UK: The Taylor Wessing Insurance And Reinsurance Review Of 2009 (PART 2)

Last Updated: 25 January 2010
This article is part of a series: Click The Taylor Wessing Insurance And Reinsurance Review Of 2009 (PART 1) for the previous article.

PROCEDURE

Joinder of insurers to proceedings between insured and brokers

Dunlop Haywards (DHL) Ltd & Ors v. Erinaceous Services Ltd & Ors [2009]21

Court of Appeal, 28 April 2009

Commercial Court, 19 November 2009

The situation is not at all uncommon. An insured's policy claim is rejected, on the grounds that it falls outside the coverage terms arranged by the broker, in response to which the insured sues the broker for having failed to procure insurance on suitable terms. Frequently the broker will respond in its defence that the policy claim is in fact recoverable under the relevant terms, and that insurers' declinature is invalid. The result is that the insured may find himself litigating the merits of the policy claim with his own broker.

In this situation, the normal approach is to make the insurers a party to the litigation, either at the instigation of the insured or (less commonly) the broker, and thus all issues will be resolved between the interested parties in one set of proceedings. Furthermore, the loser in the litigation will usually be ordered to pay the costs of both of the other parties.

In the present case the insured (DH) carried on business as a property consultant, in which it undertook commercial property management, surveying and valuations. The brokers procured on behalf of DH a primary professional liability policy with a limit of £10m covering all of DH's activities, together with an excess policy providing coverage of £10m excess of £10m. The latter policy, however, was expressed to be limited to the "assured's commercial property management activities only".

DH faced a number of claims from clients alleging negligent and/or fraudulent valuations by an employee, which were duly notified to the primary and excess policies. The excess insurers denied liability on the grounds that the claims arose out of valuation work, not commercial property management. In response, DH sued its brokers for having failed to procure excess insurance on terms suitable to its business.

In this case, it was the defendant broker who wished to have excess insurers joined to the proceedings, but this could not be achieved by means of a Part 20 Notice because the brokers had no claim in their own right against the insurers. Instead, the brokers sought to have the excess insurers added under CPR 19.2(2), which permits any party to be added to litigation "if it is desirable to add the new party so that the court can resolve all the matters in dispute in the proceedings".

In the Commercial Court, Mr Justice Field rejected the broker's application under CPR 19.2(2) in a judgment delivered In April 2008. On the basis of the clear policy terms, he concluded that the merits of any claim against excess insurers were "so weak" that the insurers ought not to be put to the inconvenience and expense of becoming parties to the litigation at all. It was, in other words, not "desirable" to add the excess insurers as a party to this litigation, and if the holder of the right to those claims wished to do so, it could pursue them by way of separate proceedings.

In a decision handed down on 28 April 2009, the decision of the Commercial Court was overturned by the Court of Appeal. The Court of Appeal said the Judge was wrong to dismiss the merits of the policy claim on a summary basis, as he had done. There was at least a good arguable case that the policy terms were a mistake; that in fact the market had not intended to restrict coverage in the manner expressed in the excess policy, and that the wording required rectification. Even where one agreement, such as is expressed in a "held covered" endorsement or in the terms of a "firm order" was superseded by another, such as a slip, there could still be rectification of the later slip and policy to reflect the earlier agreement if in fact that remained the intention of the parties. In the present case, the Court of Appeal held that the case for rectification was not so weak as to render it not "desirable" to join the excess insurers under CPR 19.2(2). Accordingly, the excess insurers were to be joined.

The proceedings then returned to the Commercial Court for trial on the merits, upon which judgment was handed down on 19 November 2009. In the event, the Commercial Court rejected the rectification claim, finding that there was indeed no claim against the excess insurers under the terms of the policy. Accordingly, the brokers were at fault in having failed to procure cover in accordance with their principals' requirements, and for which the court apportioned liability between the producing and placing brokers in the respective amounts of 80:20.

Result: Judgment for the insured against the brokers, and for the excess insurers on the policy claim.

Under article 31(1) of the Convention on the Contract for the International Carriage of Goods by Road (aka the "CMR") any legal proceedings arising out of a contract of carriage under the Convention may be brought in the courts of any contracting country by agreement between the parties or "in the courts or tribunals of a country within whose territory the defendant is ordinarily resident, or has his principal place of business".

This case concerned goods sent by an Austrian consignor ("TA") to its sister company in Italy, both insured by XL. The goods were entrusted to Hatzl, an Austrian road haulage company, but were stolen whilst their driver was asleep at a roadside parking place in northern Italy.

XL paid the policy claim in the normal way, and took an assignment from TA of its rights against Hatzl. When XL sought payment from Hatzl, however, the latter responded by issuing proceedings in the English court against XL for a declaration that it was not liable for the loss. In seeking to found the jurisdiction of the English court, Hatzl relied upon the fact that XL (not TA) was the Defendant to the claim it had issued. Since XL was ordinarily resident or had its principal place of business in England, the English court had jurisdiction to hear the matter, notwithstanding that the original parties to the contract of carriage had no connection with England at all. The trial Judge agreed, a decision from which XL appealed.

The Court of Appeal issued its judgment on 19 March 2009, reversing the Judge's decision. Applying a purposive approach to the language of the Convention, the Court of Appeal agreed with XL that Article 31(1) was not intended to apply to a defendant against whom a declaration of non-liability was sought simply in its capacity as an assignee of the rights of one of the original parties to the contract of carriage. The word "Defendant" in the Article was not to be understood in simply the procedural sense. It was intended to extend to the parties to the contract and probably also to others to whom the Convention had ascribed rights and duties, but not to an assignee, even if that assignee also happened to be one of the parties' insurers.

Result: Judgment on jurisdiction for the defendant insurers.

 

Meaning of "Defendant" under the CMR

Emmerich Hatzl & Anor v. XL Insurance Co Ltd [2009]22

Court of Appeal, 19 March 2009

Under article 31(1) of the Convention on the Contract for the International Carriage of Goods by Road (aka the "CMR") any legal proceedings arising out of a contract of carriage under the Convention may be brought in the courts of any contracting country by agreement between the parties or "in the courts or tribunals of a country within whose territory the defendant is ordinarily resident, or has his principal place of business".

This case concerned goods sent by an Austrian consignor ("TA") to its sister company in Italy, both insured by XL. The goods were entrusted to Hatzl, an Austrian road haulage company, but were stolen whilst their driver was asleep at a roadside parking place in northern Italy.

XL paid the policy claim in the normal way, and took an assignment from TA of its rights against Hatzl. When XL sought payment from Hatzl, however, the latter responded by issuing proceedings in the English court against XL for a declaration that it was not liable for the loss. In seeking to found the jurisdiction of the English court, Hatzl relied upon the fact that XL (not TA) was the Defendant to the claim it had issued. Since XL was ordinarily resident or had its principal place of business in England, the English court had jurisdiction to hear the matter, notwithstanding that the original parties to the contract of carriage had no connection with England at all. The trial Judge agreed, a decision from which XL appealed.

The Court of Appeal issued its judgment on 19 March 2009, reversing the Judge's decision. Applying a purposive approach to the language of the Convention, the Court of Appeal agreed with XL that Article 31(1) was not intended to apply to a defendant against whom a declaration of non-liability was sought simply in its capacity as an assignee of the rights of one of the original parties to the contract of carriage. The word "Defendant" in the Article was not to be understood in simply the procedural sense. It was intended to extend to the parties to the contract and probably also to others to whom the Convention had ascribed rights and duties, but not to an assignee, even if that assignee also happened to be one of the parties' insurers.

Result: Judgment on jurisdiction for the defendant insurers.

LAW AND JURISDICTION

Governing Law and Jurisdiction in reinsurance – revisited

Gard Marine & Energy v. (1) Lloyd Tunnicliffe; (2) Glacier Re & Anor [2009]23

Commercial Court, 9 October 2009

The Background This was a case giving rise to issues of both jurisdiction and governing law under a contract (or contracts) of excess of loss reinsurance issued by the Defendants, to the Claimant ("Gard"), a reinsured domiciled in Bermuda.

The reinsurance was arranged under two separate placements. An order for 7.5% of the whole was placed by way of a London market slip, to which various Lloyd's syndicates subscribed. A separate slip, for 5% of whole, was placed with the second Defendant, Glacier Re ("Glacier") a company domiciled in Switzerland.

A dispute emerged under the reinsurance between Gard and certain of the subscribing reinsurers, specifically under the Sum Insured clause and the application of the policy deductible. Glacier paid a proportion of the amount claimed against it, on the basis of its own calculation of how the deductible should apply, although it subsequently developed its case to argue that no sums were in fact due at all, and accordingly sought to recover the sum it had paid.

In March 2007, Gard issued the English proceedings against the reinsurers then in dispute, namely three Lloyd's syndicates and Glacier. The proceedings were served on Glacier in June 2007, by which time Glacier had itself issued competing proceedings against Gard in the Swiss court, for recovery of the amount it had already paid. Subsequently the Swiss court declined jurisdiction over those proceedings, on the ground that the Defendant, Gard, was not domiciled in Switzerland. At that point, the English court was asked to rule upon its own jurisdiction and as to issues of governing law.

Applicable Law

Dealing with applicable law first, the English court noted that it was obliged to apply the principles of the Rome Convention24. Article 3 of the Convention provides that a contract is to be governed by the law chosen by the parties. Such a choice may be express or it may be "demonstrated with reasonable certainty by the terms of the contract or the circumstances of the case." The 1980 report of Professors Giuliano & Lagarde, a guiding text which accompanies the Convention, offers examples of where this may be so, including where the contract is in a standard form known to be governed by a particular system of law "such as a Lloyd's policy of marine insurance..."

If no choice can be discerned at all, either expressly or by implication as above, then generally the contract will be subject to the law of the place of business of the "characteristic" performer of the contract (Art 4(2)), which in the case of reinsurance is taken to be that of the reinsurer25.

In the present case, the court concluded that there was a good arguable case in favour of English law, in preference to Swiss, on four grounds:

(1) The contract with Glacier was not, in truth, a Swiss market placement. It was a London market placement in which Glacier had merely been invited to participate. The risk was placed by London brokers who had offered Glacier a share of an existing reinsurance programme, expressly to make up for capacity constraints faced by the existing participants. The fact that the Glacier participation was recorded under a separate order did not detract from this fact;

(2) The use of a Lloyd's slip and policy pointed towards English law, applying the reasoning in Giuliano & Lagarde;

(3) The slip specifically incorporated a number of London market wordings, such as LSW196A, CL 356A, CL 365 and LSW 1001. This had previously been held persuasive in favour of an implied choice of English law.26

(4) The slip adopted a number of formulations and turns of phrase recognisable to English law, such as the form of Notice of Cancellation or the provision "Subject to all terms, clauses, conditions as Original and to follow the original in every respect...". In the Aegis case the judge had considered this to be "terminology which associates it with the law of England".

Accordingly, the "characteristic performer" test under Art 4(2) of the Convention (which in this case would have pointed to Swiss law) did not come into play.

Jurisdiction

Matters of jurisdiction as between England and Switzerland are subject to the Lugano Convention. The default position under the Lugano Convention (Art 2) is that a defendant should be sued only in his own domicile, such that in this case Glacier could only be sued in Switzerland.

There are, however, a number of specific derogations from this position, and in this case Gard relied upon two of them, in the alternative.

The Article 5(1) Argument

Under Art 5(1) of the Convention, which deals with contractual obligations, a party in a Contracting State (e.g. Switzerland) may be sued in another Contracting State (e.g.. England), if the latter is "the place of performance of the obligation in question".

As a matter of English law, however, the actual place of performance of an obligation to pay money is taken to be the place where the creditor (i.e. Gard) resides, in this case Bermuda. On this basis, there would be no "place of performance" within a Contracting State, since the required place of performance was actually Bermuda. Accordingly, so argued Glacier, Art 5(1) could not apply. The court agreed. It dismissed Gard's argument that, as a matter of practice, the debtor's obligation here was to pay money to the brokers in London, rather than (on the orthodox analysis) to seek out its creditor in Bermuda. Thus, Gard's argument in favour of English jurisdiction under Art 5(1) failed.

The Article 6(1) Argument

Under Art 6(1), the Lugano Convention also provides that where (as here) the Defendant is one of a number of defendants, he may be sued "in the courts for the place where any one of them is domiciled".

The purpose of Art 6(1) is of course to avoid the risk of contradictory judgments in different jurisdictions, but it will only apply where the claims against the various defendants are so closely connected that it is expedient to hear and determine them together in the interests of avoiding irreconcilable judgments.27 Such irreconcilability may arise from potential conflicting findings of fact or from potential conflicting decisions on questions of law28.

Glacier contended that there was no such risk in this case. Although the two slips shared common provisions, they were separate and contained distinct annotations. The claims also concerned different facts, in that exchanges were relied upon between the brokers and the London market reinsurers that were not relevant to Glacier's position.

On this point, the court agreed with Gard and rejected the position of Glacier. There was a good arguable case that, by declining English jurisdiction over the claim against Glacier (and so forcing Gard to sue Glacier in Switzerland) irreconcilable judgments would be reached between the English litigation and that in Switzerland. Both claims turned on the proper construction of the Sum Insured clause in the reinsurances. That clause was in precisely the same terms in both contracts, which contracts were placed as part of a common reinsurance programme. Further, the issue of construction fell to be determined under English law. There was no material difference between the terms of the two contracts, so the court held, and so the legal issue to be determined in both cases was the same.

The court also noted that Gard was pursuing an alternative claim in the same litigation against its broker, a claim contingent upon the outcome of the claim on the reinsurance. This made the consequence of differing judgments particularly serious. If, for example, Gard's claim against Glacier failed in Switzerland but its contingent claim against the broker was being pursued in England, what would happen if the English Court reached a different conclusion on the issue of construction? The claim against the broker might then fail, leaving Gard to "fall between two jurisdictional stools".

Accordingly, the English court confirmed jurisdiction over Gard's claims against both the London market syndicates and Glacier, as well as the contingent claim against the broker.

European anti-suit injunctions – the door closes

Allianz SpA & Ors v. West Tankers Inc (the "FRONT CONNOR") [2009]29

Court of Justice of the European Communities, 10 February 2009

Anti-suit injunctions are a commonly used tool in re/insurance litigation. The paradigm example sees a London re/insurer sued by an insured or reinsured in the courts of (say) Texas, in defiance of an exclusive English jurisdiction clause, to which the re/insurer will respond with an application for an injunction from the English court.

The legal effect of the anti-suit injunction is frequently misunderstood; the order is intended to injunct the litigant, not the foreign court. Nevertheless, anti-suit injunctions are often viewed with suspicion by foreign courts, who consider them an improper invasion into their administration of justice by the English court. Some jurisdictions, most notably France, have never granted anti-suit relief.

Within Europe in particular, the anti-suit injunction has increasingly been seen as an affront to the idea that the courts of each European state are equally well-equipped to apply what have become largely harmonised rules on the allocation of jurisdiction between them. Consequently, under the terms of EU Regulation 44/2001, the courts of member states of the European Union are now prohibited from issuing injunctions to restrain proceedings already commenced in the courts of another member state. In the case of Gasser GmbH v. MISAT Srl [2003]30, the European Court of Justice held that this would be true even where the first proceedings had been brought in defiance of an exclusive jurisdiction clause, and similarly even where a litigant had deliberately (i.e. in bad faith) issued proceedings in a member state court other than that stipulated (Turner v. Grovit [2004])31.

What remained unclear until recently was the position of arbitration clauses, because arbitration is excluded from the scope of the Regulation. Could an English court still issue an injunction restraining a party from pursuing a claim in Italy in defiance of a contractual provision referring the matter to arbitration in England? That was the question for consideration in the case of Allianz v. West Tankers.Body.

In a provisional opinion issued in February 2007, the House of Lords took the view that the court still retained the power to order injunctions in support of arbitration; Lord Hoffman noted that arbitration fell outside the system of allocation of court jurisdiction created by the Regulation and that there was nothing inconsistent with the Regulation for a party to protect, by force of an injunction, its express contractual right to have a dispute determined by way of arbitration. Nevertheless, the House of Lords conceded that the point was one upon which judges and academics in various States had expressed conflicting views, and so it referred the matter for determination by the European Court of Justice.

On 4 September 2008, the Advocate-General Kokott delivered her opinion on the matter. Contrary to the position taken by the House of Lords, her view was that the Regulation does indeed preclude the courts of a member state from issuing an anti-suit injunction in support of arbitration, in much the same way as court jurisdiction. The crucial question, she said, was whether the proceedings sought to be injuncted themselves fell within the Regulation. If they did, then it was for the court seised of those proceedings (in this case the Italian court) to determine if they should be stayed in favour of some other forum, whether that be arbitration or court litigation, in another member state. The court delivered its judgment on 10 February 2009, adopting the opinion of the Advocate General, and formally confirming that the Regulation does indeed prohibit member state courts from issuing anti-suit injunctions in favour of arbitration.

The decision is a controversial one, particularly among commentators in England, where the anti-suit concept is most developed. While the ECJ ruling does not affect the ability of the English court to issue anti-suit injunctions in restraint of proceedings brought outside Europe, it closes the door on anti-suit as a tool against competing litigation in other EU jurisdictions. To that extent, it threatens to put England at a disadvantage relative to common law jurisdictions outside the European Union, notably New York and Bermuda, where the courts remain unaffected by the Regulation.

Rome I Regulation comes into force

Regulation 593/2008 on the Law Applicable to Contractual Obligations

(the "Rome I Regulation")

In force: 17 December 2009

Contracts of insurance and reinsurance entered into prior to 17 December 2009, were subject to two separate choice of law regimes32. On the one hand, direct insurance contracts covering risks situated outside the EU, together with all reinsurance contracts (whether inside or outside the EU) were governed by the Rome Convention of 1980, as implemented in England by the Contracts (Applicable Law) Act 1990. By contrast, choice of law issues in direct insurance covering risks situated within the EU were governed by a series of EU Directives, latterly made part of English law by regulations under the Financial Services and Markets Act 2000.

As a broad rule of thumb, the Rome Convention preserved the right of party choice, as had been the position under the prior common law, whereas governing law was more heavily regulated under the Directives, the primary intention being to offer protection to consumers. Nevertheless, there was much criticism of the existing regime, not only because of the inherent inconvenience of having to refer to two separate sources of law, but also because, in the case of direct insurance, the crucial question was where the risk was "situated", a test that was not always easy to apply. In particular, questions would arise in the case of an EU risk underwritten by a non-EU insurer, or where a risk was partly inside and partly outside the EU.

The Rome I Regulation, which came into force in respect of all contracts entered into from 17 December 2009, represents an attempt to resolve some of these issues, while at the same time bringing the two separate choice of law regimes back under one roof.

Direct Insurance

The default provisions under the Regulation appear at Article 3, essentially replicating the freedom of party choice previously enshrined in the Rome Convention. However, the Regulation then goes on to make specific provision for various different types of contract. In the case of insurance these appear at Article 7, which applies to most insurance contracts "whether or not the risk covered is situated within a Member State". On the face of if, therefore, the previous distinction between risks inside and those outside the EU has been removed. In its place, the Regulation draws a distinction between "large" risks and the rest. So long as a risk qualifies as "large", whether situated within the EU or not, it will be subject to the default regime at Article 3, that is to say freedom of party choice. For these purposes, all insurance covering aircraft, railway stock, ships and goods in transit are considered "large", whatever the actual values involved. In other cases, a risk will be large where the insured's balance sheet or turnover exceeds a certain level, or if it satisfies a minimum employee headcount.

In practice, most commercial insurance contracts will qualify as "large" risks, and as such the parties will be left free to choose the governing law. In these cases, it is no longer necessary to enquire into the location of the risk. To this extent, therefore, the Rome I Regulation represents a welcome simplification of the former position.

However, if a risk fails to qualify as "large", then the question of location of the risk comes back into play. Non-large risks situated outside the EU are subject to the Article 3 regime, as with large risks. By contrast, non-large risks situated within the EU are subject to more restrictive provisions. In such cases, the parties remain free to choose the governing law by virtue of their contract, but they are limited to a menu of available governing laws. They may, for example, choose the law of the Member State where the risk is situated, or the law of the policyholder's residence. They may not, however, choose the law of the place of business of the insurer. If they fail to make a choice at all, then once again it is the "law of the Member state in which the risk is situated" that governs.

In what appears to be an attempt to overcome some of the problems identified with the former regime, the Regulation provides that, where a contract of insurance covers more than one risk, including a risk within a Member state and a risk in a third country, the special provisions on insurance apply only to the particular risk(s) located within the Member State and not to the whole contract33; in other words, insurance contracts are to be treated as severable between the EU located risk and that located outside the EU. This still does not assist, however, in the situation where a single risk spans more than one jurisdiction, one or more of which is outside the EU.

Reinsurance

Article 7 expressly does not apply to reinsurance. Instead, reinsurance falls within the default provisions of Article 3, again preserving the freedom of choice found under the Rome Convention. While some of the terminology used in the Convention has been amended slightly in the Regulation, the changes are unlikely to be significant. Where, for example, the Convention previously looked for an express choice of law, failing which a choice "demonstrated with reasonable certainty", the Regulation now calls for a choice to be "clearly demonstrated". Whether there is much to be made of this distinction remains to be seen, but either way the same default rules apply; in the absence of choice the contract will be governed by the law of the place of the "service provider", which the English courts are likely to continue to treat as that of the reinsurer34.

OTHER DEVELOPMENTS

D&O Insurance in Germany – The New Legislation Arrives

Unlike in many jurisdictions, directors and officers' liability insurance is not compulsory under German law. Nevertheless, D&O coverage is expected as a matter of good practice, as set out in the German "Corporate Governance Kodex" ("the Code"). Furthermore, the Code has for some time recommended that listed companies agree in their D&O policies upon an "adequate" deductible to be borne personally by the directors protected by the policy. By imposing a personal interest on the part of the directors concerned, it was sought to motivate them to avoid claims arising, although the question of what constituted an "adequate" deductible has remained vague.

In practice, many German companies has circumvented the requirements altogether, relying upon a standard form of derogation from the Code in their annual filings, with a statement that a deductible "would not improve the consciousness of responsibility" of their directors, or otherwise motivate them to avoid damage arising.

The German Legislature has now acted to put a stop to this practice for directors of German stock corporations. Following a period of debate in the Bundestag the new Act on the Adequacy of Managerial Salaries (Gesetz zur Angemessenheit der Vorstandsvergütung - VorstAG) was passed on 18 June 2009.

The new provisions came into force on 10 July 2009. The Act amends section 93 II 3 of the German Stock Corporation Act (Aktiengesetz – AktG), and requires that listed companies purchasing D&O insurance for their executives must impose a personal deductible to be borne by the directors of at least 10% of a loss up to an annual maximum deductible calculated by reference to the fixed remuneration of the director from time to time. Practical guidance is to be found in the accompanying Reasons (Begründung, BT-Drs 16/13433) issued by the legislator, which states that the required personal deductible shall consist of at least 10% of each loss, subject to an absolute annual cap which must be set at not less than one and a half times the annual fixed remuneration of the director. The aggregate cap is to be reviewed annually to reflect movements in the fixed element of the director's remuneration.

The requirements are applicable to all stock corporations, whether in fact listed or privately owned, although, under Germany's two tier system of corporate governance for such companies, only members of the board of directors (Vorstandsmitglied) are affected, and not supervisory board members (Aufsichtsratsmitglied).

The provisions were applied with immediate effect to all newly concluded D&O insurance contracts, while those already in existence were amended with effect from 1 July 2010. There is a transitional exception in the case of those companies already obliged under existing service contracts to provide D&O insurance cover to the director without deductible. In those cases, the policy terms may remain unchanged until the appointment of the director and the underlying service agreement expire. The statutory maximum appointment term of a board member is five years.

Interestingly, the legislation does not prohibit directors from insuring their deductible exposure separately, leading to speculation that the reforms will simply give birth to a new class of business in D&O deductible insurance. While responsibility for the premiums for such a product would have to be borne privately by the directors, there is nothing to prevent them seeking a commensurate uplift in their remuneration to cover the outlay. Furthermore, any obligation to disclose such an arrangement in corporate filings would require an amendment to the Code as it stands.

At the same time, the new Act on the Adequacy of Managerial Salaries also brings about an amendment to section 87 I AktG, which will now oblige the supervisory board members to ensure that the total remuneration of members of the board of directors is in adequate relationship to their tasks and performance, and the performance of the relevant company. It requires that the usual ("üblich") remuneration of a director is not to be exceeded without specific reasons. Furthermore, in the case of listed stock corporations, the directors' remuneration has to be consistent with the sustained ("nachhaltig") development of the company, and performance elements of directors' remuneration are to be assessed on the basis of several years, up to the entire term of appointment. Short term performance measures are no longer acceptable. The new provisions also stipulate that the responsibilities of the supervisory board with respect to directors' remuneration may not be delegated to the general meeting.

The new remuneration and D&O provisions expressly do not apply to a private Limited Liability Company (GmbH).

ECJ Decision on (Re)Insurance Portfolio Transfers Subject to VAT

Swiss Re Germany Holding v. Finanzamt München für Körperschaften [2009]

Court of Justice of the European Communities, 22 October 2009

On 22 October 2009 the European Court of Justice (ECJ) delivered judgment in the above case, concerning the VAT treatment of portfolio transfers of both primary and reinsurance business35, a case that came before the ECJ upon referral from the German Federal Tax Court (BFH).

The background to the case was this: in 2002, the former Swiss Re Germany Holding GmbH transferred 195 reinsurance contracts to an affiliated company within the Swiss Re group situated in Zurich, Switzerland, and received in return the payment of a single purchase price.

Of the transferred reinsurance contracts, some 18 were assessed as having a negative value, thereby reducing the net agreed purchase price. This being reinsurance business, the policy holders of the transferred contracts were themselves insurance companies, all of them located outside Germany, both in other EU member states and in non-member countries. They each gave their consent to the transfer. Upon execution of the transfer, however, the local Munich tax authorities determined the transfer to constitute a taxable supply of goods, applying a former decision of the BFH. Having appealed against the decision unsuccessfully to the Munich local tax court, Swiss Re filed an action with the BFH.

For its part, the BFH also took the view that a reinsurance portfolio transfer was a taxable supply, albeit a supply of services (not goods), and in the present case it held that the place of supply was Germany, the place of business of the transferor. Since no VAT exemption applied, it considered that, as a matter of German law, VAT should be charged in Germany. However, the BFH also wished to clarify whether this interpretation would violate the Sixth EU Council Directive 77/388/EEC (Sixth Council Directive) and accordingly it submitted a preliminary reference to the ECJ seeking its ruling on the following main points:

  • Are such portfolio transfers to be regarded as a "supply of services" or a "supply of goods", (since a different VAT regime applies to each)?
  • If a portfolio transfer is to be regarded as a supply of services, does it constitute a "banking financial or insurance transaction" (if so, the service would be exempt from VAT under Art 13B of the Directive)?
  • Is the transferee to be regarded as a service supplier in relation to the acquisition of those reinsurance contracts carrying a negative value and if so what difference (if any) does this make in respect of VAT obligations?

In considering the above matters, the ECJ held firstly that portfolio transfers of insurance and reinsurance business constituted a taxable supply of services, not goods, since the latter required the transfer of tangible property. The court also declined to classify the transfer as a "banking financial or insurance transaction" and hence it held that the transaction could not, in principle, enjoy the attendant VAT exemptions under Art 13B. Whether or not the relevant VAT will be deductible or refunded as input VAT depends on the particular circumstances of the case.

The ECJ also refused to qualify the portfolio transfer as two separate transactions (i.e. the first concerning the obligations assumed by the transferee to policy holders and the second concerning the transferee's right to collect future reinsurance premiums from the policy holders). The separation of a single transaction into two separate service elements to which different VAT treatments would apply was, in the court's view, an artificial construction.

Finally, on the question of the 18 contracts with a negative value, the ECJ declined to segregate those contracts from the remainder of the portfolio. While it may be true that, commercially, the transferor was paying the transferee an agreed sum of money to assume those particular contracts, the fact remained that the parties had agreed upon a total purchase price for the transfer of a single portfolio. Accordingly, the transferor was the supplier of all of the contracts for VAT purposes, and the attendant VAT was payable upon the overall net price agreed.

This ECJ ruling will have major consequences for insurance and reinsurance portfolio transfers in the future. The court confirmed that insurance and reinsurance portfolio transfers are in general subject to VAT. This should not only apply to future transactions, but also to past transfers that have not yet been finally assessed by the competent national tax authorities. Furthermore, if the transferee performs only VAT-exempt insurance services, it will not be eligible for VAT input deduction or VAT refund, with the result that the VAT imposed on portfolio transfers will effectively increase the purchase price of the portfolio.

As an aside from the ECJ ruling, it should also be noted that changes to the VAT system within EU member states are due to come into force in 2010. Those changes may well lead to a reverse charge of VAT (that is, the transferee becoming liable for VAT in its home country). Whether or not the VAT charge is deductible would then depend on the individual VAT status of the transferee, rather than the transferor. This may well give rise to structuring opportunities to avoid a VAT charge, particularly with intra-group transactions. Clearly, as the VAT solution will determine the deal structure this should be analysed at a very early stage.

As a final word of warning, manipulation of the purchase price for tax reasons (to reduce or mitigate the VAT basis) should not be considered a suitable solution. As a rule of thumb, the agreed purchase price must be one reached at arm's length. In cases of intra group transactions especially, the agreed purchase price will come under the close scrutiny of the relevant tax authorities to ensure it represents the fair market value.

Court sanctions transfer of insurance business from Lloyd's names

In Re Equitas

In the Matter of Names at Lloyd's for the 1992 and Prior Years of Account [2002]36

Chancery Division, 7 July 2009

This matter concerned an application by Equitas Ltd, and others, for an order of the court approving a Part VII transfer of the insurance business of Lloyd's names for the 1992 and prior years of account to Equitas Insurance Ltd.

As the Judge noted, the proposal was intended to bring finality to the Reconstruction and Renewal process implemented by Lloyd's 1996, in the wake of huge losses suffered, principally, in connection with asbestos and pollution liabilities. Essentially R&R separated the 1992 and prior year business from the continuing business conducted at Lloyd's, and it provided names with reinsurance to close (RITC) in respect of their liabilities for the 1992 and prior business, thereby enabling names with no other open years of account remaining to resign their membership of Lloyd's. The RITC protection was underwritten by Equitas Reinsurance Ltd, either directly or (in the case of certain business and/or certain syndicates) via retrocession. In each case, the liabilities were in turn retroceded to Equitas Ltd.

In November 2006, following a corporate acquisition by Berkshire Hathaway Inc, the liabilities of Equitas Ltd were further retroceded to National Indemnity Company of Nebraska, a Berkshire Hathaway entity. Meanwhile, the operational functions of Equitas were delegated to Equitas Management Services Ltd, soon to be renamed Resolute Management Services Ltd.

While in practical terms this scheme was intended to create economic finality for names with respect to their pre-1993 liabilities, what it did not achieve was a transfer (that is, a novation) of the names' liability to policyholders under the original contracts. At the time that the R&R process was implemented, no statutory mechanism existed to bring this about, with the result that the names retained contractual liability to policyholders, and hence the residual exposure should the assets of Equitas Ltd be insufficient to meet its RITC liabilities.

Such a scheme is, however, now possible under Part VII of the Act, with the approval of the court. Accordingly, the application in this case sought finally to transfer the underlying business, with the end of substituting Equitas Insurance Ltd as the insurer (or reinsurer) under the original policies in place of the names.

While the proposal was opposed, the Judge granted the application, having been satisfied upon a report of an FSA approved expert that it would not operate to the disadvantage of any interested parties.

Interestingly, one of the grounds of objection was raised by Mr Stephen Merrett, former active underwriter of the eponymous syndicates 418 and 421, and a former Deputy Chairman of Lloyd's. He argued that various statements emanating from Lloyd's over the years had encouraged him, and others, in the belief that RITC in fact operated to absolve names from further liability to policyholders, in that the liability was novated to the reinsurers. The present scheme, he argued, was founded on the assumption that this was not so but that, on the contrary, the names in question had remained liable in law all along. Unless the true status of RITC was definitively established, there could be no certainty that the proposed scheme would work as intended.

The court rejected this objection, noting that the same argument had in effect been raised and dismissed by the Commercial Court in the previous case of Harris v. Society of Lloyd's [2008]37. The court affirmed once again that RITC is, as its name suggests, a contract of reinsurance and nothing more. Moreover, nothing had ever been said by Lloyd's to cause names to believe otherwise.

Result: Application granted.

Footnotes

1 [2009] EWHC 386 (QB)

2 (1866) 4 F&F 905

3 [2005] EWCA Civ 112

4 [2009] EWHC 376 (QB)

5 [2008] EWHC 2804 (Comm). And see Taylor Wessing Insurance and Reinsurance Review of 2008 (http://cecollect.com/ve/ZZ656089BeB84VXJn)

6 [2009] EWCA Civ 93

7 [2009] EWHC 3122 (Comm)

8 For example, Pratt v. Aigaion Co SA ("THE RESOLUTE") [2008] EWHC 489 (Admlty). And see Taylor Wessing Insurance and Reinsurance Review of 2008 (http://cecollect.com/ve/ZZ656089BeB84VXJn)

9 [2009] EWHC 2429 (Ch)

10 [2004] 2 Lloyd's Rep 609

11 [2009] UKHL 40

12 [1989] 2 AC 852

13 [2007] EWHC 896 (Com)

14 [1998] Lloyd's Rep IR 421

15 [2001] LRLR 142

16 [2003] Lloyd's Rep IR 696

17 [1998] 2 Lloyd's Rep 600

18 [2005] 1 Lloyd's Rep 655

19 [1996] 1 WLR 1239

20 [2009] EWHC 1115 (Comm)

21 [2009] EWCA Civ 354; [2009] EWHC 2900 (Comm)

22 [1996] 1 WLR 1239

23 [2009] EWHC 2388 (Comm)

24 Recently superseded by the Rome I Regulation, to which see later

25 Dornoch v. Mauritius Union Assurance [2006] 1 Lloyd's IR 786

26 Gan v. Tai Ping [1999] Lloyd's Rep IR 229 (CA); Aegis v. Continental Casualty (11 May 2006)

27 Kalfelis v. Schroeder, Muenchmeyer, Hengst & Co [1988] ECR 5565

28 Gascoine v. Pyrah [1994] IL Pr 82

29 Case C-185/07; [2009] WLR (D) 44

30 Case C-116/02; [2004] 3 WLR 1070

31 Case C-159/02; [2002] 1 WLR 107

32 That is, in the English courts and those of other EU member states

33 Recital 33

34 Having held previously that the reinsurer is the "characteristic" performer of a reinsurance contract (Dornoch v. Mauritius Union [2006] 1 Lloyd's IR 786)

35 Case C-242/08

36 [2009] EWHC 1595 (Ch)

37 [2008] EWHC 1433 (Comm)

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