Court of Appeal decision on dangers of using standard clauses in insurance contracts

The recent Court of Appeal decision of Dornoch Ltd and others v Royal and Sun Alliance Insurance Plc [2005] EWCA Civ 238 is a useful reminder of the pitfalls and dangers of using standard clauses in circumstances where they are wholly inappropriate to the type of cover being contemplated by relevant parties.

In this case, Royal Sun Alliance ("RSA") insured a global consumer products company ("the Insured") under a Master Subscription policy for risks that included Directors' and officers' (D&O) liability. In turn RSA reinsured the policy with a number of Lloyd's Syndicates ("the Syndicates"). The reinsurance slip contained a claims control clause with the following terms:

"Notwithstanding anything herein contained to the contrary, it is a condition precedent to any liability under this policy that:

1. The Reinsured [RSA] shall upon knowledge of any loss or losses which may give rise to a claim under this policy, advise the Underwriters [the Syndicates] thereof by cable within 72 hours;
2. The Reinsured shall furnish the Underwriters with all information available respecting such loss or losses and the Underwriters shall have the right to appoint adjusters, assessors and/or surveyors and to control all negotiations, adjustments and settlements in connection with such loss or losses."

The litigation arose following allegations in US proceedings in which it was claimed that the Insured and its directors had made false financial statements about their affairs, causing investors to buy their shares at artificially inflated prices. RSA knew of the existence of these complaints by 12th December 2000, received copies of the complaint documentation on 30th December 2000, but did not notify the Syndicates about such matters until 19th January 2001.

The Syndicates claimed they had no liability to indemnify RSA because under the terms of the reinsurance they should have been informed of the complaints within 72 hours of 12th December 2000.

The issues before the High Court and the Court of Appeal centred upon the interpretation of the Claims Control clause and specifically the meaning of the word "loss" (in the Claims Control clause) and whether RSA had knowledge of the relevant loss more than 72 hours before 19th January 2001.

The Court of Appeal rejected the Syndicates' claims and held that RSA could recover under its reinsurance policy for these claims notwithstanding the existence of the Claims Control clause, because:

1. "Loss" in the Claims Control clause meant an actual loss as opposed to an alleged loss or claim.
2. Before RSA was obliged to notify the Syndicates:
   1. there had to be an actual loss
   2. the loss had to be a loss that may give rise to a claim on the reinsurance, and
   3. RSA had to have actual knowledge of that actual loss.
3. RSA had never known of any "Loss" at any relevant time prior to 19th January 2001 because the loss of the third party US complainants had never been established as a fact in US proceedings.

Of interest is what the Court of Appeal said about the use of the Claims Control clause in the reinsurance policy in issue; in the form drafted they considered it wholly unsuitable for use in the reinsurance of RSA's exposure in issue. The Court noted that reference to "loss" and to "adjusters, assessors and/or surveyors" pointed to the clause being drafted with casualty risks in mind rather than liability losses such as D&O risks. As Lord Justice Longmore commented:

"It is worth pointing out at the outset what an unfortunate dispute this is. There is a complete mismatch between the original insurance on the one hand which is on a "claims made" basis and requires notification to insurers of "claims" and the Claims Control clause on the other hand which depends, for notification purposes, on "knowledge" of "loss" on the part of RSA."

Also of interest and a reminder to those who find that unsuitable wording is used in policies was the Court of Appeal's refusal to rewrite the Claims Control clause or to give it a purposive or business common sense construction so that it had a relevance and impact to the reinsured risk in issue. This was not least because the Court was mindful that by doing so it would enable a party to take advantage of a clause which would have draconian consequences for the other party if breached. In any event it could not be sure that both parties intended to live by a clause that had a 72-hour notice period, or which made compliance a condition precedent to any liability on RSA's part.

Clearly the case is a useful reminder that underwriters need to think carefully about the relevance and suitability of what might be considered standard and tried and tested clauses (the reference to notification by 'cable' in the clause suggests a clause that had been in existence for many years beforehand): furthermore one cannot expect the Courts to intervene and rewrite and make sense of clauses where they are by their nature extremely adverse to one party to the relevant contract. At the very least, using what may transpire to be unsuitable clauses risks parties becoming embroiled in costly litigation.

Finally, the Court of Appeal also dispensed another tip which the market would be wise to heed when drafting and agreeing claims control clauses in reinsurance contracts: Longmore LJ pointed out that "knowledge" is or can be an elusive concept because in any given case a party to a contract may have difficulty in showing what another party "knows"; for purposes of clarity and certainty, such concepts should not be used in claims control clauses as the trigger for any requirements of notification to a liability insurer or reinsurer.