Cut 'n' shut – how not to come a cropper notifying losses - 2007-12-07
The obligation to notify “losses” has created the potential for uncertainty in liability reinsurance. In AIG Europe (Ireland) Limited v Faraday Capital Limited 2007 the Court of Appeal decided that AIG was in breach of a loss notification provision and could not recover under a contract of facultative reinsurance.
Facts
Smartforce provided “e-learning” courses for the IT industry. It was insured by AIG in respect of its Directors & Officers liabilities, which in turn was reinsured by Faraday. Shareholders of Smartforce commenced proceedings against Smartforce and various directors claiming that they had bought shares at an artificially inflated price on the basis of financial statements made in the accounts. Subsequently, Smartforce announced that it intended to restate the accounts and the share price fell by a third.
AIG was duly notified of the claim but the notice was not passed on to Faraday. The underlying claims were settled at a mediation and AIG gave notice to Faraday within 30 days of the settlement. Faraday refused to pay the claim on the basis that the notification of the losses was given too late and in breach of the Claims Co-operation Clause. The Clause required AIG to notify Faraday upon "knowledge of any loss or losses which may give rise to a claim". Notification of the loss was a condition precedent to Faraday's liability.
Held
It was held that what AIG had to know of was “any loss or losses which may give rise to a claim”. Once Smartforce announced its intention to restate the accounts, the sharp fall in the share price was a loss which might (and in fact did) give rise to a claim. This loss was known to AIG as it had been notified to them by Smartforce.
The Court of Appeal distinguished the case of RSA v Dornoch in which there were similar allegations that directors of Coca Cola had made false statements to cause the share price to be artificially inflated. In RSA v Dornoch, the fall in the share price could just as easily have resulted from “normal market fluctuations”, and it was decided that there was no loss until it was shown that the shares were purchased at an artificially high price.
In contrast, in Faraday, there was a positive event, ie, the announcement of the intention to restate Smartforce's accounts, which covered a substantive drop in the share price. This constituted a loss which may gave rise to a claim. The court said that to view the fall in share price as being attributable to coincidence or market fluctuation "would be to shut one’s eyes to the obvious”.
Comment
- Difficulties arose in this case because the Clause appears to have been "cut 'n' shut" from a property policy and applied to a liability reinsurance. The Clause was more appropriate to a property reinsurance where the nature of the cover is such that any losses are obviously known. For example, the destruction of a factory or the theft of a work of art.
- Generally, in a liability reinsurance, a loss cannot be known until the underlying claim is settled or adjudicated.
- This case illustrates how knowledge of a loss might arise at an earlier stage, thereby requiring notification of the loss at an earlier stage.
- As a reinsured, it is crucial to scrutinise the notification provisions and understand what precisely needs to be notified and when.
- Beware where there is a notification provision requiring the notification of “knowledge of loss” in liability reinsurance.
- Where there is any element of doubt it is well advisable for a reinsured to err on the side of caution and to notify reinsurers of any outwards claims following receipt of notification of the inwards claims. Indeed, there is every reason to do so if wording like the above Clause is to work as intended.
Please contact Paul Cha about this case or any issues relating to notification of losses.
Paul Cha
Consultant
for Mills & Reeve LLP
+44(0)20 7648 9236
paul.cha@mills-reeve.com
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