Contract clauses need to be water tight to stand up to possible litigation explains Claire Walter.

Insurers seeking to resolve disputes commercially frequently face the following issue: if I pay this contentious claim by way of a compromise (without proceeding to a judgment or arbitration award) can I recover it from my reinsurers? This issue is particularly pertinent when an insurer is facing a potential liability in the US. An insurer often has to choose between proceeding to judgment in court and running the risk of punitive damages being awarded against it (if the insured's claim is successful) or making a reasonable and business-like settlement, which ultimately may not be recoverable.

A key clause in this regard is the “follow the settlements” clause. There have been a number of disputes in relation to this clause over the last 30 years; indeed it has been evolving since the decision in Insurance Company of Africa v SCOR (UK) Reinsurance Company Limited in the mid-1980s through to the Court of Appeal's decision in Assicurazioni Generali SpA v CGU International Insurance Plc in 2004. The latest decision in Faraday Capital Limited v Copenhagen Reinsurance Company again highlights the issue.

In Faraday the follow the settlements clause provided: “This reinsurance is subject to all terms, clauses and conditions as original except as provided for herein, and to follow in all respects the settlements or other payments of whatsoever nature excluding without prejudice and ex-gratia settlements made by the original underwriters arising out of and in connection with the original insurance.”

The settlement agreement between the insured and its insurers (including Faraday) stated “The parties intend to adopt, by way of compromise and without prejudice to or waiver to their respective positions… and without the London Market Insurers admitting liability, either under the subject insurance policies or under any other theory.”The court found that the reference to “without prejudice settlements” in the follow the settlements clause could only be a reference to settlements which were made without admission of liability. As a result Faraday could not recover a settlement in which its liability was not admitted from its reinsurers.

It is an obvious but often overlooked solution that an insurer can, by approaching its reinsurers with a potential settlement at an early stage, ensure its reinsurers are on board and support that settlement before it is made.