B. What was the underlying business and risk that the Bank had intended to insure?

The Bank, through an SPV, entered into a number of commodities repo transactions with the Transmar Commodities Group in respect of cocoa beans and related products stored in warehouses in various locations around the world.

At the end of 2016, Transmar entities defaulted on the repo transactions by failing to repurchase cocoa beans and other products they had sold to the Bank subject to re-purchase. Subsequently the Transmar Commodities Group went into bankruptcy. Three of Transmar’s executives were convicted and imprisoned, in New York, for fraud. It emerged in due course that part of the Transmar fraud included the making of fraudulent misstatements about the value of its collateral. It also transpired that the quality, and therefore the value, of the cocoa products that formed the subject matter of the repo transactions was significantly lower than the Bank expected.

Following the Transmar defaults, the Bank took a number of steps, including to sell the cocoa beans and products held in warehouses, pursuant to the Bank’s rights of sale. The poor quality of the cocoa products meant that the Bank suffered a significant shortfall between the sale proceeds and the debt owed to the Bank by the Transmar entities. That shortfall made up most of the loss for which the Bank claimed against its open cover marine cargo insurance policy.

C. What happened as between the Bank on the one hand and the underwriters and brokers on the other hand?

In 2015, the Bank had specifically sought to obtain insurance coverage which would indemnify it against the risk of default and losses on resale. The Bank had requested that bespoke wording be added to its marine open cover policy so as to cover any difference between the sums received by the Bank upon its sale of goods following a default and the price at which the Bank’s customers had agreed to repurchase the same goods; hence the TPC clause.

The insurance brokers had been instructed to obtain an endorsement to include the TPC clause, as well as a non-avoidance clause, in July 2015. Those clauses were agreed by the lead underwriter but not by the following insurance market. At the time of renewal of the policy in 2016, the additional clauses were not specifically brought to the attention of some of the underwriters. In addition, on renewal in 2016, the brokers confirmed to three out of the 13 following underwriters that the risks being insured on renewal were “as before” or “as expiry” without drawing specific attention to the new provisions requested by the Bank.

D. So what were the main issues in the case in light of the various parties’ arguments?

The key issues in dispute were:

1. What was the meaning and effect of the TPC clause?

The Bank argued that the TPC clause provided cover for the risk of default and losses sustained by the Bank, even in the absence of physical loss of and/or damage to the goods. The underwriters argued that the TPC clause was part of a conventional marine cargo insurance policy, placed in a marine insurance market and, as such, the TPC clause could only be interpreted as merely explaining the basis for the valuation of the goods in the event of an actual physical loss of or damage to goods. Physical loss or damage did not occur in the present case; the Bank simply sold the commodities which were being financed by the repos but did so at less than the intended repurchase price.

2. Could the underwriters avoid the policy on the grounds of alleged misrepresentation and/or non-disclosure?

The underwriters argued that the policy should be avoided because: (i) the Bank and the brokers had not disclosed that the purpose behind the TPC clause was to provide insurance for a default in the absence of physical loss or damage; and/or (ii) the TPC and non-avoidance clause (i.e. the additions to the policy) were not specifically drawn to the attention of the underwriters upon the 2016 renewal of the policy.

3. Did the Bank fail to make reasonable endeavours or act recklessly?

The underwriters argued that the Bank was barred from recovering under the policy because: (i) it had acted recklessly or negligently when entering into the repos by not requiring that the quality of the cargo be independently tested and certified, and/or; (ii) it had failed to “sue and labour” after the first default by not hedging its exposure reasonably and/or selling the goods more speedily.

4. To what extent were the brokers at fault and liable?

The insurance brokers were alleged by the underwriters to have failed to pass information to them about the risks and/or to have failed to explain the add-on provisions - including that the purpose of the TPC clause was to cover financial loss. The Bank’s position was that if and insofar as this was the case, the brokers were liable to the Bank in negligence and/or for breach of duties of care.

E.  What did the High Court decide and why?

1. The construction and interpretation of the TPC clause

The court agreed with the Bank’s argument that, as a matter of construction, the TPC clause provided cover for credit risk and/or financial losses – regardless of physical loss of or damage to goods. This meant that the financial losses suffered by the Bank on re-sale of the goods following the defaults, were recoverable. The judgment recaps principles governing the construction of contracts, including insurance policies, as adopted by the judge based on Supreme Court authority.¹

(a) The court must, when considering the language used, ascertain what a reasonable person (who has access to the background and knowledge which would reasonably have been available to the parties at the time of contracting) would have considered was meant by such language.

(b) Evidence about the subjective intention of the parties should be disregarded

(c) Save in a very unusual case, the meaning of a clause is most obviously to be gleaned from the language of the clause. Therefore, the language used by the parties should outweigh any other considerations such as the factual matrix and the commercial consequences or implications of the natural interpretation.

(d) When the language is clear, the court should not alter the interpretation of a clause simply because it was very imprudent for one of the parties to have accepted its wording.

(e) Finally, any particular clause must be considered in its contractual context. There ought to be clear words used if a marine cargo insurance policy is to be construed as covering losses other than physical loss of or damage to goods.

In this case, the TPC clause was bespoke and carefully drafted and the language was very clear. It was not the only “add-on clause” that went beyond providing cover against mere physical loss or damage. There indeed were other add-ons, including clauses covering risks such as business contingency losses and fraudulent documentation.² In this case, the TPC clause was held to contain clear language. Accordingly, the background (e.g. the unusual nature of the TPC clause in the marine cargo market) should not and could not be used to create an ambiguity where none existed. The court therefore held that the TPC clause covered the Bank’s claims for the difference between the repo prices for the commodities and the amounts recovered by the Bank through exercising its rights of sale.

2. Could the policy be avoided by the underwriters?

• First, the court held that the Bank was not obliged to have disclosed the purpose and intention behind the inclusion of the TPC clause or the non-avoidance clause in the policy, so the underwriters’ case on non-disclosure was dismissed. The reasoning for this decision was that an assured is not required to disclose facts presumed known by underwriters. In this case, both the TPC clause and the non-avoidance clause formed part of the policy wording, and - put simply - the underwriters should have known what they had agreed to cover, if indeed they did not in fact know.
• Second, the court found that with the exception of two out of the 13 underwriters, the underwriters could not avoid the policy because either there was no misrepresentation made or, in the case of one underwriter, there was no inducement caused by the misrepresentation.
• Whilst underwriters are expected to read the terms of a policy when they first provide cover, on renewal, they may well rely on representations from brokers that there have been no changes to the policy terms or risks. However, if an underwriter does not ask the broker about changes and/or the broker does not positively affirm that there have been no changes to the policy then, whether or not the underwriter has read the policy and noticed the changes, the underwriter will be bound by any changes and there will be no finding of misrepresentation. 
• In this case, the court found that there was no misrepresentation to the lead underwriters as they had signed and stamped the endorsement in the previous year to include the TPC clause and non-avoidance clause. Whilst there was a misrepresentation to three of the 13 underwriters upon renewal, in the case of one of these underwriters there had been no inducement because that underwriter would have subscribed to the policy regardless of the changes on renewal.
• In the case of the other two underwriters, the court found that they would not have agreed to the terms had they been made aware of them and so the brokers’ misrepresentation in telling them that the policy was “as before” or “as expiry” had induced those two underwriters to enter into the policy. For reasons explained below, the brokers were found liable to the Bank for the portion of the indemnity for which these two underwriters would otherwise have been liable.
• Finally and irrespective of the above, the court further decided that the underwriters could not avoid the policy for three reasons:

(a) The clearly drafted non-avoidance clause prevented the underwriters from avoiding the policy for any reason other than fraudulent misrepresentation. The underwriters had not pleaded fraud. The fact that the underwriters did not read the non-avoidance clause did not exempt them from being bound by it. There is no authority in which it has been held, or even argued, that an insured is under a duty to disclose the presence of a contractual term in a document put before them. If the underwriters did not read the terms in front of them, that was their failure.

(b) Putting aside the non-avoidance clause, the second consideration in rejecting the underwriters’ position on avoidance was the fact that the underwriters had affirmed the policy. By their original defence and counterclaim, which did not mention anything about avoiding the policy, the underwriters had represented that the policy was binding. This served as an affirmation and a waiver of any right to avoid the policy.

(c) Finally, the court found that the policy could not be avoided because, having failed to raise the avoidance defence until after a year of their original defence, the underwriters were estopped from relying on that defence.

3. What about the Bank’s alleged “recklessness” in verifying quality and “failure to make reasonable endeavours after default to avoid loss”?

• The court agreed that the Bank had acted in good faith in taking reasonable steps to avert or minimise its loss as any prudent uninsured would have done in the circumstances. The underwriters argued that the Bank could/should have had in place hedging arrangements (which it did not usually do) and should have arranged an independent quality analysis of the goods in storage and so discovered earlier that the cocoa products were not of the desired quality.
• The court’s decision was that the steps that the underwriters argued the Bank should have taken prior to concluding the repos or upon the first incident of default were not of a kind that a prudent banker would have been expected to contemplate in the circumstances. The Bank had complied with normal banking practices given the court’s finding that it is not the norm for repo financiers to conduct quality checks, or even to ask for the certification of quality and analysis, in connection with commodity repos.
• The judgment is a reminder that the insured will only be said to have failed to “sue and labour”, such as to break the chain of causation between the insured peril and loss, where the insured fails to act to avert or minimise loss in circumstances where any prudent uninsured would have done so. In this case, the Bank had taken a number of steps upon its client’s default: sending inspectors to check the goods were in warehouses, consulting with various local law firms to ensure they had the right to sell the goods, asking for quality certificates, engaging in discussions with Transmar entities, the chief restructuring office and other bankers, speaking to other clients about the possibility of selling the goods, and accomplishing sales. The court therefore found that there was no failure by the Bank to take appropriate steps to “sue and labour”. 

4. Duties of the insured’s brokers

It is well-established law that insurance brokers owe a duty of reasonable skill and care to their clients to obtain insurance meeting their clients’ requirements and not to expose their clients to an unnecessary risk of litigation. The court concluded that the brokers breached those duties to the Bank. On the facts, it was clear that the Bank had told the brokers that it required cover against its clients defaulting under a repo and that such cover was not to be dependent on the occurrence of physical loss of or damage to the cargo. The Bank’s external lawyers had prepared the TPC clause in order to provide that protection (and the court found that it did achieve that protection).

The brokers attempted to argue that, because the Bank had taken external legal advice as to the drafting of the TPC clause, any problems with the drafting of the TPC clause were the responsibility of the lawyers. The court rejected that argument on the basis that the facts showed that the Bank looked to its brokers for their professional expertise; the brokers’ duties to the client are not reduced, still less do they disappear, because external lawyers drafted or advised on a policy.

The court held that:

(a) a reasonably competent broker would have advised the Bank from the outset that the credit risk market (not the marine insurance market) was a more appropriate market in which to place the cover the Bank was seeking. Such advice would have enabled the Bank to make an informed decision as to how to proceed. 

(b) Having gone to the “wrong” market, it became important for the brokers to explain to the underwriters what the TPC clause was intended to cover.

(c) Any reasonably competent broker would have specifically pointed out the TPC clause to the underwriters and talked through the wording and its consequences.

The court was at pains to point out that there is no suggestion that brokers generally owe a “duty to nanny” the underwriters through a policy. However, they do have a duty to protect their own clients, including against the risk of unnecessary litigation, and there may be circumstances, as in this case, in which brokers are required to give information to underwriters in order to protect their clients against future litigation arising from a misunderstanding.

F. What does this decision mean for you?

This decision arises out of the use of unique wording in what the insurers argued was an otherwise standard cargo insurance policy.

The facts however are not uncommon in the context of insuring financed commodities. The case serves as a timely reminder of the sort of disputes and issues that can arise out of insurance arrangements implemented to mitigate risk in commodities related transactions.

The significance of the decision will differ depending on one’s perspective. At the very least the decision is a clear indication of the High Court’s determination to uphold promises made by insurers in a policy which are clear on the face of the words used, irrespective of arguments and defences about the commercial background to the policy, the relevant insurance market and/or the factual matrix. Hence the court has ruled in favour of the Bank in respect of its loss following a default by its customer under repo transactions, even though the cover was procured from and given by insurers in the marine insurance market.

The decision will of course give insurance brokers pause for thought, possibly to reconsider and review the rigour of their processes for communication between insured and underwriters in light of the findings against Edge in the discharge of its duties as the Bank’s brokers.

For insureds, particularly banks and commodity market participants who engage in structured commodity finance, the decision is relevant because it highlights the importance of (a) the quality and clarity of language used in insurance policies (especially where a bespoke and /or different risk is being insured) and (b) the quality of information provided to insurers (via brokers or otherwise).

1. Rainy Sky S.A. v Kookmin Bank [2011] UKSC 50, Arnold v Britton [2015] UKSC 36 and Wood v Capita Insurance Services [2017] UKSC 24.
2. The court acknowledged that the expansion of the Bank’s cover in 2015 and 2016 to include a “fraudulent documentation” clause (including an indemnity for financial losses suffered by the Bank acting upon a fake document) was to provide cover to protect against a fraud similar to the Qingdao metals warehousing fraud, where a company deployed fraudulent warehouse receipts to raise trade finance from multiple lenders secured against the same goods.