UK: An Impediment To Back-To-Back Coverage: The "Princess Of The Stars"

English reinsurance law has cultivated a well-established practice of construing insurance and reinsurance contracts that are underwritten as "back-to-back" contracts in exactly that way. A great deal of insurance and reinsurance contracts are written on that basis, including across the Middle East. However, the presumption of back-to-back cover may not be as secure as previously thought following the ruling of the English Court of Appeal in The Princess of the Stars (October 2012) that a "follow the settlements" clause in a reinsurance policy does not negate or impinge on the general rule that a stay of English court proceedings should be granted only in rare and compelling circumstances.

Background

The "Princess of the Stars" was a roll-on roll-off passenger cargo vessel that capsized off the coast of the Philippines on 21 June 2008 after it sailed into Typhoon "Frank", which led to over 800 passengers dying, together with the loss and destruction of cargo. Owners of the cargo sued the ship owner and also brought a number of direct claims against the vessel's cargo liability insurer, "Oriental", in the Philippines. There were at least 40 sets of local proceedings involved. The insurance policies were governed by domestic law and jurisdiction.

Oriental reinsured the risk to six well-known London Market reinsurers. The reinsurance policy was subject to English law and jurisdiction and contained a follow the settlements clause in the following terms: "To follow all terms, conditions and settlements of the original policy issued by the Reinsured to the Insured, for the period specified herein, in respect of sums and interests hereby reinsured ..."

Both the insurance policy and reinsurance policy contained a Typhoon Warranty, which warranted that the vessel would not sail when there had been a typhoon warning in the relevant area. The question as to whether there had been a breach of the Typhoon Warranty, and whether this negated cover under the insurance policies, was likely to be a key point of contention in the local proceedings. In November 2010 (we assume fearing an adverse result in due course in the Philippines), reinsurers issued proceedings in England for a declaration that they were not liable to indemnify Oriental because the Typhoon Warranty in the reinsurance policy had been breached, and that Oriental was not liable under the insurance policy for the same reason. Oriental applied for a stay pending the outcome of the Philippine proceedings. In February 2012 Oriental's application for a stay of the English proceedings was dismissed.  Oriental appealed against that decision.

The Court of Appeal findings

Oriental argued that the normal position under reinsurance policies (or, at the very least, in situations where the reinsurers were bound to follow the settlements of the reinsured) was that the reinsurers should wait for the reinsured to settle their claim before the reinsurers could determine their liability as the reinsurer would be bound by any factual findings made by the Philippine courts, pursuant to the "follow the settlements" provision in the reinsurance policy. On these grounds, Oriental argued that the correct action for the court to take in England would be to stay its proceedings pending the outcome of the decision on the underlying insurance policies.

Oriental also submitted that there did in fact exist rare and compelling circumstances to warrant a stay of the English proceedings, on several grounds including:

  • that there was a risk of inconsistency between the English and Philippine courts;
  • that Oriental would be placed in an inherently unfair position by being forced to argue in the English proceedings the precise opposite of its main case in the Philippine proceedings; and
  • that its case in the Philippine courts, which may take up to ten years to reach final judgment, could potentially be prejudiced by a ruling in the English courts that there had been no breach of the Typhoon Warranty. 

Because of the 800 deaths there was a great deal of publicity about the catastrophe in the Philippines and, unsurprisingly, strong public sentiment about the fatalities. Even though the cargo claims were legally separate, Oriental was under public pressure about the Typhoon Warranty defence and was put in an extremely difficult position by having to vigorously defend the proceedings in England on the basis of there being no breach of the Typhoon Warranty in the reinsurance policy which was the precise opposite of its defence in the Philippine proceedings under the direct policy, where it was forced to argue the position put forward by the ship owner.  

Oriental's arguments were rejected, albeit "grudgingly" and "with little enthusiasm" by the Court of Appeal judges. The Court of Appeal held that the judge at first instance had used the correct test when exercising his discretion to dismiss the application for a stay. Reinsurance was no exception to the general rule under English law that a stay should be granted only in "rare and compelling" cases.  The "follow the settlements" clause found in the reinsurance policy here did not negate or relevantly impinge on that general rule. Otherwise, a stay would be normal in reinsurance cases in which the underlying claim had not been settled or concluded by court proceedings which, in the Court of Appeal's view, could not be right. 

It can be argued that the ratio (i.e. the legal principle on which the decision in the case was founded) of the Court of Appeal judgment is narrow in that it goes no further than affirming that the judge at the Court of First Instance had not wrongly exercised his discretion.  The Court of Appeal judges did not feel that they should "lightly depart from the assessment of an experienced commercial judge...".  Therefore, although the judges were alert to the unfairness of the position in which the judgment placed Oriental, they had to dismiss the appeal.  On this reading, it could be argued that the case may have less of an impact than it would have had otherwise.  However, it still opens up a gateway for reinsurers to seek a judgment on reinsurers' liability from the English court, ahead of the determination of the position under the direct policy pursuant to local law.

Potential impact on international reinsurance business

English law is unique in much of the world for presenting a developed body of jurisprudence on reinsurance law. Moreover, it has adapted over the years through a long line of cases, beginning with Vesta v Butcher [1989] AC 582 to a position where it is acknowledged that the risk covered by a contract of proportional reinsurance will usually be co-extensive with the risk covered by the underlying insurance contract (assuming there is no express indication to the contrary). This being the case, it is assumed under English law that the intention of the parties is that wording of the reinsurance contract should be interpreted as "back-to-back" with the insurance contract.  The effect of this has generally been that where local policies are subject to a different interpretation on the terms than under English law (e.g. the difference between the way in which a warranty in a local policy might be interpreted under local law v English law), English law will import the local law interpretation of the policy term in the reinsurance context. This allows policies to be reinsured on a back-to-back basis.

There have been exceptions to this rule in specific circumstances. For example, in Wasa v Lexington [2010] 1 AC 180, the House of Lords limited the rule to exclude circumstances where the underlying law of the original policy was not identifiable or ascertainable. However, except for these specific cases, the assumption still remained that the policies would be interpreted back-to-back.

The effect of the Court of Appeal decision in the Princess of the Stars arguably removes the certainty that applied on back-to-back covers which provided cedants with an assurance that reinsurance contracts governed by English law would follow the findings of a competent local court or tribunal in relation to liability under the original policy. 

What can Middle East cedants and their brokers do?

How can Middle East cedants and their brokers protect against this latest development under English law?

One option would be to ensure that both the direct policy and the reinsurance policy are subject to local law and jurisdiction. This is unlikely to produce a satisfactory result for either party, given the difficulties that ensue when seeking to interpret, or litigate a claim under a reinsurance contract in the context of a developing Middle East jurisdiction that has limited relevant jurisprudence. 

Another option would be to include an arbitration clause in the reinsurance policy.  It is less likely that an arbitral tribunal comprising market practitioners/seasoned arbitrators would be prepared to adjudicate the reinsurance position on coverage before there had been a ruling on coverage under the direct policy in the local jurisdiction.  Care would need to be taken to select an appropriate forum and set of rules for the arbitration and no doubt, in an English arbitral context, "Princess of the Stars" would be cited as a precedent which the arbitrators/tribunal should follow.

The best option would be to include modified wording to state specifically that, notwithstanding that the insurance and reinsurance policies are subject to different law and jurisdiction provisions, the clear and overriding agreement of the parties is that the policies are to be construed on a back-to-back basis.  For parties who recognize the considerable benefits of English law governing a reinsurance contract, this would appear to be the only option to ensure that the back-to-back nature of the contracts can be guaranteed under English law.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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