In a judgment handed down on 29 February 2008 in Wasa Insurance Company v. Lexington Insurance Company and AGF Insurance Limited v. Lexington Insurance Company [2008] EWCA Civ 150, the Court of Appeal has overturned the first instance decision and held that period of cover wording in the reinsurance should be interpreted on a back to back basis with the underlying insurance.

Facts

The reinsurers (WASA and AGF) sought declarations that they were not liable to indemnify their reinsured (Lexington) under a facultative reinsurance in respect of environmental clean-up costs incurred by Lexington's insured, Alcoa.

Alcoa, in the early 1990's, had been ordered by the US Environmental Protection Agency to clean up pollution at a number of its manufacturing sites in the US. The pollution occurred between 1942 and 1986. Alcoa sought to recover its clean-up costs from its insurers, including Lexington. Lexington's insurance of Alcoa was for a 3 year period from 1 July 1977 to 1 July 1980 and provided cover in respect of physical loss and damage occurring to Alcoa's property worldwide. In 2000, the Washington Supreme Court, applying Pennsylvanian law, found that Lexington was jointly and severally liable for the whole of Alcoa's clean-up costs, notwithstanding that it was on risk for only three of the 44 years when the pollution had occurred. The finding at first instance that only damage occurring during the policy period was recoverable was rejected on the basis that nothing in the policy language excluded damage that began before the policy incepted. Following the judgment, Lexington settled Alcoa's claims on the basis that it was liable for the remedial costs spanning all 44 years.

Lexington sought an indemnity from its reinsurers. The reinsurance covered the identical period and the same subject matter as the underlying insurance. Pursuant to a service of suits clause, Alcoa could select any State within the United States for the resolution of any dispute, and the laws of such State would govern the dispute. WASA and AGF contended that, notwithstanding a follow the settlements provision in the reinsurance and the Washington Supreme Court's interpretation of the period clause as not excluding damage that occurred pre-inception, the reinsurance provided an indemnity only in respect of damage actually sustained during the three-year policy period.

The first instance decision

Simon J held that reinsurers were not obliged to follow the reinsured's settlement because the loss did not fall within the scope of the reinsurance contract. The period clause in the reinsurance contract imposed a temporal limit to the cover. Distinguishing the well known House of Lords decision Vesta v Butcher, that clause was not to be construed in a "back to back" fashion with the underlying – because the period of cover of the reinsurance was "fundamental" and there was no settled meaning of the underlying at the time the reinsurances were placed as a result of the service of suits clause. (See our 16 May 2007 e-bulletin link)

Decision

The Court of Appeal has unanimously reversed Simon J's decision. Longmore LJ, who delivered the leading judgment, stated that the key question was whether by using equivalent wording in both insurance and reinsurance, the parties intended that the wording was to have the same meaning in both contracts. Longmore LJ found the "natural answer" to that question was yes. Indeed, equivalent wordings should generally be given the same construction "unless there are clear indications to the contrary."

The Court of Appeal found Simon J's reasons for distinguishing Vesta v. Butcher unconvincing. Longmore LJ felt there was no difficulty in the underlying insurance being construed at the time of the writing of the reinsurance on the basis of Pennsylvania law, assuming Pennsylvania adopted a similar approach to English law of determining the proper law of the contract (namely the jurisdiction to which it is most closely connected)

Comment

There is no doubt that the Court of Appeal were unimpressed by suggestions that the reinsured should take an intellectually unsatisfactory judgment of the Washington Court on the chin in circumstances where reinsurers were aware of the US governing law of the insurance when writing the risk. It follows that those drafting reinsurances should make clear that an English law dictionary is to govern the interpretation of the reinsurance regardless of the governing law of the underlying, if that is the intention of the reinsurance or a particular term within it.

Although some aspects of the Court of Appeal's reasoning on the service of suits clause are opaque, the overall outcome should be welcomed as largely removing the uncertainty generated by the first instance decision as to which clauses were to be interpreted on a back to back basis and which "fundamental" terms were not.

One interesting aspect of the Court of Appeal decision was Sedley LJ's reaction to a submission that reinsurance is, on a proper analysis, a type of insurance of the underlying property. Sedley LJ opined forcefully that it was now time to accept that reinsurance was clearly an insurance of the reinsured's liability not the underlying property risk. The only other Judge to comment on this issue, Longmore LJ, felt this was simply a jurisprudential question which did not affect the proper interpretation of the reinsurance in issue. Despite Sedley LJ's comments, the exact legal nature of reinsurance remains unresolved on the authorities. Given there can be real practical consequences turning on the distinction (for example, when a limitation period starts to run), it is to be hoped that the House of Lords have an opportunity to focus on the issue in the foreseeable future. It is understood that the reinsurers in this case are presently considering whether to seek leave to appeal to the House.