In previous Bulletins we reported on the Supreme and lower Court decisions in Teal Assurance Co Ltd v W R Berkley Insurance Europe Ltd. We now report upon a further Commercial Court decision in this case, in which W reinsured T in respect of a “top and drop” layer of a programme of excess professional liability insurance provided by T (a captive insurer) to the original insured, B. Importantly, cover under the underlying policies was broad, covering risks on a worldwide basis. Cover under the top and drop layer and its reinsurance was narrower, excluding US and Canadian claims.

In the previous proceedings, T argued against W that B’s losses eroded the liability tower in the order in which they were settled by T and that it was therefore open to T to order B’s losses however it chose for reinsurance recovery purposes. If correct, this would allow T to collect US losses from the lower layers of the tower, and non-US losses from the top and drop layer, giving T access to W’s reinsurance of that layer.

However, in his Commercial Court judgment (which was subsequently upheld by both the Court of Appeal and the Supreme Court) Mr Justice Andrew Smith held that it was not open to T to order the losses in this way and that those losses instead eroded the liability tower in the order in which B’s liability to third party claimants was established and ascertained.

The new decision involved the determination of a separate preliminary issue which arose as a result of T revising its case. T now argued not that it was entitled to order B’s losses howsoever it chose to settle them but instead that, on the facts, B’s liability to third party claimants was established and ascertained in an order which meant that the non-US losses impacted the top and drop layer.

One particular non-US loss had been settled by way of an agreement providing for payment by B into escrow and subsequent draw down upon the escrow funds by the third party claimant, upon certain conditions being fulfilled. T argued against W that B’s liability was established and ascertained at the (relatively late) point at which the escrow funds were drawn down upon by the third party claimant. Against this, W argued that B’s liability was instead established and ascertained on an earlier date at which the payment into escrow was made.

The Court preferred T’s arguments on this preliminary issue, holding that B suffered a loss for the purposes of its professional liability programme as and when the third party claimant drew down on the escrow funds. The programme provided an indemnity in respect of sums which B became “legally obligated to pay as damages”. Central to the court’s conclusion was its determination that the agreement by B to pay money into escrow was not an agreement to pay damages; such damages were only payable as and when the third party became entitled to draw down upon the funds.

As well as providing useful clarification that a payment into escrow will not ordinarily (assuming equivalent circumstances and contract language to those in this case) amount to a loss for the purposes of a liability policy, the case also raises interesting questions regarding the use of escrow accounts in commutations/policy buy-backs to settle uncrystallised (potential) claims and generate corresponding reinsurance recoveries in situations where a straightforward commutation of outstanding loss/IBNR reserves would not amount to settlement of a “loss” for reinsurance collection purposes.

If payments from escrow funds which have been deposited to meet future liabilities can trigger an indemnity under a liability policy then, provided care is taken not to release the reinsurer from liability before draw-down, a policy buy-back/commutation could potentially be structured by way of payment into escrow in such a way that future reinsurance/retrocession collections are not prejudiced, and so that time (for limitation purposes) does not start to run against the cedant until drawdown has taken place.