UK: Reinsureds Required to Disclose Allegations to their Reinsurers

In reaching its decision, the Court of Appeal had to choose between two decisions of a lower court (the Commercial Court). In The Grecia Express [2002] 2 Lloyds Rep 88, the Commercial Court had said that non-disclosure of mere allegations of an assured’s history of scuttling vessels did not justify an avoidance if the assured maintained that the allegations were wrong and would (if allowed) be able to prove this to the court. The allegations would only be material if the assured could not prove that the allegations were wrong.

In the subsequent case of Drake Insurance plc v. Provident Insurance plc [2003] 1 All ER Comm 759, a different judge in the Commercial Court had expressly disapproved The Grecia Express. A motor insurance contract had been avoided for non-disclosure of a speeding conviction. The court upheld that avoidance even though there was evidence that, if the speeding conviction had been disclosed, the assured’s whole history might then have been looked at more closely. An entirely separate earlier accident might then have been positively re-rated as a "nofault" accident, balancing out the speeding conviction in such a way that the terms of the insurance would not have changed after all. This information about the earlier accident (that had only come to light after the avoidance) suggested that the avoidance would not have been justified. This still did not sway the court. The Grecia Express was criticised as introducing "an additional and unwelcome element of uncertainty" because it put insurers at a greater risk of their avoidance being re-opened at trial.

In the Brotherton case, the claimants were London reinsurers who were seeking a declaration from the English court that they had validly avoided a reinsurance contract with two Colombian insurance companies called Aseguradora Colseguros S.A. and La Previsora S.A., Compania de Seguros.

The Colombian insurance companies had provided bankers’ blanket bond and professional indemnity insurance to a Colombian bank called Caja Agraria. Amongst other things, the insurance covered losses caused by dishonest or fraudulent acts of bank employees.

Leading up to the making of the reinsurance contract in late 1997, there were seven news bulletins and fifteen newspaper articles in Colombia carrying reports about alleged misconduct and related investigations into Caja Agraria’s business and the conduct of its President Mr Medina. There were allegations of corruption, embezzlement of public funds and so on. Also prior to late 1997, Mr Medina had been suspended from his post and had been served with an arrest warrant.

The London reinsurers said that the reports alone (and, all the more, the reports coupled with the fact that the investigations were taking place) were material facts that should have been disclosed to them by the Colombian insurance companies on placing. This was either because the information might increase the risk of claims under the reinsurance or because of the moral hazard involved. The facts had not been disclosed. The reinsurers avoided the reinsurance.

The Colombian insurers admitted the existence of the reports and the investigations but said that they were not material. They said that the suspension of Mr Medina and the investigations had been politically motivated and that the vast majority of the charges against him had been dropped after the reinsurance was agreed. They insisted that the information was not material even though, at the time of placement of the reinsurance, there was no objective way of knowing that it was untrue. The insurers thus argued that they should have the opportunity to prove at trial that the allegations made against Mr Medina were unfounded.

The issues for decision by the Court of Appeal were therefore whether:-

(a) The materiality of the admitted reports (or the reports coupled with the admitted investigations); or

(b) The validity of the avoidance depended on whether the allegations were true.

Having considered the two Commercial Court cases, the Court of Appeal in Brotherton preferred the reasoning in the later Drake Insurance case. The Court of Appeal held that the mere existence of allegations can be material and disclosable in such a way that an avoidance may be justified – even though those allegations may turn out to be untrue later. At the same time as it discloses the allegations, the reinsured can disclose evidence that the allegations are untrue in order to try to persuade the underwriter that the information is not material.

The Court of Appeal reasoned that the question of whether or not the allegations are true is not in itself the point. It was not for the court to establish their truth. It was for the court to establish their materiality in the mind of the underwriter. If the existence of allegations is material in itself at the time of placing, then this is enough to justify avoidance.

The Court of Appeal was concerned that a reinsured could otherwise resist disclosure of information on the basis that he could later prove its untruth even though an opportunity to prove its untruth might never arise in practice – or alternatively that the reinsured would have to prove its untruth in subsequent unnecessary litigation. A decision on materiality had to be taken at the time of placing – not at a later trial. Also, in practice, it might be very hard to assess the truth of allegations. It was easier to assess their materiality.

The matter was remitted back to the Commercial Court, which found that the facts withheld were indeed material.

The Court of Appeal decision in Brotherton has now been commented upon by the Court of Appeal in another judgment, namely the appeal judgment in the Drake Insurance [2004] 1 Lloyd’s Rep 268 case referred to above (although it should be noted that the Court has stressed that its comments are made with caution and are not aimed at deciding the case before it).

In the leading judgment, Rix L.J. has distinguished Brotherton from Drake Insurance on the basis that, in Brotherton, the new evidence relating to the Colombian allegations only came into existence after the contract of insurance was agreed while, in Drake Insurance, the "no-fault" nature of the earlier accident was known to the assured at the time of placing.

According to Rix L.J., an insurer is entitled to avoid on the basis of the true state of affairs at the time of placing, even where he is not fully aware of it at the time. On the other hand, if he does avoid the contract of insurance, then he takes the risk of evidence later emerging that the avoidance was unjustified. Where evidence that the circumstances relied upon by the insurer were not material did not exist at the time of placing, then it will be irrelevant (as was held in Brotherton) but, where the evidence did exist at the time of placing, then the right to avoid will be denied, even where the insurer was not aware of the circumstances in question.

This means that, where an insured faces unjustified allegations, it should still disclose them to its insurers. At the same time, it would be well-advised to disclose any evidence that the allegations are wrong. Similarly, a reinsured should also disclose to his reinsurers any allegation about the original assured together with any evidence that those allegations are misplaced.

One important distinction between the Drake and Brotherton cases should be borne in mind. In Brotherton the issue was the right of the reinsured to adduce evidence at the trial in the hope of persuading the Court to exercise its equitable discretion to refuse avoidance. In Drake the issue was the state of the insurers’ knowledge when they purported to avoid (i.e. the extent to which they had complied with their continuing duty of good faith). In the light of Drake, insurers/reinsurers cannot now avoid without making some basic checks before they purport do to so. This may be because the facts they rely on do not in fact exist, because if there had been disclosure the whole presentation of the risk might have taken a different turn (as in Drake) or because the insurers know or ought to know that the facts relied upon were non-existent.

In conclusion it seems that in the reinsurance context, the reinsured should disclose even possibly unjustified allegations against the original insured, as otherwise there is a risk that the reinsurance will be avoided unless there is already information available that the allegations can be refuted. However, a direct insurer may be in a more difficult position where he wishes to avoid a policy in these circumstances.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.