Note: this decision has been upheld by the Court of Appeal, in a judgment handed down on 18 May 2004. For a note on the Appeal Court judgment, click here

Background
The dispute concerned a facultative reinsurance of Banco Vitalicio, who insured the Spanish football club, Atletico de Madrid. The underlying policy provided cover against losses resulting from the club's performance in the 1999/2000 season; in particular, if their first team was relegated from the first to the second division of the Spanish Professional Football League so that the club lost income from broadcasting rights for their home matches. Vitalicio reinsured 90% of the risk in London and the European markets, 31.5% of it with the claimants in this case.

The reinsurance slip policy included under the heading "Interest":
"This insurance to indemnify the assured for their net ascertained loss of contracted television rights arising directly as a consequence of the relegation of the assured from the first division of the Professional Spanish Football League: Limit: PTS 2.900.000.000".

The "Assured" was identified as Atletico and the "Reassured" Vitalicio. Under the heading "Conditions", the slip stated "Full reinsurance clause…All other terms as original policy".

At the end of the 1999/2000 season, Atletico's first team was relegated to the second division. Vitalicio settled the claim under the underlying policy for 2.7 billion pesetas, which it paid to Audiovisual Sport, the television company to whom the club had assigned broadcasting rights. It then claimed against its reinsurers. They, however, argued that there had been a breach of warranty in the reinsurance contract, alternatively a misrepresentation of the terms of the underlying policy in that:
1. Vitalicio had actually agreed to indemnify Audiovisual, not Atletico, and
2. Reinsurers had been told that the underlying policy provided an indemnity limit of up
to 2.9 billion pesetas, when, in fact, the cover was for an agreed value of 2.9 billion
pesetas.

Atletico's agreement with Audiovisual went back several years. For the 1999/2000 season, Audiovisual were to pay Atletico a minimum of 3 billion pesetas comprising a guaranteed sum of 2.625 billion pesetas and a profit share of 375 million pesetas. But if Atletico failed to qualify for European competition, the club would have to repay 500 million pesetas. Under the arrangement, Audiovisual issued promissory notes in respect of all sums payable to Atletico in advance of the season. If the first team was relegated, Audiovisual stood to make a loss because it would be obliged to pay more under the notes than Atletico was entitled to receive. It could seek reimbursement from Atletico, but if the club defaulted, Audiovisual would have no security. Accordingly, insurance was taken out with Vitalicio against the risk of relegation.

The underlying policy named Atletico as the "policyholder" and "the same" as the insured. It stated that the cover was to indemnify Audiovisual for economic loss arising from Atletico's relegation "due to items linked to the assignment of TV and audio-visual rights entered into with Audiovisual…which has been assessed, by mutual consent and not subject to any review or subsequent valuation, in Pesetas 2.9 billion."

Judgment
Since the policy was expressly subject to Spanish law, it had to be interpreted according to Spanish rules of construction. Under the Spanish Civil Code, if the terms of a contract are clear, the literal meaning of its clauses will be relied on. But if the words appear to contradict the evident intention of the contracting parties, the parties' intention will prevail. In ascertaining that intention, regard must be had to the conduct of the parties at the time of, and subsequent to, the contract.

Applying these rules of construction to the factual evidence, the judge concluded that the intention of the parties to the underlying policy was that it would be a valued policy - a concept recognised in both English and Spanish law. He also accepted that Atletico was specifically identified as the policyholder and as the insured under the policy, even though it made provision for payment to be made to Audiovisual.

As for the reinsurance, he found that Vitalicio had intended that the cover obtained would be back-to-back, but that it had probably "not been very precise in its thinking" as to how this should be achieved. As a result, the reinsurance contract was entered into on the basis that the underlying cover provided an indemnity for Atletico's net ascertained losses up to 2.9 billion pesetas, when it fact it was for an agreed sum.

Was the fact that the underlying cover was a valued policy material to the reinsurers? Yes, if there was a realistic possibility that Atletico's ascertained loss in the event of relegation would be less than the agreed amount. Reinsurers argued that there was just such a possibility. The actual loss suffered by Atletico was inherently uncertain - in particular, there had to be brought into account the 500 million pesetas repayable if the club failed to qualify for European competition. The effect of this provision was that, if the club was relegated but, nevertheless, qualified for Europe, it would be entitled to retain 500 million, so reducing its actual loss to below 2.9 billion pesetas. The judge agreed.

The second point was whether the misrepresentation induced the reinsurers to subscribe to the reinsurance slip. The reinsurers had to show that "but for" the representation they would not have subscribed in the terms they did (Assicurazione Generale SPA -v- Arab Insurance Group [2002] EWCA 1642). Four of the nine underwriters who gave evidence stated they would not have subscribed if they had known that the underlying policy was written on an agreed value basis. The others stated they would only have done so if satisfied that the agreed value represented a reasonable assessment of the loss Atletico would sustain on relegation.

The judge found that, had they been in a position to evaluate this, the underwriters would have concluded that 2.9 billion pesetas was not a reasonable assessment. Consequently, he was satisfied that the reinsurers had been induced by the misrepresentation, and so were entitled to avoid the policy.

Reinsurers also argued that the expression "full reinsurance clause" in the slip introduced wording along the lines of "Being a reinsurance of and warranted the same gross rate, terms and conditions as to and to follow the settlements of the Reassured". The effect of this was that Vitalicio were giving reinsurers a warranty that the underlying insurance was on identical terms to those disclosed to the reinsurers - namely, that the interest they were reinsuring was an insurance of Atletico's net ascertained loss. This warranty had been breached because the insured interest was that of Audiovisual and the policy was a valued policy.

The judge would not go this far. A full reinsurance clause is generally understood to incorporate into the reinsurance all those terms of the underlying insurance that regulate the scope of the cover. By agreeing to it, the insurer agrees that all the relevant and applicable terms become terms of the reinsurance and, in return, the reinsurer agrees to accept and to follow the settlements made by the insured. But, in this case, the clause made no reference to the terms of the underlying cover being disclosed to the reinsurers (and they were not). In the judge's view, the clause was not clear enough to introduce a full-blown warranty about the terms of the underlying insurance into the reinsurance contract.

However, the reinsurers also argued that, on the proper interpretation of the slip, Vitalicio was giving an undertaking that the original insurance was properly described under the heading "Interest" - in particular, that the underlying cover indemnified Atletico for their net ascertained loss in the event of relegation up to a limit of 2.9 billion pesetas. Those undertakings were by way of warranties.

This boiled down to a similar argument as was put forward in HIH Casualty and General Insurance Limited -v- New Hampshire Insurance Co and Others [2001] 2 LLR 161. There, under the heading "Interest", the underlying contract stated that six made-for-TV films would be produced. It was held that the number of films was a term of the original policy and had been incorporated into the reinsurance contract by the words "subject to all terms as original". Not only that, the term was found to be a warranty because it went to the root of the transaction, it had a material bearing on the risk, and damages would be an unsatisfactory and inadequate remedy.

The judge in this action was satisfied that the description of the underlying cover was intended to be a term of the reinsurance, and, applying the HIH test to the present situation, concluded that it was a warranty. The fact that the underlying cover was a valued policy was material to the risk because there was a realistic possibility that the net ascertained loss would be less than the agreed 2.9 billion figure. Four of the nine underwriters who gave evidence said they would not have written the cover unless it was for an indemnity for loss actually suffered. For all nine, the nature of the underlying cover was a consideration that significantly affected their decision.