Berriman v Rose Thomson Young QUEEN'S BENCH DIVISION (COMMERCIAL COURT) (Transcript: Smith Bernal) HEARING-DATES: 23 MAY 1997 23 MAY 1997 COUNSEL: M Crane QC, S Moriarty and M Reeve for the Plaintiff; I Hirst QC and A Popplewell for the Defendant; R Slade for the Members' Agents Defendants PANEL: MORISON J JUDGMENTBY-1: MORISON J JUDGMENT-1: MORISON J: This is an application for an interim payment following a judgment in the Names' favour against their managing and members' agents. The judgment was given on 2 April 1996. There has been no appeal and time for such has expired. Therefore, I am not concerned with any risk that the plaintiffs may fail on liability. By the judgment, the underwriter of the Names syndicate 255 was held to have been in breach of duty in two respects. One, failing to obtain adequate vertical reinsurance protection on his LMX book of business. Two, utilising INX Re. As a participant on the special priority treaty (a facultative /obligatory arrangement under which the underwriter ceded to the participants risks which he wrote) when INX Re. Was obviously unsuitable (for the reasons given in the judgment) and ceding to an entity called Aneco, another participant, an excessive amount of risk. In the judgment, certain principles relating to quantum were determined. In relation to the first head, the Names are entitled to be put into the same position they would have been in if the underwriter had written the same book of inwards business but had, in relation to his LMX book, contracted a proper amount of vertical reinsurance. In summary form, the calculation of the Names' loss under this head involves the following steps: (a) determine a competent PML event; (b) make a competent assessment of the impact that such event would have on each of the relevant parts of his book of business and thus the Names' exposure to risk of loss from catastrophe; (c) calculate the notional cost of the additional reinsurance protection required properly to cover the Names so as to leave them exposed to a risk of loss no greater than 40 % of the syndicate's stamp capacity; (d) determine what unreinsured losses have actually been incurred by the Names (in relation to the LMX book of business) as a result of the lack of adequate vertical cover; (e) calculate what losses would have been incurred had the proper level of vertical reinsurance been obtained. The Names' recoverable loss is ((d) - (e)) - (c). In relation to the second head of claim, the Names are entitled to recover from the defendants all sums which INX Re. Owe but remain unpaid and irrecoverable less some discount for the risk that a competently chosen participant might not have proved creditworthy. In relation to Aneco, and I quote from the judgment: "They, the Names, are entitled to recover such sums as are due but unpaid in relation to claims in respect of that aggregate exposure ceded beyond what I have held to be the acceptable limit." Judgment, page 172. The acceptable limit was defined in the judgment, page 115, as no more than: "10 per cent of the syndicate's stamp capacity taking into account the total exposure ceded and allowing for the possibility of multiple losses." For the purpose of this application, the parties have sensibly narrowed their differences down to a number of questions which I am asked to answer. In the light of the answers, the figures can be readily ascertained and a judgment can then be made as to the amount of the interim payment. In broad terms, the Names are asking for a payment of just over #80 million and the defendants concede around #46 million. There is therefore a substantial amount at stake. The issues of principle in relation to the first head of claim: (a) what are the relevant components of the book upon which the impact of a PML event is to be assessed in calculating damages? (b) When calculating the cost of the notional extra insurance, should the cost of notional reinstatement premiums also be taken into account? (c) Do the Names have to give credit for the cost of the notional reinsurance where it exceeds the loss they have sustained as a result of that catastrophe? (d) Are the defendants entitled to credit in relation to the amount by which interest attributable to notional insurance premiums exceeds the interest in respect of actual losses? I shall deal with each of these points in turn, bearing in mind that the court is carrying out an interlocutory exercise on affidavit and that the ultimate liability of the defendants will, in the absence of agreement, have to be determined by a tribunal at some future date. For this reason, therefore, I can and I think should deal with the points quite shortly: (a) in the judgment I identified those elements of the syndicate's LMX book which Mr Bullen should have considered when assessing the impact of the worst foreseeable catastrophe upon the aggregates he had written. A catastrophe of that dimension might well have impacted other parts of his book, but I was not concerned to determine that question. It seemed to me that Mr Bullen could only be criticised for not assessing his aggregate exposure to loss in relation to the elements I identified. Damages are to be awarded on the basis that the amount of the extra vertical insurance which he should have purchased is to be determined by the application of the percentages set out in the judgment to each identified part of the LMX book, even though one of the plaintiffs' experts considered that other parts of Mr Bullen's book should also have been considered at risk of aggregation. It is not possible to carry out a different exercise now. Apart from anything else, I rejected Mr Bullen's evidence about his PML calculations. Although I acquitted him of deliberately giving dishonest evidence, I was satisfied that much of what he said was not in fact true, even though he had convinced himself of the truth of what he was saying. Therefore, there is no evidential basis for making any PML calculation, save in relation to those elements of the book which are dealt with between pages 140- 145 of the judgment. I expressly stated that the parties should calculate the PML amount in the light of these findings. However, the defendants have sought to go behind this conclusion in their affidavit evidence filed in opposition to the application for an interim payment. The consequence of this conclusion is that I consider that the defendants have overstated the aggregate exposure and therefore the notional cost of the reinsurances which Mr Bullen should have obtained. (b) Yet again, defendants are asking the court to take into account as a set- off against the plaintiff's losses in a case such as this the notional cost of reinstating the notional extra cover as that cover was impacted by the given catastrophe. Whilst it appears to be the case that reinsurance covers usually provided for at least one reinstatement so that when a layer was impacted a new premium was paid for the reinstatement of cover for that layer, the exercise with which I am concerned is 'notional' in the sense that the court is seeking to assess the damages for the losses the plaintiffs have sustained rather than seeking to rewrite the book. The plaintiffs should have been covered for catastrophe losses to a greater extent than they were. In assessing the damages they have thereby sustained, it is incorrect in principle, in my view, to deprive them of part of their damages on the basis that one can say that the defendants would have bought more reinsurance than was necessary to staunch the loss. If it is said that reinsurances always have reinstatements, then it should also be said that it is clear that no reinsurance would have been available. What the court is endeavouring to do is to find some just measure of damage which properly compensates the plaintiffs for their loss. There is a limit beyond which the court should not go in treating the notional calculation as real. I accept Mr Crane's submission that: "The judgment requires damages to be assessed on the basis that notional reinsurance was available on a first loss basis to meet the catastrophe losses which in fact occurred. By adopting this approach, losses caused by prior exhaustion of the reinsurance programme (horizontal exhaustion) are excluded from consideration. The result is that the plaintiffs have given credit on this application for the cost of purchasing a new reinsurance programme to respond to each of the three catastrophes- Piper Alpha, Exxon Valdez and Hurricane Hugo- in question on a first loss basis. This is an artificial exercise which does not mirror actual practice. The corollary must be that reinstatement costs are to be excluded. They do not reflect the cost of protecting against the loss which has actually occurred and for which damages are claimed." Further, to do as the defendants suggest would be contrary to two decisions of this court in other cases, Gooda Walker and Feltrim. The judgment on liability in this case followed closely the approach to compensation adopted by Phillips J in the Feltrim action. It would be illogical and unsound to depart from his approach to reinstatements in the assessment of compensation in this case. (c) The Exxon Valdez disaster occurred in March 1989. Had the underwriter properly fulfilled his duties, he would have bought vertical reinsurance which would have protected the Names in respect of both years of account, 1988 and 1989. The reinsurance should have been acquired in the renewal season 1988 and 1989 and in place by the date of the disaster. It is the practice at Lloyd's that the date from which a reinsurance policy incepts determines the year of account which bears the cost of the premium. The notional cost of the reinsurance is therefore properly attributable to the 1989 year of account. In fact, the Names in that year sustained very little loss attributable to this disaster, so the defendants argue that when the Names' losses in that year of account have been reduced to nil there will be a notional net credit available to the defendants (namely the notional premium and interest on it) which can be used to set off any other losses which the Names may have suffered for that year of account. In other words, they have carried through the notional exercise to ascertain the recoverable loss to the extent that the Names end up 'paying' (in the sense of losing an award they otherwise would have received) the defendants for the privilege of not having had the requisite reinsurance in place in the first instance. In my view, the defendants' approach loses sight of the wood for the trees. It is yet another example, I think, of treating the notional exercise as an end in itself. The question is how to compensate the plaintiffs for their losses. Once the losses have been reduced to nil in relation to one item, that is an end of it. There is no scope for the defendants seeking to benefit from a notional reinsurance premium which was not paid in relation to a reinsurance contract which would not in reality have been available. The plaintiffs have correctly attributed the premium to the 1989 Names and have set that notional sum against the losses attributable to that disaster. The effect of that is to reduce their loss to nil from this item. That is an end of the matter. (d) The plaintiffs claim interest in respect of the paid claims as from 31 December 1994. They have not set- off against that any interest on the premiums which would notionally have been paid. The defendants have calculated interest on the premiums from the date when it is assumed that they would have been paid and then set that off against the interest calculated on the paid claims from 31 December 1994. There are two questions which arise: Are the defendants entitled to take account of interest on notional premiums at all; and, secondly, if so, have they done the calculation in an appropriate manner? The second question permits of an easy answer. Interest must be set- off on a consistent basis. It seems to me that one can either take all interest calculations as from a particular date (having calculated a net sum due to the plaintiffs)- that is, after setting the notional cost of premium ex- interest against paid claims ex- interest; or, secondly, seek to calculate the true time value of the notional payment of premiums and the obligations to meet paid claims and then set them off. On the facts, the plaintiffs initially carried out the first exercise. The defendants, as I have said, adopted an approach which was unsustainable. The plaintiffs have now calculated what the position would be if the second exercise were carried out. The result is that their claim increases, as I understand it, by about #2 million. In these circumstances, I do not propose to give a final ruling on the submission that the plaintiffs do not have to give credit for the time value of the notional reinsurance premiums. My preliminary view is that they do. There is a time gap between the payment of the premium and the claims. The first approach which is regularly adopted where claims for damages are made for the loss of a revenue earning chattel will usually do justice between the parties because the savings in cost associated with a non- use of the chattel occur at the same time as the loss of revenue. Here, the position is different. I am reinforced in the conclusion by the fact that Phillips J has applied this approach in the Feltrim action. I turn, therefore, to issues of principle relating to the special priority treaty: (1) is the plaintiffs' recoverable loss in respect of aggregate improperly ceded to INX Re. and Aneco limited to unpaid claims in respect of Exxon Valdez and Hurricane Hugo? (2) what is the effect of reinstatements on the amount of aggregate that could properly have been ceded to Aneco? (3) what discount should be given for the possibility that some of the bad debts of INX Re. and Aneco may prove to be recoverable? (4) what is the correct treatment of interest in relation to premiums paid and debts incurred and having regard to any recoveries that might be made. The first two questions largely hinge upon the nature of the judgment on liability having regard to the issues at trial. The answer to question one is no. The breach of duty by the underwriter was his failure to satisfy himself that the two participants to the treaty were of sufficient financial standing to be trusted with the business ceded to them. Most of that business was catastrophe reinsurance in respect of which claims would only be made after a substantial disaster and at a time when the participants would or might be called on as a last resort. Thus, a great deal of evidence was adduced as to the financial integrity of the entities, having regard to the need for stability in the long term and for strength in the face of disasters which could adversely affect all, or a substantial part, of the insurance market. Thus, whilst the question of their suitability was postulated against the background of catastrophe business, the complaint was not confined to that issue. The complaint was in relation to the quality of the security. The measure of damages is that to which I referred at the outset of this judgment. As to the second question, I had hoped I had made the position plain by what was said at page 115 of the judgment to which I referred. It seems to me, and it may have been in my mind when I gave judgment, that the correct way of measuring the damage which the Names sustained as a result of Aneco's participation would be to take the current position and to make an appropriate reduction in that figure to produce a figure representing the loss which would have been sustained had a proportionately smaller share of the risks been ceded. The result of doing this is to marginally reduce the amount claimed in relation to Aneco to #12.893 million. The figure of ten per cent took account of reinstatements. It is incorrect to add to that figure on the basis of reinstatements. The discount to be given for the possibility of recoveries from INX Re. and Aneco must be taken into account when I fix the amount of the interim payment for the 1989 year of account. I shall make such a deduction in a global sum for both entities without disclosing in this judgment the basis for it. The question of recovery is commercially sensitive and I have had the benefit of some evidence. As to the fourth question, the possibility of future recoveries from Aneco and INX Re cannot in my judgment affect the question of what the plaintiffs are entitled to by way of interest on moneys due to date. Secondly, it would be appropriate to treat premium and claims as one item, as happened in practice. Premiums and claims are administered together in periodic treaty bordereaux and would be settled on a net basis. Interest should be calculated on that net basis rather than on the basis of claims and premiums being treated as separate streams. In the light of these principles, I now turn to the the question of my approach to the application and the way my discretion should be exercised. The terms of Ord.29 r.11 require the court to award an amount it thinks just, not exceeding a reasonable proportion of the damages which, in the opinion of the court, are likely to be recovered by the plaintiffs. In my view, Mr Hirst is right to stress the need in this case not to make an interim payment award which turned out to be excessive. The Names are in different financial circumstances. It may well be difficult for the defendants to recover any sums which were overpaid, either from a purely practical point of view or from a risk that one or more Names may not have the funds available for repayment. As to the risk in relation to stop loss insurance, such insurers have a lien on any sums awarded to a Name who contracted such a policy, and I do not consider that there is much risk that, were excessive amounts to be awarded, the defendants would have particular difficulty in recovering them from those insurers. I must bear in mind that the figures which have been presented to me may not be accurate. The defendants have not fully checked the raw data on which the plaintiffs' expert produced his helpful tables. There is a slight risk, as it seems to me, that there may have been a measure of double counting. The defendants' expert allowed #2.5 million as a deduction for this item. I do not consider that such a figure is justified, bearing in mind the state of the evidence on this point. In broad terms, I am satisfied that the plaintiffs' approach to this application has been entirely correct in principle. The approach to the figures has been cautious and conservative. For example- and there are others- when calculating rates of exchange, two different rates have been used, depending on whether pounds were being converted to dollars or the other way about. In each case, a rate has been taken which is favourable to the defendants. I have no reason to believe that the damages which will be awarded at trial will be less than #80 million, subject only to the deductions which must be made for potential recoveries from the two defaulting participants to the special priority treaty and subject to two other points: (1) the notional carefully selected replacements for Aneco and INX Re. might not have been creditworthy at the end of the day. (2) Mr Bullen might have chosen to operate a different system with a different participant. It seems to me that there is merit in the first point which will at trial have to be dealt with. For present purposes, I shall take the point into account by making some relatively small discount. I reject Mr Crane's submission that I must assume that the fictional replacement was bound to be creditworthy. This is not a matter which requires any significant reduction, but some. In relation to the second point, in principle it seems to me that I should approach the case on the basis that Mr Bullen would have treated the replacement in the same way as he had dealt previously with INX Re. or Aneco, as the case might be. Importantly, as it seems to me, claims are still accruing due. I cannot determine what they are likely to be at the end of the day but I have been provided with figures which show substantial sums in respect of claims which have been made since the calculations on which this application is based have been prepared. I bear in mind what Mr Hirst told me. Namely, that these are just claims which may or may not have to be paid. They may not be valid claims, but it seems to me that realistically I am entitled to consider that the plaintiffs' claim at the end of the day is certainly going to be higher than it has presently been advanced on this application. In relation to Aneco and INX Re., it would appear that a further sum for claims of about #3 million between them has been incurred since the original figures were calculated. In relation to the first head of claim- that is, the vertical reinsurance claim- the figures are more substantial. I turn therefore now to conclusion I have arrived at. The figures may be stated in this way: The plaintiffs' claim, as I have indicated, is approximately #80 million. It is apportioned rightly between two years of account. For the 1988 year of account the claim is #35,478,908. Having regard to all the factors which I have referred to in this judgment and bearing in mind that the 1988 year of account is not concerned with any issues relating to the special priority treaty (or, therefore, with chances of recovery) in my view, a just proportion of that sum would be #35 million. It seems to me that the claim, at the end of the day, is bound to be considerably more than that having regard both to the outstanding matters and to the conservative approach adopted in making that calculation. In relation to the 1989 year of account, the position is this: That, excluding the special priority treaty matters, the Names' claim as presented would be #25,901,813. Inclusive of the special priority treaty, that figure will be some #23 million more although that figure of #23 million would have to be scaled down by the factor of 76.993. In those circumstances, the figure which I have arrived at which would be appropriate to order by way of interim payment for the 1989 year of account is #37 million, making a total of #72 million to be paid by way of interim payment. I am satisfied that there is no risk that that sum will be exceeded at trial. I am satisfied that that does justice between the parties. I hope that they will be able to resolve their outstanding differences without the need for a trial on the balance, but I would be prepared to give directions as to how that should proceed if I am asked to do so. DISPOSITION: Judgment accordingly. SOLICITORS: Richards Butler; Reynold Porter Chamberlain; Cameron Markby Hewitt