Commercial Court considers issues of notification, causation, estoppel, defence costs and set-off

The main issue in this case was which policy year claims against a now insolvent insured fell under. Much of the case is fact specific, but the judge, Andrew Henshaw QC, covered the following issues, which are of general interest:

(1) Notification of a "hornet's nest"-type situation. The judge said that notification of such a situation may be limited where there is a requirement that the notified circumstances are such as to suggest that a claim is likely to arise: "Thus, to take an extreme example, a purported notification which simply stated at a high level of generality that the insured had performed a particular project badly in its entirety would be likely to be ineffective as a notification, if only because it failed to specify any particular failings or at least categories of failing that a reasonable person would consider likely to give rise to a claim. It would also fail to serve one of the purposes of a notification, namely to enable the insurer to make its own plans to deal with the potential liability. By contrast, the broad notification given in Rothschild Assurance Ltd v Collyear did refer to circumstances, namely the sample review by KPMG, that provided grounds on which to consider that the same problems had been replicated in other similar transactions that the firm had undertaken".

(2) The notification clause in question provided that the insurer agreed that any circumstance notified during the policy period "which subsequently gives rise to a claim" after the expiry of the policy shall be deemed to be a claim first made during the policy period. The judge commented that "it would be a mistake to attribute much weight to fine linguistic distinctions in this regard" and so all that was required is a causal, rather than merely coincidental, link between the notification and the eventual claim.

(3) Can an insured choose which policy to claim under? In this case, the insured argued that it could notify circumstances under one policy and a claim under a later policy, because there was no exclusion in the later policy of claims which are deemed first made in another period. The insurer sought to argue that the first notification takes priority but the judge (although not required to decide the point) favoured the argument that "In the absence of an exclusion of previously notified circumstances, and provided of course that proper disclosure is made, there is no sufficient reason why an insured should not place cover on a claims made basis for a later year and rely on such cover if claims are then made during that later year".

(4) The situation where there are two discrete losses. The Miss Jay Jay case has confirmed that where there is a single loss which has 2 proximate causes, one an insured peril and one a non-excluded uninsured peril, the loss will be covered. Conversely, if there are 2 proximate causes, one an insured peril and one an excluded peril, there will be no cover. However, the judge noted that these cases have not dealt with the situation where, rather than a unitary loss, there are two discrete losses arising from, for example, two discrete periods of delay. The judge held that in that situation, claims must be made separately and it makes no difference if a third party makes a global claim for both losses, which is then settled on a global basis. The insured must either prove its loss to the insurer in the usual way or else reach a settlement which allocates the settlement between the different losses.

(5) Had the insurer lost the right to rely on the breach of a notification condition precedent because it had not taken the point for over 6 years? On the facts, the judge found that there was no estoppel, as he did not consider that a reasonable person would have expected the insurer to tell the insured that the notification was too late, since the insurer had treated the claims as falling within a different notification. In any event, there had been no detrimental reliance by the insured: this was not a case like Ted Baker v AXA, where the insured could have easily provided missing documentation if alerted to a problem.

(6) Defence costs: The primary insurer had paid defence costs on behalf of the insured but it had subsequently become clear that the third party claim exceeded the limit of cover for its policy and fell partly within the limits of the excess policy for the same year. The primary policy contained the following provision: "In the event that a settlement is made with any party in excess of the amount of the Limit of Indemnity, Underwriters’ liability in respect of Defence Costs shall be in the same proportion that the Limit of Indemnity bears to the sum which would be eligible for payment but for the restriction of the Limit of Indemnity.”

The judge held as follows:

(a) The use of the word "settlement" in this context includes a judgment or award, as well as a compromise agreement. Accordingly, the primary insurer had overpaid defence costs as it should have paid only its proportionate share.

(b) Excess insurers said that there is a "traditional understanding", in the absence of express wording, that an insurer who assumes the conduct of a defence in exercise of a right under the policy will undertake to bear the costs. The primary insurer had paid the costs of defending the third party claim when the size of the claim under the policy was not yet known. The judge held that the primary insurer was entitled to recover its overpayment from the insured when it became clear that the claim had exceeded the policy limit, and it could not be said that the limit on the insurer's costs liability was ineffective.

(c) Having held that the primary insurer was entitled to a set-off against a claim for indemnity from the insured, the judge went on to consider whether the insurer was entitled to a set-off against a third party claimant under the Third Parties (Rights against Insurers) Act 1930 (“the 1930 Act”). The 2010 Act specifically provides that there will be a right of set-off in these circumstances, but there was no such provision in the 1930 Act and there has been caselaw debate as to whether not only the insured's rights, but also its liabilities, are transferred to the third party under the 1930 Act

In the recent case of Denso Manufacturing v Great Lakes, the judge was not required to decide the point, but said she preferred the argument that the insured's liabilities are not transferred to the third party. She relied on the Supreme Court's decision in IEG v Zurich, in which it was opined that legal set-off is "probably" precluded under the 1930 Act.

However, in this case, the judge said that the 1930 Act makes it clear that the insurer is not to have any greater liability than it would have to the original insured and concluded as follows: "The Judge’s citation from International Energy Group v Zurich Insurance suggests only that any equitable set-off will require pleading and proof that the ‘manifestly unjust’ criterion has been satisfied. In my view, therefore, the observations in Denso do not undermine [the primary insurer]’s case for saying that a right of equitable set-off arising from defence cost payments in excess of the contracted-for share …. can be asserted as a defence to a 1930 Act claim".

(7) Separately, on the facts, there had been no agreement by the insurer to treat all claims in a certain way, but if there had been such an agreement between the insurer and the insured, the judge held that a third party bringing a claim under the 1930 Act would have been bound by such an agreement.

(8) Having determined that the primary layer had a right to set-off for the overpaid defence costs, the judge went on to find that the insured could have recovered those costs in turn from the excess insurers. However, such a claim would not fall within the 1930 Act as that Act does not transfer to the third party the insured's right to recover from his insurer the costs of defending the third party's claim. Even if a transfer was possible, it would be in favour of the defence lawyers and not the insured. (Similarly, had the primary insurer been unable to set-off, it would have been unable to bring a claim under the 1930 Act against the excess insurers).

(9) Post-award interest: The primary policy required the insurer to indemnify the insured against "any claim for compensation and/or damages (including claimant's costs and expenses)". There was no definition of "compensation" in the policy, but it was argued that this included post-award interest. In Cox v Bankside Members Agency Limited [1995], it was held at first instance (and the Court of Appeal approved) that the phrase "compensatory damages" was wide enough to include pre-judgment interest awarded against the insured under section 35A of the Supreme Court 1981. However, in this case, the judge said that there was a difference between pre-judgment interest arising from a contested claim and post-judgment interest which arises from delay in paying the judgment, award, or settlement. As such, the claim for post-award interest fell outside of the scope of the policy.