Film finance: the legal issues

The film finance litigation has generated two important decisions from the Court of Appeal (both by Lord Justice Rix), which were given recently. A summary of each of these is set out below:

Incorporation and effect of warranties of underlying direct insurance into facultative reinsurance: HIH Casualty and General Insurance Ltd v. New Hampshire Insurance Co & others.

In the past, the courts have struggled with the concept of facultative reinsurances incorporating all the terms and conditions of the underlying direct insurance as often there are clauses in the direct policy that appear to make little sense in the reinsurance. The HIH v New Hampshire film financing case has illustrated the problems that can arise. In that case, the issue was whether the underlying direct insurance contained certain warranties, and if so, were they incorporated into the reinsurance. The facts are as follows.

An American film production company, 7.23 Productions, sought funding from the Law Debenture Trust Corporation Limited in the Channel Islands for a slate of 6 films, of which only 5 were actually made. Security for the loan was provided by way of an insurance policy under which Insurers would pay out in respect of any shortfall between the monies drawn down on the loan and the monies collected in as a result of sales of the various productions on a specified date (2 years after inception of the policy). The films were duly made and failed to achieve anything like the sales originally envisaged. The lending bank, therefore, made a claim under its insurance. Insurers paid out some USD 31 million and sought to recover contributions of up to 80 percent from their reinsurers. Reinsurers refused to pay out. One of the preliminary issues that were considered was whether the number of films to be made constituted a warranty and, if the answer was yes, whether that warranty was incorporated into the underlying insurance and/or the reinsurance.

In the Court of Appeal, Rix LJ considered whether the six film term was a term of the original slip policy, and concluded that it was because of the need for the revenues of each film to cross-collateralise with the revenues of each other film. Having regard to the financial structure of the deal as a whole the insurance policy could only make sense in the context of the policy covering a specific number of films. This was because the sum insured reflected the combined cost of producing the entire slate of 6 films and the premium that was stated to be a percentage of the overall costs.

Having reached the conclusion that the six film term was a term of the slip policy, the policy wording and the reinsurance slip policy, Lord Justice Rix's took the view that the grounds for holding it to be a warranty were very strong. The absence of the word "warranty" in the wording was not conclusive. The six film term went to the root of the transaction and had a material bearing on the risk of loss. Given that it would not be possible to assess any shortfall in revenue to any particular missing films, it was not possible to compensate the reinsurers by an award of damages. The position is the same whether the six film term is seen as arising out of the original slip policy itself, or out of the wording or out of a combination of the two, and whether the term is viewed from the point of view of the original insurance or the reinsurance. On that basis, the Reinsurers were not liable to pay the losses as the six film warranty had been breached.

HIH Casualty and General Insurance Limited & Others v. Chase Manhattan Bank & Others: Exclusion clauses

The second film finance decision of the Court of Appeal is an abject lesson in what can be excluded if exclusion clauses are drafted carefully and tightly.

The essence of the film finance insurance was that the parties providing the syndicated finance for the production of a film, represented by the Chase Manhattan Bank ("Chase"), stipulated for and received the security of an insurance which was designed to pay, up to the maximum of the sum insured, if for any reason the revenues generated by the film within a certain period were insufficient to repay the loan finance plus associated expenses.

The three policies with which this action is concerned are known as 'Time Variable Contingency' ('TVC') insurance. Since Chase's role was limited and Heaths' did the broking, the policies contained a 'Truth of Statement' clause. The purpose of such a clause was to distance Chase from responsibility for the placing of the insurance. The Court of Appeal had to determine the extent to which that clause did or did not operate successfully to protect Chase from complaints of misrepresentation and non-disclosure in the placing of the policies that the insurers alleged against Heaths as Chases' agent to insure. No complaints were made against Chase personally. The misrepresentations and non-disclosures alleged against Heaths were all said to have been made either fraudulently or negligently.

One of the major issues that Mr Justice Rix (who gave the only substantive judgment) had to consider was whether it is possible to exclude liability for a broker's fraud. There is of course a rule of law founded in public policy that prevents the exclusion of liability for one's own fraud. He decided that it is possible, providing that the clause is sufficiently clear, and the contract partner is properly warned of the extent of the exclusion sought. It may be different however, if the Insured is in some way implicated in the broker's fraud or if the exclusion is itself part of some fraudulent scheme.

It was decided that the Truth of Statement Clause covered and excluded negligent as well as innocent misrepresentation and non-disclosure.

If the Insured is excused the duty of disclosure, because of waiver, the waiver negatives materiality and the waiver applies to the broker too. Mr Justice Aikens (the Judge in the Court below) had already held that where a duty of disclosure (of the Insured, or his agent) had been excluded or waived altogether, then it would not matter if non-disclosure had been deliberate or fraudulent.

The relevant phrase of the Truth of Statement Clause referred to the Insured having no liability for any "information" provided. Although he decided that this referred to misrepresentation and misinformation and that an exclusion of such liability must involve an exclusion of negligence, this was not enough to exclude liability for fraud.

The Judge also had to consider whether the exclusion of the right of avoidance in the Truth of Statement Clause extended to fraudulent or deliberate concealment. The law distinguishes between innocent, negligent and fraudulent misrepresentation. However, such a distinction is not made in relation to non-disclosure. Mr Justice Rix did not think that, in the absence of express language, any line is to be drawn between the various possible clauses of or motives for non-disclosure (thereby agreeing with Mr Justice Aikens – see above). To the extent that fraud would have given a remedy under the common law, it had not been excluded by the Truth of Statement clause. In such a case, the Insurers can rescind for fraudulent misrepresentation and/or claim damages in the tort of deceit under the common law, even though any remedy pursuant to the duty of good faith may have been excluded.

This decision goes to show to what extent liability for misrepresentations and non-disclosures can be excluded. However, the more important lesson to be learnt is that careful consideration should be given to the policy wording used to ensure that it is as specific as possible. If an Insured wishes to exclude its liability for the fraudulent activities of its agent then the policy wording must state this explicitly.

It is not known whether an appeal against this decision to the House of Lords will be made.

For further information, please contact Andrew Symons by e-mail at [email protected] or by telephone on +44 (0)20 7367 3044.