First decision on s11 Insurance Act (causation test for breach of warranty)
Ever since the introduction of the Insurance Act 2015, there has been debate about how causation works in the context of section 11 and in particular the provision in sub-section 11(3) whereby the policyholder is excused from the usual consequences of a breach of warranty if it can show that its “non-compliance with the [warranty] could not have increased the risk of the loss which actually occurred in the circumstances in which it occurred.”
Policyholders had thus argued, despite the Law Commission having said this was not what it had intended, that this introduced a strict causation test. For example, where the policyholder had warranted that it had a burglar alarm but it failed to set it, it would (it argued) be open to it to show that this particular burglary was undertaken by thieves so sophisticated that setting the alarm would have made no difference - even if setting the alarm would decrease the risk of burglary in general.
Likewise, a policyholder would wish to argue that, on the actual facts of its loss, a warranty had been breached in only a minor respect, which made no difference, even if a more serious non-compliance would unquestionably have affected the likelihood of that particular loss.
This argument has now been considered, and rejected, by Mrs Justice Dias in her decision on 26 July in Mok Petro v Argo. This was a highly complex case concerning contaminated commodities, and the breach of warranty issue features only briefly at the end of the judgment. On that issue, the Judge said as follows:
“There is nothing in the wording of the section to suggest that where a term can be breached in more than one way, it is only the particular breach which must be looked at. On the contrary, it seems to me that section 11 is directed at the effect of compliance with the entire term and not with the consequences of the specific breach. … I therefore conclude that [Counsel for the Insurers] is right about this. There was no serious dispute that compliance with the warranty as a whole was capable of minimising the risk of water contamination … and that therefore non-compliance could have increased the risk of the loss which actually occurred.”
The full judgment is here: https://www.bailii.org/ew/cases/EWHC/Comm/2024/1555.pdf
Jonathan Corman is a Partner at Fenchurch Law.
CrowdStrike Outage - Insurance Recoveries
Many businesses have suffered losses following a catastrophic IT failure when an update released on 19 July by US cybersecurity firm, CrowdStrike, caused crashes on Microsoft Windows systems globally.
We are recommending that policyholders review the scope of coverage available under their cyber and property damage/business interruption insurance.
What to look out for:
- Is there cyber cover for system failure that responds to accidental (i.e. non-malicious) events such as this?
- Are there any relevant business interruption waiting periods to consider?
- What other losses are covered – such as the cost of data restoration, incident response and voluntary shutdown?
- Is there cover for supply chain failure?
- In the context of PD/BI policies, the ‘damage’ trigger will need careful consideration.
What steps do you need to take?:
- Ensure timely compliance with notification provisions and other claims conditions
- Have steps been taken to mitigate losses so far as possible?
- Make sure accurate records are kept of the sequence of events and the losses that have been incurred as a result of the outage.
Please get in touch if we can be of any assistance, or if you have any queries.
Joanna Grant is the Managing Partner of Fenchurch Law
Climate Risks Series - Part 1: Climate litigation and severe weather fuelling insurance coverage disputes
The global rise in climate litigation looks set to continue, with oil and gas companies increasingly accused of causing environmental damage, failing to prevent losses occurring, and improperly managing or disclosing climate risks. Implementation of decarbonisation and climate strategies is subject to scrutiny across all industry sectors, with claims proceeding in many jurisdictions seeking compensation for environmental harm as well as strategic influence over future regulatory, corporate or investment decisions.
Evolving risks associated with rising temperatures have significant implications for the (re)insurance market as commercial policyholders seek to mitigate exposure to physical damage caused by severe weather events; financial loss arising from business interruption; liability claims for environmental pollution, harmful products or ‘greenwashing’; reputational risks; and challenges associated with the transition towards clean energy sources and net zero emissions.
Litigation Trends
Cases in which climate change or its impacts are disputed have been brought by a wide range of claimants, across a broad spectrum of legal actions including nuisance, product liability, negligence, fiduciary duty, human rights and statutory planning regimes. Approximately 75% of cases so far have been commenced in the US, alongside a large number in Australia, the EU and UK.
Science plays a central role and can be critical to determining whether litigants have standing to sue. The emerging field of climate physics allows for quantification of greenhouse gas (“GHG”) emitters’ responsibility, with around 90 private and state-owned entities found to be responsible for approximately two-thirds of global carbon dioxide and methane emissions. Recent advances in scientific attribution may provide evidence for legal causation in claims relating to loss from climate change or severe storms, flooding or drought.
Directors of high-profile companies may be personally targeted in such claims as liable for breach of fiduciary duties to the company or its members, in failing to take action to respond to climate change, or approving policies that contribute to harmful emissions.
Recent Cases
An explosion of ‘climate lawfare’ has kicked off in recent years, with the cases highlighted below indicative of key themes.
Smith v Fonterra [2024]
The New Zealand Supreme Court reinstated claims, struck out by lower courts, allowing the claimant Māori leader with an interest in customary land to proceed with tort claims against seven of the country’s largest GHG emitting corporations, including a novel cause of action involving a duty to cease materially contributing to damage to the climate system. This was an interlocutory application and the refusal to strike out does not mean that the pleaded claims will ultimately succeed on the merits. However, the judgment is significant in demonstrating appellate courts’ willingness to respond to the existential threat of climate change by allowing innovative claims to be advanced and tested through evidence at trials.
R v Surrey County Council [2024]
In a case brought by Sarah Finch fighting the construction of a new oil well in Surrey, the UK Supreme Court (by a 3:2 majority) ruled that authorities must consider downstream GHG emissions created by use of a company’s products, when evaluating planning approvals. The Council’s decision to grant permission to a developer was held to be unlawful because the environmental impact assessment for the project did not include consideration of these “Scope 3” emissions, when it was clear that oil from the wells would be burned.
Verein KlimaSeniorinnen [2024]
An association of over 2,000 older Swiss women complained that authorities had not acted appropriately to develop and implement legislation and measures to mitigate the effects of climate change. The Grand Chamber of the European Court of Human Rights held that Article 8 of the European Convention encompasses a right for individuals to effective protection by state authorities from serious adverse effects of climate change on their life, health and wellbeing. Grand Chamber rulings are final and cannot be appealed: Switzerland is now required to take suitable measures to comply. While not binding on national courts elsewhere, the decision will be influential.
ClientEarth v Shell [2023]
The English High Court dismissed ClientEarth’s attempt to launch a derivative action against the directors of Shell plc in respect of their alleged failure to properly address the risks of climate change, indicating that claims of this nature brought by minority shareholders will face significant challenges. The Court noted that directors (especially those of large multinationals) need to balance a myriad of competing considerations in seeking to promote the success of the company, and courts will be reluctant to interfere with that discretion, making it harder to establish that directors have breached their statutory duties.
US Big Oil lawsuits
Following lengthy disputes over forum, proceedings against oil and gas companies in the US are gaining momentum, paving the way for the claims to be substantively examined in state courts. Many actions against the fossil fuel industry seek to establish that defendants knew the dangers posed by their products and deliberately concealed and misrepresented the facts, akin to deceptive promotion and failure to warn arguments relied upon in other mass tort claims in the US, arising from the supply of tobacco, firearms or opioids.
Implications for Policyholders
With increasing volatility and accumulation risk, insurers will look to mitigate exposures through wordings, exclusions, sub-limits and endorsements. The duty to defend is the first issue for liability insurers, given the number of policyholders affected and the potential sums at stake in indemnity and defence costs.
In 2021, the Lloyd’s Market Association published a model Climate Change Exclusion clause (LMA5570). Property policies exclude gradual deterioration, with express wording or impliedly by the requirement of fortuity, and liability insurance typically excludes claims arising from pollution.
Lawsuits have been filed in the US over insurance coverage for climate harm, including Aloha Petroleum v NUF Insurance Co of Pittsburgh (2022), arising from claims by Honolulu and Maui, and Everest v Gulf Oil (2022), involving energy operations in Connecticut. Policy coverage may depend on whether an “occurrence” or accident has taken place, as opposed to intentional acts or their reasonably anticipated consequences (Steadfast v AES Corp (2011).
Policyholders should review their insurance programmes with the benefit of professional advice to ensure adequate cover for potential property damage, liability exposures and legal defence costs.
In the following instalments of our Climate Risks Series, we will examine the impact of reinsurance schemes and parametric solutions, and coverage for storm and flood-related perils in light of recent claims experience.
Authors
Amy Lacey, Partner
Ayo Babatunde, Associate
Queenie Wong, Associate
"Top Down" still top law: RSA & Ors v Textainer
In the recent decision of Royal & Sun Alliance & Ors v Textainer Group Holdings Limited & Ors [2024] EWCA Civ 542, the Court of Appeal rejected an attempt by Insurers to avoid the application of the (seemingly) well-established “top down” principle to the allocation of recoveries.
Background
The (much simplified) background was as follows.
Textainer is one of the largest owners/suppliers of shipping containers.
In 2016, approximately 113,000 of its containers were on lease to a Korean company, Hanjin Shipping Co Limited (“Hanjin”). Hanjin became insolvent, and Textainer incurred a significant loss, partly in relation to containers which were never recovered and partly in relation to the cost of retrieving/repairing the others, as well as lost rental income.
Textainer had a “container lessee default” insurance programme, written in layers up to (for present purposes) $75 million, with a $5m retention. Textainer’s overall loss, as a result of Hanjin’s default, was approximately $100m. It absorbed the first $5m through its retention, and its primary and excess layer insurers (“Insurers”) paid out policy limits amounting to $75m, leaving an uninsured loss of $20m.
Textainer subsequently recovered approximately $15m in Hanjin’s liquidation.
Under ordinary “top down” principles, all of that recovery would have inured to Textainer. Insurers nevertheless claimed that they were entitled to a proportionate element of it (amounting, on the above figures, to approximately 75%).
The top down principle, and Insurers’ attempt to circumvent it
The top down approach to the allocation of recoveries was established by the House of Lords’ decision in Lord Napier and Ettrick v Hunter[1993] AC 713. It equates to assuming that the recoveries are made simultaneously with the loss and then considering how the net loss would be borne (ie, first by the retention/deductible, then by the primary layer, then carrying up the excess layers, and finally to the uninsured element).
Insurers argued that the policies in the present case were distinguishable from the stop loss policies considered in Napier. The stop loss policies, they argued, applied to a single (or "unitary") financial loss for a specified period of underwriting by the name. In contrast, the container lessee default policies did not (they argued) insure a unitary loss, but “covered the physical loss of or damage to individual containers and related costs/loss of earnings as and when those losses were incurred, eroding first the retention, then the layers of cover, one by one”.
Insurers argued that there was a fundamental distinction between the case of a single or unitary loss (as considered in Napier) and that of multiple losses, such as the present case. They argued that, although in the former case subsequent recoveries would reduce that single loss top down, where there were “multiple losses of different items of property at different times, recoveries in respect of those specific items not only could but must be allocated to the insurer who had indemnified against their loss”.
However, those arguments were at odds with the decision by Langley J in Kuwait Airways Corporation v Kuwait Insurance Co S.A.K [2000] 1 Lloyd’s Rep 252 (“Kuwait Airways”).
Kuwait Airways
In that case, the policyholder, Kuwait Airways (“KAC”), had lost 15 aircraft when they were seized Iraqi forces during the 1990 invasion of Kuwait. The relevant aviation insurers paid KAC the policy limits of $300m, leaving it with $392m of uninsured losses.
Subsequently, 8 of the aircraft, valued at c $395m, were recovered. Under conventional top down principles, that recovery would have inured to KAC, leaving its residual loss covered by the insurance payout.
The aviation insurers nevertheless attempted to have the value of the recovered aircrafts apportioned pro rata between them and KAC, on the supposed basis that “each aircraft loss was a separate loss, exemplified by the fact that each had its own agreed value in the policy, the premium was based on that value and…the payment made of $300m was in effect a payment of 300/692 of the agreed value of each aircraft”.
Langley J rejected that argument. He held that there could not be:
“… any justification for “disaggregating” recoveries where there is an aggregate limit to the indemnity. Moreover the aggregate limit (in the case of one occurrence) applied regardless of the number of aircraft lost…whether or not there were a number of losses or only one loss (there was certainly only occurrence) is my judgment nothing to the point…”.
He also held that:
“… that conclusion accords with commercial good sense. Had KAC lost only the 7 aircraft which were in fact destroyed, its insurers would unarguably have had to pay up to the limit of the indemnity without any recovery. It would be remarkable if the policy was to be so construed that, because KAC lost those 7 aircraft but also 8 others which were later recovered intact, insurers became entitled to a credit for proportion of the value of the aircraft recovered”.
Faced with those comments, which seemed to apply so closely to the present case, Insurers were compelled to submit that Kuwaiti Airwayscould be distinguished or, failing that, was wrongly decided.
The Court of Appeal’s decision
Insurers had lost in the Commercial Court in front of David Railton KC, sitting as a Deputy Judge, and were no more successful when they appealed to the Court of Appeal.
The Court of Appeal’s judgment was given by Phillips LJ, with Arnold & Falk LJJ concurring.
The Court of Appeal agreed with the Deputy Judge that the true nature of Textainer’s insurance was cover “against particular layers of loss” and that, if recoveries were not applied top down but proportionately to the insured layers as well as to the uninsured losses, Textainer would not receive the extent of the indemnity for which it had contracted. Moreover, Textainer would, if Insurers were correct, have been in a worse position than if the recoveries had been achieved before Insurers had paid out. By contrast, Dillon LJ, in the Court of Appeal in Napier, was clear that the outcome should be the same “whether the underwriters have or have not already paid the amount for which they are liable for the time the recovery is achieved”.
In short, the Court of Appeal agreed with Textainer that the reality was that the insurance was not provided in relation to individual containers, most of which, if lost, would eventually be recovered, but that “the real subject of the insurance is the multiple strands of lost rental, costs and expenses which will be ongoing and intertwined…”
Accordingly Insurers’ challenge to the top down principle failed.
Other issues
The Court of Appeal’s judgment covered two other issues.
(a) Which losses were paid by whom?
This was a factual issue. Some of Textainer’s containers had been leased to Hanjin on operating leases and some on finance leases. However, the settlement by the liquidator only applied to the containers supplied on operating leases.
This required Insurers to show (assuming their challenge to the top down principle had succeeded) precisely which containers they had indemnified and which formed part of Textainer’s uninsured loss. Only then could one allocate the recovery.
Insurers argued that there should be a “pragmatic assumption” that the losses in respect of finance leases would have occurred at the same time as, or at least in proportion to, losses in respect of operating leases, so that there was nothing to stop a pro rataapportionment of the recovery between insured and uninsured losses.
The Court of Appeal rejected that approach. It said it had been open to Insurers to adduce evidence on this issue and that, having failed to do so, they could not resort to an assumption.
(b) Under-insurance
Finally, Insurers sought belatedly to argue that, because there had been an element of uninsured loss, this indicated that Textainer had been under-insured and that its loss should be reduced by the application of average.
That argument failed. Phillips LJ held the concept of under-valuation or under-insurance has no relevance to insurance written in layers. Unlike a single policy insuring (say) a ship, where under-insurance exposes the insurer to the same risk (up to the limit of cover) but the premium has been unfairly supressed, where cover is written in layers, the cover by definition matches precisely the value of the risk which the insurer has accepted.
Conclusion
It is gratifying that Insurers’ attempt to circumvent the top down principle was so robustly rejected by the Court of Appeal. Likewise, its clarification that under-insurance and average have no relevance to insurance written in layers will also be welcomed by policyholders.
Non-damage property cover in political violence insurance: Hamilton Corporate Member Ltd v Afghan Global Insurance Ltd
On 12 June, the Commercial Court handed down judgment in an important case for the political violence insurance market regarding the meaning of “direct physical loss” and also of the seizure exclusion.
Hamilton Corporate Member Ltd v Afghan Global Insurance Ltd [2024] EWHC 1426 (Comm) arose out of the Western withdrawal from Afghanistan and the subsequent assumption of control by the Taliban. In August 2021, Anham, the original insured, lost its warehouse at the Bagram airbase in Afghanistan when it was seized by the Taliban. Anham sought to recover the US$41m loss under its political violence policy which had been issued by an Afghani insurer, which in turn was reinsured by the Claimant reinsurers.
The Exclusion
The reinsurers denied the claim (and sought summary judgment for a declaration of non-liability), relying on the following exclusion:
“Loss or damage directly or indirectly caused by seizure, confiscation, nationalisation, requisition, expropriation, detention, legal or illegal occupation of any property insured hereunder, embargo, condemnation, nor loss or damage to the Buildings and/or Contents by law, order, decree or regulation of any governing authority, nor for loss or damage arising from acts of contraband or illegal transportation or illegal trade.”
Anham sought to argue that the exclusion was inapplicable, on the grounds that in the context of the exclusion the “seizure” had to be carried out by a governing authority, which could not be said of the Taliban at the material time. However, the court (Calver J) had little difficulty in holding that the exclusion did apply, on the basis that in both settled case law and ordinary language “seizure” means “all acts of taking forcible possession, either by a lawful authority or by overpowering force”. Clearly, the Taliban fell into the latter category. The court also rejected Anham’s submission that it should not reach a decision without first hearing expert evidence as to how the political violence insurance market understood this exclusion.
Direct physical loss
The Judgment also shed light on how the Courts in this context will construe the “physical loss” of property.
The policy contained the following Interest provision:
“In respect of Property Damage only as a result of Direct physical loss of or damage to the interest insured”.
Likewise, Insuring Clause 2 indemnified Anham against “Physical loss or physical damage to the Buildings and Contents”.
Anham submitted that the warehouse had been lost, on the grounds that it had been irretrievably deprived of possession of it because of the Taliban. In making this argument, Anham sought to rely on the definition in the Marine Insurance Act 1906 of constructive total loss (namely, that, where an insured is deprived of his property and there is little chance of recovery, the courts will consider that a constructive total loss). However, Calver J unhesitatingly held that, in the context of a political violence insurance policy, “direct physical loss” meant physical destruction, not mere deprivation of use.
Interestingly, the Judgment did not cite cases such as Moore v Evans [1917] 1 KB 458 (CA) [1918] AC 185 (HL) or Holmes v Payne [1930] 2 KB 301, which held that the word “loss” was not qualified by the word “physical”.
Summary
The Judgment in Hamilton is plainly unhelpful to policyholders insured under the AFB Political Violence wording, which is widely used in the London market. Unless successfully appealed, (re)insurers are likely now to reject any claim based on this wording for loss of property where the hostile forces have not caused any actual damage to the insured interest, notwithstanding that their actions deprived the insured of the use of or access to it.
Authors
Jonathan Corman, Partner and Dru Corfield, Associate
No clear mistake and no clear cure – disappointing result in the Court of Appeal for W&I policyholder
A recent decision of the Court of Appeal, Project Angel Bidco Ltd (In Administration) v Axis Managing Agency Ltd & Ors [2024] EWCA Civ 446, provides guidance in relation to the interpretation of exclusion clauses and alleged drafting errors in warranty and indemnity (“W&I”) policies.
Background
The Parties
The Appellant, Project Angel Bidco Ltd (“PABL”), was insured under a W&I policy (“the Policy”).
PABL had purchased the shares in Knowsley Contractors Limited (trading as King Construction) (“King”). The Share and Purchase Agreement (“SPA”) included a number of warranties, listed in a Cover Spreadsheet to the Policy, including in relation to anti-corruption legislation.
King in fact became embroiled in allegations of corruption. It went into liquidation and PABL itself went into administration. PABL had paid £16.65 million for the shares. It claimed that the warranties had been incorrect, such that the true value of the shares was negligible or at most £5.2 million, and accordingly made a claim against the Respondents, Axis Managing Agency Limited and others (“Insurers”), for an indemnity under the Policy.
The Cover Spreadsheet
The Cover Spreadsheet contained a list of “Insured Obligations” which included warranties 13.5 (a) to (h) (“Warranty 13.5”). The spreadsheet contained the following rubric:
“Notwithstanding that a particular Insured Obligation is marked as “Covered” or “Partially Covered”, certain Loss arising from a Breach of such Insured Obligation may be excluded from cover pursuant to Clause 5 of the Policy.”
The Insured Obligations at Warranty 13.5 were all marked as “Covered”.
ABC Liability
The Policy stated that:
“The Underwriters shall not be liable to pay any Loss to the extent that it arises out of…
5.2.15. any ABC Liability” (“the ABC Liability Exclusion”).
ABC Liability was defined as "any liability or actual or alleged non-compliance by any member of the Target Group or any agent, affiliate or other third party in respect of Anti-Bribery and Anti-Corruption Laws”. [Emphasis added.]
The Overarching Issue
This appeal was concerned with the conflict between the “Covered” Insured Obligations at Warranty 13.5 and the ABC Liability Exclusion.
PABL argued that the scope of the Insured Obligations at Warranty 13.5 contradicted the ABC Liability Exclusion, as no loss arising out of a breach of Warranty 13.5 would ever be covered by the Policy. The Court explored the alleged conflict by asking four questions:
- Was there an inconsistency as alleged by PABL?
- If there was inconsistency, did the Policy resolve it?
- Was there something wrong with the language of the ABC Liability Exclusion?
- If a mistake had been made, was there a clear cure?
Was there an inconsistency?
Insurers argued that Warranty 13.5(e) (that the company maintained a record of all entertainment, hospitality and gifts received from a third party) and 13.5(h) (in relation to the award of contracts under the Public Contracts Regulations 2006) fell outside the exclusion. However, the Court of Appeal accepted there was a conflict between the entirety of Warranty 13.5 and the ABC Liability Exclusion.
Did the Policy resolve the inconsistency?
Insurers argued the structure of the Policy meant that the Cover Spreadsheet was subordinate to the ABC Liability Exclusion. This relegated the Cover Spreadsheet to being a “summary document”, purely intended to show which warranties were in scope of the Policy. The Court of Appeal disagreed, noting that the definition of “Insured Obligations” was linked to the Cover Spreadsheet.
Secondly, Insurers argued that the ABC Liability Exclusion was a heavily negotiated term and therefore more significant than the Cover Spreadsheet. The Court of Appeal accepted this, since the definition of ABC Liability was “detailed and wide ranging”, whereas the classification of warranties as “Covered”, “Excluded” or Partially Covered” was much broader.
Thirdly, Insurers argued the rubric in the Cover Spreadsheet showed that the ABC Liability Exclusion would take precedence, and the Court of Appeal agreed.
Was there something wrong with the language?
The Court of Appeal emphasised that, in order to correct an alleged error in a contract, it has to be clear there has been a mistake. In the first instance decision, the Judge had interpreted the ABC Liability Exclusion as follows:
“As drafted the definition would appear to cover three different species of ABC liability being:
- i) Any liability … in respect of Anti-Bribery and Anti-Corruption Laws;
- ii) Any … alleged non-compliance by any member of the Target Group or any agent, affiliate or other third party in respect of Anti-Bribery and Anti-Corruption Laws; and
iii) Any … actual … non-compliance by any member of the Target Group or any agent, affiliate or other third party in respect of Anti-Bribery and Anti-Corruption Laws.”
PABL objected to this interpretation on the grounds that a reasonable reader would expect the word “liability” to be used in the sense of liability “for” something, suggesting that the word “or” had been included by mistake and the ABC Liability definition should be interpreted as "any liability [f]or actual or alleged non-compliance …”.
The Court of Appeal concluded that, although liability would often be referred to in the context of responsibility “for” something, it would not be unusual to refer to liability “in respect of”, “arising from” or “in connection with” an excluded peril. Therefore, despite the apparent contradiction, there was nothing wrong with the language of the ABC Liability Exclusion and no drafting error could be established.
Was there an obvious cure?
For completeness, the Court of Appeal went on to consider whether there was a “clear cure” for the alleged mistake. Assuming that there was a contradiction between the ABC Liability Exclusion and Warranty 13.5 because of a drafting mistake, Insurers had a coherent and rational reason for wanting to avoid liability for loss arising out of ABC Liability, and it was unclear whether any supposed error was in the drafting of the ABC Liability exclusion or the Cover Spreadsheet. It was held therefore that no clear cure existed for the alleged mistake.
The Decision
In summary, the Court of Appeal by majority (Lewison LJ, with whom Arnold LJ agreed) found in favour of Insurers and the appeal was dismissed.
In a dissenting judgment, Phillips LJ found in favour of PABL, concluding that there was a “fundamental inconsistency” between the ABC Liability Exclusion and Warranty 13.5. This was highlighted by the fact that the Policy exclusion did not define “liability” and losses arising from non-compliance were excluded.
Impact on policyholders
The decision illustrates the importance of careful drafting of policy wordings to avoid ambiguity, with particular attention to the interaction of potentially overlapping insured and excluded perils. The scope of coverage may be significantly impacted by minimal changes to punctuation or connecting words.
The English Courts are likely to uphold the literal effect of contract terms even in the face of apparent inconsistency, in the absence of compelling evidence for a clear cure in respect of an obvious drafting error.
Ayo Babatunde is an Associate at Fenchurch Law
What is unfairly prejudicial conduct entitling a shareholder to relief from the Court – and are such claims indemnified under the company’s D&O Policy?
Successive versions of the Companies Act (most recently Section 994 of the 2006 Act (“CA 2006”)) have provided protection and relief for minority shareholders against unfairly prejudicial conduct of the company’s affairs by majority/controlling shareholders and the board of directors.
However, the petitioning shareholder has the burden of establishing such conduct.
The recent case of Re Cardiff City Football Club (Holdings) Ltd [2022] EWHC 2023 (Ch) (summarised below) emphasises that (i) even if a majority shareholder’s conduct is vindictive, unpleasant or morally unfair, it does not always follow that it will be classed as unfairly prejudicial and (ii) the conduct of a majority shareholder, even if unfairly prejudicial, must be within the affairs of the company itself, and not merely carried out in his or her personal capacity.
Background
Mr Issac was a minority shareholder in Cardiff City Football Club (Holdings Limited) (“the Company”) which is the holding company of Cardiff City Football Club (“the Football Club”). He brought a petition against Vincent Tan and the Football Club on the grounds that Company’s affairs had been conducted in a prejudicial manner. The claim related to an open offer of shares made by the Company following a board resolution in May 2018. Mr Tan was the majority shareholder of the Company who before the offer of shares owned 94.22% of the issued shares. No other shareholders took up the offer of shares. This increased Mr Tan’s shareholding to 98.3% and Mr Issac’s was reduced from 3.97% to 1.18%.
Mr Issac argued that this dilution was prejudicial because the value of his shares was diminished. He argued that the whole offer was arranged by Mr Tan due to his animosity to Mr Issac rather than for any proper commercial purpose. Whilst the Board of Directors approved the offer, Mr Issac contended that it had merely “rubber stamped” Mr Tan’s decision, in breach of Section 173 of the CA 2006, which requires directors to exercise their own independent judgment, and of Section 171 of the CA 2006, which requires an allotment of new shares to be for a proper purpose.
Mr Tan denied these allegations. He argued that he provided consideration for the new shares issued to him by agreeing to write off £67 million which was owed to him by the Company. Therefore, Mr Tan argued there was a good commercial purpose behind the offer - which improved the Company’s balance sheet - and it was not because of any animosity towards Mr Issac. and that the directors had exercised their allotment power for a proper purpose.
Mr Issac sought an order that Mr Tan should buy his shareholding for a fair value. He sought an order for sale on the basis of a 3.97% shareholding as opposed to a 1.18% shareholding.
Decision
In deciding whether there was any unfair prejudice, the Court asked the following three questions:
- Was Mr Tan's conduct the conduct of the Company’s affairs?
- Did the directors act independently?
- Did the directors act for a proper purpose?
Was Mr Tan's conduct the conduct of the Company’s affairs?
The Court answered that question in the negative.
Mr Issac argued that Mr Tan used his position as a majority shareholder to put pressure on the Board to give in to his demands. However, the Court held that this could not be seen as conduct of the Company because these acts were a personal or a private act. The Court cited Re Unisoft Group Ltd (No. 3) [1994] 1 BCLC to distinguish between the acts or conduct of a company and the acts of a shareholder in his private capacity. The Court held Mr Tan was entitled “qua” shareholder and creditor to exert commercial pressure and act in his own interests.
The Court acknowledged that Mr Tan did have personal animosity to Mr Issac, which was part of the reason he made the open offer of shares, and that his conduct was vindictive and unpleasant.
However, the Court held that there was nothing unlawful or unconscionable in Mr Tan's actions, and that what he did was unfair in a moral but not in a legal sense. There was no Shareholders' Agreement, and no provisions in the Articles of Association had been infringed. Accordingly, there was no breach of anything referable to the affairs of the Company.
The mere fact that respondents have caused prejudice to the petitioner does not always mean there has been unfairness. So, where two companies were always run as a single unit in disregard of the constitutional formalities of both of them, but with the acquiescence and knowledge of the petitioners, there was prejudice, but no unfairness (Jesner v Jarrad Properties [1992] BCC 807)
Conversely, conduct by those in control of the company may be unfair and reprehensible but not prejudicial. So, where directors entered into transactions pursuant to which (despite obvious conflicts of interest) they purchased company assets, this was unfair but no section 994 remedy was granted, as the price paid by the directors was not less than the company would have obtained from an arm’s length purchaser (Rock Nominees Limited v RCO (Holdings) Plc (In Liquidation) [2004] 1 BCLC 439 CA).
Did the directors act independently?
The Court held that the directors did act independently. There was a justifiable commercial rationale for what the Board was being asked to do. Board minutes were prepared in advance of the meeting, but there was nothing inherently wrong with that, so long as the Board had the opportunity to take its own view as the meeting developed.
Did the directors act for a proper purpose?
The Court decided that the directors did act for a proper purpose.
The Court cited Howard Smith v Ampol Petroleum [1974] AC 821, which held it would be "too narrow an approach to say that the only valid purpose for which shares may be issued is to raise capital for the company".
The allotment of the shares was deemed as being for a proper purpose, namely clearing debt owed to Mr Tan. This would improve the Company's balance sheet and provide greater financial stability.
Therefore, the Court concluded that there was no unfair prejudice.
Impact on D&O Policyholders
Directors’ and Officers’ (D&O) policies will usually respond if there has been a claim made for a wrongful act by a director, provided the director has been acting in that capacity (rather than as a shareholder). The policy will likely provide indemnity or defence costs of any director against such allegations, which is important protection as such costs cannot lawfully be met by the company.
However, in this case, because Mr Tan was held to have been acting in a personal capacity (rather than as a director in the conduct of the Company’s affairs), his costs are unlikely to have been indemnified under the Company’s D&O policy.
Ironically, the very grounds relied upon by Mr Tan and the nature of the Company’s defence would themselves have excluded the right to indemnity for defence costs under the policy, and the directors would have to seek reimbursement of costs from the unsuccessful petitioner.
This case serves as a reminder that personal acts of directors, outside the scope of their directorial duties, cannot be relied upon in claims for minority shareholder relief, and nor will they be indemnified under the company’s D&O policy, if the subject of third-party claims.
Authors
Michael Robin, Partner
Ayo Babatunde, Associate
The End of Days, or Just the Beginning? Current AI use
It’s seemingly the only thing anyone can talk about. It is hard to go to any conference, panel discussion or networking event without someone paying it lip service. And most cyber articles, opinion pieces or business plans contain some nebulous reference to it. Artificial Intelligence (“AI”) is certainly the flavour of the month. But what it is, how is it used and what does it mean for us all? This article will look at the development of AI and hopefully alleviate concerns by demonstrating how it has been part of our everyday lives for some time.
Part of the problem is that most definitions of AI are either too complicated or too broad. One with which most people work is something along the lines of “AI is a computer’s ability to perform the cognitive functions or abilities that we usually associate with the human mind”. This tends to make people think of HAL from 2001: A Space Odyssey or the more recent example of ChatGPT. But AI elements are far more ingrained in our lives than science fiction or Large Language Models. Regardless of how we view AI, it is very much present in our everyday world; whether in the personal space of helping to enable safer online payments, or travelling to work through our smartphones, to offering greater efficiency for businesses and their clients through automation and autonomy.
Although the history of AI can be traced back to 1950 – for example, Alan Turing’s paper entitled ‘Computing Machinery and Intelligence’ [1] – for present purposes it makes sense to start in the late 1970s. The 1950s to mid-1970s were a time of great advancement for AI but (like ordinary computers) they had less impact on everyday lives. The emergence of arcade games in the late 1970s can be viewed as perhaps the earliest widespread societal engagement with AI. Games like Pong, Space Invaders and Pacman may not be what spring to mind when we think of AI, but the way in which the computer responded in real time to the player’s actions can certainly be considered as artificially intelligent gameplay. Similarly, the 1997 defeat of Gary Kasparov, chess world champion, by IBM’s ‘Deep Blue’ AI system has been viewed as a milestone in the history of AI. At the time, there was widespread unease that a computer had defeated one of humanity’s great intellectual champions.
In the grand scheme of things, however, AI in the 20th century was far more widespread in popular culture than in everyday life. After 2001: A Space Odyssey, films like Star Wars, Alien, Blade Runner, The Terminator, RoboCop and The Matrix had great impact in shaping society’s (mis)understanding about AI. The dystopian sci-fi genre of cinema has perhaps been the single biggest contributor to the concern and fear around the technology. Most of the stories in these films centre around the concept of computers ‘taking over’ and subduing humanity. This unhelpfully incepted ideas about the scope and purpose of AI in the popular conscience, despite the fact that the grand narratives were entirely fictitious.
In reality, AI deployment is more nuanced, precise and limited. While the potential of the technology is astounding, the current everyday uses of AI are surprisingly narrow (meaning task-specific) albeit certainly widespread. If you unlock your smartphone with facial recognition, you use AI several times a day. If you have predictive text enabled on texts or emails, you use AI whenever you are drafting. When you use maps on your phone to navigate a car or public transport journey, the real time traffic and transport updates are analysed and evaluated by AI to assess the swiftest route. If you call a service provider and speak to an automated voice – that’s AI. If you engage with a customer chatbot – that’s AI too. If you have social media and engage with suggested posts/videos, the AI algorithms that show the content have prioritised posts based on previous ‘likes’, your location, wider online activity and user demographic. Similarly, if you use Spotify or Apple Music, AI assesses your music taste and playlists and creates a track list in a similar vein.
In business, if your company does not use AI, it is almost certain that one of your service providers does. For example, while London-based law firms are unlikely to develop their own AI software, it is highly likely that their disclosure providers use AI in document review and processing. And in healthcare, it is highly likely your local hospital is using AI, given that NHS Trusts use AI to analyse X-ray images to support radiologists make assessments. AI is also used to assist clinicians with interpreting brain scans. Whenever you fly on a plane, air traffic control systems log your flight data and use it to feed AI systems that aid efficiency in air traffic management. And in the military, AI has been used in autonomous ground vehicles and unmanned drones and it assists in the prevention of cyber warfare. Even the food you eat may have been produced with the assistance of AI, given that sophisticated farms use AI and drones to analyse soil health, crop health and yield potential, thereby applying fertilisers and water more precisely – which optimises resource use and minimises environmental impact. In short, AI has permeated consumer life, healthcare, travel, defence and agriculture in ways that may not have been realised by the man on the Clapham omnibus but are highly unlikely to be reversed.
So AI is here to stay. But it is not omnipotent, and it is not yet omnipresent. It’s been around for far longer than ChatGPT although has had more targeted deployment than people tend to think. And you’re likely using it every day. While we can’t say for sure how the technology will develop, it’s not a future discussion: it’s already happening. AI has almost certainly improved efficiency and ease in your life and hasn’t locked the pod bay doors just yet.
This is the first in a series of articles about AI by Dru Corfield and Dr Joanne Cracknell.
Dru Corfield is an Associate at Fenchurch Law and inaugural committee member of the City of London Law Society’s AI Committee. Fenchurch Law was the first law firm in the UK to focus exclusively on representing policyholders in coverage disputes with their insurers and is top-ranked by both Legal 500 and Chambers.
Dr Joanne Cracknell is a Director in the Legal Services PI Team, Global FINEX, WTW. E: joanne.cracknell@wtwco.com W: https://www.wtwco.com/en-gb/solutions/services/legal-services-practice
WTW (Willis Towers Watson) is a global insurance broker, multidisciplinary consultancy, and risk advisor with a mission to empower companies amidst rapid change
[1] Source: Turing, Alan M. (1950). Computing machinery and intelligence. Mind 59 (October): 433-60.
Risk, Regulation and Rewards: Regulatory Developments in Artificial Intelligence
With the Government’s White Paper consultation – “A pro-innovation approach to AI regulation” – having closed at the end of June, and the UK scheduled to host the first global summit on AI regulation at Bletchley Park in early November, now is an appropriate time to assess the regulatory lay-of-the-land in relation to this nascent technology.
White Paper
The White Paper was originally published on 29 March 2023. It sets out a roadmap for AI regulation in the UK, focusing on a “pro-innovation” and “context-specific” approach based on adaptability and autonomy. To this end, the Government did not propose any specific requirements or rules (indeed, the White Paper does not give a specific definition of AI), but provided high-level guidance, based on five ‘Principles’:
- Safety, security and robustness;
- Appropriate transparency and explainability;
- Fairness;
- Accountability and governance;
- Contestability and redress.
The White Paper is, in essence, an attempt to control the use of AI but not so overbearingly as to stifle business or technological growth. Interestingly, the proposals will not create far-reaching legislation to impose restrictions and limits on the use of AI, but rather empower regulators (such as the FCA, CMA, ICO and PRA) to issue guidance and potential penalties to their stakeholders. Perhaps surprisingly, the application of the Principles will be at the discretion of the various regulators.
Motives
The White Paper is markedly different to the EU’s draft AI Act, which takes a more conservative and risk-averse approach. The proposed EU legislation is detail and rule heavy, with strict requirements for the supply and use of AI by companies and organisations.
It would appear that the Government is keen on demonstrating a market-friendly approach to AI regulation, in an effort to draw investment and enhance the UK’s AI credentials. The Government wants the UK to be at the forefront of the AI landscape, and there are understandable reasons for that. The White Paper excitedly predicts that AI could have “as much impact as electricity or the internet”. Certainly the AI sector already contributes nearly £4 billion to the UK economy and employs some 50,000 people.
And the UK does have pedigree in this field – Google DeepMind (a frontier AI lab) was started in London in 2010 by three UCL graduates. The Government is optimistically throwing money at the situation, having already made a £900 million commitment to development compute capacity and developing an exascale supercomputer in the UK. Furthermore, the Government is increasing the number of Marshall scholarships by 25%, and funding five new Fulbright scholarships a year. Crucially, these new scholarships will focus on STEM subjects, in the hope of cultivating the Turings of tomorrow.
Ignorantly Pollyannish?
It all seems like it could be too good to be true. And in terms of regulation, it very well may be. The UK approach to AI regulation is intended to be nimble and able to react pragmatically to a rapidly evolving landscape, but questions arise about the devolved responsibility of various regulators. The vague and open-ended Principles may well prove difficult to translate into meaningful, straightforward frameworks for businesses to understand, and in any event are subjective to the individual regulator. It is unclear what would happen where a large company introduces various AI processes to its business functions but is subject to the jurisdiction of more than one regulator. How would there be a consistent and coordinated approach, especially given that some regulators have far more heavy-handed sanction/punishment powers than others? The Government does intend to create a central function to support the proposed framework, but given that the central function is likely over 18 months away, any dispute/contradiction between regulators before its implementation is going to be a can of worms. Furthermore, when it does arrive, is having a centralised, authoritative Government body to deal with AI not in complete contradiction to the desired regulator-led, bottom-up approach?
And with every day that passes, AI becomes more powerful, sophisticated and complex. It could be the case that all discussions of AI regulation are irrelevant, as there is no way for governments and international organisations to control it. While this risks slipping into a catastrophising and histrionic “AI will end humanity” narrative, it is certainly hard to see how regulation can keep pace with the technology. Consider the difficulty that governments and international organisations have had in regulating ‘Big Tech’ and social media companies in the past two decades, given their (predominately) online presence and global ambit, and then consider how much more difficult it would be to regulate an entirely digital technology that can (effectively) think for itself.
November Summit
In light of these considerations, it will be interesting to see what comes out of the AI Safety Summit in early November. The stated goal of the summit is to provide a “platform for countries to work together on further developing a shared approach to agree the safety measures needed to mitigate the risk of AI”. There seems an inherent tension, however, between international cooperation in relation to ‘rules of the game’ around AI and the soft power arms race in which nations are involved for supremacy of the technology. In May, Elon Musk pessimistically opined that governments will use AI to boost their weapons systems before they use it for anything else. It may be the case that curtailing the dangers of AI will need a public and private consensus – in March, an open letter titled ‘Pause AI Giant Experiments’ was published by the Future of Life Institute. Citing the risks and dangers of AI, the letter called for at least a six-month pause to training AI systems more powerful that GPT-4. It was signed by over 20,000 people, including AI academic researchers and industry CEOs (Elon Musk, Steve Wozniak and Yuval Noah Harari to name three of the most famous).
In defence of global governments, the Bletchley Park Summit is not emerging from a vacuum – there have been previous efforts by the international community to establish an AI regulatory framework. Earlier this year, the OECD announced a Working Party on Artificial Intelligence Governance, to oversee the organisation’s work on AI policy and governance for member states. In early July, the Council of Europe’s newly formed Committee on Artificial Intelligence published its draft ‘Framework Convention on Artificial Intelligence, Human Rights, Democracy and the Rule of Law’. And as recently as early September, the G7 agreed to establish a Code of Conduct for the use of AI. It would be unbalanced to suggest the international community is sitting on its hands (although note the non-binding nature of some of the above initiatives, which are nevertheless widely published by their signatories with great alacrity).
Conclusion
It is hard to predict how nations and international organisations will regulate AI, given that we are grappling with an emergent technology. It is true, however, that broad patterns have emerged. It seems the UK is taking a less risk-averse approach to AI regulation than the EU, and hoping that it can unlock both the economic and revolutionising power of the tech. The round table at Bletchley Park will be fascinating, given that it will most likely involve a melting pot of opinions around AI regulation. A sobering final thought is at the end of July the White House released a statement that the Biden-Harris Administration had secured “voluntary commitments from leading artificial intelligence companies to manage the risks posed by AI”: if the USA – the AI world leader – is only subjecting its companies to optional obligations, where does that leave the rest of us?
Dru Corfield is an associate at Fenchurch Law
AI: The Wizard behind the Data Curtain?
“What is Chat GPT?” is a frequently heard question this year. “What is AI? How does it work?” is occasionally the follow up. And for the sceptics, “Will it take my job? Is it dangerous?” One cheerful BBC News headline recently read “Artificial Intelligence could lead to extinction, experts warn”.
Artificial Intelligence (AI) and Machine Learning Technologies (MLTs) have rapidly gone from the stuff of science fiction to real world usage and deployment. But how will they affect the insurance industry, what are the legal implications, and is the whole issue really that much of a concern?
Taking the final question first, the evidence suggests that jobs are already being lost to this new technological revolution. In March 2023, Rackspace surveyed IT decision-makers within 52 insurance companies across the Americas, Europe, Asia and the Middle East. 62% of the companies said that they had cut staff owing to implementation of AI and MLTs in the last 12 months. In the same period, 90% of respondents said they had grown their AI and MLTs workforce.
It is worth drilling into the specifics of what AI and MLTs actually are. McKinsey & Company define AI as “a machine’s ability to perform the cognitive functions we usually associate with human minds”. MLTs, according to IBM, are best considered as a branch of AI, in which computers “use data and algorithms to imitate the ways that humans learn, gradually improving their accuracy”. So, taking ChatGPT (released 30 November 2022) as an example, Open AI (the developer) has trained ChatGPT on billions of documents that exist online. From news, to books, to social media, to TV scripts, to song lyrics. As explained by Boston Consultancy Group, the “trained model leverages around 175 billion parameters to predict the most likely sequence of words for a given question”. In many ways, it has to be seen to be believed. If you haven’t already, it is worth signing up to ChatGPT. It’s free and takes moments. The author has just asked it to write a Jay-Z song about the London Insurance Market and to write a story about Sun Tzu waking up in the world of Charles Dickens – both with instant, detailed results. The absurdity of the requests was done to demonstrate the power of the MLT: it is quite remarkable.
What is exciting, or scary, depending on your position, is that GPT-4 (the next version of ChatGPT) has 1 trillion parameters. It was released at the end of March and is behind a paywall. But the point is that the never-seen-before power behind the technology released only at the end of last year has become nearly 6 times more advanced in four months. Not unlike the Sorcerer’s Apprentice wielding his axe and doubling and redoubling broomsticks carrying pails of water, MLTs scythe through and consume data at an exponential rate.
So, what does it all mean for the insurance industry? MLTs can sift through data vastly faster than humans, and with far greater accuracy. The tech poses the most immediate threat to lower-level underwriters and claims handlers, as well as general administrative roles. But what about to the wider London Market?
As this firm’s David Pryce has explained*, the London Market does not have as many generalised wordings as do other insurance markets around the world. The policies written here are highly sophisticated and frequently geared towards bespoke risks. The specialism of the London Market means that, in terms of senior underwriters, while they may be informed by AI/MLTs, their judgement, gained through experience, will mean their role is fairly safe – machine learning tech is far superior at analysing past knowns than conceptualizing future risks.
Similarly, in high-value, sophisticated non-consumer insurance contracts that are the norm within Lloyd’s, questions arise about AI’s/MLTs’ potential to remove the broker role. Consider a cutting-edge ChatGPT equivalent that does the role of a broker, but is developed by an insurer for an insured. There is an inherent conflict between acting as an agent of an insured and seeking to maximise profit for the insurer. There would undoubtedly be a data bias in this metaphorical ChatGPT. In the same vein, a ChatGPT equivalent could be developed by London Market brokers, but this would miss the personalised touch that (human) brokers bring to the table (and policyholders enjoy). James Benham, Insurtech guru and podcast host, recently said that AI could stop brokers doing menial form-filing and spend more time doing what policyholders want – stress testing the insured’s policy and giving thought to what cover they need but had not considered. So while in the short term low-level work will likely be made more efficient by AI/MLTs, and lead to reductions in staff, a wholesale revolution or eradication of vast swathes of the London Market broking sector remains unlikely.
Finally, it is worth noting the speech on 14 June 2023 by Sir Geoffrey Vos, Master of the Rolls, given to the Law Society of Scotland’s Law and Technology Conference. After highlighting a recent example of an American lawyer who used ChatGPT for his legal submissions, in which ChatGPT not only grossly misunderstood/misrepresented the facts of some cases but actually made up another one for the purposes of the submissions, he cautioned the use of the MLT in legal proceedings. He further observed dryly that “clients are unlikely to pay for things they can get for free”. Perhaps specific MLTs will be successful developed in the near future to assist or stress test lawyers’ approaches (for example, Robin AI is a London-based startup that uses MLTs to assist lawyers with contract drafting), but ChatGPT is not there yet. A similar point could be made in its application to the insurance industry – simple, concise deployment of the technology will remove grunt work and effectively and cheaply simplify data, but human experience will not be replaced just yet. As with blockchain, in the short term we are likely to see more of an impact on consumer insurance contracts than high-value, bespoke, London Market insurance.
Dru Corfield is an Associate at Fenchurch Law
* See The Potential impact of ChatGPT on insurance policy wordings, Insurance Business Mag