In England, an Insured Under a Liability Policy Must Demonstrate Actual Legal Liability to be Indemnified by its Insurers

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The insured in this case, Astrazeneca Insurance Company Ltd (AIC), was the captive insurance company for the Astrazeneca group of companies (AZ) and provided liability insurance cover for the period 1 January 2001 to 31 December 2003. AIC was reinsured for a 50 percent share by XL and others (XL) for the same period. The insurance provided by AIC to AZ was on what is called a Bermuda Form liability insurance. Bermuda Forms were introduced in the mid-1980s and are contracts of insurance or reinsurance governed by New York law which provide for the resolution of disputes by London arbitration in front of three arbitrators.

However, in this case the parties agreed to amend the Bermuda Form to make it subject to English law. Further, the parties waived the arbitration clause and agreed to give jurisdiction to the English courts. The policy did not contain a “follow the settlement” clause, nor did it contain a provision covering defence costs.

AZ incurred substantial defence costs in defending and settling a number of claims made against it arising out of the alleged effects of an antipsychotic drug called Seroquel manufactured by AZ. AIC settled these various costs with AZ and, in turn, sought to be indemnified by XL. XL refused to pay, claiming that the insurance and, therefore, the reinsurance, required the insured to prove legal liability — not just arguable liability — to be indemnified, which it did not. As a result, AIC sued XL.

The English court was asked to rule on two preliminary issues, one of which was whether, in order to recover under the policy, AZ had to prove that it was legally liable to the various claimants. As the Bermuda Form had been amended to be subject to English law, the English court held that New York law was no longer needed to interpret the contract. Further, the court said that the principle of New York law put forward by AIC whereby insurers were bound by good faith settlements was one of substantive New York law and not of interpretation of contract. That principle, therefore, had no application in the present case.

The court then construed the contract, which specifically stated that AIC would indemnify the Insured for Ultimate Net Loss the Insured pays by reason of liability: (a) imposed by law.” The court concluded from this and from the principles of English law that the liability insurance provided an indemnity against actual established liability as opposed to mere allegations. As such, AZ had to demonstrate actual liability to be indemnified by its insurers. Further, the court confirmed the ascertainment of loss by a judgment or settlement did not automatically establish legal liability and, in the present case, AZ failed to prove on balance of probabilities that the settlements it made were pursuant to an actual legal liability to third parties. AIC, therefore, could not recover from its reinsurers.

AIC appealed the decision, however, the Court of Appeal affirmed the lower court’s decision. In its judgment, the Court of Appeal reminded the parties that, had the policy contained a “follow the settlement” clause, XL would have been bound by AIC’s settlements made in a reasonable and business-like manner.

Impact: Choice of law and jurisdiction clauses in a contract remain very important issues which are often forgotten or passed over during contract negotiations. As this case shows, AIC would have had better arguments when seeking recovery from its reinsurers had the contract been subject to New York law. Further, this case is a precautionary tale concerning “follow the settlement” clauses. Reinsureds, discard these at your peril.