Sarra Zemmel describes a recent Court of Appeal case that highlights the importance of complying with settlements and claims control clauses

In Eagle Star Insurance Co Ltd v Cresswell 1 the Court of Appeal unanimously decided that the claims control clause in a liability quota share reinsurance contract had the effect of a condition precedent, and that unless the cedant could establish an estoppel or waiver, its failure to comply with the clause would deprive it of reinsurance cover.

The clause read as follows:

"CLAIMS CO-OPERATION CLAUSE

The company (cedant) agree

(a) ...

(b) The Underwriters (reinsurers) hereon shall control the negotiations
]
and settlements of any claims under this Policy. In this event the Underwriters hereon will not be liable to pay any claim not controlled as set out above."

As can be seen, the clause was headed "Claims Co-operation Clause". Its effect was more that of a 'claims control clause', or even more accurately, a 'settlement and negotiation control clause'. For convenience, I have used the familiar term 'claims control clause'.

The underlying claims involved Californian environmental contamination.

It was an agreed fact that reinsurers had not controlled the negotiation or settlement of them. The cedant had made some notifications to the London market in 1991 and 1992, but the scope and effectiveness of these notifications was contested. The cedant settled the claims in 1995 without any further reference to reinsurers, and presented its claim for indemnity to reinsurers in 1998. Reinsurers declined the claim for indemnity on the basis that they had not controlled the negotiations or settlement of the claims, and had not even been given an opportunity to do so.

The construction issues were decided as preliminary issues on the basis of agreed facts. Morison J in the commercial court found that the claims control clause did not operate as a condition precedent and that the cedant was not otherwise deprived of cover by the effect of the further clauses referred to below. The Court of Appeal disagreed, and found in reinsurers' favour.

The reinsurance contract also contained several other clauses which the court considered:

1. The printed wording of the standard J1 Lloyd's form set out a standard full reinsurance clause including a 'follow settlements' obligation:

"Being a reinsurance of and warranted same gross rate, terms and conditions as and to follow the settlements of the Company ..."

2. The contract contained the following bespoke typed apportionment of costs clause - "In the event of a loss arising to which the Underwriters hereon may be liable to contribute, no legal costs shall be incurred on their behalf without their consent being first obtained and if they so consent they shall contribute to the said costs in the proportion that their share of the loss as finally settled bears to the total sum payable. If, however, a settlement of the loss be practicable prior to taking the case into Court whether by compromise or otherwise for a sum not exceeding the limits stated in the Schedule hereto, no legal costs shall be payable by the Underwriters hereon."

3. In addition to the claims control clause, the contract contained the following further typed clause:

"No settlement of a loss by agreement shall be effected by the Company for a sum in excess of the limits stated in the Schedule hereto, without the consent of the Underwriters."

The construction issue

The key issue was the proper construction of the claims control clause.

Morison J found that it did not have the effect of a condition precedent, essentially for three reasons:

- the clause did not use the words 'condition precedent';

- when the contract was negotiated in 1969 the parties had deleted a clause which (as well as being quite different substantively) used the words 'condition precedent'. Morison J inferred from this that the parties had not intended the replacement clause to be a condition precedent; and

- the third clause shown above contemplated some settlements without reinsurers' consent, from which Morison J inferred that the parties had not intended reinsurers to be involved in the settlement of all claims.

It was critical to the Court of Appeal's reasoning that the clause applied only to settlement and negotiation of claims, as opposed to the conduct of claims generally. The cedant argued that the use of the words "shall control the negotiations and settlements" either conferred an obligation on reinsurers to control negotiations or settlements, or an option for reinsurers to do so if they chose. The cedant went on to argue that such an option arose as soon as a claim under the insurance was first notified to reinsurers: if reinsurers did not then take control, they would have no later opportunity to do so. The court held that the clause allocated to reinsurers the role of controlling any negotiation, but did not, simply by use of the word "shall", confer an obligation or an option on reinsurers to do so. They said that it would be contradictory to impose an obligation on reinsurers, where this clause was clearly inserted for reinsurers' benefit.

The parties agreed that the intended effect of the words "in this event" at the beginning of the second sentence of the claims control clause was not immediately clear, but the court accepted reinsurers' submission that these words meant "in the event of there being negotiations or settlement of a claim".

Although the clause did not use the words 'condition precedent', the language was clear that in the absence of control, reinsurers would not be liable. There was no obligation as such for the cedant to inform reinsurers of negotiation or settlement of claims, but the consequence of their failure to do so was clearly spelt out. Rix, LJ stated that:

"Unless some reason is shown for excusing the agreed fact that the reinsurers did not control the negotiations or settlement of the Varian (underlying) claim then paragraph (b) of the claims co-operation clause amounts to an exclusion of their liability to indemnify Eagle Star."

The court held that the effect of the follow settlements obligation was undermined by the clause numbered 3 above. This was a straightforward application of the Court of Appeal's own reasoning in Scor 2. Similarly, consistent with its decision in Gan v Tai Ping, the court held that failure by the cedant to comply with the condition precedent concerning claims control prevented the cedant from recovering under the reinsurance at all, subject to the cedant showing, in the words of Rix, LJ, "some reason for excusing" this fact.

The court noted that as a measure of protection for the cedant, reinsurers would be subject to an implied obligation not to exercise their control right in bad faith, capriciously or arbitrarily (again, pursuant to Gan v Tai Ping).

Back to basics

The key principles of construction on which the Court of Appeal based their decision were as follows:

- Bespoke typed clauses will prevail over inconsistent printed words.

- A deleted clause is an unsafe guide to construction.

- To take effect as a condition precedent, a clause need not use the words 'condition precedent' so long as the alternative wording used is clear.

- Clauses, including follow settlements clauses, will be construed in the context of the policy as a whole.

- Other recent decision concerning follow settlements clauses.

Although the decision warrants a full article in its own right, while looking at follow settlements clauses it is worth also mentioning the Court of Appeal's recent decision in Assicurazioni Generali SpA v CGU International Insurance Plc 3. The clause in that case read:

"As original: ... this Reinsurance is declared and agreed to be subject to the same terms, clauses and conditions ... as the original policy ... and is to pay as may be paid thereon and to follow without question the settlements of the Reassured except ex-gratia and/or without prejudice settlements".

The key question was whether the words "without question" precluded reinsurers from relying on the provisos which the Court of Appeal's decision in Scor usually impose on the standard follow settlements obligation. The provisos are that for reinsurers to be bound by the follow settlements obligation, the claims as recognised by the cedant must fall within the risks covered by the reinsurance as a matter of law, and the cedant must have acted honestly and taken all proper businesslike steps in settling the claim.

The Court of Appeal held that the words "without question" did not prevent the application of those provisos. They favoured the view that the additional words served a clarifying rather than qualifying or limiting purpose.

The words "without question" were not clear enough to show that reinsurers intended to waive their right to question whether honest and businesslike steps had been taken in the settlement of the original insurance claim.

1 [2004] EWCA Civ 602.

2 The Insurance Co of Africa v Scor (UK) Reinsurance Co Ltd [1985] 1

Lloyd's Rep 312 (CA).

3 [2004] EWCA Civ 429.

Sarra Zemmel is research and technical development lawyer in Mayer, Brown, Rowe & Maw's insurance and reinsurance group at Lloyd's. Will Glassey and Lindsay McQuillian of Mayer, Brown, Rowe & Maw's insurance and reinsurance group represented the successful appellant reinsurers in the Eagle Star case.