Reinsurance agreements with non-US off-shore reinsurers usually involve a reinsurance trust with a bank acting as trustee. These trust agreements typically absolve the trustee from nearly all liability because of their ministerial role in the reinsurance transaction. This is very common in off-shore life, annuity and long-term care reinsurance agreements.
In the last several years, however, trustees have come under scrutiny because some off-shore reinsurers were not quite on the up-and-up and the assets placed in the trust accounts and managed by the reinsurers’ affiliated investment managers have been substandard. This, of course, has caused the reinsurance arrangement to collapse, regulatory issues and often the total loss of the assets meant to secure the cedent’s losses. Because these reinsurers typically do not have assets on shore, some of their cedents have gone after the trustees seeking damages.
In a recent case in New York State court, the motion court granted the trustee’s motion to dismiss but the intermediate appellate court found otherwise and reversed.
In Bankers Conseco Life Insurance Co. v. Wilmington Trust, National Association, No. 13185 (N.Y. App. Div. 1st Dep’t Apr. 20, 2021), a long-term care reinsurance deal resulted in serious problems for the cedent when the regulator declared that many of the assets in the trust account were not eligible assets. Not only were the assets not eligible, but they were non-negotiable. The cedent was forced to recapture the business and terminate the reinsurance agreements while taking a substantial loss. The reinsurer, which was not involved in this lawsuit, was the alter ego of a private equity fund that devised a scheme to defraud insurance companies.
While the trust agreement limited the trustee’s liability and responsibility–it was not responsible to determine whether the assets were eligible under state law to be placed into a reinsurance trust account–the agreement did have certain provisions that the court found important:
However, the agreements did provide that [the trustee] was not to accept into the trusts any “non-negotiable” assets, meaning assets that were not capable of being liquidated at a moment’s notice without the need to clear any administrative hurdles. Further, the agreements provided that [the trustee] would “only be liable for its own negligence, willful misconduct, or lack of good faith in connection with its performance” and that “in no event shall [the trustee] be liable under or in connection with this . . . Trust Agreement for indirect, special, incidental, punitive or consequential losses or damages of any kind whatsoever.”
In reversing the motion court and reinstating the causes of action for breach of contract and breach of fiduciary duty against the trustee, the court agreed with the cedent that the breach of contract claim was prematurely dismissed prior to factual and expert discovery. The court found that:
. . . there is merit to plaintiffs’ argument that when the assets proved not to be negotiable, they lost the benefit of their bargain and were entitled to recover as direct damages the diminution in value, and the concomitant costs of restoring the assets to negotiable status, such as professional fees.
It is simply unclear under the case law whether the trust agreements bar plaintiffs from recovering damages based on the fact that [the trustee’s] negligence in allowing the placement of nonnegotiable assets in the trusts resulted in the trusts containing assets, beneficially owned by plaintiffs, that were lower in value than they would have been had [the trustee] performed its duties. In the absence of clear precedent supporting [the trustee’s] position that the only conceivable direct damages against a sophisticated trustee who negligently performs gatekeeping duties are measured entirely based on the fees paid to the trustee, a trier of fact must resolve the ambiguity as to what constitutes recoverable direct damages versus unrecoverable consequential damages in a damages limitation provision where, as here, a gatekeeper negligently fails to perform.
On the breach of fiduciary duty claim, the court held that the trustee’s designation raised the question of whether the trustee owed a fiduciary duty to the cedent as beneficiaries of the trust separate from the trustee’s contractual duties under the trust agreement.
Even though the breach of contract and breach of fiduciary duty claims involved the same conduct, the fiduciary duty claim alleges a breach of a noncontractual duty relating to the trustee’s independent duty to perform nondiscretionary ministerial duties with respect to the negotiability of assets. Thus, the fact that [the trustee’s] failure to prevent nonnegotiable assets from entering the trusts breached both fiduciary and contractual duties does not bar plaintiffs from seeking damages related to the former (citation omitted).
Cases like these are important to banks that serve as reinsurance trustees, but are more important lessons to cedents who are attracted to off-shore deals that may be too good to be true. Keeping a watchful eye on the character and quality of the assets in any trust agreement or funds withheld account where the reinsurer is managing the investments through a related affiliate is crucial to avoiding what happened to the ceding company in this (and related) cases.