United Kingdom House of Lords Decisions

The practical importance of this defence, if sound, is obvious; and its implications have been multiplied by the levels of financial frailty experienced in the London insurance market in recent years. Across the market as a whole very large sums depend upon it, and the litigation from which this appeal stems has been brought in practice, if not in form, as a test case. The proceedings take the shape of an action by Charter for a summary declaration that payment by way of transfer of funds or other means of satisfaction by Charter under the inward policies was not a condition precedent to the liability of the syndicates. Within avery few months it proved possible to obtain the opinion of the Commercial Court in the shape of a meticulous and thoughtful judgment of Mance J., granting a declaration in those terms. Upon recourse to the Court of Appeal this decision was upheld by a majority, Staughton L.J. dissenting. The syndicates now appeal to this House.

This being, I believe, a sufficient summary of the dispute I turn to policy no. X 20693/5386. It is important to quote its terms at some length.

For ease of reference I have added numbers and letters, and have placed in italics the words around which the controversy revolves.

My Lords, to a substantial degree I accept this argument. I believe that most expressions do have a natural meaning, in the sense of their primary meaning in ordinary speech. Certainly, there are occasions where direct recourse to such a meaning is inappropriate. Thus, the word may come from a specialist vocabulary and have no significance in ordinary speech. Or it may have one meaning in common speech and another in a specialist vocabulary; and the context may show that the author of the document in which it appears intended it to be understood in the latter sense. Subject to this, however, the inquiry will start, and usually finish, by asking what is the ordinary meaning of the words used. I begin, therefore with "actually." In my opinion this word is used by way of qualification or precaution, in the sense of "really," "in truth," "not notionally" or "not prospectively." On this, I feel no doubts. The word "paid" is more slippery. Unquestionably, it is no longer confined to the delivery of cash or its equivalent. In ordinary speech it now embraces transactions which involve the crediting and debiting of accounts by electronic means, not only transfers between bank accounts by payment cards and direct debits,but also dealings with credit cards and similar instruments. Conditional payment by cheque would also be covered, at any rate outside a strictly legal context. Furthermore, I think it plain that in a document created to govern a transaction in the London insurance market payment would extend beyond remittances from debtor to creditor and would include the settlements in account with brokers which are a feature of that market. None the less, even giving "paid" an extended meaning the word would at first sight, and even without the qualifier "actually," fall well short of encompassing a situation in which the debtor had suffered no immediate financial detriment through a transfer of funds in the direction of the creditor, and would never do so.

My Lords, I have used the expression "at first sight" because I had initially thought that the meaning of the words was quite clear, and that the complexities and mysteries of this specialist market had hidden the obvious solution, and had led the courts below to abjure the simple and right answer and to force on the words a meaning which they could not possibly bear. I was not deflected from this opinion by any of the cases cited, which with few exceptions (to which I must return) seemed too remote from the present to offer any useful guidance.

What does matter is the group of provisions which establish the measure of indemnity, once a loss by an insured peril has taken place. I would break these down as follows.

(i) Clause 2(a) fixes the level at which financial prejudice suffered by Charter under the inward policies in consequence of a loss by a peril insured under this policy causes a liability to attach. This happens when the ultimate net loss in relation to each and every loss and/or catastrophe and/or calamity and/or occurrence (which I will call a set of linked losses) exceeds £3m. This sub-clause also fixes the upper limit of indemnity under the policy. An additional limit, this time fixed by reference not to each set of linked losses but to the cover for the entire policy year, is imposed by the last sentence of clause 6.

(ii) Clause 2(b) incorporates into the scheme of the policy the four sets of layered "specific" insurances (i.e. the "accounts") identified in the schedule. When an event occurs which is a peril insured under one of those sets of insurances and also under this policy the limits of all the insurances comprising that account must be exceeded before any indemnity begins to fall due under this policy.

(iii) Clause 2(c) gives meaning to clause 2(a) by defining ultimate net loss. (In fact the sub-clause omits "ultimate." This must be a mistake, for otherwise the entire group of provisions makes no sense. The word does appear in the clause as typed in the aviation policy). The purpose of clause 2(c) is to make clear that the syndicates are not to pay losses gross, but that there is to be a netting-down for recoveries, salvage and the like when ascertaining whether, and if so by how much, the relevant liabilities of Charter cross the boundary into the layer covered by this policy.

(iv) The first sentence of clause 2(d) elaborates clause 2(c) by making clear that the fixing of an ultimate net loss in respect of any set of linked losses is provisional, in the sense that the amount of it, and hence its impact if any on this layer of insurance, is to be open to recomputation if

[1997] A.C. 313 Page 386

and when items of the identified description subsequently accrue to the benefit of Charter.

(v) The proviso in the second sentence of clause 2(d) emphasises that even though the computation of an ultimate net loss is provisional, if it yields a figure broaching the bottom of the layer insured under this policy it will then be "recoverable" even if a subsequent recalculation when all the figures are in may lead to an upward or downward adjustment, or even to the elimination of any recovery at all.

(vi) Clause 2(e) is puzzling at first sight, because the use of initial capitals may suggest that, like "Specific Insurances" in clause 2(b), the expression "Underlying Excess Reinsurance Treaties and/or Contracts" has a meaning specifically ascribed for the purpose of this policy. Yet one finds it nowhere defined. In fact, however, a reading of the document as a whole shows that capitals are used indiscriminately throughout, and that they have no special significance in clause 2(e). In the light of the explanations given in argument, I accept that the purpose of the sub-clause is simply to ensure that the calculation of the ultimate net loss under sub-clause (a) does not involve a deduction of the liabilities on the underlying layers, so as to diminish the possibility of a recovery on the layer covered by this policy.

Analysed in this way, the policy makes complete sense, and works perfectly well in practice when understood as requiring the satisfaction of only two conditions before an indemnity falls due. First, that an insured event shall have occurred within the period of the policy, and second that the event shall have produced a loss to Charter of a degree sufficient, when ultimately worked out, to bring the particular layer of reinsurance into play. This reading accommodates without strain the words "if and when," in clause 2(a); for they are concerned only with the point, not of time but of arithmetic, at which the figures for the ultimate net loss reach the appropriate level. Equally, I am now satisfied that the purpose of "the sum actually paid" in clause 2(c) is not to impose an additional condition precedent in relation to the disbursement of funds, but to emphasise that it is the ultimate outcome of the net loss calculation which determines the final liability of the syndicates under the policy. In this context, "actually" means "in the event when finally ascertained," and "paid" means "exposed to liability as a result of the loss insured under clause 1." These are far from the ordinary meanings of the words, and they may be far from the meanings which they would have had in other policies, and particularly in first-tier policies of reinsurance. But we are called upon to interpret them in a very specialised form of reinsurance, and I am now satisfied that, as Mance J. expressed it in his judgment at first instance, the words in question did not have the purpose of introducing a temporal precondition to recovery in the form of disbursement or other satisfaction of the precise net commitment between Charter and its reinsured, but were there "for the purpose of measurement."

This argument draws strength from the shape of the policy. As I have already suggested, under this form of words, although perhaps not under all forms, the policy covers not, as might be thought, the suffering of loss by the reinsured in the shape of a claim against him under the inward policies, but the occurrence of a casualty suffered by the subject-matter insured through the operation of an insured peril. The inward policies and the reinsurance are wholly distinct. It follows that in principle the liability of the reinsurer is wholly unaffected by whether the reinsured has satisfied the claim under the inward insurance: see, amongst several authorities, In re Eddystone Marine Insurance Co.; Ex parte Western Insurance Co. [1892] Ch. 423. This result can undoubtedly be changed by express provision, but clear words would be required; and it would to my mind be strange if a term changing so fundamentally the financial structure of the relationship were to be buried in a provision such as clause 2, concerned essentially with the measure of indemnity, rather than being given a prominent position on its own.

Further arguments, to my mind some way short of conclusive, were advanced on each side. The syndicates pointed out a possible disconformity between the postponement of the reinsurers' liability to pay with the statutory provisions governing margins of solvency. For Charter attention was drawn to long-established contractual provisions creating just such a condition precedent as is argued for here: for example, in the running down clause and in protection and indemnity club cover against third party liabilities, the effect of which was discussed in Firma C-Trade S.A. v. Newcastle Protection and Indemnity Association [1991] 2 A.C. 1. Each side suggested reasons why such a provision would or would not make commercial sense; and proposed ways in which the hardship to the reinsured might be ameliorated by devices such as the making of a series of small "pump priming" payments, which would produce a sufficient trickle of cash to satisfy ultimately the inward claim in full, hence unlocking a recovery under the reinsurance.

"We agree with the court below, that the language of the eleventh subdivision, taken in connection with the fact that it is used in a contract designated by the parties as one of reinsurance, means that the reinsuring company shall not pay more than its ratable proportion of the actual liability payable on the part of the reinsured, after deducting all liability of other reinsurers. To hold otherwise is to utterly subvert the original meaning of the term reinsurance and to deprive the contract of its chief value. The losses are to be payable pro rata with, in the same manner and upon the same terms and conditions as paid by the reinsured company under its contracts. This means that such losses, payable pro rata, are to be paid upon the same condition as are the losses of the insurer under its contract. ... [This] ... does not mean there must be an actual payment of such liability by the insurer before it can have any benefit of the contract of reinsurance which is made with defendant."

In the second case, Fidelity & Deposit Co. v. Pink (1937) 302 U.S. 224 the contract was in very different terms. It stipulated that the reinsurer's proportionate share of the loss should be paid to the reinsured upon proof of payment by the reinsured, and on tender of documents in support. It was furthermore stipulated that the reinsured might give the reinsurer prospective notice of its intention to pay on a certain date, and might require the reinsurer to put its share of the loss in the hands of the reinsured by that date. Distinguishing the Allemannia case, without differing from the statement of general principle therein contained, the Supreme Court held that on this occasion the contract was effective to make prior payment a condition precedent to liability.

Finally, in Stickel v. Excess Insurance Co. of America (1939) 23 N.E.2d 839, an ultimate net loss clause defined that term (p. 841) as "the sum actually paid in cash in settlement of losses for which the company is liable, after making proper deductions ..." Founding on the language of the particular policy in question, the Supreme Court of Ohio found the case closer to Pink than to Allemannia, and held that once again actual disbursement was a condition precedent to recovery.

There was some suggestion in argument that there is an inconsistency between these cases. On examination I can detect none. Even the brief account given above is sufficient to make the individual decisions perfectly understandable. Whether they were all right it is unnecessary and inappropriate to consider; and it is of course true that the Allemannia case, 209 U.S. 326 was concerned with proportionate insurance, whereas the present is not. What it is permissible to say however is that the brief statement of general principle in that case accords with the law as it has been understood for many years, in common law jurisdictions and elsewhere. I can see nothing in these cases to cast doubt on the opinion which I have expressed as to the effect of the present policy.

There is one final point, directed to the wording of this particular policy. It will be recalled that clause 2(c) defined net loss as "the sum actually paid ... after making deductions for all recoveries [etc] whether collected or not." There is a discontinuity here, if the syndicates are right. There is good reason why the provisional ascertainment of the effect which the losses will have on the reinsured layer should be made in the light of forecasts about the funds which will be transferred out, and the funds which will be transferred in, on future occasions before the ultimate net loss is finally ascertained, but I can see no reason why uncollected funds should be used as a contra sum at a time when through the absence of payment under the inward policies there is nothing against which to set them. Here again, I do not regard the point as conclusive, but it does reinforce the solution at which I have independently arrived.

For these reasons therefore I consider that the interpretation given by Mance J., and Simon Brown L.J. to policy no. X 20693/5386 was correct. This makes it unnecessary to consider the alternative line of reasoning which led Nourse L.J. to conclude in favour of Charter. The position under the second policy is acknowledged to be the same.

There remains the aviation policy. There are differences between this and the first two policies which might for other purposes be important. Mance J. has drawn attention to some of them. But in my opinion none of them bear on the present dispute, and the reasoning which I have proposed applies equally to all three contracts.

In these circumstances I would dismiss the appeal.

LORD HOFFMANN. My Lords, this appeal turns upon the construction of a standard clause known as the ultimate net loss ("U.N.L.") clause which is in common use in the London excess of loss reinsurance market. Although the action concerns three particular policies of reinsurance written on behalf of two Lloyd's syndicates, it raises an issue which affects the whole reinsurance market.

The relevant provisions are set out in the speech of my noble and learned friend, Lord Mustill, and I need not repeat them. The question is whether the words "actually paid" mean that the liability of the reinsurers is limited to the sum in respect of which Charter Reinsurance has discharged its liabilities in respect of the risks which it insured. Mr. Sumption says that this is the natural meaning of the words. There is nothing in the context which requires them to be given a different meaning and that is the end of the matter.

I think that in some cases the notion of words having a natural meaning is not a very helpful one. Because the meaning of words is so sensitive to syntax and context, the natural meaning of words in one sentence may be quite unnatural in another. Thus a statement that words have a particular natural meaning may mean no more than that in many contexts they will have that meaning. In other contexts their meaning will be different but no less natural.

Take, for example, the word "pay." In many contexts, it will mean that money has changed hands, usually in discharge of some liability. In other contexts, it will mean only that a liability was incurred, without necessarily having been discharged. A wife comes home with a new dress and her husband says "What did you pay for it" She would not be understanding his question in its natural meaning if she answered "Nothing, because the shop gave me 30 days' credit." It is perfectly clear from the context that the husband wanted to know the amount of the liability which she incurred, whether or not that liability has been discharged.

To revert to my domestic example, if the wife had answered "Well, the dress was marked £300, but they were having a sale," and the husband then asked "So what did you actually pay" she would again be giving the question an unnatural meaning if she answered "I have not paid anything yet." It is obvious that the contrast which the husband wishes to draw is between the price as marked and the lower price which was charged. He is still not concerned with whether the liability has been discharged. This is not a loose use of language. In the context of the rest of the conversation, it is the natural meaning.

As construed by the courts, however, the phrase "and to pay as may be paid thereon" disappointed the expectations of the market on both sides. The original insurers assumed that it meant that if they agreed in good faith to pay under the original policy, they would be able to recover without having to prove their own legal liability. Reinsurers assumed that whatever the loss of the original insured might be, their liability would not exceed the net outlay of the reinsured, after taking all recoveries into account. Both assumptions were to prove false.

The story of how the expectations of original insurers were disappointed by the decision of Mathew J. in Chippendale v. Holt (1895) 1 Com.Cas. 197 and the subsequent development of the "follow settlements" clause to restore what had been thought to be the effect of the old clause has been told more than once, including by Scrutton L.J., who was junior counsel in Chippendale v. Holt, in Gurney v. Grimmer (1932) 44 Ll.L.R. 189, 192-194. (For subsequent developments, see Robert Goff L.J. in Insurance Co. of Africa v. Scor (U.K.) Reinsurance Co. Ltd. [1985] 1 Lloyd's Rep. 312.)

Although the commercial history of the matter is not as well documented as that of the "follow settlements" clause, it is clear that the formula "pay as may be paid thereon" disappeared from standard forms of reinsurance. The objects which it had sought to achieve on behalf of the original insurers were taken over by the follow settlements clause. It does not seem unreasonable to infer that its function in delimiting the liability of the reinsurers was taken over by the ultimate net loss clause. The U.N.L. clause shows throughout a preoccupation with ensuring that the reinsurer cannot be called upon to pay more than the reinsured has been required to pay. In Uzielli the words "pay as may be paid" had proved ineffective to achieve this result, even though they had been thought apt to do so. In his argument in Duder's case [1915] 2 K.B. 394, 398 Mr. Roche K.C., arguing for a similar result to that in Uzielli, said plaintively but truthfully, that the words "pay as may be paid thereon:" "weakened the case of the plaintiffs, and yet this court held that they could recover the full 100 per cent. and not merely the 88 per cent. for which they had settled the claim against them." It would not therefore be surprising if underwriters thought that if "paid" was not good enough to satisfy the courts, "actually paid" might drive the point home.

The U.N.L. clause in the policies before the House has been traced back in unaltered form to the early 1930s and I would not be surprised if it went even further back than that. The words "actually paid" can be found in the policy considered in Allemannia Insurance Co. of Pittsburgh v. Firemen's Insurance Co. of Baltimore, 209 U.S. 326, where they were given the construction which I suggest in this case.

I find further support for my view in the fact that the U.N.L. clause has been thought suitable for use in the London excess of loss reinsurance market. There are certainly forms of reinsurance in which it may be commercially appropriate to make discharge of his liability by the reinsured a condition of the liability of the reinsurer. It may be, as in cases of mutual insurance, that the reinsurer has an interest in making certain that the reinsured maintains sufficient liquid assets to meet his liabilities. Or it may be a protection against fraudulent claims. But the London excess of loss market operates on the assumption that a reinsurance programme will relieve the insurer of the burden of having to pay claims covered by the reinsured layers. The regulation of insurers in this country uses a test of solvency which treats reinsurance cover as a proper deduction from the insurer's liabilities. None of this would make sense if the insurer had first to satisfy the claim out of his own resources before he could call upon his reinsurers to pay.

Considerations of history, language and commercial background therefore lead me to the conclusion that the word "actually" in the U.N.L. clause is used to emphasise that the loss for which the reinsurer is to be liable is to be net and that the clause does not restrict liability to the amount by which the liability of the reinsured for the loss has been discharged. I think that this is the natural meaning of the clause.

In conclusion I would like to pay tribute to the judgment of Mance J. which deals comprehensively with the issues and all the relevant authorities and with which I am in full agreement. I would dismiss the appeal.

Appeal dismissed.

No order as to costs.