Erc Frankona Reinsurance v American National Insurance Co

In September 1998 the claimant in this case, whom I shall call “ESR”, wrote a quota share reinsurance of the defendant, to whom I shall refer as “Anico”. In April or June 1999, ESR increased their line on the reinsurance. ESR claim that they have validly avoided the reinsurance because of misrepresentation, non-disclosure or breach of warranty, and in the alternative claim that they have avoided their agreement to increase their participation. Anico deny ESR’s claims and bring a counterclaim for monies that they say are due under the reinsurance.

The reinsurance was a quota share of Anico’s interest in a programme called the National Accident Insurance Group (“NAIG”) that was written in the United States. ESR first wrote a quota share reinsurance of NAIG in 1997: it was then placed by a broker called Mr Sam Kerr-Smiley, who worked for Bradstock, Blunt and Crawley Limited (“Bradstock”), and it was underwritten for ESR by a Mr Andrew Briant of IGI Underwriting Agencies Limited (“IGI”) and a Mr Brian Denton of ESR themselves. Bradstock had been instructed in the matter by a Mr Dan Malloy of Sedgwick Reinsurance Brokers Limited (“Sedgwick Re”) in the United States. In September 1998 and in 1999 the brokers placing the reinsurance with ESR were Kininmonth Limited (“Kininmonth”).

ESR called Messrs Briant, Mr Denton and Mr Kerr-Smiley to give oral evidence, and also put in evidence a witness statement from a Mr Manfred Goodman. Anico called five witnesses of fact: Messrs Steven Schouweiler and James Stelling of Anico, Messrs John Cullis and Richard Rose of Kininmonth, and Mr Dan Malloy. They also put in evidence a statement of Mr Griffith Sargent of Kininmonth.

Mr Schouweiler’s evidence is of central importance in this case. As I shall explain, I am unable to regard him as a reliable witness: I have concluded that his oral evidence was inconsistent with the documents and his own previous statements in these proceedings, and that his account is inherently improbable. I consider that the other witnesses of fact were honest witnesses who were trying to assist the court, although I have not always been able to accept their accounts as wholly accurate.

I was assisted by three expert witnesses. ESR called Sir Alan Traill and Mr Brian Cauldwell. Sir Alan Traill has had many years experience as a placing broker in the London market in respect of direct and reinsurance business, and since retirement in 2000 has been engaged in broking activities on a consultancy basis. Mr Cauldwell has had more than 30 years’ experience in the London insurance market, mainly on the underwriting side, and has dealt in more recent years principally with personal accident insurance and reinsurance. Anico called Mr William Rendall, who retired as a Lloyd’s underwriter in 2001 with 28 years’ experience in underwriting in Lloyd’s and since then has done consultancy work and become the Head of Underwriting and Claims for the Lloyd’s Market Association. They were all fully qualified to give expert evidence, and all were seeking to assist the court with their properly impartial opinions. However, I consider that ESR were justified in criticising Mr Rendall for trespassing beyond the proper limits of an expert witness and expressing his opinions about questions of fact.

The risk to which ESR subscribed was described in the slip as a “90% Quota Share on [Anico’s] participation in the National Accident Insurance Underwriters, Inc Pool”. National Accident Insurance Underwriters Inc (“NAIU”) were a managing general underwriter incorporated in Delaware and operating out of Arlington Heights, Illinois. They were founded and at the relevant time owned by Mr Jack Bunch, who was well-known and respected in the American insurance industry. Mr Bunch died on 15 May 2000, having ceased to work for NAIU in November 1999. NAIU sold both occupational and non-occupational accident cover.

There was expert evidence about two forms of insurance available in the United States, namely “workers’ compensation” insurance and “workers’ compensation carve-out” insurance, and about whether these kinds of insurance are properly to be regarded as occupational accident cover. Workers’ compensation (“wc”) insurance is cover that employers are obliged by statute to take out in respect of personal injuries suffered at work by their employees, the benefits to be provided being stipulated by statute. (Mr Rendall commented that wc cover is more properly called workers’ compensation act cover or “WCA”). It covers compensation for death or injury, including medical expenses, and also employers’ liability for compensatory damages (as employers’ liability insurance does in the United Kingdom). Typically this is “long-tail” business, because liability can continue until an injured employee reaches a retirement age of 65 years.

Workers’ compensation “carve-out” insurance (to which I shall refer as “wcc” insurance) is reinsurance of a part of wc cover, such as the accidental medical, disability or accidental death portions, and provides benefits determined by the insurers designed to reflect those stipulated by legislation, but it does not include liability coverage. It is therefore reinsurance of part of the cover for employees required by legislation, and “carves out” a part, or parts, of the policy that the suitably licensed insurance company wishes to reinsure.

It was the evidence of the experts, and I accept, that the terms wc and wcc cover are not interchangeable with the expression “occupational accident” cover. In states where wc insurance is not mandatory, employers can take out more limited protection by insurance, such cover being referred to, for example, as “occupational accident” and “occupational disability” insurance. Thus “occupational accident” insurance refers to insurance bought specifically to cover accidents at work regardless of whether there is any legal requirement so to do. As it was put by Sir Alan Traill, “Occupational Accident is more in the nature of a generic description and not a finite description of any particular product”.

In 1997 the NAIG pool comprised three North American insurance companies who had equal shares in the programme of one third each: Crown Life Insurance Company of Regina, Canada (which is now called Canada Life and to which I shall refer as “Crown”), Anthem Life Insurance Company Limited of Indianapolis, Indiana (“Anthem”), and Philadelphia Life Insurance Company of Englewood, Colorado (“Philadelphia Life”), which was a company in the Conseco group. NAIU would underwrite risks in the name of one of the pool members under binding authorities, and the other two insurers would reinsure that company for their proportion of the risk.

The individual at Philadelphia Life responsible for their participation in the NAIG pool was Mr Schouweiler. His career in insurance began in 1972, and he worked for a number of insurance companies in the United States before joining Lamar Life Insurance Company (“Lamar”) of Jackson, Mississippi, in 1989. Lamar was acquired by the Life Partners Group, and Mr Schouweiler became Executive Vice President of Philadelphia Life and President of Partners Risk Management, a wholly owned subsidiary of the Life Partners Group. On 2 August 1996 the Life Partner Group merged with Conseco. At the beginning of 1997, Mr Schouweiler moved to Chicago. He remained with the Conseco Group until April 1998, when he was offered a position with Anico in Galveston, Texas. He started to work for Anico on 4 May 1998 and is the Senior Vice President of their health operations.

In 1995 Mr Daniel Malloy, a broker employed by Sedgwick Re, invited Mr Schouweiler, then working for Lamar, to consider participation in the NAIG pool. (Mr Malloy had been introduced to Mr Schouweiler by Bradstock.) At that time Mr Schouweiler declined participation in the pool, at least partly because Lamar did not have time to complete their due diligence procedures.

In 1996, when Mr Schouweiler had become an Executive Vice President of Philadelphia Life, he was invited to consider participation in NAIG by Anthem, with whom Mr Schouweiler had had previous dealings and who had reinsured of some of Lamar’s programmes. Mr Schouweiler met representatives of NAIU, including Mr Bunch and a Mr Irving Drobny, NAIU’s Chairman and Chief Operating Officer, at what was described as an “underwriting pool meeting” in Indianapolis. Mr Schouweiler agreed that Conseco would participate in the pool with a third share, on the basis that they were to be reinsured as to 90%.

Mr Schouweiler’s evidence was that, relying upon Mr Bunch’s reputation, the Conseco group did not investigate Mr Drobny’s background and reputation in the industry, and they did not then know that (as I shall explain) he had a criminal conviction for which he had been imprisoned and had resigned from the Illinois bar.

On 3 December 1996 Crown, Anthem and Philadelphia Life signed an underwriting agreement with NAIU as Manager to create and participate in the NAIG pool. It provided (by clause 2) that “the business transacted under this Agreement by the Manager on behalf of NAIG … shall be group, blanket and individual accident insurance or group, blanket and individual accident and health insurance, including special risks under any of the foregoing. Insurances may afford coverage world-wide. Insurances may be written on any term basis except that no policy will be issued for a term of more than three years, plus odd time not exceeding sixty days in all”. The Agreement (by clause 12) was to “become effective for business having effective dates on and after January 1, 1997…”.

NAIU had extensive responsibilities as manager of the NAIG pool: the agreement provided that “the management, supervision, direction and control of the Business shall be under [their] sole direction and control” unless the agreement stated otherwise, and gave them authority, inter alia, in respect of underwriting, collecting premiums, settlements and contesting claims in litigation. They were also given authority with regard to obtaining reinsurance for participants in the following terms: “Negotiate for and secure outside reinsurance for the common account of the Participants in the NAIG with respect to the Business. Such reinsurance (herein called “Outside Reinsurance”) shall be placed only with reinsurers with respect to which all of the Participants and Withdrawing Participants … would be entitled to full reserve credit in their financial statements filed with any state insurance regulatory authorities”.

Sedgwick Re had already taken steps to find insurers interested in reinsuring Conseco’s participation in the pool. On 15 November 1996, Mr Drobny sent Mr Malloy by fax a letter giving information which it was suggested he might use in discussions with potential reinsurers and pool participants. In it he said that NAIU believed that “for 1996 a return of somewhere between 5% and 6% would be realized”. By a letter dated 26 November 1996, Mr Claude Kellogg, NAIU’s Vice President of Operations, provided further information.

Mr Malloy approached Mr John Cullis of Bradstock in London, and Mr Cullis introduced him to Mr Sam Kerr-Smiley, because he was the broker with Bradstock who handled accident and health business from the United States. As the documents indicate and the oral evidence confirmed, it was contemplated at that stage that the Conseco company that would participate in the NAIG pool, and so need reinsurance, would be Lamar rather than Philadelphia Life.

Mr Kerr-Smiley spoke to Mr Andrew Briant of IGI about the business. IGI had an agreement with ESR under which IGI had authority to develop a general personal accident book of business on ESR’s behalf. According to Mr Denton, who was an underwriter with ESR from July 1996 until October 1999, under the arrangement IGI would assess business but submit risks to ESR for acceptance, but IGI could not bind ESR or put down their stamp. When Mr Briant and Mr Denton were cross-examined, Mr Anthony Martino, who represented Anico, challenged this evidence by reference to an agreement between ESR and IGI signed by IGI on 26 June 1997 and by ESR on 18 September 1997, in which it was provided (at article iv(b2)) that, “All contracts written by IGI will be submitted for formal acceptance of the risk by ESR… It is clearly understood that all contracts so submitted within the terms of this agreement will be accepted by ESR…” (emphasis added). They were also referred to a “letter of intent” dated 22 September 1997 written by Mr. Denton to Mr. Briant, which stated, “All business will be underwritten from IGI’s Lime Street Office and as such business will be submitted for formal acceptance of the risk by [ESR] … It is clearly understood that all personal accident lines submitted within the general understanding of this agreement will be accepted by [ESR]”. Mr. Denton explained that the letter was provided so that Mr. Briant could show it to brokers and thereby reassure them that they were not wasting their time when dealing with him. However, he said that risks written by IGI were not accepted by ESR without question and in particular treaty business was referred to ESR for their consideration.

I accept the evidence of Messrs Briant and Denton about this, and find that in practice neither of them regarded ESR as committed to risks written by IGI so that ESR’s acceptance of them was a completely empty formality, and that, at least in the case of treaty business, ESR did evaluate the business for themselves.

Mr Kerr-Smiley sought to interest Mr Briant in subscribing to a quota share on behalf of Conseco. Among the documents included in the presentation was the letter from Mr Drobny to Mr Malloy dated 15 November 1996.

Mr Briant made brief handwritten jottings during the presentation. They refer to Lamar because, as I have said, at this stage it was contemplated that Lamar would or might be the company in the Conseco Group who would participate in the NAIG pool. The notes include the words “No Texas EEII”, referring, as Mr Briant told me, to Texas Employers’ Excess Indemnity Insurance, which he described as “a form of workers’ compensation insurance”. The notes also show that, having jotted down a figure of $46million, which represented a figure for total premium and the sum of $15.33 representing a one third share of it, Mr Briant wrote “less WCA = 14% (20%).” According to Mr Briant, “WCA” stands for Workers’ Compensation Act. The notes, as he explained, reflect his understanding that NAIU had been writing some wc business, and that he deducted from the total premium that part which he understood to represent Workers’ Compensation Act business. His evidence was that he told Mr Kerr-Smiley that he would write a quota share only on the basis that this was not ceded to the treaty. He accepted in cross-examination that the figure of 14% represented the proportion of NAIG’s medical business that comprised “Texas Occupational” and therefore it seems that the calculation was inaccurate. However, I accept Mr Briant’s evidence that the figures on the sheet reflect an attempt to calculate the income if what he characterised as “WCA” was not included in the risk ceded.

As a result of his discussions with Mr Briant, Mr Kerr-Smiley sent a draft slip to Mr Malloy in which he included a provision, “Excluding, Texas Occupational/WCA business”. Mr Malloy responded by fax of 25 November 1996 that he did not “know how we can live with that exclusion. Even if the pool manager used Anthem paper for all their Texas business … each participant would indirectly be sharing in the results, since that is an authorized class of business for the Pool”. He also made a point about the definition of GNEPI (Gross Nett Estimated Premium Income) given on the slip. Mr Kerr-Smiley sent a fax on 26 November 1996 to Mr Malloy in which he referred to previous discussions about “excluding Texas “look like” WC from the Quota Share and doing a specific to cover the exclusion”; and he continued, “I hope we are still proceeding on this basis as the Texas business was/is the only problem our reinsurer had”. “Texas business” was, as Mr Kerr-Smiley confirmed in his evidence, a reference to the “Texas Occupational/WCA business” mentioned in the draft slip. In the fax of 26 November, Mr Kerr-Smiley accepted Mr Malloy’s point about the definition of GNEPI, and said that he would alter the slip. This makes clear the sequence of the faxes, which was the subject of some debate during the trial. Bradstock’s file included a copy of the slip on which Mr Kerr-Smiley had struck through the exclusion of Texas Occupational/WCA business and amended the definition. I infer that he made these changes after this exchange with Mr Malloy, and recognised (possibly after further communication with Mr Malloy) that the proposed exclusion was not going to be acceptable to Conseco.

IGI were authorised to act as underwriting agents for Caisse Centrale de Reassurances (“CCR”) and other insurers as well as for ESR, and on 28 November 1996 Mr Briant underwrote on behalf of CCR a 45% quota share of Conseco’s interest in the NAIG programme. The slip did not include any exclusion in respect of Texas occupational insurance or wc or wcc cover or Texas EEII.

Mr Briant’s evidence was that he was informed by Mr Kerr-Smiley that the business underwritten by NAIU did not include any Texas EEII. Mr Kerr-Smiley’s evidence was that Mr Briant wanted to be sure that the NAIG programme did not include any Texas EEII business, and that he believes that, when he asked Mr Malloy about this, Mr Malloy confirmed this to be the case. I cannot accept that Mr Kerr-Smiley is right about this latter point. Moreover, while I do not consider this crucial to deciding the dispute between the parties, I conclude that, although Mr Briant told Mr Kerr-Smiley that he wished to exclude Texas EEII business, the issue was not resolved between Mr Kerr-Smiley and him.

In January 1997 Mr Briant and Mr Kerr-Smiley had a discussion about whether ESR might underwrite a 45% quota share of Conseco’s interest in the NAIG pool. Mr Briant agreed to approach Mr Denton, and wrote him a memorandum dated 27 January 1997 outlining the proposal and enclosing information about the pool’s premium income and claims history and other matters. Mr Briant wrote that, “The target loss ratio is 78%”. He was cross-examined about this figure, and it became apparent that it was inaccurate and that Mr Drobny’s reference in his letter of 15 November 1996 to an expected return of between 5% and 6 % was more realistic.

The papers sent to Mr Denton included a document about NAIG on Sedgwick Re’s paper, which stated under the heading “Objective” that NAIU “is prepared to undertake any form approval and licensing requirements necessary. Irv Drobny, President and Chief Operating Officer, was for many years a key regulator in the Illinois Department and his network of relationships are invaluable in such activities”. Under the heading “History” it was said, “NAIG has been managed by NAIU since its formation. All policies are issued on the forms of one of the NAIG member companies and are distributed as evenly as possible… NAIU is also responsible for all the managerial duties including marketing, claims handling and premium collection for the group”. Under the heading “Overview”, the document stated,

“NAIU markets accident insurance to various groups and associations, as well as individuals. There are currently six categories which comprise the book with subsets within the categories for accidental death, disability income, and medical.

ESR’s response to the proposal to subscribe to a quota share of Conseco is, I infer, reflected in a letter that Mr Briant wrote to Mr Kerr-Smiley on 28 January 1997. He reported that ESR had asked whether there were any underwriting guidelines on the account, and continued:

“They are concerned as the maximum any one person limit and also the maximum known accumulation.

Eagle Star’s limits are $1.5 max aop [any one person] and $7.50m ao accumulation [any one accumulation].

They also want confirmation that the following are not underwritten:- Professional Sports

Reinsurance Business

Air or ships crews

Credit card business

I would be grateful if you could provide this additional information. Without it they will be unable to accept this account.”

The letter did not refer to wc or wcc cover, and did not indicate any concerns on ESR’s part (or Mr Briant’s part) about whether the programme included such insurance.

Mr Denton explained the background to this letter was that ESR had an outwards excess of loss reinsurance that covered personal accident business, and this determined the business that ESR would write. It had limits of $1.5. any one person and $7.5. any one accumulation, and also excluded professional sports, reinsurance business, air or ship crews and credit card business. He said that in any event, ESR would not have wanted reinsurance business because they would have had only limited information about the risks covered and because there would have been delay in learning about claims.

On 29 January 1997 Mr Kerr-Smiley made a presentation of the risk at ESR’s offices in London to Mr Denton and Mr Kieran Oliver, the head of underwriting at ESR and Mr Denton’s immediate superior. There is dispute about what was said at the meeting, and I shall return to this later in my judgment. On the same day as the meeting, and I infer at the meeting, Mr Briant signed a draft slip subscribing to a 45% quota share in the name of ESR, scratching it twice, once against IGI’s stamp and once on behalf of Eagle Star. (It is impossible to infer from the evidence why Mr Briant, and not Mr Denton or Mr Oliver, scratched it on behalf of ESR.) The final slip was signed and stamped by ESR on 26 February 1997. I shall call this cover the “1997 quota share”.

The reassured was described as “Partners Risk Management Company on behalf of Philadelphia Life, a Conseco Group Company”. Its period was from 1 January 1997 subject to cancellation at any anniversary date by either party giving 120 days notice, the first anniversary date being 31 December 1997. The type of business was “Personal Accident Account Quota Share Treaty”, the class was “In respect of all business written on behalf of the Reassured by National Accident Insurance Underwriters Limited,” and the treaty detail is stated as “To accept a 45% Quota Share of the Reassured’s 33 1/3% participation in the National Accident Insurance Underwriters Inc pool. Subject at all times to a Maximum Income Limit to this Treaty of USD8,000,000”.

The slip for the 1997 quota share (like that subscribed by Mr Briant on behalf of CCR in November 1996) was remarkable because, despite the “maximum income limit” being US$8 million, it did not specify any limit upon the policies that might be ceded to it, either in terms of amount or period of cover, and did not stipulate any exclusions from cover. The only condition was one that the quota share was “Subject to all terms, clauses and conditions as original acceptance and to follow all settlements and agreements of the Reassured in all respects”. There was no mention of discounts (such as commission, management fees and brokerage, information that the underwriter would need to work out his net premium).

The treaty wording for the 1997 quota share was not signed by Philadelphia Life until 22 December 1997, and was signed for ESR only on 9 June 1998. It provided (at article 1) that, “This Agreement is to share with [ESR] the interests and liabilities of [Philadelphia Life] arising out of Policies written on behalf of [Philadelphia Life] by [NAIU], in force at the inception thereof, or written or renewed during the term hereof, …”. “Policies” was defined as “any binder, policy, or contract of insurance or reinsurance issued, accepted or held covered provisionally or otherwise, by or on behalf of Philadelphia Life”.

The quota share agreement did not run smoothly: there were significant difficulties about the payment of premium. ESR had expected that it would be paid quarterly, but the accounting between NAIU and Philadelphia Life had not been set up on this basis. By notice dated 8 August 1997 ESR gave notice to terminate the reinsurance on 31 December 1997.

Anthem and Crown Life decided not to participate in the NAIG pool in 1998. From about the middle of 1997, NAIU and Mr Schouweiler entered into discussions about the future of the programme, and it was agreed that Philadelphia Life would underwrite the whole programme, on the condition that it was written on a “risks attaching” basis rather than a “loss occurring” basis. Indeed, it appears from an endorsement to the 1997 quota share that it was agreed that that year too should be underwritten on a “risks attaching” basis: the endorsement that was put in evidence was scratched on behalf of CCR, but ESR’s assertion that their quota share was similarly amended was not challenged, and I infer that it was.

Under a “Participation and Underwriting Agreement” between NAIU and participants in the NAIG pool for 1998, NAIU were under the same duties (as far as is relevant for present purposes) as under the 1997 Underwriting Agreement, but the provision with regard to reinsurance went on to provide that “reinsurance coverages” should be “as agreed to by Participants and recommended by Manager”. The agreement stipulated further duties, including that they should “handle each Claim in a manner and under standards customary to the insurance industry and as required by applicable law”; and that NAIU should be “allowed to subcontract duties as described herein with approval of Participant(s), which shall not be unduly withheld”. A provision under the heading, “Policy Issuance and Reinsurance” provided:

“The Business in any state shall be conducted through the issuance of insurance policies on the policy forms of an insurance company that is duly licensed in such jurisdiction to engage in the Business. Business will usually be issued on the policy forms of a Participant(s) (herein sometimes called the “Issuing Participant(s)”). In situations where that is not possible, the Manager may, with the prior written approval of the Participant(s), issue policies of an insurance company which is not a Participant in the NAIG (hereinafter referred to as an Outside Issuing Carrier). Business issued by an Outside Issuing Carrier will be underwritten, issued and administered by the Manager in the same manner as Business issued on Participant(s) Policy. The Business so written will be ceded on a quota share basis by way of reinsurance contract(s) between the Outside Issuing Carrier and the Participant(s) into the NAIG.”

Philadelphia Life required reinsurance for the 1998 programme, and Mr Kerr- Smiley was again involved in placing it. He presented the risk to Mr Briant on 30 December 1997, and on the same day Mr Briant wrote to Mr Denton. Mr Briant’s letter was headed “Philadelphia Life Quota Share 1998 Renewal”, and he set out what he called “the renewal basis”. The letter explained that the new programme was changed in that the account was not to include “K-12” student accident and medical business cover (insurance for students between kindergarten and 12^th grade), explained the change to a “risks attaching” basis of cover and other changes, and concluded “Otherwise the basis of the account of the business ceded under it remains the same”.

On 6 January 1998 Mr Briant initialled a slip on behalf of CNA Reinsurance Company Limited (“CNA”), subscribing to a 25% quota share of the 1998 programme. Initially Mr Briant indicated that ESR would subscribe to 40%. In the event, according to Mr Briant, these placings were adjusted on 14 January 1998, and both CNA and ESR took a 32.5% line. However, on 10 February 1998 Mr Kerr-Smiley wrote to Mr Malloy confirming that CNA had written a 25% line and ESR a 40% line. This discrepancy was not explored in evidence and is not important to the issues between the parties. I shall call this reinsurance written by ESR the “1998 quota share”.

The slip for the 1998 quota share again described the type of business as “Personal Accident Account Quota Share Treaty”. It was said that, “Subject at all times to a maximum first year gross premium income limit of to this Agreement of USD20,000,000. Estimated total Pool writings of USD40,000,000.” The maximum period for any one policy was to be 36 months. There was an exclusion for “K-12 and student accident business, except college sports”. The wording was to be, “As expiring as far as applicable or to be agreed”.

The problems over payment of premium continued. In May 1998 Mr Briant and Mr Kerr-Smiley met with representatives of Philadelphia Life to discuss them and the reporting of figures. The meeting had been arranged on the basis that they would meet Mr Schouweiler, but in the event he left Philadelphia Life to join Anico a week before the meeting. In his note of the meeting, Mr Briant wrote, “At the meeting I met 4 people [from Philadelphia Life]. It was made very clear from the outset that they did not have much understanding of this account, though they knew about NAIU. It appeared that the previous CEO [sc Mr Schouweiler] had kept this particular account close to him”. In my judgment, this reflects Mr Schouweiler’s personal control over the programme while he was at Philadelphia Life.

On 18 May 1998 Mr Kerr-Smiley was suspended by Bradstock for gross misconduct, and on 21 May he was dismissed. He had claimed to have placed insurances for other clients when he had not done so, and had falsified records, and he was in due course disciplined by Lloyd’s. His misconduct did not relate to the placements for reinsurance of the NAIG programme. (There was some suggestion in the course of closing submissions that Mr Kerr-Smiley had behaved dishonestly in the course of placing this business. The suggestion was not put to Mr Kerr-Smiley when he gave evidence, and there was no proper evidential basis for it. I reject it.) After Mr Kerr-Smiley left Bradstock, Mr Rose examined Bradstock’s reinsurance file and it was found to be in order.

In the summer of 1998, Mr Rose, together with Mr Cullis and Mr Griffith Sargent, left Bradstock, and they joined Kininmonth.

After Mr Schouweiler joined Anico, Philadelphia Life told NAIU that it did not wish to continue to write the NAIG programme. Mr Drobny and Mr Malloy approached Mr Schouweiler to suggest that Anico might replace Philadelphia Life. An agreement was reached between Philadelphia Life, Anico and NAIU that Anico should take over Philadelphia Life’s interest in the programme with effect from the beginning of 1998, by providing Philadelphia Life with full reinsurance cover. Anico were to be reinsured as to 90% of the risk.

Anico and NAIU signed a Participation and Underwriting Agreement in September 1998 reflecting the new arrangement. It was generally similar to the earlier agreements that NAIU had made with the NAIG pool members, and gave NAIU the same authority and duties, and included a similar provision about “Policy Issuance and Reinsurance” to that in the 1998 Participation and Underwriting Agreement. I should set out Article IV, paragraphs B and C of the agreement to show the extent of their authority:

“B Except as specifically provided otherwise in this Agreement, the management, supervision, direction and control of the Business shall be under the sole direction and control of the Manager.

C In addition to the other duties and obligations specified elsewhere in this Agreement, the Manager is hereby authorized to engage during the term hereof in the following activities in the name and on behalf of the NAIG:

1.

Establish any and all required premium rates, underwriting guidelines, rules, and policy forms for the Business, and if required, file such rates, guidelines, rules and forms with and secure all necessary approvals from any state insurance regulatory agencies;

2.

Issue, underwrite, bind, deliver and provide for the countersigning of policies of insurance in accordance with applicable law;

3.

Collect and receipt for all premiums with respect to policies of insurance issued or serviced hereunder, process policy cancellations and pay all required premium refunds, and perform all general policyholder administration and services;

4.

Compute the amount of benefits due under the Policies and make payment of such benefits due to include loss adjustment expenses with respect to the Business and establish and report reserves as determined by the actuary … on such losses to the Participants;

5.

Assume and direct the defence of the NAIG and the Participant in any lawsuit or other legal proceeding involving the NAIG or the Business, subject to the right of any Participant(s) named as a defendant therein to receive prompt notice thereof from the Manager, together with a copy of the summons and complaint, and to associate with the Manager in the defence of said Participant(s). Unless notice to the contrary is received by the manager within seven (7) calendar days after the initial notice of the lawsuit is furnished by the Manager to the named Participant(s), the Manager shall proceed with the handling of the lawsuit as it determines to be in the best interest of the NAIG;

6.

Enter into contracts with properly licensed Sub-Producers;

7.

Apply for and maintain in good standing all licenses and permits required of the Manager to conduct the Business in any state;

8.

Negotiate for and secure reinsurance, with the approval of the Advisory Committee, for the common account of the Participant(s) in the NAIG with respect to the Business. Such reinsurance (herein called “Outside Reinsurance”) shall be placed only with reinsurers with respect to which all of the Participants and Withdrawing Participants … would be entitled to full reserve credit in their financial statements filed with any state insurance regulatory authorities and shall provide reinsurance coverage as agreed to by Participants and recommended by Manager…..”.

Article IV paragraph I of the agreement also provided that NAIU should “deliver to Participant(s) a copy of each complaint, request and inquiry pertaining to any Policy, application therefore, or to this agreement received by NAIU from a state regulatory authority…”

Article XI of the Agreement was headed “Reports and Settlements,” and it provided, “Within twenty days after the end of each calendar month, the Manager shall furnish each Participant with a gain and loss report in respect of the business conducted during the month, which shall include at least a report of premiums earned and unearned, Business Expenses, losses and allocated loss adjustments, expenses paid, and outstanding loss reserves, plus any other information requested by a Participant(s) for the preparation of financial reports”.

Mr Malloy contacted Mr Cullis about the new arrangements, and on 26 August 1998 Mr Schouweiler directly wrote to Mr Cullis to say that Anico would be happy for Kininmonth to place some of the reinsurance that they required. Mr Cullis passed the enquiry to Mr Rose, who approached Mr Denton in order to interest ESR in writing reinsurance for the programme for a two-year period commencing 1 January 1998. Mr Rose had access to the Bradstock file, and he also said in evidence, and I accept, that he spoke to Messrs Briant and Denton at some length to understand the position with regard to the quota shares. However, understandably the discussion focused on the payment of premium rather than what was said by Mr Kerr-Smiley when the 1997 and 1998 quota shares were placed.

The presentation to Mr Denton included a placing document of three pages presented under a cover sheet bearing Anico’s name. It stated that, “NAIU operates as a full service MGU [managing general underwriter] providing all the necessary services including marketing, underwriting, claims and compliance”. It also referred to “the close personal and professional relationship that developed between Steve Schouweiler and Irv Drobny and others at NAIU”. The presentation also included a one-page description of NAIU in which it was said under the heading “Unique Resources” that “Special Risk Accident Insurance is our [sc. NAIU’s] only business”, and under the heading “Creative, Competitive Pricing” that “Our expertise and creativity enable us to confidently and competitively price all forms of Accidental Death & Dismemberment (AD&D), Accident Medical and Accident Disability Insurance”.

On 23 September 1998 Mr Denton agreed that ESR should write a 45% line (that is to say, to write 50% of the reinsurance that Anico required). In the event, on 30 September 1998 ESR’s line was written down to 35%. I shall call this reinsurance the “1998/99 quota share”. The 1998 quota share was endorsed with an agreement that it was “hereon cancelled ‘ab initio’ (1^st January 1998)”. On 30 September 1998 ESR scratched an endorsement to the 1998/99 cover that stated, among other things, that, “All coverage hereunder is subject to American National Insurance Company and/or Philadelphia Life in run off, being the issuing company and its participation in NAIU subject to a minimum nett retention of 10% by American National”.

Mr Denton described the 1998/99 quota share as “essentially the same book of business” as ESR had previously written. ESR argue that the 1998/99 quota share was effectively a renewal of the 1997 quota share in that it was in respect of the same book of business written by NAIU, which had passed from Philadelphia Life to Anico because Mr Schouweiler changed employer. They say that they therefore agreed to subscribe to the 1998/99 quota share in reliance upon what had been said when they underwrote the 1997 quota share, and that it was to be expected that they would do so unless changes were disclosed to them. Accordingly, their case is that it was impliedly represented when they subscribed to the 1998/99 quota share (as, they say, it was expressly represented when they subscribed to the 1997 quota share) that NAIU were not writing reinsurance business or wc or wcc business, and that NAIU were themselves to underwrite and administer the programme; or, as it is put in the alternative, it is their case that it was not disclosed that the position indicated when they subscribed to the 1997 quota share no longer obtained, as it should have been in the circumstances if there was to be a fair presentation of the risk.

The slip for the 1998/99 quota share was more detailed than that for the 1997 quota shares, with more of the usual clauses familiar with reinsurance of this kind. The type of business again described as “Personal Accident Account Quota Share Treaty”. The “maximum initial gross premium income limit to this agreement” was US$45,000,000” and the “estimated total pool writings” were US$55,000,000. The maximum period for any one policy was 36 months. The slip stated that NAIU would be allowed to deduct 15% of the premiums as payment for their “admin., claims, marketing, compliance, filings etc”.

Mr Denton also said that the wording on the slip providing for the 15% deduction for NAIU reinforced the impression that NAIU were themselves dealing with claims and providing the other services indicated. I do not accept that was indicated by the slip or that Mr Denton so understood from the slip. The deduction and its amount do not indicate whether those services were to be carried out by NAIU themselves or whether NAIU might arrange and pay for others to provide them.

The wording for the 1998/99 quota share was signed by Anico on 9 November 1998 and by Mr Denton on 6 January 1999. Article 1 provided, “This Agreement is to share with the Reinsurer the interests and liabilities of [Anico] arising out of Policies written or renewed on behalf of [Anico] by [NAIU],…” Article 6 provided that within 90 days following the end of each month Anico should render a net account to ESR showing, among other information, “loss and loss expense paid on the losses”, and also advising of the “outstanding loss and loss expense reserve”. The term ‘Policy’ as used in this agreement was to mean “any binder, policy, or contract of insurance or reinsurance issued, accepted or held covered provisionally or otherwise, by or on behalf of [Anico]”. Article 7, headedOriginal Conditions, read as follows, “All insurances falling under this Agreement shall be subject to the same terms, rates, conditions and waivers, and to the same modifications, alterations, and cancellations as the respective Policies of the Company…”. Mr Denton said that, although he read the wording, it did not occur to him to take out the references to reinsurance so as to reflect what he had been told about the business by Mr Kerr-Smiley and Mr Briant. I accept his evidence about this.

Hannover Re also wrote a 1998/99 quota share of Anico’s interest in the programme, subscribing to a 15% line. In 1999 they wanted to end their participation, and in April 1999 Anico and Sedgwick Re asked Kininmonth to enquire whether ESR wished to take over Hannover Re’s line. Mr Rose sought further information from Mr Malloy to support this proposal, describing ESR as “sticklers for facts and figures” in a fax of 13 April 1999.

Kininmonth asked Mr Denton whether ESR would like to increase their quota share from 35% to 50%. They must have indicated interest because on 28 April 1999 Mr Malloy wrote to Mr Schouweiler that, according to Mr Cullis, ESR would be willing to write the 15% line with effect from 1 January 1998, and sought instructions whether he should proceed with the placement. Mr Schouweiler replied on 29 April 1999 with instructions that the line be placed with ESR “provided [ESR] is willing to accept the revised commission”: Anico required an increase to 40% in the deductions that they might make, but would allow any commission above 32.25% to be “loaded” into the premium, so that reinsurers’ net premium was not reduced. Mr Malloy passed this information to Kininmonth in a fax of 29 April 1999, observing “As you will see, [Mr Schouweiler] has tied the placement to solving the commission issue so I’m not sure how you wish to proceed”.

On 30 April 1999, Mr Rose presented the proposal for the increased line to Mr Denton. Mr Denton scratched an endorsement, but placed the letters “TBE”, signifying “to be entered”, against his scratch. On 27 May 1999, by which time Mr Denton had ceased to work for ESR and was on “garden leave”, ESR scratched an endorsement agreeing to the increased commission that Anico required. On 3 June 1999 Mr Schouweiler sent Kinimonth a letter by fax stating that they were authorised to place the 15% increase in the quota share with ESR, the increased line being retrospective to 1 January 1999. On 4 June 1999, another underwriter initialled the endorsement for the increased line on behalf of ESR, and he deleted the letters “TBE”. On the same date Kininmonth issued an endorsement to a cover note recording the increased line and ESR’s agreement to the revised commission or deduction arrangements. On 9 and 18 June 1999 Hannover Re and Anico signed an endorsement terminating Hannover Re’s quota share with effect from 1 April 1999. There is an issue whether ESR were legally bound to the increased line when Mr Denton initialled the endorsement on 30 April 1999, or only on 4 June 1999.

ESR argue that they are entitled to avoid the 1998/99 quota share and their agreement to increase their line because Anico did not disclose information about the background of Mr Drobny. They also say that they are entitled to avoid the quota share and the agreement to increase their participation in the risk for various reasons arising from or connected with what I shall refer to as the “Reliance National policy”. More specifically they complain:

The Reliance National policy was accident insurance cover that NAIU wrote in the name of Philadelphia Life for the period from 15 January 1998 to 15 January 1999, and it was ceded to the 1998 quota share. It was given a reference number SR22655-ALGXK-01.

By an endorsement NAIU renewed the policy in the name of Philadelphia Life with effect from 15 January 1999 for “a further one-year term commencing January 15, 1999 and expiring February 1, 2000”, and the renewed cover was ceded, or purported to be ceded, to the 1998/99 quota share.

Reliance National were an insurance company, that has now gone into liquidation. The Reliance National policy named as the policyholder “Reliance National on behalf of Breckenridge Enterprises Inc et al, WC policy Number NWA 0117768-04”. (The policy referred to, with a different reference from the Reliance National policy number, was not in evidence.) The Reliance National policy provided that references to “You” were to the policyholder, and that “Your Subsidiaries and/or Affiliates”, who were named and included AMS Construction Co Inc, (“AMC”), were covered under the policy. By it Philadelphia Life agreed, “We will insure persons becoming eligible hereunder (referred to as Insureds)”, and benefits were payable only if an “Insured” sustained injury that caused a loss that was covered. The Insured were “All of your Texas based eligible employees while performing their duties”.

Under the policy Philadelphia Life provided cover for “injury to the Insured “while on your business””, that is to say while the Insured was “under your direction to further your business”. The benefits were in respect of “Loss of Life, Limbs, Sight, Speech, Hearing or Plegia”, in respect of Medical/Dental expenses, and in respect of “weekly Disability Benefit”. The policy provided for a maximum period of 52 weeks during which the weekly disability benefit would be payable, and the maximum payment was 70% of the Insured’s “basic weekly salary” subject to a maximum of $500 per week. However, there was a provision headed “Extension of Benefits” that stated that, if an Insured were totally disabled, the benefits would continue for the period of such total disablement. Thus, the cover provided by the policy was potentially “long-tail”.

Benefits were to be paid to the Insured (except medical benefits that might be paid direct to the medical services provider) or in the event of death to the Insured’s designated beneficiary or estate.

At the start of the policy, there were these words printed in bold capital letters: “This is not a policy of workers’ compensation insurance. The employer does not become a subscriber to a workers’ compensation system by purchasing this policy, and if the employer is a non-subscriber, the employer loses those benefits which would otherwise accrue under the workers’ compensation laws …”. In section V of the policy, a section headed “Other Policy Provisions” there was a term headed “Workers’ Compensation” that stated, “This policy is not a substitute for the Workers’ Compensation Law requirement”.

By a notice issued under the Texas Insurance Code, the policyholder was named as “Breckenridge Enterprises Inc., et al” and the insurer as Philadelphia Life, and notice was given to persons who were Insureds that they were insured under a policy “issued by the Insurer to the Policyholder” and that the Insurer was a member of NAIG.

Thus, under the terms of the Reliance National policy, Philadelphia Life undertook to make payments to Insureds, and they did not thereby agree to make payments to Reliance National, by way of reimbursement of payments to Insureds or otherwise. However, ESR produced evidence upon the basis of which they argue that this is not how the arrangement in fact operated.

First, ESR rely upon an affidavit by a Mr Eugene Eisenmann. It was sworn in litigation in the United States District Court, Northern District of Texas, Dallas Divisionin which Breckenridge Enterprises Inc (“Breckenridge”) and others, including Reliance National, sued Philadelphia Life and others, including NAIU. The litigation (to which I shall refer as the “Breckenridge litigation”) was settled before trial.

I am conscious of the dangers of relying upon Mr Eisenmann’s affidavit. First, I do not know how contentious his evidence was or where his own interests and those of his company lay in the Breckenridge litigation. Secondly, there has not been produced in evidence a wholly legible copy of his affidavit, and I must proceed on the basis that the passages that are illegible do not significantly affect the meaning of the parts that can be read. Nevertheless, the evidence in his affidavit appears cogent and consistent with correspondence and other documents that I have seen, and I consider that no sufficient reason has been advanced that I should reject it. I accept it as broadly reliable.

Mr Eisenmann was a Vice President of insurance brokers who did business under the name of Hanafin and Bates and who had in 1998 and 1999 obtained from Reliance National for Breckenridge, AMS and affiliated companies (to whom I shall refer as “the Breckenridge insureds”) what he described as wc insurance coverage in respect of claims between $1 and $500,000. Reliance National required to be fully reinsured and obtained such reinsurance from Southwest Underwriters, and the Breckenridge insureds provided collateral to support the reinsurance. In the second half of 1997, NAIU, acting for Philadelphia Life, approached Hanafin Bates to interest them in AMS buying insurance. (Mr Eisenmann refers to AMS, but I infer that the approach was to sell insurance to the Breckenridge insureds generally.) An agreement was reached that NAIU would provide reinsurance of the Reliance National policy for exposures between $1,000 and $100,000. According to Mr Eisenmann, the Breckenridge insureds had no reason to buy direct cover from NAIU or Philadelphia Life because they were already insured with Reliance National. The advantage of the arrangement as far as they were concerned was that the new arrangements to reinsure Reliance National reduced the costs that they incurred through providing collateral in respect of the reinsurance cover provided by Southwest Underwriters. Mr Eisenmann went on to explain that all claims submitted under the Reliance National policy had already been paid to the Breckenridge insureds by, as I understand his evidence, Reliance National.

As I have indicated, it appears from correspondence that the cover effected by the Reliance National policy operated in practice along the lines that Mr Eisenmann described. I need, I think, refer only to the following to illustrate this:

It is right to acknowledge that the correspondence is not entirely consistent in its description of the arrangements: in particular, in a letter dated 18 September 1998 NAIU wrote to Reliance National: “As we know, this is not a Workers Compensation contract, but as we discussed a reimbursement policy. It is designed to reimburse the insured (Breckenridge etc) for payments that have been made according to the terms of this policy”. However, the picture that emerges from the correspondence read as a whole is of Reliance National paying Insureds in respect of their claims and looking to Philadelphia Life for reimbursement.

Further, arrangements for handling claims under the Reliance National policy were made under an agreement made “as of” 13 December 1997 between Reliance National and Pacesetter, to which Philadelphia Life and NAIU were not party and in which Reliance National was described as the “Insurer”. Under it Reliance National engaged the services of Pacesetter to provide “certain services with respect to the investigation and payment of insurance claims”. The agreement recited that Reliance National had issued “insurance policies as are set forth on Exhibit A” and exhibit A to the agreement identified the policy “NWA0117768-04”, describing the “Line of Coverage” as “WC”. The services to be provided by Pacesetter included investigating claims, providing reserves to be established and supervising litigation. With regard to settlement of claims, they were “To adjust, settle or resist all Claims within the discretionary limit” specified in the agreement, that is to say $10,000 per claimant or per occurrence and $10,000 per occurrence for loss related expenses, and “To adjust, settle or resist all Claims in excess of the Authority Limit with the express prior approval of Insurer”, that is to say of Reliance National. Reliance National reserved the right to “assume the control and handling of any Claim at any time”.

Although their agreement was with Reliance National, at least by August 1998 Pacesetter were writing to NAIU with reports of losses incurred. For example, in a letter dated 27 August 1998 they requested NAIU that the report be passed to “the claims department” with a view to them receiving “reimbursement on behalf of AMS and Workmans Compensation Program”. According to Mr Eisenmann, on 6 October 1998, NAIU or Philadelphia Life reimbursed Reliance National for these losses. In a letter dated 6 April 1999 Pacesetter wrote to NAIU, “We understand that the re-insurance arrangement existing between NAIU and Reliance deals with the State of Texas only…..As you are aware, all Workmans Compensation cases are investigated and handled in accordance with the rules/regulations received by the Texas Workers Compensation Commission…”

I conclude that despite the terms of the Reliance National policy, the way that the arrangement worked in practice was that claims were made by Insureds to Reliance National and were investigated and settled by them, and Reliance National would look to NAIU and the participants in the NAIG programme to reimburse them. I am not in a position to say why the Reliance National policy does not reflect these arrangements or whether there were other documents between the parties to the arrangements that did do so. (As I have observed, the different policy number referred to in the Reliance National policy in the identification of the policyholder was not explained. It seems likely that the arrangements between Philadelphia Life and Reliance National and between Reliance National and Breckenridge and other Insureds have not fully emerged from the evidence that has been presented, but I must deal with the evidence that I have before me.)

It is convenient next to deal with the question when ESR were committed to the additional 15% line. Prima facie, an insurer in the London market is committed to a risk when he scratches a slip. Of course, this is not the case if he makes it clear that he does not intend to be bound by his scratch. Therefore, the questions here are whether the prima facie inference that ESR were bound to the increased line when Mr Denton scratched the slip on 30 April 1999 is displaced (i) because he indicated that this was not his intention by putting the letters “TBE” against his scratch or (ii) because it was clear from the exchanges between Mr Denton and Mr Rose had that Mr Denton did not intend ESR to be bound.

I was assisted on the first question by the expert witnesses, and in particular by Mr Rendall, whose evidence was cogent and clear. He said that the initials “TBE”, standing for “to be entered”, in themselves connote only that the underwriter does not have his records readily available to mark up his entry. Sometimes the letters are used when the underwriter is quoting for a risk rather than committing himself to it, but then it is standard and accepted practice to add further words on the slip to indicate this. Again, the initials are sometimes used when an underwriter commits himself subject to conditions, but again he indicates this on the slip. In Mr Rendall’s opinion, the initials, without more, do not indicate that the underwriter is withholding his commitment to the risk.

Sir Alan Traill said that he would not wish to be dogmatic about the significance of the letters “TBE” outside the Lloyd’s market. He proffered the view that it was a way of indicating that more information was required and until then the scratch was “qualified”, that is to say that it does not commit the underwriter. However, he made it clear that he had no firm views about this.

Mr Cauldwell too said that it was difficult to assess the precise significance of the letters “TBE”, but he expressed the view that either they might simply be a note for administrative purposes or they might reflect an oral discussion to the effect that something needed to be resolved before the underwriter was finally committed to the risk. However, Mr Cauldwell, like Mr Rendall, did not think that in themselves (and in the absence of such a discussion) the letters “TBE” connote that the scratch is not intended to be legally binding.

I accept Mr. Rendall’s evidence. I therefore conclude that the letters in themselves do not displace the prima facie position that ESR were legally bound by Mr Denton’s scratch, and I come to the second question, whether the exchanges between Mr Denton and Mr Rose meant that ESR were not so bound.

The background to the meeting between Mr. Denton and Mr. Rose on 30 April 1999 was that Kininmonth were instructed by Mr Malloy to ask ESR to consider increasing their participation and to replace Hannover Re, and when they reported that ESR were interested in doing so, they were instructed by Mr Schouweiler, through Mr Malloy, to place the increased line with ESR provided ESR agreed to change the deductions and commission arrangement. It is common ground that there was some discussion about the proposed new arrangement at the meeting, but there was a difference between the evidence of Mr Denton and that of Mr Rose about its conclusion. Mr Denton said that Mr Rose asked him to agree to an endorsement allowing increased deductions, but that he refused to do so, because it was difficult to establish that the change would not work to ESR’s disadvantage. Mr Rose’s account was that, while Mr Denton had not “specifically” or “formally” agreed to the proposed change, there had been “tacit” agreement upon it. Mr Rose acknowledged that this accord was not recorded in an endorsement that was scratched at the meeting, and explained that he did not remember having such an endorsement prepared for the meeting and thought that he might have decided to discuss the proposal before preparing the documentation.

I accept Mr Denton’s evidence that he was not then willing to accept the proposed change about commission, and conclude that Mr Denton and Mr Rose did not reach a binding agreement about the new commission arrangement at the meeting on 30 April 1999. I do, however, accept that as a result of the discussions Mr Rose was confident that an agreement would be reached about it. Indeed, as early as 13 April 1999 Mr Rose had reported to Mr Malloy, “we are almost there in terms of agreement to the increased commissions”. It does not follow that because no agreement about commission had been concluded, Mr Denton and Mr Rose did not reach a binding agreement about the increased line. It is true that if Mr Rose placed the increased line without securing an agreement about commission, he would, as he acknowledged, strictly have gone beyond his instructions from Mr Schouweiler, but I do not find it commercially improbable that a broker in his position might have done this, given his confidence that ESR would agree to the new arrangements.

After the meeting of 30 April 1999, Mr Rose apparently did not take further steps to deal with this business for a month or so. It is tempting to speculate that this might be to do with Mr Denton leaving ESR, but there is no evidence to support that suggestion. However, I do not consider that the delay supports ESR’s contention that Mr Denton did not give a binding commitment to the increased risk at the meeting. Indeed, if anything it suggests to me the opposite, since I would be inclined to expect a broker such as Mr Rose to have pressed for a firm commitment if he had not secured the business.

I have not found it easy to resolve this difference between the evidence of two witnesses who, I believe, gave honest, but understandably vague, accounts of the meeting. However, I prefer the evidence of Mr Rose. I accept that to him the initials “TBE” indicated only “something that [Mr Denton] was doing internally”, and that nothing was said that led him to think this or anything else prevented Mr Denton’s scratch from being a contractual commitment. I also consider that Mr Rose is an astute broker, who would not have overlooked it if Mr Denton had said something to that effect. I found Mr Denton’s evidence less compelling, and in particular he did not give convincing evidence about what he said to Mr Rose to indicate an intention not to commit ESR to the risk. Indeed, when he was cross-examined he seemed mistakenly to believe that an underwriter is not normally committed to a risk by his scratch, but is committed only if and when the agreement is entered in the insurers’ records, and so “formally accepted”; and accordingly he considered that the initials “TBE” in themselves showed that the agreement had not been entered and was not binding.

I emphasise that I do not consider that Mr Denton was deliberately misleading me about the meeting of 30 April 1999. Indeed, he might well have considered at the time that the initials “TBE” meant that his scratch was not legally binding. However, I prefer the evidence of Mr Rose about what was or was not said at the meeting, and find that the increased line was written on 30 April 1999.

In 1997 Mr Drobny was the President and Chief Operating Officer of NAIU. Until 1983 he had been an attorney at the Illinois bar. On 26 September 1983 he was convicted by a jury in the District Court for the Western Division of Texas on a count involving securities fraud and aiding and abetting, and he was sentenced to four years imprisonment. (Although the count charged two offences, they appear to have been two ways of formulating a single complaint.) Mr Drobny went to prison in 1986 and was released on parole in 1988. His appeal against conviction was dismissed in 1992. His offence was that he had written a cheque for $300,000 on an account which had insufficient funds to meet it, and that, when asked by the bank manager of the recipient bank whether the cheque would be paid on presentation, he had said untruthfully that he was a director of the bank on which the cheque was drawn and a man of substantial wealth, and that the cheque would be honoured. In the event, it was not.

Moreover, in 1983 Mr Drobny had faced a second charge, one of conversion of $43,000 that he held in an escrow account as an attorney. It is not clear whether this complaint was connected with the securities fraud. Mr Drobny was not convicted of an offence in respect of the escrow account, and there is no information before me about whether the charge was dropped and if so in what circumstances. However, when he was facing this charge as well as the securities fraud charge, Mr Drobny applied to the Supreme Court of Illinois for his name to be struck from the roll of attorneys, and his motion was allowed on 7 December 1983.

These facts about Mr Drobny’s background are not in dispute, and it is common ground that they were not disclosed to, or otherwise known to, ESR in 1998 and 1999. The issues are:

ESR contend that Mr Schouweiler, and therefore Anico, knew of Mr Drobny’s conviction and the escrow account charge before the 1998/99 quota share was placed in September 1998. Anico do not dispute that they are to be taken to have had knowledge of anything that Mr Schouweiler knew, but in their Defence Anico pleaded that they and Mr Schouweiler “first became aware of the … conviction having been informed of the same by an anonymous letter received in the summer of 2002, the fact of the said conviction subsequently having been confirmed by Drobny during the course of a deposition taken from him on 5 December 2002 during” the Breckenridge litigation.

By way of particulars of the pleading about Mr Schouweiler becoming aware of the conviction in the summer of 2002, Anico pleaded:

However, towards the end of the third day of the trial, after Mr Schouweiler had given his evidence, Anico for the first time acknowledged that they were “fixed with knowledge concerning Mr Drobny at least as at 26^th May 1999”, the “knowledge concerning Mr Drobny” being knowledge of his conviction and imprisonment. They referred to 26 May 1999 because by a letter of that date Mr Jack Rabin, Vice President and Chief Financial Officer of NAIU, wrote this to Mr Schouweiler: “Per your request of Irving [Drobny], I am enclosing herewith copies of our general liability and employees dishonesty coverages. A file of the active fidelity bonds is listed by state where required”. A stamp on the letter shows that Mr Schouweiler received it on 27 May 1999. Mr Rabin sent a copy of his letter to Mr Drobny. He enclosed with the letter the following: (i) a certificate of Mr Drobny’s conviction, which also recorded his sentence; (ii) a “statement of charges” made to the Supreme Court of Illinois in connection with Mr Drobny’s application to be disbarred, which described the charges about both the escrow account and the securities fraud; (iii) the order of the court striking Mr Drobny from the role of the Illinois bar; and (iv) a document headed “resume of Mr Drobny” that described him as “inactive for health reasons” between 1983 and 1988 (being the years of his conviction and of his release from prison respectively).

At about this time, the Department of Insurance of the State of Texas was expressing concerns to NAIU about their failure to disclose Mr Drobny’s conviction in an annual report that they had submitted. The Department had written to NAIU about this on 19 April 1999, and by a letter dated 13 May 1999 they wrote that “NAIU’s attribution of Mr Drobny’s erroneous biographical information to a clerical/administrative error is difficult to accept…NAIU’s 1997 correction letter was written around the same time that word of Mr Drobny’s background was beginning to circulate within the insurance community”. This matter was resolved by an order made by consent by the Commissioner of Insurance whereby it was concluded that NAIU had violated the relevant Texan statutory provisions and that they should pay a financial penalty, but their licence to act as a Third Party Administrator (that is to say, to handle claims and business on behalf of insurers) should not be revoked.

On 10 June 1999 Mr Schouweiler wrote a memorandum for Anico’s NAIU file, referring to a communication from Mr Manfred Goodman, who was formerly employed by Moody Insurance Group (“MIG”), to a Mr Bobby Moody, the founder and President of MIG. MIG were a brokerage and marketing agency that were associated with the Anico Group of Companies and offered health and other insurance. Mr Goodman said in a witness statement in these proceedings that he received some documents about Mr Drobny from a Mr Steve Lang, who thought that, because he had heard that Mr Drobny might be doing business with Anico, MIG should be aware that he was a convicted felon. Mr Goodman had passed the information on to Mr Moody. Mr Goodman said that he did not recall the exact nature of the conviction or whether the information concerned not only the conviction but also a second charge that Mr Drobny had faced, but he does recall that “the issue was about Mr Drobny going to prison and not revealing this on some other document”. He said that he either mentioned in his memorandum to Mr Moody that Mr Drobny had gone to prison or copied for him the documents that showed this or both. (In his witness statement, dated 6 August 1994, Mr Schouweiler stated that Manfred Goodman “raised the issue” with Anico, although in his oral evidence he accepted that did not know whether that was the case: I conclude that in fact Mr Goodman communicated directly only with Mr Moody.)

I should set out Mr Schouweiler’s memorandum of 10 June 1999:

“Re: Irving Drobny

Manfred Goodman raised the background of Mr. Drobny as a potential issue for ANICO. The following are the salient points raised by Bobby Moody, Jr. pursuant to Goodman’s memo and the description of the current relationship with Mr. Drobny and National Accident Insurance Underwriters.

On 24 June 1999 Mr Schouweiler was sent an e-mail headed “NAIU” by a Mr Mike Moriarty, an employee of Anico. In it, Mr Moriarty wrote this:

“While you were out, I received the May 26, 1999 letter from Jack Rabin cover to the general liability and employee dishonesty coverage schedule pages. I don’t know if you were aware, so I want to bring to your attention the other documents that were attached to the package but not mentioned in the letter.

These additional items are Mr. Drobny’s resume, a copy of a 1983 court document showing a guilty verdict for Mr. Drobny and several documents respective of Mr. Drobny’s resignation from the Illinois Bar. This entire package has been made a part of the NAIU file.

After seeing these materials, I went back and looked at the materials I have on the Violent Crime Control and Law Enforcement Act of 1994, particularly the section dealing with insurance. The act is very broad in its application. However, the act contains a proviso whereby an individual to whom the act applies can escape application of penalties if he has received written consent from any regulatory official authorised to regulate the insurer and the consent specifically refers to the subsection of the act allowing for the exception.

In reviewing your June 10^th memo to the file concerning Goodman’s findings about Mr. Drobny, I saw that you believe Mr. Drobny has a letter from the Illinois DOI that satisfies the requirements of the Federal act. Given the seriousness of the requirements of the act, do you think we could get a copy of the letter for out files?

Let me know if there is anything I need to do.”

Mr Schouweiler replied to Mr Moriarty at 3.57 am on 27 June 1999 in the following terms: “I had a copy of the letter at one point but either didn’t copy it from Conseco’s files or (likely) mislaid it. He [sc Mr Drobny] has a letter from the IL DOI [sc Illinois, Department of Insurance]. I intended to make the attachments a part of the file”.

Mr Schouweiler was referring to a letter from the Illinois Department of Insurance (“DoI”) to Mr Drobny dated 10 September 1998. On 3 September 1998 Mr Drobny had written to the Illinois DoI to obtain written consent to engage in the business of insurance, and explained in his letter about his conviction, describing it as “an isolated circumstance which is fifteen years old”, and pointing out that the offence did not relate to the business of insurance. He did not mention the charge about the escrow account. In their response dated 10 September 1998, the DoI consented to Mr Drobny’s “continued employment as an officer or director of the third party administrator”, adding that should he wish to engage in any other aspect of the insurance industry which might be or become an activity licensed by them, he would be required to meet and maintain any standards which might be applicable under state law. Of course, Mr Schouweiler could not have seen this letter when he was at Philadelphia Life because he left them in April 1998.

Despite these exchanges and e-mails, it is Anico’s pleaded case:

Anico plead that the fact that that Mr Drobny had faced charges of two separate criminal offences, one of which led to prosecution and a conviction, “appears to have eluded” Mr Moriarty in view of the terms of his e-mail of 24 June 1999 and the reference to a “guilty verdict for Mr Drobny” resulting in “Drobny’s resignation from the Illinois Bar”. Mr Moriarty did not give evidence (either orally or by a written statement): this part of Anico’s pleaded case depends entirely upon the inference to be drawn from Mr Moriarty’s e-mail, and I am unable to draw that inference. The documents that Mr Moriarty described as “documents that were attached to the package” included a certificate of Mr Drobny’s conviction and sentence by the Texan court on 26 September 1983. Mr Moriarty specifically drew Mr Schouweiler’s attention to what he described as “a document showing a guilty verdict for Mr Drobny”. He mentioned separately “several documents respective of Mr Drobny’s resignation from the Illinois Bar”. I conclude that when he wrote his memorandum Mr Moriarty knew about the conviction by the Texan court and was seeking to draw it to Mr Schouweiler’s attention.

In his witness statement Mr Schouweiler said that, having drafted his memorandum of 10 June 1999, he “determined that no further action was necessary because of the age of the charge, the fact that I had worked with NAIU for a number of years with no difficulties, the fact that Drobny had approval from the Illinois Department of Insurance to continue insurance work, and the fact that NAIU was managed and owned by Bunch who had a very good reputation in the industry”. Anico’s solicitor explained in a letter dated 17 August 2004 how Mr Schouweiler made this decision: “Mr Schouweiler met with Mr Irwin M (Buddy) Herz in the hall of the Anico offices. … he is the senior partner of Greer Herz & Adams (general counsel to Anico) and a member of the Anico board of directors. Mr Schouweiler and Mr Herz discussed Mr Schouweiler’s note to the file of 10 June 1999 and the Drobny conviction, made their decision and took no further action.”

Mr Schouweiler also stated in his witness statement that on 29 June 1999 Anico received from Messrs Inglish & Monaco, an Illinois law firm who acted for NAIU, a copy of the letter from the Illinois DoI dated 10 September 1998, but again Mr Schouweiler did not “feel that any action was necessary”.

Mr Schouweiler did not state in his witness statement when or how he learned about Mr Drobny’s conviction, or refer to the anonymous letter that, according to Anico’s pleading, informed Anico of the conviction in the summer of 2002. Mr Stelling too made no mention of the anonymous letter in his witness statement dated 6 August 2004: he simply said, “During the course of my work on the NAIU account, I became aware of a conviction regarding Irving Drobny, President of NAIU. I can't recall how I became aware of the conviction but I testified as to my knowledge of his conviction in a deposition dated 24 July 2002. … I really have no more information as to the Drobny conviction.”

In a request for further information made on 17 November 2004 ESR sought further information about how Mr Schouweiler learned about Mr Drobny’s background. Anico’s response, dated 13 December 2004, was signed by Mr Schouweiler himself.

When he was cross-examined, Mr Schouweiler repeated that he first learned that Mr Drobny had been convicted of securities fraud in the summer of 2002 in the Breckenridge litigation.

Mr Schouweiler was also asked about what he had learned in May and June 1999, and about the memorandum that he wrote to the file, Mr Moriarty’s note and his e-mail in response. He said that before writing his memorandum he had read Mr Goodman’s note to Mr Moody, but he does not recall what it said. He said that he did not read the enclosures with the memorandum (including the certificate of conviction) because he passed them over to Mr Moriarty. Even if Mr. Goodman’s note memorandum did not directly refer to Mr Drobny going to prison, I find it difficult to suppose that it did not refer in some way to the fact that Mr Drobny had a criminal record. After all, that is what Mr Lang had written about. I cannot accept that Mr Schouweiler could have read Mr Goodman’s note without learning this. I also regard it as unlikely that he did not read Mr. Goodman’s note.

Further, as I understood his evidence, Mr Schouweiler said that, when he referred in his memorandum to a letter “acknowledging” the felony, he understood that to mean that Mr Drobny was accused of a felony, the conversion from the escrow account, and not to actually committing a felony. It is true, as Mr Martino emphasised, that Mr Schouweiler is not a lawyer, but I do not consider that this begins to explain the reference to acknowledging the felony. Mr Schouweiler is an experienced businessman, and I reject the suggestion that he would have used these words unless he thought that Mr Drobny was guilty of a felony (even if, of themselves, the words do not indicate knowledge that Mr Drobny was convicted of the offence). Anico’s denial of this is the more difficult because Mr Schouweiler said, when asked about the reference in Mr Moriarty’s e-mail to a letter from the Illinois DoI, that he knew in 1999 “vaguely” that persons convicted of a crime required permission to act in the insurance industry.

Understandably, Mr Schouweiler was asked in cross-examination to explain his understanding of the reference in Mr Moriarty’s memorandum to “guilty verdict”. At one point he accepted that he had realised that Mr Drobny had been convicted of an offence of dishonesty, adding that he had not understood that the conviction related to a securities fraud and had thought that it related to the problem with the escrow account. However, later in his cross-examination he said that, despite the reference to a guilty verdict, he had not appreciated that Mr Drobny had been convicted of an offence, rather than merely been accused of conversion from the escrow account. Again, I find it impossible to accept that Mr Schouweiler could have misunderstood the obvious meaning of Mr Moriarty’s words.

Mr. Schouweiler was also pressed to explain the last paragraph of his e-mail of 24 June 1999. He explained that the “letter” of which he had a copy “at some point” was not the letter of 10 September 1998 from the Illinois DoI (which had, of course, been written after he had left Conseco), but a note for the file that he had written while at Conseco, or Philadelphia Life, after his conversation with Mr Bunch. Although his e-mail of 27 June 1997 was sent in the middle of the night and this might explain minor lapses in phraseology, nevertheless I am unable to accept this explanation: a note to the file is not naturally described as a letter, and this would not meet Mr Moriarty’s suggestion in his e-mail of 24 June 1999 that Anico should obtain a copy of the letter from the Illinois DoI to Mr Drobny.

Finally, Anico’s case is that Mr Schouweiler spoke with Mr Drobny in June 1999 after both had been sent Mr Rabin’s letter of 26 May 1999, which had enclosed a certificate of the conviction. I find it improbable that Mr Drobny conducted that discussion on the basis that Mr Schouweiler was unaware of it. Even if Mr Schouweiler had overlooked the certificate, Mr Drobny would not have known this.

ESR submitted that I should reject Mr Schouweiler’s explanation of these exchanges and his evidence about when he came to learn of Mr Drobny’s background. I accept that submission, and for the reasons that I have indicated, I regard Mr Schouweiler’s evidence about this as incredible. However, it does not follow that by the time that the 1998/99 quota share was placed, Mr Schouweiler had learned of Mr Drobny’s conviction and the charge that he had faced over the escrow account.

ESR submit that I should conclude that Mr Schouweiler was aware of these matters by September 1998. First, they say that Mr Schouweiler’s relationship with Mr Drobny was such that he probably would have known of Mr Drobny’s background. In a deposition of Mr Drobny taken on 3 April 2003 in the Breckenridge litigation Mr Drobny said that he and Mr Schouweiler had a “personal relationship”, that they were friends, and that they had been friends since they started doing business together. Mr Schouweiler, on the other hand, told me that he would not describe Mr Drobny and himself as friends. The evidence suggests, and I conclude, that Mr Drobny gives the truer picture. Indeed, in the documents included in the presentation of the 1998/99 quota share is a reference to “the close personal and professional relationship that developed between Steve Schouweiler and Irv Drobny and others at NAIU”. Anico say that this was a “mere puff”, but I am not prepared to dismiss it as misleading. More revealingly, in a letter to Mr Drobny and dated 28 June 1998, which is introduced with sentiments that on the face of it suggest friendship, Mr. Schouweiler concludes with the words: “By the time you make the next visit the weather should cool off and [Mrs Schouweiler] should have the boat in the water and it might be time for a weekend on the water – bring who ever”. Mr Schouweiler explained in cross-examination that (surprisingly) this was not an invitation to a weekend on the water and he did not, in fact, have a boat, and that he was making a joke because he was inviting Mr Drobny to join him on a boat that did not exist. Whatever the position about that, the tone of the letter certainly suggests to me that Mr Schouweiler had developed a personal as well as a business relationship with Mr Drobny.

Against this background, I conclude that Mr Schouweiler knew about Mr Drobny’s background when he was still with Conseco, and consider that two pieces of evidence support this conclusion. First, in a letter dated 11 March 1997 that Mr Bunch sent on behalf of NAIU to the Texas DoI, NAIU drew the Department’s attention to the fact that NAIU had given incorrect information to them in respect of an application for a licence to be a third party administrator in that they had said that no officer had ever been convicted of a felony whereas, as NAIU put it, in 1983 Mr Drobny had been convicted of “a single count of aiding and abetting a violation of the federal securities laws…”. In that letter NAIU assured the Department that “...all of the insurance companies on whose behalf NAIU administers business have been made aware of Mr Drobny’s prior conviction”. (At that time Philadelphia Life were, of course, a company on whose behalf NAIU administered business.)

Mr Schouweiler was in charge of health operations while he was employed by Philadelphia Life and was the executive responsible for their participation in the NAIG programme. He said in cross-examination that he was responsible for the “entire operation”, and that he would expect that any important information about the good standing and character of a senior NAIU executive to have been referred to him. It seems to be most unlikely that, if Mr Bunch, or anyone else at NAIU, had made aware Philadelphia Life (or Conseco) of Mr Drobny’s conviction before Mr Schouweiler had left Philadelphia Life, it did not come to Mr Schouweiler’s attention. Indeed, Mr Schouweiler said in cross-examination that Mr Bunch’s letter of 11 March 1997 was wrong because he was confident that Philadelphia Life was not informed about Mr Drobny.

Secondly, Mr Schouweiler was asked in cross-examination about the particulars that he gave in response to question 20 in the request of 17 November 2004, in which he referred to being “vaguely aware of a problem with an escrow account”. He said that he had heard a rumour that Mr Drobny had “surrendered his licence” to practise at the Illinois bar, and in, he believed, the first quarter of 1998, he asked Mr Bunch about it. Mr Schouweiler said that Mr Bunch told him that Mr Drobny had had a problem with a trust account, and he had had to resign from the bar, but that noone had been harmed by what Mr Drobny had done. According to Mr Schouweiler, Mr Bunch was upset that “something that was that old … was still plaguing Mr Drobny”. Mr Schouweiler said that he did not remember whether he asked Mr Bunch what the problem was, and in any case he made no enquiries to find out more about it. I infer that at this time Mr Bunch will have known about Mr Drobny’s conviction: certainly, by a letter dated 11 March 1997 NAIU notified the Texas DoI of it. This being so, if Mr Bunch had the conversation described by Mr Schouweiler, he was being misleading about Mr Drobny’s background. I find it impossible to accept this. Apart from the fact that Mr Schouweiler himself gave evidence about the good reputation that Mr Bunch enjoyed in the insurance industry, it would be absurd for Mr Bunch to try to mislead Mr Schouweiler in this way. It was surely most unlikely, and Mr Bunch would have realised that it was most unlikely, that an insurer in Mr Schouweiler’s position would not make further enquiries about Mr Drobny and his background and learned of the conviction, and Mr Bunch and NAIU would then have been be indefensibly compromised.

I reject Mr Schouweiler’s evidence that he did notknow about Mr Drobny’s conviction before leaving Conseco and that he was unaware of it at the time that ESR underwrote the quota share of Anico, and conclude that he, and therefore Anico, knew of it by that time. I also conclude in view of the discussion that Mr Schouweiler had with Mr Bunch that he knew about the charge concerning the escrow account by then.

ESR relied upon two other matters in support of this part of their case. I mention them only briefly because I do not find them persuasive. First, it is said that Mr Schouweiler carried out “due diligence” enquiries before Philadelphia Life made the underwriting agreement with NAIU, and that those enquiries would have been likely to have revealed Mr Drobny’s background. There is no sufficient evidence about any enquiries that were made to justify this.

ESR also rely upon a letter dated 13 May 1999 from the Texas DoI to NAIU’s lawyers, Messrs Inglish & Monaco of Chicago, which referred to “NAIU’s 1997 correction letter” (clearly, I think, a reference to Mr Bunch’s letter of 11 March 1997) having been written “around the same time that word of Mr Drobny’s background was beginning to circulate within the insurance community”. They argue that, given Mr Schouweiler’s standing in the American insurance industry, he would surely have heard such rumours. Mr Schouweiler told me that he had not done so. Mr Briant and Mr Denton had not heard rumours about Mr Drobny, although they, of course, were working in London and not in the United States. More significantly, Mr Malloy told me, and I accept, that he heard no rumours about Mr Drobny around that time. If he had not done so, I see no reason to conclude that Mr Schouweiler had done so.

I should add that in their pleading, Anico referred to Mr Stelling, as well as Mr Schouweiler, becoming aware of Mr Drobny’s conviction in the summer of 2002, but in his evidence Mr Stelling said that he did not recall how he became aware of it. He had been with the Conseco Group before moving to Anico, but said that he had not heard rumours about Mr Drobny. I accept Mr Stelling’s evidence.

Since I conclude that Anico knew about Mr Drobny’s background, ESR do not need to rely upon their alternative arguments about what Anico ought to have known and based upon NAIU’s knowledge of Mr Drobny’s background, but I go on to deal with these issues.

ESR have an alternative argument that even if Mr Schouweiler did not actually know about Mr Drobny’s background, in the ordinary course of business he ought to have been aware of it, and so they are entitled to avoid the quota share because it was not disclosed to them. I accept that argument at least in so far as it is directed to knowledge of the conviction.

On his own account, Mr Schouweiler was told enough about Mr Drobny in his conversation with Mr Bunch to have led any insurer to have made enquiries of Mr Bunch about the problems that Mr Drobny had had and how they had been resolved, unless the insurer was deliberately avoiding acquiring information that he felt that he might prefer not to know. After all, Mr Drobny was the Chief Operating Officer of a company whom Philadelphia Life had authorised to underwrite a significant amount of business in their name. It is obvious, it seems to me, that an insurer in the position of Philadelphia Life would have wanted to know what problems with a trust account were still “plaguing” Mr Drobny, unless it was deliberately decided that it was, or might be, convenient to remain ignorant of them. Had Mr Schouweiler enquired, he would surely have learned of Mr Drobny’s conviction, if not more about his background. Lest it be said that these are criticisms of Mr Schouweiler when he was acting for Philadelphia Life and not Anico, I add that, having not made proper enquiries when at Philadelphia Life, he ought equally to have enquired about what Mr Bunch was referring to before agreeing that Anico should underwrite the NAIG programme, and would surely have done so unless he decided that it was, or might be, convenient to remain in ignorance.

The courts do not readily impute to an insured information that he did not know on the basis that he ought to have known it: see for example Simner v New India Assurance Co Ltd., [1995] 1 Lloyd’s LR 240 at p.253. In Economides v Commercial Assurance Co plc, [1998] QB 587 at p.601 Simon Brown LJ said that the only duty of an assured in the position of the claimant in that case was one of honesty, but he acknowledged that that required that the assured did not wilfully shut his eyes to the truth. That was a case in which the assured was a private individual and not an company or business; and so, it might be said, there was no question of such an assured being (in the words of section 18 of the Marine Insurance Act 1906, which reflects the common law that applies to non-marine insurance: PCW Syndicates v PCW Reinsurers, [1996] 1 Lloyd’s Rep 241) “deemed to know [circumstances] which in the ordinary course of business ought to be known to him”, and the test to be applied here is less demanding than that adopted by Simon Brown LJ. However, even applying that test, I conclude that, if Mr Schouweiler did not actually know about Mr Drobny’s conviction, that is because he deliberately decided that he did not want to know about Mr Drobny’s past, although it must have been obvious to Mr Schouweiler that Mr Bunch had information that might well be relevant to the NAIG programme and the reinsurance of it.

It is clear, and not, as I understand it, disputed by Anico, that by September 1998 NAIU knew of Mr Drobny’s background, that is to say of his conviction for securities fraud and his imprisonment, of the charge of conversion from the escrow account, and of his name being struck off from the roll of the Illinois bar. It was known not only to Mr Drobny himself, their Chief Executive Officer, but also, as I infer, to Mr Bunch and probably others, and the information had been passed on to the Texas DoI on behalf of NAIU. ESR argue that, even if Anico did not themselves know about Mr Drobny’s background by September 1998, they are entitled to avoid the 1998/99 quota share because NAIU knew of it.

Chitty on Contracts (at para 41-030) refers to the judgment of HH Judge Diamond Q.C. in Simner v New India Assurance Co Ltd, (loc cit), in which he identifies three kinds of situation where the insured will be under a duty to disclose matters known to his agent, namely “(i) where the agent, although not effecting the insurance on behalf of the assured, is relied upon by the assured for information concerning the subject matter of the insurance (sometimes referred to as an “agent to know”); (ii) where the agent is in such a predominant position in relation to the assured that his knowledge can be regarded as the knowledge of the assured; and (iii) where the agent is used to effect the insurance (in which case the agent is required to disclose not just all material circumstances which the assured is bound to disclose, but also every material circumstance which ought to be known to the agent, or communicated to him, in the ordinary course of business)”.

Where marine insurance is involved, the first and the second of these kinds of situation are reflected in section 18 of the Marine Insurance Act, 1906, and the third is reflected in section 19. These sections also set out the common law principles that are applicable in the case of non-marine insurance, and they are in the following terms (so far as relevant):

“18(1) …the assured must disclose to the insurer, before the contract is concluded, every material circumstance which is known to the assured, and the assured is deemed to know every circumstance which, in the ordinary course of business, ought to be known to him. If the assured fails to make such disclosure, the insurer may avoid the contract. …

18(5) The term “circumstance” includes any communication made to, or information received by, the assured.

19(1) …where an insurance is effected for the assured by an agent, the agent must disclose to the insurer –

(a)

every material circumstance which is known to himself, and an agent to insure is deemed to know every circumstance which in the ordinary course of business ought to be known by, or to have been communicated to, him; and

(b)

every material circumstance which the assured is bound to disclose, unless it come to his knowledge too late to communicate it to the agent.”

I shall consider the application to this case of the three kinds of situation in reverse order, and therefore first consider whether the third kind of situation is found here. This question is not properly formulated in terms of whether NAIU are agents whose knowledge should have been disclosed, but whether what they knew about Mr Drobny ought to have been disclosed because it ought in the ordinary course of business to have been known by or communicated to Kininmonth, who were, in the words of section 19, Anico’s “agents to insure”. This follows from the decision of the majority of the Court of Appeal, Rose and Saville LLJ, in PCW Syndicates v PCW Reinsurers [1996] 1 Lloyd’s Rep 241, who considered that section 19 and the common law principle in non-marine insurance cases that it reflects are directed to knowledge of an agent who actually deals with the insurers and directly makes the contract of insurance. This view has been forcefully criticised (see, for example, Butler & Merkin, Principles of Reinsurance Law, A-0611), but I must follow the decision of the majority of the Court of Appeal. NAIU were therefore not agents of this kind, and the question is whether the agents who did effect the insurance, Kininmonth, ought in the ordinary course of business to have known about Mr Drobny’s background because in the ordinary course of business NAIU would have informed those effecting reinsurance on Anico’s behalf about it.

ESR refer to the provision in the Participation and Underwriting Agreement whereby NAIU were authorised to “negotiate for and secure reinsurance” for the “common account of the Participant(s) in the NAIG with respect of the Business”. Accordingly, it is argued that NAIU were given a specific contractual role, as agents or intermediaries on behalf of Anico in obtaining reinsurance. However, this, as I see it, leads to the question whether the 1998-99 Quota Share was placed by or through NAIU exercising that authority.

The evidence of Mr Malloy was that Sedgwick Re were not NAIU’s agents in any way, because, I infer, they considered themselves to be acting for Philadelphia Life and then for Anico. Both from the contemporary exchanges and on the basis of his evidence, I have formed the impression that Mr Malloy is an experienced and clear-thinking broker as well as an honest witness, and I accept his evidence about this. The documents show that unsurprisingly there was some direct contact with contact between NAIU and Sedgwick Re, but this in itself is in no way inconsistent with what Mr Malloy told me. NAIU supplied information about such matters as the business that had been written or that it was projected would be written. They did not assume a role of passing on information about the officers of NAIU, or any other information comparable to that about Mr Drobny about the non-disclosure of which ESR complain, and ESR do not submit that they did. Their argument is based simply on the fact that NAIU knew of a material fact for disclosure. This does not engage with the question why the information ought in the ordinary course of business to have been known by or communicated to Kininmonth. Given that NAIU did not exercise their authority to negotiate for and secure reinsurance and given that they did not in fact assume the role of passing on information of the kind in question, there is no basis for saying that the information ought in the ordinary course of business to have been known by or communicated to Kininmonth.

As I understand ESR’s closing submissions, they do not assert that the second of these kinds of situation described in Simner arises here. It cannot be said that NAIU’s relationship with Anico was such that NAIU had a predominant position that meant that their knowledge is to be regarded as that of Anico.

ESR do argue that upon the facts of this case NAIU were agents such as those in the first kind of situation described by HH Judge Diamond. As I understand it, they advanced two narrow arguments based upon specific obligations of NAIU under the Participation and Underwriting Agreement, and a more general argument.

One of the narrower arguments that ESR sought to advance was based upon the provision in the Participation and Underwriting Agreement that NAIU were under a duty to deliver to participating insurers copies of any “complaint, request, and inquiry” from a state insurance regulatory authority; and it was said that Mr Drobny’s letter to the Illinois DoI dated 3 September 1998 and the Department’s response dated 10 September 1998 were covered by that clause. That argument was rightly abandoned: the letter of 3 September 1998 was not received by NAIU, and the letter of 10 September 1998 was not a “complaint, request or inquiry”.

ESR also advanced an argument based upon the provision in the Participation and Underwriting Agreement that NAIU were under a duty to apply for and maintain in good standing all licenses and permits required of NAIU to conduct the pool’s business in any state, and, as ESR’s argument runs, NAIU therefore knew of Mr Drobny’s background in their capacity as Philadelphia Life’s agents and then Anico’s agents because they needed to notify regulators of it; and therefore Philadelphia Life and also Anico are fixed with that knowledge.

I am unable to accept that argument. The Participation and Underwriting Agreement authorises NAIU to maintain the licences and permits that they require to conduct the business. However, those are authorisations, as I understand the position, to enable NAIU to apply for their own licences, not authorisations for the insurers participating in the pool. There is no evidence that NAIU applied for any authorisations on behalf of Anico (or any other pool insurer) or, indeed, that they would have been entitled to do so.

However, the more general question also arises whether because NAIU ran the NAIG programme, they were Anico’s “agents to know” about that part of Anico’s underwriting, and so whatever they knew about it was to be disclosed. I cannot accept this. When considering whether information known to an agent is subject to the duty of disclosure owed by the principal insured to his insurer, it is necessary to identify with some precision the nature of the information in question. (For example, in Proudfoot v Montefiore, (1867) LR 2 QB 511, the case in which Cockburn CJ gave his judgment which is often regarded as formulating the relevant legal principle, the agent was said to have a duty “in the ordinary course of business” to communicate to his principal information “as to the state of ship and cargo”.) The question therefore is whether Anico, by appointing NAIU their agents, were relying upon NAIU for information not only about the NAIG programme and the business written under it, but also for information about NAIU’s officers and employees. I do not accept that they were, and I do not accept that NAIU were Anico’s “agents to know” that information.

I add that in their closing submissions ESR also argued that, because NAIU were relied upon for information and therefore this case gives rise to the first of the three kinds of situation described in Simner, NAIU were under an obligation to provide, or ought in the ordinary course of business to have provided, information about Mr Drobny’s conviction and the charge of conversion to Sedgwick Re, Bradstock and Kininmonth. For similar reasons, I do not accept that way of putting the case.

I therefore reject ESR’s arguments about non-disclosure about Mr Drobny in so far as they rely upon NAIU’s knowledge about his background.

Anico also argued that NAIU’s knowledge does not assist ESR because of the nature of the information about Mr Drobny. Mr Martino relied upon the principle stated in the Hampshire Land case, [1896] 2 Ch 743 that there is an exception to the general rule that a principal is affected by notice to his agent if the agent is acting in fraud of the principal and the matter of which he had notice is relevant to the fraud. He argued that, just as in those circumstances the principal is not regarded as having received notice, so here Anico are not affected by NAIU’s knowledge about frauds that Mr Drobny committed, or was charged with committing, against third parties before being employed by NAIU. The Hampshire Land case, he argued with support from the judgment of Colman J in Kingscroft v Nissan Fire & Marine, unreported 4 March 1996, exemplifies a more general principle that applies wherever, because of the nature of the information in question, it cannot be inferred that the agent will reveal it in the ordinary course of business.

I shall need to return to the argument that Mr. Martino advances in reliance upon the Kingscroft case in another context. For the present it suffices to say that, in my judgment, it does not assist Anico here. There is no reason to suppose that the nature of the information about Mr. Drobny was such that NAIU would have declined to disclose it. Mr Martino submitted that it might, if revealed, have “caused disquiet among NAIU’s principals”. This submission takes no account of the statement in Mr Bunch’s letter of 11 March 1997 to the Texas DoI that NAIU had provided the information to insurance companies for whom they wrote business. Even if (which I do not believe to be the case) for some reason no letter was sent to Philadelphia Life, I do not accept that NAIU did not generally disclose the information to insurers for whom they acted: I cannot believe that Mr Bunch was so foolhardy as to write a complete untruth in such a letter to the DoI.

An insured is obliged to disclose material facts, that is to say circumstances that would be taken into account by a prudent insurer when assessing the risk (even if those facts would not, of themselves, have had a decisive effect on his decision whether to accept the risk and if so on what terms and at what premium). I have to consider whether (a) Mr Drobny’s conviction and (b) the charge against him in relation to the escrow account were material in this sense to ESR’s decision to write the 1998/99 quota share.

The expert witnesses were all of the opinion that Mr Drobny’s conviction was a material fact. Sir Alan Traill specifically considered whether the letter from the Illinois DoI might mean that the conviction was immaterial, and he rejected that suggestion, expressing the opinion that, while a competent broker would present the letter to persuade the underwrite to write the risk, nevertheless it was for the underwriter to assess it. Similarly it was for the underwriter to assess the significance of the age of the conviction. Mr Cauldwell regarded the conviction as an obviously material fact for disclosure, observing that Mr Drobny was President and Chief Operating Officer of NAIU, and, as one of their most senior managers, could exercise control or influence over underwriting decisions, claims handling and use of premium funds. Mr Rendall also believed that the conviction was material to the reinsurers’ decision whether to write the risk.

I accept that evidence. I was referred to observations in other cases about the materiality of past convictions or offences and about the relevance of their age. They did not assist me to decide whether on the facts of this particular case Mr Drobny’s conviction was relevant. Here:

Mr Martino submitted that nevertheless the conviction was not material to the writing of the quota shares, relying particularly upon the letter from the Illinois DoI, the age of the conviction, and the fact that it did not relate to the risks, or indeed to insurance in any way. (He cited the observation of Phillips J in Deutsche Ruck v Walbrook, [1995] 1 Ll LR 153 that the fraudulent diversion of commission in that case “does not, on the face of it, have an impact on the risk being reinsured”.) I do not accept that for these or any other reasons, a prudent insurer would not take Mr Drobny’s conviction into account when assessing the risk and deciding whether to accept it.

Sir Alan Traill and Mr Cauldwell considered that for similar reasons the charge of conversion from the escrow account was material. Mr Rendall’s evidence about this was different, and he described the charge as “not particularly material”. I prefer the opinion of Sir Alan Traill and Mr Cauldwell, and take the same view about the materiality of the conviction and the materiality of the charge. Of the five considerations that I have identified above, all but the first apply to the charge. Moreover, there is no dispute that the charge of conversion alleged that Mr Drobny had deliberately removed funds from the escrow account when it was not proper to do so, and such an allegation against an attorney is undeniably a serious one. Of course, the fact that the charge was brought does not mean that Mr Drobny had in fact converted the funds, and there is no evidence that he did do so. However, I consider that in assessing the quota share and deciding whether and if so on what terms he would write it, a prudent underwriter would have wanted to take it into account, and weigh its significance after discovering the nature of the charge and the basis for it. (If the insurer had requested this information, the likelihood is that he would have learned of the conviction.)

I have referred to the materiality of these matters to the placing of the 1998/99 quota share. For similar reasons, I conclude that both the conviction and the charge were material to ESR’s agreement to increase their quota share in April 1999.

Anico’s duty was to make a fair presentation of the risk, and, on the basis of my findings that Anico knew of Mr Drobny’s conviction and the conversion charge and that these matters were material to the risk, this would have involved disclosing them to ESR before they committed themselves to the risk.

Mr Denton said that he would have wanted to know about Mr Drobny’s convictions and would have expected to have had them disclosed to him before the quota shares were placed. He said that ESR would not engage in business with a company where “key functions” were controlled by someone with a conviction for dishonesty, partly because of the danger that funds might be misapplied, but also because he would be concerned about whether ESR could rely upon the representations and the underwriting and other decisions of such a person.

Mr Denton also said that,he would not have had authority to underwrite the risk if Mr Drobny’s conviction had been disclosed, but he would have had to refer the proposal to Mr Oliver, who, he was sure, would have declined it. These considerations would have been the stronger in view of (i) the problem that had been encountered with the payment of premium after ESR first took a quota share of this business, and (ii) what was said about Mr Drobny in the placing documents. Mr Denton did not think that the broker could have said anything when seeking to place the quota share that would have made the risk acceptable to ESR if they had known of Mr Drobny’s conviction. He considered the position would have been the same had the charge of conversion from the escrow account been disclosed, given that the charge was one of dishonesty.

Anico argue that I should reject this part of Mr Denton’s evidence and find that he would have written the quota share even if these matters had been disclosed. They make two points. First they say that Mr Denton’s underwriting was manifestly sloppy and imprudent, and fell far below the standards which would be regarded as normal in the London market. This submission is supported by the evidence of Mr Rendall, and can readily be illustrated: the slips for the 1997 quota share had extraordinarily little information about the risk; Mr Denton made no real enquiries about NAIU before accepting the quota share; and, on his own evidence and ESR’s own case, he relied upon representations about the business written in the NAIG programme which sensibly should have been recorded on the slip or elsewhere.

Secondly, Mr Denton’s evidence was vague and in some respects unreliable. For example, he believed that he had scratched the slip for the 1997 quota share on 29 January 1997, whereas in fact Mr Denton had done so.

I accept that these criticisms of Mr Denton and his evidence are valid so far as they go. However, they do not lead me to reject his evidence that the disclosure of Mr Drobney’s background would have affected his, and ESR’s, underwriting decision. It is understandable that his recollection about the meetings at which the quota shares were presented and written was vague, but the evidence about how he would have responded to disclosure about Mr Drobny does not depend upon his recollection of particular events, and the criticisms that Anico made of his evidence do not cast doubt upon his evidence about how he would have responded to disclosure of these matters. Further, if Mr Drobny’s background had been presented sufficiently frankly for there to have been a fair presentation of the risk, Mr Denton would surely have understood what he was being told however careless his assessment of the risk in other respects, and this would have led him to assess afresh whether NAIU were sufficiently reliable for ESR to write the quota share as they did.

I therefore conclude that ESR have shown that the failure of Anico, through their brokers, to make a fair presentation with regard to Mr Drobny’s conviction and the conversion charge did induce ESR to write the risk. For similar reasons I conclude that it also induced them to increase their line in 1999.

It follows that ESR have established that they are entitled to avoid the 1998/99 quota share because of non-disclosure about Mr Drobny.

Although in view of this conclusion they do not affect my decision, I should consider the other issues between the parties. ESR contend that when the 1997 quota share was placed, Mr Kerr-Smiley made representations to Mr Denton about the NAIG programme, and that these affect the 1998/99 quota share because, when that was placed in September 1998, it was understood to be a renewal of the 1997 and 1998 quota shares, and was so treated by all parties; and that it therefore was or ought to have been apparent that ESR agreed to take the 1998/99 quota share in reliance upon and induced by the representations that had been made when the 1997 quota share was agreed.

As ESR’s case was opened by Mr Colin Wynter, who appeared for ESR with Mr Ben Lynch, the representations that ESR allege were made to Mr Denton were about the intention as to what insurance should be included in the NAIG programme and how the programme should be managed:

ESR complain that in fact the business that Anico reinsured by the 1998/99 quota share included the Reliance National policy, and that:

The meeting at ESR’s offices on 29 January 1997 was attended by Mr Oliver and Mr Denton of ESR, by Mr Briant and by Mr Kerr-Smiley. It lasted about an hour.

Mr Oliver made some notes, and these record figures about the amount of “Occupation” and “Texas Occupation” insurance written in the NAIG programme. Mr Oliver did not give evidence and no other witness explained the notes. As I read them, there is nothing that indicates an intention or wish to exclude any class of business, and they are of little help in determining the issues about what was said at the meeting.

Before the meeting, ESR had raised questions and sought reassurances about the NAIG programme that are reflected in Mr Briant’s letter of 28 January 1998, and I accept Mr Denton’s evidence that their concerns were prompted by the terms of ESR’s excess of loss cover. Mr Kerr-Smiley gave evidence that “he thinks it likely” that at the meeting he provided the confirmation requested in Mr Briant’s fax of 28 January 1997, including the confirmation that the programme did not include reinsurance. Mr Briant gave similar evidence that he believes that the confirmation requested in the fax was provided during the presentation at the meeting, although he acknowledged in cross-examination that, unsurprisingly, he could not say “categorically” that it was. Mr Denton said that at the presentation Mr Kerr-Smiley and Mr Briant stated that NAIU underwrote a book of direct personal accident insurance that contained no reinsurance business.

I see no reason to doubt that evidence, and I accept it. It is unlikely that, after ESR had raised the matters reflected in Mr Briant’s letter, both Mr Oliver and Mr Denton would have neglected to mention them during the meeting and have allowed ESR to be exposed in respect of their excess of loss cover; and if these matters were raised, I cannot believe that Mr Briant would have scratched the slip for ESR unless Mr Kerr-Smiley gave ESR reassurance about them.

I have concluded that, although in November 1996 Mr Briant told Mr Kerr-Smiley that he wished to exclude Texas EEII business, it was not clearly resolved what (if any) wc or associated business would be included in the NAIG programme. Further, it is not clear from the evidence quite what business Mr Briant understood to be included in the NAIG programme: certainly in a letter to an actuary called Mr Kent Nickerson dated 4 March 1997, he stated that the account included “Occupational PA Carve-Out” cover. However, as their pleaded case makes clear, ESR do not rely upon anything said to Mr Briant rather than Mr Denton, and it suffices to say that I do not consider the evidence about what was said between Mr Briant and Mr Kerr-Smiley strengthens ESR’s case about what representations were made to Mr Denton.

Mr Denton gave evidence that wc business had a bad reputation in the London market, and that, when underwriting US health or accident risks, he always asked the broker whether it was intended that such business should be written. The written presentation that had been made to ESR referred to NAIU underwriting “Texas Occupation” business, which Mr Denton understood to be cover for accidents at work that provided for a defined payment for particular injuries, whereas, as Mr Denton understood it according to his evidence, wc cover provided indemnities for employers against workers’ claims without “set payments for particular injuries” but covering potential claims for loss of earnings and occupational sickness and lifetime medical benefits.

In his written evidence Mr Denton said that Mr Kerr-Smiley informed him that NAIU would not be writing wc or wcc business. In his oral evidence he said that he asked Mr Kerr-Smiley whether NAIU wrote “WCA” and was told that they did not. (He did not refer to wcc cover.)

I am not convinced by the evidence of Mr Denton about this, and conclude that ESR have not discharged the burden of proving this part of their case:

I come to the question of what was said at the meeting about NAIU themselves underwriting, administrating the NAIG programme and handling claims. Mr Denton’s evidence was that he understood from Mr Kerr-Smiley that NAIU themselves underwrote the risks and handled resultant claims. He explained in cross-examination that Mr Kerr-Smiley drew his attention to a document or brochure in which it was said what services NAIU provided, and Mr Kerr-Smiley said something to the effect that NAIU underwrote the risks and did the claims handling and that their brochure confirmed that.

Mr Denton did not identify the document or brochure to which Mr Kerr-Smiley was referring, and no document has been drawn to my attention in which it is stated, or clearly indicated, that NAIU would not use the services of third parties to assist them to manage the NAIG programme. As far as claims handling is concerned (and in fact ESR’s complaint relates only to Pacesetter being engaged to handle claims), the document presented to ESR before the meeting simply referred to NAIU “being responsible for” claims handling.

I am not persuaded that anything that Mr Kerr-Smiley said at the meeting went significantly further than that. There is no evidence that settlement of claims was directly mentioned during the 29 January 1997 meeting or that a distinction was there drawn between settling claims and claims handling in a general sense. Mr Denton acknowledged that he would regard it as normal for an insurance company to engage a third party assessor to help with claims, and did not suggest, as I understood his evidence, that Mr Kerr-Smiley led him to understand that NAUI would not do this. At one point when he was cross-examined Mr Denton said that Mr Kerr-Smiley pointed out that NAIU “did underwriting and claims handling themselves”, but later his evidence was that Mr Kerr-Smiley said that NAIU “did the claims handling and provided that service”. Mr Briant and Mr Kerr-Smiley did not give evidence about what, if anything, was said about this, and I do not consider Mr Denton’s evidence sufficiently specific or consistent to prove this part of ESR’s case.

I therefore conclude that ESR have proved that Mr Kerr-Smiley represented to Mr Denton that the NAIG programme did not include reinsurance, but have not otherwise proved the representations that they allege were made at the meeting.

In reaching these conclusions, I have not overlooked the evidence of Sir Alan Traill that the slip for the 1997 quota share, and in particular that the description of the type of business as “Personal Accident”, gave an indication of the business to be written in the programme. He said that by 1996 a competent and specialist underwriter of personal accident business would know that it was incorrect to include wc or wcc business (which is “long-tail” business) in a personal accident account, which should include only “short-tail” business. There is no reason to doubt Sir Alan Traill’s evidence, but ESR did not rely upon this point in the case that they pleaded and opened, and there is no evidence that Mr Denton or anyone involved in placing the quota shares drew this inference from the statement of the type of business on the slip.

ESR argue that they can rely upon the representations made by Mr Kerr-Smiley when he was broking the 1997 quota share to avoid the 1998/99 quota share because it ought to have been apparent to those involved that ESR were (or might be) still relying upon those representations when deciding whether to subscribe to the 1998/99 quota share; and similarly that they can rely upon them to avoid the agreement to increase their line. In support of this part of their argument ESR say:

The third of these propositions is not in dispute. I am also prepared to accept that the 1998/99 quota shares could fairly be characterised as a renewal of the previous quota shares in that ESR might reasonably suppose that, prima facie, they were reinsuring a risk similar to that for which they had previously reinsured Philadelphia Life. The difficulty facing this part of ESR’s case is in establishing that those involved in placing the 1998/99 quota share ought in the ordinary course of business have been aware about ESR relying on representations made when the 1997 quota share was placed. They supported this part of their case in their closing submissions by reference to what ought to have been known by or communicated to (i) Kininmonth and their employees, and (ii) NAIU.

Sir Alan Traill pointed out that, when the business is transferred between brokers, it is considered essential in the market that there should be full cooperation in handing the files from the old to the new broker so that the new broker can carry out properly his duties to the assured. There was such cooperation in this case between Bradstock and Kininmonth, and Bradstock’s file was available to, and read by, Mr Rose. The problem in this case is not about the file being available to Kininmonth, but that it contained nothing to indicate that Mr Kerr-Smiley made the oral representations in the course of his presentations that ESR allege or which, in my judgment, ought to have alerted Mr Rose that Mr Kerr-Smiley might have made the representations alleged.

Specifically, the files did not include the letter from Mr Briant to Mr Kerr-Smiley dated 28 January 1998, which referred to ESR wanting confirmation that (among other things) reinsurance policies were not written in the NAIG programme. The files did include the exchanges resulting from Mr Briant’s request in November 1996 that “Texas Look Like WC” be excluded, but the documents do not indicate anything other than that this request was rejected. Mr Rose could not have discerned from these exchanges that Mr Kerr-Smiley had represented that wc or wcc cover were not included in the programme, and it was not suggested to him in cross-examination that he could have done so.

I accept Mr Rose’s evidence that, before presenting the 1998/99 quota share to Mr Denton, he made himself familiar with the Bradstock files relating to the placing of earlier quota shares. However, in view of what they contained, or rather did not contain, ESR rightly did not pursue in their closing submissions their pleaded contention that Mr Rose had actual knowledge of any representations made by Mr Kerr-Smiley.

Moreover, I understand that Sir Alan Traill and Mr Rendall agree, and in any case I find, that in these circumstances there is no reason that Kininmonth ought to have been aware, or would in the ordinary course of business have been aware, of whatever representations Mr Kerr-Smiley made.

It might be said that Mr Kerr-Smiley can be criticised for careless practices in that he did not keep file notes of what he said to ESR. That does not assist ESR. Mr Kerr-Smiley acted for Philadelphia Life. Neither he nor Bradstock acted for Anico. In any case, there is no evidence that in this regard Mr Kerr-Smiley was not following his usual practice or the usual practice of Bradstock, and, as MacGillivray on Insurance Law (10^th Ed) states (at para 17-13), an assured “is deemed to know only what he would be expected to know in the ordinary course of his own business, making allowance for its imperfect organisation, prior to the conclusion of the insurance. Therefore he is not deemed to be aware of matters which he would have found out if he had re-organised his schedule or business system at the time in question….The principle is that if he should have been informed of certain facts in the ordinary course of his actual business, he will be deemed to know them even if, due to a failure in communication, he is not actually made aware of them”.

I reject the argument that Mr Rose, or others working for Kininmonth, or Kininmonth themselves, knew or ought in the ordinary course of business to have known or had communicated to them any representations made by Mr Kerr-Smiley to Mr Denton

ESR also contend that in the ordinary course of business NAIU ought to have known of the representations that Mr Kerr-Smiley made. This contention, as I understand it, is based upon their argument that NAIU were acting as Anico’s agents to place the quota shares or had assumed a duty or role to pass information of this kind to Anico’s agents to place them. I already have rejected this submission.

I add that ESR pleaded in support of this part of their case that it was or ought to have been apparent to Sedgwick Re that Mr Kerr-Smiley had made the alleged representations. In his opening submissions, Mr Wynter advanced this submission on the grounds (i) that Mr Malloy provided Mr Kerr-Smiley with the information to make the representations that he did; (ii) that Mr Kerr-Smiley ought to have recorded what he said in Bradstock’s file and (iii) that Mr Kerr-Smiley ought in any event to have communicated what he said to Mr Malloy. The first of these contentions was not supported by evidence. The second does not provide any basis for knowledge on the part of Mr Malloy, who would not have seen Bradstock’s file. The third was not pursued in cross-examination of Mr Malloy. Mr Wynter rightly did not advance this argument in his closing submissions.

ESR’s case that the representations were false is based upon the fact that before the 1998/99 quota share was placed, the Reliance National policy had been written and the arrangements for handling claims had been made with Pacesetter; and before the agreement by ESR to increase their participation had been made, the Reliance National policy had been renewed. In opening ESR’s case, Mr Wynter said that the misrepresentations were about the intentions for the NAIG programme and how it was to be run (or, in the terminology of section 20 of the Marine Insurance Act 1906, about “expectation or belief”). However, the parties’ submissions proceeded on the basis that, as far as the placing of the 1998/99 quota share and the agreement to increased participation is concerned, the issue whether the alleged misrepresentations were false rested upon the Reliance National policy that had then been written and the claims handling arrangements then in place were in accordance with Mr Kerr-Smiley’s representations, and on the basis that the representations, which were about the future when they were made, had been translated by the passage of time and the events that had happened into representations of present fact. Certainly, Anico did not argue, for example, that the allegation being of one of belief or expectation, ESR had to prove that the representations were not made in good faith (see section 20(5) of the Marine Insurance Act, 1906), and ESR did not allege that they were not made in good faith.

In determining whether a representation as to a matter of fact is true, the test laid down by the Marine Insurance Act 1906 for cases of marine insurance is whether “the difference between what is represented and what is actually correct would be considered material by a prudent insurer” (see section 20(4)), and the common law governing cases of non-marine insurance reflects this: Avon Insurance plc v Swire Fraser Ltd., [2000] All ER (Comm) 573. This is what is required if there is to be a fair presentation of the risk by the insured, and, while in other cases there might be room for debate whether a misrepresentation must be material in order to afford grounds for avoiding a contract (see Chitty on Contracts (29^th Ed.) para 6.036), in cases such as this, that is to say where the question is whether an insured has made a misrepresentation of fact in presenting the risk to the insurer, the question of materiality is inextricable from the question whether the representation was false (in a legally significant sense and as the representation would reasonably have been understood, rather than literally).

ESR argue that the Reliance National policy was one of reinsurance, and that this difference from the position represented by Mr Kerr Smiley was material to ESR’s decisions to write the quota shares, including the 1998/99 quota share, and to ESR’s decision to increase their line in it. (ESR’s complaint here is that the Reliance National policy itself was one of insurance, not of course that under the arrangement reached in the summer of 1998 they reinsured Philadelphia Life, nor that when the Reliance National policy was renewed in the name of Philadelphia Life and, as Anico claim, ceded to the 1998/99 quota share, it was intended that ESR should continue to reinsure Philadelphia Life, although this, as I shall explain, gives rise to a dispute as to whether this arrangement fell within the terms of the 1998/99 quota share.)

I do not understand that there is any dispute between the parties that the question whether the NAIG programme included reinsurance was material to a company underwriting a quota share reinsurance. Mr Cauldwell gave cogent reasons for this: that if the programme comprised direct business, the cedant, in whom the reinsurer has put his faith, has control over it, but if the business is reinsurance, the cedant’s control is the less and the quota share reinsurer does not know who will be controlling what is written. Similarly Sir Alan Traill said that the cedant was likely to be worse informed about any reinsurance risks that he wrote than about direct insurance. Anico did not suggest that I should reject the expert evidence about this, and I accept it.

Anico argue that the Reliance National policy was one of insurance and not of reinsurance. Mr Rendall expressed this opinion, and while I am not persuaded that expert evidence was strictly admissible on the question (I understand him to have been giving his view about whether the Reliance National policy was in fact (and in law) reinsurance and not whether the market would have regarded it as such), I see force in his observations if the enquiry is confined to the terms of the policy itself. He considered that Reliance National were acting as agents for Breckenridge, and said that, “There are occasions when an insurer provides the main insurance needs for a client but for one or more classes does not provide the coverage itself and acts as an intermediary in arranging cover for such classes on behalf of the client. It can be surmised that this is the case here. Whatever the reason, it is clear that there are not two policies involved and that there is a direct contractual arrangement between Philadelphia Life and Breckenridge and its employees. Whether or not it was intended that reinsurance should not be written by NAIU on behalf of Philadelphia Life, there is no reason why the Breckenridge Policy should not have been ceded to the treaty.”

If this question turned simply upon interpreting the Reliance National policy itself, I would conclude without difficulty that ESR have not proved this part of their case. However, as I have concluded, in practice the cover reflected in the Reliance National policy operated rather differently.

There is no fixed or established definition of reinsurance in English law. As MacGillivray on Insurance Law (10^th ed) states (at para 33-1), “the English authorities do not provide a satisfactory definition of reinsurance, and the evolution of reinsurance in its various forms has made it difficult to achieve a comprehensive definition”: see too Toomey v Eagle Star, [1994] 1 Lloyd’s Rep 516, 522 and Skandia International Corp v NRG Victory Reins Ltd., [1998] 1 Lloyd’s Rep 439, 455. I cannot accept that, given that, as I have found, Mr Kerr-Smiley represented that the NAIG programme was not to include reinsurance, the parties intended that this representation referred to reinsurance in a defined or technical sense, but rather intended it to refer, and understood it to refer, to arrangements whereby NAIU and the NAIG participants reimbursed another insurer for losses that he incurred in respect of claims that that other insurer (rather than NAIU) managed and controlled. In practice, the nature of the arrangements for the cover reflected in the Reliance National policy was that Reliance National were reimbursed for losses incurred by them in respect of claims that they, and not NAIU, managed. NAIU did not exercise the control that they would have had, or would have been expected to have had, if the cover had been conventional direct insurance.

Accordingly, I consider the statement of Mr Kerr-Smiley had been falsified by the time that the 1998/99 quota share was placed. I can see that some might regard the complaint as being more properly characterised as one of non-disclosure rather than misrepresentation, and ESR do plead the point alternatively as a matter of non-disclosure. However it be characterised, I consider that, had Anico (or a relevant agent of theirs) had (or been in a position in which they would be deemed to have had) the relevant knowledge, there would not have been a fair presentation of the risk in this regard.

The expert witnesses agreed that the Reliance National policy did not provide wc cover, and is a form of wcc cover. I accept this and agree that the cover can properly be so described. The question whether this would mean that a representation made by Mr. Kerr-Smiley was misleading once the Reliance National policy had been written, so that it gave rise to a misrepresentation when the 1998/99 quota share was subscribed and when ESR agreed to increase their participation, would depend upon exactly what was said by Mr. Kerr-Smiley. Since I have concluded that the ESR have not proved any such representation, I cannot comment further upon this

I can deal with ESR’s claim that there was a misrepresentation about the arrangements for claims handling in the same way. Again, the question whether the arrangements with Pacesetter falsified something said by Mr. Kerr-Smiley would depend upon exactly what he said, and I have found that ESR have not established that he made any such representation. However, I add this: ESR’s complaint depends wholly upon the authority over claims given to Pacesetter. Under that agreement, the authority conferred on Pacesetter was limited and could be withdrawn. Sir Alan Traill considered that, while a general managing underwriter such as NAIU should supervise all adjustments and settlements, third parties might properly be engaged for specific purposes if it was economical to do so. I did not understand Mr Cauldwell’s evidence to be significantly different from this. I am not persuaded that the arrangement with Pacesetter was such that, even if Anico made the representation that ESR allege, the difference between that representation and the position that obtained under the Pacesetter arrangement would have been considered material by a prudent insurer.

I should add that in his written opening, Mr Wynter also asserted that NAIU gave binding underwriting authority to Reliance under the Reliance National policy, and therefore were not underwriting themselves. This is not pleaded as a separate basis of complaint about the policy, and was not developed in argument.

Since I have declined to find that Mr. Kerr-Smiley made representations that the NAIG programme did not include any wc or wcc business, it follows that there is no question of Mr. Denton being thereby induced to enter into the 1998 quota share or to increase ESR’s line. The same applies to the alleged representation about NAIG themselves underwriting insurances, administering the programme and handling claims under it. I should, however, decide whether the representation about the programme including reinsurance induced Mr. Denton to write, or to increase, the 1998/1999 quota share.

The law with regard to what must be proved by an insurer (or reinsurer) about inducement was summarised by Clarke LJ in Assicurazioni Generali SpA v Arab Insurance Group, [2002] EWCA Civ 1642 at para 62 as follows: “(i) In order to be entitled to avoid a contract of insurance or reinsurance, an insurer or reinsurer must prove on the balance of probabilities that he was induced to enter into the contract by a material non-disclosure or by a material misrepresentation. (ii) There is no presumption of law that an insurer or reinsurer is induced to enter into the contract by a material non-disclosure or misrepresentation. (iii) The facts may, however, be such that it is to be inferred that the particular insurer or reinsurer was so induced even in the absence of evidence from him. (iv) In order to prove inducement, the insurer or reinsurer must show that the non-disclosure or misrepresentation was an effective cause of his entering into the contract on the terms that he did. He must therefore show at least that, but for the relevant non-disclosure or misrepresentation, he would not have entered into the contract on those terms. On the other hand, he does not have to show that it was the sole effective cause of his doing so.”

It was important to ESR in view of their excess of loss cover that the NAIG programme should not include reinsurance. Mr Denton’s evidence was that if he had been told that it included, or would include, reinsurance business, he would not have agreed to write quota shares of the account. I accept that evidence, and consider that ESR have proved this part of their case in respect of both the 1998/99 quota share itself and the agreement to increase their line.

ESR have an alternative case in misrepresentation. They say that the three page placing document provided to them in September 1998 was misleading in two respects:

I do not consider that these parts of the document, whether read in isolation or as part of the document as a whole, bear the interpretation or implications that ESR assert. Moreover, Mr Denton did not give evidence that he so understood the document or that he relied upon it as having that meaning or that it influenced him in any way that assists ESR’s case. I therefore reject these contentions of ESR.

ESR also contend that the three alleged representations constituted warranties in the quota share agreement between Anico and ESR, and that Anico were in breach of them. For the reasons that I have explained, I reject this claim. However, I should in any event have declined to find that the parties evinced an intention to incorporate these matters as terms of the quota share, not least because they did not take steps to have them reflected in the contractual documentation. (In stating this, I do not overlook the opinion expressed by Sir Alan Traill that the wording and terms of the slip, including the deductions, indicated that the NAIG programme comprised direct and not reinsurance business, but this was not part of the case that ESR pleaded and presented). Indeed, ESR’s argument that there was a warranty that the account did not include, or would not include, reinsurance is not easily reconciled with the treaty wording, and ESR do not seek rectification of it.

It is not in dispute that Reliance National presented to NAIU claims arising under the Reliance National policy on the following dates:

The dispute about this claim is a narrow one. I understand it to be common ground, and in any case I find:

ESR pleaded that when the agreement was reached, Anico knew of these losses, but that allegation was not pursued. The losses were known to NAIU. The issue is whether NAIU’s knowledge gives ESR grounds for avoiding the agreement for non-disclosure.

ESR submit that under the Participation and Underwriting Agreement of September 1998, NAIU were obliged to make a report to Anico within 20 days of the end of each calendar month and that it was to include information about losses such as those under the Reliance National policy. They say that, in the ordinary course of business, a managing general underwriter such as NAIU ought to make reports in accordance with their contractual obligations, and therefore in the ordinary course of business NAIU ought to have reported the losses under the Reliance National policy within 20 days of the end of each month. Had they done so, before they concluded the agreement that ESR should increase their participation Anico would have known of the losses incurred to the end of March 1999.

Anico’s response to this argument is that NAIU had a motive not to disclose the losses to Anico because they would have revealed incompetence on their part, and in these circumstances knowledge of the losses is not to be attributed to Anico under the common law, which is reflected in section 18 of the Marine Insurance Act, 1906. In support of this argument, they again cite the judgment of Colman J in Kingscroft v Nissan Fire & Marine (unrep), 4 March 1996, to which I have already referred.

In that case, Colman J struck out an allegation of non-disclosure pleaded by way of defence to a claim under two reinsurance treaties entered into by members of a pool with the defendant company. The treaties had been arranged on behalf of the pool by reinsurance agents, and it was alleged that sums deducted by way of overriders had been wrongfully diverted by directors of the agents. In light of the decisions of the Court of Appeal in PCW Syndicates v PCW Reinsurers, [1996] 1 Lloyd’s LR 241 and Group Josi Re v Walbrook Insurance Co Ltd, [1996] 1 Lloyd’s LR 345, the defendants (to use Colman J’s expression) “sanitised” their pleading to remove all positive allegations of intention to misappropriate on the part of the agents. Colman J declined to allow the defendants to circumvent the Court of Appeal decisions in this way. In the course of his judgment he referred to Proudfoot v Montefiore, (1867) LR 2 QB 511 and Blackburn Low & Co v Vigors, (1887) 12 AC 531, and said that the effect of the speeches in Blackburn Low is that an underwriter is entitled to assume that an agent whose function is to acquire for an assured information of the kind which includes the particular material facts will in the ordinary course of business have passed that information to the assured. He observed that if the agent in question is not an agent to know the particular kind of information, there is no warrant for the assumption that in the ordinary course of business he will have transmitted the information to his principal. He derived from the Hampshire Land case (cit sup) the points that (i) it is relevant to ask whether it is possible to infer the agent to transmit the information will fulfil his duty in respect of the information, and (ii) it is not only in cases of fraud that it might be impossible to infer performance by the agent to transmit. He said that as a matter of general principle, and on the proper construction of section 18 of the 1906 Act, “the circuit of transmission of information may be broken even in cases where the agent … is not fraudulent. It may be broken in all those cases where, because of the nature of the information in question, it cannot be inferred that he will reveal it in the ordinary course of business”.

I am prepared to adopt for the purposes of this judgment the approach of Colman J, although it is to be observed that the Court of Appeal, upon an application for leave to appeal, did not endorse it and would, as I understand the judgment of Brooke LJ [1996] EWCA Civ 903, have granted leave had the appeal otherwise had merit. However, even adopting this approach, it does not seem to me that it assists Anico. After all, NAIU were under an express obligation to report losses. I cannot accept that ordinarily a managing general underwriter would consider that poor results in themselves reveal incompetence on their part; still less can I accept that in the ordinary course of business a managing general underwriter would, in breach of express obligations, fail to report losses for that reason. After all, in due course the losses will have to be made known to the insurer if they are to be paid. The facts of this case are far removed from those arising in the Kingscroft case, and the observations of Colman J do not, in my judgment, apply to them.

It follows that I accept ESR’s argument that they are entitled to avoid the agreement to increase their line in the 1998/99 quota share because of non-disclosure of the losses arising from the Reliance National policy.

In their Particulars of Claim ESR pleaded a case that the 1998/99 quota share does not respond to some claims made by Anico, namely claims arising from:

This part of the pleaded case, which is not reflected in ESR’s prayer for relief, was not mentioned by Mr Wynter when he opened ESR’s case (although a brief reference to it was made in his written opening) and it was not developed by ESR during the trial before me. In Mr Wynter’s written closing submissions, this claim was briefly mentioned, but the argument was not developed beyond the statement that Mr. Cauldwell agreed with it in so far as it relates to the Reliance National policy. No reference is made to the fact that Mr. Rendall is recorded in the joint memorandum of the experts’ discussions as disagreeing with Mr. Cauldwell about this, and Mr. Rendall (like Mr. Cauldwell) was not cross-examined about this. In view of my conclusions that ESR are entitled to avoid the 1998/99 quota share, the point does not arise. Had it done so, I should have asked for further submissions about it.

I conclude that ESR are entitled to avoid the 1998/99 quota share itself and the agreement to increase participation because of non-disclosure about Mr Drobny’s background, and that they would be entitled to avoid the agreement to increase participation because of non-disclosure of losses. I shall hear submissions about the order that I should make.