This decision helpfully clarifies what constitutes a "loss" which triggers a Claims Co-operation clause. In particular, it confirms that in the right circumstances, a "loss" within the meaning of the clause may be found to have occurred, regardless of whether it has been ascertained by judgment or settlement.

The case involved a Directors E & O Policy, which insured the directors of Smartforce, a US Company. On 19 November 2002, Smartforce made an announcement that it intended to re-write the previous three years' accounts, identifying four separate accounting errors which had distorted those accounts. The announcement was followed by a fall in the price of Smartforce's shares from $4.63 to $3.07 at close of business on 19 November. Shareholders commenced proceedings against Smartforce and its directors, alleging that the misstatement of Smartforce's accounts had artificially inflated the value of its shares beyond their true worth.

Smartforce notified the claims to its insurers, AIG Europe (Ireland) Limited, in December 2002. AIG failed, however, to notify the claims to its reinsurers. The proceedings were settled for a payment of US$30.5 million, following which AIG notified the settlement to reinsurers on 19 April 2004. Faraday, one of the reinsurers, refused to settle the claim, relying upon a Claims Co-operation clause contained in the reinsurance policy, which provided:

At first instance, the Judge found in favour of AIG, following the decision in Dornoch. He found that the "loss" referred to in the Claims Co-operation clause was the underlying loss of the Claimants attributable to an act of Smartforce or of its Directors, rather than an "alleged" or a "potential" loss. The Claimants proceeding against Smartforce could not be said to have suffered a "loss" until they had been proved to have purchased shares at a value that was inflated due to the default of Smartforce's directors or officers in the execution of their duty.

The Court of Appeal disagreed. The decision in Dornoch was distinguished - that case involved a claim resulting from a fall in share price which could just as easily have resulted from normal market fluctuation, rather than from a misstatement of the value of the company in question. There could, therefore, be no "loss" until it was established at trial or by settlement that the shares had been bought originally for an artificially high price.

In Smartforce's case, the facts were different. There was an identifiable event in the form of the announcement on 19 November 2002 of Smartforce's intention to restate its accounts, which was followed by a sharp fall in the value of the shares. There was a clear causal relation between the two. The Court of Appeal held that, on any view, the sharp fall in the share price which took place on 19 November 2002 was a loss which "may" give rise to a claim and which, as a matter of fact, in due course did give rise to the claims which were ultimately settled for $30.5 million. AIG knew, therefore, that a loss had occurred which had given rise to a claim when they were notified by Smartforce in December 2002 that claims had been made against them. Consequently, Faraday had no liability to make any payment to AIG under the terms of the reinsurance policy.