UK: Claims Co-operation Clauses - the Pendulum Swings Towards Reinsurers

Subject to the terms and conditions of the policy, the effect of reinsurance is to transfer financial risk from the reinsured to the reinsurers. Generally, the risk has to be established, by judgment, award or settlement, before the reinsurers can be called upon to indemnify the reinsured under the policy. The effect of the normal ‘follow the settlements’ provision would be to bind reinsurers to settlements and compromises reached by the reinsured provided that they were made bona fide and in a proper and businesslike manner (see Insurance Company of Africa v. Scor (UK) Ltd. [1983] 1 Lloyd’s Rep 541, [1985] 1 Lloyd’s Rep 312). In the light of this decision, reinsurers (and especially reinsurers who were assuming a significant percentage of the underlying risk) began to insert claims co-operation clauses in their policies, in an attempt to give them more control over the ability of their reinsured to reach compromises which would trigger their liability to make payment. A standard clause, set out below, has been the subject of recent judicial examination by the English Court of Appeal.

Tai Ping placed facultative reinsurance with Gan for an erection all risks and third party liability policy issued by Tai Ping to Winbond, covering the erection of a building in Taiwan. During the currency of the policy, the building being constructed was damaged by fire. Initially, Tai Ping claimed to avoid the contract for misrepresentation, but on Winbond issuing proceedings and prosecuting those proceedings, a settlement was reached. Gan alleged, amongst other things, that Tai Ping failed, in breach of the reinsurance contract, to co-operate in the investigation and assessment of the loss and failed to obtain Gan’s prior approval for the settlement.

The claims co-operation clause in the reinsurance contract, stated to be a "condition precedent to any liability under this Policy", read as follows:

• "a The Reinsured shall, upon knowledge of any circumstances which may give rise to a claim against them, advise the Reinsurers immediately and in any event not later than 30 days;

• b The Reinsured shall co-operate with Reinsurers and/or their Appointed Representatives subscribing to this Policy in the investigation and assessment of any loss and/or circumstances giving rise to a loss;

• c No settlement and/or compromise shall be made and liability admitted without the prior approval of Reinsurers."

The appeal dealt with a number of issues decided at first instance by Longmore J., the first of which was whether, under paragraph (c) of the claims co-operation clause, Tai Ping only required Gan’s consent to a settlement and/or compromise where liability was admitted. Longmore J. had held that the words were clear and made sense, even though there was no real reason why reinsurers would wish to invoke the clause only where there was an admission of liability. Mance LJ, relying on the basic principles governing the interpretation of documents set out by Lord Hoffmann in Investors Compensation Scheme v. West Bromwich B. S. [1998] 1 MR 896, held that this approach ignored the fact that the clause did not read naturally. He considered, and Latham LJ and Sir Christopher Staunton agreed (though for different reasons), that the clause operated as if the words "and liability" were to read "and no liability". Thus, any settlement or compromise, whether or not liability was admitted by Tai Ping, required the prior consent of Gan.

There was no serious argument before the Court of Appeal that the clause was not a condition precedent. The main question was: condition precedent to what? Tai Ping argued that the condition precedent was limited to the application of the ‘follow the settlements’ provision in the Full Reinsurance clause, so that, if Tai Ping had breached the clause, it could still recover from Gan if it could show that it was liable for the claim under Taiwanese law. The Court rejected that interpretation: if Tai Ping breached the claims co-operation clause by settling without prior approval it could not recover at all.

Longmore J. held at first instance that it was necessary to give business efficacy to the policy by implying into the claims co-operation clause a term that reinsurers' consent to a settlement or compromise etc. could only be withheld on reasonable grounds. There was no 'follow the leader' clause in this case, and Longmore J. considered it wholly unreasonable to allow one reinsurer to withhold consent for a settlement without any basis for doing so, when (for example) all the others had agreed.

In the Court of Appeal, Mance LJ considered that Longmore J.’s approach was too simplistic. The Court of Appeal set aside Longmore J.’s affirmative answer to this question, but refused to make a declaration on the issue. Mance LJ did, however, provide some guidance, stating that he would accept some general qualification that reinsurers should act bona fide in deciding to withhold their consent to a settlement and should not do so when no reasonable reinsurer could possibly refuse. Extraneous considerations, such as the reinsurer’s retained interest or financial exposure, should not be taken into account, although reinsurers should review the underlying claim objectively. There was, however, no requirement for reinsurers to establish before refusing consent that there were reasonable prospects for successfully resisting the insured’s claim or for achieving a lower settlement than that proposed through negotiation or by further defence of legal proceedings.

These were appeals on preliminary issues decided by Longmore J. and as such there remain issues to be decided in the proceedings, which too may be appealed. Indeed, Tai Ping have asked for permission to appeal this judgment further. However, the effect of this judgment is to prevent reinsureds who are subject to such claim co-operation clauses from overcoming a breach of their terms (either by failing to notify reinsurers, failing to co-operate with the reinsurers’ claim investigation and/or by settling without prior approval) from subsequently ‘curing’ the breaches by proving to the court that they were in fact liable for the underlying claim. In that sense, the appeal is a victory for reinsurers, who ought to be more confident that their reinsureds will consult them properly in future and provide them will all necessary information to allow them independently to assess the merits of the underlying claim at an early stage. The judgment should not be seen as a carte blanche to reinsurers to act unreasonably in exercising their discretion under the terms of claims co-operation clauses, however.

© Herbert Smith 2002