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American International Marine Agency of New York Inc & Another -v- Christine E Dandridge & Others

The "AVON"

May 2005

The question which fell to be determined was whether a widely worded "follow the leader" clause could be incorporated into a contract of reinsurance, such that if the reinsured is precluded from denying a claim by reason of a decision of his leader at the primary insurance level, so too would his reinsurers be precluded from refusing to indemnify him.

The "AVON" was insured under a hull and machinery policy placed as to 85% in the French market pursuant to a slip expressed to be "for French market use only". The Claimants subscribed to the remaining 15% line and their participation in the insurance was evidenced by a binder, containing an extremely broad "follow the leader" clause requiring them to "follow the French leader in all respects except ex gratia".

The policy was on the Institute Time Clauses (Hulls) with additional clauses, including the usual classification warranty. The insured value was stated to be $2.5 million.

The Claimants reinsured their participation in the hull and machinery policy against total loss only. In the usual way, the reinsurance was stated as being "subject to the same clauses and conditions and against the same perils as in the original policy or policies [but against total loss only]".

The owners of the vessel decided to change classification societies part way through the policy term to facilitate a final laden voyage en route to the scrap yard. In doing so, they breached the class warranty. When the brokers learned of this, they approached the French market leaders and obtained their agreement to continue the insurance in spite of the breach of warranty, albeit at the reduced insured value of $1.5 million, more accurately to reflect the vessel's value as scrap.

The vessel subsequently grounded in bad weather and was declared a constructive total loss. The Claimants paid their 15% share of the loss, on the basis that the French leader had authority under the "follow the leader" clause to waive the breach of class warranty so as to bind the entire slip. The Claimants then turned to their reinsurers. However, they declined the claim and the matter came before Mr. Richard Siberry Q.C, sitting as a Deputy Judge in the Commercial Court. To streamline what would otherwise have been a four day trial involving seven predominantly overseas witnesses for a relatively modest sum, the parties agreed to proceed to a one day trial on the basis of agreed facts and issues.

The Judge ultimately found for the reinsurers but, in doing so, he introduced an additional issue to those formulated by the parties; namely, whether the general incorporation provision in the reinsurance was apt to incorporate the provisions from the binder (including the "follow the leader" clause) or rather whether they referred to the insurance as a whole. The Judge preferred the latter analysis, holding that the reinsurance did not incorporate the "follow the leader" clause.

The Judge considered that the underlying question in determining such issues of incorporation was whether the parties intended the particular clause in question to be incorporated. This will depend on the construction of the reinsurance as a whole and on the surrounding circumstances. The Judge found that the binder post-dated the reinsurance. In the absence of an agreed fact as to exactly when the Claimants agreed their participation in the insurance, the Judge had to infer that this was not until they signed the binder. He therefore found that the general words of incorporation referred to the insurance as a whole, which did not include the binder containing the "follow the leader" clause.

Whilst that was sufficient to dispose of the claim in favour of the reinsurers, the Judge nevertheless expressed his opinion, if he was wrong on the construction point, as to whether the "follow the leader" clause satisfied the four criteria for incorporation set out in HIH Casualty & General Insurance Limited -v- New Hampshire Insurance Co (2001), namely

1. whether it was germane to the reinsurance;
2. whether it made sense in the context of the reinsurance, with or without acceptable manipulation;
3. whether it was consistent with the express terms of the reinsurance; and
4. whether it was apposite for inclusion in the reinsurance.

The Judge accepted, without having to determine the point, that there were very compelling arguments that the Claimants were bound by the French leader's agreement to waive the breach of warranty and/or would be estopped from asserting the automatic termination of the policy under Clause 4 of the ITC as against the insured. Further, the Judge accepted the Claimant's contention that the presumption should apply that the scope and nature of facultative reinsurance was intended to be back-to-back with the underlying insurance (save that the reinsurance in this case would respond to total loss only). However, the Judge concluded that the "follow the leader" clause did not meet any of the four criteria in HIH -v- New Hampshire.

The Judge concluded that, because a "follow the leader" clause only indirectly affects the relationship between a following underwriter and the insured, it is neither germane nor apposite to a contract of reinsurance. The Judge drew support for his conclusion from the reinsurers' submission that the interests of insurers and reinsurers may diverge, such that what may be thought by the leader to be in the interests of the underlying insurers may be potentially very prejudicial to the interests of reinsurers. To illustrate this, the Judge cited the example of the reduction in the insured value. Whilst this reduces the maximum exposure of the underlying insurers, it also has the effect of reducing the threshold at which the vessel becomes a constructive total loss, which of course is one of the circumstances in which the total loss only reinsurance responds.

The Judge also concluded that the "follow the leader" clause was inconsistent with the express provisions of the reinsurance, which bound the reinsurers to "continuations and/or deviations and/or extensions [of the underlying insurance], whether notice be given or not". The Judge thought such an express clause would be rendered nugatory were in fact the reinsurers to be bound by all variations to the insurance by the leader, with or without notice to the reinsured or their reinsurers.

Finally, the Judge concluded that a clause requiring the Claimants to follow the French leaders at the underlying level would have to be subjected to unacceptable manipulation before it could be incorporated into the reinsurance. In particular, he observed that the incorporation of the "follow the leader" clause, without manipulation, would appear to require the reinsurers to follow the French leader on such matters as rates, which cannot have been the intention. Rather, the reinsurers would make up their own minds as to the appropriate rates for the total loss only cover they wrote.

Although the case was ultimately determined on the initial point of construction, it is the Judge's obiter dicta observations on the incorporation of leading underwriter clauses into reinsurance which are of general application and therefore of particular interest to both insurance and reinsurance practitioners.

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