June 2007
INSURANCE & REINSURANCE
An English High
Court decision
confi rms position
under English law
that reinsurance
contracts are not
contracts of liability
insurance
FOCUS
THE WASA V LEXINGTON
DECISION: IMPLICATIONS FOR
AUSTRALIAN REINSUREDS
Partner Michael Quinlan and Senior Associate Robert Carey consider the
implications for Australian reinsureds of the decision of the English High Court
in WASA International Insurance Company Limited v Lexington Insurance
Company [2007] EWHC 896 (Comm), which examines the relationship between
ostensibly 'back to back' insurance and reinsurance contracts.
HOW DOES IT
AFFECT YOU?
00 The decision in WASA International Insurance
Company Limited v Lexington Insurance
Company confi rms that ostensibly 'back to
back' insurance and reinsurance contracts
are separate contracts that must each be
construed according to their own governing
law. The law governing each contract may
(and often will) be different.
00 The decision confi rms that even where terms
are directly incorporated into reinsurance
contracts from original insurance contracts,
ostensibly identical terms may be construed
differently according to the system of law
governing each contract.
00 The decision confi rms the position under
English law, that reinsurance contracts are
not contracts of liability insurance. Australian
insurers reinsured into London should,
therefore, not assume that the construction
given by Australian courts to particular
terms in insurance contracts, or indeed the
affect of the Insurance Contracts Act 1986
(Cth) on such terms, will necessarily be
refl ected in decisions of the English courts in
corresponding reinsurance disputes.
00 If followed in Australia, the decision may
further complicate issues relating to the
application of the I nsurance Act 1902
(NSW) and section 6 of the Law Reform
(Miscellaneous Provisions) Act 1946 (NSW)
to reinsurance contracts.
BACKGROUND
The Aluminium Company of America ( Alcoa )
was insured under a policy issued by Lexington
Insurance Company ( Lexington ) (the original
insurance contract ) for loss of, or damage to, its
property occurring during the period between
1 July 1977 and 1 July 1980. The original
insurance contract included a US service-
of-suit clause requiring Lexington to submit
to the jurisdiction of any court of competent
jurisdiction within the US.
Lexington obtained facultative reinsurance for
part of this risk from AGF Insurance Limited
( AGF ) and other insurers in the London market
for whom WASA International Insurance
Company Limited ( WASA ) was the successor
in interest (the reinsurance contract ). The
reinsurance contract did not include express
clauses in relation to governing law and
jurisdiction. As it was placed on the London
market by London brokers using London forms
it was held to have been governed by English
law, and therefore also subject to English
jurisdiction.
The reinsurance contract included a 'full
reinsurance clause', which stated:
warranted same gross rate, terms and
conditions as and to follow the settlements
of [Lexington]
Between 1942 and 1986, Alcoa suffered
damage to numerous of its manufacturing sites
in the US through contamination by waste
and pollutants. In the early 1990s, the US
Environmental Protection Agency required Alcoa
to clean up the pollution at many of those sites.
Alcoa sought to recover its clean-up costs from
various insurers including Lexington.
THE DISPUTE
UNDER THE
ORIGINAL
INSURANCE
CONTRACT
Alcoa commenced proceedings against
Lexington and other insurers in the Superior
Court of Washington State, seeking to recover
clean-up costs for a number of sites. The
Superior Court jury found that damage had
occurred to various sites during the period of
cover under the original insurance contract.
However, the jury was unable to determine an
appropriate basis for apportioning the clean-up
costs related to contamination occurring during
particular periods.
The trial judge, Judge Kathleen Learned,
applying Pennsylvania law, held that 'as a
matter of law' the contamination of Alcoa's
sites had occurred by a linear process and was
divisible. Her Honour held that the clean-up
costs could be apportioned on that basis.
However, Judge Learned's decision was
overturned on appeal to the Washington State
Supreme Court. The Supreme Court held that as
damage had occurred during the period of cover
under the original insurance contract, cover
under that policy had been triggered. As there
was no exclusion in relation to damage occurring
outside of the period of cover, Lexington was
liable for all of the clean-up costs at those sites.
The matter was remitted to the Superior Court.
However, Lexington entered into a settlement
with Alcoa on the basis of the Supreme Court's
decision, under which it agreed to pay Alcoa in
excess of US $100 million.
THE DISPUTE
UNDER THE
REINSURANCE
CONTRACT
Lexington sought to recover part of the amount
paid under the settlement agreement from AGF
and WASA, which commenced proceedings in
the High Court in London seeking a declaration
that they were not liable to indemnify Lexington
under the reinsurance contract. While the
reinsurance contract was placed before the
European Convention on the Law Applicable to
Contractual Obligations (the Rome Convention )
came into force, it was common ground that on
common law principles the reinsurance contract
was governed by English law, having been
placed on the London market by London brokers
using London market forms.
In the Commercial Court, Justice Simon
followed the decisions of the Court of Appeal in
Tommey v Eagle Star [1994] 1 Lloyd's Rep 516
and British Dominion General Insurance v Duder
[1915] 2 KB 394 and held that reinsurance
was not a species of liability insurance. Rather,
the affect of the full reinsurance clause was to
incorporate the subject matter of the original
insurance contract into the reinsurance contract.
The subject matter thus incorporated was
damage to Alcoa's property occurring during the
period of cover, not damage occurring outside
that period, which Judge Learned had held was
separate. His Honour held further that there
was nothing about the inclusion of a follow-the-
settlements clause in the reinsurance contract
or the presumption of back-to-back cover, which
could displace the period clause. Justice Simon
regarded the period clause as fundamental
to the bargain made by Lexington with its
reinsurers.
In reaching this conclusion, Justice Simon
distinguished the decision of the House of Lords
in Forsikringsaktieselskapet Vesta v Butcher
[1989] AC 852 and affi rmed the orthodox
position that the original insurance contract and
the reinsurance contract, though 'back to back',
were separate contracts, each to be construed
according to its own governing law. His Honour
dismissed the construction given to the original
insurance contract by the Washington State
Supreme Court as 'back to front'.
THE DECISION
IN VESTA V
BUTCHER AND
THE POSITION
OF AUSTRALIAN
REINSUREDS
Prior to the decision in WASA v Lexington ,
Australian insurers with reinsurance contracts
governed by English law would no doubt have
assumed that they would be able to rely upon
the decision in Vesta v Butche r, where terms
were directly incorporated into their reinsurance
contracts (which would be construed according
to English common law principles) from
insurance contracts they had underwritten (to
which the Insurance Contracts Act 1986 (Cth)
would apply). In many cases, such terms may
have had a limited or different effect as a result
of the application of the Insurance Contracts Act
to that which they would have at common law.
In Vetsa v Butcher , a Norwegian fi sh farmer
insured its farm with Vesta, a local insurer,
under an insurance contract governed by
Norwegian law. The insurance contract included
a condition requiring the insured to maintain a
24-hour watch over the farm. The insured did
not comply with that condition. In September
1978, a severe storm struck the farm, cages
were destroyed and many fi sh were lost.
However, even if the insured had complied with
the 24-hour-watch condition, it could not have
prevented or mitigated the loss. Norwegian law
included a provision similar in affect to s54 of
the Insurance Contracts Act, which precluded
Vesta from refusing to pay the claim on the
basis that the insured had not complied with the
24-hour-watch condition. Vesta settled with the
insured on that basis.
Vesta was reinsured by Lloyd's underwriters
under a reinsurance contract governed by
English law. That contract included a full
reinsurance clause similar to the one in WASA
v Lexington . The reinsurers argued that the
position under Norwegian law did not preclude
them from relying upon the breach of the 24-
hour-watch condition (as incorporated into the
reinsurance contract and as construed under
English law) to refuse to indemnify Vesta.
The House of Lords held that while the
reinsurance contract was a separate contract
governed by English law, the relevant Norwegian
law provision was well known in the London
market, and the reinsurers were deemed to have
agreed to the incorporation of the 24-hour-watch
condition into the reinsurance contract on the
basis that it would be construed so as to have
the same effect as under Norwegian law.
Australian reinsureds under reinsurance
contracts governed by English law could
probably still expect to rely upon Vesta v
Butcher in similar circumstances, ie where
under original insurance contracts governed by
Australian law, s54 of the Insurance Contracts
Act results in a similar position to that faced by
the reinsured in Vesta . However, they should be
aware that in WASA v Lexington , Justice Simon
distinguished Vesta v Butcher on the basis that
the decision of the Washington State Supreme
Court was not based on any well-known principle
of US law, but on its own strained construction
of the original insurance contract.
CONTACTS
www.aar.com.au
Michael Quinlan
Partner, Sydney
Ph: +61 2 9230 4411
Michael.Quinlan@aar.com.au
Andrew Buchanan
Partner, Brisbane
Ph: +61 7 3334 3244
Andrew.Buchanan@aar.com.au
Jenny Thornton
Partner, Perth
Ph: +61 8 9488 3805
Jenny .Thornton@aar.com.au
Louise Jenkins
Partner, Melbourne
Ph: +61 3 9613 8785
Louise.Jenkins@aar.com.au
Simon McConnell
Partner, Hong Kong
Ph: +852 2840 1202
Simon.McConnell@aar.com.au
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COMMENT
WASA v Lexington should serve as a warning
to Australian insurers who are reinsured under
contracts which are, or maybe, governed by
English law. As Australian courts extend the
operation of the Insurance Contracts Act in ways
that appear to undermine more 'fundamental'
terms of insurance contracts, as they have
arguably done in decisions such as FAI General
Insurance Co Limited v Australian Hospital
Care Pty Limited (2001) 204 CLR 641, the
willingness of other courts to follow may be
tested with adverse consequences for Australian
reinsureds.
The decision confi rms the position under
English law, that the direct incorporation of
terms and conditions from an original insurance
contract into a reinsurance contract does not
alter the separate nature of the two contracts.
Each must be construed according to its own
governing law and a reinsured cannot assume
that courts in different jurisdictions will always
reach consistent conclusions as to the affect
of a particular term. The position is the same
under Australian law. However, in assessing the
legal affect of terms and conditions incorporated
directly into reinsurance contracts from original
insurance contracts, even according to common
law principles (which apply to reinsurance
inmost states), Australian courts are more likely
to be comfortable with a construction that is
consistent with the affect of the Insurance
Contracts Act on the corresponding term in the
original insurance.
In WASA v Lexington , Justice Simon
reaffi rmed a view long held by English courts,
that reinsurance is not a species of liability
insurance, but an insurance of the same subject
matter as the original insurance. If the decision
on this point is followed in Australia it could
potentially affect the application of New South
Wales state insurance legislation to reinsurance
contracts. If correct, it may mean that the
subject matter of life and marine reinsurance
contracts is life and marine insurance (as
opposed to the liabilities of life and marine
insurers), and that such contracts are excluded
from the operation of the remedial provisions
of the Insurance Act 1902 (NSW), pursuant to
regulations made under s25 of that Act.
Finally, if it is accepted that reinsurance is not
itself a species of liability insurance, then s6 of
the Law Reform (Miscellaneous Provisions) Act
1946 (NSW) may not be capable of applying
to reinsurance contracts. Section 6 provides a
mechanism by which a third-party claimant may
enforce directly against an insurer a statutory
charge over insurance monies payable in respect
of the liability of an insured to that third party.
However, s6 applies only to insurance contracts
indemnifying an insured against 'a liability to
pay damages or compensation'.
download THE WASA V LEXINGTON DECISION: IMPLICATIONS FOR AUSTRALIAN REINSUREDS
