Lexington Insurance Co v AGF Insurance Ltd

The House of Lords allowed the appeal and restored the judgment of Simon J. The court held that a proportional facultative reinsurance is a separate contract governed by its chosen law (here English law) and, absent clear terms to the contrary, its cover must be construed according to that law. A reinsurance in respect of property on a "losses occurring during" basis will, under English law, cover only damage occurring during the stated period of cover. "Full reinsurance" or "follow the settlements" clauses do not, of themselves, import into an English-law reinsurance the effect of a foreign court's interpretation of the underlying primary insurance when that interpretation produces a materially different temporal scope of cover.

The Lords emphasised the strong but rebuttable commercial presumption that reinsurance is "back-to-back" with the primary insurance; however, where the reinsurance is governed by a different law and that law gives clear temporal effect to the reinsurance period, reinsurers are not to be held liable for liabilities that, under the governing law of the reinsurance, fall outside the policy period. The court distinguished Vesta and Catatumbo on their facts.

The appeals concerned whether two London reinsurers (AGF and Wasa), who reinsure Lexington for a 36-month period from 1 July 1977 to 1 July 1980 under English law, were liable to contribute to a multi-million dollar settlement that Lexington had paid to its insured (Alcoa) for long-running environmental contamination. The underlying DIC insurance (issued to Alcoa) was interpreted by the Supreme Court of Washington, applying Pennsylvania law, to cover remediation costs attributable to contamination that had occurred both before and after the policy period provided some contamination "manifested" itself during the policy period. Lexington paid and settled for US$103 million and sought contribution from its reinsurers for their respective proportions.

Nature of the claim: Lexington sought indemnity under proportional facultative reinsurance for amounts it had paid in settlement of Alcoa's claims under the primary DIC policy.

Issues framed:

• Whether the reinsurance, governed by English law, should be construed so as to mirror the Washington Supreme Court's interpretation of the primary insurance (i.e. to respond to loss manifesting in the reinsurance period even if substantial damage occurred before or after that period);
• The legal effect of "full reinsurance" and "follow the settlements" clauses where the underlying insurance and reinsurance are governed by different laws;
• Whether any special circumstances (including market practice, the terms of the slip and foreseeability of the Washington decision) meant the reinsurers must respond despite the differing governing law.

Reasoning and disposition: The House held that the reinsurance is an independent contract whose terms are to be construed under its governing law (English law). Under English principles a time-limited occurrence policy covers only damage occurring during the stated period. The Lords accepted the strong commercial presumption that reinsurance is intended to be back-to-back with the underlying insurance but held that this presumption does not override clear and ordinary English-law meanings of the reinsurance wording. The Washington Supreme Court’s application of Pennsylvania law - reached in complex multi-policy litigation applying American choice-of-law rules - could not be treated as a predictable or binding "legal dictionary" for construing the English-law reinsurance. Vesta and Catatumbo were distinguished: those cases involved identifiable foreign legal effects at the time of placement and were therefore not analogous. Accordingly the appeals were allowed and the trial judge's decision (Simon J) restored.

Appeal allowed. The House held that the reinsurance contracts, governed by English law, must be construed under English principles and do not, on their true construction, cover pre-existing or post-expiry property damage merely because a foreign court (applying a different governing law to the primary policy) held the primary insurer liable. The "full reinsurance" / "follow the settlements" concepts do not import into an English-law reinsurance a materially different temporal scope derived from another jurisdiction where that was not a predictable or incorporated legal meaning.

On appeal from the Court of Appeal [2008] EWCA Civ 150; the House of Lords allowed the appeal and restored the judgment of Simon J at first instance.