HIH Casualty and General Insurance Limited and others (Respondents) v Chase Manhattan Bank (Appellants) and others HIH Casualty and General Insurance Limited and others (Appellants) v Chase Manhattan Bank (Respondents) and others (First Appeal) HIH Casualty and General Insurance Limited and others (Appellants) v Chase Manhattan Bank (Respondents) and others (Second Appeal) (Conjoined appeals)
24. I have had the advantage of reading the opinion of my noble and learned friend Lord Bingham of Cornhill. For the reasons given by Lord Bingham I would also make the order which he proposes.
Film finance insurance
25. This appeal is concerned with a new high risk, high premium insurance product used in financing film production. The risk insured against is that a party who has advanced money for the production of a film against the security of a defined share of future revenue will fail to recoup his advance within a specified period. It is high risk, first, because the commercial success of a film is notoriously difficult to predict and, secondly, because a good deal will turn upon how the lender's revenue entitlement is defined. If all expenses have first to be paid, the lender will be subject to unpredictable cost overruns. Fees, commissions, royalties, overriding payments to director and stars and similar skimmings may also deplete the lender's share of gross revenue. And in an industry where possession of the money tends to be nine-tenths of the law, much will depend upon who banks the money and keeps the books. It is a form of insurance in which the players need to have their wits about them.
The original TVC facility
26. The use of insurance in connection with film finance appears to have been developed about ten years ago by a company called Screen Partners Ltd ("SPL") in conjunction with Heath North America & Special Risks Ltd, a specialist subsidiary of Heath Insurance Broking Ltd. I shall refer to them both as Heaths. They occupied the usual somewhat ambiguous position of insurance brokers in taking the initiative in putting together an insurance product and offering to procure it for lenders of film finance. Lenders who participated in such a scheme would make it a condition of the loan that the borrower, the production or distribution company, should procure the issue of an insurance policy and pay the premium and any other associated expenses. But in presenting the proposal to underwriters Heaths acted in their traditional role as agents for insured.
27. In 1992 a number of insurers (including six of the eight involved in these proceedings) subscribed to a line slip for film finance insurance which was renewed annually until 1996. The insurance offered was known in the market as a "time variable contingency" or "TVC" facility. Several films were declared under the line slip and, so far as the insurers were aware, the outcome was uniformly successful.
28. The insurers attributed this happy state of affairs, at least in retrospect, to certain features of the arrangements which limited their risk. First, the underwriters were advised by an independent risk manager (a role played under the line slip by SPL) who reviewed the script, production budget, revenue estimates and certain other matters. Secondly, the rights of other persons such as the distributor, producer, director, lead cast and other investors to payment out of the gross revenue were subordinated to the rights of the insured until the insured loan had been fully repaid. Thirdly, the gross revenues were paid into a designated collection account under the control of the lending bank. Fourthly, the insurers were able, in the event of a revenue shortfall and prospective claim, to take control of the distribution of the film.
The Phoenix slate
29. The policies in issue in the present proceedings were devised by Mr Graham Bradstreet, a film finance consultant, who operated through a company called Premier Media Ltd ("PML"). On 7 July 1995 PML entered into an agreement with a newly formed American production company called Phoenix Pictures Inc ("Phoenix") by which it undertook to find TVC insurance to support borrowings for films which Phoenix proposed to make. PML warranted that the insurance would be broked by Heaths and that underwriting capacity of between US$75m and US$120m would be available to insure all films produced by Phoenix during a period of at least three years. It was a condition of the agreement that PML should be the underwriters' risk manager. Pursuant to the agreement, PML obtained from Heaths an undertaking that it would use its best endeavours to procure TVC insurance for the bank or banks providing finance for Phoenix's films during the currency of the agreement. In the event, the bank which agreed to act as leader in the syndicated financing of what has been called the "Phoenix slate" of films was Chase Manhattan Bank, now called JP Morgan Chase Bank. I shall call it "Chase".
30. Five contracts of insurance for films forming part of the Phoenix slate were placed between June 1996 and March 1997. Two, for films called The Mirror has Two Faces ("Mirror") and The People vs Larry Flynt ("Flynt") were placed facultatively, insurers subscribing to primary and excess slips for Mirror on various dates between June and September 1996 and to a primary slip for Flynt on various dates in October 1996. The contracts of insurance relating to the other three films were placed by declarations off a line slip which was scratched by various insurers between June and September 1996. The declarations were made in November 1996, December 1996 and March 1997.
31. Separate policies were issued for Mirror and Flynt. A single policy in respect of the line slip was issued, referring to the three declarations. The terms of the three policies are in all material respects identical. For the purposes of these proceedings the parties have taken the first layer policy issued for Mirror as representative of the others.
32. The policy was taken out for the benefit of Chase by a company called Elmwood Films Inc, a corporation formed solely for the purpose of borrowing money from Chase and acquiring the participation in revenue which was to be assigned to Chase as security. Elmwood entered into a Reimbursement and Term Loan Agreement ("RTLA") with Chase and the other banks providing the syndicated loan by which it borrowed money on a non-recourse basis, that is to say, its liability was limited to whatever was recovered by Chase under its security. Elmwood's entitlement to the revenue assigned to Chase was derived from a Revenue Participation Agreement ("RPA") made between itself and TriStar Pictures Inc ("TriStar"), a company associated with Phoenix which held the distribution rights. Under the RPA, Elmwood acquired its revenue participation in return for payment of the money it was borrowing from Chase. The RPA contained an elaborate definition of the revenue to which Elmwood (and so Chase) would be entitled.
33. It was a condition precedent of the RTLA that Elmwood should take out the insurance policy in the name of Chase and pay Heaths a sum sufficient to pay PML's fee, the insurance premium, tax and brokerage fees.
34. There have been substantial shortfalls in the revenue assigned by way of security to Chase in respect of all five films and it has made claims under the policies. The insurers have repudiated liability on the grounds of misrepresentation and nondisclosure, either fraudulent or negligent, on the part of Heaths as broker. I shall in due course outline these allegations in detail. No allegation is made against Chase itself.
35. Chase has brought proceedings in respect of the Mirror and Flynt insurances, which the insurers are defending on the ground that they have lawfully rescinded the contracts of or for insurance and counterclaiming for damages against Chase and Heaths for misrepresentation and nondisclosure. The insurers in turn have brought proceedings against Chase and Heaths in respect of the three line slip insurances, claiming that the contracts have been rescinded and damages. The three actions have been consolidated. Chase claims that upon the true construction of the policies, the insurers are not entitled to repudiate liability or claim damages against Chase even if all the allegations made by the insurers against Heaths are true. As the issue is one which, if resolved in favour of Chase, would result in it recovering under the policies, Longmore J ordered the questions of law and construction to be tried as a preliminary issue:
The case for the insurers
36. As the preliminary issue is in the nature of a demurrer, requiring an assumption that the insurers' allegations are true, it is necessary to summarise the facts which have been pleaded. It must however be emphasised that there has of course been no trial and the allegations against Heaths are strongly denied.
37. First, it is said that Heaths made a number of misrepresentations. The insurers' primary case is that Heaths knew that it was being untruthful and the misrepresentations were therefore fraudulent. In the alternative, they say that if there is some honest explanation, Heaths should reasonably have known that the representations were untrue and were therefore negligent.
38. The principal misrepresentation alleged is that the risk involved in insuring the Phoenix slate was substantially the same as that under the 1992 line slip. In fact it was very different because, first, the risk manager was PML, which had a financial interest in procuring the insurance in accordance with its agreement with Phoenix and was therefore not independent; secondly, the revenue assigned to Chase was subject to numerous prior deductions of uncertain extent; thirdly, the revenue was not paid into an account controlled by the bank but directly to the distributor, TriStar, which passed on to the bank whatever remained after making such deductions as it thought appropriate and fourthly, the insurers could not assume control over distribution if the revenue fell short or a claim was made.
39. Heaths are also said to have represented that the 1992 line slip was claim free. This, as I have said, had been the impression of the insurers, but they say that Heaths concealed a claim by paying it themselves.
40. Next, Heaths are said to have concealed various material pieces of information. One was that SPL had expressed extremely unfavourable views about terms of the revenue participation agreement assigned to Chase ("among the most dangerous that Hollywood has ever devised"). The scale of deductions to which Chase's interest was subordinated made a shortfall virtually certain even if the film earned much more than had been estimated. Both the Lloyd's market and the original lead insurer, which had initially subscribed to the facultative insurances and line slip, were said to have shared this concern and withdrawn but Heaths are alleged to have falsely represented that they withdrew for other reasons.
41. The amended Particulars of Claim condescend to a good deal more detail and we were told that they have since been further amended, but the above summary should be sufficient for the purpose of enabling the preliminary issues to be determined.
The common law
42. Apart from the special provisions of the policy to which I shall come, the misrepresentations and nondisclosures alleged by the insurers would entitle them to avoid the contracts. This follows from sections 17-20 of the Marine Insurance Act 1906, which codified the common law in an area in which there is no difference between marine and other insurance and which have therefore been accepted as having general application: see PCW Syndicates v PCW Reinsurers  1 WLR 1136, 1140. Section 17 provides that a contract of insurance is "based upon the utmost good faith" and may be avoided by either party if the utmost good faith be not observed by the other. Section 20 requires, as part of the obligation of good faith, that any material representations made by the insured or his agent during the negotiations for the contract should have been true. Section 18 imposes obligations of disclosure of material circumstances upon the insured; these, as I have said, are not alleged to have been broken, but section 19 imposes upon an agent a separate obligation to -
It is this obligation which is alleged to have been broken, either dishonestly or negligently, by Heaths.
The Truth of Statement Clause
43. Chase contends however that the right of the insurers to avoid the contract on these grounds is excluded by what the policy calls the "Truth of Statement Clause". The clause has of course to be construed in its setting in the policy as a whole and I shall refer to some other parts of the policy which are said to throw light on what it was intended to mean. I start, however, by setting out the terms of the clause, dividing it for convenience (as it was by the judges in the courts below) into 8 paragraphs, sentences or phrases. This clause is taken, as I have said, from the policy issued in respect of Mirror:
44. It is a condition precedent to this policy that:
45. Phrases 6 to 8 are the only parts of the clause directly relied upon, so the earlier parts need only a brief explanation. The "questionnaire" was scheduled to the policy. Section I identified Elmwood as the applicant for insurance, gave the name of the film, the production company, the individual producers, the director and principal cast (Barbra Streisand and Jeff Bridges) and the distributors, attached the script and budget and stated the dates of commencement and completion of the principal photography. Section II contained some revenue estimates but was prefaced by a comprehensive disclaimer of which the following sentence gives the flavour:
46. Section III (largely blank) dealt with the bank facility being granted. The schedule ended with a certificate by PML as risk managers, saying that they had analysed the budget and were of opinion that the proposed TVC sum was an appropriate amount to be insured under the policy.
47. No complaint is made of any untruth in any section of the questionnaire. Nor has any reference been made to the due diligence clause which is mentioned in phrase 5. As I have said, the insurers' complaints of nondisclosure and misrepresentation are directed solely at Heaths and go much wider. As a defence to these complaints, Chase relies upon phrases 6-8.
48. The insurers admit that the general intention behind the Truth of Statement clause is to prevent Chase from losing the benefit of the policies because it failed to disclose material circumstances which it was "deemed to know" for the purposes of its own obligations under section 18 or because of nondisclosures or misrepresentations on the part of its agents in general and Heaths in particular. The main purpose, it was said, was to "distance" Chase from responsibility for anything said by or known to the other players. This purpose was easily explicable on the ground that Chase was, to the knowledge of the insurers, not in the usual position of an insured who, as Lord Mansfield said in Carter v Boehm (1766) 3 Burr 1905, 1909, could be expected to have knowledge of "the special facts upon which the contingent chance is to be computed." Chase was in no better a position to estimate the risk than the insurers themselves. The insurers concede that the clause protects Chase to the extent of relieving it from any personal obligation of disclosure and in protecting it from rescission on account of innocent misrepresentations or nondisclosures by Heaths or other agents. But the insurers say that, as a matter of construction, the language does not cover fraudulent or negligent misrepresentations or nondisclosures and they buttress part of this argument by a submission that, as a matter of law, a party cannot protect himself from liability to have a contract rescinded on account of the fraud of the agent who made it on his behalf.
49. Chase, on the other hand, says that phrase 6 not only relieves Chase itself of any obligation of disclosure but indirectly has the effect of waiving any disclosure obligations on the part of Heaths as well. Alternatively, phrases 7 and 8 expressly relieve for nondisclosure by Heaths and there is no reason to make exceptions for nondisclosures which can be characterised (if this is conceptually possible) as fraudulent or negligent. The same phrases also relieve Chase of liability for any representations by Heaths, whether fraudulent, negligent or otherwise, either because the language is wide enough to cover representations of any kind or because they deprive Heaths of authority to make such representations on behalf of Chase. Chase denies the existence of a rule of law preventing the exclusion of liability for the fraud of a contracting agent. It will therefore be seen that, apart from the question of general law about excluding liability for fraud, the issues turn entirely upon the construction of the Truth of Statement clause.
Phrase 6 and section 19 of the Marine Insurance Act 1906
50. I shall begin with the effect of phrase 6. Lord Grabiner QC, who appeared for Chase, accepted that it appeared to deal solely with the disclosure obligations of the insured. It said nothing about disclosure by agents, which was dealt with in phrases 7 and 8. Lord Grabiner also accepted that, as Lord Macnaghten explained in Blackburn, Low & Co. v Vigors (1887) 12 App. Cas. 531, 542-543, the duty of an agent to disclose circumstances within his own knowledge was independent of the duty of the insured. But Lord Grabiner referred to the opening words of section 19, which said that the agent's duty of disclosure was ?
This meant that if the circumstances in question need not have been disclosed by the insured under section 18, they need not be disclosed by the agent under section 19. The point was made by Saville LJ in Société Anonyme d'Intermediaries Luxembourgeois v Farex Gie  LRLR 116, 157:
51. Section 18(3)(c) provides that the insured need not disclose "any circumstances as to which information is waived by the insurer". Phrase 6, said Lord Grabiner, was a waiver of disclosure by Chase of any information whatever. It followed that the agent need not disclose any information either. And if the agent had no obligation to disclose anything, his failure to do so could not be characterised as fraudulent or negligent, whatever his motives may have been: National Westminster Bank v Utrecht-America Finance  3 All ER 733, 750, para 51, per Clarke LJ.
52. Aikens J. rejected this argument (see  1 Lloyd's Rep 30, 50) but Rix LJ, who gave the judgment of the Court of Appeal, accepted it. He said, at  Lloyd's Rep 483, 509, para 137:
53. I respectfully think that Aikens J. was right. The insurers may have waived disclosure of information on the ground that it was not material or that they were prepared to treat the information as not being material. In that case, I agree that the reasoning of Rix LJ would be pertinent and, for the reasons given by Saville LJ in the SAIL case, it would be illogical to say that good faith required the agent to disclose circumstances which the insured would not have had to disclose. In the SAIL case the circumstance which it was claimed that the broker should have disclosed was that the insurer (for whom he also happened to be acting as broker for the purpose of obtaining reinsurance by way of retrocession) had not actually obtained it. Saville LJ said that the insured had no obligation to disclose this fact under section 18 because it was a matter which the insurer, in the ordinary course of his business, ought to have known: "in the ordinary course of his business an insurer ought to know the state of his retrocession". It followed that the duty of disclosure by the insured was excluded by section 18(3)(b). It was in this context that Saville LJ said that the broker could not be under an obligation to disclose circumstances which his principal would not have had to disclose.
54. The reasoning of Saville LJ seems to me to depend upon being able to identify the circumstances which the principal insured is not obliged to disclose. It is those circumstances which need not be disclosed by the agent either. But I do not think that phrase 6 can be construed as constituting a waiver of any particular circumstances or all circumstances whatever. In my opinion the more natural construction is that it is a waiver personal to the principal insured. He is relieved of the obligation of disclosure without prejudice to the question of whether the circumstances would otherwise have had to be disclosed or not. The structure of phrases 6 to 8 suggests that the draftsman was well acquainted with sections 17-20 of the 1906 Act and its distinction between the obligations of the principal insured and the agent. Phrase 6 deals with the principal insured by excluding his disclosure obligations altogether. The disclosure obligations of other parties are the subject of phrases 7 and 8, which does not exclude them but limits their effect by saying that they shall not be a ground for the avoidance or cancellation of the policy. Phrases 7 and 8 contemplate that the disclosure obligations of the agent exist despite the exclusion of the principal's obligations by phrase 6.
55. Phrase 6 does not therefore in my opinion impinge upon Heaths' duty of disclosure. Any limitation upon the effect of nondisclosure must be found in phrases 7 and 8.
56. The next question is whether phrases 7 and 8 had the effect of limiting the authority of Heaths to make representations on behalf of Chase. If they did, then Chase say that it does not matter whether they were fraudulent or negligent. Chase cannot be liable for them because they were not made on its behalf.
57. This argument was rejected by the judge and the Court of Appeal and as I agree with the reasons they gave, I can be brief. Phrase 7 does not purport to limit the authority of Heaths or any other agent acting on behalf of Chase. What it does is to limit the liability of Chase for their misrepresentations or nondisclosures made or omitted on its behalf. It is to be contrasted with one of the miscellaneous clauses of the policy, which says:
The Canada Steamship guidelines
58. As I have said, the insurers accept that phrases 7 and 8 prevent them from rescinding the agreement on account of innocent misrepresentations or non -disclosures by Heaths. But they say that the language does not cover fraud or negligence. I shall first consider the question of whether it covers negligence.
59. Phrases 7 and 8 do not say anything about negligence one way or the other. They simply exclude liability for "any information provided...or nondisclosure". Mr Sumption QC, who appeared for the insurers, submitted that in the absence of express reference to negligence, the words should not be construed as sufficient to cover it. This, he said, was a consequence of the rules for construing exemption clauses formulated by Lord Morton of Henryton in Canada Steamship Lines Ld v The King  AC 192, 208: