It's Cocoa, Jim, but not as we know it: Court's modern interpretation of underwriters' and brokers' duties #3 - A broker's harsh reality

This is the third article in our series following the decision in ABN Amro Bank N.V. v Royal & Sun Alliance Insurance plc and 13 Underwriters and Edge Brokers (London) Limited, in which RPC acted for Edge.

 Please click here for our first article, setting out a more detailed background to the case. 

We have also explored the defence strategy deployed by the Underwriters in this case and set out some of the arguments by which Underwriters sought to avoid liability under the policy. To refresh your memory, please follow this link.

This article focuses on brokers' duties. It is well known in the market that brokers are subject to a harsh regime when it comes to coverage disputes between their client and insurers and the inevitable claim over in negligence against the broker.  A broker is under an obligation to identify the scope of cover required by an insured and advise on that cover, as well as taking reasonable steps to arrange the cover and ensure it meets the client's requirements.  In cases where insurers succeed in avoiding policies or declining the claim, attention then turns to the broker for failing to arrange adequate cover.

The claims against Edge

As set out in our previous articles, Underwriters' defence to the Bank's claim was initially based upon the construction of the TPC. However, six months before trial, Underwriters sought to avoid the policy altogether based on non-disclosure of policy terms and alleged misrepresentations.

The Bank pursued a claim over against Edge on the basis that if the Underwriters were entitled to avoid the policy and/or the TPC did not respond, Edge would have breached its duty to take reasonable steps to procure the cover its client required (the Main Claim).

Additionally, irrespective of the outcome of its claim against Underwriters, the Bank sought to recover from Edge its irrecoverable costs of the claim against Underwriters (the Costs Claim).

The Costs Claim was based on the so-called FNCB Duty (first recognised in FNCB Ltd v Barnet Devanney (Harrow) Ltd [1999] 1 Lloyd's Rep 459). This is the duty of a broker to procure cover that clearly and indisputably meets its client's requirements and thereby does not expose the client to an unnecessary risk of litigation. The Bank argued that the cover was not clear and indisputable as Underwriters had been able to dispute it, resulting in the litigation.

The Main Claim

As explained in our previous articles, only two of the 14 Underwriters (Ark and Advent) successfully defended the Bank's claim, on the basis of estoppel by convention. The other 12 Underwriters were liable to the Bank. Accordingly, Edge was liable to the Bank only for Ark and Advent's shares of the indemnity.

A key issue in the Main Claim was Edge's obligations to Underwriters when presenting the risk. All 14 Underwriters sought to avoid the policy for non-disclosure. They argued that because the TPC was such an unusual clause in a marine cargo policy, Edge should have specifically drawn their attention to it and explained its meaning. The Court rejected this argument on the basis that it is the underwriter's role to read and understand the policy.

For brokers, this is a welcome (if perhaps unsurprising) finding. If the Court had found the contrary, a broker would need to mention every single term that might affect the underwriter's evaluation of the risk in order to prevent a successful non-disclosure defence. Thankfully the Court refused to impose any duties on the broker in this regard.

The Costs Claim

For the purpose of the Costs Claim, however, the above reasoning was distinguished from the duties the broker owes to its insured client.

As noted above, the FNCB Duty requires a broker to procure cover that clearly and indisputably meet its client's requirements and thereby does not expose the client to an unnecessary risk of litigation. If litigation arises out of wording that a broker has selected or drafted, or otherwise advised upon or taken responsibility for, the FNCB Duty will – other than in very exceptional circumstances – be breached.

In this case, the wording was not drafted by the broker, but the Bank's own lawyers, Norton Rose Fulbright (NRF).  Edge argued that the Bank relied on NRF, rather than Edge, to draft the wording and to advise as to its correct position in the policy. Therefore, if the cover was not clear and indisputable, this was the fault of NRF, rather than Edge.

The court rejected this reasoning. It held that whilst "the Bank was looking principally to NRF for advice in connection with the drafting of the wording of the proposed amendments…..it is clear that the Bank was looking to Edge for its professional expertise and advice as well". The Court was influenced by the fact that, whilst NRF drafted the TPC, the Bank put various questions to Edge regarding the clause and its location in the policy.

The Court's decision emphasises the need for the broker to assess all of the terms of the policy and ensure underwriters understand them.  Here, the Court found that the TPC was an unusual term for a marine cargo policy and that it was foreseeable that an underwriter may not understand it. This was decided on a fact specific basis and did not apply a blanket principle that clauses needed to be explained to underwriters.  The Bank had instructed Edge to ensure the TPC was included and that the cover obtained met its requirements, in order for it not to be exposed to potential litigation.  Edge therefore had a duty to ensure that Underwriters understood the TPC. The Court found this should have been done in order to satisfy Edge's duty to its client, the Bank. This is quite separate from any duty of disclosure to Underwriters.

Notwithstanding the above reasoning, there is an important qualification to the FNCB Duty.  A broker will not be liable if the insurer takes a thoroughly bad point on the construction of the policy to try to evade liability.   As we explained in our previous article, Underwriters had deployed the  "kitchen sink" defence strategy in order to try to avoid paying the claim. However, whilst Edge sought to rely on this qualification of the FNCB Duty, the Court did not agree. It found the Underwriters' construction arguments were not spurious, even though it agreed those arguments 'pay little or no regard to the actual wording of the TPC'. The Court went on to say 'to the extent that they were based upon the factual matrix and context and the commercial consequences of the Bank's construction, they did in my view have sufficient strength as not to warrant being described as spurious."

Accordingly, Edge was found to have breached the FNCB Duty. However, Edge was not required to pay any damages in respect of the Costs Claim. This was because the Bank had to give credit for the premium and retention under an alternative credit risk policy which the Court found it would have obtained, and that credit exceeded the irrecoverable costs of the Bank's claim against Underwriters.

Commentary

In theory, a broker does not breach the FNCB Duty where insurers raise a spurious coverage defence. But in this case, almost all conceivable defences were advanced by Underwriters and were found not to be spurious. What constitutes a 'bad point' on construction or coverage, if (as in this case) the full range of defences available to an insurer are not bad points, but merely reasonable and foreseeable arguments in defence? It is difficult to see what further arguments could have been adopted that would constitute a spurious defence.

It is not controversial that if a broker is negligent, it should bear the consequences of that negligence, usually in the form of an indemnity to the client in respect of the claim that would have been covered but for that negligence. However, in this case, even though the brokers were found to have been negligent, this did not affect coverage, except with regard to Ark and Advent's shares.

Despite this, Edge was found to be liable for the Bank's irrecoverable costs (i.e. those costs not recovered from Underwriters), although the alternative cover "buffer" came to Edge's rescue.