Errors-and-omissions clauses arose in reinsurance as a way to rectify clerical errors in lengthy bordereaux. But in today's adversarial environment, what exactly does an E&O clause excuse?
Does it excuse an error in the amount of premium ceded? Does it excuse a failure to include a risk in facultative obligatory reinsurance? Does it excuse including a type of risk not covered, or even a late notice of a loss perhaps? The answer depends on the wording of the clause and how well the limited proper application of these clauses is understood.
An E&O clause, for example, might read: "Any inadvertent delay, omission or error shall not be held to relieve either party from any liability, which would attach to it hereunder if such delay, omission or error is rectified immediately upon discovery."
To understand the clause's origins and meaning, picture a mid-19th century office--rows of clerks with fountain pens, transcribing into lengthy bordereaux long lists of risks reinsured, premium ceded and losses paid. The point is that the clerks are communicating objective information, having nothing to do with the terms of the agreement. Using an E&O clause to rewrite the agreement is not equitable rectification, a strategy used to remedy issues not fixable by paying damages, but instead allows one party's unexpressed intentions to recast the original deal.
The case of Economia Commerciale v. National General Insurance is an example in which the cedent entered all cessions in a register and notified the reinsurer within seven days that it was on the risk, thereby creating the reinsurer's liability. The court found that liability was not "affected by any accidental omission . . . or by any unintentional or clerical omission, error, or slip, or other inadvertence."
The justices ruled that the reinsurers could not avoid liability if the cedent showed the failure to send the advice was in fact accidental.
Some recent attempted uses of the clause are to correct errors of judgment--not errors in the flow of information. Case law and commentary on this clause is sparse and often decided for or against the reinsurer based on factors other than the E&O clause. Nonetheless, the following authorities demonstrate that using stock clauses without thought could lead to novel and unintended results.
TYPES OF RISK
Parties choose the subject matter and terms of their contract. For reinsurance to work, the reinsurer must be able to define the type of risk reinsured. An E&O clause alone cannot be used to expand the subject matter of a treaty, a proposition confirmed by Aetna Insurance v. Glenn Falls Insurance.
In Aetna, a dual agent for the insurer and the reinsurers ceded an inland marine risk under a treaty that excluded inland marine risks. The court ruled that, standing alone, the E&O clause did not make the reinsurer liable. Absent special facts, excluded classes of risks are simply excluded, despite E&O clauses.
Can an E&O clause justify retroactively including a risk in a facultative obligatory treaty? If so, moral hazard abounds. For example, in one facultative/obligatory hull treaty, a cedent ceded a hull in 1970 but failed to include the next year's cover--the year the ship sank. Noting that the cedent could "backdate" the error, one treatise (Gerathewohl et. al.'s "Reinsurance Principles and Practice," vol. I) concluded that "application of the E&O clause in such a case would upset the entire direct insurance/reinsurance relationship, as it would be virtually impossible for the reinsurer to prove the real nature of the error made by the direct insurer."
The only conclusion is that the E&O clause cannot be used to achieve this result.
Where the "error" is failing to disclose information that would have prevented the agreement from existing, the E&O clause cannot "bootstrap" coverage. In Pan Atlantic Insurance v. Pine Top Insurance, the reinsurer sought to avoid a 1982 cover due to nondisclosure of 1981 losses. The cedent claimed the nondisclosure in 1981 was inadvertent and insisted the 1981 E&O clause rendered nondisclosure moot. While finding that the nondisclosure was inadvertent, the courts agreed that the clause had no application to a precontractual nondisclosure or misrepresentation.
The opinion in Highlands Insurance v. Continental Insurance is even stronger. Here, the misrepresentation was the existence of fire-control measures. The cedent relied on an E&O clause, but the court disagreed, stating that it was "quite inconceivable that it was intended to apply to a . . . precontractual material misrepresentation."
The E&O clause cannot be used to retrospectively declare a risk to an open cover either. In Glencore International v. Alpina Insurance, the reinsurer denied recovery for products not disclosed preloss. The court agreed.
Some atypical claims-reporting clauses in treaties contain E&O language that can eviscerate claims-reporting duties intended to protect the reinsurer.
In Inland Mutual Insurance v. Peerless Insurance, for example, the cedent reported late, but then kept the reinsurer involved in settlement decisions. After an adverse verdict, the reinsurer denied for late notice. The court ruled that the reinsurer was liable because the claims-notice clause made late reporting a permissible error or omission.
Stuyvesant Insurance v. United Public Insurance reached a different conclusion. The cedent notified the reinsurer of an excess-of-policy claim it had settled. This treaty also contained a variant claims clause with E&O language. While the reinsurer prevailed on other grounds, the court was not impressed by a claim of clerical error in failure to provide notice, stating that "both insurance companies were knowledgeable, experienced companies, hence, were not excusable for failure to have full knowledge and complete information as to the terms of said pertinent insurance policy."
One case, Pan Atlantic Insurance v. Pine Top Insurance, suggests that, where an excess of loss treaty also contains a follow-the-fortunes clause, the E&O clause may excuse timely notice of claims. Pan Atlantic's value for this proposition is sharply limited by the fact that it expressly states that it was not construing the clause itself.
E&O clauses cannot be used after the loss to re-estimate the cedent's probable maximum loss as well.
Do E&O clauses belong in excess-of-loss reinsurance? If so, what do they do? Some treatises contend that they have no place, and create only confusion. Lord Justice Johan van Zyl Steyn struggled with this issue in the Pan Atlantic case, involving an E&O clause in an excess treaty.
"This is a difficult question," he wrote. "The reinsured is obliged to allow inspection of its books (and to) notify the reinsurer of claims as soon as practicable, and to supply all relevant papers. . . . It seems therefore that article XV can at least apply in respect of inadvertent omissions from the post-treaty flow of information."
But was this intended or, rather, an accidental transplant of a clause from a proportional treaty?
E&O clauses can have subtle and sometimes deliberate variations in wording. But all too often, stock clauses are used without attention to their implications. There are almost as many variations of E&O clauses as there are parties using them. The E&O clause is a method of correcting misinformation, not a method of changing the terms of the agreement or subjective decisions under the agreement. With the E&O clause, wording does matter.
is general counsel of Swiss Re's Commercial Insurance.
June 1, 2007
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