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Equitas v MMI and the power to choose - relevance beyond the Fairchild Enclave

  • United Kingdom
  • Insurance and reinsurance - E-briefings

13-05-2019

Summary

In a case of wider significance than may first appear, the Court of Appeal in Equitas Insurance Limited v Municipal Mutual Insurance Limited [2019] EWCA Civ 718 has decided that EL insurers who have settled mesothelioma liabilities arising from multiple years of negligent exposure without allocating such losses to a single year, may not seek to recover a full reinsurance indemnity from the reinsurer in a year of their choosing, notwithstanding the fact that at the underlying insurance level employers may engage in such “spiking” as a result of the Fairchild enclave. 

Instead, when confronted with this situation a term is implied into the reinsurance contract according to which the EL insurer must present its outward reinsurance claims in respect of the loss on a pro rata time on risk basis, unless there is some other rational basis for ascertaining contribution to the risk in each relevant policy year. 

The implication of such a term is supported by a line of cases in which the English Courts have imposed rationality limitations on a party’s exercise of a contractual discretion affecting the rights of both parties as a matter of construction of the contract, including cases where the discretion was expressed to be absolute.  Those decisions have generally been aimed at ensuring that the discretion is not abused and are consistent with principles of good faith. The Courts have already applied similar logic in the context of claims co-operation clauses in reinsurance contracts and may be willing to venture further to other situations too.  Accordingly, this judgment is also relevant to those operating outside the Employer’s Liability market.

The Fairchild Enclave

The Fairchild enclave is a series of judgments enabling a victim of mesothelioma to recover full damages from any employer that negligently exposed him or her to asbestos during a period of employment, it being the case that causation is virtually impossible to prove in such cases in circumstances where the Courts and legislature have determined that victim protection is paramount. 

The enclave includes the well-known “trigger” litigation, which confirmed that in this context the exposure to asbestos would amount to infliction of injury during the policy period as EL policies generally require to be triggered.  Most recently, the Supreme Court case of International Energy Group Ltd v Zurich Insurance Plc UK Branch [2015] UKSC 33, extended the Fairchild rule to permit employers to pursue a full indemnity from the EL insurer in the year of their choice, subject to the insurers’ right bring contribution and recoupment claims respectively against insurers liable for other periods of insurance and the insured in respect of periods for which it was not insured. 

Court’s analysis

However, the Court of Appeal in Equitas v MMI could not see that it was necessary to extend the Fairchild enclave further to the reinsurance level in order to adequately ensure victim protection.  It thus started from the premise that a reversion to orthodoxy (i.e. a pro rata allocation) was desirable if this could be achieved in a legally principled way. 

The Court reached its desired outcome by reference to a line of cases that imposed a constraint on the discretion of one party entitled to exercise a contractual choice affecting the rights of both parties to the contract i.e. that such discretion was to be imposed in a manner that was not arbitrary, capricious or irrational.

Lord Justice Males recognised precedent identifying a category of contractual rights which were “absolute” and in relation to which the decision-maker’s discretion is unfettered.  However, he did not agree with the judge-arbitrator in the first instance decision that there were no grounds for implying such a term in the context under consideration.  Males LJ noted that whether or not a contractual right is absolute is to determined following a process of construction taking into account the parties’ characteristics, terms of the contract as a whole and the contractual context.  Leggatt LJ further observed that “The language in which the power is expressed is not decisive.”

The Court stated that there were “powerful”  reasons to imply a term in this context, noting that “spiking is inconsistent with the presumed intentions and reasonable expectations of the parties at the time when the contracts were concluded.”  In particular, the parties would not have expected that the insurers would be presented with such an option given the “elementary” principle of liability insurance law that the insured cannot select the period and policy to which the loss attaches.

Comment

We find it difficult to disagree with this decision, albeit with all due respect to MMI’s argument that reinsurance is but a species of insurance and there is no basis to treat them differently.  We share the Court’s view that, as the objective of victim protection has already been adequately ensured by the Fairchild enclave, there is no need to perpetuate it further to the reinsurance level, especially where to do so would do violence to the fundamental period element of a reinsurance contract.      

The decision is potentially of wider importance to the insurance market given its guidance on the exercise of contractual discretion.  In fact, the judgment shines a light on Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd (Nos 2 & 3) [2001] EWCA Civ 1047, in which the Court of Appeal construed a claims co-operation clause in a reinsurance contract such that the reinsurer could not withhold consent to a settlement by reference to considerations which were wholly extraneous to the subject matter of the particular reinsurance or arbitrarily.  Parties to insurance and reinsurance contracts should always think carefully when being called upon to make a contractual election – it may be that they cannot act as they wish despite indications to the contrary in the contractual language.

 

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