"Follow The Fortunes" Not Absolute: England's House Of Lords Reaffirms Independence Of Reinsurance Contracts
August, 2009
Last Thursday, England's highest court, the House of Lords, delivered its opinion in the long-running case of Wasa v. Lexington [2009] UKL 40. The House of Lords overturned the Court of Appeal and reinstated the ruling of the Commercial Court. It held that UK-based reinsurers Wasa and AGF did not owe indemnity under their reinsurance contracts with Lexington for environmental clean-up costs incurred by Lexington's insured, Alcoa. The Supreme Court of the State of Washington, applying Pennsylvania law, held that Lexington was liable for Alcoa clean-up costs attributable to contamination at Alcoa sites occurring during the forty-four year period 1942 – 1986, even though Lexington's property policies only covered "all physical loss of, or damage to" Alcoa's property for the three-year period July 1, 1977 – July 1, 1980. The Washington Supreme Court held that:
"It seems clear from the policy language that any physical loss or damage manifesting itself during the time that a….policy was in effect was covered by the policy, including pollution damage starting before the policy inception."
AGF and Wasa's "back to back" reinsurance contracts covered the same time period as the Lexington policies and provided that the reinsurance would "follow the settlements" of Lexington. The main issue in the case was whether the reinsurers would owe indemnity to Lexington for pollution occurring over a virtually unlimited time period, where there is no question that, under English law, an insurer in the position of Lexington would owe no indemnity to its insured for losses that occurred before or after the express period of coverage.
The parties agreed that the reinsurance contracts were subject to English law and the House of Lords expressed the position that:
"Under English law, nothing could be clearer than that a contract providing cover for loss and damage occurring only during the specified three-year period could not be construed as covering in addition damage occurring before (or, for that matter, after) that three-year period."
In recognizing that reinsurance is a separate contract, "which may contain its own independent terms requiring to be satisfied before insurers can claim indemnity under it," the House of Lords held that no British reinsurer issuing a policy of reinsurance in 1977 could ever have reasonably anticipated that it would owe indemnity under a decision by an American court that converted a three-year period of coverage to a virtually unlimited period of coverage. The House of Lords was obviously concerned with the potential ramifications on predictable business dealings:
"If Lexington were right, some very uncommercial consequences would flow if the reinsurers had agreed to accept only two years of the risk, rather than the three years of the underlying risk accepted by Lexington, leaving Lexington to reinsure the third year of cover elsewhere; or if the London market had elected to reinsure Lexington by way of three separate one-year policies…."
The Wasa case re-emphasizes that the "follow the fortunes" doctrine is not absolute and, while cedants and their reinsurers could certainly enter into contracts where the reinsurer promises to indemnify the cedant for any amounts the cedant is found liable to pay, that result is not automatic. The reinsurance contract will be construed on its own terms.
While Lexington's liability in the case arose in the context of environmental clean-up actions, it is clear that the Wasa decision will have far-reaching implications in a number of risk areas, including toxic tort, clergy sex abuse cases, and myriad others.
The House of Lords' opinion can be found here.