Wasa & AGF v. Lexington (CofA)

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Note: this decision has been appealed to the House of Lords. The appeal is due to be heard in May 2009. Editor, 15 November 2008

Wasa International Insurance Company Ltd and AGF Insurance Ltd v Lexington Insurance Company
English Court of Appeal: Pill, Sedley and Longmore, LJJ: [2008] EWCA Civ 150: 29 February 2008
Christopher Butcher QC, instructed by Chadbourne & Park, for the appellant, Lexington
Alistair Schaff QC and Siobhan Healy, instructed by Addleshaw Goddard, for Wasa
Neil Calver QC and Stephen Midwinter, instructed by Charles Russell, for AGF
The Court of Appeal, reversing the judgment at first instance, held that reinsurers were obliged – under a ‘follow the settlements’ clause in the reinsurance policy - to follow the (mis)fortunes of the primary insurer where, by reason of a local judgment, the latter had been held liable to indemnify its insured against pollution damage that had taken place before, during and after the three-year period specified in both the primary insurance and the reinsurance policy.

The Court of Appeal’s decision highlights the risk that the scope of the reinsurance can be dictated by the law of the underlying policy, even if that was not known or predictable at the time the policy incepted.

DMC Category Rating: Developed

This case note is based on an Article written by Victoria Anderson, solicitor in the London office of the firm Edwards Angell Palmer & Dodge. The article first appeared in the June 2008 Edition of the firm’s quarterly newsletter ‘Insurance and Reinsurance Review'.

The Facts
Lexington insured Alcoa from 1 July 1977 to 1 July 1980 in respect of loss or damage to property at Alcoa’s manufacturing sites worldwide under a policy dated 22 August 1977 (the Insurance). There was no express choice of law clause but the Insurance contained a standard US Service of Suit clause. Wasa and AGF provided reinsurance cover to Lexington for all risks of physical loss or damage to the property occurring in the same three year period covered by the Insurance (the Reinsurance). The period of cover in the Reinsurance was described as "36 months 1.7.77...".

The Reinsurance was broked in the London market on one of two alternative London forms and incorporated a full reinsurance clause as follows: "Being a Reinsurance of and warranted same gross rate, terms and conditions as and to follow the settlements of the ... Company...". There was no express choice of law clause, but it was common ground that the construction and legal effect of the Reinsurance was governed by English law.

Environmental damage was sustained at a number of Alcoa’s sites during the relevant three year period. The damage arose out of continuing failures on Alcoa’s part in dealing with waste products and the failure of manufacturing units to contain pollutants. Importantly, these failures first began causing damage in 1942 and continued at least until 1986.

In the early 1990s, the US Environmental Protection Agency and various state environmental agencies required Alcoa to clean up this pollution and contamination. Alcoa began proceedings against its insurers, including Lexington, in the courts of the state ofWashington in order to determine whether, and to what extent, Alcoa was entitled to be indemnified for the clean up costs. The Washington Supreme Court, reversing the findings of the Superior Court, held that, as a matter of Pennsylvania law (the state where Alcoa’s headquarters were located), Lexington’s insurance of Alcoa was to be construed as rendering Lexington jointly and severally liable for the remedial costs of cleaning up all the environmental damage at various specified sites whether the damage occurred within the three year policy period or not.

Lexington then settled Alcoa’s claims in the region of US$103m on the basis that the Insurance covered the cost of cleaning up the damage, irrespective of whether the damage had been sustained before, during or after the period specified by the Insurance.

After Lexington had made a demand for indemnity under the Reinsurance, Wasa and AGF commenced proceedings in the English Commercial Court seeking a declaration that they were not obliged to indemnify Lexington in respect of its settlement with Alcoa. The principal defence raised was that the claims settled by Lexington did not fall within the terms and conditions of the Reinsurance, which only provided for losses occurring during the three year policy period.

At first instance, Simon J held that Wasa and AGF were not liable, as the period of reinsurance was clear and sacrosanct and the principle that you get only the cover you pay for in terms of time was fundamental.

The Court of Appeal decision
The Court of Appeal allowed the appeal, finding unanimously in Lexington’s favour. Lord Justice Longmore considered that the question to be asked was not whether the Reinsurance was intended to be back to back (as submitted by Lexington) or whether the Reinsurance was intended only to apply to loss and damage occurring within the policy period (as submitted by Wasa and AGF), but whether the parties intended that, to the extent that they used the same or equivalent wording in the Reinsurance as in the Insurance, they intended that wording to have the same meaning in both contracts.

The period clauses, he concluded, were effectively identical, although expressed in slightly different words, and so it was natural to assume that the parties’ intention was that the wording should have the same meaning in each contract. The Court relied on authorities which supported the proposition that the same or equivalent wordings should be given the same meaning in the Reinsurance as the Insurance unless expressly stated to be otherwise (Vesta v Butcher [1989] AC 852 and Groupama vCatatumbo [2000] 2 Lloyd’s Rep 350). Longmore LJ considered that his view that the wording, which appeared in both contracts, was to be given the same meaning in both contracts was supported by the fact that the reinsurers accepted the premium on the same basis as Lexington.

The court strongly rejected the submission by Wasa that the reinsurers had not taken the risk of a change in law in any one of the large number of American jurisdictions. The court held that reinsurers must themselves take that risk, if they reinsure an American insurance company, just as the insurers must take that risk. It was in respect of this argument that Lord Justice Longmore added a postscript to his judgment stating the following:

"No one can pretend that the decisions of the United States courts in relation to asbestosis and pollution claims are remotely satisfactory from the point of view of insurers let alone reinsurers. Reinsurers’ arguments ... had a whiff of an assertion ... that Lexington were an American Corporation and had therefore to take unsatisfactory American decisions on the chin, while reinsurers were English (or doing business on an English Market) and could not be expected to do so. That, of course, will not do."

Longmore LJ also commented that a way around this problem would be for reinsurers to use the Bermuda Form, although it is not clear how that would have helped Wasa and AGF on the key issue in this case.

The court rejected the submission by the reinsurers that reinsurance was an insurance of the subject-matter of the primary insurance and not an insurance of the insurer’s own liability. This was dismissed by Lord Justice Longmore as a "misconceived submission", whilst Lord Justice Sedley stated that "the need for the fiction that reinsurance covered the primary risk and not the insurer’s own potential liability is thus long spent. The practice and vocabulary of reinsurance law have for a long time now reflected the reality that what is reinsured is the insurer’s own liability".

Subject to the appeal to the House of Lords, as matters presently stand, AGF and Wasa will have to follow Lexington’s settlement and pay for decades of pollution costs rather than just the three years’ cover specified in the Reinsurance. Reinsurers will need to be alive to the fact that where their reinsureds face seemingly unreasonable local judgments, they may well be obliged to follow their reinsureds’ misfortunes. It would have been interesting to see if this decision remained the same if reinsurers had explicitly required the Reinsurance to be governed by English law (rather than the parties accepting that it applied through English rules). Such proactive selection of governing law might have been construed as a positive intent to have the clear period clause enforced. In the future, reinsurers could try to ensure that future contracts specify that the period of cover is given primacy and losses outside the period of cover are specifically excluded.

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