DMC Category Rating: Developed

This case note is based on an Article in the June 2005 Edition of the ‘(Re)insurance Bulletin’, published by the Insurance team at the international firm of lawyers, DLA Piper Rudnick Gray Cary. DLA Piper is an International Contributor to this website.

Background
London & Manchester Assurance Co Ltd gave advice to individuals on their personal pensions plans. Its professional indemnity cover for the year 1 February 1993 to 31 January 1994 consisted of a primary layer (underwritten by Syndicate 657 at Lloyd’s) and a first excess layer, underwritten partly by Syndicate 657 and other Lloyd's syndicates and partly by the defendant insurance companies.

On 28 January 1994, in the context of renewal negotiations, the legal services manager of the insured sent a letter to the broker addressed to "Lloyd's underwriters", confirming that he knew of no circumstances likely to give rise to a claim under the PI policy, other than (1) matters currently under investigation that were not likely to exceed the deductible, and (2) "pension transfers and opt-outs which are a matter of public record and relate to all pension providers. Detailed investigation will be conducted into pensions-related transactions in accordance with any SIB/LAUTRO guidelines and notification of any potential claims given to underwriters in the usual way".

This referred to the declared intention by the relevant regulatory bodies to carry out an investigation into alleged pension mis-selling. At that time, the precise nature and scope of the review had not yet been determined, but the end result was that the insured had to pay over £9 million in compensation.

The insured claimed on its 1993/4 insurance, on the grounds that the claims arose out of circumstances notified to insurers by the letter of 28 January 1994. The Lloyd's syndicates involved accepted liability, both under the primary and excess layers. But the insurance companies involved in the excess layer denied the claim, alleging that the insured had failed to notify them at all and so was in breach of a condition precedent. They had only found out about the claims in 2002.

The primary policy
The primary layer policy, written on a claims made basis, excluded any claim or loss arising out of circumstances or occurrences known to the insured before inception. General Condition 2 provided:
"THE ASSURED shall as a CONDITION PRECEDENT to their right to be indemnified under this Policy give to the Underwriters notice as soon as possible during the period of this Policy as set forth in the Schedule:

Such notice having been given to Underwriters THE ASSURED shall give to the Underwriters as soon as possible full details in writing of the circumstances which may give rise to a claim or loss against them or any of them. Any claim or loss to which that circumstance has given rise which is subsequently made after the expiration of the period specified in the First Schedule shall be deemed for the purposes of this Policy to have been made during the subsistence hereof".

The excess layer
The leading excess layer policy (underwritten by the Lloyd's syndicates) incorporated a set of clauses known as the AWGS Excess Wording. The other excess layer policies incorporated the terms of the Lloyd's excess policy.

Liability would not attach to the excess layer unless and until the underwriters of the underlying policy had paid or had admitted liability or had been held liable to pay the full amount of their indemnity and it was a condition that the underlying policy would be maintained in full effect. Once the underlying policies had been totally exhausted, the excess layer would "drop down" and operate as the primary policy.

As for notifying claims, clause 5 provided:

"Any claim(s) made against the Assured or the discovery by the Assured of any loss(es), or any circumstances of which the Assured becomes aware during the subsistence hereof which are likely to give rise to such a claim or loss, shall, if it appears likely that such claim(s) or loss(es) may exceed the indemnity available under the Policies of the primary and Underlying excess Insurers, be notified immediately by the Assured in writing to the Underwriters hereon".

Under clause 7, "Except as otherwise provided herein, this policy is subject to the same terms, exclusions, conditions and definitions as the Policy of the primary Insurers…".

Incorporation
One of the preliminary issues addressed by the High Court was whether the notice clause in General Condition 2 of the primary layer (including the circumstances extension) was incorporated into the excess layer by clause 7 ("subject to the same terms, exclusions, conditions and definitions"). The judge concluded that it was. Although, in many cases, a notice clause would be considered collateral to the risk (and therefore incapable of being incorporated by such general wording), in this case, not only was the clause a condition precedent to liability, but it included an extension of cover to include claims arising from circumstances notified during the policy period. Both matters had an important bearing on the risk.

The issue was not appealed, but Lord Justice Mance, giving the leading judgment in the Court of Appeal, confirmed that he entirely agreed with the judge's reasoning. The scheme would have been incoherent had the extension been included in the primary layer but not in the excess layer.

The effect of incorporation
Once incorporated, did General Condition 2 give rise to a separate duty to notify claims or circumstances to the excess layer insurers? At first instance, the judge thought not. It was sufficient that notice of claims or circumstances were given to the primary layer.

The insurers appealed this point, arguing that incorporation created an additional obligation to notify the excess layer and that this was a condition precedent to their liability. Once incorporated, "underwriters" in General Condition 2, clearly referred to the excess layer insurers.

The Court of Appeal unanimously disagreed. If the insurers were right, notice in every case would have to be given to the excess layer, followed as soon as possible by "full details in writing". They would be receiving volumes of material about claims or potential claims in which they would never realistically be interested.

Clause 5 in the excess policy expressly dealt with notifications to the excess layer and specifically required notice of claims or circumstances only if they appeared likely to exceed the indemnity available under the primary layer. This suggested the excess layer insurers were only interested in matters likely to affect their layer and, unless and until such a situation arose, were prepared to leave the handling of lesser matters to primary insurers.

It was also important to remember that General Condition 2 had been incorporated only by the general words of clause 7, whereas clause 5 was an express clause in the excess layer wording. The incorporated terms had to be read in a way consistent with the general tenor of the express language used.

Valid notice
The insurers also argued that, in any event, the insured's letter of 28 January was not a valid notice because it had been written in the context of renewal negotiations and so was addressed, not to the primary insurers for the current year (1993/4) but to those contemplating providing cover for 1994/5.

The Court of Appeal, however, agreed with the judge that it was perfectly possible for the letter to serve two purposes to the extent that the same insurers were involved in both years of cover. It not only gave notice of circumstances which might give rise to a loss to the expiring year, but also gave an assurance to the 1994/5 insurers that the insured was not aware of any other circumstances that might do so.

Innominate term
The point on which the Court of Appeal differed from the judge - and the point of most general interest - concerned the nature and effect of clause 5.

This, the judge had concluded, was not a condition precedent to liability under the excess policy but was an innominate term of the sort envisaged by the Court of Appeal in Alfred McAlpine Plc v BAI (Run-off) Limited [2000] 1 Lloyd's Rep 437. If it could be established that there had been a sufficiently serious breach of clause 5, the excess layer could reject liability for the claim.

In McAlpine v BAI, the insured failed to give notice of an accident involving one of its employees as soon as possible, or indeed at all. Lord Justice Waller in the Court of Appeal put forward the possibility that, although the notice clause was not a condition precedent, it was an innominate term, which meant that a breach, if sufficiently serious, would entitle insurers to defeat the claim even though it did not amount to a repudiation of the whole insurance contract. The breach would either have to demonstrate an intention not to pursue a claim, or be one that had very serious consequences for the insurers. It was held in that case, however, that insurers had had sufficient details to investigate the claim and had not suffered irremediable prejudice.

The Court of Appeal in this case agreed with the judge that clause 5 was not a condition precedent. The policy clearly distinguished between the requirement for primary insurers to be notified as soon as possible (which was a condition precedent) and the excess layer's need to be notified only when it seemed likely it would be affected (which was not). This was a standard market wording used by and between professionals who could be taken to be well aware of the way in which such a clause would operate.

But, by a majority of two to one, the Appeal Court found that a breach of clause 5 was not capable of repudiating the claim.

No basis for a new doctrine
A claims notification clause is normally an ancillary provision, meaning that the term itself does not go to the root of the whole contract. When an ancillary provision is breached, the remedy is damages. But it was proposed in McAlpine v BAI that, even though the term requiring notice was ancillary, breach (if sufficiently serious) was repudiatory of the particular claim to which the breach related.

This supposes that an insurance contract is severable into separate parts, like a contract for sale by instalments (under which failure to make due delivery of one instalment may be accepted as repudiatory of that instalment, but does not necessarily mean the whole contract comes to an end). But insurance is a composite contract. The premium is not normally divided and allocated to any particular risk or claim.

Nor was there any authority to suggest that, in the absence of any express or implied term, a party to a composite contract might be relieved from a particular obligation because there had been a breach of an ancillary term. Either fulfilment of the term was made conditional to insurers' liability or it was not. There was no basis for a new doctrine of partial repudiatory breach, nor for finding an implied term in the contract that meant insurers would be free of liability in the event of a serious breach and/or a breach with serious consequences. If insurers had suffered prejudice by the breach, that prejudice was likely to be capable of being quantified in damages (even if only as a loss of a chance) and could be set off against the insurance claim.

In Lord Justice Mance's view, if insurers wanted or needed a new form of protection, they should expressly include it in their insurance contracts and see if the market would accept it: "English insurance law is strict enough as it is in insurers' favour. I see no reason to make it stricter."

Lord Justice Waller, the third Appeal Court judge hearing the case, was left to defend his position in McAlpine v BAI. In his view, the law should be flexible enough to recognise the innominate term as a possibility. This was in accordance with what he considered the parties would have contemplated and with the principles of justice.

He acknowledged that situations in which breach of a notification clause would be repudiatory would be very rare. The sort of serious prejudice he had in mind was, for instance, where the insurer had no chance at all to examine the circumstances of the claim and was simply unable to say whether some action could have been taken to defeat the claim. In such circumstances damages for loss of a chance was illusory as a remedy.

In this particular case, however, where the excess layer underwriters had agreed that notice of claims and circumstance should be given to the primary layer, they would have very little chance of demonstrating that they had suffered serious prejudice.