UK: Without Prejudice Settlements can prejudice your reinsurance recoveries

Settling contentious claims without prejudice to liability is an everyday occurrence for most Insurers. The vast majority of claims which are subject to litigation are settled at some point in the course of the proceedings, and the settlement is usually expressed to be without admission of liability. Most Insurers would tend to assume that provided inwards settlements are reasonable and businesslike they will be able to recover the appropriate share of such settlements from their Reinsurers. The recent decision in Faraday v Copenhagen Re, however, is a reminder for Reinsureds to check carefully the wording of the follow the settlements language in their reinsurance contracts before making such an assumption.

Settling contentious claims without prejudice to liability is an everyday occurrence for most Insurers. The vast majority of claims which are subject to litigation are settled at some point in the course of the proceedings, and the settlement is usually expressed to be without admission of liability. Most Insurers would tend to assume that provided inwards settlements are reasonable and businesslike they will be able to recover the appropriate share of such settlements from their Reinsurers. The recent decision in Faraday v Copenhagen Re, however, is a reminder for Reinsureds to check carefully the wording of the follow the settlements language in their reinsurance contracts before making such an assumption.

Faraday Capital Ltd v Copenhagen Reinsurance Co Ltd [2006] EWHC 1474 (Comm) concerned a facultative Reinsurance by Copenhagen Re of Faraday’s participation in an excess layer of a property insurance programme covering an insured known as Nevada Power.

The facts of the underlying dispute between Nevada Power and its Insurers, including Faraday, were fairly unremarkable. Nevada Power suffered two consecutive electrical failures at its Clark Generating Station in Las Vegas. Insurers admitted liability for the first failure, but contested liability in respect of the second failure. Nevada Power filed proceedings in the United States District Court for the District of Nevada.

The Nevada proceedings were ultimately settled by way of a lengthy settlement agreement. This constituted a full and final release but "by compromise and without prejudice to [the parties’] respective positions". The settlement was based on legal advice from Mendes & Mount.

So far, so standard. Many claims, large and small, are subject to dispute. Some of these disputes go to litigation, others are settled in advance of litigation. It is fairly typical for settlement agreements to be expressed to be without prejudice to liability. In the States, "with prejudice" and "without prejudice" are specific terms of art applied to the dismissal of proceedings, but the same concepts apply equally in other jurisdictions.

The difficulty for Faraday was that its reinsurance with Copenhagen Re included a follow the settlements clause as follows:

"This reinsurance is subject to all terms, clauses and conditions as original except as provided for herein, and to follow in all respects the settlements or other payments of whatsoever nature excluding Without Prejudice and Ex-Gratia Settlements made by the Original Underwriters arising out of and in connection with the Original Insurance." [our emphasis]

Mr Justice Aikens’ judgment in the Commercial Court focused on the construction of the words highlighted.

But for the these words, there would have been no dispute between Faraday and Copenhagen Re. Both parties accepted that in the absence of such language the appropriate legal test would simply be that the settlement should be proper and businesslike, as set out in Insurance Company of Africa v Scor (UK) Reinsurance Company Limited [1985] 1 Lloyd’s Rep 312.

The "Ex-Gratia" language does not seem to have been particularly contentious. It refers to a payment where there is no liability – typically a payment made as a goodwill gesture or for purely commercial reasons. There was no suggestion that the settlement in issue was Ex Gratia.

The "without prejudice" language was more contentious. It may be noted first of all that the use of the terminology "without prejudice" here is slightly different to its usage in the context of "without prejudice correspondence". Without prejudice correspondence in the course of a dispute is correspondence seeking to achieve a compromise. In English proceedings, and in most other Common Law jurisdictions, without prejudice correspondence is protected from disclosure by privilege. The use of the term "without prejudice" in the context of a settlement, however, is a reference to the basis of the settlement, as opposed to the process leading up to that settlement.

The Reinsured, Faraday, sought to argue that the reference to without prejudice settlements should be construed as being limited to provisional, non-final or non-binding settlements. Faraday tried to suggest that excluding settlements such as their agreement with Nevada Power would be uncommercial and could not have been intended.

The Reinsurer, Copenhagen Re, by contrast, argued that the term "without prejudice" was intended to refer to any settlement in which liability is not admitted. This would include final and binding settlement agreements, such as the settlement in issue. The parties had clearly agreed to exclude settlements of this kind, and there was nothing uncommercial about giving effect to such an agreement.

Aikens J preferred Copenhagen Re’s construction. He held that "settlement" means any binding agreement, which could be in any form – ranging from a formal settlement agreement to an underwriter’s scratch. Purely provisional agreements would not come within the ambit of the clause to begin with, so there would be no need then to exclude them. The reference to without prejudice settlements, therefore, could only be a reference to settlements without admission of liability.

Aikens J said:

"But the reinsurers are entitled, in my view, to insist that if the original insurer is not prepared to admit liability under the original policy then, for the purposes of establishing the reassured’s entitlement to recover under the reinsurance, the reassured must prove that there was, in fact, a liability under the original policy."

It seems to us that on the basis of the follow the settlements clause in front of him, Aikens J had little option but to arrive at this conclusion. The clause is not uncommercial in the sense that no reasonable party can have intended this construction.

The clause is, nevertheless, highly disadvantageous to the reinsured. It may conclude a perfectly reasonable and businesslike settlement with its assured, based on sound legal advice, but be unable to recover from its reinsurers. It seems questionable why a reinsured would agree to such disadvantageous language.

Where such a clause is included, a reinsured will need to balance out the potential risks of admitting liability as part of any settlement, against the difficulty of recovery from reinsurers if liability is not admitted. The inclusion of such a clause may have the somewhat perverse effect in certain cases of encouraging admission of liability, even where liability is questionable.

Overall, the case is a salutary lesson to reinsureds and their brokers to take care in drafting follow the settlements clauses, and to ensure that the language is fair to both parties.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

The original publication date for this article was 12/07/2006.