In Flexsys America LP v XL Insurance Co Ltd [2009] EWHC 1115 (Comm) the Claimant, Flexsys America LP (Flexsys) sought to recover the balance of its legal costs from the defendant XL Insurance Company (XL) under a Master Policy when its Local Policy (which covered Flexsys), taken out with XL Select, was exhausted. It also sought a declaration that it was entitled to be indemnified by XL in respect of the potential damages to a third party, Korean Kumo Petrochemical Company Limited (KKPC), and its costs of defence.

Flexsys incurred legal costs of US$2 million in defending a claim brought by KKPC. Flexsys claimed indemnity from its insurer XL Select under the Local Policy, which provided Flexsys with cover for "Personal and Advertising Injury". XL Select settled the claim, which totalled US$1 million, the applicable limit under the Local Policy. Flexsys then sought to recover, under the Master Policy, the balance of its legal costs and an indemnity in respect of its potential liability in damages to KKPC, relying on a "drop down clause" in the Master Policy, which was governed by English law. The "drop down clause" provided that:

"In the event of partial exhaustion of a local policy this Policy will pay in excess of the reduced underlying Limit of Indemnity

In the event of total exhaustion of a local policy this Policy will continue in force as the underlying insurance subject to the terms Exceptions and Conditions of the particular local Policy."

Flexsys argued that as the settlement exhausted the Local Policy, as per the second sentence of the drop down clause, the Master Policy should drop down to provide cover on the terms of the Local Policy.

It was held by the Court, which followed XL's construction of the drop down clause, that Flexsys' claim was not covered by the Master Policy. The Master Policy would not respond in circumstances where the underlying claim, although within the Local Policy, was outside the terms of the Master Policy. Tomlinson J found that "exhaustion" in both sentences in the drop down clause should be interpreted in the same way and, therefore, referred to payment of one or more prior claims, and not, as suggested by Flexsys, the instant claim, which Flexsys alleged triggered the drop down. In that way the second sentence, like the first, filled a gap and provided a reinstatement of the Local Policy to be available to meet the claims subsequent to the claim(s) which achieved total exhaustion of the Local Policy. It provided new cover from the ground up, but subject to the Local Policy terms, conditions and limits. XL's construction was consistent with the two sentences in the drop down clause achieving broadly similar objectives.

In any event it was found by the Court that KKPC's claim against Flexsys was not one based on negligence or recklessness, but rather that Flexsys set out deliberately to injure KKPC by making statements about its products which it knew to be untrue. As such, Tomlinson J found that liability in respect of such conduct was also clearly excluded from the ambit of the Local Policy cover. Therefore, Flexsys was not entitled to the declaratory relief claimed.

Although Flexsys v XL Insurance demonstrates an English court's interpretation of a drop down clause the judge was careful to note that there was no single universally applied form of words and that each clause must be looked at on its own merits.