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Allens Arthur Robinson

Focus: Reinsurance and the Insurance Act 1902

22 April 2009

In brief: A successful appeal against a reinsurance arbitration has provided guidance on the interpretation of the NSW Insurance Act 1902. The recent decision is significant for all cedants and reinsurers whose contracts are subject to New South Wales law. Partner Michael Quinlan (view CV) and Senior Associate Mark Lindfield explain.

How does it affect you?

  • This is the first time that a court has interpreted and applied section 18B of the Insurance Act 1902 (NSW) in a reinsurance context.
  • The judgment emphasises the important distinction between terms of a policy that define the scope of its cover and terms that limit or exclude cover.
  • Reinsurers should carefully consider whether to continue to include arbitration clauses by default in their treaty wordings: the cost may be no less than litigation, the arbitrators may apply the law incorrectly and the result can be difficult to appeal.

Background

Toward the end of 1998, as HIH Winterthur Holdings Limited (HIH) proceeded with its takeover of FAI Insurances Limited (FAI), FAI's directors sought run-off cover to protect themselves from claims that might be made after the takeover arising from their pre-takeover actions as directors. They successfully arranged a seven year run-off directors' and officers' liability (D&O) policy, issued by GIO Insurance Limited, now known as Gordian Runoff Limited (Gordian).

At the same time, Gordian was negotiating a renewal of the reinsurance of its professional indemnity and D&O portfolios. As was usual industry practice, in the absence of an express term providing for the treaty covering underlying policies of greater than 12 months plus 'odd time', the expiring treaty covered underlying policies with a maximum term of 18 months. Gordian now sought reinsurers' agreement to reinsure multi-year D&O policies. Reinsurers agreed, stating that they would be prepared to reinsure underlying policies for up to three years in duration. Gordian did not inform reinsurers about the FAI policy.

In early 2001, Rodney Adler and other former directors of FAI notified Gordian of likely D&O claims against them. Gordian then notified its reinsurers of the FAI directors' claims for indemnity and sought confirmation that they would be covered by Gordian's D&O reinsurance treaties. The reinsurers responded that they would not be covered: the FAI policy provided cover for seven years but Gordian's reinsurance treaties did not cover underlying contracts longer than three years.

Gordian pressed its claim, stating that the terms of the placing slip, produced by its reinsurance brokers and stamped by reinsurers, did not contain an express term limiting underlying policies to a maximum of three years. Gordian asserted that it was entitled to reinsurance cover for underlying D&O policies of any duration, limited only by its own underwriting guidelines.

Reinsurers responded that they had made clear at all times that they were only prepared to cover underlying D&O policies with a term of up to three years. This was made clear during the negotiations between the parties and was reflected in the reinsurers' quotation slip, in Gordian's own correspondence stamped by reinsurers and later in a reinsurance treaty wording agreed to by Gordian's reinsurance broker.

The parties agreed to have their dispute resolved by arbitration, consistent with the manner in which reinsurers and cedants have traditionally sought to resolve their disputes. Gordian sought a declaration that the D&O reinsurance treaties would indemnify it for its liabilities under the D&O policy issued to the former FAI directors.

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The arbitration

In July 2008, the arbitration proceeded before a panel of three arbitrators selected by the parties.

Allens Arthur Robinson acted for the reinsurers.

The arbitrators found that in 1998 Gordian's expiring reinsurance treaty provided cover for underlying D&O policies with a term of up to 12 months (or 18 months in some cases) and that, on renewal, the reinsurers had agreed to an extension that covered underlying D&O policies of up to three years in duration.

The arbitrators ruled that Gordian's reinsurance treaties did not cover D&O policies that permitted claims to be made and notified to Gordian more than three years from inception. The FAI policy was such a policy.

However, that was not the end of the matter.

In 2006, the Supreme Court of New South Wales had determined that section 19 of the Insurance Act 1902 (NSW) applied to reinsurance.1 At the arbitration, Gordian sought to rely on two sections of the Insurance Act so as to compel its reinsurers to accept the D&O claims made on the FAI policy:

  • Section 18 of the Insurance Act which excuses an insured's failure to perform a term or condition of an insurance contract where the insurer is not prejudiced by that failure: Gordian argued that its failure to request that reinsurers specially accept the FAI policy could be excused by s18.
  • Section 18B of the Insurance Act which states that if an insurance policy excludes or limits the insurer's liability on the happening of particular events or the existence of particular circumstances, then the insured is nevertheless entitled to indemnity for a loss if those events or circumstances did not cause or contribute to the loss. Section 18B is subject to a proviso which is that it should not apply unless it would not be reasonable in all the circumstances to require the insurer to do so: Gordian argued that the seven year 'limitation' on underlying D&O policies did not cause or contribute to the claims made by the former FAI directors, because those claims were made and notified within the first three years of the underlying policy.

The arbitrators did not accept that s18 of the Insurance Act assisted Gordian. They did, however, accept that s18B applied. They found that the seven-year term of the FAI policy was a circumstance within the meaning of s18B that did not contribute to Gordian's loss because the claims against the former FAI directors were made within the first three years. In other words, the reinsurers agreed to cover policies issued for three years, the claim was made within three years, therefore the claim was covered, regardless of the fact that the policy on which the claim was made was not covered by the reinsurance treaty being of seven years' duration.

The reinsurers sought leave to appeal to the New South Wales Supreme Court from the arbitrators' decision, which was resisted by Gordian.

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The appeal

Before giving leave to appeal against an arbitration to which the Commercial Arbitration Act 1984 (NSW) applies, the New South Wales Supreme Court must be satisfied that, among other things, either:

  • there has been a manifest error on the face of the award; or
  • there is strong evidence of an error of law and the determination of the question of law may add, or may be likely to add, substantially to the certainty of commercial law.

Justice Einstein was satisfied that both of these tests were satisfied.

His Honour found that the arbitrators' interpretation of s18B of the Insurance Act contained clear errors and, as no other court had previously considered the application of s18B to reinsurance, it was important to clarify how that section operated.

The court ruled that the three contentious steps taken by the arbitrators were:

  • characterising the reinsurers agreement to extend the reinsurance cover to three year D&O policies as an 'exclusion' or 'limitation' within the meaning of s18B;
  • concluding that Gordian's loss was not caused or contributed to by the FAI directors' claims being made within the first three years; and
  • failing to apply the proviso to s18B in circumstances where it was not reasonable to require the reinsurers to indemnify Gordian.

His Honour ruled that the context of the facts of this case meant that to say cover was limited to underlying policies of up to three years was doing no more than describing the scope of cover: namely, what the parties agreed would actually be included. Section 18B, whether given its grammatical or natural sense, is concerned with policy limitations or exclusions triggered by particular events or circumstances and is not concerned with the underlying scope of cover. The scope of cover does not depend on the happening of events, the occurrence of circumstances or the triggering of anything.

According to the court, the arbitrators correctly found that the parties had agreed the scope of cover and, at Gordian's express request, had extended the scope of cover under the treaty expiring in 1998. However, the court found that by characterising this scope of cover as an exclusion or limitation, the arbitrators had incorrectly characterised the agreement as one which contained the elements required by s18B.

Justice Einstein rejected Gordian's contention that the reinsurers had not established that the arbitrators were obviously wrong.

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Comment

This decision is an important one for the reinsurance industry because it is the first judicial interpretation of s18B of the Insurance Act in a reinsurance context.

The court has made clear that while s18B may offer a remedy to cedants under reinsurance treaties, it does not have the effect of extending the scope of cover agreed between the cedant and the reinsurer.

The decision is also significant because it provides useful guidance on when the thresholds to permit an appeal under the Commercial Arbitration Act will be met.

Finally, the outcome highlights the importance for reinsurers to consider carefully whether they should continue to use arbitration clauses in their reinsurance contracts. The present dispute involved senior counsel being briefed on both sides over a very long period and ultimately produced an arbitral award that the court found was 'clearly wrong'. The outcome of the appeal was the right one for reinsurers but raises the question of whether reinsurers should agree to arbitrate all disputes under reinsurance treaties. Alternatively, reinsurers might consider whether they should dispense with arbitration clauses, or limit their operation to the resolution of disputes that do not involve questions of law.

Footnotes
  1. HIH Casualty and General Insurance Limited (In Liquidation) v R J Wallace and Ors [2006] NSWSC 1150.

Published 22 April 2009

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