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DECLARATIONS
Winter 2002–2003
Existing . . . “to promote the free exchange of knowledge . . . to make its members
more effective managers . . . and to establish a working association with others in a
highly specialized field of insurance.”
DECLARATIONS — WINTER 2002–2003
Dear Members and Friends,
OFFICERS 2002-2003
The Excess Surplus Lines Claims Association had an impressive meeting this past
PRESIDENT September at the Westin Savannah Harbor. Ken Feinberg was our keynote speaker
DALE A. DIAMOND 2003
SENIOR VICE PRESIDENT and provided us with insights as to the aftermath of the tragedy of September 11,
AXA CORPORATE SOLUTIONS REINS CO.
17 STATE STREET 2001. Included within the Photo Gallery in this issue are snapshots from our meetings
NEW YORK, NY 10004
(212)493-9365 and social events. Hopefully, you will find them of interest.
VICE PRESIDENT/PRESIDENT ELECT
TIM HUGHES 2004
VICE PRESIDENT
ESSEX INSURANCE CO. This publication enjoys great relationships with various organizations. As always,
4521 HIGHWOODS PARKWAY
GLEN ALLEN, VA 23060 I extend my appreciation to the Federation of Defense & Corporate Counsel, who
(804)273-1437
TREASURER/DECLARATIONS EDITOR
again have contributed two articles to this publication. I would also like to express
JAMES T. MCNAMARA 2004
SENIOR VICE PRESIDENT
my appreciation to the Association of Defense Trial Attorneys and in particular James
SWISS RE
55 EAST 52ND STREET,42ND FLOOR
Jennings who has written in back to back issues. I would like to welcome the
NEW YORK , NY 10055
(212)317-5392
International Association of Defense Counsel which contributed an article on Time-
SECRETARY Bar.
MICHAEL G. BECKMAN 2004
ASSISTANT VICE PRESIDENT – CLAIMS
CNA RE
333 SOUTH WABASH, 39TH FLOOR. With this issue, I would like to note that we have tried to again freshen up the pub-
CHICAGO,IL 60604
(312)822-7302 FAX: lication. I am deeply grateful to Catherine Kalaydjian, my co-editor, who will ultimately
DIRECTORS (TERM EXPIRATION) become the editor of this publication. We have some new ideas which we hope to
MICHAEL J. DEGNON 2003
ASSISTANT VICE PRESIDENT – CLAIMS include in our summer edition.
ZENITH INSURANCE CO.
21255 CALIFA STREET.
WOODLAND HILL, CA 91367
(818)587-2732 We look forward to our members continuing their contributions to the publication
RONALD SMILLIE 2003
SENIOR VICE PRESIDENT, CLAIMS
and providing their feedback on various topics.
ST. PAUL RE, INC.
195 BROADWAY
NEW YORK, NY 10007
(212)238-9642
It is always with great sadness that we acknowledge the loss of someone who has
JOHN T. SPECKMAN 2003 meant a great deal to our organization. Unfortunately within the last year, Bud
EXECUTIVE VICE PRESIDENT
RAMPART INSURANCE COMPANY Brown, former President of the Association and a Vince Donohue Award winner,
20 EXCHANGE PLACE
NEW YORK, NY 10005
(646)495-2855
passed away. Bud will be greatly missed, but his contributions to our organization
JERRY E. HART 2004 will endure.
VICE PRESIDENT CLAIMS
UNITED NATIONAL INSURANCE CO.
THREE BALA PLAZA EAST, SUITE 300
BALA CYNWYD, PA 19004 As always, I remind you that any change in a company address, zipcode, telephone
(610)668-3261
GARY BASS 2005 or facsimile number, name of representative or alternate or titles, should be reported
CLAIMS AND R/I DIRECTOR
FARADAY UNDERWRITING LIMITED.
to the Executive Administrator, Andy Andersen. Company names change must be
8TH FLOOR, NEW LONDON HOUSE
6 LONDON STREET
reported to Membership Chairman, Ed McKinnon.
LONDON EC3R 7QL ENGLAND
(020)7702-3333
RONALD F. MOORE 2005
VICE PRESIDENT
I second our President’s message imploring our membership to suggest possible
JOHN P. WOODS COMPANY, INC.
NEW PORT TOWER
new members and encourage new blood to step forward and contribute and make
525 WASHINGTON BOULEVARD
JERSEY CITY, NJ 05054
our organization stronger,
(201)216-9000
WALTER V. O’GRADY 2005
SENIOR VICE PRESIDENT, CLAIMS Regards,
GMAC RE CORPORATION
6000 MIDLANTIC DR., 7TH FLOOR Jim , Cathy
MT. LAUREL, NJ 08054
(856)778-3270
CATHERINE A. KALAYDJIAN 2005
VICE PRESIDENT
QBE REINSURANCE CORP.
WALL STREET PLAZA
88 PINE STREET
NEW YORK, NY 10005
(212)894-7595
INTERNATIONAL LIAISON
RAYMOND J. BASSETT
MANAGING DIRECTOR
AON LIMITED
8 DEVONSHIRE SQUARE
LONDON EC2M 4PL ENGLAND
(020)7505-7173
EXECUTIVE ADMINISTRATOR
E.A.”ANDY” ANDERSON
317 WEST COLLEGE STREET
CARTHAGE,TX 75633
(903)693-5357
GENERAL COUNSEL
MICHAEL J. MERLO
MERLO, KANOFSKY & BRINKMEIER
208 S. LASALLE STREET, SUITE 950
CHICAGO, IL 60604
(312)553-5500
DECLARATIONS — WINTER 2002-2003
President’s Message
Unfortunately, the turmoil in the Just a simple request. As we all go
insurance and reinsurance market through our rolodexes, our palm pilots,
place continues, following the tragic or our computer databases just pull
events of September 11, 2001. Change out your X/S directory to see if your
is not a comfort generating process. friends, or business associates are
Unfortunately, many of us either already represented. If not, please either
have, or are, suffering in the valley contact the company to see if they
of confusion between our past comfort are interested in membership or let
levels and future comfort levels, at least us know of the identity of that poten-
in so far as our employment is con- tial member and the Excess Surplus
cerned. Mergers and acquisitions in Lines staff and officers will take it
the insurance and reinsurance indus- from there.
tries, and insolvencies, will continue.
The number of professional claims To all of our members, please try
people in the insurance and rein- to recommend at least two new can-
surance market place will continue didates for membership over the
to decline. These are some of the course of the next few months. This
sad facts of life today. 'new blood' will be vital to our con-
tinuing missions.
With economic reality staring us
all in the face, it is often difficult to Our London one day seminar will
join new organizations, spend money be on May 14 at Lloyds, in the Old
on association memberships, attend Library. Please call Ray Bassett at
expensive meetings, or travel to conventions at distant 011-44-207-505-7173 or Gary Bass at 011-44-207-702-
corners of the planet. Having attended Excess Surplus 3333 for details. The New York seminar will be on
Lines meetings for over twenty years, I would like to think May 8 at 101 Park Ave Club - please call Ron Moore (201-
that we fill a niche for all of our member companies, asso- 216-9600) or Jerry Hart (610-668-3261) for details.
ciate members and honorary members by providing
higher levels of education at our seminars in New York Also – and this is important - don't forget to set aside
and London, and our annual meeting in the fall of each September 14th through September 17th, 2003 for our
year. next Annual Meeting at the Rancho Bernardo Resort,
just north of San Diego. We will have the 'run-of-the
If there is any message which I would like you to house' as the resort's only group. The golf course looks
pass along during the coming year it is that I would great, and the weather should be warm and sunny.
like to encourage all of you to step forward to reach Also, don't forget that Ken Feinberg of the WTC Victims
out to qualified non-members to see if they would like Compensation Fund has agreed to return as our keynote
to become members. This vibrant organization has speaker!
been in existence for thirty-one years and I would love
at some point in the future to look down (hopefully) Thank you for all of your support, and best wishes
upon a live, vibrant organization a hundred years from for a happy and healthy 2003.
now. I am sure we all share this vision.
– Dale A. Diamond
DECLARATIONS — WINTER 2002-2003
3
Membership News
AT THE FALL 2002 MEETING OF THE BOARD OF DIRECTORS,
THE FOLLOWING WERE APPROVED:
NEW MEMBERS DELEGATE
Capital Indemnity Corporation Regular Kent Lawson
Combined Specialty Group Regular John Intondi
Great American Custom Regular C. Robert Golenor
Omni Whittington Group Run-off Andy Campbell
Reinsurance Solutions International, L.L.C. Claim Mgmt Brian Johnston
Riverstone Claims Management, LLC Run-off Ottheinz Larisch
R.J. Kiln & Co Regular Ashley Lawrence
Westport Reinsurance Management, LLC Regular Vern Ismen
NAME CHANGES
Benfield Greig Ltd. Graham Rose
Converium Reinsurance North America Jeffrey Jarman
Faraday Underwriting Limited Gary Bass
Mitsui-Sumitomo Marine Management Robert MillerNorth
North American Specialty Ins. Co. Pete Grimes
Willis Limited Stephen Potts
HONORARY MEMBERSHIP
George Casale
IN MEMORIAM
Bud Brown
Past President, 1980
Vince Donohue Award, 1989
DECLARATIONS — WINTER 2002-2003
4
Declarations Contents
FEATURES DEPARTMENTS
10 Mass Pharmaceutical Litigation Letter From the Editor Inside Cover
This primer takes you through
topics such as recent examples
of Mass Torts, Medical Monitoring
President’s Message 3
and CGL coverage issues.
By Forrest C. Wilson III Membership News 4
25 D & O Liability to Corporate Creditors
Introducing the Officers and
Can Creditors seek a remedy
Directors of the Association 22
from a corporation’s Directors
and Officers?
By James W. Jennings and Letters of the Law 8
Ellen S. Moore
29 Time Tamers Savannah Photo Gallery 6
Everyone needs to be
reminded to manage time.
ADTA Notes 28
By Robin Fogel
31 Non Disclosures
What happens when one
party feels the other party
has withheld material
information during the
underwriting process?
By Peter Schwartz
43 Time Bar
The authors gives us a review
of this important issue.
By Louise Bagnall and
Bill Perry
DECLARATIONS — WINTER 2002-2003
5
Memories From Savannah
DECLARATIONS — WINTER 2002-2003
6
DECLARATIONS — WINTER 2002-2003
7
Letters of the Law
The Federation very much • Excess and Surplus Lines Section;
appreciates and values its close
relationship with the Excess • Extracontractual Liability Section;
and Surplus Lines Claims
Association. Last September • Insurance Coverage Section;
in Savannah, at the 33rd Annual
X/S Conference, the Federation • Insurance Industry Section;
was honored to present anoth-
er all-star FDCC panel discussing • Life, Health and Disability Section;
cutting-edge insurance issues.
Entitled AImplications of • Property Insurance Section; and
Enron/Anderson: Tips and
Robert V. Dewey, Jr. Traps for the Unwary,@ the • Reinsurance Section.
panel featured presentations by Colin Croly, who is a
member of both X/S and FDCC, and Federation mem- In addition, our Corporate Members Forum, which
bers Lori Iwan, Jim Semple and Vincent Vitkowsky. The includes all non-practicing attorney and non-attorney
program was designed to highlight the primary issues members of the Federation, i.e. company executives,
of concern for primary, reinsurance and excess/surplus includes representatives of at least 90 different insur-
lines carriers, and focused on how the various insurance ance carriers and/or related businesses such as third party
markets were impacted by problems occasioned by administrators. A number of X/S members are also
Enron/Anderson, including trigger-occurrence and allo- FDCC members, including President Dale Diamond
cation of loss issues, reinsurance issues, and analysis and President-Elect Tim Hughes. At the risk of omit-
of covered and uncovered losses. These issues were ting someone, I will not attempt to name the other
also discussed in articles by Lori Iwan and Jim Semple common members, but if my count from the X/S
in the Summer 2002 edition of Declarations. Membership Roster 2002-2003 is correct, we have more
than ten other common members.
The FDCC has been privileged to contribute to your
CLE program and also to Declarations, and would like In addition, the Federation is involved in a number
to continue to provide expertise on issues of interest of joint projects with the insurance industry. For exam-
and concern to X/S membership. For example, in this ple, just this past fall the FDCC was involved in putting
issue an update on claims against pharmaceutical com- on a program in New York City partnering with the
panies is being authored by Forrest ASkip@ Wilson of Manhattan Institute Center for Legal Policy on
Mobile, who is a Vice Chair of our Product Liability AConsumer Fraud Statutes: Recipe for Consumer
Section, and an article concerning the consequences Fraud Prevention or Fraud on the Consumer?@, which
of non-disclosure of material information during the to a large extent focused on the issues arising from
underwriting processCfrom the perspective of the U.K. Avery v. State Farm and related claims against insur-
underwriterCis being written by Bob Allen of the ance carriers; we put on a joint program with the PLRB
Insurance Coverage Section and his London-based in Chicago entitled, ACritical Issues for Senior Property
partner, Peter Schwartz. We hope that these subjects Insurance Executives and In-House Counsel@; and our
will be of particular interest to many X/S members. Reinsurance Section put on a mini-seminar at Lloyd=s
in London focusing on the events of September 11 upon
There is considerable synergy between our respec- the European insurance market.
tive organizations. A primary focus of the Federation
continues to be the insurance business. For example, Looking ahead, our Ninth Annual Litigation
here are a few of our very active substantive law com- Management College will be held June 23-27, 2003 on
mittees which focus directly on insurance issues: the campus of Northwestern University at the Kellogg
School of Business= Allen Center in Evanston, Illinois.
• Alternative Dispute Resolution Section; The FDCC Litigation Management College is often
referred to as our Acrown jewel.@ The College is spon-
• Construction, Fidelity, Surety and Public Contract sored by the Federation as a service to claim professionals,
Section; third party administrators and self-insured corporate
litigation managers working in the insurance indus-
DECLARATIONS — WINTER 2002-2003
8
try and/or litigation throughout the country. The fun- Lori Iwan (phone (312) 332-8455, e-mail lei@iwan-
damental objective of the College through its curriculum cray.com) of Chicago is the Dean of the College this
is to provide a learning environment for claims pro- year, and Bill Clayton (phone (954) 463-2200, e-mail wclay-
fessionals that enhances litigation management and ton@fowler-white.com) of Miami is the Dean of Curriculum.
negotiation skills. Registration is now open for the 2003 College and there
is an early registration discount for commitments made
The College consists of an intensive five-day series prior to April 1, 2003. Electronic registration and
of workshops and participatory interactive education- details regarding the 2003 program are available on
al experiences. The curriculum is designed for claim the FDCC website at www.thefederation.org. If you
professionals to meet, study, and discuss issues of com- are interested in additional information about the pro-
mon interest with the focus on the increasingly important gram, please do not hesitate to contact either of the
area of litigation management. The curriculum is Deans.
based on enhancing key skills that are in daily demand
in the job of claims professional. A hypothetical case Robert V. Dewey, Jr.
based on a real claim that proceeded through trial and President
coverage disputes forms the backdrop for hands-on Federation of Defense and Corporate Counsel
workshops. Core topics such as bad faith, coverage
issues, case budgets and plans, case evaluations, and
negotiations are covered in depth. Instruction on emerg-
ing topics such as electronic discovery and Internet
research round out the week.
The target group for the College is claim and litiga-
tion management professionals with five to fifteen
years claim and/or litigation management experience.
Everyone who attends should leave with new and
enhanced skills to improve the work of litigation man-
agement. The program strives to enhance what individual
companies do through internal training programs. The
faculty is made up of experienced practicing attorneys
and claims professionals.
DECLARATIONS — WINTER 2002-2003
9
A REVIEW OF THE CURRENT STATUS OF
MASS PHARMACEUTICAL LITIGATION
1
Forrest C. Wilson III
I. Introduction of the connection between the product and their perceived
injury, but the must also be aware of their ability to file
Although there are few reported decisions involv- suit against a manufacturer or industry. Over the past
ing insurance coverage for drug and medical device twenty-five years, the media has focused more on prod-
claims, given the large verdicts and settlements in uct related risks and the multiple injuries resulting
these cases, there is a potential for disputes involving from them. The media have emphasized blaming busi-
coverage. What is reported up the chain of primary nesses and reporting on potential litigation faced by
and excess coverage carriers as an individual case or even particular businesses or industries. Karen A. Geduldig,
a small handful of cases can quickly evolve into hundreds Casey at the Bat: Judicial Treatment of Mass Tort
or thousands of claims, with exposure of hundreds of mil- Litigation, 29 Hofstra L. Rev. 309 (2000) . Once the media
lions or billions of dollars, implicating all levels of has drawn attention to a potential source of mass tort
coverage. The purposes of this article are: to provide litigation, the litigation events can create their own
excess and surplus lines managers with recent exam- publicity such as coverage of large verdicts. Deborah R.
ples of how these claims can quickly develop into mass Hensler & Mark A. Peterson, Understanding Mass
torts; to explain the typical claims asserted in these Tort Personal Injury Litigation: A Socio-Legal Analysis,59
cases; and to provide some insight into developing areas Brook. L. Rev. 961, 1022 (1993). This aspect of the mass
of the law in this area. Hopefully, this will allow you tort phenomenon is apparent given the widespread
to more fully understand the implications that these law- press coverage that accompanies the withdrawal of a drug
suits have for insurance coverage, both primary and from the market and the coverage frequently given to
excess, and to give some guidance to both underwriters large adverse jury verdicts.
and claims handlers for potential problem areas.
In the world of mass torts, as more cases are filed,
I. Rise Of Mass Pharmaceutical Torts that has the effect of causing more cases to be filed.
Much of the recent notoriety associated with phar- As courts become more familiar with the handling of large
maceutical product liability litigation has arisen in the numbers of similar claims, they become capable of han-
context of mass torts. Mass torts are typically defined dling more and more similarly situated claims. Likewise
as groups of cases, which involve more than 100 plain- plaintiffs’ law firms benefit from efficiencies of scale. The
tiffs. Report of the Advisory Committee on Civil Rules more specialized a firm becomes with regard to a par-
and the Working Group on Mass Torts to the Chief ticular type of case, the easier it becomes for the firm
Justice of the United States and to the Judicial Conference to handle large numbers of those cases. The more
of the United States, 187 F.R.D. 293 (1999) ("The Report"). familiar courts become with these types of cases and the
There are several reasons for the recent explosion in the more specialized the plaintiffs’ bar becomes, the more
volume of mass torts. Because of advances in tech- cases can move through the system and, depending on
nology, manufacturing, distribution and marketing, the outcome, the more incentive the plaintiffs’ bar has
more products and services are used by more people. The to file more cases.
Report at 300. "An ill-conceived pill ..., costing but a few
cents each, can place a huge corporation at risk [and] Pharmaceutical product litigation presents a unique
cause serious injury to individuals whose claims can- phenomenon in mass tort litigation due to the heavily
not be resolved ... simply because of the numbers of regulated nature of pharmaceutical products. Plaintiffs
similarly injured." The Report at 300. Furthermore, frequently argue that the rise in number of mass torts
particularly in the pharmaceutical product arena, is due to the fundamental tension between the Food
advances in science and epidemiology made it possi- and Drug Administration’s (FDA’s) role in carefully
ble to discover and follow causative connections between evaluating the safety and efficacy of new drugs and
products and injures that were previously undetectable. the need to make potentially life saving experimental
The Report at 300. drugs available to the people who need them as quick-
ly as possible. The plaintiffs’ bar has argued that in
Another force in the evolution of mass pharmaceu- recent times, this inherent tension has been resolved
tical torts has been the modern mass media. In order in favor of placing drugs on the market quicker at the
for mass torts to be filed, claimants must not only be aware expense of a traditional thorough review by the FDA.
The AIDS epidemic placed a great deal of political pres-
DECLARATIONS — WINTER 2002-2003
10
sure on the FDA which was viewed as impeding the 18, 1999, the manufacturer entered into a Nationwide
development of and access to new medications. This result- Class Action Settlement Agreement valued at approx-
ed in a liberalization of the FDA approval guidelines, imately $3.75 billion.
which was consistent with the sentiment that the risk-
benefit analysis of new drugs could better be made by The size of the verdicts in the diet drug cases was due
the people whose lives depended on them. Michael D. to two factors. First, plaintiffs were able to paint the
Greenberg, AIDS, Experimental Drug Approval, And The manufacturer defendant in a bad light using internal
FDA New Drug Screening Process, 3 NYU J. Legis. & Pub. documents. Second, given the fact that the alleged
Pol. 295 (2000). Plaintiffs’ lawyers have argued, and will injuries involved heart and lung damage, plaintiffs,
no doubt continue to argue, that the increase in num- even in the face of strong evidence to the contrary,
ber of pharmaceutical product liability cases is a result were able to inflate the severity of their damages.
of the relaxed regulatory framework with regard to These factors, coupled with the trials occurring in tra-
the approval of new drugs. ditionally plaintiff friendly venues, led to the large
verdicts.
I. Examples Of Recent Pharmacuetical Claims
In The Mass Tort Context A. Rezulin
Another example of recent large-scale product liability
There have been a comparatively large number of phar- litigation involves the diabetes drug Rezulin. The FDA
maceutical products, which have drawn attention approved Rezulin in 1997 as a treatment for Type 2
recently due to either the number of claims surround- diabetes. Rezulin was withdrawn from the market in
ing them or the size of the verdicts rendered in cases March of 2000 after reports began to surface concern-
involving them. As can be seen, given the magnitude ing liver damage, which occurred in some patients who
of claims presented in some of these litigations, it is had been taking the drug. Over 2200 cases have been
clear that excess and surplus issues will be implicated. filed in state and federal courts. In January 2002, the
first Rezulin case went to trial and resulted in a jury
A. Diet Drugs verdict of $24.9 million. There have been at least three
One of the largest mass torts in recent years involved additional cases tried to verdict involving Rezulin. One
the diet drugs Pondimin and Redux. Pondimin had case resulted in an award to the plaintiff of $43 million
been on the market since 1973, while Redux was in compensatory damages. The other two both result-
approved by the FDA in 1996. The primary allega- ed in defense verdicts. Again, as with diet drugs,
tions leveled against those drugs concerned their plaintiffs were able to paint the company in a bad light
propensity to cause heart valve damage, and, in rare cases, and emphasize the severity of their alleged damages.
primary pulmonary hypertension, a fatal lung disease.
In terms of a timeline for the development of this liti- A. Propulsid
gation, the first notice of any problems with the diet drugs Another recent pharmaceutical product, which has
Pondimin or Redux came in March of 1997 when the Mayo created a large amount of litigation, is Propulsid.
Clinic began to investigate the association between Propulsid was approved in 1993 for the treatment of gas-
use of the drugs and heart valve damage. The Mayo Clinic troesophageal reflux disease. Propulsid was withdrawn
published an article describing twenty-four cases of from the market in March of 2000 after the FDA received
heart valve damage in patients using the drugs in reports linking the drug to cases of heart damage. In
August of 1997. In re Diet Drugs Products Liability September of 2001, the first case went to trial and
Litigation, 2000 WL 1222042 (E.D. Pa. August 28, 2000). After resulted in a plaintiff’s verdict for $100 million for ten
further reports of heart valve damage associated with plaintiffs. To date, more than five hundred cases have
the use of Pondimin and Redux surfaced, the drugs been filed in state and federal courts.
were voluntarily withdrawn from the market by the
manufacturer on September 15, 1997. Id. at * 2. A. Baycol
Subsequent scientific studies confirmed the link between Perhaps the most recent mass pharmaceutical prod-
valvular heart disease and the use of Pondimin and uct litigation surrounds the drug Baycol. Baycol was
Redux. Id. at * 2. Within approximately two years of initially approved for use as a cholesterol-lowering
the withdrawal of the drugs from the market, approx- drug in 1997. The drug was voluntarily withdrawn from
imately 18,000 cases were pending against the drugs the market in August of 2001, after reports were sub-
manufacturer. Id. at * 2. mitted to the FDA linking the drug to approximately 40
deaths. To date, more than five hundred state and
There have been a number of verdicts rendered in diet federal lawsuits have been filed against the manufac-
drug trials, each in favor of the plaintiff. They include turer. No Baycol cases have been tried.
a jury verdict for the plaintiff in August of 1999 for
$23 million, a jury verdict for five plaintiffs in Mississippi I. THE CLASS ACTION DEVICE
for $150 million, and a jury verdict for the plaintiff in
state court in Texas for over $56 million. On November As plaintiffs’ counsel pursue mass actions against
DECLARATIONS — WINTER 2002-2003
11
drug companies, a powerful tool is the class action. each plaintiff may have taken the drug having read a
Using this device, a group of plaintiffs can band togeth- different warning label. Rezulin, 210 F.R.D. at 67.
er under one or more representative plaintiffs to institute Additionally, the fact that prescribing physicians are involved
a court action for damages or injunctive relief. Although affects issues of actual knowledge of each of the plain-
there may be some variance in state procedural rules tiffs and the learned intermediary defense. Id. Likewise,
(and, indeed, some states, such as Mississippi, do not members of the plaintiff class in cases involving med-
provide for class actions), generally, the rules safe- ical devices may have encountered different makes and
guard fairness and due process by mandating that the models, administered by persons with varying degrees
following four conditions be present: (1) the class of of experience, and for any number of different ailments.
plaintiffs is "so numerous that joinder of all members American Medical, 75 F. 3d at 1081.
is impracticable" (numerosity); (2) "there are questions
of law or fact common to the class" (commonality); (3) Apart from the factual nature of the plaintiffs’ claims,
"the claims or defenses of the representative parties the manufacturer’s affirmative defenses will likely
are typical of the claims or defenses of the class" (typ- involve individual fact questions as well. Defenses,
icality); and (4) that the representative parties will such as assumption of risk, contributory negligence,
fairly and adequately pursue the class interests (ade- and the statute of limitations, inherently stand on
quacy of representation). Fed. R. Civ. P. 23(a). questions of fact peculiar to each plaintiff. PPA, 208
F.R.D. at 631. Such individual concerns weigh against
In addition to meeting each of those four mandato- a finding of typicality and commonality as well as the
ry conditions, a class action must also fall into one of classification of a class under Rule 23(b)(3) for the pre-
three categories: (1) prosecution of separate actions by dominance of common questions over individual questions.
individual members of the class would create a risk of
inconsistent judgments establishing incompatible stan- These differences often impede the required Rule
dards for the defendant or would substantially impair 23(a) findings of typicality and commonality and the Rule
the ability of others to pursue their rights; (2) the defen- 23(b)(3) finding that common questions of law or fact
dant has acted or refused to act, making injunctive or predominate over individual issues. Individual issues
declaratory relief appropriate with regard to the entire regarding causation and defenses generally preclude cer-
class; or (3) questions of law or fact common to the tification of a class. For these reasons, those putative
members of the class predominate over questions affect- classes that have been certified are few, and usually arise
ing the individual members, and class action is superior in the context of a settlement.
to other procedures. Fed. R. Civ. P. 23(b). At least in
the litigated context, as opposed to settlement, class For example, in PPA, a class action involving
actions with drug and medical devices have not met a Phenylpropanolamine, a common ingredient in over-the-
great deal of success in certification. counter cough-cold medications and appetite suppressants,
the court found that the group of plaintiffs did not com-
A. Class Actions Against Drug and Medical prise a class under any subpart of Rule 23(b). 208
Equipment Companies in General F.R.D. at 630. Notably, the court refused to certify the
plaintiffs as a 23(b)(3) class because the plaintiffs failed
to show that common issues predominated over individual
Class actions involving the manufacture and sale issues:
of drugs and medical devices present unique problems
not present in a typical mass tort action arising out of Here, the proposed classes comprise a multitude
a single incident. Unlike, for example, an action by of individuals with different backgrounds, per-
passengers injured in a plane crash, most personal sonal characteristics, medical histories, health
injury claims against manufacturers and sellers of problems, and lifestyles. These individuals alleged-
drugs and medical devices involve as many different inci- ly consumed one or more of a variety of different
dents as there are class members. See In re American PPA-containing products, produced by various
Med. Sys., Inc., 75 F.3d 1069, 1084-85 (6th Cir. 1996); defendants. The products were consumed at dif-
In re Phenylpropanolamine (PPA) Prod. Liab. Litig., ferent times, in different amounts, and with
208 F.R.D. 625, 631 (W.D. Wash. 2002). Each member varying results. That is, some individuals sus-
of the plaintiff class in a prescription drug action may tained a single injury, others multiple injuries,
have taken a different dose, at a different time, for a dif- and still others no physical injuries whatsoever.
ferent period of time, or perhaps in combination with
any number of other drugs. Moreover, each plaintiff would Id. at 631. Likewise, the Rezulin court, encountered
inevitably come to the table with a different medical his- the same barriers and denied certification under 23(b)(3)
tory. See PPA, 208 F.R.D. at 631-32; In re Rezulin as well:
Prod. Liab. Litig., 210 F.R.D. 61, 66-67 (S.D.N.Y. 2002).
[T]he individualized nature of the causation inquiries
In cases involving allegations of inadequate warnings,
DECLARATIONS — WINTER 2002-2003
12
is not surprising, as class members took Rezulin nationwide putative classes exists. Many states have
at different times, for different periods, in differ- not recognized a cause of action for or a remedy of med-
ent amounts, and while undergoing different levels ical monitoring, and those that have done so require different
of liver and other health monitoring. Moreover,. elements of proof. Id. (finding the nationwide class
. . the issue whether Rezulin caused physical would not be manageable in light of the differing laws
injury to a specific class member will depend on regarding medical monitoring). This has not only cre-
his or her unique characteristics such as family and ated management problems in nationwide putative
medical background, preexisting medical conditions, class actions, but has also brought to bear the federal
age, gender, life style, drug or alcohol use, quan- policy under the Rules Enabling Act that parties should
tity of Rezulin ingested, duration of course of not be able to choose the law most amiable to their
treatment, whether it was used as an initial ther- case simply by choosing a forum. In re Diet Drugs
apy and whether Rezulin was used alone or in (Phentermine, Fenfluramine, Dexfenfluramine) Prod.
conjunction with other drugs. Liab. Litig., No. CIV. A. 98-20626, 1999 WL 673066
(E.D. Pa. Aug. 26, 1999).
210 F.R.D. at 66-67. Clearly, the individual issues
presented by those putative class actions presents an Another issue exists where a putative class seeks
impediment to certification. certification under Rule 23(b)’s injunctive classifica-
tion. Some courts have classified medical monitoring
Those cases in which a plaintiff class has been cer- actions as equitable, while others have not. Regardless,
tified involve a class definition of fact pattern of usage problems may arise where medical monitoring claims
and injury with much less extensive individual factu- are accompanied by requests for damages. In order to
al issues. For example, in In re Diet Drugs (Phentermine, fall within a 23(b)(2) class certification, the request for
Fenfluramine, Dexfenfluramine) Products Liability injunctive relief must predominate over the monetary
Litigation, the court certified a settlement class where relief. Rezulin, 210 F.R.D. at 67-68.
it found that the products were essentially one single
product marketed by one manufacturer, where use of Additionally, the certification of a class including
the product "spanned a finite and relatively short peri- both symptomatic and asymptomatic plaintiffs caus-
od of time", and where members of the class suffered a es new commonality problems and raises issues of
common heart valve injury. Phen-Fen, Nos. 1203, 99- fairness. To include a symptomatic plaintiff in a class
20593, 2000 WL 1222042, at *40-44 (E.D. Pa. Aug. 28, action seeking solely medical monitoring would pre-
2000). That settlement involved a subclass structure vent that plaintiff from ever receiving compensation
allowing for different relief depending on the extent of for injuries. An asymptomatic plaintiff, on the other hand,
injury and amount of use. However, at least in the would be free in the future to sue for medical injuries
non-settlement context, certification of broad classes has that may arise later. Some Pennsylvania trial courts
been few. have cured this problem by limiting the class to include
only those persons exposed to the product who have
A. Medical Monitoring Class Actions Against Drug thus far been asymptomatic, have not been diagnosed,
and Medical Equipment Companies or have not filed suit. In re Pennsylvania Diet Drugs
Litigation, No. 9709-3162, 1999 WL 962583 (Pa. Com.
Class certification in medical monitoring actions is Pl. March 12, 1999) (certifying medical monitoring
equally as dubious. Again, courts readily find the class for persons having ingested the products, but lim-
issues to be too individualized to be appropriate for iting the class to those "who have not been diagnosed"
class adjudication. In medical monitoring cases, plain- with pulmonary injury); Phen-Fen, No. CIV. A. 98-
tiffs encounter not only the individual issues of causation 20626, 1999 WL 673066 (conditionally certifying a
encountered by plaintiffs in other class actions against narrow medical monitoring class for persons who ingest-
drug companies, but they also face the individualistic ed the products for over thirty days during a finite
issues of whether exposure increased each member’s risk period and who have not filed a claim in court).
of injury and whether medical monitoring is necessary
or even useful. These issues inevitably involve ques- A. Consumer Fraud Class Actions Against Drug
tions of each plaintiff’s medical history and whether and Medical Equipment Companies
each plaintiff is already monitored for other reasons. Rezulin,
210 F.R.D. at 67-68 (finding that "the evidence shows Finally, as more lawsuits involving prescription
that many patients formerly on Rezulin already are drugs allege fraud-based claims in addition to tradi-
having blood chemistry tests, including liver studies, per- tional personal injury clams, courts must address those
formed, in some cases, as part of their routine medical claims in the class action context. These claims encounter
care and, in other cases, because the labels for the two the same impediments to certification as the consumer
newer diabetes drugs that replaced Rezulin so recom- fraud cases involving insurance and other financial
mend."). products. A federal court in New York, although not address-
ing a consumer fraud action, hypothesized that even a
Moreover, a recurring management problem for consumer fraud claim not involving physical injuries would
DECLARATIONS — WINTER 2002-2003
13
likely require numerous individual determinations A. Strict Liability
that would impede class certification. Plaintiffs in Many pharmaceutical product liability claims are
Rezulin argued that the court’s focus on the individu- brought pursuant to some form of strict liability doctrine.
alized determinations of causation in a products liability The foundation for most modern iterations of strict
case were misplaced, as the essence of their claim was product liability is section 402A of the Restatement
the defendant’s deception regarding the product. In (Second) of Torts. That section provides:
rejecting this argument, the court replied: "[I]t appears
entirely probable that even a consumer fraud theory would (1) One who sells any product in a defective con-
require individualized proof concerning reliance and dition unreasonably dangerous to the user or
causation, which are hornbook elements of a fraud consumer or to his property is subject to liability
claim . . . ." Id. at 68. for physical harm thereby caused to the ulti-
mate user or consumer, or to his property, if
I. CAUSES OF ACTION ASSERTED IN PHAR-
MACEUTICAL PRODUCT MASS TORT (a) the seller is engaged in the business of sell-
LITIGATION ing such a product, and
Whether filed as a class action or an individual law- (b) it is expected to and does reach the user or
suit, the claims typically asserted in pharmaceutical cases consumer without substantial change in the con-
are as follows: dition in which it is sold.
A. Negligence (2) The rule stated in Subsection (1) applies
The concept of negligence is one of the most basic although
in American jurisprudence. Every state has adopted the
concept of negligence in some form. The basic elements (a) the seller has exercised all possible care in the
of a negligence claim are (1) the presence of a duty; (2) preparation and sale of his product, and
a breach of that duty; (3) proximate causation; and (4)
damages resulting therefrom. Pharmaceutical product (b) the user or consumer has not bought the prod-
liability cases typically involve, among other things, uct from or entered into any contractual relation
claims for negligence. While the specific allegations with the seller.
concerning negligence vary from case to case, they can
cover the entire life span of a product. They can cover Most states have adopted some form of strict liabil-
such areas as the design and/or development (testing) ity in the area of product liability claims. In 1998, the
of the product at issue, marketing of the product at American Law Institute released the Restatement of the
issue, and the warning labels that accompany the prod- Law Third pertaining to product liability claims. Section
uct at issue. The claims involve second-guessing the 6 of the Restatement (Third) specifically addresses a sell-
manufacturer’s pre-marketing safety testing as well er’s liability in the context of prescription drugs and
as its handling of post-market adverse events. medical devices.
A. Wantonness/Gross Negligence (a) A manufacturer of a prescription drug or med-
Nearly all jurisdictions also recognize a separate ical device who sells or otherwise distributes
tort, which embodies the same general principles as a defective drug or medical device is subject to
negligence but requires a higher mental state of culpability. liability for harm to persons caused by the
This mental state has been described as a conscious defect. A prescription drug or medical device
or reckless disregard for the safety of others. Claims is one that may be legally sold or otherwise
sounding in wantonness or gross negligence involve distributed only pursuant to a health-care
the same type of activities as general negligence, i.e. the provider’s prescription.
design, marketing or labeling of the pharmaceutical
product at issue. Wantonness claims are frequently (b) For purposes of liability under Subsection (a)
asserted in cases involving pharmaceutical products a prescription drug or medical device is defec-
because some states do not allow for the recovery of tive if at the time of sale or other distribution
punitive damages without a showing of the higher men- the drug or medical device:
tal state of culpability required to prove wantonness.
Thus, evidence used to establish a claim for wantonness, (1) contains a manufacturing defect as defined in
if believed by the trier of fact, will generally be sufficient § 2(a); or
to allow for a recovery of punitive damages. Also, fre-
quently defenses, which apply to claims for negligence, (2) is not reasonably safe due to defective design
will not apply to claims for wantonness and/or gross as defined in Subsection (c); or
negligence.
(3) is not reasonably safe due to inadequate instruc-
tions or warnings as defined in Subsection (d).
DECLARATIONS — WINTER 2002-2003
14
(c) A prescription drug or medical device is not (1) Unless excluded or modified (Section 2-316), a
reasonably safe due to defective design if the warranty that the goods shall be merchantable
foreseeable risks of harm posed by the drug is implied in a contract for their sale if the
or medical device are sufficiently great in rela- seller is a merchant with respect to goods of that
tion to its foreseeable therapeutic benefits that kind. Under this section the serving for value
reasonable health-care providers, knowing of of food or drink to be consumed either on the
such foreseeable risks and therapeutic bene- premises or elsewhere is a sale.
fits, would not prescribe the drug or medical
device for any class of patients. (2) Goods to be merchantable must be at least
such as
(a) pass without objection in the trade under the
(d) A prescription drug or medical device is not contract description; and
reasonably safe due to inadequate instruc-
tions or warnings if reasonable instructions (b) in the case of fungible goods, are of fair aver-
or warnings regarding foreseeable risks of age quality within the description; and
harm are not provided to:
(c) are fit for the ordinary purposes for which
(1) prescribing and other health-care providers such goods are used; and
who are in a position to reduce the risks of
harm in accordance with the instructions or warn- (d) run, within the variations permitted by the
ings; or (2) the patient when the manufacturer agreement, of even kind, quality and quanti-
knows or has reason to know that health-care ty within each unit and among all units involved;
providers will not be in a position to reduce and
the risks of harm in accordance with the instruc-
tions or warnings. (e) are adequately contained, packaged, and labeled
as the agreement may require; and
(f) conform to the promises or affirmations of fact
(e) A retail seller or other distributor of a pre- made on the container or label if any.
scription drug or medical device is subject to
liability for harm caused by the drug or device (3) Unless excluded or modified (Section 2-316)
if: other implied warranties may arise from course
of dealing or usage of trade.
(1) at the time of sale or other distribution the
drug or medical device contains a manufac-
turing defect as defined in § 2(a); or
UCC § 2-314. The crux of the plaintiff’s case with regard
(2) at or before the time of sale or other distribu- to a warranty claim is to prove that the drug in ques-
tion of the drug or medical device the retail tion did not perform as intended, i.e. if the drug was supposed
seller or other distributor fails to exercise rea- to control heartburn, it failed to do so for that plaintiff.
sonable care and such failure causes harm to Breach of implied warranty claims can often be effec-
persons. tively defended by demonstrating that the injury of
which the plaintiff is complaining is unrelated to the stat-
ed indication for which the plaintiff took the drug. In
other words, if the plaintiff took the drug for heart-
A. Breach of Implied Warranty burn control, a breach of warranty claim can usually be
In addition to the claims discussed above, plaintiffs defeated by showing that, despite whatever other prob-
typically assert claims for breach of implied warranty, lems the plaintiff is claiming the drug in question
most commonly a claim that the drug in question vio- caused, it did in fact control the plaintiff’s heartburn.
lated the implied warranty of merchantability. Most, While breach of warranty claims are frequently assert-
if not all, states have adopted statues pertaining to ed by plaintiffs, they are rarely the primary focus of
this warranty language based on the section 2-314 of the case.
the Uniform Commercial Code. That section provides:
DECLARATIONS — WINTER 2002-2003
15
A. Failure to Warn 2. As a proximate result of the exposure, plain-
The concept of tort liability arising from a failure to tiff is at a significantly increased risk of
warn has general application in nearly all product lia- contracting a serious latent disease;
bility claims. The written warnings that accompany
pharmaceutical products, both prescription and over 3. The risk of contracting a serious latent dis-
the counter, are developed in conjunction with the Food ease is now greater than the risk of contracting
and Drug Administration. Plaintiffs will typically chal- that disease had the plaintiff not been exposed
lenge the content of this labeling by arguing that the to the substance;
defendant should have included additional informa-
tion about known potential risks. 4. The increased risk of the disease makes it rea-
sonably necessary for the plaintiff to undergo
A. Fraud/Suppression periodic diagnostic medical examinations dif-
Frequently, pharmaceutical product liability cases ferent from what would be prescribed in the absence
involve allegations of fraud and/or suppression. Fraud of the exposure; and
is synonymous with the term misrepresentation. In
order to establish a claim for fraud in its simplest 5. Monitoring procedure exists that makes the early
terms, a plaintiff must prove that the defendant made detection of the disease possible.
a material misrepresentation, which the plaintiff relied
on to his detriment. Some states have different "clas- See Brown v. Westinghouse Electric Corporation,
sifications" of fraud depending on the knowledge of the 522 S.E.2d 424 (W. Va. 1999) and Bourgeois v. A.P.
party making the representation. Green Indus., Inc., 716 So. 2d 355 (La. 1998).
The misrepresentation can be intentional, reckless Recent cases involving medical monitoring include
or negligent. These distinctions can impact the types the adoption, by West Virginia, of a cause of action for
of damages available. Claims of suppression are also the recovery of medical monitoring costs for exposure
frequently asserted. Plaintiffs frequently argue that phar- to a proven hazardous substance, Bower v. Westinghouse
maceutical companies have failed to disclose information, Elec. Corp., 522 S.E.2d 424 (W. Va. 1999), and the
which they were under a duty to disclose. This tort rejection of such causes of action by Alabama, Hinton
frequently involves much of the same evidence as the v. Monsanto Company, 813 So. 2d 827 (Ala. 2001), and
allegations concerning the failure to warn claim. The Kentucky, Wood v. Wyeth-Ayerst Laboratories, 82 S.W.3d
tort of suppression or concealment differs from mis- 849 (Ken. 2002). These cases detail the strengths and
representation in that the analysis shifts to focus on weaknesses of the various positions on each side.
information that was not disclosed to the injured party.
In Wood v. Wyeth-Ayerst Laboratories, the Kentucky
A. Medical Monitoring Supreme Court considered a medical monitoring claim
During the last few years, a number of courts have filed as a class action on behalf of opt-outs from the
adopted causes of action for "medical monitoring," nationwide class action settlement involving the appetite
under which a plaintiff, who does not allege or prove any suppressant Fen-Phen. The court affirmed the decisions
present physical injury to support a tort claim, is allowed of the lower courts dismissing the claims. The Supreme
to recover as damages the cost for medical monitoring Court granted review because of developments in toxic
in the future. Although the majority of decisions in the tort litigation in other states. In that case, plaintiff’s
field of medical monitoring involve toxic exposure cases, complaint specified her injury as "significantly increased
some of the decisions involve prescription drugs. risk of serious injury and disease." Id. at 852. The
Regardless, the holdings of toxic tort cases should apply plaintiff, citing articles in medical journals, argued
equally to a prescription medications fact situation. that because experts have recommended ongoing diag-
These cases, particularly in the class context, impli- nostic testing for people who took Fen-Phen, she had suffered
cate millions of dollars in damages – medical monitoring a cognizable injury. However, the court, relying on
costs – for individuals that may not even have been the traditional tort requirement of a present physical
injured. injury to support a cause of action, rejected plaintiff’s
claim and affirmed the dismissal of the complaint.
In those states, which recognize a cause of action
for medical monitoring, although the factors vary, the Although it acknowledged the potential benefits
following are generally required: from medical monitoring, which include fostering early
diagnosis and treatment and assuring that wrongful-
1 The plaintiff has been significantly exposed ly exposed plaintiffs recover the costs of medical
to a proven hazardous substance through treatment, it found those were outweighed by the poten-
the tortuous conduct of the defendant. The tially negative effects, which include the fact that
plaintiff must present the appropriate scien- lump-sum awards might not be used for medical costs,
tific evidence demonstrating a link between problems with administering the relief, and expend-
exposure and human disease; ing large sums on medical monitoring which may later
DECLARATIONS — WINTER 2002-2003
16
be needed to fully compensate those actually injured. of this analysis made the adoption of this cause of
action appear to be a reasonable extension of existing
The Supreme Court of Alabama recently rejected law. The lone dissent argued that this creation of a
the cause of action in response to a certified question new cause of action should be decided by the legislature,
from the Northern District of Alabama dealing with not the court.
alleged toxic exposure to PCBs. That case also involved
a putative class action, and the question to the Alabama Those states that have adopted medical monitoring
Supreme Court was whether Alabama law recognizes include: Arizona (Burns v. Jaquay-Mining Co., 752
a distinct cause of action for medical monitoring in the P.2d 28 (Ariz. Ct. App. 1987)); California (Potter v.
absence of manifest physical injury or illness. After Firestone Tire & Rubber Co., 863 P.2d 795 (Cal. 1993));
noting that past Alabama cases have required a man- Louisiana (Bourgeois v. A. P. Green Industries, 716
ifest, present injury before plaintiff can recover in costs So. 2d 355 (La. 1988)) (the legislature later modified it
and that a number of commentators have agreed with to require pre-cost injury); New Jersey (Ayerst v.
this requirement, the Supreme Court concluded as fol- Township of Jackson, 525 A.2d 287 (N. J. 1987));
lows: Pennsylvania ( Redland Soccer Club v. Dept. of Army,
696 A. 2d 137 (Pa. 1997)); Utah (Hansen v. Mountain
Although we acknowledge that other juris- Fuel Supply Co., 858 P.2d 970 (Utah 1993)); and West
dictions have recognized medical monitoring Virginia (Bower v. Westinghouse Elec. Corp., 522 S.E.2d
as a distinct cause of action or as a remedy 424 (W. Va. 1999)). Those states that have expressly refused
under other tort causes of action, even in the to adopt medical monitoring include: Alabama (Hinton
absence of a present physical injury, we do v. Monsanto Company, 813 So. 2d 827 (Ala. 2001));
not and need not know how such jurisdictions Delaware (Mergenthaler v. Asbestos Corp., 480 A.2d
coordinated that recognition with the tradi- 647 (Del. 1984)); Kentucky (Wood v. Wyeth-Ayerst
tional tort-law requirement of a present injury. Laboratories, 82 S. W. 3d 849 (Ky. 2002); and Nevada
Here, the plaintiff has not alleged a present injury. (Badillo v. American Brands, 16 P.3d 435 (Nev. 2001)).
He seeks simply to recover the costs of moni-
toring his health to detect whether he develops As medical monitoring claims migrate from the area
an illness or an injury in the future as a result of toxic exposure to prescription drugs, courts should exer-
of his exposure to PCBs. He has not alleged a cise caution in finding that plaintiffs have met their
cause of action under our long-standing tort law, burden of proof. While the toxic tort cases typically
and we find insufficient justification to expand involve exposure to a known or readily acknowledged
Alabama law in the direction urged by plain- hazardous substance, this is rarely the case with the FDA
tiff. approved prescription drugs. As is apparent from the
elements of this cause of action, expert issues pre-
813 So. 2d at 829. dominate these cases. Because the plaintiffs have the
burden of proof, a meaningful Daubert analysis is crit-
A contrary decision came from the Supreme Court of ical in defending these actions.
Appeals of West Virginia, when it answered in the
affirmative the following certified question that fol- I. EMERGING AREAS
lows: "Whether, under West Virginia law, a plaintiff
who does not allege a present physical injury can assert There are some developing areas of the law, which
a claim for recovery of future medical monitoring costs have the potential of increasing liability on the part of
where such damages are the proximate result of defen- the drug and medical device manufacturers and, cor-
dant’s tortuous conduct." Bower v. Westinghouse Electric respondingly, the potential exposure of their insurers.
Company, 522 S.E.2d 424 (W. Va. 1999). The court began You should be aware of these in evaluating claims and
by reviewing those states, which have accepted and also in the underwriting of coverage.
rejected claims for medical monitoring. From the start,
its analysis of this issue varied from that of Kentucky A. Direct to Consumer Advertising and Its Effect on
and Alabama. Rather than beginning with the analy- the Learned-Intermediary Doctrine
sis typically used by courts in rejecting this cause of One of the most important defenses relied upon by
action – whether the plaintiff states a present physical pharmaceutical manufacturers in litigation is the
injury – the court began with the concept that it is "learned intermediary" defense. This doctrine, which
appropriate for a plaintiff to recover future medical applies in the context of failure to warn claims involv-
expenses when such expenses are proved with rea- ing prescription pharmaceutical products, provides
sonable certainty. Using that starting point, the court that a "pharmaceutical manufacturer generally dis-
then rejected "the contention that the claim for future charges its duty to warn the ultimate user of prescription
medical expenses must rest upon the existence of pre- drugs by supplying physicians with information about
sent physical harm." 522 S.E.2d at 430. Viewing the drug’s dangerous propensities." Perez v. Wyeth
medical monitoring merely as future medical expens- Laboratories, Inc., 734 A.2d 1245 (N.J. 1999). This
es rather than wrestling with the present injury aspect doctrine relies heavily upon the prescribing judgment
DECLARATIONS — WINTER 2002-2003
17
of physicians to excuse drug manufacturers from the duty billion worth a year since the FDA loosened its drug-
to warn the consumer: promotion rules in 1997." "FDA Says it Will Stop
Misleading Drug Ads," Associated Press, December 10,
First, courts do not wish to intrude upon the 2002. These advertisements appear to work, or there
doctor-patient relationship. From this per- would be no justification for these large expenditures.
spective, warnings that contradict information Consumers are influenced to seek medication by these
supplied by the physician will undermine the advertisements, and the courts have wrestled with the
patient’s trust in the physician’s judgment. effect of these advertisements on the learned inter-
Second, physicians may be in a superior posi- mediary doctrine.
tion to convey meaningful information to their
patients, as they must do to satisfy their duty In early cases dealing with information prepared by
to secure informed consent. Third, drug man- manufacturers and provided to patients, courts were hes-
ufacturers lack effective means to communicate itant to find that patient brochures or other informational
directly with patients, making it necessary to pamphlets obviated the doctrine. For example, in Polley
rely on physicians to convey the relevant infor- v. Ciba-Geigy Corporation, 658 F. Supp. 420 (D. Alaska
mation. . . . Finally, because of the complexity 1987), the court concluded that a patient brochure pro-
of risk information about prescription drugs, vided to physicians for distribution to patients did not
comprehension problems would complicate vitiate the learned intermediary doctrine, but found
any effort by manufacturers to translate physi- that such brochures may be admissible on adequacy
cian labeling for lay patients. For this reason, of the warning to the physician if other information is
even critics of the rule do not suggest that inclusive. Despite these holdings, which applied the learned
pharmaceutical companies should provide intermediary doctrine despite direct communications from
warnings only to patients and have no tort the manufacturer to the consumers, a number of courts
duty to warn physicians. began indicating that they would treat advertising dif-
ferently. For example, in Shanks v. Upjohn Company,
Lars Noah, Advertising Prescription Drugs to 835 P.2d 1189 (Alaska 1992), the court implied that
Consumers, Assessing the Regulatory and Liability advertising can create an exception to the learned inter-
Issues, 32 Ga. L. Rev. 141, 157-159 (1997). The over- mediary doctrine. However, it was not until the Norplant
whelming majority of states have adhered to the learned litigation in the late 1990s that courts began dealing head-
intermediary doctrine, although there have been some on with this issue.
traditional exceptions to that rule. 2
In an early Norplant decision from Texas, the court
During the 1980s, drug manufacturers began broad- held that there was no exception to the learned inter-
er advertising of prescription pharmaceutical products mediary doctrine despite the fact that the defendant had
directly to consumers. The Food and Drug Administration engaged in advertising directly to the consumer. In re
("FDA") enacted a number of regulations governing Norplant Contraceptive Product Liability Litigation,
these advertisements, although the FDA has declined 955 F. Supp. 700 (E. D. Tx 1997). The holding in that
to exercise the level of control that it exerts through its case was predicated upon the fact that the plaintiff
labeling regulations. The FDA regulations on this sub- had not seen any advertisements according to the
ject, based on language in the Food, Drug and Cosmetic record. However, in Perez v. Wyeth Laboratories, Inc.,
Act, govern advertising in the print and broadcast 734 A.2d 1245 (1999), the court, in one of the most
media. In print advertisements, the manufacturer must thorough decisions dealing with this subject, held that
include a "brief summary" of all risk-related informa- the learned intermediary doctrine does not apply to
tion found in the approved package labeling. For direct marketing of prescription drugs to the consumer.
broadcasting advertisements on radio and television, the In that case, the court, after examining in detail the tra-
advertisement must contain a "major statement" of ditional underpinnings for the learned intermediary
the major risks of the drugs, and it must make ade- doctrine, concluded that in the context of direct con-
quate provision for the dissemination of the approved sumer advertising, the theoretical basis for that doctrine
package labeling in connection with the advertisement, did not exist. The court concluded that the tradition-
through, for example, a toll free telephone number, al doctor-patient relationship, with its foundation in
web page, or reference to a magazine or newspaper the informed consent doctrine, no longer exists. The court
where the material is printed. noted that, in addition, managed care had reduced the
amount of times that doctors could spend with patients,
As direct to consumer advertising increased through- thereby reducing the time they could inform them of risks
out the 1990s, courts struggled with how to apply, or not and benefits. Finally, the vast expenditures of pharmaceutical
apply, the learned intermediary doctrine. By the late companies on advertising demonstrated that they now
1990s, drug companies were spending approximately had an effective means to communicate directly with patients.
$1 billion in advertising to consumers. As recently Thus, the court found that, in cases of direct consumer
reported by the Associated Press: "Drug advertising advertising, the learned intermediary doctrine did not
aimed at patients instead of doctors has tripled to $2.7 apply. When the manufacturer complies with the FDA
DECLARATIONS — WINTER 2002-2003
18
advertising, labeling and warning regulations, there to allow consumers to easily "make product-to-prod-
is a rebuttable presumption that it has satisfied its uct comparisons across all therapeutic classes, and
duty to warn of the potentially harmful side effects of begin to recognize where to find information that is
the product. There should be more developments in this critical to the best use of any OTC drug product." 64
area in the future. However, the elimination of the Fed. Reg. at 13258.
learned intermediary doctrine as a defense in these
cases will dramatically alter the manufacturer’s lia- The United States Constitution’s Supremacy Clause
bility. establishes that federal law rules where a state law
conflicts. Kanter v. Warner-Lambert Co., 122 Cal. Rptr.
A. Over-the-counter (OTC) Drugs and the Learned 2d 72, 79 (Cal. Ct. App. 2002). Nevertheless, state
Intermediary Doctrine laws are not preempted unless Congress makes its
In the sale of over the counter (non-prescription intent to preempt clear and manifest. Id. at 80. This
drugs), there is no prescribing physician. For this rea- intent can be either explicit in a statute’s provisions
son, a manufacturer’s duty to warn of any possible or implied by its purpose. Id.
risks associated with OTC drugs runs not to the physi-
cian, but to the ultimate purchaser. Happel v. Wal-Mart The FDA has reported that it will rely on FDA
Stores, Inc., 766 N.E.2d 1118, 1126 (Ill. 2002); (both Modernization Act of 1997 (FDAMA)’s section 412(a),
citing Reyes v. Wyeth Labs., 498 F.2d 1264, 1276 (5th which added to 21 U.S.C.A. § 379r, in addressing pre-
Cir. 1974)). See also Torsiello v. Whitehall Labs., 398 A.2d emption issues relating to the labeling regulations. 64
132 (N.J. Super. Ct. App. Div. 1979), for an extensive Fed. Reg. at 13272. Section 379r, titled "National
discussion regarding this distinction between pre- Uniformity for Nonprescription Drugs", includes an
scription and non-prescription drugs. Therefore, the learned express
intermediary doctrine does not shield the manufac-
turer from liability. preemption provision, providing that no State
or political subdivision of a State may estab-
In Mitchell v. VLI Corp., the court found this to be lish or continue in effect any "requirement"
true even where the plaintiff obtained a sample of the that relates to a nonprescription drug that is
OTC product directly from her doctor. 786 F. Supp. "different from or in addition to, or that is oth-
966, 970 (M.D. Fla. 1992). Because the product was avail- erwise not identical with" a requirement under
able over-the-counter, the fact that the plaintiff’s doctor the act.
gave it to her did not invoke the learned intermediary
doctrine. Id.; but see Torsiello, 398 A.2d at 138 ("‘An 64 Fed. Reg. at 13272. The section defines a "require-
important and sound exception to the requirement that ment" that relates to nonprescription drugs to include
warning be made to the consumer, however, is made in "any requirement relating to public information or any
products cases in which the intermediary is not a mere other form of public communication relating to a warn-
conduit of the product but rather administers it on an ing of any kind for a drug." 21 U.S.C.A. § 379r(c)(2). However,
individual basis, or recommends it in some way,. . ."). the section does provide for an exemption process for cer-
As more drugs move into the OTC area, this may result tain state regulations. §379r(b). Moreover, subsection
in increasing exposure to manufacturers and their (e), the savings clause, expressly states that the section
insurers. will not affect any action or liability under any state’s
product liability law.
A. Federal Preemption of State Law Regarding Labeling
of OTC Drugs In considering the possibility of preemption in OTC
A developing area of the law with regard to OTC drug label actions, the courts have followed an analy-
drugs is the issue of whether federal law regulating sis similar to that of the United States Supreme Court
labeling of OTC drugs preempts state laws in that area. in Medtronic, Inc. v. Lohr, 518 U.S. 470 (1996). Medtronic
On March 17, 1999, the FDA revamped its labeling involved preemption of a state common-law negligence
regulations of OTC drugs. See Over-the-Counter Human action by the Medical Device Amendments (MDA),
Drugs; Labeling Requirements, 64 Fed. Reg. 13254 which contains a provision expressly proscribing state
(March 17, 1999) (codified at 21 C.F.R. § 201.60-.66). The regulation of medical devices. Id. at 482-83. Section 379r
import of this overhaul lies in its strict, uniform require- "precisely tracks the language of the Medical Device
ments on both the substance and the format of OTC Amendment." Green v. BDI Pharm., 803 So. 2d 68, 74
drug labels, its purpose being to ensure such labels are (La. Ct. App. 2001).
easy to read and understandable to the general public.
64 Fed. Reg. at 13254, 13276. These requirements Medtronic and its progeny have limited preemption
instruct drug manufacturers on matters from font, type under the MDA to cases where the FDA has fashioned
size, bullet points, and spacing to matters such as the specific requirements pertaining to specific medical
inclusion of sodium content and the use specific words devices, See Martin v. Telectronics Pacing Sys., Inc., 105
to convey certain information. 21 C.F.R. § 201.60-.66. F.3d 1090 (6th Cir. 1997), and, following Medtronic,
The FDA’s aspiration in creating this uniformity was courts have held that FDA premarket approval (PMA)
DECLARATIONS — WINTER 2002-2003
19
leads to such preemptive, device-specific regulations, Steele medically associated with "a rare form of vaginal can-
v. Collagen Corp., 63 Cal. Rptr. 2d 879 (1997); Mitchell cer called ‘clear cell carcinoma’ and a benign vaginal condition
v. Collagen Corp., 126 F.3d 902 (7th Cir. 1997); Kemp called ‘adenosis’ among women who were exposed to
v. Medtronic, Inc., 231 F.3d 216 (6th Cir. 2000). See the drug in utero." Aetna Cas. & Sur. Co. v. Abbott
Lichtman, Jeffrey S., The Emerging Jurisprudence of Labs, Inc., 636 F. Supp. 546, 547 n.1 (D. Conn. 1986).
Preemption and the Labeling of Over-the-Counter Drugs, Due to the latent manifestations of the disease, drug com-
Drug and Medical Device Litigation, at 82 (May 2002). panies and their insurance carriers began a long battle
Moreover, the Ninth Circuit has held that state to determine in which coverage periods the injuries
common laws are requirements that are subject to pre- occurred.
emption where they impose different or more extensive
regulations on manufacturers than under federal law. With respect to when an injury arose, the courts
Id. (citing Papike v. Tambrands, Inc., 107 F.3d 737, chose between three formulas: (1) the time of expo-
741 (9th Cir. 1997)). sure, i.e. when the mother ingested the DES; (2) the time
of manifestation, i.e. when the daughter discovered
Cases involving OTC drug labeling follow a similar the disease; or (3) the multiple trigger theory, i.e. expo-
analysis. In Green v. BDI Pharmaceuticals, the court sure, manifestation, and the latent period. Eli Lilly
found that federal law preempted the plaintiff’s state & Co. v. Home Ins. Co., 764 F.2d 876, 880 (D.D.C. 1985).
law failure to warn claims where the FDA had specif- Under the multiple trigger theory, each insurer from the
ically regulated the labeling of the subject product, a time of ingestion to the time of manifestation is liable
bronchodilator and expectorant drug. 803 So. 2d 68, 74- to indemnify the insured. Ely Lilly & Co. v. Home Ins.
75. Again, in Ohler v. Purdue Pharma, L.P., the court Co., 482 N.E.2d 467, 471 (Indiana 1985). Additionally,
pointed out, although in dicta, specific FDA regula- some courts applied an injury-in-fact theory, and oth-
tions that clearly preempt state law regarding labeling ers found that the question turned purely on context.
of non-prescription drugs. No. CIV. A. 01-3061, 2002 764 F.2d at 881.
WL 88945, at *12 & n.32 (E.D. La. Jan. 22, 2002).
In Aetna Casualty & Surety Co. v. Abbott Laboratories,
Even more recently, a California court has stated Inc., the court chose to apply an injury-in-fact inter-
that the "parallels between the premarket approval pretation. 636 F. Supp. 546, 548-50 (D. Conn. 1986). The
process for medical devices and the new drug applica- court followed the Second Circuit’s lead, citing to that
tion process with respect to product labeling are striking." court’s opinion in American Home Products Corp. v.
Kanter v. Warner-Lambert Co., 122 Cal. Rptr. 2d 72, 83 Liberty Mutual Insurance Co., 748 F.2d 760 (2d Cir.
(Cal. Ct. App. 2002). Similar to a PMA in the medical 1984). As the court explained, the Second Circuit Court
device cases, the court found that the monograph3 of the of Appeals rejected the manifestation theory because some
drug at issue was specific to that drug and detailed bodily injuries do not immediately produce symptoms
the federal requirements for its labeling, and there- and rejected the exposure theory because exposure and
fore preempted state law that required different labeling. injury are separate and distinct occurrences that could
Id. at 84. "Although the over-the-counter drug mono- take place at different times. Id. at 548-49.
graph system does not require each manufacturer to submit
its label for approval," the court nevertheless conclud- In contrast, in Eli Lilly & Co. v. Home Insurance
ed "that system also establishes a federal requirement Co., the Indiana Supreme Court applied the multiple
regarding labeling that can preempt conflicting state require- trigger formula in order to "giv[e] effect to the policies’
ments." Id. at 83. dominant purpose of indemnity." 482 N.E.2d at 471. This
holding, the court stated, was in keeping with the rule
I. COMPREHENSIVE/COMMERCIAL GENER- of interpretation that courts are to give effect to the
AL LIABILITY (CGL) COVERAGE insureds’ reasonable expectations. Id.
There is an absence of reported decisions dealing The same issue arises, of course, in other expo-
with insurance coverage and drug and medical device sure/latent disease cases, such as asbestosis. The courts
claims. Although general coverage principles should apply, were split in those cases as well. The Fifth and Sixth
some specific cases are discussed below. Circuits opted for the exposure formula. The First
Circuit, for the manifestation theory. And the Pennsylvania
A. The DES Cases and Latent Diseases courts have chosen the multiple trigger analysis. See
In a series of reported cases, the courts have con- Eli Lilly & Co. v. Home Ins. Co., 764 F.2d at 880.
sidered Comprehensive General Liability (CGL) coverage
of "bodily injury" claims for latent diseases. For years A. Coverage of Advertising Claims Against Drug
prior to 1970, hundreds of drug companies manufactured Companies
and sold the drug diethylstilbestrol (DES) as treat-
ment for expectant mothers at risk for miscarriages. Eli Commercial General Liability policies (CGL) cover
Lilly & Co. v. Home Ins. Co., 653 F. Supp. 1, 3 (D.D.C. "advertising injuries". In Knoll Pharmaceutical Co.
1984). Sometime in the early 1970’s, DES became v. Automobile Insurance Co. of Hartford, where the
DECLARATIONS — WINTER 2002-2003
20
policies covered advertising injuries "arising out of" therapy for each patient. Some courts have also found a duty to warn
directly of the risk and side effects of those products in cases involv-
the insured’s libelous or slanderous actions, the court ing oral contraceptives, holding that the active role of the patient
found that the policies covered indirect injuries to the in deciding to use the drug and the passive role of the prescribing
plaintiffs as a result of the insured’s actions for the physician in that process mitigates against the application of the
doctrine. See In re Norplant Contraceptive Product Liability
purposes of the duty to defend. 152 F. Supp. 2d 1026, Litigation, 955 F. Supp. 700 (E. D. Tx. 1997) (citing those deci-
1035 (N.D. Ill. 2001). Specifically, the plaintiffs brought sions but stating that the majority of courts considering that issue
the action for misrepresentations in advertising, not have rejected such an exception). In each of these instances, the
courts have focused on the absence of meaningful physician input
for slander or libel directed at the plaintiffs. However, into the use of the prescription drug: with mass immunizations, the
the court interpreted the language not to exclude such critical individualized doctor-patient relationship advisory rela-
indirect injuries from the insurer’s duty to defend its insured. tionship was believed to be absent; in the case of oral contraceptives,
the patient’s involvement in selecting the drug was seen as criti-
cal. However, beyond the narrow confines of these two areas, the
The Eleventh Circuit also visited the duty to defend role of the physician in the prescribing process has insulated the
issue in Elan Pharmaceutical Research Corp. v. Employers company from the duty to warn.
Ins. of Wausau, another advertising injury case. 144
F.3d 1372 (11th Cir. 1998). In noting the distinction between
the duty to defend and the duty to indemnify, the court ABOUT THE AUTHOR
stated the rule that "an insurer must provide a defense
against any complaint that, if successful, might poten- Forrest C. Wilson III
tially or arguably fall within the policy’s coverage." Id. is a member of the law firm
at 1375. The policy in Elan included patent infringe- of McDowell Knight Roedder
ment in the course of advertising in its definition of & Sledge, L.L.C. He prac-
"advertising injury". Id. Although courts have defined tices in the fields of personal
"advertising activity" both broadly and narrowly, the court injury litigation, products
found the defendant’s "dissemination of clinical stud- liability, transportation,
ies to develop a market for one of [its] products" to be premises liability, and insur-
within the definition provided in the policy, i.e. widespread ance defense. He graduated
dissemination of material promoting goods, services, from the University of
or products. Id. at 1377. Alabama, B.S. 1983, and
from the University of
Forrest C. Wilson III Alabama School of Law,
I. CONCLUSION
J.D. 1986. He is a member of the American Bar
While excess and surplus insurance coverage and Association, Alabama Defense Lawyers Association,
handling issues have not yet generated instructive case National Association of Railroad Trial Counsel,
law in pharmaceutical product liability litigation, this Defense Research Institute, and Federal of Defense
is clearly an area that should generate decisions in the & Corporate Counsel (Vice Chair, Products Liability
future. The number of claims and enormity of plaintiffs’ Section 2002-2003).
verdicts in pharmaceutical litigation continues to
increase. As discussed in this paper, numerous dif-
ferent prescription and over the counter drugs are
currently the subject of mass tort litigation. The types
of claims being made in this field are fairly consistent,
and carriers should anticipate that those similar claims
will be made in the future. The question is which drug
will be the next one to cause an explosion in claims
and losses and how that will affect the pharmaceutical
industry and its insurance carriers.
1
Mr. Wilson would like to acknowledge his partner, Archibald T. Reeves
IV, who provided invaluable assistance in the preparation and
editing of this article.
2
Because of the absence of this procedural device, lawyers in
Mississippi may join hundreds of plaintiffs in a single case to
aggregate claims and create a mass action. At least currently,
Mississippi trial courts have been reluctant to sever parties and those
cases move forward as mass actions.
3
One exception has been in the field of mass immunizations. In
those cases, courts have found an independent duty on the part of
manufacturers to warn consumers exists because, in mass immu-
nizations clinics where patients receive vaccines, there is usually
no physician present to weigh the risks and benefits of the drug
DECLARATIONS — WINTER 2002-2003
21
Introducing the Officers and Directors of the
Association
Dale A. Diamond James T. McNamara
President Treasurer
Dale is Senior Vice President Jim is a Senior Vice President
- Claims and General Counsel with the Swiss Re Financial
for AXA Corporate Solutions Services Business Group. Within
Reinsurance Company. Dale the business group , Jim is respon-
began his claims career in 1968 sible for claims on traditional
with Liberty Mutual. He spent excess business as well as post
time with US Aviation Underwriters closing activities on a variety of
Dale A. Diamond before moving into the reinsurance James T. McNamara financial reinsurance transac-
area and with Munich American tions . Prior to his sixteen years
Re in 1978. He has also practiced law with the firm of with the Swiss Re Group , Jim worked for Liberty
McCarter & English. Dale is a former Chairman of Mutual, Home Insurance Company and Skandia America
the RAA Claims Committee. He is a graduate of . Jim holds a BA and MBA from Iona College .
Brooklyn College, and Seton Hall Law School.
Timothy F. Hughes Michael G. Beckman
Vice President / President Secretary
Elect
Mike is an Assistant Vice
Tim is Vice President – Casualty President with CNA Re. After
Claims with Essex Insurance managing accounts in the Surplus
Company. He has the responsi- Lines Division, Mike moved to
bility of managing the casualty the Facultative Operation, where
claims operation on a nationwide he is responsible for the resolution
basis. Essex Insurance Company Timothy F. Hughes of all Property and Casualty loss-
is an Excess/Surplus Lines es. Thirty years in the claims Michael G. Beckman
Insurance Company and is a part of Markel Corporation. arena has afforded Mike the oppor-
tunity to work and manage on the primary level, as a
He started his claims career with GAB Business reinsurer and on the broker level.
Service, Inc. in 1977 and has also worked for CNA
Insurance, Hanover Insurance Company and North- Mike received his B.S. Degree in History/English
American Claims Management Company before starting from the University of Minnesota in 1971. He attained
the Essex Insurance Company Claim Department in 1989. the designation of SCLA (Senior Claims Law Associate)
from the American Education Institute, and is active
Tim is a member of the Virginia State Claims with various reinsurance associations.
Association and Richmond Claims Association. He has
testified as an expert witness in both state and feder-
al court on Insurance Company Operations, Insurance
Claims Handling, Bad Faith, Case and Origin Fires,
Construction Values and Estimating Techniques. He
is a graduate of California State University, Dominquez
Hills.
DECLARATIONS — WINTER 2002-2003
22
Gary Bass Jerry E. Hart
Director Director
Gary is the Claims Director Jerry is Vice President of United
at Faraday Underwriting National Insurance Company.
Ltd. He joined the compa- He joined the Company in 1996
ny in 1993. He currently sits and is responsible for overall
on the two most senior mar- management of the Claims
ket claims bodies, the Lloyd’s Department including traditional
Claims Business Panel and technical staff handling admit-
the Lloyd’s Market Association Gary Bass Jerry E. Hart ted and surplus lines property
Underwriting and Claims and casualty business in addi-
Group. Gary has held various claims positions within tion to a significant TPA management operation. As a
the London market for over 25 years. He currently program writer, United National writes a broad range
holds membership in numerous organizations, includ- of business lines. Jerry's prior claim experience includes
ing: The British Insurance Legal Association, Director ten years with Crawford and Company as an adjuster
of Pembroke, member of the Insurance Institute, a and account director and twelve years with TCO
committee member of the Insurance Institute Non- Insurance Services, specializing in products and contractor's
Marine Lecture Group, a market representative on the exposures. Jerry graduated from the University of
New Cap and HIH Creditors Committees, Honorary California at Santa Barbara in 1975 with a B.A. degree
Secretary of the Lloyd’s Football Club, LMP2001 Claims in Psychology.
Working Group. He has been a regular speaker at con-
ferences worldwide during the past 15 years, and some
credits include talks to the following groups: Lloyd’s Catherine A. Kalaydjian
of London Press, BILA, Excess and Surplus Lines, Director
Bermuda Reinsurance Conference, Swiss Re., Business
Briefing Consultants, Andrews Publications, Defense Cathy is Vice President – Claims
Research Institute, PLA Conference, NABRICO of QBE Reinsurance Corp. and
Conference, London Panel Auditors, London Actuarial QBE Insurance Corp. In this posi-
Society, Barlow Lyde & Gilbert Conference. tion, she is responsible for the
overall claim management of the
companies. Prior to joining QBE
Michael J. Degnon in 1997, Cathy held the position
Director of VP Claims of Resolute
Reinsurance Company, a whol-
Mike is a native Californian ly owned subsidiary of
who began his insurance career GEICO/Berkshire Hathaway, for Catherine Kalaydjian
in 1975 with the Farmers Insurance 10 years. She started her 22-year
Group as a Field Liability Claims career in claims as a Casualty adjuster for GAB Business
Adjuster. He moved on to sev- Services and then the Excess Surplus Claims Manager
eral other local insurance companies for Integrity Insurance Company. Cathy just stepped
before he joined Buffalo Reinsurance down from a 2-year term as the President of the APIW-
Michael Degnon Company in 1985. He joined The Association of Professional Business Woman. She has
Zenith Insurance Company’s also held the position of 1st VP Program Chair and
Reinsurance Division in 1989 and presently holds the Treasurer with the organization over the last 6 years.
position of Assistant Vice President of Reinsurance Prior to this Cathy was an active member of the IRU
Claims. Mike graduated from California State University, Claims and Education Committee and was a frequent
Northridge in 1975 and attained the designation of guest speaker with Strain Reinsurance Seminars. Cathy
Chartered Property Casualty Underwriter (CPCU) in graduated with honors from Siena College, Loudonville
1993. He also holds an Associate in Reinsurance (ARe) NY with a BA in Marketing Management.
designation. Mike has previously held the position of
Director for the Excess & Surplus Lines Claims Association
and Chairs the Golf Tournament each year. He is also
an active member in the Intermediaries & Reinsurance
Underwriters Association.
DECLARATIONS — WINTER 2002-2003
23
Ronald F. Moore John T. Speckman
Director Director
Ron is a Vice President at the Jack is Executive Vice President
reinsurance broker John P. Woods and Claims Director for Rampart
Co. He frequently coordinates Insurance Company. He joined
claim reviews and liaisons between Rampart in August 2001, after
cedents and their reinsurers. the sale of SOREMA North America
Prior to joining the company he Reinsurance Company, where he
was an assistant vice president at held the position of Senior Vice
Ronald Moore St. Paul Re and vice president President and Claims Director
at Christiania Re. Before enter- for both SOREMA and Fulcrum
ing the reinsurance arena Ron was vice president of Insurance Company. He began
Yasuda Fire & Marine Insurance Co. of America, where his claims career in 1968 with John T. Speckman
he created and developed the primary and excess claim Royal Insurance Company, joined
departments. North American Re in 1980 and moved to Hansa Re in
1989, prior to joining SOREMA in 1994. Jack has been
He received his BS from St. John's University and an instructor at an IRU Mini-session and was an IRU
an MBA from the College of Insurance. He also achieved member from 1989 to 2000. In addition, he is a mem-
his CPCU designation and was on the education com- ber of the International Association of Special Investigation
mittee with the IRU. Units. He is a former member of the New York and
Hempstead Claims Managers Associations and the
Loss Executives Association. Jack is a graduate of
Walter V. O'Grady, Jr. Mercy College, Dobbs Ferry, New York. He received his
Director CPCU designation in 1985 and his RPA designation
in 1998.
Walter is Senior Vice President
- Claims with GMAC RE Corp.
He began his claims career with
INA in 1969. There he held claim
supervisory & underwriting posi-
tions with the Admiral Insurance
Co., from 1976 to 1985. Walter
joined GMAC RE as a facultative Walter V. O’Grady
underwriter in 1986 and assumed
responsibility for management of claims in 1987. He received
a B.A. in History from Seton Hall University and has
earned the designations of Associate in Reinsurance
(ARe) from the American Institute for CPCU and Senior
Claims Law Associate (SCLA) from the American
Education Institute.
Ronald H. Smillie
Director
Ron has over 24 years of diver-
sified claims and management
experience, in both the primary
and reinsurance markets. He has
been employed with St. Paul Re
since 1986, in various positions. In
April of 1998, he assumed the man-
Ronald H. Smillie agement of the St. Paul Re Claims
operation and was promoted to
Senior Vice President, during 2000. Ron is involved with
various reinsurance associations. He is currently representing
St. Paul Re on both the RAA and BRMA Claims Committee.
Ron has a B.S. Degree in Biological Science from the
California State University system.
DECLARATIONS — WINTER 2002-2003
24
DIRECTOR AND OFFICER LIABILITY
FOR BREACH OF DUTY TO
CORPORATE CREDITORS
By James W. Jennings, Jr., Esq. with the assistance of Ellen S. Moore, Esq.
of Woods, Rogers & Hazlegrove, P.L.C.Roanoke, Virginia
There can be little doubt that litigation involving the corporate veil was not justified where the parties
liability of officers and directors is a growing area with pursued did not use their corporate positions to commit
efforts made to expand theories of recovery not only an act fundamentally unfair to creditors.
for errors and omissions but for what is viewed as cor-
porate acts made by directors through board of directors In FDIC v. Sea Pines Company, 692 F.2d 973 (4th Cir.
actions. One approach that is being pursued with some 1982) the United States Court of Appeals for the Fourth
frequency is attempting to pierce the corporate veil to Circuit held that a parent corporation’s use of the assets
hold officers and directors liable to creditors of a corporation of its subsidiary corporation, which the common direc-
on the grounds that the directors used corporate assets tors of both corporations knew was insolvent, to prefer
to pay themselves or officers and shareholders in pref- itself was fundamentally unfair to the subsidiary’s
erence to third party creditors. Where this cause of creditor and justified piercing of the corporate veil of the
action is permitted, courts view the preference as a subsidiary and entering judgment against the parent
breach of a fiduciary duty that runs as a matter of pol- for outstanding deficiencies owed by the subsidiary.
icy to creditors.
Among the transactions at issue, the parent, acting
Where courts find a duty on the part of the officers through common directors, mortgaged the equity of
and directors that runs directly to the creditors, the the subsidiary as collateral for debts of the parent and
corporate veil is pierced in order to impose a remedy against credited debts owed by the subsidiary to the parent.
directors, officers and shareholders because the cred- When this transaction was completed the subsidiary had
itors are in contractual relationships with the corporation a negative net worth. There were other transactions involv-
itself and not with the officers, directors or sharehold- ing sales and leasebacks among the parent, the insolvent
ers. An important issue in each of the cases where the subsidiary and other subsidiaries. The insolvent sub-
corporate veil is pierced is the nature of the remedy. sidiary and other subsidiaries were manipulated for
the benefit of the parent to the detriment of the insol-
Are the directors liable only to restore assets or are vent subsidiary’s creditors. In particular, a guarantee
they subject to judgments for monetary damages includ- by the parent of rent payments owed by the insolvent
ing consequential damages? There are courts that subsidiary was cancelled.
make the defendants liable for the debts of the corpo-
ration while other courts limit the recovery to an The Fourth Circuit commenced its analysis of the
equitable tracing of assets transferred from the corpo- case by delineating the duties of directors. Directors "hold
ration. The cause of action brought may take many forms a place of trust, and by accepting the trust are obliged
at law or in equity as an errors and omissions case, to execute it with fidelity, not for their own benefit,
fraud, equitable accounting, or it can be brought as a but for the common benefit of the stockholders of the cor-
self dealing case not grounded in fraud. poration." Id. at 976 (citation omitted). When the
corporation becomes insolvent, however, "the fiducia-
The United Stated Circuit Court of Appeals for the ry duty of the directors shifts from the stockholders to
Fourth Circuit applying South Carolina and Virginia the creditors." Id. at 976-77.
law and The Supreme Court of Virginia have held that
directors and officers of a corporation and the parent cor- The court likened this case to that of Koehler v. Black
poration of a subsidiary face liability where assets of the River Falls Iron Co., 67 U.S. (2 Black) 715, 17 L. Ed. 339
corporation that have been pledged to creditors have been (1862), in which the corporate officers were found to
diverted to officers, directors or the parent corporation have breached a fiduciary duty to stockholders and
to satisfy claims of officers and directors instead of creditors by placing a mortgage on the property of the
paying creditors when the corporation is insolvent. corporation when it was insolvent in order to secure
There are also cases, which have been brought against the debts owed by the corporation to themselves. 692
shareholders under the same theory. The courts first F.2d at 977. In Sea Pines, the court did not attempt to
examined whether the corporation was insolvent when trace assets or valuate the transactions but held the cor-
the actions were taken. Second, the courts found that porate parent liable to the extent of the debt of the
piercing the corporate veil was justified where those subsidiary.
pursued took action that not only directly benefited
them but also was also fundamentally unfair to cred- While piercing the corporate veil, the remedy fash-
itors. The courts, on the other hand, have found piercing ioned was different in Rapids Construction Company,
DECLARATIONS — WINTER 2002-2003
25
Inc. v. Malone et al, 1998 U.S. App. LEXIS 4649 (4th right to use the Rudd name, incorporating the new
Cir. 1998) where The United States Court of Appeals business as Rudd’s Swimming Pool Management &
for the Fourth Circuit, applying Virginia law held that, Service Company, Inc., ("Management"). Management
under the "trust fund doctrine," a creditor could recov- gave two promissory notes to Supply in consideration
er assets of an insolvent corporation that were improperly for the transfer. In 1979, Walter Cheatle became a
distributed to shareholders. Defendants Malone and Hall 50 percent shareholder and director in Management
were directors, officers and sole shareholders of ADCO, with DeMarr. In August 1979, Supply filed for bankrupt-
which hired plaintiff Rapids Construction Company cy and the bankruptcy trustee abandoned the two
("Rapids") as a subcontractor to install drywall in a promissory notes of Management held by Supply. Since
retail store in Virginia. When ADCO failed to pay their names were similar, Management’s business dete-
Rapids for its work, it obtained a judgment against riorated as well, having difficulty in obtaining credit and
ADCO for $70,588.88, which ADCO also failed to pay. having supplies delivered. In 1981, a third investor, John
ADCO was insolvent. Between the time the debt came Cusack, invested $125,000 in Management’s business,
due but before judgment was obtained, Hall and Malone but insisted that none of his investment be used to pay
caused ADCO to forgive some shareholder debt due outstanding liabilities of Management. In March 1981,
from themselves in exchange for the surrender of stock Supply filed an action against Management to recover
Malone held in the company, leaving some debt still on the promissory notes and later to recover on an open
owed to ADCO by the shareholders. After Rapids account indebtedness. In September 1981, pursuant to
obtained the judgment against ADCO, Hall and Malone a plan of reorganization, Management transferred
transferred most of ADCO’s assets to other companies. assets and some liabilities to a new corporation, Regency
Pools of Virginia ("Regency"). Supply obtained a default
Citing Marshall v. Fredericksburg Lumber Co., 162 judgment against Management for the amounts owed.
Va. 136, 173 S.E. 553 (1934), the court found that a Since it could not collect the amounts owed it by
creditor may "recover in equity assets of an execution- Management, Supply brought an action against
proof corporation that have been improperly distributed Management, Regency and the DeMarrs, the Cheatles
to shareholders." In Marshall, the Virginia Supreme and Cusack, alleging that the transfer of assets to
Court found that directors of a corporation, in order to Regency constituted grounds for piercing the corpo-
avoid a debt, "had caused the corporation to use its rate veil of Regency and Management.
funds to repurchase the stock held by two of the direc-
tors at a time when ‘the corporation was insolvent.’" The court started with the proposition that "a corporation
However, the Rapids Court refused to follow FDIC v. is a legal entity separate and distinct from the share-
Sea Pines Company in imposing its remedy because holders or members who compose it." Id. at 212.
the Virginia remedy differs from that of South Carolina. "Therefore, a decision to refuse to recognize this immu-
This case, the court reasoned, rested upon the "trust fund nity constitutes ‘an extraordinary exception’ to be
doctrine." permitted only when it becomes necessary to promote
justice." Id. In order to pierce the corporate veil, "the
The authorities seem to be uniform to the plaintiff must show that the corporate entity was the
effect that the assets of the corporation are alter ego, alias, stooge, or dummy of the individuals
subject to an equitable lien in favor of the cred- sought to be charged personally and that the corpora-
itors, and that such creditors may follow such tion was a device or sham used to disguise wrongs,
assets, or the proceeds thereof, into whatsoever obscure fraud, or conceal crime." Id. Here, the court
hands they can trace them and subject them found that corporate formalities were followed in the estab-
to such debts, except as against a bona fide lishment of Regency and there was a valid corporate purpose
purchaser for value. for the reorganization of Management. The individu-
al directors were not personally liable to Supply, "having
Id at 13. Here, the trust fund doctrine applied where neither endorsed the promissory notes nor guaranteed
the controlling shareholders caused the corporation to the open account indebtedness." Thus, no personal
purchase their stock, reducing the corporation’s receiv- liabilities were avoided by the reorganization, nor did
ables and leaving it unable to pay its creditor. the directors commingle corporate and personal assets
or siphon off corporate assets into their own pockets.
Where there is no personal benefit or preference
flowing to directors or shareholders the corporate veil Further demonstrating the necessity for fundamental
will not be pierced. In Cheatle v. Rudd’s Swimming unfairness and personal benefit to an officer, director
Pool Supply Co., Inc., 234 Va. 207, 360 S.E. 2d 828 or shareholder in order to pierce the corporate veil is O’Hazza
(1987) the Supreme Court of Virginia found that grounds v. Executive Credit Corporation, 246 Va. 111, 431 S.E.
did not exist for piercing the corporate veil where a 2d 318 (1993). Again, the Supreme Court of Virginia
company, pursuant to a plan of reorganization, trans- again found that insufficient grounds existed to pierce
ferred all assets, but not all liabilities, to a new corporation. the corporate veil when the plaintiff failed to establish
Prior to 1978, Kenneth Rudd, sole stockholder of Rudd’s that the corporation was undercapitalized and that
Swimming Pool Supply Co., Inc. ("Supply") had estab- the shareholders had breached their fiduciary duty to
lished a business in Virginia managing, supplying and the corporation or its creditors. In January 1987,
servicing swimming pools. John DeMarr, purchased Francis and Susie O’Hazza provided the initial capitalization
the management portion of Rudd’s business and the of $10,000 for Sounds You See, Inc. and made their
son Guy O’Hazza the president of the corporation. The
DECLARATIONS — WINTER 2002-2003
26
O’Hazzas lent the corporation $64,000 in 1988 and attorney, who did not advise him of any potential legal
$75,000 in 1989. In October 1988, Guy O’Hazza problems. Greenberg, however, did not participate in
approached Executive Credit Corporation ("ECC") to gain the daily operations of Allstate.
its assistance in funding the installation of sound equip-
ment into the Hilton Hotel in Baltimore, Maryland. Citing O’Hazza and Cheatle, the court noted that
Once installed, ECC would own the equipment and Greenberg had not developed Allstate’s policy or pro-
lease it to the hotel for a profit. ECC lent Sounds You cedures. Indeed, he had consulted an attorney before
See, Inc. money, which was partially repaid. The deal becoming a majority shareholder in Allstate. Thus, he
with the Hilton Hotel fell through, however, and Sounds had not incorporated Allstate "for the purpose of disguising
You See, Inc. refused to repay the remaining money wrongful actions or concealing a crime." Nor had he
to ECC. determined the amount of Allstate’s fees, solicited cus-
tomers or handled employment matters. He also, in recouping
The court noted that "[i]gnoring the separate existence his loan, had received interest only after Allstate had
of a corporation and imposing personal liability on to extend the repayment of the loan and was paying other
shareholders for debts of the corporation is an extraor- investors a higher rate as well. Thus, he did not use Allstate
dinary act to be taken ‘only when necessary to promote to "evade a personal obligation, to perpetrate fraud or
justice.’" Id. Piercing the corporate veil was permissible a crime, to commit an injustice, or to gain an unfair
only when "the shareholder sought to be held person- advantage." Id.
ally liable has controlled or used the corporation to
evade a personal obligation, to perpetrate fraud or a crime, The case law that has been developed in this area to
to commit an injustice, or to gain an unfair advantage." pierce the corporate veil for the benefit of a corporate
Id. Here, the court first found that ECC failed to show creditor requires that the corporation be insolvent, but
that $10,000 was insufficient initial capitalization for the courts have not defined insolvency for this pur-
the corporation, particularly when the corporation pose. There also has to be a benefit derived by the
showed $9,412 in profits the first year. Moreover, the party pursued in the piercing of the veil coupled with
later loans made by the O’Hazzas were not grounds a finding of fundamental unfairness to the creditor
for piercing the corporate veil. The court also found bringing the action. There are two approaches to the
that the fact that the O’Hazzas created the company, remedy, the first being a tracing of the assets transferred
in part, to give their son a job and to derive a tax ben- to the party pursued and the second being an imposi-
efit from the subchapter S election by the corporation tion of the liability of the corporation on the party
did not evidence any impropriety or show that the cor- pursued. Efforts to expand the liability of directors
poration was a sham. The court noted that the O’Hazzas and officers can be expected to include attacking direc-
also hoped that the corporation would be a viable func- tors, officers and shareholders of corporations, which are
tioning business, and it operated as such for much of its not insolvent, but where there is unfairness or self-
corporate life. Nor did the O’Hazzas breach their dealing involved.
fiduciary duty to the corporation or its shareholders
by their failure to oversee the corporation’s activities.
Furthermore, the transaction entered into between ABOUT THE AUTHOR & THE ADTA
Sounds You See, Inc. and ECC was entered into in
good faith with an intent to benefit the corporation, so James W. Jennings, Jr.,
ECC was not the victim of any fraud. No grounds exist- a principal in the law firm
ed, therefore, for piercing the corporate veil. of Woods, Rogers &
Hazlegrove of Roanoke,
In Greenberg v. Commonwealth of Virginia, 255 Va. Virginia, president of The
594, 499 S.E. 2d 266 (1998), the Virginia Supreme Association of Defense Trial
Court again found insufficient grounds to pierce the Attorneys. ADTA members
corporate veil against the chairman of a check cash- are selected trial lawyers
ing corporation which allegedly made loans in amounts of the Bars of the various
and at interest rates in violation of the Consumer States of the United States,
Finance Act ("CFA"). From February 1992 to February District of Columbia, Puerto
1993, Allstate Express Check Cashing, Inc. ("Allstate") Rico and the Provinces of
operated a check cashing/cash advance business in Canada. Membership is
James W. Jennings, Jr.
which Allstate cashed checks for individuals without check- limited to one lawyer per
ing accounts for fees starting at 2 percent and advanced metropolitan area (unless an area’s population
customers cash for fees of 25 or 30 percent. In 1993, the exceeds 1,000,000). Each member is experienced in
Commonwealth of Virginia brought suit against Allstate the trial of civil cases, particularly on behalf of defen-
alleging that it had violated the CFA by making loans dants. All members regularly represent insurance
in amounts and at interest rates prohibited by the Act. companies and self-insureds and are experts in the
In 1994, the Commonwealth filed a bill of complaint fields of law pertaining to dispute resolution for the
against Allstate’s chairman, Jerome Greenberg, alleg- insurance industry. ADTA has enjoyed its associa-
ing that Greenberg actively participated in the illegal tion with The Excess/Surplus Lines Claims Association
acts and sought to pierce the corporate veil. Greenberg and appreciates the support it has received from it
had loaned Allstate $60,000 prior to its initial capital- in the many joint projects undertaken by the defense
ization, after consulting about the business with his organizations.
DECLARATIONS — WINTER 2002-2003
27
ADTA NOTES
This is the first opportuni-
ty that a President of the
Association of Defense Trial
Attorneys (ADTA) has had to
contribute to Declarations. I con-
sider the opportunity a privilege
and an honor.
ADTA’s relationship with
the Excess/Surplus Lines Claims
Association has expanded and
grown stronger over the last
Steven R. Enochian couple of years and our mem-
bership hopes to continue that trend in the coming
years. In the past our members have sporadically con-
tributed articles to Declarations. We hope that with this
issue we will become regular contributors. In this issue
you will find an article written by one of our members.
James Jennings, our immediate past president, has
written an article discussing the liability of corporate
officers and directors post-Enron.
As this issue of Declarations goes to press ADTA,
an organization made up of select defense attorneys
around the country, has just concluded its Executive Council
meeting in Napa, California and we are busy planning
our 2003 Annual Meeting which will be held at the
beautiful Silverado Resort located in the Napa Valley
of California. Our meeting will run from April 23, 2003
through April 27, 2003. We are looking forward to wel-
coming your President, Dale Diamond, to that meeting
and further cementing our relationship.
My presidency will be ending in April, 2003 and
therefore this will be my first and only chance to write
this note. I have thoroughly enjoyed working and trav-
eling with George and Anita Casales and Jim and Millie
Caballero. They are all tremendous representatives
of your organization. I look forward to spending some
time with Dale Diamond, Tim Hughes and Jim McNamara
before my term ends.
Steven R. Enochian
President
DECLARATIONS — WINTER 2002-2003
28
Time Tamers
By Robin Fogel
Do you ever feel like your whole day has slipped by 4 Plan
without getting anything done? Do you ever wish you
had a few more hours in the day? Clients tell me that Everyone admits that planning is important but
at the end of their workday they often wonder where the most people don’t dedicate the time to actually do it. Planning
day went. More importantly they worry about work is deciding what to do. Planning is a habit. Planning is
that did not get done. a way to control as much of your time as possible while
recognizing that not everything is in your control.
When I work with clients on issues of time man-
agement and priority setting we set up a process that Good planning includes some of the questions you asked
I called APAPS- Attitude, Prioritize, Analyze, Plan, yourself while trying to understand where your time went:
and Schedule. How much time does this activity take? Do you regu-
larly underestimate how long something takes? Does this
1. Attitude activity have a starting and ending time? How much
flexibility is needed for the unexpected -- things you
Do you have control over your time or are you at the cannot control? Continually ask yourself: Is this the
mercy of your environment? Is your workload man- best use of my time?
ageable or overwhelming? Do you have a "can do"
attitude? Attitude is critical. Most people have a daily to-do list but weekly plan-
ning is even more important. It gives you a longer
Time management is really self-management. For some, perspective and allows for more options. Use a planner
considerable time is wasted procrastinating. Do you that best suits you-paper, electronic, some combina-
ever spend time thinking about doing something instead tion --record -- appointments, meetings, calls, errands.
of just doing it? Or, do you have trouble getting start-
ed, especially if it is something you don’t want to do? If 5. Schedule
you believe you can do something, you’ll find a way –
attitude is key. Nothing happens unless there is a space in your day
for it to happen. Scheduling is deciding when to do
2. Prioritize something. It is picking the best time for the activity.
The most effective time managers can accurately pre-
Decide what is important. In today’s environment dict how long a task will take. I tell clients that this is
you will never have time for everything. But, if you an art and not a science, it takes practice. If you rou-
are clear about your priorities you can spend your time tinely underestimate the time a task will take, double
effectively. Remember, 80% of value comes from 20% of the time and follow these steps:
your effort. Do you spend too much time reacting to
others’ priorities or doing busy work. Learn to identi- • Schedule the most important activities for each day
fy your high value 20% and concentrate your effort and pick a specific time. Things that are scheduled
there. Don’t let the trivial stuff take over your work are more likely to happen.
or your life.
• Set time limits for everything you do. Determine
3. Analyze how much time you can reasonably devote to this
task.
Figure out where your time is going. Keep a time
log. Guessing is not very effective. Before you can con- • Group related items and actions whenever pos-
trol your time you have to understand how it is being sible.
used. Are those activities where you spend your time
consistent with your priorities? How much time do you • And know what your best time of the day is, when
spend reacting-- answering phone calls or emails, react- you are most effective. Set this time aside for
ing to interruptions or to someone else’s priorities? Do important projects.
you spend more time than necessary on projects? Analyze
your schedule - what is working? What isn’t? Three final time tamers:
DECLARATIONS — WINTER 2002-2003
29
The single most useful piece of information is to Robin Fogel is the President of Robin Fogel & Associates, LLC.
She is a career and life coach dedicated to helping individuals and
identify who or what is interrupting you and how much small business owners stay focused and achieve their goals. She
time it is taking. If telephone calls and emails are eat- has worked extensively in the areas of time management and pri-
ing too much of your day, set aside specific times to ority setting. More information at coachrobinfogel.com.
make and respond to these calls and emails. And, at the
same time ask yourself if these are truly interruptions
or if they are part of the business that you need to plan
ABOUT THE AUTHOR
for and schedule.
Robin Fogel, Career
Meetings can be time wasters or an effective use of
& Life Coach. Robin Fogel
your time. If you can before attending or scheduling a
started her coaching business
meeting, clarify the purpose of the meeting and stick to
after more than 20 years
it. Have an agenda, have a start and ending time and
experience as a Human
come prepared.
Resource Director and
Assistant State Treasurer,
Paperwork can be a problem (and a huge time drain)
and as community volun-
unless you develop a system for dealing with it. It’s
teer.
been said that there are only three things to do with paper-
dump it, delegate it or act on it. So, analyze your paper-
Her specialty is coach-
work, screen and sort, develop criteria for what to keep
ing people in career or
and what to dump, use tickler files and schedule time Forrest C. Wilson III personal transition, espe-
to deal with your paperwork.
cially those who are asking what’s next? She believes
that everyone deserves a life that balances work
Take control of your time, and remember, you have
they enjoy doing, time for friends and family, and for
to spend time to make time. Understand where your
them self. She has helped individuals, community
time is going and how that fits with your priorities,
groups, and public and private corporations formu-
spend the time each day or week to plan for what needs
late and achieve their goals.
to get done and when to do it. You’ll be amazed by the
result
DECLARATIONS — WINTER 2002-2003
30
"Non-Disclosure under the Utmost Good Faith
Doctrine in English Law:
Alive and Kicking or Being Dumbed Down?"
By Peter Schwartz
The English common law doctrine of good faith in insur- island of Sumatra in the East Indies, by its being taken
ance contracts is well over 200 years old. During that by a foreign enemy. The governor also had an insur-
time, it has been codified into statute and subjected to able interest in goods, which he owned, which were
attacks and criticisms at various times. Some say that, kept at the fort. In fact, the event insured against
in modern commercial practice, the duty of good faith occurred: the fort was taken, by Count D’Estaigne, dur-
is honoured more in the breach than the observance. Others ing the policy period. The defendant underwriter, Mr
believe that it may be an anachronism in a modern Charles Boehm denied that underwriters were liable to
age of remorseless commercial pressures, instant com- indemnify the insured because of a fraud, as a result of
munications and hybrid transactions. Nevertheless, the concealment (non-disclosure) of circumstances
it survives through occasional criticisms that harsh which ought to have been disclosed - particularly, the
judgments make bad law and create uncertainty. It weakness of the fort, and the probability of it being
is occasionally amputated through precise draftsman- attacked by the French. In support of the insurer’s
ship, in exclusion clauses, in certain types of contract. defence, two letters from the governor, were relied
Now the elderly doctrine faces further calls for reform, upon - one to his brother, his trustee, the plaintiff in the
in a movement which would like to see a new Insurance case and the second to the governor of the East India
Contracts Act, "for a new Century" - just as happened Company.
shortly after the start of the previous Century.
The first letter to his brother indicated that the gov-
Whilst it is acknowledged that the duty of utmost good ernor was more afraid than before that the French
faith is reciprocal, this article concentrates upon the dis- would attack. The governor wrote to his brother that
closure obligation of the insured to their insurers (to include rather than remain idle, (since they could not muster
reinsurers). a force to relieve their friends at the coast), the French
may pay him a visit. The governor speculated to his broth-
Whereas the components of utmost good faith, are the er that the French had such an intention the previous
twin obligations to make full and proper disclosure year. In the same letter he asked his brother to arrange
and to avoid making material mis-statements, this the insurance. In his second letter to the East India Company,
article focuses on the former. Furthermore, whilst the the governor wrote that the French had, in the previ-
duty of utmost good faith, (through the process of dis- ous year, a plan on foot to take the fort by surprise and
closure), continues through the lifetime of the contract, that they would probably revive that idea. He also
in varying degrees, this article concentrates upon the stated that the fort was badly supplied with arms,
development of the English law of non-disclosure, at point stores and ammunition and expressed his view that if
of contract. Finally, some remarks are offered upon there was an attack by a European enemy, it could not
how insurance contract law may develop in the future. be repelled.
Origins of the Common Law Duty of Good Faith The underwriters argued that they had a right to
know as much as the insured himself knows about the
The common law doctrine of "good faith" in insurance weakness and absolute indefensibility of the fort. They
contracts originated in the 18th Century. Lord Mansfield asserted that if the governor had disclosed what he
is credited with first articulating this concept in Carter knew or, what he ought to have known, he could not have
v Boehm (1766) 3 Burr 1905. Whilst many practition- obtained the insurance of the fort. Therefore, this was
ers are aware of the reason for the celebrity of this a fraudulent concealment and the underwriters were
case, they may not be familiar with its facts. They are not liable.
worth summarising, to put the learned Judge’s rea-
soning into context. The Court held that…"the insurance is a contract
upon speculation". Lord Mansfield explained the gen-
The action was based upon a 12 month policy of eral position that the special facts upon which the
insurance, commencing 16 October 1759, taken out for contingent chance is to be computed, lie most com-
the benefit of the governor of Fort Marlborough, George monly in the knowledge of the insured only: the
Carter, against the loss of Fort Marlborough on the underwriter trusts to his representation, and proceeds
DECLARATIONS — WINTER 2002-2003
31
upon confidence that he does not keep back any cir- tingency occurring than Governor Carter could at Fort
cumstance in his knowledge, to mislead the underwriter Marlborough, in September 1759. The underwriter
into a belief that the circumstance does not exist, and knew the success of the operations of the war in Europe.
to induce him to estimate the risk, as if it did not exist. He knew what naval force the English and French had
Lord Mansfield further stated that the keeping back of sent to the East Indies and much more. In these cir-
such circumstance is a fraud, and therefore, the insur- cumstances, and with this knowledge, he insured against
ance policy is void. Although the suppression of the general contingency of the fort being attacked by a
information may happen through a mistake, without any European power. If there had been any plan or design
fraudulent intent, Lord Mansfield felt that, in such a on foot, or any enterprise begun in September 1759,
situation, the underwriter was still deceived and the pol- to the knowledge of the governor, it would have varied
icy is void, because the risk run is really different from the risk understood by the underwriter; because not
the risk understood and intended to be run, at the time being told of a particular design or attack then sub-
of the agreement. sisting, he estimated the risk upon the footing of an
uncertain operation which may or may not be attempt-
Even from the date of the origins of the doctrine, ed. However, the governor had no notice of any design
Lord Mansfield was careful to explain that the duty of subsisting in September 1759. There was no such
good faith was reciprocal. He opined that an insur- design in fact. The attack was made without premed-
ance policy would equally be void, against the underwriter, itation, arising from a sudden opportunity, with the
if he concealed the fact that he insured a ship on her voy- assistance of the Dutch. Lord Mansfield found that
age, which he privately knew to have arrived. In such the general state and condition of the fort, and of its strength
a case, an action would lie by the insured, to recover the was, in general, well known by most people acquaint-
premium. ed with Indian affairs or the state of the company’s
factories or settlements and could not be kept secret or
Lord Mansfield went as far as to state that the gov- concealed from persons who should endeavour, by prop-
erning principle of "good faith" is applicable to "all er inquiry, to inform themselves. The noble Lord
contracts and dealings". This appeared to extend the concluded that the underwriter here, knowing the gov-
"good faith" doctrine beyond insurance contracts. "Good ernor to be acquainted with the state of the place;
faith forbids either party by concealing what he pri- knowing that he apprehended danger, and must have
vately knows, to draw the other into a bargain, from his some ground for his apprehension; being told nothing
ignorance of that fact, and his believing the contrary." of either; signed the policy, without asking a ques-
tion….It is a withering conclusion which has valid
Even so, during the 18th Century, the English Court resonance, when applied to analogous circumstances,
placed limitations on the duty of disclosure. Lord today.
Mansfield expressly pointed out that the insured need
not mention what the underwriter knows or ought to In consequence, it was clear that although the insured
know or, what he takes upon himself the knowledge is under a duty to disclose material facts to the insur-
of or, what he waives being informed of. Neither need er, he need not disclose facts which the insurer knows
the underwriter be told of what lessens the risk agreed or is deemed to know. This seems to be fair enough. From
and understood to be run by the express terms of the its earliest days, the duty of good faith in making insur-
policy nor, to be told general topics of speculation; for ance contracts was a mutual obligation. It contemplated
example, the underwriter is bound to know every cause an active process of disclosure and questioning between
which may occasion natural perils such as the diffi- the insured and the insurer but, within sensible bound-
culty of the voyage, the types of weather; the probability aries.
of lightening, hurricanes, earthquakes which may occur
or, political perils which may arise. At the beginning of the 20th Century, the English
Court was still saying that it:
In crystallising the duty of good faith, Lord
Mansfield held that: "is an essential condition of the policy of insur-
ance that the underwriters shall be treated with
"The reason of the rule which obliges parties to good faith, not merely in reference to the inception
disclose, is to prevent fraud, and to encourage of the risk, but in the steps taken to carry out the
good faith. It is adapted to such facts as vary the contract". Boulton v Houlder Bros & Co [1904] 1KB784
nature of the contract; which one privately knows, @ 791
and the other is ignorant of, and has no reason to
suspect. The Marine Insurance Act 1906
On the specific facts, the Court determined that the Two years later, the principle of good faith and fair
underwriter in London, in May 1760, could make a dealing in insurance contracts was codified in the
much better judgment about the probability of the con- Marine Insurance Act 1906, ("MIA 1906"). Under the
major heading "Disclosure and Representations", sec-
DECLARATIONS — WINTER 2002-2003
32
tion 17 of the Marine Insurance Act 1906 provided as communication made to, or information received
follows: by, the assured.
"17 Insurance is uberrimae fidei 19 Disclosure by agent effecting insurance
A contract of marine insurance is a contract based Subject to the provisions of the preceding section
upon the utmost good faith, and, if the utmost as to circumstances which need not be disclosed,
good faith be not observed by either party, the where an insurance is effected for the assured by
contract may be avoided by the other party." an agent, the agent must disclose to the insurer
-
It is notable that at this point, the bar was raised from
the standard of mere "good faith" contained in the pre- (a) Every material circumstance which is known
vious case law to "utmost good faith" in the statutory to himself, and an agent to insure is deemed
expression of the duty. One may reasonably suppose to know every circumstance which in the ordi-
that "utmost" good faith means something more than nary course of business ought to be known by,
plain "good faith". One would ordinarily understand it or to have been communicated to, him; and
to mean the highest degree of good faith.
(b) Every material circumstance which the assured
Sections 18 - 20 of MIA 1906 provide as follows: is bound to disclose, unless it come to his
knowledge too late to communicate it to the agent.
"18 Disclosure by assured
20 Representations pending negotiation of
(1) Subject to the provisions of this section, the contract
assured must disclose to the insurer, before
the contract is concluded, every material (1) Every material representation made by the
circumstance which is known to the assured, and assured or his agent to the insurer during the
the assured is deemed to know every circumstance negotiations for the contract, and before the c
which, in the ordinary course of business ought contract is concluded, must be true. If it be
to be known by him. If the assured fails to untrue the insurer may avoid the contract.
make such disclosure, the insurer may avoid the
contract. (2) A representation is material which would
influence the judgment of a prudent insurer in
(2) Every circumstance is material which would fixing the premium or determining whether he
influence the judgment of a prudent insurer in will take the risk.
fixing the premium, or determining whether
he will take the risk. (3) A representation may be either a
representation as to a matter of fact or
(3) In the absence of inquiry the following cir as to a matter of expectation or belief.
cumstances need not be disclosed, namely:-
(4) A representation as to a matter of fact is true,
(a) Any circumstance which diminishes the risk; if it be substantially correct, that is to say, if the
difference between what is represented and
(b) Any circumstance which is known or presumed what is actually correct would not be considered
to be known to the insurer. The insurer is material by a prudent insurer.
presumed to know matters of common notoriety
or knowledge and matters which an insurer in (5) A representation as to a matter of expectation
the ordinary course of his business, as such, ought or belief is true if it be made in good faith.
to know.
(6) A representation may be withdrawn or cor
(c) Any circumstance as to which information is rected before the contract is concluded.
waived by the insurer.
(7) Whether a particular representation be
(d) Any circumstance which it is superfluous to dis- material or not is, in each case, a question of fact."
close by reason of any express or implied
warranty. It is clear that the principles of utmost good faith
apply alike to non-marine insurance and reinsurance
(4) Whether any particular circumstance which is contracts. This was made clear by Mr Justice Steyn, (as
not disclosed be material or not is, in each case, he then was) in Highlands Insurance Co v Continental
a question of fact. Insurance Co [1987] 1 Lloyd’s Rep 109:
(5) The term "circumstance" includes any "I would add that the Marine Insurance Act, 1906,
DECLARATIONS — WINTER 2002-2003
33
was a codification of the common law; that the between themselves, as if they had not entered into
common law should be presumed to be the embod- the contract. This may involve a complex unravelling
iment of common sense; and that common sense of numerous financial transactions. The process of
rebels against the idea that there should be a dif- putting the parties back into their pre-contract position
ference between marine and non-marine insurance does not take place under the terms of the relevant
in relation to non-disclosure and misrepresenta- contract, because this has been rescinded but, under the
tion". law of restitution. Accordingly, the remedy for breach
of the statutory duty of utmost good faith cannot be
It is worth reproducing the provisions of the rele- the payment of damages. It is much more severe.
vant sections of MIA 1906 in full because, they are a rather Furthermore, in avoidance, it is not simply the rele-
concise exposition of the guiding principles. Each sec- vant claim which is avoided but , the whole policy. An
tion and sub-section is helpful in giving explicit guidance, attempt by an insurer to keep the policy alive but argue
although no comprehensive all-embracing definition that it is not obliged to pay the claim on the grounds of
is attempted, for understandable reasons. The vari- non-disclosure, may risk the loss of the right to avoid,
ety of possible circumstances is too huge. Nevertheless, as was shown in the case of West v National Motor and
the fundamental components of the duty of utmost Accident Insurance [1955] 1 Lloyd’s Rep 207. Rescission
good faith are to ensure proper disclosure of all mate- is also retroactive. The insurer is not liable for claims
rial circumstances and to avoid making misrepresentations arising between the making of the contract and the
about material facts, circumstances or beliefs. time of avoidance (Standard Accident v Pratt, 278P
2d, 489). In order to constitute a valid avoidance, the
Up until the mid-1980’s, Court time was mainly insurer must return the premiums paid under the pol-
taken up with resolving disputes concerning alleged icy.
breaches of the duty of utmost good faith, in the context
of the formation of the contract - namely the under- For some time, the remedy of avoidance of the con-
writing process. During the last 10 - 15 years, the tract, ab initio, has been criticised as being too severe,
English Courts have become accustomed to dealing in certain circumstances. It is said that other remedies
with closely fought issues concerning allegations of should be available which are proportionate to the
breach of the duty of utmost good faith, in the context harm or damage caused by the non-disclosure and
of the performance of the contract and particularly, reflecting the culpability and conduct of the offending
the claims process. party.
Since this article considers solely non-disclosure of However, the advocates of radical reform in this
material information during the underwriting process, area should not lose sight of the fact that the purpose
and its consequences under English law, it is instruc- of the doctrine "is to prevent fraud and to encourage good
tive to evaluate, as the doctrine moves from the 18th to faith", thereby giving a fair presentation to enable the
the 21st Century, whether the English Courts are man- insurer to understand and evaluate the risk to be run.
aging to strike a fair balance between the interests of A sanction which is too lenient may encourage pro-
the policyholder in having legitimate claims paid and posers of insurance and reinsurance, (and their agents),
the interests of the insurer/reinsurer in receiving the to cut corners and take a chance. Such fluidity and
risks that they bargained for. In the words of Lord the resultant uncertainty would not be in anyone’s
Mansfield: interests. Yet, the English Courts have shown signs of
interpreting the requirements imposed by the duty of
"The question therefore must always be whether utmost good faith, in keeping with the standards of
there was, under all the circumstances at the time the times, and the nature of the particular transac-
the policy was underwritten, a fair representa- tion, and the conduct of the parties, in an effort to
tion; or a concealment; fraudulent, if designed; maintain the appropriate balance of interests and to do
or, though not designed, varying materially the object justice.
of the policy, and changing the risque understood
to be run". In the formation of an ordinary contract, unless
expressly stated otherwise, the legal maxim of caveat
Interpretation of ss 17-20 MIA 1906 emptor (let the buyer beware) applies, despite Lord
Mansfield’s assertion that good faith (perhaps as dis-
It is important to bear in mind that section 17 of tinct from utmost good faith) is applicable to "all
MIA 1906 prescribes that if utmost good faith is shown contracts and dealings". This means that one con-
not to have been observed by either party the contract tractual party is under no general positive duty of
may be "avoided", (rescinded) by the other party. The disclosure to the other party. In the case of insurance
statutory duty imposed by section 17 enables the and reinsurance contracts, the legal duty of uberrima
aggrieved party to rescind the contract ab initio, there- fides (utmost good faith) does apply. This difference of
by restoring the parties to the position they were in, as approach (and obligation) in relation to contract for-
DECLARATIONS — WINTER 2002-2003
34
mation, can sometimes lead to misunderstandings and of MIA 1906. Scrutton L.J. said in his judgment that
differences of expectation between the parties. There he could understand the way in which cargo was ten-
are signs that this may have occurred, during the last dered might put the underwriter on enquiry - for
few years, where insurers and reinsurers have been example if the celluloid shipment has an odd name, of
asked to support and participate in complex special- which the underwriter has not heard before, such as "fiber-
ist transactions involving interaction with the banking loid" or "pyralin". Further, if an underwriter is told, "I
and capital markets. In such circumstances, it is advis- propose to ship pyralin" and does not ask, "what on
able for all parties to analyse the true nature and earth is that?", he may waive the disclosure to him of
substance of the transaction, not only to understand the ordinary qualities of pyralin or fiberloid. But, the
the commercial deal proposed but also to determine learned Lord Justice asserted that if any particular
which legal principles and obligations may apply. shipment of pyralin or fiberloid has some peculiar qual-
ity, which would not ordinarily follow from, or be
In view of the statutory duty of utmost good faith, imposed disclosed by, saying "This is pyralin", …. that is clear-
since 1906, upon each contractual party, to inform the ly a matter which ought to be disclosed. The owners argued
other with all material information relevant to their against insurers that …"It is a possibility that this
decision to participate, each party must conduct them- cargo which you were asked to insure may have suffered
selves in negotiations and contract formation in a more certain damage, and as there is a possibility, and you
rigorous way than if they were negotiating a non-insur- are told of this cargo, and you do not ask the question,
ance contract. On the one hand there is the positive obligation you are bound by any possibility which might happen
on the prospective insured to consider and disclose all to the cargo". Lord Scrutton felt that this line of argu-
material facts and on the other, the burden on the ment would destroy the obligation to disclose because,
prospective insurer to consider that information and if insurers insured a ship, it was obvious that it is a
other relevant information in the public domain which possibility that anything may have happened to the
need not be disclosed but which the insurer ought to know ship. If insurers come to insure a cargo, it is a possi-
in the ordinary course of his business, and thereafter bility that anything may have happened to the cargo.
make all necessary enquiries both to understand and Lord Scrutton then went on to make an assertion which
evaluate the risk and not waive disclosure of any impor- encapsulates the delicate balancing act for an under-
tant information. writer to perform, in recent times, in relation to the
duty of disclosure. He said:
An interesting case arose in 1927, which went to
the Court of Appeal, in which the English Court was obliged "I have always understood the proper line
to consider the full impact of section 18 MIA 1906. that an underwriter should take, except in mat-
Greenhill v. Federal Insurance Company Ltd [1927] ters that he is bound to know, is absolutely to
1KB 65 concerned insurance of a consignment of celluloid, abstain from asking any questions, and to leave
which had suffered damage by reason of a protracted the assured to fulfil his duty of good faith, and
voyage from New York to Halifax, Nova Scotia. It was make full disclosure of all material facts, with-
insured by its owners for a further voyage from Halifax out being asked. And it seems to me to be of great
to Nantes, in France, without disclosing the circum- importance to the general duty of disclosure that
stances of the prior voyage. In the first voyage, the that position of the underwriter should be main-
celluloid had been loaded on the Julienne and, upon tained, and not whittled away by alleged waiver."
the evidence, it became seriously damaged through
contact with salt water. The celluloid had been car- Whilst one might sympathise with Lord Justice
ried on deck for part of its voyage to Halifax. The same Scrutton’s wish to protect the interest of the under-
celluloid was subsequently shipped on the steam ship writer, it may not give sufficient weight to the reciprocal
Watuka from Halifax to Nantes upon the voyage which duty of utmost good faith. Although sometimes it is
was the subject of the policy in the present case. obvious, it may be, on occasion, difficult for an under-
writer to determine whether a broker has properly
It was held that the pre-carriage of the celluloid on fulfilled his client’s duty of disclosure so that the under-
the Julienne, through what one of the witnesses in the writer is not put on enquiry to seek further information
case described as an astonishing voyage, was a mate- about anything he considers to be material. It is clear
rial fact to be disclosed to the underwriters by the though that the underwriter must be fully attentive
owners, when effecting the policy in respect of the at all times.
Watuka voyage. It was accepted, by both parties, that
the first voyage was a material fact to be disclosed. The Oceanus and Pan Atlantic phase
The Court found in favour of the insurers in relation to
the dispute over whether or not disclosure in fact took Over 50 years later, when the world of trade and
place. Having determined this question in favour of commerce had changed very significantly, the Court
insurers, the Court of Appeal considered the owner’s best of Appeal was faced with a similar predicament in the
contention - namely that there was a waiver of the case of Container Transport International v. Oceanus
duty to disclose, within the meaning of section 18 (3) (c) Mutual Underwriting Association [1984] 1 Lloyd’s Rep 476.
DECLARATIONS — WINTER 2002-2003
35
In his comprehensive and well known judgment, closed or misrepresented was one which a notional pru-
Kerr L.J. considered extensively the theoretical and dent insurer would have taken into account in reaching
practical difficulties concerning the interpretation of his decision whether or not to accept the risk or in fix-
section 18(2) MIA 1906 concerning materiality. He ing the premium.
balanced the competing interests in the following way:
Controversially, the Court of Appeal determined
"the principle is that if a certain fact is mate- that it was not necessary to show that the actual under-
rial for the purposes of ss. 18(2) and 20(2), so that writer would have been influenced by the non-disclosure
a failure to draw the underwriter’s attention to it or misrepresentation to act in a different way. The
distorts the fairness of the brokers presentation decision was criticised in the English market because
of the risk, then it is not sufficient that this fact it encouraged ingenious reinsurers to base rescission defences
could have been abstracted by the underwriter on the objective test of what a prudent underwriter
from material to which he had access or which would have done, whilst ignoring what the actual under-
was cursorily shown to him. On the other hand, writer had done. It was relatively easy for an insurer
if the disclosed facts give a fair presentation of to show that the facts not disclosed or misrepresented
the risk, then the underwriter must enquire if he were worth consideration by the underwriter in for-
wishes to have more information." mulating his decision by calling expert underwriting evidence,
even though their actual underwriter would not have
It seems therefore, that once the threshold point acted any differently if the withheld or misrepresent-
has been reached, in any specific circumstances, where ed facts were made known to him. Such was the extent
a fair presentation has been made, the burden trans- of the concern in the English insurance market, imme-
fers to the insurer or reinsurer to request more information, diately following the decision, at what was portrayed
if he wishes. However, at that time, the insured’s duty as a charter to protect the incompetent underwriter, that
of disclosure has been satisfied. In such a situation, the it was necessary to find another case, to take to the
preferable view seems to be that, after the disclosure House of Lords, to re-address some of the more unset-
threshold point had been reached, in any individual tling aspects of that judgment.
case, a failure by the insurer to ask further questions
should not lead to an inference of wavier against the insur- A landmark judgment arrived within the next decade,
er because this may result in the dangerous erosion of in the case of "Pan Atlantic Insurance Company Limited
the duty of disclosure which Lord Justice Scrutton v. Pinetop Insurance Company" [1994] 2 Lloyd’s Rep
feared, over 50 years previously. In any event, the 427. The facts were relatively straightforward and for
Oceanus case became notorious for interpreting the present purposes can be easily summarised.
definition of materiality in s. 18 MIA 1906 in a much
criticised way. A predominantly US casualty account was reinsured
by Pine Top with Pan Atlantic, under various excess of
In CTI v. Oceanus, CTI hired out containers for loss reinsurance contracts in 1980, 1981 and 1982. As
ocean transportation. Frequently, problems occurred part of the placing information to the underwriter of Pan
regarding the liability of the container lessees for repairs Atlantic, the placing broker had shown the underwriter
under the container hire contracts. It was agreed that the loss record for the risk for 1980 and 1981. The loss
CTI would cover an initial part of certain repair costs. record for 1981 was inaccurate. It showed losses of
CTI obtained insurance of their exposure to the cost US$235,768, whereas, as the reinsured were aware,
of repairs for the containers, initially through Crum the true position was that US$468,168 of claims had been
& Forster. As a result of their concerns with the claims incurred. Also, Pine Top’s broker had failed to disclose
experience, Crum & Forster quoted renewal on terms to Pan Atlantic’s underwriter the loss record for the
which were not acceptable to CTI. The cover was placed years 1977 - 1979. When the case was heard in the
subsequently with Lloyd’s but, Lloyd’s also became Commercial Court, the Judge held that, in relation to
unhappy with the claims experience - following which Pine Top’s failure to disclose their loss record for 1977
the insurance was proposed to and placed with Oceanus. - 1979, there had been a fair presentation of the risk.
Subsequently, Oceanus, became unhappy with the He weighed up whether the duty of disclosure had been
claims and alleged that incomplete information con- fulfilled either on the right side of the borderline or,
cerning the claims history was presented to them, whether the doctrine of waiver should defeat any
constituting a material misrepresentation. Expert evi- reliance on the alleged material non-disclosure. On
dence was produced to the Court, on behalf of Oceanus, the facts, the Judge concluded that an underwriter
that a prudent insurer, within the terms of s. 18 (2) of knows full well that the earlier years are the only real
MIA 1906, would have been influenced in his judgment guide to assessing a risk and its rate. The Court held,
in determining whether he would take the risk or in fix- on the evidence, that the broker brought along for the
ing the premium, if he was made aware of the full facts. underwriter to see the history in relation to the earli-
The Court of Appeal decided that the correct test of er years and that history, if the underwriter had bothered
materiality was whether the fact which was undis- to study it, was a perfectly fair presentation of those ear-
DECLARATIONS — WINTER 2002-2003
36
lier years. The Judge felt that the broker did not have amount of expert evidence which they were being asked
an obligation to tell the underwriter how to do his job. to consider on market practice and issues of construc-
The Court of Appeal agreed with the Judge and so did tion. Fortunately, the Commercial Court Judges are generally
the House of Lords. In relation to the alleged materi- well versed in the practices and procedures of the
al non-disclosure of the additional US$230,000 of losses English insurance market. Therefore, they were becom-
in respect of the 1981 underwriting year, - Pan Atlantic ing increasingly keen to disallow "fishing expeditions,"
were entitled to avoid. The Court of Appeal, applying in the discovery process, for materials of dubious rel-
the prudent underwriter test previously formulated in evance and to reserve to themselves the duty of placing
the Oceanus case, upheld the trial Judge, as did the a legal construction upon disputed contracts of insur-
House of Lords, who adopted the conclusion of the trial ance and reinsurance. This was, after all, the function
Judge that: of the Court. In Marc Rich v Portman [1997] 1 Lloyds
Rep 225, Lloyd’s underwriters alleged that the brokers
"If these additional losses had been brought had failed to disclose the loss experience of the insured
to his…[i.e. the actual underwriter of Pan Atlantic]… and the demurrage claims made or paid by them as
attention in the way that he was looking at this charterers to ship-owners for vessels performing voy-
business by reference to the short record, it might ages from Kharg Island/Ain Sukhana or voyages out of
well have influenced him as to the terms of the renew- Constantza and pleaded further non-disclosure of par-
al". ticular features of the port of Ain Sukhana which would
be likely to give rise to demurrage claims - such as bad
Even so, the House of Lords took the opportunity of weather, difficult tides, likelihood of congestion and
reformulating the test of "materiality". There is now other such matters. The insured argued that, even if
a two part test which needs to be satisfied. The House the allegedly material facts had been disclosed, it would
of Lords did not change the first limb. It is still necessary not have affected the judgment of the actual under-
to demonstrate materiality by reference to a hypo- writer who was described in submissions to the Court
thetical prudent underwriter. However, as the second on behalf of the insured as …"a man who had abro-
limb, it is now necessary to show that the actual under- gated his underwriting functions and existed in an
writer was induced by the misrepresentation or intellectual stupor". In consequence, the insured asked
non-disclosure to enter into the contract. that their insurers disclose their actual underwriter’s
writings, over a period of five years, presumably in
As ever, Lord Mustill gave some helpful guidelines order to try to undermine his competence. Understandably,
in his speech in the House of Lords [1994] 2 Lloyds insurers had declined to agree to such broad ranging dis-
Rep 427 @ 453: closure.
"…I have concluded that it is an answer to a defence At the trial, Mr Justice Longmore (as he then was)
of misrepresentation and non-disclosure that the observed that it would be most unfortunate, as a con-
act or omission complained of had no practical sequence of the Pan Atlantic case:
effect on the decision of the actual underwriter. As
a matter of common sense however even where the …"if cases of this kind were to be saturated
underwriter is shown to have been careless in with inquiries about a plethora of risks written by
other respects the assured will have an uphill the actual underwriter on occasions other than
task in persuading the Court that the withhold- the time when the relevant risk was itself written.…
ing or misstatement of circumstances satisfying the question whether the actual underwriter was
the test of materiality has made no difference. induced to write the relevant risk is to be deter-
There is ample material both in the general law mined by reference to the actual risks underwritten
and in the specialist works on insurance to sug- and their immediate context. The question in
gest that there is a presumption in favour of a this case is then whether the underwriter abrogated
causative effect". his functions in relation to these risks, not in rela-
tion to numerous other risks written on different
Although the judgment was viewed as striking a occasions".
fairer balance on the question of "materiality" between
the reinsured and the reinsurer, it is significant that ss.17 In St Paul Fire & Marine Co (UK) Limited v McConnell
- 20 MIA 1906 make no reference to a concept of "induce- Dowell Contractors Limited [1995] 2 Lloyds Rep 116, four
ment". insurers of a construction project successfully avoided
a contractors’ all risk cover because the insurers had been
Things settled down during subsequent years, as innocently informed that the plans to construct the
the English Courts applied the refined tests set out in Marshall Islands Parliament and administration build-
Pan Atlantic, in a variety of non-disclosure cases. Many ings provided for deep as opposed to shallow foundations.
of these were settled but, Judges became concerned After major subsidence had occurred, the insurers
about the explosion of documentation being called for argued that if the actual design of the foundations had
in the disclosure (discovery) process in litigation and the been disclosed, the three actual underwriters who gave
DECLARATIONS — WINTER 2002-2003
37
evidence on behalf of their companies would have acted by s. 17 MIA 1906. He pointed out that the right to avoid
differently. They brought additional evidence, through the contract, ab initio, in s. 17 is different from the
an expert underwriter, that the hypothetical prudent applicable remedy for breach of the duty of utmost good
underwriter would also have done so. The Court of faith during the performance of the contract. The right
Appeal concluded that in view of the consistent evi- to rescind under s. 17 enables the innocent party to
dence from three insurers, supported by expert evidence, rescind the contract ab initio thereby totally nullify-
there was no evidence to displace a presumption that ing the contract and requiring everything done under
the underwriter of the fourth insurance company was the contract to be undone, including any adjustment of
similarly induced, by the misrepresentation or non- the parties’ financial positions. Lord Hobhouse explained
disclosure of the plans for the piled foundations, to that this was entirely appropriate where the lack of
issue a policy on the same terms. Accordingly, the pre- good faith has preceded and been material to the mak-
sumption referred to by Lord Mustill in the Pan Atlantic ing of the contract. However, when the want of good faith
case in favour of materiality operated. first arises after the making of the contract and during
its performance, he felt that it becomes anomalous and
Developments during the last few years disproportionate that a breach should entitle the
aggrieved party to avoid the contract, from inception.
Between the 20th and 21st Century, the English Accordingly, Lord Hobhouse considered that there was
Courts continued to see several cases focusing upon a clear distinction between the pre-contract duty of
allegations of non-disclosure of material facts and con- disclosure and any duty of disclosure which may exist
sequent breach of the duty of utmost good faith, in the after the contract has been made. The Courts have
contract formation process. However, recent case law consistently set their face against allowing the insured’s
has witnessed new types of transactions, often blend- duty of good faith to be used by the insurer as an instru-
ing banking and insurance principles and practice. ment to enable the insurer himself to act in bad faith.
Some insurers and reinsurers have developed an appetite Lord Hobhouse concluded that for the insurers to suc-
for the assumption of part of the operational or business ceed in avoiding the contract, ab initio, under s. 17
risks of their insured, rather than risks incidental to those MIA 1906, due to non-disclosure during the perfor-
business activities. The high sums at stake arising mance of the contract, the insurers would have to show
from fall-out from film finance insurance, mortgage that the claim was made fraudulently.
indemnity insurance, residual value insurance, surety
bonds, financial guarantees and many other insurance It is becoming increasingly common, in certain species
products has ensured that non-disclosure disputes con- of commercial insurance and reinsurance policies, to
tinue to appear periodically for determination before the try to exclude the full force of the consequences of the
English Court. With different business cultures, back- avoidance remedy under s. 17 MIA 1906, by including
grounds and practices, the parties to a transaction may an inadvertent non-disclosure clause. This provides
also encounter a mis-match of attitude and expecta- that the insurers can only rescind the policy for non-dis-
tion, which is easy to overlook in the euphoria of the contract closure if the non-disclosure arose otherwise than from
formation stage but, less easy to do so when unantici- fraudulent conduct or an intention to deceive. Sometimes
pated and substantial losses come pouring in. Some insurers such clauses expressly allow insurers the right to
unhappy with their bargain, may claim that they have exclude losses relating to non-fraudulent non-disclo-
been misled (or worse) and some policyholders, with sure, rather than allowing the policy to be rescinded,
the benefit of recent insurance or reinsurance prod- ab initio.
ucts, feel that their expensive security is seeking to
wriggle off the hook. Nevertheless, the doctrine of As previously mentioned, it is clear that banks and
utmost good faith continues to be alive and well because, financial institutions are not protected by the common
if that were not the case, recently observed attempts to law duty of utmost good faith in their day-to-day lend-
eliminate or dilute its impact, through the introduc- ing and financing business. Where serious and substantial
tion of exclusion clauses, may not have occurred. sums of money are at stake or professional reputations
are involved (or both), banks frequently demand bullet-
In Manifest Shipping Co Limited v UniPolaris proof protection and instant recourse, rather than run
Insurance Co Limited (The "Star Sea") the insurers the risk of insurers seeking out a breach of some per-
relied on s. 17 of MIA 1906, pleading that the owners ceived and intangible archaic utmost good faith obligation.
of the vessel failed to disclose facts relating to an ear- Furthermore, in soft market conditions and where
lier fire aboard another vessel, Kastora, at the time there is premium hungry excess capacity, insurers
when the insurers’ solicitors were investigating the have been persuaded to dilute or dispense with the "all
Star Sea claim. In giving the leading speech in the or nothing" remedy of avoidance under s.17 MIA 1906.
House of Lords, Lord Hobhouse distinguished between Banks, capital providers and financiers often demand
a contractual obligation of good faith in the perfor- a less harsh approach to the consequences of breach.
mance of a contract and the statutory duty imposed
DECLARATIONS — WINTER 2002-2003
38
The case of HIH Casualty and General Insurance receive the revenues from the films and were part of the
Limited v Chase Manhattan Bank [2001] Lloyds Rep 483 financing arrangements between Chase and those
concerned the interaction between the film, banking involved in the proposed films. In related actions, HIH
and insurance industries. Chase was the agent for a syn- sued Chase and Heath seeking to avoid the line slip
dicate of banks making loans to finance the production facility and/or the declaration made under that facili-
of five films. HIH underwrote financial contingency ty due to non-disclosure and misrepresentation made
insurance in favour of Chase, acting as agent for all by Heath in the course of the negotiations. HIH alleged
the other lenders. Heath were the brokers who nego- that these non-disclosures and misrepresentations
tiated the insurance arrangements. The overriding were fraudulent or negligent. The second and third
commercial objective was for the revenues from the actions were brought by Chase against HIH under the
five films to repay the debt in favour of the syndicate separate policies of financial contingency insurance
of banks. As a condition for financing the films, Chase claiming an indemnity under the two policies. The
received the security of a "financial contingency insur- Court was required to look at three preliminary issues,
ance" designed to pay up to the maximum of the sum on the assumption that the allegations made by HIH
insured, if for any reason the revenues generated by the were true. The issues were:
films within a certain period were insufficient to repay
the loan finance plus associated expenses. (1) could the parties exclude altogether or limit the
consequence of breach of the duty to make
Since Chase’s role was limited and the insurance proper disclosure;
broking was done by Heath, the insurance policies con-
tained a "Truth of Statement clause" - the purpose of (2) could the parties exclude or limit remedies for
which was to distance Chase from the responsibility the fraudulent conduct of an agent; and
for the placing of the insurance.
(3) was the policy effective to remove underwrit-
The insurers issued a line slip facility which was a ers’ rights to avoid where the broker (as the agent
contract for insurance. Under this line slip three dec- of the insured) had been negligent or fraudu-
larations were made by off-slips in respect of the three lent in not disclosing material information.
of the five films. Separate policies of financial contin-
gency insurance were issued in respect of the remaining In a long judgment, the Court concluded that the
two films. parties could exclude or limit whatever liability they pleased,
subject to two caveats. First, a party could not exclude
The Truth of Statement clause provided, in liability for its own fraud, as a matter of public policy.
summary, as follows: Secondly, the ability to exclude the operation of the
Misrepresentation Act 1967 was subject to the Unfair
[1] It is a condition precedent to this policy that: Contract Terms Act 1977.
Elmwood Films Inc has truthfully completed
Section 1 of the Questionnaire to the best of its The Court also clarified that there is no duty of
knowledge…[2] Provided that Elmwood Films utmost good faith in conducting negotiations for insur-
Inc completes the sections of the Questionnaire ance (i.e. a line slip facility) as opposed to a contract of
required to be completed by it and delivers insurance (i.e. the individual policy) where there was
the same to the Lead Insurers [3] (it being a duty of utmost good faith.
acknowledged that any mis-statement in any
part of the Questionnaire…shall not be the In conclusion, the Court of Appeal held that the
responsibility of the insured or constitute a insurance contract must clearly reflect the party’s
ground for avoidance of the insurers’ obligations intent to exclude rights of avoidance in particular cir-
under the Policy….)…[5] Subject to the obli- cumstances. Following analysis of the Truth of Statement,
gations of the Insured under "General the Court decided that whilst it did exclude the duty of
Conditions--Due Diligence Clause"…[6] the disclosure of the insured, it did not exclude or limit
insured will not have any duty or obligation to the duty of disclosure of their agents, the brokers. It
make any representations, warranty of dis- remains to be seen whether the way in the market
closure of any nature express or implied…[7] moves in future will be to continue to place commercial
and shall have no liability of any nature to pressure on insurers and reinsurers to give up or dilute
the insurers for any information provided by their right to avoid an insurance policy for material
any other parties and [8] any such informa- non-disclosure via increasingly long and complex tai-
tion provided by or non-disclosure by other lor made exclusions. If this occurs, clear and unambiguous
parties…shall not be a ground or grounds for wording must be used.
avoidance of the insurers’ obligations under
the Policy…
Elmwood Films were the purchasers of the right to A recent judgment in the Commercial Court con-
DECLARATIONS — WINTER 2002-2003
39
firmed, if there was any doubt, that an insured (and their (1) The duty of disclosure should remain, as it
brokers) must act in utmost good faith by giving full and would be "undesirable and impractical" to
proper disclosure of all material information. In New totally abolish the duty of disclosure. Although
Hampshire Insurance Co. v Oil Refineries Limited the duty to disclose material facts remains,
[2002] 2 Lloyd’s Rep 462, ORL, based in Israel, pro- the standard of disclosure should be modified.
duced oil products and instructed their insurance A fact should only have to be disclosed if (a) it
brokers to secure public and products liability insurance is material in the sense that in would influence
in London. The risk was written on the basis of a a prudent insurer in deciding whether to accept
claims history for the prior five years. Subsequently, the risk, and, if he accepts it, on what terms;
insurers discovered that during the winter of 1988/1989 (b) it is known to the insured or would be ascer-
about 380 greenhouse flower growers had suffered loss tained by a reasonable person applying for
and damage as a result of the supply by ORL of defec- the insurance; and (c) it is something which a
tive oil. The claims history provided on behalf of the insured reasonable person in the position of the insured
did not include claims made prior to 1989, which were would disclose to its insurers.
in progress at the time of placement. ORL claimed
that there was reference to the substantial flower grow- (2) The standard required for answers by an
ers’ claims in the possession of the insurers, contained insured to questions in proposal forms should
in an expert’s report, on an entirely different matter - be that of a reasonable insured on the above
which the relevant underwriter denied ever having basis. An insured should be considered to
seen. Even so, ORL contended that the insurers were have discharged his duty of disclosure in rela-
on notice of the claim, but had failed to make further tion to the answers to specific questions, if,
inquiries. In consequence, ORL pleaded that insurers after making such enquiries as are reason-
had waived notice of the flower growers’ claims and able having regard both to the subject- matter
had invalidly avoided the policy. of the question and to the nature and extent
of the cover which is sought, the insured
The trial Judge had to consider whether the non- answers the questions to the best of his knowl-
disclosure was material. He had no doubt that it was edge and belief. Explicit warnings should be
and that the non-disclosure did induce the insurers to given in proposal forms (a copy of which should
make the contract in the terms in which it was made. be provided to and retained by the insured)
The insurers were able to demonstrate that the method as to the existence and extent of the insured’s
which the underwriter undertook to calculate the pre- duty of disclosure and the consequences in the
mium involved reference to the claims history, as an important event that the insured fails to fulfil its disclo-
component of the premium calculation. This case is sure obligations.
good authority for the proposition that an insured can-
not give limited disclosure of material facts and then argue Recent Calls for Reform
that the insurer could have asked for further infor-
mation, but by not doing so, had thereby waived the Some 18 months ago the British Insurance Law
materiality of the withheld information. The utmost good Association ("BILA") appointed a Sub-Committee "to exam-
faith disclosure threshold had not been reached. ine areas of insurance law causing concern in the
insurance market and in insurance disputes and to
The Next Step: The 1980 Law Commission Report: make recommendations to the Law Commission as to
"Insurance Law: Non-disclosure etc. the desirability of drafting a new Insurance Contracts
Act in respect of marine and non-marine insurance
The Law Commission, a publicly funded UK gov- and/or other reforms to current legislation".
ernment body, was asked in 1980 "to consider the effect
on the liability of an insurer, and on the rights of the On 1 September 2002, BILA published the Sub-
insured, of non-disclosure and/or misrepresentation Committee’s report, entitled "Insurance Contract Law
by, or on behalf of, the insured and other topical issues. Reform Recommendations to the Law Commission".
This assignment was given to them in the light of the In essence, the significant and dramatic changes pro-
proposed EEC Insurance Directive ("The Directive on posed by the Law Commission in 1980 and by various
the Co-ordination of the Legislative, Statutory and academics and members of the legal profession in
Administrative Provisions governing Insurance Contracts") recent years were, in large part, supported by BILA. The
which promoted the harmonisation of insurance contract Sub-Committee concluded that the Statements of
law, but which never materialised. The Law Commission Practice and the operation of a "fair and reasonable" approach
stated that the English law of non-disclosure and breach by the Insurance Ombudsman was not sufficient to
of warranty was, without doubt, in need of reform and remove the inherent unfairness vis-à-vis insureds under
that such reform was long overdue. The Law Commission the current law. BILA believes that legislative reform
proposed the following: is necessary to provide added protection for insureds.
The BILA report suggests that the starting point
DECLARATIONS — WINTER 2002-2003
40
for reform is the implementation of the recommenda- The BILA report also recorded that the question of
tions of the 1980 Law Commission Report and the delay in paying valid claims should also be given some
enactment of the draft Insurance Law Reform Bill consideration. The question why a claim under an
included in the Report, subject to certain amendments insurance policy should be treated under the law as a
including: claim for damages, rather than a straight debt claim should
be revisited. The report suggests that contracts should
• The Doctrine of Utmost Good Faith: The Report expressly provide that that any claims under an insur-
recommends that this doctrine should not be abol- ance contract should be treated as a debt and that it be
ished, but should be subject to certain modifications. an implied term that the debt will be paid within a
Utmost good faith should apply to the whole peri- reasonable time. The proposed amending legislation calls
od of the contract. Naturally, the nature of the duty for the creation of an implied term of the contract that
will vary depending upon the phase and circum- each party shall act towards the other party with utmost
stances of the relationship (see The Star Sea). good faith and that there should be no right of avoid-
ance in respect of post-contractual failure to act with utmost
• The Test for Non-disclosure and Misrepresentation good faith, except where the breach is materially fraud-
pre-contract: The BILA report supports the con- ulent. The remedy for breach would be damages to
clusions of the Law Commission Report 1980 - compensate the wronged party for his actual proved
namely, the appropriate test should be whether a loss, according to ordinary principles of damages.
reasonable insured would have considered the Avoidance will be available only in respect of a mate-
undisclosed matter to be material to a prudent rially fraudulent breach. If the breach is a materially
insurer. fraudulent breach of the implied term, in the sense
that the fraud would have an effect on the underwrit-
• The Remedies available to insurer/reinsurer in the ers’ ultimate liability and the gravity of the fraud or its
face of non-disclosure/misrepresentation: Since the consequences were sufficient, this would enable the
sole remedy currently available for non-disclo- insurer to terminate for breach of contract.
sure or misrepresentation is avoidance of the
contract, whether the misrepresentation or non- The BILA report recommends that the following
disclosure was fraudulent, negligent or innocent, market co-insurers should be deemed to be induced by
the BILA report concludes that reform is necessary misrepresentation or non-disclosure, if all the leaders
in this area for the protection of the insured. The were induced.
Report recommends:
So where does that leave us?
• retaining the right to avoid where there has been
fraudulent or reckless misrepresentation or Even hardliners in the insurance industry opposed
non-disclosure. to change, may accept privately that reform is long
overdue. The duty of disclosure, as it presently stands,
• in situations where there has been innocent or can operate too harshly against the insured. For exam-
negligent misrepresentation, BILA recom- ple, the insured may not be aware that, after giving
mends "principles of proportionality" should be his responses to questions on a proposal form, he is
introduced. still under a duty to disclose any other material facts
to which none of the questions related. Also, in relation
• BILA also recommends that, in relation of to renewals, an insured may not know that in law a
non-disclosure and misrepresentation, the renewal constitutes a new contract of insurance and
Marine Insurance Act 1906 should be amend- so his duty of disclosure arises afresh, at every renew-
ed, as follows (a) if a breach is fraudulent, the al, so that he is under an obligation to disclose any
insurer can avoid the policy from the outset, but material facts arising in the interim. Perhaps after
with no return of premium to the insured; (b) all, the duty of disclosure is not too stringent but, the
where the breach is not fraudulent, and the insur- range of remedies available do not adequately allow
er would not have agreed to enter into the for different degrees of culpability which merit differ-
contract if it had known of the undisclosed ent remedies, in order for the dispute to be dealt with
circumstances, the insurer can avoid the con- fairly. The ultimate sanction of avoidance should
tract, but with a return of premium to the remain but, only for the ultimate breach (e.g. fraud). An
insured; (c) where the breach is not fraudu- all or nothing sanction in the modern world should not
lent and the insurer would have entered into apply regardless. It is perhaps for this reason, that
the contract, but on other terms, the insurer the BILA report makes an additional suggestion to the
is not entitled to avoid the policy, but is not liable effect that there should be a change in the law so that
to indemnify the insured for a loss proximately insurers are put under a duty to ask reasonable ques-
caused by the undisclosed or misrepresented tions about a risk on matters it considers are material
circumstance. and which require further information.
DECLARATIONS — WINTER 2002-2003
41
This may signal a future and welcome market-wide ignorant or foolish. Much better to admit your
emphasis on true underwriting skill and judgment, ignorance before accepting the business. In most
combined with verbal craftsmanship in documenting con- cases everyone will be ignorant too."
tracts of insurance and reinsurance. There is still room
for underwriting flair but, with discipline. It is difficult to argue with Mr Kiln’s good sense and
long experience of both active underwriting and review-
In conclusion, I cannot do better than repeat the ing the underwriting of others in his capacity as a
clearly expressed advice and underwriting approach leading arbitrator. His cynicism is understandable.
of Mr Robert Kiln, the well known former Lloyd’s under- Fortunately, the English Courts will step in decisive-
writer, in seeking to minimise the risk of being involved ly, when required to do so, to enforce the long standing
in disputes concerning alleged non-disclosures and duty of utmost good faith, in the underwriting process.
breaches of the duty of utmost good faith. These com- However, before seeking assistance from the Courts, it
ments were made in Mr Kiln’s book "Reinsurance is advisable for insurers to have taken all reasonable
Underwriting" - the first edition of which was pub- steps to help themselves, in the underwriting process,
lished in England in 1989. Mr Kiln’s views are as and to be able to produce evidence to demonstrate that
appropriate today, as when they were first committed they have done so.
to paper.
nb The views expressed in this article are those of the author
"My experience during the last few years as only. They should not be attributed either to Baker & McKenzie or
an arbitrator, expert witness or consultant in to any of the author’s colleagues at the firm. The contents of this arti-
some seventy disputes in the reinsurance field cle are for general interest only. Care should be taken to obtain
specific legal advice on specific situations.
has been any eye opener. The disputes have
involved a total of several billion dollars in total,
nearly all of them arising out of bad faith by one ABOUT THE AUTHOR
or all parties allied to sheer greed or stupidity.
For example, by reassureds and their brokers Peter Schwartz
deliberately misleading their reinsurers by "clever Peter Schwartz joined Baker
& McKenzie as a Partner,
wordings" or by non-disclosure or veiled non-dis- based in the London office,
closure. Reinsurers not even reading slips, or if in 1999. He has over 20
they have, not understanding them and produc- years’ broad experience in
ing them and producing no wordings and not liability insurance and non-
asking questions. marine reinsurance. He is
currently Chair of Baker &
McKenzie’s
The courts in the UK (but not so in the USA) have European
come down strongly in favour of requiring dis- Insurance/Reinsurance
closure of any information which would influence Practice Group.
a prudent reinsurer. They have placed less stress
Peter Schwartz Peter graduated with an
on the duty of the reinsurer to ask questions.
honours degree in Law from the University of Leeds in
1975 and was admitted as a solicitor in England in
There are two views on most of these disputes.
1978.
One is that some reassureds, and in particular
placing brokers, have deliberately and consis- Peter joined the Law Department of Alexander
tently taken innocent reinsurers for a ride. The Howden Group, as a commercial lawyer in 1976 where
second view is that reinsurers have imprudently he was engaged for several years on a wide range of
taken on contracts, and having deliberately done predominantly non-contentious corporate and commer-
so, are now ratting on those contracts, often years cial matters, within the insurance sector.
later for any reason they think will delay pay-
Subsequently, he has developed commercial, regula-
ment and force a compromise, or even a verdict, tory and dispute specialisms with well known City of
in their favour. London and US firms. Peter advises in relation to new
products, agency and intermediary relationships, inves-
Good faith and integrity, if it ever existed, has tigations, due diligence, financial institutions,
long gone out of the window. In my view both professional liabilities, and discontinued operations.
He specialises in the resolution of major international
views have validity and both are equally com-
non-marine reinsurance disputes, some of which have
mon." resulted in reported judgments, adopting a solution-ori-
entated approach.
"Never underwrite something you do not fully
understand. Never agree to initial something you Peter is a member of the IBA, BILA, and the CII. He
do not understand. Never worry about asking speaks regularly at conferences and seminars on risk
questions, never worry about being considered related issues in London and overseas.
DECLARATIONS — WINTER 2002-2003
42
TIME-BAR IN INSURANCE/REINSURANCE
CONTRACTS – AN INTERNATIONAL
CONCERN
By Bill Perry and Louise Bagnall
From the international perspective, and particu- It is always therefore worth bearing in mind where
larly in the context of international insurance recoveries, an action might best be brought, avoiding any mis-
the length of the time-bar or limitation periods in any conception that the English Courts would apply English
particular country is crucial when it comes to ascer- time-bar law to a foreign law contract. Equally, other
taining whether an action is legally statute barred. foreign jurisdictions may also apply time-bar on a sub-
Limitation periods can vary widely from country to stantive law basis and this should be researched before
country or state to state. any choice of jurisdiction is made.
In New York and California, for example, the respec- The relevant English legislation on choice of law is
tive limitation periods are 6 years and 4 years; in France the Contracts (Applicable Law) Act 1990 when both
direct insurance claims are time-barred at 2 years contracting parties are domiciled in the EC. It brings
whilst reinsurance claims are barred at 10 years, and into force the Rome Convention ("Rome"). Rome applies
in Italy there is a 1 year time-bar on insurance claims whether or not the law it specifies is that of a con-
and a 1 year time-bar on reinsurance claims relating to tracting state (article 2). Rome’s basic rule is that the
premiums, whereas there is a 2 year time-bar for any law chosen by the parties applies, and that their choice
other reinsurance claims. can be: "express or demonstrated with reasonable cer-
tainty by the terms of the contract or the circumstances
Consequently, in addition to the differences between of the case" – article 3.1 In the absence of such choice,
different governing laws, there is also the problem of ascer- the contract is: "governed by the law of the country
taining when the limitation period starts to run for with which the contract is most closely connected" –
different types of insurance/reinsurance contracts. This article 4.1. That country is to be presumed (subject to
article aims to highlight the importance of such dif- contrary evidence, and certain special cases) to be that
ferences in the English courts, by way of example, in order of the party: "who is to effect the performance which is
that a Claimant is not denied the opportunity of pur- characteristic of the contract" – article 4.2. Thus in
suing a valid claim through the defence of statutory reinsurance contracts, that party is the reinsurer.
time-bar.
Rome does not apply (inter alia), however, to con-
Which governing law? tracts of direct insurance when the risk is situated
within the EU (article 1.3), or to arbitration or jurisdiction
A number of countries (including most of the USA) agreements (article 1.2(d)). Under English common
will apply the local law of the court or the seat of the law, if there is no choice of law, the applicable system
arbitration in a particular jurisdiction, irrespective of of law for such a contract will be the system of law of
the governing law of the contract. In the English courts the country with which the contract is most closely
prior to 1 October 1985 the question of limitation was connected.
also considered to be a matter of procedural law.
However, from that date the Foreign Limitation Periods There is case law that implies that since using the
Act 1984 came into force and fundamentally altered London market brings many such disputes within the
the previous rules. ambit of the English jurisdiction, foreigners coming to
London to use the London insurance market are sub-
Section 1 of that Act provides that where in any mitting to English law as a result of that choice to come
action in a court in England and Wales the law of any to England to place their insurance. In his 1992 judg-
other country is to be taken into account in the deter- ment1 HHJ Laurie asserted that "the advantage of the
mination of any matter, the law of that other country international insurance market to insurers and insured
relating to limitation shall apply. The time-bar issue alike must be that people from different countries come
became that of substantive law relating to the gov- to get the same thing interpreted in the same way
erning law of the contract, rather than procedural law everywhere." Thereby stressing the point that the
relating to the jurisdiction, as had previously been the application of English law needs to be consistent, regard-
case. less of whether the insureds are domiciled differently,
DECLARATIONS — WINTER 2002-2003
43
in order to prevent the same policies from meaning recent authority which ran contrary to the accepted
different things when different legal systems are applied theory, Callaghan and Hedges v Dominion and Others9
to them and to ensure fairness and certainty. confirms Chandris and held that Transthene was both
obiter and wrong and that actually the marine princi-
In a relatively recent case2 where the defendant ple should be applied to property insurance. It was
reinsurer was based in the USA and the claimants held that time runs from the date of the original loss,
were insurance companies in the US, Canada, Ireland albeit that its quantum is at that point unknown. This
and the UK Mr Justice Moore-Bick decided that the position was also affirmed in passing, in respect of
contracts before him which were negotiated through property insurance, by the Court of Appeal in Sprung
brokers in London and made in the usual manner of the v Royal Insurance10 . Consequently it seems relative-
London market, which included a relatively specialised ly clear.
form of reinsurance developed in the London market and
incorporated slips referring to a number of standard The second category of direct insurance is that of
London market clauses, were to be governed by English liability claims. It was determined by the House of
law. Similarly, AIG Europe (UK) Ltd v The Ethniki3 , Lords in Bradley v Eagle Star11 that an insured person
and AIG Europe SA v QBE International Insurance4 cannot sue for an indemnity from insurers unless the
are precedents for confirming English law in reinsur- amount of his liability has been established "by action,
ance contracts where general words did not amount to arbitration or agreement" at which point the cause of
a clear demonstration that all the terms of the under- action has accrued. This approach was followed in
lying contract, including the jurisdiction clause, were Lefevre v White12 where it was decided that time would
the subject of consensus between the parties. begin to run under the Act at the date on which the insured
accepted an insurer’s repudiation of liability, with the
The limitation period in the English courts establishment of liability being made by judgment by
award or by settlement.
Should your contract be governed by English law,
in the context of insurance and reinsurance time-bar is Incidentally, as MacGillivray points out, Bradley v
primarily concerned with limitation in contract. By Eagle Star affirms the position on liability insurance in
Section 5 of The Limitation Act 1980 ("the Act") no Post Office v Norwich Union Fire Insurance Society
action founded on simple contract can be brought after Ltd13 which probably means that Chandris cannot
the expiration of 6 years from the date the cause of apply to liability insurance and reinsurance but is jus-
action accrued. Generally speaking, insurance and tified in the marine context by reference to specific
reinsurance contracts are simple contracts (as opposed provisions in the Marine Insurance Act 1906.
to contracts under seal) and therefore one will only
ever be concerned with the 6 year limitation period. Reinsurance
It has been established that reinsurance contracts fol-
Since time starts to run when the cause of action low the pattern of liability insurance, in that the cause
accrues, it is of paramount importance to ascertain the of action accrues when the underlying liability is ascer-
date of accrual. There is no statutory definition of the tained by agreement, by award or by judgment. The leading
term "cause of action" in the Act and so it is necessary authority is Daugava v Henderson14 where the Court
to turn to the case law, which distinguishes various of Appeal decided that a reinsured’s cause of action
types of insurance and reinsurance claims regarding the did not accrue until its liability was ascertained. The
deemed date from which the cause of action arises. English courts have consistently followed this approach
for reinsurance contracts, the most recent case being in
Direct Insurance 1995.15 In excess of loss reinsurance the cause of action
accrues when the reinsured’s established liability reach-
In the case of direct insurance the case law seems to es the excess point. In a variable excess of loss contract
fall into two categories. The first category is that of this is the reaching of the primary excess point not the
hull and first party property insurance claims where Chandris final excess point when ascertained.16
v Argo Insurance Co Limited5 is the leading authori-
ty. It was held in that case that the cause of action Effect of Contractual Terms
for an indemnity under a marine policy against liabil-
ity to contribute in general average arose at the time In English law the general law as to the commencement
of the general average loss. This judgment was approved of the limitation period can be displaced by contractu-
by the Privy Council in 19836 and was also followed7 in al terms. In this respect the trend of the Courts is
1992 in "The Italia Express No 2" where the judge found towards a reluctance to find that a contract extends
that the cause of action arose as soon as the insured event the limitation period, or defers the accrual of the cause
had occurred even though the loss might not be quan- of action, other than by clear terms where such an
tifiable at the time of the occurrence, nor the insurers implication is strictly necessary. That was the posi-
have notification of the loss. Although Transthene tion in Callaghan v Dominion in direct insurance, and
Packaging Co Ltd v Royal Insurance (UK) Ltd8 was a also in a reinsurance contract in North Atlantic Insurance
DECLARATIONS — WINTER 2002-2003
44
Company v Bishopsgate. In theory, at least, it is pos- It should be noted that acknowledgements do not
sible to extend the limitation period through contractual affect claims for unliquidated damages, and this
terms, but the wording and intention of the parties is particularly relevant to reinsurance claims. In
will need to be very clear. Davies v Fenton Insurance17 it was decided that
a reinsurance recovery (or certainly one that has
Time-bar as a defence to be pursued through the courts) is probably
unliquidated.
The court will only dismiss a time-barred claim if
the Defendant raises it as a defence. The Act bars the Davies v Fenton is only a business list county
remedy but does not extinguish the right of action as court decision and would not be binding upon a High
limitation is a matter of procedure, not of substance, there- Court Judge who heard a different case which
fore the right continues even though it cannot be raised the same issue. However, a Court of Appeal
enforced. In these circumstances, it is for the Defendant decision in Edmunds v Lloyd’s Italico SpA18 held
to raise the issue in his written statements of case and that a claim under a reinsurance policy was a
is not a point the Court would take of its own volition. claim for damages rather than a debt (no men-
(This is not always the case in foreign law, where some- tion was made as to whether that was an unliquidated
times the limitation rules are substantive and destroy claim for damages.) Additionally, in Scott Lithgow
the underlying right itself). v Secretary of State for Defence19 the House of
Lords contrasted the position in English law with
Staying or avoiding the limitation period that of Scots law where under Scots law an action
The English courts will not stay a limitation period on insurance monies is a claim for a liquidated
on the basis of mere practicalities. If, for example, a rein- sum. Finally, although not binding on the English
surer is very large and has had difficulty organising courts but nevertheless a guide to an English
its affairs in the 6 year period this is not a good enough Court to which it is cited as to what its decision
reason and the court will not pay heed to such an ought to be, the Supreme Court of the New South
excuse. The accrual of the cause of action for reinsur- Wales Court of Australia20 set aside a Statutory
ance is at the point when the underlying liability is Demand on Reinsurance Australia Corp. Ltd. on
ascertained by agreement, by award or by judgment, and the basis that the reinsurance claim was not a
cannot therefore be postponed until, for example, the debt but was a claim for unliquidated damages.
rendering of an account.
There is thus no binding English law precedent,
There are some potential ways for staying or avoid- but because of the result of the above decisions
ing the limitation period, for example: it would plainly be wiser to work on the basis that
limitation periods with regard to reinsurance con-
1. Agreement between the parties, where the parties tracts in the English courts cannot be suspended
enter into a "stand still" or "tolling" agreement. by acknowledgements, so one would have to stick
Obviously it may not be to the advantage of one to the 6 year period in the absence of any other way
of the parties to enter into such an agreement. of staying the period.
2. An action can be commenced by issue of a Claim 4. The Act does postpone the running of time in
Form, which stops time running. Once the claim cases where there has been deliberate conceal-
form has been issued the Claimant has 4 months ment of the facts which give rise to the cause of action.
in which to serve it and the Particulars of Claim This has been confirmed in the House of Lords
on the Defendant. case Cave v Robinson21 where it was held that
Section 32 (2) of the Act applied to a deliberate com-
3. The limitation period can be suspended by Section mission of a breach of duty and thereby entitled
29 of the Act which establishes that a where a the Claimant to postpone the limitation date oth-
right of action has accrued to recover a debt or erwise applicable to his claim.
liquidated damages claim and the debtor acknowl-
edges the claim or makes any part-payment in 5. A time-bar defence may be defeated if there has
respect of it, the right of action is deemed to have been a clear admission of liability, which occurs most
accrued on (and not before) the date of acknowl- frequently where reinsurers have admitted lia-
edge or payment. A current limitation period bility for the claim but have disputed quantum, and
may be repeatedly extended under this rule by which some writers seem to treat as different
further acknowledgements or payments, and the from an acknowledgement. Where there has been
6 year period will begin to run each time. No par- an unambiguous admission of liability reinsur-
ticular form is required as to the acknowledgement ers will be precluded from relying on the limitation
form, all that is necessary is that the debtor should defence .22
recognise the rights against himself.
DECLARATIONS — WINTER 2002-2003
45
6. Lastly, the making of an English insolvency wind- 19
(1989) 45 BLR
ing-up order will suspend the running of time on 20
Odyssey Re (Bermuda) ltd v Reinsurance Australia Corp Ltd 12
claims in respect of (most types of) debts owed by April 2001 NSWSC 266
(not those owed to) an insolvent company or indi- 21
Martin William Cave v Robinson Jarvis and Rolf (a firm) [2002] UKHL18
vidual.
22
Rendell v Hills Dry Docks and Engineering Company [1900] 2 QB
Arbitrators applying English law should also enforce 245
time-bar when raised as a defence. This may not be the
case under certain foreign laws. Giving notice of appoint-
ment of an arbitrator will stop time running in a ABOUT THE AUTHOR
limitation period.
"Bill Perry is a Partner and is Head of Litigation
Reviewing the approach of the English courts under- and Joint Head of the Rinsurance and Reinsurance
lines that the issue of time-bar is a complicated one to Group at the London office of Charles Russell. Bill
get to grips with and is highly relevant to international has long experience in reinsurance and insurance of
recoveries, particularly if the limitation period begins all kinds. He is Vice Chairman of both the Business
to run from the date of loss, as it does with hull or Litigation Committee and the Property Insurance
property insurance. Add to this the international fac- Committee, and a member of the Reinsurance
tor where different governing laws prescribe different Committee of the International Association of Defense
time-bar periods which may well be enforced in juris- Counsel. "
dictions other than that of the governing law of the
contract, as is the case in the English courts, and it "Louise Bagnall is an Assistant Solicitor at Charles
becomes clear that it is an issue that the insurer and Russell and is also located in the London office.
reinsurer want to keep under tight control. Louise practises in both reinsurance and insurance."
1
Sovereign Marine and General Co Limited v Mamistvalov – not
reported – Judgment 19th May 1992 (QBD)
2
The Lincoln National Life Insurance Co and Others v Employers
Reinsurance Corporation 5 February 2002 Lawtel, Times Law
Reports - February 2002
3
CA [2000] 2 All ER 566
4
[2001] 2 Lloyd’s Rep 268
5
[1963] 2 Lloyd’s Rep 65
6
Castle Insurance Co Limited v Hong Kong Islands Shipping Co
Limited [1983] 2 Lloyd’s Rep 376
7
Apostolos Konstantine Ventouris v Trevor Rex Mountain ("The
Italia Express" No 2) [1992] 2 Lloyd’s Rep 281
8
[1996] LRLR 32
9
[1997] 2 Lloyd’s Rep 541
10
Unreported; CA 14 June 1997
11
[1989] 1 Lloyd’s Rep 465
12
[1990] 1 Lloyds Rep 569
13
[1967] 2 QB 363
14
Versicherungs und Transport AG Daugava v Henderson [1934] 34
Com. Cas.154
15
Halvanon Insurance Company Limited v Companhia de Seguros do
Estado de Sao Paolo & Others [1995] 4 Lloyd’s Reinsurance Law
Rep.303
16
North Atlantic v Bishopsgate [1998] 1 Lloyd’s Rep 459
17
unreported, 6 September 1996 Business list, Central London
County Court
18
[1986] 1 WLR 492
DECLARATIONS — WINTER 2002-2003
46
Due Dilligence
DECLARATIONS — WINTER 2002-2003
47
PRESORTED
STANDARD
US POSTAGE
PAID
Boston, MA
Permit No. 54271
Published at 320 Stuart Street, Boston, MA 02116
Rancho Bernardo Inn
San Diego, California
September 14-17, 2003
DECLARATIONS — WINTER 2001–2002
