Paul Toomey Of Syndicate 2021 v Banco Vitalicio De Espana SA De Seguros Y Reasseguros

This is an appeal, with the permission of Longmore LJ, from the judgment of Andrew Smith J given in a dispute between Spanish insurers and reinsurers in the London market arising out of a contingency reinsurance. Although several points appeared in issue at one stage of the appeal, it became clear as the appeal was argued that the main issue turned on the nature of the obligations between the insured under the original policy and the contractor to which it had sold television and similar rights. In order to explain the issues, it is necessary to summarise the facts fairly briefly.

On 23 August 1999, the Appellants (the Insurers) agreed to insure Club Atlético de Madrid SAD (the Club) in respect of the economic loss that might arise from the first team being relegated from the First Division of the Spanish Professional Football League.

The Club had entered into this policy because it had been required to do so by a television company Audiovisual Sport SL (Audiovisual) which had provided it with advances against payments that would become due for television rights, but which would be repayable if the Club’s first team was relegated from the First Division. Promissory notes had been provided by Audiovisual to cover the payments of Pts 3.48bn for 1999/2000 season with maturity dates between September 1999 and August 2000; these were subsequently replaced and re-issued by notes for Pts 2.9bn in July 1999 with later maturity dates. The policy issued by the insurers in essence provided security to Audiovisual for their exposure under the notes. It will be necessary to set out the provisions of the agreement between the Club and Audiovisual in more detail (see paragraph 19 below).

The Insurers were to front the cover. They therefore had obtained through their brokers, Tyser & Co, indications of the availability of reinsurance of the risk on the terms of a draft reinsurance slip. The description of the interest reinsured in the draft slip was identical to the terms of the reinsurance slip policy (set out at paragraph 6 below) which was effected shortly after the Insurers provided the underlying policy of insurance to the Club; the interest was described as an insurance which indemnified the Club for the net ascertained loss of contracted television rights arising directly as a consequence of the relegation of the assured from the first division with a limit of Pts 2.9bn. Points that may have arisen on the timing of the placements were not pursued during the appeal and it is therefore not necessary to set out the circumstances surrounding the placing.

The reinsurance contracts made by Insurers were with reinsurers in the London and continental markets. The Insurers retained only 2% of the risk; 32% was placed in London and 66% on the continental market. The reinsurance in London was with a number of reinsurers led by the Respondent (the Reinsurers) and effected on the terms of a slip policy. The Reinsurers were not shown, prior to their acceptance of the reinsurance, the underlying policy issued to the Club.

That slip policy provided:

To win the Copa del Rey pts 500,000,000

The Club’s first team was relegated from the first division of the Spanish Professional Football League to the second division on 7 May 2000 at the end of the 1999/2000 season; as a consequence, the Club’s second team was relegated from the second division.

A claim was made by the Club against the Insurers. The Insurers settled that claim with the Club for Pts. 2.7bn in December 2000 and made the payment to Audiovisual. The continental market settled the claim made by the Insurers under the reinsurance.

However, the Reinsurers refused to pay. In February 2001, they commenced these proceedings for rescission and for declarations that the reinsurance had no binding effect and that they had avoided the policy. The action was tried before Andrew Smith J in March 2003. The reinsurers succeeded and a declaration was made that the Reinsurers had been discharged from all liability under the slip policy from inception of the policy and were therefore under no liability to the Insurers.

At the trial there were a number of matters in issue, but the issues which arose for decision on this appeal were, in the result and after argument at the outset of the appeal, confined to much narrower issues, as various findings of fact and on Spanish law made by the Judge were not challenged on appeal.

The Reinsurers’ reasons for rejection of the claim which remain relevant to the issues in the appeal were:

The Insurers had made a material misrepresentation in the draft slip as to the nature of the underlying insurance in that that insurance was in fact a valued policy, and not, as represented in the description of the interest, an unvalued policy indemnifying the Club for the net ascertained loss of contracted television rights arising from relegation. The Judge decided this in favour of Reinsurers; the Insurers contended that he was wrong in deciding that the representation was material.

The description of the underlying policy in the slip was a warranty and there had been a breach for the same reason. The Judge held that the description was a warranty and that there was a breach. The Insurers contended that he was also wrong in so holding.

The reinsurance contained an express warranty (by reason of the terms of a clause commonly incorporated into reinsurance contracts known as the “full reinsurance clause”) that the terms of the underlying insurance and the reinsurance were the same; there had been a breach. The Judge decided this against Reinsurers on the grounds that the full reinsurance clause did not give rise to such a warranty. The Club contended that he was correct in so deciding, but the Reinsurers cross-appealed.

It is convenient to consider first the issue in relation to the avoidance of the policy on the ground that there had been a misrepresentation in the draft slip.

The policy issued by the Insurers provided by section 1 that they were to pay an indemnity for

After hearing the evidence, including expert evidence on Spanish law, the Judge made several findings in respect of the misrepresentation case advanced by Reinsurers which were not challenged on appeal:

The representation made in the draft reinsurance slip was that the underlying policy issued by the Insurers to the Club was an indemnity policy with a limit of Pts 2.9bn and not a valued policy.

The underlying policy in fact issued by the Insurers to the Club was, as a matter of Spanish law, a valued policy under which the indemnity was agreed at Pts 2.9bn, even if this amount exceeded the loss actually suffered by the Club.

This was, as the Judge found at paragraph 46 of his judgment, an error because the Insurers were fronting the risk and it had been intended that the insurance policy provided to the Club should reflect the terms quoted for the reinsurance; that

There was therefore a misrepresentation as to the nature of the underlying policy.

The Reinsurers had, on their evidence (which the Judge accepted), been induced to enter into the contract by the representation in the draft slip.

None of those findings was challenged. This Court was not concerned how the mistake came to be made; an investigation of that would involve the brokers who were not parties to these proceedings; any such issue may be a matter for another court.

However, in the law of insurance and reinsurance, in order for an insurer or reinsurer to succeed in establishing his right to avoid for misrepresentation, he must not only show that he was induced by the misrepresentation to provide the insurance or reinsurance but also prove that the misrepresentation would be material to a prudent underwriter. The requirement that materiality to a prudent underwriter must be shown is an important protection to the insured; this dispute is one of the rare cases where the issue has arisen and shows the potential importance of this protection.

Materiality to a prudent underwriter is generally established, as it was in this case, by expert evidence. Expert reports on the question of materiality had therefore been exchanged prior to the trial. The experts had been able to agree that if the original policy was a valued policy for Pts 2.9bn, then:

As materiality is a question of fact, the issue, on the basis of the agreement reached between the expert underwriters, was whether there was a realistic possibility that the net ascertained loss in the event of relegation would be less than Pts 2.9bn. The Judge found that there was. The issue that arises on this part of the appeal is whether the Judge was right in so concluding. In turn this issue essentially turns on the terms of the contract made between the Club and Audiovisual.

The agreement between the Club and Audiovisual relating to the first team can be summarised as follows:

As initially entered into on 19 July 1996, it covered the five seasons from the 1998/9 season to the 2002/3 season.

For the right to broadcast, the Club were to be paid annually a minimum of Pts 2bn (plus VAT); this comprised a fixed guaranteed sum of Pts 1.75bn and a share of the net profit obtained by Audiovisual from the exploitation of the rights of at least Pts 250m. The fixed sum was payable in twelve monthly instalments.

The Club were also to be paid a further Pts 1bn if it finished the season among the top four teams in the first division.

If, however, the Club’s first team was relegated, it was to be paid only Pts 150m for all broadcasting rights of the home games in the second division, without any limit on the number of matches that might be broadcast.

The agreement was amended by an addendum dated 16 August 1996.

The period of the agreement was changed to seven seasons from 1996/97.

The amount to be paid to the Club was increased to a minimum of Pts 3bn, a guaranteed sum of Pts 2.625bn (indexed) and the minimum payment by way of the share of the profits of Pts 375m. The guaranteed sum was to be paid in 12 monthly instalments starting in September each year.

There was to be no bonus for finishing among the top four teams; the agreement had been re-structured so that the Club were to repay Pts 500m to Audiovisual if it did not do so.

These terms were amended on 30 July 1998 as recorded in a board resolution of Audiovisual; the condition triggering the obligation to repay Pts 500m became the Club’s failure to qualify for European competition (either the Champions League or the UEFA cup), which the Club could do by finishing among the top seven teams in the First Division of the Spanish League or by winning the Copa del Rey.

The Club had a separate agreement with Audiovisual dated 8 July 1996 for broadcasting rights in respect of the home games of the second team. Under that agreement, the Club were to be paid a minimum of Pts 150m, comprising a guaranteed sum of Pts 120m and a share of the profits from exploitation of the broadcasting rights of not less than Pts 30m. If the second team were relegated to the third division (which would happen automatically if the first team were relegated), then the Club was entitled to no payment.

The Insurers contended that there was no realistic prospect that they would ever have to pay Audiovisual less than Pts 2.9bn. They calculated that the payments would be:

Fixed amount of Pts 2.65bn with indexation: Pts 2,764,034,851

25% of Audio visual net profit Pts 375,000,000

Less income for the team in 2^nd Division -Pts 150,000,000

Plus loss of 2^nd Division team income Pts 150,000,000

Total: Pts 3,139,034,851

The Reinsurers contended that there was a realistic possibility that the loss would be below Pts 2.9bn:

The Club had to bring into account the obligation to repay Pts 500m if it did not qualify for the European competition.

The loss resulting from the relegation of the second team from the second division was not to be brought into account.

The Club might be able to reduce the loss sustained through negotiation with Audiovisual.

The Judge found in favour of the Reinsurers; his conclusion, at paragraph 65, was based on the first contention advanced by Reinsurers:

The Judge rejected the other two grounds advanced by Reinsurers and they were not pursued on appeal.

On behalf of the Insurers it was contended that the Judge was wrong on the following grounds:

The risk insured was the relegation of the first team from the first division and the loss of television rights consequent on that; the fact that the Club might have had to return Pts 500m because it did not qualify for a European competition was irrelevant, as that was not the contingency which was insured. The obligation to refund Pts 500m arose at a different time and on different conditions; the relegation occurred at the end of the 1999/2000 season in April or May 2000; the consequences of the failure to qualify (if in fact the Club failed) was a different condition and the repayment would be at the end of 2000/1 season.

It was impossible to speculate about the prospects of qualifying for Europe had the Club remained in the first division; it mattered not for this purpose whether the Pts 500m was treated as a refund or a bonus. It was impossible to quantify the value of this.

I cannot accept these submissions. Taking the indemnity provisions of the underlying policy issued by the Insurers to the Club together with the evidence of the experts, the relevant factual enquiry was to determine whether there was a realistic possibility that the net ascertained loss in the event of relegation from the first division would be less than Pts 2.9bn; for this purpose, it had to be assumed that the prudent underwriter would have considered the contracts between the Club and Audiovisual.

The risk against which the Club was insured was the economic loss which arose from the Club losing its status as a member of the first division and which was linked to the contract with Audiovisual. This loss, described in the reinsurance as the net ascertained loss of contracted television rights, could only be determined by calculating the difference between what the Club would have earned by being a member of the first division for the 2000/1 season and what it would have earned in that season after relegation. It is the 2000/1 season that is relevant as that is the season when the loss would be suffered consequent upon the relegation at the end of the 1999/2000 season.

In the second division, after relegation, the Club would have earned in the 2000/1 season Pts 150m. If it had remained in the first division it would have earned Pts 3bn and indexation, but would have had to pay back Pts 500m if it had not qualified for a European competition.

It seems to me clear that on an analysis of the contractual arrangements, the contingent liability to repay the sum of Pts 500m had to be brought into account:

I accept that the contingency of the Club not qualifying for the European competition was not an insured risk.

However, in my view, that was irrelevant, because qualification for the European competition was an integral part of the scheme for the payment by Audiovisual for the broadcasting rights. It was necessary to take account of the provision relating to the obligation to refund in the event of the failure to qualify because it was a necessary part of the calculation in contrasting the earnings from Audiovisual that would have been received in the 2000/1 season had the Club been relegated with the earnings the Club would have received after relegation.

In determining what the Club would have received, it was necessary to consider the terms of the contract with Audiovisual. Under the terms of the contract it would only have been entitled to retain the sum of Pts 500m, on the assumption that it had remained in the first division for the 2000/1 season, if it had qualified for the European Competition; the retention or repayment of that sum would in every sense have had a significant bearing on the Club’s earnings for the season 2000/1. Thus in calculating the earnings for the 2000/1 season, the contingency of repayment had to be brought into account.

As the Judge recorded, the Insurers accepted that if the arrangements had been structured so that the sum of Pts 500m was a bonus payable only if the Club entered the European competition, then the calculation of the earnings for the 2000/1 season would have had to have been made without the Pts 500m. In my view, as what the policy covered was “economic loss”, it could make no difference whether the payment of Pts 500m was structured as a refundable amount or an amount payable, as the obligation to make the payment or to make the refund would both be determined by the same event. The arrangement for the sum to have been a refundable payment purely went to cash flow and did not affect the overall position of the Club for each season.

The event which determined the repayment of the Pts 500m clearly related, by reason of the terms of the clause set out at paragraph ii)(c), to the earnings for the relevant period, as it was referable to the period during which the Club would suffer economic loss arising from relegation. This was also the way in which the Club and Audiovisual had operated the contract, because at the end of the 1999/2000 season (after which the first team was relegated) when the Club had failed to qualify for the European competitions, it was required by Audiovisual to repay Pts 500m plus VAT in respect of the consideration for the 1999/2000 season.

It follows therefore that in calculating the earnings that the Club would have received if it had remained in the first division for the 2000/1 season, the contingent obligation to refund the Pts 500m had to be brought into account.

But even if the contingent obligation to repay should have been brought into account in principle, it was, as I have said, contended by the Insurers that that obligation could not be valued and therefore could not in fact have been brought into account. On the facts, I cannot accept that contention.

It is clear in the first place that it was possible to make such a valuation. Revenga International Group Inc, the loss adjusters appointed to adjust the claim under the insurance policy did so. What their actual assessment was is irrelevant to the issue, but it is of interest to note that they considered that the chances were 50%, though this was a figure that the Reinsurers submitted was far too high in the light of the Club’s declining fortunes. Secondly, even if those adjusters had not in fact done so, it seems clear to me that the contingent obligation was capable of valuation. It is part of the ordinary business of broadcasters to value the broadcasting rights of a particular club; they will take into account all the factors relating to a club, particularly their view of its prospects. Thus, for example, if the rights in respect of the Club were to have been assigned, the right to repayment if the Club did not qualify for the European competition would have been part of that valuation.

As the contingent obligation to refund had to be part of the calculation of economic loss resulting from relegation and as it was capable of valuation, it was clear on the figures that there was at the very least a realistic possibility at the time the reinsurance was placed, that the net ascertained loss could have been less than Pts 2.9bn.

On this issue therefore, I have reached the conclusion that the Judge was correct and that the Reinsurers were entitled to avoid the reinsurance on the grounds of misrepresentation.

A further argument was advanced by the Insurers before us (though it was not before the Judge) to the effect that by the terms of the slip policy, the Reinsurers’ obligation was limited to the amount necessary to indemnify the Club for its loss up to an overall limit of Pts 2.9bn; it did not matter therefore that the Insurers were obliged to pay to the Club under the underlying policy an agreed amount, as the Reinsurers could only be liable to indemnify the Insurers for the loss actually suffered by the Club. The fact that the underlying policy was a valued policy was therefore immaterial as it could not affect their obligation to pay. As the Reinsurers had not contended that the settlement with the Club was unreasonable, they had therefore not suffered any loss.

I cannot accept this argument. The reinsurance was a proportional reinsurance and the obligation of the Reinsurers to pay was therefore proportional to the actual liability under the underlying policy. The interest clause described the underlying policy; this was necessary as reinsurance is the insurance of an insurable interest in the subject matter of an original insurance (see the judgment of Hobhouse LJ in Toomey v Eagle Star [1994] 2 Lloyd’s Rep 516 at 522). The interest clause was, however, not determinative of the obligation to pay. Although the formal words of the slip policy stated that the reinsurers were reinsuring the interest as set out in the slip, this assumed that the interest was correctly described, as the obligation was to pay a proportionate amount of the underlying liability. As the interest clause misdescribed the underlying policy for the reasons given, then that misdescription was material, as the Reinsurers were entering into a policy where they had been misled as to the nature of the underlying contract which, given the proportional nature of the reinsurance, determined their obligation to pay.

In my view, this further ground of appeal fails. The Reinsurers were entitled to avoid the reinsurance for misrepresentation. I would therefore dismiss the appeal.

In the light of the conclusion I have reached on the issue of misrepresentation, it is not strictly necessary for me to deal with the issue of breach of warranty. I will, however, do so briefly.

The reinsurers advanced their claim for breach of warranty on two bases:

They contended that the term in the slip as to the description of the interest was to be construed as a warranty. As there had been a breach of the warranty at the inception of the policy, the Reinsurers were discharged from liability from the inception of the policy.

In the alternative, they contended that the contract contained an express warranty that the terms of the insurance and the reinsurance were identical. They relied on the Full Reinsurance Clause; there are at least two versions of this clause, but each contains the following relevant wording:

It was accepted by the Insurers that because the terms of the insurance and reinsurance were not identical, then there was a misdescription in the slip policy. They submitted, however, that that did not entitle the Reinsurers to treat the policy as discharged from inception, as the term relating to description was not a warranty and that there was no breach of the full reinsurance clause. It is convenient first to deal with the issue as to whether the term in the slip as to the description of the interest was a warranty.

Both parties were agreed that the approach to the question as to whether the description amounted to a warranty was conveniently summarised in the judgment of Rix LJ in HIH Casualty and General Insurance Ltd v New Hampshire Insurance Co, [2001] EWCA (Civ) 735, [2001] 2 Lloyd’s Rep 161 at paragraph 101:

In a helpful passage in MacGillivray on Insurance Law (10^th Edition, 2003) the editors, in relation to the position on the construction of an insurance policy, comment at paragraph 10-30:

The editors of MacGillivray, in my view rightly, emphasise that the court is concerned to look at the document as a whole in order to determine the intention of the parties. Furthermore regard must also be had to the draconian effects of a breach of warranty in that a breach discharges the insurer, even if it is not causative of the loss. In many policies of insurance and reinsurance, the parties make clear in the contract whether the term is a warranty or not; if the term is important to the insurer or reinsurer, he can seek to make the term an express warranty. In such circumstances, the insured or reinsured knows where he stands and that a breach can discharge the insurer. A court should, where there is no express agreement, approach the issue of construction with these considerations in mind.

The Judge considered that the question turned on the importance to the risk of the fact that what was being insured was not an indemnity limited to Pts 2.9bn, but a pre-determined amount. He considered that because of the significance to the underwriting decision of the question as to whether it was an indemnity policy or a valued policy, the detail with which the underlying policy was described in the slip and the fact that the description was given by way of definition of the interest all demonstrated that the description was a term and, applying the first and second tests set out by Rix LJ, it was a warranty. He did not consider that damages would be a satisfactory remedy because it would be unrealistic to expect reinsurers to demonstrate that the Club’s net ascertained loss was less than the amount of the settlement of the claim and to establish the measure of the difference.

The Insurers’ principal contention was that it was difficult to see how it could be contended that the term was a warranty if it was concluded that the misdescription was not material. They also contended that damages would be an adequate remedy.

In the present case, counsel for the Reinsurers accepted that if the misdescription was not material, it might be difficult to contend that the term was a warranty. However, it was contended that it was a warranty in view of the importance of the description to them in the light of the fact they had not seen the underlying wording when they signed the slip.

In the particular circumstances of this case, I have come to the view that the term was indeed a warranty. The underwriters had entered into the reinsurance without sight of the underlying policy; the term as to the description went to the root of the transaction and was descriptive of and bore materially on the risk. The Reinsurers’ obligation was to provide proportional reinsurance of the risk insured under the underlying policy by the Insured. They were therefore entitled to treat the description of the underlying policy as a warranty, as it provided the description of the risk they had agreed to reinsure. Furthermore, in the circumstances of this case, the fact that a breach discharges the entire reinsurance is not a draconian remedy, as the terms of the underlying contract were so important to what the Reinsurers thought that they were reinsuring. Those two considerations are in my view the decisive considerations. In addition, but I do not regard this as significant, it would have been clear to the parties that it might have been difficult to quantify damages for any breach as to the description of the underlying policy; that was because quantification would have involved an exercise in assessing the differences in liability or in the settlements which would have been had to have been made in contrasting the different approaches to these issues. There was therefore force in the argument that damages might not therefore have been a satisfactory remedy, but that, as I have said, is not a consideration I have taken into account.

The issue relating to the scope of the full reinsurance clause is one of wider significance. The Judge decided this against the Reinsurers. It was, as I have said, contended by the Reinsurers that the scope of the clause was to provide a warranty that the underlying insurance was on identical terms to the reinsurance. They relied primarily on a passage in the speech of Lord Griffiths in Vesta v Butcher [1989] AC 852 at 896 where he stated:

The Judge rejected the Reinsurers’ contention and held that the effect of the clause was to incorporate into the reinsurance contract the terms of the underlying reinsurance which regulated it. He considered that the argument to that effect made by Mr Longmore QC to the House in Vesta v Butcher had apparently been accepted by Lord Templeman (with whom Lord Bridge and Lord Ackner agreed). He considered that this construction accorded with the view of the market on the clause and that it was difficult to read the words of the clause in the way suggested by Lord Griffiths.

In view of the clear conclusion I have reached on the appeal, and because the issue only arose on the cross-appeal (which does not therefore arise), it is not necessary, in my view, to express any view on this difficult issue. In the circumstances and given the history of the clause, I wish to make it clear that I am expressing no view, one way or the other, on the construction of the clause nor on the opinion expressed by the Judge that the construction he adopted was in accord with the view of the market. These issues must remain for decision in a case in which they actually arise for decision.