This case note is based on an Article in the April 2005 Edition of the ‘Bulletin’, published by the Marine and Insurance teams at the international firm of lawyers, DLA Piper Rudnick Gray Cary. DLA Piper is an International Contributor to this website.

Background
On 24 March 1989, the Exxon Valdez ran aground in Prince William Sound off the coast of Alaska, causing an oil spill of 258,000 bbls of crude oil. The cargo was owned by Exxon Corporation, the vessel by a subsidiary, Exxon Shipping Corporation ("ESC"). There followed a massive containment and clean-up operation carried out by ESC (until it was declared insolvent in August 1989) and then by Exxon. In all, ESC spent about US$800m and Exxon about US$1,200m on the clean-up, which was completed in June 1992.

At the time of the casualty, the Exxon Valdez was entered with the International Tanker Indemnity Association Limited ("ITIA"), a mutual P&I insurer set up in the aftermath of the Torrey Canyon disaster of 1967. ITIA provided cover for liabilities assumed under the Tanker Owners' Voluntary Agreement Concerning Liability for Oil Pollution ("TOVALOP") and those for which the owner was legally liable under statute or otherwise by reason of a discharge or threatened discharge of oil. ESC, as owner of the Exxon Valdez, recovered the full US$400 million available under this cover.

The primary cover
In addition, both Exxon and ESC were named insureds under a Global Corporate Excess ("GCE") policy. This was divided into three sections. Section I covered loss of or damage to property; section IIIA provided protection against marine liabilities (including oil pollution but only if not covered by the ITIA Rules); and section IIIB covered third party liabilities of a non-marine nature arising out of the insured's commercial activities in relation to the energy industry.

Under section I (and "subject to the Basis of Recovery Article"), insurers agreed to pay "all losses incurred by the Insured as a result of physical loss or damage to Property of any kind owned by the Insured or property of others held in trust or for which the Insured may have assumed responsibility or for which the insured has an obligation to insure, repair or replace". In addition, insurers agreed to indemnify the insured for all sums which the insured paid or incurred as costs or expenses on account of (amongst other things) "Removal of or attempted Removal of Debris or Wreck of Property and/or Residential Structure covered hereunder". The Basis of Recovery Article confirmed that recoverable loss under the policy included "expenses incurred in removal or attempted removal of debris or wreck [of] property…"

Section I went on: "Notwithstanding anything contained as above there shall be no recoveries hereon for liabilities as described under the [Insured's] Liabilities Polices…" This clause was commonly referred to as the Notwithstanding clause.

All three sections of the GCE policy included service of suit and arbitration clauses. Sections I and IIIA provided that, in the event of a failure to pay under the policy, insurers would, at the request of the insured, "submit to the jurisdiction of any Court of competent jurisdiction within the State of New York". If the option were exercised "all matters arising hereunder shall be determined in accordance with the law and practice of the court selected". The equivalent clause in section IIIB was slightly different, in that it referred to "any court of competent jurisdiction within the United States".

The arbitration clauses in sections I and IIIA provided that, in the event of a dispute, the matter "may, upon the agreement of the parties" be referred to arbitration, that any such arbitration would take place in New York and, to the extent arbitrators followed the rules of law, "such law shall be that of the state of New York to the exclusion of all other laws". The arbitration clause in section IIIB provided that any dispute "shall at the request of either party" be referred to arbitration in New York and that the arbitrators could abstain from following strictly the rules of law.

The reinsurance cover
The reinsurance was in Joint Excess of Loss Committee terms. These stated:

"It is a condition precedent to liability under this contract that settlement by the Reassured shall be in accordance with the terms and conditions of the original policies or contract".

In addition, the Claims Clause provided:

"All loss settlements by the Reinsured shall be binding upon the Reinsurers, provided that such settlements are within the terms and conditions of the Original Policies and within the terms and conditions of this policy and the Reinsurers shall pay the amounts due from them upon reasonable evidence of the amounts paid being given by the Reinsured".

Some of the reinsurance contracts also included a seepage and pollution exclusion, which excluded loss arising from seepage and pollution "on land", but confirmed cover for "seepage, pollution or contamination covered by Protection and Indemnity policies".

The settlement
In October 1990, the Superior Court of the State of Alaska held that Exxon, as owner of the cargo, was under strict liability for all damage proximately caused by the oil spill. In 1991, the Federal Court in Anchorage awarded private claimants damages of US$287 million and US$5 billion in punitive damages, (later reduced to US$4 billion). In 1992, Exxon settled claims brought by the US Federal Government and the State of Alaska for US$900 million.

Exxon claimed against insurers under all three sections of the GCE policy. In March 1996, the primary insurers (bearing in mind the likely reaction of a jury if the matter ever got to court) settled all Exxon's claims under the property cover (section I) for US$300 million. Exxon's claim under section IIIA proceeded to trial in Texas, where the jury found against insurers. Judgment was entered on 3 July 1996 for about US$410 million. Insurers filed a notice of appeal but, on 23 January 1997, entered into a global US$480 million settlement of all Exxon's section IIIA and IIIB claims.

Excess of loss reinsurers, however, refused to pay up because, they argued, the settlement was not within the terms of the underlying policy and so fell outside the reinsurance cover. Insurers issued proceedings.

High Court decision
In May 2004, the High Court held that reinsurers were not liable. The judge found that the governing law of the GCE policy was English law. As a matter of English law, there was no cover under section I because, on its true construction, it did not cover pollution clean-up costs. Had the policy been governed by New York law, however, section I would have been construed as covering pollution clean-up. But, in any event, whether under English or New York law, there was no cover because of the provisions of the Notwithstanding clause.

There could also be no recovery for ESC's putative claim under section I because there had been no settlement of ESC's claim.

As for the section IIIB claim, the judge held that there was no cover for clean-up costs under section IIIB under English law, although there would have been had New York law applied.

The judge also held that the seepage and pollution exclusion (which appeared in most of the outward reinsurances) excluded liability on the part of those reinsurers to indemnify insurers in respect of clean-up costs, even if they were covered by the GCE policy.

The insurers appealed against the decision.

The Court of Appeal Judgment
Governing law
The first point that struck the Court of Appeal was whether it could really be true that the terms of an insurance contract placed in the London market could have such a different meaning, depending on whether it was being construed by an English court applying English law or a New York court applying New York law. One would expect both courts to reach the same conclusion about the intention of the parties ascertained from the written documents. Consequently, it should not, in the end, matter which law applied to the contract.

Nevertheless, the Court of Appeal concluded that New York law applied. Looking at the arbitration and service of suit clauses, it seemed to be beyond doubt that they pointed to an inferred choice of New York law as the proper law of the contract. But was this enough to displace the circumstances surrounding the placement that pointed to English law? The policy referred to standard English clauses, the placing brokers were in London and most of the placement had been made in London.

In the Court of Appeal's view, the key provision was the arbitration clause in section IIIB, which provided for compulsory arbitration in New York should either party request it. It was difficult, if not impossible, to infer a choice of English law when a substantial part of the contract provided for any difference between the parties (if either requested it) to be determined by an arbitration to which the law, if applied, would necessarily be that of New York. Taken with the (non-compulsory) arbitration clauses in sections I and IIIA and the service of suit clauses, this all pointed to New York law being the applicable law of the contract.

Removal of debris
The crucial issue, however, was whether the phrase "Removal of or attempted Removal of Debris" in section I of the GCE policy and in the Basis of Recovery Article covered pollution clean-up costs.

The insurers relied heavily on a US case, Lexington Insurance Co v Ryder System Inc 142 Ga. Apt.36, 234 SE 2d 839, which concerned an all-risks policy which included cover for stores of oil and for the cost of "removal of debris formerly part of the insured property and no longer suitable for the purpose for which it was intended". A leak from underground storage tanks contaminated the surrounding earth. The Court of Appeals of Georgia held that clean-up costs were covered. Oil was part of the insured property and, following the leak, it was no longer suitable for its purpose. The word "debris" could mean waste material resulting from the destruction of some article.

In addition, the insurers argued, the phrase had to be construed in context. This was a high-level catastrophe cover for the Exxon group. Section I included cover for loss of or recovery of cargo and the cost of removal of debris of cargo. The only types of cargo identified were crude oil and refined or in-process products. Cover was provided even if the expenditure was incurred solely as a result of a governmental or other authoritative order, such as an order for clean-up.

Reinsurers, however, argued that pollution clean-up was such a serious and well-known risk that one would expect to see an express reference to it. On its natural meaning "debris" did not describe oil or the process of clearing up an oil incident. The overall structure of the policies supported the view that oil pollution risks were covered only by section III, not section I.

At first instance, the judge found that, under English law, "debris" did not cover pollution clean-up, but that under New York law, it did. The Court of Appeal agreed that clean-up costs were not covered, but also held that this conclusion would be the same whether English law or New York law applied.

Although insurers' submissions based on the Lexington case were powerful, they were not enough to persuade the court that it had been intended that "removal of debris" would cover pollution clean-up costs. "Debris" was not a natural way to describe spilled oil or pollution from spilled oil and there would have to be some significant feature or provision in the policy if it was to have that meaning. Nor was the term used in the international conventions that deal with oil pollution and which formed the background to this policy.

Having reached this conclusion, the meaning of the Notwithstanding clause became irrelevant, since none of the detailed arguments put forward could change the simple fact that "removal of debris" did not cover clean-up costs following an oil spill. It was also unnecessary to look at the ESC claim. Whether under English or New York law, ESC never had a claim under section I for the costs of removal of debris.

The section IIIB claim
Section IIIB covered liability "in respect of all offshore and/or inshore and/or onshore Drilling, Production, Exploration operations and all transportation activities including all terminal and pipeline operations". In addition, an endorsement covered liability for personal injury or damage to third party property caused "directly or indirectly by seepage, pollution or contamination arising out of the operations of the Insured". A watercraft exclusion meant that only Exxon, not ESC, could claim under this section, but did it cover the loss in question?

The insurers argued that "all transportation activities" was wide enough to cover the ocean movement of oil in a tanker and such transportation was an operation of the insured.

At first instance, the judge disagreed. Applying English law, he found that the overall coverage structure of the GCE policy was clearly intended to prevent any overlap between the three sections. The watercraft exclusion in section IIIB indicated an intention to confine all marine transportation claims to section IIIA. As for "operations", this covered a range of industrial activities but not carriage by sea. Had the contract been governed by New York law, however, he thought the conclusion would have been different because the court would have given the overall structure of the policy relatively less weight.

The Court of Appeal upheld the judge's decision on English law but, once again, held he had been wrong to think the position would be any different under New York law.

Seepage and pollution exclusion
The question whether the seepage and pollution exclusion, which appeared in certain of the reinsurance policies, applied was only relevant to exclude liability under sections I or IIIB. The reinsurance policies, unlike the underlying GCE policy, were governed by English law. The clause excluded loss arising from seepage and pollution "on land", but provided cover for "seepage, pollution or contamination covered by Protection and Indemnity policies".

The reinsurers argued that "on land" described where the effect of the seepage, pollution or contamination was located. Almost all the clean-up costs were directed to contamination of the land, not the sea, and so fell within the exclusion. The insurers said "on land" referred to where the pollution originated. Since the pollution in this case originated from a ship at sea and not from the land, the exclusion did not apply. The High Court judge agreed with reinsurers that it referred to where the pollution was located.

Having concluded that there was no relevant liability at all, the Court of Appeal did not need to decide the issue. It was, however, divided on the meaning of the exclusion. There was nothing in the phrase to determine whether what was being looked at was the source (as distinct from the physical presence) of the seepage, pollution or contamination. Two of the three Appeal Court judges thought that the phrase referred to the source and that, since the pollution in this case occurred at sea, the exclusion did not apply. But Lord Justice Rix thought that if the parties had wanted to differentiate between sources, so as to exclude on-shore sources while leaving offshore sources covered, they would have used clearer language. However, it was not necessary to reach any conclusion on the point.

Comment
DLA Piper Rudnick Gray Cary note that the case graphically demonstrates the perils of settling under primary insurance when the reinsurance cover is subject to a provision that all loss settlements will be binding, provided that they are within the terms and conditions of the insurance and within the terms and conditions of the reinsurance. There are thus two hurdles at which the claim may fall. In this case, Exxon’s claim failed at the first – settlement not within the terms of the primary policies - and, in the opinion of Lord Justice Rix, would probably have failed at the second as well – claim not covered under the reinsurance policies.