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House of Lords Hands Down Landmark Reinsurance Decision: Lexington Insurance Co. v. AGF Insurance Ltd.

August 18th, 2009 Asbestos-Related Claims, Environmental Contamination Claims, Follow-the-Settlements/Follow-the Fortunes, House of Lords, Reinsurance Allocation, Reinsurance Claims Comments Off on House of Lords Hands Down Landmark Reinsurance Decision: Lexington Insurance Co. v. AGF Insurance Ltd. By Philip J. Loree Jr.

Part I of a Two-Part Post

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 coterminous, 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 Lexingtonmay, 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.  .  .  .

         

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