Note: this decision has now, March 2005, been upheld on appeal. To access the note on the Court of Appeal judgment, click here

DMC Category Rating: Developed

This case note is based on an Article in the May 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.

Facts
RSA wrote a 21.5% line on Coca Cola's D&O insurance for the period April 1997 to April 2002 and reinsured 100% of its participation by means of two Lloyd's slip policies representing two layers of reinsurance.

The Coca-Cola Company and three of its directors and officers were defendants in two class actions brought in the US District Court in Georgia by claimants who had bought Coca Cola shares between 1999 and 2000. They alleged that directors and officers of Coca-Cola had dressed up the company's financial statements in such a way as to enhance artificially the level of the company's stock. Having bought shares at what they maintained were inflated prices, the claimants incurred large losses when prices fell dramatically.

The first class action began on 27 October 2000 and was notified to the lead insurer on 1 November. The second action began on 13 November 2000 and was notified on 20 November. The lead insurer informed the following market (which included RSA) on 12 December 2000. On 30 December, RSA received copies of the two Complaints from its brokers. On 19 January 2001, it notified the claims to its reinsurers.

The reinsurers, however, said that they were not liable because RSA had failed to notify the claims within the time required under the reinsurance policies. RSA issued these proceedings for a declaration.

The insurance policy
The original insurance was arranged in three layers, a primary layer, a first excess layer and a second excess layer. RSA wrote a 21.5% line on each, but only on condition that it could reinsure 100% of the D&O risk.

The D&O section of the policy was divided into two parts: (1) losses arising from claims against the company or against directors and officers who had been indemnified by the company and, (2) losses arising from claims against directors and officers who had not been indemnified by the company.

"Loss" in the first section was defined as "any amount the Named Insured shall have paid with respect to any Securities Claim and any amount the Named Insured shall have paid to a Director or Officer as indemnity for a claim", including defence costs. "Loss" in the second section covered "any amount which the Insureds are legally obligated to pay for Claim for Wrongful Acts", including defence costs.

Both sections included a notification clause that provided that, as a condition precedent to the its right to an indemnity, the insured should notify any claim in writing "as soon as practicable during the policy term…" as well as "any circumstances that may subsequently give rise to a claim", together with the reasons for anticipating a claim. Once a claim was notified, insurers would be "entitled to effectively associate in the defence and the negotiation of any settlement of any claim" and the insured agreed not to settle without their prior written consent.

The reinsurance policies
The two reinsurance contracts were in the same terms. Both included a full reinsurance clause, which provided:
"Being a Reinsurance of and warranted same gross rate, terms and conditions as the Original Policy, so far as they may be applicable hereto and shall pay as may be paid thereon, but subject nevertheless to the terms, clauses and conditions of the Reinsurance".

Both reinsurance contracts also contained a claims control clause, which provided:
"Notwithstanding anything herein contained to the contrary, it is a condition precedent to any liability under this policy that:
(a) The Reassured shall upon knowledge of any loss or losses which may give rise to [a] claim under this policy, advise the Underwriters thereof by cable within 72 hours.
(b) The Reassured shall furnish the Underwriters with all information available respecting such loss or losses and the Underwriters shall have the right to appoint adjusters, assessors and/or surveyors and to control all negotiations, adjustments and settlements in connection with such loss or losses".

It was this 72-hour deadline that reinsurers claimed RSA had breached. The requirement was more onerous than the notification provision in the underlying cover, which only required notification "as soon as practicable". It was established that the lead reinsurer had seen a copy of the D&O section of the insurance policy before taking on the risk, but the evidence suggested no particular consideration had been given to how the claims control clause in the reinsurance would operate.

There was no real dispute that the claims control clause operated as a condition precedent to reinsurers' liability. RSA, however, argued that the draconian effect of the clause meant that it should not be given the meaning that was most onerous to the reinsured unless the clause was clear and, therefore, obviously intended to have such a consequence. This clause was not sufficiently clear. The key questions, however, were: whose "loss" was being referred to and what constituted "knowledge of a loss which may give rise to a claim under the policy"?

Whose loss?
The parties accepted that the word "loss" in the claims control clause denoted an actual loss (as opposed to an alleged loss) and that the loss had to be such as could give rise to a claim under the reinsurance. But did the clause refer to the loss of the third party claimants who had lost money on their shares, or to Coca Cola's liability to compensate those claimants, or even to RSA's loss in paying out under the insurance policy?

Reinsurers argued that "loss" referred to the losses of the third party claimants. They had suffered actual (rather than alleged) losses when their shares fell in value. This was a loss that was capable of giving rise to a claim on the insurance and, which, therefore, "may give rise" to a claim on the reinsurance. In support, they maintained that the second part of the claims control clause gave them the right to control the negotiation and settlement of the underlying third party claims. This right would be useless unless the loss to be notified was the third party claimants' loss. In any event, the contra proferentem* rule applied to the construction of the clause because it had been put forward by RSA's brokers. Consequently it should be construed against RSA.

RSA, however, argued that "loss" meant the loss to Coca Cola and its directors and officers, as only such a loss would give rise to a claim on the original insurance and the possibility of a claim on the reinsurance. Since this was liability insurance, Coca Cola only suffered a loss when its liability was ascertained, by settlement, judgment or arbitration (Post Office v Norwich Union Fire Insurance Society Ltd [1967] QB 163). Consequently, there was no obligation on RSA to inform reinsurers until the class actions had either been settled or the court in Georgia had given judgment.

But when did RSA have knowledge of such loss? And what was meant by knowledge in this context? Reinsurers argued that RSA had knowledge of the third party claimants' losses when it was told of the two class actions on 30 December 2000. Since these were losses that might give rise to a claim on the reinsurance, they should have been notified to reinsurers within 72 hours.

RSA, however, said that, by that date, it only knew that the third party claimants were asserting that they had suffered losses. Whether they had actually suffered losses still had to be proved. It could not therefore be said that RSA had actual knowledge of any actual loss suffered by the claimants before they notified the claims to reinsurers on 19 January.

Judgment
As regards the clarity of the 72-hour clause, the judge thought the intention behind the clause was obvious. If the reinsured did not notify within 72 hours, its right to an indemnity would be lost.

As regards the meaning of "loss", the judge did not find any of the arguments put forward as to the possible practical and commercial implications of one interpretation or the other particularly persuasive. The issue boiled down to basic rules of construction, namely, ascertaining the meaning that the document "would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract" (ICS Limited v West Bromich BS [1998] 1 WLR 896).

He also disagreed that the contra proferentem rule applied. Although the claims control clause was put forward by RSA's brokers, it was not put forward for RSA's benefit, and it was the reinsurers, not RSA, that now wanted to rely on its terms. Nor was this a question of deciding on a narrower or wider interpretation of the clause. There were two distinct interpretations. The proper meaning could not depend on who had put forward the clause. The judge agreed with a comment made by Lord Justice Mance in Gan v Tai Ping [2001] Lloyd's Rep IR 667, that standard clauses, such as claims control clauses, should receive a uniform construction, whoever proposed them.

This was a reinsurance of legal liability. The terms of the underlying cover had been known to reinsurers when the contracts were concluded and the reinsurance was on the same terms as the underlying insurance, so far as applicable, and covered the same subject matter. Although the cause of action between insured and insurer under the original insurance did not arise until the loss of the original insured had been ascertained, and the cause of action between reinsured and reinsurer did not arise until the loss of the reinsured had been ascertained, nevertheless, both those rights of action arose out of the same underlying event - the actual loss of the third party claimant. Against this background, the judge concluded that the loss referred to in the claims control clause meant the actual loss or losses of the third party claimants against the original insured.

As regards the question of knowledge, the judge agreed with RSA. The knowledge required was actual, not constructive, knowledge of the third party claimants' actual losses. Since RSA did not have actual knowledge of the actual losses of the third party claimants against Coca Cola, it had not breached the condition precedent to notify reinsurers.

The question of actual knowledge would be a question of fact in each case. The judge said he appreciated that, in some cases, the reinsured would only obtain actual knowledge of an actual third party loss when that loss had been proved in court or arbitration proceedings between the third party claimant and the insured or accepted as part of a settlement between them. But until it had actual knowledge, the reinsured was under no obligation to notify.

Comment
It is difficult to reconcile the judge's decision on the question of loss with his conclusion that the reinsured must have actual knowledge of that loss before the obligation to notify reinsurers arises. It seems unlikely that many reinsurers will be happy to wait until the underlying claim is settled or decided before hearing of it. It will be interesting to see if the decision is appealed.

*The "contra proferentem" rule is a rule of construction to the effect that, where a contractual clause is ambiguous, the ambiguity is resolved against the interest of the party relying on that provision.