The U.S. corporate defendant's captive insurer's dilemma: third party liability claims and recovery under English law.

• Author: Woloniecki, Jan

IT HAS BEEN said that Great Britain and the United States are two nations separated by a common language. They might also be compared as two jurisdictions separated by a common law. A recent illustration of the divergence in legal analysis on the other side of the pond is provided by a series of English decisions which place defendants facing large product liability and other third party claims in the U.S. in an invidious position when they seek to be indemnified for commercially prudent settlements of those claims from insurers who in turn look to reinsurers for payment.

The manufacturer of a product that has not been withdrawn will typically defend product liability lawsuits vigorously, and any settlements that the manufacturer enters will naturally be without any admission of liability. The manufacturer may have good reason to believe that it was not liable and that it is settling on the basis of a well-founded fear of adverse jury awards that may not be overturned on appeal. The manufacturer will, in those circumstances, expect its product liability insurers to pay the settlement, provided of course that the settlement was reasonable considering the potential exposure. Let us suppose the insurer, who faces the prospect of a coverage law suit in the U.S. which he is advised he will lose, agrees to pay the claim.

The insurer may well be a "captive" wholly-owned by the manufacturer/ policyholder. Let us assume that the captive has received independent advice and acts as a commercial insurer. In the case of any large claim upon a captive insurer, a substantial part of its liability will be reinsured. It is likely that these reinsurers are located in either London or Bermuda. It will come as an unpleasant surprise to both the captive and its parent to find that, after having settled the loss, when they come to London to collect from their reinsurers, they will likely be met with a response like the following: We are not obliged to pay unless you prove that the manufacturer/policyholder was under a legal liability. A reasonable settlement based on a well founded fear of a large adverse jury verdict does not prove that the manufacturer/policyholder was under a legal liability. An English judge isn't interested in predictions of what a U.S. jury would have done and whether such a verdict (no matter how perverse) was likely to be sustained on appeal. You have to prove to the English judge as the trier of fact that, based upon the evidence and the relevant U.S. law as explained to him or her by experts, the manufacturer/policyholder was indeed liable.

This state of affairs will strike many U.S. lawyers as bizarre, yet it represents the current state of English law. We discuss the recent cases below and argue that they represent a departure from commercial common sense which has always been the hallmark of English common law since the days of Lord Mansfield. We suggest that the English Court of Appeal and the House of Lords should look again at the relationship between insurance and reinsurance and construe the, admittedly arcane, language of reinsurance contracts in a way that reflects the commercial expectation of the parties. We suggest that Bermuda courts should also make this shift.

Follow the Settlements

The case of Chippendale v. Holt (1) is an example of an early dispute over contracts of reinsurance in the English courts. The case was concerned with a preliminary issue between a reinsured and its retrocessionaire regarding what the reinsured had to prove to recover from the reinsurer. The reinsurance contract provided that the reinsurer was obliged, "to pay as may be paid thereon." It was common understanding of underwriters in the nineteenth century that this language required the reinsurer, "to pay without further inquiry any claim honestly paid by the [original] insurer. (2) However, the Commercial Court held the reinsured had to show that the claim for which he sought indemnity was indeed covered under the contract; it was not sufficient to simply demonstrate that payment had been made in good faith under the original contract. The London market's response to Chippendale v. Holt was to provide for a contractual obligation on the part of reinsurers to "follow the settlements" of their reinsureds. (3)

The House of Lords decision in Hill v. Mercantile & General states the fundamental position of English law with respect to a reinsurer's contractual obligation to follow the settlements of his reinsured. Lord Mustill noted:

There are only two rules, both obvious. First, that the reinsurer cannot be held liable unless the loss falls within the cover of the policy reinsured and within the cover created by the reinsurance. Second, that the parties are free to agree the ways of proving whether these requirements are satisfied. Beyond this, all the problems come from the efforts of those in the market to strike a workable balance between conflicting practical demands and then to express the balance in words. (4) The English Courts' approach has been to focus carefully on the particular words of the loss settlement clause in the reinsurance contract rather than to adopt broad general principle as to the obligation of a reinsurer to "follow the fortunes" of the cedant.

A recent example of the English approach to contractual construction is provided by Assicurazioni Generali Spa v. CGU International Insurance plc. (5) In that case, the reinsurance contract provided that CGU reinsured Generali on the "same terms ... as the original policy ... and is to pay as may be paid thereon to follow without question the settlements of the Reassured except exgratia and/or without prejudice." (6) Generali had settled a claim under the original policy and brought an action for summary judgment against its reinsurers on the reasonable assumption that the reinsurance contract meant what it said and that reinsurers were obliged to follow Generali's settlements "without question."

The deputy judge (Mr. Gavin Kealey QC) held that the words "without question" did not relieve Generali of the obligation to take all proper and business like steps in relation to settlements nor did they deprive CGU of the right to argue that settlements were not within the scope of the reinsurance contract. He concluded, applying Insurance Company of Africa v. Scor (7) and Hiscox v. Outhwaite (No. 3), (8) that the "follow the settlements" clause had the following effect:

The Defendants are bound by all settlements made by Generali (except ex gratia and without prejudice settlements) (a) provided that the claims so recognised by Generali fall within the risks covered by the contract of reinsurance as a matter of law: by which is meant in this context as explained above, provided that the claims were settled on a basis which, if and assuming it to be valid, falls within the risks covered by Generali's outward contract of reinsurance as a matter of law; and (b) provided that Generali acted honestly and took all proper and businesslike steps in making such settlements. (9) Whether or not the settlement was ex gratia depended upon an investigation of the real basis upon which Generali settled. Accordingly, the defendant reinsurers were given unconditional leave to defend. The Deputy Judge justified his interpretation of the "follow the settlements" clause on the following basis:

Since a contract of insurance and a contract of reinsurance are two separate...