It's Cocoa, Jim, but not as we know it: Court's modern interpretation of underwriters' and brokers' duties #1 - An overview of the case

In this series of articles we take a look at the decision in ABN Amro Bank N.V. v Royal & Sun Alliance plc and 13 Underwriters and Edge Brokers (London) Limited. In this article we give an overview of the case. The remaining articles will focus on particular areas of the case, these will be: 1. Underwriters' duties 2. Brokers' duties 3. Witness evidence

Background

Last month, the Commercial Court handed down its judgment in ABN Amro Bank N.V. v Royal & Sun Alliance plc and 13 Underwriters and Edge Brokers (London) Limited.  Tim Bull, Matt Wood and Elizabeth Singleton of RPC's Professional & Financial Risks team in London acted for the 15th defendant, Edge.

ABN Amro Bank N.V. (the Bank) held a marine cargo and storage insurance policy (the Policy) with a market of London cargo insurers (Underwriters), led by Royal & Sun Alliance (RSA). The Bank had held the Policy since 2008, albeit with updated cover over the years.   

The Bank (through a subsidiary SPV, Icestar) conducted repo transactions, where it bought commodities from its client, held them for an agreed period and then resold the commodities to the client.  In 2015, the Bank sought to expand the Policy to cover the risk that its client would not repurchase commodities under a repo transaction, forcing the Bank to resell the commodities to a third party.  This was effectively a credit risk.

The Bank instructed its own lawyers, Norton Rose, to draft the relevant Transaction Premium Clause (TPC) and Edge brokered it to the London marine cargo market as an addition to the Policy. The TPC provided cover for the Transaction Premium "that the Insured would otherwise have received and/or earned in the absence of a Default" by the Bank's client "for whatever reason". 

The Transaction Premium was defined as the amount equal to the difference between the pre-agreed price (i.e. with the client) and the actual sale price (i.e. the price obtained on the open market after default). On renewal in 2016, the TPC was incorporated into the marine cargo slip, which all Underwriters signed.

Later in 2016, the Bank was left holding cocoa products under repo agreements, when two clients, Transmar and Euromar, defaulted.  Senior executives of both companies were convicted and imprisoned in the US for fraud.  There had been no physical loss or damage (PLOD) to the cocoa. This was exactly the risk that the Bank had sought to insure against under the TPC. 

When notified of the defaults, RSA initially confirmed cover. Eight months later, once the amount of the loss was known (over £30million), RSA and the following market changed their mind and declined cover.  The reason given was that the TPC was not a free-standing insuring clause for financial losses not involving PLOD (i.e. credit risks), but rather a basis of valuation for PLOD losses. This was the opposite of what the TPC was designed to do – i.e. to provide cover for default "for whatever reason".

The Bank, acting as a prudent uninsured, sold the cocoa products on the open market and claimed the balance under the Policy. The claim was issued against the Underwriters and Edge.

Although the initial defence advanced by the Underwriters was based upon the construction of the TPC, the Underwriters served an amended defence, seeking to avoid the Policy based upon alleged non-disclosure by the Bank, through Edge, of the TPC itself and the Bank's and its lawyers and brokers' subjective opinion as to what the TPC was intended to cover. 

Alternatively, if the Policy was valid, the Underwriters sought to decline cover on additional grounds, including arguments concerning RSA's authority to bind the other Underwriters to the TPC, and failures by the Bank to mitigate its loss and check the quality of the cocoa. The Underwriters also substantially disputed quantum based on an allegation that the Bank should have taken out or maintained hedges following the defaults.   

Decision

Mr Justice Jacobs rejected all of the above defences raised by the Underwriters. He found that the TPC meant what it said and that it did provide financial default/credit risk cover.

All arguments of avoidance were rejected. In particular the Judge rejected the argument that a proposer or its broker is under a duty to draw a clause in a policy to an underwriter's attention and explain its meaning and intent. The underwriter should read the policy! If he or she has any questions, these should be raised and answered honestly by the broker. In this case, none of the Underwriters asked any questions concerning the TPC. Indeed, the majority of the Underwriters did not even read the policy presented to them, despite this being an internal "risk management" requirement. 

Although the Judge found that there was an unintentional misrepresentation to three underwriters, they could not avoid as the policy contained a non-avoidance clause. For good measure, the Underwriters were found to have affirmed the Policy when they served their Defence (raising coverage arguments) and neglected to repeat their previous reservation of rights. 

Two Underwriters did succeed in escaping liability due to the rather obscure rule of estoppel by convention. It was found that they wrote the Policy on the incorrect assumption that the Policy was the same as the previous year ("as expiry") as a result of these words being used by the broker. They therefore proceeded on the basis that the Policy did not contain the TPC. The Bank, through Edge, was found to have acquiesced in this common assumption and it was held that the Bank was estopped from asserting that the TPC applied to those Underwriters.

The Bank succeeded in all of its arguments. Edge succeeded in most of its arguments, including the key construction and avoidance arguments. Edge, however, was found to have breached its duty to the Bank because, as the Bank's broker, it owed the Bank a duty to protect it against the unnecessary risk of litigation. It was held that although Norton Rose drafted the TPC, the Bank looked to the broker for their professional expertise and advice and Edge should have ensured that all Underwriters were clear on the meaning and effect of the TPC.  This would have prevented the dispute. Edge was therefore liable for the Bank's irrecoverable costs on this basis. As it happened, Edge argued successfully that no costs were payable as the amount of irrecoverable costs was extinguished by the discount the Bank had to give for the costs of alternative cover. 

Commentary

While the judgment does not make ground-breaking new law, it does provide a modern interpretation of the existing law. Underwriters have to read the documents put in front of them and cannot rely on brokers to highlight particular clauses – understanding the coverage which a policy provides is central to an underwriter's job. Underwriters, like all commercial parties, will generally be held to contractual documents which they have signed. 

If insurers wish to preserve rights of avoidance, it is imperative that any reservation is properly worded and repeated so as to minimise the risk of affirmation. The duties of brokers to obtain clear and indisputable cover are onerous. 

The Judge also took considerable time to highlight the importance of contemporaneous evidence over witness recollection or reconstruction.  

Given this judgment's importance, three further articles will follow, the first of which is in relation to underwriters' duties. Please click here for the full Judgment.