The recent case of Faraday Capital Ltd v Copenhagen Reinsurance Co Ltd has explored the limits of follow the settlements clauses when insurers have entered into a without prejudice settlement of an underlying claim. Aidan Christie QC examines the question whether a timely concession might sometimes be to insurers’ benefit.

We are all reluctant to make concessions – possibly because of an innate unwillingness to yield or through fear of the consequences of an unguarded concession. Most of us dislike the thought of conceding anything, to anyone.

When insurers settle a claim, they often include a provision in the settlement agreement that says the settlement does not constitute any admission or concession of liability on their part to the insured. If the settlement is in full and final settlement of the claim, such a provision is probably redundant but I suspect that most insurers feel happier if it is included. Their concern is not so much for the compromised claim, but rather that an admission or concession of liability might, in some way, create a precedent for other similar cases. However, could the insurer’s refusal to concede liability actually prejudice the insurer?

The case of Faraday Capital Ltd v Copenhagen Reinsurance Co Ltd [2007] 1 Lloyd’s Rep IR 23 suggests that it could. Faraday subscribed to the excess layer of a policy protecting Nevada Power in respect of property damage within the US. Following damage at a generating station operated by Nevada

Power in Las Vegas, Faraday and other insurers entered into a settlement agreement with Nevada Power. The preamble to the agreement provided that it was “by way of compromise and without prejudice to or waiver to” the respective positions of the parties to the agreement. The agreement itself stated that it was “intended to be and is a compromise between the parties and shall not be construed as an admission of coverage under the [policy]”.

So far so good, until Faraday sought to recover under its outward reinsurance. That contract included a follow the settlements provision whereby reinsurers agreed “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”.

It was written 100% by Cop Re. Cop Re’s position was simply that the underlying settlement agreement was a without prejudice settlement and did not come within the ambit of the follow the settlements clause. They argued that they were not bound, by virtue of the loss settlements provision, to follow the settlement agreed by Faraday.

The case came before the Commercial Court by way of a preliminary issue. With the notable exception of Insurance Company of Africa v SCOR (UK) Reinsurance Co Ltd [1985] 1 Lloyd’s Rep 312 (CA), most cases involving follow the settlements clauses have tended to come to the courts either by way of preliminary issue or summary judgment, and this is not altogether satisfactory. It can deceive one into thinking that the case decides more than it actually does. Faraday is a good example.

The issue in Faraday was whether, as a matter of law, the settlement agreement between Faraday (and other insurers) and Nevada Power fell within the follow the settlements provision or was excluded from it. The court was not being asked to determine whether Cop Re was actually liable to indemnify Faraday; it was only being asked to determine whether Faraday could rely upon the follow the settlements provision. That is, of course, a significant issue because there are major advantages to a reassured in being able to do so. If Faraday could rely upon the follow the settlements provision, Cop Re would have been obliged to indemnify Faraday so long as the claim recognised by Faraday fell within the risks covered by the reinsurance as a matter of law, and Faraday acted honestly and took all proper and businesslike steps in making the settlement (the two limbs of the SCOR test).

A follow the settlements clause in a reinsurance or retrocession agreement removes from the reinsured or retrocedant the need to prove that it was liable as a matter of law to indemnify its own policyholder.

Instead, it is enough that the settlement was reached in a bona fide and businesslike fashion. By contrast, if it could not rely upon the follow the settlements provision, Faraday would have to go through the much more laborious process of proving that it was liable to Nevada Power under the original policy and that the claim was covered under the reinsurance.

To this extent, the case is reminiscent of SCOR itself. In SCOR, the Court of Appeal held that the follow the settlements clause was effectively emasculated by a claims co-operation clause by which the reassured undertook not to settle any claim without the approval of reinsurers. However, that did not necessarily mean that the reinsured was not entitled to an indemnity from its reinsurers; it meant only that it could not invoke the follow the settlements clause against its reinsurers.

In the event, although the reinsured in SCOR was unable to invoke the follow the settlements clause, it had proved at trial that the claim fell within the reinsurance and was able to recover from reinsurers.

In the more recent case of Eagle Star Insurance Co Ltd v Cresswell [2004] Lloyd’s Rep IR 537 the reinsured was less fortunate. Compliance with the “claims co-operation” clause was a condition precedent to reinsurers’ liability to pay any claim, not just a question of the curtailment of the obligation to follow settlements. Breach of the “claims co-operation” clause meant that reinsurers had no liability at all.

In Faraday, the reinsurance contract was explicit in stating that the follow the settlements clause did not include without prejudice or ex gratia settlements.

A without prejudice settlement is made where there is no admission of the existence of any liability by the underwriter under the terms and conditions of the original policy to indemnify the insured. An ex gratia settlement is one that is made where there is a payment of money by the insurer to the insured where there is no liability under the policy to indemnify the insured (see Assicurazioni Generali Spa v CGU International Insurance Plc [2004] Lloyd’s Rep IR 457).

On its face, the settlement agreement in Faraday was plainly a without prejudice agreement and excluded from the follow the settlements clause. The Judge found this conclusion neither uncommercial nor impractical. The exclusion of without prejudice and ex gratia settlements from the follow the settlements provision was designed to encourage insurers to give proper and businesslike consideration to their liability to the original insured, and to act honestly in settling the claim. If they did so, there was no reason not to admit liability and bring the settlement within the ambit of the follow the settlements clause.

Further, reinsurers were entitled to insist that if the original insurer was not prepared to admit liability under the original policy then, for the purposes of establishing the reassured’s entitlement to recover under the reinsurance, the reassured must prove that there was in fact a liability under the original policy.

What are the lessons to be drawn from Faraday?

The first and obvious point is that it is important to scrutinise one’s reinsurance cover to see precisely what falls within a follow the settlements provision and what does not. If without prejudice or ex gratia settlements are excluded from the follow the settlements provision, then it is vital that the insurer takes this into account when it settles any direct claim.

Second, although follow the settlements clauses provide a significant benefit for a reinsured in the sense that they relieve the reinsured of the obligation to prove liability under the direct policy, it is still open to a reinsured, in the absence of such a provision, to prove its liability for the loss and its entitlement to indemnity under its reinsurance.

Paradoxically there might be times when it is better to concede than to resist.

Aidan Christie QC specialises in insurance and

reinsurance law at 4 Pump Court, Temple, London