Equitas Re Shortchanging of Corporate America Made Easy Part I How Equitas Re Gets Away with It
—C. E. Golding and D. King-Page, Lloyd's (McGraw-Hill Book Co. Inc. 1952), p. v.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.
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.
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.
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.  EWHC 1621 (Ch) (Lewison J); Re Home Insurance Co.  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 . 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:  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.  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.