Following the publication of our client alert dated 20th January 2016, we have been asked to consider a series of issues relating to insurance arrangements designed to maximise the benefit of cover for the interests of a third party, such as a lender, an investor/shareholder and a recipient of services. In this client alert, we flag the principal issues that have been raised and seek briefly to address them.
1. How can the recipient of services in the commodities sector enhance its position with respect to insurance cover procured by third party vendors performing services such as storage, warehousing, transportation or custodianship, where such third parties are contractually obliged to procure insurance?
In our view, obtaining additional insured status should provide the best protection; however a recipient of services should request to see the actual policy terms, not just the risk details on the certificate of insurance. This will show all the policy requirements and exclusions which should be checked. For example, the existence of an “insured against insured” exclusion, will prevent recovery in circumstances where the recipient of services might wish to claim against the third party vendor/supplier. For this type of loss, it will be better practice to make sure that the third party vendor/supplier maintains a separate “Errors and Omissions” policy.
Even if it is not possible to analyse the policy terms, it is good practice to obtain a copy of the full policy wording. Otherwise, if there is a problem in the future, any delay in obtaining the policy potentially puts you at risk of not complying with time limits for notification of claims.
In an ideal world, the policy should be a composite policy insuring each insured for its own respective rights and interests as if under a separate policy. This should include a severability clause, providing that if there has been any breach by the third party vendor/supplier, this will not affect the interest of the recipient of services under the policy.
In various countries, a local policy will be a compulsory requirement for anything considered to be a local risk. Consideration should be given as to whether or not any reinsurance policy placed by the local insurer contains a cut through clause. This will enable direct action against the reinsurer by an insured in the event of the insolvency of the insurer. Cut through clauses are effective in the United States and are readily enforced in England under the Contract (Rights of Third Parties) Act 1999.
If the recipient of services also has their own insurance programme in place, the question of double insurance should be considered. The recipient of services should check their own insurance policy and make sure that the insurers are aware of their arrangements with the third party vendor/supplier. The recipients of services should check the ‘other insurance’ clause in their policy to ensure that it will respond after payment under the third party insurance or failure by that insurance company to pay. It is important to make sure that the recipient of service’s own insurance policy does not contain a clause stating that, if the subject matter of the insurance is insured under another insurance policy, then the insurance will cease to have effect or be void. Some policies will just provide for notice of the second insurance to be given to them.
2. What risks, if any, does an investor/shareholder incur by seeking “additional or co- insured” status on the liability policies of its corporate investments? Does the act of requesting to be named as an additional insured on another entity’s liability policies create a liability for the shareholder and/or increase exposure to a piercing of the corporate veil?
The short answers to these two questions are “none” and “no” respectively.
However, this is very likely to be tied up with questions of the laws (a) in which the investment entity is incorporated; and (b) of the courts in which the integrity of the investment as a separate legal entity is challenged. Our short answers therefore assume that either English or New York law apply.
Subject to very few exceptions, it is not generally possible as a matter of English law to look behind the separate legal personality of a company and to attribute liabilities arising from its acts/omissions to its shareholders. The exceptions to this rule include where the investment entity is, in fact, acting as the agent of the shareholder. Another instance in which a shareholder may incur liability for the actions of its subsidiaries or investments is where such shareholder has been acting as the shadow director of the company. A shadow director is any person (or entity) with whose instructions the directors of the company are accustomed to act.
Whether or not the person or entity controls and directs the activities of a company to such an extent as to create an agency or for that person to be regarded as a shadow director is a question of fact and degree. The relevant facts would be required to point towards control and direction. It is our view that requesting to be named or in fact being named as an additional insured on an investment’s policy does not materially enhance the risk.
The harsh and practical reality is that in cases involving significant exposures (pollution and/or liabilities for environmental damage), claimants may well attempt to direct their focus towards a shareholder and to assert claims, especially where the shareholder is one with deep pockets and a brand to protect. The risk of such claims and attempts cannot itself be avoided. However, it is our view that a risk management strategy involving reliable insurance cover is a sensible strategy for the distribution of the risk of liability on the part of the investor/shareholder. The mere naming as an additional or co-insured on a policy together with the investment entity should not change the risk in any meaningful way. The position would in our view be the same whether or not co- insured status was being sought in addition to the investor’s own insurance programme or not.
A best practice that we recommend is that if additional or co-insured status is desired, this amendment to the policy be accomplished via a specific endorsement to the policy. Rather than relying on the more traditional certificate of insurance showing additional insured status, one seeking such status should have their entity identified in an endorsement appended to the policy. This will eliminate any debate or issues as to whether such status exists, or under what circumstances.
3. If a lender’s interests are the subject of a loss payee endorsement to the borrowers’ first party property insurance, will this be sufficient to ensure that insurance proceeds will fund re-building/continuation of operations after a major incident? Secondly, can the lender be confident that a borrower’s conduct will not jeopardise the lender’s interest in the insurance?
In short, because a loss payee provision does not provide an insurer with the protection that is provided by additional insured status, a lender cannot be confident of its position.
A well-drafted loss payee clause will give a lender the right to receive insurance proceeds directly from insurers, enabling it to direct the proceeds to ensure repair/continuation of operations. If the policy is governed by English law, this right will be enforceable directly against insurers, so long as the Contract (Rights of Third Parties) Act has not been excluded. However, the lender has no right to make the claim under the policy and will only benefit to the extent that such a claim is held, or agreed, to be recoverable. If the borrower/insured has failed to take steps to maximise the insurance recovery, a loss payee will be unable to correct the position as it has no separate insured status.
The clause ought to ensure that a lender is put on notice, by the insurer, of any impending cancellation or termination of cover resulting from a failing by the borrower. If the breach is non-payment of premium, the lender will have the opportunity to rectify that breach by paying the premium. If it is a breach the lender cannot rectify, it will at least put the lender on notice and provide an opportunity to seek other insurance protection.
The insured risk may well be situated in an overseas jurisdiction which has a requirement that the direct insurance is placed with a local insurer. In almost all circumstances, this local cover will operate as fronting insurance only, and be reinsured into a market such as London. The London reinsurers will often insist on having full control of all claims made against the original insurance. In these circumstances, a lender should work with its local counsel to fully understand the effect of local laws in respect of a loss payee interest and also seek to ensure that an enforceable ‘cut-through’ clause is endorsed on the reinsurance policy, allowing the lender to ‘follow the money’ payable by the insurers/reinsurers.
Issues such as these should generally be reviewed by counsel familiar with the jurisdiction(s) in which the risk exists. Many countries, and many states within the United States, have specific requirements for the enforceability of such provisions that need to be complied with.