At the urging of U.S. policyholders, a Scottish court recently rejected a Scottish insurance company’s efforts to close its books and avoid full liability for long-tail claims when the insurance company is solvent and entirely capable of paying claims.

Under U.K. law (§899 of the Companies Act of 2006), insurance companies that are solvent may, with the approval of a requisite number of creditors (i.e., policyholders), enter into a “solvent scheme of arrangement.” Such a “scheme” enables the solvent insurance company to cut off its liability completely, including for incurred but not reported (“IBNR”) claims, and close its books entirely. While an insolvent insurance company can also enter into such a scheme, comparable to a U.S.-style liquidation, the ability of solvent insurance companies to do so has no such parallel in the U.S. Thus, many U.S. policyholders with insurance written by U.K. insurance companies, such as the London Market, are surprised to learn that they can lose valuable and often irreplaceable insurance coverage for long-tail liabilities, despite their objection, from solvent U.K. insurers through such schemes. U.S. policyholders for many years have objected to such a practice with little success as solvent scheme after solvent scheme was sanctioned by U.K. courts. However, a recent decision by a Scottish court finally offers some of the additional protections U.S policyholders were seeking.

With the decision, In re Scottish Lion Insurance Company Limited,1 Lord Glennie of the Scotland Court of Session dealt a critical blow to the ability of the Scottish Lion Insurance Company Limited (“Scottish Lion”), a London Market company, to enter into a solvent scheme of arrangement. Scottish Lion, fully able to meet its financial liabilities, sought to close its books on long-tail claims through a solvent scheme of arrangement. The company received permission last year to convene a meeting at which time creditors would have the opportunity to vote on whether to enter such a scheme. The vote ostensibly passed the requirements of U.K. law with at least a majority in number representing 75% in value of the creditors present at the meeting voting for the scheme. Scottish Lion then moved for a Scottish court to sanction the scheme and set a date by which all claims, including all IBNR claims, had to be submitted. Several U.S. creditors opposed the sanction, challenging both the manner in which creditors’ votes were valued and the ability of a solvent insurance company to force unwilling creditors into a scheme of arrangement through a majority vote.

The Scottish court ruled that the U.S. creditors were entitled, at that stage of proceedings, to challenge the valuation of the vote, including challenges that the vote was unfair and not representative, affected by special interests, and that the counting and valuation of the vote was flawed in methodology or contained other significant errors. The U.S. creditors challenged what they considered selective devaluation of votes by Scottish Lion, particularly of votes against the scheme. Lord Glennie also ruled that while there is not an explicit rule against sanctioning solvent schemes in the face of creditor dissent, justification is required to demonstrate why dissenting minority creditors should be bound by the decision of the majority. The court reasoned that, unlike insolvent schemes, where financial difficulties necessitate binding dissenting minority creditors to the will of the majority, solvent schemes lack such financial justification. The court stated that there might be reasons apart from financial uncertainty justifying a solvent scheme; however, such reasons must be made apparent when seeking to sanction the scheme. The court also stated “unreasonableness seems to me to stem from the fact that where the company is solvent it is unnecessary for the body of creditors or class of creditors to [agree] as a whole that there should be any scheme, still less a scheme forced upon unwilling participants.”

In a separate order that followed this decision, the court entered a final judgment refusing to sanction the scheme. Scottish Lion stated plans to appeal the decision.

This ruling and the court’s refusal to sanction the scheme are important victories for U.S. policyholders seeking to protect their insurance coverage, particularly occurrence-based, long-tail liability insurance coverage, which is a valuable and often irreplaceable corporate asset. The Scottish court has recognized the unfairness that U.S. policyholders for years have argued is present in the ability of a solvent insurance company to close its books against the objections of dissenting policyholders. Should this decision be upheld on appeal, it will serve as an important check on future solvent schemes of arrangement.