Svenska Handelsbanken v Sun Alliance and London Insurance Plc (No 2)
| Jurisdiction | England & Wales |
| Judge | Rix J. |
| Judgment Date | 19 January 1996 |
| Date | 19 January 1996 |
| Court | Queen's Bench Division (Commercial Court) |
Queen's Bench Division (Commercial Court)
Rix J.
V V Veeder QC, R Jacobs and J Lockey (instructed by Clyde & Co) for the plaintiff insured.
E Glasgow QC, S Ruttle and S Wilken (instructed by Davies Arnold Cooper) for the defendant insurers.
The following cases were referred to in the judgment:
Allen v RoblesWLR [1969] 1 WLR 1193.
Bank of Nova Scotia v Hellenic Mutual War Risks Association (Bermuda) Ltd (“The Good Luck”)ELR [1992] 1 AC 233.
Banque Bruxelles Lambert SA v Eagle Star Insurance Co Ltd [l995] CLC 410.
Barber v Imperio Reinsurance Co (UK) Ltd (unreported, 15 July 1993, CA).
Barnard v FaberELR [1893] 1 QB 340.
HIT Finance Ltd v Lewis & Tucker Ltd (unreported, 17 March 1972, QBD).
Mackintosh v MarshallENR (1843) 11 M & W 116; 152 ER 739.
Morrison v Universal Marine Insurance CoELR (1872) LR 8 Ex 40.
Pan Atlantic Insurance Co Ltd v Pine Top Insurance Co Ltd [1994] CLC 868; [1995] 1 AC 501.
Peyman v LanjaniELR [1985] Ch 457.
Redgrave v HurdELR (1882) 20 ChD 1.
Smith v ChadwickELR (1884) 9 App Cas 187.
Standard Life Assurance Co v Weems (Thomson v Weems) (1884) 11 R(HL)48; (1884) 9 App Cas 671.
Insurance — Commercial mortgage indemnity insurance — Insurance policy to cover bank advance secured on mortgage of commercial property — Property sole asset of borrower — Policy covered credit risk of default and security risk of property realising less than relevant percentage of value — Bank evaluated property risk but not credit risk of borrower before making advance — Insufficient rental income from property to repay loan — Borrower defaulted on loan repayments — Whether insurer entitled to avoid policy for breach of warranty, misrepresentation and non-disclosure.
This was an action by the plaintiff insured under two commercial mortgage indemnity insurance (“CMI”) policies which the defendant insurer sought to avoid for breach of warranty, misrepresentation and non-disclosure.
The plaintiff insured made an advance in May 1990 of £39.5m to a company (“T Ltd”) which owned five office buildings valued at just under £44m, but had no other assets. The purpose of the five-year loan was to refinance three mortgages advanced to T Ltd, which was formed in November 1987 and acquired the five properties in May 1988. The loan was of 90 per cent of the value of the properties, which covered the insured in full, subject to the maximum sum insured, for principal, interest and costs. The loan was made up of three policies, two with the defendant insurer. The bottom-slice policy covered 0 to 70 per cent. The “mezzanine” policy was for £1.5m to cover loss arising from the bottom-slice policy if the value of the properties should fall to 70 per cent of the valuation. The top-slice of 70 to 90 per cent was covered by other insurers.
Although the insured conducted a property evaluation, a credit analysis of T Ltd was not regarded as necessary before the advance was made. The loan was approved as an advance to a borrower with a positive cash flow. If the transaction had been characterised as an investment on insufficient cash flow, a credit analysis would have been required. The insured knew that the rental income produced by the properties amounted to only 39 per cent of the interest due to the insured under the loan. The shortfall would continue even with favourable rent reviews. To provide additional security, £2.6m of the advance remained with the insured in a blocked deposit account. It was intended to meet a shortfall of rental income for a period of one year in the event of default. The beneficial owner of T Ltd also provided an unsecured personal guarantee of the whole interest payable and £10m of the loan.
T Ltd failed to make the fifth quarterly interest payment. The loan went into default. The insured claimed under the CMI policies. The insurer purported to avoid the policies for breach of warranty, misrepresentation and non-disclosure. The insured brought an action claiming sums due under the policies.
The insurers complained of misrepresentations and non-disclosure as to, inter alia, the sufficiency of the blocked deposit account, the credit analysis of the transaction and of T Ltd and its beneficial owner, and breach of the co-lender clause in the conditions incorporated into both policies by which the insured confirmed that it had carried but before the date of the policy “such investigations and made such enquiries in relation to the mortgagor and the property in accordance with the standard property lending criteria observed by it (i) in carrying out credit analysis and document negotiations in relation to secured property lending transactions…and it is not as a result of such investigations and enquiries aware of any facts or circumstances which it would disclose to the (insurer)…and which it had in fact not disclosed to the (insurer)'.
Held, giving judgment for the defendant insurers:
1. The co-lender clause only dealt with the knowledge of the insured, not what it ought to know or was deemed to know within s. 18(1) of the Marine Insurance Act 1906. By confirming that it had carried out the investigations and enquiries according to its own standard property lending criteria, that confirmation was a warranty or condition precedent of the insurance, breach of which went to the heart of the risk undertaken by the insurer.
2. The insured failed to conform to its own criteria in agreeing to make the loan to T Ltd without investigating the ability of T Ltd to service it. The blocked deposit could not transform T Ltd's insufficient cash flow into sufficient cash flow because it was for too short a period, could only be used in the event of default and derived from the loan itself. In allocating the transaction to the category of sufficient cash flow transactions, the insured was ignoring its own standard lending criteria. The insured was accordingly in breach of the co-lender clause.
3. The insured was in breach of the implied warranty that it had relevant criteria for credit analysis in relation to T Ltd, or misrepresented that it had such criteria.
4. Since the true reason for the insured's inadequate investigation of the transaction and its readiness to approve the loan to T Ltd was the fact that the insured had 100 per cent CMI cover, the insured was in breach of warranty in the co-lender clause. There was no waiver, affirmation or estoppel to prevent the insurer from relying on the breaches of the co-lender clause or the misrepresentations in it. It followed that the insurer was discharged from liability under the CMI policies.
Rix J:
This action is concerned with the plaintiff assured's claims under two policies of a form of insurance known as commercial mortgage indemnity insurance (“CMI”). Under a CMI policy the insurer covers a lender of an advance secured on the mortgage of commercial property against the risk that, following a default by the borrower, the security will not repay the principal of the advance, interest and associated costs. Such cover typically insures the assured for up to 70 per cent of the agreed value of the property. However, CMI insurance is, or at any rate has been, available for up to 90 per cent of the property's value. Where, therefore, a lender advances 90 per cent of the value of the mortgaged property and takes out CMI insurance for 90 per cent, he is covered in full, subject to any limitation on the maximum sum insured, for principal, interest and costs, In such a case, the lender has effectively laid off the whole of the risk associated with his advance, and has even secured his lender's profit. In such a case, the loan may be described as being “off balance-sheet”. Typically a lender would not advance more than 70 per cent or so of the value of the property without such cover. The availability of such insurance therefore enables the lender to advance more than he would otherwise have been willing to do. Such cover of in excess of (say) 70 per cent of the value of the property is known as “top-slice” cover. Cover for 0-70 per cent of the value (“bottom-slice”) enables a lender to side-step internal limits restricting lending in certain categories. Thus, for instance, a bank may limit itself to a property “book” of £500m: CMI insurance enables it to increase the size of its property lending beyond such limits.
CMI insurance may have been around in one form or another for longer than I am aware from the evidence before me in this case: but certainly the bullish property market in the second half of the 1980s generated substantial growth in the writing of CMI insurance, and led to insurers entering the CMI market for the first time, apparently in the belief that it afforded an opportunity to share in the profitability of the property market with little risk. In fact such insurance has proved to be extremely risky, as has I believe become notorious in the similar case of residential property mortgage indemnity insurance. The losses have in one sense been driven by the fall in the respective markets, for residential or commercial properties. The downturn in such markets which began at the very end of the 1980s or the start of the 1990s (I am running the risk of some inaccuracy here by generalising over two different markets) have caused substantial losses. It is said that the, downturn in at any rate the commercial market was of unprecedented sharpness; but I suspect that each generation has to learn anew the lessons of earlier times. The losses have been exacerbated by the fact that CMI insurance covers not only the principal of the advance but also interest and associated costs. Thus, if over the period of the borrower's default and the sale of the property there is an accumulation of unpaid interest not covered by the rental, income derived from the property, the insurance covers the appropriate percentage of such interest too...
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