Equitas Re Shortchanging of Corporate America Made Easy Part I How Equitas Re Gets Away with It

Journal Issue

May 2006

Column Name

Insurance Issues

Citation

ABI Journal, Vol. XXV, No. 4, p. 22, May 2006

Topic Tags

Insurance

International Insolvency

Journal HTML Content

It is strange that while "Lloyd's" is a household word all
over the world, comparatively few people, even in the United Kingdom, have
any idea of how business is carried on there.... 
—C. E. Golding and D. King-Page, Lloyd's (McGraw-Hill Book
Co. Inc. 1952), p. v.
</blockquote>
Author's Note: This article deals with English law and relevant circumstances
as of March 2, 2006. Detailed discussion of Equitas Re is at Astor's Equitas
Re Handbook (2002; ISBN 1 873994 26 5). Detailed discussion of insolvency
at Lloyd's and Equitas Re is at Astor's Insolvency at Lloyd's and Equitas
Re, 2nd Ed. (2006; ISBN 1 873994 90 7). The author's own technical terms
are defined at his Master Glossary, downloadable from www.astorlaw.com/downloads.
The reader should note the considerable legal complexity of the Lloyd's enterprise
and the 'Equitas' construct, of which the present article conveys only an indication.
 </blockquote>

U.S. corporations, long trusting to massive asbestos, pollution and health hazard
(APH) insurance bought (usually cheaply) and sold (usually fulsomely) in London,
are now discovering the hard way the extent to which some U.K. insurers really
intend to honor their obligations. U.K. 'solvent' and insolvent insurers alike
are finding it congenial to shelter from long-tail insurance creditors behind
the Companies Act 1985, and s.425 schemes of arrangement,1 a discreditable trend
likely to continue.
The mother of all such APH-related U.K. insurer manoeuvres is the customised2
'Equitas' construct, set up in 1996 to protect the insolvent3 Lloyd's of London
from its own unquantifiable U.S. long-tail APH liabilities. Equitas Reinsurance
Ltd. ('Equitas Re') is the captive reinsurer principal4 and claims-handling
agent5 created by the Lloyd's enterprise and insurance regulators with the apparent
intention—and certainly with the result—of camouflaging the true
legal picture from U.S. corporate APH creditors of the Lloyd's enterprise and
of buying many of them off as cheaply as possible.
Some such corporations seem to have failed to master the 'Equitas' construct's
technical detail before selling out their "Lloyd's" insurance back
to the Lloyd's enterprise for a fraction of its true value in abjectly cheap
commutations and or claims settlements done delusionally and unnecessarily cheaply
at Equitas Re. In that process, they have deprived themselves of some or possibly
all the insurance needed in the future to pay their APH and other creditors
in full. This tale is therefore not only about the Lloyd's enterprise's and
Equitas Re's insolvency, but about the possibility of some spectacular insolvencies
at some EquitasRe-assured-at-Lloyd's U.S. corporations—and some of their
creditors—caused directly by their self-impoverishment at the hands of
Equitas Re. Investors and financiers will be left empty-handed. Expect also
a significant attempt by the corporations involved or their advisers to conceal
from objective scrutiny—including by fancy and misleading accounting—quite
how damaging to the corporation these deals have really been. The 'Equitas'
saga should therefore be of present interest to each affected corporation's
board, shareholders, bankruptcy trustee (actual or in waiting) and their respective
outside lawyers.
Some Blameless

There are, of course, some U.S. corporate-assured-at-Lloyd's boards, CFOs and
outside insurance lawyers whose approach to, and knowledge and practice of,
relevant "Lloyd's" and 'Equitas' law and/or practice has been faultless.
They have been rigorous and scrupulous at all material times in ascertaining,
and disclosing to their investors, the whole truth and nothing but the truth
about their London insurance assets, and in doing deals at Equitas Re based
on sufficient accurate information and sound advice. This article should not
be read as criticising them in any presently relevant way.
How Has Equitas Re Done It?
How has Equitas Re managed to bamboozle relevant EquitasRe-assureds-at-Lloyd's
into doing such damaging deals? For the last 10 years and continuing, U.S. corporate
EquitasRe-assureds-at-Lloyd's have had the full might of mythology, professional
ignorance and political self-interest ranged against them. They have had no
assistance from the Lloyd's enterprise, Equitas Re, U.K. or U.S. state insurance
regulators or, in many cases, their own Lloyd's brokers and U.S. specialist
insurance lawyers. But there is one more challenge the assured has had to contend
with in claim and commutation negotiations with Equitas Re: the latter's now
notorious negotiating ploys. The author estimates that since its formal inception
on Sept. 3, 1996, Equitas Re has or will have used these ploys to save the Lloyd's
enterprise avoid paying around $20 billion, possibly much more, to corporate
America in insurance and reinsurance claims. Here they are.
Ploy 1: 'The Lloyd's Enterprise Has Transferred All Its Pre-1993 Liabilities
to Equitas Re' 
The notion that the Lloyd's enterprise, or any member of Lloyd's, transferred
any insurance liabilities to Equitas Re is wholly unfounded in English law.
The only way in English6 law whereby relevant components of the Lloyd's enterprise
could lawfully have transferred to Equitas Re insurance liabilities incurred
at Lloyd's was either by statutory contractual novation under Insurance Companies
Act 1982, Sch. 2C7 or by common-law contractual novation. Each option was considered
at the time and rejected.8 The transfer of liability so insistently averred
by the Lloyd's enterprise and Equitas Re—and insinuated by insurance regulators
and Lloyd's brokers—never happened.
So why does Equitas Re allege a transfer in commutation and claims settlement
negotiations? Why is there no honest disclosure of the fact that every valid
claim on every insurance contract sold at Lloyd's is collectible 100% at Lloyd's,
not x% at Equitas Re? Because the transfer proposition sounds plausible, because
few assured-side lawyers have demonstrated that they have done the work necessary
to disprove it, and because the uninformed and misinformed U.S. corporate EquitasRe-assured-at-Lloyd's
itself acquiesces in it so readily. And not surprisingly. The Lloyd's enterprise
provides no claims-handling office or facility for EquitasRe-reinsured liabilities;
the popular press erroneously characterises RRC 4, §3 as a transfer;9
insurance regulators in the United Kingdom, New York, Illinois, Canada and other
jurisdictions have approved the 'Equitas' construct and do nothing to inform
or advise Equitas Re-assureds-at-Lloyd's of the truth (the New York Insurance
Department has been particularly unhelpful); and Lloyd's brokers see no commercial
advantage in handling old-year claims, so encourage their old clients to settle
at Equitas Re 'while you still can.' This is a formidable range of facts on
the ground.

Ploy 2: 'The EquitasRe-Assured-at-Lloyd's Has Been Validly Dispossessed
of His Right to Recourse for Any Part of the Claim' 
If there has been no transfer of liability from the Lloyd's enterprise to Equitas
Re, it follows that the EquitasRe-assured-at-Lloyd's remains fully entitled
to recourse to the enterprise for 100% of his procedurally and substantively
valid claim as and when it arises, not x% at an outward reinsurer such as Equitas
Re. Lawyers unfamiliar with recourse at Lloyd's10 will seek in vain an instrument
expressly depriving any EquitasRe-assured-at-Lloyd's of this entitlement. But
some substantial U.S. corporate EquitasRe-assureds-at-Lloyd's appear to have
bought into Ploy 2 completely, becoming fixated on maximising how much Equitas
Re is graciously prepared to pay them right now, not on getting 100% from the
Lloyd's enterprise as and when due, including through litigation where appropriate.
The not-unreasonable, legally unassailable expectation that the rectitudinous,
financially robust, business-as-usual Lloyd's of London—motto 'Fidentia'—should
honour its old-year APH liabilities in full, as Cuthbert Heath famously ordained
after the 1906 San Francisco earthquake, plays badly to the new generation of
members of Lloyd's: large corporations keen to distance themselves from insurance
liabilities they had no part in acquiring, from which they stand no chance of
directly benefiting,11 and towards which they have no intention of contributing.
Those corporate members, some with publicly quoted shares, do not seem to appreciate
that those liabilities adhere to the enterprise—and thus to members of
Lloyd's—as much as to relevant SYA participants,12 and that an inalienable,
inviolable incident of membership of Lloyd's is contributing sufficiently to
a Central Fund sufficient to pay all valid claims in full precisely because
relevant EquitasRe-reinsured SYA participants may be dead, untraceable or impecunious.
It is the regulatory price that the enterprise's members pay for being able
to trade insurance at Lloyd's. They too appear to have been misled on this point
by their own lawyers, or perhaps they are taking a calculated risk and will
resign from Lloyd's, leaving the Central Fund bereft, when the 'Equitas' construct
fails.
There is an additional recourse dimension when dealing with insurance sold
at Lloyd's to U.S. buyers, viz., the various MO and BO dedicated and not-dedicated
claims payment securitisation trust and other funds mandated by U.S. state insurance
regulators and furnished accordingly by the Lloyd's enterprise. Far from withdrawing
these funds, the Lloyd's enterprise was required by various U.S. state regulators
to make them available specifically to cover in full all EquitasRe-reinsured
liabilities.13 And the Lloyd's enterprise must maintain them at a minimum level,
or else risk having them seized by local insurance regulators. That there has
been no pressure on these funds is due to cheap sell-outs and reticence to sue,
not because the liabilities are not due.

Ploy 3: 'Equitas Re Is Impecunious. We Can't Afford to Pay You More'
Lawyers will seek in vain an instrument making Equitas Re's personal finances
of the slightest legal relevance to any EquitasRe-assured-at-Lloyd's in the
first place. But some substantial U.S. corporate EquitasRe-assureds-at-Lloyd's
appear to have bought into this ploy completely, becoming convinced of its relevance
and truth rather than dismissing it as irrelevant whether or not true. Curiously,
despite being one of Equitas Re's most insistent and successful negotiating
lines, it does not seem to have attracted the scrutiny of any insurance regulator
required to monitor Equitas Re's solvency.
Ploy 4: 'Equitas Re Is About to Go Bust. Take What You Can Get Now'
The 'Equitas' construct's sleight of hand appears to have substituted for the
Lloyd's enterprise a conventional U.K. reinsurer subject—apparently unlike
the enterprise—to ordinary financial frailties. It has no ready supply
of members; apparently no right to call on the enterprise, shareholders or sureties
for capital or guarantees; it must stand on its own two feet as long as its
assets hold out; thereafter it is as susceptible as any other conventional insurer
to insolvency precipitates and processes, and its creditors as conventionally
vulnerable to proportionate paltry payouts. All true, and all irrelevant. Equitas
Re's only legal creditors in the first place are EquitasRe-reinsured SYA participants,
not EquitasRe-assureds-at-Lloyd's.
Ploy 5: 'When Equitas Re Does Go Bust, Go Sing to Each Syndicate Member
for Your Money!'
It can be asserted without the least fear of contradiction that the assured-at-Lloyd's
has no obligation whatever to recourse to, or collect from, any natural solus.
The enterprise could not and does not work in that way legally, regulatorily,
practically, administratively, procedurally, commercially or otherwise. Recourse
is to the Lloyd's enterprise. How the enterprise marshals money to pay its liabilities
is its problem.
The front-office (cf. back-office) collection relevance of a solus
is widely misunderstood, including by lawyers and judges. There is little awareness
or perception of the distinctions between, in relation to a particular insurance
contract sold at Lloyd's, the original contracting insurer, the present active
insurer, the jurisdictionally proper defendant to a particular coverage claim,
and the collection-judgment debtor. These roles are not synonymous. For example,
the original contracting insurer may be long dead and not capable even through
agents of defending a claim. In relation to a collection judgment, claimium
is never disbursed to the successful claimant by any present active insurer,
even through an agent. Rather, disbursement is made in the back office from
various back-office funds at the Lloyd's enterprise, usually through a disbursement
mechanism called Central Accounting. How the enterprise marshals money to do
this is its own affair, into which no assured-at-Lloyd's need, ordinarily, ever
inquire.

This ploy closely resembles the (exquisitely gauchely named) "dead man's
stop" ruse considered by prospective EquitasRe-reinsured SYA participants
before the 'Equitas' construct was formalised. The very tactic, now routine
at Equitas Re, of inviting EquitasRe-assureds-at-Lloyd's to do undervalued commutations
because of the inaccessibility to the assured-at-Lloyd's of the originalis solus
was considered (in a slightly but not presently materially different context)
before the 'Equitas' construct was formally set up,14 its inherent dishonesty
noted,15 and rejected by a prominent firm of city solicitors16 and its own sources.17
Not in a position to make the argument for themselves, and the Council of Lloyd's
fastidious of its own reputation, EquitasRe-reinsured SYA participants are now
perfectly happy for their reinsurer and run-off agent Equitas Re to make the
spurious argument for them.
Ploy 6: 'When Equitas Re Goes Bust, You'll Have to Prove in Its Insolvency
Along with Everyone Else'

The genius of this ploy is to conjure a massively complicated insolvency process
in which thousands of EquitasRe-assureds-at-Lloyd's compete not at Lloyd's,
or even in relation to the dedicated funds furnished by the Lloyd's enterprise
and mandated by insurance regulators specifically to pay Equitas Re-reinsured
liabilities, but for the limited pot of Equitas Re's money (a conventional version
of what might already have happened, and what might yet happen, at Lloyd's itself
absent a plausible 'Equitas' construct or equivalent). But as Equitas Re's only
insurance creditors are EquitasRe-reinsured SYA participants, the ploy has little
relevance or resonance—certainly none of any compelling quality—for
EquitasRe-assureds-at-Lloyd's.
Notwithstanding, some substantial U.S. corporate EquitasRe-assureds-at-Lloyd's
appear to have bought into the ploy wholeheartedly, overlooking the prospect
of the Lloyd's enterprise continuing to do business as usual in relation to
its more recently acquired and relatively more palatable liabilities. The perniciousness
of the 'Equitas' end-game is that the 'transfer' mythology will be corrected,
all EquitasRe-reinsured liabilities will then revert to the Lloyd's enterprise,
and all assureds-at-Lloyd's, old and new alike, will then have to compete for
what will at that point be assets insufficient to pay all valid claims in full.
It will be the most spectacular, complex, time-consuming and remunerative of
all commercial insolvencies.
Part II will cover anticipating, preventing and remedying a materially cheap
'Equitas' deal: injunctions, declarations, class actions, malpractice suits,
Department of Justice and SEC proceedings in relation to Equitas deals.
<h3> Footnotes</h3>
 1 The latest version of s.425 is at www.astorlaw.com/downloads. Recent English
cases include (for example) Re British Aviation Insurance Company Ltd.
[2005] EWHC 1621 (Ch) (Lewison J); Re Home Insurance Co. [2005] EWHC
2485 (Ch) (Mann J). Also see R.J. Astor, "U.K. Solvent Schemes of
Arrangement: Insurance Creditors and the Court Finally Bite Back," ABI
Journal, vol. 24, no. 7, September 2005.

2 In the then-absence of any prescribed formula to deal with an insolvency
of the entire Lloyd's enterprise. There is still no such formula despite EU
Council Directive 2001/17/EC (March 19, 2001) on the reorganisation and winding-up
of insurance undertakings and Insurers (Reorganisation and Winding-up) (Lloyd's)
Regulations 2005 (SI 2005/1998). On the latter's inadequacy to deal with enterprise-level
(or any other) insolvency at Lloyd's, see R.J. Astor, "Meltdown
at Lloyd's: New Law, Old Problems," Tolley's Insolvency Law & Practice,
December 2005, vol. 21, no. 6, p. 191.
3 See, for example, S&M, §60 (pp.21-22): The Council itself
raised the prospect of insolvency when, in the proposals for R&R published
in May 1995, it stated: "...we fully expect that Lloyd's will pass the
solvency test in August of this year [1995]. However, to be confident about
our longer term future, we must confront the following principal financial challenges
facing the Society... The net assets of the Central Fund are forecast to be
around £300m. by the end of 1995. Further draw-downs on the Central Fund
are expected in 1996. We have concluded that, unless decisive action is taken,
the resources of the Central Fund may be exhausted before the end of 1996. The
enterprise's financial situation deteriorated in 1996.
4 See generally RRC 4, §3.
5 See generally RRC 4, §9.

6 The 'Equitas' construct's principal governing law.
7 See now Financial Services and Markets Act 2000, Part VII and Financial
Services and Markets Act 2000 (Control of Business Transfers) (Requirements
on Applicants) Regulations 2001 (SI 2001/3625). For Part VII process directed
expressly to the Lloyd's enterprise, see, for example, Financial Services
and Markets Act 2000 (Control of Transfers of Business Done at Lloyd's) Order
2001 (SI 2001/3626).
8 See, for example, S&M, p.8 ('Statutory Finality'): 25. At common
law, it is not possible to assign or "novate" an obligation under
a contract, i.e. by transferring the obligation to another person, without
the consent of the person to whom the obligation is owed. In other words, Names
cannot be released from their obligations to policyholders except with the policyholders'
consent. Under English law, the only way there might be of overcoming this difficulty
is with powers conferred by an Act of Parliament. We have, therefore, considered
the relevant statutory provisions under which this might be possible. These
are Section 85 and Schedule 2C of the Insurance Companies Act 1982, Section
425 of the Companies Act 1985 and Section 58 of the Insurance Companies Act
1982. In our view, neither Section 425 of the Companies Act 1985 nor Section
58 of the Insurance Companies Act 1982 is applicable to Lloyd's Names. 26. However,
a statutory transfer of Names' insurance liabilities into Equitas could be effected,
with the approval of the Department of Trade and Industry (the "DTI"),
under Section 85 and Schedule 2C of the Insurance Companies Act 1982. Such a
transfer would operate as a novation and would therefore provide a complete
release to Names from their obligations to policyholders. However, it seems
likely that such a transfer would not extend to Names' corresponding assets,
i.e. the benefit of reinsurance. In other words, it would not be possible
to effect a statutory transfer of syndicates' reinsurance programmes into Equitas
without the consent of each and every reinsurer. The DTI has confirmed that
this is their interpretation of the legislation. Lloyd's is of the view that
it would not be practicable to obtain the consent of every reinsurer. We are
not in a position to assess the difficulties of doing so. Certainly, in our
view, the risk of losing the benefit of all reinsurances is too great to justify
pursuing this possibility further unless the consent of all reinsurers could
be obtained. See at ibid., App. 2 (pp.45-47), the list of lawyers whose
views Slaughter and May took into account in preparing S&M.

9 Try the Nexis search and from Jan. 1, 1996.
10 Until 1996, there was no need to figure out recourse at Lloyd's because
every valid claim was handled at Lloyd's and paid from funds at or furnished
by the Lloyd's enterprise.
11 The corporation formally known as a Lloyd's (see Lloyd's Act 1871,
s.3) is not an investment vehicle and does not distribute the profits of its
members.
12 This argument distinguishes between a mere member of Lloyd's in general
and the particular member who sold insurance in his capacity of SYA participant.
Member-level and SYA-participant-level capacities and liabilities are materially
different. A full discussion is outside this article's scope. It is discussed
in detail in Astor's Law of Lloyd's, 2nd Ed. 
13 Key provisions of key trust deeds are set out, annotated, in Astor's
Equitas Re Handbook.
14 See, for example, S&M, §77(1) (p.29): 'In the alternatives
to R&R which have been put to us, different ideas have been put forward
about how the cost to Names of fulfilling their underwriting obligations might
be mitigated. In broad summary, these ideas are:...(2) that in a "managed"
run-off of Lloyd's substantial commutations of claims and buy-backs of policies
could be negotiated, resulting in substantial savings for Names'.

15 See, for example, S&M, pp.30-31: [79] It is suggested...that
long-tail syndicates should take advantage of "Dead Man's Stop" and
thereby reduce their liabilities considerably. In our view, it would be very
difficult for a responsible Council to adopt or allow a general policy of this
nature. We have two principal reasons for this view. [80] The first is that
the Council would have to be convinced that implementation of such a policy
would not put in doubt the credibility of all policies of insurance written
at Lloyd's. The proposal amounts to taking advantage of complexities in the
Lloyd's system designed for the benefit of Names (to enable them as individuals
to carry on business as insurers and to enter and leave the system when it suits
them) and turning them to the disadvantage of policyholders. Once it became
known that this was being done, on a generalised basis, however good the arguments
to justify it may be thought to be, any sensible policyholder at Lloyd's, present
or prospective, would seek cast-iron assurances that this would not occur in
his case or take his business elsewhere. The authors of S&M appear to have
overlooked that the SYA participant is not liable to the assured-at-Lloyd's
as a solus in the first place.
16 Who expected 'well-advised policyholders...to join together in action groups
(just as Names have done) to combat any concerted attempt on the part of Names
to apply "Dead Man's Stop", in particular to enforce rights common
to all or most of them, such as to compel the provision of information': S&M,
§82(e) (p.32). It is indeed remarkable, if not incredible, that there has
been no mass litigation against the Lloyd's enterprise by EquitasRe-assureds-at-Lloyd's
facing attempts by the mystery-mongers at Equitas Re to materially shortchange
them (application for declaratory relief against the enterprise is considered
in the next article in the present series).
17 See S&M, §87 (p.33): The principal financial advantage to
Names from the LNAWP Plan is said to be the pressure which policyholders will
come under to commute (or "buy back") their policies at substantial
discounts because of anxiety about solvency. We do not disagree that, in theory,
in such a situation, policyholders would be willing to negotiate policy commutations,
possibly at substantial discounts. However, in our view, the LNAWP Plan underestimates
the practical difficulties which would arise in the run-off which it proposes.
These are listed in paragraph 75. In particular, run-off managers would not
be able to commute on behalf of all the Names in their syndicates: They would
only be able to commute on behalf of Names whose solvency is certain and, as
we have mentioned above, they will not be certain about that because many Names'
reinsurances would have ceased to be fully effective. It will be difficult for
managing agents to identify which Names are solvent and which are insolvent.
Furthermore, the relevant reinsuring syndicates (whose consent to commutations
will also be required) will experience exactly the same difficulty. In short,
the principal financial advantage which LNAWP hopes its proposal will provide
for Names will, in our view, be difficult to achieve.

Journal Authors

Richard Astor

Journal Date

Monday, May 1, 2006 - 12:00

Bankruptcy Rule

2006

none