On 30 July 2009, in Lexington Insurance Company v Wasa Insurance Company and Lexington Company v AGF Limited, the House of Lords has handed down opinions overturning the Court of Appeal and finding that an English law facultative proportional reinsurance was not to be construed on a "back to back" basis with an underlying insurance The dispute has generated widespread interest in the reinsurance community and the House of Lords' decision, and the reasoning for that decision, is of considerable importance to the construction of English law reinsurance contracts where the governing law of the underlying insurance is foreign.

The Facts

The reinsurers (Wasa and AGF) sought declarations of non-liability in relation to a claim by their reinsured (Lexington) for environmental clean-up costs incurred by the underlying insured, Alcoa.

Alcoa had been ordered by the US Environmental Protection Agency to clean up pollution occurring between 1942 and 1986 at a number of its manufacturing sites in the US. Alcoa sought to recover its clean up costs from its insurers, including Lexington, which had insured Alcoa for a 3 year period from 1 July 1977 to 1 July 1980 in respect of physical loss and damage to Alcoa's property worldwide and in a contract which contained a US "Service of Suit" clause which required the State in which Alcoa commenced litigation to apply its law to the dispute (including its own rules as to establishing the governing law). Following a Washington Supreme Court ruling in 2000 which found Pennsylvanian law was the governing law, Lexington was held to be jointly and severally liable for the whole of Alcoa's clean up costs notwithstanding that it was on risk for only the three year period of the insurance policy, as opposed to the 44 years during which pollution had taken place. Lexington accordingly settled Alcoa's claims and sought an indemnity from its reinsurers.

The reinsurance was governed by English law and covered an identical period and subject matter to the underlying insurance, as well as containing a follow the settlements provision. However, the reinsurers contended that notwithstanding the Washington Supreme Court's interpretation of the period clause in the insurance as not excluding damage which occurred pre-inception, the reinsurance provided an indemnity only in respect of damage actually sustained during the three year period of cover.

The first instance decision

Simon J held, distinguishing the well known House of Lords' decision in Vesta v. Butcher, that reinsurers were not obliged to follow the reinsured's settlement, because the loss did not fall within the scope of the reinsurance. Simon J considered, rather, that the period clause in the reinsurance imposed a "fundamental" temporal limit to cover and, as there was no settled meaning in the various jurisdictions in the US of the period clause of the underlying policy at the time the reinsurance was placed, the reinsurance should not be construed as back to back with the insurance.

The Court of Appeal decision

The Court of Appeal unanimously reversed the first instance decision, holding that the key question for determination was whether by using equivalent wording in the insurance and the reinsurance the parties intended the wording to have the same meaning in both. The natural answer to this was, according to the Court of Appeal, yes: the same or equivalent wording in the insurance and reinsurance should generally be given the same construction and construed on a "back to back" basis "unless there are clear indications to the contrary". The Court of Appeal had little difficulty in finding that Pennsylvanian law governed the underlying insurance at inception and thus that the reinsurance wording should be construed on the same basis as Pennsylvanian law would construe it.

The House of Lords' opinions

The House of Lords unanimously allowed Wasa and AGF's appeal. The leading opinions were handed down by Lord Collins and by Lord Mance.

The House of Lords has found that in principle the terms of a facultative proportional reinsurance should be construed on a back to back basis with the underlying insurance. However, at the time the insurance contract was effected, there was no identifiable governing law of the insurance (due to the service of suits clause) which could provide a basis for construing the contract of insurance any different to its ordinary English law meaning. Further, the reinsurance could not be construed as meaning it would respond to any liability the insurer may in due course be found to have by a US Court. In those circumstances, the reinsurance should take its ordinary English law meaning, namely that it only responded to damage occurring during the reinsurance policy period.

Comment

Once the House of Lords had decided that the underlying insurance had no settled meaning as differing governing laws might ultimately apply, it is perhaps unsurprising that it went on to find the reinsurance was not to be construed as if governed from the start by Pennsylvanian law.

What is perhaps of more interest now is the relationship between this decision and the House of Lords' decision in Vesta – i.e. when exactly is a proportional reinsurance to be construed on a back to back basis with the underlying? There appear to be two themes emerging from the opinions. First, it seems that there are some "fundamental" aspects of a reinsurance contract which will always be construed in accordance with English law and without regard to the underlying – Lord Mance talks of "… the definition of the risks and the period insured and the period for which they are insured." Secondly, a distinction appears to be drawn between allowing a reinsurer to take "uncommercial and technical points" (as in seeking to rely on the draconian consequences of a breach of warranty under English law as the reinsurer did in Vesta) and the approach adopted by the reinsurers in this case. We are left with not inconsiderable uncertainty and scope for argument going forward.

In terms of the wider effect on the market, some had questioned whether the decision at first instance will make the London market less attractive. It is difficult to see how this will be the case. The House made it clear that the position could be dealt with should the parties wish to do so, either by making the reinsurance itself expressly subject to the relevant foreign law or by including a contractual term dealing with the manner of interpretation of the reinsurance.

Finally, it is of some interest that the House proceeded on the basis that reinsurance is in the nature of an insurance of the underlying risk rather than a liability insurance of the reinsured. The contrary position was not argued, perhaps surprisingly given the latter had been held to be the case by one of the Court of Appeal judges and is supported by some authority. While of limited importance in this case, the point is potentially of importance generally in the context of when a cause of action under a reinsurance contract arises. If reinsurance is in the nature of an insurance on the underlying risk, it is arguable a cause of action arises at an early stage when the underlying loss happens rather than when the reinsured liability to the insured is established by judgment or settlement (a point on which Lord Mance had something to say in obiter dicta in Gan v Tai Ping).