James Hosking and Marcel Engholm Co-Author Article for the Bahrain Chamber for Dispute Resolution International Arbitration Review

May 2023- In an important decision for the many US ceding companies with London-market reinsurance, the Second Circuit ruled this week that Equitas must follow ICSOP’s settlement with its insured on an “all sums” basis, even though English law generally does not recognize the all sums doctrine.  The Insurance Company of the State of Pennsylvania v. Equitas Insurance Limited, Case No. 20-3559-cv (2d Cir. May 22, 2023).  Equitas had denied coverage of a loss that, although paid in accordance with the Hawaii law that governed the underlying policy, would not have been recognized English law, which governed the reinsurance.

The District Court had ruled on summary judgment that Equitas breached its reinsurance contracts with ICSOP (an AIG member company) when it failed to pay its $7.25 million share of ICSOP’s $20 million policy limits settlement with Dole Food Company.  That settlement resolved claims by homeowners for alleged environmental pollution at a California housing tract developed by a Dole subsidiary in the 1960s.  Although ICSOP’s policy was for a three-year term, it settled on the basis that the policy must respond to Dole’s liability for 44 years of continuous pollution as required by the all sums doctrine.  In jurisdictions that follow the all sums approach, all insurers on the risk during a period of continuous contamination are jointly and severally liable for the entire loss up to their policy limits.

ICSOP had purchased two facultative reinsurance certificates for its umbrella policy from Equitas’s predecessors, underwriters at Lloyd’s of London.  The umbrella policy and the reinsurance certificates all had the same three-year period of cover, from 1968-1971.  The parties agreed that the facultative certificates were governed by English law.

Equitas rested its denial of ICSOP’s reinsurance claim on the House of Lords’ ruling in Wasa International Ins. Co. v. Lexington Ins. Co. [2010] 1 AC 180.  In Wasa, the Lords recognized that there is generally a “strong” presumption under English law that facultative reinsurance contracts are “back-to-back”, i.e., coextensive, with the reinsured policy, such that the terms of coverage incorporated from the underlying policy into the reinsurance are interpreted as they would be by the law governing the underlying policy.  Nonetheless, the Lords concluded that the back-to-back presumption did not apply on the facts presented.  Therefore, they ruled, because English law did not recognize the all sums doctrine, the English law reinsurance contacts did not respond to an American cedant’s all sums settlement.

Equitas argued that Wasa established a blanket exception to the back-to-back presumption whenever the underlying policy provided coverage on all sums basis under its governing law.  They read Wasa as holding that the period of cover is “fundamental” under English law, and that therefore, English reinsurers have no obligation to cover an all sums settlement that would impermissibly require them to bear losses incurred outside the coverage period of their contracts.

Equitas emphasized that ICSOP’s claim closely resembled the Lexington claim that Wasa had rejected.  Specifically, both Lexington’s policy and the facultative certificate that reinsured it were subject to a three-year term.  And, also as in ICSOP, Lexington had paid for decades of of environmental damage on an all sums basis.

However, as the Second Circuit recognized in its 45-page opinion, the two cases differed in one crucial respect:  the way that the all sums rule came to govern the reinsured policy.  In particular, the Lexington policy at issue in Wasa did not specify the law of the contract.  Rather, the Washington Supreme Court’s decision to apply Pennsylvania law, and therefore the Pennsylvania all sums rule, followed extensive litigation involving dozens of insurers who had issued over one hundred policies in various states.  The Lords emphasized that the Washington court’s complex, multi-party, multi-policy choice of law analysis turned entirely on facts that could not have been known to or anticipated by the reinsurers at the time of placement.  The inability of the reinsurers to predict that the underlying policy would be construed under Pennsylvania law, they held, overcame the the usual back-to-back presumption and made it appropriate to construe the reinsurance contracts under English law, without regard to the law found to govern the reinsured policy.  Since English law did not recognize the all sums doctrine, the reinsurance contracts did not cover the loss.

Based on the importance of the Lords’ choice of law discussion to the result in Wasa, the Second Circuit agreed with ICSOP that Wasa established a narrow exception to the back-to-back presumption where the law governing the reinsured policy could not be ascertained at the time of binding.  Because the underlying ICSOP policy explicitly provided for the application of Hawaii law, the back-to-back presumption applied.  Since ICSOP’s payment under the all sums doctrine was consistent with the policy’s governing Hawaii law, it was also within the scope of Equitas’s facultative reinsurance cover.

The Court likewise dismissed Equitas’s argument that the back-to-back presumption was inapplicable because Hawaii had not adopted the all sums doctrine until decades after the parties entered the reinsurance contract. The Court noted that Wasa itself considered it “elementary” that insurers and reinsurers alike “take the risk of any change in the law.”

Succinctly summarizing its rejection of Equitas’s arguments in favor of extending Wasa, the court stated:  “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.”

Finally, the Court also rejected Equitas’s separate, late notice defense.  According to Equitas, ICSOP’s supposed failure to provide timely notice of its claims “went to the root of the contract” and permitted Equitas to rescind the reinsurance contracts in their entirety.  Noting that no English court had ever granted such relief, the Court saw “no reason to go where no English court has gone,” especially since Equitas failed to offer any evidence that it was prejudiced by ICSOP’s allegedly untimely notice.

ICSOP’s legal team included Bill Goldsmith from AIG and Peter Chaffetz, Drew Poplinger, Alex Walsdorf and Oslen Grant from Chaffetz Lindsey.  The full order can be found here.