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	England and Wales High Court (Commercial Court) Decisions
You are here: BAILII >> Databases >> England and Wales High Court (Commercial Court) Decisions >> Sphere Drake Insurance Ltd. & Anr v Euro International Underwriting Ltd (Revision 1) [2003] EWHC 1636(APPENDIX 1) (Comm) (08 July 2003) URL: http://www.bailii.org/ew/cases/EWHC/Comm/2003/1636(APPENDIX_1).html Cite as: [2003] EWHC 1636(APPENDIX 1) (Comm)

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IN THE HIGH COURT OF JUSTICE
QUEENS BENCH DIVISION
COMMERCIAL COURT

		Royal Courts of Justice Strand, London, WC2A 2LL
		8 July 2003

Mr Justice Thomas:

The way the case developed

1. The way in which SD put the case from the outset in their pleading was that there was no genuine underwriting assessment of the risks presented to EIU by SCB and that SCB knew that.
2. This case was advanced largely on the basis that there had been no attempt to assess the proper premium to charge for the programmes accepted because the anticipated losses far exceeded the premiums charged; on the basis of a conventional underwriting approach, an honest underwriter would have been expected to charge a premium commensurate with the risk. Although there was reference to the use of cheap reinsurance to make unprofitable business profitable and to taking reinsurance into account, there was no mention of the terms "net underwriting" or "arbitrage" in the original defence. In the light of the denial at the meeting of 4 January 1999 referred to in Part I, that might not be entirely surprising.
3. However, in his witness statement, Mr Henton referred to using reinsurance to transform gross loss into a profit; Mr Brown's and Mr Butler's witness statements spoke of arbitrage.
4. There was an exchange of expert evidence in mid-2001:

i) It was clear from the work of Mr Jackson that in respect of many risks, no assessment had been made on the conventional basis; he dealt with net underwriting briefly and concluded that the acceptance of the risks could not be justified on that basis.

ii) The reports of Mr Hines and Mr Greig set out their view that the risks could have been accepted because reinsurance was available for business that was bound to make a loss; a profit could have been made by passing the losses to reinsurers and making a turn; they described this as "arbitrage" or "net underwriting".

5. Joint memoranda were produced by the experts on certain questions, including a question as to the adequacy of the placing information and as to whether it would have appeared to the placing broker that the EIU Defendants could not have accepted the risk and if so why.
6. On 4 December 2001, SCB's solicitors wrote a letter that accepted that a number of the programmes (identified in Part II) could only have been written on a net basis. In essence it was accepted that these programmes were written on the backs of reinsurers.
7. In answer, it was maintained by SD that the practice of accepting this type of business on the back of reinsurance was inherently dishonest and, whether or not inherently dishonest, it was dishonest without the fullest disclosure to those participating in it. It was clear to me throughout the long trial that the focus of SD's case was not, as was from time to time suggested by SCB, on the inherent dishonesty of the market (though that was part of SD's case) but of dishonesty in the specific circumstances of the activities of SCB and in particular gross dishonesty on the part of SCB in the dealings of Mr Brown and Mr Butler with Mr Henton.
8. SD focused their case on the business presented by SCB to EIU and accepted by them; they contended that the acceptance by EIU of gross loss making business on the back of reinsurance was dishonest in the specific circumstances. As is set out in Part I, this was a wide-ranging case, but one which concentrated on what had actually happened on specific occasions and on each of the programmes written.

Mr Henton's evidence

9. Although Mr Henton had provided detailed statements, the EIU Defendants were without legal representation for sometime before the trial; a full explanation of the basis on which Mr Henton had written the 35 programmes only properly emerged during his very lengthy cross-examination. This lasted for 20 days from day 30 to day 49 of the trial. Mr Whitcombe, who had given evidence before Mr Henton, had not been able to provide any such explanation in his evidence.
10. Towards the end of Mr Henton's evidence, I asked leading counsel for SD to provide Mr Henton with a written summary of their case against him. SD did so on 20 May 2002. I requested that this be done so that Mr Henton could see clearly, as a litigant without representation, how, in the light of the evidence he had given and the questions put to him, SD advanced their case.
11. It was clear from SD's cross-examination and as confirmed by paragraph 2(7) of that document that SD were advancing a case against Mr Henton (as had been fairly put to him in his cross-examination) that, if net underwriting was a legitimate business practice, then he did not actually undertake any assessment of the programmes he had accepted on a net basis.

The exchanges between SD and SCB in May and August 2002

12. On 23 May 2002 (day 51 of the trial), following a conversation between leading counsel, SCB's solicitors wrote to SD's solicitors to ask for clarification of the basis of the case that was being made against SCB; SCB stated that they accepted that a prudent underwriter would not have written many of the risks on a gross basis and that the case turned in part on the principle of whether net underwriting was a legitimate business practice. The letter continued:

"We do not, however, understand your clients to be making any alternative case against our clients along the lines that if net underwriting or arbitrage is permissible, then nevertheless our clients knew that that EIU were going about it in such a way that amounted to a dishonest breach of duty to your clients."

They specifically referred to paragraph 2(7) of the document provided by SD as giving rise to their wish for clarification.

13. The solicitors to SD replied on 27 May 2002, maintaining that their case was set out in the pleadings. The letter then summarised their case; in summary, the solicitors stated:

"SD also contends that the EIU defendants conducted no underwriting assessment whatever of the programmes they accepted. SD's case is that they did not bother..."

They referred to the pleadings where SD had pleaded that EIU had made no underwriting assessment and that SCB knew this and added:

"The allegation means precisely what it says. There was no underwriting assessment."

The letter continued by stating that they were bound to set out the matters which they had set out in paragraph 2(7) of the summary of their case; that paragraph was intended to make clear that Mr Henton had not undertaken any assessment on a net basis. They added that although it was not clear what an assessment on a net underwriting basis was meant to consist of, Mr Henton had made no assessment; their case remained against SCB that Mr Henton had made no genuine underwriting assessment. They made it specifically clear that SCB knew of the mismatch between the inwards and outwards reinsurances.

14. The solicitors to SCB responded on 28 May 2002; their letter concluded:

"If however, there was a legitimate basis for net underwriting, we do not understand SD to say that EIU did assess the risks in a way which meant that they were in breach of fiduciary duty and SCB must have known that. Nothing in SD's pleadings or your letter or anywhere else has stated any such case."

15. These letters were, unfortunately, not drawn to my attention at the time and I was unaware of any difficulty until day 86 of the trial. It was the subsequent submission of counsel for the SCB Defendants (as made to the court on 3 October 2002 – day 91 of the trial) that SCB understood this correspondence to mean that no alternative case was being made to the effect that if net underwriting was in principle honest, the SCB Defendants knew that Mr Henton had not underwritten on that basis; the only case made was the general case that EIU had made no genuine underwriting assessment at all. The calling of SCB's witnesses commenced on 29 May 2002 and continued until 31 July 2002.
16. Towards the end of the factual evidence in July 2002, I suggested that the experts might meet further to consider the position in the light of all the evidence that had been given in relation to the 35 programmes. To assist them, the lawyers for SD and SCB prepared a series of questions which were agreed in an exchange of correspondence in early August 2002. Amongst the questions were:

"1) Would it have appeared to any competent placing broker that the EIU defendants could honestly have accepted the risk:

(a) on a gross underwriting basis

(b) on a net underwriting basis

and if so why?

2) Would a competent placing broker have known that no honest underwriting assessment (whether gross or net) had been made by the EIU defendants?

3) Were the prior year losses/anticipated future losses so great as to make it clear to a competent broker that the business was unwriteable by an honest underwriter (whether on a net or gross basis)?"

17. The experts produced further reports. Mr Jackson, in his further report, set out his view that a reasonable broker would have known that there had been no underwriting assessment whether the underwriting was done on a net or a gross basis. Mr Hines produced as his further report, notes which explained how an underwriter might write a book of such business on a net basis and then produced at my request, a sample plan to show how that might be done; the detailed explanation of net underwriting by Mr Hines and the production of the plan were important for a number of reasons, including the contention that with such a plan business could be accepted very quickly on a net basis.

The issue raised on 24 September 2002

18. Shortly after the trial resumed in September 2002 on day 86 (24 September 2002) SCB raised the question as to the scope of the case being made against them in relation to their knowledge that there had been no underwriting assessment on a net basis. I directed that the parties exchange submissions and in the light of those, ruled that, given the stage the trial had reached, the broad relevance of net underwriting to the issues in the case, the work done by the experts and other considerations, the better course was for the expert evidence to be given and finished and the decision on the scope of the pleadings to be dealt with in final submissions.

The contentions of the parties

19. SD's position can be summarised as follows:

i) They accepted that their case was framed by reference to the gross position, not the net position; that they had not pleaded a case in respect of particular programmes that the retained premium would be insufficient to cover the retained losses.

ii) They maintained, however, that the allegation that there was no genuine underwriting assessment had always been comprehensively formulated.

iii) They contended that they had put to Mr Brown and Mr Butler that a lot of detailed information would be required for net underwriting, but no such information was provided to Mr Henton in several programmes.

iv) They accepted that Mr Jackson's report of September 2002 went further; he had concluded that brokers must have known that an underwriter who had the information and did the net calculations would realise that some programmes, including the Hallmark scheme (Programme 19), would be obviously unprofitable after reinsurance.

v) SCB had put forward no case on what net underwriting was done by Mr Henton; they had merely pleaded that SCB, as brokers, had no idea what assessment was carried out by EIU as underwriters; it was not for the brokers to consider how an underwriter arrived at his decisions; it was not for the broker to assess whether there was sufficient information for an underwriting assessment.

vi) SCB had never advanced a case as to the net underwriting they believed Mr Henton had done; SCB had only maintained that the programmes could be written net.

20. SCB's position can be summarised as follows:

i) During the cross-examination of Mr Butler and Mr Brown, although a case was put to them that there had been no underwriting assessment at all, there was no suggestion that SCB knew that a particular risk would lose money for SD on a net basis or that Mr Henton had inadequate information to make a net underwriting assessment, save in the case of Programme 34. I have referred to that evidence at paragraph 901 of Part II.

ii) In summary it was submitted:

"There was simply no attempt to suggest to SCB's witnesses that they knew the business could not be written net by EIU."

iii) Mr Jackson's report of September 2002 made assertions on what the broker must have known without any warning to SCB.

iv) As SCB's witnesses had given their evidence, it would be unfair to them to allow the net underwriting case to be advanced. There had been no exploration with them of their knowledge of the details of the net underwriting process.

Conclusion

21. In reaching a conclusion on this issue, it is important to bear in mind that the concept of net underwriting gross loss making business on the backs of reinsurers was, until this litigation, an activity that was nowhere described in writing, even though part of the PA market had been engaged in the practice.
22. The way in which net underwriting could be carried out only emerged slowly during the course of the litigation; although it did become clear that one aspect of net underwriting appeared to depend upon the ability to estimate whether it was possible to meet from the premium received: (1) payment in respect of the likely number of losses which had to be paid within the retention, (2) the cost of the reinsurance programme, and (3) other costs, no coherent explanation of net underwriting was provided until September 2002. It was only then that Mr Hines produced his note which explained how a net underwriter might plan and write a book; he then subsequently produced, at my request, an underwriting plan to enable me to understand the process of net underwriting and had elucidated the process in his oral evidence.
23. That said, I have no doubt that on the pleadings it was open to SD to advance against SCB a case that they knew that there had been no underwriting assessment on whatever basis that underwriting assessment might be said to have been made.
24. Furthermore, it was clear from detailed consideration of the appendix to Mr Greig's original report that he was addressing his observations to net underwriting, the perception of the information required for such underwriting and whether it appeared to a broker that the risk could be underwritten.
25. Although the exchange of correspondence between the solicitors in May 2002 was not as clear as it should have been, it was agreed in August 2002 that the experts should address the questions I have set out at paragraph 16 above. I cannot understand how anyone who agreed those questions could have been under any doubt that the case being made included a case that SCB knew that the programmes could not have been accepted on a net basis and that no genuine underwriting assessment had been made whether on a gross or a net basis.
26. I am therefore quite sure that SCB must have understood, or be taken to have understood, that there was a case against them that they knew that no genuine underwriting assessment had taken place, whether on a net or gross basis.
27. However, I must take into account the very real difficulties that were caused in the trial by the lack of legal representation of EIU; as Mr Henton gave his evidence and explained the basis of the acceptance of many of the risks on a net basis, the case against him was very fairly put and summarised in the document of 20 May 2002 (to which I have referred). However, there had not been properly developed at that time, so that either SD or I understood it, an explanation as to how net underwriting could be conducted on a planned basis; in these circumstances, a case was not put to either Mr Butler or Mr Brown as to how they must have appreciated that Mr Henton had neither planned his net underwriting nor how he could not have made any underwriting assessment when the programmes were presented in the context of the existence or absence of such a plan.
28. In these circumstances and as the allegations against Mr Brown and Mr Butler are of such grave dishonesty, I have reached the conclusion (though with some hesitation in the light of the matters to which I have referred) that it would not be fair to them as individuals that I should consider against them a further and specific case on each programme that, in addition to all the other allegations of dishonesty, they knew that no underwriting assessment had been made on a net basis.
29. Once it became clear from SCB's underwriting expert that an underwriter could make a quick decision on whether the risk should be accepted on a net basis if he had done a considerable amount of research and had prepared a plan based on that research, it was clear that the question of whether they knew that there was no such plan had never been explored. Although it was powerfully (and rightly) said by SD that this was the consequence of the late emergence of this point from SCB and Mr Hines, I do have to bear in mind that (1) EIU might have addressed this issue prior to the commencement of the trial if they had been represented, and (2) SCB throughout did not want their underwriting expert to address issues of underwriting from the perspective of the underwriter as opposed to the broker. It is right to observe, however, that it would have been very much more helpful to the Court and may well have shortened the trial if Mr Hines had provided the evidence he provided in September and October 2002 prior to the start of the trial.
30. It is only because of these unusual circumstances that I have reached the conclusion that, although the case is fully open to SD on the pleadings, it is necessary in the interests of fairness to restrict the scope of the case they should be permitted to advance against SCB:

i) It would not have been fair to allow Mr Brown and Mr Butler to be recalled to answer further questions in relation to each of the programmes; Mr Butler's and Mr Brown's cross-examination had each lasted 11 days. As issues of dishonesty were raised in relation to most of the programmes and the other programmes were relied on by the parties for other reasons, it would probably not have been possible to restrict further cross-examination to certain programmes.

ii) As no questions were put to Mr Butler and Mr Brown in relation to their knowledge of Mr Henton's net underwriting as it might have been done on the basis of the existence or absence of a plan, I do not consider it fair to allow a case to be made against them that they knew that no underwriting assessment had actually been made on a net basis.

iii) My conclusions therefore in relation to the programmes contain no findings in relation to whether Mr Brown and Mr Butler knew that no underwriting assessment had been made on a net basis; in particular I do not consider it fair to form a judgment on whether Mr Brown and Mr Butler knew from loss frequency calculations that some of the programmes might be unprofitable on a net basis; they were never asked about that and no exploration was made as to their knowledge of the existence or absence of an underwriting plan of Mr Henton's; although the question of whether an underwriting analysis had been done by Mr Henton was explored with them, that was not explored by reference to the existence or absence of an underwriting plan of the kind described by Mr Hines.

31. However, that is as far as I consider it is right or fair to restrict SD's case as set out in the pleadings.
32. I reject any suggestion that it was not fairly put to SCB that they did not provide sufficient information from which an assessment either net or gross could be made. It is a broker's duty to make a fair presentation of the risk to the underwriter; that is a duty which exists whether the underwriting is on a net or gross basis. As generally much less information was needed to write a risk net than to write it gross, SCB clearly knew the minimum information that would be needed on any risk; they gave extensive evidence on what they regarded as standard information in this market for net underwriting – see paragraphs 210 and following of Part I. Indeed, as their evidence showed, because they had been in the market for so long, they could identify the contracts that had to be written net. I am quite sure therefore that it is entirely fair for the case to be advanced against SCB which included, in particular, the following:

i) They knew of the mismatch in reinsurance from December 1997 onwards; that point was made expressly clear in SD's solicitors' letter of 27 May 2002.

ii) They knew that the information provided was not up to date or (as for example in Programme 8) important information on their file was not made available.

iii) They knew that the information presented was wholly inadequate to allow any assessment to be made, whether on a net or gross basis.

iv) They knew in most cases whether or not the business presented was likely to be profitable or not on a gross basis.

I also consider it fair that there remained open to SD other specific points canvassed in cross-examination such as Mr Brown's knowledge of the profitability to Clarendon of the reinsurance programme placed for the MELEX scheme (Programme 14) (described at paragraphs 307 and following of Part II).