Oil on troubled waters

Oil on troubled waters

Fifteen years after the Exxon Valdez grounding and fourteen years after Iraq’s invasion of Kuwait, the re/insurance community is still facing legal issues arising out of these events. By Andrew Symons and Richard Tosh.

It is well documented that the unprecedented run of catastrophe losses in 1988 to 1990 caused severe losses to the global re/insurance market. Following the worst storms to hit the UK and Europe for over 100 years (1987) and the destruction of a major North Sea platform (Piper Alpha, in 1988), the market had started to anticipate hardening conditions over subsequent years. But then came the worst year of all, 1989, with the Atlantic Richfield (“ARCO”) loss arising from a pipeline explosion which damaged an oil platform in South Passfield, Louisianna(March), the grounding of the Exxon Valdez which led to the world’s worst environmental disaster (also March), Hurricane Hugo devastating the US East coast (September), and the Phillips Petroleum petro-chemical plant explosion (October). Just as it appeared that matters could not get any worse for the retrocession market, in 1990 Saddam Hussein invaded Kuwait and snatched the Kuwait Airways Corporation (KAC)’s fleet of aircraft along with a large amount of equipment and spares, causing an insured loss of over $500m.

Each of these catastrophes resulted in a gross loss in excess of $500m and in most cases in excess of $1bn. In turn, the losses to the retrocession market were magnified many times; in the case of Piper Alpha this was estimated to have resulted in a loss of $15bn, compared to a gross loss to the direct market of approximately $1.5bn. A large proportion of these losses now fall on the run-off market. Two of the losses, the loss of the KAC aircraft and spares and the losses arising from the grounding of the Exxon Valdez, have caused particular legal difficulties for the run-off market.

Aggregation of losses: how many events?

The House of Lords decided in Hill v M&G (which was an application by some of KAC’s reinsurers to recover from their retrocessionaires by way of summary judgment their share of the $300m interim payment they had paid to KAC) that there were arguable issues as to whether the KAC aircraft and spares were losses arising out of one or more events, so a full trial was needed. The Hill v M&G case never reached trial, thus the aggregation issues remained outstanding. Although the Commercial Court held in KAC v KIC (the coverage dispute under the primary War Risks policy) that the KAC aircraft and spares were lost out of one occurrence - the invasion on 2 August 1990 - and not merely when the aircraft were flown away, so far as excess of loss reinsurers were concerned the findings in relation to the war risks policy were not binding on them. An issue that remained unresolved was whether the loss of the 15 KAC aircraft and spares and the one British Airways aircraft arose out of one or more events.

In order to resolve these issues, approximately 30 participants in the London excess of loss reinsurance market agreed to be bound by the outcome of a test case that was heard in the London Commercial Court, examining the one or more events issue. The court decided that although the KAC aircraft and spares were removed over the course of weeks after the invasion, these losses arose out of one event and thus could be aggregated for the purpose of making excess of loss recoveries.

Following the ‘unities’ test laid down by Rix J in the KAC v KIC proceedings, the court held that there was unity of intent on the part of the Iraqis both to capture the aircraft and spares and to deprive KAC of them permanently. There was also unity of time: the Iraqis’ objective was achieved when the airport was captured, and there was unity of cause, which was the invasion. There was also unity of location as all the aircraft and spares were located at the airport.

As far as the BA aircraft was concerned, the court held that it was not lost as a result of the invasion and capture of the airport. On the evidence, there was no intention by the Iraqis to permanently deprive BA of the aircraft, so there was no unity of intent. It was not clear what the Iraqis’ intentions were in relation to the plane as it simply remained stranded at Kuwait Airport from the time of the invasion, unlike the KAC aircraft that were flown away, so there was no unity of time. The court also found that there was no unity of cause because the BA aircraft was not, in common sense terms, lost until the eventual destruction of the aircraft some six months later during Operation Desert Storm.

The Court of Appeal commented that although it had been referred to the relevant case law, the question that it had to consider was one of impression on the facts. T Nevertheless the practical consequence to the run-off market was that the overwhelming majority (98%)of the Kuwait losses were properly aggregated as arising out of one event.

Exxon Valdez – follow the settlements

In contrast to the aggregation issues arising in Kuwait, the underwriters of Exxon’s global corporate excess policy (which provided coverage of over $800m), were sued in Texas by Exxon for up to $5bn in respect of the costs Exxon had spent in cleaning up and removing the oil debris, punitive damages, interest and costs. Faced with the prospect of a jury trial in Texas and having already lost the first part of the claim under section III of the policy, the primary insurers settled all of Exxon’s claims under their policy for $780m.

In 1997, in Commercial Union v NRG Victory, some of the primary insurers sued their reinsurers for their share of the settlement. The reinsurers argued that the insurers were not liable to Exxon under the primary policy and deployed some of the defences that insurers had raised in the Texas proceedings against Exxon. The insurers sought to argue that the settlements were reasonable and businesslike and therefore reinsurers were liable under the follow the settlements clause. However, this clause also required the reinsured to prove that the settlement fell within the terms of the underlying direct policy as well as the reinsurance.

The Court of Appeal determined that this provision required the reinsured to prove that they were under a legal liability under the primary policy. A judgment awarded against the insurer was sufficient to establish that the insurers were liable provided that:

• the judgment was made by a court of competent jurisdiction;
• the judgment had not been obtained in the foreign court in breach of an exclusive jurisdiction clause;
• the insurers had taken all proper defences (and therefore these had been rejected); and
• the judgment was not manifestly perverse.

The insurers put forward evidence from the Texan lawyers saying, in effect, that although there were arguable coverage issues under the primary policy, the fact that the case was to be heard by a Texas jury, which is often unfavourable to insurers and biased against them when insurers are arguing for a limitation of cover, meant that underwriters would lose. The lawyers had therefore recommended settlement.

The Court of Appeal did not accept that this was sufficient to show that the insurers were legally liable under the policy, as the recommendation to settle appeared to be based on the lawyers’ prediction of human behaviour (i.e. the Texas jury) rather than any legal grounds. As a result, the court refused permission for summary judgment and directed that the matter had to go to a full trial where, in effect, the issues relating to the construction and coverage under the policy would effectively be re-argued in order to show that the insurers were under a legal liability to the insured. Although the insurers settled with Exxon, the dispute switched to being one between the insurers and their reinsurers.

As a result of this decision, most, if not all, of the LMX market stopped paying Exxon claims or paid under a reservation of rights. However, there are ongoing proceedings in the London Commercial Court, which will effectively determine these coverage/liability issues, and determine whether, as a matter of applicable law, the settlements made by the primary insurers fall within the terms and conditions of the primary policy. This action may, if successful, finally unblock the Exxon claims settlements, which are locked up in the LMX spiral.

For further information, please contact Andrew Symons at [email protected] or on +44 (0)20 7367 3044 or Richard Tosh at [email protected] or on +44 (0)20 7367 2884.

Andrew Symons is a partner and Richard Tosh is a lawyer in the insurance and reinsurance group of London law firm CMS Cameron McKenna.

This article was first publised in Global Reinsurance.