Lexington Insurance Company v AGF Insurance Limited
Lexington Insurance Company v AGF Insurance Limited; Lexington Insurance Company v Wasa International Insurance Company Limited
House of Lords: Lords Phillips, Walker, Brown, Mance and Collins:  UKHL 40: 30 July 2009
Available on BAILII @ http://www.bailii.org/uk/cases/UKHL/2009/40.html
Neil Carver QC and Stephen Midwinter (instructed by Carter Perry Bailey LLP) for AGF
Jonathan Sumption QC and Christopher Butcher QC (instructed by Chadbourne & Park LLP) for Lexington
Alistair Schaff QC and Siobán Healy (instructed by Addleshaw Goddard LLP) for Wasa
REINSURANCE: PROPORTIONAL FACULTATIVE REINSURANCE POLICY: PHYSICAL LOSS AND DAMAGE TO PROPERTY: TEMORARAL SCOPE OF A TIME POLICY: WHETHER REINSURANCE POLICY IS TO BE CONSTRUED AS PROVIDING BACK-TO-BACK COVER WITH THE PRIMARY INSURANCE POLICY WHERE UNCERTAIN GOVERNING LAW OF INSURANCE POLICY PROVIDED WIDER SCOPE OF COVERAGE
In reversing the decision of the Court of Appeal, thereby restoring the judgment of the Commercial Court, the House of Lords held that as a matter of the true construction of the reinsurance contract it did not provide coverage for the reinsured where:
(1) the governing law of the primary insurance contract was uncertain when the reinsurance was placed, giving no basis upon which to consider the interpretation of the primary insurance contract to be other than in accordance with English law (which governed the reinsurance contract); and
(2) the law held to govern the primary insurance contract provided for coverage of losses suffered outside the period of cover, where the primary insurance contract and reinsurance contract were “losses occurring during” policies.
Forsikringsaktieselskapet Vesta v Butcher  AC 852, distinguished.
Groupama Navigation et Transports v Catatumbo CA Seguros  2 Lloyd’s Rep 350 (CA), distinguished.
Case note by Jim Leighton, BSc (Hons), LLB (Hons), LLM (Maritime Law), Solicitor (England & Wales) of Singapore law firm T S Oon & Bazul and International Contributor to DMC’s CaseNotes
A further note on this case is available at []
The insurer provided insurance cover to Alcoa, the US aluminium company, in relation to its environmental risks (clean-up costs of pollution and contamination damage) for “all physical loss of or damage to” Alcoa’s property only for the three-year period 1 July 1977 to 1 July 1980. There was no express governing law clause in the contract but it did contain a US “Service of Suit” clause obliging a party served with proceedings to accept US court jurisdiction. The insurer (reinsured) obtained proportional facultative reinsurance contracts in the English market.
Alcoa made a claim against the reinsured along with claims against a number of its other insurers in the US. The Supreme Court of Washington, applying Pennsylvanian law, held that the reinsured was liable to pay for environmental risks suffered by Alcoa to its property during a period of 44 years (1942-1986). Significantly, the law of Pennsylvania was not chosen as the governing law by an analysis of the primary insurance and its surrounding circumstances. It was chosen because Pennsylvania was merely the most significant commonality between the insured, the polluted/contaminated sites, the insurance brokers and all of the defendant insurers (including the reinsured).
The reinsured sought to claim on its reinsurance contracts with the reinsurers. The reinsurance contracts covered, as did the primary insurance, the three-year period 1 July 1977 to 1 July 1980 and were governed by English law. The reinsurers claimed that they were not liable to reinsure the reinsured for any property damage which occurred outside the three-year period of the reinsurance contracts as a matter of English law (British Dominions General Insurance Co Ltd v Duder  2 KB 394). The reinsured claimed it was entitled to be reinsured to the same extent to which it was liable to insure Alcoa for its losses under the primary insurance (essentially because of a strong presumption that liability under a proportional facultative reinsurance policy is co-extensive with liability under the primary insurance policy).
The appeals therefore raised the question of the extent to which the coverage under a proportional facultative reinsurance contract was, or should be construed as being, co-extensive with the coverage under the insurance contract. If the reinsurance was co-extensive it would (effectively) be treated as an indemnity for the insurer in respect of any liability sustained under the insurance contract.
The parties agreed (as a matter of fact) that:
1. the reinsurance contracts were governed by English law; and
2. under English law, a contract of reinsurance in relation to property is a contract under which the reinsurer insures the property that is the subject of the primary insurance; it is not simply a contract under which the reinsurer agrees to indemnify the insurer in relation to any liability that it may incur under the primary insurance.
The following matters were also common ground:
1. there was no significant difference between the terms of the primary insurance and the reinsurance;
2. under English principles of construction, the reinsurance covered only damage to property caused during the period of the cover;
3. the Supreme Court of Washington, applying Pennsylvanian law to the construction of the primary insurance, held that it covered incremental damage to property that included damage that occurred both before and after the period of cover, provided only that part of the damage occurred during the period of cover; and
4. the decision of the Supreme Court of Washington was not perverse.
The Commercial Court found for the reinsurers. The reinsured appealed and the decision was reversed by the Court of Appeal. The reinsurers then appealed to the House of Lords.
The leading speeches of this unanimous decision were given by Lord Collins and Lord Mance (which were said to be “in harmony” by Lord Phillips).
In characterising the nature of the reinsurance, Lord Collins stated: “The reinsurer takes a proportional share of the premium and bears the risk of the same share of any losses. Consequently, the starting point is that normally reinsurance of that kind is back-to-back with the insurance, and that the reinsurer and the original insurer enter into a bargain that if the insurer is liable under the insurance contract, the reinsurer will be liable to pay the proportion which it has agreed to reinsure… It is not necessary to characterise the reinsurance policy as liability insurance to achieve this result, which is essentially a question of commercial intentions and expectations.”
He considered that: “Those commercial intentions and expectations should not be frustrated by allowing reinsurers to take uncommercial and technical points based on the difference between the effect given to terms in the insurance and the reinsurance under their respective governing laws. That was the basis of the decision in Forsikringsaktieselskapet Vesta v Butcher  AC 852, when the relationship between a contract of insurance and a contract of reinsurance in the international context was considered by this House twenty years ago.” However he was of the opinion that “these appeals raise more difficult and fundamental questions than those in Vesta v Butcher.”
Lord Collins noted that the insurer had become liable in the United States to the insured for losses suffered by the insured which could not have been anticipated in 1977. However, he did not consider this to be the unusual or distinguishing feature in this case, as insurers and reinsurers have to accept liability for losses which are not anticipated. He considered the unusual or distinguishing feature to be that the US courts which imposed the liability on the insurer applied the law of a state which imposes joint and several liability for the whole of the clean-up costs in environmental claims on all insurers at risk during the period when pollution occurred, provided that some pollution had occurred during the policy period in the relevant policy.
He considered that the solution to the question in the appeal, and the reasons why the reinsurers’ appeals should be allowed, were to be found in the following steps:
“(1) In order to establish liability against a reinsurer, the reinsured has to establish that the loss is within the risk assumed under the underlying insurance contract; and that the relevant risk has been assumed under the reinsurance contract.
(2) Whether the relevant risk has been assumed under the reinsurance contract is a question of construction of that contract.
(3) In principle the relevant terms in a proportional facultative reinsurance - and in particular those relating to the risk - should be construed so as to be consistent with the terms of the insurance contract, on the basis that the normal commercial intention is that they should be back-to-back.
(4) Where the insurance contract and the reinsurance contract are governed by different laws, it remains a question of construction of each contract under its applicable law as to what risk is assumed, and there is no special rule of the conflict of laws which governs the consequences of any inconsistency.
(5) Both the insurance contract and the reinsurance contract were “losses occurring during” (or “LOD”) policies (or “occurrence policies” as they are known in the United States), which in English law means that an insurer (or reinsurer) is liable to indemnify the insured (or reinsured) only in respect of loss or damage which occurs during the policy period.
(6) There was not in 1977, when the insurance contract and the reinsurance contract were concluded, any identifiable system of law applicable to the insurance contract which could have provided a basis for construing the contract of reinsurance in a manner different from its ordinary meaning in the London insurance market.
(7) The effect of the decision of the Supreme Court of Washington is to impose liability on Lexington under the contract of insurance for loss and damage which occurred both before and after (as well as during) the policy period in the reinsurance contract.
(8) It is common ground that under English law an insurer (or reinsurer) would not be liable for losses occurring before and after the policy period.
(9) Although normally any loss within the coverage of the insurance will be within the coverage of the reinsurance, there is no rule of construction, and no rule of law, that a reinsurer must respond to every valid claim under the insurance irrespective of the terms of the reinsurance.
(10) The reinsurance contract cannot reasonably be construed to mean that it would respond to any liability which “any court of competent jurisdiction within the United States” (the phrase in the Service of Suit clause) would impose on Lexington irrespective of the period of cover in the reinsurance contract.”
With reference to the judgment of the House in Vest v Butcher, Lord Mance stated: “There was here no identifiable legal dictionary (formal or informal), still less a Pennsylvanian legal dictionary, which can … be derived from the interaction or operation of the terms of the insurance and reinsurance and which could lead to any different interpretation of the reinsurance wording [other than in accordance with English law].”
Lord Mance also stated: “I find it impossible to adopt [the answer which the Court of Appeal gave in the present case] in circumstances where Lexington’s liability has been held to arise under a system of law which was applied to the insurance not by reason of the terms of the insurance or their operation, but in the context of a choice of law on a blanket basis to cover also a large number of other independent insurances and claims”.
While the House has chosen to distinguish the nature of the question in this case as different from that in Vesta v Butcher and Groupama v Catatunbo, it is perhaps a matter of degree as to the distinction to be drawn. The leading judgments do not appear to pinpoint a fundamental reason for drawing such a distinction. One might equally have argued that the reinsurers took the risk of an unfavourable law being chosen to apply to the insurance contract when no express law clause was specified in the primary insurance contract. This is particularly so where the reinsurers take a proportionate amount of the premium. Whether they decide to write the risk on the basis of the premium offered is essentially down to an assessment of the likely risks faced, seeking to balance the potential risk and reward. If they chose to write on the basis of an unknown governing law, they chose to write the policy blind to the potential risks faced.
Why should a distinction be made between the legal effect of breach of a warranty under the different laws of the contracts for insurance and reinsurance (viz. Vesta and Groupama) and the effect of the law applied to the insurance overriding the period of cover, unlike the law of the reinsurance? Particularly so when both the reinsured and reinsurer did not think the result of the decision of the US courts to be perverse. It is certainly arguable that there are some good economic reasons for allowing the appeal, given the potential for wholly unforeseeable and crushing liabilities to undermine the financial viability of this type of reinsurance. But without clear articulation of justifiable reasons of an economic nature, this decision risks appearing to reintroduce protectionism based on technical points, which Vesta and Groupama sought to avoid.
Under the circumstances, if a reinsured wishes to obtain English reinsurance that is more likely to cover claims on a (broadly) back-to-back basis, then it would be preferable to ensure that the governing law of both contracts is English, or, at the very least, a governing law is expressly defined in the primary insurance. This would ostensibly marginalise the risk of reinsurance cover of this nature being legitimately denied for lack of an applicable “legal dictionary” for the primary insurance. But, under English law, the extent to which reinsurance cover may be considered back-to-back or operate as an indemnity is, as the House made clear, ultimately a matter of the true construction of the reinsurance contract in each case.