Peter Chaffetz Explores Disputes in the Insurance Industry at Offshore Disputes Week

June 2023— Published by Law360 on June 15, 2023. Authored by Peter Chaffetz and Andrew Poplinger.

In a recent Law360 guest article, our friend and well-known English insurance solicitor Chris Foster, argued that English facultative reinsurers should not be required to pay their share of an American cedent’s all sums settlement, because English law does not recognize the all sums principle.

According to the article, the U.S. Court of Appeals for the Second Circuit’s ruling to the contrary in The Insurance Company of the State of Pennsylvania v. Equitas Insurance Limited misapplied English law and is therefore wrongly decided.[1]

We respectfully disagree with the article’s analysis and conclusion. In the interests of full disclosure, we were counsel to ICSOP in the case at issue.

In ICSOP, the ceding company, ICSOP, had paid the full limits of a three-year policy to settle its insured’s environmental liabilities that had accrued over a period of 40 years.

The policy was governed by the law of Hawaii, one of several American jurisdictions that apply the all sums approach, under which third-party liability insurance is construed to cover all liability —based on the insuring clause’s reference to “all sums” — arising over a period of years out of an indivisible process of environmental contamination, as long as any part of that contamination occurred during the policy period.

Equitas, the successor in interest to Lloyd’s of London syndicates, which had issued two facultative certificates reinsuring the ICSOP policy, had denied the claim, but the Second Circuit affirmed summary judgment in favor of ICSOP, holding that, as a matter of English law, the English law reinsurance certificates were back to back, i.e., concurrent, with the ICSOP policy they reinsured. Therefore, although the reinsurance was governed by English law, Equitas had to cover the loss in accordance with Hawaii law governing the underlying policy.

There was no dispute that the reinsurance contracts were governed by English law. Therefore, the task before the Second Circuit was to predict how the U.K. Supreme Court — formerly the House of Lords — would have decided the issue.

Noting that the Second Circuit conducted its own research into English case law not cited by either party, the article argues that the court missed a key English Court of Appeals precedent — Equitas v. Municipal Mutual Insurance — that should have led it to reach the opposite conclusion.[2]

As we explain below, the unanimous Second Circuit decision is entirely consistent with English law. Its limited reliance on the English cases the article discusses was apt, and the Equitas v. MMI decision that the article says the court failed to consider — to the extent it is relevant at all— supports rather than undermines the Second Circuit’s conclusion.

 

The Dispute and Decision in ICSOP

Equitas did not dispute that Hawaii law applied the all sums rule, nor that it was reasonable for ICSOP to settle with its insured on that basis. Instead, Equitas claimed that it had no obligation to pay its share of the loss because the reinsurance was governed by English law, which did not recognize the all sums rule.

Equitas acknowledged that, under English law, it is generally accepted that facultative reinsurance written on an as-original basis — incorporating the terms of the underlying policy — is presumed to be back to back with the underlying policy, such that the scope of reinsurance coverage is coextensive with the scope of coverage under the law governing the underlying policy, even if English law would take a different view.

However, Equitas argued that the back-to-back presumption cannot apply to bind an English reinsurer to a U.S. cedent’s all sums settlement, because the policy period is fundamental under English law, and the all sums rule requires insurers and reinsurers to pay for losses occurring outside the coverage period of their contracts. In Equitas’ words, the all sums rule was anathema to English law, and could never apply under an English law reinsurance contract, regardless of whether the reinsurance was otherwise back to back.

Alternatively, Equitas argued that the back-to-back presumption was inapplicable to this case, because Hawaii did not adopt the all sums rule until after the reinsurance was bound, and therefore, even if the reinsurers knew they were reinsuring a Hawaii law risk, they did not know that Hawaii would later adopt the all sums rule.

Equitas relied principally on the House of Lords’ decision in Wasa International Insurance. Co. Ltd. v. Lexington Insurance Co., which held that, under the facts of that case, English reinsurance contracts, although written as original, did not cover the cedent’s payment for 40 years of environmental contamination under a policy determined to be subject to Pennsylvania’s all sums rule.[3]

The Second Circuit rejected Equitas’ interpretation of Wasa. It concluded that the reason the House of Lords found the back-to-back presumption to be rebutted in Wasa was that the underlying policy in that case did not specify a governing law, and the reinsurers could not otherwise have anticipated at the time of contracting that the policy would ultimately be governed by Pennsylvania law and its all sums rule.

The present case was distinguishable because the ICSOP policy included an express Hawaii choice-of-law provision, and therefore the reinsurers knew at the outset that they were reinsuring a Hawaii law risk. Whether it was sensible for the House of Lords to make the presence or absence of a governing law clause the basis for its ruling in Wasa is a separate question on which the Second Circuit did not comment.

The Second Circuit further held that Wasa did not stand for the proposition that the period of cover is fundamental. The principal basis for this conclusion was that one judge in Wasa, Lord Simon Brown, stated explicitly in a short, separate opinion that the case should have been decided on that basis, but no other judge joined in that opinion. Rather the two Lords whose opinions gained support from a majority of the five-judge panel relied on the choice- of-law issue.

Finally, the court also rejected Equitas’ change-in-law theory, again relying principally on Wasa, where the majority opinions noted that it was elementary that insurers and reinsurers alike take the risk of changes in the law.

The court succinctly summarized its conclusion: “We do not believe that the United Kingdom Supreme Court would condition [the back-to-back] presumption on the importance of a policy term or the predictability of how a foreign court might later interpret that term.”

 

The Second Circuit’s Reliance on English Authorities Not Cited by the Parties

Reflecting the seriousness with which the Second Circuit panel took its responsibility to assess the likely outcome under English law, and in particular to assess Equitas’ contention that the period of cover was so fundamental under English law as to defeat the back-to- back presumption, the court reviewed developments in English law subsequent to Wasa, including two U.K, Supreme Court decisions not cited in the briefs of either party.

Those cases, Durham v. BAI (Run off) Ltd.[4] and International Energy Group Ltd. v. Zurich Insurance PLC,[5] followed the passage of legislation that made employers jointly and severally liable for the entire injury of any mesothelioma victim who was exposed to asbestos at the employer’s facility for any period of time, regardless of how many years that employee may have faced similar exposure while working for other employers.

In Durham, the court held that insurers had to cover their policyholders’ newly created joint-and-several liability for mesothelioma claims, essentially changing the trigger of coverage under such policies. Subsequently, in Zurich, the U.K. Supreme Court extended Durham to adopt a version of the all sums rule, holding that insurers are jointly and severally liable for the entirety of their insured’s liability under the Compensation Act.

The Second Circuit observed that the adoption of the all sums rule in Zurich rebutted Equitas’ argument that the all sums rule was anathema to English law. The court explained the narrow basis of its reliance on Zurich:

The point of our reliance on Zurich is that the case recognized a circumstance where an insurer can be jointly and severally liable for the whole of the insured’s tort liability even though that liability might have accrued after the policy period’s expiration. That recognition defeats Equitas’s argument that the all sums rule is anathema to English law.

The court again drew secondary support from Durham and Zurich for its conclusion that Equitas assumed the same risk as ICSOP of changes in Hawaii law. It noted that in those cases, the U.K. Supreme Court acknowledged “that the relevant policies were executed

before the various legal developments leading to those decision had occurred … but that did not stop the Lords from imposing liability on insurance carriers in [Durham] and joint-and- several liability upon insurance carries in Zurich.”

It would therefore be “incongruent to make the change-of-law point decisive here where it was not in those cases.”

The Second Circuit was careful to note that these cases were limited to the narrow context of mesothelioma claims, and it was not suggesting that these cases predict that English law would adopt a similar all sums rule in the context of long-tail environmental liability cases.

 

Equitas v. MMI Supports Second Circuit’s Decision

This brings us to the article’s principal criticism of the Second Circuit ruling: that the court misconstrued English law because it failed to consider the MMI decision, in which the U.K. Court of Appeal disallowed a ceding company’s all sums allocation of its asbestos settlement to a reinsurer. The article asserts that, “had the court been aware of [that] decision, it would and should have reached the opposite view”

Initially, we note that after the article was published, the Second Circuit denied Equitas’ petition for rehearing based on the same theory — that the MMI decision, properly considered, would have required an opposite ruling. The Second Circuit gave no reasons for that denial, but it is clear that the MMI decision does not support the article’s or Equitas’ criticism of the Second Circuit ruling.

First, the MMI decision did not involve an underlying policy governed by foreign law, a fact at the crux of both Wasa and ICSOP. In MMI, both the insurance and reinsurance at issue were governed by English law. Rather, MMI turned entirely on whether the cedent, although having the right to present its reinsurance claims on an all sums basis, following Zurich, acted in bad faith in doing so under the facts of that case.

Specifically, MMI had issued 30 annual employers’ liability policies, each of which, under Durham and Zurich, covered 100% of all claims arising from any exposure to asbestos during the policy period. Based on that all sums liability, MMI paid the full amount of the insured’s liability for these claims. But, it did so without allocating its payment across the 30 potentially responding annual policies.

However, when it came to the reinsurance cession of that loss, MMI ceded the entire claim arising from multiple years of exposure to a single reinsurance year. By doing that, it avoided years with high deductibles or insolvent reinsurers, thereby maximizing its reinsurance recovery. The court described that one-year allocation as “spiking.”

The Court of Appeal held that: (1) as a matter of construction, the reinsurance contracts covered the claims on the same all sums basis as the underlying insurance policies, i.e., they were back to back; but (2) MMI’s contractual discretion to allocate the claims on an all sums basis for reinsurance purposes was subject to an implied limitation of good faith.

As former Lord Justice Andrew Leggatt explained in the MMI decision, “the justification for implying this [good faith] term is that the implication is necessary to prevent the insurer’s power to allocate its loss among policy years from being abused.”

The first of those holdings actually supports the result in ICSOP, because the only question before the Second Circuit was whether the reinsurance should be construed as back to back with the ICSOP policy. What the court did in MMI is entirely consistent with what the Second Circuit did in ICSOP.

Also, importantly, the Court of Appeal construed the insurance and reinsurance in MMI as back to back, notwithstanding that the U.K. Supreme Court did not impose the all sums construction on insurers until its ruling in Zurich, long after the insurance and reinsurance policies were bound. This refutes the suggestion that the reinsurers’ liability cannot be expanded by post-binding legal developments.

The article’s criticism of the Second Circuit’s ruling in ICSOP illogically rests on the result of the second holding in MMI, i.e., rejection of the attempted reinsurance cession. But the reason for that rejection was that MMI’s right to present its reinsurance claims on an all sums basis was tempered by an implied obligation of good faith, and that spiking the cession of claims that were covered by multiple of MMI’s policies to the single year that would yield the largest recovery was not in good faith.

That reasoning is irrelevant to the dispute in ICSOP, where there were no such allocation

issues, because the reinsurance claim arose from a single policy and ICSOP presented the claim to its reinsurers on the same basis on which it had settled with its policyholder.

Equitas conceded that ICSOP’s settlement decision was reasonable, and its only argument against payment was that the reinsurance should not be construed as back to back with the ICSOP policy. As shown, on that issue, MMI actually confirms that the Second Circuit decision in ICSOP properly construed English law.

Peter Chaffetz is a founding partner and Andrew Poplinger is a partner at Chaffetz Lindsey LLP.

Disclosure: Chaffetz and Poplinger were counsel to ICSOP in the case at issue.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of their employer, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] Case No. 20-3559-cv (2d Cir. May 22, 2023).

[2] [2019] WLR 613.

[3] [2010] 1 AC 210.

[4] [2012] UKSC 1.

[5] [2015] UKSC 33.