“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.
