If ever there was a case that truly underlined the importance of contract certainty - and of issuing a policy in a timely fashion - it is the ongoing battle between insurers and World Trade Center Properties. In the first of a two part series, Peter Schwartz explains the latest twist in the tale.

The outcome of SR Interational Business Insurance Co v World Trade Center Properties LLC is a sea change in an ongoing saga.

The Second Circuit Court of Appeals in the US recently gave judgments following appeals from two separate jury trial verdicts to determine whether the coordinated terrorist attacks of 11 September 2001 constituted one or two occurrences under multiple insurance contracts. The background factual scenario is now well known. The parties were various property interests in the WTC ("Silverstein") and many insurers who provided multi layered coverage, underwritten on a "per occurrence" basis. The two phases of the litigation concerned whether Silverstein could recover in excess of $7bn.

The "occurrence" debate

Never has the word "occurrence" been so significant. With one exception, none of the insurers had issued the final policy or wording. Instead, temporary binders provided interim coverage until a final policy was issued. Unfortunately, since the binders left the term "occurrence" undefined, the Second Circuit was required to conduct an individualised inquiry to determine what each pair of contracting parties - Silverstein and each insurer - intended the word "occurrence" to mean, in each binder/slip, applying New York law.

At Phase I, the jury found that nine of the 12 insurers and all 20 Lloyd's syndicates were bound to Willis's specimen "broker" form (WilProp form). The other three insurers who did not succeed in Phase I had their claims adjudicated in Phase II, alongside six US insurers (who were not involved in Phase I) who conceded that their coverage was not governed by the WilProp form. The Phase II jury decided that all nine of these insurers issued binders, (and with Allianz, a final policy), that contemplated a two-occurrence basis.

In the appeals, Silverstein challenged the judgments entered against them following Phase I. The Phase II insurers challenged the judgments entered against them following Phase II. The Second Circuit consolidated the parties' appeals and heard oral arguments in tandem. In the lead judgment, Judge John Walker Jr, remarked wryly that both sides claimed they were entitled to judgment as a matter of law and both appealing sides argued that the judgments against them were secured by a variety of evidentiary errors and mistaken jury instructions. However, neither side admitted that any errors contributed to the judgments in their favour.

The Second Circuit reminded themselves that: "In deciding which terms are to be implied in a binder, reliance may be placed on the extrinsic evidence of the parties' pre-binder negotiations. In particular... any policy form that was exchanged in the process of negotiating the binder, together with any express modifications to that form, is likely to be the most reliable manifestation of the terms by which the parties intended to be bound while the binder was in effect. In the absence of such a policy form underlying the negotiations or sufficient extrinsic evidence of the negotiations to determine the parties' intentions, the terms to be implied would likely be the customary terms of the insurer's own form."

The Second Circuit recognised that the underwriting submission provided to many insurers was a copy of the Wilprop form. This was intended as a starting point for the parties as they negotiated a final policy form. They appreciated that the Wilprop form was designed to be pro insured - containing a broad definition of "occurrence" - which limited the number of deductibles which the insureds would have to absorb, in the event of a loss. Silverstein conceded it was normally in an insured's interest to be entitled to lump together related events that would otherwise be deemed separate occurrences, into a single occurrence to avoid absorbing multiple deductibles. However, this assumed that a claimed loss was less than the "per occurrence" limit. Since the terrorist attacks resulted in a loss which greatly exceeded the total one occurrence limit of $3.54bn, the pro insured WilProp form had the perverse effect of favouring insurers. It treated the events of September 11 as a "single occurrence" and subjected any recovery under its terms to the one occurrence limit.

The Second Circuit recognised that, assuming a claimed loss of less than the single occurrence limit, it would be in an insurer's interest to narrowly define the term "occurrence" so as to require an insured to pay multiple deductibles for any loss arising out of a series of related events. However, if a loss exceeded the one occurrence limit, a narrow definition of "occurrence" would be disadvantageous to the insurer. It could enable an insured to bring multiple claims for any loss arising out of a series of related events and recover several times the one occurrence limit.

The case

These issues are aptly illustrated by the decision of the Second Circuit, in relation to the London and European insurers' position and in particular by the outcome of SR Interational Business Insurance Co v World Trade Center Properties LLC. Silverstein's appeal asserted three main arguments - that the insured was entitled to:

- Judgment, as a matter of law, against the London insurers and Swiss Re;

- A new trial, involving all insurers, due to prejudicial evidentiary errors; and

- A new trial, based on errors in the district court's instructions to the jury.

The Second Circuit weighed carefully Silverstein's argument that interpreting the "form" section of the slip only to apply to the final policy period "defies common sense". This is because it meant that the London "insurers were somehow willing to give up any say as to what policy form would ultimately govern their risk once the formal policy was issued, but nonetheless were requiring that the WilProp form apply during the slip period". They disagreed with this and adopted the London insurers' argument that it was equally plausible that "they were prepared to waive their rights to agree (to the final policy) form because... other capable co-insurers would do that work for them". The Court noted that London insurers did not participate to the same extent as some other insurers, such as Swiss Re, since 25 London-based insurers provided approximately 20% of the total coverage.

The Second Circuit held that the expression "agreement of wording waived", in the "form" section of the slip, did not apply to the slip period - until the final wording was actually agreed, as submitted by or on behalf of Silverstein. It is the WilProp form which applies to the slip/binder period. The "agreement to wording waived" provision only comes into operation if and when the wording is agreed by the lead insurer. The Appeals Court held that the jury was entitled to conclude that Swiss Re did not agree to change the form after it had bound to the WilProp form.

Silverstein also argued that the district court prejudicially abused its discretion in excluding evidence of "London custom" - alleging that since the London insurers did not follow their usual practice of specifically referring to a particular form by name on the slip, the London insurers did not intend to bind to the WilProp form. Interestingly, the Appeals Court agreed that evidence that the London insurers did not follow a market custom and practice is relevant to determining the parties' intent. But, they decided that Judge Mukasey fairly balanced competing interests. The Second Circuit concluded there was no abuse of discretion in structuring the use of the evidence in this way. In addition, the Appeals Court held that the district court did not abuse its discretion in allowing some insurer's witnesses to testify as to which policy form they thought they had bound.

The Second Circuit dismissed, as "without merit", Silverstein's arguments that the jury instructions were legally deficient and contributed to the jury verdicts favourable to London insurers. The Appeals Court concluded that the District Court's instruction to the jury did not negate Silverstein's "no form" argument or contradict New York law.

They also rejected the possibility that Willis withdrew the WilProp form before it had been accepted by Swiss Re. This involved a detailed consideration of the ramifications of Swiss Re's silence after having received the Travelers policy form. A note from the jury to the judge seeking direction, during their final deliberations, on what happens if a party proposes a change to another policy form but the parties do not all agree that a change will take place, drew the judicial response that "if there was an initial agreement, that agreement continues to control unless and until the parties agree that it does not control". This advice helped the jury to return their verdict in favour of Swiss Re "moments later" and the Second Circuit decided that the District Court had given the jury balanced instructions which contemplated many possible outcomes.

In their concluding remarks, the Second Circuit, warned against the presumption that, even though it was in both sides' interests to develop congruent coverage, all insurers must have bound to forms that contemplated the same coverage during the slip/binder period. This ignored the "overwhelming evidence" that different insurers issued interim binders governed by different forms. The court pointed out that these forms were designed with different interests in mind - and unsurprisingly, yielded different results.

The Silverstein parties have applied for an en banc review (a rehearing by all the judges of the appellate court) of the Second Circuit decision.

Peter Schwartz is a partner at Mayer Brown Rowe & Maw. At his previous firm, he advised one of the European insurers in the WTC litigation.