Protection from insolvency

The collapse of the Kwelm companies has given rise to the world's largest insurance insolvency.

Through HS Weavers, their underwriting agent, the Kwelm companies underwrote insurance risks situated mainly in North America and have suffered massive losses in respect of pollution, asbestos, professional indemnity, medical malpractice and other claims.

These claims have a "long tail" and will continue to come in over the next 30 or 40 years. The present estimate of the ultimate liabilities of the Kwelm companies ranges from between $6 billion to $10 billion.

This represents half the total liabilities written by Weavers, which also acted as agent for 20 other insurance companies outside the LUI Group.

The companies became insolvent between 1990-1992 and the provisional liquidators, Coopers & Lybrand, were appointed to control the businesses. This was the first substantial insurance collapse for 20 years and threw up a number of difficult issues.

Of paramount concern to certain creditors was the extent of the protection afforded by a statutory corporation, the Policyholders Protection Board (PPB). This had been set up in 1975 to pay 90 per cent of unpaid claims (without financial limit) due from an insolvent UK insurance company to certain types of policyholders - individuals and partnerships.

In the 1970s and 1980s Weavers wrote enormous amounts of cover for large US accountancy firms, all of which practised as partnerships throughout the US. Were these foreigners entitled to compensation from the board?

The board raises its money by way of a levy on solvent UK insurers, which were reluctant to accept that foreigners should benefit from a purely domestic fund. The legal question of whether or not foreign policyholders resident in the US qualified for protection was unclear.

Proceedings against the board were brought by three classes of creditors and two UK insurers liable under the levy. The House of Lords decided that the board did protect foreigners and, in this way, served to "underpin the London market". To date it has paid out roughly $300 million, and its ultimate exposure in respect of the Weavers business could be as high as $1 billion.

The UK insurance industry has lobbied for a change in legislation to reduce the burden on solvent companies of claims from their insolvent brethren.

A scheme of arrangement, drafted by Clifford Chance, was entered into with the 100,000 creditors of the companies which provided for the payment to creditors of percentages of their claims as and when they are agreed by the run-off company set up to deal with the Kwelm liabilities.

This scheme was unprecedented in its complexity. To date $700 million has been set aside to pay creditors' claims.

Weavers was one of the lead underwriters in the London market of third party liability insurance cover provided for industrial corporations in the US, many of which have been hit by claims in respect of asbestos and pollution losses.

These losses have been the primary cause of the problems in the Lloyd's market, the collapse of the Weavers underwriting pool, and a mass of litigation in the US between the corporations and their various insurers (including Kwelm), which argue that they are not liable for these type of losses.

The Kwelm companies are defendants to over 350 such cases going through the US courts in 37 different states.

This litigation was costing the Kwelm companies an estimated $10 million a year and the provisional liquidators found it impossible to control this litigation. New York firm Shearman & Sterling was instructed to obtain an injunction in the US bankruptcy court in New York to prevent this litigation continuing, and an order was eventually made granting the injunction and staying the litigation in all the other states.

This injunction was made permanent, so all claims now fall to be handled in accordance with the terms of this scheme. This form of relief had never been used on such a scale and in such a complex situation.

Two inspectors appointed by the DTI reported in September 1993 that, in their view, the three principal directors of the LUI/Weavers/Kwelm group had wrongfully diverted in the region of $50 million of commissions to individuals and companies resident in Liechtenstein. This led to the bringing of proceedings by the Kwelm companies (and others) for the recovery of these commissions.

Finally, there were considerable disputes in the early days of the collapse of the pool over the ownership of the substantial assets managed by the Weavers agency; sums placed on bank deposit, reinsurance assets, sums held as collateral for letters of credit, and so on.

Weavers, the agent, sought to exercise proprietary rights over these assets, largely in an effort to repay substantial sums that were owed to some of its principals whose cash had been used to fund claims paid to policyholders. What became known as the 'Weavers pool litigation' started in 1991/1992 and involved a large number of pool companies, reinsurers, brokers and Weavers itself.

The death knell for Weavers in this raft of litigation, came in a judgment given by Mr Justice Harman when he held that £98 million placed on deposit with various banks was owned absolutely by the Kwelm companies.

The collapse has established a number of precedents in relation to the PPB, schemes and the case of the US courts which have been of considerable value to the creditors and advisers caught up in the recent spate of London market insolvencies.

Roger Enock is a partner Freshfields.