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Wasa Int’l Ins. Co. Ltd. v. Lexington Ins. Co.

Issue Discussed: Follow the Fortunes/Settlements

Submitted by Ethan Torrey

Date Promulgated: July 30, 2009

Issue: Follow the Fortunes

In Wasa Int’l Ins. Co. Ltd. v. Lexington Ins. Co., [2009] UKHL 40, the United Kingdom House of Lords held that facultative certificates, governed by English law, did not cover liability for damages incurred both before and during the certificate period, even though the identical primary policies reinsured by the certificates, governed by Pennsylvania law, did cover liability for damages that had occurred both before inception and during the policy period. The Lords noted the “strong presumption” that liability under a proportional facultative reinsurance certificate is co-extensive with liability under the primary policy it reinsures. However, they emphasized that the reinsurance certificate comprised an independent contract, and that, under English law, reinsurance covers only damage to property caused during the policy period.

Background:

Lexington Insurance Company issued a policy to Aluminum Company of America insuring against “all physical loss of, or damage to, the insured property,” and covering the period July 1, 1977 – July 1, 1980. The policy contained a service of suit clause, providing that Lexington submitted to the jurisdiction of any court within the United States, but did not contain an express choice of law provision. Alcoa sought indemnification for environmental damages incurred between the years 1942-1986, and the ensuing litigation in Washington state court ultimately involved 70 insurers, hundreds of policies, and 58 sites. The Washington court applied Pennsylvania law to the entire action under conflicts of laws principles, and declined to select governing law with respect to individual policies, with the caveat that if unique issues arose with respect to specific insurers or sites, it would revisit the issue. The court held that joint and several liability applied and, accordingly, Lexington was liable for environmental damages that occurred both before inception and during its policy period. The ruling exposed Lexington to potential liability of $180 million, and Lexington settled the matter for $103 million.

Lexington purchased facultative certificates from its reinsurers that were identical in every relevant respect to the underlying policies (including the policy period of July 1, 1977 – July 1, 1980), except that they were governed by English, not Pennsylvania, law. The certificates contained a follow the settlements provision. The reinsurers declined to reimburse Lexington, because Lexington could not identify the portion of the settlement that was attributable solely to the contract period of the certificates.

House Of Lords’ Ruling:

The House of Lords concluded that “there is no principled basis for treating the scope of the 3 year reinsurance as the same as the insurance, which has been interpreted under the law of Pennsylvania not to contain any limitation as to time of the physical loss or damage to property,” because such construction would be fundamentally inconsistent with English law and the nature and effect of reinsurance. The Lords noted the “strong presumption that liability under a proportional facultative reinsurance policy is co-extensive with liability under the primary policy.” However, they emphasized that the reinsurance comprised an independent contract and that, under English law, “nothing could be clearer” than the rule that reinsurance covers only damage to property caused during the policy period. The Lords also concluded that it would “change completely” the “nature and effect” of reinsurance contracts if they were held to cover liabilities from damage that occurred during any period, as long as some of the damage occurred during the policy period.

Critically, according to the Lords, it could not have been predicted, at the time of the reinsurance contract, that Pennsylvania law would govern the insurance contract. The Washington state court applied Pennsylvania state law globally to all insurance policies implicated in a complex coverage action involving 70 insurers and hundreds of policies, based on factors unconnected with the primary insurance policies issued by Lexington. The Lords held that there was “no basis for interpreting [the reinsurance] as covering any liability which might subsequently be held to arise under the insurance in any State whose law might, after disputes had arisen under it and other separate insurances, be applied by reference to factors extraneous to the particular insurance to which alone the reinsurance related.” The Lords concluded that it was “fanciful” to posit that it could have been predicted in 1977, when the policies were bound, that Pennsylvania law would have applied to the primary insurance. Instead, they concluded that “there was in 1977, when the insurance contract and the reinsurance contract were concluded, no identifiable system of law applicable to the insurance contract which could have provided a basis for construing the contract of reinsurance in a manner different from its ordinary meaning in the London insurance market.” In such situation, they concluded, where the governing law of the primary policies was not ascertainable, neither that law nor the follow the settlements doctrine can override a clear temporal limitation in the reinsurance certificates.

Conclusion:

The Lords held that “[t]he reinsurance contract cannot reasonably be construed to mean that it would respond to any liability which ‘any court of competent jurisdiction within the United States’ (the phrase in the Service of Suit clause) would impose on Lexington irrespective of the period of cover in the reinsurance contract,” because such a construction would be fundamentally inconsistent with English law. The principle that liability under a proportional facultative reinsurance policy is co-extensive with liability under the primary policy does not apply where, at the time the reinsurance contract is entered into, the law governing the primary policy is not identifiable or ascertainable. _______________________________
1Ethan Torrey is a senior litigation associate in the Boston law firm of Choate, Hall & Stewart LLP, specializing in insurance and reinsurance law.