problems because the amount of each loss or occurrence is generally not high enough to exceed the retention of the excess of loss treaty.   Over  a period, however, the aggregate amount of loss covered by the policy may well exceed the retention of the excess of loss treaty if the aggregate amount of loss were deemed a single loss or occurrence for the purposes of the treaty.  

The aggregate extension clause effectively extends the aggregate cover of the underlying policy into the excess of loss treaty.  Instead of subjecting each individual loss or occurrence to a separate retention and limit, it allows the aggregation of losses or occurrences when the underlying cover is written on an aggregate basis. 

Aggregate extension clauses come in various forms and may be interpreted in various ways.  Here is the relevant portion of an aggregate extension clause used in the London Market, which was construed by the English Court of Appeal (Civil Division) in Yasuda Fire & Marine Co of Europe Ltd v. Lloyd’s Underwriting Syndicates No. 209, 356 & Ors., [1998] Lloyd’s Rep. LR. 343 (C.A.) (available here): 

As regards liability incurred by the reinsured for losses on risks covering on an aggregate basis, this agreement shall protect the reinsured excess of the amounts as provided for herein in the aggregate any one such aggregate loss up to the limit of indemnity as provided for herein in all any one such aggregate loss.

Notwithstanding that this agreement is effected on a losses occurring during the period basis, all aggregate original policies coming within the scope of this agreement shall be covered on a risks incepting during the period basis.  Furthermore, where an original aggregate policy is issued for limits relevant to an overall period greater than 12 months with an inception date during the period of this agreement then such original policy shall be covered hereunder for the whole of its period notwithstanding any annual resignature. Long term policy periods with annual limits are to be treated as each annual period being a separate policy with the anniversary date being regarded as the inception date.   .   .   .   

In Yasuda the English Court of Appeal (Civil Division) explained the purpose and intent behind aggregate extension clauses. Yasuda illustrates that the key purpose of an aggregate extension clause is “to provide effective reinsurance where the reinsured is covering aggregated losses exceeding certain limits” by “carr[ying] through into the reinsurance policy the same principle of aggregation as exists in the original policy which has been written ‘on an aggregate basis:’”

The aggregate extension clause has been in existence in one form or another for some 60 years.  It is a standard clause in the sense that it is one of the clauses with a more or less standard wording which is then incorporated into reinsurance contracts.  The … [most] important [purpose of the aggregate extension clause] is to provide effective reinsurance where the reinsured is covering aggregated losses exceeding certain limits. The classic example used to illustrate this is drawn from the products liability field and what are called ‘Coca Cola losses’.  A producer such as Coca Cola sells large numbers of articles each of which involves a small product liability risk, as for example from the bursting of a defective bottle.  Statistically in any given year there will be an anticipated number of claims which the producer has to pay.  The producer is concerned not only that any one of these claims may substantially exceed the norm but also the number of claims that have to be paid in any given period may exceed the norm.  Therefore the producer may take out products liability insurance which covers him against the risk of having to payout more than a certain sum in the aggregate in respect of such claims.   This is a simple and uncontroversial example of an insurance covering the assured ‘on an aggregate basis’.  Similarly, it provides an uncontroversial illustration of the operation of the aggregate extension clause in a reinsurance policy.  Under the ‘Coca Cola’ type of cover, once the aggregate excess has been reached, the original insurer becomes liable to pay every claim that comes in during the relevant period (possibly subject to an overall policy limit). The aggregate extension clause enables the original insurer to pass on those liabilities, in the aggregate, to the reinsurer.  It carries through into the reinsurance policy the same principle of aggregation as exists in the original policy which has been written ‘on an aggregate basis’.

Id. (emphasis added; citations omitted)

Aggregate Limits and an Aggregate Retention do not Necessarily Mean the Underlying Cover was Written on an Aggregate Basis

One important thing to keep in mind about aggregate extension clauses is that they come into play only when the underlying insurance is written on an aggregate basis.  That the underlying policy has aggregate limits and even an aggregate deductible does not necessarily mean that the cover is written on an aggregate basis.  As the English Court of Appeal in Yasuda pointed out, the underlying cover is not written on an aggregate basis where the insured’s right to recover is predicated on each individual loss or occurrence satisfying a deductible or retention, even where the underlying cover also contains an aggregate deductible and an aggregate limit: 

In the present cases the question arising under the  aggregate extension clause has to be considered in relation to the original policies issued by the reinsured all of which included terms imposing an each and every claim excess and limit.  Thus, as part of the establishment of the original assured’s right to recover from the reinsured, the original assured had to demonstrate that each individual claim exceeded the excess or ‘retention’ figure stipulated.  If it did not, then no claim could be made under the original cover against the reinsured.  If it did, the right of recovery of the original assured was then confined to the amount of the excess but was subject also to a per claim limit. It is thus an essential feature of the cover provided by the reinsured to those it was insuring that each claim satisfy an each and every loss criterion.  Whatever else one may think, this is the antithesis of providing cover on an aggregate basis.  .  .  . 

.  .  .  . 

The argument of Yasuda and the other reinsureds is that notwithstanding the each and every loss clauses in the original cover, there were other features of the cover provided by one or more of the original insurance policies, which nevertheless justified the conclusion that the original cover was provided on an aggregate basis.  Thus, consistently with their arguments to which I have earlier referred, Yasuda rely upon the fact that the original cover was in all cases subject to an overall limit, maybe with a right of reinstatement and was in most cases also subject to an aggregate retention which had to be exceeded before any claim could be made under that cover.  They rightly point out that such provisions would be expected to be features of cover on an aggregate basis. Thus, in the Coca Cola type policy to which I have referred earlier, the claims qualify for recovery under the policy because they in the aggregate exceed a certain level.  It is a feature of that type of policy that the risk which is being insured is one which deals with the aggregation of claims and is not concerned with their individual size.  But this serves to demonstrate that the feature upon which the reinsured seek to rely in the present cases does not suffice to demonstrate that the cover was ‘on an aggregate basis’.  It leaves unanswered the question whether it is then necessary to look at each individual claim and ask whether it individually exceeds a certain limit.  If it is necessary to do this, then it no longer remains possible to say that the cover is on an aggregate basis:  it is on an each and every claim basis.

.  .  .  . 

In the relevant policies of original insurance, once the aggregate retention has been exceeded, the claim still has to be looked at on an individual basis to see whether it individually exceeds a certain sum and, if it does, the right to recover from the original insurer is defined by reference to a per claim excess and limit.  Where that is the case, the basis of cover is not on an aggregate basis: it is upon an each and every loss basis.  I do not accept the argument of the reinsureds that any element of aggregation trumps the other features of the cover. It is the basis of the  cover which has to be looked at.  This may involve an evaluation of the features or characteristics of the cover but it does not permit one element of aggregation to be pointed out and the remainder of the features of the cover to be ignored. I accept the submission of the reinsurers that cover which requires criteria to be applied to each and every loss and imposes an each and every loss excess and limit cannot be said to be cover provided on an aggregated basis.

Id.   

If you, the reader, have gotten this far, then perhaps you would like to delve into a discussion of ”Aggregate Extraction Clauses.”  But these clauses – which conjure up some of the more frightening scenes from Marathon Man (1976) – are better left for another day.  .  .  .

In today’s Nuts & Bolts post we take a brief look at honorable engagement clauses, which are sometimes referred to as “honorable undertaking” clauses.  Honorable engagement clauses are, for practical purposes, a species of choice of law clause.   Generally, they confer upon arbitration panels a degree of freedom to depart from the strict rules of law and evidence, and to interpret the contract as an honorable engagement rather than literally according to its terms.  They are premised on the now arguably outmoded historical concept that a reinsurance contract is more than a contract, but an honorable undertaking, a deal that  is closed when the parties shake hands over a cocktail (or three), and one by which the parties are honor-bound to abide.  They also recognize that reinsurance is an arcane business with its own peculiar set of customs, practices and norms, and that, if the parties so agree, arbitrators should be reasonably free to apply these norms in deciding a case, even if a court faced with the same facts would or could not. 

Honorable engagement clauses are more common in older reinsurance contracts than in those written today.  But many reinsurance disputes arise out of long-tail asbestos or environmental claims arising out of decades-old contracts, a great many of which contain these clauses.  And the clauses can have some significant implications in those disputes.

Some Examples of Honorable Engagement Clauses

Honorable engagement clauses are typically found within the arbitration clause itself, but occasionally appear in a separate clause.  Some contracts contain both honorable engagement clauses and ordinary choice-of-law clauses, which designate a particular jurisdiction’s law as governing.    

Honorable engagement clauses come in various types and may be interpreted in various ways.  We shall focus on examples found in the Brokers and Reinsurance Market Association (“BRMA”) arbitration clause wordings, which are available, along with other BRMA standard clauses, here. 

BRMA arbitration clauses 6C, 6E and 6I contain the following honorable engagement clauses, which one might term “classic.”  Each confers upon the arbitration panel a good deal of latitude in interpreting the contract and departing from otherwise applicable law: 

BRMA 6 C

The arbitrators shall interpret this Contract as an honorable engagement and not as merely a legal obligation; they are relieved of all judicial formalities and may abstain from following the strict rules of law.

BRMA 6 E

All arbitrators shall interpret this Contract as an honorable engagement rather than as merely a legal obligation.  They are relieved of all judicial formalities and may abstain from following the strict rules of law. They shall make their award with a view to effecting the general purpose of this Contract in a reasonable manner rather than in accordance with a literal interpretation of the language.

 BRMA 6 I

The arbiters and the umpire are relieved from all judicial formalities and may abstain from the strict rules of law, interpreting this Contract as an honorable undertaking rather than as a merely legal obligation. 

 When honorable engagement clauses are contained in contracts that also contain choice-of-law clauses, interpretive tension may result.  The honorable engagement portion of the arbitration clause says that the arbitrators do not have to apply the “strict” rules of law, but the choice of law provision says that a particular body of law nevertheless applies: 

BRMA 6 J

The Arbiters shall consider this Contract as an honorable engagement rather than merely as a legal obligation and they are relieved of all judicial formalities and may abstain from following the strict rules of law.  .  .  . 

Any arbitration proceedings shall take place at a location mutually agreed upon by the parties to this Contract, but notwithstanding the location of the arbitration, all proceedings pursuant hereto shall be governed by the law of the state in which the Company has its principal office.

Certain honorable engagement clauses relieve the interpretive tension by saying that the choice-of-law provision supplies the governing law only to the extent that the arbitrators look to the law for guidance:

 BRMA 6 L

The panel shall be relieved of all judicial formality and shall not be bound by the strict rules of procedure and evidence. Unless the panel agrees otherwise, arbitration shall take place in  (City, State),  but the venue may be changed when deemed by the panel to be in the best interest of the arbitration proceeding. Insofar as the arbitration panel looks to substantive law, it shall consider the law of the State of __________.  .  .  .  The panel shall interpret this Contract as an honorable engagement rather than as merely a legal obligation and shall make its decision considering the custom and practice of the applicable insurance and reinsurance business as promptly as possible following the termination of the hearings. 

Closely related to honorable engagement clauses are clauses that might more accurately be referred to as “custom and usage” or “custom and practice” clauses.  These clauses may relieve the arbitrators from following strict judicial formalities and rules of evidence and procedure, but do not necessarily authorize them to refrain from following applicable law.   They do, however, command the arbitrators to make their decision with regard to applicable custom, practice and usage, and in that sense they are not unlike honorable engagement clauses.  Sometimes they, too, appear in contracts containing choice-of-law clauses.  Here are some examples: 

BRMA 6 P

The Board shall make a decision and award with regard to the terms expressed in this Agreement, the original intentions of the parties to the extent reasonably ascertainable and the custom and usage of the property and casualty insurance and reinsurance business, which decision and award shall be in writing and shall state the factual and legal basis for the decision and award.  .  .  .  

 BRMA 6 R

The Panel shall be relieved from applying the strict rules of evidence and/or procedure and shall make its decision based on the custom and practice of the insurance and reinsurance business with a view toward effecting this Contract in a reasonable manner. 

 BRMA 6 A

The arbitrators shall not be obliged to follow judicial formalities or the rules of evidence except to the extent required by governing law, that is, the state law of the situs of the arbitration as herein agreed; they shall make their decisions according to the practice of the reinsurance business. 

BRMA 6 B

The board shall make its decision with regard to the custom and usage of the insurance and reinsurance business.  The board shall issue its decision in writing based upon a hearing in which evidence may be introduced without following strict rules of evidence but in which cross-examination and rebuttal shall be allowed. 

 BRMA 6 F

The Arbitrators or Umpire as the case may be shall determine any reference in accordance with current reinsurance market practice pertaining during the period of this Contract.  .  .  .

The Court of Arbitration shall take place in New York and the law applicable to both the aforesaid Contract and this arbitration clause shall be the law of New York State.

Here is an example of a custom and usage clause with a choice of law clause that could be interpreted as authorizing the arbitrators to depart from otherwise applicable substantive law (as opposed to simply evidence and procedural law):    

BRMA 6 O

The panel shall be relieved of all judicial formality and shall not be bound by the strict rules of procedure and evidence. Unless the panel agrees otherwise, arbitration shall take place in  (City,  State) , but the venue may be changed when deemed by the panel to be in the best interest of the arbitration proceeding. Insofar as the arbitration panel looks to substantive law, it shall consider the law of the State of _________.  .  .  .

 The panel shall make its decision considering the custom and practice of the applicable insurance and reinsurance business as promptly as possible following the termination of the hearings.   .  .  . 

Some Key Points to Remember

There are at least three important points to keep in mind about honorable engagment and custom and usage clauses, and this list is not intended to be exhaustive.  First, while the clauses may confer varying degrees of discretion upon arbitrators to depart from the strict rules of law and to eschew strict interpretation of the contract language, they are not limitless in scope.  While the limits of the authority they confer will depend upon the wording of the clause and that of the rest of the contract — and those limits may, indeed, be blurry — the arbitrators’ decision must have a colorable basis in the contract and the applicable law.  In considering whether the award has a colorable basis, however, some interesting questions may arise concerning whether the interpretation of the honorable engagement clause itself is a question of arbitrability, which ordinarily a court must decide, or a question for the arbitrators, which the court must review deferentially like any other arbitrator determination.      

Second, honorable engagement clauses may have important implications on how each side presents its case to the arbitrators.  They can provide affirmative support for arguments that may lack support in the contract or applicable law, but which are based on equity and fairness, or on what the advocating party believes the arbitrators will consider the applicable customs, practices, and norms of the reinsurance industry.  By the same token, the party opposing such an argument must be prepared to deal with the implications of the honorable engagement clause, and to argue that its position is supported not only by the elusive concept of “honorable engagement,” but also by the terms of the contract and applicable law.  To the extent that one party may sense that the other has the better side of the ”honorable engagement” debate, that party may be able to assert legitimately that the clause cannot be interpreted to permit the result advanced by the other party, and to reserve its rights to challenge an award based on that interpretation. 

Third, these clauses can have important implications for Federal Arbitration Act satellite litigation.  For example, if an award is challenged on the ground that the arbitrators exceeded their authority by manifestly disregarding the law or by rendering a decision that did not draw its essence from the reinsurance contract, the honorable engagement clause may provide the party defending the award with a powerful argument for rejecting the challenge.  While the other party may argue that the clause is not broad enough to justify the award, it will have to demonstrate that the interpretation of the scope of the honorable engagement clause raises a question of arbitrability that must be determined by the court.  Otherwise, if there is even a colorable basis for the arbitrators’ interpretation of the clause itself, the reviewing court will have no choice but to accept it, even if it would have interpreted the clause differently.  And even if the court interprets the clause de novo, it may find it broad enough to authorize the award.