26 April 2007

Addleshaw Goddard acts in landmark reinsurance case concerning the scope of 'follow the settlements' clauses in reinsurance contracts

WASA v Lexington (Commercial Court, 25 April 2007)

The Commercial Court yesterday delivered judgment in a landmark case concerning the interpretation of 'follow settlements' clauses in reinsurance contracts.

Addleshaw Goddard acted for the successful claimant, WASA International Insurance Company Limited ('WASA') in proceedings against its reinsured, Lexington Insurance Company ('Lexington').   WASA sought a declaration that it was not liable to indemnify Lexington in respect of a settlement that Lexington had entered into with its own insured, the Aluminum Company of America ('Alcoa'), for the cost of remedying pollution and environmental damage at numerous sites across the US. The settlement was entered into on the basis of Washington State court rulings determining that Lexington was liable to provide insurance coverage for all damage incurred by Alcoa, irrespective of whether the damage had taken place before, during or after the insurance coverage years.

The contracts

Lexington insured Alcoa in respect of loss or property damage at various of Alcoa's worldwide sites, with a limit of $20 million loss or damage arising from any one occurrence. The period of the insurance was from 1 July 1977 to 1 July 1980.   The reinsurance contract between Lexington and WASA also provided cover subject to a limit of $20 million per occurrence, and a retention of $1.675 million, with a back-to-back period of cover from 1 July 1977 to 1 July 1980.   The reinsurance contract contained wording requiring WASA to follow the settlements of Lexington.

The proceedings in the United States

From around 1942 and continuing to at least 1986, Alcoa had sustained widespread environmental damage at various of its sites in the US.   The estimated clean-up costs ran into hundreds of millions of dollars.   In late 1992, Alcoa began proceedings in the Washington courts seeking coverage from its insurers for its clean-up costs.   Lengthy proceedings in the US courts followed, including a jury trial in which the jury returned an incomplete verdict, and an appeal to the Washington Supreme Court.

Lexington had argued both before the Washington State Superior Court and later before the Supreme Court for a pro rata allocation of the damage, so that it would be held responsible only for the part of the damage which occurred during the relevant 1977-1980 period.   However, in 2000, the Washington Supreme Court rejected those arguments and determined instead that Lexington was jointly and severally liable for the remedial costs of cleaning up all the environmental damage at various specified sites, whether the damage had been sustained before, during or after the 1977-1980 period, provided that at least some damage had occurred within that period .

Following the judgment, Lexington settled Alcoa's claims and sought a recovery from its reinsurers including WASA.

Issues raised in the English proceedings

The Commercial Court (Mr Justice Simon) had to decide the following questions:

1     Whether, as a result of the follow settlements clause, the reinsurance contract required WASA to indemnify Lexington in respect of the Alcoa settlement or whether WASA was only liable to provide an indemnity under the reinsurance in respect of losses occurring during the 1977-1980 period of the reinsurance contract.

2     Whether, on interpretation of the reinsurance contract, there was a one-off retention of $1.675 million or whether this was a per-occurrence retention.

3     Whether Lexington was entitled to recover the costs it had incurred in defending the insurance claim.

The decision

WASA succeeded on all 3 questions. The Commercial Court held:

1     A period clause in a reinsurance contract is of fundamental importance. The follow settlements clause and back-to-back nature of the insurance and reinsurance contracts were important features of this reinsurance, but were not sufficient to displace the importance of the period of cover of the reinsurance.   WASA had agreed to reinsure Lexington in relation to Alcoa's property damage occurring between 1 July 1977 and 1 July 1980 only.   The reinsurance contract could not be construed under English law as if it provided cover in respect of the cost of remedying damage whenever such damage occurred (both before and after the policy period) solely on the basis that some damage occurred within the policy period.

The Judge noted that the original insurance contract did not contain any express choice of law clause and the service of suit clause in it only provided that Lexington would submit to the jurisdiction of any court within the US.   He noted that US law was not uniform on the question of allocation of liability across coverage years.   He concluded therefore that there was no US law interpretation of the period clause in 1977 which could be written into the insurance contract and by reference to which one could infer that the parties to the reinsurance contract had contracted. He rejected Lexington's submission that the period provision in the reinsurance contract could be properly construed by reference to the particular interpretation subsequently placed upon a similar period provision in the original insurance by a particular US state court which happened to be seised of the underlying insurance dispute over 20 years later – that would lead to an effect which was not so much back-to-back as 'back-to-front'.

2     The Judge accepted WASA's argument that, on the face of the reinsurance contract which provided for a reinsurance of $20 million per occurrence, it would be odd to have a one-off retention in what was primarily a per-occurrence reinsurance contract.

3     The Judge also held that, in the absence of express provision in the reinsurance contract or proof of a universal market practice in the relevant market, there was no ground for implying coverage in a reinsurance contract for expenses incurred by the reinsured in defending claims (Baker v Black Sea applied).

A welcome development

The case marks a welcome development for reinsurers and provides clarification on a point of law on which there was previously no legal precedent.

The ruling serves to check any erosion of the essential principle that a period clause is fundamental to a reinsurance contract.   Follow settlements clauses, even in back-to-back contracts, do not mean that reinsurers will automatically be obliged to provide coverage to their reinsured irrespective of the period terms of the reinsurance.   The Court's decision has struck the right balance between the potentially conflicting purposes served by follow settlements clauses: on the one hand of avoiding the investigation and litigation of the same issues twice and, on the other, giving due importance to the fact that the reinsurer's bargain should not be eroded by an agreement over which the reinsurer has no control.