DMC Category Rating: Confirmed

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
Royal & Sun Alliance ("RSA") wrote a 21.5% line on Coca Cola's Directors and Officers Liability 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.

Coca-Cola and three of its directors 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 the directors had dressed up the company's financial statements in such a way as to enhance 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.

The insurance policy
The relevant section of the D&O policy covered financial loss suffered as a result of claims made against Coca Cola or its directors by third party claimants. "Loss" 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.

The policy was written on a claims made basis and included a notification clause, which provided that, as a condition precedent to its right to an indemnity, the insured should notify any claim in writing "as soon as practicable during the policy term". Once 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
The reinsurance contracts 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".

They 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 deadline that reinsurers claimed had been breached. RSA knew about the claims by, at the latest, 12 December 2000 and should have notified reinsurers within 72 hours.

First Instance
At first instance, the judge concluded that the loss which had to be notified was that of the third party claimants who had bought shares at artificially inflated prices, rather than the loss of Coca-Cola in being required to compensate those third party claimants. RSA was, however, only obliged to notify "upon knowledge of any loss" and this meant actual knowledge of an actual loss (as opposed to a claimed or alleged loss). RSA did not have this knowledge before 19 January 2001, when notice was in fact given, so there had been no breach of the clause. The reinsurers appealed.

Court of Appeal Judgment
Mismatch
The first point noted by the Court of Appeal was the complete mismatch between the underlying insurance, which required notification of "claims" to insurers, and the claims control clause in the reinsurance, which based notification on the reinsured's "knowledge" of "loss". This was compounded by the very short timescale within which the reinsured had to notify and the draconian consequences if they failed to do so.

Although this was a fairly standard notification clause, its terms were clearly more appropriate to a property damage policy than to a liability policy. The need for a 72-hour notice provision might make sense in the case of a fire or where a cargo was rotting on the quayside, but the need for urgency was less clear in a liability policy.

Loss
On appeal, reinsurers sought to withdraw a concession made before the High Court that "loss" in the claims control clause referred to an actual loss. No actual loss would arise until the third party's claims against Coca Cola were ascertained and quantified by judgment or settlement. This would render the second half of the claims control clause redundant, as there was no point in having a right to control or influence negotiations if reinsurers were not to be advised about a loss until after judgment.

Reinsurers now argued that, in order to make any practical sense, the clause must refer to a "claimed" or an "alleged" loss. The Court of Appeal agreed that this would have been much better, but unfortunately it was not what the clause said.

There were dangers in the court deciding what the parties must have meant, particularly when, as here, they selected a clause "off the shelf" which turned out to be unsuitable. If the court were to change "loss" to "claimed loss", what was to prevent it changing the draconian time limit of 72 hours? It was not part of the court's function to give a common sense construction to one part of a clause in favour of one party in order to enable that party to take advantage of another part of the same clause to avoid liability.

In any event, any clause that seeks to exempt a party from liability must be clearly worded (Photo Production Ltd v Securicor Transport Ltd [1980] AC 827). This was not the case with this claims control clause.

Reinsurers then argued that RSA incurred an actual loss when it first incurred liability for the costs of defending the claims against Coca-Cola and that this triggered the 72-hour notice clause. The Court of Appeal thought this was ingenious, but wrong. Costs considerations could not influence the primary question of the meaning of "loss". That would be to let the tail wag the dog.

The question whose loss was being referred to was not relevant to the appeal. Whether it was the third party claimants' loss or the insured's loss made no difference in this situation. The judge had decided it was the third party claimants' loss, and, had they had to deal with the issue, the Court of Appeal would have agreed.

Knowledge
Once it was concluded that "loss" meant "actual" rather than "alleged" loss, it followed that RSA could not have had knowledge of any loss by December 2000 or January 2001.

Knowledge of an actual loss might have arisen earlier had it been a different type of underlying claim - where, for instance, it was alleged that the directors' actions caused the share price to collapse. In those circumstances, once the reinsured was notified of the claim it could be said that it had knowledge of a loss which might give rise to a claim under the policy.

But this was a comparatively unusual claim, in that the third party claimants still had to prove that the directors' conduct caused the share price to be artificially high at the time when they bought shares. Whether or not there was a loss depended on whether it could be established that Coca-Cola stock would have had a lower value if the financial position had been accurately stated. This would not be established until judgment in the US court. Consequently, RSA had no knowledge of an actual loss and was not in breach of the notification clause.

In the words of Lord Justice Longmore: "The moral of this case is that "knowledge" is (or can be) an elusive concept because in any given case a party to a contract may have difficulty in showing what another party "knows". It would, therefore, be better if "knowledge" were not used as the trigger for any requirement of notification to a liability insurer or reinsurer".