AIG Europe (Ireland) Ltd v Faraday Capital Ltd

Under a standard-form claims co-operation clause in liability reinsurance, “loss” means actual loss rather than an alleged or potential loss. It need not, however, be the loss ultimately quantified in the underlying claim. A sharp fall in share value following an announcement of accounting restatement may itself be a loss which may give rise to a claim. The reinsured need not know that the loss was attributable to insured wrongdoing or recoverable under the underlying policy before notification is required. Whether knowledge must be subjective or objective remains open where actual knowledge is established. Earlier authority was distinguished because the present case involved a positive event capable of triggering the loss.

AIG sought indemnity from Faraday under a liability reinsurance policy after shareholder class actions against Smartforce and its directors were settled for $30.5 million. The reinsurance contained a claims co-operation clause making notification of any loss which might give rise to a claim a condition precedent. Smartforce announced that its accounts would be restated, and its share price fell sharply, but AIG did not notify Faraday until shortly before the settlement.

Morison J held that no loss was established until the underlying claims were settled and gave judgment for AIG. Faraday appealed. The central issue was whether an actual loss existed, and was known to AIG, before liability and attribution had been finally established.

Appeal allowed. Lord Justice Longmore delivered the leading judgment. Lord Justices Thomas and Dyson agreed. Judgment was entered for Faraday.

1. The claims co-operation clause required notification of any actual loss which might give rise to a claim. “Loss” did not mean an alleged or potential loss. It did not necessarily mean the loss that would ultimately constitute the underlying claim.
2. The earlier decision in Royal Sun Alliance v Dornoch [2005] EWCA Civ 238 [2005] Lloyds IR Rep 544 was distinguishable. In that case there was no event, apart from alleged artificial inflation, which could trigger the loss. Here, Smartforce’s announcement that its accounts would be restated was a positive event followed by a fall of about one-third in the share price. Treating that fall as coincidence or ordinary market fluctuation would ignore the obvious. Its later recovery did not erase the loss.
3. From the shareholders’ perspective, the fall was a loss which might give rise to a claim. AIG knew of that loss when it was notified that claims had been made against Smartforce in December 2002. The clause did not require AIG to know that the loss was attributable to defaults by Smartforce’s officers covered by the underlying policy. Morison J’s contrary conclusion had no warrant in the wording and was inconsistent with the concept of a loss which might give rise to a claim.
4. The court did not decide whether knowledge under the clause was subjective or objective. That question was unnecessary because AIG knew of the relevant loss on the facts.
5. Faraday’s alternative construction, based on the negotiations, failed. The documents did not establish an agreement that “loss” included alleged loss. They arguably showed an agreement to notify reinsurers when AIG received notification from its insured. If such an agreement had been omitted from the policy by mistake, rectification might have been available, but no rectification claim had been brought.

1. Court of Appeal (Civil Division) [2007] EWCA Civ 1208 (22 November 2007): Faraday’s appeal allowed and judgment entered for the appellant.
2. High Court of Justice, Queen’s Bench Division, Commercial Court (Morison J, 2004 Folio 1056): held that the relevant loss was not established until settlement of the underlying shareholder claims and gave judgment for AIG. The Court of Appeal disagreed.