Two recent cases have highlighted potential issues associated with an insurer’s requirement to notify its reinsurer in D&O claims. Colin Peck outlines the dangers for reinsurers of using standard notification clauses
There are important parallels between how English courts dealt with claims notification provisions in the recent cases of Royal & Sun Alliance v Dornoch (March 2005) and AIG v Faraday (October 2006).
The cases provide an interesting insight into how the English courts are currently interpreting claims notification provisions in the reinsurance of underlying directors & officers (D&O) insurance policies, and a valuable guideline in terms of both day-to-day handling of claims and the drafting and use of wordings. Both cases focused on what triggers the requirement to notify a reinsurer where there is a condition precedent requiring the reinsured to notify “any loss or losses which may give rise to a claim”.
The court considered what was meant by the words “loss or losses”. Whose loss, and what type of loss must it be before reinsurers need to be notified? In doing so, they were asked to decide between an approach that involved adopting the literal meaning of the words and an approach which reinsurers believed gave effect to the commercial purpose of the clause. The cases highlighted a mismatch between the claims provisions contained in some underlying D&O insurance policies and those contained in the reinsurance.
In R&SA v Dornoch, R&SA were part of the following market subscribing to a master subscription liability policy in favour of Coca-Cola, part of which provided cover for D&O and securities-related risks. That part of the policy was on a claims-made basis and it was a condition precedent that insurers be notified of any “claim as soon as practicable”. R&SA reinsured itself with Brockbank Syndicate 861 and others, subject to a full reinsurance clause and a claims control clause which stated: “Notwithstanding anything herein contained to the contrary, it is a condition precedent to any liability under this policy that: (a) The reassured shall upon knowledge of any loss or losses which may give rise to a claim under this policy, advise the underwriters thereof by cable within 72 hours.”
The second part of the clause gave reinsurers the right to appoint adjusters, assessors and/or surveyors and to control all negotiations, adjustments and settlements in connection with such loss or losses.
Class actions underway
In October and November 2000 class actions were instituted in the US against Coca-Cola and three of its directors. The claimants had purchased stock in the company between March 1999 and March 2000 and alleged that there had been a fraudulent scheme to inflate the value of the stock. The value of the stock subsequently fell upon the release of further information.
The lead insurer was notified of the claims in November 2000 and R&SA was notified in December 2000. R&SA’s reinsurers were notified, via their broker, in January 2001. Reinsurers denied liability on the basis that the 72-hour time limit in the claims control clause had not been complied with.
In the UK Commercial Court, Mr Justice Aikens held that for time to start running under the claims control clause, R&SA must have been aware of an actual, not alleged, loss and that the loss in question was that of the claimant shareholders, not of Coca-Cola or its directors. On the facts, he found that R&SA was unaware of such a loss prior to January 2001 and hence, reinsurers could not deny liability.
In the Court of Appeal, judgment for R&SA was upheld, although on different reasoning. Reinsurers were permitted to argue that “loss” meant an alleged loss by the claimant shareholders. The central issue became whether the word “loss” meant “actual loss” or “alleged loss”? Reinsurers argued that it must mean “alleged loss” in order to make sense of the inclusion of the claims control clause and so allow them to be involved in the defence of the underlying insurance claim. For it to mean “actual loss” would make no sense commercially.
The Court of Appeal rejected this, finding that “loss” meant “actual loss” of the claimant shareholders. An actual loss would be established once the liability of Coca-Cola or its directors had been ascertained by way of judgment or settlement. R&SA did not know of an actual loss even by January 2001, as it was still in dispute. Hence, there had been no breach of the claims control clause.
“The cases highlighted a mismatch between the claims provisions contained in some underlying D&O insurance policies and those contained in the reinsurance
The Court of Appeal did point out how unusual the claim was which had been brought against Coca-Cola and its directors. The complaint was that their conduct had caused the share price to be artificially high at the time of purchase. Had that been a proven fact at the time R&SA received notice of the complaint in December 2000, then there may have been an “actual loss” which might give rise to an insurance claim. But that was not the case at the time the insurer was notified of the claims, as that depended on the claimants proving that Coca-Cola stock would have had a lower value at the time of their purchase had it not been for the company’s conduct. Had the complaint been that the directors had done something to make the share price fall (rather than rise), the court said the position might have been different.
Very similar facts and wording came before Mr Justice Morrison in October 2006 in the case of AIG v Faraday. In that case, AIG settled a number of claims on an underlying D&O insurance policy arising from class actions in the US against a company called Smartforce. Faraday declined to pay on the reinsurance on the basis that the notification of loss/claims cooperation clause had not been complied with.
The clause was structured in very similar terms to that in the R&SA v Dornoch case. It was stated to be a “condition precedent” and required notice of “any loss or losses which may give rise to a claim” to be given to reinsurers “as soon as reasonably practicable and in any event within 30 days”.
Mr Justice Morrison held that the losses in question were those of the claimants against Smartforce. He also considered that the words “loss or losses” were essentially different from words such as “alleged” or “claimed” or “potential”, and so the “loss or losses” concerned were “actual losses” of the claimants against Smartforce. On the facts, he found that AIG did not know of any actual loss until 23 March 2004, following the outcome of a mediation in respect of the underlying class actions. As reinsurers had been notified on 19 April 2004, AIG had complied with conditions of the claims clause.
Although Mr Justice Morrison, as a Commercial Court judge, was obliged to follow the Court of Appeal’s reasoning in R&SA v Dornoch, he expressed no concerns about having to do so. AIG v Faraday, following as it does the reasoning in R&SA v Dornoch, confirms that this is how the English courts will interpret such claims provisions. AIG v Faraday is subject to appeal, although given the Court of Appeal’s approach in R&SA v Dornoch, it is unlikely to be overturned.
Reinsurers would appear to have a problem. They include such claims cooperation clauses in their reinsurance contracts in order to give them advance notice of any claims likely to be made on the reinsurance. This is to enable them to set reserves; and to allow them an opportunity to become involved in, and possibly control, the handling of the underlying insurance claim. The decisions in both recent D&O cases deny reinsurers those rights and effectively make those claims provisions redundant. How is that the courts have come to this interpretation of those clauses?
In both R&SA v Dornoch and AIG v Faraday, the courts specifically referred to a mismatch between the claims provisions in the insurance and those in the reinsurance. In both cases, the underlying insurance was on a “claims made” basis, and required notification to insurers of “claims”. However, the reinsurance required notification once there was “knowledge” of a “loss or losses”.
In neither case was the court prepared to rewrite the parties bargain to remedy that mismatch. The court expressly pointed out that the parties could have done that themselves by better use of language in the reinsurance. This was particularly so given the draconian consequences of the clauses in question. The court was not prepared to rewrite one part of the clause, whilst leaving another part – the length of time given for notifying reinsurers – untouched. In both cases the language used in the claims provisions in the reinsurance was more suited to a property damage policy, than to the reinsurance of a D&O liability insurance policy.
Both cases demonstrate the dangers in using a standard clause in a reinsurance policy, without considering whether it does, in fact, achieve reinsurers the desired result; namely to have early notice of and involvement in the handling of a claim at the insurance level. In both cases the court gave a clear indication that the claims provisions in the reinsurance would have been better suited if they had referred to “alleged” or “potential” losses, or alternatively if it had referred to a claim being made under the direct policy.
Colin Peck is a partner in the insurance and reinsurance group at London law firm Lawrence Graham LLP.