The recent case of Teal Assurance Company Ltd v WR Berkley Insurance (Europe) Ltd & anor [2013], demonstrates the tensions which can arise in cases involving several layers of insurance cover subject to different terms and conditions. Partner, Amy Lacey explains.

The Supreme Court unanimously dismissed the insured’s appeal, reaffirming the general rule that parties cannot choose the order in which claims are paid other than by reference to the date on which first party loss is incurred, or third party liability is established and quantified.

The dispute arose from insured claims against Black & Veatch Corp (“BV”), an international engineering company based in the US. BV’s professional indemnity insurance programme for 2007/2008 involved a US$5 million primary layer of cover, underwritten by Lexington; which operated above BV’s deductible and self-insured retention of US$10 million any one claim and US$20 million in the aggregate; with US$55 million cover under the next 3 layers of excess cover underwritten by BV’s own captive insurer, Teal Assurance Co. Ltd. (“Teal”); and a final US$10 million layer of “top and drop” insurance underwritten by Teal, and reinsured with W R Berkley Insurance (Europe) and Aspen Insurance UK Limited, for 50% each.

Each of the excess layer policies, including the “top and drop” policy, were expressed to be subject to the same terms and conditions as the primary policy. In the usual way, each excess layer was intended to provide cover only to the extent that indemnity under the underlying policies became exhausted. Unlike the underlying policies, however, the “top and drop” insurance excluded US and Canadian claims.

The excess layer policies included wording in common market form, confirming that liability to pay: “shall not attach unless and until the Insurers of the Underlying Policy(ies) shall have paid or have admitted liability or have been held liable to pay, the full amount of their indemnity inclusive of costs and expenses” (Clause 1).

Numerous claims against BV were made and notified to insurers during the policy period, some of which involved liabilities in the US and Canada, and others which did not. The central issue on appeal was whether BV (and Teal) could decide which claims were to be paid from the primary and/or lower excess layers, in order to ensure that claims to be met from the final “top and drop” layer were not those emanating from the US and Canada, and could in turn be passed on to reinsurers.

At first instance and on appeal, the Courts below had held that claims fell to be allocated under the successive layers as and when BV’s liability to third parties was ascertained by agreement, judgment or award, following the general principles of liability insurance established in Post Office v Norwich Union Fire Insurance Society Ltd [1967] 2 QB 363 and Bradley v Eagle Star Insurance Co. Ltd. [1989] AC 957).

On appeal to the Supreme Court, Teal argued that Clause 1 had the effect that the insurance cover was partially exhausted only when the claim was met by the insurer, rather than when the claim was ascertained against the insured party under the usual principle of chronological ordering. Teal contended that Clause 1 operated effectively as a primary insuring clause, so that the underlying tower could not be exhausted until insurers had paid or been held liable to pay the full amounts covered under those policies. Thus BV could seek indemnity in respect of a second, later claim (involving US or Canadian liabilities) that was made against it prior to seeking indemnity in respect of an earlier claim, and it would be the second claim that first acted to erode the indemnity that was available under the policy as it was paid first by insurers.

Lord Mance, giving the judgment of the Supreme Court, rejected Teal’s arguments as artificially looking at the insurance programme from the top down and being difficult to reconcile with the basic philosophy of cover for risks lying outside an insured’s own deliberate control. Whilst an insured can legitimately hold off from notifying a claim, or even withdraw or abandon a claim for indemnity, Teal’s proposition that all such claims could be pursued with priority being adjusted as against the successive layers was inconsistent with accepted principles of liability insurance. Although the primary policy required BV to have “paid” the retention and deductible prior to indemnity being afforded, the wording in this context was better understood as a reference to liability having been incurred and did not depend upon monies literally having been paid across.

The Supreme Court’s decision is welcomed as providing certainty to the market on ordering of ascertained losses for purposes of exhaustion of primary and successive layers under general liability insurance principles. However, there is no suggestion that parties would be precluded from departing from the standard approach using sufficiently clear policy wording.

It is interesting to note that Teal’s argument included submissions that the “hold harmless fiction” is wrong and insurers’ primary obligation should be to pay valid claims, such that late payment could give rise to a claim in damages. The absence in English law of a remedy in damages to compensate a policyholder for consequences of a wrongly refused claim has long been questioned (Sprung v Royal Insurance (UK) Ltd [1999]) and proposals have been made for reform. On 28 January 2014 the English and Scottish Law Commissions released draft clauses in their insurance contracts bill, including the introduction of a duty to pay claims within a reasonable time. This provision creates an implied term in every insurance contract such that an insured who suffers loss as a result of breach could, for the first time, recover contractual damages from the insurer. The insurer will, however, have a defence if it can show that it had reasonable grounds for disputing the claim.