Toby v Allianz Global Risks US Insurance Company – FSD 152 of 2013 (IMJ): illegality in insurance contracts and the operation of the loss payee clause and financial loss exclusion
The Grand Court of the Cayman Islands has recently handed down its decision in Toby v Allianz Global Risks US Insurance Company – FSD 152 of 2013 (IMJ) a claim concerning aviation hull insurance in which Ben Elkington QC acted for the successful defendant insurer. A copy of the decision is available here.
In reaching her 210-page decision in this factually and legally complex matter, the Honorable Justice Ingrid Mangatal, described the task as “not … too dissimilar from a pilot trying to safely land an aircraft where there is no existing territory.” Pippa Manby summarises the landing path taken before considering the court’s approach to three specific matters: (a) the operation of the loss payee clause; (b) the illegality issue in the context of insurance claims in light of the Supreme Court’s decision in Patel v Mirza; and (c) the financial loss exclusion.
The claim related to a Cessna aircraft (“the Aircraft”) leased by the plaintiff, Toby, a Cayman Islands exempted LLC from Cessna Finance Corporation (“CFC”) pursuant to a Finance Lease dated 18 March 2008 (“the Finance Lease”).
The Aircraft was insured by the defendant, Allianz Global Risks US Insurance Company (“Allianz”), for the policy year 2012/13 (“the Policy”). The agreed value of the Aircraft for the purposes of the Policy was US$14m (“the Agreed Value”). The Policy provided cover for “confiscation, nationalization, seizure, restraint, detention, requisition for title or use by the order of any government.” The Policy contained an Airline Finance / Lease Contract Endorsement (AVN67B)(“the Endorsement”) the effect of which was to add CFC as an additional insured providing that, in the event that a claim was payable on the basis of a Total Loss, settlement should be made to, or to the order of CFC. The Policy excluded “loss, damage or expense caused by one or any combinations of the following … any debt, failure to provide bond or security or any other financial cause under court order or otherwise (“the Financial Loss Exclusion”). The Policy also included a condition that: “The due observance and fulfilment of the terms, provisions, conditions and endorsements of this Policy shall be conditions precedent to any liability of Insurers to make any payment under this Policy, in particular the Insured should use all reasonable endeavours to ensure he complies and continues to comply with the laws (local or otherwise) of any country within whose jurisdiction the aircraft may be, and to obtain all permits necessary for the lawful use of the aircraft” (“the Law Compliance Condition”).
The Aircraft operated flights in and out of Brazil utilising the country’s temporary admission regime. It was confiscated by the Brazilian authorities via a notification letter dated 20 June 2012 as part of an effort to crack down on perceived illegitimate use of the temporary admission regime. Following various civil and criminal proceedings, the Aircraft was sold by the Brazilian authorities three years later.
On 26 February 2013 Toby gave formal notice of a claim under the Policy. Allianz sought to decline the claim by letter dated 22 April 2013 and later sought to avoid the Policy by letter dated 12 March 2014.
Proceedings were commenced by Toby against Allianz in December 2013. Proceedings were commenced by CFC against Allianz in July 2014. The claims were directed to be tried together but the claim brought by CFC was settled on payment by Allianz of US$3.6m.
Having made extensive factual findings including as to matters of Brazilian law, the judge determined that Allianz was not entitled to avoid the Policy. She also held that the loss fell within the coverage afforded by the Policy and that the illegal use exclusion was not applicable. However, the claim failed for various reasons as Toby had not complied with the Law Compliance Condition and had also failed to comply with the notification requirements. The Loss Payee Clause precluded Toby from claiming directly against Allianz. Further, Toby’s failure to pay the appropriate import duty was either the sole proximate cause, or one of the proximate causes of the loss of the Aircraft which was a financial cause caught by the Financial Loss Exclusion in the Policy.
Given the length and complexity of this judgment, this discussion must necessarily be limited. Consideration is given, in turn, to the court’s approach to (a) the illegality issue in light of the Supreme Court’s decision in Patel v Mirza; (b); the operation of the financial loss exclusion; and (c) the operation of the loss payee clause
The Illegality Defence
Allianz argued that it would be contrary to the public interest for Toby to be able to enforce its claim in circumstances where the Aircraft had been seized by Brazilian authorities for non-payment of import tax. If Toby’s claim were not so barred, it would be placed in a win/win situation: either its failure to pay tax would go undetected (in which case it would save US$£2.4m), or its failure would be detected and the Aircraft would be confiscated (in which case it would have a claim on its insurance for that amount and would still not have to pay the import duty). Allianz relied on Geismar v Sun Alliance and London Insurance Ltd  1 QB 383 and the Cayman courts’ obligation not to assist in the breach of foreign revenue law.
The parties to the claim agreed that the Court should apply the three-stage test for the application of an illegality defence set out in the speech of Lord Toulson in Patel v Mirza  UKSC 42, where he held that:
“… it is necessary a) to consider the underlying purpose of the prohibition which has been transgressed and whether that purpose will be enhanced by denial of the claim, b) to consider any other relevant public policy on which the denial of the claim may have an impact and c) to consider whether denial of the claim would be a proportionate response to the illegality, bearing in mind that punishment is a matter for the criminal courts. … The public interest is best served by a principled and transparent assessment of the considerations identified, rather by than the application of a formal approach capable of producing results which may appear arbitrary, unjust or disproportionate.”
The judge noted that the doctrine would not have barred CFC’s claim as CFC had not been involved in the illegal conduct. It was open to her to consider the doctrine even though Toby had not been convicted of any criminal conduct. Toby had been subject to punishment. She concluded that, on an application of the three-stage test in Patel v Mirza, it was not appropriate to apply the illegality doctrine to defeat the claim as:
- The relevant prohibition which had been transgressed was that against the provision of an indemnity in respect of punishment for a crime. The issue in the case was whether Toby’s right to an indemnity under the Policy should be enforced not whether Brazilian import duties should be enforced.
- There was a countervailing public interest in the desirability of holding parties to their bargains.
- The relevant purpose supporting the denial of the claim because of the prohibition of an indemnity in respect of punishment of a crime was outweighed by the public interest in enforcing contractual obligations. There was no public policy interest in denying an indemnity to an insured who had used all reasonable efforts to comply with Brazilian law. It would be disproportionate to allow Allianz to resile from their promise not to rely on the prohibition on the provision of an indemnity in respect of punishment for a crime where the insured had used all reasonable efforts to comply with the applicable laws.
The Financial Loss Exclusion
The parties agreed that the Financial Loss Exclusion would only apply where “the other financial cause” (here, the failure to pay import tax) was a proximate cause of the loss.
Allianz argued that this was a fairly standard clause in a War risks policy which aimed to exclude an insurer’s liability to indemnify the insured for a loss arising because the insured (or a third party) was unwilling or unable to pay sums which ought to have been paid. It argued that one of the grounds on which the Aircraft was confiscated was a decree which applied where taxes have not been paid. Thus the non-payment of tax caused the confiscation and this was a financial cause which was a proximate cause of the loss. Allianz relied on the wide interpretations given to such a clause by the Court of Appeal in The Wondrous  2 Lloyd’s Rep 566 and The Aliza Glacial  2 Lloyd’s Rep 421.
Toby argued that the proximate cause of the confiscation was the authorities’ finding that Toby’s beneficial owner, Mr Lamacchia, was guilty of “simulation” and not the non-payment of import duty. That non-payment was simply part of the chain of events leading to the confiscation, not its effective and dominant cause.
The judge determined that Toby’s failure to pay the appropriate import duty was either the sole proximate cause or one of the proximate causes of the loss of the Aircraft. This was a financial cause caught by the Financial Loss Exclusion and was thus excluded from cover.
The Loss Payee Clause
Allianz argued that Toby was not entitled to recover any damages from it because Allianz was not in breach of any obligation owed to Toby. Any obligation to make payment was to CFC alone. In the Endorsement, CFC and “any financier and affilitates” were named as the contract party/ies and as those entitled to settlement in the event of any Total Loss. Allianz’s case was that, as it had reached an agreement with CFC, it had settled with the only party to which it had any obligation to make any payment. Insofar as Toby was dissatisfied with the fact that it had not received any insurance proceeds, this was a matter to be taken up with CFC pursuant to the terms of the Finance Lease Agreement. In claiming directly against Allianz, Toby was impermissibly trying to cut across the carefully constructed contractual mechanism agreed between CFC, Toby and Allianz by way of the Finance Lease, the Policy and the Endorsement.
Toby argued that Allianz’s obligation to pay the Agreed Value was owed to CFC and Toby. The Loss Payee Clause was a procedural rather than a substantive provision which had been released by CFC’s settlement with Allianz. Allianz was now liable to pay to Toby the balance of the Aircraft’s Agreed Value.
The judge held that it was “clearly correct” that Allianz was due to pay CFC and not Toby in the event of a Total Loss. The parties had carefully constructed a contractual mechanism dealing with their respective rights and the Loss Payee Clause was a substantive provision setting out that CFC had the exclusive right to claim against Allianz under the Policy.
The Doctrine of Illegality
This is the first insurance case dealing with illegality after the Supreme Court’s decision in Patel v Mirza and thus may be of wider market interest. The judge’s comments in this respect were obiter but provide an interesting application of Lord Toulson’s three-stage test in an insurance context.
It is respectfully suggested that the judge identified the wrong prohibition which had been transgressed: the correct prohibition to consider would have been that at the heart of the illegality itself, i.e. the prohibition against evasion of appropriate import duties, not how this reflected on the present claim. In holding that the relevant prohibition was that against the provision of an indemnity in respect of punishment for a crime, the judge was not starting at stage one by identifying the prohibition but rather looking at the illegality issue more in the round; taking off before pushing back from the stand (to abuse a flying analogy).
The judge’s decision at stage three was strongly influenced by the existence of the Law Compliance Condition. For an insurer to rely on the doctrine of illegality, the insured must have complied with that condition and so have taken reasonable steps to comply with the law. In those circumstances, it would be disproportionate to allow an insurer to escape its contractual obligation to pay. However, had that condition not existed, it is likely that the judge would still have reached the same view given the finding that she made in relation to stage one. Such an approach may be concerning: insureds who intentionally flout the law should not be able to obtain an indemnity for the consequences of such conduct simply because of the countervailing public interest in holding insurers to their contractual bargain.
The moral of the story may be that Insurers who wish to rely on illegality defences should ensure that the clauses of their policies dealing with such issues are drafted in sufficiently wide terms.
The Financial Loss Exclusion
The decision in this respect is unsurprising given the width of the clause as drafted and the precedent cases cited by Allianz which have given such clauses a wide meaning. Toby’s submissions to show that there was no financial cause strained at the facts of the matter and ignored the fact that the failure to pay the import duty was at the heart of the confiscation decision.
The Loss Payee Clause
Loss payee clauses commonly appear in aviation insurance contracts. The decision in this respect, although untrammelled by prior authority, is unsurprising. The judge applied the clear wording of the Policy and Endorsement and took account of the contractual mechanism agreed between the parties in reaching the conclusion that Toby was never entitled to recover against Allianz. Following this decision, insurers may feel more comfortable settling with the beneficiary of the Loss Payee clause without concern for claims of the other party to the Policy.
Whilst this decision could appear unfair to Toby given the value of the settlement reached with CFC and its ability to access those settlement sums, that was a matter that would be solved by stronger remedies in respect of insurance recovery for the hire-purchaser in the Finance Agreement or equivalent and not by ignoring the wording of the Policy and the Endorsement and the contractual nexus between the three parties.