UK: Explosion Exclusions And Additional Conditions

A recent case has provided an interesting analysis of two discrete coverage points as between a reinsurer and his reinsured.

The reinsured provided cover for an oil refinery and brought a claim under a facultative reinsurance policy it held with the reinsurer in respect of two settled claims. Both losses had occurred in 2001 from incidents at an oil refinery owned by Coastal Aruba Refinery Company, a subsidiary of El Paso Energy Corporation. The first claim related to a vessel into which crude oil was pumped and the second claim related to damage to a reactor unit.

The reinsurers denied cover on the basis that neither loss fell within the scope of the reinsurance cover. The court held that the reinsurance would respond to the first loss but not the second and the court’s reasoning makes interesting reading. In particular, the court held that:

• the underwriter’s knowledge at the time of making the contract could be used to construe the contract and it did not matter that this knowledge was gained during the course of negotiations;

• to constitute an "explosion" an event must demonstrate manifest violence and a shattering destruction and must be accompanied by a loud bang or an explosive noise; and

• a reinsurer will be able to question the factual basis of a settlement where the reinsurance is not back to back, as it cannot be assumed that the just because the loss fell within the original cover it would automatically fall within the reinsurance cover.

Further reading: Aegis Electrical and Gas International Services Company Ltd v Continental Casualty[2007] EWHC 1762

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Full Article

In Aegis v Continental Casualty [2007], the High Court considered whether the two losses settled by Aegis fell within the terms of the facultative reinsurance cover issued by Continental Casualty.

Background

Aegis insured El Paso by way of a "Package Policy" designed to wrap around El Paso’s cover with OIL, the energy mutual insurer. The cover was for 12 months from 29 January 2001.

The reinsurance was underwritten by Continental Casualty for 12 months from 1 February 2001. The slip described the interest as "In respect of the Machinery and Equipment of the Original Assured plant(s) Onshore and/or the property as original" and the conditions provided that the cover was "To follow the terms, clauses, conditions, exceptions and settlements of the original policy wording as far as applicable hereto."

Reinsurers’ denial of cover for the first loss related to the interpretation of the additional conditions attached to the reinsurance slip. Were it not for these conditions, the reinsurance cover would have been back to back cover for the specific "onshore property" section of the direct policy. However, the reinsurance underwriter, when initialling the slip, wrote on it the words "Subject to B[oiler]& M[achinery] conditions attached pages 1-3." This document, entitled "Boiler & Machinery Coverage Defined", was physically attached to the slip and provided definitions of "Accident" and "Object". These definitions were such that both parties agreed that if they were found to apply to the reinsurance contract as a whole (as argued by reinsurers), then reinsurers would have no liability for the loss.

Aegis argued that the definitions should apply only insofar as the word ‘accident’ and ‘object’ were used in the underlying policy – namely in two (relatively inconsequential) clauses, 10 and 21. The words were not used in the definition of cover or perils insured and so, in their view, did not define or limit the scope of the reinsurance in any way.

The Decision

The court was not persuaded by Aegis’s arguments; particularly because the reinsurance underwriter did not see the underlying policy at the time of underwriting. As such she was not aware whether, and in what context, the words ‘accident’ and ‘object’ appeared. It would be unrealistic to suppose that she would have taken the trouble to negotiate particular definitions of the underlying policy without having first seen it and appreciated the context in which the defined words appeared.

Further, if Aegis’s line of argument was correct, it did not sit well with the heading "Boiler & Machinery Coverage Defined". To define two relatively minor terms of cover did not constitute ‘..Coverage Defined’ as the heading suggested. Accordingly, the court held that reinsurers were right to decline cover in respect of this loss.

As an interesting aside, the court rejected Aegis’s argument that the reinsurance underwriter’s knowledge (or otherwise) of the underlying policy at the time of making the contract could not be used to construe the policy as it is recognised law that what the parties said or did at the time of negotiations is not a legitimate aid to construction. In Smith J’s view, the negotiation stances adopted by each party at the time of negotiating the contract could be distinguished from the knowledge to be attributed to the parties when they made the contract, irrespective of whether this knowledge was gained during the course of negotiations.

Reinsurers denied cover in respect of the second loss on the basis that the damage fell within the exclusions for loss or damage from explosion found within the definition of "Accident" referred to above.

The reactor unit was damaged on account of excessive heat and associated build up of pressure being generated due to chemical reactions within the vessel. This caused the wall of the vessel to bulge producing cracks and tears to the unit. Shortly thereafter, a fire was reported. Reinsurers’ expert witness testified that the sudden outpouring of gas caused an "abrupt noise" and generated a shock wave. In spite of this, the judge noted the absence of witness evidence describing a bang or loud explosive noise.

Having considered the various loss adjusters’ reports and heard expert witness evidence, the court was not persuaded that there was an explosion at the reactor unit. The court considered that the word ‘explosion’ "connotes violence and manifest violence of a kind which has not been shown to have been present in this case, and it connotes a shattering destruction which too is absent." Furthermore, although the noise produced would have been marked, it was not dramatic.

Smith J considered his conclusions consistent with those of Mr Justice Staughton in Commonwealth Smelting Ltd. v Guardian Royal Exchange Insurance Ltd, [1984] 2 Lloyd’s Reports 608 as approved by the Court of Appeal (at [1986] 1 Lloyd’s Reports 121). Staughton LJ identified the following characteristics of an explosion: (i) a violent event (ii) a noisy event and (iii) an event "caused by a very rapid chemical or nuclear reaction, or the bursting out of gas or vapour under pressure". In Smith J’s opinion, neither criteria (i) or (ii) had been met. Lord Justice Parker’s judgment in the Court of Appeal added a further criteria that for an explosion to have occurred, some of the damage must have been caused by the explosion itself. Smith J did not comment on this in his judgment but, arguably, this was not the case in this instance as the bulging and cracking occurred before the rupture of the unit wall.

In any event, Smith J concurred with Aegis’s argument that, in order for the damage to fall within the explosion exclusion, reinsurers must show that the explosion was the proximate cause of the loss. In order to be able to do this, reinsurers would have to argue that the cracking and bulging should be taken as a single event, and that the event as a whole should be characterised as an ‘explosion’. This is not consistent with any of the loss adjuster reports - which predominantly refer to the damage as ‘bulging and cracking’ - and is at best an artificial interpretation of events. Accordingly, the court held that Aegis were entitled to reinsurance cover in respect of the second loss.

As it was, Aegis did not need to rely on their argument that the "follow the settlements" provision prevented reinsurers from disputing the factual basis on which they settled the claim with El Paso. This was fortunate, as the court, in a lengthy obiter dicta analysis, ultimately rejected the argument. The claimant could not rely on Robert Goff LJ’s judgment in The Insurance Co of Africa v Scor (UK) Reinsurance Co Ltd, [1985] 1 Lloyd’s Rep 312.The policy was not entirely back to back and it could not be assumed that because the loss fell within the original cover, it would automatically fall within the reinsurance cover (subject only to legal questions as to what the reinsurance covers). Further, the follow the settlements clause was qualified with the words "insofar as applicable" which the court interpreted to mean as that the follow the settlement provisions should apply only insofar as the risk was covered by the reinsurance.

This case predominantly serves as a reminder to reinsureds to make sure that they are obtaining the reinsurance cover they think they are. A follow the settlements provision does not necessarily equate to back to back cover and a reinsured must undertake a thorough analysis of any additional conditions added by reinsurers. As this case proves, a set of seemingly minor additions can radically alter the scope of cover provided by the reinsurance, and leave a reinsured exposed to claims he might have assumed were covered by reinsurance.

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 22/08/2007.