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Lloyd's May Fare Better In England;

In U.S., Investors May Have Upper Hand

San Francisco Daily Journal

Monday, September 22, 1997

By Pamela A. MacLean Daily Journal Staff Writer

Lloyd's of London, as quintessentially English as Beefeaters and Big Ben, may be very sorry it ever brought Americans into the fold to underwrite insurance. Sorry to the tune of billions of dollars.

The venerable British insurance giant is entangled in American courts, in particular the 9th U.S. Circuit Court of Appeals, Lloyd's is mounting the latest in a series of major legal battles to extricate itself from American courts and head back to England, where it may fare far better legally.

The bottom line for all sides is who will get stuck paying the claims for billions of dollars of insurance liability for such things as asbestos health injuries, toxic pollution (Shell Oil's multibillion-dollar cleanup of Rocky Mountain Arsenal) or disasters (like the Exxon Valdez oil spill).

At issue in the 9th Circuit is whether thousands of Americans who contracted with Lloyd's to invest in syndicates underwriting insurance risks are bound by English law, or whether, as the Americans argue, the Lloyd's investments are securities subject to American securities law in American courts, Richards v. Lloyd's of London, 95-55747.

Traditionally, the people who joined Society of Lloyd's to underwrite insurance risks were referred to as "names." If the names in this case are bound by English law, they may be obligated to pay for years of insurance claims and their options for fighting it limited to fraud suits against Lloyd's. In England, Lloyd's has enjoyed special-protection legislation that names contend may even provide some immunity from suit.

On the other hand, if the names are protected by U.S. law, they may avoid the onerous insurance obligations and be able to attack Lloyd's handling the names' investment under more favorable American securities laws. Although four federal appeals courts have already sided with Lloyd's in finding the internal dispute between Lloyd's and its American investors should go back to London, a three-judge panel of the 9th Circuit sided with the plaintiffs in March. The panel ruled Lloyd's forum selection contract provisions void and stated that U.S. securities law barred waiver of American courts as the forum to review the dispute.

Now an 11-judge en banc review is set for October 23 in a case almost certain to go the U.S. Supreme Court in the arcane legal fight over choice of law and forum. But the case also has implications for the regulatory reach of U.S. Securities and Exchange Commission and the ability of California insurance regulators to enforce policy coverage in a dispute between a foreign insurer and its American underwriters.

No one knows exactly how much money is at stake, but the Lloyd's U.S. reinsurance market in 1995 was $5.2 billion, with $3.8 billion in California alone.

The SEC for the first time stepped into the case in the 9th Circuit fearing that its own powers may be implicated in the ultimate outcome. The California insurance commissioner also stepped in as an amicus, arguing that while it does not take sides in the dispute, it want to protect the claims of thousands of policy holders against rescission of the insurance coverage by Lloyd's syndicates.

If the fund created to cover downstream insurance claims runs dry, the 9th Circuit ruling could also mean potential financial ruin for several hundred Americans who put up their wealth to underwrite a variety of insurance risks through Lloyd's, according to plaintiffs lawyers.

The 300-year tradition of Lloyd's insurance began in a London coffeehouse run by Edward Lloyd in which wealthy merchants agreed to underwrite the risk of sailing commercial ships around the world. As insuring ships grew more complex and riskier, a system developed for creating syndicates of wealthy people, the so-called names, willing to underwrite the risk of a wide variety of casualty and property losses.

The names put up a small amount of money to cover administration expenses, then in effect pledged all their assets to cover the longshot potential of catastrophic losses. Names post letters of credit to Lloyd's to cover their share of potential insurance losses, according to Dean Hansell, Lloyd's American attorney with LeBoeuf Lamb Greene & MacRae in Los Angeles.

In exchange, year after year hefty checks arrived for the names, representing profits on Lloyd's insurance and investments after payment of policy claims.

Hansell said the names "are brought to London and the unlimited liability risk is explained. They sign a statement that they understand the high risk," he said.

To become a name in the Society of Lloyd's has long held the cachet of aristocracy and conservative, secure investment. Although there have been losing years a Lloyd's syndicate insured the Titanic, for example the names made tremendous amounts of money in the 1970s and 1980s, Hansell said.

But even during the heyday of the 1970s, things began to sour for many insiders at Lloyd's who saw the potential wave of liabilities for future decades of paying off health claims from such things as asbestos, according to court papers.

Lloyd's is a major reinsurer worldwide, meaning it insures insurance companies. This only increased the risks. The Lloyd's practice of reinsuring until the close of all claims placed many names at substantial risk of loss as the full magnitude of liability from asbestos alone became know. These liabilities going on for decades were known as "long-tail claims."

Plaintiffs attorney Stephen Kroft, of McDermott Will & Emery in Los Angeles said Lloyd's was warned by independent auditors in 1982 of potential catastrophic high risk to asbestos-affected syndicates through the reinsurance process.

But the suit alleges Lloyd's ignored the warning, kept the information hidden and instead recruited more and more names, mostly in America, and placed them in some of the syndicates with the highest risk for long-tail claims.

During the 20 years from 1970 to 1990, Lloyd's recruited thousands of names, increasing American participation in syndicates from 6,000 to 34,000, and at the same time lowering the financial requirements for joining its exclusive ranks.

Kroft says in the suit the names were the victims of securities fraud and were sold, in essence, unregistered securities in violation of Securities Acts of 1933 and 1934.

The plaintiffs, bolstered by the SEC support argue Lloyd's provision of England as the choice of forum and law in its syndicate contracts is void. American securities law prevents investors from waiving America as the forum for federal securities disputes, according to court papers.

Lloyd's maintains it does not sell investments but regulates and manages the insurance market in England, much the same as the New York Stock Exchange regulates the sale of stock. The firm argues that the American names must take their fraud claims to English courts for resolution.

Lloyd's points to ruling in nearly identical cases in the 2nd, 6th, 7th and 10th Circuits that all found the names' relationship with Lloyd's "truly international."

But Kroft said the three-judge appeals panel in the 9th Circuit was the first one that "got it right on the securities statute. They are forcing Lloyd's to litigate in the U.S., and Lloyd's doesn't like it," he said. The other courts asked if it was "bad public policy to enforce the clauses. [The other circuits] want to get into fairness and policy," he said.

Roughly 80 percent of the plaintiffs around the world have already settled with Lloyd's, as have securities commissioners in nine states, including California, who claimed investors were defrauded.

Philip Feigin, Colorado's commissioner of securities and the lead negotiator in the Lloyd's settlement with the states and majority of plaintiffs, said: "The way a name gets out of a liability is to pass it along, like a hot potato, to sell the obligation to someone else. That is the reinsurance game."

Feigin said with asbestos, rather than years of profits for names, it looked like a "long, slow bleeding process."

"Many states took the position that the investments the names made were securities," Feigin said. "That position was never litigated. Those enforcement actions were dripped in exchange for Lloyd's upping the settlement in the U.S. by $40 million."

He said the SEC saw which way the cases were going and "finally believed they had to raise these legal questions," or the SEC might find itself bound by the forum and choice of law provisions in future disputed securities cases. The SEC jumped into the case after five years, "if for no other reason than it figured out what may be good for the goose may be good for the gander," Feigin said.

Leonard Venger, of Manatt Phelps & Phillips, representing the California insurance commissioner, said: "The insurance commissioner does not take sides in the dispute between the names and Lloyd's underwriters. However, we vehemently take the position that as part of any remedy the names may get, they may not rescind insurance contracts."

Plaintiffs argue that there may be the basis for common law rescission of insurance obligations of the names. They argue the alleged fraud and nondisclosure of material information by Lloyd's to its investors would allow rescission of the obligations.

Rescission is the chief fear of insurers. "The failure to pay valid claims would have an enormous, adverse domino effect by rendering insolvent those insurers dependent upon reinsurance obtained in the Lloyd's market, who in turn would be unable to meet their own reinsurance obligations to other insurers, with the end result being a wave of insurance company failures throughout the United States," Venger stated in court papers.

But the danger of mass insurance failures seems past with the settlement of bulk of names around the world.

Feigin said the appeals court is being asked to decide on the one hand whether the Americans invested in a security, or from Lloyd's point of view does the choice of law and forum contract provision prevail, thus eliminating American jurisdiction.

"It is really a which comes first, the chicken or the egg question," Feigin said. "This is a fascinating and very difficult decision. You can see both sides. I don't want some scammer to grab some forum I can't see, such as the Ivory Coast, just because it's in an agreement. In the same sense, I can see it's grossly unfair in a major commercial contractual agreement to have someone get out of forum selection by spuriously saying it is an investment contract," Feigin said.

The names have"an extremely strong case if [the court] says it was an investment contract," he said. "But it is a pretty bad case if [the court] waves a wand and says it was not," Feigin said.

Venger said the Lloyd's settlement with most of the names around the world involved creating a new reinsurance company called Equitas, which was just approved in late 1996. That eliminated the significant crisis in the insurance industry. But it is unclear what the total damage might be if the plaintiffs in this case should win.

Feigin, who negotiated the settlement, said Equitas allowed the British and Americans to form a sinking fund reinsurance company. That means it has a set pool of money, in the neighborhood of 10 million to 15 million. It will not issue any new insurance and will pay out claims until the fund is dry. Equitas was to cover what were expected to be the total of outstanding pollution, asbestos and other claims on most of the losing syndicates.

The fighting names, those still pursuing the lawsuit, contend that if Equitas fails after the last pound is spent, and if there are still claims, the liability may still fall back on the individual names who were last in the syndicate.

That, according to Feigin, is the hot potato everyone is trying to avoid.

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