Note: this decision has now, March 2005, be upheld in large measure by the Court of Appeal. The Court of Appeal disagreed with the trial judge on the question of the proper law of the primary insurance policy, holding it to be New York law rather than English law, but went on to say that there was no difference between New York law and English law on the key issues. As regards the meaning of "on land", the Court of Appeal - although it was not necessary for its decision - expressed differing views. One judge confirmed the interpretation favoured by Mr. Justice Colman, while the other two thought that the phrase referred to the source, rather than the effect, of the pollution. To access a note on the Court of Appeal judgment, click here

DMC Category Rating: Confirmed

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.

The primary cover
The largest underlying policy was the GCE policy, under which both Exxon and ESC were named insureds. 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 International Tanker Indemnity Association 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…".

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 and made no reference to New York 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".

The loss recoverable under the contract was defined in the Ultimate Net loss clause as "the sum actually paid by the Reinsured in settlement of losses of liability after making deductions for all recoveries…", and in the JELC Net Loss clause as "the sum paid by the reassured in settlement of loss, damage, liability or expense…after deduction of all salvage and recovery…".

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 under all three sections of the GCE policy. In March 1996 (bearing in mind the likely reaction of a jury if the matter ever got to court), the primary insurers settled all Exxon's claims under the property cover (section I) for US$300 million. In January 1997, they settled all Exxon's claims under the section IIIA and IIIB policies for the global sum of US$480 million. 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.

Judgment
Applicable law
The first question was, what law governed the GCE policy? The policy pre-dated implementation of the 1980 Rome Convention on the law applicable to contractual obligations, so the starting point was to look at whether the parties had made an express choice of law or whether one could be implied. It was accepted that, since the risk had been presented to the market as a single package, it had been the intention of the parties that the same law would apply to all three sections.

The claimants relied on the service of suit and arbitration clauses to argue that New York law applied. But the service of suit clauses only gave the insured an option to choose the jurisdiction of the New York (or, under section IIIB a United States) court. The choice of law, such as it was, was contingent on the insured being entitled to exercise its option and on actually doing so. If the insured made that choice, then whatever had been the applicable law of the contract would be varied by substituting one body of law for another. An unexercised choice of law clause, however, cannot give rise to more than a minimal implication that the contract was to be governed by that law (Armadora Occidental SA v Horace Mann Insurance Co [1977] 2 Lloyd' Rep 406). Similarly, the choice of law in the arbitration clauses was contingent on the matter having been referred to arbitration in the first place. The section I and IIIA clauses were not even binding arbitration agreements, only agreements to agree.

The court, therefore, had to look at other features relevant to the applicable law. Although Exxon's headquarters were in New York, the service of suit clauses referred to New York or the US and the policy provided for payment of premium and losses in US dollars, the factors in favour of English law outweighed these considerations. The sections all referred to standard English clauses, the placing brokers were in London, most of the policies were negotiated in London and issued through Lloyd's and the ILU in London and those policies issued in the Scandinavian market adopted the London policy wording. Where contracts of insurance are placed in the London market and issued in London, there is a strong inference that the policies are intended to be governed by English law (E.I. Du Pont de Nemours and Co v I.C. Agnew [1987] 2 Lloyd's Rep 585). In this case, the judge was satisfied that English law applied.

Removal of debris
The next issue was one of construction. Did the phrase "Removal of or attempted Removal of Debris" in section I of the GCE policy and in the Basis of Recovery Article cover pollution clean-up costs?

The judge found that "debris" is not a word that normally applies to liquids. But had the parties intended that the word should cover an oil spill of this sort? The judge thought not. If the parties had wanted the property section of the insurance to cover oil clean-up costs, they could easily have included such a provision. Instead, the liability sections of the policy made specific reference to pollution risks and liabilities, all of which indicated that the cost of removal of debris and liability for pollution were treated as two distinct areas of cover. This was supported by evidence from the market as to the very limited availability of reinsurance cover for pollution clean-up risks at the time.

Even if this was not the case and section I covered the clean-up costs, the judge was satisfied that the claim was excluded by the "notwithstanding" clause ("Notwithstanding anything contained as above there shall be no recoveries hereon for liabilities as described under the [Insured's] Liabilities Polices…"). The claimants argued that "liabilities" should be construed strictly. Exxon had incurred the costs voluntarily and not in response to a claim for which it had been found liable. Such costs could not be recoverable under the liability sections of the policy, so escaped being caught by the "notwithstanding" clause.

The judge disagreed. The clause was specifically designed to avoid an overlap between the property cover and the liability sections of the policy. Any claim Exxon had (including any claim for costs incurred in mitigation of the loss) was in respect of its liability or anticipated liability and so fell within section IIIA of the primary policy. As owner of the oil, it was strictly liable under Alaskan law for all damage proximately caused by the spill.

Since Exxon was not entitled to recover clean-up costs under section I of the GCE policy, reinsurers were not bound to indemnify the claimants in respect of the settlement of the section I claim.

The position of ESC
ESC was a named insured under the GCE policy, but never made a claim, even though as bailee and carrier of the oil, it had an insurable interest. By the time settlement was reached, any claims it might have had would have been time-barred under English law.

Exxon alone was a party to the section I settlement agreement, under which insurers released Exxon and its affiliates for all claims insurers might have against them, and Exxon released insurers in respect of its claims for coverage of Exxon Valdez claims and agreed to indemnify insurers if an Exxon affiliate brought a claim against them.

Assuming for the moment that "debris" in section I covered oil pollution clean-up, the judge was satisfied that the section I settlement was not made to settle any claim asserted, or which could have been asserted, by ESC, or any claim by Exxon Corporation for expenditure incurred by ESC. Not only had ESC brought no claim, it was time-barred from doing so. Consequently, the settlement was not one that could come within the Ultimate Net Loss or the JELC Net Loss clause in the reinsurance, which referred to sums paid by the reinsured in settlement of loss or liability of the underlying insured. At the time the settlement was paid, ESC had no claim that was recoverable against its insurers .

The judge, however, commented that agreeing to indemnify insurers if an affiliate should bring a claim against insurers in the future is not the same as saying that insurers' liability to that affiliate is discharged in consideration of a payment by insurers.

Could ESC have claimed under sections IIIA or IIIB? The same time bar applied, but even if that had not been the case, the marine liabilities covered by section IIIA excluded liabilities, costs and expenses insured by the indemnity provisions of the ITIA Rules (which provided oil pollution cover) and section IIIB excluded cover for claims made against the insured "arising out of the ownership or bareboat charter of any watercraft".

Section IIIB claim
Because of the watercraft exclusion, only Exxon could claim under section IIIB of the policy, but did it cover the loss in question? The section 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". The claimants argued "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.

The judge disagreed. The overall coverage structure of the GCE policy was clearly intended to prevent any overlap between the three sections. Although "transportation activities" was capable of including marine transport, the watercraft exclusion in section IIIB indicated an intention to confine all marine transportation claims to section IIIA. From this, the judge inferred that the words in context were restricted to carriage associated with drilling, production and exploration work. As for "operations", this covered a range of industrial activities but not carriage by sea.

The Seepage and Pollution exclusion
In any case, the reinsurance contracts included a Seepage and Pollution Exclusion excluding loss arising from seepage and pollution "on land", but confirming cover for "seepage, pollution or contamination covered by protection and Indemnity policies". The judge read the exclusion as applying to seepage and pollution affecting land whether it originated on land or offshore.

If, therefore, contrary to his conclusion, Exxon was entitled to claim clean up costs under sections I and IIIB of the GCE policy, it would be caught by this exclusion. As it was, the exclusion still provided reinsurers with a defence to Exxon's section IIIA claim.