UK: Global liability settlements - Lumberman’s revisited

On 26 January 2006 the Commercial Court handed down an important decision in relation to what an insured must prove in order to recover from its liability insurers in relation to settlements. In the decision of Enterprise Oil Limited v. Strand Insurance Co Ltd Aikens J confirmed that an insured must prove the following:

• Actual liability to a third party

• The settlement must not be for more than the amount for which the insured would have been liable.

In common with Colman J’s decision in Lumberman’s Mutual Casualty v Bovis Lease Lend Limited, the insured’s contribution to the settlement did not apportion particular sums to particular causes of action or heads of damage. As such, the lack of structure in the agreement potentially gave rise to difficult legal issues as a result of the Lumberman’s decision. The judgment contains an important appraisal of the Lumberman’s decision which will serve as a useful point of reference for insureds and reinsureds in structuring settlements in the future.

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Full Article

On 26 January 2006 the Commercial Court handed down an important decision in relation to what an insured must prove in order to recover from its liability insurers in relation to settlements. In the decision of Enterprise Oil Limited v. Strand Insurance Co Ltd Aikens J confirmed that an insured must prove the following:

• Actual liability to a third party

• settlement must not be for more than the amount for which the insured would have been liable.

In common with Colman J’s decision in Lumberman’s Mutual Casualty v Bovis Lease Lend Limited, the insured’s contribution to the settlement did not apportion particular sums to particular causes of action or heads of damage. As such, the lack of structure in the agreement potentially gave rise to difficult legal issues as a result of the Lumberman’s decision. The judgment contains an important appraisal of the Lumberman’s decision which will serve as a useful point of reference for insureds and reinsureds in structuring settlements in the future.

The case related to Enterprise Oil’s contribution to a settlement agreement in 2002 between Enterprise and various other defendant companies and a US company, Rowan, and its associates in relation to a drilling contract. In proceedings in Texas, Rowan alleged that the defendants had committed a variety of torts under Texas law. These included interference with a service agreement and interference with prospective contractual and business relationships. Under each cause of action Rowan sought damages for the monies it said it would have received "but for" the torts which had been committed.

The case settled before trial. The settlement agreement provided that liability of the defendants would be joint and several. The defendants decided amongst themselves what sums each would pay and executed the settlement agreement. The settlement agreement did not record any details as to how much each defendant contributed and in respect of which cause of action.

Aikens J heard the dispute which subsequently arose between Enterprise and its insurers in respect of Enterprise’s claim for an indemnity in relation to the settlement. Enterprise contributed $84.225m to the global settlement of $175m. The primary insurer was Strand Insurance Company Limited, Enterprise’s captive insurer. Strand had placed reinsurance on the Lloyd’s and Overseas Companies Markets on "back to back" terms with the original policy. The reinsurance contained a claims control clause. Therefore, the dispute between Enterprise and Strand was effectively reinsurers disputing the claim in the shoes of Strand.

In order to obtain an indemnity under a liability policy it is a general principle of insurance law that an insured has to establish a legal liability to a third party (whether that liability arise by way of judgment, arbitration award or settlement). In relation to settlements, it is not sufficient to demonstrate liability to a third party simply by relying on the fact of the settlement. Further, any settlement has to be reasonable, that is to say that an insured must not settle for more than the amount for which it would have been liable.

Aikens J held that the question as to whether Enterprise was or would have been liable to Rowan in Texas was governed by the principle established in the Court of Appeal decision of Commercial Union Assurance Company PLC v. NRG Victory Reinsurance Ltd. This case provides that in circumstances where proceedings have commenced but a foreign court has not actually determined a matter, an English court has to decide what the foreign court’s decision would have been following the principles of the applicable law and any relevant rules of construction. Such an approach allows the Court to consider factual evidence only. On the facts, and as a matter of Texas law, Aikens J concluded that Enterprise were not able to prove any interference with the Service Agreement and that, as such, Rowan would not have recovered anything from Enterprise under this head of loss. Effectively, that finding defeated the claim.

Despite his finding on liability, Aikens J went on to consider what the consequences would have been for Enterprise if it had been found liable. Enterprise had entered into a settlement for a specified sum without any allocation of figures in order to compromise both insured losses (wrongful interference with the service contract) and uninsured losses (punitive damages and irrecoverable costs). Reinsurers relied upon Colman J’s Lumberman’s decision which provided that an insured cannot recover anything at all under a liability policy if the claim under the policy is founded on a settlement agreement with a third party which has not specifically identified an amount that is covered by an insured peril under the policy. Aikens J commented:

Aikens J analysed the steps taken by Colman J in arriving at the Lumberman’s decision and concluded that, in his view, an insured does not have to attribute an amount of its loss to an insured peril covered under a liability policy in the wording of a judgment, award or settlement. His principal reason for this finding was that an insurer will always have the right to challenge whether an insured was, in fact and law, liable to a third party and has the right to challenge the quantum of that liability and whether the loss is within the scope of the policy whatever is stated in a judgment, award or settlement.

Aikens J also commented upon the function of "ascertainment" as identified by Colman J. Colman J found that "ascertainment" is a "source of evidence" as to liability and quantum of the insured to the third party. Aikens J accepted that if the insured has negotiated a settlement which identifies certain heads of claim as being referable to certain causes of action that are within the terms of the policy, then that will be evidence that the insured has suffered a loss under the policy. However, that would always be open to challenge by insurers. Colman J found that "no amount of extrinsic evidence" at a trial as to what part of a settlement constituted a loss under the policy could create a cause of action under the policy. He, therefore, concluded that where there is a failure to indicate losses in a settlement agreement by reference to insured liability, a claim under the policy would be bound to fail in total.

Aikens J, in disagreement with Colman J, stated that in circumstances where an insurer challenges a settlement (however well structured the agreement maybe) the question as to whether there has been a loss covered by the policy would have to be decided on evidence extrinsic to the settlement agreement as put forward by both parties.

Aikens J also commented that following Colman J’s conclusion would lead to great commercial inconvenience and to artificial statements in judgements, awards and settlements. He concluded that to insist that parties to a settlement identify the particular sums that are attributable to particular heads of claim would become a pre-condition of an insured recovering under its liability policy and would discourage the settlement of disputes and create more litigation.

Aikens J found that, had the point been relevant, reinsurers would not have succeeded in their argument that the Lumberman’s decision would have prevented Enterprise from making a recovery.

The comments of Aikens J in this case relating to Lumberman’s are not binding in that the issue relating to apportionment of settlement monies in global settlements did not have to be decided in this case. However, the analysis of the Lumberman’s decision will no doubt be heavily cited by insureds until such stage as this uncertain area of the law is ruled upon by a higher court.

For further background in relation to the Lumberman’s decision please see below:

Lumbered: the salutary story of Lumbermens Mutual Casualty Company -v- Bovis Lend Lea

Originally pubished January 2005

The recent decision of Mr Justice Colman in the Commercial Court in Lumbermens Mutual Casualty Company -v- Bovis Lend Lease Limited provides some salutary lessons for those advising contractors on the settlement of construction claims and for those setting up contractor’s professional indemnity policies and handling claims under them.

The dispute between Bovis Lend Lease and their Insurers arose out of the settlement of a separate action between Bovis and Braehead Glasgow Limited in relation to the final account for the construction of a retail and leisure centre in Glasgow. To cut a very long story short, Bovis had claimed £37,778,266 from Braehead and Braehead had promptly counterclaimed, in the alternative, £103,594,367 or £75,770,225. A settlement was ultimately achieved on the basis of a payment by Braehead to Bovis of £15 million in full and final settlement of all disputes under the building contract. Some of these disputes related to allegations covered under Bovis’ PI cover; others arguably did not. The method of calculation of the £15 million figure was not identified in the settlement agreement. Bovis then sought to recover £19,463,221 from their professional indemnity insurers on the basis of an assessment by their solicitors of the value of the insured element of the counterclaim brought by Braehead. The PI Insurers promptly issued declaratory proceedings in the Commercial Court by maintaining that they had no liability to pay any part of the £19,463,221 claimed.

Directions were given under declaratory proceedings for a hearing of preliminary issues. In very broad terms, the first two issues revolved around whether the Settlement Agreement reached with Braehead had any relevance at all to the ascertainment of Bovis’ loss. The third and fourth issues related to the proper interpretation of the insuring clause.

Colman J’s decision was as follows:

An Insured under a liability policy needs to establish three constituents before he can show that the Insurer is under an obligation to indemnify the Insured in respect of particular sums paid in settlement of a liability to a third party. These were as follows:

"Firstly, there has to have occurred an eventuality which has rendered the Insured liable to a third party. Secondly, the eventuality and the consequent liability has to be within the scope of the cover provided by the policy. Thirdly, it must be established that such liability has caused loss to the Insured of an amount within the scope of the contractual indemnity"

Colman J found that where a settlement was entered into which did not distinguish between insured and uninsured heads of claim the settlement agreement itself was of no evidential value to the ascertainment of indemnifiable liability under the policy. Rather, it was incumbent on the Insured to establish that he did in fact have a liability to the relevant third party in respect of insured heads of claim and the amount of the damages properly payable in respect of such liability.

Bovis’ policy contained two separate operative clauses. Insuring clause 1 covered Bovis in respect of liability arising in respect of claims made "as a result of any neglect, error or omission" in the performance of the insured activities. Insuring clause 2 of the policy provided breach of warranty and fitness for purpose cover, but only (per Memorandum 7 (i) of the Policy) where the relevant contract was disclosed to Insurers by means of an annual declaration to be made by the Insured prior to the expiry of the period of insurance. (No such declaration was made in respect of the Braehead contract).

Colman J construed these clauses in the following way:

(a) Cover in respect of "neglect, error or omission" extended beyond mere negligence but did not embrace deliberate acts or omissions by the Insured. This followed a relatively conventional line of authority including George Wimpey & Co Limited -v- DV Poole.

(b) Proper construction of Insuring Clause 1 read together with Insuring Clause 2 was, however, that the latter was intended to apply to any claim for breach of contract and the former to "liabilities which may arise independently of constituting a breach of contract". Colman J then gave an example of how Insuring Clause 1 was to work in the following scenario:

"… If the Assured can be sued in tort for non-deliberate neglect or error or omission or for non-deliberate breach of warranty of authority without formulating the claim as one for breach of any contract between the Assured and a third party, there will be cover under Clause 1, subject to the other provisions of the policy"

(c) Because, as a matter of fact, Bovis had not declared the Braehead contract in accordance with Memorandum 7(i) of the Policy there was no cover under Insuring Clause 2 and, to the extent that the liability arose exclusively as a result of Clause 2.5.2.5 as a building contract (which attested to the fitness or suitability of any work or materials used for the works), the claim was unsustainable under the policy because it could not be brought independently of the contract.

There are clearly some lessons to be learnt from this Judgment.

The first is that if one is a contractor who wishes to keep open the possibility of passing part of the financial cost of a settlement of a claim which includes insured and uninsured elements to PI Insurers it is vital that Insurers are pulled into the process of evaluating the claim and are tied into a specific contribution to any settlement ultimately achieved with the Claimant. If it proves impossible to tie the Insurers into the deal an attempt could be made to agree with the Claimant an agreed split of the settlement sum between covered and non-covered heads of claim. This is, however, very much a second best option for the following reasons:

A. The Claimant will inevitably extract a price for such an arrangement: there is no reason from the perspective of his claim why such an apportionment should be needed.

B. It is clear from Colman J’s evidence that the allocation will need to be verifiable. This means that it must be supported either by a plausible assessment of the insured element which is agreed by both Claimant Insured or by other evidence (which may, at the time of settlement, only be in the possession of the Claimant).

If no deal on apportionment to insured and uninsured heads of loss is struck with the Claimant it looks very much from Colman J’s judgment as though the Insured is well and truly snookered. There will be no judgment, award or final adjudication, the settlement agreement will not trigger an entitlement to indemnity and it does not even appear that there is scope for the Insured to bring home his claim by showing that, but for the settlement, the claim against him would have succeeded. On the face of it this appears a pretty unjust result.

The decision also has significant implications for the drafting of design & construct professional indemnity policies.

The first point is that in spite of the fact that there has been authority in existence for decades to the effect that the formulation "neglect, error or omission" extends beyond mere negligence, professional indemnity insurers have consistently included it in policy wordings that are not intended to extend this far. In part this has been the result of broker pressure in a soft market but there is no real justification for the practice being perpetuated in the current hard one.

The second point is that while the "two part" drafting of Bovis’ operative clause is somewhat unusual, there is a good prospect that Colman J’s logic in the interpretation of Insuring Clause 1 (covering "neglect, error or omission") would also extend to such a clause that existed in isolation without a second insuring provision which gave the Insured cover in respect of fitness for purpose obligations under specific contracts by annual declaration. If that logic was to be applied, the practical effect would be to limit the Insured’s right of indemnity to claims that could otherwise be brought in tort or for breach of statutory duty and that would effectively rule out the possibility of indemnification in respect of claims for pure economic loss.

It has to be said that construing a simple "neglect, error or omission" insuring clause so as to exclude pure economic loss would be contrary to what most current UK PI Insurers would regard as the mutual contractual intent. It is frequently stated that one of the features of professional indemnity cover is specifically that it does provide a measure of protection in respect of contractual claims for pure economic loss, albeit not contractual claims which are brought on the basis of the breach of an express contractual warranty or guarantee. If, in any given policy going forward, the intention is to cover claims for pure economic loss but to exclude claims brought solely on the basis of a breach of a strict obligation of fitness for purpose those advising the Insured on policy wordings do need to pay considerable attention to revisions to the standard wordings to make that intention clear.

The decision of Colman J is subject to appeal.

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 01/02/2006.