Legal Updates

Commercial Law – Insurance Law – Knowledge of Claim – Re-Insurers

In the case of AIG Europe (Ireland) Ltd v Faraday Capital Ltd [2007], the claimant insurer provided a directors and officers policy of insurance (“the Underlying Policy”) to an Irish company. The Irish company was subsequently merged with a company from the United States. The Underlying Policy was accordingly converted into a ‘run-off policy’ which covered risks arising out of claims made in respect of wrongful acts before the merger.

In November 2002, the management of the newly merged enterprise announced that it was going to restate the financial statements of the company for a period of three-and-a-half years prior to the merger. However, on the day of that announcement, the company's share price dropped by a third.

Class actions were brought in the United States against the assured company’s directors. The class actions alleged that as a result of financial statements (namely the company accounts), the value of the company shares had been artificially inflated beyond their true worth.

Notification of those claims was given to the insurer in December 2002 (as required by the Underlying policy) within 30 days of claims being notified to the insured. However, the insurer did not pass the notice on to the defendant re-insurers within the same time period.

After a substantial period of time had passed, the claims were settled in March 2004. Within 30 days of that settlement, the insurer notified the re-insurers. The insurer paid out under the Underlying Policy and subsequently sought to recover monies from the re-insurer. The re-insurer refused to pay, and accordingly the insurer issued proceedings.

The dispute in this case centred upon a ‘claims co-operation clause’ in the reinsurance. That clause provided as follows:

“... It is a condition precedent to liability under this policy that:

(a) The re-insured shall upon knowledge of any loss or losses which may give rise to a claim, advise the re-insurers thereof as soon as is reasonably practicable and in any event within 30 days ...”

The re-insurer argued that the losses had not been notified within 30 days as required by the clause.

The High Court ruled that the word “loss” in the ‘claims co-operation clause’ could not mean an alleged or potential loss, and that a claimant could not be said to have suffered a loss until it had been proven that he had bought shares at a value which was inflated due to the default of the company's directors or officers in carrying out their duties.

The High Court accordingly concluded that the loss referred to in the clause was the loss of the claimants attributable to the acts or defaults of the insured, for which there was cover under the Underlying Policy. Therefore, since it was not proved that any fall in the value of the shares was attributable to any act or default of the company's directors until the underlying insured settled the claim in March 2004, the notice to the re-insurers of April 2004 was within the 30 days as specified in the clause.

Therefore, it was decided that the insurer could recover from the re-insurers.

The re-insurers appealed to the Court of Appeal against this decision arguing that although “loss” meant “actual loss” rather than “alleged loss”, there had been a loss which might give rise to a claim once the share price fell as a result of the insured's announcement in November 2002, that it intended to restate the company's accounts.

The insurer argued that there could be no loss until it was established that the claimants had purchased their shares at an artificially high price. That fact was not known to the insurer until the insured had settled the claims in March 2004. The insurer further pointed out that the share price had in fact risen subsequent to the fall in November 2002.

The appeal was allowed. It was held that:

§        On the facts of the case there had been a positive event which covered the substantive drop in the share price due to the announcement in November 2002. To say that the one third drop in share price was (or might have been) coincidence or market fluctuation would be to ignore the obvious. That conclusion was not offset by showing that the share price had later risen as there was still an undoubted loss which occurred in November 2002.

§        The loss envisaged in the clause was not necessarily the loss which would in due course constitute the claim.

§        What the re-insured needed to know was “any loss or losses which may give rise to a claim”.

§        The sharp fall in the share price in November 2002 was from the shareholder's point of view a “loss”. Accordingly it was a loss which “might” have given rise to a claim. On the facts of the case it actually gave rise to numerous claims which the insured in due course settled for what seemed good reasons.

§        It was also true to say that that “loss which may give rise to a claim” was “known” to the insurer.

§        They knew when they were notified in late December 2002 that claims had been made against them. There were no other reasons why they would have been notified within 30 days of the said date.

§        There was every reason why the insurers should have notified the re-insurers if the clause was going to work as intended. Therefore the insurers had known of a loss which might have given rise to a claim much earlier than 30 days before they actually notified re-insurers in April 2004. They would have known soon after they were themselves notified of the claim in December 2002. Accordingly, judgment was granted in favour of the re-insurer on that issue.

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© RT COOPERS, 2008. This Briefing Note does not provide a comprehensive or complete statement of the law relating to the issues discussed nor does it constitute legal advice. It is intended only to highlight general issues. Specialist legal advice should always be sought in relation to particular circumstances.


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