Anna March explains the latest developments - and their

Over the past few years, film finance insurance (and reinsurance) litigation has been widely reported in both the insurance and legal press.

A reported £2bn has been claimed throughout the industry, and the combination of the number of cases, complexity of the legal issues and, ultimately, the amount of money at stake have made the film finance litigation unique.

Key issues have been debated by some of the country's leading insurance lawyers and scrutinised by the courts. A number of decisions have been appealed and the higher courts have reached innovative solutions and set precedents which are important to all in the reinsurance market.

One case decided last year, GE Reinsurance Corp v New Hampshire Insurance Co and Willis Ltd1 ('Destination'), built on previous film finance decisions and clarified two key areas of reinsurance law: breach of warranty and the presumption of back-to-back cover.

The facts

The Destination case concerned a different type of insurance from that considered in the majority of the film finance cases. The Destination policy protected default by the production company on repayment of a loan, as opposed to (broadly) insurance of revenue shortfall on a slate of films.

The insured instructed the broker, Willis, to place insurance. As Destination wanted to deal with only two insurers, certain companies which were originally intended to be co-insurers became reinsurers. New Hampshire agreed to front up to 40%, in addition to its own 20% share of the risk. As such, it was the intention of all parties that the reinsurance be 'back-to-back' (i.e. that the reinsurance cover would match the insurance cover).

The reinsurance slip contained the following key provisions, described as 'conditions':

- 'Full Reinsurance Clause';

- 'as per original policy to be issued'; and

- 'Contracts of employment in respect of Steve Stabler as Chief Executive Officer... to be maintained for the duration of the Policy' (the 'Stabler wording').

No mention of the Stabler wording was made in the insurance policy.

In fact, Stabler, described as "the creative mind" of the company, left the employment of Destination during the term of the policies and Destination became insolvent. As a result, it defaulted on its payments. New Hampshire paid the resulting claim under the direct policy and claimed under its reinsurance policy. The reinsurers claimed that two warranties relevant to the reinsurance contract had been broken, one of which was the Stabler wording. The other requirement was not determinative of the case.

The case came before Mr Justice Langley, the judge assigned to manage all film finance cases. As such, he can probably be said to have a better grasp of the interlocking legal and commercial issues affecting those cases than any other judge.

Breach of warranty

The first issue clarified by Destination was the law regarding breach of warranties. In a previous film finance dispute, HIH v New Hampshire2

('Rojak'), the Court of Appeal outlined three 'tests' for holding that a term of an insurance policy is a warranty:

- whether it goes to the root of the transaction;

- whether it is descriptive of or bears materially on the risk of loss; and

- whether damages would be an unsatisfactory or inadequate remedy.

In Destination, the court applied the three tests set out in Rojak and determined that the Stabler wording was in practice a warranty. Significantly, the court ignored the fact that the Stabler wording was described in the reinsurance slip as a 'condition'.

The Court of Appeal had confirmed in Rojak that a term may in fact be a warranty, despite not being labelled as such. Destination goes one step further and suggests that a term may be classified as a warranty despite being described by the parties as something entirely different - i.e. a condition.

The significance of this decision comes from the different remedies which each category of contract term attracts. A breach of warranty automatically discharges a reinsurer from any liability under the contract as from the date of the breach. Conversely, for a breach of condition (unless it is determined to be a condition precedent), the reinsurer's remedy is usually a cross-claim in damages. Clearly the parties need to be aware that a term will attract such remedies when the contract is drafted, rather than when a claim is litigated in court. This finding is also noteworthy in relation to another element of the Rojak decision - and of general application in the film finance context. The insurance policy in Rojak contains what is known as a 'truth of statement clause'. The Court of Appeal found, as a matter of construction, that unless the truth of statement clause expressly referred to the exclusion of breach of warranty defences, this could not be implied into it. Following Destination, those parties intending to exclude insurers' remedies for breach of warranty will need to exclude not only remedies for those terms described as warranties, or even those terms which are not described at all, but also terms specifically described as something else if there is a chance that the courts will determine that term to be a warranty.

Back-to-back cover

The second area of significance of Destination is in relation to the presumption of matching reinsurance cover. This is a key issue in the interpretation of reinsurance contracts. In the late 1990s and early 2000s, it appeared that the courts were prepared to go to quite considerable lengths to preserve the parties' intention to provide back-to-back reinsurance cover.

Previous cases had concerned the incorporation of a warranty in the insurance policy into the reinsurance contract or the inclusion of warranties in both the insurance and reinsurance policies. In the leading case3, the insurance contract was governed by Norwegian law and the reinsurance contract was governed by English law. The words 'as original' purported to incorporate terms from the underlying policy into the reinsurance cover. As the effect of a breach of warranty had no effect under Norwegian law unless it was causative of the loss, the House of Lords held that the warranty should have the same effect in each contract. This meant that although a breach of warranty in English law would usually discharge liability, the reinsurers were not entitled to that remedy. The court was anxious to preserve back-to-back cover unless the policy specifically provided otherwise.

This principle was extended quite considerably by the Court of Appeal.

In Groupama v Catatumbo4, there was an express warranty in the reinsurance policy rather than simply a warranty incorporated from the underlying policy. This was worded in similar, although not identical, terms but the effect of the applicable laws of the reinsurance and insurance contracts meant that insurers would be liable to pay the claim, whereas reinsurers could avoid liability.

The Court of Appeal held that the parties could not have intended the warranties to have a different effect. Therefore the express warranty in the reinsurance contract was held to be inapplicable. The court was also influenced by the fact that the underlying warranty was also incorporated into the reinsurance policy by the words 'as original'. This incorporated warranty was therefore given precedence over the express reinsurance wording in an attempt by the court to preserve the presumption of back-to-back cover.

Similarly, an earlier film finance decision regarded the presumption of back-to-back cover as so fundamental that it was prepared to expand the law on incorporation of insurance terms. Incorporated terms are often 'manipulated', for example, so that references to 'insured' becomes references to 'reinsured'. The Court of Appeal in Rojak held that the question of whether a term was incorporated could not be separated from the meaning of the term. The court will therefore allow incorporation of a term in unmanipulated form if the effect of manipulating the term would change its meaning and give the reinsurers' independent rights against the reinsured, violating the presumption of matching cover.

This proactive approach demonstrates the importance which the law has attached to the presumption of back-to-back cover. Destination, however, reveals that there are limits to the extent to which the courts will be prepared to manipulate a wording in order to give effect to this presumption.

Mr Justice Langley began his analysis by warning that, where there may be several parties bound by the terms of a re/insurance slip following separate negotiations, the court should be particularly cautious before conducting such an exercise. Care should be taken before ascribing a meaning to the words used, other than their usual meaning, in an attempt to deduce the objective intention of the parties.

In Destination, it was agreed by all parties that the expectation on placement was that the reinsurance and insurance should be back-to-back, not least because all parties were aware that New Hampshire was acting as a 'front' for the reinsurers (previously intended to be co-insurers).

Nevertheless, the court held that the presumption of back-to-back cover could not be used to delete an express provision in a reinsurance contract where there was nothing in the direct policy concerning the same issues.

The position in Destination differed from previous cases because the reinsurers claimed breach of an express term in the reinsurance, when there was no comparable clause in the insurance policy. It should be noted that this was not a new departure for the law. In fact, the Court of Appeal noted in Catatumbo that had the two contracts contained warranties expressed in irreconcilable terms, or had the reinsurance contained a warranty which had no counterpart in the insurance, the result might have been different.

Nevertheless, Destination does show that, although the courts rely heavily on the presumption of back-to-back cover, this will not always be sufficient to overcome deficiencies in drafting.

It is worth noting that the court held that New Hampshire could claim 100% of its liability from the brokers on the grounds of negligence. Brokers should therefore pay particular note to the wording of the reinsurance cover in circumstances where the parties instruct them to place back-to-back cover.

Conclusion

The film finance cases have afforded the courts the opportunity to clarify various aspects of reinsurance law. Limits to the presumption of back-to-back cover have been established. The law of warranties, on the other hand, has been extended. The moral of the story, as always, is that insurers, reinsurers and brokers must pay meticulous care to drafting. Although the courts try to give effect to the objective intention of the parties, any ambiguity may leave one party with an unanticipated result. The film finance litigation is likely to continue to be an area to watch - particularly if any of the cases lead to a full trial.

References

1 [2003] EWHC 302

2 [2001] EWCA Civ 735

3 Vesta v Butcher [1989] 1 AC 852

4 [2000] 2 Lloyd's Rep 350

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