Court finds credit risk cover in marine policy and considers a broker’s duties at placement

In ABN Amro Bank N.V. v Royal & Sun Alliance Insurance plc (and others) [2021] EWHC 442 (Comm), the Court found that an “unusual” and “unprecedented” clause provided credit risk cover in an all risks marine cargo policy. This lengthy decision explores a number of issues including construction of policy wordings, rectification and estoppel, non-disclosure and misrepresentation, as well as the duties of an insurance broker. In particular, the judgment considers the extent to which a broker is under a duty to explain the meaning of particular clauses to insurers.

Background

The dispute related to a £35 million insurance claim made by ABN Amro Bank NV (the Bank) against fourteen insurers, led by RSA. Edge Brokers London Limited (Edge) were the broker of the relevant policy and a party to the proceedings.

In 2016, the Bank suffered losses when two of the leading players in the world cocoa market, known as Transmar and Euromar, suffered financial collapse. Senior executives of both companies were convicted and imprisoned in the United States for fraud.

A SPV of the Bank known as Icestar B.V. (Icestar) was involved in the provision of structured commodities finance to clients of the Bank, including Transmar and Euromar.  The finance provided by Icestar comprised transactions known colloquially as “repo” transactions pursuant to which Icestar provided working capital by purchasing Transmar and Euromar’s commodities (cocoa products) for a defined period of time, at the end of which the clients were contractually obliged to purchase them back.

In the event, Transmar and Euromar did not repurchase the cocoa products from Icestar as they were contractually obliged to do. The Bank’s losses therefore related to Icestar’s subsequent disposal of the cargo to third parties. The cocoa products sold by Transmar and Euromar proved to be of poor quality. There was therefore a significant shortfall between what could be recovered under sales to third parties and the amounts owed by Transmar and Euromar.

The dispute with insurers arose because the Bank’s 2016/17 all risks marine policy (the Policy), which predominantly provided cover for physical loss and damage to cargo, contained an “unusual” clause, referred to as the Transaction Premium Clause (TPC).  The TPC had been added as a bespoke clause midway through the previous year’s 2015/16 policy (in July 2015) and had been drafted by external lawyers.  At the same time as the TPC was added, a Non Avoidance Clause (discussed further below) was also added to the wording.

The Bank and Edge contended that the TPC widened the scope of the Policy from cover only for physical loss and damage to cargo, to include risks not dependent on physical loss (including the shortfall incurred by Icestar).  In other words, the Policy was extended to provide credit risk insurance in the event of financial default.

The key parts of the Transaction Premium Clause provided:

“Underwriters note and agree that, in respect of any Transaction, it is hereby confirmed that the Insured is covered under this contract for the Transaction Premium that the Insured would otherwise have received and/or earned in the absence of a Default on the part of the Insured’s client.”

“‘Default’ means a failure, refusal or non-exercise of an option, on the part of the Insured’s client (for whatever reason) to purchase (or repurchase) the Subject Matter Insured from the Insured at the Pre-agreed Price.”

Issues in dispute

There were a number of issues in dispute which were considered by Jacobs J:

• The construction of the TPC and whether, as contended by the Bank, the TPC provided credit risk insurance and so responded to the claim.
• Whether the Policy should be rectified to give effect to the alleged mutual intention of the parties, or whether there had been estoppel by convention.
• Whether there had been a non-disclosure or misrepresentation by the Bank prior to inception.
• Whether the Bank acted recklessly or negligently when it entered into the “repo” transactions which precluded a claim on grounds that the Policy required the Bank to do “all things reasonably practicable to prevent any claim being made under [the Policy]”.
• Whether there was a failure by the Bank to “sue and labour” in attempting to mitigate its loss.
• The liability of Edge in placing (or amending) the Policy.

Construction of the TPC

The Bank and Edge contended that the TPC provided credit risk insurance in respect of all risks of financial default and so responded to the claim.  Insurers disagreed and argued that the TPC was concerned with the basis of valuation for all of the risks covered under the Policy. They pointed to the fact that neither RSA nor any of the other insurers wrote credit risks.

Jacobs J provided a helpful summary of the legal principles which govern the construction of policies of insurance. In particular, referring to the three well-known key Supreme Court decisions from the last decade: Rainy Sky SA v Kookmin Bank [2011] UKSC 50, Arnold v Britton [2015] UKSC 36 and Wood v Capita Insurance Services Ltd [2017] UKSC 24. He summarised that:

“The court must ascertain what a reasonable person – i.e. a person who has all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract – would have understood the contracting parties to have meant by the language used. This means disregarding evidence about the subjective intention of the parties.”

In considering the TPC, the judge noted that:

• The brokers were operating in the London marine market, where the core business of the cargo insurers was the writing of risks concerning physical loss and damage to cargo whilst in transit or in store.
• There was no precedent for marine cargo insurers extending cover under a marine cargo policy to protect the insured in respect of the contractual default of a counterparty leading to a non-physical loss on cargoes which the insured had purchased. The judge thought this was the “first and (probably) only example of such a policy having been written in the marine market.”
• The Policy did contain three “add-ons” which did not require physical loss or damage including cover for “fraudulent documentation” which provided an indemnity for “direct financial loss” and the evidence suggested that the market was soft in 2015-2016 (and therefore might have been a good time for participants to try something new).
• Whilst the Policy contained many provisions which indicated that it was intended to cover the risk of physical loss and damage to cargo, the existence of the three “add-ons” meant the judge thought it could not be approached on the basis that it was nothing more than a “plain vanilla” policy wording limited to cover for physical loss and damage.
• Insurers’ argued that the Bank’s position was commercially absurd because the Bank would have received credit and financial guarantee cover in respect of every cargo that was owned by the Bank, without paying any additional premium.

Jacobs J found that in a case such as this one, where he was concerned with a carefully drafted clause, “the language used by the parties is the most important consideration in the overall unitary exercise of construction”. He found that the wording of the TPC was “clear” and there was no wording which would confine the clause in the manner proposed by the insurers.  Following the approach of Lord Neuberger in Arnold v Britton, he noted that he should be slow to reject the natural meaning of a provision “simply because it appears to be a very imprudent term for one of the parties to have agreed.”

Rectification of the Policy

Insurers’ alternative position was that a number of conversations between Mr Beattie (the underwriter at RSA) and Mr Mullen (the broker at Edge), in July 2015 when the TPC was added to the 2015/16 policy, evidenced that the parties were in agreement that the TPC was a ‘basis of valuation’ extension giving rise to a collateral contract, or the basis of a claim for rectification of the Policy.

The judge referred to the test for rectification as clarified by the decision of the Court of Appeal in FSHC Holdings v GLAS Trust [2020] Ch 365:

“it is necessary to show either (1) that the document fails to give effect to a prior concluded contract or (2) that, when they executed the document, the parties had a common intention in respect of a particular matter which, by mistake, the document did not accurately record. In the latter case it is necessary to show not only that each party to the contract had the same actual intention with regard to the relevant matter, but also that there was an outward expression of accord meaning that, as a result of communication between them, the parties understood each other to share that intention.”

In the alternative, insurers argued that there had been estoppel by convention, which arises if (i) there is a relevant assumption of fact or law, either shared by both parties, or made by party B and acquiesced in by party A, and (ii) it would be unjust to allow party A to go back on that assumption.

Insurers said that Edge presented a document (containing the TPC) as a “wish list” in July 2015 (mid-way through the 2015/2016 policy). They argued that the underwriter at RSA made it clear that he understood that the TPC wording concerned the basis of valuation of goods which had been lost or damaged.  Insurers said that the understanding between Edge and RSA was that the wording did not extend to trade credit or financial guarantee.

Edge’s position was that it had told RSA that the wording changes being presented had been drafted by the Bank’s external lawyers, and that RSA had signed this by way of agreement. Edge maintained that the underwriter at RSA did not say or make clear that he understood the TPC to be a basis of valuation which applied in the event of physical loss or damage.

After considering the evidence, the judge found in favour of the Bank in holding that the evidence needed for the case of rectification, collateral contact and estoppel did not exist. The judge found that when presented with the TPC as an endorsement to the Policy, the RSA underwriter had failed to recognise the complexity and potentially far-reaching nature of the terms proposed and had agreed to it by signing the documentation. The judge was also not persuaded that there was any tacit understanding between the parties that the TPC was only applicable to physical loss or damage or that it was a basis of valuation clause.

Non-disclosures and misrepresentations

Various non-disclosures and misrepresentations were alleged by different insurers against the Bank including:

• Failure to disclose the Bank’s purpose or intention in requesting the inclusion of the TPC.
• Non-disclosure of the presence of a ‘Non-Avoidance Clause’ (NAC) which prevented avoidance for anything other than fraudulent non-disclosures or misrepresentations (and fraud was not alleged).
• Non-disclosure of the July 2015 endorsement to the market subscribing to the 2016/17 Policy. The 2015 endorsement contained the TPC and the NAC.
• Misrepresentation that the Policy was “as expiring”.
• Misrepresentation that the Policy covered the Bank only for loss or damage to products where finance was provided.

The insurers’ case on avoidance failed for two key reasons:

The NAC

Insurers sought to argue that the Bank could not rely upon the NAC because it was not expressly mentioned to them at the time the Policy was renewed.  There was a non-disclosure of the NAC itself.  Jacobs J disagreed.  The starting point was the principle that a person who signs a document knowing that it is intended to have legal effect is generally bound by its terms, whether he has actually read them or not.

The only relevant question then was whether the clause should be construed so as to extend to all non-fraudulent (i.e. “innocent”) misrepresentations or non-disclosures or whether, as insurers had sought to argue, it did not apply to non-disclosures relating to the NAC itself.  The judge found that the NAC was comprehensive and its effect was that any avoidance case must be based on fraudulent non-disclosure or misrepresentation.

Affirmation

The Bank and Edge argued that affirmation provided a complete answer to any arguments about non-disclosure and misrepresentation, because insurers had not sought to preserve avoidance arguments at earlier stages in the proceedings (including in their Defence), nor had they tendered a return of the premium.  As established by case law, it must be established that the insurer has full knowledge of the facts entitling him to avoid the policy and knowledge of the legal right to do so.  Furthermore, any party’s election to affirm must be communicated in clear and unequivocal terms by either words or conduct.

Although reservations of the right to avoid the Policy had been intimated in prior correspondence, the insurers’ Defence relied on the terms of the Policy and made rectification arguments (which were predicated on the existence of an enforceable agreement to be rewritten). The Defence did not include any plea of avoidance or a reservation of the right to do so, which Jacobs J considered to be significant.  He commented that a reasonable person, when served with the Defence, would reasonably conclude that the insurers accepted that there was a binding policy, and had taken the view that arguments about non-disclosure or misrepresentation, previously reserved, were not being pursued. The Bank and Edge’s arguments as to affirmation were therefore upheld.

Jacob J’s findings regarding the NAC and affirmation rendered it unnecessary to consider the misrepresentations and non-disclosures relied on by insurers, but these were addressed. We have picked out two issues of note.

Failure to disclose the Bank’s purpose or intention in requesting the inclusion of the TPC

Insurers alleged that the Bank had failed to disclose its purpose or intention in requesting the inclusion of the TPC.  The judge found that the evidence of the majority of the insurers was that they had not read the slip or did not recall reading it. Neither the Bank nor Edge had disclosed what they considered to be the purpose of the TPC but nor had the insurers asked any questions about it (the judge not accepting RSA’s evidence on this point).

The judge did not accept the proposition that the insured has a duty to tell the insurer of unusual policy terms or explain their purpose and effect because an insurer cannot reasonably be expected to read the policy terms. The judge was not referred to any authority in which a policy had been avoided for non-disclosure of terms which were set out in the written contract subscribed by underwriters, or non-disclosure of the effect or purpose of such terms.

In contrast to Iron Trades Mutual v Cia de Seguros Imperio (1992) Lloyd’s Rep. IR 213, where a deliberate decision was made by the brokers not to draw a wording change to the attention of the insurers, the judge found that there was no “moral fault” in the present case, because the TPC was a prominent clause. The nature of the market meant that cargo underwriters could not assume that policies went no further than covering physical loss or damage, because add-ons were common and a professional underwriter could be expected to read the slips that (s)he signs.

Misrepresentation that the Policy was “as expiring”

Jacobs J found that inaccurate representations had been made to three insurers that the Policy was “as expiring”.  Whilst the preceding year’s policy had been amended by endorsement in July 2015 to include the TPC and the NAC, this endorsement had not been circulated to the following market. Although there had been a misrepresentation, the judge found that such representation only induced two insurers – Advent and Ark.  In any event, the effect of the NAC and affirmation as discussed above defeated the insurers’ avoidance case.

In the alternative, insurers argued that the Bank was prevented by estoppel from asserting that the Policy was on terms that differed to the terms of the preceding year’s policy.  In short, it was submitted that as insurers had been told that the Policy being signed was “as expiry” and their attention was not drawn to changes such as the TPC or the NAC, then the Bank was estopped from relying on those clauses.  The advantage of this argument for insurers was that it circumvented the difficulties in the avoidance case and, in particular, the effect of the NAC and affirmation.  The judge found that for two insurers – Advent and Ark – the Bank was estopped from asserting that the Policy included cover in respect of credit risks and/or financial default.

Lack of quality checks by the Bank

A further issue for the judge was whether the Bank had breached the Policy by not verifying the quality of the underlying goods. The Policy contained a requirement for the Bank to do all things reasonably practicable to prevent a claim under the policy. The insurers argued that the Bank was negligent in failing to take steps to physically verify the quality of the cocoa products it intended to buy as collateral, and was in breach of the Policy.

The Bank argued that the clause created an obligation which materialised only when the insured peril was expected imminently or had already occurred, and was therefore not engaged at the time when Bank purchased the goods under the repo transactions. This argument was dismissed by Jacobs J, who held that the obligation was ongoing throughout the policy term.

The key question was whether the required standard for breach of ‘reasonable precautions’ clauses is recklessness or ordinary negligence. Jacobs J held that the applicable standard was recklessness. The alternative (of negligence) would negate a core part of the insurance cover, considering that both the all risks cover and the TPC covered negligence of the Bank.

Further, it was held that the standard could not be different for the TPC than for other policy provisions, as “reasonable steps” should be given a consistent meaning when applied to all parts of the policy. The judge considered this to be particularly the case where the General Conditions were stated to apply to all sections of the contract.

The judge then considered whether the Bank had been reckless and found that it had not; in not physically verifying the quality of the collateral the Bank had not failed to comply with the normal practice and procedures of repo financiers.

Failure by the Bank to “sue and labour”  

The Policy contained a standard “sue and labour” provision which imposed a duty on the Bank to take reasonable measures to minimise or avert potential loss, subject to a qualification in the Policy that the Bank was entitled to elect an appropriate course of action in its discretion, as long as it acted in good faith.

The insurers argued that the Bank should have taken certain actions following the initial default by Euromar, which in the circumstances gave rise to a real risk that the remaining deals across Euromar and Transmar would all default.

The Bank’s key arguments in response were that to have breached the provision, their conduct must have been so unreasonable as to break the chain of causation, which would require extreme facts, and that they must have acted in bad faith. Although the Bank acknowledged that with hindsight it arguably should have taken out hedges in relation to the Euromar transaction, the amount lost by not doing so was comparatively minor.

It was common ground that for any of the “sue and labour” arguments to succeed, it would be necessary to show that the chain of causation had been broken, and that a “bare assertion that losses could have been avoided” was not sufficient.

Jacobs J referred to the recent Supreme Court judgment of Arch Insurance and others v FCA [2021] UKSC 1 which held that “[h]uman actions are not generally regarded as negativing causal connection provided at least that the actions taken were not wholly unreasonable or erratic”.

The question, therefore, was whether the insured had failed to act to avert or minimise loss in circumstances where any prudent uninsured would have done so. Jacobs J did not consider that a reasonable banker would have reacted any differently to the Bank in the circumstances, and that its conduct was not unreasonable and conformed with standard practice. The most that could have been said was that the Bank might have acted differently, but he acknowledged that was very different than saying that any prudent insured would have done so.

The liability of Edge

There was no dispute that Edge would be liable in the event the insurers’ defences based upon rectification, estoppel, or collateral contract were to succeed.  As these did succeed in relation to two insurers, Ark and Advent, Edge was held liable for the Bank’s losses arising from its inability to recover from Ark and Advent.

Jacobs J went on to consider Edge’s liability to the Bank in respect of their claims against the remaining insurers, even though those claims had succeeded.  This is because the Bank claimed that Edge was liable for any costs irrecoverable from insurers.

A broker’s duties

It was common ground that Edge owed duties of reasonable skill and care to the Bank: to procure the insurance cover required by the Bank; and to procure cover that clearly and indisputably met the Bank’s requirements, and so did not expose it to an unnecessary risk of litigation (as per FNCB Ltd v Barnet Devanney (Harrow) Ltd [1999] Lloyd’s Rep. IR 459 and more recently Standard Life Assurance Ltd v Oak Dedicated Ltd [2008] EWHC 222 (Comm)).

There was also no dispute that Edge was told that the Bank required cover against the consequence of a client defaulting under a repo transaction, and that such cover was not to be dependent on the occurrence of physical loss or damage to the cargo. The Bank contended that any irrecoverable costs of pursuing the underwriters would be recoverable from Edge for breach of the FNCB duty.

The Bank argued that Edge was in breach of various brokers’ duties including:

• broking a clause the broker did not understand or for a client whose insurance needs the broker did not understand;
• failing to use in-house expertise and advise the client to seek specialist advice where necessary; and
• failing to take all reasonable steps to ensure that the effect of the cover obtained was clear.

In particular, the Bank argued that Edge’s broker had not understood the TPC, had failed to explain its intended effect to insurers and, if Edge had acted competently, ultimately the Bank would have received advice that credit risk cover was available from the credit risk market.

In its defence, Edge argued that if the TPC did not provide the coverage which the Bank wanted, this was because of the way the TPC had been drafted by external lawyers.  If, as the Court found, the TPC did provide coverage which the Bank was seeking, Edge could not be held responsible for the consequences of insurers advancing spurious arguments.

Edge argued that there was no duty on the broker to highlight and explain to insurers the Bank’s subjective understanding or intention about the Policy. This would be a “duty to nanny”, putting the broker in a difficult position. Edge admitted that the duty of a broker was to obtain insurance cover which meets a client’s requirements and leaves no room for significant debate. However, they argued that the Bank was relying on its solicitors, who had drafted the TPC, to obtain clear cover for credit risk.

Jacobs J did not agree with Edge’s analysis and stated that the Bank was clearly looking to Edge for their professional expertise and advice, even though it had engaged solicitors to advise on questions of coverage. The engagement of external lawyers did not negate the Bank’s reliance on its broker, and further Edge was not aware at the time that specialist insurance lawyers had even been engaged.  Edge had responsibilities as market experts and advisers, and their duties were not reduced by reason of the fact that the Bank’s solicitors had drafted the TPC.

The judge further considered that Edge fell below the standard of a reasonably competent broker in omitting to advise the Bank that the credit risk market was the appropriate market in which to place the cover, and that specialist brokers within Edge should have been engaged. Considering that the wrong market was being approached, it was all the more important for the broker to explain to the insurers what the TPC was intended to address.  The judge stressed that this was not because the clause was unclear but because the clause was unusual and unprecedented in the market in which the cover was being placed.

In addition, although Edge were not obliged to explain their client’s subjective understanding of certain terms, they were under a duty to their client to take steps to check that the insurers had the same understanding as the Bank. Placement of cover without discussion with the insurers exposed the Bank to the unnecessary risk of litigation.

Jacobs J did not consider this to be an imposition of a “duty to nanny” (the insurer). Ultimately the question is what is required on the facts in order to fulfil a broker’s duty not to expose their client to unnecessary risk of litigation. That may (and in this case did) require a broker to give information to insurers which would protect the position of their client, in order to avoid potential problems in the future. The judge was clear that this is not a duty to protect insurers, but flows from the duty to protect your own client.

Causation

Having decided that Edge breached their duties to the Bank, Jacob J then addressed issues of causation and quantum that would have arisen in the event that the claim against the insurers had failed.

The key question was whether the Bank would have sought and paid for credit risk insurance from specialist credit risk insurers, and what cover would have been available, if the Bank had been advised differently. Applying Allied Maples Group Ltd v Simmons & Simmons [1995] 1 WLR 1602, this meant the Bank would have to show on the balance of probabilities that they would have acted to obtain the benefit of cover (or avoided the risk of not being covered for the relevant defaults), and that there was a substantial chance that suitable specialist insurers would have underwritten the risk, which chance the Bank had lost.

Jacobs J considered that the Bank would have taken out standalone cover, and that it was irrelevant whether that cover would have been in respect of transactions with Transmar and Euromar only, or in respect of a wider group of its customers. He accepted the Bank’s evidence that the credit risk insurance was “necessary” and not just a “nice to have”. He also decided that there was a real and substantial chance that credit insurers would have agreed to write insurance which would have provided satisfactory protection against the Bank’s losses in relation to Transmar and Euromar, noting the soft market conditions, attraction of the Bank as a customer and the apparently good financial position of Transmar.

Edge was therefore held liable for any costs liability of the Bank towards Ark and Advent, as well as any irrecoverable costs in the action against those two insurers. The judge also noted that his conclusion that the Bank would have been able to claim against Edge if their claim against insurers had failed would be relevant in the event of any successful appeal by the insurers against his judgment.

Comment

The Court’s decision that insurers were bound by the express and “clear” terms of the Policy wording is, on one view, not surprising.  Even though the wording in question was “unusual and indeed unprecedented in the market in which the cover was being placed”, the Court was not persuaded that arguments based on commercial consequences should result in a different conclusion.  To do so would result in the contract being effectively rewritten, with one party being penalised and the other achieving a benefit that it had not bargained for. It might be thought hardly to need saying, but the judgment makes plain that insurers should read the terms of the policies they are writing.

For brokers, the judgment highlights the need to advise clients about the most appropriate market for the cover they are seeking.  As the judge in this case noted, the broker had responsibilities as a market expert and adviser irrespective of the role of the external lawyers in drafting the TPC. Whilst it may surprise some that the broker was also under an obligation to explain to the insurers what the TPC was intended to address, the judge was clear that this was in the context of the clause being unusual and unprecedented in the particular market (cargo) in which the cover was being placed.  The judge explained this as being part and parcel of the FNCB duty to protect the client from the unnecessary risk of litigation. The judgment did not set out any clear rules which delineate what a broker should or should not do in order to procure cover that clearly meets its client’s requirements and does not expose it to an unnecessary risk of litigation, and instead said that it must depend on the particular facts and circumstances of the case.