DMC Category Rating: Confirmed

Background
The Parties and their Contractual Relationships
JLT placed insurance cover to protect Law Debenture Trust ("LDT") against the risk that certain films which it had financed would not generate sufficient revenue to repay that finance. HIH and others underwrote that insurance. As part of an overall arrangement, JLT placed reinsurance on back-to-back terms with New Hampshire, Axa and others. Accordingly, JLT was broker and agent both for the insured in relation to the original insurance and for the reinsured in relation to the reinsurance.

The finance was provided for three slates of films, H1, H2 and H3, which were intended to comprise six, ten and five films respectively. There were slip policies in respect of each slate and each slip contained a waiver of rights clause by which HIH agreed "to the fullest extent possible under applicable law" not to seek to avoid or rescind the insurance or reject any claim under it. The intention was that the insurance be as close as possible to being a guarantee.

In addition, HIH entered into side agreements with Flashpoint Ltd, the company responsible for arranging the financing and marketing of the slates of films, to be its risk manager, responsible for procuring the production of the films within budget and to schedule, to exploit the films commercially and to provide status reports on the films and the revenues produced.

The Films
The insured films, which were intended to be low-budget affairs, appear also to have been stinkers. In late 1999 and early 2000, it became clear that each of the three slates was not successful and their returns would fall far short of the projected revenues. More significantly, the risk management reports of Flashpoint, distributed by JLT in late 1998 and early 1999, demonstrated that five instead of six films would be produced on slate H1, six instead of ten on H2, and four instead of five on H3.

As a result of the shortfall in revenues, HIH paid out a total of US$54m in 1999 and 2000 in respect of the three insurances. HIH sought recovery from its reinsurers but New Hampshire and others did not pay up, relying on a breach of warranty as to the number of films produced. The court found that there had been such a breach and that the waiver of rights clause referred to above was not sufficient to protect HIH. Consequently, HIH found itself having paid out US$54m to its original insured but without the vast majority of cover from its reinsurers.

The Claim Against the Brokers
Having failed to recover against the reinsurers and with a massive shortfall in funds, HIH turned to its brokers to seek recovery. It alleged that, if JLT had alerted it to the potential increase in coverage risk for it resulting from the reductions in the numbers of films, it would have instructed JLT to seek the reinsurers’ agreement to maintain coverage notwithstanding the reductions or at least to take their views so as to eliminate any uncertainty on the matter. JLT defended itself on the basis that it did not owe any such duty or that, if it did, it had not breached it, or that, if there had been a breach, it had not caused any loss to HIH, since it paid LDT’s claim, in the case of H1, without having found out whether the reinsurers would indemnify it, and in the case of H2 and H3, when it knew that the reinsurers would not indemnify it.

The First Instance Court’s Decision
At first instance, the Commercial Court found that JLT owed HIH a post-placement duty to alert it to any coverage issues arising from the reduced number of films; that JLT had breached that duty; but that the breach had not caused HIH loss because even if JLT had brought the potential coverage issues to HIH’s attention and HIH had sought the views of the reinsurers, that would not have made any difference to the reinsurer’s rejection of liability to indemnify HIH. Both HIH and JLT appealed against the parts of the judgment that were adverse to them.

Judgment
The Court of Appeal dismissed both parties’ appeals, finding that, in the context of an overall scheme in which JLT had placed both insurance and reinsurance, the brokers did owe a duty to alert HIH to the possible coverage problems arising from the reduction in the number of films.

The duty required the brokers to do more than just act as a "post-box" passing information received from Flashpoint on to HIH without further comment. The fact that, in this as in many other situations, the brokers owed duties to both insured and reinsured and those duties might come into conflict did not relieve the brokers from fulfilling their duty towards HIH.

While pointing out that there was not much evidence on the topic and indicating that it was decided by a "fine margin", the Court of Appeal found that JLT had breached its duty because it failed to draw HIH’s specific attention to the film reductions referred to in the update reports. JLT escaped liability to HIH, however, because the Court of Appeal found that JLT’s breach of duty had not caused any loss to HIH. The Court of Appeal held that the true cause of HIH’s loss was that it paid the original insured’s claims when it had no legal liability to do so. In the case of the H1 slate of films, it made the payments when it had not sought the views of the reinsurers on their validity. In the case of H2 and H3, HIH made the payments even when it knew that the reinsurers disputed the validity of the claims. The applicability of that cause was not affected by the breach of duty by the brokers.

Comment
Brokers’ Duties
This decision may highlight a few areas of concern for brokers:
• Post-Placement Duties: For some time now, brokers have been concerned about creeping increases in their duties to their clients and this case may add, or at least clarify, a duty to alert the client to the impact of information that may have a negative effect on the cover and obtain the client’s instructions on it. This is more than a mere "informational" duty and particularly, applies where, as the Court of Appeal said here, the broker "has been at the centre of devising and structuring a risky scheme for insurers and reinsurers". The Court of Appeal also suggested that the existence of such a duty is even more apparent in the case of consumer insurance.
• Conflicts of Interest: The Court of Appeal recognised that it is very common in the market for the same brokers to place associated insurance and reinsurance cover and thereby to owe duties as agent to both the insured and the reinsured. As Auld LJ said, "the role of the insurance broker is notoriously anomalous for its inherent scope for engendering conflict of interest." The Court of Appeal stressed, however, that the fact that a broker may owe conflicting duties to different parties does not mean that it is exempt from carrying out those duties. As here, even though fulfilling a duty to inform a reinsured client of potential problems with a cover may be prejudicial to an insured client, the broker must still fulfil that obligation.

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