The recent decision of the Commercial Court in IRB Brazil Resseguros SA v CX Reinsurance Company Ltd [2010] EWHC 974 provides useful guidance for reinsureds and reinsurers on the extent to which market settlements of underlying disputes will be upheld when shares of those settlements are presented to reinsurers.

Although to a degree fact-specific, the decision will be of interest not only to reinsureds and reinsuers participating in the market settlements in issue – some of the biggest long-tail asbestos and products settlements – but also to reinsureds generally in settling underlying disputes and in presenting claims to reinsurers.

Mr Justice Burton's judgment may provide guidance on a number of issues including the obligation to follow settlements and the extent to which it is necessary to re-prove that settlements fall within the underlying policy and the reinsurance contract, the allocation of settlements to different policy periods, aggregation of claims and the recoverability of future claims. Following on from the Equitas decision in 2009, the end may be in sight for reinsurers raising purely negative defences putting their reinsureds to proof on liabilities rather than raising substantive challenges.

Reinsureds may also be encouraged to believe that the recoverability of settlements in respect of future liabilities – possibly even including IBNR – may be less of a difficulty than previously believed.

The Judge also re-affirmed the Court's unwillingness to interfere too readily with decisions by arbitrators, even though he was critical of some of the language adopted by the Panel in expressing its conclusions.

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Background

CX Re claimed from its reinsurer IRB in respect of its share of a number of market settlements, of which six were in issue in the appeal in front of Burton J. They included two settlements relating to silicon breast implants (AHS and 3M), two in respect of contaminated blood products (Baxter Travenol and Revlon), one asbestos settlement (Owens Corning) and one environmental pollution settlement (Stauffer). In the award being appealed, the Panel noted that these were market settlements and the basis of allocation was generally supported throughout the market. These settlements typify the market's approach to the resolution of long-tail liabilities, and the implications of the decision may therefore go beyond recoveries arising out of the six settlements in issue.

CX Re had arbitrated its claims against IRB arising out of a number of settlements, including the six in issue, and in front of the Panel was essentially successful in all of its claims. IRB appealed to the Commercial Court.

Follow the settlements

The treaties in question all included a "double-proviso" follow the settlements clause:

"All loss settlements made by the Reinsured, including compromise settlements, shall be unconditionally binding upon Reinsurers provided such settlements are within the conditions of the original policies and/or contracts and within the terms of this reinsurance, and the amounts falling to the share of the Reinsurers shall be payable by them upon reasonable evidence of the amount paid being given by the Reinsured."

A clause along these lines is often referred to as a Hill v M&G clause after the decision of the House of Lords in Hill v Mercantile & General Reinsurance Co plc [1996] 1 AC 1239 construing such a clause.

There was no difference between the parties on the correct legal approach, and Burton J endorsed that approach. He observed that to satisfy each of the provisos (that the settlements were within the terms of the underlying policies and within the terms of the reinsurance) it was necessary to demonstrate those liabilities on the balance of probabilities. It would not be good enough to show that the claims arguably fell within the underlying or the reinsurance – a lower threshold. The burden of proving that each of the provisos was satisfied fell on the reinsured. However, Burton J did not dissent from the Panel's comment that this burden did not require the reinsured to prove such matters to "an absolute standard". Applying the reasoning in Equitas v R&Q [2009] EWHC 2787, the evidence required to meet the standard of proof could include appropriate computations and modelling to allocate to different policies and different years, both at the direct and reinsurance level.

Although Burton J simply applied the existing law on following settlements, the tone of the judgment may be construed as a little more pro-reinsured and pro-settlement than some previous decisions in this area. Burton J cited approvingly the comment of Gross J in Equitas that "it is perhaps not to be forgotten that the Settlements Clause remains ... a follow the settlements clause, designed to avoid the need to investigate the same issues twice". The decision will encourage reinsureds to believe that provided their settlements are reasonable and businesslike – which may not be a difficult threshold to overcome if they are supported by the market generally – the evidence required to satisfy the balance of probabilities tests on each of the provisos may not be too onerous. The Equitas and IRB decisions taken together will make it more difficult for reinsurers to rely on negative "putting to proof" defences. The first proviso in Hill v M&G clauses may be seen as less of an obstacle than previously.

Burton J's decision addresses a number of specific issues on the particular settlements from which guidance may be derived. The Judge emphasised that he was not deciding these issues himself, but, rather, determining the arbitrators' right to rule as they had done. He treated these issues as essentially factual – applying the agreed law to the settlements in issue – and thus the question was not whether the Panel were right or wrong but simply whether they were entitled to apply the law as they had done. Nevertheless, there are some clues in the judgment as to the approach the Commercial Court itself might adopt if deciding the same issues in the future.

In relation to AHS, 3M, Baxter and Revlon, IRB challenged the Award on the basis that the Panel may have applied the incorrect standard of proof. In places, the Award referred to settlements "arguably" falling within the terms of the underlying and/or the reinsurance, whereas, as noted above, and as was agreed, the correct test is the balance of probabilities. Burton J found that in fact – despite "infelicities" in their language – the panel had applied the correct balance of probabilities test.

Each of these settlements involved some determination of the appropriate level of settlement and allocation to different contracts and years of account for cases where there were thousands of underlying claimants. The Judge's endorsement of the Panel's approval of the reinsured's methodology – reliance on professional advice and market consensus as to the appropriate level of settlement – as satisfying the balance of probabilities test will encourage reinsureds entering into such settlements to believe that their contributions are more likely to be recoverable from reinsurers. Burton J noted approvingly the Panel's comments about the difficulties that would otherwise be faced by reinsureds who, after arguing points against their insureds but settling the underlying cases without resolving those issues, then need to present claims against their reinsurers on the assumption their insureds would have succeeded.

Allocation

On allocation to particular years – an issue relevant to the AHS, 3M, Corning and Stauffer settlements, the Court upheld the Panel's view that it was appropriate to allocate an overall settlement across a number of years on a proportionate basis, provided a reasonable and businesslike methodology was adopted. Indeed, it would be appropriate to infer that proportionate allocation across a period was reasonable, and that could be sufficient in itself to meet the balance of probabilities threshold. Following the same approach, it seems to us unlikely that a reinsurer would be able to challenge allocation simply by trying to pick holes in the reinsured's methodology, without putting forward an alternative approach to allocation.

Future claims

On 3M there was an additional allocation issue, which was the treatment of that part of the settlement which related to future claims by victims against the insured. The reinsureds had settled with 3M on the basis of a policy buy-back settling all present and future claims. The entire settlement was allocated proportionately across the same policy periods. Although Burton J did not explore the issue on depth, the decision on this point may lead to questioning of the perceived wisdom in the market that settlements in respect of future liabilities – particularly if they are labelled as IBNR – will not usually be recoverable from reinsurers.

Aggregation

Burton J's approach to the aggregation issue, which arose from the Corning settlement, was again to uphold the Panel's decision, rather than determining for himself whether there was a single loss or series of losses arising from one event. Burton J did criticise a reference by the Panel to a single cause, because the relevant contractual language referred to aggregation by event, although in fact the Panel seem to have concentrated on whether the Corning claims constituted a single loss rather than a series of losses arising from one event.

Although it had been suggested by CX Re that "the determination of [Corning] to engage in the insulation business and to install Kaylo insulation products over a twenty year period" could constitute a single event, that does not appear to have been the basis for the Panel's decision. The Judge accepted that the Panel would have been entitled to reach that conclusion, but did not express any views of his own on the number of events. Had he done so, it would have been difficult to reconcile a determination that Corning's decision to engage in the insulation business was a single event with previous English authority. In particular, it would be inconsistent with the ruling in Caudle v Sharp [1995] Lloyd's Rep 433 that Richard Outhwaite's "blind spot" was not an event (but was a single cause). This authority would have been very well-known to the Panel, because one of the arbitrators was Mr Outhwaite himself.

Powers of arbitrators

A theme that emerges strongly in the judgment is the autonomy of the arbitrators. Although Burton J pointed to "infelicities" in the Panel's language, he stressed the importance of concentrating on the substance of the Panel's award over the form, and avoiding "nit-picking". The application of established legal principles to particular factual scenarios is ultimately a matter for arbitration tribunals, and the Courts will be reluctant to intervene.

Conclusion

Taken together, the arbitration Award and the Commercial Court judgment in this case, following on from the decision in Equitas, should encourage reinsureds who structure their settlements with insureds in a reasonable and businesslike manner to believe that their reinsurers will be bound to follow those settlements.

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

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 01/06/2010.