This case note is based on an Article in the April 2004 Edition of the ‘Bulletin’, published by the Marine and Insurance teams at the international firm of lawyers, DLA. DLA is an International Contributor to this website

Background
The original insured, Pirelli Cables Inc, was engaged by Hydro Quebec to supply and install three single armoured, high-density submarine power cables in a river in Quebec. Pirelli was insured by Continental Insurance Company, which, under a longstanding arrangement, provided a front for Generali on Canadian risks.

The relationship between Continental and Generali was governed by a quota share reinsurance agreement, which provided that Generali's liability "shall follow that of [Continental] in every case, and shall be subject in all respects to all the general and special stipulations, clauses, waivers and modifications of [Continental's] policies and any endorsements thereto".

Generali reinsured 80% of the risk with seven ILU reinsurers and various Lloyd's syndicates under a broker's open cover. The cables project was the subject of a declaration, which provided under the heading "Conditions":

"As original: anything herein to the contrary notwithstanding, this reinsurance is declared and agreed to be subject to the same terms, clauses and conditions, special or otherwise, as the original policy or policies and is to pay as may be paid thereon and to follow without question the settlements of the Reassured except ex gratia and/or without prejudice settlements".

The loss and the settlement
About a year after installation, one of the cables failed as a result of abrasions caused by rock on the riverbed. Pirelli notified the claim to Generali and also asked for an extension of the policy to cover the repair work, which was agreed. Unfortunately, the repair operation was not a success and resulted in all three cables being lost.

The claim gave rise to a host of coverage issues, including whether there was one occurrence or two, whether the losses came under a wear and tear exclusion, whether they were sudden and unforeseen, whether there had been an effective agreement to extend the cover for the repairs or whether the second loss came under the 24-month maintenance guarantee period, and, of course, quantum.

Generali eventually settled Pirelli's claim for Can$4million. It then claimed under its reinsurance, setting out the basis on which it considered that it had been liable for the loss: that there had been one loss not two, that it had been caused by faulty design and/or fault in erection/bad workmanship and that it fell within the cover provided by the maintenance guarantee.

The Lloyd's syndicates approved the settlement and paid Generali their proportion of the claim without dispute, but the ILU reinsurers challenged the claim. The matter was referred to the court (and subsequently appealed) as a preliminary issue.

The Scor provisos
If there is no follow the settlements clause in a reinsurance contract, then the insurer/reinsured must show that the loss falls within the cover of the underlying policy and within the cover created by the reinsurance. The parties are, however, free to agree on ways of proving whether these requirements are satisfied and this is done by various forms of "Follow the Settlements" clauses (Hill v Mercantile and General Reinsurance Co Plc [1996] 1 WLR 1239).

But the fact that a reinsurance contract contains a ‘follow the settlements’ clause does not mean that reinsurers have relinquished all right to challenge a settlement. The court in Insurance Company of Africa v Scor (UK) Reinsurance Company Limited [1985] 1 Lloyd's Rep 312 recognised two important provisos to insurers' right to be indemnified – firstly, that the claim so recognised by insurers has to fall within the risk covered by the contract of reinsurance as a matter of law and, secondly, that insurers have acted honestly and have taken all proper and businesslike steps in making the settlement

Back-to-back
Generali argued that, because the insurance and reinsurance were back-to-back, then, as long as insurers acted honestly and had taken proper and businesslike steps to reach the settlement, and (in the terms of this particular ‘follow the settlements’ clause) it was not made ex gratia or without prejudice, reinsurers were bound to accept it. Coverage issues arising on terms that were identical in the insurance and reinsurance, once settled by insurers on the underlying insurance, could not be raised again by reinsurers under the reinsurance. Reinsurers could only raise issues on terms unique to the reinsurance.

Without question
At first instance, Generali also argued that the words "without question" precluded reinsurers from challenging any settlement made under the underlying policy on any ground, except settlements made ex gratia or without prejudice. The judge disagreed, holding that the words simply emphasised that, subject to the two Scor provisos, the reinsurers had to follow the insurers' settlements, save those that were ex gratia or without prejudice.

On appeal, Generali argued that "without question" prevented reinsurers from relying on the second Scor proviso - that the settlement was reached honestly and in a proper and businesslike manner. It claimed reinsurers would have felt adequately protected by the fact that Generali was retaining 20% of the risk. The judge's interpretation rendered the words redundant when they had clearly been intended to narrow the scope of the Scor provisos.

Judgment
On the ‘back-to-back’ issue, the Court of Appeal disagreed with Generali’s position. The decision in Scor confirmed that a ‘follow the settlements’ clause prevented reinsurers from arguing that insurers' settlement with the insured was not within the terms of the original policy, either as to liability or amount. But it did not prevent them from raising issues as to the scope of the reinsurance. Just because the reinsurance was back-to-back did not mean that insurers were automatically entitled to an indemnity as long as the settlement under the primary policy had been reached honestly and in a proper and businesslike manner. Insurers still had to show that the loss fell within the cover created by the reinsurance as a matter of law.

In Hiscox v Outhwaite (No. 3) [1991] 2 Lloyd's Rep 524, insurers, acting in a proper and businesslike way, made payments under the Wellington agreement* for which they were not legally liable under the insurance. It was held that, even though the cover was back-to-back, reinsurers were not precluded from raising issues as to the scope of the reinsurance contract and were able to argue (successfully) that the claims did not fall within the risk covered by the reinsurance.

The Court of Appeal also agreed with the judge on the significance of the phrase "the claim so recognised" in the Scor provisos. Insurers do not have to show that the claim, in fact, fell within the reinsurance as a matter of law, but that the "claim so recognised" by them did so. Where it is arguable that a claim is covered by the underlying insurance as a matter of law and insurers, having fully considered the position, decide that it is covered and settle on that basis, reinsurers will be bound. Otherwise, reinsurers would be able to re-open coverage issues in the underlying cover and the whole purpose of the follow the settlements clause would be defeated.

On the ‘without question’ issue, the Court of Appeal agreed with the trial judge that the words simply emphasised that, subject to the two Scor provisos, the reinsurers had to follow the insurers' settlements, save those that were ex gratia or without prejudice Very clear words would be required to limit the scope of the provisos. The wording of this clause was not clear enough.

*Note: the ‘Wellington agreement’ was a claims handling facility set up by producers and their insurers to deal with a large number of asbestosis claims.