UK: Wasa V Lexington - Reinsurers Take Note!

Wasa International Insurance Co Ltd and AGF Insurance Co Ltd v Lexington Insurance Co (Court of Appeal, 29 February 2008). On 29 February 2008, the English Court of Appeal handed down its judgment in this follow the settlements case reversing the decision of the judge at first instance.

The judge at first instance had decided that the insurance and reinsurance contracts were not completely back-to-back and, as a matter of law, the reinsured's settlement of the insurance claim did not fall within the terms of the reinsurance, so that the reinsurers did not have to follow it. The Court of Appeal, however, concluded that although there were some differences in the insurance and reinsurance contracts, the parties intended that they should have the same effect and, therefore, as a matter of law, the reinsured's settlement of the insurance claim did fall within the terms of the reinsurance, so the reinsurers were liable to follow the reinsured's settlement.

This is a significant decision, especially for reinsurers. In the past where there have been differences between the insurance and reinsurance contracts the English courts have tended to find that the contracts were not back-to-back and reinsurers did not have to follow the settlement of the reinsured. Has this position now changed?

The facts

From noon on 1 July 1977 until noon on 1 July 1980 Lexington Insurance Co ("Lexington") insured the Aluminium Company of America ("Alcoa") in respect of loss or damage to property, with a limit of liability of "$20,000,000 loss or damage arising from any one occurrence" and a per occurrence deductible of $250,000. There was no express choice of law clause in the insurance contract. It, however, did contain a US Service of Suit clause.

Lexington obtained facultative reinsurance for the risk from the London reinsurance market, including Wasa International Insurance Co Ltd ("Wasa") and AGF Insurance Co Ltd ("AGF"), "as original" for the period "36 months 1.7.77. L/U and/or pro rata to expiry of original", subject to a limit of $20,000,000 per occurrence. The slip policy made reference to the "J1 or NMA 1779" forms which stated: "

The slip policy also referred to "Full R/I Clause No. 1 as amended":

Again, there was no express choice of law clause in the reinsurance contract. It, however, was common ground that it was governed by English law.

In the 1990s, the US Environmental Protection Agency and various state environmental agencies required Alcoa to clean up pollution and contamination at numerous manufacturing sites. Alcoa subsequently began proceedings in the state of Washington against various insurers who had provided property insurance to Alcoa during the period from 1956 to 1985 seeking a declaration of entitlement to insurance coverage in respect of the clean-up costs at the manufacturing sites. Lexington was one of the defendants.

Applying the law of Pennsylvania, where Alcoa was incorporated and had its centre of business, the trial judge held in the proceedings that there had been property damage at several of Alcoa's manufacturing sites, that at each relevant site there had been two occurrences, and that the appropriate apportionment was to divide the total repair costs for each site by the number of years in which the damage had occurred and then allocate the appropriate proportion to each year. The evidence showed that the damage had occurred over many years before the inception of the insurance with Lexington and for some years afterwards, and so by using the allocation formula Lexington was liable for only a relatively small percentage of the overall loss. Furthermore, certain of the losses at particular sites fell below Lexington's deductible.

On appeal, however, the first instance decision was reversed. The Supreme Court of Washington held that insurers, including Lexington, were jointly and severally liable to Alcoa for all of the damage, including that which had occurred before the insurance with Lexington incepted and afterwards. Lexington then faced a claim from Alcoa of about $180 million. So, in 2003, Lexington agreed a settlement with Alcoa whereby it would pay it $103 million. This was a proper settlement on that interpretation of the law.

The decision at first instance

Following Lexington's settlement, Wasa and AGF commenced proceedings in London seeking a declaration that they were not liable to pay Lexington the settlement sum on the basis that the reinsurance contract was governed by English law and that, as a matter of English law, reinsurers could only be liable for the costs of remedying damage to property which actually occurred between 1 July 1977 and 1 July 1980. Reinsurers could not be liable for the costs of remedying damage which occurred before or after the period of the reinsurance. The judge at first instance upheld that contention, so Lexington appealed to the English Court of Appeal.

The Court of Appeal's judgment

The Court of Appeal focused on the period clauses in the insurance and reinsurance contracts. It stated that the starting point was to ask whether the parties intended that, to the extent the same or equivalent wording was used in the insurance and reinsurance contracts, they had the same meaning in both contracts. In relation to the period clauses in the insurance and reinsurance contracts, the Court of Appeal held that, although expressed slightly differently, they were effectively identical. Furthermore, it went on to determine that the parties did intend that the period clauses should have the same meaning. If this was not to be the case, there would need to be clear indications to the contrary.

The Court of Appeal stated that the period clauses in the insurance and reinsurance contracts had to have the same effect because the reinsurance contract was a contract to indemnify the reinsured, Lexington, against liability under the insurance contract. Therefore, the conclusions reached by the Supreme Court of Washington in relation to the insurance contract also had to be applied to the reinsurance contract.

The judgment against Lexington in the US was not one which either Lexington or Wasa and AGF were expecting. The judgment, however, was a possibility. By accepting the premium on the same basis as Lexington, and by using words which were more or less indistinguishable from those in the insurance contract, the Court of Appeal decided that Wasa and AGF had agreed to cover that possibility.

The Court of Appeal strongly rejected the idea that unsatisfactory US court decisions should remain with the US insurer, rather than London market reinsurers. That was not what reinsurance was about. In this respect, Longmore LJ, who gave the main judgment, stated:

Conclusions

As matters currently stand therefore, Wasa and AGF will have to follow Lexington's settlement and consequently pay for decades of pollution costs rather than those arising during the three specified years' cover. This is so even though there were differences between the insurance and reinsurance contracts, making this a significant case.

Disputes relating to follow the settlements usually involve insurance and reinsurance contracts that have differences, and the same is true with this case. As stated above, however, whereas in the past the English courts have tended to find in favour of reinsurers in such circumstances, here the Court of Appeal has decided the matter in the reinsured's favour and seems to have done so in no uncertain terms. Does this set the stage for the future? Is there now uncertainty as a result of this decision?

It seems that Wasa and AGF will seek leave to appeal the Court of Appeal's decision. It will be interesting to see if they obtain leave to appeal to the House of Lords and, if so, how the House of Lords decide this matter. Watch this space!

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