25 April 2007

US law of environmental liability coverage and English reinsurance contracts

The Facts 

Lexington insured Alcoa in respect of loss or damage to property, on their Special Floater form, referred to as a difference in conditions insurance, from noon on 1 July 1977 until noon on 1 July 1980. The insurance contained a standard US Service of Suit clause. 

Download (pdf)

Wasa and AGF provided facultative reinsurance in respect of all risks of physical loss or damage to the property reinsured occurring in the period of 36 months from 1 July 1977. Applying English common law principles, the reinsurance was governed by English law and incorporated the words "being a reinsurance of and warranted same gross rate, terms and conditions as and to follow the settlements of the [reassured]". The slip provided for a choice of contract forms, one of which contained the obligation, "to pay or make good to the Reinsured all such Loss as aforesaid as may happen to the subject matter of this Reinsurance, or any part thereof during the continuance of this Policy".

The Claim and the Settlement

In the early 1990's, various US environmental agencies found that Alcoa had wrongfully caused pollution for some 44 years up to the mid 1980's, and required the company to clean up contaminated land and water at numerous sites. Alcoa began proceedings in the Superior Court in the state of Washington against various insurance companies which had provided liability or all risks property insurance to Alcoa during the period. The Superior Court selected three sites to be the subject of an initial trial. In due course, most of the insurers sued by Alcoa were found not to be liable, either because the claim against them was time barred or because the losses were excluded. Subsequently, evidence was heard as to the existence, extent and time of occurrence of damage at each test site. At the conclusion of the trial, Alcoa filed a motion asking the trial court to hold that, as a matter of law, the pollution damage was indivisible - that is, there was no way to distinguish between pollution damage occurring prior to policy inceptions and pollution damage occurring after policy inceptions. The court denied the motion, and proceeded to allocate the damage on a pro rata, yearly basis, including under the Lexington policy.

On appeal, the Supreme Court of the state of Washington reversed the trial judge's ruling on allocation and held that Lexington were jointly and severally liable to indemnify Alcoa for all property damage, including damage which had occurred before the policy with Lexington had incepted. The trial court had failed to examine the Lexington policy, the insuring clause of which was very broad and contained no limitation as to the time of the physical loss or damage to property. The policy covered physical loss or damage manifesting itself during the policy period, including pollution damage starting before policy inception.

The action was returned to the Superior Court, which ordered a re-trial in relation to the tests sites. Lexington attempted unsuccessfully to minimise the effect of the Supreme Court's decision on allocation and, shortly before the re-trial, agreed to pay Alcoa some US$103m in a compromise settlement. Lexington then requested its reinsurers to indemnify it in respect of the settlement and for legal costs incurred. In response, Wasa and AGF sought declarations of non-liability.

English Commercial Court proceedings

In the Commercial Court, Simon J held that Wasa and AGF were not required to indemnify Lexington in respect of the settlement with Alcoa, as the legal analysis of Lexington's liability reflected in the settlement was excluded by the period clause in the reinsurance. The key part of Simon J's reasoning was that, even where a reinsurance incorporates a full reinsurance clause, if the insurance and reinsurance are governed by different systems of law, equivalent terms in the two contracts will not be given the same legal definition if the parties could not have had in mind, at the time of entering into the contract, a legal definition taken from the caselaw of the local system of law. In the present case, the effect of the period clause remained undefined under relevant state law as at 1977. Indeed, there would have been uncertainty at the time of entering into the reinsurance, inherent from the Service of Suit clause, as to which legal system would ultimately apply.

Simon J stated further that the follow settlements clause and the back to back nature of the insurance and reinsurance were both important features of the reinsurance. However, they were not sufficient to displace the prescribed period of cover, which was fundamental. The reinsurers had agreed to reinsure Lexington in relation to Alcoa's property damage occurring during the three year period from 1 July 1997. The reinsurers had not agreed to reinsure Lexington in relation to an earlier or later period, nor in relation to its liability generally to Alcoa, nor in relation to a period of cover which might be determined by whatever US law interpretation was placed on the period clause in the insurance contract.

It was significant to Simon J that the trial judge had held that it was possible to identify damage occurring during the policy period. This was not a case where there was a dispute as to when damage occurred, so that Lexington might argue that a settlement was made on the basis that damage might have occurred during the policy period. Lexington had settled on the basis that it was liable for the costs of remedying damage outside the period of cover because, in the words of the Washington Supreme Court, of the absence of an exclusion in the policy for physical loss or damage that may have begun spreading before the policy inception.

It followed that the loss claimed by Lexington was not one which fell within the reinsurance contract as a matter of English law. The judge left open whether Lexington could make a claim under the reinsurance in respect of loss occurring within the three year period of the reinsurance.

Moral

An appeal is being contemplated. Meanwhile, t he courts' response to the attempt to collect on English reinsurance, for losses reflecting the US approach of spreading liability for clean up to the deepest available pocket, has been to draw out the constraints on the legal implications of insurance and reinsurance contracts being back to back, and consequently on the scope of the follow settlements obligation.

If you require any further information in relation to the way in which these developments impact upon your business please contact Nicholas Bradley, William Sturge, Colin Peck, David Breslin or Carolyn Haigh on 020 7337 7671 at Lawrence Graham LLP.