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	England and Wales High Court (Commercial Court) Decisions
You are here: BAILII >> Databases >> England and Wales High Court (Commercial Court) Decisions >> Sphere Drake Insurance Ltd. & Anr v Euro International Underwriting Ltd (Revision 1) [2003] EWHC 1636(1) (Comm) (08 July 2003) URL: http://www.bailii.org/ew/cases/EWHC/Comm/2003/1636(1).html Cite as: [2003] EWHC 1636(1) (Comm)

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IN THE HIGH COURT OF JUSTICE
QUEENS BENCH DIVISION
COMMERCIAL COURT

		Royal Courts of Justice Strand, London, WC2A 2LL
		8 July 2003

Mr Justice Thomas:

1. The judgment is arranged as follows:

   i) Part I:

   a) Summary

   b) Section 1 of Part I: The parameters of the action and the issues

   c) Section 2 of Part I: A description of the market

   d) Sections 3-13 of Part I: A narrative account of the events

   e) Section 14 of Part I: My conclusions

   ii) Part II: The programmes written by EIU; the index to Part II is contained in that Part

   iii) Part III: The contracts identified by EIU as declinatures; the index to Part III is contained in that Part

   iv) Appendix 1: The scope of the case against SCB

   v) Appendix 2: Diagrams and charts

   
    
   

   INDEX TO PART I

   	Paragraph No.
   INTRODUCTION AND SUMMARY	2
   (a) The business of trading in losses generated by Workers’ Compensation insurance	5
   (b) The duty of disclosure	8
   (c) The business of SCB and the market in 1992-1996	12
   (d) The involvement of SD	16
   (e) The dishonesty of EIU and SCB	22
   1. THE PARAMETERS OF THE ACTION	35
   (1) SD’s claim against EIU for breach of fiduciary duty	39
   (a) Were fiduciary duties owed by EIU?	40
   (b) The content of the fiduciary duties	48
   (c) The alleged breaches	50
   (d) Mr Broad’s knowledge	53
   (e) Position of SD if Mr Broad knew	56
   (f) Liability of EIU as accessories	62
   (g) EIU’s counterclaim	63
   (2) Dishonest assistance by SCB in breach of the fiduciary duties	64
   (a) Assistance	66
   (b) Dishonesty in relation to the business	70
   (c) The position of Mr Brown and Mr Butler	73
   (d) SCB’s knowledge of the position of SD	75
   (e) Other issues	79
   (3) Conspiracy	81
   (a) The combination	82
   (b) The unlawful means	85
   (c) The intention of causing damage and the damage caused	89
   (4) Fraudulent misrepresentation by EIU	91
   (5) Causation of loss and mitigation	94
   (a) Defence to the payment of equitable compensation	94
   (b) The failure to mitigate	99
   (6) The standard of proof	106
   (7) Approach to the credibility of witnesses	108
   (8) The issues between EIU and SCB	109
   2. THE MARKET THAT TRADED IN LOSSES	111
   (1) Workers’ Compensation business in the US	112
   (a) US Workers’ Compensation	115
   (b) Alternatives to WC Insurance	121
   (c) EEII and CSLI	123
   (d) The reinsurance of WC and alternative WC:WC carveout	127
   (e) “Occupational accident”	132
   (2) The development of the market for trading in losses	136
   (a) The competitive market in original WC business	136
   (b) The state of the PA market	142
   (c) Arbitrage and net underwriting	145
   (d) The development of a market for the reinsurance of WC carveout	148
   (e) The reinsurance of gross loss making business	151
   (f) The diminution of the premium	159
   (g) The competitive advantages to primary insurers	162
   (3) The “PA spiral”	164
   (a) The nature of a spiral	165
   (b) Conventional PA business	168
   (c) Ordinary consequences of spirals as understood by 1992	170
   (d) The spiral that resulted from trading in losses	173
   (e) The extraordinary nature of the PA spiral	178
   (4) The experts	179
   (5) The way in which business might be written in the market	188
   (a) How could business be written?	188
   (b) The risks involved in trading in WC carveout losses	191
   (c) Mr Hines’ methodology	192
   (d) The need for sustainable outwards reinsurance	200
   (e) What was shown by the plan	202
   (6) The evidence as to what happened in practice	208
   (a) The evidence of Mr Crane	208
   (b) The information generally provided	210
   (c) The standard considerations when business was accepted	215
   (d) The crucial role of the broker in putting the retro in place first	218
   (7) The tail of WC carveout and alternative WC business	221
   (a) Long or short tail?	222
   (b) The views of Lloyd’s underwriters on the position prior to 1994	225
   (c) The classification imposed by Lloyd’s for 1995	228
   (d) The practice in 1995 and after	231
   (e) The effect of the spiral on the tail	234
   (f) Conclusion	238
   (8) An analysis of the business of the market	240
   (a) The common ground	240
   (b) The position of those who were not parties to this action	242
   (c) “Pass the parcel” or “Russian roulette by proxy”	245
   (d) The issue	252
   (e) Innovative markets and legitimate business	257
   (f) A development of a legitimate practice?	260
   (g) The business could not be written on a sustainable or rational basis	264
   (h) Were those who participated foolish or imprudent?	277
   (i) The need for due diligence	283
   (j) Innocent capacity	291
   (k) The fact that the market was nowhere described	304
   (l) The position of the regulators	309
   (m) The position of reinsurers on the higher layers	311
   (n) Full disclosure would have ended the market	317
   (o) An analogy with pyramid schemes	320
   (p) The position of the brokers	332
   (9) Conclusion on this market	335
   (10) The plea against SCB about their understanding of the underwriting	341
   3. SCB AND THE MARKET: 1992-1996	346
   (1) The market	346
   (2) The brokers in the market: SCB and WFD	347
   (a) SCB	348
   (b) WFD	362
   (3) The relevance of events between 1993 and 1996	363
   (a) SD’s case: the need for capacity and the contrived spiral	365
   (b) Mr Brown’s and Mr Butler’s experience of the market	370
   (4) The market in 1993	381
   (a) The contraction of the market and the spiral	381
   (b) Syndicate 103 and Mr Bird	384
   (c) Mr Henton	392
   (d) The information provided to the Names on Syndicate 103	396
   (e) Mr Billyard and Duncanson & Holt	409
   (f) The placing of the reinsurances in 1993 and the creation of the spiral	416
   (5) The market in 1994	422
   (a) Continued contraction and new capacity from the US	422
   (b) SCB’s proposal to Phoenix and Hackett	424
   (c) The spiral in 1994	428
   (6) The market in 1995	435
   (a) The spiral for 1995	435
   (b) Lincoln National	437
   (c) American Reliable	443
   (d) The spiral and the relationship between WFD and SCB	445
   (7) The spiral for 1996	450
   (a) The participants for 1996	450
   (b) Mr Billyard’s move to Bermuda: JEH Re and Realm UM	453
   (c) The placing of the contracts that formed the spiral	455
   (8) The origins of EIU	460
   (a) Mr Whitcombe and Syndicate 1053	460
   (b) Mr Bird’s and Mr Whitcombe’s plan to form an insurance company	464
   (c) The proposal produced in late 1994 for marketing EIC	481
   (d) The proposal prepared with Bank Julius Baer	489
   (9) Relations between SCB, Mr Whitcombe and Mr Henton until 1997	493
   (a) Contact between Mr Henton and SCB	493
   (b) SCB’s knowledge of Mr Whitcombe’s proposals	497
   (c) WFD	502
   (10) The emergence of cash flow and other problems among the participants	503
   (a) Syndicate 305	504
   (b) Syndicate 464	506
   (c) Mr Owen, Syndicate 718 and the North American participants	508
   (d) Syndicate 103: cash flow problems	512
   (11) Conclusions on the spirals in 1993-6 and the search for capacity	523
   (a) Mr Brown’s and Mr Butler’s position	523
   (b) Conclusion on the relations between EIU and SCB	530
   (c) Were the spirals deliberately created?	533
   (d) What was known about the problems of the spirals?	542
   4. THE NEGOTIATIONS FOR THE BINDER	543
   (1) The position of Mr Whitcombe at the end of 1996	543
   (2) SD and its personnel	546
   (a) General	546
   (b) Mr Broad	553
   (c) The involvement of others at SD in the operation of the binder	558
   (d) Mr Broad’s experience of PA business	562
   (e) The PA account at SD	566
   (3) The introduction of Mr Whitcombe to SD	571
   (a) Horace Holman	571
   (b) Mr Whitcombe’s initial request	574
   (c) The first meeting	577
   (d) The production of a draft binding authority	585
   (e) The first business plan	587
   (f) Further meetings between Mr Broad and Mr Whitcombe	596
   (4) The preparation of the second business plan	598
   (a) The work done and the presentation to Mr Broad	599
   (b) The importance of the plan	603
   (5) The description in the plan of the business to be written	607
   (a) The general nature of the business to be written	607
   (b) The profitable nature of the business to be written	611
   (c) Mirroring the business of Syndicate 103	615
   (d) The description of the business as “occupational accident”	620
   (e) Premium income and the type of business to be written	624
   (f) The agreement for participation in a QS: Mr Bird	628
   (g) The description of the reinsurance programme	632
   (h) Mr Broad’s evidence on his understanding	637
   (6) Other representations in the plan	642
   (a) The role of Mr Henton	643
   (b) What was said to others as to who was doing the underwriting	646
   (c) The position of Mr Downey	647
   (d) Mr Whitcombe’s past underwriting	657
   (7) The final negotiations	661
   (a) The prudent approach to granting a binding authority	661
   (b) The way the negotiations were conducted	663
   (c) The draft restriction to facultative reinsurance	666
   (d) SD’s reinsurance programme for 1997	672
   (e) EIU’s knowledge of the reinsurance programme	678
   (f) The signing of the slip	685
   (g) Mr Broad’s discussions with Mr Philo	687
   (8) The terms of the binding authority	690
   (a) The slip	690
   (b) The estimated gross premium income	693
   (c) Could treaty business be written?	695
   (d) Recognised market leaders	701
   (e) Commission	703
   (f) Length of contracts	705
   (g) The reference in the slip to the business plan	706
   (h) HHI as cover holder: the role of EIU	707
   (i) Amendments to the binder	710
   (9) Conclusion	711
   (a) The scope of the binder	711
   (b) The case advanced by EIU and SCB	712
   (c) The suitability of the reinsurance programme for arbitrage	715
   (d) Did Mr Broad authorise the writing of gross loss making business?	720
   (e) Did Mr Broad intend to authorise the writing of treaty business?	731
   (f) Were there any fraudulent misrepresentations?	733
   5. THE INITIAL WRITINGS	739
   (1) The state of the market at the beginning of 1997	739
   (a) The evidence	739
   (b) Conclusion	745
   (2) The way in which EIU commenced business	752
   (a) Contact with SCB prior to 27 January 1997	753
   (b) Supply to SCB of a copy of the binder	758
   (c) The writing of the four programmes on 27 January 1997	761
   (d) EIU’s business with WFD on 28 January 1997	766
   (e) EIU’s submission to their bankers in late January 1997	772
   (f) The request to WFD to seek reinsurance on 3 February 1997	779
   (g) Agreement on the confirmation procedure on 5 February 1997	787
   (h) Mr Whitcombe’s role in confirming the risks	791
   (i) The way the confirmation procedure was carried out subsequently	796
   (3) The need for a leader on American Reliable	799
   (a) The problem	799
   (b) The allegation of a discussion with Mr Smith	801
   (4) The information provided to SD in February 1997	809
   (a) The general nature of the way in which dealings were done	809
   (b) The meal at the pub at Tadworth on 7 February 1997	813
   (c) No information provided about the leader problem	817
   (5) The deal in relation to American Reliable and Phoenix	818
   (a) The problem faced by Phoenix	818
   (b) The discussion between Mr Brown and Mr Johnson	823
   (c) The deal	828
   (d) The confirmation by Mr Whitcombe	833
   (6) Conclusion	834
   (a) Overall amount of business written to SCB	834
   (b) The funnel of losses to SD	838
   (c) The effect on the business that could be written by the participants	844
   (d) Conclusion on the deal relating to Phoenix and American Reliable	850
   (e) EIU’s approach to the writing of the business	859
   (f) Was there an understanding between EIU and SCB?	866
   (g) Was there collusion?	872
   (h) SCB’s knowledge of the position of SD and their dishonest assistance of EIU	879
   6. THE ATTEMPTS TO OBTAIN REINSURANCE	889
   (1) The provision of bordereaux in early 1997	889
   (a) The first bordereau provided to SD in early 1997	902
   (b) The “class” bordereaux	911
   (c) Information that should have been obtained from the bordereaux	922
   (d) 14 March 1997: premium income limit and the bordereaux	926
   (2) Instructions to obtain separate reinsurance	926
   (a) Mr Whitcombe’s understanding of the business by March 1997	926
   (b) The meal at the pub at Tadworth on 21 March 1997	931
   (c) EIU cease to write business	941
   (d) The instructions given to SCB and WFD	945
   (e) The 20% line put down by American Reliable	951
   (f) Mr Broad’s involvement on 21 April 1997	954
   (g) The information prepared for reinsurers on 4 April 1997	957
   (h) Further activity: 13-14 May 1997 – LMX	959
   (i) The meeting of 19 May 1997	964
   (j) SCB’s approaches to Mr Billyard, Mr Cackett and others	970
   (k) SCB’s failure to place the reinsurance of SD	978
   (l) WFD’s placement for the period of 12 months at 1 January 1997	983
   (m) Enquiries by SD about the writing of LMX business	995
   (n) Further meetings between Mr Whitcombe and Mr Broad in 1997	1004
   (3) Relations between SD, HHI and EIU: commission and claims	1007
   (a) Increase in commission under the binder	1007
   (b) Offset of reinsurance premiums	1011
   (c) Claims, including the Gianni Versace claim	1012
   (4) Changes at SD	1019
   (a) The internal review at SD and the business plan	1019
   (b) The acquisition of SD by Fairfax	1023
   (5) Business written by EIU in October 1997	1025
   (a) WEB	1025
   (b) Presentations for special acceptance by Mr Broad	1030
   (c) Declinatures	1031
   (d) Other risks written	1032
   (6) The change in Mr Bird’s position	1033
   (a) The termination of the Lincoln National lineslip	1033
   (b) CIGNA and the Aviary lineslip	1039
   (7) Conclusion on SD’s knowledge in relation to the business written	1049
   (a) Knowledge from the bordereaux	1049
   (b) Was Mr Broad told that gross loss making business had been written?	1057
   7. THE EVENTS LEADING TO THE YEAR END PLACINGS	1074
   (1) The attempted exclusive arrangement with WFD	1074
   (a) The possibility of reinsurance for15 months at 1 October 1997	1074
   (b) The discussion of an exclusive arrangement	1076
   (c) Keyport and Mr Durling	1080
   (d) The failure of the arrangements with Keyport and WFD	1083
   (e) Conclusion on the arrangements	1087
   (f) The programme placed for 15 months at 1 October 1997	1092
   (2) EIU’s business plan for 1998	1094
   (a) Mr Watson’s request to Mr Broad on 7 November 1997	1095
   (b) The first underwriting report: 17 November 1997	1098
   (c) The circumstances of its production: alterations to the text	1101
   (d) The description in the report of the business written in 1997	1105
   (e) The description in the report of the plans for 1998	1109
   (f) Mr Broad’s understanding of the report and his dealings with it	1112
   (3) The placing of shares in SCB	1118
   (4) The offer of reinsurance from Mr Brown	1122
   (a) SCB’s knowledge of the desperation of EIU	1122
   (b) The market for 1998	1123
   (c) Mr Billyard’s quotation on 12 November 1997	1131
   (d) The conflict of evidence as to the time EIU were told	1136
   (e) The meeting between EIU and SCB on 15 December 1997	1141
   (f) The events of 17 December 1997	1145
   (g) SCB’s conversations with EIU on 22 and 23 December 1997	1149
   (h) An assurance given about the spiral?	1154
   (i) The further meetings that day with HHI and Mr Brown	1161
   (5) The writing of the Christmas Eve programmes	1166
   (a) The proposal put to Mr Broad	1166
   (b) The meeting at Balls Brothers	1172
   (c) The writing of the programmes	1174
   (d) 29 December 1997: the further presentation to Mr Broad	1180
   (e) Mr Watson’s authorisation of the increase in the premium income	1183
   (f) The Christmas Eve bordereau	1188
   (g) Subject to reinsurance	1194
   (h) The confirmation of the Christmas Eve risks by EIU	1197
   (6) The creation of a spiral for 1997	1199
   (7) The premium and the losses	1205
   (a) The premium shown on the Christmas Eve bordereau	1205
   (b) The commission and the losses	1213
   (8) The New Year’s Eve programmes	1215
   (a) The writing of the New Year’s Eve programmes	1215
   (b) The premium income and the losses	1219
   (9) The placing of the reinsurance programmes	1222
   (a) The programmes	1222
   (b) The placing of the programmes with Mr Billyard	1228
   (c) The initial stop loss for 1998	1234
   (d) New Cap Re and New Cap Re (Bermuda)	1235
   (e) The reinsurances placed between September and December 1998	1239
   (f) No spiral at first in 1998	1241
   (10) Conclusion on the actions of EIU and SCB	1243
   (a) SD’s case	1243
   (b) SCB secure EIU’s subservience to their interests	1246
   (c) Was the subjectivity in respect of reinsurance satisfied?	1251
   (d) No assurance about the spiral for 1997	1254
   (e) Appreciation of the effects of the spiral created for 1997	1255
   (f) Appreciation of the problems caused by the spiral	1266
   8. EARLY 1998	1268
   (1) The business written in early 1998	1268
   (a) The position of WFD and the exclusive arrangements	1268
   (b) The programmes written in early 1998	1273
   (c) Programme 16 – Unum	1275
   (2) The information given to SD on 2 February 1998	1277
   (a) Internal discussions at SD on 8 January 1998	1277
   (b) 2 February 1998: HHI’s meeting with Mr Broad	1280
   (c) The endorsement for the premium for 1998	1282
   (d) The premium bordereau for 1997	1284
   (3) The documents presented on 11 February 1998	1290
   (a) Further amendments to the binder	1290
   (b) The class bordereau	1295
   (c) The second underwriting report: January 1998	1299
   (4) Other events in February to April 1998	1309
   (a) 26 February 1998: the further endorsement	1309
   (b) The report to Mr Broad of Mr Zuberi’s comments	1313
   (c) 11 March 1998: Mr Broad’s request for details of Programme 28	1316
   (d) The request on 23 April 1998 for a claims fund	1320
   (5) Conclusion on Mr Broad’s knowledge	1322
   9. THE EVENTS LEADING TO CESSATION	1329
   (1) The final programmes	1329
   (a) The developments at Syndicate 103	1329
   (b) The last seven programmes	1338
   (c) Writing the business after the avoidance at Syndicate 103	1339
   (d) The premium written for 1998	1343
   (2) The further attempts to obtain more from Mr Broad	1346
   (a) The request for an increase in the premium income limit	1346
   (b) 20 May 1998: further amendments to the binder	1349
   (c) Mr Broad’s dissatisfaction with HHI’s administration	1351
   (d) The third underwriting report: May 1998	1355
   (e) Misleading information about the stop loss reinsurances	1363
   (3) The involvement of others at SD	1367
   (a) Renewed signs of concern within SD about the binder	1367
   (b) 3 June 1998: the meeting between Mr Whitcombe and Mr Watson	1373
   (c) The internal enquiries at SD about the binder and the reinsurance	1379
   (d) The meeting between Mr Broad, Mr Smith and EIU on 16 June 1998	1385
   (e) The different positions on the premium income limit	1389
   (f) The provision of a file by EIU to Mr Broad	1396
   (g) Mr Broad’s agreement to a change in the rate of commission	1403
   (h) The quota share with ESG	1412
   (4) The involvement of Mr Barnard	1423
   (a) The continuation of the internal enquiries after 16 June 1998	1423
   (b) Mr Barnard’s visit to London	1427
   (c) Mr Barnard’s actions after the meeting	1433
   (d) The ordering of a review by Mr Mather and Mr Coppinger	1437
   (5) The investigations by Mr Mather and Mr Coppinger	1441
   (a) The visit of Mr Mather and Mr Coppinger to Bermuda	1441
   (b) MSC and the proposed reinsurance by SD	1446
   (c) The reaction to the visit by Mr Billyard, SCB and EIU	1462
   (d) Mr Mather’s and Mr Coppinger’s visit to EIU	1469
   (e) Agreement of the moratorium	1474
   (6) The termination of Mr Broad’s employment	1478
   (a) The debriefing meeting at SD on 29/30 July 1998	1478
   (b) The report of Mr Mather and Mr Coppinger	1484
   (c) The decision that no more business would be written	1491
   (d) SD’s knowledge of the losses	1498
   (e) Approval by SD of the ESG quota share on 11 August 1998	1500
   (f) Mr Broad’s departure from SD	1503
   (7) Conclusion	1506
   (a) Mr Broad’s position and knowledge	1506
   (b) What an audit would have revealed	1528
   (c) MSC and the role of SCB	1532
   (d) EIU’s further subservience to the interests of SCB	1535
   10. THE EVENTS OF AUGUST AND SEPTEMBER 1998	1539
   (1) The background	1539
   (a) The termination of the facility from John Hancock	1539
   (b) Mr Whitcombe’s and Mr Henton’s search for new capacity	1543
   (2) SD’s questions in July 1998 and the answers given	1550
   11. PROGRAMME 33: THE WRITING AND COVER UP	1552
   (1) Mr Billyard’s need for LMX retrocession	1552
   (a) SCB’s intention that Mr Billyard write LMX for 1998	1553
   (b) Mr Billyard’s LMX business in 1998	1557
   (c) Attempts by SCB to obtain reinsurance for Mr Billyard	1559
   (d) Why was SCB attempting to get reinsurance for Mr Billyard?	1563
   (2) EIU’s agreement to provide retrocessional cover	1570
   (a) SCB’s decision to approach to Mr Henton	1570
   (b) The assessment of Programme 33 by Mr Henton	1572
   (c) The cession of SD’s outwards reinsurance; specific reinsurance	1576
   (d) The further meeting on 10 June 1998	1587
   (e) The line put down on 19 June 1998	1591
   (f) The events after the signing of the slip; the fax to Mr Billyard	1598
   (g) The extent of the spiral	1605
   (h) The losses under Programme 33	1611
   (3) The cover up	1613
   (a) The position at the end of July 1998: no specific reinsurance	1613
   (b) The questions posed by SD	1615
   (c) The preparation of draft responses in early August 1998	1620
   (d) The meeting of 7 August 1998	1626
   (e) The discussion between Mr Whitcombe and Mr Henton	1630
   (f) More discussions about the responses and attempts to find reinsurance	1633
   (g) Mr Brown’s co-ordination of the responses	1644
   (h) The explanation sent to SD on 9 September 1998	1648
   (4) The subsequent events	1652
   (a) The placement of the higher layers of the cessions treaty with New Cap Re	1652
   (b) The placement of the lower layer of the cessions treaty with All American per WEB	1655
   (c) Information given to SD about what had happened	1659
   (d) The increase in the premium income to $11m	1661
   (e) The agreement in February 1999 to offset the income	1665
   (5) Conclusion	1671
   (a) The placing of Programme 33	1671
   (b) The cover up in respect of Programme 33 and MSC	1680
   12. PROGRAMME 26 AND THE BREACH OF THE MORATORIUM	1685
   (1) The placing of the programme	1686
   (a) Mr Cackett and Mr Billyard	1686
   (b) Christmas Eve	1691
   (c) 23 February 1998	1692
   (d) The information provided on presentation on Christmas Eve	1694
   (e) The basis of acceptance	1698
   (f) The position on losses	1703
   (g) Conclusion on the acceptance	1704
   (2) Mr Cackett’s wish for changes: Unicover	1706
   (a) Mr Cackett’s wish to change the security	1706
   (b) Mr Cackett’s wish to add Unicover business	1711
   (c) The enormity of Mr Cackett’s involvement in Unicover	1713
   (d) Mr Billyard’s agreement to the “all sources” endorsement	1718
   (3) EIU’s acceptance of Unicover business	1726
   (a) The question raised in the audit	1726
   (b) SCB’s approach to EIU on 10 August 1998	1728
   (c) Mr Cackett’s request for more reinsurance	1732
   (d) The failure to get Mr Billyard to replace SD	1734
   (e) The agreement of CIGNA to front for SD	1740
   (f) A lunch at Willie’s Wine Bar in September 1998?	1742
   (g) The signing of further slips and endorsements	1748
   (h) SD were not told	1756
   (i) The repudiation by CIGNA	1758
   (4) Conclusion	1761
   (a) Was there a breach of the moratorium?	1763
   (b) Did SCB know of the moratorium?	1766
   (c) What were EIU told about the “all sources” endorsement?	1769
   13. THE AFTERMATH	1773
   (1) Events of the autumn of 1998	1773
   (a) SD instruct lawyers	1773
   (b) Attempts by SD to obtain co-insurance or reinsurance	1774
   (c) Mr Broad’s actions after leaving SD	1777
   (d) Further investigations by SD	1781
   (e) Quotations for reinsurance for 1999	1791
   (2) The meeting of 4 January 1999 between SD, EIU, SCB and HHI	1796
   (a) Arrangements and attitudes	1796
   (b) The Unicare programme (Programme 34)	1801
   (c) Arbitrage	1804
   (d) The spiral	1812
   (e) Quotations for reinsurance on losses occurring on or after 1 January 1999	1814
   (f) Unicover	1816
   (g) Disclosure to reinsurers	1817
   (h) Follow-up correspondence	1819
   (3) Mr Broad’s letter of 7 January 1999	1825
   (a) The meetings between Clyde & Co and Mr Broad	1825
   (b) An initial meeting at The Saigon Times	1827
   (c) The meeting at The Saigon Times on 7 January 1999	1829
   (4) The final events	1836
   (a) Further discussion of reinsurance	1836
   (b) Termination of the binder	1841
   (c) Commencement of proceedings in New York	1842
   (5) The losses	1847
   (a) The gross position	1847
   (b) The effect of the reinsurance purchased	1849
   (c) The block reinsurance with Swiss Re	1855
   (6) Conclusion	1856
   OVERALL CONCLUSIONS	1861
   (1) General	1861
   (2) Alternative findings in relation to Mr Broad	1867

   
    
   INTRODUCTION AND SUMMARY

2. The trial of this action involved the operation of a reinsurance market in the 1990s which traded in losses generated by US Workers' Compensation business; during the course of the trial it was necessary to undertake a detailed examination of whether the course of conduct between certain brokers, agents and insurers and the acceptance of 35 separate programmes of reinsurance were dishonest and fraudulent.
3. The overall sums at issue in the action are large; on some programmes the losses are in excess of $10m with one programme sustaining a loss of over $71m (a loss ratio of 7,300%); the total losses sustained thus far are in the order of $250m. There are a considerable number of related actions and arbitrations here, in Bermuda and in the United States; the total sums at issue that have been lost in this reinsurance market are very much larger, though their size must be seen in the context of the size of the overall market for US Workers' Compensation insurance, out of which this business developed.
4. In these circumstances, this judgment is inevitably very long. Although I have annexed charts and diagrams to assist in understanding the complex facts, I have endeavoured to summarise my conclusions in the following paragraphs. It is, however, only a summary and all my findings and conclusions are set out in the main sections of Parts I, II and III of the judgment.

(a) The business of trading in losses generated by Workers' Compensation insurance

5. This action arose out of the part of the reinsurance market which, in the 1990s, traded in the losses generated by US Workers' Compensation insurance (WC insurance) and related products. The participants were a small circle of brokers, agents and insurance companies which operated in that market, principally in London and Bermuda, though with some participation from the United States. The sums involved in this market are large (several billion US dollars), but that must be viewed in the context of the US market for WC insurance where, in 1997, they were in the order of $40bn; the losses that have been sustained by those who participated (whether wittingly or unwittingly) in trading in these losses are undoubtedly of a very high order; the Claimants in this action (who were only engaged in the market for 18 months) have sustained losses claimed against them in the excess of $250m.
6. There is no description of the business of this market in any textbook, paper or lecture; nor (as far as the evidence before the Court revealed) was there any proper prospectus or description of the business of this market prepared for anyone who became involved in it in any capacity, whether as a participant (such as a capital provider or Name at Lloyd's) or as a regulator or in some other capacity.
7. It is therefore necessary first to give a summary of the nature of the business in this market:

i) WC insurance in the US was, in the 1990s, a mature and tightly regulated market; there was good information available about the predictability of loss, and the premiums that could be charged were regulated in general terms so as to allow for the expectation of a very modest underwriting profit in the order of 2.5%. It was a highly competitive market; rates declined and during the 1990s, the overall loss ratios were negative, deteriorating on the evidence to 115% in 1997 on an accident year basis.

ii) In the 1980s, alternative insurance products had been developed. Underwriters in London and particularly a small group of underwriters at Lloyd's who wrote personal accident business (PA business) became involved in the business of providing the reinsurance of WC insurance business and related alternative WC insurance. This market grew as the business in other areas such as aviation had declined.

iii) One of the ways in which alternative WC insurance operated was that the greater part of a standard WC policy would be reinsured after business comprising Section B of the Workers' Compensation Act (WCA) had been carved out (Section B business was then reinsured separately); the resulting reinsurance was known as WC carveout. The removal of Section B was not significant; about 90% of the liabilities under WC insurance was covered by the reinsurance after the carveout of Section B. WC carveout was nonetheless treated as an accident policy and many life companies, particularly in the US, were able to reinsure what was WC business on this basis.

iv) WC carveout was often described by those in this market as "occupational accident" within the PA market; that was a term generally used in the insurance market as a whole to describe group PA or insurance of accidents at work. The term could give rise to misunderstanding; WC carveout was liability business, not accident business.

v) Some of those that provided reinsurance of WC carveout did so at a premium which was far less than what they knew they would have to pay out by way of claims; they were therefore deliberately writing reinsurance which they knew and intended would make a gross loss; this was wholly different from conventional reinsurance and was not done for ordinary competitive market reasons such as for writing loss leading business.

vi) They did so only on the basis that they had outwards reinsurance by way of retrocession at a price which enabled them (1) to pay a small portion of each loss by way of retention, (2) to pay the premiums for their own outwards reinsurance by way of retrocession and (3) to make a small profit. They were therefore writing this business on the basis that they would make a "turn" and not assessing the risk and the premium in the manner of conventional insurance; some called it "arbitrage" or "net underwriting". It would more accurately be described as deliberately accepting business known to produce losses in excess of the premium charged on the backs of reinsurers who would be expected to pay the losses for even less premium.

vii) Those that provided the retrocession received substantially less premium than the underlying reinsurers but had to pay the greater part of the losses; they therefore made an even greater gross loss, but were prepared to do so on the basis that they in turn had a retrocession from which they could therefore make a turn. Those that provided that retrocession had reinsurance themselves by way of a further retrocession and so on. The reinsurer at each tier was in effect passing the bulk of the losses on to the reinsurer at the next tier for progressively less premium (the total premium on each successive tier was often 25% of that on the tier above); they were trading in losses. For example a series of contracts that produced $50m of the $70m loss on one programme had been reinsured for a gross premium of $148,392; the loss ratios on these contracts were between 20,000% and 30,000%.

viii) It was those who acted in this way that formed, with those who accepted the business, the reinsurance market that traded in losses with which this trial was concerned.

ix) The brokers who arranged the reinsurances earned brokerage at a rate of 10%-15% on each trade; sometimes it was more. This further progressively reduced the amount of premium that was available to pay the losses and enriched the participating brokers by "churning" on each successive trade.

x) Between these reinsurers and retrocessionaires in this small part of the insurance market there arose a spiral which entailed the losses being passed round between participants. Spirals in the catastrophe market had caused disastrous losses to Names at Lloyd's as a result of catastrophes in 1988-90. In the catastrophe market, there had been at least the prospect of profit in some years for those who might end up with the liabilities as catastrophes did not occur each year. In the market that reinsured WC carveout losses, there were heavy and certain losses on an enormous scale which had to be paid year in year out.

xi) The scale of the WC losses took about three or so years to manifest themselves and the participants in the spiral market then suffered serious cash flow and other problems.

xii) It was plainly a market that was unsustainable and would end, as it has, in disaster, with the massive losses produced year in year out by WC business landing on some of those who participated in this market, resulting in litigation on an extensive scale.

xiii) The market was, in my view, rightly characterised, as one the Defendants' experts accepted, as "pass the parcel" or "Russian roulette by proxy".

How did this happen?

(b) The duty of disclosure

8. There was obviously a duty to disclose to any reinsurer, the fact that the business to be reinsured with him was being written deliberately on the basis that the business would make a gross loss, with a loss ratio in some cases of many hundreds of per cent (or more than 1,000%); the reinsurer would be expected to pay for those losses but receive a premium that was far less than the premium that had been received by the reinsured. There also had to be specific disclosure of any business of this type that had a spiral content. That duty was generally sufficient to constrain the way in which the insurance market did its business.
9. It was also essential that any person committing his capital, whether as a Name on a syndicate at Lloyd's or as a company giving authority to an underwriting agent, was told of the nature of the business as it was so fundamentally different from conventional insurance and carried very high risks.
10. The market which traded in losses in this way was one in which no rational and honest person would participate (either by committing his capital or by writing a line on a reinsurance of the business) if he had understood the market and proper disclosure had been made:

i) The risks were enormous; for example, the business was opaque, losses of any size had to be anticipated; even a small participation of 5% of an account could expose the participant to huge losses.

ii) Losses were passed higher to successive tiers of reinsurance.

iii) Each time the losses were passed, the premium was diminished by the commission the brokers took and by the need to reinsure at a premium that enabled the reinsured to pay his retained losses.

iv) There were delays and severe cash flow implications.

v) There were risks of insurers avoiding or becoming insolvent and of the inability to renew the reinsurances once the reinsurers appreciated the losses.

vi) The market was obviously unsustainable.

11. No contemporary written document that properly explained the way in which the business of this market worked was produced during the course of the trial.

i) In the only document that was before the Court, which was provided to the then regulator, the Department of Trade and Industry (DTI), the true nature of the business was deliberately and fraudulently concealed.

ii) No report by managing agents of Lloyd's syndicates that participated in this business and which were produced to the Court set out the true nature of this business so that the Names could appreciate the very grave risks quite different to conventional insurance and reinsurance that were being run through participation in this business, though evidence was given that the nature of the business was explained to members' agents.

iii) In the case of Syndicate 103, the reports sent to Names dishonestly concealed the nature of the writing of this type of business by the syndicate and Mr Alan Bird, who was the active underwriter, knew that the reports were seriously misleading.

iv) No description was given in documents provided to those invited to participate in the business nor was it described in the prospectus issued by SCB on its IPO on NASDAQ in November 1997.

v) The business was classified as "short tail" by Lloyd's and many in the market acted on this basis; this was a practice that was fundamentally wrong and the result of a failure to take account of the true nature of the business and impact of the spiral, well known though these were.

(c) The business of SCB and the market in 1992-1996

12. In 1992, the Fourth and Fifth Defendants, to whom I shall refer collectively as SCB, were formed; the individuals who were primarily involved were the Sixth Defendant, Mr Nicholas Brown, and the Seventh Defendant, Mr Jeffrey Butler; others involved at SCB included from 1994, Mr Bird, the underwriter at Syndicate 103 to whom I have referred.
13. SCB was formed as the result of combining Mr Brown's expertise in placing reinsurance of WC carveout and related business in the PA reinsurance market with the business of Mr Mark Cooke of Stirling Cooke, who had developed an extensive business in alternative WC products in the US. It was the ambition of SCB and, in particular, of Mr Brown to expand the company into a group that provided a full range of insurance products; SCB, as their prospectus for their IPO in November 1997 made clear, used the reinsurance arrangements it made to give it a competitive advantage in the US market; by providing reinsurance at cheaper rates, this enabled them to offer their products at more attractive terms in the US. This was achieved through the process of finding others who would write retrocessions at even cheaper rates in the way which I have described. SCB became the leading brokers in the market that traded in losses in the way which I have described. However the IPO prospectus did not describe that market, essential though it was to an assessment of the reinsurance arrangements on which SCB relied. Like all the other documents, it was silent on the true nature of that market.
14. It had become, during the 1990s, progressively difficult to find insurers willing to provide cheap reinsurance and retrocession. From 1993, SCB deliberately constructed tight spirals which had the effect described of passing losses on this business from those who wrote lower layers of reinsurance of this business to those who wrote higher layers and rated those higher layers on the basis that they would only be reinsuring catastrophe type losses and thus would attract lower rates. They thus protected those who were prepared to provide the lower layer reinsurances which were so important to the sustaining of this market and to the US business of the SCB group to whom they provided cheap reinsurance. SCB acted with others, including Mr Bird (when at Syndicate 103), Mr Johnson (who was then a broker at Willis Faber & Dumas (WFD)) and Mr Reginald Billyard (who had been an underwriter at Lloyd's when he was employed in the London company market and then when he operated a facility in Bermuda on behalf of John Hancock Mutual Life Insurance Company).
15. SCB were constantly searching for new markets. By the end of 1996 there was no market for writing the retrocession of gross loss making business with a spiral element.

(d) The involvement of SD

16. The Claimants, Sphere Drake Insurance Limited (SD), became involved in the business as a result of the grant of a binding authority by one of their directors, Mr Victor Broad, to a former Lloyd's underwriter, Mr John Whitcombe, the Second Defendant, in January 1997. The binding authority (which was granted through Horace Holman International (HHI), insurance brokers) was subsequently transferred to a company formed by Mr Whitcombe, Euro International Underwriting Limited (EIU), the First Defendants, and the business accepted under it was written by the Third Defendant, Mr Christopher Henton (who had been deputy to Mr Bird at Syndicate 103). Very high commission was payable under the binder.
17. During the 1990s and prior to the grant of the binding authority, SCB had had discussions with Mr Henton, during which SCB had made it clear that they would offer gross loss making business to the reinsurance vehicle that Mr Whitcombe was attempting to form and which eventually became EIU.
18. When SD granted the binding authority to EIU, the nature of the business to be written was fraudulently misrepresented to Mr Broad. At no time during the time when the programmes were written was he ever told that gross loss making business was being written on the backs of reinsurers. This crucial fact was deliberately concealed from him.
19. During the 18 or so months when the binder operated, Mr Henton accepted a total of 119 contracts of reinsurance under the binder; 112 of these were placed with him by SCB; four of the contracts were placed by the WFD, but no allegations were made against WFD in respect of these contracts; three contracts were written for other brokers. Some of the 112 contracts were part of the same reinsurance programme:

i) In the result it was possible to look at the 112 contracts as 35 programmes; five were written on 27 January 1997 and in March 1997, one was written in October 1997, 12 were written on Christmas Eve 1997, five were written on New Year's Eve 1997 and the remainder were written between January and July 1998. The premiums in respect of the programmes were (as of 7 March 2002) $24.89m and the losses were $230.68m; the losses have risen since that date to over $250m, as is to be expected, and are still rising.

ii) Many of these reinsurance programmes (and almost all of those which have produced significant losses) were written by Mr Henton in the knowledge that the bulk of the business was WC carveout or related business and that the programmes would make a gross loss; in some cases, gross losses of several hundred percent could have been anticipated from the figures provided, in contrast to the break even position or very small loss ratios at which the insurance had been written at the primary level; at that primary level in the US in which SCB were active as brokers, managing general agents and (in 1996 and after) as the owners of an insurance company, the commissions, fees and overriders generally were sufficient to cover any small underwriting loss at that primary level.

iii) Mr Henton had accepted programmes which he knew would make gross losses, in some cases of many millions of dollars, in the expectation, on his evidence, that he would be able to recover most of the losses from reinsurers (who would know that the contracts reinsured by them were gross loss making and who would, in turn, be passing on these losses to others); he believed that the premium he would receive would be greater than the sum of (1) the retained losses he would have to pay and (2) the premium on the outwards reinsurance of the bulk of the loss; by that means he would make a "net underwriting" profit.

20. It was contended on behalf of SD that the acceptance of this business under the binder was dishonest; SD had not authorised the acceptance of this type of business under the binder and they knew nothing about it; they characterised the way of doing business in the market I have described as a racket. It was also contended by SD that SCB knew that the acceptance of this business by EIU was dishonest and were in breach of EIU's duties under the binder; that SCB had dishonestly assisted EIU in breaching those duties. A claim in conspiracy was also put forward. This was strongly denied by EIU and SCB; they contended that SD had known what was happening and that they did nothing different to others in the market. In view of the gravity of the allegations of dishonesty, it was common ground that I should apply the criminal standard of proof in determining whether SD had proved their claims.
21. If SD's case was correct, then the dishonesty of SCB and those involved with them in this particular part of the reinsurance market was, by reason of its sheer scale, the amounts of money involved and the corruption of standards it brought about, probably as grave as any in the long history of the insurance and reinsurance market.

(e) The dishonesty of EIU and SCB

22. A detailed examination of the facts and of each of the programmes as set out in this long judgment has made me sure that EIU and SCB acted with grave dishonesty; the events set out a chronicle of deception that induced insurers to become involved in a business in which they would never have been involved if the business had been properly explained to them; there was thereafter an attempt to lock them into that business. I have set out, in each of the sections of this judgment, my conclusions on dishonesty and my reasons for those conclusions; although I summarise those findings below, it is important to emphasise that a detailed examination of each of the programmes and the background events underlines the scale of that dishonesty.
23. Within five days of the grant of the binder, Mr Henton had agreed to write four programmes for SCB. One of those was the lowest layer of a reinsurance SCB had been unable to place (the reinsurance of American Reliable, a company within the American Bankers Group Inc., which had participated in the spirals) at all in the market.

i) Mr Henton was, however, prepared to write it 100% on the terms put forward by SCB. He was not permitted to lead business by the terms of the binder without the assent of Mr Broad; in order to avoid going to Mr Broad, SCB constructed with WFD, a deal under which American Reliable and another participant in the spiral, Phoenix, a company within the Phoenix Life Group, agreed to write a "lead" line of 10% on each other's reinsurances with Mr Henton "following" each with a line of 90%.

ii) One consequence of this deal was that specific contracts protecting the "occupational accident" account written under the facility granted by John Hancock to Mr Billyard were placed and ultimately reinsured with SD; these are the contracts where the losses are in excess of $50m to which I referred at paragraph 7.viii) above.

24. Until Christmas Eve 1997, apart from one small contract, no further business was written. It was impossible for EIU to find outwards reinsurance and they were in a desperate position as they had exposed SD to enormous losses without any outwards reinsurance; they had no prospect of obtaining any outwards reinsurance for the business that they had written or which would enable them to write more business in 1998.
25. Unknown to EIU, Mr Brown had obtained from Mr Billyard (under the facility from John Hancock) in mid-November 1997, a commitment to provide outwards reinsurance to SD in order to cover EIU's writings in 1997 and 1998. This had been done with the intention of ruthlessly exploiting EIU's desperate position. On Christmas Eve 1997, Mr Brown offered that outwards reinsurance to Mr Henton and Mr Whitcombe on terms; those terms were that EIU would write 1997 business (which SCB had been unable to place or on which they wished to reduce the lines Mr Billyard had written on behalf of John Hancock) and on the understanding that EIU would write this type of business for SCB in 1998. Mr Henton and Mr Whitcombe agreed to this as they had little alternative (as Mr Brown knew). Mr Henton accepted a number of programmes on Christmas Eve 1997 and thereafter which he knew would create gross losses to SD and which he and Mr Whitcombe knew were not in SD's interests to accept and to which SD had not consented. Mr Henton had acted in a way which was entirely subservient to the interests of SCB and which was contrary to the interests of SD, as SCB knew.
26. Four contracts illustrate what was done:

i) One of the reinsurance programmes accepted a 100% reinsurance of the business written under a lineslip granted by CIGNA Re Europe under which the "administrator" was Mr Bird, by then an employee of SCB. He had the decisive influence on what was written; the losses on that reinsurance programme are in excess of $35m, the loss ratio being over 5,700%.

ii) EIU were also asked on Christmas Eve 1997 to provide a reinsurance in order to enable SCB to settle a dispute in relation to contracts which they had placed in 1995 with Mr Billyard when he had worked for a pool operated by Duncanson & Holt; Mr Henton agreed to provide what SCB wanted at a premium they specified by a specially crafted contract that sought to bring reinsurances of 1995 business within the scope of the binder. Mr Whitcombe deserves credit for stopping this dishonest transaction; however Mr Henton and SCB attempted to continue the arrangement but were unsuccessful largely because of the suspicions of Duncanson & Holt.

iii) One of the contracts written on New Year's Eve 1997 was devised by SCB for the purpose of persuading Lloyd's Syndicate 53 to lead an excess of loss contract of WC carveout business which the active underwriter, Mr Ian Crane, had declined because of the scale of the inevitable losses. The contract written by Mr Henton (together with another contract written under the lineslip from CIGNA Re Europe) virtually guaranteed the syndicate a profit and transferred the losses to SD.

iv) On the one contract on which a profit was certain, Mr Brown demanded, and received, brokerage for SCB of 50%.

The commission that EIU stood to make on the Christmas Eve programmes was between 15% and 20% of the estimated premium income of $10.5m. If this estimate had been realised, the commission earned would have been $1.8m.

27. The sheer scale of the nature of the business and the dishonesty can be seen by an examination of the programmes written, including further programmes written during 1998. It is right to point out that a very few showed a prospect of a profit, but the premiums under these were generally small.
28. In mid-1998, SCB, Mr Billyard and EIU agreed in principle to put together an arrangement to replace the facility for John Hancock under which it was contemplated that substantially all the business written by Mr Billyard would be fronted by a US company and reinsured by EIU.
29. In June 1998, the senior management of SD began to inquire into the binder and, in mid-July 1998, sent representatives to see Mr Billyard in Bermuda. As a result of what they had learnt from that visit, an inspection of EIU was carried out and a moratorium was imposed on the acceptance of further business under the binder. The contemplated arrangement with Mr Billyard could not therefore proceed.
30. Although SCB and EIU had colluded together in August and September 1998 to answer questions that had been raised by SD, particularly in relation to the reinsurance programme that had been placed in April 1998 to protect part of the account that had been written by Mr Billyard, SCB deceived EIU in August 1998 into accepting an endorsement to a reinsurance of business written by Centaur Underwriting Ltd., a Bermuda agency where the underwriter was Mr John Cackett, another former Lloyd's underwriter. That endorsement was intended to help Mr Cackett in relation to the volume of premium that he was receiving under another WC scheme, Unicover, where the annual premiums anticipated by him were over $1billion and where the rumours in the market were such that reinsurance of the business by August 1998 was unplaceable.
31. At a meeting on 4 January 1999, SD confronted EIU and SCB with the allegation that they were writing loss making business on the back of reinsurance. Although this was what they had done, EIU and SCB dishonestly denied it. They tried to persuade SD to continue with the business and in fact offered to try and find outwards reinsurance for the losses to which SD were exposed and for which the outwards reinsurance that had been obtained at Christmas Eve 1997 was insufficient. SD refused and terminated the binder. They then began proceedings in the US against EIU, SCB and others in April 1999, but the US proceedings were subsequently dismissed and the present proceedings were begun in 2000.
32. Mr Brown was the driving force in the dishonest enterprise which I have described in this judgment. He was motivated by ambition to make SCB a full-service insurance company and by greed in earning large sums of money through brokerage of the business provided; the diagram from the prospectus which I have set out under paragraph 361 amply demonstrates those opportunities. He set about achieving his ambition with ruthlessness and where it suited his purpose, with singular dishonesty; his dishonesty extended to the prospectus issued for the IPO in November 1997 where, to his knowledge, the true nature of the way in which SCB reinsurance business was written was deliberately concealed. Mr Butler aided and abetted him in the placing of the gross loss making business, as did Mr Bird.
33. In the very many respects that I have set out in the following sections of this judgment, I have concluded that EIU acted extensively in dishonest breach of their duties. They were brought into the business which SCB had wanted reinsured and they were ruthlessly exploited by SCB; they were in that sense a victim of SCB's ambitions. I am sure that Mr Henton had acted dishonestly in accepting most of the programmes (as identified in Part II of this judgment); Mr Whitcombe had known that Mr Henton was writing gross loss making business on the backs of reinsurers and had also acted dishonestly, though to a much lesser degree than the others. I am also sure that in many respects, SCB, Mr Brown and Mr Butler had dishonestly assisted EIU in their dishonest breaches of duties as fiduciaries to SD.
34. However, although Mr Broad was deceived and the trust he reposed in Mr Whitcombe as a former Lloyd's underwriter was betrayed, the way in which he approached the granting of the binder and his supervision of it was characteristic of the standards prevalent at the time of the Sasse affair at Lloyd's in the 1970s. He had signed documents without reading them, had paid little attention to the bordereaux supplied and had been prepared to make decisions in wine bars and pubs with no proper notes or documentation being produced to record such decisions as may have been made on such occasions. He had paid no proper attention to the internal controls in place and had failed to conduct any inspection or audit. Mr Broad's conduct had fallen well below that which was to be expected of any competent underwriter; if he had not acted with such gross negligence and dereliction of duty (which SD's internal controls failed to prevent), the dishonesty of EIU and SCB would have been investigated long before it was.


 
1. THE PARAMETERS OF THE ACTION

35. The pleadings in this action were very extensive, but as the trial progressed the issues became clear and by the completion of the closing submissions the principal claim made by SD against EIU was one for dishonest breach of fiduciary duty and the principal claim against SCB was one for dishonest assistance in that breach of duty. Other claims were also advanced. It is convenient to consider these and other issues that arose under nine headings, under which I will set out the conclusions of law which I have reached.
36. SD and SCB (along with Mr Brown and Mr Butler) were each represented by highly skilled and experienced teams of counsel and solicitors. The skill and energy with which each team conducted this very difficult trial was a model of its kind in demonstrating not only how very complex facts could be marshalled and presented but also how allegations of considerable gravity on both sides could be presented with the highest professionalism. Each provided the greatest possible help and assistance to the Court for which I am most grateful.
37. It was a matter of great regret that EIU, Mr Whitcombe and Mr Henton had virtually no legal representation at the trial; they had expended considerable sums prior to the commencement of the trial and were consequently in a position where they could no longer afford the cost of legal representation. Their application for legal assistance was refused. At one stage after the opening, there was a prospect that some financing might be found and a short adjournment was given whilst that was explored; it came to nothing. The only legal assistance they received during the trial was that given by Orchard & Co and Mr Tom Weitzman of counsel for a few days during which Mr Weitzman skilfully conducted the important cross-examination of Mr Broad.
38. Although counsel for SD and SCB did all they could to assist and time was afforded to Mr Whitcombe and Mr Henton whenever needed, they were nevertheless clearly handicapped given the nature of the case. I have brought this obvious handicap into account in considering the findings I have had to make.

(1) SD's claim against EIU for breach of fiduciary duty

39. SD's principal claim against EIU, Mr Whitcombe and Mr Henton was that they had acted in dishonest breach of the fiduciary duties owed to SD. To establish this, SD had to prove that:

i) EIU owed fiduciary duties.

ii) EIU had breached those duties; no case short of dishonesty was advanced by SD. The main case was that the business accepted by EIU was business that no honest underwriter would have accepted and that it was accepted in manifest disregard of SD's interests.

(a) Were fiduciary duties owed by EIU?

40. The first question that arose was whether EIU, Mr Whitcombe and Mr Henton owed any fiduciary duties to SD or whether duties were owed only to HHI which, it was accepted, owed fiduciary duties to SD in turn. It was not disputed that, in the light of Henderson v Merrett Syndicates Ltd. [1995] 2 AC 145, duties of care were owed by EIU, Mr Whitcombe and Mr Henton to SD. It was contended, however, that on the present state of the authorities, no fiduciary duties were owed by EIU, Mr Whitcombe and Mr Henton to SD. It was suggested by SCB that this probably did not matter; this was because duties would be owed to HHI by EIU and Mr Whitcombe as the named underwriters; if there was any breach of such fiduciary duties, there could be dishonest assistance by either Mr Henton or SCB in respect of this breach, or, if HHI was involved in breach of fiduciary duties to SD, dishonest assistance in respect of that breach. SCB accepted that there could be dishonest assistance in breach of fiduciary duty where the fiduciary, though in breach of duty, had not acted dishonestly: see Royal Brunei Airlines Sdn. Bhd. v Tan Kok Ming [1995] 2 AC 378. It would not therefore be material if I found on the facts that HHI had not acted dishonestly.
41. I agree with the analysis of SCB that it probably makes no difference to the outcome of this action as to whether EIU, Mr Whitcombe or Mr Henton owed fiduciary duties to SD or only to HHI. The central issue is whether EIU, Mr Whitcombe or Mr Henton had acted in dishonest breach of fiduciary duty and whether SCB had dishonestly assisted them. However the question as to whether fiduciary duties are owed in such circumstances to the ultimate principal is a point of general importance and, as I have reached a clear view that fiduciary duties were owed, I will briefly set out my reasons for that view.
42. The fact that there was no privity of contract between SD and EIU and the named underwriter did not mean that there could be no fiduciary duty: see Powell & Thomas v Evan Jones & Co. [1905] 1 KB 11. It is necessary to examine the entire circumstances, particularly the ways in which the appointment of the agent and of Mr Whitcombe was made, and the duties that were entrusted to the named underwriter. As I have set out, the clear understanding between SD, HHI and Mr Whitcombe was that the underwriting was to be done by Mr Whitcombe and he was specified as the underwriter; this was later amended to include EIU and Mr Henton. As underwriter, Mr Whitcombe, EIU and Mr Henton were in a position to risk the capital of SD as they had been 'given its pen' to write contracts of insurance and reinsurance. Given the extent of that authority and the circumstances of the appointment, I have no doubt that the relationship was one that gave rise to, and was understood to give rise to, the highest degree of trust between SD and those who were authorised to underwrite.
43. The same conclusion as the one I have reached above was also one that was reached when the point had arisen in the early 1980s in connection with the relationship between the members of syndicates at Lloyd's (the Names) and the active underwriters of those syndicates. At Lloyd's at that time, Names appointed members' agents to conduct their underwriting affairs; those agents then placed Names on syndicates that were managed by the members' agents themselves (where they were also managing agents), or by other entities known as managing agents, who employed a professional underwriter, known as the active underwriter, to write risks on their behalf. There was therefore no contractual relationship between the active underwriter and the Names, or between the managing agent and the Names, where that managing agent was not also a member's agents of such Names. Although, as I have mentioned, it was decided in 1994 in Henderson v Merrett that a duty of care was owed in such circumstances, an important issue had arisen in the early 1980s as to whether a fiduciary duty was owed, as certain active underwriters had used the Names' funds for their own purposes and had derived benefits from that use. The issue was considered on two occasions, as referred to in The Report of the Committee of Enquiry into Regulatory Arrangements at Lloyd's under the Chairmanship of Sir Patrick Neill QC (January 1987, Cm 59).
44. The first occasion on which the question of whether a fiduciary duty was owed in such circumstances was considered in a Report dated 8 August 1983 by Mr Anthony Colman QC (as he then was) and Mr Stephen Hailey FCA on Syndicates underwritten by T.R. Brookes and others and Fidentia Marine Insurance Company. The Report concluded that an active underwriter, whether or not in a direct contractual relationship with the Names, owed a fiduciary duty to the Names. The position of an active underwriter was one which gave rise to the highest degree of trust between the person with the authority to bind the syndicate and the Names on that syndicate.
45. The second occasion on which the issue was considered was in the decision of the Lloyd's Disciplinary Committee against Mr Grob, Mr Comery, Mr Posgate and Mr Benbassat (Case No. 8404/4) made on 14 December 1984. The decision of the committee, chaired by Mr Johan Steyn QC (as he then was), dealt with the matter at paragraph 17 of its decision as follows:

"The question arises, however, whether the relationship between an underwriter and the Names on his Syndicate is of a fiduciary nature. On behalf of Mr. Posgate it was argued that the relationship was not of a fiduciary nature. The point has never arisen for decision. The categories of fiduciary relationships are, however, not closed. It was pointed out the Fisher Working Party made no mention of such a relationship. There is, however, no indication that the Fisher Working Party considered this point. It is clear that the existence of a contractual relationship is not essential to the existence of a fiduciary duty. See Powell & Thomas v Evan Jones & Co. [1905] 1 KB 11. It was, however, argued that the position of an underwriter vis-à-vis the Names on his Syndicate is analogous to that of a director vis-à-vis the shareholders of a company. A director of a company does not owe a fiduciary duty to the shareholders of a company. It is, however, important to bear in mind that when investing in a company shareholders do not place at risk their entire fortunes. In contradistinction Names plainly do place their entire fortunes at risk. This seems to us to be a very material distinction. Moreover, it seems to us that the relationship in the Lloyd's market between an underwriter and the Names on his direct Underwriting Syndicate is a particularly close one. Taking into account the way in which Underwriting Syndicates operate in the Lloyd's market, we conclude that there is a fiduciary relationship between an underwriter and the Names on his Underwriting Syndicate."

46. The relationship between those entrusted with the underwriting under the binder granted by SD was, in my view, the same as that which existed in the Lloyd's market between the underwriter and the Names; exactly the same considerations arise.
47. As set out at paragraph 690, Mr Whitcombe was named in the binder as the underwriter who was authorised to accept business; I consider that he owed fiduciary duties to SD from that time. On 8 September 1997 (see paragraph 708), the slip was amended to identify EIU as the company authorised to accept business and as being responsible for the operation of the agreement; I consider that EIU owed fiduciary duties to SD from that time. On 11 February 1998, Mr Henton was added as a named underwriter (see paragraph 1292); I consider that he owed fiduciary duties to SD from that date.

(b) The content of the fiduciary duties

48. It was common ground that the extent of those fiduciary duties was most clearly set out in a passage in the judgment of Millet LJ in Bristol & West Building Society v Mothew [1998] Ch 1 at 18, where His Lordship drew a clear distinction between a duty of care and a fiduciary duty:

"A fiduciary is someone who has undertaken to act for or on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence. The distinguishing obligation of a fiduciary is the obligation of loyalty. The principal is entitled to the single-minded loyalty of his fiduciary. This core liability has several facets. A fiduciary must act in good faith; he must not make a profit out of his trust; he must not place himself in a position where his duty and his interest may conflict; he may not act for his own benefit or the benefit of a third person without the informed consent of his principal…"

49. The content of those duties fell into two main headings in this case:

i) The duty to act in good faith and in the interests of SD, and not to have regard to the interests of any person other than SD.

ii) The duty to disclose and to report to SD all material information in relation to the binder and the business written under it. It was common ground that an innocent failure to pass on information would not amount to a breach of fiduciary duty; there had to be a deliberate concealment of information in bad faith.

(c) The alleged breaches

50. In Bristol and West, Millett LJ said at page 18:

"The nature of the obligation determines the nature of the breach. The various obligations of a fiduciary merely reflect different aspects of his core duties of loyalty and fidelity. Breach of fiduciary obligation, therefore, connotes disloyalty or infidelity. Mere incompetence is not enough. A servant who loyally does his incompetent best for his master is not unfaithful and is not guilty of a breach of fiduciary duty."

51. SD alleged the following:

i) EIU operated the binder in deliberate disregard of the interests of SD; SD's interests were subordinated to those of EIU (in their remuneration) and to those of SCB and its cedants, so that the binder was operated as a facility for their benefit. EIU engaged in writing gross loss making business on a massive scale with the intention of passing the losses to reinsurers notwithstanding that EIU knew that that would not be in the interests of SD and which could not in any event be done honestly.

ii) EIU made no genuine assessment of the programmes presented but accepted them without regard to their commercial viability as viewed from SD's standpoint.

iii) EIU accepted numerous programmes which no honest or faithful agent would have accepted.

iv) EIU exposed SD to a high degree of accumulation.

v) EIU exposed SD to the risks inherent in contrived reinsurance and in spirals.

vi) EIU misrepresented and concealed the true nature of the business written.

vii) EIU continued to expose SD to liabilities or increased liabilities after they had agreed to a moratorium in July 1998.

viii) EIU exceeded the premium income limits under the binder.

52. The main issue on breach was on whether EIU had acted dishonestly and this was closely linked to the question of whether SD or HHI had known that the binder was being used to write gross loss making business on the backs of reinsurers. SCB submitted that a distinction should be drawn between Mr Henton and Mr Whitcombe. Mr Henton did not have any direct contact with Mr Broad before December 1997 and little thereafter. It was with Mr Henton that SCB dealt.

(d) Mr Broad's knowledge

53. The second principal issue on breach was on whether SD, through Mr Broad, knew what business was being written. Mr Broad denied that he knew what business was being accepted and in particular that Mr Henton was writing gross loss making business on the back of reinsurance.
54. As a very large amount of information was provided to SD in writing, and no enquiry of the type that a prudent insurer ought to have made was undertaken by Mr Broad into the business being written, the essential issue was whether Mr Broad was giving dishonest evidence in saying that he did not know what was being written or whether his evidence was truthful but that his conduct fell very substantially below that to be expected of any competent insurer.
55. The essence of the dishonesty of which SD complained was that EIU had written gross loss making business on the backs of reinsurers and that the gross losses, which would be inevitable, ran into tens of millions of dollars. The real issue therefore was whether Mr Broad knew of this. There was also an issue as to the knowledge and position of EIU and SCB if SCB knew what was being done by EIU.

(e) Position of SD if Mr Broad knew

56. If Mr Broad had known of what was being done, then the acts and knowledge of Mr Broad acting within the scope of his authority would be attributed to SD, even though he was acting in fraud of SD, provided that the third parties dealing with Mr Broad did not know that he was exceeding his authority in doing so.
57. SD contended that if Mr Broad knew what was being done, then that knowledge was not to be imputed to SD; as the writing of the business was an obvious fraud on SD and an inherently dishonest racket, then if Mr Broad knew that, he became a party to the dishonest venture; SCB and EIU knew that he was a party to that dishonest venture.
58. In view of the clear findings to which I have made, it is only necessary for me to refer to short passages which set out the legal position:

i) In Rolled Steel Products v British Steel [1986] Ch 246 at 295, Slade LJ said:

"If, however, a person dealing with a company is on notice that the directors are exercising the relevant power for purposes other than the purposes of the company, he cannot rely on the ostensible authority of the directors and, on ordinary principles of agency, cannot hold the company to the transaction."

ii) In Heinl v Jyske Bank (Gibraltar) Ltd. [1999] Lloyd's Rep Bank 511 at 519, Nourse LJ summarised the position as follows:

"Where an agent is known by the other party to a purported contract to have no authority to bind his principal, no contract comes into existence. The agent does not purport to contract on his own behalf and the knowledge of the other party unclothes him of ostensible authority to contract on behalf of the principal."

59. It is not necessary in the circumstances for me to examine the extent of the principle in Re Hampshire Land Company [1896] 2 Ch 743.
60. At my request, Mr Broad was informed by a letter dated 3 January 2003 that this alternative case was being made by SD; the allegation was of such gravity that, in the light of the observations of Ackner J in Rustenberg v Pan Am [1977] 1 Lloyd's Rep 564 at 570, I considered that he should have had an opportunity of answering the allegation directly as SD's position on this aspect was directly hostile to his. He sent me written submissions dated 22 January and 12 February 2003 which I have considered carefully.
61. The legal position in respect of the knowledge of HHI and of the main broker involved at HHI, Mr Graham Smith, must be approached on the same principles.

(f) Liability of EIU as accessories

62. SD also contended that if EIU or Mr Whitcombe or Mr Henton did not owe fiduciary duties to SD, they were nevertheless liable as accessories on the same basis as SCB.

(g) EIU's counterclaim

63. A counterclaim was made by EIU for the commission due. This was stayed by the Order of Andrew Smith J dated 8 December 2000. Although the findings I have made in this judgment may well be conclusive of the counterclaim, it is not necessary for me to deal with it further in this judgment.

(2) Dishonest assistance by SCB in breach of the fiduciary duties

64. SD's principal claim against SCB was that they had dishonestly assisted in the breach of EIU's fiduciary duties in respect of sub-paragraphs i) to vii) of paragraph 51 (subject to one issue – on the scope of the allegation in relation to the knowledge of the underwriting, discussed below), but not in respect of sub-paragraph viii).
65. SCB accepted, as I have set out, that it was not strictly necessary for SD to establish that EIU had acted dishonestly (see Royal Brunei v Tan), but this was of no practical significance in any event as the case made against EIU was only one of dishonesty.

(a) Assistance

66. SD had to establish first that assistance was given by SCB; SD's case was that SCB were orchestrating the business and that SCB knew of the circumstances in which the programmes were being accepted by EIU.
67. SCB submitted that it was not for a broker to divine why an underwriter was accepting business; if the risk was one which the broker was surprised that the underwriter had accepted at the terms proposed, it might be because the underwriter had thought it commercially advantageous, or it might be because the underwriter was foolish, or there might be some other reason. The broker would have no knowledge of the underwriter's underwriting plan; he would not know the balance of the underwriter's book; he would not know what other risks the underwriter had written to other brokers; he would not know about the underwriter's outwards reinsurance programme; he would not know about potential accumulations. He was therefore not in a position to assess whether there was a commercial justification for what was being done by the underwriter. The broker's task was to present the business; he was not meant to make an underwriting assessment and it was not his job to try and work out why the underwriter was accepting the business.
68. SCB also submitted that once it was accepted either (1) that there was a commercial rationale for "net underwriting", or (2) that the broker had a perception that there was a commercial rationale, or (3) that the broker thought that the underwriter had a perception of a commercial rationale (as might be the case if the underwriter had very cheap outwards reinsurance), or (4) that the broker thought that the underwriter was a fool, then no criticism could be made of the broker for presenting the business to the underwriter and the broker certainly could not be characterised as dishonest; a broker could not be expected to calculate, on any risk or programme, whether there was, for the underwriter accepting the risk, in fact a commercial rationale for accepting that risk or any group of risks.
69. SD accepted that SCB's submissions might be correct if the relationship between broker and underwriter was that which existed in the ordinary course of business, but that was not the position of SCB in respect of this business.

(b) Dishonesty in relation to the business

70. SD next had to prove that the assistance was dishonest. In Twinsectra Ltd. v Yardley [2002] UKHL 12, the House of Lords made it clear that it had to be proved that:

i) The defendant's conduct was dishonest by the ordinary standards of honest and reasonable people.

ii) The defendant knew that what he was doing would be regarded as dishonest by honest people; he could not escape a finding of dishonesty by setting his own standards of dishonesty and by not regarding as dishonest what he knew would offend the normally accepted standards of honest conduct. It therefore had to be shown that the defendant was conscious that he was transgressing ordinary standards of honest behaviour. This second element was conveniently referred to as "subjective dishonesty".

71. It was SCB's case that the practice of accepting business known to be gross loss making and making a profit on the backs of reinsurers was objectively honest; it was for SD to prove that it was not. This is a complex issue and I will consider it after describing the market.
72. SCB submitted that there cannot have been any breach of duty or any dishonest assistance in respect of programmes where it was accepted that the programmes would have been accepted on a conventional underwriting basis.

(c) The position of Mr Brown and Mr Butler

73. In any event, SCB contended that Mr Brown's and Mr Butler's view of the business that they had grown up in was that it was honest; it was for SD to prove that Mr Brown and Mr Butler had realised that it was dishonest. To this end, SCB relied on the business that they had done in the market since the late 1980s and also relied on the operation of the market between 1992 and 1996 (which is described in Section 3 of this Part of the judgment). Although no plea of dishonesty in relation to those years was made by SD initially, I permitted them, by amendment during the course of the trial, to allege dishonesty in relation to the placing of business in the years 1992 to 1996. It was therefore common ground that I had to reach a conclusion on the honesty of SCB, Mr Brown and Mr Butler in relation to their dealings in that period.
74. It was accepted by SD that even if I conclude that the business in which SCB and EIU participated was obviously dishonest and fraudulent by any objective standard, unless SD also established the subjective dishonesty of SCB, Mr Brown and Mr Butler, they would fail in their claim against SCB. The position was the same as regards Mr Whitcombe and Mr Henton.

(d) SCB's knowledge of the position of SD

75. It was also necessary for SD to prove that SCB, Mr Brown and Mr Butler knew that SD were not willing participants in the business; SCB contended that it was necessary for SD to show that SCB did not know that SD did not know of or consent to what EIU were doing. I accept that submission.
76. Mr Brown and Mr Butler submitted that others had written this type of business. How were they to know that SD had not agreed to accept this type of business as a willing participant? They simply did not know that. I accept that it is an important factor that I must and did take into account that there were those in the PA market who wrote this type of business, as I set out in the next section of this part of the judgment, and that the business accepted by SD was, in general, much the same type of business that had been placed by Mr Brown and Mr Butler in that market.
77. In addition, SCB relied upon:

i) the involvement of HHI;

ii) the approval by SD of the bordereau setting out the programmes agreed on Christmas Eve 1997 and of the reinsurance programmes placed at the same time;

iii) the reasonable assumption that SD would monitor and control the binder;

iv) the inevitable discovery of the true position; and

v) the information provided by EIU in a letter dated 25 February 1998 which was used in connection with Programme 16 (Unum) to the effect that SD were aware of what was being underwritten.

78. SD relied on six principal points to show that SCB knew that SD were not willing participants and that there was collusion:

i) the business was obviously contrary to the interests of SD;

ii) the fact that nothing was ever said about the true nature of the business and the misleading nature of the SCB prospectus;

iii) the arrangements made in February and March 1997 which enabled Programmes 2 (Phoenix) and 3 (American Reliable) to be accepted by Mr Henton without reference to Mr Broad;

iv) the conduct of SCB in relation to Programme 16;

v) the conduct of SCB and EIU in August 1998 in relation to the enquiries that were made about Programmes 26 (Mr Cackett's specifics) and 33 (JEH Re – 66.6666% QS); and

vi) the meeting between SD, HHI, EIU and SCB on 4 January 1999.

(e) Other issues

79. At one stage, SD advanced a claim against SCB for procuring breach of fiduciary duty, but that was not pursued as it was accepted that there was no such tort on the basis of the decision in Metall und Rohstoff v Donaldson Lufkin & Jenrette Inc. [1990] 1 QB 391 at 481.
80. There was one important pleading issue that is to be dealt with in this judgment, but it is easiest to explain this issue after a description of the market in which the business was written has been set out.

(3) Conspiracy

81. SD's secondary claim was made against both EIU and SCB; SD contended that EIU and SCB had conspired together to use unlawful means with the intention of injuring SD. The relevant law is summarised in Kuwait Oil Tanker v Al Bader [1999] EWCA Civ 1528 at paragraphs 111 and following. In summary, four matters had to be proved:

(a) The combination

82. First, a combination with a common intention to achieve a common end is required; what has to be proved is set out at paragraph 111 of Kuwait Oil Tanker. It was not disputed that there were overt acts if it was proved that there was a combination.
83. The conspiracy alleged was that EIU and SCB and the individually named Defendants conspired to operate the binder without regard to the interests of SD and in deliberate disregard of the fiduciary duties owed to SD; they did this by placing reinsurance business with SD without any meaningful information, without any proper assessment, regardless of its profitability, regardless of the serious inevitable losses that would occur, and as part of a scheme. As SD accepted, it was essentially the same case as the one made against EIU for breach of fiduciary duty and as that which was made against SCB as accessories to that breach.
84. Although it was alleged that Mr Bird and Mr Johnson acted dishonestly in relation to various matters, there was no allegation that they were co-conspirators in this regard.

(b) The unlawful means

85. Secondly, the use of unlawful means had to be proved. The unlawful means relied on by SD was the breach of fiduciary duty. SCB's contention was that the claim made by SD in conspiracy was in effect either a claim of a conspiracy to procure a breach of fiduciary duty or a claim of a conspiracy to assist in breach of fiduciary duty; as to the former, SD accepted, on the basis of Metall und Rohstoff, that there could be no tort of procuring a breach of fiduciary duty and as to the latter, that it added nothing to the dishonest assistance claim. SCB's primary contention was that it was therefore unnecessary to decide whether a breach of fiduciary duty could constitute unlawful means. But if it was, they contended that a breach of fiduciary duty could not constitute unlawful means.
86. The editors of Clerk & Lindsell (18^th edition, 2000) comment that:

"There is no good reason why unlawful means in this type of conspiracy should not be coterminous with its scope in the other economic torts …. We have seen that not all equitable wrongs appear to be "unlawful means" but where a serious contravention occurs it will still be open to the courts to regard such wrongs as applicable in conspiracies."

87. The question as to whether a breach of fiduciary duty can constitute unlawful means has not been decided. It was suggested by SD that Toulson J had decided in Yukong Line Ltd. of Korea v Rendsburg Investments Corporation of Liberia (No.2) [1998] 1WLR 294 at 311 that breach of fiduciary duty could constitute unlawful means for the purposes of a claim in conspiracy. However, I do not consider that Toulson J decided this point as His Lordship was concerned in Yukong Line about deciding whether the breach of fiduciary duty alleged had to be actionable at the suit of the claimant; His Lordship decided that it had to be and, as the breach was not actionable, the claim failed. In Surzur Overseas Ltd. v Koros [1999] 2 Lloyd's Rep 611, Waller LJ expressed the view that it was difficult to see why unlawful means for the purpose of conspiracy should be different from unlawful means for the purpose of other economic torts. In Kuwait Oil Tanker, the Court of Appeal considered the claim for breach of fiduciary duty separately from the claim for conspiracy. It does not appear to have been argued that a breach of fiduciary duty could amount to unlawful means, but the Court made no decision to that effect and the decision would not of itself preclude my holding that it did.
88. The point was only argued briefly as it was SCB's submission that the claim of conspiracy added nothing to the claim for dishonest assistance on the facts of this case. The principal argument for holding that a breach of fiduciary duty cannot constitute unlawful means is that the principles of equity already provide a sufficient remedy for breach of fiduciary duty. Although that is correct on the facts of this case, there could be circumstances where there was no remedy available in equity for conspiracy. Although this point is best left for decision when it actually arises, at present I see no reason why a sufficiently serious breach of fiduciary duty could not constitute unlawful means for the purpose of establishing a conspiracy when a breach of contract could.

(c) The intention of causing damage and the damage caused

89. Thirdly, the intention of causing damage has to be established, although any such intention need not be the sole or predominant purpose. It was common ground that a passage in the judgment of Woolf LJ in Lonrho v Fayed [1990] 2 QB 479 at 494 set out the relevant position:

"…frequently it will be fully appreciated by a defendant that a course of conduct that he is embarking upon will have a particular consequence to a plaintiff, and the defendant will have decided to pursue that course of conduct knowing what the consequence will be. Albeit that he may have no desire to bring about that consequence in order to achieve what he regards as his ultimate ends, from the point of view of the plaintiff, whatever the motive of the defendant, the damage which he suffers will be the same. If a defendant has deliberately embarked upon a course of conduct, the probable consequences of which to the plaintiff he appreciated, I do not see why the plaintiff should not be compensated."

The issue is one of fact. SD's case was that SCB and the other conspirators at the very least appreciated that SD would probably be injured, either through engaging in the underwriting of WC carveout business on the backs of reinsurers (as it was a dishonest activity), or through the acceptance of programmes which would lose money after reinsurance (in respect of which there was insufficient information to form a judgment on profitability, even after taking reinsurance into account). SCB's answer was that those who engaged in underwriting on the backs of reinsurers always intended to make a profit.

90. Fourthly, it had to be shown that damage was caused. SD said that it was enough that some damage had been caused. There can be little doubt, though the determination of quantum was not part of the trial, that SD had suffered at least some loss even if the outwards reinsurance was taken into account.

(4) Fraudulent misrepresentation by EIU

91. SD also claimed against EIU, Mr Whitcombe and Mr Henton, damages for fraudulent misrepresentations which they contended had induced the acceptance of the binder; they relied on the documents that were presented and on what had been said orally to Mr Broad.
92. Three principal representations were alleged:

i) That the book of PA business would be produced through a range of brokers, that it would be short tail, that it would be low to medium risk, that it would be written on the basis of a prudent risk review and the application of selective underwriting criteria in order to produce substantial underwriting profits, and that it was believed to be profitable.

ii) That Mr Whitcombe's past underwriting at Lloyd's Syndicates 456 and 1053 had been profitable.

iii) That the management of EIU would include Mr Peter Downey, a well known and highly respected underwriter in London. Although EIU was only formed on 13 December 1996 and Mr Whitcombe and Mr Henton only became directors on 12 February 1997, SD contended that there was an actionable representation to the effect that Mr Downey was closely involved in the management of the business and that he would become Chairman when EIU was incorporated; moreover it was alleged by SD that this representation was a continuing one until the binder was agreed on 21 January 1997, by which time EIU had been incorporated.

93. These representations were said to be untrue to the knowledge of Mr Whitcombe and Mr Henton.

(5) Causation of loss and mitigation

(a) Defence to the payment of equitable compensation

94. Although contributory negligence was no longer a defence to an intentional tort in the light of the decision of the House of Lords in Standard Chartered Bank v Pakistan National Shipping Corporation (Nos. 2 and 4) [2002] UKHL 42, SCB maintained that a defendant was not responsible in equity where the claimant was the author of his own misfortune and who, after due notice and opportunity, failed to take the most obvious steps to alleviate his losses.
95. The general position in equity is not dissimilar; I agree with the views of Blackburne J in Nationwide v Balmore Radmore [1999] Lloyd's Rep PN 241:

"I therefore take the view that where, in order to establish a breach of fiduciary duty, it is necessary to find that the fiduciary was consciously disloyal to the person to whom his duty was owed, the fiduciary is disabled from asserting that the other contributed, by his own want of care for his own interests, to the loss which he suffered flowing from the breach."

96. However, SCB contended, on the basis of the judgment of Carnwarth J in Corporacion National del Cobre de Chile v Sogemin Metals Limited [1997] 2 All ER 917 that a defence was available where the claimant was the author of his own misfortune. Carnwarth J referred to Canson Enterprises v Boughton & Co [1991] 3 SCR 535, Supreme Court of Canada, where McLachlin J stated:

"When a plaintiff, after due notice and opportunity, fails to take the most obvious steps to alleviate his or her losses, then we may rightly say that the plaintiff has been 'the author of his own misfortune'. At this point the plaintiff's failure may be so egregious that it is no longer sensible to say that the losses which followed were caused by the fiduciary's breach. But until that point, mitigation will not be required."

97. It is self-evident that once a principal knows that the fiduciary is not to be trusted or probably not to be trusted, the principal cannot recover if losses then occur as a result of a failure to withdraw the authority of the fiduciary.
98. However, it was SCB's contention that this principle arose when SD was, on an objective basis, to be taken as knowing the facts (even if the person concerned did not actually understand or read the facts provided to him), and that it operated in similar circumstances as the duty to mitigate at common law.

(b) The failure to mitigate

99. During the course of the final submissions, the nature of SCB's case as to the position in equity and the duty to mitigate was refined; they very helpfully provided me with a note in January 2003 which set out their contentions which can be summarised as follows:

i) Once SD had suffered loss – upon the writing of the first contract on 27 January 1997 or upon its confirmation, it was not necessary for any actual loss to have been sustained as it was then highly probable that claims would exceed premiums.

ii) SD had actual knowledge of the facts from that time:

a) which made it objectively reasonable for SD to investigate further in order to prevent possible loss and damage to SD;

b) which, if reasonably investigated, would have actually led to the discovery of the wrong to, or losses sustained by, SD.

100. SCB further submitted that if SD had such knowledge they could not recover in respect of the losses which could have been avoided through reasonable action on their part; SD had failed to take reasonable action in order to avoid losses, for example:

i) SD had failed to stop EIU writing the business which was complained of;

ii) SD had failed to procure outwards reinsurance for the business that had been written.

101. SD submitted that this was entirely misconceived and that it was an attempt to circumvent the decision in Standard Chartered Bank.
102. SCB, in support of their submission that knowledge of the facts should have led to further enquiry, referred me to paragraphs 16-051 and 17-059-60 of Benjamin's Sale of Goods (6^th edition, 2002), and to an unreported decision of the Court of Appeal in Schering v Resibel (26 November 1992); it is clear that the argument, if correct, has very significant financial consequences.
103. As it was the primary case of SCB that SD knew all along what had happened (through Mr Broad), SCB's submissions on mitigation depended upon my rejecting their primary case on SD's knowledge and in making alternative findings as to what information was provided to SD and what ought to have been objectively deduced from that. I was helpfully supplied with a list of alternative findings and I have endeavoured to deal with many of these in the judgment. However, as I made clear, given the very complex nature of the issues before me, it would be very difficult to deal with this issue until I had made my primary findings; it was clear that any argument on mitigation would involve yet further alternatives based on what was known when. I made it clear that although I would make as many findings as I felt I could, I would reserve the argument on this issue to a further hearing; the parties would then know the primary findings which I had made on the main issues and be able to develop the arguments in relation to mitigation on the basis of those findings as well as ask me to make any further findings which are considered necessary.
104. Clearly the submissions made by SCB would in practice radically reduce the effect of the decision in Standard Chartered Bank. It would permit a person who has defrauded another to say that on the actual facts known, the victim should have investigated further and would therefore have been able to prevent the loss from the fraud. Although I have grave doubts about the submission made because it will, in many cases, prevent foolish victims of fraudsters from recovering their losses, it seems to me that as the sums at stake could be very large indeed and as a decision should be based on firm facts reached after full argument, I will express no further view on the argument advanced by SCB in respect of mitigation and on the related topic of equitable defences and reserve the issue for further argument.
105. There was also an issue as to whether account should be taken of the adverse loss development policy purchased by SD in May 1999 (as set out at paragraph 1855). There was a dispute of principle as to whether it should be brought into account; SD submitted that it should not, on the basis of the principles in Bradburn v GWR (1874) LR 1 Ex 1. The policy in question had not been examined by SCB; its scope and terms are unknown to me. I reserved to further argument any issues that remained on this.

(6) The standard of proof

106. The standard of proof applicable in civil cases is a flexible standard; SCB submitted, on the basis of the decision of the House of Lords in R (McCann) v Crown Court at Manchester [2001] 1 WLR 1084 (in relation to the standard of proof applicable under orders made under section 1 of the Crime and Disorder Act 1998 and similar cases) that I should, in practice, apply the criminal standard because the allegations made by SD were so serious and amounted to allegations of serious criminal conduct involving many millions of dollars.
107. This was not disputed by SD; therefore, in view of the gravity of the allegations made, I have adopted the criminal standard of proof in respect of the allegations involving dishonesty and I have only found such allegations proved when I have been sure.

(7) Approach to the credibility of witnesses

108. In the very difficult task of assessing the credibility of the witnesses, I have adopted the approach of Robert Goff LJ in Armagas Ltd. v Mundogas S.A. (The Ocean Frost) [1985] 1 Lloyd's Rep 1 at 57 as approved by the Privy Council in Grace Shipping v Sharp & Co. [1987] 1 Lloyd's Rep 207 at 215:

"Speaking from my own experience, I have found it essential in cases of fraud, when considering the credibility of witnesses, always to test their veracity by reference to the objective facts proved independently of their testimony, in particular by reference to the documents in the case, and also to pay particular regard to their motives and to the overall probabilities. It is frequently very difficult to tell whether a witness is telling the truth or not; and where there is a conflict of evidence such as there was in the present case, reference to the objective facts and documents, to the witnesses' motives, and to the overall probabilities, can be of very great assistance to a Judge in ascertaining the truth."

(8) The issues between EIU and SCB

109. As regards the nature of the business and the way in which most of the programmes were accepted, there was an identity of interest between EIU and SCB, though as was made very clear by SCB, they were brokers and not underwriters and were consequently not making any case on the underwriting of the programmes.
110. There were three primary areas where there were serious disputed issues of fact between EIU and SCB:

i) whether any assurance was given by Mr Brown about the spiral in December 1997;

ii) about what was said and done when Programme 33 (JEH Re – 66.6666% QS) was accepted; and

iii) about what was said when the "all sources" endorsement was presented under Programme 26 (Mr Cackett's specifics).

111. THE MARKET THAT TRADED IN LOSSES
112. As an essential element of an examination of the case of dishonesty that was made by SD, it is first necessary to explain the part of the insurance and reinsurance market in which EIU and SCB were engaged. It is therefore necessary to explain that market in more detail and to begin by explaining how the underlying business was reinsured.

(1) Workers' Compensation business in the US

113. The original insurance risks that formed the underlying business were characterised by those engaged in it as PA business. Although the reinsurance programmes with which the trial was concerned did include the reinsurance of some PA risks properly so called, in that it was traditional PA business, the predominant content of the programmes were reinsurances of what was known as carveout of US Workers' Compensation and related business.
114. This type of business was not PA business in any proper sense of the term, but was in fact liability business – all the original risks operated as contracts of indemnity to employers who were liable to their employees for WC or WC related benefits.
115. The market for this type of insurance and reinsurance operated as follows.

(a) US Workers' Compensation

116. In the US, employers are liable in tort at common law for injuries to their employees. States began from the early 1900s to enact employers' liability laws generally known as Workers' Compensation Acts (WCAs). These laws differ from State to State but generally under them, an employer is obliged to provide benefits if the employee is injured at work regardless of fault; the employer must be insured (or can be self-insured in certain States under specified conditions); if the employee claims under the WCA, the employer is generally relieved of liability at common law. Time limits for notification and for making a claim are short – typically within 1-2 years of knowledge of the injury.
117. Insurances of WCA liabilities are provided by licensed private insurers in some States, in other States by a State fund, and in some other States there is an option between private insurance and a State fund. The provision of insurance by insurers is heavily regulated and every insurer must be approved by the State in question; terms, time limits, deductibles and ratings are controlled by the State. If an employer cannot obtain insurance, he is provided with insurance by a State fund or special carrier under policies known generally as "assigned risk policies"; these are financed by a levy on the private insurers doing business in that State.
118. Self-insurance is permitted under limited circumstances and is usually subject to requirements for specific excess insurance to limit the liability for a loss from a particular occurrence and for aggregate excess insurance to cover accumulation of claims in any one year; policies provided for these purposes are known as "spec. and agg. insurance".
119. Under standard WC policies, the policy provides:

Section A: WC benefits payable by the employer under State legislation; the provisions differ from State to State, but they often provide for unlimited medical expenses and long term income benefits for disablement.

Section B: employers' liability to employees for work-related injuries where the employer is not immune under WC legislation.

120. There is much public information; there are detailed statistics about the classes of business written; rates have to be filed by the issuing carrier.
121. Parallel to these State laws, Federal law provides for similar schemes for maritime employees through the Longshore and Harbor Workers' Compensation Act.

(b) Alternatives to WC Insurance

122. In some States, employers can opt out of the requirement to obtain standard WC insurance and a market developed to provide alternatives. In Texas, a statute permitted employers to self-insure or opt out (on stringent conditions, including more stringent liability at common law).
123. Insurance for this was often known as "alternative workmen's compensation business".

(c) EEII and CSLI

124. One of the alternative types of policy provided was "Employers' Excess Indemnity Insurance" or EEII. This was a product which was developed by Mr Cooke (when at Bowring and at Blackwall Green in the 1980s) in conjunction with Mr Billyard, the then active underwriter of Syndicate 398 (see paragraph 409). Mr Cooke subsequently continued this business at his own company, Stirling Cooke, which then merged to form SCB. EEII business was primarily placed directly in London under a lineslip with Mr Cooke and Mr David Tarsh, the two of them being those primarily involved at SCB.
125. EEII was available in certain States, primarily in Texas, where employers could opt out of WC into policies with an approved format. The policy provided an indemnity for the liability of employers at common law with a substantial deductible up to a given maximum per person and occurrence limits.
126. It had been a very successful product but was in decline by August 1995 because of fierce competition from other alternative WC schemes and traditional WC insurance. Part of that competition was provided by SD Bermuda in 1993/4 when they acquired Mr Al Harding's book of EEII business in Texas.
127. SCB also developed CSLI – Combined Single Limit Indemnity Insurance, which was similar to EEII but was intended for smaller employers to cover the deductible under the EEII policy.

(d) The reinsurance of WC and alternative WC: WC carveout

128. An insurer was, at the material time, normally free to obtain reinsurance in any way desired; in the US, the obtaining of reinsurance was generally not regulated under State law, but the extent of reinsurance might have been taken into account in licensing.
129. Further in the US, life companies were not generally permitted to insure WC business, either because they were not permitted to accept the liability under Section B of the standard WC policy or because they were only licensed to write life, PA and health business; only insurers who were licensed to insure property and casualty business could write WC insurance.
130. A market developed for US insurers of WC to reinsure their liabilities under Section A separately from Section B. The reinsurance of Section A came to be called "carveout business". The precise extent of the carveout would depend on the terms of the contract, but it usually excluded liability under Section B, the main types of occupational disease and cumulative trauma (that is, injury sustained over a period of time such as Repetitive Strain Injury). The objective of this separate reinsurance was to make it marketable to a broader market including the traditional PA and life insurance market, as life insurers were permitted to reinsure Section A as it did not contain the broader element under Section B. In the 1980s, such reinsurance came to be written in the PA reinsurance market in London.
131. Typically the amount of premium attributable to Section B was, at the material time, between 6% and 10%. In the B&S scheme (Programme 9), 6% was deducted from the estimated gross premium income for Section B coverage – see paragraph 180.ii) of Part II. I accept the evidence of SD's expert underwriter, Mr Robin Jackson, that the exclusion of employers' liability was in fact not significant.
132. Although as a matter of analysis, WC carveout and alternative WC business was clearly liability business as it indemnified the employer against the WC payments he had to make under Section A, it was treated by many who wrote it as akin to PA business. They looked on it as business that could be written as part of a treaty covering PA business, unless specifically excluded.

(e) "Occupational accident"

133. Another term that came to be used amongst those that were engaged in WC carveout and alternative WC business was "occupational accident".
134. In the general insurance and reinsurance market, the term "occupational accident" was not used to refer to WC carveout, but to group PA for companies (see also paragraph 651.ii)) or to the insurance of accidents at work.
135. However, amongst those who wrote insurance or reinsurance of WC or alternative WC business, the term "occupational accident" was used to refer to WC carveout business or to alternative WC. It was not a term of art.
136. Nonetheless, as it was a term that had a quite different meaning to those in the general market, the use of this term could give rise to confusion; it was used by some as a euphemism for WC carveout and alternative WC business as such business was seen to be very unattractive by many in the general market.

(2) The development of the market for trading in losses

(a) The competitive market in original WC business

137. The WC market in the 1990s was, by any standards, a large market. It was the largest commercial line of insurance in the US; it was estimated by Paine Webber that the WC market was almost 10% of the insurance industry's entire premium volume and about 20% of the commercial lines' premium volume. Estimates of the volume of premium income differed; SD's expert's evidence was that it was in the order of $30bn; it was Paine Webber's estimation in December 1999 that, at the peak of the market in 1991, the premium volume was $32bn but that it had subsequently fallen to $25bn in 1999; however, their figure excluded the alternative WC market. In November 1997, the prospectus issued for the placement of shares in SCB on an IPO gave a figure of $42.4bn for the entire market. There was also a difference as to the volume of premium income that alternative WC represented; the SCB prospectus gave a figure of $16.4bn (or 39% of the entire WC market); SD's expert gave an estimate of about $5bn when agreeing with a question put by SCB's counsel that it was "only a tiny fraction of the overall US market". I consider the figure in the SCB prospectus likely to be the more accurate; for example, a scheme known as the Unicover scheme (to which it will be necessary to refer) had an annual premium income in the order of $4bn.
138. Original WC and alternative WC insurance was not inevitably gross loss making; rates were calculated on a basis that generally allowed for an underwriting profit of 2.5%, though some felt that it was uneconomic even at these rates. On these rates it was difficult for an excess of loss (XL) reinsurer writing on a conventional basis to make a profit, unless restrictions were imposed.
139. The expert evidence was that much of the WC market was underpriced in the 1990s. Rates peaked in 1993 and thereafter declined in a fiercely competitive market; according to figures published in 2000, with which SD's expert agreed, were, from the expert's own experience, in the right area; the combined ratio for WC business was in the region of 120% in the years 1988-90. Margins then improved but this attracted more competition and by the mid-1990s, prices were driven down by insurers going for market share; for 1997 the combined ratio was 100.8%, in 1998 it was 107.6%, and in 1999 it was 115%; on an accident year basis the figures were worse – 115% in 1997 and 122% in 1998.
140. There was also some evidence that the SCB book of business was only profitable on a gross basis at the primary level or that the loss ratios were only marginally unprofitable. This could be seen in the programmes written by EIU where such information was available – see, for example, the B&S programme (Programme 9) (see paragraphs 194 and following of Part II).
141. It was clear from the evidence before me that many large insurers of WC business with premium incomes of $1bn-$2bn did not rely on reinsurance; some indeed thought that investment income could cover the gap on the loss ratios to which I have referred. However, as I shall explain, it was also clear that the ability of some underwriters (probably the smaller companies) in writing original WC and related business to compete in this market and to sustain loss ratios of the modest level described was dependent on underpriced reinsurance and, in particular, on the development of a market in reinsurance that traded in the losses generated by WC and related business.
142. If, as was usually the case, the reinsurance structure of a primary insurer was in place before that underwriter wrote the business, a primary insurer was able to offer better rates (or more commission) where reinsurance was being provided by reinsurers who were prepared to write the business, even though they knew that they would receive far less in premium than they would have to pay in losses.

(b) The state of the PA market

143. Traditional PA business encompassed policies that usually paid a fixed sum (and often a limited amount of medical cover) on injury or death caused by an accident; it was available on an individual or group basis; sometimes it was provided by a free-standing policy; sometimes as part of a package, as for example, packages provided by credit card companies. Such policies were written in London by companies and at Lloyd's where a number of specialist and aviation syndicates had traditionally written this type of business.
144. By the beginning of the 1980s at the latest, there was only a limited amount of traditional PA business available in London; several insurers were interested in writing the business and there was undoubtedly overcapacity and fierce competition from the 1980s which continued until after the time with which this trial was concerned. This was evidenced by numerous statements by underwriters complaining about poor underwriting conditions and about competitors accepting business at terms that were uneconomic.
145. That overcapacity softened rates and led primary insurers to seek lower rates from reinsurers and a broadening of the coverage. It also led to insurers looking for alternative ways of doing business and making a profit for their capital providers.

(c) Arbitrage and net underwriting

146. A feature of the insurance market has always included arbitrage – an underwriter insuring business he thinks will be profitable and increasing the potential for profit by favourable reinsurance. It is also clear that in some catastrophe markets where losses are certain but where it is uncertain on whom the losses will fall, underwriters have arbitraged.
147. In a soft market, as existed in the late 1980s and 1990s, it was possible for underwriters to obtain reinsurance at such favourable terms that they could write insurance at rates where the premium would not cover the losses – or using a market phrase, they were writing "below the burn"; the losses would be paid by reinsurers who were prepared to write at a loss. The decision of the reinsurer to write below cost is an ordinary incident of such market conditions resulting from overcapacity; as long as proper disclosure was made, there could be no complaint. It is clear from the many contemporary underwriting reports and articles written in the period from 1970 to the 1990s (which were considered in the course of the evidence), that there were several insurers in the different sections of the insurance market who were prepared to offer reinsurance at below cost and that there were others who used the availability of such reinsurance at below cost to write business below cost and improve their market share; those who took advantage of such reinsurance would be taking on gross loss making business and be making their profit upon passing the losses to their reinsurers. Those who obtained such reinsurance at below cost and who wrote their insurance on that basis were described as "net underwriting" or "arbitraging" because they were, in effect, trading a risk and making their profit on the differential in rates. Some did not like the term "arbitrage" as the participants were carrying a retention and preferred the term "net underwriting" instead; the latter was a term which SCB used during the trial to refer to any approach to underwriting which relied on outwards reinsurance to turn gross loss making business into business which was profitable when reinsurance recoveries were brought into account.
148. Although there were many who did not like this practice (as the contemporary reports and articles showed) and stood aside from it, preferring to continue to write in the expectation of an underwriting profit, it was an undoubted feature of the soft market conditions that some insurers were able to arbitrage or engage in net underwriting; in other words, they could trade gross losses by way of arbitrage. An article published in the Insurance Review in May 1997 summarised the position:

"Rates are too low, but they have no other business to compensate. Common sense says withdraw. Behaviour learnt in the market says keep going, things might get better … The market as a whole cannot learn and never will."

(d) The development of a market for the reinsurance of WC carveout

149. It was in those market conditions that there developed in the 1980s within the PA market, a market in the reinsurance of WC carveout and alternative WC business at a cost where premiums were far less than the anticipated losses.
150. As I have explained, the way in which the liabilities were carved out made carveout business appear akin to traditional PA business and thus attractive to those who had written PA business; it was for that reason that this form of liability business came to be written in the PA market and it was therefore in this market that the market for trading in losses developed. By 1990 the market which wrote this business was an established part of the PA market; several companies and syndicates in the London market wrote it as part of their PA account, though other writers of traditional PA business did not write such business. Although SD questioned whether the market that traded in WC carveout and related business was a market, I accept that there was such a market and that it formed part of the PA market.
151. Although WC carveout business was different to traditional PA business, it was treated as PA business for the purposes of whole account PA treaties and the business was commonly referred to in the market as PA business. However, it is important to distinguish between traditional PA business and WC carveout and related business (such as alternative WC business like EEII); I shall generally refer to WC carveout and related business simply as WC carveout business in the interests of simplicity as in most circumstances there was no important material difference between them.

(e) The reinsurance of gross loss making business

152. Business on which it was virtually inevitable, from the information provided, that the losses under the reinsurance would exceed the premium by a substantial margin was referred to during the evidence as "gross loss making business". I shall use that phrase in this judgment in that sense; it is very important to distinguish such business from business which turns out to make a gross loss but where the underwriter anticipated that there might be losses having written the reinsurance on the basis that he considered the premium which he charged (together with investment income) sufficient to pay the losses. By gross loss making business I mean business where it is a virtual certainty that there will be losses which will far exceed the premium, and by referring to those who wrote gross loss making business I mean those who deliberately decided to write gross loss making business in the knowledge that the losses would exceed the premium by a significant amount.
153. As the losses in WC insurance and WC carveout and related insurance had a high frequency and were usually for sums well under $100,000, the reinsurance which the direct or primary insurers needed (and was available) was usually XL reinsurance above a relatively small retention and sometimes on a quota share (QS) basis with an XL programme to cover their retention, with a common account XL reinsurance for the QS reinsurers. The features of the XL reinsurances with which the trial was concerned were:

i) the retentions were low; at the beginning of the 1990s, retentions at one stage were as low as $1,000, rising to $5,000 and then to $10,000;

ii) unlimited reinstatements were provided; and

iii) the premiums charged were insufficient to cover the likely losses, even at the first tier.

154. It might be asked why any reinsurer would write such business unless it was for a common commercial purpose – such as the writing of a modest amount of unprofitable business in order to enter a market, to maintain market share or to cultivate the cedant or the broker in order to obtain other business. Although reinsurers did write some business for those purposes in the PA market as in other parts of the market, reinsurers generally wrote carveout business on a large scale where huge losses were inevitable because there were other reinsurers who were prepared to reinsure them on terms which enabled these reinsurers to make a profit. I will refer to the reinsurers who successively reinsured the business as first tier reinsurers, second tier reinsurers, third tier reinsurers and so on; I use the word 'tier' to distinguish this from the vertical layers of XL reinsurance which might be available at each tier.
155. First tier reinsurers were able to offer such reinsurance only because they were able to purchase reinsurance programmes for the risks they had assumed at a cost which, if they had calculated correctly, would enable them to make a profit; they would be concerned to see that the premium they received was sufficient to pay the retentions on each loss and to pay the premium for a reinsurance programme written by second tier reinsurers who would then assume the remainder of the losses. The features of the programmes which were obtained were: low retentions, unlimited reinstatements at no additional premium at the lower layers (horizontal coverage), coverage to a very high limit (vertical coverage) and aggregate stop loss reinsurance to protect the overall account from a high volume of losses within the retention. These first tier reinsurers were sometimes referred to by those in this market as "direct writers"; as this term invariably refers to writers of primary insurance in the rest of the insurance and reinsurance market, it is therefore very confusing and I have not used it save where it was necessary to do so.
156. The premium paid to the second tier reinsurers would therefore be significantly less than the premium paid to the first tier reinsurers, though they would have to bear, in this type of business, a significant part of the loss at the working layers. It was inevitable that they would lose money unless they in turn had reinsurance at a cost which would move the losses to a third tier reinsurer at even less premium.
157. The evidence was that reinsurance on each tier was often available at a premium of 25% of the premium received. As the losses were passed on, the premium became smaller and smaller. Each was writing reinsurance on the backs of his reinsurers.
158. The striking characteristics of the market that provided these tiers of reinsurance were that:

i) Reinsurance was available on this basis at working layers of XL reinsurance of this type of business – that is to say the lower layers where there would always be, in WC and related business, a high frequency of claims and where one would expect to see, as SCB's expert put it, "horrendous losses".

ii) As losses were inevitable at these working layers and the reinsurances were only being placed on the basis that the inevitable losses were being passed on, those doing business in the market were in fact trading in losses.

iii) The premiums that were paid were therefore not commensurate with the risk of gross loss as in conventional reinsurance, but were merely to pay the retained losses, to pay the reinsurance premium and to make the turn described by the participants as "the net profit".

iv) The premiums became progressively smaller in successive tiers of reinsurance as is illustrated below.

v) There were many more in the market that were prepared to accept business of this kind as first tier reinsurers, than there were those who were prepared to write second and subsequent tiers as retrocessionaires.

vi) No one would begin to accept inwards reinsurance until his outwards reinsurance was in place; the folly of doing otherwise was obvious.

vii) It was inherent in this type of business that there would be reciprocal arrangements. No one was going to commit himself to the protection of others without having obtained outwards reinsurance of his own.

159. There was no longer such a market as it had changed in 2000 or 2001, such that contracts were being written in the anticipation of a gross profit.

(f) The diminution of the premium

160. The effect of successive tiers of reinsurance on the premiums can be illustrated by a simple example taken from what might have been anticipated on a big programme with a significant loss ratio; the following was put to Mr Henton in the course of his cross-examination on Programme 3 (American Reliable):

i) The first tier reinsurer obtained a net premium of $1m for anticipated losses of $7m – a loss ratio of 700%.

ii) As reinsurance was available for this business at about 25% at least until 1996, the second tier reinsurer would obtain $250,000 on which he would have to pay a brokerage of 10% or 15%. Assuming that the first tier reinsurer broke even and paid $750,000 in total as the amount of the retained losses, the second tier reinsurer would have to face losses of about $6m-$6.5m on that premium.

iii) The third tier reinsurer would then get 25% of the second tier reinsurer's premium but would still have to pay the losses of $6m less the second tier reinsurer's retention.

iv) That then must be replicated down the chain; the loss ratios would ultimately become enormous.

161. As shown at paragraph 846.xvi), it was this mechanism that produced the single largest component of the loss of $71m on Programme 3 (American Reliable) through a specific reinsurance programme that was ceded to that programme; a further illustration is provided in Programme 21 (Venton) at paragraphs 688 and following of Part II.
162. In addition, a commission had to be paid to the broker on each tier; the brokerage in the market was in the order of 10%-15%.

(g) The competitive advantages to primary insurers

163. The fact that low retentions were available enabled primary insurers to take bigger exposures and larger lines; the effect of reinsurance under which the premiums were less than the inevitable losses was to enable primary insurers to offer more competitive rates; if they had cheap loss making reinsurance written by first tier reinsurers on the backs of other reinsurers, the primary insurers could offer lower prices. This drove the market down.
164. These arrangements were also important to intermediaries. SCB expressed the importance of reinsurance arrangements to their competitive position in these terms in the prospectus issued in November 1997 for the IPO on NASDAQ:

"[SCB] structures and markets comprehensive programs to transfer risk from an insured to insurers and ultimately to reinsurers in the workers compensation market as well as other specialty casualty lines. [SCB] is able to offer these programs primarily as a result of the strong relationships and expertise it has developed through its reinsurance brokering activities. Furthermore, although certain of [SCB]'s programs utilize an independent primary insurance carrier, [SCB] is capable of providing or obtaining the services and products required at each stage of the risk transfer process. [SCB] believes these programs are cost-effective to the insured and provide additional business to reinsurers with excess underwriting capacity. Thus, [SCB] is able to provide retail agents and insureds with the advantages of being a single source provider of risk management services and products, whilst also maximising its own revenues at each stage of the risk transfer process.

Generally, in the risk transfer process, alternative market insurance carriers will not offer products directly to the retail agent or insured unless they have effective reinsurance programs in place. The economics and quality of these reinsurance arrangements affect the insurance carrier's ability to compete with other insurance products. Insurance carriers use the services of reinsurance brokers or other intermediaries to arrange these reinsurance programs. [SCB] believes that its reinsurance brokering operations give it a competitive advantage over other industry participants and allow it to structure more cost-effective alternative products."

(3) The "PA spiral"

165. As the losses from WC and WC carveout insurance moved from the first tier of reinsurance into other tiers, the position became complicated by the existence of a spiral. In due course it will be necessary for me to examine whether that spiral was deliberately created, but it is first necessary to describe it.

(a) The nature of a spiral

166. The most well known examples of spirals are those which arose in the London market excess of loss (LMX) catastrophe market in the late 1980s; the LMX market was described by Phillips J in Deeny v Gooda Walker Ltd. [1996] LRLR 183 (the case arising out of these well known spirals) at pages 188-9; His Lordship explained how the XL market had developed as part of the mechanism to share risk.
167. In an XL market, a spiral can arise from the writing of two types of business:

i) by way of XL reinsurance of another's XL account; and

ii) by way of XL reinsurance of another's whole account which contained an element of XL reinsurance business.

Spirals can occur quite unintentionally in markets where companies write XL on XL of each other's business; indeed there is often likely to be some spiralling in a retrocessional (retro) market where insurers reinsured the same companies and then reinsure those risks within the same market. The existence of spirals are therefore an inevitable feature of such markets. The use of terminology was somewhat imprecise; spiral business was often referred to as "LMX incl retro" or as "retro LMX" or simply as "spiral"; as XL on XL reinsurance of companies in Bermuda and in the US could contain spiral business, there was no material distinction between international XL and LMX where there was a spiral element in it.

168. The characteristics of a spiral were described by Phillips J in Deeny at page 190 and I gratefully adopt it:

"Many syndicates which wrote XL cover took out XL cover themselves. Those who reinsured them were thus writing XL on XL. They, in their turn, frequently took out their own XL cover. There thus developed among the syndicates and companies which wrote LMX business a smaller group that was largely responsible for creating a complex intertwining network of mutual reinsurance, which has been described as the spiral. When a catastrophe led to claims being made by primary insurers on their excess of loss covers, this started a process whereby syndicates passed on their liabilities, in excess of their own retentions, under their own excess of loss covers from one to the next, rather like a multiple game of pass the parcel. Those left holding the liability parcels were those who first exhausted their layers of excess of loss reinsurance protection.

So far as the individual syndicate was concerned, the effect of the spiral was to magnify many times the impact of a particular loss. That is because claims were repeatedly made in respect of the same loss as it circulated in the spiral. I was told that claims in respect of the Piper Alpha loss exceeded, by a multiple of about 10 the net loss that was covered on the London market.

This gearing effect did not, of course, result in an ultimate payment of a greater indemnity than the initial loss. As the loss passed through the spiral, however, it impacted repeatedly on successive layers of reinsurance cover, and ultimately concentrated on those reinsurers who found their cover exhausted.

….

The spiral effect of claims was diminished or extinguished by individual retentions, whether before reinsurance protection commenced or after it had been exhausted, by co-insurance and by "leakage" to reinsurers outside the London market, so that the extent to which catastrophe claims spiralled depended to a degree on the size of the loss, or more precisely that part of it which entered the London market. Thus, the higher the level of the layer of excess of loss protection, the lower the risk that it would be impacted. The effect of the spiral was, however, significantly to reduce the comfort that could properly be derived from being exposed only to what appeared to be a very high layer of loss. Another effect was to transfer from the insurers to the brokers a very substantial part of the overall premiums in respect of a risk, for on each excess of loss reinsurance, brokerage fell to be paid at a rate of 10 per cent of the premium."

(b) Conventional PA business

169. A characteristic of the market where these spirals occurred was that catastrophes which historically had not occurred often were being reinsured; as the working party appointed by Lloyd's into the LMX market and chaired by Mr Graham Lyons observed in respect of catastrophe business (published in October 1988):

"A book of LMX business will have a high profitability level in loss free years and high risk of large accumulating loss in bad years. To be profitable in the long run the profits made in the good years must exceed the losses made in the bad years."

In several years the returns were profitable as there were no catastrophes; that was its attraction – see the report of Sir David Walker referred to at paragraph 170.ii) below.

170. It was clear on the evidence that traditional PA business was reinsured in a market which also gave rise to the potential of a spiral. But in traditional PA business, the kind of loss that gave rise to a spiral was the loss resulting from an accident to a person who was insured for a high value (such as a motor racing driver); indeed, as SCB's underwriting expert explained, in the period in which he was writing PA business in the late 1980s, the participants in the market would hardly get anything other than accidents to those insured for a high value. This market was therefore one which dealt very much in the same type of catastrophe risk as had been the subject of the LMX spirals considered in Deeny.

(c) Ordinary consequences of spirals as understood by 1992

171. By 1992 at the very latest, the consequences of spirals were well understood in London – apart from talks that were given by very experienced London market practitioners such as Mr Richard Outhwaite and Mr John Emney, there had been detailed considerations through:

i) the Lyons Working Party Report of October 1988; and

ii) a Report under the Chairmanship of Sir David Walker into the LMX spiral published in June 1992; the committee included Mr John Lock and Mr Leslie Lucas, two men of immense distinction and experience in reinsurance.

Many of these conclusions were reinforced by the judgments of Phillips J in Deeny (given in October 1994) and in Arbuthnott v Feltrim Underwriting Agencies Ltd. [1995] CLC 437 (given in March 1995).

172. From the reports and the judgments of Phillips J it was clear that:

i) The writing of this type of business required "special skills, knowledge and nerve", for example, it was essential to understand the aggregate exposure and to protect against it. A plan for XL underwriting was essential. Phillips J observed at page 198 of Deeny:

"Written underwriting plans have, I believe, now become the norm at Lloyd's. This was not the case during the period with which I am concerned. Absence of written underwriting plans cannot be treated as evidence of lack of competence. What was, in my judgment, important was not that a plan should be written down, but that a plan should exist and be followed."

ii) The loss within the spiral would be diminished by retentions of each participant, either at the bottom (the retention) or at the top (when the vertical cover of a participant was exhausted) or by leakage (when the loss reached a layer where it was reinsured in whole or in part by those outside the spiral).

iii) A spiral could inflate the ultimate net loss so that small losses could be carried into catastrophe layers, though the ultimate payment in respect of the original loss would remain the same.

iv) A spiral within a market often operated to concentrate exposure at the top end of the spiral rather than to disperse it as reinsurance normally does.

v) The transparency of risk was eroded.

vi) Higher or catastrophe layers should not have been rated as conventional XL because they were subject to losses spiralling up; the Lyons working party pointed this out in 1988. Phillips J very clearly described it as irrational at page 203 of Deeny:

"It is clear on the evidence that the growth of the spiral in the 1980's was accompanied by the development of an irrational rating structure. This was due I believe to an approach to rating which ignored the manner in which the spiral greatly reduced the extent to which risk reduced as the layer of cover rose. The practice was first to rate the lowest layer and for subsequent layers to be rated at progressively lower rates, each rate being a reduction on the rate of the preceding layer. In the result the premium rate, at least of the upper layers, fell far below what might have been adequate to reflect the risk. The highest layers were, for a time, being written at 2 per cent, or even l per cent rate on line. The steps by which the rate reduced to this modest percentage from the rates charged on the lower layers were far too steep and failed to have regard to the manner in which once a loss entered the London market it could spiral up through it."

Although many may have stayed away from the market as they recognised the irrationality of the rating, others, as one of the witnesses before Phillips J made clear, recognised it and took advantage of it.

vii) Spirals could convert losses on short tail business (such as losses from a hurricane) into much longer tailed business; the settlement of losses arising from Hurricane Betsy had taken 10 years; the Lyons Report recommended that LMX should be known as "long short tail".

viii) The insolvency of any of those reinsuring LMX business would reduce the impact of a spiral as it acted to increase the retrocedant's retention, but as the Lyons working party observed:

"Further this can lead to a type of domino effect where the retrocedant's own solvency becomes threatened. This again reduces the spiral."

ix) The margins of profitability were observed by the Lyons working party to be small; there could only be very few winners; most would be losers.

x) The brokerage charged in the market was 10%. Each time the risk was passed around, the premium was diminished by 10% and that sum was passed to the broker. The Lyons Report in 1988 observed that the main beneficiary of the market was the broker who took 10%. As Sir David Walker's report observed 3½ years later, at paragraph 2.17:

"The final factor in creating a seriously underpriced business was the market's acquiescence in allowing brokerage of 10% of premium in all LMX transactions."

173. It was also suggested that if a spiral worked perfectly and logically it would disperse loss, provided that there was a sufficient amount in the spiral to pay the losses through the retention. Although this was theoretically possible and might have happened in the case of smaller losses, it does not appear to have happened in practice.

(d) The spiral that resulted from trading in losses

174. It is clear that once reinsurance of WC carveout business passed into the second tier of reinsurance (and became retrocession business), it was likely to contain XL on XL of those who reinsured WC carveout, WC related business and PA business. In such circumstances there was a risk of a spiral which was magnified by the fact to which I have referred, and there were far fewer who were prepared to write retrocession business than first tier reinsurance.
175. However, any spiral that arose in this market was different in a major respect to that described by Phillips J which had occurred in the catastrophe market and in the traditional PA spiral in two critical respects:

i) As was set out in the judgment in Deeny, the spiral there involved 12 major catastrophes; although it is possible in any spiral for small losses to spiral, the hallmark of the spiral resulting from the writing of carveout business was that it consisted very largely of a number of small losses. As SCB's underwriting expert rightly pointed out, the market had moved to a different era in this respect.

ii) The spiral in the catastrophe market involved risks where there was a real chance that there would be no major catastrophe that would give rise to a loss; there was a genuine fortuity and a chance of profit in good years for all participants. In the spiral that operated in respect of WC carveout and related business, losses were inevitable year in, year out. As the reinsurances in the spiral merely operated to pass on those losses at an ever reducing premium, huge losses would have to be paid each year out of premium that was also diminished on every tier and every layer of reinsurance through the payment of brokerage.

176. As there were a relatively small number of participants in this market, losses would inevitably accumulate from the various XL contracts that had been written. For example, if there was a loss of $100,000 sustained by Company A on a contract written, and that company was reinsured by Company B, Company C and Company D on an excess of loss basis xs $5,000 and then Company B also reinsured Company C and Company D on the same basis, the loss would accumulate in the hands of Company B. In conventional insurance this was considered undesirable but in this market it was not, as Company B would itself be reinsured on the same basis as the others and would only have one retention for the loss, although it would be paid a premium on all the reinsurances.
177. For the same reason, as it was advantageous to receive cessions of the lines of co-reinsurers on a risk, it was also advantageous to write lines on higher layers of the same risk as there was more premium but only one retention and the additional loss was passed on to reinsurers; the additional premium obtained on a higher layer, or through the cession back of a co-reinsurer's participation, or on the higher layer, was profit. As long as the accumulation was within the vertical limit of the reinsurance programme, it did not matter as the gross loss would be passed on to reinsurers. This might be standing a conventional approach on its head but was normal thinking in this market – see Programme 24 (JEH Re/Cackett) at paragraph 740 of Part II. The same applied to Programme 29 (Longshoremen) – see paragraph 771 of Part II.
178. The effect of the spiral in relation to carveout business was therefore:

i) to transfer losses rather than the risk of losses;

ii) the losses were concentrated on a small number of the participants; they were only dissipated to the extent of the retentions or leakage;

iii) a very substantial part of the premium was passed to the brokers, as they took their brokerage at each turn;

iv) the further down the chain the losses were transferred, the less premium would be available to reduce the exposure of the reinsurer;

v) losses would spiral until either there was sufficient leakage or one of those in the spiral ran out of cover on either a vertical or horizontal basis;

vi) working layer losses would be carried into the higher layers;

vii) because of the time that elapsed whilst losses spiralled, notification of working layer losses would not be made to those on higher layers for some time and they would therefore not probably appreciate the extent of their exposure until that time; and

viii) the ultimate payment would be delayed because of the effect of quarterly accounting.

(e) The extraordinary nature of the PA spiral

179. I agree with the way in which the nature of the PA spiral was put by Mr Peter Greig, SCB's broking expert:

"Overall, the outstanding feature of the PA spiral market was that it traded in loss-making business, particularly at the lower layers of cover. In effect losses were traded between participants."

(4) The experts

180. It is next necessary to refer to the experts who gave evidence for SD and SCB. No expert gave evidence on behalf of EIU. Two underwriters gave evidence.
181. Mr Robin Jackson (who was called by SD) was a distinguished underwriter with a long experience of WC business:

i) He began his career in the market in 1955 as a broker at CT Bowring; between 1960 and 1971, he was an underwriter and then a Vice-President in the Casualty Department of General Re in New York, one of the major reinsurers in the world. From 1971-1976, he was the Managing Director of Unionamerica Insurance Company in London. Between 1977 and 1988, he became active underwriter of a large non-marine syndicate managed by the Merrett Group, of which he became a director. He was Chairman of, or served in, several insurance market groups and was Chairman of a reinsurance company established by Lloyd's. He continued to be active in the market during the 1990s, though not as an underwriter.

ii) He had always written with the intention of making a gross profit, but the losses he had passed on to his reinsurers when he wrote with low retentions had turned out to be very heavy. He had never engaged in the practice of accepting business known to be gross loss making business on the backs of reinsurers; he disliked that practice and regarded it as unprofessional and in some circumstances, dishonest. He had analysed the information provided on each programme with immense industry and his analysis of that information from the standpoint of conventional reinsurance was largely accepted. His report on the details of the programmes was, in my judgment, a masterly analysis. As there was no dispute about much of that analysis I have not had to lengthen this judgment still further by setting it out, but it is right that I should acknowledge the immense industry and clarity that the analysis displayed.

iii) SCB submitted that he was not objective and that he was willing to assume the mantle of the advocate; that this lack of objectivity could be seen in the derogatory language he used in describing the market and the way in which he criticised transactions. I do not accept that submission and have found his approach objective and helpful, though his evidence had to be viewed in the light of his experience; whereas he had great experience of WC business, he had little experience of the PA market and none of net underwriting in the insurance market.

iv) A suggestion was made by SCB that he was not independent because he was, at the time he wrote his report and until November 2001, a non-executive director of New Line Managing Agency Ltd. This company was acquired in 1998 by Fairfax Financial Holdings Ltd. who had, in 1997, become the owners of SD. His non-executive directorship was disclosed in his report. I am sure that his evidence was not in any way affected by this (as SCB very properly accepted in their closing submissions) and that he gave evidence with complete independence.

v) It was also suggested by Mr Henton that Mr Jackson was a hypocrite because Mr Jackson had had reinsurances with low retentions and that Mr Jackson's reinsurers had suffered very considerable losses as well. I do not consider this criticism well-founded; there is a fundamental distinction between an underwriter who writes with the anticipation of a gross profit but whose account in fact turns out to be heavily loss making, and an underwriter who writes with the intention of making a gross loss and passing that loss on to his reinsurers.

182. Mr Anthony Hines (who was called by SCB) was an underwriter of long experience and distinction:

i) He had also begun his career in 1955 as a broker and had joined the underwriting box of a Lloyd's aviation syndicate in 1957. He became the deputy underwriter of that syndicate in 1969 and became the active underwriter of his own syndicate in 1977, a position which he retained until 1992.

ii) He was Chairman of, or served on, a number of market bodies; he was a member of the Council of Lloyd's from 1989-92. He was the Chairman of a major run-off company which was formed by Lloyd's and was the Director of Underwriting for a managing agency during the 1990s; in that capacity he had the responsibility for monitoring one PA syndicate.

iii) He had some experience of PA business but had not written any since 1992; he generally wrote in the middle layers and upwards. He had virtually no experience of WC or WC related business as he had only written some Texas carveout business at a high level in the late 1980s which had been profitable on a gross basis. His real experience was in aviation underwriting and the greatest experience of arbitrage which he had was in reinsurance by way of arbitrage in that market. He was, however, much more knowledgeable than Mr Jackson about the PA market, but less knowledgeable than Mr Jackson about WC business.

iv) He had reinsured his syndicate where it could be expected that, at the lower layers of the programme, there would be losses which would exceed the premium, but where it would be expected that the programme would have been profitable overall; he had also written small lines on lower layers where it would be unprofitable, but had balanced those lines with lines on higher layers which would be profitable. He had not previously written gross loss making business.

v) Although he was a witness of complete integrity and independence, I accept the submission of SD that he would not face up to the fact (and the consequences that flowed there from) that the reinsurance with which this action was concerned involved the deliberate writing of business that year in year out was certain to give rise to huge losses that had to be paid; he was not as objective as Mr Jackson and in general I preferred the views of Mr Jackson.

183. Two brokers gave evidence.
184. Sir Alan Traill (who was called by SD) was a very experienced broker:

i) He had begun his career in broking in 1956 with Morice Tozer and Beck Ltd., Lloyd's brokers, and had gained extensive experience in reinsurance. He formed his own firm in 1973 and remained with that firm after it had been taken over, until 1987. After working as a broker in another firm, he formed Colburn Traill Ltd. in association with Colburn French & Keen. In 1996, he joined First City Insurance Group and retired in 2000. He had held various offices in professional broking bodies.

ii) His experience of PA business dated from 1981; he had placed one pure PA XL programme for some years but no PA whole account treaties. He had never dealt with WC or WC carveout business.

iii) He had never placed business on anything other than on a gross basis; he was familiar with the practice of arbitrage – an underwriter writing an original risk at one rate with a view to making a profit and obtaining reinsurance at a cheaper rate, but he had never come across the practice of writing gross loss making business and passing the losses on to reinsurers. He questioned whether it was proper for any broker to handle that type of business.

iv) He was a man of complete integrity and I found him to be a witness whose evidence I accepted generally, particularly on the professional standards and duties of brokers

185. Mr Peter Greig (who was called by SCB) was an experienced aviation and PA broker:

i) He had joined Sedgwicks in 1977 as a broking clerk and had begun to carry out some broking in 1978. He joined Bain Dawes as a broker in 1982 and through the various mergers was, by 1996, the Managing Director of the Accident and Health division of Aon; from September 1999-November 2000, he was the Managing Director of the division at Aon which dealt with reinsurance including carveout. In September 2002, he joined another broking firm, Arthur J Gallagher & Co.

ii) In his report, he stated that the core of the business he dealt with was spiral and arbitrage business. His evidence was that he placed reinsurance business which was at or below burning cost; it was obvious to him that the underwriter accepting that business was not going to be retaining it and must have been passing it on to reinsurers below the burning cost in order for it to work for him.

iii) As a broker, he and his team dealt with retrocessional business placed in the PA market, particularly when at Bain Dawes; his general evidence about the operation of the PA market (including the market for the reinsurance of WC carveout) was very helpful and was accepted to be accurate in most respects.

iv) However, I regret to say that I did not find his detailed analysis of the programmes sufficiently analytical or objective as appears from the occasions on which I have referred to it in Part II; wherever his evidence and that of Sir Alan Traill conflicted in relation to standards and duties applicable to brokers, I accepted the evidence of Sir Alan Traill.

186. The task of the experts was considerably complicated by the fact that it was only during the cross-examination of Mr Henton that it became clear what EIU's detailed factual case was as to the acceptance of the programmes; this was an unfortunate consequence of EIU's lack of legal representation. This meant that each expert either had to read the transcripts of the factual evidence or had to attend many days of evidence. The burden on them was enormous.
187. It was perhaps understandable that in these circumstances, despite encouragement by counsel and solicitors and by the Court, the two underwriters who had given expert evidence had not been able to reach a degree of common ground; this only emerged in their cross-examination which lasted over several days in each case. For example, Mr Jackson, in the course of his cross-examination, accepted many of the features of the market which were set out in the report of Mr Hines and in particular accepted that there were those who had written business at a loss in a soft market and who passed those losses on to reinsurers. In the case of Mr Hines, there was similar movement; in the joint memorandum, he took the position that on the materials in respect of each programme, he could only provide an indication as to whether it was "very probable", "probable" or "possible" that the programme would make a loss or a profit; in his cross-examination, it was quite clear that he could identify the programmes which he expected would make losses on a very considerable scale. The fact that each was prepared to accept the view of the other on a number of matters during their cross-examination was no reflection on their integrity, independence or level of expertise. It was in my judgment, one of the consequences of a very long trial where much of the primary evidence emerged during the course of the trial for the reason I have given. I found that the evidence which each gave to be of great assistance and the weight that I have attached to it depended on the nature of that evidence relative to the experience of each and to its logical cogency, though I found Mr Jackson's evidence by far the more impressive and objective overall.
188. However, having seen the way in which common ground was reached in the cross-examination of the underwriters, the brokers were, with encouragement, able to reach a considerable degree of common ground and their oral evidence was completed in about a day each. I found the evidence of Sir Alan Traill of the greatest assistance in matters relating to the general practice of broking and of the standards in the market; it was clear that Mr Greig was the expert who was closest to the market; indeed, as I have observed, much of the general description of the market that was given by him was accepted. He, however, had no experience of the kind of loss ratios that were evidenced by the placement information in respect of some of the programmes, and that he had no experience of the placement of tight spirals; as I have said, in relation to the standards and duties of brokers, wherever their evidence conflicted, I preferred the evidence of Sir Alan Traill.

(5) The way in which business might be written in the market

(a) How could business be written?

189. It is convenient to begin by examining the way in which such business might be written. The trial was concerned with those that wrote a book, not a one-off contract, of this business; although the basis on which a one-off contract could be written is described (see Programme 19 – Hallmark), I am concerned with examining the writing of books of this business. Although SCB submitted that there may have been different methods of writing a book of such business, the only method which was put forward was the one which was advanced by Mr Hines.
190. It was Mr Hines' evidence that, whereas an underwriter in any part of the insurance market could engage in arbitrage to maximise his profit, he did not have to. However, in his view, no underwriter could competently write significant amounts of spiral or XL on XL business and make a profit without engaging in arbitrage; I did not understand Mr Jackson to dissent from that view.
191. Those that participated in the writing of the business aimed to come out at a profit through the careful matching of reinsurance, through the monitoring of their maximum loss to ensure that it did not exceed their vertical cover, and through a careful calculation of the rate they would receive against what they would have to pay out by way of retention, reinsurance premium and other costs. Mr Hines considered that the writing of spiral business was therefore almost a mathematical exercise with an underwriter having to calculate his inwards aggregate income and horizontal exposure with great accuracy; it involved considerable skill. That skill involved a clear understanding of the risks.

(b) The risks involved in trading in WC carveout losses

192. The risks involved in the market for trading in WC carveout losses were substantial particularly if the business had a spiral element, and were very different to those encountered when writing reinsurance business in the conventional market.

i) Opacity: The opacity or lack of transparency was a characteristic of the spiral market to which I have referred; all participants including higher layer reinsurers therefore had to arrange their participation on that assumption; it was generally not possible to find out more about the content of a spiral account other than that the reinsured or retrocedant was also writing spiral business; it was not possible to know the sum of the net retentions of the other spiral participants.

ii) A loss of any size could be anticipated: A significant feature of the business of this market was that any insurer who participated in it had to anticipate that he might receive losses of any original size from any contracts he had written. As Mr Brown accurately expressed, once an insurer had crossed the threshold and had decided to participate in the writing of this type of business, particularly if it had a spiral element, he should expect that a loss of any type or size could come from any quarter and should thus reinsure accordingly; once a person participated in XL on XL business, he had to adopt a different philosophy in order to write that type of business. As an underwriter of this business did not know the details of the business reinsured, he had to assume that each of the XL on XL risks he reinsured could be exposed to the same loss and should therefore reinsure to 100% of the aggregate exposure. This conclusion was arrived at by assuming a maximum loss on each layer and then totalling them up. He would subsequently have to keep within that limit. If he did not, he was at risk of receiving the entirety of the loss if the other participants in the spiral had cover to their maxima; he would run out of cover first.

iii) A very small percentage of spiral business had to be treated in the same way as a large percentage: The amount of spiral business that was accepted under a reinsurance did not matter; even if a reinsurer agreed to take, as part of a general programme, 1% of 0.1% spiral business written by his reinsured, the reinsurer, in turn, had to have a full reinsurance programme covering the business and had to reinsure his aggregates to 100% under that programme. Any prudent person who knew about the risks would buy reinsurance to 100% of his aggregates; Mr Hines' evidence was that there were some spiral underwriters who did not do this, but that this was not prudent in his view; I accept and agree with that evidence. In any event, the cost of reinsurance was very low at high layers. It was Mr Bird's evidence that reinsurance for the top $30m had only cost him $50,000 in 1992.

iv) The risk to high layers of working layer losses: I have already referred to this risk; it was important as regards writers of all layers of reinsurance of this business, as on whatever layer one participated, even a very high layer, a working layer loss could affect that layer because of the way in which the business was written. The fact that a participant would not know the sum of the net retentions on the layers below him meant that he would not know the size of the original loss which might penetrate that layer; he had to anticipate working layer losses.

v) Cash flow: Mr Emney had pointed out as early as October 1990 that the problems that would arise from a spiral included the financing of claims prior to the collection of recoveries from reinsurers.

vi) The delay in losses coming through: The scale of the losses would not become apparent for some time; a delay of three or more years might occur before the scale started to become apparent.

vii) The insolvency of reinsurers: As the participants were passing large known losses to their reinsurers, it was essential to have reinsurers that enjoyed the highest security rating; the consequences of a reinsurer's insolvency would be serious. Mr Brown's evidence was that this was no different in principle to a syndicate or company that leveraged on the back of their reinsurance but, in my judgment, it was different in terms of degree as in conventional insurance there was at least the prospect that the losses would not be disproportionate to the premium, whereas in this business losses on an enormous scale were being passed on often for very little premium.

viii) Avoidance by reinsurers: As reinsurers would be asked to pay very substantial losses for which they had received little premium, there was an obvious risk that reinsurers would examine whether there had been full disclosure on presentation of the contract.

ix) Continuation of reinsurance: Another consequence of the passing of large losses to reinsurers was the risk that they might not renew and that new reinsurers might be difficult to find. This could be very damaging, particularly where the risks had been accepted on a risks attaching during (RAD) basis, but the outwards reinsurance had been placed on a losses occurring during (LOD) basis. This was because if inwards reinsurance was written on an RAD basis, there would be liability for losses that occurred on policies underwritten in the year in question, even if the loss occurred in the following year; losses in the following year would not be covered by outwards reinsurance written on an LOD basis; if such outwards reinsurance was not renewed, then there would be no cover for the losses under inwards reinsurance written on an RAD basis that occurred the following year. Furthermore, if no outwards reinsurance could be found, there would still then be ongoing costs for which, unless provision had been made, there would be no income from ongoing business.

x) The business of the cedant: As Mr Greig explained, a reinsurer who provided retrocessional cover to a cedant who was writing spiral business would assume that the cedant was arbitraging the risk.

xi) Mismatch between reinsurances: In addition to these risks, an underwriter had to take into account the possibility that he might underestimate his vertical exposure and hence have insufficient vertical cover, or that there might be a mismatch between his inwards exposure and his outwards reinsurance, or that he might miscalculate the liability he retained.

(c) Mr Hines' methodology

193. As I have already set out at paragraph 171.i), it was essential that an underwriter had to plan his underwriting and that he followed that plan. Mr Hines described, in general terms, what the plan should contain – the class to be written, the level at which he planned to write, the maximum line size, his maximum vertical exposure and his horizontal exposure; where he intended to write LMX business the plan would deal with the aggregate exposure, how much had to be accepted by way of reinsurance and how much would be retained net. His view was that an underwriter could determine whether to accept a given risk only after he had prepared a plan, as he would need to see if the risk presented fits within the overall plan; only if satisfied that it fell within the plan and that the business he had written did not preclude him from accepting that risk, would he consider the merits of an individual risk and the terms and rate offered. With a plan, the underwriter would be able to decide whether to accept a given risk within a very short period of time. He expanded on the contents of a plan for business that was to be written on a net underwriting basis in his third report which was served towards the conclusion of the trial.
194. In view of the importance of this evidence to the main issues (including the issues of whether WC carveout business could properly be written on the backs of reinsurers and of whether it was possible to assess risks quickly with such a plan), he produced, at my request, a sample of a plan during the course of his evidence. As I shall mention, unless the business plan submitted by EIU to SD was regarded as such a plan, there was nothing in the voluminous documentation produced that amounted to such a written plan and no examples of plans for net underwriting were set out in any textbook or manual; Mr Hines' evidence was that it would not be common to produce such a full plan and that some underwriters might indeed not commit anything to writing, but a plan working out how the account was to be written was essential.
195. I am therefore greatly indebted to Mr Hines for producing a sample of a plan in order to show how a rational and competent underwriter might have gone about underwriting a book of gross loss making WC carveout business. Mr Hines made it very clear that his own PA book was small and comprised only a small segment of his own syndicate's account; it was very different to the business written by EIU as he had tended to write in the middle to high levels with only a small involvement at the lower layers; the book he had written was not subject to the high loss frequency of WC carveout business to which the book to be written by EIU was exposed.
196. His evidence was that it was possible to draw up a plan that a competent underwriter seeking to write the type of account Mr Henton had written might have produced; it was done by applying the principles of net underwriting to the classes of business that EIU had written. He worked on the basis that there was a preponderance of PA retro business – principally carveout and a small amount of first tier reinsurance of WC carveout business; he assumed that the account would comprise $5m of first tier reinsurance business and $17.5m of spiral business with the risk of accumulation. He assumed that:

i) it was a startup operation;

ii) the underwriter was able to obtain a reinsurance programme with unlimited reinstatements on each loss and have a retention of $5,000; and

iii) the plan was prepared in November 1996 for business to be written in 1997.

197. The plan was in two parts as the steps needed to formulate the plan for the spiral part of the account were different to those required for the part of the account in which first tier reinsurance was written. The main steps in formulating the plan for the spiral account were:

i) Framework for the inwards business: The levels at which the business would be written needed to be formulated and the aggregate exposure and anticipated premium income on each level of XL reinsurance calculated; the plan assumed that $15m of premium income would be generated by writing at levels of XL reinsurance which were under $500,000 and the balance at levels xs $500,000 and xs $1m; the total aggregate exposure would be $17.5m.

ii) Calculation of the cost of outwards reinsurance: It was necessary to have outwards reinsurance up to $17.5m; this was taken to be available at a rate of 35% with an excess point of $5,000. It was also necessary to have an aggregate stop loss (in order to protect the retention) which would take effect when the losses reached 85% of net premium income and to protect it for a further 25%. The combined cost was calculated to be $6.7m.

iii) Calculation of the maximum number of individual losses: This was a crucial calculation. Mr Hines took the figure of 2,250 which he considered generous. He based this on information provided to him by Mr Bird; Mr Bird had consulted Mr Billyard in 1991 and had been told that he had received some 1,200 spiral losses in 1991; Mr Bird had based the account he wrote in 1992 on 1,500 losses; SCB had also provided Mr Hines with information which showed the level of losses on accounts written by Mr Billyard, Mr Bird and Mr Colin Owen (referred to at paragraph 416.viii) below) in 1993-4 (which adjusted to the projected premium income of $17.5m) showing a range of 500 to 1,209. He also took into account the loss figures on one of the main programmes. I have already referred to accumulations at paragraph 175 above; it was of the greatest importance that there would be an accumulation of losses in this type of business across the book and for that reason it was essential to have regard to the book as a whole in order to make that calculation; it would not then be necessary to examine the loss frequency for an individual risk. Provided that the risk fell within the parameters of the plan, it could be assumed that the losses in respect of a particular risk, taking into account accumulation, would be within the plan as a whole.

iv) Calculation of the cost of the retentions: On the assumption that there would be 1,500-2,250 individual losses, the cost of the retained losses at $5,000 per loss would be $7.5m-$11.25m; the aggregate stop loss would operate to reduce this by up to $2.15m. The maximum loss would therefore be $9.1m.

v) The calculation of the net profit: The gross profit would be $17.5m less $6.7m (cost of outwards reinsurance), less cost of the retentions of $7.5m-$9.1m, less expenses of $1.125m, leaving a net profit of between $580,000 and $2.18m.

198. A similar process would be carried out in respect of the first tier reinsurance account. The essential difference was the calculation of retained losses. Mr Hines considered that this could be calculated as follows:

i) There was available a very large amount of data relating to WC business which was equally applicable to WC carveout. Claims in WC business were relatively frequent and predictable; in alternative WC there was the prospect that there might be a reduced frequency. This was because SCB would sometimes offer alternative WC business to large companies, suggesting a high self-insured retention, a safety inspection programme, drugs testing and other measures to change the loss record and to reduce the frequency of claims.

ii) From the data relating to WC business it was possible to calculate the number of losses that might have to be paid either from the ground up (FGU) or from a specific attachment point.

iii) It was possible, on the basis of the data, to produce estimates for workers in a particular State or a particular occupation (hazard group); it was very important to be able to take into account the different loss frequencies from industry to industry.

iv) Using this information the underwriter could plan the business he wanted to write; if, as anticipated, he planned to write XL contracts or QS contracts within the first $1m and retain only $5,000 (under the outwards reinsurance programme discussed), he could calculate the number of retained losses and use this as a benchmark; Mr Hines appended a calculation showing how the information was used to calculate the number of retained losses.

v) The vertical aggregate exposure would also have to be calculated but would be less than for the spiral book.

vi) Mr Hines calculated that the direct book might make a profit of $950,000 on a premium income of $5m.

199. The next crucial step in Mr Hines' methodology was the underwriting and monitoring in accordance with the underwriting plan:

i) When each risk was presented the underwriter would assess it against his plan; for example, if it was a first tier reinsurance, the underwriter would check and see how the business measured against the State or hazard group benchmark set out in the plan. If it was worse than the benchmark or if the premium income was too much, he could reject it quickly.

ii) If the risk was to be written under the spiral account, the underwriter would assess whether the risk fell within the plan, measured against matters such as the premium income, rate, layers and aggregate exposure; because of the probability of accumulation, he would not be concerned with loss frequency; if there was information about loss frequency he could cross check that against his estimate for the number of retained losses across the book as a whole.

iii) He would only be concerned to monitor, in general, the level of the gross loss which he would be passing on to his reinsurers; the competent net underwriter would be concerned to seek to minimise the losses he passed to his reinsurers as the sustainability of the business depended upon there being a market for reinsurance; the best way to achieve that was to write business that was not significantly gross loss making to the reinsurers. However, he would not be concerned with it in the same way as would a conventional underwriter seeking to ascertain what premium to charge in order to cover the gross losses.

iv) He would enter each risk into a "day book" or spreadsheet so that he could quickly ascertain the state of his account on a day-by-day basis.

200. I accept that the methodology set out by Mr Hines was one that could be applied to the net underwriting of a book of business and that there were underwriters in the insurance market who approached net underwriting on such a mathematical basis. In principle it was not very different from the approach to the net underwriting of an individual risk, as what the underwriter was seeking to do was to be sure that the premium income he received was sufficient to pay for his expenses, the cost of outwards reinsurance and the retained losses (see paragraph 209). The crucial assumptions related to (1) the calculation of the number of losses, (2) the expenses, and (3) the price and availability of outwards reinsurance.

(d) The need for sustainable outwards reinsurance

201. Such underwriting depended on the availability of outwards reinsurance. It was Mr Hines' evidence that if losses of the magnitude generated by WC carveout business written on the scale at which EIU wrote were to be transferred to outwards reinsurers, there would be major problems in renewing the outwards reinsurance programme.
202. It was indeed obvious, assuming the plan to be workable, that the underwriting could not be carried out for more than a very short time as outwards reinsurance would cease to be available given the scale of the losses transferred in WC carveout business. I am sure that it was an unsustainable method of doing business for more than the very short term.

(e) What was shown by the plan

203. The figures in the underwriting plan were produced net of brokerage as this was the way in which Mr Hines as a Lloyd's underwriter would have prepared the plan; although brokerage of 15% would have been in the order of $3m and the premium income would have therefore been greater by this amount, I do not consider that it mattered that the plan was prepared on this basis, as long as the loss ratios and all the other figures took this into account, as they did.
204. As I have mentioned, Mr Hines had no experience at all of producing a plan for a high frequency of loss; as he accepted, loss frequency was one of the crucial components of the plan and it was more difficult to assess where the loss frequency was high.
205. I am quite satisfied that the plan demonstrated that WC carveout and related business could not be written rationally or prudently if the methodology in the plan was applied to the assumptions that had to be made in the market in 1997 – this is no criticism of Mr Hines. He had to proceed on the assumptions provided to him and he could not give evidence about those assumptions; it was his methodology that was important. The assumptions critical to the plan were issues of fact that were to be determined on the evidence:

i) An XL reinsurance programme with unlimited reinstatements was assumed to be available at a premium of 35%; Mr Hines made that assumption after discussion with Mr Butler; it appears that the rate was one based on the reinsurance programmes that were placed for Lincoln and the other participants in the spiral for 1996. As I set out at paragraph 746, there was no market at all which would have provided reinsurance of spiral or retro business for 1997.

ii) The retention was assumed to be $5,000; by the end of 1996 I am sure that if any reinsurance had been available the retention for such retro or spiral business would have been $10,000, as that was the figure at which Mr Billyard and others had obtained reinsurance for 1997. If that figure had been used, then the plan, as Mr Hines accepted, would probably have "been blown out of the water", unless the actual loss figures sustained by SD were applied and then only if the losses in 1997 were taken into account and not the later losses attributable to the underwriting in 1997 which were covered by the plan (which would not be correct for the reasons set out below).

iii) There was no allowance for the cash flow costs of funding the claims whilst they moved around the spiral; as Mr Hines' plan took credit for all the premium in the first year, then all the cash flow costs would have to be set against that premium to determine the sustainability of the plan. It was obvious that such costs were a major consideration and, for the reasons given at paragraph 191.v) and at paragraphs 503 and following, that was known to those who wrote carveout business by the end of 1996. It was obvious, as Mr Hines accepted, that these costs would have to be brought into account, though by oversight he had not done so. US prime rate between 1994 and 1999 was at least 8%. As it would have to be anticipated that gross losses at least in the order of tens of millions of dollars would have to be financed, the figures are of such magnitude that this alone would have made untenable any attempt to underwrite spiral business on the backs of reinsurers.

iv) The plan showed the profit at the end of the first year based on the whole of the premium being taken into account against only the losses in the first year. It did not bring into account losses that would occur in the second and third years on reinsurances written in the first year; there were bound to be such losses especially in respect of the many contracts that were written on an RAD basis. Thus although the whole of the premium had been brought into account for the first year, the losses had not been. Mr Hines accepted that losses in subsequent years had to be brought into account if credit was to be taken for the whole premium in the first year. However, once the whole of the losses that would occur (including those that would occur after the end of the year) were brought into account against the whole of the premium, it was clear that the plan was unsustainable. To illustrate this, SD first took the losses that had occurred under programmes written in 1997; it could be seen that of the 5,308 individual losses (after taking into account accumulation within programmes) which occurred on programmes written in 1997, 1,624 occurred in 1997, 1,672 occurred in 1998, 1,931 occurred in 1999, 77 occurred in 2000 and four occurred in 2001. However, to give a fairer picture of the impact (because of the effect of accumulation between programmes and between the years), they took all the business written by Mr Henton in 1997 and 1998 and accumulated the losses that had occurred; this was done as a loss on a programme written in 1997 could also be a loss on a programme written in 1998, given the fact that a number of contracts written in 1997 were on an RAD basis and/or commenced on 1 October 1997; this showed that there were 1,169 losses in 1997, 2,807 losses in 1998, 2,007 losses in 1999, 93 losses in 2000 and three losses in 2001.

v) SCB submitted that a net underwriter would prepare a plan on a current year or on a going concern basis; he plainly would, but if the calculations were done for a second and third year and the years looked on as a whole, exactly the same conclusions would result.

206. SD submitted that an examination of the plan showed that "the dark art of net underwriting is an illusion".
207. I am greatly indebted to Mr Hines for having produced the plan; I am sure that the plan demonstrated that such business was unwriteable in the years with which I am concerned – 1997 and 1998. Had any such plan been prepared by any of those engaged in this market, whether in writing or not, then any plan prepared honestly would have demonstrated that the prospect of making a profit was illusory in the market conditions as they prevailed in 1997 and 1998.
208. The underwriting plan produced was of course only Mr Hines' methodology. It was suggested that other underwriters might have had different methodologies; however, there was no evidence of any other possible methodology and I am sure there was no other methodology which did not follow the same basic principles.

(6) The evidence as to what happened in practice

(a) The evidence of Mr Crane

209. The account of underwriting WC carveout business as a first tier reinsurer, given by Mr Ian Crane, an experienced Lloyd's underwriter whose experience is referred to at paragraph 563 of Part II, in effect represented a conventional underwriting approach, though he referred to it as doing the mathematics. Mr Crane's evidence (as referred to in more detail at paragraph 512 of Part II) was that the one risk which he wrote on a net underwriting basis (Programme 19 – Hallmark) was very much the exception to his general intention of writing for a gross profit; writing gross loss making business entailed greater risks for his Names. I have accepted his evidence that that was a one-off transaction, though I have concluded (as set out at paragraph 561 of Part II) that his conduct in relation to it was well below the standards to be expected of a Lloyd's underwriter. He would not want details of the individual risks bound, but would want statistics (which varied in quality), and triangulations sometimes if the account was old enough for them to be of value. Many of the books of business were too new for triangulations to be of value; furthermore the income fluctuated often and in such cases one had to look carefully at each year. With such books of business, he took into account the fact that the accounts had a five year life, looked at the losses and the development on each of the years, and applied his experience to see how the years would develop. He would do a fairly careful mathematical calculation to see whether he should write the risk and if so, at what rate.
210. However (as explained in more detail at paragraphs 508 and following of Part II), in the contract he had written on a net basis, he had carried out a calculation similar to the calculation carried out by SCB which set out the premium he would receive, the cost of the outwards reinsurance which protected his participation on an XL and an aggregate stop loss, and how many retained losses there would have to be before there was a net loss. The calculation showed that the retained losses would have to exceed the sum of the retained losses over the previous four years by a considerable margin before he made a loss and that a profit was therefore likely. As referred to at paragraph 199, this approach to a one-off contract was not, in principle, different from the mathematical approach of Mr Hines to the writing of a book but was feasible as there was sufficient certainty of information for such a calculation to be done in a one-off contract, though no allowance was made for expenses and interest.

(b) The information generally provided

211. Although those underwriting such business on a conventional basis needed at least the type of information described by Mr Crane, in most of the programmes considered in this action and accepted, according to Mr Henton, on a net underwriting basis, the information supplied was merely limited to the following:

i) The slip for the proposed reinsurance and that for the previous year, if the presentation was for a renewal.

ii) An information sheet or questionnaire; each broking firm had their own and the information that was supplied varied; some brokers had very full questionnaires (see, for example, Programme 22 (Syndicate 53) at paragraph 573 of Part II). Some cedants did not use questionnaires but supplied their own information. The questionnaires used by SCB and WFD usually gave:

a) the estimated premium income;

b) the breakdown of the account to be reinsured; and

c) the line structure.

iii) The loss record; this usually gave the premiums and losses in previous years. If it was a renewal for 1 January, the figures were usually as at the second quarter of the year. Sometimes further information was provided or was available which showed the number of losses (see, for example, Programme 3 (American Reliable) at paragraph 83 v) of Part II, Programme 18 (Clarendon "direct") at paragraph 485 of Part II and Programme 21 (Venton) at paragraphs 682 and 683 of Part II).

iv) The quote sheet for the programme (if available).

v) Any other information supplied by the reinsured; sometimes there was none.

212. Mr Brown's evidence was that the information provided was limited to what I have set out and that it was standard practice that business was placed in this market on the basis of such information; this was the same in 1997 and 1998 as it had been in earlier years and it was the same for all brokers. Cedants did not give details of underlying accounts as net underwriting was a financial transaction rather than an assessment of the original risk. Some asked for financial details of the reinsured, others did not. In addition, SCB took with them the broking pack containing information on the prior years of the programme being broked, as well as the prior years' slips; they also summarised the relevant information about the programme that was to be written. Mr Butler's evidence was to the same effect – see for example paragraph 484 of Part II.
213. SCB did not usually supply in this market:

i) triangulations;

ii) information about the underlying business (such as the type of business or its geographic location), unless it was available; and

iii) information about the individual account and rating details, or information as to how the inwards reinsurance being presented fitted into the overall reinsurance programme of their client.

Their evidence was that this was standard practice in the market (see for example the evidence set out in Part II at paragraphs 35(vi) and 484).

214. It was the evidence of Mr Butler and Mr Brown that if an underwriter wanted more information he only had to ask.
215. It was Mr Greig's evidence, which I accept, that in the spiral market for WC carveout, the information provided about the spiral part of the account was confined to: the fact that it was spiral business, the size of the account and the loss record; for the reasons explained, the cedant had no other information. The lack of information was not a difficulty because the insurer accepting such business was only doing so on the grounds that he was relying on his comprehensive outwards reinsurance programme.

(c) The standard considerations when business was accepted

216. It was quite clear on the evidence that there were those in this market who would knowingly accept business where the loss ratios were many hundreds of percent.

i) Mr Brown's evidence was that some reinsurers accepted business where the loss ratio was running at several thousand percent in previous years; he did not know if there was any business that was too bad to write. It was possible to place business which had experienced bad loss ratios year after year.

ii) Mr Butler's evidence was that a gross loss ratio of 1,000% was not uncommon; he was not surprised at the level of gross losses that had occurred on the programmes that had been written by SD; for many contracts, loss ratios of several hundred percent or a thousand percent could be anticipated; a loss of $20m on a low layer would not be surprising, but he was surprised at the loss of over $71m that has in fact occurred on Programme 3 (American Reliable) as he had never seen a loss of that magnitude in one year on one low level XL contract. He would not have been surprised that there would be gross losses of tens of millions of dollars on the entire programme written by SD, as the market worked on that basis.

iii) Mr Johnson's evidence was that he could have anticipated loss ratios in the hundreds percent, but not the thousands.

217. On the evidence as it emerged from those who actually wrote and placed the reinsurance of WC carveout and related business in this market, the principal considerations that were taken into account when contracts of this kind were being considered were as follows:

i) The business was usually gross loss making at the working layers and high loss ratios on a gross basis could be anticipated. Where spiral business was included, loss ratios in the order of some hundreds of percent could be anticipated.

ii) The size of the anticipated losses did not mean that the risks were unplaceable; if participants were writing on an arbitrage basis, the scale of the gross loss did not matter as they would be looking to their outwards reinsurers to pay.

iii) The underwriter would carry out an assessment as underwriters did reject some risks. An underwriter would normally be concerned about loss frequency, as he wished to be sure that the premium received was enough to pay the retentions on each loss as well as the cost of outwards reinsurance, though he would look at the book as a whole because of accumulations. He would also want to know the effect on his aggregates to ensure that the anticipated losses could be covered within it.

iv) Up to 1995 or 1996, the cost of the reinsurance xs $10,000 could typically be obtained for 25% of the premium as there was a market that could be found to write at this level.

v) The underwriter also had to allow for brokerage and commissions; in the market, the brokerage was 10% or 15% on each XL contract; on direct business, the acquisition costs were generally at least in the order of 35%-40% and sometimes up to 50%. It was important to take into account the effect of the deductions on the premium income as it might convert business which was profitable in the underlying scheme into unprofitable business – see, for example, Programme 14 (MELEX) at paragraphs 308 and following of Part II, and Programme 17 (Clarendon Temps) at paragraphs 459 and 465 of Part II.

vi) The relevant premium needed to pay the cost of the retentions and outwards reinsurance (where the underwriter was an agent) was the net premium received by the principal. In the case of SD, it was the net amount after brokerage on the programme, the fee to EIU and the commission to HHI had been paid.

218. There were further matters that an underwriter had to take into account when he wrote WC carveout business in a spiral, to which I have already referred.

(d) The crucial role of the broker in putting the retro in place first

219. It is clear that the broker played a crucial role in this market.
220. There was evidence to which I refer at paragraph 1079 and which I accept, that the broker generally first put in place for the reinsurer he wished to use, an outwards retrocession for the inwards reinsurances he wished to place with that reinsurer, on the understanding that that reinsurer would then write the inwards reinsurance of that broker's clients, as those inwards reinsurances would then use up the outwards retrocession programme and its aggregates. That reinsurer could write the business of other brokers provided it did not aggregate with the business of the broker who had placed the outwards reinsurance. The business that would aggregate and therefore be exclusively written to the broker would be that which was hardest to place – international XL business and all retro or spiral business.
221. With such a facility in place the brokers were in a position to drive the market, as I have no doubt they did, as it enabled them to earn so much brokerage. In the case of SCB, it enabled them to further the competitive position of their US business and to render certain the prospect of earning the fees that they earned at each stage of the process – see the diagram at paragraph 361.

(7) The tail of WC carveout and alternative WC business

222. There was one other important feature of the business that I must examine before expressing my conclusions. A very important consideration for any underwriter is the period of time which has to elapse before the ultimate loss position can be predicted with a degree of reliability. If the ultimate loss position can be ascertained quickly, the underwriter does not have to maintain reserves and can ascertain his profit; this type of business is classified as 'short tail'; if the ultimate loss position is not likely to be ascertained for some time, reserves have to be maintained and the business is classified as 'long tail'.

(a) Long or short tail?

223. There was a dispute as to whether WC carveout and alternative WC business (which typically excluded WCA Section B business) was to be regarded as short tail business, medium tail business or as having the characteristics of long tail business.
224. There was a conflict of evidence given by those in the market:

i) Mr Jackson's view was that WC business was very long tail business; that the carveout of employers' liability under Section B of WC policies and occupational disease made no difference to the tail of the business. Mr Whitcombe agreed (with the benefit of the knowledge he had by the time of the trial) with Mr Jackson's view, but he did not do so at the time as he did not understand the business and had relied on the Lloyd's classification instead.

ii) Mr Hines considered that carveout business was medium tail (if it had sunset or commutation provisions) and that it would then be equivalent to PA business if the carveout excluded employers' liability.

iii) Mr Crane (who had begun to write WC carveout business at Syndicate 53 in the late 1980s, and who became the leader of the SCB lineslip when Mr Billyard left Lloyd's) said that it was both short tail and long tail – it had its own classification.

iv) Mr Bird's evidence was that at the time they were working on the DTI submission/business plan (see paragraphs 467 and following) in 1993/4, the average sunset clause and commutation period was three years, but that it gradually moved to five or seven years; it was thus accurate at that time to describe it as short tail. By 1995, the period was five years and in 1996 it moved to seven years. It then moved to nine years.

225. In considering these views, it is important to have regard to two matters:

i) The Reinsurance Association of America (a trade organisation of reinsurers and reinsurance brokers in the US, whose members write over 75% of the reinsurance coverage provided by US reinsurance companies and its affiliates) provided a biennial study on historical loss development for WC business; a graph showed losses for primary insurers growing for seven years, but then tailing off and reaching 90% in 31 years; for reinsurers, losses still grew after ten years.

ii) During the material time, the period for which sunset or commutation clauses were given became longer; by 1997, the period had become five or seven years; a fax from Mr Billyard on 11 February 1998 noted that the trend was six or seven years when asked to include a five year commutation clause in the contract with WEB Management LLC (WEB) on Programme 12 (JEH Re "direct").

(b) The views of Lloyd's underwriters on the position prior to 1994

226. Lloyd's had audit codes for the purpose of classifying various categories of business. The usual practice was for the leader to classify the business by marking the slip with the code. WC and employers' liability was classified at Lloyd's as long tail and was coded 'WC'. Traditional PA and sickness business was classified as short tail and was coded 'K'.
227. Those underwriters who reinsured carveout and alternative WC business considered that carveout should not be classified as 'WC' as it had no liability component, but should instead be coded 'K', which was the code for PA business. This was, on the evidence before me, apparently accepted by several Lloyd's auditors and by the regulatory authorities at Lloyd's.
228. At the end of 1991, there was a dispute as to whether EEII business should be treated as PA and coded 'K'. One of those who participated in this market, Mr Owen (see paragraph 416.viii)), did not agree that it should be and would not treat it as PA business for the purposes of reinsurance. A slip was taken round the market by Mr Brown and there was general agreement that it could be coded 'K'; alternative WC business was therefore also treated in the same way as WC carveout.

(c) The classification imposed by Lloyd's for 1995

229. In September 1994, Lloyd's announced changes to the audit codes for the 1995 year of account; Mr Crane sat on the committee that dealt with the problem that had arisen because there were several classes of business that were coded as if for PA but which patently were not ordinary PA. His evidence was that at the time, Lloyd's wanted to ascertain the amount of XL business being transacted and wanted to bring that under control; the committee came to the view that about six separate codes were needed for business that was not ordinary PA. The recommendation was put to the Lloyd's Policy Signing Office (LPSO) and the Council of Lloyd's and they agreed, as he understood that they had wanted tighter controls.
230. On 29 September 1994, new codes were issued for the 1995 year of account which gave the designation 'KA' for "Personal Accident and Health Carve out". It defined PA carveout as follows:

"This classification to be used for the provision of PA Benefits where a pre-determined sum is payable for stated benefits which are also limited by time (e.g. 52 weeks) and are carved out of any legal liability policy.

This classification cannot be used for any business which includes any form of legal liability either directly or indirectly where the amount of loss payable may be subject to a court award or negotiated settlement."

This change was referred to in Feasey v Sun Life Assurance Company of Canada [2002] EWHC 868 (Comm) where Langley J pointed out that the advantage of classification as PA meant that the business did not require the provision of substantial reserves.

231. I have no doubt but that the vast bulk of the WC carveout and alternative WC business which formed the subject of this action did not fall within the definition of business that could be classified as 'KA', as the benefits under it were not a pre-determined sum and were not limited by time; future liabilities could be commuted but that was merely an acceleration, not a limit in time.

(d) The practice in 1995 and after

232. Lloyd's only had short tail and long tail classifications.
233. It was the evidence of Mr Crane that:

i) As WC carveout business was not long tail business, Lloyd's called it short tail as it suited them to simplify it in that way. This was not for audit purposes but for some other purpose which he was unable to identify. He did not know why Lloyd's treated it as such.

ii) The auditors did not treat it as short tail but sui generis – not quite as long tail as liability business; no competent underwriter would treat it as short tail.

iii) In his experience, this type of business peaked at 10 years and after 12 years, it came back to where it was at eight years. One had a reasonable idea of the future at about five years, as the development was miniscule between five and eight years; until five years the development could be volatile, partly because a lot of the business was treaty business and was not necessarily administered efficiently.

iv) The business was not classified as long tail as it had a finite life because of the sunset and commutation clauses.

234. Even after the 1994 change to which I have referred, it is clear that those writing WC carveout classified the business under code 'KA'. For example, the SCB lineslip was classified as 'KA' by many Lloyd's underwriters; many brokers placed business to it. The same was true of all the programmes which are the subject of this action – they were coded 'K' or one of the 'K' equivalents. I therefore accept the evidence of Mr Greig that it was assumed by reasonably competent brokers that WC carveout business could be treated as short tail, unjustifiable and wrong though this in fact was.

(e) The effect of the spiral on the tail

235. The effect of the spiral was to extend the period in which claims might be made for very many years. The question therefore arose as to the extent that this had been taken into account in determining whether the business was short or long tail.
236. Mr Crane thought that this had been considered when designating the 'KL' code for PA LMX business; it was thought that claims would pass through the spiral quickly, though this was because most on the committee (referred to at paragraph 228 above) wrote low level business and that spiralled very quickly. Although a spiral could take 25 years as most XL business is accounted for on a quarterly basis, within Lloyd's most were already out well before then as the reinsurances were written low down and all their layers had by then been exhausted.
237. Mr Brown's evidence was that non-marine losses for the 1980s were, at the time of the trial, still in a spiral and it was the evidence that the spiral for WC carveout business might take 25 years to produce the loss to the person who would ultimately bear it.
238. It was clear from the conclusions of the Lyons working party (to which I have referred at paragraph 171.vii)) that it was well understood in Lloyd's that spiral business was not short tail business; it was not clear whether this had been covered in the audit requirements.

(f) Conclusion

239. Although there can be no doubt that WC carveout and alternative WC business was in fact not short tail and that the business could be very long tail where a spiral was involved, it was nonetheless coded in the market with codes that were apposite to short tail business.
240. This practice was fundamentally wrong and was the result of a failure to take account of the true nature of the business and the impact of the spiral, well known though these were. Whether that failure was brought about by turning a blind eye to the issue or was due to mere incompetence is not a matter for me to determine. All that it is necessary for me to decide was that the business was not short tail, but that many in the market acted as if it was.

(8) An analysis of the business of the market

(a) The common ground

241. I have already described the PA market (including the market for WC carveout), but before setting out my conclusions, it is necessary to set out the principal matters which were common ground between the experts:

i) It was almost inevitable that there would be a spiral content in the retrocessional business in the PA market.

ii) In the years up to 1998, the working layers of PA reinsurance and retrocessional business (whether spiral or non-spiral) were consistently loss making.

iii) Business could only be written profitably in spiral and working layer reinsurance on the basis that a reinsurer would have its own outwards reinsurance programme which made it possible to write business that was likely to be loss making; such business became more unprofitable as it went down the chain. That would be well known to the brokers and reinsurers trading in the London market.

iv) Those in the market were making a profit by trading losses on the differential in rates and in that sense arbitraging.

v) If full disclosure was made, it did not matter what the incurred loss ratio was; such business could be honestly ceded by a reinsured.

vi) Heavy losses were inevitable each year and had to be paid by someone.

242. There was some discussion as to whether the aviation market also traded in losses in the same way. Between 1990 and 2001, there were only three years in which original gross premiums in aviation business exceeded claims industry wide; each year a competent underwriter would expect, from airline statistics, that there was a likelihood that he would be writing a gross loss making account. It was to be anticipated that there would be just over 20 or so major hull losses each year and these losses were passed on to reinsurers. There was certainty as to loss, but uncertainty as to where it would fall; those writing in that market could not therefore expect to avoid exposure to loss very often. Mr Hines seemed to suggest, when cross-examined by Mr Henton, that one of the syndicates whose aviation accounts he had reviewed in 2001 was deliberately writing gross loss making business on the backs of reinsurers; it was therefore submitted that the aviation market operated in the same way as the market for WC carveout business. On a careful analysis of Mr Hines' evidence, he did not go that far but seemed to be saying that the whole book in an aviation account might be expected to make a gross loss in most years, though in some years it would be profitable; although there might be a given number of losses each year, it was not possible to know where they would fall and some accounts would therefore be profitable and some would be loss making. It would therefore seem that the aviation market is different to the market with which I am concerned; certainly the level and frequency of claims are very different and I am not persuaded that the markets are the same. In any event I have not had any depth of evidence about the aviation market and will express no view on it. If it did operate in the same way as the market for WC carveout business, then all it would demonstrate is that the practices in the WC market were replicated elsewhere but that, on the analysis I have adopted, makes no real difference.

(b) The position of those who were not parties to this action

243. As I shall explain in more detail, it was SD's case that those engaged in this market by deliberately accepting loss making business on the backs of their reinsurers were engaged in a racket that involved dumping inevitable normal losses on innocent capital providers and innocent reinsurers who were not aware of the true nature of the business they were accepting. In their final submissions, they made it clear, in the light of the convergence of the expert evidence, that if a cedant or a broker disclosed the nature of the business it was not in itself improper to cede gross loss making business.
244. It is therefore important for me to emphasise, in the light of these allegations that:

i) Mr Greig's evidence (which I accept) was that a retrocessional market for WC carveout business was in existence from the mid-1980s. He named in his report, a number of insurers who were amongst those prepared to accept WC carveout business on a retrocessional basis; they were Mr Cackett (at Syndicate 957 and Centaur Underwriting Ltd. (Centaur)), Mr Billyard (at Syndicate 398, Duncanson & Holt and JEH Re), Mr Owen (at Syndicate 718), American Reliable Insurance Company (American Reliable), New Cap Re, Lincoln National, Gan Minster (Gan), SRRF, Clarendon Insurance Group (per Raydon), Phoenix Home Life Mutual Insurance Company (Phoenix) (referred to at paragraph 424.i)), and SD (per EIU). Each of these entities features in the factual account that follows, as writers of retrocessional WC carveout business, where their roles in the matters which form the subject of this trial are explained. However, I must make clear (as I made clear throughout the trial) that I have not made any determination of their state of knowledge or of the honesty or competence of their conduct, save in relation to specific issues which are relevant to the trial and then only in circumstances where I consider it fair to do so.

ii) Mr Greig also listed the brokers who placed such retrocessional business as including WFD, Crawley Warren, Aon and Rattner Mackenzie, in addition to SCB. It is clear that each of these did place such business, but I have treated each of these in the same way as I have treated those who wrote retrocessional business.

iii) Many of those who participated in the market did so through agents; although at one stage it was suggested by SD in a proposed amendment that none of the providers of capital of the participants in this business had knowingly participated in this market and that SCB knew that; I made it clear that it was inappropriate for the Court to determine the position of persons who were not direct parties to the dispute. It is not for me to determine whether any of the principals or capital providers of those agents were or were not misled as to the true nature of the business, save SD.

iv) There were a number of companies who participated at high layers of reinsurance placed in this market that sustained working layer losses as a result of the spiral; it is again not for me to determine why any particular reinsurer did so or whether any particular reinsurer was misled.

v) There were underwriters who deliberately wrote gross loss making business; it was not suggested by SD that if such an underwriter ceded such business he was acting wrongly unless dishonest knowledge could be shown. Again I am not concerned with determining whether any particular underwriter had acted in that way, save for those who were directly concerned with the action before me.

245. My sole task is to consider the submissions made by SD in so far as it is necessary for me to determine the dispute between SD, EIU and SCB. Inevitably, however, this has led me to consider the general issues relating to this market.

(c) "Pass the parcel" or "Russian roulette by proxy"

246. It was inevitable in this market that although the effect of the spiral was to inflate losses, there were still enormous real losses that had to be paid:

i) Losses had to be paid year in, year out, as WC was the kind of business where losses were inevitable year in, year out.

ii) The losses were passed down the chain for an ever decreasing amount of premium.

247. The losses had to be paid.

i) Mr Bird's evidence was that he did not know who paid the losses in the end, but it would be, he thought, a company prepared to absorb the losses and to "take it on the nose". He did not concern himself with that, provided that he was protected.

ii) Nor did Mr Brown know, but that was the case with many catastrophes.

iii) Mr Butler's evidence was that he did not know where the losses would go; he did not know if they were spread (as often happened in the reinsurance market) or whether the spiral concentrated them as he had no way of knowing the extent of the spiral.

iv) Mr Whitcombe did not know how the losses were dissipated; they had to be paid by someone.

248. SCB submitted that the losses were dissipated through the operation of the reinsurance; losses that entered a spiral were paid either by the retentions at the bottom, or in the course of the spiral, or when the loss reached the top because a person had insufficient outwards reinsurance.
249. I am satisfied, in relation to the business I have examined, that that did not happen because the retentions were too small; the structure of the outwards reinsurances and the spiral concentrated the losses on certain insurers rather than dissipating them.
250. As Mr Hines emphasised in his evidence, it was essential for any participant to pass the loss away from him; it was therefore inevitable, as the losses had to be paid, for the losses to end up with someone who in fact "had got it wrong" by not having adequate outwards reinsurance that would pass the loss on to someone else.
251. In the result, as was accepted by Mr Hines, the business conducted in the market for WC carveout was like a game of "pass the parcel" or "Russian roulette by proxy" with the losses likely to end up with a capital provider who had received virtually no premium; those who played the game did so in the belief that "when the trigger was pulled" they had adequately protected their capital provider through outwards reinsurance. Although in Mr Hines' view it was not a lottery, he accepted that the losses had to end up with someone and had to be paid by that person.
252. Mr Whitcombe also accepted that it was like a game of "pass the parcel" or "Russian roulette with most of the barrels loaded"; whoever was left holding the parcel faced ruin or would try and avoid paying.

(d) The issue

253. How did the losses fall upon those who ended up with them?
254. SD contended that the losses ended up with such persons because the market was a dishonest scheme or racket:

i) The market was not economically sustainable as the losses were so vast. The loss ratios (which were entirely predictable) ran into hundreds of percent, demonstrating that the difference between premium and losses was so great that the business was uninsurable.

ii) No one who knew what was happening in the market would want to retain any part of the risk beyond that to be covered by the retained premium. They would pass on the loss to the next reinsurer at even less premium and the process would continue until the losses were eventually dumped on some reinsurer for virtually no premium. It was inevitable that passing losses to reinsurers on this scale would lead to reinsurers leaving the market or becoming insolvent.

iii) No rational person would ever knowingly take on such losses; the market operated to dump these losses on someone who did not know the true nature of the business.

iv) The market was only sustainable because the knowing participants were able to cheat the ignorant through the mechanism of passing the losses to them, particularly through the spiral.

v) Those "in the know" took steps to make sure the losses did not end up with them and passed on the losses to innocent victims – either providers of capital who had given an agency to a knowing participant who then wrote the business, or to other insurers who had become reinsurers without appreciating the true nature of the business.

vi) The spirals were deliberately created to move the loss to those who did not appreciate what they were accepting; it was akin to the creation of a false market.

vii) The spiral had a further advantage in that it deferred the losses for many years; when the losses eventually had to be paid by someone who could not recover from a reinsurer, there would have been such a lapse in time that those who had set the spiral up would no longer be around and so would not have to account for their actions.

viii) They contended that the primary motivation for SCB's participation in the business from 1992 onwards was to enable them to provide cheap reinsurance in order to be more competitive in the WC market in the US, and to enable them to earn the considerable commissions that were provided through the placement of the reinsurances.

ix) It was dishonest to accept business which was known to be loss making with the intention of ceding it to reinsurers if the ceding underwriter knew that the reinsurer was cheating his capacity or was participating in a dishonest scheme.

255. It was contended by SCB and EIU that this market was no different from any other:

i) There were several instances where underwriters in the insurance and reinsurance market accepted business which they knew would make gross losses; there was also the recognised practice of arbitrage in the insurance market to which I have referred; the business of this particular part of the reinsurance market was no different to other business which was placed in the reinsurance market.

ii) Those who participated in writing gross loss making business in this market were doing no more than participating in ordinary market practices; they did so because they perceived a commercial advantage in doing so.

iii) As in any market, the losses which were not dissipated might fall on those who were outsmarted by others in the market.

iv) By 1998, this way of doing business had been in successful operation for at least 10-12 years.

256. The role of the spirals was also crucial:

i) It was SCB's case that:

a) these were accidental;

b) all the participants were aware of the nature of the business;

c) the position could alter dramatically if a new reinsurance was interposed; and

d) a break in the chain would break the spiral.

ii) SD accepted that spirals could occur as an ordinary incident of trading in some markets. Furthermore, it was the natural effect of a spiral that it would bring about delay and inflate claims so that comparatively small claims would hit the higher layers in due course. However, SD's case was that:

a) The spirals were deliberate and their purpose was to funnel losses to those in the higher layers who thought that they were reinsuring catastrophe risks and not working layer losses.

b) The whole structure was a pack of cards with the spiral being used to delay its collapse; as each tier of reinsurance was taking much more out by way of premium than could be passed on to pay for the losses transferred to the reinsurer, a spiral had to be used to delay the inevitable implosion.

257. It is first necessary to consider the circumstances in which it was not in dispute that arbitrage and loss making business could be written in the reinsurance market viewed as a whole.

(e) Innovative markets and legitimate business

258. SD did not contend that any broker or underwriter who ceded business that was bound to make a loss to a reinsurer was dishonest. There were reasons why an underwriter might write business that was bound to make a loss; examples were:

i) loss leaders to maintain market share;

ii) acceptances to maintain relations with a producer or broker in the expectation of receiving good business; and

iii) carrying on business in a soft market so that advantage could be taken of a hard market when the underwriting cycle changed.

Provided that there was full disclosure and compliance with the continuing duties of good faith and reasonable care owed to the reinsurer, there could be no complaint in such cases; it was up to the reinsurer who knew the full facts to decide whether he wanted to reinsure such business. In any event, accepting loss making business in these circumstances was entirely consistent with a market where the ultimate objective was to write for a profit.

259. SD also accepted that arbitrage was acceptable in the reinsurance market where there was significant uncertainty as for example existed in the catastrophe market. An underwriter would often take on the risk of a catastrophe in the expectation that it might not happen and that he would therein make a profit, but if it did happen, he had so arranged his outwards reinsurance that he would not have to bear any of the loss. There have been a number of distinguished underwriters who have written with the expectation of making an underwriting profit but who, through skilful use of outwards reinsurance, have ensured a profit even if there was no underwriting profit.
260. The insurance market in London has always been innovative. The fact that a new way of doing business emerges is part of the evolution of that market. Thus an extension of arbitrage or the practice of writing gross loss making business might be quite unexceptional.

(f) A development of a legitimate practice?

261. However, SD contended that the development of the writing of WC carveout and related business in the instant proceedings was not the case of an innovative development of existing and legitimate practices:

i) This was not a case concerned with the reduction of rates in order to retain market share or any other recognised form of legitimate economic activity.

ii) Nor was it concerned with markets where a chance would be taken on the happening of a loss; losses on a massive scale were inevitable.

262. The essence of SD's case was that:

i) There could be no ordinary commercial or economic rationale for participating in business that was so grossly loss making on the backs of reinsurers. The risks inherent in the business were so considerable for such small profits.

ii) The losses had to be passed on to others. No one would knowingly take such losses on and no person was likely to have done so.

iii) The market in such business was only sustainable for the reasons set out at paragraph 253 above.

263. In answer, SCB maintained that:

i) There were markets where business was written on a net basis where there was no uncertainty as to whether there would be losses, and losses were inevitable.

ii) There was no difference in principle between those markets and the market for trading in losses generated by WC carveout business; in each, gross losses were certain at some time and had to be passed on; the uncertainty was as to the number and frequency at which the losses hit particular layers.

iii) Arbitraging the difference in rates between the higher and lower layers was an essential feature of the business, as had been made clear in Deeny.

iv) It was clear that for a period since the mid-1980s there had been a market where it was possible to write and cede such business. Mr Hines had explained that with an outwards reinsurance programme in place, an underwriter could accept risks if the premium was sufficient, in order to pay the retained losses and the outwards reinsurance premium. The assessment of a programme would be made very carefully at the beginning of the year and each risk was merely examined to see if it fitted into the plan.

v) There was therefore a rational way in which the business could be written and there were those who were prepared to participate in the reinsurance. No one entered the market without understanding the risks thoroughly.

264. To examine these conflicting arguments, it is convenient:

i) First to consider whether a rational and prudent underwriter would have knowingly participated in a market where such business was carried on if the huge inevitable losses were all passed on and paid by those who knowingly participated in the market.

ii) If not, whether those who knowingly participated in the business of the market were either imprudent, or participated because they knew that the losses could be passed on to innocent victims or to the imprudent.

(g) The business could not be written on a sustainable or rational basis

265. It was important, as SCB submitted, in determining the question as to whether the business in this market could be written on a rational basis, to put oneself in the position of those writing the business at the time; at that time there were reasons why the writing of such business might appear attractive; the business could be written on a rational basis and with the anticipation, based on reasonable grounds, that it would be profitable. For example:

i) A person who was offered the kind of deal Mr Crane was offered on Programme 19 (Hallmark) would find it attractive as it was virtually certain that he would make a net profit.

ii) An underwriter who had evaluated the risks to which I have referred at paragraph 191 above and had placed his reinsurance with a knowing participant which had a rating of A+ would have minimised the risks of avoidance and insolvency; he would have made a commercial judgment that it was a business in which he should participate as the risks were worth running; he would have appreciated the risk that he might have got his calculations wrong, but who did not think he had, and would have run that risk.

266. As the business in this market was, on the evidence before me, business that could only be written on an arbitrage basis by reinsuring 100% of the aggregates and by making a profit on the differential in rates, it is my view that there were only two bases on which it could be argued that the business could be written rationally (as Mr Railton accepted during the course of closing submissions):

i) If the risks were single risks – by performing the kind of calculation which was carried out by Mr Crane, provided that the relevant information was available.

ii) If a book of such business was to be written – by writing the type of plan which Mr Hines prepared for the Court (as has been described at paragraphs 195 and following), provided that the relevant information was available for this to be done.

No other approach was suggested or was tenable.

267. In this trial, I was not concerned with the placing of individual risks such as the one-off risk that Mr Crane wrote (which I set out in relation to Programme 19 – Hallmark). I was concerned with the placing of a book of business and therefore have to consider whether it was possible to adopt the rational approach involved in preparing a plan and putting in place the other prudent arrangements that would have been essential to conduct business where inevitably very large gross losses of tens of millions of dollars would be passed into a spiral or on to other reinsurers.
268. Mr Bird's evidence was that in relation to the spiral part of the account that he had written at Syndicate 103, the elements mentioned by Mr Hines had been considered by him and had been applied by him without having committed it to writing; he did not know if Lincoln National had prepared a plan, nor did he know whether CIGNA Re Europe had done so for the lineslips that had been operated with his advice; he had not prepared one.
269. But no plan was produced from Mr Billyard or Mr Paul Murray (referred to at paragraph 358 below). No documentation evidencing the kind of research that would have been necessary was produced. As set out at paragraph 206 above, if any honest plan had ever been produced, it would have shown that the business could not have been written honestly.
270. Furthermore, business of this kind was unsustainable for anything other than for the very short term as it would in effect be impossible after a very short time to renew any outwards reinsurance programme which ultimately had to absorb this degree of loss. Indeed, it is quite clear that this is precisely what had happened.
271. It was suggested by Mr Greig that those who wrote this business did so because of the existence of a soft market at that time. It is obvious that the existence of a soft market will result in a downward pressure on rates; insurers and reinsurers will write business at rates at which they will sustain a loss in order to stay in the market; they will follow rates down. There is abundant evidence (some of which was very helpfully set out by Mr Greig in his second report) that this happened and that there was a downward pressure on rates and that insurers were able to buy reinsurance on very advantageous terms which were likely to result in a loss to their reinsurers. However, this cannot explain why any prudent person would accept a substantial volume of gross loss making business where the gross loss ratio was several hundred percent, other than that this was done because he was able to transfer the losses to others.
272. It was Mr Greig's evidence that although it was obvious that the losses had to go somewhere, as long as individual participants believed that they would be protected if they had done their job properly, they continued to participate in the business. Although I accept that that was Mr Greig's own perception of the market, he had no experience of the kind of loss ratios that were evidenced by the placement information in respect of some of the programmes and he had no experience of the placement of tight spirals. Moreover, I am sure that no honest and prudent underwriter would write carveout business on a net basis involving participation in a spiral or in retro business, as the risks to which I have referred at paragraph 191 were so great – the losses had to be paid and the outwards reinsurance was not sustainable for anything but for the very short term, as events proved.
273. It was submitted by SCB that the view of an honest reinsurer as to losses not covered by the retention (and as I have mentioned, constituted the vast bulk of the loss) was that:

i) The losses might be paid by a reinsurer who did not have, or who ran out of, cover either because he had misunderstood the information given to him, or had made an error in his calculations, or had misjudged his aggregate exposure, or had taken a calculated risk as to leaving part of his aggregate unreinsured, or had had a mismatch between his inwards and outwards cover, or whose outwards reinsurance had failed. Such a reinsurer would take the view that those who participated in such business must look after themselves.

ii) Such a reinsurer would not think at all; as long as he had looked after himself, he should not have any concern about the position of others.

iii) The honest reinsurer would nonetheless be concerned to ensure that there was full disclosure to his outwards reinsurer and would assume that that there was proper disclosure at each stage, as each reinsurer would have a vital interest in ensuring that his own outwards reinsurance stood up.

274. I do not accept that any prudent and honest person would, in the light of the spirals that hit the catastrophe market in 1989 and the years immediately following, not have given any thought as to who paid the losses. If the honest reinsurer believed that all those who participated in the market were knowing participants and that there was no innocent capacity to whom the true nature of the risk had not been disclosed, then it was inevitable that the losses would be borne by the participant who had miscalculated their reinsurance.
275. Furthermore, it was obvious to any honest and prudent participant that any spiral market was fundamentally unstable; it was the evidence of Mr Hines that any spiral market was likely to be a passing phenomenon as participants in the market were not retaining risk but were transferring risk at ever cheaper and more unrealistic rates; however, that risk had to be retained somewhere. In his view, experience had shown that the risk was usually retained by those who had failed to monitor their exposures and reinsurance needs and who had ended up retaining more than they had planned. He concluded:

"If all the participants did their job properly, it would not be possible to arbitrage."

276. However, in the market for WC carveout losses, unlike other spiral markets, a participant was trading not in risk but in enormous losses; the honest participant would be gambling that he was the person who had not miscalculated and that another participant had made that miscalculation so that "the parcel" being passed round was left with that other person and not with him.
277. Bearing in mind the fact that participants such as Mr Billyard and EIU were dealing with gross losses that would inevitably be running into tens of millions of dollars and that the devastating consequences of the catastrophe spirals of 1988-90 were well known, no rational or prudent or honest reinsurer would have taken such a risk for so small a reward. I am sure that no prudent person would have written WC carveout with a retro or spiral element or have participated in this business above the first tier.

(h) Were those who participated foolish or imprudent?

278. As I have rejected the analysis that the business of the market which traded in WC carveout losses could be written on a rational basis, it is next necessary to consider whether those who knowingly conducted business in this market were extremely foolish in that they did not understand the risks, or did not guard against them, or thought that it was an easy way of making a profit.
279. There are those in any market who think that they understand the business better than others; as Mr Brown pointed out, most thought that those writing spiral business had to reinsure their aggregates in full, but there were others who took a different view and did it slightly differently. If a participant has miscalculated, he has no one but himself to blame for the consequent losses.
280. I also bear in mind the fact that there were obvious examples of imprudence by those who conducted business in this market:

i) There was little regard to documentation; although engaged in arbitrage they did not put in place the documentation that was actually necessary, but used the documentation of a conventional reinsurance transaction instead. There are other areas of the reinsurance market where documentation has not been adapted to reflect the real nature of the business. So it might perhaps not be surprising that an imprudent and foolish underwriter would not consider the elementary steps of insisting on adequate and watertight documentation that would properly reflect the transaction and provide for instant payment in what was essentially an arbitrage exercise and not conventional insurance or reinsurance. There is nonetheless another alternative explanation for the fact that although the business of the market was essentially financial the documentation was that used in the reinsurance market – it could be that conventional documentation was used in order to make the business appear like conventional reinsurance, even though in truth it was not.

ii) Many of the procedures in this market were lax; however that does not necessarily point to imprudence on the part of a knowing participant; it is equally consistent with the fact that the participant thought that he was not at risk of loss:

a) For instance, Realm National agreed to B&S writing risks from an assigned risk pool without any business plan or other written proposal (see Programme 9). It would be unthinkable for any prudent business to operate in this way unless that business was passing the risk to others.

b) The terminology employed was loose and imprecise (as I have mentioned at paragraph 166); for example, LMX was excluded quite often, but not international XL, despite the fact that the business of both were the same and that the two principal writers of LMX business in London – Mr Cackett (see paragraph 1687) and Mr Billyard were writing the same type of business but that it was not designated LMX business as they were no longer writing business in London.

281. The rating structure might be another example; I have already referred to Phillips J's description of this as irrational (see paragraph 171.vi)). Mr Greig pointed out that it was not logical to give a discount on the various levels as a reinsurer would do in business without a spiral element. Thus the rating of spiral business in this way could be seen as an obvious example of imprudence in that those writing it adopted a rating structure that was irrational and which any prudent person should have known was irrational.
282. The rating could, however, be the consequence of those writing at these rates not understanding that the business they were writing contained a spiral element. It must be remembered that there were a number of different reinsurers who wrote high level XL reinsurance to whom these spiral losses were passed; they provided reinsurance to those at lower layers, priced (as Mr Greig pointed out) on the basis that there was no spiral element. It stretches credulity, particularly in the light of the report of the Lyons working party and of the judgment of Phillips J, to believe that they were all imprudent, when there is the alternative explanation that they so rated the business because they were not told of the mechanism beneath them by which the inevitable heavy losses would be transferred to them.
283. However, I am sure that many of those who were prime movers in this market fully understood the risks, were not foolish or imprudent, but were prepared to write this type of business. I am sure that they did so, not because they had not thought about where the losses were going, but because they knew that there were others to whom the losses could be passed (who did not understand the business and who would accept such enormous losses from those who understood the business) for so little premium.

(i) The need for due diligence

284. It is obviously prudent and to be expected that any participant new to any market would endeavour to understand the risks in that market. As Phillips J stressed in Deeny at page 207:

"Successful excess of loss underwriting, particularly if it involved significant spiral business, called for an approach to underwriting which differed from that of conventional direct insurance and called for a high degree of skill…"

285. If a participant enters the market when he does not understand those risks or miscalculates what those risks are, he has no one but himself to blame if he makes significant losses; he is presumed to know about the trade of the market in which he writes (cf section 18(3)(b) of the Marine Insurance Act 1906 and the cases decided on that sub-section). The capital provider or the senior management of a company should not entrust such business to someone who does not understand it.
286. No other participant in a market owes a duty to protect those who knowingly enter a market but who do not understand it, are imprudent, or who miscalculate; indeed, it is likely that a person who is imprudent or foolish or who miscalculates in any market will be ruthlessly exploited by those who understand the market; he is at risk of having dumped on him risks which no one else wants.
287. As a broker is under a duty to act in the best interests of his principal, he will often not hesitate to place business with a person who is providing good cover with good security but on terms more favourable than others. If that underwriter is doing so because he does not understand the risks, or is imprudent or a fool, no complaint can be made against the broker who fairly presents the risk in accordance with the principles of good faith. The fact that the underwriter may be a fool and not understand a risk fairly presented is the fault of his capital provider and not the person presenting the risk to him.
288. There are many examples in the relatively recent history of the insurance and reinsurance market of people who were so obviously imprudent that they are best described as fools, but who were nonetheless given authority to write business by their capital providers and who then went on to incur very large losses for their capital providers. Some of these fools did so because they did not understand the market. It was no surprise that their foolishness had been exploited by their fellow underwriters and brokers; the insurance and reinsurance market is, in this respect, no different to any other market.
289. The evidence of Mr Bird, one of the main participants in this business, was that a person should carry out his own due diligence:

i) It was obvious to him when he looked at the way that the market operated (when he entered it in 1991) that with a $1,000 retention for direct writers, they were writing on the backs of reinsurers and that the losses would fall on the first tier reinsurers above the retention. As those first tier reinsurers were a smaller market and had low retentions ($1,000 at that time), it was obvious that they were writing on the backs of their reinsurers in the retro market.

ii) It was obvious to him, because of the size of the retro market, that there would be a spiral.

iii) Therefore a person coming in at $500,000 should have realised that he was not writing catastrophe business, but that he was in there "body and soul" and that he should have had appropriate outwards reinsurance protection as a professional.

iv) The premium charged for the level at which a person participated was a commercial decision for him on the basis that he had entered the market and knew how the market operated.

290. SCB submitted that any person who agreed to write XL or XL on XL was entering a market where he would either know or should know the risks; it was extremely unlikely that there was any underwriter who wrote a reinsurance of that type without appreciating the risks that spiral business entailed.
291. However, it must have been obvious that the due diligence necessary was not easy for a person outside the market that traded in losses to implement; the key component in Mr Hines' plan for the spiral part of the account was the calculation of the loss frequency for spiral business of this type. As I have set out at paragraph 196.iii), Mr Bird's evidence was that he obtained the necessary information from Mr Billyard and the information used by Mr Hines was derived from the statistics of those actually writing the business. It was by no means easy to see how a newcomer to this business could have obtained the necessary information, save by enquiry of an existing participant in the business.

(j) Innocent capacity

292. It was not disputed by SCB that there had to be full disclosure to any reinsurer that gross loss making business was being written and where business contained a spiral element, that fact as well.
293. I accept that a person who regularly wrote in the London market would probably realise, from the slips and information provided in this type of business, that there was gross loss making business and that spiral business was being passed to him. Furthermore, no participant in the London market could have failed to be aware of the risks posed by spirals in the light of the spiral in the LMX catastrophe market in 1988-90 (considered in Deeny).
294. There is no necessity for me to determine whether it would have been necessary to go further in the case of an underwriter in London. Someone writing in the PA market would probably understand from the standard information provided by this market that the effect of a spiral on such business produced enormous losses of many tens if not hundreds of millions of dollars each year; he would understand that those losses had to be paid by those in the spiral year in, year out, and that that was the risk he was taking. It is fair to say, as SCB submitted, that writing gross loss making business of this kind on the backs of reinsurers was "not a dark and secret art" and was well known to those who wrote in the PA reinsurance market in London. However, underwriters in London outside the PA market might not have understood or have been expected to understand that, as this type of business was so different from spirals in the catastrophe market where the inevitability of enormous loss year in, year out was not the basis on which other spiral markets operated. It is not necessary for me to determine that.
295. I accept that a person coming to write business in the London market would be expected to have undertaken the necessary due diligence; indeed, he would be presumed to know the ordinary practices of the market in London.
296. The precise ambit of what a person coming to the London market is to be presumed to know might be a difficult question in some cases; there is no difficulty in brokers taking more time and trouble to explain the characteristics of business in London to potential reinsurers; indeed their reputation and that of the London market depends on it. However difficult such a question might be in some circumstances, I am sure that the practices and characteristics of this market, particularly the deliberate writing of gross loss making business for no other purpose than to pass the loss to reinsurers, were so extraordinary that the fullest explanation of that market was necessary; reinsurers were not to be presumed to know of such practices.
297. Moreover I cannot accept that a careful and prudent underwriter who did not regularly write in the London market would understand from the descriptions of the business given in the slips that I have seen in this trial or from the information provided (which were standard for this business), that they were accepting business which was being deliberately written to produce losses far in excess of the premium, and that they would be receiving through a spiral, not the fortuity of loss, but the inevitability of loss.
298. There can be many instances where XL on XL reinsurance is written where there is a risk of a spiral, as it was common ground that spirals could occur when XL on XL is written. Persons doing business outside the London market might well understand, from the slip and information provided, that the business was the conventional type of reinsurance described in such classic works on reinsurance as Kiln or Gerathewhol. They would have no reason to suppose that such a description connoted business that was being deliberately written in the knowledge that it would make a gross loss, particularly if the gross losses had loss ratios of several hundred percent.
299. It is important to emphasise that to many in the market, it would never occur to them that there were others in the market who would write business in the knowledge that it would make a loss and thereafter pass those losses on to their reinsurers; it was striking that a broker of the stature and experience of Sir Alan Traill had never come across this activity in his 44 years in the London market. Such a practice would have been viewed by many, once told about it, as contrary to the whole ethos and professionalism of conventional underwriting; obviously this practice was known to those brokers (and there were several other than SCB) and insurers who wrote in the PA market and in this market which was within the PA market, but no one outside it would have appreciated this. The fact that a loss record showed poor loss ratios did not mean that the underwriter was deliberately creating those loss ratios.
300. Reinsurers would obviously expect that losses in any particular year might far outstrip premium, but the conventional view was that over a period of time premiums and investment income would be greater than claims such that a profit could be made; as Sir David Walker's report observed at paragraph 3.14:

"We note at this point in time that informal pay back arrangements in reinsurance business have generally worked well as a means of ensuring that, over a period, a reinsurer who sustains sizeable losses is able to recoup his position through being able to levy higher premium rates subsequently."

That was not the practice of those who wrote gross loss making WC carveout business on the backs of reinsurers; they deliberately intended to pass enormous losses for as many years as they could to reinsurers. A prudent and conventional reinsurer would not understand that any prudent and honest insurer would deliberately write loss making business in order to pass it on to him; he would regard this as contrary to the whole ethos of the business and a breach of the duties of care and good faith; furthermore, a conventional insurer would not think that any rational insurer would do that as he would not be able to sustain his reinsurance. It was a striking feature of Mr Crane's evidence in making a decision to accept business he knew to be gross loss making that he was not prepared to pass those losses to his own reinsurers on his general account; he would only do so with a contract (Programme 19 – Hallmark) which would transfer those huge losses to SD whilst he made a turn on the business.

301. I am therefore sure that there were a number of reinsurers worldwide who, if shown the type of slip presented to reinsurers and loss statistics in respect of higher layers, might well consider that they were writing conventional reinsurance business and not appreciate that they might be exposed to working layer losses that had been accepted on the basis that there would be inevitable gross losses. They would be the "innocent capacity" identified by Mr Hines. If they agreed to write the reinsurance of WC carveout business written on a gross loss making basis, they would be unaware of the risks that they were actually running and, as Mr Hines said, needed to be told, in clear terms, what this business in truth involved and how different it was from conventional reinsurance.
302. Indeed, in considering the impact upon the higher layers, it is important to recall that 99% of the claims in WC business are below $100,000 and that the vast concentration of claims are below $5,000; in Mr Crane's experience, most losses were below $100,000; he thought that 1% of losses by number were over $100,000 and in loss terms these were less than 15%; very few were in the bracket $100,000 to $500,000; if they exceeded $100,000, they were likely to exceed $500,000.
303. A person writing the reinsurance of WC or WC carveout or WC related business at high levels would therefore not expect many losses. Although clearly claims under $5,000 would not, as a result of the spiral, impact on higher layers, if, as will be seen to be the case, the sum of the retentions of the low level participants in the spiral is only $30,000, then such losses which would otherwise clearly not impact on higher layers will do so as a result of the spiral.
304. Clearly where someone was being offered business which appeared on its face to be conventional business but which in truth was business that was being written deliberately in order to generate gross losses, particularly if it was spiral business, then on ordinary principles there was clearly a duty of the fullest disclosure. Only if the broker knew that the person to whom he was offering the reinsurance knew the true nature of the business being offered, would he be absolved from explaining it to that person; I accept that the slips and the information provided to those who wrote business in the PA reinsurance market in London would be sufficient for a reinsurer within that market. They were obviously insufficient to anyone who did not write business in the PA reinsurance market in London who did not know what the business actually involved.

(k) The fact that the market was nowhere described

305. The writing of LMX and XL on XL is described in Kiln; there are papers on it; for example, Mr Emney had given addresses on it in the late 1980s to the Institute of London Underwriters (see Deeny at page 203).
306. It was a striking feature of this market and of the business conducted in it that no description of what was being done was ever put in writing, whether in presentations to those being asked to write the business, or in documents where it was essential that it be properly described, or in any other document, at least in so far as the evidence went and the searches of the parties disclosed; in particular:

i) There was no description in the documents passed to the DTI in 1993 (see paragraphs 467.vi) and 474.iii) below); however, it is right to observe that there was no evidence as to whether the regulatory authorities at Lloyd's were provided with a proper description of the business; no evidence was adduced as to whether they were or were not (see further paragraph 310 below).

ii) There was no description in any document prepared for those invited to participate in this business (see, for example, the documents referred to at paragraphs 427 (Phoenix and Hackett), 490 (prospective investors in EIC) and 987 (Mr Traxler).

iii) There was no description in syndicate accounts to Names which enabled them to know the true nature of the business being written – examples are Syndicate 103 (Mr Bird), Syndicate 398 (Mr Billyard) and Syndicate 718 (Mr Owen). In his 1995 accounts, Mr Owen stated that Sturge Non-marine Syndicate Management Ltd. (Syndicate 718's managing agent) had made an enquiry into the PA LMX market and had ceased paying claims:

"The major problem following Sturge's decision unilaterally to cease certain claims payments was that the LMX account itself took on a much higher profile than we would have wished."

Although there was some evidence that members' agents might have been told, the nature of writing gross loss making business on the backs of reinsurers was so completely different to conventional reinsurance that it was obvious that any capital provider had to be made aware of what was being done and of the risks that that entailed. Names at Lloyd's were no different; as Mr Crane accepted, the risks which they were running were very much greater and that was why his participation on the Hallmark programme (Programme 19) was very much the exception. At paragraph 407 I have made specific findings in relation to the reports to the Names of Syndicate 103; the position of other syndicates is not a matter for me. The only material point from the evidence adduced before me as to what printed material was provided to the Names is that it was an obvious feature of the business of this market that no one was prepared to describe it in print.

iv) There was no description in the SCB prospectus; I have set out at paragraph 163 the way in which SCB described in the prospectus, the importance to them of the reinsurance; it is striking that that document did not describe the fact that the reinsurance was placed on a basis that was gross loss making and that it was built on the risk that the reinsurance might not respond.

307. If the business of this market was one which was open and one where the participants would have been content for others to understand what was in truth and in fact the business of that market, there would have been documents describing the business to be written and the way in which the market worked, particularly documents addressed to those invited to participate in it as capital providers or regulators.
308. As the risks were so considerable and the business was essentially an arbitrage exercise that required others to pay inevitable and enormous losses, it was essential that capital providers understood the risk of non-payment by reinsurers and that reinsurers understood that they would be required to pay enormous losses; in the latter case this would guard against the risk of the reinsurer not paying promptly or refusing to pay. In such circumstances, any honest person entering into the business would have required documentation which properly explained the nature of the business.
309. On the contrary, the fact that no one was prepared to describe it properly strongly supports the conclusion that if it was described to anyone, no prudent person would honestly participate in it; it was, in short, a type of business that if properly described, no prudent person would touch.

(l) The position of the regulators

310. SCB submitted that there was no evidence that the regulators were at any material time unaware that gross loss making business was being placed in the PA reinsurance market, particularly in the spiral market. They submitted that it was inconceivable that the regulators did not know that original rates were below the burn, that working layer XL reinsurance was gross loss making, that reinsurers' retentions were very small, and that retrocessional and spiral business (which could only sensibly be written on an arbitrage basis) was being ceded, placed and written in the market.
311. I am not prepared to draw that inference; as to the DTI, I deal later with the application that was made to them by Mr Bird and Mr Whitcombe for the authorisation of an insurance company. As to the position of Lloyd's, I set out the position in relation to enquiries made of them at paragraph 517. I have already observed at paragraph 239 that the circumstances in which the business was given a code for which there can be no justification is not a matter on which I should make any further findings; it would not be right for me to draw any inference one way or another as to the knowledge of Lloyd's, or as to why the market was permitted to continue after the results of the catastrophe spirals of the 1988-90 had been seen.

(m) The position of reinsurers on the higher layers

312. For these reasons I am therefore sure that there was innocent capacity in the sense of persons who might have prudently entered into contracts of reinsurance at a high layer on the basis of the information provided without realising that they were taking on inevitable working layer losses from this type of business.
313. There are further factors that underline this:

i) There was no benefit to any higher layer reinsurer who was only participating on higher layers for the purpose of passing on working layer losses to someone else because:

a) the premium was too small to make a turn; and

b) the premium would not have paid the retention.

ii) The losses would, in such a case, pass into the higher layer reinsurer's own outwards reinsurance at a very low layer, but at a premium that was small, as it was only a fraction of the higher layer premium – see further paragraph 1204.

iii) The lower layer outwards reinsurer would therefore be getting working layer losses for a catastrophe premium and there would thus have to be disclosure of the full facts about the existence of a tight spiral in this market and its effect in funnelling losses up to higher layers. There would be no chance of the outwards reinsurer accepting the outwards reinsurance unless they were part of a similar scheme. The higher layer reinsurer was therefore in fact unreinsurable.

314. It was submitted by SCB that if a case of conspiracy to dump the losses on higher layer reinsurers was to be made out, it was a necessary first step to be satisfied that those involved had thought of where the losses would go; the only concern that an underwriter would have was that the losses would be passed on to his reinsurer, he would however not be concerned with where the losses went thereafter. Nor would he be concerned about what his reinsurers told their reinsurers.
315. I accept that might well be the approach of many an underwriter in many circumstances, but it is not applicable where the reinsurer only writes the reinsurance on the basis that his reinsurance will be reinsured. Once there is that element of circularity, there is then an obvious concern to anyone involved to make sure that the losses are ultimately taken away from those involved in writing each other's reinsurances and passed to someone who will not pass it back.
316. SCB contended that the higher layer reinsurers would be accepting the higher layers as part of a book on an aggregating and accumulating basis and that those reinsuring them would be those who had crossed the threshold into writing this type of business and must therefore be taken to appreciate that they might be reinsuring working layer losses.
317. Although it is not necessary for me to decide the position of any of the reinsurers on the higher layers in this case, it is clear that they were either "in the know", or they did not understand the business they had written, either as a result of their own imprudence or because they had not been told of its true nature. It is difficult to conceive that there would be anyone so imprudent and foolish as to undertake this business if it was properly explained to him, but that must remain a possibility.

(n) Full disclosure would have ended the market

318. It was not in dispute that there had to be disclosure to reinsurers of the gross loss making nature of the business which they were accepting.
319. As I have sought to demonstrate, if the true nature of the business was made known to and understood by all who participated in it, the market would obviously be unsustainable. In all the circumstances, the probability is that this market only continued because "those in the know" never made clear the true nature of the business to those to whom they transferred the losses, though there must remain the real possibility that there was someone who was so imprudent that he was prepared to accept the inevitable losses, despite the true nature of the business having been explained to him.
320. I cannot therefore conclude that the market inevitably involved the defrauding of reinsurers or principals; there remains the possibility that however clearly the position was explained, there was nevertheless someone sufficiently imprudent who participated. I reach that conclusion because there remains the possibility that someone might participate in the market by writing small lines or by taking a selective approach.

(o) An analogy with pyramid schemes

321. I questioned during the course of the trial whether the attack being made by SD on this market extended to an averment that it was contrary to public policy; as it was being contended by SD that one of the consequences of this market was that it would result in the ruin of what they contended were innocent capacity, I questioned whether there was a broader issue relating to systemic risk. The Lyons working party had pointed to the risk of a domino effect of insolvency in 1988.
322. As the evidence progressed, it became clear that although the losses were enormous by any scale there was no real likelihood of systemic risk as there were sufficient participants of very substantial financial strength (as many participants were large life insurance companies or, with one or two exceptions, were companies with a very strong asset base). It was obviously essential to those seeking reinsurance for these huge and inevitable losses that their reinsurers were of the highest financial strength; it was no doubt very helpful to those seeking reinsurance that, for the reasons explained, life insurance companies were in a position to write carveout business; why any particular life insurance company or life insurance companies in general became underwriters of gross loss making liability business on the backs of reinsurers, or became participants in the exceptionally hazardous business of spirals, is not a matter for me to determine, but it does explain why there was little likelihood of systemic risk if one of these companies was left "holding the parcel" – they had the capital to pay for it.
323. SD made it clear that they did not seek to contend that any of the contracts which were written by EIU were illegal as it was not appropriate that that issue be decided in a case where only one of the parties to the contracts was present. I agree with that view and am of the opinion that any issue of illegality should only be determined when both parties to a contract alleged to be illegal were present.
324. However, SD contended that an analogy could be drawn with pyramid schemes and chain letters. The essence of pyramid schemes and chain letters is that those who join can recoup the costs of joining and make a profit by recruiting others to the scheme. In Re Senator Hanseatische [1997] 1 WLR 515, the Court of Appeal considered such a scheme and held that it was a lottery and that it was illegal on that basis. However, in a separate judgment with which Lord Woolf MR agreed, Millett LJ added at pages 524-525:

"It is, however, another feature of the scheme which is far more pernicious and which gives much greater cause for concern. This is the certainty that the scheme will cause loss to a large number of people, and that the longer the scheme is allowed to continue the greater the number who will inevitably suffer loss. This is the necessary consequence of the fact that, in order to recover his money (let alone make a profit), each new participant must recruit several further participants, who then find themselves in the same situation. Those who have only just joined can have had no opportunity to enlist further members. Until they do so they have lost their money. Yet at every stage of the life of the scheme from start to finish such members not only greatly outnumber those who recruited them, but outnumber all other members of the scheme put together.

The number of persons who are sufficiently gullible to be persuaded to join may be very large but it is obviously finite; so is the amount of money which can be raised by a scheme of this kind. The scheme is bound to come to an end sooner or later. When it does most of its members will have lost their money. This is not merely likely; it is a mathematical certainty. It is as certain as the fact that the organisers, who take almost two-thirds of the money paid by each new participant, will have made a substantial profit. The scheme is merely a device for enabling the organisers and a relatively small number of early recruits to make potentially very large profits at the expense of the much larger number of those who are recruited later. Every new participant is in truth gambling on the scheme continuing long enough for him to recover his money and, he hopes, make a profit. But the scheme is not, of course, held out to him on this basis.

Schemes of this kind are inherently objectionable and the court has consistently held that it is just and equitable to wind up companies which operate them. They tend to be sold on a false and deceptive basis, sometimes explicit but usually implicit, that they are a certain source of profit for those who join and are capable of lasting indefinitely."

325. SD submitted that the trading in the market with which I am concerned had certain similarities to the scheme considered in Senator Hanseatische:

i) It was a mathematical certainty that the liabilities incurred by those participating in a reinsurance scheme in this market would far exceed the income that could be earned, as the gross losses would far exceed the premiums, particularly after commissions and brokerages had been taken by intermediaries who bore none of the risks. As the losses were passed on at each stage, there was less premium to pay for them.

ii) It was inevitable that enormous losses would have had to be paid; in a pyramid scheme, these would fall upon the many new recruits. In this market, the losses would be concentrated; that did not make it any less pernicious.

iii) As in a pyramid scheme, new recruits had to be found; to induce a participant to write gross loss making business, a person had to be found to take those losses. In such a way a chain was created, but it would never in practice be infinite and the losses would ultimately have to be paid by the person or persons in the chain left with the losses. Just as in a pyramid scheme, it did not matter that those persons could not be identified precisely.

iv) The Court is, in pyramid schemes, astute to protect the interests of consumers against exploitation; there was a public interest in protecting the insurance and reinsurance market from abuse.

326. Another analogy which SD provided was the so called "Ponzi schemes" which was considered by the US Supreme Court in Cunningham v Brown 254 U.S. 1, but, as they rightly submitted, such schemes contained further elements of fraud, and if any analogy was to be drawn, it was with pyramid schemes.
327. SD also relied on the analogy of a false market in the sense the term is referred to in Scott v Brown, Deering, McNab & Co. [1892] 2 QB 724; they submitted that spirals were contrived and that capacity was found to take the losses. Unless the true effect of the spiral was explained to them, they might be the victims of a false market in that they would think that they were writing catastrophe business whereas, as a result of a contrived spiral, they were not.
328. I accept that there are analogies to this market that can be drawn with pyramid schemes; there are certainly many features of this market which were undesirable. One feature was, as I have remarked, that some of the capacity induced to enter the market were life insurance companies, no doubt because their very high security ratings were seen as providing the type of security required to be able to pay the very large losses. Another feature of the market was the concentration of loss on a few carriers.
329. However, I do not consider that it is necessary for me to draw on the analogies.
330. It seems clear to me, as I am concerned with reinsurance, that the ordinary principles of disclosure suffice. If the nature of the business was properly disclosed, then in my judgment no complaint could be made about the writing of gross loss making business on the back of reinsurance.
331. However, for the reasons I have given, it is unlikely if proper and honest disclosure was made to any new capacity being asked to reinsure such business, that any prudent capacity would have ever participated in the business and that the market would have ever continued. But as I have said, there is the possibility that someone imprudent would nonetheless be prepared to write the business.
332. Furthermore, it must be recognised that markets must be free to function within the existing law and regulatory structure. In my judgment, the existing principles of the law relating to fiduciaries, misrepresentation, conspiracy, deceit and disclosure already provide a sufficient legal framework to determine the issues in this action relating to this market as between these parties; it is not necessary therefore to embark on the much more difficult task of determining whether the operation of that market would be contrary to public policy by analogy with pyramid schemes and chain letters, though if in any future case arising out of the operation of this market, the issue of the illegality of the contracts written in it arises, the issue will have to be addressed.

(p) The position of the brokers

333. In general, a broker is not concerned with the reason why an underwriter writes a risk; as long as the broker makes a fair presentation, it is a matter for the underwriter as to whether and why he accepts the risk. The broker's duty is owed to the cedant of the risk; it would not be for him to question why an underwriter would be prepared to write a risk at terms that appeared exceptionally favourable to his client. It would be his duty to try and secure the writing of the risk.
334. There would be many matters that would not ordinarily be known to a broker; they were helpfully listed by SCB; they included knowledge of the discussions between the underwriter and his principal as to the type of business to be written, the underwriter's business plan, the underwriter's reinsurance programme, his commission and expense rates, the business offered by other brokers and his internal reporting requirements.
335. It was Mr Greig's evidence that it would be difficult for a broker to tell why a reinsurer to whom he was presenting unprofitable PA or WC carveout business was prepared to accept it; it would not matter to the broker why the reinsurer did so; the broker would not ordinarily know the outwards protections of the reinsurer. If the business was very unprofitable, it might seem likely to the broker that the reinsurer had relied predominantly on outwards reinsurance, but he would not know. As a statement of the general position, this is unexceptional.

(9) Conclusion on this market

336. I have considered the evidence in relation to the market as the case made by SD did involve an attack on the market. Although the attack was initially on the basis that the practice of writing gross loss making business on the backs of reinsurers was illegitimate and dishonest, and that this was the initial evidence of their experts, they subsequently accepted that such a practice could not be illegitimate, let alone if there was proper disclosure. Notwithstanding this, it remained their case that with proper disclosure, the market could not have continued.
337. My conclusions can be summarised as follows:

i) Deliberately writing business that is known will produce losses far in excess of the premium on the basis that reinsurers will be expected to pay for the losses for even less premium, is so alien to the ordinary practices of conventional insurance that it must be specifically disclosed. If the business has, in addition, a spiral element, that must also be disclosed.

ii) The risks in writing the reinsurance of WC carveout business in this way were so great that no rational or prudent underwriter could have ever undertaken it; similarly, no rational or prudent person providing capacity would have ever authorised the writing of such business.

iii) There would have been no market for reinsuring WC carveout business in the way I have described if there had been full disclosure either to those who had provided the capacity (such as Names), or to life insurance companies, or to reinsurers offering lines, even though there was always the possibility that there might have been some reinsurers who were so imprudent that they would provide reinsurance for small lines.

iv) The prime movers in the market were prepared to write the business because they knew that there were others to whom the losses could be passed who did not understand the business and would therefore accept the losses from those that did for little premium.

v) It was not inherently dishonest to place or cede such business if there was full disclosure.

338. However, those are only general conclusions about the market; when turning to the facts of the case it will be necessary to consider the programmes accepted by Mr Henton individually and in totality.
339. In their closing submissions, SCB submitted that there could be no criticism of SCB unless SD could show that they knew that the capacity was being cheated and/or that the underwriter was participating in a dishonest scheme; no complaint could be made that the placing of gross loss making business was by itself inherently dishonest.
340. Although I have made these findings on the evidence in relation to the market, it was essential, if SD were to make good their various claims, that they proved that the Defendants to this action acted in the way SD alleged, with the relevant knowledge and dishonest state of mind.
341. It is therefore to the facts of this specific action that I now turn, but before doing so, it is necessary to deal with an issue on the pleadings.

(10) The plea against SCB about their understanding of the underwriting

342. In their pleadings, SD alleged that SCB knew that no honest underwriter acting in the interests of his principal would write the business placed with EIU.
343. SCB accepted that such a case was made against them, but on the basis that it was premised on the assertion that the acceptance of gross loss making business against reinsurance was dishonest.
344. SCB contended, however, that SD had not pleaded a case against them that they knew that no genuine underwriting assessment had been made on a net basis and that SD had made no alternative case that if net underwriting could be done honestly, it was not done honestly to the knowledge of SCB on the facts of this case.
345. For the reasons set out in Appendix 1, I have concluded that although the full case advanced was fully open to SD on the pleadings, in the circumstances relating to the way in which the issues emerged and evidence was given, I do not consider it fair to allow a case to be made against Mr Brown and Mr Butler (and therefore against SCB) that they knew that no underwriting assessment had actually been made by EIU on a net basis and that the acceptance of a contract was dishonest for that reason.
346. However, as explained in Appendix 1, I do not consider it unfair to restrict the scope of SD's case in any other way – for example SCB's knowledge about the mismatch on reinsurances, or about the lack of information or of up to date or readily available information or as to whether the business would be gross loss making.

3. SCB AND THE MARKET: 1992-1996

(1) The market

347. I have set out in the preceding section, a description of the market. I now turn to the claim advanced by SD on the basis that:

i) there was as part of the PA market, a market that traded in losses generated by WC carveout business;

ii) there were many who wrote such business as first tier reinsurances and a smaller number who wrote it as retrocessional business; and

iii) there were brokers other than SCB who participated in this part of the market.

(2) The brokers in the market: SCB and WFD

348. The leading brokers who participated in the reinsurance market were Marsh, Crawley Warren, Rattner Mackenzie, SCB and WFD.

(a) SCB

349. The origins of the Bermudan group holding company, Stirling Cooke Brown Holdings Ltd. (which was incorporated in 1995) was in the Fourth Defendant (SCIB). SCIB had started business in 1985 as an insurance broker. One of its principals was Mr Cooke; he was not called to give evidence. From the late 1980s it specialised in the placement of alternatives to traditional WC (as described at paragraph 123) and in the arrangement of associated reinsurance programmes. From 1989 it was able to place business in Lloyd's through an umbrella arrangement and it became a Lloyd's broker in 1991.
350. It built up, principally through Mr Cooke, a network of managing general agents (MGAs) in the US for the production of original business and its handling in an integrated manner. Until Mr Brown joined Mr Cooke and SCB was formed, the business of SCIB had not included the placement of the reinsurance of London market underwriters who wrote WC carveout or alternative WC business; it therefore had very little involvement in the retrocessional market for WC carveout and alternative WC business.
351. Mr Brown had begun his career in the market in 1977 with Eberli Shorter, dealing with direct aviation business. After a year he moved to Thompson Graham (which was purchased by Jardine Matheson). He became involved in reinsurance including LMX spiral aviation business as a claims broker. He first became involved in PA business when he moved to Bain Dawes in 1985. Initially he was a claims broker and helped out on placing; he subsequently became a full time placing broker, specialising in PA reinsurance.
352. Mr Butler began his career in the market straight from school in 1982 as an aviation claims broker. After about 14 months he went to the aviation reinsurance side of Jardine Thompson Graham and worked for Mr Ian Wilson (Mr Brown's manager) and Mr Brown; he learnt about reinsurance claims. He reported to Mr Brown. He moved to Bain Dawes with Mr Brown. They developed together, as described below, a substantial amount of LMX and retrocessional business.
353. In the late 1980s Mr Brown met Mr Cooke; they discussed merging the business that Mr Cooke had developed in the direct market and that which Mr Brown had developed in the reinsurance and retrocessional market. Their relationship strengthened after Mr Brown had secured the market's approval to treat EEII as PA business and coded it 'K' (as described at paragraph 227).
354. It was decided that Mr Brown would leave Bain Dawes with Mr Butler and that they would form a broking firm which would bring together insurance and reinsurance business. They would be able to handle the inwards business and the outwards reinsurance within a single group and thus enhance their market position and earn more. It became their ambition to develop the group into a full service insurance group, providing not only broking and underwriting services, but also owning an insurance company; their reinsurance arrangements in the PA reinsurance market in London were a very important component of their strategy for (as explained at paragraph 163) it gave them a competitive advantage in the US market, quite apart from the revenue stream described below.
355. When Mr Brown and Mr Butler left Bain Dawes, Mr Butler was put on three months' gardening leave and joined SCB in August 1992; Mr Brown had six months' gardening leave. They brought with them to SCB a very substantial amount of Bain Dawes' account for reinsurance and retrocession of PA, WC carveout and alternative WC business.
356. When Mr Brown moved to SCB, he became the Managing Director of the Fifth Defendant (SCRIB) (which has been an insurance broker since 1992) and a director of SCIB; he became the Managing Director of SCIB from late 1994. Mr Butler started as an associate director at SCRIB in August 1992 and was made a director in 1996 or 1997. Both SCRIB and SCIB are wholly owned subsidiaries of Stirling Cooke Brown Holdings Ltd.
357. As to the division of work between Mr Butler and Mr Brown, Mr Brown basically ran the company. In 1992 there were only five staff; everything went through Mr Brown. As the company got bigger, Mr Butler stepped into Mr Brown's role; they both tried to know what the other was doing and about what was going on within the company.
358. Apart from the network of MGAs built up in the US and the associated services of claims handling and risk management, SCB also established, in Bermuda, a facility for writing reinsurance business and captive management.
359. In 1992 SCB formed Raydon Underwriting Management Company Ltd. (Raydon) to underwrite reinsurance business in Bermuda. Its first underwriter was Mrs Penny Cooke, the wife of Mr Cooke; Mr Murray then became its President and Chief Underwriter; he had been an underwriter at Lloyd's at MF Baird Syndicates 31 and 32, and then an underwriter for Stockholm Re in Bermuda. He did not give evidence. In 1995 they established another underwriting agency – Realm Underwriting Management Ltd. (Realm UM) (see paragraph 453). SCB also owned Comp Indemnity Reinsurance Company Ltd. (CIRCL); this was a Bermuda-based company which primarily reinsured WC, but which also insured associated property and general liability risks; by 1996 its gross assumed premiums were $12.5m.
360. In January 1996 SCB formed Realm Investments Ltd. (a Bermuda-based holding company) as part of its ambition to become a full service insurance and reinsurance group with the aim of being able to deal with every aspect of insurance and reinsurance thereby earning a fee on each stage of the process. As part of this strategy, after an investment by Goldman Sachs of over $19m in order to acquire 34% of SCB, SCB acquired, in September 1996, Realm National Insurance Company (Realm National), a US-licensed property and casualty insurance company. In December 1997 (see paragraph 1118), the group issued shares on NASDAQ, mainly to raise further capital for Realm National.
361. By the time of the issue of the shares on NASDAQ:

i) SCB were the leading brokers in the PA market for writing gross loss making business on the backs of reinsurers; that was the evidence of Mr Johnson of WFD and EIU and was clearly borne out by the weight of other evidence.

ii) SCB had MGAs and offices in Texas, Florida and New York which marketed its products, underwrote, and handled claims, earning commissions of 13%-17% of premiums. Two of these were involved in writing the original business on Programmes 17 and 29.

iii) The group used independent carriers such as the Clarendon Insurance Group (see paragraph 429.i) to issue policies, but hoped, by using Realm National, to be able to earn fees and underwriting profits. Some of the business of Realm National was reinsured by SD under programmes such as Programme 9. The fees that were generated through business with Clarendon formed a significant percentage of SCB's revenue; Mr Cooke was responsible for that relationship.

iv) Through SCIB and SCRIB, the reinsurance and retrocession of the business was placed, earning further commissions; they earned commissions on all 35 programmes that had been written by EIU.

v) Realm UM and Raydon also earned fees by acting as MGAs for companies that insured and reinsured the business. Raydon was involved in the underwriting of five programmes – Programmes 9, 14, 15, 18 and 35. Realm UM was involved in the underwriting of one – Programme 25.

vi) SCB had an interest in JEH Re (see paragraph 453.ii)) which wrote business which was reinsured under Programmes 1, 12, 28 and 33.

vii) SCB had a lineslip, first from Lincoln National (see paragraph 438 below), and then from CIGNA (see paragraph 1039), the business under the lineslips being reinsured under Programmes 4, 11, 23 and 29.

362. As Mr Brown accepted, the lion's share of SCB's income was derived from businesses which were connected with WC insurance in the US; their revenues had risen from $4.8m in 1992 to $46.8m in 1996 and the profitability had similarly risen. A diagram in the prospectus for the IPO (reproduced on the following page) set out how they were able to earn income at each stage of the process; this ability to earn fees at each stage was a very important aspect of SCB's success and was an important driving factor in the realisation of their ambition to expand the group.


(b) WFD

363. WFD were also heavily involved in this business:

i) The principal broker who dealt in this class of business at WFD was Mr Johnson, whose assistant was Mr Michael Davis (not the same Michael Davis who was the underwriter at Syndicate 103 and at the Busbridge Syndicate).

ii) Mr Johnson had begun his career in broking in the late 1970s at Wigham Poland and had taken over the PA account there when the broker handling that account left. Wigham Poland were purchased by E.W. Payne (Sedgwick) and he remained with them until August 1990.

iii) He began working at WFD in February 1991 and remained there until July 1998; he was an executive director and the head of a department that was part of the European Division of WFD. When he left WFD he moved to Alwen Hough Johnson.

iv) His evidence was that SCB were the undoubted market leaders and that SCB had access to more markets than he did; that evidence was correct.

(3) The relevance of events between 1993 and 1996

364. Although it was my view that there were a very substantial number of issues for decision in this trial which did not require an examination of the market between 1993 and 1996, SCB and SD nevertheless both wished me to do so, though for differing reasons. I agreed, but in approaching the events of this period, I very much took into account the fact that many of those involved did not give evidence to the Court.
365. SCB relied on the events to show that the business they placed with SD was no different to that which was placed in the market prior to 1997. SD's case was more complex.

(a) SD's case: the need for capacity and the contrived spiral

366. It was SD's case that between 1993 and 1996, SCB were seeking to develop and strengthen their position in the US in order to establish themselves as a full service insurance group; to this end, they needed those who were prepared to provide cheap reinsurance for WC, WC carveout and alternative WC products. They pursued this aim in two ways – giving those who provided reinsurance to them a means of passing losses on, and seeking new capacity.
367. The first way was their establishment of a contrived spiral as part of scheme which SD characterised as "profoundly dishonest" as it depended on falsifying ordinary expectations and appearances and exploited the ignorance of those with whom they placed reinsurance:

i) As set out at paragraph 253.viii), it was SCB's strategy to use its broker's access to the market in London and elsewhere to provide cheap reinsurance for the WC and carveout business that it was marketing in the US.

ii) They found reinsurers who would write business for them at the first tier at rates that would result in the business being gross loss making; they arranged for the those first tier reinsurers who wrote at the lower levels of XL reinsurances to reinsure amongst themselves at artificially low rates at successive levels of XL reinsurance. This was done as a means of funnelling up losses from knowing players to the unsuspecting reinsurers at the higher levels. It was also done to conceal the fact that, as a result of the spiral, the unsuspecting reinsurers at the higher levels would have to pay losses which would normally not be paid by higher layer reinsurers; the effect of the spiral was to delay notice of those losses to the higher layers so that the fact that they would have to pay the losses was concealed from them for a longer period.

iii) The reinsurers at the higher layers would, as SCB knew, rate the business in accordance with the ordinary appearance of the business and thus charge a significantly lower rate than that charged by primary layer underwriters on the basis that they would not be paying working layer losses; they would be acting on a false premise arising out of the creation of a tight spiral.

iv) The participating underwriters at the lowest layers were asked to write the programmes in one go.

v) By the time the losses came in the underwriters had moved on. They were orchestrating a massive fraud through the contrived spirals to feed hopelessly loss making business in at the bottom at very low rates that would eventually end up in the hands of unsuspecting underwriters who thought that they were writing catastrophe business.

vi) This enabled SCB to earn massive commissions and to undercut their competitors in the WC market in the US by charging rates which would be suicidal without the underpriced reinsurance cover.

368. This was denied by Mr Butler and Mr Brown:

i) Mr Brown's and Mr Butler's evidence was that anyone who wrote in the retro market must be aware of the risk that losses might spiral up. As set out at paragraph 191.ii), once an underwriter crossed the threshold of writing retro business, he was at risk of losses spiralling up irrespective of the layer at which he was writing. Any underwriter who entered the market had to buy reinsurance to cover the full level of his aggregates; he should not have been in the market if he failed to do so .

ii) Each underwriter decided whether or not to write the business. There was no plan – each underwriter was free to accept or reject risks.

iii) Mr Brown said that they had acted no differently to WFD, Aon or Crawley Warren; others in the market had also used Mr Bird and Mr Billyard. They did not use the new participants exclusively; Crawley Warren used Phoenix as well. Mr Brown's evidence was that the fact was that they used the same markets as other brokers – WFD's files showed that.

iv) Mr Brown's evidence was that it was SCB's practice in this market to collect the contracts that were to be underwritten into a block and book a long appointment with the underwriter in order to go through them with him; this was the practice that had been developed at Lloyd's because of the 1 January renewal season.

v) Spirals simply arose in the market when underwriters used the same reinsurers to reinsure themselves and an effect of a spiral could be to delay the ultimate payment of losses.

369. The second way in which SCB pursued their aim was to seek new capacity; amongst those whom SCB hoped would provide new capacity was a new company that was to be formed first by Mr Whitcombe and Mr Bird, and then by Mr Whitcombe and Mr Henton. If they were able to do this, then the new company would become a participant in the business. SD relied on a passage in Mr Whitcombe's evidence (see paragraph 490.i)) as an admission that there was an agreement with SCB that SCB would bring business to the new company which the new company would then write as a participant in the market.
370. This was also denied by SCB:

i) Mr Butler's evidence was that if the new company had got off the ground, they would have offered it business, but that they had no agreement or arrangement with them. It would have been up to them if they wanted to participate in spiral business. There was no agreement in place and Mr Whitcombe was mistaken if he had thought that there was.

ii) Mr Brown could not say whether the new company would have come into the spiral arrangements if it had been formed.

iii) Mr Henton denied that he was going to follow Mr Billyard, or that he had had any involvement in the SCB proposal referred to at paragraph 424, or that he was to be a part of any arrangements operated by Mr Billyard.

(b) Mr Brown's and Mr Butler's experience of the market

371. The evidence of Mr Brown, Mr Butler and Mr Johnson was that they considered that the business they had placed was business that could properly and honestly be written in the market. It was submitted on their behalf that even if I concluded that they had acted dishonestly on an objective basis, they were not subjectively dishonest within the meaning of the decision of the House of Lords in Twinsectra.
372. As this was an important issue, I permitted evidence to be adduced in relation to the business placed by them prior to 1993; this comprised:

i) Renewal lists of Bain Dawes' in respect of business placed principally by Mr Brown and Mr Butler between 1987 and 1993; they gave evidence principally by reference to a schedule as to the underwriters whom they believed were ceding or writing gross loss making and/or spiral business.

ii) Documents comprising cover notes and other materials in relation to business which was placed in 1991 and 1992 by Mr Brown and Mr Butler; Mr Brown and Mr Butler set out their evidence in the form of schedules that identified the loss ratios of the cedants (Mr Billyard, Mr Cackett, Mr Robin Payne of Syndicate 305 (referred to at paragraph 504) and Mr Keith Smith of Syndicate 257), which could have been calculated from the placing information supplied to the underwriters who had reinsured them; these showed loss ratios of up to 2,343%; this demonstrated that such business could be placed in the PA reinsurance market and that Mr Brown and Mr Butler had placed it on the type of information which was typical in the PA reinsurance market.

iii) Renewal lists of Sedgwick for 1990-2 showing similar information in respect of business which was placed by Mr Johnson; he gave evidence principally by reference to a schedule as to the underwriters whom it was believed were ceding or writing gross loss making and/or spiral business.

373. SD submitted a schedule in which they abstracted from syndicate reports, the accounts of the types of business written by some of the underwriters which had been identified by Mr Brown and Mr Butler as knowingly writing gross loss making business and ceding it to reinsurers. None of them reported to their Names that they were writing gross loss making business on the backs of reinsurers; amongst the syndicates whose reports were examined were Syndicates 305 (Payne), 398 (Billyard), 464 (Hall) and 957 (Cackett).
374. In considering this material I was concerned to evaluate the evidence of Mr Brown, Mr Butler and Mr Johnson as to their belief:

i) I cannot reach a conclusion as to whether any particular insurer was in fact writing gross loss making or spiral business; the evidence did not enable me to do so and it would be unjust for me to express any view without evidence from the insurers.

ii) It appeared from the most detailed information (that provided by Aon) that the loss ratios in 1991 were not generally as severe as those in the business placed by SCB with EIU, that the lines were smaller and that many participated on the higher layers as well as the lower layers.

iii) The business placed with EIU and in the years 1993-6 was predominantly WC carveout; on the evidence before me (in so far as it went), the accounts written prior to 1993 contained a less heavy element of carveout.

iv) There were many more participants in the market in the years prior to 1993; although there were plainly spirals, there was no evidence that they comprised as few participants as those in 1993 and thereafter. Indeed, given the number of participants in the market, it is highly probable that they were not tight spirals and had comprised many participants.

375. Mr Brown and Mr Butler also relied on SCB's renewal lists and the prior year's placing files for placing business with EIU in 1997 and 1998; these showed that the business with large gross loss ratios had been placed on the limited information of the type set out in paragraphs 210 and following.
376. Mr Butler's evidence was that from the time he entered the market, insurers were prepared to write business where they were aware, on acceptance, that claims to the contract were likely to exceed the premium; they wrote such gross loss making business on the basis that they had an outwards reinsurance programme which would take the losses. They would do so year after year.
377. Mr Butler looked on those with retentions as low as $1,000 (but which gradually rose during the 1990s, first to $5,000, and then to $10,000) as engaging in net underwriting. He identified a number of well known syndicates at Lloyd's whom he believed were accepting gross loss making business on an arbitrage basis, including the syndicates underwritten by Mr Billyard and Mr Cackett; he also identified other brokers (including Crawley Warren, Robert Bruce Fitzmaurice, E.W. Payne and Alwen Hough Johnson) who placed the same business as SCB. He placed that business on the basis of the limited information to which I have referred at paragraphs 210 and following. As so many were writing gross loss making business on an arbitrage basis, he considered this an ordinary way of doing business in the market.
378. Mr Brown's evidence was to the same effect, though his experience was longer than that of Mr Butler's. His evidence was that there were reinsurers who would write such business where the loss ratios year after year were several thousand percent. They only did so on the basis that they had outwards reinsurance. Such reinsurance had been available with unlimited reinstatements from at least 1989.
379. Mr Johnson's evidence was to the same effect; he had placed numerous reinsurances with very low retentions of gross loss making business where the gross loss ratios ran into hundreds of percent; he had done so on the type of limited information set out at paragraphs 210 and following. He considered that underwriters could act on this basis as they could predict their retained losses fairly accurately as it was a matter of frequency rather than severity. He understood that the worst things an underwriter in the market could do was not to purchase adequate reinsurance cover and not to achieve his premium income as the underwriter would then not be able to pay the premium on his outwards reinsurances; indeed Mr Brown confirmed this as underwriters of this business often did not want to be signed down.
380. This evidence accords in general terms with the general evidence I have set out in relation to the London PA reinsurance market and that part of it which reinsured WC carveout business. I accept that Mr Brown, Mr Butler and Mr Johnson believed, along with others in that market, that provided there was a fair presentation of the risk and that there was full disclosure:

i) gross loss making business could be ceded to reinsurers who would write such business on the basis of outwards reinsurance;

ii) reinsurers could write such business;

iii) such business could be placed with those who were active participants in the PA reinsurance market on the basis of the typical information to which I have referred at paragraphs 210 and following.

The key factor was a fair presentation and disclosure; each knew of their duty to give disclosure and to make a fair presentation.

381. I set out my further conclusions at paragraphs 523 and following.

(4) The market in 1993

(a) The contraction of the market and the spiral

382. There were a number of syndicates and companies that wrote PA business, WC carveout and alternative WC (either directly or through a front or through a QS) and which then sought to place the reinsurance of that business; among those which wrote such business for SCB were Syndicate 53 (Mr Crane), Syndicate 957 (Mr Cackett), Busbridge Syndicate 959 and Theakston Syndicate 1101.
383. Prior to 1992 there were a number of syndicates at Lloyd's which would write reinsurance or retrocession down to very low levels. The market at Lloyd's contracted in 1992 for 1993; there were a number of syndicates who could not continue as they did not have support; the market became smaller and started to move into the company market.
384. It was common ground that in 1993 there was a spiral amongst those who wrote the reinsurance of PA, of WC carveout and of alternative WC business. The four main participants of the spiral were:

i) Syndicate 103;

ii) Mr Billyard at Duncanson & Holt Europe Ltd. (D&H)'s London Accident Reinsurance Group II (LARG II) pool;

iii) Mr Owen at Syndicate 718; and

iv) Mrs Penny Cooke at Raydon for North American Fidelity & Guarantee (NAF&G).

Mr Butler's evidence was that there were others.

(b) Syndicate 103 and Mr Bird

385. Syndicate 103 is important to the account of events as its active underwriter between 1991 and 1993 was Mr Bird who subsequently joined SCB; its business was said to be the model for the business subsequently written by EIU.
386. The syndicate was originally an aviation syndicate whose active underwriter during the 1980s was Mr Peter Guinnery. His deputy was Mr Michael Davis who took over on his death. In 1987 Mr Davis started writing LMX for the 1988 year; according to Mr Henton, a large part of the LMX account was broked to the syndicate by Mr McNamara of Bain Dawes, whose assistant was Mr Brown. Mr Davis was one of the joint leaders on the Stirling Cooke EEII lineslip and he also wrote other WC carveout business. Some of the PA business he wrote was, according to Mr Johnson, gross loss making business.
387. In July 1991 Mr Bird was appointed by the managing agent, Knightstone Ltd., as the active underwriter when Mr Davis left to join the Busbridge Syndicate. Mr Bird had joined the insurance market in 1966; he was a clerk at first, then a broker and then he became an underwriter in 1980 when he was made an assistant underwriter at Syndicate 109; he became the deputy underwriter in 1989. When he was appointed as the active underwriter of Syndicate 103 in 1991, most of the business for 1991 had already been written; he wrote the account for 1992 and 1993. A decision in May 1993 was made by Mr Trevor Bradley, the Managing Director of Knightstone, that Syndicate 103 would not write an account for 1994. Mr Bird had had one of the largest lines on the syndicate without a personal stop loss (£75,000); in 1997 or 1998 he had bought, before (according to the evidence which he gave to the Court) he was aware of the avoidance of some of the syndicate's reinsurances (see paragraph 522), a personal stop loss from Lloyd's through CentreWrite which indemnified him against all the losses.
388. Under Mr Bird the Syndicate focused on PA and related classes of business – direct business, lineslips, LMX and treaties. Mr Bird discontinued the aviation business which was written by Mr Davis and 99% of the syndicate's business for 1992 was PA business; its stamp capacity reduced from £14m in 1991 to £6m in 1992. According to Mr Henton, Mr Bird moved the location of the syndicate's box from the ground floor to the second floor where another syndicate within the same group had its box; this meant that he was next to Mr Billyard and near Mr Owen, as this was an area which PA brokers visited regularly.
389. The PA business for 1991 included a book of LMX business which had been written by Mr Davis and which was about 30% of the account; of that 30% about 30% comprised retro and spiral business. Mr Bird continued to write this as the overall net figures from 1988 to when he took over the syndicate were good and the income was in sterling which was useful to pay syndicate expenses. He only wrote xs $100,000. He did so on the basis that it would make a gross loss, but that outwards reinsurance was in place to pay for the losses so that the syndicate's net exposure would be its retention of $5,000. It was not clear whether there may have been other parts of the account that contained gross loss making business, but this was not appreciably more than the 10% of the account which was retro and spiral business. It was Mr Bird's further evidence (as set out in a letter dated 8 January 2003) that only about 10%-15% of the account written by the syndicate was WC carveout and that it was higher level contracts often with multi-life warranties; Mr Henton disputed whether this was accurate; for reasons I have set out, I attach no credence to Mr Bird's unsubstantiated assertions.
390. The cost of outwards reinsurance was about 25%-30% of the income at Syndicate 103; the gross loss made had been turned into profit by outwards reinsurance in the 1989 to 1991 years – Syndicate 103 was writing against reinsurers on certain sections of the account. Mr Davis and Mr Bird both wrote risks that would not produce a gross profit as they both participated on working layer protections where this was not probable. Although retro and spiral business was only 10% of the book, it was expected to produce gross losses several times the premium; by the end of 1995 the loss ratio on the reinsurances of the syndicate for the 1991 underwriting account was in the order of 800%.
391. Mr Bird's evidence was that at the time, he did not think of the effects of the spiral either (1) in moving any loss greater than the sum of the retentions into the higher layers, or (2) in delaying the notification to those in the higher layers, or (3) on the cash flow of the syndicate.
392. Mr Butler's evidence was that Mr Bird wrote quite a lot of business for SCB, including the EEII lineslip; the reinsurances of the syndicate were placed by several brokers besides SCB, including Rattner Mackenzie, Crawley Warren and Robert Bruce Fitzmaurice. Mr Johnson placed some of the gross loss making business with Mr Bird at working levels but only above $100,000. Syndicate 103 led on some schemes and there was no difficulty in completing the business.

(c) Mr Henton

393. The other reason why Syndicate 103 is important to this case is that Mr Bird's deputy at Syndicate 103 was Mr Henton and it was at that syndicate that Mr Henton learnt about the type of business that he was to write on behalf of SD at EIU. He was born in 1965. He first worked for Alexander Howden Ltd. and joined Syndicate 103 in 1986. He served first as an assistant to Mr Guinnery and then became a deputy to Mr Davis at Syndicate 103 in 1989. He was with Mr Davis until 1991 when Mr Bird was appointed and he subsequently became Mr Bird's deputy. Mr Henton was not a Name on the syndicate.
394. Mr Henton learnt about the business being written by the syndicate when he was a deputy; he sat within hearing distance of Mr Bird, either alongside him or opposite him, and saw the risks being broked and then entered the line; he generally assisted, wrote traditional PA direct business and looked after claims. At the syndicate, Mr Davis and Mr Bird wrote the treaty accounts and, although Syndicate 103 was mainly a follower, they rated the risks where they were leaders and Mr Henton saw them do this. Mr Henton did not write LMX business himself, though he did assist. It was the underwriter who put the reinsurance together, though he said that he assisted in this. He said that he had helped prepare the report to the Names for 1993. Mr Henton did not recall the business being catastrophically loss making – there was some business which would make gross losses of 100%, 200% or 300%. His evidence was that the reinsurers took losses as this was a widespread feature of the market. Rates were low.
395. Mr Henton's CV and job description (produced in February 1997) exaggerated (as he accepted) his knowledge and role. At Syndicate 103, he had never led or written LMX, XL or spiral business and he did not have a significant role in the placing of the reinsurance.
396. In June 1994 Mr Henton ceased to be employed by Syndicate 103; until March 1995 he was self-employed as an insurance consultant. He then became an employee of City Run-Off Ltd. (subsequently renamed Eastgate), an agency that handled the run-off of various syndicates, including Syndicate 103.

(d) The information provided to the Names on Syndicate 103

397. The third reason why it is necessary to refer in some detail to Syndicate 103 is in relation to the information provided to the Names on that syndicate about the intentional writing of gross loss making business and of spiral business.
398. Mr Bird's evidence was that the board of Knightstone (of which he was a member) knew that he was writing spiral business. Although he would not have referred to it as gross loss making business but only as spiral business, the board would have known about the true nature of the business as, in his view, the very nature of spiral business was that it was gross loss making business; he discussed this matter fully with Mr Bradley and the business plan was put before the board. He would have expected Mr Whitcombe, who was also a director of Knightstone from July 1991, to know about this.
399. Mr Bird also maintained that he discussed this matter with the main supporting members' agent, HG Poland (Agencies) Ltd., as they were interested in the spiral and WC carveout part of the account. His evidence was that there were rumours in the market at the time that it was not quite as short tail as it purported to be. He had told the agents that he would write the business provided that he could buy reasonably priced aggregate protection; he had made clear what the business was in very plain terms.
400. However, there was nothing in the syndicate reports which described the spiral or the fact that gross loss making business was being written, until the 1995 accounts were written after Mr Bird had left. Those accounts described the business in the following terms:

"It is a feature of the personal accident market that comprehensive reinsurance coverage is available with very low retentions. Consequently, there is scope for losses to "spiral". Our ultimate loss projections indicate that net retained claims from this source will be very modest but it must be recognised that future inwards claims will be substantial and that the final net loss is dependent on the response of reinsurers."

A more realistic description of the spiral was not given until serious problems had arisen in 1997 – see paragraphs 514 and following. Nothing was said about the fact that gross loss making business had been written.

401. Mr Bird's explanation for the fact that the Names were not told of the true nature of the business being written was that he did not think that the report and accounts sent to the Names was a place where one had to explain to the Names what was being written – they had already committed themselves for the year by the time the report and accounts came out; it was for the members' agents to advise the Names on the type of business being underwritten. He also maintained that a reader of the accounts could see from the accounts that recoveries from outwards reinsurance greatly exceeded the premiums.
402. Mr Bradley's report on the 1991 account of Syndicate 103 described the account as:

"To some extent yesterday's expenses and yesterday's liabilities are being funded out of today's premiums. Part of the solution has to come from future profitable underwriting. This market needs above all competent Underwriters who are going to write, not for turnover, but for profitability."

This was agreed by Mr Whitcombe, rightly in my judgment, to be grossly misleading. In Mr Bird's report on the 1991 account, no mention was made of the fact that gross loss making business and spiral business was being written on the back of reinsurance.

403. In the report on the 1992 account written on 25 May 1993 and therefore written at a time when Mr Bird was still responsible, it was stated by Mr Bradley:

"David Rowland has pointed out that the market cannot be left to its own devices any longer. Otherwise it may bring itself to the brink of destruction. The LMX spiral will no longer exist and the long tail losses of the past will be ring fenced…"

404. Nothing was said about the spiral business being written in Syndicate 103's PA account; Mr Bird's evidence was that Mr Bradley would have known that he was writing retrocessional spiral business and gross loss making business on the back of reinsurance.
405. In the accounts for 1993 (signed in May 1994), Mr Bird (who shortly afterwards left when the syndicate passed to Eastgate) commented on the 1992 account and the decision, after a detailed review, to restrict the 1992 account to PA and related classes only. He said:

"The benefits of these changes are now obvious. The incurred loss ratio as shown in the report is some 40 percentage points better than 1991 at the same stage. Lloyd's have been provided with a forecast profit of between 17.5% and 22.5%."

The true nature of what had been written by Syndicate 103 as part of its PA business was not explained.

406. Mr Bird said that the accounts were audited by Littlejohn Frazer; he did not recall discussing the spiral with them, but they had been involved in the non-marine market spiral and knew of its effects. Littlejohn Frazer were also the auditors to EIU and Mr Whitcombe.
407. Mr Whitcombe's evidence was that not explaining it to the Names was how the agency "got away with it for so long" and that that contributed to Lloyd's getting such a bad name. He accepted, as set out at paragraph 401, that one of the passages in the 1991 report was grossly misleading.
408. I am sure that the reports to the Names of the syndicate concealed the true nature of what was being written and that Mr Bird knew that the passages in the reports to which I have referred at paragraphs 401 to 404 were seriously misleading. It was obvious to Mr Bird, after the problems that had arisen in relation to the spirals in 1988-90, that any Name would want to know that he was engaged in spiral underwriting and was deliberately writing gross loss making business on the backs of reinsurers. I am sure that Mr Bird dishonestly concealed the position from his Names during the years in which he was responsible for the report because he knew that he could only engage in that activity if he hid from them the true nature of the business he was conducting on their behalf. In reaching that conclusion I have taken into account EIU's submission that it was Mr Bird's general demeanour to be generally uncommunicative and defensive.
409. No evidence was called from Littlejohn Frazer and I reject Mr Bird's evidence that he had discussed the matter with them. No auditor of any integrity or probity could have possibly connived in the deception of the Names.

(e) Mr Billyard and Duncanson & Holt

410. Mr Billyard was the deputy underwriter of Syndicate 398 from 1974 to 1982 and the underwriter from 1982 to 1992. Mr Billyard had two principal accounts: (1) his direct account for WC carveout and alternative WC business, and (2) his LMX spiral or retrocessional account.
411. In 1992 Mr Billyard moved to D&H. This was part of the D&H group of underwriting agents in the US, London and in other insurance markets. D&H established a pool known as LARG which operated from 1990. All the reinsurance for this was placed by Bain Dawes. A second pool was established in 1992 known as LARG II to write LMX and WC carveout business. Mr Billyard became the underwriter of that pool from late 1992 to mid-1995 when he left to go to Bermuda (see paragraph 453). According to Mr Brown, Mr Billyard had been asked on many occasions to join D&H by Mr Tom Brown, the President of D&H.
412. The risks written by Mr Billyard at D&H were fronted by Chubb Insurance Company of Europe (Chubb) and Federal; Phoenix was among the participants. When Mr Billyard joined D&H he took the lead on the EEII lineslip which he had led for SCB at Lloyd's; where clients still wanted a Lloyd's lead this was done by Mr Bird at Syndicate 103 in 1992 and 1993. Mr Billyard was succeeded by Mr Raymond Hoare (who gave evidence principally in connection with Programme 16).
413. There was no detailed evidence as to the precise nature of the account written by Mr Billyard at D&H, but it was clear that he wrote a huge volume of gross loss making and spiral business on the backs of reinsurers; as will be seen, he continued to participate in a programme of reinsurance with low retentions. From the information provided in relation to one series of contracts written by Mr Billyard at D&H which it was necessary to examine, the gross losses on SCB business placed with him were very large (see paragraph 357 of Part II). It was Mr Butler's evidence (given in connection with a similar request to Mr Cackett by his principals, considered in relation to Programme 24 – see paragraph 722 of Part II) that Federal Insurance Company (Federal) and Chubb had raised the retentions in 1995-6 against Mr Billyard's wishes.
414. Mr Billyard was, according to Mr Crane, the recognised lead on WC carveout business for probably 99% of the risks; this was one part of his account; the other part comprised retro excess of loss business. Mr Billyard continued to be the lead when he joined D&H whilst Mr Crane became the Lloyd's lead. It was Mr Crane's evidence that Mr Billyard ceased to be the leader of WC carveout business when he went to Bermuda.
415. Mr Billyard led the majority of the business placed by SCB.
416. By 2002 Mr Billyard was in his late 70s; he was fit and had given evidence in an arbitration in the US between John Hancock Mutual Life Insurance Company (John Hancock) (for whom Mr Billyard underwrote when he moved to Bermuda) and Realm National in relation to the B&S scheme (see Programme 9) in which John Hancock lost. He was not called to give evidence in this trial. SD contended that he had highly material evidence to give to the Court and should have been called as he was an employee of the SCB group in 1997-8. Counsel for SCB told the court that because of the litigation that was taking place, SCB had reason to believe that Mr Billyard would not co-operate with them in any way; he was in fact quite likely to do the reverse.

(f) The placing of the reinsurances in 1993 and the creation of the spiral

417. It was Mr Butler's evidence that after joining SCB from Bain Dawes in August 1992 he became involved in placing the reinsurances because (as set out at paragraph 354) Mr Brown was on gardening leave for a longer period than he was. The reinsurances that formed the spiral were placed as follows:

i) Mr Bird asked Mr Brown in August 1992 to get an indication of the market rates for his reinsurance for 1993 so that he could insert a price into his business plan. It was his agency's policy that he could not write any LMX until he had reinsurance in place. Mr Brown, Mr Butler and Mr Billyard met at The Green Man public house at Heronsgate in August 1992 to discuss about the market, as Mr Brown was still on gardening leave then.

ii) Mr Billyard traditionally "kick started" the market. Mr Billyard was approached and gave an indication of the rates, though Mr Brown could not recall if they were given at The Green Man.

iii) Mr Billyard then quoted for Mr Bird. No statistics were provided. The programme was different to the one in 1992 as the retention was $5,000 in 1993 whereas it had been $1,000 in 1992, and the layering was changed in 1993. Mr Billyard provided an overall percentage rate for the first $3m.

iv) The quote was given for the first $3m as this was for the first block of cover which Syndicate 103 usually quoted. Mr Bird completed his underwriting plan by taking the rates for the higher layers from the previous year as he did not expect that the rates would move much.

v) Mr Bird denied that he had quoted for the provision of reinsurance; Mr Brown's evidence was that indications had been provided. I am sure that Mr Bird at about the same time gave either a quote or an indication for the reinsurance of Mr Billyard's LMX account; the overwhelming probability was that the quote or indication was given at about the same time to enable the business to be written, and on condition that Mr Billyard would provide Mr Bird's reinsurance. Mr Bird did not fully commit the syndicate, as he was not then certain that the syndicate would go forward.

vi) The quote or indication was given without statistics; Mr Bird's explanation was that Mr Billyard's LMX account was new for D&H from 1 January 1993.

vii) The quote or indication was not available, but the evidence indicated that the rates were similar to Mr Billyard's and were probably the rates which Mr Billyard wanted, though Mr Bird would not have quoted for the layer below $100,000 as the syndicate did not have the capacity to take the premium volume on the lower layers.

viii) Thereafter programmes were placed for Mr Owen of Syndicate 718. This was a syndicate within Sturge. Mr Owen did not like EEII business and consequently did not participate on the lineslip; he had, as set out at paragraph 227, objected to EEII being classed as PA and had refused to reinsure it. He had lost income and had then come back in after a year, from which point in time he was happy to accept EEII on a reinsurance basis. He left Syndicate 718 in 1995, as set out at paragraph 436.i).

ix) NAF&G's participation, which came last, was through Raydon where the underwriter was Mrs Penny Cooke. Mr Brown's evidence was that this was a company which was introduced to Bermuda by Mr Jim Parkinson of Stockholm Re who had a facility on their behalf. Mr Parkinson had asked Mr Mark Cooke to write PA business for them and NAF&G had given a facility to Raydon. NAF&G were originally a Bermuda-based company that subsequently moved to Belgium. Mr Brown's evidence was that the market had lost confidence in them in 1993 as there were doubts about their security.

418. In the result the four largely reinsured one another. The reinsurances began at an excess point of $5,000 and all four reinsured one another to the layer of $500,000; this was with only limited leakage (as on the evidence I am satisfied that the participation of Mr Cackett and of Mr Terry Panter (of Syndicate 1121) in Mr Owen's reinsurance went back into the spiral) – this is shown in Table A. .
419. The rates for the reinsurances were similar and came to about 24%-25%; the 1992 rate for Syndicate 103's programme was 27.91%.
420. Those who gave evidence denied that the spiral for 1993 was contrived or that there was any reciprocal understanding:

i) Mr Butler did not accept that there was a reciprocal deal; they were charging market rates.

ii) Mr Bird's evidence was that there was no reciprocal deal as Mr Billyard wrote more aggregate for Mr Bird than Mr Bird did for Mr Billyard, and that Mr Billyard was getting nothing from Mr Bird for his bottom layer. Although they reinsured one another, there was no understanding; it just evolved each year from the way in which the market operated.

iii) Mr Bird's evidence was that what mattered to him was the total aggregate (vertical and horizontal) and the total price – the layering within that did not matter. When he was investigating the market at the time he took over the syndicate, he found that Mr Billyard had started the market and others had then supported him and he had subsequently quoted for more reinsurances. Although the market had reduced for 1993, no one appreciated quite how much it had reduced by; many such as Mr Cackett had stayed out of the market. Mr Bird did not know or care who was reinsuring whom as long as his programme was placed. He placed his programme as high as was possible, as the cost of the programme at the top was negligible.

iv) Mr Brown did not accept that there was a tight spiral; such spirals occurred in other markets such as the non-marine property and casualty markets.

421. There was participation by others, particularly on the reinsurance of Mr Owen's syndicate, including Manulife (a Canadian company), Transamerica Occidental Life Insurance Company (Transamerica) (who had participated through an underwriting agency in Toronto, Reinsurance Risk Management where the underwriter was Mr Peter Lerner who had worked for Manulife), Mr Graham Williams (Syndicate 256) and CIGNA. These provided the leakage save where there were reinsurances back into the spiral. In the case of Mr Owen, as is clear from Table A. , he had a wider spread of participants than the others.
422. As I have made clear at paragraph 243, I am not going to make any findings in relation to the actual knowledge of those others who had participated. In particular, although evidence was given before me as to the involvement and knowledge of Manulife (who also had a 25% QS of Syndicate 103), I do not make any findings in relation to their knowledge. Similarly, although it will be necessary to refer to the circumstances of the successful avoidance by Transamerica of their reinsurance of Syndicate 103 (see paragraph 522), I make no findings as to their knowledge for the purposes of these proceedings.

(5) The market in 1994

(a) Continued contraction and new capacity from the US

423. The process of contraction of the market in London continued; the position in Lloyd's with syndicates losing their capacity and being unable to continue was the same for the year-end 1993. There was, however, an influx of new capacity from North America which I was told was anxious to participate in the London market; such companies often had considerable capacity. This replaced the loss of capacity at Lloyd's.
424. A decision was made in 1993, as set out at paragraph 386, that Syndicate 103 would cease to underwrite and it was not a participant for 1994. Mr Butler's evidence was that they did not need new capacity when Syndicate 103 dropped out. However, SCB had set about finding new capacity in the summer of 1993 for the 1994 year.

(b) SCB's proposal to Phoenix and Hackett

425. Sometime between the second and third quarter of 1993, SCB produced a business proposal for 1994 to try and assist with the capacity problem both in the direct and in the reinsurance market. It was put forward, according to the evidence given by SCB, in the form of a discussion document, but according to Mr Brown it was written with two persons in mind and was given to them:

i) The first was Mr Robin Ekwall of Phoenix, an insurer based in Hartford, Connecticut and which was part of the Phoenix Life Group; the underwriters at Phoenix were Mr Ekwall and Mr Steve Wright. When Mr Ekwall and Mr Wright left to form WEB (see paragraph 1026), Mr Marty Huey, who had been their line manager, looked after matters until Mr Glenn Swanick arrived at Phoenix. Mr Huey was assisted by Mr Fred Sawyer. At the end of 1996 or in early 1997, Mr Swanick joined Phoenix from Manulife; he had been the head of the special risks division. Phoenix and Manulife participated on the LARG pools and on another pool known as the LDG LMX pool. SCB had been put in touch with Phoenix by Mr Tom Brown, the President of D&H; Mr Brown's evidence was that Phoenix had liked Mr Billyard's underwriting.

ii) The second was Mr James Hackett Senior of James E Hackett Reinsurance Corporation (Hackett). Hackett was an MGA founded in 1991 for the purpose of underwriting group health and accident reinsurance. It had obtained an exclusive authority under an agreement dated 1 April 1991 to underwrite the reinsurance of PA, WC carveout and WC related classes for John Hancock. The initial period of this agreement was until 31 December 1996. Hackett's management fee was 6%. By an addendum to the agreement dated 4 November 1996, JEH Re Underwriting Management (Bermuda) Ltd. (JEH Re) – see paragraph 453.ii)) was added with effect from 1 April 1991 and the term of the agreement was extended to 31 December 1997, with automatic renewal for successive periods of 12 months unless 12 months' notice was given. Its main office was in Milford, Connecticut (where the President was Mr Hackett Sr and one of the underwriters was Mr Jim Cody until he left in 1997). There was also an office at Philadelphia (where the underwriter was Mr Robert Carey). Mr Hackett Sr had written a little London market business and had come to London on a few occasions.

426. The SCB proposal was based on what Mr Brown and Mr Butler had done at Bain Dawes; at Bain Dawes they had presented a proposal to a company that they would write all their business to them as a single broker and that they would handle all claims collections.
427. The proposal contained a number of important points:

i) It referred to Mr Billyard resigning from his syndicate (where he had made a substantial profit for his Names) and setting up a facility for D&H; it said that he had left because of dwindling stamp capacity and because of the opportunity to work without the restrictions of Lloyd's; it claimed that, barring one or two very small and isolated cases, no specialist PA syndicate had lost money from that class and that the proposal represented:

"a great opportunity for the 1 January 1994 renewal season, for a number of companies to take advantage of present market conditions in London and gain a reasonable market share in this short tail profitable area of reinsurance."

ii) It proposed that SCB would offer the reinsurer who accepted the proposal, all the inwards business from SCB. The majority of contracts would be led by Mr Billyard at D&H or by "a very well respected Lloyd's syndicate" (according to Mr Butler and Mr Brown that was a reference to Mr Cackett, though he did not in fact write any of the contracts as he had stopped writing retro); the line offered would be no bigger than that of the leader's. Each reinsurer would be free to accept or decline any individual contract offered. In essence what the reinsurer who accepted the proposal would be doing was:

"replacing capacity, which a year ago would have been written by Lloyd's syndicates following the same lead."

iii) SCB would monitor written aggregates and premium income and provide a claims service; this was a considerable attraction for any participant, though it was SCB's position that one broker had to provide all the inwards business to make it work. All inwards claims would be approved by participating reinsurers, but the claims would all be presented by SCB who, once approved, would then allocate the claims to the outwards reinsurance programme. The system was subsequently used where brokers other than SCB placed the business with the relevant companies.

iv) SCB would provide an outwards reinsurance programme which would cover the vertical aggregates written by a reinsurer which accepted the proposal with unlimited reinstatements and a retention no higher than that of the leading reinsurer's and which was for the same cost; that outwards reinsurance programme would cost 25% of net premium income which would leave them exposed to 1% of their per contract limit as a net retained amount; the proposal provided an example of a reinsurance programme (which was in fact Mr Billyard's 1993 reinsurance programme). In effect, any reinsurer participating in this scheme would retain 75% of the premium in order to pay the retained losses. The proposal claimed that there was therefore "a prospect of a very healthy profit".

v) It stated that "P.A. makes money on a gross basis".

428. The proposal did not refer to the fact that this was in essence trading in losses or that profits could only be made on the backs of reinsurers, nor was any mention made of spirals, just as nothing had been said to the Names on Syndicate 103 (see paragraphs 396 and following).

i) It was the evidence of Mr Butler that SCB did not set this out as each company that joined the scheme decided, in respect of each risk offered, whether it wanted to write the risk; they would know from the figures that the business was loss making and that a profit could only be made on the back of reinsurance; the document was a discussion document, the companies would be seen before they joined the scheme and the decision made on each risk would show that it was profitable only through reinsurance.

ii) I do not accept that evidence. The proposal did not honestly or properly describe the nature of the business being offered nor did it mention any of the risks of which any provider of capital or participant in the business should have been made aware before they agreed to participate in it. I am sure that the document should have spelt this out, but had it done so, no rational person, for the reasons I have set out at paragraphs 273 and following, would have participated in the business.

iii) I am sure that Mr Brown and Mr Butler were each aware of the risks of the business and the need to describe the true nature of the business and the risks involved; I am also sure that they each appreciated that it was dishonest not to spell out the true nature of the business and the risks associated with it to anyone who was not conversant with the business and who was being invited to participate in it. This was something they knew had to be done before any person committed their capital; it was not sufficient merely to present the risks as it was not possible for a person not conversant with the PA reinsurance market, for the reasons I have given at paragraphs 294 and following, to tell the true nature of the business from the placing information provided.

iv) Both Phoenix and Hackett accepted the proposal. It was the evidence of Mr Brown that the concept appealed to Phoenix as they would, in effect, be getting more business led by Mr Billyard, but without the cost of getting it through the pool. It was SCB's evidence that Phoenix and Hackett understood the nature of the business which they were writing.

v) I make no findings as to what Mr Brown or Mr Butler might have orally informed those at Phoenix, Hackett or John Hancock. The question of the knowledge of the true nature of the business of those at Phoenix (particularly the senior management) or at John Hancock was not a matter that was in issue at the trial for the reasons I have given at paragraph 243.

(c) The spiral in 1994

429. The main participants in the spiral for 1994 (as shown in Table B. ) were:

i) Mr Billyard at D&H;

ii) Mr Owen at Syndicate 718;

iii) Clarendon per Raydon;

iv) Phoenix through Mr Ekwall; and

v) John Hancock per Hackett.

430. NAF&G had dropped out due to concern in the market about their financial stability and had been replaced by the Clarendon Insurance Group, including Clarendon National and Clarendon America. The Clarendon Insurance Group was an independent group of companies which, by 2001, was owned by Hanover Re.

i) Clarendon was an insurance company that specialised in acting as a policy-issuing company, in that it fronted risks and reinsured all or almost all its exposure. It was licensed in several states and was considered good security.

ii) It granted an underwriting authority to Raydon on 1 January 1993 for writing LMX reinsurance business.

iii) It was the evidence of SCB that the SCB proposal was not sent to Mr Murray, the underwriter at Raydon who accepted the business, as he was an experienced XL underwriter and understood the market; the claims were all handled in Bermuda. Phoenix and Hackett became participants through the SCB proposal which I have described.

431. A chronology setting out the dates on which the reinsurances of Clarendon, Mr Billyard and Mr Owen were placed was provided:

i) D&H (Mr Billyard) signed the slip for Clarendon and Mr Owen on 18 October 1993.

ii) Mr Owen indicated that he would write the lower layers for Mr Billyard and Clarendon on 28 October 1993 and signed the slips on 16 November 1993 for Clarendon and some for D&H (Mr Billyard).

iii) Clarendon indicated that they would write the lower layers for Mr Billyard on 25 October 1993 and signed the slips on 15 February 1994; they signed the slips for Mr Owen on 7 February 1994.

iv) There was no chronology for the placement of the reinsurances of Phoenix and of John Hancock (per Hackett); on Phoenix's reinsurance for $95,000 xs $5,000, D&H (Mr Billyard) put down a line for 100% on 8 November 1993 and a 100% line on the reinsurance of John Hancock (per Hackett) was put on 18 October 1993; on 16 November 1993, Mr Owen put down a 100% line on the reinsurance of John Hancock (per Hackett) as well as putting down 100% lines for Clarendon per Raydon and some further lines for D&H in addition to those put down on 10 November 1993.

The evidence of SCB was that they approached the underwriters with a block of slips and it was therefore not surprising if many of the slips were signed on the same day.

432. In the result, as in 1993 and as can be seen from Table B. , the participants in the spiral wrote substantially all of one another's reinsurances in the layers up to $1.5m or $2m or $3m excess of a retention of $5,000; there was little leakage apart from the five original retentions. Small lines (6% each) were written by Folksam International Insurance Company (Folksam) on the layers $300,000 xs $200,000 and $500,000 xs $500,000 protecting Clarendon; Folksam also wrote a 6% line on the layer $500,000 xs $500,000 protecting Phoenix and a 6% line on the layer $500,000 xs $500,000 protecting JEH Re; however, the reinsurance of Folksam xs $10,000 was placed by SCB, and Folksam's reinsurance was therefore placed back into the spiral. Thus with the exception of the retentions of Folksam, there was no leakage from the spiral below $1m. Losses above the sum of the retentions of the participants of the spiral ($25,000) would, subject to Folksam's retentions, spiral up to the higher layers, generally to those layers xs $1m. Mr Brown's evidence was that SCB did not involve others in the lower layers as they did not know of others who were prepared to write this business to them, though there may have been others who would have been willing to write such business for other brokers.
433. As can be seen from Table B. , there were others who participated in the higher layers. These included CIGNA, State Mutual (per SRFF, an underwriting agency described later in this paragraph), Folksam, Crown Life Insurance Company (a company based in Saskatchewan, Canada), QBE, Lincoln National Life Insurance Company (Lincoln National), Manulife and Transamerica. These provided the leakages save where there were reinsurances back into the spiral as occurred in the cases of SRRF and Folksam. SRFF was an agency based in Philadelphia where Mr Connie Lehane was its main underwriter; it was partly owned by LDG. Lincoln National had written these high levels through its home office before it granted SCB a lineslip – see paragraph 437 below.
434. Those who gave evidence denied that the spiral for 1994 was contrived or that there was any reciprocal understanding:

i) Mr Butler's evidence was that it was not a coincidence that all the participants put down 100% lines on Phoenix's reinsurance, as referred to in paragraph 430; he already had the reinsurance covered and the followers had put down 100% lines as they did not want theirs to sign to nothing; the dates were not a coincidence as SCB visited each underwriter with a stack of slips. He never told Phoenix and Hackett that they would have to write the reinsurances of the others, but SCB did tell them that they would have to write a line similar to that of the leader's. Mr Butler then qualified his answer and said that they were told that they would be offered it, but were not told that they would have to write it; they would have to follow Mr Billyard but would not have to follow anyone else on Mr Billyard's reinsurance.

ii) Mr Butler's evidence was that this was exactly the same as he had done at Bain Dawes in previous years; it was not contrived. They had not contrived the spiral – each was free to participate or decline; he took out a bag of slips in front of them and presented each risk individually.

435. Lincoln National, Transamerica, Manulife and Crown Life were seeking to avoid their reinsurances on the basis that they were not told and that they did not know that they were sitting on top of a spiral; that they were in fact writing working layers and not catastrophe layers. Again, for the reasons I have explained at paragraph 243, I have made no findings in relation to the knowledge of those who had participated in the spiral.

(6) The market in 1995

(a) The spiral for 1995

436. It was common ground that there was a further spiral in 1995, of which the main participants were as set out in Table C. :

i) Clarendon per Raydon;

ii) American Reliable;

iii) Phoenix through Mr Ekwall;

iv) Lincoln National; and

v) John Hancock per Hackett.

437. Two of those who were participants in 1994 had dropped out:

i) Mr Owen ceased to be involved in 1995 because he had left Sturge; Syndicate 718 had ceased underwriting at the end of 1995. In his accounts for 1993 written in December 1994, Mr Owen noted the longer tail development in the LMX account as more claims were entering the market because of the low net retentions.

ii) As set out at paragraph 412, there was no detailed evidence about the account which Mr Billyard wrote at D&H; however, it was clear that he had changed his stance for 1995; he had either increased his retentions or had reduced his retro writings; he was leading SCB's direct business, but not LMX or retro business.

(b) Lincoln National

438. Lincoln National was a life insurance company based in Fort Wayne, Indiana. It was an 'A' rated company and was part of the Lincoln National Group. As set out at paragraph 432, they had written some reinsurances of the spiral through their home office at Fort Wayne in 1994. The principal persons involved at Lincoln National were Mr Dale Vollenweider (Vice President of Lincoln National's PA XL division) and Mr Joe Schenkel.
439. Lincoln National granted a lineslip to SCB from 1 October 1994; this was known in the market as the "Big Ben" facility. It is necessary to set out a little of the background in some detail as business under the lineslip was reinsured by EIU in 1997.
440. The background, on the evidence given to the Court by SCB, was:

i) Lincoln National were quite keen to expand their business, including their WC carveout business and were considering a London office. A lineslip was suggested as the best means of accessing the London Market without going to the expense of establishing an authorised insurance company that was approved by the DTI; the lineslip was also to be regarded a pre-runner of establishing such a company.

ii) SCB offered Lincoln National a proposal under which they could write risks in WC carveout, LMX and EEII business; they would be offered risks in all three categories which they could accept or decline. They decided to write all three.

iii) Mr Bird (whose activities after the closure of Syndicate 103 are considered at paragraph 465 below) was approached in the summer of 1994 by Mr Brown to act as the "administrator" of the lineslip. He began work with them on 1 October 1994. He had had several conversations with Lincoln National's underwriters in Fort Wayne.

441. The account was split into three sections, as set out in the lineslip:

a) Section A: "direct" reinsurance of carveout business excluding LMX;

b) Section B: PA LMX; reinsurance was to be provided excess of a retention of $20,000 with unlimited reinstatements in layers up to $15m or $20m. The cost of the reinsurance for this was estimated at 35% of accounted net premium income on a retention of $20,000;

c) EEII.

The estimated net premium income was $27.5m, but this was not broken down as between classes. There was an overrider of 3.5% and a profit commission of 20%. The facility provided that:

"[SCB] undertake to arrange and administer the proposed reinsurance programme…."

442. The lineslip, according to SCB's evidence, operated as follows:

i) The lineslip was open to all brokers in London, though the majority of business was SCB-produced. Brokers other than SCB were told that they could approach Mr Bird in London with their slips.

ii) Mr Bird collated the information provided by brokers, put it into an agreed form and sent it out with the slip and placing information as an offer to Lincoln National's underwriters in Fort Wayne – Mr Vollenweider and his colleagues; Mr Bird also made a recommendation and he then discussed the risk with them on the telephone. The recommendation was in writing at first, but after a while it was oral. In direct business he would do an analysis of the loss information where possible, as Lincoln National wanted to write business under Section A of the lineslip for a gross profit. On LMX, figures were given which showed it was gross loss making business and no analysis was provided; this evidence was a good example of the clear difference in the approach to conventional underwriting and in accepting business on the backs of reinsurers in a spiral.

iii) Mr Bird had no authority to underwrite; he could only process the premiums and the claims. Mr Bird's evidence was that it was his role to advise and Lincoln National relied on his experience and expertise as they were writing a London style account; the underwriting decision was made at Fort Wayne. His evidence was that they declined or changed the rates very often. He said that they wrote their own carveout and WC account and that they did not merely "rubber stamp" his recommendations. Mr Bird went to Fort Wayne regularly to make presentations about the business.

iv) The premium income limit under the slip for the first year was $35m; there was the potential of $50m-$60m of WC carveout under Section A of the lineslip and the income to Section B of the lineslip was $9m or $10m. Lincoln National had entered into a QS treaty with European Specialty Group (ESG) and Clarendon. ESG operated two pools that had commenced business on 1 January 1994, one writing medical business and one writing PA and sickness benefit business; the PA pool was led by Chiyoda Fire and Marine Insurance Company (Europe) Ltd. (Chiyoda) and the PA underwriter was Mr Brian Cauldwell. The QS was initially placed to cover a specific account in 1994 and was then placed as a general QS of Section A of the lineslip in order to relieve the premium that was being written. It was Mr Bird's evidence that this was done as Mr Vollenweider could not go to his principals to get an increase in the premium income limit. The general QS of Section A of the lineslip was placed by SCB from 1 October 1995 and there was a discussion as to whether EIU would write this – see paragraph 629.

443. What was Mr Bird's role?

i) SD contended that the arrangement of the facility in the way described in the evidence of SCB was a device to circumvent the provisions of the Insurance Companies Acts and that the underwriting was in fact done by Mr Bird.

ii) Mr Whitcombe's evidence was that he was told by Mr Bird in late August or early September 1994 that he (Mr Bird) was to underwrite an account for Lincoln National out of SCB's offices.

iii) As I have set out at paragraph 407, Mr Bird had deliberately deceived his Names and as I have set out at paragraph 479, had deliberately deceived the DTI. He was a person on whose evidence I could place no reliance.

iv) I heard no evidence from Lincoln National; given the dispute between SCB and Lincoln National, SCB could not have called them to give evidence and it is therefore not appropriate for me to determine whether the facility was set up as a device to circumvent the Act.

v) However, on the evidence before me, I am sure that what Mr Bird told Mr Whitcombe was the truth – Mr Bird was to do the underwriting and as a matter of fact did the underwriting during the operation of the facility.

vi) This was important to SCB as it meant that they had the underwriting of one of the participants in the spiral under their direct control through Mr Bird. Under the terms of the facility agreement they were also tasked with arranging and administering the terms of the reinsurance, just as they had offered to do in the proposal that was put to Phoenix and Hackett.

(c) American Reliable

444. American Reliable was a company within the American Bankers Insurance Group Inc. (Bankers). It is again necessary to explain the background to their participation in the market as EIU wrote a reinsurance of American Reliable in 1997 which has sustained gross losses in excess of $71m.
445. The principal person involved in the writing of PA business at American Reliable was Mr Richard Durling. He was not called to give evidence at the trial.

i) Mr Durling had joined Bankers in 1992 and had underwritten travel and other business for them. Prior to that he had been at Lloyd's, first at the Bohling Syndicate, and then at Darling Syndicate 1162 where he was deputy until 1992; Mr Johnson had known him since the 1970s when he was working for the Bohling Syndicate.

ii) In 1994 Mr Durling persuaded Bankers to give him an underwriting role so that he could participate in the PA market. He continued to work for Bankers, but acted as an introductory agent for American Reliable. American Reliable was used because the capitalisation of Bankers' UK authorised company, Bankers Insurance Company Ltd., was too small.

iii) It was the evidence of Mr Johnson that the underwriting decisions were made in Arizona by either Mr Chuck Yaros or Mr Dan Folse. It was his evidence that Mr Durling was a filter and not the underwriter and that American Reliable did reject some risks which were presented to them. Mr Durling made a quarterly report to them and would go out twice a year either to Arizona or to Miami (where Bankers' head office was located). There was, however, a memorandum written in October 1994 by Mr George Whipple of the broking firm JP Woods (who had been approached by Mr Johnson to find reinsurance for American Reliable) which recorded Mr Johnson as stating:

"Richard Durling … is the underwriter who will be operating via the London contact office. For DTI approval purposes, it was stated that the underwriting decision making will occur in the USA, as American Reliable is domiciled in Arizona.

This proposed program is an exclusive to WFD and the majority of the business initially to be written will be the WFD account."

Mr Durling, in his CV, had described himself as underwriting in this period. On the whole of the evidence before me, I am sure that it was Mr Durling who in effect made the underwriting decisions.

iv) Bankers subsequently closed their London office and for 1997 Mr Durling formed TLA Underwriting Agencies Ltd. (TLA), which acted for American Reliable – see paragraph 740.iv) below.

v) It again appears that American Reliable (or another company within the Bankers group) sustained very significant gross losses as a result of participation in this business; disputes arose between them and those with whom they had reinsurance contracts.

(d) The spiral and the relationship between WFD and SCB

446. The principal evidence about the placing related to the way in which American Reliable became a participant. This evidence is also important as it goes to the nature of the relationship between SCB and WFD and to the way in which the spirals came into existence.

i) Mr Brown went to see Mr Durling after the latter had obtained permission to write this business for American Reliable, but Mr Durling was only prepared to write the business if it was placed through WFD. Mr Brown then spoke to Mr Johnson and matters progressed from there. If SCB wanted to use American Reliable on a risk, they had to approach WFD and ask WFD to put it before Mr Durling.

ii) It was the evidence of Mr Johnson that by November 1994 he was in contact with Mr Butler to get things moving on American Reliable's lower layers. They saw Mr Bird and a deal was done – if Lincoln National or any other low level writer would provide protection to American Reliable, then American Reliable would have to provide some support to them; in essence his evidence was that American Reliable reciprocated with Lincoln National and there was an element of cross-trading.

iii) It is clear that there was to be cross-trading. Mr Johnson's evidence was that there was an arrangement with SCB wherein they would work together on some accounts and share markets accordingly.

iv) On 8 December 1994 Mr Brown sent a fax to Mr Ekwall at Phoenix in order to tell him that American Reliable had given a quotation to be one of their reinsurers for 1995; that SCB would be working with WFD and that SCB would offer WFD some business and WFD would offer a cross-section of WFD's account to SCB's markets; business would continue as 1994 save that some of the business would be from WFD. Mr Johnson accepted the accuracy of this fax; indeed confirmation that this was the arrangement is provided by the fact that: (1) a copy of the reply from Mr Ekwall was on Mr Johnson's file, (2) Mr Johnson's evidence that the retro market regarded Phoenix as exclusive to SCB, and (3) that Mr Johnson had told Mr Durling that he (Mr Johnson) was accessing markets via SCB. Furthermore, a fax on 28 December 1995 from Mr Johnson to Mr Butler set out the lines which American Reliable indicated for CIGNA and Phoenix (subject to their outwards reinsurance programme); the fax also asked for quotes for SRRF and for American Reliable. Mr Johnson did not believe that CIGNA reciprocated, but he accepted that this showed them working together with SCB to access each others' markets.

v) Mr Brown's and Mr Butler's evidence, however, was that SCB had no captive market that was theirs – all the spiral participants wrote to other brokers. Mr Butler did not believe that the arrangement with WFD was anything more than that which existed in the market for the exchange of business. Mr Durling would have been aware that Mr Johnson was accessing the markets via SCB, as would American Reliable.

vi) Information was provided to SCB on 3 January 1995 about American Reliable's PA account:

"The reinsured proposes to write a selective London Market Excess of Loss account for 1995. The account will include some xl on xl.

Estimated premium income for 1995

US$5,000,000

Line structure

US$500,000 any one layer

US$2,500,000 any one programme."

This was very little information, but it was Mr Johnson's evidence that more could have been provided if the reinsurers had sought more.

vii) SCB, on the basis of this, helped place some of American Reliable's reinsurances.

viii) Mr Bird's evidence was that Lincoln National agreed to write a spiral account under the lineslip at primary levels; it was Mr Vollenweider who wrote at the higher layers through the Fort Wayne office (Lincoln home office); Lincoln National knew that Phoenix, John Hancock and Clarendon supported their programme and they wrote the other layers and the other programmes.

447. The retention of American Reliable was $10,000 and that of the others was $5,000. As in 1993 and 1994, all the participants reinsured one another up to $3m except in the case of American Reliable where it was $2.5m. Thus any inwards loss to a participant excess of $30,000 would spiral up to the layers excess of $3m or $2.5m.
448. The others who participated in the higher layers included Crown Life, North American Life (through Insurance Services Associates (ISA), an agency in Canada where the underwriter was Mr David Burry), Syndicate 1121 (Mr Panter) (placed through WFD, who arranged their reinsurance) and Lincoln National (as explained at paragraph 445.viii) above). In any event, Lincoln National wrote at higher layers under the lineslip and at their home office.
449. SCB denied that there was a contrived spiral or that there was any reciprocal understanding:

i) Mr Brown did not accept that the risks were written at the same time; all the participants were individuals who decided whether to accept a risk or not; WFD placed some of the layers with Clarendon and all with American Reliable; they were not part of the conspiracy.

ii) Mr Butler's evidence was that the insurers were offered layers and decided to write them or decline them as they saw fit. There was no plan and no scheme.

iii) Mr Johnson's evidence was that although he did not know at the time that there was a very small number of reinsurers reinsuring themselves up to $3m, he did appreciate that there was a reciprocal exchange with Phoenix and Lincoln National at different levels. He accepted that there was reciprocal trading, that American Reliable entered the market, that he did do a deal with SCB to show each other's markets their business, and that there was a spiral. However, he did not accept that he had set this up with SCB or that it was a very tight spiral. He also accepted that the effect of the closed spiral was to transfer the losses higher, but he did not know that at the time; he did not know that there had been any such intention. He thought that there would be additional participants at lower levels who would have retentions that would cause a leakage.

450. Lincoln National and Crown Life had sought to avoid cover. The Crown Life line had been placed for 1995 through Mr Whipple with Mr David Claughton and Mr Michael Swanick at Crown Life. Again, for the reasons I have explained at paragraph 243, I have made no findings in relation to the knowledge of those who participated in the spiral at the higher layers.

(7) The spiral for 1996

(a) The participants for 1996

451. The participants in the spiral for 1996 (as is shown in Table D. ) were:

i) Phoenix;

ii) John Hancock per JEH Re (as Mr Billyard had moved to Bermuda);

iii) Lincoln National; and

iv) American Reliable.

452. Clarendon (who had participated through Raydon) had decided to come out of LMX business at the end of 1995; they had dropped out because of their experience in not being paid by Mr Owen's syndicate – see paragraph 509; Clarendon's management had by then excluded LMX business. Although Mr Owen eventually resumed payment, Clarendon had by then come out of LMX business and did not return.
453. There were no new participants save that Mr Billyard had resumed writing, but this time for John Hancock through JEH Re.

(b) Mr Billyard's move to Bermuda: JEH Re and Realm UM

454. As set out in paragraph 410, Mr Billyard left D&H and moved to Bermuda in the summer of 1995. He took up two positions:

i) Mr Billyard became President of Realm UM (an SCB group company) in July 1995. He was employed to write for North American Life (who wrote Lincoln National's 1996 XL for its direct account). The evidence given to me was that he had made noises about wanting to leave the UK and that North American Life were keen to do something; there were personal reasons why he wanted to live in a warmer climate. Realm UM then became dormant until 1997 when it became an underwriting manager for Republic Western Insurance Co. (Republic Western) (see paragraph 1442.iv)). Save to the extent that Republic Western was used, Mr Billyard did the bulk of his underwriting through JEH Re.

ii) Mr Billyard became underwriter and President of JEH Re (the affiliate of Hackett referred to at paragraph 424.ii)) from 12 December 1995. He had originally gone to write for Realm UM, but had also had discussions with Hackett. JEH Re was owned by Hackett (51%), Realm Investments Ltd. (an SCB group company) (39%), and Mr Billyard (10%). JEH Re shared Hackett's facility from John Hancock as the result of the addendum to the underwriting agency referred to at paragraph 424.ii). Administrative functions were outsourced to Realm Investments Ltd. and so little by way of investment had been required from SCB; although he had a deputy, Mr Christiansen, Mr Billyard did almost everything in relation to the underwriting.

455. When in Bermuda, Mr Billyard led about 90% of SCB's business; he wrote large lines – often 100%. There was frequent communication between SCB and Mr Billyard over the telephone.

(c) The placing of the contracts that formed the spiral

456. The direct evidence about the placing of the contracts was:

i) American Reliable's wish, according to Mr Johnson, was to expand and write lower down; a contemporaneous memorandum referred to "("chute" to FAI for this business)". This was a reference to FAI having a QS of American Reliable's business for 1996.

ii) The memorandum also referred to the position of D&H and recorded that they would be unlikely to do anymore "RB deals"; this referred to Mr Billyard, but Mr Johnson said he did not recall if it referred to low level arbitrage.

iii) The rates for the reinsurances were in the same "ball park". Mr Butler said that this was because it was a market.

iv) Mr Billyard was the market leader but, according to Mr Butler, each participant in the market had the option as to whether or not to follow him; Mr Butler said that the proposal put to those who participated was that they could look at a block of premium income and that if they wrote that block, SCB would suggest an outwards reinsurance programme.

v) Mr Brown did not know if Mr Billyard wrote all his lines on the same day or whether Mr Bird did; a broker would try and offer the whole programme to an underwriter so that he could select the layers which he wished to write and those which he wished to decline.

vi) Mr Bird said that Lincoln National decided to participate; they also wrote the protections of SRRF for WFD. Mr Johnson said that Lincoln National were aware of the spiral, as was apparent from their fax to Mr Whipple of JP Woods on 16 October 1995; these concerns arose because they were reinsuring their own reinsurer and were worried about a spiral effect. They wrote a reduced line for American Reliable for 1996, but wanted to be removed for 1997.

457. The retention of American Reliable in 1996 was $10,000 and that of the others was $5,000. As in 1993, 1994 and 1995, all the participants reinsured one another up to $3m, except in the case of Lincoln National where it was $2m and the case of American Reliable where it was $2.5m (subject in each case to leakage to the extent of the retention on the layer written by SRRF, as described in the next paragraph). Thus an inwards loss excess of $25,000 would spiral up to the layer excess of $500,000 and after a retention of $10,000 by SSRF, would spiral up to the layers excess of at least $2.5m or $3m.
458. The participants in the higher layers included Crown Life, Manulife, and Reinsurance Group of America (RGA) (per Great Rivers Reinsurance Management (GRRM)) and Reassurance Co of Hannover. SRRF (on behalf of First All America) were also on the higher layers, but they were involved in the lower layers subject to their being reinsured by WFD – that reinsurance being 50% by JEH Re and 50% by American Reliable. Their involvement was therefore only a leakage to the extent of their retention of $10,000. It was not suggested that SRRF were part of the spiral scheme.
459. Mr Brown's evidence was that the position of SRRF was important because it illustrated the fact that participants in the market did not know who was in it for what.
460. Before setting out my conclusions on the spirals in the years 1993-6, it is convenient to set out the origins of EIU.

(8) The origins of EIU

(a) Mr Whitcombe and Syndicate 1053

461. As set out at paragraph 386, Syndicate 103 ceased underwriting at the end of 1993. A merger was then contemplated with Syndicate 1053 under a new managing agency, of which the active underwriter was Mr Whitcombe, but the members' agents would not agree to the then plans to form a composite syndicate.
462. Mr Whitcombe began work in the insurance market in 1960 and became an underwriter at Lloyd's in 1977 when he was invited to set up his own syndicate, Syndicate 456, of which he was the active underwriter from 1978 to 1988; the business written was mainly financial institutions, E&O and third party, products liability and some construction risks. He also underwrote a small amount of direct PA business comprising the insurance or reinsurance of individuals. He had a treaty one year (1978) for $90,000 xs $10,000 which guaranteed a profit and had been placed by Mr Christopher Moran.
463. In 1989 he became the active underwriter of Syndicate 1053, managed first by the Hexad Partnership and then from 1991 by Knightstone (formerly known as John Poland & Co.); a large part of the business of the syndicate consisted of bankers' blanket bond and professional indemnity, with a small amount of other business including fire, third party products and traditional PA. Syndicate 1053 ceased underwriting at the end of 1993.
464. Mr Whitcombe became a Name on Syndicate 103 when it became part of the same agency as his syndicate; his evidence was that he had no idea of what Syndicate 103 did in detail as he was never told in detail what it did and Mr Bird never told him of the spiral, even though Mr Bird (whom he had known since the 1970s when Mr Bird worked for Greenway Insurance Brokers Ltd.) had got to know him better by then.

(b) Mr Bird's and Mr Whitcombe's plan to form an insurance company

465. After the failure of the plan to merge Syndicates 103 and 1053 under a new managing agent, Mr Whitcombe began to consider forming an authorised insurance company to be known as Euro International Insurance and Reinsurance Company Ltd. (EIC). By August 1994 Mr Whitcombe was out of work. He spent the next two years trying to establish the company.
466. Mr Bird and Mr Whitcombe first contemplated buying a UK subsidiary of a US company which had authorisation from the DTI. That was not pursued and they decided, after consulting Ernst & Young, to seek authorisation for a new company. They were introduced to Mr John Philpott of Ernst & Young (a well known expert in the formation of insurance companies and in the obtaining of authorisation) by Mr Abbott, the audit partner at Ernst & Young who dealt with the syndicates under the management of John Poland & Co.
467. Almost at the conclusion of the factual evidence, after Mr Whitcombe, Mr Brown and Mr Bird had given evidence, the draft application to the DTI and other papers were made available by the Financial Services Authority (FSA). Mr Whitcombe, Mr Brown and Mr Bird were recalled to give further evidence. I wish to record my considerable gratitude to the FSA for the very helpful and speedy way in which the FSA assisted the Court by the provision of these very important documents.
468. The draft application sent to the DTI on 15 April 1994 was based upon a plan to combine the businesses of Syndicates 103 and 1053:

"The primary objectives of the company are to continue to afford existing clients the opportunity to place their business with an entity offering first class security and service, fair and reasonable assessment of their needs, whilst at the same time providing rational and proven returns to was provided investors."

Much of the information in the draft application was supplied by Mr Bird. The reinsurance cost figures (which showed that it was to be a large account) were worked out by Mr and Mrs Bird. They used the syndicate figures for Syndicates 103 and 1053 and then grossed them up in order to relate to the anticipated premium income – that accounted for the degree of precision. The figures were reviewed by Mr Philpott. The main points material to this action which were set out in the draft application were:

i) It recorded that both of the syndicates had proven records of profitable underwriting and thus the formation of EIC would afford to clients the opportunity to continue to place their business; it was envisaged that the style of account would be similar and that the same underwriting criteria would apply. It included PA business among the principal classes of business and described it as follows:

"Personal Accident will be underwritten on its own or in conjunction with other related classes such as sickness, comprehensive travel and the like. The market is substantial, perhaps £2 billion worldwide.

The key to underwriting a personal accident and health account is a sound knowledge of the market and a prudent assessment as to the requirements of any reinsurance programme purchased to protect the account underwritten. The present portfolio of business written has an assessable exposure to any one or series of events and extensive reinsurance, to protect this, is placed with top rated security in the world wide market. Consequently, profits can be reasonably predicted as indeed the experience and results of the specific syndicate has shown. We are confident that a similar reinsurance programme can be purchased for the foreseeable future so that the proven profits of the syndicate can and will be duplicated in the company."

ii) The draft application described the rating of PA business:

"A rating table for direct individual Personal Accident business is included … As previously discussed all other types and classes are in the main experience rated and as such fixed rating does not apply."

iii) The proposal stated that they had ascertained that reinsurance could be acquired:

"We believe that in most cases, Reinsurance, especially proportional, can only be written where a sense of partnership and mutual understanding exists between reinsured and reinsurer. To this end initial in depth assessment and investigation of all reinsureds will be a pre-requisite and we intend to ensure that regular face to face meetings take place between our underwriters and management and those of our cedants at all levels.

In the main there are no formal rating guides for these classes of business. They are experience (loss ratio) rated…

It has been established that reinsurance arrangements similar to those enjoyed by the syndicates can be secured…

As regards Personal Accident Insurance, this does have the potential for a catastrophe type exposure and particular attention must be paid in recording known concentrations or risk and build up of accumulations from excess of loss writings to ensure that sufficient vertical protection is purchased.

The proposed reinsurance programme and line structures are as delineated in the attached schedules. These mirror those of the syndicates and illustrate the line size to exposure levels across all classes. Whilst one has no witting intention to do other than afford a fair risk to reinsurers it is crucially important that the company's exposure both in terms of vertical catastrophe and attritional aggregates are recognised and catered for. To that end, the proposed programmes should suffice."

iv) The proposal stated further:

"As would be the case for any new venture, investors are looking for a reasonable return on their funds. However, investments in an insurance company are based on a far greater time frame evidencing the need to build adequate reserves which truly reflect the nature of the business written. It is only through such a cautious approach that an ultimate true profit may be made rather than an illusory get rich quick scheme, the results of which we are all too familiar [with] as a London Market."

v) Although Mr Whitcombe agreed that what was being proposed was a traditionally structured reinsurance programme, he said that its true nature was apparent from the structure of the reinsurance programme which took it down to $5,000; the account to be written with that sort of reinsurance was a volatile account and would obviously give rise to a number of losses. Mr Bird's evidence was that this did not give the impression that they were relying upon reinsurance to cater for unforeseen losses; the passage which referred to aggregates was referring to the unknown build up of accumulations within the spiral and direct XL accounts.

vi) Nothing was however said about writing retro or spiral business or that the business would include gross loss making business that could be turned into a profit only on the backs of reinsurers.

vii) The draft application also envisaged that Mr Brown would be a non-executive director and a shareholders' representative; it pointed out that SCB would offer business to EIC and would place part of the reinsurance, the dealings being on an arm's length basis like any other broker.

469. Until the provision of these documents, no evidence had been given about Mr Brown's proposed involvement as director. Further evidence was therefore given in relation to both his involvement and to the terms of the draft application. It was the evidence of Mr Whitcombe, Mr Brown and Mr Bird that they had forgotten about Mr Brown's involvement until the application was disclosed.
470. It was SD's contention that in the light of the allegations made against EIU and SCB, it was inconceivable that they had forgotten about the involvement of Mr Brown in EIC as a director. I set out my conclusion on this at paragraph 532.
471. It was Mr Whitcombe's evidence that he recalled that the first time he had met Mr Brown was when they had a meeting in the Directors Club prior to the submission of the application to the DTI. Mr Brown's evidence was that Mr Whitcombe and Mr Bird either understood or knew that he (Mr Brown) was trying to raise capital; it was his evidence as well as that of Mr Whitcombe's and Mr Bird's that he was to be involved as he was to help in raising the necessary capital; that it was not intended that he play any part in the management of the company. SCB were not to provide capital, but Mr Brown was to act as the representative of the shareholders who did.
472. Mr Whitcombe's and Mr Bird's evidence was that to this end a proposal was prepared (similar to the proposal described at paragraph 481) and Mr Brown was asked to give it to anyone who might be interested in providing capital. On 20 April 1994, Mr Brown wrote to Mr Lamb of Daiwa Securities America Inc., with whom he and Mr Cooke were in discussion about raising capital to purchase an insurance carrier; in the covering letter Mr Brown said that he had dealt with both underwriters who had had excellent results and who had become victims of Lloyd's inability to support small syndicates. He forwarded the proposal.
473. On 7 June 1994, the DTI wrote to Ernst & Young with a number of questions on the draft proposal:

i) One of these related to a reference in the financial projections to business of £292,500 being "warehoused". The DTI wanted to know if this was the renewal of syndicate business which had been written by another reinsurer and, if it was, how it was intended to be transferred. A reply was sent on 12 July 1994 by Mr Whitcombe and Mr Bird to Mr Philpott; this reply was provided to the DTI. In it they stated that the business had been written by another carrier which could be passed back by way of QS. There was no firm evidence before the Court as to whether this related to spiral business written by Syndicate 103, or as to which insurer was doing the "warehousing" for the proposed company.

ii) Another one of the questions related to the position of Mr Brown; the DTI wanted to know if the major shareholders included producing brokers. They also questioned the experience of Mr Henton and the very low retentions. In the reply that was provided to the DTI, they stated that producing brokers would not be shareholders and that they would discuss the question of capital at a meeting with the DTI; the reply also dealt with the other points raised.

474. Before turning to that meeting with the DTI, it is necessary to deal with the position of Mr Brown. I am satisfied that he ceased to be directly involved in the proposal, that he was not going to be a director, and that he did not have any further direct involvement in the capital-raising that was attempted. I am sure that he was not going to commit the capital of SCB to such a venture as he was well aware of the risk of underwriting WC business as a spiral underwriter and of the obvious imprudence of committing SCB capital to a venture that involved participation as a risk bearer in a spiral.
475. A note of a meeting with the DTI on 18 July 1994 attended by Mr Whitcombe, Mr Bird and Mr Philpott was made available by the FSA after Mr Whitcombe and Mr Bird had been recalled and had given their further evidence:

i) It appears from that note that by July 1994, Daiwa were no longer interested and it was hoped that another bank would provide the capital; the DTI were told at the meeting that there would be no broker directors.

ii) According to the note, Mr Whitcombe and Mr Bird told the DTI that the underwriting philosophy and parameters would be set at board level and that Mr Whitcombe and Mr Bird would be involved in the more complex risks and oversee the more standard underwriting done by Mr Henton. They also told the DTI that they were confident that they could obtain reinsurance with the low retentions. Mr Bird's evidence was that they were intending to continue the retro and spiral business of Syndicate 103, but that he could not recall whether this had been discussed with the DTI. Mr Whitcombe's evidence was that it was not the intention to write gross loss making business and that as far as he was concerned, the business was to be written on a conventional basis; he was sure that nothing was said to the DTI about the writing of gross loss making business or spirals.

iii) Nothing was recorded as having been said about the intention to write gross loss making business, or about the spiral, or that that part of the account would only be profitable on the backs of reinsurers. I am sure that if they had said anything it would have been recorded; any mention of writing spiral business would have attracted a note because of the serious issues that had arisen from the spiral business written at Lloyd's and of those that had occurred in 1988-90 and which had given rise to the litigation in Deeny (referred to at paragraph 165).

476. The failure to set out the true nature of what was intended followed on from the concealment of the true nature of the business from the Names on Syndicate 103 (as set out at paragraph 407); it adopted the same approach in not describing the true nature of the business as in the proposal produced by SCB for Phoenix and Hackett (as set out at paragraph 427).
477. Mr Bird's evidence was that:

i) He had anticipated that the DTI would have gone through Syndicate 103's figures and had seen that it was gross loss making business; the DTI had been told that EIC was going to write mainly the same account as Syndicate 103's and would be hoping for the same results. By this evidence I am quite satisfied that he meant to imply that the DTI should have appreciated that EIC were going to write deliberately gross loss making business and that there was no need for him to have told the DTI.

ii) He thought that the DTI would have understood what was being written by Syndicate 103; I reject that explanation as incredible. No person of Mr Bird's obvious intelligence could have possibly believed that officials at the DTI would have known what Syndicate 103 was writing, other than what could be discerned from that which was written in the syndicate accounts or from that which was provided in the draft application. Those syndicate accounts said nothing about the true nature of that part of the account which included retro and spiral business; on the contrary, as I have found, those accounts were intended by him to mislead the Names and to conceal the true nature of the business which he was writing and the risks which they were in fact running.

In addition to his evidence, I have considered two submissions made by him in writing dated 8 January 2003 and 4 February 2003; in these submissions, he made the further point that he did not think that he was doing anything out of the ordinary at Syndicate 103 and that he therefore did not think that there was anything he needed to tell the DTI specially. I reject that explanation as disingenuous; the statements made in the draft application gave the impression that this was a conventional account; if he believed that writing gross loss making business was not out of the ordinary, it would have been properly described for the benefit of the DTI.

478. There can be little doubt that the officials at the DTI considered the figures and information carefully; that can be discerned from their query in relation to the business "warehoused". If they had been able to discern that gross loss making retro and spiral business was being written they would have obviously queried it, but, as I have already found, the accounts and information were intended by Mr Bird to conceal the true position from the Names. Furthermore, I am sure that it would have been almost impossible to discern that gross loss making business was being deliberately written:

i) The triangulated figures on the 1989-91 accounts provided showed the loss ratios for the PA account to be no more than 72% after three years.

ii) Figures for Syndicate 103's whole account for the 1990 and 1991 accounts as at December 1993 showed the accounts to be unprofitable on a gross basis but profitable on a net basis; however, no explanation was given and the result could have been due to any number of matters.

iii) The text stated that Mr Bird had, when he had taken control, eliminated all aviation business and had produced for the 1992 year a considerable improvement in pure year loss ratios over the 1991 year. As the loss making figures related to the whole account, a reader could well have understood that the figures showing a maximum of a 72% loss ratio (given for the PA account) related to that part of the book which was going forward.

iv) The mere fact that losses were made for several years but that the account was made profitable by reinsurance did not imply that the syndicate was deliberately writing gross loss making business.

479. Mr Bird also relied upon the fact that he was accompanied by someone from the auditors to the syndicate; the auditors had been Littlejohn Frazer and they had been succeeded by Ernst & Young, of which Mr Philpott was an employee; he was, however, a specialist in the setting up of insurance companies and was not one of the auditors of the syndicate.
480. I am sure that Mr Bird knew that the officials at the DTI would not have appreciated from the figures that he was deliberately writing gross loss making business. He obviously knew that it was of paramount importance to make sure that the regulators fully understood what was intended as well as the solvency risks that were being run by writing gross loss making retro and spiral business. I am quite sure that it must have been perfectly obvious to Mr Bird that the officials at the DTI were entitled to a clear and easily understandable explanation of the business that he was intending to write in this way; he took a deliberate and calculated decision not to tell them as he knew that they would have rejected any such proposal once he mentioned the truth of what he had been involved in and of the operation of the spiral. Instead, he intended, if challenged thereafter, to pretend that the nature of the business was obvious from the figures. In my view this was typical of the deliberate and calculated dishonesty that I regret to say was characteristic of Mr Bird.
481. It was during the summer of 1994 that Mr Bird entered into discussions with Mr Brown that led to his employment in connection with the Lincoln National lineslip (as set out at paragraph 439.iii)) from October 1994. From that time Mr Bird was not directly involved in the plans to form an insurance company but, as I set out below, I am sure that he remained the vital link between Mr Whitcombe and Mr Henton and SCB.

(c) The proposal produced in late 1994 for marketing EIC

482. No copy of the proposal produced for marketing EIC (referred to at paragraph 471) and which was aimed at attracting investment was available. However, a version produced after Mr Bird had joined SCB (as he was not mentioned in the proposal) was available to the Court.
483. In this proposal and in subsequent proposals, Mr Henton took the place of Mr Bird (who had moved to SCB) as the individual responsible for underwriting the PA account because Mr Henton was the person with experience of this class of business and had contacts. Mr Bird's evidence was that he had a lot of confidence in him as his deputy; he had the skill and competence to carry out that role. It was Mr Henton's evidence that he was going to be involved in EIC as an employee and as Mr Bird's deputy; he was not involved in any discussions when Mr Bird was involved, but when Mr Bird left, he became involved in helping with the business plans and in the parts relating to PA business.
484. Mr Henton, as I have mentioned at paragraph 395, went to work for Eastgate in June 1994, first under a consultancy contract and then as a full-time employee from 1995. Eastgate dealt with the run-off of Syndicate 103. Mr Henton's evidence was that although he had helped with the transfer of the run-off of Syndicate 103 to Eastgate, he ceased to have any involvement in this after he became an employee of Eastgate, despite diary entries put to him at which it appeared that Syndicate 103 would be discussed. Mr Whitcombe's evidence was to the same effect.
485. Mr Henton was named in the proposal as part of the team and as the person who was to be responsible for underwriting all classes of PA business.
486. The proposal contained much of the same information as the draft application submitted to the DTI, though it contained more. It began:

"Rarely does one have the chance to enter a niche market, create a company staffed by an ideal mix of people, all of whom are of proven worth and experience, and, from inception, service an enviable portfolio of consistently profitable business. This is just such an opportunity."

Mr Whitcombe's evidence was that he believed that the business of Syndicate 103 was consistently profitable.

487. The essence of what was in this proposal was contained in all their other attempts to market the proposal – the fact that it was a low to medium risk portfolio, that the business was business that had been written by the syndicate and which was highly profitable, that it was "deemed short tail", that a cautious approach would be followed and illusory schemes avoided, and that they were going to make an in depth assessment of all reinsureds. Mr Whitcombe accepted that they were setting out a traditional and careful approach to underwriting.
488. The proposal made it clear that at least initially, it was intended that the business that the company should write would include PA and health. The proposal also referred to informal discussions with many major brokers.
489. However, nowhere in the plan was it stated that they intended to write gross loss making or spiral business. Mr Whitcombe's evidence was that investors were interested in making profits; it was also his evidence that there was a certain amount of 'salesmanship' in the document, but that they would discuss the true nature of the business face-to-face.

(d) The proposal prepared with Bank Julius Baer

490. In August 1995, Mr Whitcombe and Mr Imran Zuberi (an underwriter who had worked for Continental Insurance and who was also to be a director of EIC as the representative of prospective shareholders) prepared a business plan and investment proposal with Mr James Normand of Bank Julius Baer & Co Ltd. (Julius Baer) with a view to raising funds. Mr Henton wrote a letter dated 9 August 1995 to Mr Normand (to which I refer at paragraph 490.vi) below) and saw the proposal, but his evidence was that although he could recall being involved with Mr Whitcombe in discussions with Julius Baer as to how the proposal was to be presented, his was a limited involvement. This proposal contained many of the features of the earlier proposal.

i) It again described the business as a low to medium risk portfolio which offered the highest growth potential and returns. The proposed first year's PA premium for 1996 was £46.5m, rising to £57.2m in 1998.

ii) The proposal mentioned Mr Henton as an assistant underwriter though it was in fact intended that Mr Henton was to be the underwriter. This was a mistake as they had lifted the passage from an earlier version of the proposal without updating it.

iii) It set out a description of the reinsurance in the following terms:

"Proposed reinsurance programs

Maximum exposures and potential aggregates will vary according to class. In the case of banker's blanket, professional indemnity and third party, whilst there is a notional aggregate risk purely through a "clash" exposure, there is no exposure to a catastrophe loss within the generally accepted understanding of that expression. As regards personal accident, this does have the potential for a catastrophe type exposure and particular attention must be paid in recording known concentrations of risk and build up of accumulations from excess of loss writings to ensure that sufficient vertical protection is purchased."

This was, Mr Whitcombe accepted, a classic description of reinsurance against catastrophe and accumulation; it could only be read as being conventional reinsurance which was purchased for traditional reasons, however, his evidence was that it might be read differently if it was read with the reinsurance structure.

491. What was particularly significant about the proposal were the references to a particular broker who would be important in producing business to the company; the broker was not named but was clearly SCB.

i) The proposal referred to informal discussions with brokers and stated that the promoters were confident of support:

"A review of the projected underwriting accounts illustrates that, initially at least, a majority of the business that it is intended EiC should write is PA and Health. Most of this emanates from the US and in turn the major part will flow to EiC from one particular specialist broker in London with which members of the management team have particularly close business connections."

I am sure that this was a reference to SCB and of Mr Henton's relations with them; EIC were also expecting to write some of Mr Bird's reinsurance following his move to SCB. Mr Whitcombe's evidence was that Mr Henton was dealing with Mr Brown and Mr Butler. Mr Henton's evidence was that the "specialist broker" referred to in the proposal was SCB and that the "connection" referred to was Mr Bird as he was going to support EIC; however, Mr Henton could not recall if he had had any particular discussions with Mr Bird. Mr Whitcombe's evidence was that he expected the major part of the business to come from SCB and that the business would mirror Syndicate 103's book. There was no agreement that the major part of the business would indeed come from SCB as there was merely an offer of business from SCB. Mr Bird's evidence was that this all might be a reference to SCB. I am sure that the person telling what was the nearest to the truth was Mr Whitcombe.

ii) The proposal stated at paragraph D13:

"A large part of the business categorised in the forecast underwriting accounts as non-proportional accident and health reinsurance is represented by one particular product line. This product is employers' excess indemnity insurance, a relatively new line deriving from the relaxation in the United States of the requirement of employers under the Workers Compensation Act to use the Government-run Workers Compensation System, allowing them to opt out and instead to make their own insurance arrangements."

Mr Whitcombe's evidence was that he did not understand to what this was a reference. The product was described in Mr Henton's letter of 9 August 1995 to Julius Baer to which I refer in more detail at paragraph 490.vi) below. Mr Butler did not accept that this was a reference to him and Mr Brown as they did not produce EEII; his evidence was that that was a reference to Mr Cooke and Mr Tarsh.

iii) The proposal stated:

"The volume of this business has exploded over the last few years and continues to grow at a phenomenal pace as more and more employers opt out of the state system. In the UK this business is being placed by one particular broker which is finding it increasingly difficult to find UK insurers with the capacity to underwrite the business available.

"The particular individual at that broker responsible for this business is an ex-colleague of John Whitcombe and of Chris Henton. He welcomes EiC because of its ability to absorb some of the growth in this product line and to provide an alternative home for the existing flow of this type of insurance risk. Moreover, the tight terms on which these policies are written and the history of the claims on them indicate a high level of profitability."

To whom was this a reference?

a) Mr Whitcombe's evidence was that Mr Bird had promised to show business to EIC.

b) Mr Henton's evidence was that Mr Bird had not made any commitment, but that as there was premium growth, Mr Bird was looking for a market to which business could be written. Mr Henton denied that this had anything to do with the SCB proposal in 1993 (referred to at paragraph 424).

c) Mr Butler's evidence was that he could not recall any discussions with Mr Henton about the placing of business; he would have met Mr Henton several times a year to discuss what they were each doing but nothing specific was proposed; people in the market often said that they had some plans and would ask for support in the event that they got the proposal up and running.

d) Mr Brown's evidence was that he had had no contact with Mr Whitcombe or Mr Henton in relation to this; he did not know if Mr Bird had.

e) Mr Bird's evidence was that this was not a reference to him; those responsible for EEII were Mr Cooke and Mr Tarsh. His only connection with EEII was the fact that Lincoln National wrote it under the lineslip. EEII business had declined and was not important by then as WC was back in favour. However, in his statement, his evidence was that they had had premium income problems in 1995 and that was why they had had the QS with ESG and Clarendon (see paragraph 441.iv)).

Again I am sure that Mr Whitcombe's evidence was nearest to the truth as I am sure a promise was made by Mr Bird that SCB would provide business to EIC if formed. I am also sure that Mr Bird was giving untruthful evidence; he had had premium income problems which EIC would help to solve; the fact that the draft referred to the business as EEII was a mistake on the part of Mr Whitcombe who never properly understood the details of the business; the promise was to provide reinsurance of PA carveout and alternative WC business.

iv) The proposal also stated:

"2.1 Gross premiums written – these are derived from detailed discussions from the brokers which will provide the business (as they did to the syndicates that John Whitcombe and his deputies previously ran). The high volume of business forecast underlines the promoters' assertion that the proposal is not a typical start-up but rather has the characteristics of an acquisition.

2.2 Reinsurance premiums paid – again these are the product of detailed discussions with reinsurers, concerning the cost of the application of a reinsurance programme designed specifically to lay off the risk of the business that it is planned should be written to a level that optimises the return to EIC."

Mr Whitcombe denied that this was a reference to SCB – they had had discussions with many brokers, but he had probably spoken to Mr Bird and he thought Mr Henton might have spoken to SCB. Mr Henton's evidence was that he had had no detailed discussions with SCB. Mr Butler's evidence was that he could not recall any discussions, but if an underwriter had asked him about retentions or free unlimited reinstatements, he would have told him what was available in the market. There would have been nothing beyond that. Mr Bird was vehement in his denial that these were references to SCB.

v) The conclusion was expressed at paragraph F1 in these terms:

"Although EiC is a new company, it is by no means a classic start up. Its foundation has been promoted by a virtual guarantee of a substantial line of profitable business."

Mr Whitcombe's evidence was that this was a reference to discussions with many brokers on whom they could rely, because of their long years in the market, to provide a virtual guarantee; it was not a reference to SCB. Mr Henton's evidence was that this was a reference to brokers' promises to offer business which they would then accept or reject; it was to be a mixed account; there were no detailed discussions with Mr Brown, Mr Butler or Mr Bird.

vi) In his letter of 9 August 1995 to Julius Baer, Mr Henton referred to EEII as a major new product which SCB had developed and which suggested that the business was considerably profitable. The letter referred to a 35% loss ratio; he could not recall where the figures had come from but a possibility was Mr Bird. It also referred to the well-developed relationship that Mr Henton enjoyed with the producing broker. Mr Henton's evidence was that there was "over hyping" in the letter, but that the developer of the product was SCB. With the letter Mr Henton had enclosed a description of EEII business which he accepted had exaggerated the role that he had played; he also accepted that the business had been promoted to Julius Baer as being profitable on a gross basis. It also stated:

"The opportunity to E.I.C is superb. The combination of a shrinking Lloyd's market and the long and well-developed relationship I enjoy with the producing broker would allow me to participate to the desired level. In conjunction with the purchase of complimentary reinsurance coverage to safeguard against the unlikely and the unexpected I would expect to receive a significant return for our participation."

Mr Henton's evidence was that this was a reference to SCB. I am sure that it was and although it contained an element of exaggeration that the rest of the document contained, it was in substance true and he had indeed received assurances from Mr Bird on behalf of SCB.

492. As I have set out above in respect of some of the evidence to which I have referred, I am sure that the evidence nearest to the truth was that of Mr Whitcombe's. I am also sure that discussions took place between Mr Henton and Mr Bird, and that Mr Bird made, on behalf of SCB, promises that they would offer to EIC WC carveout and alternative WC business which was known by Mr Henton to be gross loss making business and which would contain spiral business and which was only writeable against reinsurers. Mr Bird's evidence that his responsibility in SCB was solely in relation to the lineslip was merely a half truth; he had made the promises to Mr Henton with the full knowledge of Mr Brown who was interested in finding new capacity to write SCB's business – this was clearly evidenced by the surviving proposal which was made in the summer of 1993 to Phoenix and Hackett (referred to at paragraph 424) and by the passage in the Julius Baer proposal referred to at paragraph 490.iii).
493. It was on the basis of this promise that Mr Whitcombe was able to make the statement that the new company would have a virtual guarantee of a substantial line of profitable business; at that stage, Mr Whitcombe did not know what the business of Syndicate 103 in fact was or what the disastrous consequences of that business to Syndicate 103 would be; he might well have believed that the writing of such business might be profitable.

(9) Relations between SCB, Mr Whitcombe and Mr Henton until 1997

(a) Contact between Mr Henton and SCB

494. As set out at paragraph 470, Mr Whitcombe's evidence was that he had first met Mr Brown in 1994; he had not dealt with SCB at his syndicates. His evidence was that he did not meet him again until 1997; he had been upset when Mr Bird had left without warning to join SCB. He did not meet Mr Butler until 1997. By 1997 he understood that SCB had produced business to Syndicate 103 and that Mr Henton had had a good relationship with them as well as with Mr Johnson and Mr Davis at WFD and with Mr Garry Lockett at Crawley Warren. Mr Whitcombe and Mr Henton had also tried to target a wide range of brokers in 1994. They had no particular strategy; they used all their contacts in the market to try and get business from as many brokers as they could.
495. However, Mr Henton had known Mr Butler since 1986 when Mr Butler was a claims broker at Bain Dawes; they had got to know each other when Mr Butler had started to place business at Syndicate 103; they had a quite good rapport and had occasionally met for lunch or a beer, just as Mr Henton had done with other brokers. Mr Henton had met Mr Butler occasionally between 1993 and 1997 as he had Mr Davis at WFD. He had mentioned EIC but had done no more than that and had received encouragement from Mr Butler of the possibility of doing business with SCB. The only entry in his diary for a meeting with Mr Butler was for 11 April 1996. Neither Mr Butler nor Mr Brown could recall a lunch with Mr Henton which was mentioned in Mr Brown's and Mr Butler's diary as having taken place on 11 April 1996. Expense claim documents were produced by SCB on day 70 of the trial; according to Mr Brown these were prepared by him and his secretary some time after the event but, although the exact dates and locations might not be right, the events had indeed taken place. These documents showed Mr Butler entertaining Mr Henton to lunch at The Emperor on 26 April 1996. Mr Henton thought that he was to be interviewed for ESG in April 1996 and Mr Butler might have offered support to him.
496. Mr Henton met Mr Bird fairly regularly, though in his evidence Mr Bird untruthfully described this contact as occasional. The expense sheets showed that Mr Henton had met Mr Bird at Benjy's in the City on 31 January, 9 April, 30 May, 13 August, and at Benjy's and Planters Inn on 3 November 1996. Mr Bird met Mr Whitcombe for lunch on 5 November 1996 at The Marine Bar near Lloyd's.
497. Mr Henton had met Mr Brown when Mr Brown was broking business to Mr Bird and Mr Davis at Syndicate 103; Mr Henton's evidence was that he did not meet him socially save at general events. The expense sheets showed that Mr Brown took Mr Henton to lunch on 5 May 1996 (with Mr Henton's former principal at Syndicate 103, Mr Davis and Mr Busbridge). Mr Henton was also invited to a football sponsorship day on 13 April 1996 and a golf day on 22 July 1996; Mr Brown's evidence was that SCB's claims department had invited Mr Henton as Mr Henton was working for Eastgate at that time.

(b) SCB's knowledge of Mr Whitcombe's proposals

498. Mr Bird's evidence was that he could not recall discussing the proposals produced by Mr Whitcombe after he had joined SCB on 1 October 1994. He had no knowledge that SCB were intending to give EIC support.
499. Mr Butler's evidence was that he had some recollection of a proposal, but could recall nothing specific. He accepted that the references in the proposals could have been to SCB. He could recall no discussion about the arrangement of reinsurance for the proposed company; if it had got off the ground they would have tried to place business with it and arrange its reinsurance.
500. Mr Brown must have clearly known a great deal about the proposal in 1994. His evidence, however, was that it was not up to him to comment on the description of the business, or on the fact that there was no mention of spirals. He thought that if the risk was reinsured properly, it was properly described in the EIC document.
501. Mr Brown said that there had been no extensive discussion with him; he might have said, as he said to others, that SCB would support them if they got the proposal up and running, provided that the security was acceptable. There had been no detailed discussions.
502. Mr Brown's evidence was that he had had no further involvement with EIC after the proposal had been forwarded to Mr Lamb of Daiwa.

(c) WFD

503. Discussions were also held with WFD as by August 1995 WFD had identified Mr Whitcombe and Mr Henton as a potential new market which would write retro business – see WFD's "think tank" memorandum of August 1995 (referred to at paragraph 1079.i)).

(10) The emergence of cash flow and other problems among the participants

504. I have already referred at paragraph 191 to the risks inherent in writing WC carveout and related business in a retro and spiral market. By the end of 1996 at the very latest, it was well known to those operating in the PA reinsurance market that those risks could result in serious and substantial problems, caused by the writing of carveout business in London or, as it was known, "PA LMX spiral" or "the PA spiral". Principal among the early problems to manifest themselves were cash flow problems, the risk of which, as set out at paragraph 191.v), Mr Emney had pointed out in as early as October 1990.

(a) Syndicate 305

505. Syndicate 305 had participated in spiral business in 1990 and 1991 through their underwriter Mr Payne (to whom I have referred briefly at paragraph 371.ii)); Mr Payne resigned in 1991. In 1993, the 1990 year was left open; according to the accounts of the syndicate, this was because of the unpredictability of the reinsurance recoveries owing on the PA LMX account of the syndicate. According to the accounts published in May 1994, the 1991 year was left open because of the "PA spiral"; there was unpredictable loss development which meant that the year could not be closed and there were consequently cash flow problems. These points were repeated in 1995, according to the published accounts, where it was noted that the claims were steadily increasing in volume. The 1990 and 1991 accounts were eventually closed into Equitas.
506. Mr Brown's evidence was that he did not know of this; he only knew that syndicates were contracting or merging. He knew that the syndicate was in run-off, but not for the reasons set out. This was a syndicate which had brought retentions down. Although the claims department of SCB dealt with claims, his evidence was that he did not know the details; in any event, claims for the 1990 and 1991 years would have been dealt with at Bain Clarkson.

(b) Syndicate 464

507. Syndicate 464 (EP Hall) had written gross loss making business and had participated in the spiral between 1989 and 1991 when the syndicate had ceased underwriting. The underwriter was Mr Brian Cauldwell, who subsequently moved to Chiyoda where he wrote LMX business and was also the PA underwriter for the ESG pool (as I have set out in connection with the Lincoln National QS referred to at paragraph 441.iv)).
508. The syndicate had derived an increasing proportion of its income from the PA market. In 1992, it left the 1989 year open but no specific reasons were given in the accounts. In 1995 (according to the 1994 accounts), cash flow problems had emerged. The accounts had described the spiral as a "merry go round" in a short passage:

"In the late 1980s, the PA market was able to buy reinsurance at lower and lower levels so that by 1990 each underwriter could obtain reinsurance in excess of … $1,000, and in some cases it was possible to reinsure even this small retention. Reinsurers were themselves able to buy reinsurance and in this way created the PA spiral whose money swapping activity shows no sign of slowing down. Syndicate 464 is one of the participants in this merry go round."

(c) Mr Owen, Syndicate 718 and the North American participants

509. By 1996, considerable losses on the 1994 year had become apparent; on 21 February 1996, Mr Ekwall of Phoenix wrote to Mr Brown about the losses. The information supplied in response showed that the largest losses were from the other four spiral participants – D&H had incurred losses of $17.5m, Clarendon had incurred losses of $16.4m, John Hancock had incurred losses of $12m and Owen had incurred losses of $10.1m; there also were significant claims (but not as large) from Mr Cackett, CIGNA and Folksam. Phoenix's retained losses were $3m; their gross losses were vastly greater, but it was impossible to know the true extent of the losses because of the effect of the spiral in inflating the claims figures in the accounts.
510. The losses were highlighted because after Mr Owen had ceased to be employed by Sturge (see paragraph 436.i)), Sturge had ceased paying Syndicate 718's claims which were made by certain reinsurers on the PA LMX account. Sturge had instigated investigations into the scope and content of what had been written for 1993 and 1994. In the course of the later part of 1995, Mr Owen set up his own agency – Owen & Wilby Underwriting Agency Ltd. He had resumed payments and had tried to deal with the position by dialogue (according to his report written in 1996 when he reported on the inability to close the 1993 account). The syndicate suffered cash flow problems. It appears that Clyde & Co (SD's solicitors) were instructed to investigate and they concluded that investigation by April 1997; the results of Clyde & Co's investigation were not before the court and although the syndicate resumed payments, I cannot draw any inferences as to the result of their enquiries one way or another from the cessation of payment and the resumption of payment.
511. Mr Brown's evidence was that he knew that payment of claims had ceased for a while and that he knew of the dispute between Mr Owen and Sturge; Syndicate 718 subsequently commenced proceedings against SCB.
512. On 17 June 1997, Mr Butler expressly referred to the difficulties that had been caused as a result of Mr Owen's cessation of payment in order to explain why it was impossible to find reinsurance – see paragraph 977.

(d) Syndicate 103: cash flow problems

513. As set out at paragraph 399, nothing was said in the accounts sent to the Names until the accounts for 1995. In the accounts for 1995, it was apparent that the syndicate was being paid far more from its reinsurers in claims than the syndicate was paying in premiums; the loss ratio to reinsurers by this time was 800%.
514. By no later than October 1996, Syndicate 103 was experiencing cash flow problems as that was the reason for a cash call which was given in a letter dated 10 October 1996 to the Names. Mr Henton's explanation was that they had used the funds of prior and open years to deal with the cash flow impact of the spiral; after the Equitas settlement that was not possible; also there was a new computer system at Eastgate which was not as efficient as the system used at Syndicate 103. Mr Bird's evidence was that the syndicate had not had cash flow problems as it had always been their aim to get their claims in first; however, when the 1991 and 1992 years went into Equitas, the syndicate lost its cash reserves and this caused the problem; when the syndicate went into run-off, it was to be expected that it would produce a loss because it would have had to absorb the run-off expenses.
515. The position was reported to the Names in different terms when, on 21 March 1997, Eastgate wrote to the members' agents to explain the need for a cash call. First, the letter stated that two significant PA reinsurers had temporarily stopped paying each other's claims in the second half of 1996 with the consequence that the presentation of claims to Syndicate 103 had been delayed; when the payment had resumed in 1996, there was a substantial increase in the level of claims and they had therefore investigated. This was a reference to Transamerica and Mr Owen.
516. The letter then referred to the fact that Syndicate 103 had participated in the PA spiral and an outline of the spiral was given (including the fact that the participants had reinsured one another at the lower levels); this was a brief outline, but fuller than that which had been given in the 1995 report (see paragraph 399):

"A small number of Lloyd's syndicates and London market insurance companies wrote extensive books of [PA] business. In seeking to protect themselves against excessive claims for a particular loss event, reinsurance protection was purchased on an excess of loss basis for each loss above a defined level. In most instances the defined level was US$5,000 so that any claim in excess of that figure would be recoverable from reinsurers up to a specified limit. All of this is standard insurance practice, but in this instance the direct insurers tended to reinsure each other particularly at the lower levels of reinsurance protection. These participants have then purchased higher layers of reinsurance protection and typically a reinsurance programme may provide protection up to £100m.

The unusual feature is that most of the reinsurance protections have the benefit of unlimited free reinstatements i.e. when a policy's limit has been exhausted, it is immediately renewed at no additional cost and is therefore available in full for other losses."

517. The letter then went on to describe the cash flow impact which had arisen because the syndicate had only collected on the claims that the syndicate had paid out at the end of each quarter. It stated that a committee had been formed as it was in no one's interest for "this extraordinary situation to continue". The letter attributed the deterioration from three main sources: (1) the number of claims entering the spiral – 200 additional claims of $5,000 had been projected, (2) interest of £280,000 on overdrawn cash balances because of the cash flow problems, and (3) the provision of 10 years of run-off costs at current rates, as that was the period that was projected for the spiral to unwind.
518. The letter concluded by stating that they had written to Lloyd's, urging that a full investigation be made into the manner in which this class of business had been written. Enquiries were made by Lloyd's into the conduct of the participants in the 1993 spiral. At my request information was sought from Lloyd's on 9 April 2002; Lloyd's confirmed, in a letter to Clyde & Co on 23 April 2002, that there had been an enquiry, though the DTI were not advised of it. As there was no further information from Lloyd's, at my request Clyde & Co wrote to the Chairman of Lloyd's on 9 July 2002, asking for more information about the enquiries. Lloyd's asked for the expert reports in these proceedings; these were supplied on 10 October 2002. Lloyd's never responded. They neither assisted the Court by making available any information about the enquiry, nor by making available the documents or other information obtained by the enquiry; they also offered no explanation as to why they were unable to assist. I very much regret their failure to respond to the Court's request for assistance. I have had to reach conclusions about a market in which many syndicates participated without the benefit of any assistance from Lloyd's as a regulator in that market, even though they had conducted their own enquiry into the said market.
519. On 25 April 1997, the report for the 1996 year was signed and was thereafter sent to the Names. It described the spiral in the PA market and its effect; it noted the establishment of a committee of participants and repeated much of what was in the letter of 21 March 1997. It notified a further cash call of 50% in addition to the cash call that had been made in October 1996:

"The underlying reason for the syndicate's loss and cash flow problems has been identified as the participation at the lower end of the so-called 'personal accident spiral' (PA spiral). There follows an outline of the mechanics of the PA spiral.

"… The syndicate has cover for 1993 losses up to $50m with unlimited free reinstatements and thereafter up to $130m with limited reinstatements.

"In practice, an original loss of as little as £12,500 or $25,000 will enter the spiral and keep being passed from reinsurer to reinsurer, increasing on a cumulative basis, until the number of retentions in each programme equals the original loss. A large loss will continue to spiral until it reaches the top of the reinsurance programme and will fall to be borne by the reinsurer who has not bought sufficient protection to cover the inward risk assured. Syndicate 103 only reinsures at the lower end of the spiral so does not appear to be exposed to retained losses following exhaustion of vertical reinsurance cover. However it is exposed to the high volume of losses of which it must retain $5,000. The severity of the spiral and consequently the number of original losses which will impact on Syndicate 103 has only recently become apparent.

The security on the reinsurance programme is currently deemed to be good. However, cash flow difficulties arise because reinsurance collections may only be made at each quarter end.

As it is in no-one's interest to allow the spiral to continue, a committee of spiral participants has been formed to seek ways to mitigate the serious impact on cash flow and costs. The relatively small number of participants gives cause for optimism. However, it may take at least a year to achieve full agreement and any solution may have a material cost impact on the syndicate. One immediate benefit of the increased co-operation among participants is that it has been possible to gain a more comprehensive picture of the total volume and value of claims entering the spiral. The information, while not entirely complete, has required a reassessment of the reserves set at 31 December 1995.

As previously reported the syndicate purchased a policy to cover paid retentions. This was placed 100% with Dai Ichi Kyoto, a company now in liquidation. A provision for bad and doubtful debts of £820,000 has been made in respect of this policy."

520. Although Mr Brown accepted that this accurately described the spiral, his evidence was that he did not know of the cash flow problems of the syndicate even though he often saw Mr Bird when he was in London; his evidence was that any syndicate that went into run-off had cash flow problems and Lloyd's had seen 200-300 syndicates close in this period. He maintained that he did not know, even though this was the same problem as that suffered by Mr Owen's syndicate.
521. Mr Whitcombe's evidence was that he had skimmed the letter of 21 March 1997 when he received the cash call; he may have heard some comment about the matters referred to in the letter; he had not read the report of 25 April 1997 but wished he had.
522. Mr Bird pointed to the fact that in December 1998, the net loss ratio was still below 100% on an incurred basis and that an underwriting profit was still being shown. This was because the accounts appear to have been prepared on the basis that reinsurance recoveries would be paid; the protections under the spiral operated to restrict each loss to the underlying retention without going out through the top or coming back in any other way, even though Transamerica had given notice of avoidance at that stage; I attach no significance to this evidence of Mr Bird's as it is difficult to understand how the accounts could have been prepared on this basis, given the notice of avoidance by Transamerica.
523. The final step in the events was the avoidance by Transamerica. The Names were informed of this in February 1998 (as described at paragraph 1331).

(11) Conclusions on the spirals in 1993-6 and the search for capacity

(a) Mr Brown's and Mr Butler's position

524. I have set out at paragraphs 370 and following, the evidence of Mr Brown, Mr Butler and Mr Johnson as to their understanding of the market.
525. I accept, as I have set out at paragraph 379 in the case of each of them, that they, along with many others, considered it ordinary and acceptable market practice in the London PA reinsurance market for underwriters to write gross loss making business on the basis that the losses would be passed to reinsurers. I also accept that they were used to placing such business within the London market on the basis of the limited information of the kind referred to at paragraphs 210 and following, but which would set out the amount of any spiral business in the account being reinsured and which would describe the account as a reinsurance of PA business including business either described as occupational accident or as WC carveout or as some such similar description.
526. I am sure that by 1992 they appreciated that gross loss making WC carveout business with very high gross loss ratios could only be reinsured by finding a market that would reinsure first tier underwriters. They knew and understood that in finding a market to reinsure first tier reinsurers, they had to do so on the basis of a fair presentation of the risk and on the basis of full disclosure, which, as I stated at paragraph 379, was the key factor.
527. I had the opportunity of observing Mr Brown during a long and searching cross-examination by leading counsel on behalf of SD. Mr Brown was a very shrewd and experienced broker; he was not only a man of very considerable intelligence, but was also a man driven by the determination to achieve the plans for his group (to which I have referred at paragraph 353). To this end, he was prepared to be quite ruthless. He understood from his long experience in the market, the difference between what was honest and proper by the ordinary standards of the market and what was not; it was clearly dishonest by the ordinary standards of the market to deliberately make a presentation of a risk that was unfair and misleading and it would be dishonest to construct an artificial spiral that was intended to, and would have the effect of, pushing working layer losses up to higher layers. Mr Brown understood that to be dishonest.
528. Although Mr Butler was less experienced that Mr Brown, he was also a man of very considerable intelligence, though more easy going and jovial in his dealings. I am also sure that he understood the difference between what was honest and proper by the ordinary standards of the market and what was not. He was in the same position as Mr Brown.
529. It was the evidence of Mr Butler that he normally started to place business with Mr Billyard as leader and then approached such others as were available for the following lines; that any underwriter who was prepared to accept spiral business knew of the dangers of that business and that one of the dangers included the prospect that small losses could spiral up to higher layers; by writing the business they knew of the dangers beneath them. Mr Brown's evidence was to the same effect.
530. Throughout this period, it was their aim to ensure that they had had the capacity to reinsure WC carveout and related business and this is what governed their actions in a market that was becoming increasingly difficult.

(b) Conclusion on the relations between EIU and SCB

531. SCB's aim to ensure that they had capacity for their WC business was the explanation for their interest in EIC. As set out at paragraphs 490 and 491, I am sure that the proposal containing references to the production of business to EIC were references to promises and firm offers by SCB to provide business. I am also sure that Mr Bird knew what was in the proposals and had passed that information on to Mr Brown as SCB were becoming increasingly anxious in their search for new capacity to write their WC carveout, retro and spiral business – this was so essential to their plans for expansion.
532. I am sure that there was a common understanding between Mr Brown and Mr Bird on the one hand, and Mr Whitcombe and Mr Henton on the other, that if Mr Whitcombe and Mr Henton were able to establish EIC, SCB would offer its WC carveout and alternative WC business to EIC and Mr Henton would write such business as part of the EIC account.
533. I am also sure that Mr Brown and Mr Bird had not forgotten, contrary to what they had claimed in their evidence (referred to at paragraph 468), about Mr Brown's involvement in EIC. They did not say anything about it because they had wanted to maintain an ordinary broker-reinsurer relationship between SCB and Mr Whitcombe and EIC.

(c) Were the spirals deliberately created?

534. But was SCB's aim to maintain the reinsurance market for their WC business also reflected, as SD alleged, in the deliberate creation of spirals?
535. In considering the submission that the spirals were deliberately created, I bear very much in mind that:

i) It would be very difficult for a broker to construct a spiral.

ii) Any spiral could be altered, as it was graphically put, by the stroke of a pen through a new reinsurance placed by a spiral participant; any of the reinsurers involved could have gone to another broker and could have placed further reinsurance without SCB being aware, or without collusion with the other participants.

iii) A broker would not ordinarily know the reinsurance programme of an insurer with whom he placed business.

iv) That the tables and diagrams produced do not show the complete picture as some of the reinsurers whose participation represented leakages from the spiral might be reinsured back into the spiral.

v) Mr Greig's evidence was that the trading of lines at the bottom end of a programme was not unique; it was sometimes necessary that there was a swapping of capacity in order to kick start a programme. He was aware that this was a regular experience at the bottom end of the PA LMX market over a number of years, including 1997 and 1998, and he believed that this also happened in the aviation retro market. However, as he accepted in cross-examination, he had not been involved in the placing of a tight spiral and no one at Bain Dawes or Aon had, to his knowledge, done so either.

vi) It was an accepted practice in the market that in order to write or complete a reinsurance programme, a reinsurer would on occasion agree to write a small line on another's reinsurance in return for that reinsurer writing a line on his.

vii) A reinsurer at the bottom layer would not be able to work out to which particular reinsurer a loss would go; there was a risk that a loss could be passed back by a higher layer reinsurer and therefore pass back into the spiral.

536. However, I am sure that the spirals for 1993-6 were deliberately created:

i) There is sufficient evidence and the diagrams and charts were sufficient for me to be able to form a clear judgment.

ii) Mr Brown, Mr Butler, Mr Bird, Mr Johnson and Mr Billyard all knew that the writing of the reinsurance of WC carveout and related business at working layers would produce gross losses and that such business could only be written on the back of reinsurance. I have no doubt at all that Mr Brown and Mr Butler had a clear understanding of the very large losses that were likely to befall a reinsurer writing WC carveout business at any tier; they were not surprised at gross loss ratios of several hundred percent and those loss ratios would increase with each retrocession which in turn diminished the premium. I am also sure that they understood that no reinsurer would write reinsurance that would produce such enormous losses without an outwards reinsurance programme to transfer those losses to someone else.

iii) Those familiar with this business would only agree to provide reinsurance if they could be assured that the inevitable losses that would be sustained could be passed on to someone else.

iv) By 1993 the market which was prepared to write WC carveout on a retro basis had contracted to do so; through the link between Mr Brown and Stirling Cooke which led to the formation of SCB, SCB had become a major broker in the market for this type of business. Their strategy was, as set out at paragraph 353, to develop the group and they needed to ensure that they could remain competitive in the US WC insurance market through the reinsurance they were able to place in the London PA reinsurance market.

v) Those who wrote WC carveout reinsurance at working layers or who provided reinsurance to those who wrote reinsurance at working layers could only continue to do so if the losses were passed away from them to others.

vi) I am sure that there was no overcapacity in the market that was prepared to write retro and spiral business which was substantially made up of gross loss making WC carveout business; I am sure that SCB were constantly on the look out for those who could be persuaded to participate in the retro and spiral market.

vii) It is very striking that in no document did they or anyone else ever properly describe the business – neither in the one to which I have referred at paragraph 424, nor in those to which I will refer hereafter; they did not even explain the true nature of the business at a meeting held with SD on 4 January 1999 (see paragraphs 1804 and following).

viii) It was therefore very important to SCB that Mr Bird, Mr Billyard and Mr Owen continued to write working layer XL reinsurance for carveout and working layer retrocessions in 1993; the losses had to be passed on to someone else. I am sure that SCB arranged for Mr Bird and Mr Billyard to quote in 1992 for the 1993 year on the basis that the other would reciprocate; Mr Bird and Mr Billyard did so without any information and did so at the same rates; they did so as they intended to ensure that they did not keep the losses but that these were transferred to those in the higher layers. The fact that one or more might not have quoted for the other did not matter as what mattered was the quote for the whole layer. I reject Mr Bird's evidence as untruthful as, for the reasons I have given at 442.iii), I have concluded that he was a man on whose evidence I could place no reliance. Nor did it matter that Mr Bird did not insure the lowest layers of the other participants in 1993, for the effect of the spiral of reinsurances between NAF&G, Mr Billyard and Mr Owen in 1993 was to pass losses exceeding $15,000 to Mr Bird's layer; after his retention was paid the loss then continued in the spiral.

ix) SCB set about finding new capacity for 1994 (through the document sent to Phoenix and Hackett in the summer of 1993 (see paragraph 424)) in order to replace the anticipated loss of Syndicate 103; they arranged a similar strategy to pass the losses away from them and the other low layer participants.

x) In 1995 there was clear co-operation between SCB and WFD in constructing a spiral.

xi) The creation of these tight spirals, the effect of which (particularly in 1995 and 1996) was to push losses to very high layers, was not accidental particularly given the small number of participants and the consistency in what was achieved.

xii) In late 1997 (as set out at paragraphs 1077 and following (particularly paragraph 1089)), Mr Johnson tried to establish an arrangement with Mr Henton under which losses would have spiralled.

xiii) I could understand an argument based on reciprocity if small lines had been taken on some parts of one another's programmes in order to get them started or completed, but this was not what was done. I am sure that they took significant lines on one another's reinsurance for the purpose of pushing working layer losses up to the higher layers.

xiv) Mr Brown, Mr Butler and Mr Johnson and the knowing participants did not care who wrote the losses at the higher layers as long as they were of sufficient security to pay for them. They were not selecting a particular reinsurer as a dump but were constructing a mechanism where the losses would be carried away from them and reinsured at very cheap rates; there was a prospect that the reinsurers would not realise the true extent of the losses being passed to them as the delays inherent in a spiral would delay the notification and transmission of the losses. There was a small risk that the loss might re-enter the spiral as a result of one of the participants reinsuring a high layer reinsurer, but that was a small risk which the participants were prepared to take as it would be an appreciable time before such losses came back to them.

xv) The rates for the higher layers were cheaper than the rates for the lower layers – the higher the layer, the lower the premium. As I have observed at paragraphs 171.vi) and 280, this rating was irrational if the business which was being reinsured was spiral business. SCB submitted that no adverse inference should be drawn because there were some in the London market (such as the syndicate of which Mr Hines had been the underwriter) who had participated in the higher layers of Mr Bird's reinsurance in 1993. I do not know the particular circumstances in which the underwriter of Mr Hines' former syndicate had participated; unless he had had reinsurance arrangements of his own, the obvious inference is that he had not understood the business. However, as I have already observed at paragraph 281, it stretches credulity to believe that there were so many who appreciated the true nature of the business and the inevitable working losses that they would have to pay yet were prepared to rate it on the conventional basis for XL reinsurance. For the reasons which I have given at paragraph 312, it would further strain credulity if all of these were prepared to do so on the basis that they would pass those enormous losses into the lowest layer of their outwards reinsurance programmes.

xvi) The effect of these spirals is illustrated in charts which were produced to the Court by Mr Jackson ((Charts A B C D)); these must be subject to similar qualifications to those set out at paragraphs 1202 and following in respect of Chart 3 which was produced by Mr Hunt in relation to the spiral created in 1997.

xvii) I reject the evidence of Mr Brown and Mr Butler that spirals were not created as untruthful. In giving his evidence, Mr Brown was frequently evasive in his answers. On occasions, instead of answering the question, he referred to the 1998 business plan of the Alternative Risk Transfer (ART) division of SD and claimed that they were doing the same kind of business as SCB. However, as set out at paragraph 1439 below this was not writing gross loss making business on the backs of reinsurers. As set out in numerous passages of this judgment, it is clear that he had acted dishonestly and had told lies. He was not a witness of truth. Nor was Mr Butler; although his evidence was given more openly, it was clear from numerous passages in this judgment, that he had acted dishonestly and had told lies.

537. I am sure that Mr Brown, Mr Butler, Mr Bird and Mr Johnson understood and intended that the effect of the spirals was to push working layer losses (particularly those in 1995 and 1996) up to layers where catastrophe losses would ordinarily be experienced (as set out at paragraph 535.xi).
538. Although a reinsurer writing spiral business should have appreciated that a small loss could spiral up to a higher layer, no one writing spiral business would anticipate that there would be deliberately constructed beneath their layers, a mechanism that would not leave to chance the transfer of the losses to the higher layers. Whether any particular company which wrote catastrophe layers understood that this would happen is not a matter for me to determine as I have explained. Although a determination has been made in respect of Transamerica, the findings are not treated as evidence before me any more than the allegations made by others are.
539. It was submitted by SD that Mr Billyard was a participant in the deliberate creation of these spirals and that he understood their purpose and effect. As I have set out at paragraph 415, he was not called to give evidence. Although in all the circumstances I do not draw any adverse inference against SCB from the fact that he was not called, he could have been called and it must have been obvious to SCB and to him what the allegations were.
540. It was submitted on behalf of SD that Mr Billyard had had ample notice of the allegations against him as someone employed within the SCB group, and that it would be fair in all the circumstances to make findings against him if the evidence supported such findings. I accept that submission; he had had ample notice of the allegations. I have taken into account the fact that I have not received any evidence or explanation from him as to his role; however, I am sure that he acted dishonestly and that he was a participant in the deliberate creation of the spirals; he knew and intended that the spirals would transfer working layer losses to catastrophe layer underwriters.
541. A spiral was re-created at the end of 1997; my conclusions in respect of this are set out at paragraphs 1255 and following. The fact that SCB was then prepared to alter the reinsurance arrangements made at the beginning of 1997 which had resulted in SD being the dump for loss making business without consultation with Phoenix or American Reliable so that a spiral was created without their knowledge, was no reason why SCB would not have co-operated with them in earlier years to create a spiral. By the end of 1997, neither Phoenix nor American Reliable were of any use to SCB as capacity for facilitating the placing of their gross loss making business; SCB acted to their detriment in 1997 when they were of no further use to SCB, but that did not mean that SCB did not act with them at an earlier point in time when they were of use to SCB in placing gross loss making business. It was but an example of the ruthless characteristics of the way in which SCB acted.
542. The motivation of SCB, Mr Brown and Mr Butler was:

i) To enable those in the SCB group to compete more effectively in the market for WC and alternative WC in the US and to expand its operations, as set out at paragraphs 163 and 353. The provision of cheap reinsurance (as set out at paragraph 140) provided through the arrangements described enabled SCB to be more competitive.

ii) To earn the very considerable commissions of 10%-15% which were paid each time the same business was passed round and round.

(d) What was known about the problems of the spirals?

543. As I have set out at paragraphs 191 and 503, those who wrote WC carveout business were aware of the problems arising from this business. It was a small market and I am sure that Mr Brown, Mr Butler and Mr Johnson were, by 1996 at the very latest, aware of the cash flow problems actually being experienced and that these were the direct consequence of the spirals that had been created. They were all persons with an acute knowledge of the market (see, for example, their explanations to Mr Henton at the meeting of 19 May 1997, referred to at paragraph 965). In the case of Mr Brown and Mr Butler, the problems of Mr Owen's syndicate and those of Syndicate 103's were problems which had directly affected contracts which SCB had placed and which were affecting the ongoing business; I am sure that they were well known to Mr Brown and Mr Butler and reject their evidence to the contrary as untruthful.

4. THE NEGOTIATIONS FOR THE BINDER

(1) The position of Mr Whitcombe at the end of 1996

544. By mid-1996 the proposals for an insurance company had not progressed; capital providers could not be found to fund the investment. Mr Whitcombe reached the conclusion that money could not be raised in the foreseeable future. It was, as he said, more or less dead. He had been out of work for two years and he was fairly short of income.
545. In December 1996, EIU was formed as Mobileimport Ltd.; it changed its name to EIU on 28 February 1997. It was a company with a very small capitalisation.
546. In due course EIU employed, in addition to Mr Henton, Mr Michael Dickson (who had a binder from Mr Michael Davis' syndicate at Lloyd's to write man on the street PA); these were written to contacts of his; Mr Terry Leonard, who was also employed by EIU, had a property binder. None of these had any involvement in the matters considered at the trial; the fact that they were employed by EIU should not in any way cast any doubt on their professionalism or integrity.

(2) SD and its personnel

(a) General

547. By 1995 the ultimate holding company of SD, a public company listed on the NYSE, had two main insurance companies – SD in London and Sphere Drake Insurance (Bermuda) Ltd. in Bermuda. SD's business was mainly international property and casualty and treaty reinsurance; it also wrote facultative reinsurance. It had withdrawn from financial institutions business in mid-1996 and shortly thereafter from marine business. The total premium income of SD was in the order of £300m.
548. In January 1996, Mr Michael Watson was appointed the Chief Executive Officer; he was a chartered accountant by profession rather than an underwriter; he had worked in the banking and financial services prior to his appointment as CEO. He gave evidence to the Court. It was EIU's submission that he was both glib and unctuous and that his evidence was a mixture of truths, half truths and lies. I reject that submission. I am sure that he was a witness of undoubted integrity and he did his honest best to assist the Court to the best of his recollection. As Chief Executive Officer and a person with little background in underwriting, he was not initially involved in underwriting, which Mr Paul Philo, SD's Chief Underwriting Officer, supervised under the general direction of the board. In August 1997, Mr Philo left and Mr Watson became more involved in the underwriting. Mr Philo did not give evidence and no explanation for that was given; in the circumstances, it is to be inferred that he would not have given evidence which was favourable to SD.
549. SD had several divisions including a specialist treaty and specialist facultative department based in London. Each division was headed by a director who was a member of SD's board; SD's back office functions (claims, premium handling, reinsurance security) were carried out by a separate group company, with some of those functions being carried out at an office in Brighton. SD also had a reinsurance desk under Mr Nick Vassilides which dealt with a variety of functions relating to reinsurance.
550. On 4 April 1996, SD's rating by Standard & Poor was reduced from BBB+ to BBB, though it maintained its Best's rating of B++.
551. It appears that like some other organisations that underwrote business in London, its procedures were not as tight as modern business had required. Therefore, on 29 November 1996, Mr Philo issued a manual entitled "Underwriting Policies, Procedures and Guidelines" under the cover of a memorandum. The memorandum explained that this was the culmination of the work of a team headed by one of the underwriters and continued:

"The contents of the guide should not be completely foreign to you. The guide is not intentionally voluminous, as I have no desire to see underwriters bogged down by page after page of meaningless rules that inhibit our ability to be creative. The contents are therefore designed to standardise our procedures and to ensure that we adopt good house keeping practices at all times. I am fully aware that some of the requirements will take time to implement. Nevertheless, many of the guidelines are immediately achievable … and I ask you to ensure that they are adopted without delay…"

552. The Guide contained many provisions designed to encourage prudent underwriting and proper business practice; for example, it set out the requirements for business plans; it required that all outwards reinsurances were to be vetted by the Reinsurance Committee prior to purchase; that the account underwriter was to be responsible for giving orders for reinsurance and for ensuring that cover notes were received on a timely basis; the security on the reinsurance was to be signed off by a department known as the Security Control Department.
553. Specific provision was made in the Guide for binding authorities:

"All agency agreements where underwriting authority is delegated must be signed off by the Chief Underwriting Officer The agreement must be supported by relevant information such as financials, market reputation etc.

Account underwriters writing cover or lineslip business must obtain full copies of all declarations. All agents who have been delegated underwriting authority by the company must be audited at their premises at least annually"

(b) Mr Broad

554. Mr Broad initially began his career in insurance in 1957 as a broker and moved to underwriting in 1969. He had worked for the Excess Insurance Company and then for the underwriting part of CT Bowring's business which controlled the facultative underwriting, including Terra Nova Insurance Company. In 1973, he was appointed the active underwriter of Syndicate 370 which he had established. He had specialised in non-marine contingency, property, household and fire business. The syndicate ceased writing business in 1993. It had been profitable until the 1989 underwriting year; in 1989 a small loss was made, but in 1990 and succeeding years, heavy losses were sustained –principally from a book of personal stop loss policies and also from a scheme which insured supply teachers.
555. He had joined SD in 1994 as a director and underwriter in charge of the International Facultative Department; he wrote a general non-marine account, much as had been written at Syndicate 370. His salary was supplemented by a bonus related to the overall profitability of SD. By 1996 he had had close to 30 years' experience of underwriting.
556. The business written in the department was direct business; it also wrote facultative reinsurance but not treaty. SD had a separate treaty department which was located in a different room. Mr Broad had had no authority within SD to write treaty business.
557. Mr Broad left SD on 13 August 1998 in the circumstances described at paragraphs 1503 and 1504.
558. He had thereafter been employed by Holt (UK) Ltd. (Holt); serious allegations were raised about his conduct there but these were all denied by him. Evidence could not be adduced to contradict his denials and I have come to no view about them.

(c) The involvement of others at SD in the operation of the binder

559. Mr Broad's underwriting team in the International Facultative Department comprised Mr Keith Tunstall and Mr Andrew Rayner, his deputies, and Miss Sonia Heywood. Mr Tunstall had worked with Mr Broad since 1976 when Mr Tunstall had joined Terra Nova; he had followed him to Syndicate 370, to SD, and then to Holt when Mr Broad left SD. Mr Tunstall gave evidence to the Court; he was loyal to Mr Broad as they had worked together for so long and was confident of Mr Broad's underwriting ability, but he did his honest best to help the Court. Mr Broad's evidence was that it was his general policy to keep his team informed as to what was happening and to discuss matters informally. There were also formal meetings of the department each week.
560. Mr Broad's evidence was that he would have kept his underwriting team informed with respect to the binder granted to EIU in the circumstances described later in this section. Mr Tunstall's evidence was that although he and Mr Broad worked closely together, they were not hand in glove all the time; he was not involved in monitoring the performance of the EIU binder. If Mr Broad had a pet subject (like the EIU binder), he worked on his own, excluding others. Mr Tunstall had little to do with the EIU binder save on occasions; he was unaware, for example, that $3m of premium income had been written in the first 2½ months. Mr Tunstall's evidence was that he could not recall the binder ever being mentioned at the weekly meetings of the International Facultative Department. Mr Tunstall had only seen Mr Whitcombe with Mr Broad at Balls Brothers when having a drink; it was not a meeting, but a nod across the bar.
561. In 1998 underwriting files at SD's Brighton office were kept within the Technical Services Department or the Technical Support Department. At SD's London office, they would be kept in one of the filing cabinets in the underwriting room of the relevant department. Mr Nick Bentley (whose appointment to SD in 1998 is set out at paragraph 1380) had not found an underwriting file for the EIU binder at either of these locations. Mr Tunstall could not recall consulting a file for the binder. Mr Bentley's experience of underwriters' files at SD was that it varied from underwriter to underwriter. Most files had a slip, endorsement and the information which was supplied at broking. He considered that many of the procedures in the document drawn up by Mr Philo were a wish list which was not fully complied with.
562. In 1998 reinsurance was subject to a security committee that comprised Mr Watson, Mr Robert Forness (the Chief Operating Officer of SD) and some of the underwriters; Mr Phil Heaney researched the security of companies. As set out at paragraph 548 above, there was also a reinsurance desk which consisted of Mr Vassilides and Mr Alan Groves whose function it was to give advice on reinsurance programmes. There was also an outwards reinsurance area which looked after recoverable losses. It was Mr Bentley's understanding that the underwriter was meant to check with the reinsurance desk and with a central figure within SD before purchasing reinsurance. It was Mr Broad's evidence that the broker on any outwards programme had to take a list of the proposed security to SD's reinsurance security desk for approval.

(d) Mr Broad's experience of PA business

563. PA business had been written at Syndicate 370. In 1989 the syndicate employed Mr Keith Thorogood. He was a specialist PA underwriter previously employed by the Merrett Underwriting Agencies to write a PA account at Syndicate 799 of which Mr Jackson, the underwriting expert called by SD, was the leading underwriter. Mr Broad's evidence was that although he kept an eye on what Mr Thorogood was writing, he had left the underwriting and the putting together of a reinsurance programme to Mr Thorogood. The account included treaty business, some WC carveout and alternative WC business. The PA account grew from 6% of the premium income in 1988 to 36% in 1991. Although the account had initially appeared to go well, losses were incurred from 1990 to 1992.
564. SCB investigated, to the extent that they were able, the reinsurances that had been placed to protect Syndicate 370's PA book from 1989 until when Mr Broad left in 1993 when the syndicate ceased writing business. It is clear that the reinsurers on those reinsurances made a gross loss and that when the reinsurances were renewed, it was clear that gross losses had been sustained; further the retentions were low, sometimes as low as $1,000 xs $4,000. Those that reinsured the syndicate included Mr Bird, Mr Billyard, Mr Cackett and others who deliberately wrote gross loss making business, but Mr Broad was not aware of that. On the evidence before the Court, it is highly probable that Mr Thorogood wrote gross loss making business, but I am sure that Mr Broad was not aware of that.
565. Although Mr Broad did leave the general running of the account to Mr Thorogood, he would discuss the placing of the reinsurance with Mr Thorogood. Mr Broad's evidence about the extent of the discussions was not consistent. He was certainly aware that Mr Thorogood kept very low retentions on his reinsurance programme and that the losses were large in number. However, the information available to test the position on the renewal of the reinsurances was not available in the necessary detail; furthermore, the reinsurances had been placed 10 years previously on a part of the account that was not his area of responsibility. I cannot therefore conclude that Mr Broad focused his discussions with Mr Thorogood at the time on the fact that the reinsurances of the syndicate may well have been gross loss making on renewal. Nor can I conclude that Mr Broad understood that the account included WC carveout and occupational accident business; he could not recall that fact, nothing showed that he should have appreciated it, and I am quite satisfied that, given Mr Broad's scant regard for reading documents or in enquiring into the work done by others, that he would have given no more than a cursory glance at any documents which had been put before him by Mr Thorogood.
566. Mr Broad was insistent on a high retention when he started to write PA business at SD; he did not like low level insurance as he considered that it was uneconomical to collect such small amounts from reinsurers. This was his position in relation to reinsurance when the binder was granted; his retention was $60,000. If he had had experience of and had understood the writing of gross loss making business, I am sure that he would have insisted on reinsurance being in place with a very low retention before any business was written.

(e) The PA account at SD

567. In 1995 Mr Broad and Mr Tunstall started a small PA account. It was the intention to write $1m in 1995, but they only wrote about $200,000; they had planned to write $1m in 1996, but only wrote $750,000; in 1997 they wrote about $1m. It was Mr Tunstall's evidence that this was Mr Broad's idea but that it was his job to develop the business with the brokers. The business that they were attempting to get was traditional direct PA business – individual accident, travel and sports, but they did not get a good response. There was overcapacity in the market, PA brokers were a very close-knit fraternity, and the fact that SD did not have an 'A' rating did not help. Mr Broad also attributed the failure to get business to Mr Tunstall's lack of success in marketing the business; Mr Broad had given Mr Tunstall a "strong talking to".
568. Reinsurance was bought for this account. The information sheet provided to reinsurers for the 1995 year stated:

"The account will consist mainly of direct business and excess of loss reinsurance of direct writing companies. No so called "LMX" business will be written."

A breakdown of the account was given. This included "PA. Treaty x/l (ex LMX) 20%", indicating therefore the intention to write an account with 20% XL treaty business excluding LMX business. Another page set out the line that was to be written on PA treaty XL. The information sheet for the 1996 year contained the same information. Mr Broad signed that.

569. Mr Broad's explanation for the inclusion of the reference to an intention to write 20% treaty business was that the brokers, Crawley Warren, would have filled out the questionnaire from their records of the business he had written previously; it would have been brought into the underwriting room and he would have signed it. The broker would have tried to obtain the widest scope of cover and it would not have worried him if he had seen it as he had had no intention of writing it. His evidence was that he did not write treaty business. However, Mr Tunstall's evidence was that it was his understanding that there was an aim to obtain 20% PA treaty, though they did not in fact write any.
570. I accept Mr Broad's explanation. I reject the suggestion that he was keeping open the option of writing treaties. He was not permitted to do so and none was written in this account. However, no underwriter who paid proper attention to documents would have signed the information sheet, but as was evident on other occasions, Mr Broad acted imprudently and had acted below the standards of a prudent underwriter by signing a document he had not read.
571. The reinsurance programme obtained which permitted treaty business (but not LMX business) to be written is more conveniently described at paragraph 672.

(3) The introduction of Mr Whitcombe to SD

(a) Horace Holman

572. The person who had brought Mr Whitcombe and Mr Broad together was Mr Graham Smith of HHI. Mr Smith was a broker of many years' experience, having worked at Griffiths & Armour before moving to HHI in August 1996. He had been invited by Mr Paul McCarthy of HHI to join his team and to bring non-marine business to HHI. Mr Smith was interviewed by Mr Langley of SD's solicitors on 27 July 1999 and on 14 and 25 June 2001; Mr Smith suffered from hypertension and heart disorder; he died suddenly in August 2001 before the trial had commenced. It was submitted by EIU that he was in a very poor state of health at the time of his interviews in 2001; although no evidence of that was given, I accept that submission as evidence and have taken his state of health and the stress he was under into account in considering the notes of his interview. EIU had served a summary of his evidence and had intended to call him to give evidence by means of a witness summons. SD had not intended to call him, but notes of the interviews with Mr Langley were made and these were served by SD; clearly, these notes have to be viewed in the context in which they were made; neither EIU nor SCB had had the opportunity of asking him questions or putting documents to him.
573. No witness from HHI gave evidence although it was clear that Mr McCarthy and possibly others were interviewed by all the parties prior to the trial. No party nonetheless saw it fit to call any of them to give evidence. As they could have been called to support the case of either SD or EIU on the issue of what each knew, I do not consider it appropriate to draw any adverse inferences.
574. Mr Smith had known Mr Whitcombe for approximately 25 years; Mr Whitcombe had regarded him as a close friend. Mr Smith had known Mr Broad for some time. Mr Whitcombe had described Mr Smith as not always being as sober as he should have been; it was alleged that he drank too much at lunch. Mr Smith was also dyslexic. Mr Henton had described Mr Smith as a competent broker.

(b) Mr Whitcombe's initial request

575. Mr Whitcombe had heard in the market that SD had dismissed the underwriting team that had written financial institutions, E&O, D&O and related classes of business. He had hoped that there might have been an opening at SD for him to write, possibly with a team, those classes of business which had been his experience. Mr Whitcombe knew Mr Broad had run his own syndicate and that he was by then a director of SD. He did not then know that Mr Broad was a facultative underwriter; he could not recall Mr Smith telling him that Mr Broad was a facultative underwriter. He only knew that Mr Broad was an underwriter for facultative business in either January 1997 or at the meeting on 7 February 1997. He had asked Mr Smith to arrange for him to see Mr Broad.
576. It was Mr Broad's recollection that he was approached by Mr Smith about Mr Whitcombe; Mr Broad had known of Mr Whitcombe as an underwriter at Lloyd's and had heard nothing bad about him. He had met him once in either late 1993 or early 1994, when Mr Whitcombe was considering setting up an insurance company; Mr Whitcombe's evidence was that the discussions about the insurance company had taken place in 1994.
577. Mr Broad's evidence was, in contrast, that Mr Smith had brought him a proposal in relation to PA business; he had been told by Mr Smith that Mr Whitcombe had written PA business and other business profitably throughout his career at Lloyd's, and that Mr Whitcombe had developed a book of general PA business which was available through his personal connections; this was of interest to Mr Broad as he was finding it difficult to develop his own book of PA business; the approach was not prompted by the dismissal of the team that had written financial institutions and E&O business. There was some discussion about whether there was an opening for Mr Whitcombe at SD, but Mr Broad and Mr Smith had agreed that Mr Whitcombe had wanted to be his own man.

(c) The first meeting

578. The first meeting between Mr Broad, Mr Whitcombe and Mr Smith took place sometime in October 1996.
579. Mr Broad's evidence was that Mr Smith brought Mr Whitcombe to SD's offices so that Mr Whitcombe could "sell himself" to SD. They talked generally and Mr Broad explained what he wanted – a simple PA account that they had not been able to access themselves. Mr Whitcombe told him that he had wanted to set up a company but that nothing had come of it.
580. It was accepted by Mr Whitcombe that he had told Mr Broad that there was a lot of PA business in the market, but that there was a core of good quality business that was only shown to a limited number underwriters. Mr Whitcombe also accepted that he had said that he knew a number of the underwriters and producing brokers. Mr Broad's evidence was that Mr Whitcombe had then said that the underwriters and brokers were prepared to allow him access to this "cream" business or words suggesting that it was properly rated first class business. Mr Whitcombe accepted that he had said this, except for the reference to "cream" business. Mr Whitcombe accepted that he would have said something similar to that set out in the text of the EIC proposal quoted at paragraph 485 to Mr Broad, though he would not have said that they had a portfolio of consistently profitable business; he would have only said that they had had connections.
581. Mr Broad's evidence was that they had discussed SD's suitability and the proposal generally; one of SD's key selling points was that they were authorised to write direct PA business in the US. Mr Whitcombe denied that he had been interested in SD's authorisations.
582. Mr Broad's evidence was that he had wanted to use Mr Whitcombe's contacts in the PA market to write a simple PA account and that they had discussed the way of doing this. As there was no possibility of granting Mr Whitcombe a binder for PA business, they therefore discussed the possibility of SD employing Mr Whitcombe or of an arrangement being reached for a binder to be granted to a Lloyd's broker. Mr Broad could not recall if Mr Henton was mentioned, but that would have been of no relevance, as it was Mr Whitcombe who was emphasising his personal contacts in PA business.
583. Mr Whitcombe's evidence was that the meeting lasted between 15 to 20 minutes. At the meeting they discussed the business he had written. He mentioned that he had had access to a cartel of PA business through Mr Henton and had told Mr Broad that he would bring Mr Henton with him; he had spoken of the business being good quality. It was Mr Broad who had suggested that Mr Whitcombe would not fit into SD as an employee and had suggested a binder as a means of writing the business. Mr Whitcombe's evidence was that his selling point was Mr Henton's ability to access the cartel operating in the PA market. Mr Broad was interested in PA and the other business that Mr Whitcombe was proposing to write; Mr Broad told him to get a business plan which he would then submit to Mr Philo.
584. Mr Whitcombe accepted that he had said nothing about the importance of reinsurance to the WC carveout business which he was intending to write; he did not say that he would be writing loss making business on the back of reinsurance. Nothing was said about treaties. He did not, however, give Mr Broad the impression that it was a facultative direct account.
585. Neither Mr Broad nor Mr Whitcombe's memory of the initial events was very clear; I am quite sure that Mr Whitcombe was very keen to obtain remunerative employment and I do not consider that he was necessarily intent on a binder at that stage as he had been prepared to take any reasonable proposal offered, bearing in mind what had happened over the past three years. However, I have no doubt that Mr Broad had made it clear that what he had wanted was the conventional PA account that he had asked Mr Tunstall to write (without success) and that Mr Whitcombe had painted an as attractive picture of PA business as he could; I have little doubt that he would have used phrases such as "cream business". This was the way in which the proposals and business plans had been put together and was the kind of expansive language that had been used by Mr Whitcombe. It was most improbable that he had mentioned Mr Henton as what Mr Whitcombe had been interested in was in getting some form of remuneration for himself and for this it was necessary for him to stress his own contacts.

(d) The production of a draft binding authority

586. By 15 October 1996, a draft slip for a binding authority had been produced; it is clear that the person who drafted the slip thought that it was for business that was to be written in the direct reinsurance department; it was EIU's evidence that it was based on a slip that had been placed by HHI for a Belgian client. The slip contained manuscript changes, some of which was in Mr Smith's handwriting, some in Mr Whitcombe's handwriting, including the reference to "as disclosed in the business plan", and some in the writing of another person. The brokerage had been amended from 5% to 2% direct and 1% reinsurance. Mr Whitcombe struck through a provision for the confirmation of acceptances, as that was only appropriate for a lineslip which he did not want.
587. This document did not contain any of Mr Broad's writing and I accept that he did not see it.

(e) The first business plan

588. Mr Whitcombe then prepared a business plan with the help of Mr Zuberi. Mr Henton had considered the proposal to establish EIC as dead; he was not seeing Mr Whitcombe regularly; he had not spoken to him between April and October 1996. He was therefore not aware of the approach to SD until he received a telephone call after Mr Whitcombe had met Mr Broad for the first time in October 1996 to say that a binder was being contemplated. He then met Mr Whitcombe who told him that they were putting together a business plan for a binder for PA business and the business which Mr Whitcombe had written. He agreed to participate. Mr Henton maintained that he was not involved in drafting the first plan, but he knew of it and he knew that PA was included; he accepted that he probably saw it before it was delivered.
589. Mr Henton's evidence was that Mr Whitcombe had asked him if he would write an account similar to Syndicate 103's. They had discussed whether £10m of premium income could be achieved; he believed that Mr Whitcombe was quite familiar with Syndicate 103's account.
590. On 1 November 1996, Mr Whitcombe wrote a letter to Mr Broad, sending a business plan which he said Mr Smith had asked him to prepare. The letter was delivered through Mr Smith. The letter commenced by Mr Whitcombe thanking Mr Broad for "your outline agreement" to a binding authority for the classes of business shown on the slip. The letter then continued:

"Graham Smith has asked me to prepare a business plan and I am enclosing what I believe you require…

I have estimated premium income at £10m representing 50% PA classes and 50% others and believe that they are both achievable properly and prudently and represent an ideally balanced account. Income will of course be carefully monitored and there will be no possibility of over writing."

591. It was Mr Whitcombe's evidence that he was not present when Mr Broad made the "outline agreement", but that it was his understanding that the outline agreement was on the terms of the first draft slip. He understood that Mr Broad had wanted to proceed, subject to Mr Philo's approval.
592. Mr Broad's evidence, though he did not have an actual recollection, was that the letter and plan were brought to him by Mr Smith who would have talked to him whilst he looked at the plan; he also said in his evidence that he had read it some of it closely, but that he did not show it to anyone else within SD. He had not asked for this, but Mr Smith might have thought he had. The meeting would have lasted between 10 to 15 minutes Mr Smith would have taken the letter and plan away and at the end. Mr Broad did not keep a copy.
593. It is not necessary to refer to the content of the first plan in detail; it was, as EIU submitted, a "lift" from the EIC business plan; some of the first plan was repeated in the second plan submitted. However, it is important to note that the plan envisaged that the kind of business in which Mr Whitcombe was experienced in would be written in addition to what was described as PA. The plan described the business written by Syndicate 103 and that which was written by Syndicate 1053 – financial institutions, E&O, D&O cover and related classes; it was made clear that that the style of account to be underwritten by EIU would mirror that of the syndicates; the same underwriting criteria would apply. The plan also stated that it had been established that reinsurance arrangements similar to those enjoyed by the syndicates could be secured for EIU.
594. It was Mr Broad's evidence that he had made it clear to Mr Smith what he had wanted – a low to medium risk PA account of the kind he had tried to write. He was told that Mr Whitcombe was a PA specialist and that he had had contacts; he thought that those contacts would bring him the kind of business he had wanted. Although the plan submitted by EIU referred to financial institutions, E&O and related classes, as well as to PA, it was always the intention that Mr Whitcombe should only write PA business. Mr Broad's evidence was that he had made it clear he did not want the business of Syndicate 1053. He maintained that he was not told that Mr Whitcombe's expertise lay in that type of business; he understood that he had had expertise in PA business.
595. Mr Broad denied in his evidence that he had given Mr Whitcombe an outline agreement; he thought that this was Mr Whitcombe trying to take matters further than they had gone. Nonetheless he was interested in proceeding but the proposal did not loom large in his thinking; his department had over 200 facilities.
596. It was suggested by SD that the terms of the letter indicated that there had been no prior meeting between Mr Broad and Mr Whitcombe; I do not accept that and am satisfied that there was the prior meeting at which Mr Broad had, as set out at paragraph 584, made clear what he had wanted – a simple PA account of the type which Mr Tunstall had unsuccessfully attempted to write. Mr Whitcombe, however, had no expertise in PA business and was attempting to try and introduce the kind of business with which he was familiar, in addition to PA business; his statement that there was an outline agreement was typical of the exaggeration to which Mr Whitcombe was prone.

(f) Further meetings between Mr Broad and Mr Whitcombe

597. There was a brief meeting between Mr Broad and Mr Whitcombe in the period between the meeting with Mr Smith at which he presented the letter of 1 November 1997 and the next letter sent on 26 November 1997. It was a brief meeting; I accept the evidence that no meeting with Mr Broad ever lasted more than 15-20 minutes. Mr Whitcombe's evidence was that he had been told by Mr Broad that he had referred the first plan to Mr Philo and that SD would not write the type of business for which they had just dismissed their underwriting team. Mr Broad then offered a binder for PA business only and they therefore had to redraw the plan. Mr Whitcombe recalled saying either at the first meeting or the subsequent meeting or at both meetings, that the PA business would be written by Mr Henton. Mr Broad accepted that he had probably told Mr Whitcombe on this occasion that he was only interested in PA business.
598. Mr Whitcombe did not meet Mr Broad again until after the binder had been signed; they then met with Mr Smith over a meal at a pub at Tadworth on 7 February 1997 – see paragraph 813.

(4) The preparation of the second business plan

599. A second plan was then prepared and it was on the basis of this that the binding authority proceeded. In accordance with Mr Broad's wishes, all reference to writing financial institutions, E&O, D&O cover and related classes was omitted and the proposal was one purely for writing PA and related business. It was Mr Whitcombe's evidence that he was never asked to prepare a plan for a direct and facultative PA account and that he did not do so.

(a) The work done and the presentation to Mr Broad

600. Mr Whitcombe, with Mr Henton's assistance in providing the information, prepared the new business plan which he then forwarded to Mr Smith under cover of a letter dated 26 November 1996 which was addressed to Mr Broad; the style of the prose used was that of Mr Whitcombe's. Mr Henton's view was that it was a sales document, but he accepted that it had to be full and frank.
601. The letter of 26 November 1996 began by referring to the discussion with Mr Broad and continued:

"The business plan has been amended to specifically address that part of the account which you would like to write and I think it answers most likely questions.

I appreciate your management's views on the Financial Institution ands related business at this juncture…

On balance, Vic, I believe that I an do for [SD] something that they cannot do for themselves and at a cost that is far less than your present operating costs."

602. The new plan contained some new passages and some passages from the earlier version where PA business had been dealt with.
603. Mr Smith took the letter and the plan to Mr Broad; Mr Broad said that he would have discussed it for about 15-20 minutes. Mr Broad's evidence was that he did not look at it closely, rather he listened closely to what Mr Smith said. He could not recall in the witness box whether he had actually read the whole plan or only specific parts of it. Mr Smith's account, as set out in the interview notes, was that he gave the proposal to Mr Broad without comment and that when he came to pick it up, Mr Broad was very happy and did not ask any major questions.

(b) The importance of the plan

604. Mr Whitcombe accepted that the presentation had to be a good faith presentation which gave a full and frank description of who was to do the underwriting, the type of business that was to be written, the underwriting philosophy and the premium income.
605. Despite the obvious importance of the plan, Mr Broad did not keep a copy or initial it. Subsequently on 5 July 1997 (as set out at paragraph 984), he scratched the plan to show that he had seen it. This was done when they were putting together documents to put in a file (see paragraph 1021). He looked at this as a "tidying up job".
606. The plan is of central importance:

i) SD relied on it as containing a number of misrepresentations in relation to the business to be written;

ii) SD and EIU relied on it as describing the business to be written; and

iii) EIU relied on it, as I understood their case, as being the plan necessary for "net underwriting".

607. It is convenient first to deal with those parts of the plan that described the business to be written and then to consider the other issues that arose on the plan.

(5) The description in the plan of the business to be written

It is convenient to consider the way in which the plan described the business under several different headings.

(a) The general nature of the business to be written

608. The plan began by describing the proposed business in these terms:

"Background

…Against this new background the EiC's promoters propose Euro International Underwriters Ltd hereinafter EIU to underwrite a low to medium risk account specialising in Personal Accident and related classes. A balanced PA line portfolio mix will be achieved through specialisation and accessibility through the long-standing relationships with international production sources.

Therefore this proposal has been prepared for Sphere Drake Insurance PLC."

609. Mr Henton's evidence was that "low to medium risk" meant low to medium risk after reinsurance. Mr Whitcombe accepted that this was not spelt out, but that he had made it clear that this was the position and that it was a very volatile account. Provided that the reinsurance stood up and was collectable, this was business with a minimal risk. "A balanced PA line portfolio" referred to a mixture of PA business.
610. The plan then described the business as "deemed short tail":

"Accident and Health

In essence, the Accident and Health sector is deemed short-tail (emphasis added) and, therefore, requires little further reserve on expiry, enabling high release of profit for Sphere Drake Insurance PLC."

611. Mr Whitcombe accepted that traditional PA business was short tail; that in a direct or facultative PA account, the results would be obvious shortly after the expiry of the year in which business was written. He said that he had relied on the Lloyd's classification (explained at paragraphs 225 and following) in describing carveout business as short tail. By the time of his evidence at the trial, he agreed with Mr Jackson's views, but this was not the case in 1996; he knew at the time that it had a slightly longer tail, but relied on the Lloyd's classification. Mr Henton's evidence was that although carveout business had a longer tail, it was not long tail and was classified as short tail.

(b) The profitable nature of the business to be written

612. EIU's ability to obtain what they described as highly profitable business was then described in greater detail in a section written by Mr Henton and Mr Whitcombe:

"The proposal

…It is a fact, however regrettable, that the top-draw business within the PA classes is, to a great extent, controlled by a cartel. The promoters have access to this concept and, following very quiet discussions on a no-name basis, have established their acceptability to the parties concerned. The worth of these relationships cannot be over-stressed. Certainly one may underwrite a Personal Accident account but without acceptance within the circle, the required level of profit is illusory…

Accident and Health in recent years has been highly desirable product line to both underwriters at Lloyds and in the growing company market. This line of business has been proven to be highly profitable and professionally conducted within the London market. EIU's underwriters have proven that with the strict adherence to the pre-set underwriting limits and along with prudent risk review against selective acceptance criteria substantial underwriting profits are possible (emphasis added). Within the Accident and Health sector Personal Accident on its own or in conjunction with other related classes such as sickness, comprehensive travel and the like but excluding medical expenses business proves to be highly desired and difficult for new entrants. The London market for this class of business is led by a group of Lloyds and Company underwriters in union with key brokers who have a strong hold on the PA reinsurance market and operate on a market understanding of a cartel (emphasis added).

The global market of such business is estimated to be far in excess of £2 billion.

It is the intention to concentrate exclusively on the agreed business plan herein and to capitalise on the underwriters extensive expertise and knowledge with the targeted production sources…"

613. It was Mr Whitcombe's evidence that the reference to "very quiet discussions" had been a reference to discussions Mr Henton had had with SCB; he (Mr Whitcombe) had never written occupational accident business; it was the experience of Mr Henton to which reference was being made; though Mr Henton had never written a treaty, he had sat beside Mr Bird and had obtained the necessary experience through being a deputy; the reference to EIU underwriters' proven results was a reference to Syndicate 103. It was however made clear in the meetings and in the plan that he (Mr Whitcombe) had had no connection with Syndicate 103.
614. Mr Whitcombe accepted that the passage referring to accident and health being a "highly desirable product line" read as if it was talking of conventional business; he did not view arbitrage business as conventional and as a matter of fact could be seen as its antithesis. The reference to "top draw" was to business profitable on a gross basis. "Concept" was a reference to net underwriting.
615. Mr Henton considered that the use of terms such as "cartel" had not been good and that there had been an unfortunate choice of words; this had been intended as a reference to SCB and other brokers; he could not recall any particular discussions, just general talk. The group of underwriters probably included Mr Bird, Mr Billyard, Mr Cackett and Mr Owen. Although the text referred to discussions on a no names basis, he could not recall any discussions with Mr Brown or Mr Butler. The "pre-set underwriting limits" were the limits per programme, the phrase "selective acceptance criteria" was a reference to considering the risk against the reinsurance programme, looking at the risk and the line size. There was nothing by way of underwriting limits or criteria written down; it was just experience. "The prudent risk review" was the process of considering the risk carefully and of making sure that one understood it; however, in the PA market, the provision of information was minimal. When this was written, he also had in mind the kinds of things that might happen on a renewal season and that they might write many risks in three hours.

(c) Mirroring the business of Syndicate 103

616. The plan made it clear that EIU wanted to write the business that had been underwritten by Syndicate 103; it had referred to Syndicate 103 as follows:

"History

Lloyds Syndicate 103 was formed in 1948 to underwrite an aviation account. From the outset a proportion of its business was Personal Accident. Over the years this section of the account began to predominate so much so that by 1990 it represented in excess of 90% of the premium income written. For the 1992 underwriting year all aviation business and certain marginal areas of the personal accident book was eliminated. It is this account which is proposed to be underwritten by EIU on behalf of [SD].

Illustrative statistics of previous underwriting performance are attached by way of complete informational background. It should be noted that all figures are shown nett of acquisition costs and reinsurance."

617. Unlike the first plan where the text was similar to the DTI application and the figures showed that the business had made gross losses (see paragraph 477), the figures attached to the second plan were net figures and it was therefore not possible to tell that the account was gross loss making.
618. Under the heading "The proposal", after setting out the passage at paragraph 611, the plan stated:

"It is envisaged that the style of account written will mirror that of Lloyd's syndicate 103 and a similar underwriting criteria will apply."

Mr Henton's evidence was that they were never asked what the criteria were.

619. By the time he had prepared the plan, Mr Whitcombe accepted that he had had a good idea of the business that had been written by Syndicate 103; it was a treaty reinsurance account comprising carveout business principally; he had seen its accounts and he had been a member of the syndicate. He understood that their philosophy was to get a bottom line profit by writing against reinsurers and by making a profit on the difference in rates between inwards and outwards business; he accepted that some of the business written was loss making as most carveout business had that characteristic. He knew that others wrote against reinsurers and he had heard of Mr Cackett, who was said then to be a "very good underwriter", but not of any others. He had regarded this as a "fair risk" to reinsurers if they had been aware of it.
620. Mr Whitcombe accepted that the accounts of Syndicate 103 had been misleading as they did not make it clear that the business was loss making and involved a spiral (see paragraph 399); the description of Syndicate 103 in the plan did not make it clear that the business which was deliberately written was loss making business that also involved spiral business; on the contrary, he accepted that it gave the impression that Syndicate 103 wrote a mix of PA business which was short tail and low to medium risk.

(d) The description of the business as "occupational accident"

621. The proposal then went on describe the PA account:

"THE PERSONAL ACCIDENT ACCOUNT

The key to underwriting a profitable personal accident and related classes account is a sound knowledge of the market and a prudent assessment as to the requirement of any reinsurance programme purchased to protect the account underwritten. The portfolio business written will have an assessable exposure to any one or series of events and extensive reinsurance, to protect this, will be placed with top rated security in the world-wide market. Consequently, profits can be reasonably predicted as indeed the experience and results of the specific syndicate has shown. We are confident that a similar reinsurance programme can be purchased at the present time so that the proven profits of the syndicate can and will be duplicated on behalf of SD.

OCCUPATIONAL ACCIDENT

Occupational Accident was developed alongside the Employers Excess Indemnity Insurance product. EEII was predominantly sold in Texas and has since proved not to be as profitable as the Occupational Accident product. Occupational Accident coverage has been offered in a number of American States where the laws and regulations are not as strict on insurers as Texas. It is for the mentioned reasons and higher profit potential this product is included in the overall Personal Accident account."

622. It was made clear that a high proportion of the income would be US dollar-based, as the US dollar was the preferred currency for a number of international clients. The business was further described under the heading "The Portfolio's Exposure" (written by Mr Henton, according to Mr Whitcombe):

"THE PORTFOLIO'S EXPOSURE

The overall portfolio will permit worldwide coverage subject to the required licenses in effect.

The account will be exposed in North America, the Occupational Accident line emanates entirely from the states although similar products do exist for European countries."

623. The business was not described in the business plans prepared for EIU as WC carveout, but as "occupational accident". Mr Whitcombe could not explain why, but accepted that it should have been referred to as carveout. He accepted the suggestion that the description "occupational accident" implied accident insurance (as if the employee was insured) and not insurance where the employer was insured; he accepted that the term would not have conveyed the true nature of the business. It was in the sense of an accident policy that the words might be understood in the general insurance and reinsurance market (as set out at paragraph 133) and as Mr Peter Downey had (see paragraph 651.ii)). Mr Whitcombe accepted that this was the impression Mr Downey had of this business.
624. Mr Whitcombe's evidence was that he did not tell Mr Broad that it was WC carveout business until the meeting on 7 February 1997; he accepted that the plan should have done that; the plan gave the wrong impression as to the business that was to be written; it was not "top draw" business.

(e) Premium income and the type of business to be written

625. The proposal set out the projected premium income as being £10m in the first year, £14m in the second year and £20m in the third year. These were enormous figures for a soft market, particularly compared with the type of account Mr Broad had tried to write himself.
626. The account mix was stated to be:

Non proportional treaty 40%

Occupational accident 15%

Direct 15%

Proportional treaty 30%

This information was based on Mr Henton's input.

627. Under the heading "The Portfolio's Exposure" there was further reference to the writing of reinsurance business:

"Excess of Loss on Excess of Loss will be written predominantly through the international X/L account (emphasis added). The LMX market does not exist in the same form as long as three years ago. The dwindling number of Lloyd's syndicates prefer to write direct business only, but still seek reinsurance for their accounts.

Aggregate exposures will be carefully monitored and accounts will be written when adequate portfolio reinsurance is in place."

628. Mr Henton's evidence was that the reference to XL on XL was intended to explain that spiral and retro business might be written; they also had in mind that they might write gross loss making business and that cheap reinsurance would be used to turn it into a net profit, but that was only to be one section of the account

(f) The agreement for participation in a QS: Mr Bird

629. In the information referred to at paragraph 625, there was a note against "proportional treaty" which stated that the proportion might vary as a substantial proposed QS participation "has been agreed" with an established production source.
630. Mr Henton's evidence in his statement was that that this was a reference to a QS of the Lincoln National lineslip (to which I have referred at paragraph 441.iv)); he had spoken to Mr Bird and Mr Bird had indicated that a participation on the QS would be offered to EIU. Mr Henton accepted, in cross-examination by SCB, that he had been told by Mr Bird that EIU might be offered a line on the QS, but that nothing had been promised. He also accepted, in cross-examination by SCB, that nothing had been agreed and that therefore "agreed" was too strong a word to use; it had only been spoken of. Mr Henton, after considering his evidence about this further, then said that it was agreed that if EIU could get the binder Mr Bird would see if he could offer EIU a line on the QS.
631. Mr Bird's evidence was that he had no knowledge of that at all and that he did not know if that was a reference to the Lincoln National QS which had come up for renewal in October; he had not offered a participation to Mr Henton; he might have mentioned the QS or Mr Henton might have been aware of it, but he could not remember; he had not promised anything as he would have remembered that; he had no recollection about being told about SD until early 1997, though he had had lunch with Mr Whitcombe in November 1996 (see paragraph 495).
632. As set out at paragraph 490.iii), Mr Bird had given a similar promise that was recorded in the earlier EIC proposal. I am also sure that he had given a further promise in relation to this proposal, as the need for an insurer to take income remained pressing; the plan, in referring to the agreement of a QS participation, was broadly correct as a promise had indeed been given. I reject Mr Bird's evidence to the contrary as untruthful; Mr Henton's change of evidence was an attempt to make his evidence fit as nearly as he could with Mr Bird's. There was, in my view, a clear understanding that a participation would be offered and that was why the note in the business plan was written in the terms in which it was.

(g) The description of the reinsurance programme

633. The reinsurance programme was described; that description began:

"ACCOUNT REINSURANCE PROGRAM

As regards Personal Accident, this does have the potential for catastrophe type exposure (emphasis added) and particular attention must be paid in recording known concentrations of risk and build up of accumulations from excess of loss writings to ensure that sufficient vertical protection is purchased."

634. Mr Whitcombe and Mr Henton accepted that this was a classic description of conventional reinsurance. Mr Bird's evidence was that this passage (which was also in the 1994 proposal) referred to the unknown build up of accumulations from the XL account, both within the spiral and the direct XL account; his evidence was that he would not have used the plain speaking language of "loss making business on a gross basis"; in 1994 they were intending to write a spiral account which was similar to that of Syndicate 103's.
635. The plan continued:

"The proposed reinsurance programmes and line structures are as delineated in the schedules shown. These mirror those of syndicate 103 and illustrate the line size to exposure levels. Whilst one has no whiting intention to do other than afford a fair risk to reinsurers (emphasis added) it is crucially important that the EIU accepted exposures both in terms of vertical catastrophe and attritional aggregates are recognised and catered for. To that end the proposed programmes more than suffice…

Discussions with brokers have confirmed similar reinsurance programme to that detailed herein for syndicate 103 is still possible at favourable terms."

A table described Syndicate 103's reinsurance programme.

636. Mr Whitcombe's evidence was that the plan could have been better worded; it was a rushed job and it was cobbled together out of various documents; it was a plan designed to make net profits. He considered that there was a "fair risk to reinsurers" if they were knowledgeable parties; there would be no disclosure as it was a market that operated in its own fashion. He said that it was pretty obvious that EIU were taking the exposure down to a minimum; anyone in this market would understand that this was a reinsurance of loss making business, but he agreed that it did not say that. However, it was not necessary for it to do so as it was all part of the negotiation; the nature of the business and the volatility of it had been described to Mr Broad.
637. Mr Henton's evidence was that they could have put things more clearly. He accepted that a fair description of gross loss making business would have been that this was an account which depended for its financial viability on an ability to transform loss making business into a profit by passing on those losses to reinsurers at even less premium. His evidence was that they believed that it was a fair presentation to focus on net profit and on the need for reinsurance; the reinsurance programme planned was reflective of what Syndicate 103 had and its cost was also reflective of that. By 1997 reinsurance was more expensive and the availability was less. The cover proposed was low layer and was available down to $10,000. He thought in November 1996 that the cost of reinsurance would be 30%-35% of net premium income.

(h) Mr Broad's evidence on his understanding

638. Mr Broad's evidence was that he always wrote for an underwriting profit; although he knew that there were underwriters who wrote on "the backs of their reinsurers", he did not regard this as sustainable; if it was done deliberately, he regarded it as dishonest; he would not do it. It was like a doctor saying he was successful because he got an overrider from the undertaker. Mr Broad had seen the effect of the spiral that had developed in the LMX catastrophe market at Lloyd's in the late 1980s and had considered that LMX business was an area to avoid.
639. Mr Broad's evidence was that he had made it clear to Mr Smith that he only wanted to write a simple PA account of direct insurance and facultative reinsurance which SD had been unsuccessful in developing. They had a discussion of what Mr Broad wanted. Mr Smith would have known that what was in the first plan was unacceptable. Mr Broad had made it clear to Mr Smith what he wanted – a direct and reinsurance PA account; by that it was obvious to Mr Smith, as an experienced broker, what Mr Broad did not want and that was the type of business that Syndicate 103 had underwritten. There were bits of the business plan he wanted – good underwriting, and sound relationships applied to the PA business he wanted. His primary objective was profit.
640. It was the position of EIU and SCB however, that the second plan made clear a number of matters, some of which were clear from that part of the first plan that dealt with the PA account:

i) The account would mirror that of Syndicate 103's. Mr Broad must have appreciated that the revised plan was essentially the same as regards PA business as the first plan.

ii) The figures made clear the nature of the business.

iii) The business written would include treaty business.

iv) Reinsurance was essential to make the business profitable.

v) The premium income would be £10m.

vi) The business was only deemed short tail.

vii) XL on XL would be written.

641. Mr Broad's evidence in response was that:

i) He had been told that Mr Whitcombe had contacts in the type of PA business which he wanted to write and that Mr Whitcombe was a PA underwriter. Mr Broad said that he was not interested in the business of Syndicate 103 and had rejected that proposal.

ii) He had not examined the figures provided in any detail as the binding authority was only for part of the account – PA.

iii) Mr Smith knew that SD had a treaty department and if Mr Smith had wanted a facility to write treaty business, he knew that he should have gone to SD's treaty department; Mr Smith knew that Mr Broad was not in the business of writing treaty business. What Mr Broad had wanted was expressed in the slip, which contained no provisions to write treaty business.

iv) He accepted, when looking at the matter during his cross-examination, that it was clear from the figures for the results of Syndicate 103 in 1989-91 in the first business plan that Syndicate 103 only made a profit through the use of reinsurance; however, he qualified that evidence by pointing out that the information did not give the inwards and outwards reinsurance to close. At the time of presentation by Mr Smith, he did not believe that he had looked at the figures.

v) He accepted in cross-examination that it was obvious from the plan that the objective was very limited risk participation and that the main objective was risk transfer to reinsurers; the plan was proposing an account that would be written against reinsurers; that reinsurance was crucial to the proposed account. He made it clear, however, that he did not agree with that way of underwriting and that he had not agreed to it.

vi) He did not want the premium income of £10m specified in the plan; he wanted £1m.

vii) He understood the reference to "deemed short tail" to be to the Lloyd's categorisation but understood the account to be short tail and not to include treaty business.

viii) He understood that they were specialising in low to medium risk business. He read the plan overall as stating that they wrote highly desirable and highly profitable business. He relied on the fact that what he was being offered was a prudent underwriting proposal. He appreciated that what he was being offered in the plan was what was intended and that things did not always work out as intended.

642. It is important to emphasise (as set out at paragraph 616) that net figures were given in the second plan and that it was not possible to tell that the business which Syndicate 103 had written had been gross loss making. Furthermore, even knowledge that the syndicate had made a gross loss in certain years did not make it clear that the underwriter had deliberately set about writing gross loss making business against his reinsurers.

(6) Other representations in the plan

643. SD contended that there were three other material misrepresentations in the plan – (a) the failure to mention Mr Henton, (b) the position of Mr Downey and (c) Mr Whitcombe's past underwriting record.

(a) The role of Mr Henton

644. The section in the plan about the management team did not mention Mr Henton, though it was always understood that Mr Henton would be doing the underwriting. This was in contrast to the earlier proposals where Mr Henton had been mentioned. Mr Henton had appeared in the plan prepared with the assistance of Julius Baer (see paragraph 489.ii)) and in the original EIC plan (see paragraph 484); Mr Whitcombe accepted that it should have been in the plan, but said that there had been no intention to mislead by omitting reference to him; there was no suggestion in the plan that anyone other than Mr Whitcombe would be doing the underwriting. However, Mr Whitcombe's evidence was that he (Mr Whitcombe) did not understand WC carveout business. Mr Whitcombe would have done some of the underwriting if it had been other forms of PA underwriting which he understood, but the business did not turn out that way.
645. Mr Whitcombe could not explain the absence of any reference to Mr Henton in the business plan, save to say that it had all been a bit of a rush by cutting and pasting. It was not because Mr Henton had no experience. His evidence was that he had made it clear at the outset to Mr Broad that this was to be the case, but he could not be precise as to when this was; he believed that he had told him before the meal at the pub in Tadworth on 7 February 1997 – see paragraph 813 below.
646. It was Mr Smith's account that Mr Henton was mentioned to Mr Broad in November 1996 or earlier and that he raised his position again when the slip was being finalised (see paragraph 686). Mr Henton's evidence was that he believed that he was not mentioned in the plan as it was never intended that he was to be a part of the management team, but Mr Smith knew of Mr Henton's involvement and of his connections with Syndicate 103. Mr Henton did not think that he was left out because he was inexperienced. He did not meet Mr Broad until December 1997.

(b) What was said to others as to who was doing the underwriting

647. Mr Whitcombe was also stated to be the underwriter on the information sheet supplied to reinsurers (considered below at paragraph 957) in these terms: "The Underwriter is John Whitcombe who has had many years of experience in Lloyd's". Mr Whitcombe said that he was the underwriter named on the cover note; Mr Johnson knew that Mr Henton was doing the underwriting.

(c) The position of Mr Downey

648. Mr Downey was included in the management team as the proposed Chairman of EIU. Mr Downey was and is a very well known and very well respected senior figure in insurance and reinsurance in London. He had spent 36 years with the Mercantile and General Reinsurance Company and had then become the General Manager of Cologne Re (UK) from 1984 until his retirement in 1992; he remained with the company as its Non-Executive Chairman until mid-1994.
649. The covering letter dated 26 November 1996 made Mr Downey's involvement clear:

"Please read the attached and note that Peter Downey is happy to continue with our activities in the capacity of Chairman. His connections and assistance to us all will be invaluable."

The plan referred to Mr Downey in the following terms:

"A group of successful London market insurance professionals, led by Peter Downey (emphasis added) former chairman of Cologne Re (UK), John Whitcombe a Specialist Lloyds Underwriter and Imran Zuberi former European Development Manager for Continental Insurance all of whose CV's are attached, were persuaded to contemplate the setting up of an insurance company. A comprehensive Feasibility Study was prepared and promoted in the name of EiC. The insurance company proposal was based upon a £50 million capitalisation, and this received approval in principle from the Department of Trade and Industry subject to capital (emphasis added).

With the significant changes occurring in the corporate capital market for the insurance sector and the continuous interface by the EiC's team within the London insurance market, new opportunities emerged. EiC's proven underwriting expertise and its accessibility to the projected line of business of Personal Accident and its related classes could be transferred to an underwriting vehicle supported by a reputable insurer/reinsurer with acceptable market security (emphasis added)."

650. The purpose of including Mr Downey was, as Mr Whitcombe accepted, to have him on the board and also to show support from a recognised figure in the market. It would show that EIU was a professional and not an amateur organisation.
651. The draft of the slip which was stamped on 8 January 1997 contained, in manuscript, a reference to Mr Whitcombe being self-employed and to be currently giving thought to the formation of a service company; this was then added to the final version. It was the intention of Mr Whitcombe and Mr Henton that such a company be put in place as it in fact was. Mr Broad's evidence was that it was envisaged that there would be a company; mentioning Mr Downey was to give it credibility; it would have mattered to him if there was to be no company, as he understood that it was the clear intention to have one.
652. The position was in fact as follows:

i) In the summer of 1993, after Mr Downey had retired from his executive role at Cologne Re, he was approached by Mr Whitcombe and had had a meeting with Mr Bird. Mr Whitcombe and Mr Bird outlined the proposal to form EIC. They asked him to be Chairman; the company was to be a risk-bearing entity and was to write the business which Syndicates 103 and 1053 had written. He was told at the meeting with Mr Bird that Syndicate 103 was a PA and health syndicate and that Syndicate 1053 wrote professional indemnity business.

ii) He assumed that Syndicate 103 was underwriting what he understood to be PA business. There was a conversation about "occupational accident business" which he understood to be group PA for companies, an understanding common in the general insurance and reinsurance market, as set out at paragraph 133. I am sure that he had no idea that the syndicate was deliberately writing gross loss making retro and spiral business on the backs of reinsurers, or of the deception of the Names on the syndicate as to the true nature of the business being written or as to the risks that they were in fact running.

iii) At the early stage he had no understanding of the role that reinsurance was to play, but he subsequently saw some figures prepared for the DTI and commented that the retentions seemed low.

iv) After studying some papers he agreed to be Chairman; he was quite happy to be involved with Mr Whitcombe and his view of Mr Bird at the time was favourable. Mr Whitcombe viewed Mr Downey's involvement as a plus as the DTI needed someone of his stature.

v) There were a number of meetings about the proposal in 1994; they needed to raise capital. Discussions continued in 1995 whilst attempts were made to raise finance. His final meeting with Mr Whitcombe before 2000 was in about February 1996; no suggestion was made at that meeting that EIC would operate as an underwriting agency.

653. In the autumn of 1996, there was a final conversation between Mr Downey and Mr Whitcombe. The evidence given at the trial was:

i) Mr Downey's evidence was that he had telephoned and enquired about EIC and about raising capital; Mr Whitcombe had spoken about EIC in general terms and, as usual, was hopeful. He could not recall Mr Whitcombe saying: "We are trying something new; there seems to be a reasonable prospect of success. Are you happy to continue?". He did not reply that he was happy to be involved in anything that they were able to do; Mr Whitcombe said nothing about forming an underwriting agency. Mr Downey's recollection was that all Mr Whitcombe might have referred to was a new source of capital; Mr Whitcombe never made clear that there were going to be changes. Mr Whitcombe never said anything more than in previous telephone conversations. Had the question arisen, he would have told Mr Whitcombe that he would never be involved in an underwriting agency; that was because he liked to be in control of his own underwriting; he was generally opposed to supporting someone who was rewarded by commission. After the conversation, Mr Downey decided that he would not telephone him again but wait for news. He heard nothing further.

ii) Mr Whitcombe's evidence was that he had misunderstood Mr Downey; he had wrongly assumed that he would join an agency company. Although he had never mentioned the agency venture to Mr Downey, his understanding was that Mr Downey wanted to be involved in whatever they did. Mr Whitcombe had made a wrong assumption and there had been a misunderstanding.

654. However, subsequent to these events and prior to the trial, Mr Downey had seen Mr Whitcombe in May 2000 at a meeting arranged by Mr Smith. Mr Whitcombe had told Mr Downey that he believed that he had telephoned Mr Downey in November 1996 and had mentioned "the agency route". Mr Downey told him that he had not and that he could not have done so in November 1996 for reasons which he explained to Mr Whitcombe.
655. Mr Henton's evidence was that he had met Mr Downey in connection with EIC several times; as regards EIU, Mr Whitcombe had told him that Mr Downey was happy to be involved.
656. Mr Broad's evidence was that Mr Downey had been referred to at the first meeting with Mr Whitcombe when he said that Mr Downey was involved; Mr Broad believed that Mr Downey was the Chairman of EIU and that there was an ongoing relationship. He had no recollection of being told by Mr Whitcombe that Mr Downey was not involved either then or later; Mr Whitcombe's evidence was that he had later corrected the position to Mr Broad.
657. In the further plan prepared for a bank in late January 1997 (to which I refer at paragraph 772), there was no reference to Mr Downey; Mr Whitcombe said that this was because they could not afford him. He had never discussed the salary Mr Downey had wanted for EIU, though he had done so for EIC; he rejected the suggestion that reference to Mr Downey had been removed because the bank might actually ask to see Mr Downey.

(d) Mr Whitcombe's past underwriting

658. The plan stated:

"[Mr Whitcombe] started two syndicates, 456 and 1053, neither of which ever made a loss whilst under his control…"

659. SD contended that this was untrue as there had been a loss in the 1991 and 1992 years, as shown in the syndicate accounts published on 3 or 4 July 1996. No point was taken on the 1993 year nor was any point taken on Syndicate 456 where Mr Whitcombe had underwritten profitably between 1978 and 1988 prior to underwriting for Syndicate 1053.
660. Mr Whitcombe's evidence was that what was stated in the business plan was correct as the loss had not happened when the syndicate was under his control. However:

i) The 1991 year was closed into Equitas at a loss of £2.493m, as shown in the accounts as at 31 December 1995. As the accounts stated, the loss was due to claims under a policy written for the solicitors' indemnity fund and for bad debts on reinsurance recoveries. Mr Whitcombe's explanation was that although he knew of this, as he had seen the accounts and was very annoyed, it was nothing to do with him as Equitas had charged too high a premium for the reinsurance to close. They took high premiums to bolster up the funds. Without the reinsurance to close premium into Equitas of £2.678m, the profit (before reinsurance to close) would have been £600,000; if he had been able to do the reinsurance to close in the ordinary way, the premium would have been much less than that charged by Equitas.

ii) The 1992 year had been closed into Equitas with a loss of £1.669m. The accounts stated that losses were due to bad debts on reinsurance recoveries. The reinsurance to close premium charged had been £3.45m.

I am sure that the statement that the syndicates had not made a loss was untrue and must have been known by Mr Whitcombe to be untrue. A profit could not be determined without taking into account the amount that had to be paid for the reinsurance to close premium. I consider that the honest approach would have been to look at the results on the basis of the premium fixed by Equitas, as that was in fact what had happened, but even if it was permissible to look at the matter on the basis of what Mr Whitcombe would have fixed as the premium for the reinsurance to close if he had been the active underwriter, it is inconceivable that the reinsurance to close premiums would have been so low on the 1991 year that a profit could have resulted.

661. Mr Broad was not aware that the syndicates had ceased underwriting in 1993; for all he knew, the syndicates may have been merged. All he actually knew was that Mr Whitcombe had departed.

(7) The final negotiations

(a) The prudent approach to granting a binding authority

662. Mr Broad accepted that it was prudent to consider various matters before a binding authority was granted:

i) a full investigation of the cover holder and his experience;

ii) a full investigation of the type of business to be written;

iii) absolute clarity as to what could and could not be written;

iv) a clear understanding of the underwriting approach of the cover holder;

v) the reinsurance programme;

vi) clear provisions for reporting, inspection of records and accounting;

vii) the adequacy of the system at the insurer for analysing the information provided by the cover holder; and

viii) the estimated premium income and anticipated loss ratio.

Where the premium income was to be high and the cover holder was to fix the rates, then the need for diligence was even greater.

663. It was the evidence of Mr Tunstall that binders were granted to brokers on an evaluation of premium, loss ratios, the experience of the broker and the class of business. It was the standard practice at SD to have an account on the books at SD before a binder was offered; they would then be monitored on a monthly basis for premiums and claims and would be visited once a year.

(b) The way the negotiations were conducted

664. All the negotiations were conducted between Mr Smith and Mr Broad; Mr Whitcombe discussed matters with Mr Smith but his evidence was that they had had a lot of problems getting hold of Mr Broad as he was away frequently. As far as Mr Whitcombe was aware, Mr Smith reported back to him on the progress being made, but whether he really did or not, he did not know as Mr Smith may have forgotten some things; "with Smithy, you could never tell".
665. Mr Whitcombe's evidence was that he saw some slips but he mainly discussed matters with Mr Smith; Mr Smith would not let him see any slip which showed his brokerage; there were no further questions about the nature of the business or of Mr Whitcombe's ability to write the account or the reinsurance (save when Mr Whitcombe subsequently started to ask questions about the reinsurance – see paragraph 682) or as to the source of the account. He was never told that Mr Broad rejected any part of the business plan.
666. Mr Henton was kept informed by Mr Whitcombe; he continued his employment with Eastgate and did not give notice until the binder was finalised. He then gave 14 days' notice.

(c) The draft restriction to facultative reinsurance

667. Mr Broad's evidence was that there had been a discussion at the beginning about the level of commission; they allowed for 25% original commission and the difference between 25% and 40% was to be 12.5% for Mr Whitcombe, with a cap of 40%. A note in HHI's file set out a commission calculation: it provided for commission on direct business to be an average of 22.5% with 12.5% plus 5%, and on facultative reinsurance to be an average of 27.5% plus 10% plus 2%, equalling 40% in each case. It was Mr Smith's account that this referred to commission in respect of the business to be written, but the plan talked about other business. Mr Whitcombe's evidence was that this was an earlier document relating to other business and not to PA.
668. On 8 January 1997, Mr Broad scratched a slip dated 7 January 1997 (the third version). This was then was amended in manuscript and, as amended, survived as the fourth draft slip. One of these amendments was highly material.
669. Either Mr Broad or Mr Smith added the word "facultative" to the words "Interest: Direct and reinsurance business", so that it read:

"Interest: Direct and Facultative Reinsurance business".

This was not carried through into the final slip which was stamped on 21 January 1997, though all the other changes were.

670. It was Mr Broad's evidence that this manuscript expressed what he always intended and he had discussed this with Mr Smith; Mr Smith would not have allowed the manuscript change to the slip without a discussion; the manuscript change, however, had not been carried through to the final typed slip because of an oversight on the part of Mr Smith. Mr Broad had not spotted it when he scratched the final typed slip. Mr Smith's account, on the other hand, was that the insertion of "facultative" had been a mistake and that the slip was then amended to bring it into line with the business plan; Mr Smith was sure that he had both the new and old version of the slip with him when he saw Mr Broad next and that he would have gone through the amendments with Mr Broad. Mr Broad was adamant that if Mr Smith had known treaty business was to be written he would have amended the slip to include treaty and would have taken it to the treaty division of SD; Mr Smith had never said that the word "facultative" had to come off the slip.
671. Mr Whitcombe accepted that, as a matter of general practice, when a slip with manuscript on it has been stamped, then any future version should include that manuscript. Mr Whitcombe's evidence was that he never discussed such a change with Mr Smith; he would have never been prepared to limit the binder in this way; such a limitation was never discussed. He was never told that treaty business was not to be written or that he was not to write XL on XL, LMX, XL spiral or retro business.
672. I will set out my conclusion on this later – see paragraph 731.

(d) SD's reinsurance programme for 1997

673. When, as set out at paragraph 566, Mr Broad had started a small PA account at SD, he, Mr Andrew Rayner and Mr Tunstall had asked Crawley Warren and Robert Bruce Fitzmaurice if they would obtain a reinsurance programme. It began with a retention of $50,000 and thereafter was placed in layers up to $10m on an LOD basis; treaty business could be written, but there was an exclusion of LMX. The reinsurances each contained a provision for minimum and deposit (M&D) premiums based on the intention to write $1m; the adjustable rate for 1995 was 20.6%. As the anticipated amount of business was never written in 1995 or 1996, the M&D premiums were a high proportion of the cost and contributed to the unprofitability of the account.
674. The programme was renewed for 1997, using Mr Keith Steed, who had moved to Rattner Mackenzie from Crawley Warren. The retention remained at $50,000 and the coverage was extended to $10m. The first layer ($150,000 xs $50,000) was placed with Unum Life Insurance Company (Unum) and Syndicate 1121 (Panter), the second layer ($300,000 xs $200,000) with Unum, the third layer ($500,000 xs $500,000) with QBE and Syndicate 48, the fourth layer ($1.5m xs $1m) with a group of companies underwritten for by D&H, and the fifth layer ($7.5m xs $2.5m) by four companies led by Manulife; the fourth and fifth layer reinsurers included Phoenix.
675. On 17 January 1997, the board of SD decided that all its outwards reinsurances should have a co-reinsurance by SD of 10%; the orders on the reinsurances were then all reduced to 90%, SD being its own reinsurer for 10%.
676. The programme for 1997 excluded LMX business howsoever assumed. It had limited reinstatements. On the bottom layer there were two free reinstatements and five further reinstatements, each at 100% additional premium. The next layer had two free reinstatements and two further reinstatements, each at 100% additional premium. There were limited reinstatements on the other layers.
677. Mr Broad's evidence was that he was unaware of the exclusion of LMX business but assumed that incidental LMX would be covered. He was content with this as he did not think that EIU would be writing LMX business; they had always said that they would not write that type of business and it was Mr Broad's instruction not to do so.
678. No mention of the EIU binder had been made to the reinsurers for 1997. However, the information sheet did disclose that premium income was being written under binding authorities, as SD had about 200 of them. Mr Broad accepted that the information sheet did not disclose the level of premium income on the EIU binder, but he was not sure that it would ever be achieved.

(e) EIU's knowledge of the reinsurance programme

679. On 8 January 1997, Mr Broad scratched what had survived as the third version of the slip with the words "sub r/i, sec tba" – subject to reinsurance, security to be agreed. He had amended the slip to reduce the premium income to £1m (from the £5m on the slip) and had agreed commission (including brokerage) as not exceeding a deduction of 40% from original gross rate (OGR).
680. Mr Broad's evidence was that Mr Smith was trying to persuade him to buy reinsurance and that he had initialled the slip in this way so that if Mr Smith produced a reinsurance programme he found acceptable, he had the option of taking it, though he might go ahead without it. He was also uncertain what SD's final reinsurance programme was at that stage, though he was always intending to use it. He did not proceed on the basis set out in the third version of the slip, as he had had reinsurance for the binder and he did not want to spend money on other reinsurance until he saw how the business had developed; he wanted to avoid a commitment to large M&D premiums. The provision relating to reinsurance was therefore not carried through to the signed slip.
681. His evidence was that he told Mr Smith of the reinsurance programme and that they ran a net retention of $50,000. He would have shown Mr Smith the cover notes for the previous year; he would have later told Mr Smith of the security. He did not give copies of the cover notes to Mr Smith. He did not tell Mr Smith of the LMX exclusion or of the two life warranties which were contained in some of the layers, though he had assumed that incidental LMX business would be covered.
682. He had told Mr Smith that he was satisfied that the business to be written fell within the terms of his reinsurance; he agreed with Mr Smith's account that he had been told of Mr Whitcombe's advice that XL protection was needed and that he had told Mr Smith that he did not need it as he had his own.
683. Mr Whitcombe's evidence was that before finalisation of the binder he was told that SD had no reinsurance for losses below $60,000; this was a mistake for, as set out at paragraph 680 above, the retention was only $50,000. He said that he wanted to see the details of the reinsurance. It was from February 1997 onwards (see paragraph 815.iii)) that he definitely wanted to see the cover notes. It was crucial to see what the reinsurance was and he had to know what it was, but Mr Broad was very coy.
684. Mr Henton's evidence was that he was told by Mr Whitcombe that SD's programme would cover the business he was to write; he was told at some point during January that the retention was $60,000. He assumed that the programme had unlimited reinstatements and that there were the standard exclusions.
685. Mr Bird's evidence was that he had had lunch with Mr Henton in 1997, during which Mr Henton had told him that he had not seen the SD reinsurance programme, though he had been told that it protected the business that was being written; Mr Bird had told him to get that in writing.

(f) The signing of the slip

686. On 21 January 1997, the binder was signed by Mr Broad; he increased the premium income limit to £2m, with the final figure to be agreed on 31 March 1997. It was Mr Broad's evidence that Mr Smith was pressing for a higher premium income figure; Mr Broad wanted a gradual start. Revisions to the slip were made on 22 January 1997.
687. As set out at paragraphs 643 and following, Mr Henton had not been mentioned in the plan. It was Mr Smith's account of matters that he had tried to get Mr Broad to agree that Mr Henton should have authority to underwrite, but that Mr Broad would not agree and had wanted to see how Mr Whitcombe got on as the underwriter. Mr Broad's evidence was that Mr Henton may have been mentioned, but not in the context that he would be underwriting; the only basis on which he proceeded was that Mr Whitcombe would be doing the underwriting. Mr Henton's account was it was always intended that he would be the underwriter, and that this was known to Mr Smith, Mr McCarthy and Mr Broad.

(g) Mr Broad's discussions with Mr Philo

688. Mr Broad's evidence was that he discussed the granting of the binder with Mr Philo. Although there were formal procedures nominally in place by that time, the binder was never formally signed off. Mr Broad made the decision to grant the binder.
689. Mr Tunstall was not involved in the negotiations or in any review of the business plans; his evidence was that Mr Broad dealt with those matters; it had been Mr Broad's practice, when he had a pet subject (as mentioned at paragraph 559), to work alone on it to the exclusion of others.
690. A copy of the signed binder was provided to SD's back office at Brighton.

(8) The terms of the binding authority

(a) The slip

691. The important terms of the slip as finally agreed were:

"COVER HOLDER: [HH]

CLASS OF BUSINESS:

Business written by the Cover holder and designated 'Accident Business', being Personal Accident and related classes, but excluding Medical Expenses Business written as such.

NAMED UNDERWRITERS:

The persons authorised to accept and who are responsible for the operation of this Agreement are:

J.H. Whitcombe, Esq.

PERIOD OF INSURANCE:

Not to exceed 12 months plus odd time.

GENERAL CONDITIONS:

As per wording T.B.A.

Warranted all business written on a co insurance or reinsurance basis following recognised Market leaders, unless with prior written approval with Insurers/Reinsurers hereon.

Original policy conditions on established Market Forms.

The Cover holder is authorized to sign collective / subscription policies and endorsements thereto, in respect of risks declared hereunder and shall retain a copy on file and forward a further copy to Underwriters with the bordereau to which it applies.

Built in Reinsurance protection hereon to be agreed through Horace Holman International Limited.

Conversion rate = $2-£1

ACCEPTANCES

All risks accepted hereunder by the Cover holder to be submitted on monthly Bordereaux.

BORDEREAUX AND ACCOUNTS :

Monthly bordereaux for premium and claims to be submitted to Underwriters within 14 days of the end of each month.

Monthly accounts of premium and claims, which to be settled within 45 days of the end of each month.

DEDUCTIONS

O.G.R. less various commissions not exceeding [40%] in all claims.

INFORMATION

The initial Estimated Gross Premium is TBA 31/3/97 not exceeding £2m (to be increased by mutual agreement) and information as disclosed in the Business Plan."

692. A cover note setting out these terms was provided by HHI to Mr Whitcombe; the terms were almost the same (except that brokerage and one or two minor points were omitted). A corrected version was sent.
693. No wording was ever produced; this was raised in a letter from Mr Henton to Mr Smith on 23 April 1998; Mr Broad's evidence was that it was not a matter for him.

(b) The estimated gross premium income

694. It was Mr Smith's account that Mr Whitcombe had wanted to write £10m all along, but that Mr Broad did not want to sign an estimated premium income of £10m but would increase it gradually. He had wanted to see how the account progressed and be sure that it justified the estimated premium income. It was also his evidence (as was the evidence of Mr Broad) that Mr Broad had only wanted to give £1m, but that he had increased it to £2m. The provision in the slip was not meant to be a cap.
695. Mr Whitcombe accepted that he needed Mr Broad's approval before he could write more than the estimated gross premium shown on the slip; he considered that the reason for this was that Mr Broad wanted a slow start; Mr Whitcombe's evidence was that he was told over the pub meal on 7 February 1997 that an increase in the premium income would be no problem. By the time of the trial, Mr Whitcombe thought that Mr Broad wanted to conceal what he was doing from SD; at the time he thought that Mr Broad did not want to make a splash in the market, but he did not know the reason for it.

(c) Could treaty business be written?

696. There was no exclusion of treaty business; it is clear that treaty business was permitted on any ordinary reading of the slip.
697. Mr Broad was adamant that he and Mr Smith knew that treaty business was not to be written; the whole tenor of the slip was facultative and if treaty business was to be included the slip would have had "treaty" written all over it. It was not necessary to exclude treaty business as it was a typical facultative slip and any competent broker would specify on the slip what was to be covered.
698. However, in evaluating that evidence, it is necessary to bear in mind the fact that treaty business was expressly excluded in many of the other binding authorities that were granted.
699. It was suggested that there were several terms of the slip which made it clear that treaty business was not to be written. Mr Whitcombe's answer was:

i) The slip referred to "Original policy conditions on established market forms". He assumed that there were established market forms for treaty business; he accepted that there were established market forms for facultative PA business.

ii) He assumed that there were collective or subscription policies.

iii) Although monthly accounts were not appropriate for treaty business as the accounting would be quarterly, they did not intend to write only treaty business.

iv) He could not say whether the claims provision was more like a facultative provision.

v) Mr Whitcombe accepted that the slip should have made clear that international XL and LMX business was to be written.

700. There was a manuscript draft bordereau in Mr Smith's handwriting which provided for a code to be inserted as to whether the business was direct, facultative, XL or treaty. Mr Broad said that he was shocked to see this and did not think that Mr Smith thought that the binder included treaty business. Mr Smith's account was that he had discussed this with Mr Broad; Mr Broad's evidence was that he had not. Mr Whitcombe's evidence was that he had agreed the format of the bordereau with Mr Smith. There was an entry in Mr Whitcombe's diary on 13 February 1997 about this; he discussed the type codes with Mr Smith and agreed them; the type codes were the nature of the business. The actual provision of information by bordereau to SD is considered at paragraphs 889 and following.
701. Mr Henton's evidence was that he was never told he could not write treaty business; if he had been, he doubted whether he would have left Eastgate as he was not confident he that could bring in any business other than that.

(d) Recognised market leaders

702. Mr Whitcombe's evidence was that Mr Broad had insisted on the clause that they followed recognised market leaders; Mr Henton's evidence was that the purpose of this clause was that he was to follow and not to lead, unless he got prior written approval. He said that "recognised" meant recognised in the market – the whole PA market and not merely the London PA market.
703. Mr Henton said he discussed this with Mr Smith and had mentioned to him Mr Bird, Mr Billyard and others as names who would lead.

(e) Commission

704. The commission taken by EIU was the difference between the brokerage which they allowed to the broker and 35%; as they usually allowed 15% to SCB, the commission taken by EIU was 20%. EIU considered that the term "original" in the term "OGR" applied to the gross premium rate on the slip presented to them as on XL reinsurance that was the only rate – that was the original business that they were seeing. On top of this, HHI received 5% brokerage, making the deduction 40% in total.
705. Mr Henton said that OGR did not mean the rate on the business as originally underwritten; the rate was high to cover acquisition costs on other business, such as commission that would have to be paid to a cover holder under a binder on a travel account. It was not possible to work out the OGR on the kind of business which EIU underwrote; SD suggested that this showed that Mr Broad never intended that the binder be used to write the business that they wrote.

(f) Length of contracts

706. Under the EIU binder, the period authorised was 12 months plus odd time; that was amended on 26 February 1998 (as set out at paragraph 1309) for some contracts to a maximum policy period of 36 months subject to reinsurance. By granting the authority to write longer periods under the original contracts subject to reinsurance, Mr Henton accepted that if EIU was to write such cover, they had to ensure that there was reinsurance to cover this.

(g) The reference in the slip to the business plan

707. Mr Broad's evidence was that the reference to the business plan in the slip had not been removed as Mr Smith was not a methodical broker and had not removed it; for Mr Broad, it remained a proposal he had rejected.

(h) HHI as cover holder: the role of EIU

708. Under the binder, HHI were appointed the cover holder and Mr Whitcombe was the named underwriter. Mr Broad's evidence was that he had included Mr Whitcombe as the named underwriter because he was told that Mr Whitcombe had the expertise to write PA business. On 4 February 1997, by an endorsement to the binder, it was noted that SD had approved "Mr Whitcombe as underwriter for this contract." On 21 February 1997, HHI delegated "matters of underwriting, claims and accounts" to Mr Whitcombe by letter.
709. By an endorsement dated 8 September 1997, the 'Named Underwriters' section of the binder was amended to read:

"The company authorised to accept and who are responsible for the operation of this agreement is [EIU]. The named underwriter being J.H. Whitcombe Esq."

710. On 11 February 1998, the general conditions of the binder were amended (see paragraph 1292). One of the amendments was:

"Mr. Chris Henton added to authorised persons to accept as Named Underwriter."

(i) Amendments to the binder

711. Various amendments were made to the slip:

i) On 5 February 1997, the form of stamp impression for subscription to the slip was agreed as:

"Accepted under contract No 50413 per Sphere Drake Insurance Co subject to written confirmation."

At the same time, the format of the confirmation of acceptance was agreed (see paragraph 787).

ii) On 14 March 1997, Mr Broad agreed to an increase in the estimated premium income to "N/e £3.5m" (see paragraph 923).

iii) Amendments were made in July 1997 (paragraph 1008), 8 September 1997 (see paragraph 708), 29 December 1997 (see paragraph 1187), 2 February 1998 (paragraph 1282), 11 February 1998 (see paragraphs 1292 and 1294), 26 February 1998 (paragraph 1309), 20 May 1998 (see paragraph 1349) and June 1998 (paragraph 1411).

(9) Conclusion

(a) The scope of the binder

712. The terms of the binding authority as set out in the slip were very wide; they did not preclude the writing of treaty business including LMX, retrocessional and international XL business. I reject Mr Broad's assertions to the contrary as untenable as a matter of construction.

(b) The case advanced by EIU and SCB

713. The case made against SD and Mr Broad was that as he had failed to get into the PA market through his own efforts, he had succumbed to the temptation to overcome or mask his failure by writing PA business for premium and seeking profits on a net basis; Mr Whitcombe would do this by emulating the way in which Syndicate 103 had done business. Mr Broad had done so because of perceived pressures to perform from within SD, but he had attempted to obscure that fact from others within SD. He had done this by using a binder (rather than writing it directly), keeping sole control over the account and trying to ensure that the account had a slow start so that it did not attract attention. It was submitted that the temptation was strong since he had a reinsurance programme in place that permitted treaty business to be ceded under it (see paragraphs 567 and 672).
714. EIU and SCB contended that Mr Broad knew that the account was to mirror that of Syndicate 103, that treaty business was to be written, and that the business plan made it clear that a profit could only be made through "net underwriting". Amongst the points they emphasised were:

i) Mr Whitcombe's letter of 26 November 1996 had referred to the second business plan being tailored to address Mr Broad's specific requests; this evidenced the fact that Mr Broad had rejected the financial institutions business but was accepting the type of business written by Syndicate 103. There was nothing to show that Mr Broad had rejected the second plan apart from his own assertions. On the contrary, the slip expressly referred to the business plan.

ii) The slip did not exclude treaty business, though this was excluded in other contracts written by Mr Broad.

iii) The premium income was enormous and Mr Broad knew that this could never have been achieved in a soft market through a conventional direct account.

iv) No one else at SD was involved; the binder should have been signed off by Mr Philo.

715. It is easiest to examine the case made by EIU and SCB by first asking whether Mr Broad had authorised the writing of gross loss making business and then by considering whether he had authorised the writing of treaty business.

(c) The suitability of the reinsurance programme for arbitrage

716. Mr Whitcombe accepted that it was suicidal to write WC carveout business on a gross loss making and spiral basis without reinsurance cover, but he believed that there would be no difficulty in getting it.
717. There can be no doubt that SD's reinsurance programme for 1997 (as described at paragraph 675) was one that could not be used for writing gross loss making business on the backs of reinsurers:

i) it excluded LMX business howsoever assumed;

ii) it had a retention of $50,000 at the bottom and 10% on each layer; and

iii) it had limited or paid reinstatements on most layers.

718. It was also clear that no person writing gross loss making business against reinsurers should accept any inwards business without an adequate reinsurance programme in place; to do otherwise would be to expose himself to the risk of bearing the losses himself.
719. If Mr Broad had understood and had agreed that the account to be written was to comprise, even in part, gross loss making business written against reinsurers, he would have been exposing SD to a risk of certain loss without insisting that a proper reinsurance programme was in place. It was Mr Broad's evidence (as referred to at paragraph 676) that he was unaware of the LMX exclusion, but I reject the suggestion that he was content to go ahead because he had forgotten about this exclusion; to write such business would necessitate the most careful attention to reinsurance.
720. It was suggested by SCB that Mr Broad did not buy additional reinsurance because it would be expensive if no business was generated; its reinsurance in the past had been under-utilised and buying more reinsurance would attract attention to the binder. I reject these suggestions. It is clear that if gross loss making business was to be written, there was a significant amount of such business available (as was in fact written within days of the binder being signed); this would have been obvious to anyone who was thinking of entering into that particular business. If that type of business was to be written, reinsurance was essential before any business was written as the losses would be enormous without it; nothing could be more calculated to draw attention to the binder than enormous losses which were not covered by reinsurance.

(d) Did Mr Broad authorise the writing of gross loss making business?

721. The case made against Mr Broad was plainly one of dishonesty – a deliberate decision on his part (1) to write, in a clandestine way, business which he knew he was not allowed to write; (2) to subject SD to very large losses, as no adequate reinsurance programme was in place; and (3) even if such a reinsurance programme had been in place, in any event to expose SD to the very significant risks that would be entailed in writing the volume of business contemplated.
722. I am sure that Mr Broad was never told and never understood that gross loss making business was to be written; he never authorised the writing of an account of gross loss making business to be written on the backs of reinsurers. I am sure that he was an honest underwriter; there was no evidence of any pressure on him to do something which was so utterly out of character and to engage in a course of conduct in which he had never previously engaged.
723. During the course of his cross-examination on the first report produced by EIU in November 1997 on the business written under the binder, Mr Broad expressed himself with great vehemence and emotion at the gross loss making business that was in fact written; he said that he had expected Mr Whitcombe to underwrite for an underwriting profit and not to write on the backs of reinsurers; he had considered that to be conduct that would ruin people's careers, ruin a company and was done by those "who did not care a damn about it as long as they made money". He said that his trust had been betrayed and that he had been made to look like a fool. I am sure that that was honest evidence and, as I will set out, he had in fact behaved with great foolishness and dereliction of duty, but he had not acted dishonestly.
724. In considering Mr Broad's evidence, I approach the matter on the basis that he was aware, as he stated, of the practice of some underwriters in writing gross loss making business and making a profit through reinsurance, that the market was soft, and that in a soft market some underwriters wrote at uneconomic rates which would result in a gross loss, or as it is sometimes put, "below the burn". One way of doing this was to write against reinsurers. However, it is also clear, on such evidence as was available, that Mr Broad was truthful in his evidence that it had not been his personal practice to do this. Furthermore, I accept his evidence that he was under no pressure to write more premium income.
725. Mr Whitcombe accepted that many underwriters would not want to have anything to do with a scheme to write gross loss making business on the backs of reinsurers as there was a high risk that reinsurers would not pay and there were potentially huge cash flow implications; to do such business the participant had to be in the know.
726. I have no doubt at all that for an agent to write such an account without making it very clear that that was the type of account to be written was dishonest. The difference from conventional insurance and reinsurance was so significant and the risks in writing such business on any scale were so great that the fact that it was the intention to write such an account had to be made clear.
727. EIU maintained that the first five programmes, those accepted on Christmas Eve 1997, those accepted on New Year's Eve 1997 and the last batch of contracts made during 1998 was the kind business of that they intended to write; according to EIU, Mr Broad should have understood that as it was spelt out in the plan.
728. It was submitted by SCB that it was not surprising that EIU did not mention that they would write massively loss making business because they had no idea as to the sort of business they were going to be offered. They intended to write "net" and that was sufficiently brought across in the business plans. I reject that submission. As I have already found at paragraph 531, I am sure that there was a common understanding between SCB and Mr Whitcombe and Mr Henton in relation to EIC that SCB would offer them their book of WC carveout business and that Mr Henton would write it; as I set out below (see paragraphs 753 and following and paragraphs 866 and following), there were meetings between SCB and EIU before the binder was signed during which I am sure that that was re-affirmed. Mr Henton clearly knew, at the time the plan was submitted and before the binder was granted, that they intended to write business that was gross loss making on a large scale as that was what he would be offered by SCB. As Mr Henton accepted when cross-examined on behalf of SD, the sort of book that was actually written was by and large the book which he had intended to write.
729. However, there was nothing in the business plan to make that clear. It is important to note that in the second plan (as set out at paragraph 616), it was not even possible to tell from the figures that what had been written had turned out to be gross loss making business as the figures were given net of reinsurance; moreover, the description in the plan of the need for reinsurance was described in conventional terms. It was suggested that there was nothing deliberate in this; it could have been better worded, but there was nothing dishonest about it. I reject that submission. I am sure that, for the reasons given at paragraphs 733 and following, the plan was deliberately drafted to conceal the true intent to write gross loss making business.
730. Furthermore, Mr Whitcombe accepted that he had never told Mr Broad that they were going to write a massive account on a gross loss making basis; they expected that some risks would have a gross loss from day one, but they hoped to make a gross and net underwriting profit on others. It was also Mr Smith's account (as set out at paragraph 1322) that Mr Whitcombe and Mr Henton never told him that they were going to write gross loss making business or that they were going to engage in arbitrage.
731. Mr Broad acted in breach of SD's procedures in not seeing Mr Philo; I infer that had Mr Philo given evidence he would have been highly critical of Mr Broad's conduct and he would have been right to be highly critical. Mr Broad should have given more thought about the question as to where Mr Whitcombe was to get business in a soft market and as to the type of business that he might get. This was gravely negligent and his conduct was in breach of internal procedures, but I am sure that he did not know that gross loss making business was to be written.

(e) Did Mr Broad intend to authorise the writing of treaty business?

732. As I have rejected the case that Mr Broad authorised the writing of gross loss making business, it is difficult to understand any motivation on his part for having authorised treaty business to be written. I have come to the conclusion that Mr Broad, although he acted in a manner that was manifestly imprudent, did not intend to authorise the writing of treaty business as described in the plan, though, as I have set out at paragraph 711, the slip (on its proper construction) permitted the writing of treaty business.

i) Mr Broad trusted Mr Smith and trusted Mr Whitcombe too when he met him.

ii) I am sure that the omission of Mr Henton's name from the plans was a deliberate act on the part of Mr Whitcombe; Mr Henton had been mentioned in the earlier proposals and the only credible explanation was that Mr Whitcombe removed the reference to him as he was selling the business to Mr Broad as business that Mr Whitcombe, an experienced Lloyd's underwriter, could be trusted to write. Any mention of Mr Henton as the underwriter might have given rise to questions.

iii) Mr Broad did not read the plans put before him save to glance at some of the paragraphs; as I saw on many occasions during his long cross-examinations, it was one of Mr Broad's characteristics that he did not read documents with any degree of care or attention – he usually just skimmed them over or glanced at them.

iv) Mr Broad's approach was to listen to the broker and to trust him to summarise the information accurately without paying careful attention to what was put in front of him. I am sure that Mr Broad had made up his mind to grant the binder without any proper examination of the documents; he had simply listened to Mr Smith and had glanced at each plan for no more than the 15-20 minutes that each of the two meetings lasted. He did not even bother to take a copy.

v) Mr Broad made it clear what he wanted – good direct PA business; he thought that this was to be provided; he was not interested in what was in the plan.

vi) Mr Broad had scant regard for the internal procedures of SD; he was an immensely proud man and had felt himself entirely competent to run the business without observing the most basic internal controls.

vii) Mr Broad's approval of the binder without going through the most elementary procedures was characteristic of the standards prevailing at the time of the well known Sasse affair at Lloyd's in the 1970s; his conduct might have seemed staggering in view of the fact that the Sasse affair had occurred 20 years earlier and that it had then been 15 years after the introduction of stringent regulation in the Lloyd's market where he had carried on business; however, that grossly unprofessional conduct was, in my experience, still prevalent in the London market in the 1990s. An instance of it in relation to binding authorities can be found in Syndicate 1242 v Morgan Read & Sharman Ltd. (the Travel Insurance Litigation) [2001] EWHC (Comm).

viii) Mr Broad did, however, restrict the premium income to £2m; that was a cap (as Mr Whitcombe appreciated) because Mr Broad wanted to be able to review the binder.

ix) The commissions to which Mr Broad agreed were entirely consistent with direct business; they were obviously far too large for XL treaty reinsurance.

733. Implicit in my conclusion is my rejection of a significant part of the evidence given by Mr Whitcombe and Mr Smith. In particular, I am sure that Mr Smith failed to carry through to the last version of the slip, the amendment made to restrict the business that was to be written to facultative business (see paragraph 668). The commission terms were entirely consistent with the writing of a facultative and direct account and not that type of XL reinsurance which was characteristic of the business that Mr Henton was to write.

(f) Were there any fraudulent misrepresentations?

734. In the course of his cross-examination by Mr Henton, Mr Jackson accepted that the plan made it obvious to a reasonable underwriter that treaty and XL on XL business was to be written and that retro and spiral business (both LMX and international) would be included; the retention was surprisingly low; however, he maintained his view that the plan as read by an underwriter bore no relation to the book subsequently written. I have taken that evidence and the other evidence into account in reaching my conclusion as to what a reasonable underwriter would have understood and what would have been intended. I am sure that the business plan contained misrepresentations which I am sure Mr Whitcombe and Mr Henton knew to be untrue and which were intended to conceal the true nature of the account to be underwritten by Mr Henton, namely that it was to comprise a significant amount of gross loss making WC carveout business that was to be written on the backs of reinsurers. It was not a document innocently prepared in a way that could have been better expressed, but a carefully crafted document which was intended to deceive any reader and to disguise the true nature of what was to be done:

i) The business to be written was not low to medium risk.

ii) The business did not provide "rational and prudent returns"; profit could not reasonably be predicted.

iii) It was not business of which Mr Whitcombe had any knowledge. As was clear from Mr Whitcombe's evidence when being cross-examined about the programmes actually written by EIU, he had little understanding of the business to be written; he had been a traditional underwriter and at that time had no knowledge or experience of the kind of business that had been written at Syndicate 103.

iv) It could not conceivably be described as "top draw" business or business to which it was difficult to gain access.

v) There was to be no prudent risk review and no use of selective underwriting criteria in the way in which the business was to be written.

vi) It was perfectly obvious to Mr Whitcombe and Mr Henton that anyone being asked to write gross loss making business needed to be told this fact in clear and unambiguous terms. The business plan did not state this fact anywhere, even if the document was analysed in detail by a careful and prudent underwriter.

735. Mr Whitcombe plainly knew that it was dishonest to say that EIU had the experience to write the business without saying anything about his own lack of experience and about what Mr Henton was to do. As Mr Henton was familiar with the business that had been written by Syndicate 103, he knew that what was said in the plan was dishonest.
736. I am also sure that Mr Whitcombe never approached Mr Downey to be Chairman of the venture when it was decided that it was to operate as an underwriting agency; I reject his evidence that there was a misunderstanding. Mr Whitcombe simply added the statement in the letter about Mr Downey continuing, in the hope that he might agree, but knowing full well that he had not yet agreed.
737. Nevertheless, as I am sure that Mr Broad paid virtually no attention to the plan, it is clear that he did not rely on anything that was stated in it.
738. However, I am sure that Mr Broad understood from what he was told by Mr Smith, based on the plan and other conversations with Mr Whitcombe, that Mr Whitcombe would be writing a conventional PA account; although that was the intention that Mr Whitcombe and Mr Henton had wanted to convey to Mr Broad, that was in fact never their intention as it was envisaged that Mr Henton (rather than Mr Whitcombe) would write a substantial book of gross loss making WC carveout business on the back of reinsurance. On that basis I am sure that Mr Whitcombe and Mr Henton had deceived Mr Broad into giving them a binder which they had intended to use for a purpose that they knew he had never authorised.
739. SD also contended that it was a misrepresentation that the business was short tail. I am satisfied that there was a misrepresentation but that the misrepresentation was not fraudulent:

i) Mr Henton's evidence was that Syndicate 103 always classified its WC carveout business as short tail under the letters 'KD' – PA written by an aviation syndicate; 'K' was the classification for the PA business of non-marine syndicates. Mr Henton classified EEII as PA as that was the way in which he understood the market treated the business after the slip referred to at paragraph 227 had been taken round the market. Mr Bird agreed; he had followed Mr Billyard; he had regarded such business as short tail as it contained commutation and sunset clauses at three years. After Mr Henton had left Syndicate 103, I accept that he did not see or know of the 1994 regulation referred to at paragraph 229, and that he thought that WC carveout business was treated as short tail.

ii) I accept Mr Henton's evidence in the light of the evidence as to the way WC carveout business was in fact classified. In stating that the business was short tail he was not acting dishonestly in any way and I am satisfied that Mr Whitcombe relied upon Mr Henton.

5. THE INITIAL WRITINGS

(1) The state of the market at the beginning of 1997

(a) The evidence

740. In general, as I have set out at paragraphs 138 and 144, the conditions in the insurance and reinsurance market were such that there was overcapacity and a downward pressure on rates. As I have also set out at paragraph 723, Mr Broad's evidence was that he was not granting the slip to get premium income and was under no pressure to write for premium income; he did not want to follow the market down.
741. Mr Brown's evidence was that in 1997/8 there was plenty of capacity for direct and first tier reinsurance. As regards retrocession, there was a fragmentation in the market; WFD, Rattner Mackenzie and Aon had become more insular. His evidence about those who would write retro was:

i) Lincoln National had decided that they were not going to write LMX retro through the Big Ben lineslip.

ii) Phoenix was prepared to continue; Mr Ekwall and Mr Wright had left, but Mr Huey was continuing to write the business with the involvement of Mr Sawyer and Mr Swanick.

iii) Mr Billyard was continuing at JEH Re but Mr Butler's evidence was that he was either reducing or withdrawing from retro business and he would not cover those with retro accounts. Mr Brown did not believe that Mr Billyard was having problems with John Hancock at this time and that he was still writing retro, though moving away from his account being so heavily weighted to retro business. SCB's understanding was that they would be cutting back significantly, but that Mr Billyard was not withdrawing completely; this was what Mr Butler subsequently told Mr Henton (see the account of the broking of Programme 1 at paragraphs 10 and 11 of Part II). Mr Billyard had, however, written to Mr Johnson (see paragraph 745.iii)a)) stating that he would not be writing LMX retro business.

iv) Mr Durling (whose position was described at paragraph 444) had authority to continue for American Reliable. When Bankers closed their London office and moved back to their head office at High Wycombe, Mr Durling formed TLA – which was appointed an agent for American Reliable. According to the evidence of Mr Johnson, TLA operated only as an introductory agent for American Reliable for 1997 and that the underwriting decision was made by American Reliable.

742. It was Mr Brown's evidence that there were others in the market, but that these would not write to SCB:

i) Lincoln National's London office: In 1996, Lincoln National established a London office at which the underwriter was Mr Tim Dumenil; he had been at Zurich Re and had written PA retro business to Crawley Warren. He would not write business to SCB. The office was at first a contact office with underwriting decisions being made in Fort Wayne, but they subsequently purchased a UK-authorised insurance company (see also paragraph 1036).

ii) Gan Minster Insurance Group (Gan): This was a French company which was a client of Bain Clarkson, to whom the claims service had been offered. The underwriter was Mr Tim Sparkes (who had joined Gan before 1992); he wrote to Bain Clarkson and did not switch to SCB; he was an arbitrage underwriter of various accounts – PA and non-marine; Mr Sparkes wrote business to Mr Johnson of WFD. Mr Sparkes moved to New Cap Re in 1998 (see paragraph 1129).

iii) Syndicate 1121 of which Mr Panter was the underwriter: According to Mr Brown, he was a writer of retro business to WFD. The PA underwriter at the syndicate was Mr Patrick Denis.

743. Mr Cackett continued to write WC carveout business on a net underwriting or arbitrage basis on a large scale, but he was not a person who would write the reinsurance of spiral business.
744. There was little evidence that these had any material effect, save for Gan which wrote part of a very significant reinsurance of JEH Re – see paragraphs 846.v) and following, though it was clear that Gan's underwriter, Mr Sparkes, was only prepared to write with a limited number of reinstatements and not the unlimited number of reinstatements which this business required at lower layers; nor was there any evidence that these others were prepared to write spiral business as reinsurers in 1997. Mr Greig was shown the list of those who wrote business to SCB and WFD where the retentions were below $15,000; his evidence was that those who wrote to SCB were a significant part of the market and that it did not surprise him that they overlapped in part with those on the WFD lists; apart from Gan he could not think of others who were writing such business in 1997-8. There was reference to the possibility that Aon and Rattner Mackenzie might have had markets available; however, on all the materials before me, there was no evidence that there was a market which was prepared to write retrocessions of WC carveout business, particularly any with a spiral element.
745. Mr Johnson's evidence was that there was a move away from the writing of spiral business for 1997. As far as he knew, Mr Billyard, Lincoln National, and Clarendon had withdrawn. He had prepared "as if" statistics in December 1996 for American Reliable (see Programme 3 at paragraphs 76 and following of Part II) removing spiral losses, as he had thought that there was no spiral market at the end of 1996. Mr Henton's evidence was similar in that a lot of capacity prepared to write retro – JEH Re, Phoenix and Lincoln National had left the market; he had moved in, seeing an opportunity.

(b) Conclusion

746. There can be no doubt that the market was prepared to write retro and spiral business was either very poorly or dead. By the end of 1996 I am sure that it was dead, certainly in so far as there were those who were prepared to write such business for either SCB or WFD; if contrary to the finding I have made, there were others who were prepared to write business to brokers such as Aon or Rattner Mackenzie, then these were insurers who were not prepared to provide SCB and WFD with the reinsurances that they needed for their business.

i) As set out above, Lincoln National had left the market. There was no evidence that they were writing spiral business through their new office and, in the light of the experience that they had by that time, it was highly improbable that they would have authorised such business to be written.

ii) The reinsurance programme for Mr Billyard had been covered 50% by Phoenix on 31 December 1996 and by American Reliable on 10 January 1997 (see paragraphs 5 and 6 of Part II); however, they had no reinsurance protection for this programme. This was essential given the nature of the underwriting undertaken by Mr Billyard and from what they had seen in previous years. Even if he was not writing retro or spiral business, Mr Billyard could only have been reinsured on a net underwriting basis as there were large gross losses in the account; many of those would have come from the non-spiral part of the account.

iii) On American Reliable's programme, there was no one to write the lowest layer ($490,000 xs $10,000) and it was difficult to get lines on other layers:

a) When Mr Johnson tried to renew the lines placed with John Hancock through JEH Re, Mr Billyard responded on 10 December 1996 stating that that he would not be writing LMX retro business. Mr Johnson also tried Mr Cackett who declined on 27 December 1996.

b) RGA Underwriting Agency Ltd. (RGA) agreed to write a line on the layer $750,000 xs $500,000 on 30 December 1996.

c) Mr Johnson gave SCB a renewal order to place the layers that they had placed in 1996 with Phoenix, JEH Re and Lincoln National. His evidence in his statement was that it was possible that he commented to Mr Butler on how hard the market had become.

d) Mr Johnson's evidence was that he had passed on Mr Billyard's refusal to Mr Durling; in consequence, Mr Durling would not write spiral business until reinsurance was in place.

e) On 13 January 1997, Phoenix agreed to write a line of 25% on the layer $750,000 excess $500,000, and a line of 40% on the next layer which had limited reinstatements, however, he declined the lower layer.

f) By the end of January 1997, Mr Johnson had not completed the primary $1.25m for American Reliable.

iv) There was no one to write the programme for Phoenix, even though they had requested renewal on 24 December 1996 and had written 50% of Mr Billyard's programme on 31 December 1996.

a) Sometime in January 1997, American Reliable declined to reinsure Phoenix.

b) Mr Butler referred to the fact that the market had a shortage of capacity for 1997 in a fax on 31 January 1997 when telling Phoenix that he could not place reinsurance for them; many of Phoenix's existing primary reinsurers had either withdrawn from retro underwriting of cedants protecting London market business or had utilised their capacity for the year. SCB were therefore trying to find new reinsurers for Phoenix. He also suggested that they might try other brokers who provided business to them as those other brokers might have reinsurers who would write the reinsurance.

c) Prior to that date American Reliable had declined to reinsure Phoenix.

d) The other brokers who provided business to Phoenix (including Crawley Warren) did not in fact provide the reinsurance; the only way in which Phoenix obtained its reinsurance was through the arrangements described below at paragraph 831. This is again further support for the fact that there was no one else prepared to write reinsurance of spiral business despite Mr Brown's suggestions that there were.

v) SCB submitted that the fact that American Reliable and Phoenix were without the cover they needed did not pose a serious commercial problem for SCB; Phoenix were primarily writing business to Crawley Warren and had committed themselves to the reinsurances of Mr Billyard and of Lincoln National. They knew what they were doing as they had reinsured Mr Billyard and, as in previous years, it was obvious that Mr Billyard's writings were going to produce large gross losses and could only be reinsured on an arbitrage basis. Although Mr Brown pointed to the fact that those at Phoenix had been involved with the reinsurances of Mr Billyard for some years and must have known that the account was gross loss making when they had written it, it was obvious, in my judgment, that they did so in the anticipation of reinsurance which they had looked to SCB to provide.

vi) Mr Billyard had made it clear to Mr Johnson in writing that he was not writing retro business, though it was SCB's evidence that he had not made that clear to them. It was suggested by SCB that Mr Billyard might have told Mr Johnson that he was not writing retro business as he did not want to write any more to them. However, as set out above, if what Mr Billyard had said was untrue, then Mr Durling had reinsured him on the basis of that untruth.

747. Thus I am sure that it was impossible for WC carveout business to be reinsured on a retro or spiral basis at the end of 1996; Mr Johnson's view was correct in the sense that the market which would write such business had come to an end; there was no one prepared to write such business. Furthermore, when attempts were made to find reinsurers for SD for reasons that will become apparent, there was no one prepared to provide it on the necessary unlimited reinstatement basis except American Reliable and they only provided it, on the evidence of Mr Johnson set out below at paragraph 832, as part of a special arrangement.
748. Furthermore, I consider that just as Mr Durling had concluded that he would not write retro or spiral business without reinsurance in place, Mr Billyard's statement to WFD on 10 December 1996 that he would not write retro or spiral business was true at the time; he knew that it could not be written without the kind of arrangements that had been in place in prior years and that the market for putting them in place had gone. Writing this type of business was again dependent on there being another reinsurer who, as a new entrant, would be prepared to provide cover for retro and spiral business. The market was dead because reinsurers had withdrawn from it as a result of the losses sustained.
749. In these circumstances, a new entrant into the market should, if this was a market to which the ordinary rules of the insurance and reinsurance market applied, have been able to obtain a considerable improvement in rates for offering cover. If there had been an ordinary market or an underwriter capable of exploiting that market, very high rates would have been charged because American Reliable and Phoenix must have been most anxious for cover.
750. However, if high rates had been charged or limited reinstatements had been offered or large retentions had been insisted on, it would have defeated the objective of writing against reinsurance for this type of business; if the rates for retrocession were too high or the terms did not provide sufficiently low retentions or a sufficiently large number of reinstatements, then it would have been impossible for the market to continue and for SCB to use it for the purposes of their WC, WC carveout and alternative WC business in the US. The market could only continue if the rates and retentions were low enough and the reinstatements were sufficiently high in number in order to enable the loss making business to be written on the back of such insurance.
751. Just as SCB had participated in the creation of spirals to transfer losses to higher layers to enable the market for the reinsurance of gross loss making business to be carried in the period 1993-6 for the purpose of furthering the competitive position of the group in obtaining WC insurance business in the US and in earning brokerage, they were anxious to find a means of continuing this market.
752. It was in these circumstances that Mr Henton entered the market and embarked on writing the business.

(2) The way in which EIU commenced business

753. As set out at paragraph 685 the binder was signed on 21 January 1997. Within six days, EIU had provisionally accepted four substantial programmes from SCB with a gross premium income estimated to be over $2.5m.

(a) Contact with SCB prior to 27 January 1997

754. As I have set out at paragraphs 494 and 495, contact was maintained between Mr Henton and Mr Butler and Mr Bird. As I have found at paragraphs 629 and 631, I am satisfied that Mr Bird was told of the negotiations for the binder and that he had promised to provide a QS. I reject his evidence that he was not kept apprised of the formation of EIU as untruthful.
755. Mr Henton's evidence was that he mentioned the SD binder to Mr Butler in a telephone call in mid-January 1997 but that he probably did not mention the binder to Mr Bird until early 1997; he only saw Mr Brown when he went to SCB to write the first risks on 27 January 1997. He did not think that there were any discussions with SCB; he merely gave Mr Butler a call and arranged the meeting at which he wrote the first contracts. It was Mr Brown's evidence that he did not know of EIU until early 1997.
756. However, Mr Whitcombe's evidence was that although he did not meet Mr Brown and Mr Butler between October 1996 and mid-January 1997, Mr Henton did, and from him Mr Whitcombe understood that SCB would have some business to show them. There was an understanding that SCB would offer the type of business written by Syndicate 103 (XL carveout) and that that had involved a spiral. Mr Whitcombe's evidence is supported by:

i) Mr Henton recorded, in a chronology written by him in December 1997:

"As a result of some discrete conversations during the writing of the Business Plan and the early placing stages of the Binder, we managed to secure promises that business would be reserved for our participation."

This document was not put to any witness but was expressly raised by me during the course of oral closing submissions. I am satisfied that a similar point was put by reference to earlier documents; I offered the parties an opportunity of dealing with it further if they wanted to. In the circumstances, it is fair for me to take it into account as a document of some probative value as it was contained in an internal note and was not intended as a piece of marketing.

ii) The expense sheets of SCB showed that Mr Brown had lunch with Mr Henton on 7 January 1997 at The Directors Club near Lloyd's; Mr Brown and Mr Henton said that there was no such meeting. I have some doubt as to whether this expense claim is entirely accurate as it referred to a firm of brokers with whom Mr Henton had no obvious connection; it was suggested that Mr Butler would have been present and as there was no evidence that he was present, it was improbable that there had been a meeting. I find, however, that Mr Brown and Mr Henton did meet at this time; it seems most unlikely that Mr Brown would have recorded Mr Henton's name if he had not met him at about this time and I can see no reason why Mr Brown could not have met Mr Henton without Mr Butler being present.

iii) There was also an entry in Mr Butler's diary for a meeting with Mr Henton on 14 January 1997. Mr Butler's evidence was that he met with Mr Henton either on that day or at a date at about that time; Mr Henton told him that EIU were making good progress with SD; they discussed the level and type of business that SCB might have available and be able to offer EIU. He could not recall if specific accounts such as JEH Re, Phoenix or American Reliable were mentioned.

757. It was SD's case that there was a meeting at which "the deal was done" – that SCB would present WC carveout, alternative WC, retro or spiral business and similar gross loss making business to EIU, and that EIU would write such business under the facility if they got it. Mr Brown denied that; if SCB had wanted to offer EIU a deal, they would have offered EIU an "in and out" claims service, but they did not.
758. I set out my conclusions on this at paragraphs 866 and following, after having considered the entirety of the evidence relating to the first five programmes.

(b) Supply to SCB of a copy of the binder

759. Mr Henton gave Mr Butler a copy of the cover note for the binder. His evidence was that he did this so that SCB could check on the security and recognise EIU's authority. Mr Butler put the timing of this as being on or around 22 January 1997 – the date of the cover note.
760. Mr Butler gave the cover note to Mr Richard Wells, SCB's compliance officer, who advised on 28 January 1997. Mr Butler also gave Mr Wells a copy of the endorsement of 5 February 1997 which related to the way in which the slip was to be stamped. SCB were satisfied with the terms but wanted Mr Whitcombe to have E&O insurance.
761. Mr Wells was not told that the business to be covered under the binder was likely to make significant gross losses; he had expected to be told this as it was relevant to security; this is a small but further example of the fact that no one ever properly spoke of the business that was to be written.

(c) The writing of the four programmes on 27 January 1997

762. On Monday 27 January 1997, Mr Henton met Mr Butler at SCB's offices. The meeting lasted 1½ hours and Mr Henton wrote four programmes; it was Mr Butler's evidence that it was quite usual for SCB to place several programmes at a single long meeting with an underwriter, particularly at renewal times. At that time, Mr Henton was working for Eastgate and he did not leave that employment until Friday 14 February 1997. He therefore wrote the first four programmes out of working hours. The first four programmes written were:

P1 John Hancock (per JEH Re) – Mr Billyard's LMX account

P3 American Reliable

P4 Lincoln National

P5 John Hancock – the account written by Hackett

In relation to the American Reliable programme, no one had been found who would write the bottom layer (see paragraph 745); there was a problem for Mr Henton in writing a line on the bottom layer because of the leader clause (as explained at paragraphs 799 and following). The details of the first four programmes are set out in Part II. It was the evidence of Mr Henton and Mr Butler that no mention was made of the writing of a reinsurance of Phoenix (Programme 2).

763. Apart from writing the four programmes, Mr Henton also accepted a reinsurance of Clarendon which was not eventually taken up (see paragraph 4 of Part III). He declined some risks – see paragraphs 7 and following of Part III. Each programme would have been considered for about ¼ hour. He accepted that he wrote 2/3rds of the available premium income for 1997 under the binder at this one meeting, but his evidence was that he understood that more premium income capacity would be made available.
764. Mr Whitcombe was not present; his evidence was that he did not understand the business. He could rely on Mr Henton who had been in the business for a long time. Mr Whitcombe accepted that he had no way of checking Mr Henton's underwriting. In EIU's defence (which was signed with a statement of truth), EIU pleaded that Mr Henton had recommended the programmes for acceptance and that Mr Whitcombe had made the acceptance, subject to written confirmation. Mr Whitcombe's evidence was that this was an error as there was a misunderstanding as to what the system was.
765. Mr Henton's acceptance of each risk was on a provisional basis. His evidence was that he had, however, at that stage satisfied himself that each was a risk that he had wanted to write and that he did not personally need to study it any further; confirmation could not be given until Mr Whitcombe had given his approval and he needed to take Mr Whitcombe through each risk.
766. Mr Butler thought that Mr Henton was making the decision and the meeting had concluded with Mr Henton making his scratch. I am sure that the decision to accept the risk was essentially made at that meeting.

(d) EIU's business with WFD on 28 January 1997

767. Mr Johnson's evidence was that WFD knew of the efforts to form EIC through Mr Kelvin Pont of WFD, with whom Mr Whitcombe was in close contact; they would have supported it, subject to security and other criteria (see the "think tank" minutes referred to at paragraph 502).
768. On 28 January 1997, Mr Henton visited Mr Davis and Mr Johnson of WFD; he had written to them shortly before asking for their support. Mr Johnson's evidence was that they had showed him a number of risks, including American Reliable and parts of the SRRF programme. Mr Henton provisionally accepted the two layers of the American Reliable programme that were being broked by WFD, as well as the two layers of the SRRF programme (but this was not eventually taken up). The probability was that Mr Henton was shown the bottom layer of American Reliable but declined it; it was unknown to WFD at this time that he had agreed to write this to SCB (who were acting jointly with WFD). SD advanced no case of dishonesty in relation to this business which was written to WFD.
769. A copy of the cover note produced by HHI was also given to WFD so that they could be satisfied as to the security.
770. It was Mr Whitcombe's and Mr Henton's evidence that their primary intention was to foster relations with WFD; that is why they approached them to place their reinsurance, as they wanted to encourage WFD rather than SCB (see paragraph 783).
771. As set out below, relations with WFD remained throughout the year. EIU gave the impression that the relations with WFD were very strong; in the submission to the bankers referred to at paragraph 772, reference was made to WFD, but not to SCB by name; in the proposal for E&O insurance dated 21 April 1997, EIU put down that 50% of their business came from WFD; there was again no reference to SCB.
772. It was Mr Henton's evidence that they targeted WFD and SCB as they were more likely to produce business to EIU; they gradually approached other brokers during the summer of 1997.

(e) EIU's submission to their bankers in late January 1997

773. Mr Whitcombe and Mr Henton submitted a proposal to their bankers (or proposed bankers), which was prepared by, amongst others, Mr Henton and EIU's finance director. The plan mentioned that they had a confirmed premium income of $2.274m (the business written in January 1997, according to Mr Henton), with $1m anticipated in March and $5m in October. The premium anticipated in October was to be a potential share on Mr Bird's QS as referred to in the business plan and noted on one of the bordereaux; it was, according to Mr Henton, only a possible QS. The figures for 1998 showed $2.274m as "confirmed" income – that was to be the renewal of the first programmes accepted in 1997; they anticipated a further $13.5m in 1998. The same pattern repeated itself in 1999. The plan showed total premium income for PA of $8.274m in 1997, $15.774m in 1998 and $23.661m in 1999. Mr Whitcombe's evidence was that he had understood that Mr Broad would provide the authority to write this amount.
774. A passage in the submission made clear the importance of SCB to EIU, though it did not mention SCB by name:

"All premium income figures have been purposely understated … As a result of numerous discussions we are aware that the personal accident account, in particular, will almost certainly significantly exceed the figures shown. The confirmed line shown in 1997 and subsequent years represents payment months advised to us by the placing brokers. It is unusual to be in the fortunate position of a known cash flow on a new venture; it is a happy position."

775. SD submitted that this passage was of importance because of the reference to "known cash flow"; this, they submitted, was evidence of the agreement that EIU would write the business offered.
776. The importance of SCB to EIU was underlined in a letter dated 29 January 1997 which was obtained by Mr Henton from Mr Brown for the purpose of submission to the bankers; it stated that SCB would be able to provide EIU with between $5m and $7.5m of premium income on a written basis in the first year, and that they hoped to be able to expand this over the coming years.
777. Mr Henton's and Mr Brown's evidence was that Mr Henton had asked him, probably on 27 January 1997, to provide such a letter; Mr Brown had assumed that Mr Henton had done the same thing with other brokers and Mr Brown had previously done this for other clients as well.
778. Although SCB were of such importance in fact, the submission did not mention them but only WFD and Lloyd Thompson; Mr Whitcombe's evidence was that there was no reference to SCB as he did not then think that they would figure to the extent which they did.
779. Although I accept that the provision of $5m of premium was a small proportion of SCB's book which was said to be in the order of $100m, it was of vital importance to EIU's existence and to SCB's ability to place its retro and spiral business.

(f) The request to WFD to seek reinsurance on 3 February 1997

780. As set out at paragraph 682, Mr Whitcombe believed, from what he had been told, that SD's reinsurance had a retention of $60,000 (though it was in fact $50,000).
781. According to the evidence of Mr Henton and Mr Butler, Mr Henton was asked by Mr Butler on 27 January 1997 if Mr Butler could provide reinsurance, but Mr Henton had told Mr Butler that it was taken care of and that he did not need help from SCB. Mr Henton did not provide any details of the reinsurances which they had and Mr Butler knew nothing of SD's reinsurances for the business written.
782. Mr Butler's evidence was that there were others in the market other than Mr Billyard, Phoenix and American Reliable who may have written low level business – Mr Cackett, Mr Owen, Gan, the Panter Syndicate and SRRF, but he did not know of anyone other than Phoenix, American Reliable and Mr Billyard who might have written SD's LMX business, but he considered that such reinsurance could have been placed with them through other brokers.
783. However, six days later, Mr Henton asked WFD to place a lower layer on the basis that the commission was split with SCB.
784. On Monday 3 February 1997, Mr Henton had an initial discussion with Mr Davis of WFD; this was recorded in a note made by WFD. Mr Henton's evidence was that he telephoned WFD and asked them to place or quote for the layer $50,000 xs $10,000 shortly after he became aware that the retention by SD was $60,000; this was done without speaking to Mr Broad; Mr Whitcombe was to discuss that on Friday 7 February 1997 at dinner with Mr Broad (see paragraph 813). Mr Henton gave Mr Davis the basic information and discussed the split of brokerage with SCB and gave instructions for the placing of the layer $50,000 xs $10,000. Mr Johnson said that he was told that EIU had the use of SD's existing programme xs $60,000 and had wanted a layer below that. The information provided by Mr Henton was set out in an information sheet which recorded that the premium income was to be £5m written and £3m signed.
785. When it was suggested to Mr Henton (when being cross-examined on behalf of SCB) that SCB were unaware of the split in commission at this stage, he accepted that that might be so. It was also SCB's case that they were unaware of any problem with reinsurance until 25 March 1997. There was no evidence as to why Mr Henton proposed the split of commission or as to why WFD agreed. This is a remarkable feature as brokers do not normally give away commission. It was suggested by SCB that it was agreed they should receive it because they had placed such a large amount of inwards business.
786. This conversation between Mr Henton and Mr Davis took place after programmes had been provisionally accepted on 27 and 28 January 1997 but before any confirmations had been given. This is significant as Mr Henton must have known that to confirm the reinsurance of Mr Billyard would have left him with significant losses if there was no reinsurance below $60,000 (though it was in fact $50,000). His evidence was that he could not recall what he was told by WFD about the prospects of obtaining reinsurance, but he could not recall being told of any difficulty. I am sure, in the light of Mr Johnson's evidence about the market, that he would not have been told that it could be placed easily.
787. What then happened is set out at paragraph 832.

(g) Agreement on the confirmation procedure on 5 February 1997

788. On 5 February 1997, prior to the confirmations being given, the form of stamp impression for subscription to the slip was agreed and was shown to Mr Broad as:

"Accepted under contract No 50413 per Sphere Drake Insurance Co subject to written confirmation."

At the same time, a document was agreed which was to be used as the format for the confirmation of acceptance.

789. Mr Henton's evidence was that the idea of the confirmation came from HHI so that the risk could be run past Mr Whitcombe, as they knew Mr Henton was doing the underwriting. Mr Whitcombe's evidence was that Mr Broad had wanted this two stage acceptance procedure as Mr Henton would be doing the underwriting.
790. Mr Broad rejected this as incredible; if Mr Henton was to be the underwriter, then he should have been added to the slip as the underwriter. Mr Broad's evidence was that it was shown to him as a courtesy, but he was not interested in how Mr Whitcombe gave his confirmation.
791. Each slip for contracts written under the binder was stamped with the agreed stamp and was initialled by Mr Henton using Mr Whitcombe's initials.

(h) Mr Whitcombe's role in confirming the risks

792. After the first four programmes had been written, Mr Henton then telephoned Mr Whitcombe to ask him to approve what had been done. The programmes were confirmed by Mr Whitcombe on dates between 6 February 1997 (the WFD contract) and 19 February 1997. The delay in confirmation was said by Mr Whitcombe to be due to the fact that he and Mr Henton were unable to get together.
793. As they had no permanent office, Mr Henton's evidence was that he would have explained these contracts to Mr Whitcombe over lunch at The Mail Coach, a wine bar about five minutes' walk from Eastgate's offices. Mr Whitcombe's evidence was that he thought that the discussion had been at a bar or at The Captains' Room at Lloyd's, though as they had piles of papers, it was unlikely to be at a bar.
794. Mr Whitcombe's evidence was that they would have spent 1–1½ hours doing this. He knew that minimal information was all that was provided. Mr Henton showed him the placing information on the first five risks as he carried those around with him. Mr Henton would have then explained the risk to Mr Whitcombe and would have chatted to him about them; according to Mr Henton, Mr Whitcombe understood that the underwriting was on a net basis. Mr Henton clarified that this was the position with the exception of Programme 5 where Mr Henton had reasonably expected to make a gross profit.
795. Mr Whitcombe could not recall what he was shown by Mr Henton when asked to approve a contract; he could only imagine that it was what Mr Henton had kept. It was likely that he was shown the slips, but he could not be sure about that or whether he had seen the other placing information. Mr Henton would explain the business and tell him what the story was and he would say fine; he did not look at the placing information as it would not have meant much to him at that time. His recollection was that he was told that the first few contracts were likely to go into a gross loss position.
796. Taking into account Mr Whitcombe's evidence as a whole, I do not consider that he ever properly understood the business that Mr Henton was accepting. He essentially left the business to Mr Henton and his confirmation was purely nominal as he was not in a position to make any assessment of the individual contracts.

(i) The way the confirmation procedure was carried out subsequently

797. The procedure by which Mr Whitcombe gave the confirmation continued until the end of 1997; when they obtained their own premises in March 1997, the procedure was not changed. Even when Mr Henton became the named underwriter, the procedure remained essentially unchanged, though they then did not discuss each risk, Mr Henton just "got on with it".
798. It was Mr Whitcombe's evidence that, in 1998, he signed a whole number of confirmation sheets in blank in order to save time; it was possible that the confirmation sheet for Programme 3 was one which he had signed in blank.
799. As set out at paragraph 791, Mr Whitcombe confirmed two of the layers on the American Reliable programme (Programme 3) which was placed by WFD on 6 February 1997. He accepted that he probably knew of the SCB layers by then and that he knew of the problem in relation to a leader on the bottom layer of the American Reliable programme. Mr Whitcombe did not tell Mr Broad about these – getting any sort of business sense out of Mr Broad was, at times, "rather hard going". It is necessary to explain that problem in more detail.

(3) The need for a leader on American Reliable

(a) The problem

800. As set out at paragraph 745, no one had been prepared to write:

i) the lowest layer of American Reliable's reinsurance; and

ii) any part of the programme for Phoenix.

801. As mentioned at paragraph 761 on 27 January 1997, Mr Henton had been asked to write the bottom layer of the American Reliable programme by Mr Butler and he had wanted to write the entirety by taking 100% of the layer. However, he could not do so under the terms of the leader clause on the slip without the prior approval of Mr Broad; matters were left with Mr Butler on the basis that EIU would seek prior approval from SD. The evidence was that Phoenix was not mentioned.

(b) The allegation of a discussion with Mr Smith

802. Mr Henton discussed about obtaining SD's approval with Mr Whitcombe later that day. It was Mr Whitcombe's evidence that he knew that EIU could not write a 100% line; Mr Whitcombe could not recall any discussions about accepting 100% lines for the American Reliable and Phoenix programmes; he knew that they could not.
803. Mr Henton's evidence was that he also saw Mr Smith about the American Reliable programme; his was evidence that he saw Mr Smith at the meeting with Mr Whitcombe and he gave Mr Smith a spare copy of the placing information so that it could be taken to Mr Broad; Mr Smith advised that it was too early in the operation of the binder to seek the approval of Mr Broad and he suggested that they find a leader. They discussed the size of the line that a leader needed to have and agreed that EIU could write a much larger line than the leader who could take a small line. He recalled Mr Smith looking at the placing information, but he did not make any comment on it and he probably gave it back. However, it was Mr Henton's evidence that Mr Smith could see from the figures that it was gross loss making business.
804. Mr Whitcombe's evidence was that he was not present when Mr Henton saw Mr Smith; he learnt from Mr Henton that Mr Smith had suggested going to the brokers and asking them to get someone else to lead it.
805. A decision not to go and seek the approval of Mr Broad was made on 28/29 January 1997. Mr Henton's evidence was that he then told Mr Butler that he could not write the risk without a leader, but he did not speak to Mr Butler again until 7 March 1997 when a leader had been found. Mr Butler knew, as he had seen the cover note for the binder, that a leader was required. Mr Brown's evidence was that if he had been asked to see Mr Broad he would have done so, but it was Mr Henton's decision not to go.
806. Mr Whitcombe thought that if the layer for the American Reliable programme was led, it was within the spirit of the binder for EIU to write 90% and kick the programme off:

"To me in Lloyd's one really did not write 100% of a risk. I mean I did not. It was not, if you like, done. But obviously on this side of the fence it seemed to be a fairly common activity."

Mr Whitcombe accepted that outside the market for the writing of WC carveout business, a following line would ordinarily be less than the leader's; it was unusual outside this market to write a lead line that was so much smaller than the next participant's.

807. Mr Whitcombe had great difficulty in maintaining, during his cross-examination, that seeking a leader in the way proposed complied with the provision of the slip for recognised market leads. Mr Whitcombe agreed that they should have gone to Mr Broad and got a special acceptance, but he said that Mr Broad might only have written this if there had been a "jolly good broking story".
808. There was no suggestion of a subsequent discussion with Mr Smith about the leader's line. However, what lines were subsequently written by EIU could be seen by reading bordereaux which were provided to HHI and SD; nevertheless, what was much more important was the fact that it was not possible to tell from the bordereaux, the circumstances in which the large line was written by EIU.
809. Before describing those circumstances (see paragraph 818), it is necessary to refer to the way in which information was provided to SD and, in particular, to a meeting over a pub meal on 7 February 1997.

(4) The information provided to SD in February 1997

(a) The general nature of the way in which dealings were done

810. After the conclusion of the binding authority, there was some communication in writing between SD and EIU; all of that (with one or two possible exceptions, such as the request made by Mr Whitcombe in early 1998 to help with obtaining a binder relating to D&O business) passed through Mr Smith. It was Mr Broad's evidence that not everything was passed on to him, even though Mr Smith was, as far as Mr Broad was concerned, the only person he dealt with at HHI. Mr Broad had met Mr McCarthy of HHI just once for an informal lunch and on two other occasions, and it was not his impression that Mr McCarthy was closely involved.
811. Mr Whitcombe said that he had no reason to believe that Mr Smith was not keeping Mr Broad properly informed; he did not think that Mr Smith would hide anything, though he was "off the wall" occasionally.
812. There were also meetings between Mr Broad and Mr Whitcombe. It was Mr Broad's evidence that he never met Mr Whitcombe without HHI, save when they had run into each other at Balls Brothers at the London Underwriting Centre. Mr Whitcombe's evidence was that if he could find Mr Broad in his office, Mr Broad would tell him that they would meet downstairs, meaning Balls Brothers; he preferred to meet there and not in his office. Mr Whitcombe did not know why – he assumed that Mr Broad liked a drink. This conflict is not of importance as it was not in dispute that Mr Smith was present at all the important meetings.
813. However, contact between EIU and HHI was more frequent. Mr Henton's evidence was that he saw Mr Smith and Mr McCarthy regularly as they came to EIU's office two or three times a week.

(b) The meal at the pub at Tadworth on 7 February 1997

814. Mr Broad met Mr Whitcombe and Mr Smith for a meal at a pub at Tadworth near Mr Broad's home on 7 February 1997. Mr Broad's evidence was that Mr Smith had suggested a meeting as Mr Whitcombe was staying with Mr Smith overnight and the pub at Tadworth was also near to Mr Smith's home. There was a second meeting at the pub on 21 March 1997. In his evidence, Mr Broad could not clearly distinguish what had happened at each of the two evenings.
815. There is a serious conflict of evidence as to what had happened. Mr Broad's evidence was that:

i) The evening was, according to Mr Broad, a social occasion and they did not discuss the binder, though he later accepted that it had cropped up.

ii) Mr Broad was told by Mr Whitcombe the binder was going well; Mr Broad told him that he wanted a low key approach and a discussion on an increase in the premium income may have come up.

iii) He was assured by Mr Whitcombe that the business was good contract business; he recalled this. He considered the distinction between contracts and treaties important for if a treaty account had been proposed, the broker would have been sent to the treaty division.

iv) Mr Broad accepted that there was a discussion about a bottom layer of reinsurance. He was not sure whether this was discussed on this occasion or over the subsequent meal on 21 March 1997. At one of the two meetings, a decision was made that a layer for $50,000 xs $10,000 should be obtained. At first he did not feel he wanted it, but they kept on pressing and he did not object to the low layer $50,000 xs $10,000; he gave instructions for it to be placed.

816. Mr Whitcombe's evidence was that:

i) It was an occasion for business and although largely social, it was not purely social. He thought that the occasion lasted between 3-3½ hours.

ii) He was sure that there had been a discussion about the business accepted under the binder – he would have described the type of business and the premium income. It was at that meeting that he told Mr Broad that it was WC carveout business and the words "WCA carveout" were used.

iii) There was a discussion about reinsurance; he wanted to know the retention and the extent of SD's coverage. Mr Broad had promised the cover notes, but they were slow in coming.

iv) He told Mr Broad that "net profit was the name of the game", that the business was "very volatile at the lowest layers" and that was why a lower layer of reinsurance was needed at $50,000 xs $10,000. He accepted that in saying this he was not telling Mr Broad that they were deliberately writing gross loss making business on the backs of reinsurers, nor was he giving Mr Broad a true idea of the type of account being written.

v) He also told Mr Broad of Mr Henton's involvement, though his evidence was that Mr Smith had told Mr Broad earlier.

vi) Net accounting was agreed.

vii) He learnt at that meeting that Mr Broad was a facultative underwriter, but that Mr Broad had always maintained that binders were his responsibility.

viii) He told Mr Broad that Mr Downey was no longer part of EIU – see paragraph 655.

817. I will set out my conclusions later as to what Mr Broad was told as to the nature of the business, but it is highly probable that it was on that occasion that the instruction to place the bottom layer was given.

(c) No information provided about the leader problem

818. Mr Whitcombe knew by 7 February 1997 of the problem in finding a leader for the bottom layer of the reinsurance of American Reliable, but he did not tell Mr Broad (see paragraph 798 above). Indeed when Mr Broad was asked on 5 February 1997 to amend the slip to provide for the form of acceptance (see paragraph 787), no mention was made to him of the wish to write a 100% line or of the need to find a leader.

(5) The deal in relation to American Reliable and Phoenix

(a) The problem faced by Phoenix

819. As set out at paragraph 804, Mr Butler knew that a leader was needed for the reinsurance of American Reliable, but his evidence was that he could not recall who had come up with the solution. This solution would have to apply to Phoenix as well if EIU were to be asked to write their reinsurance too.
820. The circumstances in which a "leader" for American Reliable's reinsurance was found were as follows.
821. Phoenix had given instructions to SCB on 24 December 1996 to renew their cover as expiring; this had been canvassed earlier, probably at the Self-Insurance Institute of America conference in October 1996. The reinsurers in the previous year had been Lincoln National, Mr Billyard and American Reliable. However, as set out at paragraph 745.iv), there was no one to write it. Lincoln National had withdrawn. Mr Butler's evidence was that Mr Billyard was reducing his capacity and they did not have reinsurers available to cover Phoenix. American Reliable were not going to write retro for the reasons set out at paragraph 745.iii).
822. After Mr Henton had offered to write the bottom layer of American Reliable's programme on 27 January 1997, Mr Butler faxed Mr Swanick on 31 January 1997 stating that they could not place cover for Phoenix; they had not got the placing information until the beginning of the year and that put SCB in a bad starting position in the market that had a shortage of capacity for 1997; many of the existing primary reinsurers of Phoenix had either withdrawn from retro underwritings of cedants protecting London market business or had utilised their capacity. They were trying to find new reinsurers. As Mr Henton accepted, this showed how valuable EIU were to SCB.
823. Nothing happened in attempts to find a "leader" for the bottom layer of American Reliable's reinsurance or to find reinsurance for Phoenix until sometime in February 1997.

(b) The discussion between Mr Brown and Mr Johnson

824. During the week of 3 February 1997, Mr Brown, Ms Alex Barnes (Mr Brown's assistant) and Mr Butler were in the US and had visited Lincoln National; Mr Brown could not recall a discussion with Mr Butler about Phoenix and American Reliable. After the visit, Mr Butler went on holiday.
825. In addition to the problem in relation to American Reliable, Phoenix continued to be concerned about their lack of reinsurance. On 13 February 1997, Mr Swanick wrote to Mr Brown stating that Mr Huey had understood from Mr Butler in October 1996 that Phoenix's programme for its LMX business would be placed for 1997; although Mr Butler had said that it might be more expensive, he did not say that there would be a problem. Placing a reinsurance programme was a top priority for Phoenix.
826. By 25 February 1997 a solution was found for both American Reliable and Phoenix; it is clear from a letter of that date that the solution was arrived at following a discussion between Mr Johnson and Mr Brown as the letter contains a reference to a discussion. The evidence was:

i) It was Mr Johnson's evidence that on about 6 February 1997, he was told by Mr Butler that he was thinking of placing the bottom layer of American Reliable's reinsurance with SD; then or shortly thereafter, Mr Butler may have mentioned that EIU could not lead risks. He (Mr Johnson) was then told that a lead line was needed. SCB mentioned also that Mr Henton was keen to write the protections of Phoenix. Towards the end of February 1997, either Mr Brown or Mr Butler came up with the solution that Phoenix would write a 10% lead line on American Reliable's bottom layer and that in return American Reliable would write lines on the primary $2m of Phoenix's reinsurance.

ii) Mr Brown's evidence was that he had no recollection of the conversation with Mr Johnson and was unsure if it was he who had that conversation with Mr Johnson; it was not of any relevance. There was no discussion of a quid pro quo even though WFD had asked SCB to place American Reliable's reinsurance.

iii) Mr Butler could not recall how this came about.

827. I am sure that a deal was agreed between Mr Johnson, Mr Brown and Mr Butler, under which they would seek to procure an agreement between Phoenix, American Reliable and EIU, under which Phoenix and American Reliable would each write 10% lines on each other's programmes and Mr Henton would then write the balance under the binder.
828. Evidence was given by Mr Johnson that there was a further aspect of the deal – EIU would, in return, get a line on the reinsurance xs $10,000 from American Reliable. EIU had asked WFD to place such a layer on 3 February 1997 (see further paragraph 832). This evidence emerged when Mr Johnson gave his evidence and was never put to Mr Henton, Mr Brown or Mr Butler. No allegation was made against EIU or SCB in respect of this. EIU and SCB denied that they knew of it.

(c) The deal

829. The deal had at least three parts and was carried into effect.
830. The first part was the reinsurance of Phoenix by American Reliable:

i) On 25 February 1997, Mr Brown wrote to Mr Johnson following the discussion to which I have referred, asking him if Mr Durling would quote for four layers of reinsurance each of $500,000 for Phoenix for 12 months at 1 January 1997 on an LOD basis. The letter stated that the underwriting information would be provided when Mr Butler returned, but that the account had changed dramatically since Phoenix first started writing LMX business and that the majority of business written in 1997 had been of direct writers; very little retrocessional business had been written. The estimated premium income would be $5m. The letter did not state that Phoenix had written the retrocession of Mr Billyard.

ii) Mr Johnson saw Mr Durling that day and obtained a quote for the reinsurance of Phoenix for the four layers, with the bottom layer being $480,000 xs $20,000 at a rate of 15%; he sent the quote to SCB on 26 February 1997. The letter setting out the quote concluded:

"The American Reliable will write between 5% and 15% of the above and have stressed that they would not normally write this type of reinsurance, but have quoted purely in consideration of who the Client is."

iii) This made it plain, as was Mr Johnson's evidence, that the quote was intended as a reciprocal trade. Mr Brown's evidence was that he did not know what Mr Durling meant; he was sure that Mr Durling had reasons for thinking that way.

iv) Mr Johnson's evidence was that although Mr Durling did not have the claims statistics, that might not have mattered as the account had changed dramatically and information was given about the premium income and the line size. American Reliable could take a view on the loss experience because, as American Reliable had participated on Phoenix's reinsurance on the higher layers in earlier years, they would have had the claims information and American Reliable wrote a similar account on the higher layers.

v) On 28 February 1997, Mr Butler sent the quote and information that was given by Mr Durling of TLA to Mr Huey of Phoenix; the letter concluded:

"With regards to the American Reliable Quotations above, as we discussed we effectively had to trade some dollars in order to get these quotations and I have attached the layer we discussed that you would lead for them. As mentioned, if you could write a 10% lead line, we can finish the layer behind you. The above quotes are obviously subject to us obtaining your agreement to write this layer."

Mr Johnson accepted that this described the position accurately. Mr Brown's evidence, however, was that he did not know what dollars had to be traded; although he had done the deal with WFD, he was not necessarily aware that there was going to be a dollar trade at that time; he was not saying he did not know, but he could not now say that he did.

vi) Mr Butler's evidence was that he might not have mentioned Phoenix to Mr Henton, but he said that he was always confident of finishing a risk. It did not show that Mr Henton would do what was wanted.

vii) On 4 March 1997, Mr Huey replied to Mr Butler; he attached data (which he said had been sent on 24 December 1996) which had mentioned a premium of $7.5m and a "normal underwriting programme maximum of $3m". He had also wanted to see American Reliable's "as if" figures and the information sheet of 14 October 1996. He said that if the premium estimate and the underwriting maximum were acceptable to the reinsurers, then the terms of the quote by American Reliable for the reinsurance of Phoenix were acceptable to Phoenix.

viii) On 5 March 1997, Mr Davis of WFD provided a revised quote from American Reliable; it was identical to the one of 26 February 1997 save that the M&D premiums were specified at 90% and the premium income estimate and maximum underwriting lines wanted by Phoenix were revised. Mr Butler then informed Phoenix that American Reliable had maintained their quote with the new figures.

ix) On 7 March 1997, Mr Butler sent to WFD, the slips reinsuring Phoenix for American Reliable's acceptance.

831. The second part of the deal was the reinsurance of American Reliable by Phoenix:

i) As set out at paragraph 829.v) above, on 28 February 1997, Phoenix had been sent the slip for American Reliable's bottom layer and had been asked to write a line of 10%; on 4 March 1997, Phoenix asked for American Reliable's figures.

ii) On 5 March 1997, Mr Butler sent American Reliable's information sheet and loss figures to Phoenix and asked them to sign and return the American Reliable slip for the bottom layer of American Reliable's reinsurance.

iii) The deal was then concluded by an exchange of slips.

iv) Phoenix were insistent when returning the slip on 19 March 1997:

"I am pleased to fax a signed slip for our 10% share of the American Reliable $490,000 xs $10,000 layer. As discussed with Glenn Swanick and noted in your fax of yesterday, please do not release the slip or a copy to American Reliable and please do not advise them that we are providing this cover until we are in an equivalent position, that is until, signed slip and signed cover notes for 100% of the four primary layers (to $2,000,0000) of our outwards reinsurance program as we have been discussing are in your possession and are being forwarded to us.

In consideration of your placing this Phoenix's outward reinsurance program as we have been discussing, we agree to write 10% of the American Reliable $490,000 xs $10,000 layer described in your fax of February 28, and as noted above are forwarding a slip for it."

v) I did not hear evidence from the underwriter at Phoenix, but it was obvious that he only did so because of the promise of the reinsurance he would get in return. He had earlier rejected the lower layer on its merits – see paragraph 745.iii)e).

832. The third part of the deal was the reinsurance of Phoenix and American Reliable by Mr Henton:

i) On 7 March 1997, Mr Henton went to see Mr Butler; the purpose of the meeting was to sort out the American Reliable layer and to get a leader for it. The meeting lasted about ½ hour.

ii) The evidence given by Mr Brown and Mr Butler was that Mr Henton was asked to write a reinsurance of Phoenix and that he was told of the arrangement that had been made between Phoenix and American Reliable. It was Mr Henton's evidence that he did not know of the arrangement before, but he may have. Mr Butler's evidence was that Mr Henton may not have known of Phoenix before this. He would have explained the position to Mr Henton and it would have been for Mr Henton to decide whether to write any lines.

iii) Mr Henton's evidence was that although he could have written one of the programmes without the other, he knew that the deal between American Reliable and Phoenix would have fallen apart. But the question did not arise as he was happy to write both.

iv) He subscribed to the programme for Phoenix for 90% on the reinsurance on which American Reliable had written 10%. He endorsed the slip "Following lead line from American Reliable". As set out in paragraph 105 of Part II, Mr Henton had expected the line to sign down, but it did not.

v) He subscribed to the lowest layer of American Reliable for 90% on the reinsurance on which Phoenix had written 10%. He endorsed the slip "Following 10 per cent lead line from Phoenix Home Life" (see paragraphs 75 and following of Part II for the underwriting information supplied).

833. On Mr Johnson's evidence given for the first time in cross-examination, there may have been another part of the deal – the agreement by American Reliable to reinsure SD. Although I will outline what his evidence was, no case was made by SD against EIU on this and I will therefore make no finding on it nor treat it as part of the deal. Indeed the evidence given by EIU and SCB was that SCB did not know of any lack of reinsurance until 25 March 1997.

i) As set out at paragraph 783, on 3 February 1997, Mr Henton had asked WFD to get a quote for reinsurance to reduce the retention to $10,000 by buying a layer $50,000 excess $10,000.

ii) It was on 25 February 1997 that Mr Durling quoted or gave an indication for a line of 20% on the layer. Mr Johnson said that it may or may not have been the same day as that when Mr Durling agreed to write the Phoenix programme (see paragraph 825).

iii) Mr Johnson said that this was part of the arrangement under which SD had agreed to reinsure American Reliable; it was a line of $10,000 which was done as a "capacity swap".

iv) He was sure that he would have broked it to Mr Durling on the basis that it was to be a reciprocal deal, though very little was being given to SD.

(d) The confirmation by Mr Whitcombe

834. Mr Whitcombe's evidence was that he was not aware that Phoenix was writing 10% of American Reliable and vice versa. He could now see that there was a "capacity swap"; he doubted that he had picked that up at the time, though he might have done. He was quite content for it to happen; it was reciprocity between reinsurers and that was common. He thought at the time that there was some commonality of exposure between American Reliable and Phoenix and although he could not recall discussing it with Mr Henton, he assumed that Mr Henton had picked it up. Mr Whitcombe confirmed the bottom layer on the American Reliable programme and the contracts for Phoenix on 7 March 1997.

(6) Conclusion

(a) Overall amount of business written to SCB

835. The gross premium income for these five programmes (calculated on the basis of the estimated premium income shown on the slips) was $4.9m; this exceeded the limit in the slip of £2m. Mr Whitcombe said that these programmes were accepted on the understanding from Mr Broad that there was no problem with premium income. Mr Henton's evidence was that HHI knew this and Mr Broad had assured them that income was not a problem; they expected the Phoenix risk to sign down and that would have brought the income down. As set out at paragraph 923, they obtained an increase in premium income to £3.5m on 14 March 1997.
836. The fee earned by EIU on the fully adjusted premium for the first five programmes (including the Phoenix programme) was $978,000.
837. The fact that so much was written to SCB was characteristic of the way in which the binder was operated throughout its duration. Between the granting of the binder in January 1997 and October 1998, 119 contracts of reinsurance were accepted under the binding authority from the following brokers:

i) SCB 112 contracts

ii) WFD 4 contracts

iii) MRM Hancock 2 contracts

iv) HHI 1 contract

838. The contracts written to SCB can be grouped into 35 programmes which were written in the following periods:

i) January-March 1997: 5 programmes

ii) October 1997: 1 programme

iii) Christmas Eve 1997: 12 programmes

iv) New Year's Eve 1997: 5 programmes

v) 1998: 12 programmes

(b) The funnel of losses to SD

839. The effect of the first three programmes (as matters stood after 7 March 1997) was that there was a funnel which ended up by concentrating or funnelling the losses above the combined retention of JEH Re, American Reliable and Phoenix (that is, a combined retention of $40,000) into SD (as set out in Chart 1 produced by Mr Hunt).
840. Mr Hunt had begun his career in insurance at Lloyd's in 1967 when he worked as an assistant to the underwriters at Syndicate 440/47; from 1973 to 1984 he worked in the company market before returning to Lloyd's in 1984. In 1990 he retuned to the company market and in 1995 set up his own firm, an investigations consultancy. In his time at Lloyd's and in the company market he had had extensive underwriting experience, including experience of North American and LMX business. He was a careful and competent witness who greatly assisted the Court with the work he had done which illustrated the way the reinsurance operated. The diagram annexed as Chart 1 shows the position as it was when the first five programmes were written.
841. This was not the same type of arrangement as the spiral that had existed in 1993-6, but the intention and effect (set out at paragraphs 535 and 536) was similar in that it passed the losses away from American Reliable, Phoenix and Mr Billyard. The following four examples, which have been taken from Mr Hunt's report, illustrate the point:

i) Assuming an inwards loss of $50,000 to Phoenix.

a) Phoenix would have retained the first $20,000 and would have sought recovery of the next $30,000 under the first layer of their outwards programme (the layer $480,000 xs $20,000).

b) 90% of the first layer of Phoenix's outwards programme was placed with SD and 10% was placed with American Reliable. Thus the loss to SD would have been $27,000 and the loss to American Reliable would have been $3,000.

c) SD would therefore have had to retain as unreinsured, the entirety of the $27,000 loss to them from Phoenix.

d) American Reliable would have had to retain the first $10,000 of loss to them before they could have recovered from reinsurers under their outwards programme (the layer $490,000 xs $10,000). American Reliable would thus have had to retain all of the $3,000 loss to them from Phoenix.

e) Conclusion: The net effect of the spiralling of a $50,000 inwards loss to Phoenix would have been that Phoenix would have retained $20,000, American Reliable would have retained $3,000 and the unreinsured SD would have retained $27,000.

ii) Assuming an inwards loss of $50,000 to American Reliable.

a) American Reliable would have retained the first $10,000 and would have sought recovery of the next $40,000 under the first layer of their outwards programme (the layer $490,000 xs $10,000).

b) 90% of the first layer of American Reliable's outwards programme was placed with SD and 10% was placed with Phoenix. Thus the loss to SD would have been $36,000 and the loss to Phoenix would have been $4,000.

c) SD would therefore have had to retain as unreinsured, the entirety of the $36,000 loss to them from American Reliable.

d) Phoenix would have had to retain the first $20,000 of loss to them before they could have recovered from reinsurers under the first layer of their outwards programme (the layer $480,000 xs $20,000). Phoenix would thus have had to retain all of the $4,000 loss to them from American Reliable.

e) Conclusion: The net effect of the spiralling would have been that American Reliable would have retained $10,000, Phoenix would have retained $4,000 and the unreinsured SD would have retained $36,000.

iii) Assuming an inwards loss of $100,000 to any of the four.

It is not necessary to set out a detailed explanation, but the effect can be summarised in the following table prepared by Mr Hunt:

"Assumption: $100,000 inwards loss, loss falling between 1 January and 31 March 1997

if the $100,000 then through the spiralling process it is eventually inwards loss retained by… started as a loss to.. SD John Hancock Phoenix Am Reliable

1. SD 100,000

2. J Hancock 60,000 10,000 20,000 10,000

3. Phoenix 72,000 20,000 8,000

4. Am Reliable 81,000 9,000 10,000"

iv) Assuming an inwards loss of $500,000 to any of the four.

It is not necessary to set out a detailed explanation, but the effect can be summarised in the following table prepared by Mr Hunt:

"Assumption: $500,000 inwards loss, loss falling between 1 January and 31 March 1997

if the $500,000 then through the spiralling process it is eventually inwards loss retained by… started as a loss to.. SD John Hancock Phoenix Am Reliable RGA

1. SD 500,000

2. Hancock 460,000 10,000 20,000 10,000

3. Phoenix 470,000 20,000 10,000

4. Am Reliable 469,405 20,000 10,000 595"

842. I am sure that SCB must have understood that the broad effect of the agreements that had been made was to funnel the losses to SD in broadly the manner described by Mr Hunt and that Mr Henton would have appreciated that he was making SD a funnel for the losses. If Mr Whitcombe had thought about that or had tried to understand the business he was confirming at that time, he would have understood that he was making SD the funnel for the losses as no other conclusion was possible.
843. It was submitted that the concentration would have been dissipated through the operation of SD's reinsurance. However, very significant gross losses must have been anticipated which, in the result, have been in the order of $100m; it would obviously be essential that SD and their reinsurers understood the nature of the business being written and had agreed that it be written and be reinsured by them. I have set out at paragraphs 719 and following, my conclusion that EIU had not told SD of the nature of the business being written and I set out below at paragraphs 879 and following, my conclusion on the knowledge of SCB.
844. When, as set out at paragraph 985 below, SD obtained the full placement of the layer $50,000 xs $10,000 with American Reliable, the net effect was not materially different. Mr Hunt's evidence to that effect was not seriously disputed and I accept it; it is set out in diagrammatic form in Chart 2. The position was not materially different as the placement was with a spiral participant, American Reliable, and there was therefore no leakage from the spiral and the greater part of the loss still came back to SD; it altered the route of the spiral and the distribution of the loss; this can be further illustrated by a table produced by Mr Hunt showing what happened if there was an inwards loss of $100,000:

"Assumption: $100,000 inwards loss, loss falling between 1 January and 30 June 1997

if the $100,000 then through the spiralling process it is eventually inwards loss retained by… started as a loss to.. [SD] John Hancock Phoenix Am Reliable

1. SD 86,000 4,000 10,000

2. John Hancock 60,000 10,000 20,000 10,000

3. Phoenix 70,000 20,000 10,000

4. Am Reliable 76,000 14,000 10,000"

(c) The effect on the business that could be written by the participants

845. On the evidence before me, it was clear that with the reinsurance in place, Mr Durling was in a position to accept retro and spiral business – see the evidence of Mr Johnson at paragraphs 75 ii) c) and 76 v) of Part II. This was illustrated by the specific occupational accident protections of Mr Billyard's direct account that were written by Gan and American Reliable and which caused a very significant part of the loss of $71m on Programme 3.
846. To understand how this came about it is necessary first to refer to the specific occupational accident protection of the Lincoln National account which was written under the Big Ben facility (what was referred to as Programme 4b) – see Diagram 4b (see paragraph 1.ii) of Part II) that is annexed to this judgment:

i) WFD had placed with Gan, a specific occupational accident reinsurance of Lincoln National's account which was written under the Big Ben facility for $45,000 xs $25,000 with 29 reinstatements (with a cover note dated 28 January 1997); a backup to this, with unlimited reinstatements, was placed with American Reliable on 16 January 1997.

ii) A layer above this was needed – $180,000 xs $70,000. There is a document dated 27 January 1997 which clearly indicated that Mr Henton quoted on that day, a rate of 1.33% and had offered to write 100% of the layer; the rate was the same as that for which Mr Billyard had written the contract for 1996. Mr Henton's evidence, after he had seen the quote, was that it was his intention to put this contract to Mr Broad, but that he did not do so after Mr Smith had advised him that a recognised leader should be found. However, the only other subscriber was Mr Billyard and the evidence makes clear that he was not offered this contract until 20 March 1997 and Mr Billyard did not accept it until 21 March 1997 (see also the fax of 17 February 1997 referred to at paragraphs 846.ii) and 846.iii)). Nonetheless there was a confirmation sheet dated 12 February 1997 showing that EIU had accepted 50% of the contract; if that document bore the correct date, then there was no leader at that time. Mr Henton's evidence was that he must have been told that he "was or would be following a recognised leader". If he was told that there was a leader, that would have been a lie; if he was told that there would be a leader, Mr Henton had no authority to write the business as SCB must have known. Mr Butler's evidence was that he would have expected Mr Billyard to write the contract as he had written it 100% in the preceding year. However, unless Mr Billyard would do SCB's bidding, Mr Butler cannot have known whether Mr Billyard would renew on the same terms as the previous year or for how much. I am sure that Mr Butler knew that acquiring a subscription in these circumstances was the clearest breach of the leader clause in the slip, but he was nevertheless prepared to go ahead.

iii) There is another point. The copy of the slip in SCB's file showed on a page, the two subscriptions from Mr Billyard (50%) and EIU (50%) which are undated, and on a separate page, the confirmation from EIU bearing the date of 12 February 1997 (to which I have referred). The date of the subscription of Mr Billyard was not shown, though "leader" was written against Mr Billyard's subscription. No one looking at the slip could have told that the subscription of EIU had been given at a date when there was no "leader"; in fact, SCB knew that Mr Billyard was not the leader as there was already a committed contract by EIU before he was approached. This was a dishonest document. EIU's copy of the slip was for 1996 and their file did not contain a copy of the subscription, only of the confirmation.

iv) There was no loss so far recorded by American Reliable on their backup layer to Gan, but as at March 1998, the incurred loss on the layer written by Mr Henton was $328,891. As is set out at paragraph 1038, Lincoln National has avoided many of the programmes on which it participated; it appears that very few claims have therefore been processed and it is therefore not surprising that no losses have so far been recorded by American Reliable.

847. It was this programme for Lincoln National that formed the background to the placing of a specific reinsurance programme for Mr Billyard's occupational accident writings. The programme as placed is set out in Diagram A (see paragraph 1.ii) of Part II) and the programme was placed in the following circumstances:

i) On 11 February 1997, details of this specific reinsurance of Lincoln National were sent to Mr Brown in Bermuda for him to discuss with Mr Billyard.

ii) On 17 February 1997, Ms Barnes, who was in London, sent a fax to Mr Billyard, describing the three layers of the programme that "Alan Bird has purchased"; it gave a rate of 4.5%-5% as the cost of the layers providing cover up to $250,000 xs $25,000. This document makes it very clear that Mr Billyard could not have subscribed to the third layer of the specific occupational accident reinsurance of Lincoln National at that time as it would otherwise have been unnecessary to describe the programme to him.

iii) It was suggested in Ms Barnes's fax of 17 February 1997 that Mr Billyard purchase coverage up to $500,000; this would have the benefit of introducing new reinsurers who did not participate on Mr Billyard's general covers. Ms Barnes was clearly suggesting that the specific contracts would remove the losses on occupational accident business at these lower levels from Mr Billyard's generals programme for his direct business placed in October 1996 and led by Lincoln National. Ms Barnes went on to say that SCB would use the information and income for the direct account; they would try for an inception date matching the generals or, if not, for 1 January 1997.

iv) Mr Billyard must have agreed with this suggestion because on 25 February 1997, the same day as that when Mr Durling gave the quote for Phoenix's reinsurance (see paragraph 829.ii)) and the indication for a 20% line on the layer $50,000 xs $10,000 of SD's outwards reinsurance programme (referred to at paragraph 832.ii), Mr Durling provided quotations for a backup layer for $180,000 xs $70,000 and for a layer $250,000 xs $250,000.

v) On 27 February 1997, Ms Barnes sent to Mr Billyard, what she described as indications provided by WFD; no copy of the enclosed indications were available but what was enclosed must have been the quotes from Mr Durling and the quotes from Gan for the rest of the programme.

vi) On 7 March 1997, in the same letter as that in which Mr Butler sent the slips reinsuring Phoenix to WFD in order to get American Reliable's subscription put onto the slips (see paragraph 829.ix)), Mr Butler asked WFD to ask Gan to trim the rates and to reduce the M&D premiums.

vii) Gan clearly agreed and on 18 March 1997, revised quotes were sent to Mr Billyard and an order was given to WFD that day, though Mr Billyard's written confirmation of the order did not follow until 19 March 1997.

viii) On 18 March 1997, Gan signed slips with limited reinstatements for:

a) the layer $45,000 xs $25,000; and

b) the layer $180,000 xs $70,000.

ix) On 21 March 1997, as set out above, Mr Billyard subscribed to the higher layer of the specific protection of the occupational accident account of Lincoln (Programme 4b) (see paragraph 845.ii) above).

x) On 24 March 1997, Mr Durling and American Reliable signed their slips for 100% of the backup layers of the contracts written by Gan; they also signed a slip for the layer $250,000 xs $250,000 at a rate of 3.5% or 3.75%, a considerable reduction on the quote given on 25 February 1997.

xi) There was then some further negotiation; on 3 April 1997, instructions were given for the layer $250,000 xs $250,000 to be placed at 3.75%; American Reliable then wrote 100% of that layer on 14 April 1997. This was reduced to 75% when IGI Underwriting Agencies Ltd. (IGI), an agency which wrote for CNA Reinsurance Company Ltd. (CNA) and whose underwriter, Mr Andrew Briant, had previously worked at Lloyd's, agreed to write a line of 25%.

xii) Gan were reinsured by American Reliable on an LOD basis for 12 months at 1 January 1997 for $240,000 xs $10,000; the cover note was dated 12 February 1997.

xiii) American Reliable reinsured its liabilities under Programme 3.

xiv) On the layer $45,000 xs $25,000, the combined premium was 2.8% for the limited reinstatement policy and the backup; they were then ceded to SD for a fraction of that.

xv) By way of example, the gross premium received by SD in respect of the cession to them of American Reliable's participation in the contracts in which it insured Mr Billyard directly was $101,853; the premium received by SD in respect of the cession to them of the reinsurances of Gan was $46,538; that totalled $148,392 or net to SD of $96,455.

xvi) As at June 2001, the claims under these specific reinsurances were:

a) against Gan on Gan's first layer – $1.8m;

b) against American Reliable on the backup to Gan's first layer – $27.01m;

c) against Gan on Gan's second layer – $7.2m;

d) against American Reliable on the backup to Gan's second layer – $20.027m; and

e) the top layer (75%) of $5.961m – $4.472m.

The incurred claims against American Reliable under these specific contracts totalled $51.509m with loss ratios in the order of 20,000% to 30,000% under the lower layers, with an overall loss ratio in the order of 8,500%. They also reinsured Gan 100% in respect of the $9m claimed against Gan, subject to Gan's retention; Gan's loss ratios were in the order of 500%-1,000%. This liability, subject to the retention by American Reliable, fell to be recovered under the first layer of SD's reinsurance of American Reliable (Programme 3). The claims against SD are in the order of $40m for a received gross premium in the order of $150,000. The figures were not on the adjusted premium, but that would make no material difference to the order of magnitude of the figures.

xvii) These contracts are listed in the list of contracts inuring to the benefit of either Programmes 12 or 28 which reinsured the account written by Mr Billyard for John Hancock.

848. The operation of these contracts illustrated how the cession of one or two contracts on which the premium was tiny caused catastrophic losses.
849. Although Mr Johnson said that he was surprised at the size of the loss, I have no doubt at all, as this account reinsured Mr Billyard's occupational accident account where the estimated underlying income premium was $40m, that enormous losses could have been anticipated; Mr Billyard was known to SCB and Mr Johnson to be an arbitrageur; they knew that the business he wrote contained a heavy element of gross loss making business. As Mr Johnson's evidence showed, the rate charged by American Reliable on the backup layer was very small; a very high loss ratio in addition to the high volume of claims must have been obvious. I am therefore sure that this specific contract was only written by American Reliable when SCB knew that they could dump the inevitable massive losses on SD.
850. I am also sure that SCB appreciated that once the tripartite deal they had done was in place this contract would be put through, with the losses flowing to SD; they suggested Mr Billyard enter into this contract on 17 February 1997 and it was placed after the deal was concluded. The fact that Mr Durling gave the quote for Mr Billyard on the same day as the quote for Phoenix was not explored at the trial; I do not therefore find that the placing of the contract was part of a wider deal, or that there was any wider deal than the tripartite deal which I have found was concluded; I only find that these specific reinsurances were the direct consequence of the tripartite deal having been concluded.

(d) Conclusion on the deal relating to Phoenix and American Reliable

851. As I have set out, I have no doubt at all that a deal was agreed; it comprised so far as SCB was concerned, the reciprocal arrangement between Phoenix and American Reliable on the back of which Mr Henton would write their reinsurance on the basis that he was "following lead lines".
852. SCB maintained that these arrangements amounted to a "capacity swap" which was a feature of the market. Mr Butler's evidence was that he had carried out similar transactions at Bain Clarkson as a means of completing a programme. Another way of describing it, suggested by Mr Butler, was that this was "trading dollars to get programmes home"; he had seen this at Bain Clarkson in the early 1990s.
853. There was no real dispute that it had been traditional for many years in the reinsurance market for companies to swap capacity or to make arrangements on the basis of "reciprocity"; a common example was an insurer in one country offering the reinsurance of a specific book to an insurer in another country and accepting the reinsurance part of the book of another in return. Another example (provided by Sir Alan Traill from his own experience) was that of States who wished to stem a currency outflow arising from the placement of reinsurance by only permitting this if others would place their reinsurance with companies within that State. This was traditionally called "reciprocity". It was also not in dispute that an insurer would sometimes write a small line on a slip of business that would not normally be acceptable in order to enable the broker to finish the placement, in return for some business from the insurer who was being insured under the slip.
854. It was contended by SCB that capacity swaps in the PA market were common; the evidence as to the practice in that market can be summarised as follows:

i) Mr Jackson's evidence was that the swapping of one or two per cent lines happened with a fair degree of regularity; however, he had not come across them for 10 years; he gave an example of a broker requesting that he write a line on the reinsurance of one of his largest reinsurers so that the reinsurer's programme could be completed; he did so on that occasion and on probably about a dozen occasions in all; the essence of it was writing a small line to help someone out where he did not particularly want to do it. He could not say what the practice was in the PA market. There would be no objection to a swap if the reinsurers concerned were prepared to accept the lines on the merits of the risk.

ii) Mr Hines' evidence was very much to the same effect; his experience was of writing a line of a few percentage points in order to finish the risk off; he also was familiar with the practice of swapping parts of a book to provide a better spread. He was not aware of any other practice.

iii) Sir Alan Traill, in addition to the example of reciprocity I have given, was familiar with the practice of swapping small lines to finish a placement; he had, however, no experience of the PA market of or any practice of kicking off a programme by swapping lines.

iv) However, there was evidence from Mr Brown, Mr Butler and Mr Greig. I have already referred at paragraph 534.v) to Mr Greig's evidence about trading lines or swapping capacity to kick start a programme. Mr Butler's evidence was that he had come across the practice at Bain Dawes and of a person not quoting for the other unless he had the other quote first. Mr Brown's evidence was that they had carried out capacity swaps in the market for a long time.

v) It may be that the PA market had some broader understanding of capacity swaps that included the kick starting of programmes; I am prepared to assume that it did and that those that acted in this way believed that they were acting honestly; in putting it in this way, I make no finding one way or the other as to whether this was an honest practice.

855. It was SD's case that the tripartite deal was a dishonest contrivance to circumvent the requirements of the leader clause; this was done as taking the programmes for specific approval would have entailed telling Mr Broad the true nature of the business being written:

i) Mr Butler accepted that the purpose of the leader clause in the binder was to impose quality control. Mr Johnson knew of the need for a recognised market leader under the binder as he had been told this by Mr Butler and had seen the binder. He was aware that the provision of a leader would give EIU the capability to write the business and he may have made Mr Durling aware of it. In his view, recognised market leads would have included Mr Billyard, Lincoln National, Mr Cackett, Phoenix and American Reliable. Mr Johnson also knew that Phoenix had declined to write American Reliable and that American Reliable had declined to write Phoenix.

ii) I am sure that Mr Brown, Mr Butler and Mr Johnson clearly knew that the purpose of the clause was being circumvented as the "lead lines" were only written by the two companies after they had refused to write the business before and were only writing it because that would enable them to get their own reinsurance.

856. However:

i) Mr Butler maintained that the deal did not make a mockery of the leader clause as both Phoenix and Mr Durling were recognised market leads.

ii) Mr Johnson's evidence was that the purpose of the leader clause in the binder was to either stop a person from coming into the market in too high a profile as a leader, or to write behind those who knew what they were doing and who were willing to write the risk after having considered it. He maintained that position calmly despite the fact that neither American Reliable nor Phoenix wanted to write the contract on their own without the reciprocal deal; he never had any doubt that EIU could write the risk. He maintained that there were real lead lines and that the rates were considered.

857. SCB also said that although the bordereau to be submitted would not have shown that there had been a capacity swap, the fact that EIU had written 90% lines was apparent from the information provided to SD in the bordereau. The bottom layers had estimated premium incomes of $1m and it was therefore to be expected that SD would ask for the slips.
858. I am sure that the arrangement was dishonest and that it was known by Mr Brown, Mr Butler and Mr Johnson to be dishonest and was constructed to enable them to get the reinsurances of Phoenix and American Reliable to be written and the losses from the business to be transferred away from Mr Billyard, American Reliable and Phoenix:

i) Although I accept that Phoenix and American Reliable were regarded as "recognised market leaders" for the purpose of the clause in the binder, the "lead lines" were each provided by a company that had refused to write the risk on an earlier occasion. Each only did so to enable their reinsurance programmes to be written. Neither Mr Durling, the person accepting the business at American Reliable, nor the underwriter at Phoenix were called to give evidence, but I am sure that they only agreed to participate in the reinsurances of each other in order to get their own reinsurance done; they had earlier rejected the business on its own merits.

ii) The leader clause was obviously intended to ensure that EIU followed a person properly leading the risk; it was to operate as a quality control mechanism. These were not lead lines in any proper sense of the word. To describe such lines as "lead lines" was an obvious sham unless the full circumstances of the subscription was made known. I am sure that it was known to be a dishonest contrivance by those who knew that its objective was to give the impression that there were genuine lead lines. This is a conclusion I have reached quite irrespective of the underlying nature of the business.

iii) I reject the suggestion that the essence of the arrangement was a "capacity swap" or some form of acceptable reciprocal arrangement. I make no finding as to the knowledge of those at the home offices of Phoenix and American Reliable as to how it was perceived, but as between those who knew that its purpose that was not the essence of the arrangement; the essence of the arrangement was the dishonest device that gave the semblance of a genuine lead line.

iv) Those who had been offered or had written or had broked the reinsurance of the lower layers of the reinsurance programmes of Mr Billyard, American Reliable and Phoenix must have known that the effect of SD's participation was to funnel the losses (in the way described) into SD and any reinsurers it had.

v) I am sure that no insurance company which understood the effect of what was being done would have ever agreed to the arrangement which would bring to it the certainty of such large losses, unless it was to pass those losses onto some other reinsurers, making full disclosure of what it was doing to those other reinsurers. That sequence could obviously be repeated but as it would have to end somewhere, I am sure that no reinsurance company which ultimately bore the risk and to whom there was proper disclosure of the arrangement would have ever agreed to it.

vi) I am also sure that if it had ever been explained to Mr Broad he would never have agreed to it; as I have set out at paragraphs 720 and following, he would not have agreed to write gross loss making business on the backs of reinsurers.

vii) I am sure that sometime before 25 February 1997 there was a discussion between Mr Butler and Mr Henton about finding a way round the leader clause during which the position of Phoenix was mentioned and during which, for the reasons given, Mr Henton agreed to write the reinsurance programme for Phoenix. Mr Henton was a willing participant in the deal as he was anxious to write the business and earn the anticipated commission. The evidence of Mr Johnson (referred to at paragraph 825.i)) was that Mr Butler had also mentioned that Mr Henton was keen to write the protections of Phoenix. I consider Mr Johnson's evidence on this to be the truth and that there was an agreement sometime before 25 February 1997 that Mr Henton would write the reinsurance of Phoenix as part of an overall deal. I am certain that SCB was not going to put the deal together without being sure that Mr Henton would reinsure Phoenix.

859. As to the role of those concerned:

i) Mr Henton:

a) I reject, as a fabrication, Mr Henton's evidence that he asked Mr Smith to take the matter to Mr Broad; it was Mr Henton's case that he was engaged in arbitrage in accepting Programmes 1, 3 and 4. However, he plainly knew that without reinsurance to cover losses down to a retention of $10,000, he had exposed SD to certain loss in accepting these programmes. It would have been essential to tell Mr Broad what had happened.

b) Moreover, EIU had confirmed Programmes 1 and 4 and some of the layers on Programme 3 that had been written after they had asked WFD (as set out at paragraph 783) to place the lower layer of SD's reinsurance. I have considered carefully whether an explanation for the confirmation was whether there was some understanding between WFD and Mr Henton that reinsurance would be provided. However there is no evidence of this; I regard the confirmation of these programmes in the knowledge that reinsurance had not been obtained for the lowest layer as dishonest conduct towards SD as EIU were confirming contracts which had been written on an arbitrage basis without even the reinsurance at the low level that was essential to avoid loss. That fact would also have had to have been disclosed to SD.

c) Although I am prepared to assume that Mr Smith knew that the lead lines were only 10%, I reject, as a further fabrication, that Mr Henton gave Mr Smith the placing information; there is no independent support for it and Mr Henton's evidence to the Court was characterised by him lying whenever it suited him; Mr Smith's account was, as I have set out, that he had no idea that the business was gross loss making. Mr Henton gave evidence that he had discussed the matter subsequently with Mr McCarthy and had explained to him what had happened. Although I draw no inference (as I have stated) from the fact that Mr McCarthy was not called to give evidence, I am sure that Mr Henton's evidence that he explained what had happened to Mr McCarthy was a further fabrication.

d) Mr Henton knew that the writing of the programmes in the circumstances in which the so-called "lead lines" were obtained was a serious breach of the leader clause as he knew how and why the lead lines had been procured. He knew that he had had no right to agree to these programmes without the express approval of SD; he knew that in seeking such approval he would have had to make the fullest disclosure – that would have involved him disclosing the type of business it was, the nature of the deal he had done, the fact that he had exposed SD to certain loss by writing the business without any reinsurance in place for losses below $50,000 (for the reasons I have given) and that the effect of accepting the Phoenix and American Reliable programmes would have in funnelling a significant amount of loss into SD and their reinsurers.

e) He knew that what he was doing was grossly dishonest and that through his conduct EIU were acting dishonestly to SD.

ii) Mr Brown:

a) Mr Brown's evidence in relation to the deal was untruthful. I had a very long and careful opportunity of watching Mr Brown give evidence. His denials were hesitant and his evidence in relation to the contemporary documents was wholly unconvincing; he knew he had done the deal with Mr Johnson and he had not forgotten it.

b) Mr Brown knew and intended that the objective of the deal was to provide reinsurance to American Reliable and to enable the spiral to start again and for retro business to be written, as it had been in the earlier years; it also provided reinsurance to Phoenix and the opportunity to earn substantial commissions. Until reinsurance was in place, Mr Durling would not write spiral business and Mr Billyard could not because his reinsurance with American Reliable was written on terms that he was not writing spiral business. He had a strong motivation to put the deal in place. Mr Brown also knew that the effect of the deal was to funnel a very substantial part of the losses into SD and their reinsurers.

c) Mr Brown understood the business of writing gross loss making business on the backs of reinsurers and that full disclosure was needed for any person who was considering giving authority to write such business. I am sure, from the various proposals that SCB prepared, that he never made any such disclosure and that he was prepared to put documents that to his knowledge did not honestly describe the business into circulation; a clear example of this was the document which was sent to Phoenix and Hackett which I found to be dishonest – see paragraph 427.ii).

d) Mr Brown knew that the provision of "lead" lines was a device by which Mr Henton could claim that the leader clause was satisfied and claim that it was therefore unnecessary to seek the approval of SD. He knew that the purpose of the device was to remove the necessity of going to SD and thus to avoid the need to give disclosure of the full circumstances of the arrangement.

e) He acted in a dishonest manner, knowing full well that SD had no knowledge of what had been done and that the losses they and their reinsurers would incur might well be enormous as a direct result of the dishonest arrangements he had constructed.

iii) Mr Butler:

a) I am sure that the architect of this dishonest arrangement was Mr Brown.

b) Mr Butler's knowledge and motivation was the same as Mr Brown's; he had helped him carry it out and knew the purpose of the device and the fact that it was dishonest.

iv) Mr Johnson:

a) Mr Johnson was not separately represented and WFD were not parties to this action, though at one stage prior to the trial they had made an unsuccessful application to intervene in the action. In these circumstances, I have proceeded on the basis that I have only made findings in respect of Mr Johnson where those were strictly necessary for the decision in this case.

b) Nonetheless, his participation in this transaction was relied on by EIU and SCB as supporting the acceptability of what had been done. In these circumstances, it is necessary to reach a view on his conduct. He had a copy of the binder. I have no doubt at all that he was a party to the dishonest and deceptive contrivance and that he was a willing participant in the deal with Mr Brown.

c) I do not, however, make any findings one way or the other in relation to what Mr Durling or American Reliable knew or were told. I heard no evidence from them and it is not necessary for me to make any findings in relation to their conduct.

(e) EIU's approach to the writing of the business

860. On Mr Henton's own evidence the first five programmes were accepted at two meetings which lasted in total for two hours; he knew that all the programmes would be gross loss making except Programme 5. How did he approach the acceptance of these programmes?
861. I have set out the evidence and my conclusions in relation to each programme in Part II, but it is convenient first to look at Mr Henton's evidence as to what his overall approach was:

i) To write this business profitably one had to understand the market – the product and what was carved out; however, it was clear that he did not understand much about the US WCA; for example, he did not know about the rating of the original business, but his evidence was that the rating was the responsibility of the original underwriters, even though the rate he received was directly related to that.

ii) In his first statement, his evidence was that he believed that the fact that the binder was protected by reinsurance was an essential part of his underwriting approach; in saying that, he did not mean that he only considered the net position as he always had regard to the gross position as well; he considered that the majority of the programmes had a fair prospect of making a gross profit; he qualified this in his oral evidence by saying that he looked at certain risks on a net basis only.

iii) As set out at paragraphs 192 and following, it became clear from Mr Hines' evidence that the only way in which an underwriter could write arbitrage business was to do so on the basis of a properly researched and prepared underwriting plan.

iv) It was Mr Henton's evidence that he had such an underwriting plan; he had obtained the necessary information from Mr Bird and had done the necessary planning.

v) Mr Henton's evidence was that it was essential to monitor for accumulations and to check on his aggregates; there was accumulation in the first five programmes that he had written and the position was more complex after the Christmas Eve programmes. His evidence was that he did monitor for accumulations by adding together the exposures under the programmes, but that he did not think that one loss would go through all the programmes; I accept that evidence as there was a contemporary document that showed this.

862. Mr Henton's approach to the information required can be summarised as follows:

i) What was normal in the market was what was provided for most programmes.

ii) It was not necessary to have information about the underlying business – see, for example, Programme 3 (American Reliable) at paragraph 83.iii) of Part II or Programme 2 (Phoenix) at paragraph 101 of Part II.

iii) He was not interested in other matters or in the detailed information supplied – see for example Programme 14 (MELEX) at paragraph 313 of Part II; where there was a special programme such as that in relation to Programme 29 (Longshoremen), it did not matter that he did not understand it – see paragraph 769 of Part II.

iv) He did not need to know anything about the person he was reinsuring – see, for example, Programme 15 (Clarendon EEII) at paragraph 334 of Part II.

v) It might sometimes be important that the business was said to be getting better (as in Programme 19 – Hallmark – see paragraph 534 of Part II), but that was not always the case (as in Programme 21 – Venton, where he did not expect things to get better – see paragraph 685 of Part II).

vi) Triangulations were not necessary – see for example Programme 14 at paragraph 314 of Part II.

vii) Mr Henton's evidence was that one did not need to know the details of the underlying business; that was, in his view, also Mr Billyard's approach – see Programme 18 (Clarendon per Raydon – "direct" at paragraph 485.ii) of Part II). One did not need to know much of the detail of the underlying contract – the skill was in working out the reinsurance to cover the losses – see the Programme 19 (Hallmark) at paragraph 551 of Part II. This was to be contrasted with the approach of GIO Insurance Ltd. of Australia (GIO) which wanted a full list of the contracts written by Mr Billyard when they were considering whether to write the QS of his non-proportional book (Programme 33) – see paragraph 1550.

863. In evaluating Mr Henton's evidence, it was important to bear in mind that:

i) He had little experience of underwriting; such as he had was as a deputy on Syndicate 103 which had stopped underwriting at the end of 1993. He had not made any important underwriting decisions in that capacity. For the next three years he had been engaged in run-off business. He was only 32 years of age when he began accepting business at EIU.

ii) He had learnt from Mr Bird what he knew about writing gross loss making business on the backs of reinsurers; that is an important factor for, even though I have concluded at paragraph 407 that Mr Bird had acted dishonestly in the conduct of the business of Syndicate 103 and that he had misled his Names, there was no evidence that Mr Henton had been involved in the deception of the Names.

iii) It was Mr Henton's evidence that he was not aware of the tight spiral in relation to Syndicate 103 that was referred to in the letter subsequently sent to Names in February 1998 (as set out at paragraph 1331); that the four referred to there could be Mr Bird, Mr Billyard, Mr Cackett and possibly Mr Owen. He knew that Syndicate 103 wrote Mr Billyard's reinsurance and vice versa; he knew that SCB broked the outwards reinsurance of Syndicate 103 and part of Mr Billyard's. His evidence was that he was not aware of the tight effect of the spiral and of smaller losses going into higher layers.

iv) However, he accepted the first programmes when he did not have any details of SD's reinsurance programme; he knew that it was impossible to write on the backs of reinsurers without having precise information about the reinsurance programme.

v) The relationship with SD was conducted by Mr Whitcombe, who did not have any real understanding of the underwriting of gross loss making business on the backs of reinsurers.

vi) As set out at paragraphs 941 and following, EIU ceased underwriting when they learnt that SD's reinsurance programme did not cover the business that had been written.

864. Taking into account these matters, was the acceptance by Mr Henton of these first five programmes dishonest or, in so far as the acceptance may be open to criticism, was it the work of someone who was merely negligent or doing his incompetent best?
865. I have set out my conclusions in relation to the acceptance of each of the first five programmes in Part II. Looked at overall, I am sure that Mr Henton's acceptance of the programmes was not that of an inexperienced person doing his incompetent best or of someone acting negligently; it was dishonest:

i) I accept that when at Syndicate 103 he did not know of the deception of the Names. I set out at paragraph 1257 my conclusions with respect to his knowledge of spirals.

ii) Mr Henton, although inexperienced, was a person of considerable intelligence and ability and with an acute trader's instinct; I had the opportunity not only of seeing him during a long and searching cross-examination, but also of observing him cross-examine others on behalf of EIU, Mr Whitcombe and himself. The entirety of his evidence and his conduct of the case amply demonstrated his abilities.

iii) I am sure, as I have set out at paragraphs 727 and following, that when he was involved in assisting Mr Whitcombe in the drafting of the business plan to be submitted to SD, he had intended to write gross loss making business on the backs of reinsurers and he appreciated that what was said in the plan did not describe what he had intended to do; I am sure that the reason for not giving a proper description was that he fully understood that no insurer would be prepared to give authority to write such business if a proper description was given.

iv) I am therefore sure that when he commenced in accepting gross loss making business for SD, he knew that he did not have the authority of SD to do so.

v) I reject his evidence that he had an underwriting plan as a dishonest invention. He had done no research, though that was essential to the preparation of a plan – see for example his evidence referred to at paragraphs 36 iii) b) and 58 iii), 315 and 769 of Part II; If there had been such a plan, he would have clearly needed to revise any such plan in December 1997 when reinsurance was offered by SCB for that year; no such revision took place as there was no plan. He claimed for example that the skill was making sure that he had the requisite outwards insurance – see for example paragraph 551 of Part II- but he had no plan for this. As I have already concluded in the case of Mr Bird, if Mr Henton had in fact prepared a plan, it would have shown that the prospect of any profit was an entire illusion – see paragraphs 206 and 268.

vi) There were three meetings at which groups of programmes were accepted – 27 January 1997, Christmas Eve 1997 and New Year's Eve 1997. Assuming that net underwriting of this business could be done speedily with an underwriting plan, as there was no underwriting plan, it is clear that there could have been no justification whatsoever for Mr Henton to have even considered accepting the programmes at those meetings; there was clearly insufficient time for the analysis required.

vii) It is obvious that no honest underwriter would write on the backs of his reinsurers without knowing the details of his reinsurance programme. Mr Henton accepted that he knew by 3 February 1997 and before Programmes 1, 4 and 5 were confirmed, that the reinsurance programme had an excess point of $60,000 (though it was in fact $50,000); I am sure that he knew this on 27 January 1997 as he must have asked Mr Whitcombe about it. Was it due to incompetence that he had exposed SD in this way to the inevitability of certain loss as there was no low layer in place?

viii) I am sure that Mr Henton fully understood the consequences to SD of having accepted Programmes 1 and 4 without such reinsurance in that he had exposed SD to the inevitability of certain loss. Even if he had hoped for reinsurance, no honest underwriter would have committed SD by confirming the reinsurances without at least telling them of the very substantial losses that they would have had to pay if reinsurance could not be obtained. He had done so because he had decided to write the business SCB had offered and to do their bidding.

ix) His evidence was, as set out at paragraph 744, that he saw an opportunity in the market. He was right and he should have exploited it; he certainly had the ability, intelligence and trading instinct to do so. However, he made no attempt to do so, but on the contrary was prepared to write business on the terms put forward by SCB for reasons explained at paragraph 875.iv). An example of his acquiescence is his acceptance of the rate proffered on programme 3 – see paragraph 91(iii) of Part II.

x) I have set out in Part II my detailed conclusions in relation to each of the programmes accepted by Mr Henton; it is clear that he had not considered the gross position in many of them as there was no information which enabled him to do it. In the course of his cross-examination, his evidence shifted to an emphasis on the net approach.

Accepting that Mr Henton thought that underwriting gross loss making business on the backs of reinsurers was a proper business activity, I am nonetheless sure for the reasons I have set out, that Mr Henton knew that what he was doing was dishonest in all the circumstances.

866. Mr Whitcombe's evidence was that he knew that some of the business would be gross loss making but thought that some would not be; on the figures in respect of many of the programmes he had accepted, it would have been commercially absurd to write them unless there was "a good broking story". Mr Whitcombe, however, had no real understanding of the business and he had also acted dishonestly in going along with Mr Henton's acceptance of business which he did not really understand and which he knew Mr Broad had not approved.

(f) Was there an understanding between EIU and SCB?

867. As set out at paragraph 756, it was SD's case that that SCB would present WC carveout, alternative WC, retro or spiral business and similar gross loss making business to EIU, and that EIU would write such business under the facility if they got it.
868. As I have set out at paragraph 531, there was a common understanding between SCB and Mr Whitcombe and Mr Henton that if they were able to establish EIC, then SCB would offer its WC carveout and alternative WC business to EIC and Mr Henton would write such business as part of the EIC account.
869. As SCB rightly pointed out, brokers will often indicate to a proposed new company that they will offer the new company business if the company gets going and is of sufficient security to be acceptable to the brokers' client. This was plainly an ordinary business practice. If the new company had said that they would consider such business if offered and there was an informal understanding to that effect, it would again seem to me to be an ordinary business practice. In such a case the new company would not be binding itself in any way to accept such business, but would consider it when presented and would only accept it if it was in their interests to do so.
870. If this ordinary example is varied and the broker offers a type of business, say professional indemnity insurance, and the new company indicates that it will write business of that type, again this seems to me to be an ordinary and acceptable business practice; professional indemnity insurance is ordinary insurance business and the new company is not committing itself to accepting any specific risk but only risks which it considers in the interests of the company to accept.
871. Indeed it would seem to be ordinary prudence on the part of someone embarking on a new company to seek such support and have such informal understandings; the same is the case in respect of the establishment of an underwriting agency as the principal will need to know that the person to whom he gives authority will be supported.
872. There can be no doubt that there was at least an understanding between EIU and SCB to the effect that SCB would present WC carveout, alternative WC, retro or spiral business and similar gross loss making business to EIU, and that EIU would write such business under the facility if they got it.

(g) Was there collusion?

873. Unless there was something inherently wrong in accepting business of the type described, then in my view there was nothing wrong in a limited understanding of the type described in the preceding paragraph. EIU would be reserving to itself the right to consider in each case whether the writing of any particular contract was in the interests of its principal. However, it is clear that there had to be full disclosure of the type of business to be written by EIU to its principal, SD.
874. I have already found at paragraph 721 that SD were not told that gross loss making business would be written against reinsurers when they agreed to write the binder; EIU knew that they were not authorised to write such business though Mr Whitcombe himself (as opposed to Mr Henton) might not then have fully understood the very grave risks to which SD were being exposed.
875. It was submitted by SCB that there was no collusion between them and EIU; they merely offered EIU business and Mr Henton was free to accept or decline as he saw fit. They pointed to the fact that Mr Henton did not write everything he was offered; they submitted that EIU were keen on pursuing a relationship with WFD and that this was inconsistent with a collusive relationship with SCB.
876. However, I am sure that there was an arrangement under which EIU would write SCB's business; I am also sure that SCB saw in Mr Henton an underwriter who had a facility from SD which they could ruthlessly exploit and Mr Henton was prepared to acquiesce in that exploitation:

i) I have no doubt at all that a promise of business was made by Mr Bird in October 1997 (as I have set out at paragraph 631).

ii) It is difficult to understand why those involved denied that there was any understanding at all; for example, Mr Whitcombe denied that the writing of the first programmes was consistent with what they had said in their business plan (the plan that was written with the assistance of Julius Baer) where they had said that this was not a typical startup as they had had the virtual guarantee of a substantial line of profitable business.

iii) I am sure that Mr Brown and Mr Butler had lied about their meetings with EIU; they had promised that business would be forthcoming and as Mr Henton's note (referred to at paragraph 755.i)) set out, he had been promised that business would be reserved for him.

iv) As I have set out at paragraph 864.ix), Mr Henton made no attempt to exploit the position he was in. I am sure that he did not do so and that he was prepared to write at the terms put forward because he was prepared to do SCB's bidding. If he had attempted to charge a rate that reflected the market opportunity, that would have been pointless to SCB as they would not have been able to use the reinsurance to support their market for WC, WC carveout and alternative WC in the US (as explained at paragraph 749). He was not prepared to act independently of their commercial interests and charge a rate that reflected the position he was in.

v) He was delighted to write the business offered by SCB on 27 January 1997 as the commissions that would be earned by EIU were so large for the XL business that he was writing; he did not care what loss might be caused to SD and their reinsurers.

vi) The agreement of WFD to the proposal of Mr Henton for the split commission with SCB on the bottom layer (see paragraph 784) is a remarkable feature; in my judgment it is entirely consistent with an understanding between EIU and SCB as it ensured that SCB received the benefit of commission on the reinsurance for the business they had brought to him and is inconsistent with an approach to WFD; EIU clearly wanted to develop a connection with SCB.

vii) It is also remarkable that WFD is referred to in the proposal sent to EIU's bankers but that SCB was not mentioned by name (as set out at paragraph 773); it is WFD that is referred to in the proposal for E&O insurance (see paragraph 770), even though SCB had provided almost all the business. This was relied on as suggesting a desire to develop a relationship with WFD as opposed to SCB; I do not accept that. It is more consistent with a desire to play down the actual relationship with SCB.

viii) The proposal to EIU's bankers (set out at paragraph 773) referred to a "known cash flow". That pointed to a confidence that business would be provided; I have nevertheless not accorded much weight to this as both Mr Whitcombe and Mr Henton were prone to exaggeration.

ix) In reaching this decision, I have taken into account the fact that neither on 27 January 1997 nor subsequently did Mr Henton write everything that was offered to him – see my conclusions at paragraphs 171 and following of Part III.

877. The ruthless exploitation of the facility granted by SD was pursued for SCB's wider commercial interests:

i) SCB submitted that it would not have been "the end of the world" if SCB had not obtained reinsurance for Phoenix; that was an understatement in my view. I have little doubt that SCB did not have any real concern about the interests of Phoenix (for they had already committed themselves to reinsure the two entities that SCB used extensively – Mr Billyard and the Big Ben facility granted by Lincoln National, and they did not participate on other programmes); on Mr Butler's evidence, SCB did not even offer the reinsurance programme of Phoenix to Mr Henton on 27 January 1997.

ii) SCB were, however, much more anxious about the position of American Reliable as they had offered that to Mr Henton. There were a number of reasons for this. Mr Billyard had wanted to be able to write spiral business and there were a number of reasons why SCB would have wanted him to be able to do so. SCB had told Mr Henton of Mr Billyard's intention and had recorded it on the information sheet. However, Mr Billyard had told Mr Johnson that he would not write spiral business prior to his reinsurance being written by American Reliable. Although no such assurance was given to Phoenix, Mr Billyard would not be able to write spiral business unless American Reliable were willing to reinsure it as he could not take the risk of being without American Reliable's reinsurance. Mr Durling and Mr Johnson were experienced enough to know that that could not be done without their being reinsured for such business. I am sure that because of the dealings between Mr Johnson and Mr Brown and Mr Butler, they each understood that position.

iii) If Mr Henton had been able to write 100% of American Reliable's bottom layer, that would have solved the problem; Mr Billyard and American Reliable would have been able to write spiral business and SD would, with Phoenix, have borne a significant part of the loss. That did not matter to SCB at all. They would have been able to use their reinsurance arrangements to help the competitive position of their US business and earn their commissions.

878. However, in achieving the deal necessary to bring about the reinsurance of American Reliable, they had to overcome the restriction in the binder through the dishonest contrivance I have found was employed. The result achieved by SCB was that even though more of the loss was funnelled into SD, the arrangements benefited SCB by enabling them to earn even more brokerage through their placement of Phoenix's reinsurance programme as well as benefiting EIU through the commission which they earned on the significant premium income that Phoenix had paid.
879. This ruthless exploitation of the opportunity offered through the binder to further the interests of SCB's WC business in the US and to pursue their ambition to be a full service insurance group (as set out at paragraph 353) was characteristic of the way in which SCB behaved throughout and is exemplified by the way in which the Christmas Eve and New Year's Eve programmes were placed, by the placing of Programme 33 and by the "all sources" endorsement under Programme 26 (Mr Cackett's specifics).

(h) SCB's knowledge of the position of SD and their dishonest assistance of EIU

880. But did SCB know that Mr Henton was acting in breach of his duties to SD and if so, from when?
881. As I have set out, the contracts that comprised the first five programmes were contracts that SCB had placed in prior years and although the gross loss ratios and the predominance of WC carveout and related business were in some cases higher, the contracts were no different in their essential characteristics from business that had been placed in the market that I have described, where contracts of this type were placed. If full disclosure was or could have been made, there was nothing improper in placing this business. Moreover, as Mr Henton knew precisely the nature of the business he was accepting, there could be no complaint about SCB not disclosing the nature of the business to him.
882. Thus the issue as to SCB's knowledge must be approached on the basis I have set out in the previous paragraph. Furthermore, ordinarily as brokers, they would be entitled to assume that an agent would only be writing the business on the basis of his principal's approval; there was nothing in the binder itself to put them on notice that SD had not approved this type of business; a broker conversant with the terminology of the PA reinsurance market would assume that a binder in those terms extended to cover this type of business. A broker conversant with the business would also assume that no insurer would write this type of business without a reinsurance programme that would transfer the enormous losses away.
883. It was SCB's case, as set out in a letter written by their solicitors on 4 December 2001 and in the evidence of Mr Brown and Mr Butler, that some of the programmes were only writeable on the backs of reinsurers; Mr Brown and Mr Butler expressed views that some risks (such as Programme 5) might be good gross writes or were marginal. They also maintained that the precise way in which EIU looked at a risk was not their concern and that it was not their concern to second guess an underwriter. Indeed, as I have set out at paragraph 333, there were many matters that would not ordinarily be known to a broker about an underwriter's thinking and he would therefore not know why an underwriter would accept or reject a particular contract. Nonetheless, I am sure that Mr Brown and Mr Butler knew:

i) whether the contract was likely to make a gross loss and the probable extent of that loss; they would therefore know whether it was likely that the contract was being accepted on the backs of reinsurers; and

ii) the level of information needed to make a decision whether the risk was to be written on a gross basis or on the backs of reinsurers. I have already referred at paragraph 211 to their evidence as to the standard of information that was provided in this market.

They would however not be concerned to work out why an underwriter had accepted a particular risk, or to second guess his acceptance of a risk.

884. When Mr Butler visited Mr Henton on 27 January 1997, he knew that Mr Henton would be prepared to write gross loss making business for SCB. The result of the meeting was that Mr Henton was prepared to acquiesce in the terms put forward and to write business that SCB had not been able to place elsewhere. He knew that Mr Henton did not seek to exploit the position he was in. Mr Butler may have suspected that Mr Henton was acting in EIU's own interests and not those of SD's, but I cannot be sure that he knew on 27 January 1997 that SD had not authorised the writing of the business, or that in accepting the contracts Mr Henton was not acting faithfully in the interests of SD. It is possible that he might have deduced that the position was that SD were prepared to go along with the business as well and pass the losses to their own reinsurers.
885. However, I am sure that when shortly after 27 January 1997 Mr Brown and Mr Butler devised the scheme by which a "lead" line could be written, they were by then fully aware that SD had no knowledge of the nature of the business being written by EIU. The primary purpose of the deal put together by them was to enable the reinsurances to be written without telling SD what was being done. From that time onwards they knew that SD was ignorant as to the gross loss making business being written under the binder as the whole purpose of the dishonest contrivance was to avoid going to SD. From that time on they knew also that Mr Henton would act in a way that was generally subservient to their interests and contrary to the interests of SD and acted on that basis thereafter. They fully appreciated that their own conduct in placing business with Mr Henton and dealing with placed with him in such circumstances was dishonest. The fact that Mr Henton would so act was clearly shown to them by his acceptance of the Lincoln specifics without a leader and his writing the 90% lines on Phoenix and American Reliable in the circumstances I have described.
886. I am sure that Mr Brown and Mr Butler and through them, SCB, knew from that time that EIU were deliberately concealing what they were doing from SD and were dishonestly assisting them in their breach of fiduciary duties. As subsequently set out, SCB colluded with Mr Henton in respect of Programme 16 (Unum) in an attempt to ensure that the true nature of what was being written was kept from SD; in the summer of 1998, Mr Brown and Mr Butler acted in relation to Programme 26 (as subsequently set out at paragraph 1768.iv)) so that no one had to go to SD and explain what had been done.
887. As I have mentioned, it was submitted by SCB that Mr Brown and Mr Butler could not have had that knowledge and would not have placed business with Mr Henton had they known that he was acting contrary to the interests of SD and without their authority, as SD would have found out in due course by an audit which they would have expected any reasonably competent insurer to carry out.
888. There are a number of reasons why I reject this submission:

i) As appears from many of the matters considered in this judgment, I am sure that both Mr Brown and Mr Butler had lied whenever it had suited them; I reject their evidence that the prospect of an audit was a matter that ever concerned them.

ii) They knew that no carrier could sustain losses of the level that would arise for more than a short period of time; they were therefore only using SD for a short period of time. They therefore took the risk that what was being done would not be discovered whilst they were using SD.

iii) They knew, however, that losses would not come through for some time and that there was a fair chance that the true nature of the business would not be closely investigated until the losses came in. Unless an analysis was made of the placing information, there was nothing on the face of the slips that disclosed the true nature of the business. But once the true nature of the losses were discovered, then the insurer was of no further use to them in any event.

iv) In the event of questions being asked, they would be able to take the position (which was a truthful one) that the agent knew precisely what had been done.

v) They knew that the business would require a run-off reinsurance and would use the prospect of providing such reinsurance as a means of escaping from any criticism. As set out hereafter, it is striking that SCB offered run-off reinsurance but with the condition of continuing to write for another year (see, for example, paragraphs 1791 and 1793).

889. I am therefore sure that SCB dishonestly assisted EIU in the writing of all the business that was written by EIU for SCB and its clients, and that this was done from no later than 3 February 1997; as all the programmes other than Programmes 1, 4 and 5 were written after that date, the dishonest assistance extends to all contracts. As to the Programmes 1, 4 and 5 which were provisionally accepted on 27 January 1997, Programmes 1 and 4 were confirmed on 12 February 1997 and Programme 5 on 19 February 1997. Did SCB know before those dates that SD were unaware of the nature of the business being written? I am sure that they did. Although the deal was not done until about 25 February 1997, Mr Brown and Mr Butler must have known of the position with regard to SD when the difficulty in relation to the leader clause emerged; as set out at paragraph 804, Mr Butler was told by Mr Henton that he was not going to Mr Broad shortly after 28/29 January 1997; this must have been before 3 February 1997 as Mr Butler was away that week (see paragraph 823). I am sure that Mr Henton would have told Mr Butler why he could not go to Mr Broad and that from that time on SCB started to consider how they could get round the problem. They therefore knew, prior to the confirmation of Programmes 1, 4 and 5, that the business was being accepted by EIU without the authority of SD and that SD were ignorant of the true nature of the business, though at the time the contracts were provisionally accepted, I cannot be sure that SCB had had that knowledge.

6. THE ATTEMPTS TO OBTAIN REINSURANCE

(1) The provision of bordereaux in early 1997

(a) The first bordereau provided to SD in early 1997

890. Under the terms of the binder, it was the duty of HHI to provide monthly bordereaux to SD.
891. As set out at paragraph 699, Mr Smith produced a manuscript form for the bordereau required by the terms of the binder and on 13 February 1997, Mr Whitcombe met Mr Smith and discussed the format of the bordereau.
892. The bordereaux were prepared by Mr Henton on a spreadsheet on his computer; the information required was abstracted and printed on to sheets which listed the business written and which gave certain details about it.
893. The first bordereau, for business written as at 31 January 1997, covered the business which was written on 27 and 28 January 1997 and was prepared whilst Mr Henton was an employee of Eastgate; the bordereau was probably prepared on Eastgate's computer. Mr Henton's evidence was that he photocopied everything he had on Eastgate's machine one lunchtime so that he had two copies of everything (as he believed that they had to submit copies of policies under the terms of the binder); he had handed one of the copied sets to Mr Smith.
894. The bordereau showed:

i) the name of the reinsured;

ii) the period;

iii) the inception date;

iv) the type of business (whether it was LOD or RAD and whether it was XL);

v) the broker;

vi) the excess point, the limits, and the written and signed lines; and

vii) the premium, including the adjustable rate and the currency; the figures were taken using the M&D premiums and not the adjusted premium; Mr Smith knew that, as Mr Smith's interview notes confirmed.

895. Mr Henton kept much more information about the risks on the spreadsheet on his computer than was shown on the bordereau provided to SD; the information contained in the columns of the spreadsheet that were not supplied had the word "hide" marked against them. The information that was not supplied included the estimated premium income, the commission to the broker, the date of closing, EIU's commission, the exposure and the estimated date of receipt of the income.
896. On 3 March 1997, Mr Whitcombe wrote a manuscript letter to Mr Broad in which it was stated that a bordereau for the month of January 1997 was enclosed; an increase in the premium income limits to £3.5m was sought. It was Mr Whitcombe's evidence that the letter was provided to Mr Smith in a sealed envelope which also contained the bordereau, the slips and the full placing information sent with the slips (in accordance with what they believed to be the terms of the binder). Mr Henton said that the slip for Programme 1 would have been enclosed with the relevant underwriting information.
897. Mr Smith's account was that slips came with the first bordereau; he thought that Mr Broad might have looked at them. Mr Broad, however, did not believe that he had seen the letter and he said that he did not see the slips. Mr Broad's evidence was that the slips were never brought to him; Mr Smith would know that he did not want them. He would not have expected to see the slips under the terms of the binder; the reference in the binder to forwarding of a copy of the policies to SD was not applicable to the slips. He believed that he told Mr Smith that he did not want to see the slips, but accepted that if he had seen the slip for Programme 1 only briefly he would have seen that it was a whole account XL treaty reinsurance which covered LMX. He would have then asked what was going on and would have cancelled the cover if he had known that it was that sort of business.
898. Mr Whitcombe's initial recollection was that he met Mr Broad at the Institute of London Underwriters' coffee bar on 4 March 1997 and was told that having received copies of the slips with the first bordereau, Mr Broad did not want copies of the slips in the future. Mr Broad denied that there had been such a meeting and Mr Whitcombe later accepted that there had been no such meeting.
899. Mr Broad's evidence about the provision to him of the first bordereau (which covered the business written in January 1997) was that it was brought to him by Mr Smith. He was surprised at the rapid growth in the account. He had asked Mr Smith how it was going. Mr Smith had told him that Mr Whitcombe had done a very good job and that there was a lot of income; Mr Broad had replied that he was glad to see that Mr Whitcombe was doing well. It was unclear to Mr Broad what sort of business Mr Whitcombe had been writing, although it seemed to him to be mainly XL. Mr Broad had asked what sort of business it was. He could not recall if Mr Smith had said that they were contracts or that he had then went away and came back and had said that they were contracts and not treaties; they were standard PA contracts and that Mr Whitcombe was familiar with them. Mr Broad said that he gave Mr Smith an example of what he meant by contract – a contract for an amenity group or something like that; Mr Smith agreed.
900. Mr Whitcombe denied that Mr Smith had ever come to him and had asked him the question which Mr Broad said he had been asked; he would not have told Mr Smith that they were standard PA contracts or that he was familiar with them. In his second witness statement, Mr Whitcombe said that it was quite likely he was asked by HHI about the risks bound and would have said that they were all in line with the account breakdown in the business plan, as part of the non-proportional account; "of their type, the risks bound were standard contracts".
901. A further bordereau was produced showing the business written as at the end of February 1997; Mr Broad scratched this bordereau on 14 March 1997 (see paragraph 924).
902. When asked about this bordereau, Mr Smith's account was that he used to take the bordereaux to Mr Broad; in most cases Mr Broad would look at them and would ask questions or hang onto the bordereaux; he could not recall any comments on the specific bordereau.

(b) The "class" bordereaux

903. Mr Whitcombe's and Mr Henton's evidence was that Mr Smith told them that Mr Broad did not want the load of paper that Mr Whitcombe provided (the slips and the other documents) and asked for a summary instead.
904. As a result, Mr Henton produced a further bordereau for business written as at 28 February 1997. This contained a description of the class of business written, taken directly from the slip. Thereafter there were two bordereaux – one showing the information originally provided and one showing the description of the class of business written – this further bordereau being call the "class bordereau".
905. Mr Broad said he did not recall seeing the "class bordereaux", though he scratched one on 11 February 1998 (as set out at paragraph 1295 below) together with the other documents he was presented with on that day; he did not believe he had ever seen them and he had not said that he wanted them.
906. On the first class bordereau there were references to the contracts containing LMX and also references to commutation and sunset clauses. Mr Broad accepted in his evidence that from the description on the class bordereau it was evident that the business being written was treaty business including LMX.
907. In the first class bordereau that remained extant, the descriptions in the case of JEH Re did not follow the wording of the slip; the wording on the slip was "All W.C.A. "Carve-Out" business to have Sunset Clauses not exceeding 5 years, and commutation clauses at 5 years as original". On the version given to Mr Broad, the description was "All business classified as Accident and Health and related benefits issued by various companies and reinsured by the reinsured. All Occupational Accident business to have Sunset and Commutation clauses as original".
908. A deliberate change had therefore been made to remove the words "W.C.A. "Carve-Out"" and substitute this with the more ambiguous term "Occupational Accident" discussed at paragraphs 134 and 135.
909. Mr Henton's evidence was that the request was made by Mr McCarthy at The Tea House, a pub in Creechurch Lane. He was unable to say that the request came from Mr Broad, but assumed that it had; he could not recall any reason being given; the words meant the same to Mr Henton and he thus saw no significance in the change. His evidence was that later in 1999 he was told by Mr Smith that the request came from Mr Broad. Mr Whitcombe's evidence was that the words "WCA carveout" were removed at Mr Broad's request; he believed that they were asked to do this by Mr McCarthy who was relaying a request from Mr Broad. Mr Whitcombe accepted that the substitution showed a very different type of business and that "occupational accident" was the term shown in the business plan; at the time he did not draw the inference of concealment or consider why the change was made. At the time he did not believe that Mr Broad was concealing something from SD, but he did now.
910. Mr Broad's evidence was that he was not involved in the alteration to delete the word "carveout" and to substitute "occupational accident". In February 1998, there was a further alteration in the class bordereau; this bordereau was scratched by Mr Broad in its altered form on 11 February 1998 – see paragraph 1296. I set out my conclusion on this at paragraph 1067.
911. From this time onwards monthly bordereaux were provided by EIU to HHI with one sheet showing the business written and the other being the class bordereau.

(c) Information that should have been obtained from the bordereaux

912. Mr Whitcombe's and Mr Henton's evidence was that they believed that Mr Smith was showing Mr Broad the bordereaux, though Mr Henton's evidence was that he subsequently learnt (from a conversation with Mr Smith) that Mr Smith did not show Mr Broad all the bordereaux; Mr Smith had not passed on the monthly bordereau where there were no changes.
913. There was a copy of the class bordereau showing the business written as at 28 February 1998 which contained various manuscript annotations relating to the business. Though this was disclosed by HHI, it was not clear whose writing it was. It was probably not Mr Smith's but might have been Mr McCarthy's; it can reasonably be inferred that someone at HHI had asked questions about the business at the time.
914. Mr Broad did not recall reading the bordereaux. It was his evidence that SD received about 200 bordereaux a month and that it was not his practice or function to read them; he was waiting to see what happened. He said that the account names on the bordereaux, such as Lincoln National and John Hancock, would have meant nothing to him save that they were large US companies. He did not regard what was described as treaty business. He did not consider that the rates were necessarily cheap – it was impossible to tell without information about the rating history. He was not looking to see if Mr Whitcombe would be writing the kind of business that Syndicate 103 had written. He considered that he was entitled to rely on matters being brought to his attention as he expected the business to be conducted in the utmost good faith; he trusted them as to the way in which the binder would be run.
915. Mr Broad's evidence also was that he wished that he had gone through them with a toothcomb, but that was not his practice. He accepted that, if he had gone through them, it would have become apparent to him that Mr Whitcombe was writing treaty business. He was shown three bordereaux in 20 months, but he did not read them as it was not his job to do so. He was being assured by the broker that it was a marvellous binder and had no reason to examine them in detail.
916. As set out at paragraph 893, the bordereaux showed who the broker was and thus showed that almost all the business came from SCB. Mr Broad's evidence was that the intention was that the business should come from a whole range of brokers; that the business did not come from a whole range of brokers was not a matter of overwhelming concern; the fact that it mostly came from SCB did not really register.
917. Mr Broad said that he had no recollection of seeing any of the subsequent bordereaux in 1997, though he did scratch the bordereau for business written as at 30 April 1997 on 11 June 1997 – see paragraph 942 below.
918. He did see the bordereau for business written as at 31 January 1998 on 11 March 1998 and he requested full details (by a manuscript note on the document) about the entry in relation to Programme 28 as it had such a large premium to SD – $7.5m; he did not then think that it was treaty business, though he accepted, looking at the matter at the time of the trial, that it looked like a treaty (see further paragraph 1316).
919. Mr Broad's evidence was that Mr Smith would have taken the bordereaux away and sent them on to Brighton. They might have gone to Brighton or to the clerks in his department.
920. The bordereaux sent by EIU to SD could not be found either at SD's offices in London or in Brighton where SD had their "back office"; there was nothing that could be found as a "HHI bordereaux file".
921. The general practice of SD was for SD to send bordereaux to Brighton, though some underwriters kept them in the underwriting room in London. At Brighton they should have been put into the data system but were not as there had been problems with the system; only the slip details were put into the system. If the bordereaux stayed in London they were not put into the system as most underwriters wanted to focus on underwriting and not on data capture.
922. Mr Tunstall's evidence was that it was standard practice to file bordereaux; they were only checked very rarely. He believed the bordereaux were sent to Brighton for people to input into the system. Mr Bentley's evidence was that there was no reason for the bordereaux under the EIU binder to be sent to Brighton necessarily; the slip had been entered FDO (for declaration only) in March 1997 and net accounting was occurring; there was thus nothing for the staff at Brighton to enter. An internal SD memorandum confirmed that the bordereaux were not in fact sent to Brighton.

(d) 14 March 1997: premium income limit and the bordereaux

923. Mr Whitcombe's letter of 3 March 1997 (to which I have referred at paragraph 895) also stated:

"I have several contracts coming up which are worth writing and I feel an increase to £3.5m on a $2-[£]1 ratio will suffice for quite sometime."

924. Mr Broad agreed to an increase in the premium income limit on 14 March 1997 from the agreed £2m to £3.5m; Mr Whitcombe was told of the increase by Mr Smith in a letter dated 21 March 1997. Mr Broad had no specific recollection of a discussion with Mr Smith about an increase in the limit, though he accepted that it might have been discussed over the meal at the pub on 7 February 1997. His evidence was that he had agreed to the increase because he had been allocated £3.5m to write PA business and had decided to give the allocation to the binder as SD had written little themselves; although he accepted that the account had grown very quickly, he agreed to this increase without any proper enquiry as to the business that had been written.
925. Mr Broad did not go through the bordereau which he had scratched that day (to which I have referred at paragraph 900). This showed the business that had been written as at 28 February 1997 and that the premium income for the business written had risen to $2.5m and £283k (about $3m in total); this large rise was due to two contracts written for American Reliable and four for Phoenix. It showed that low layers had been written and that lines of 90% had been accepted (except for one of the American Reliable contracts ($500,000 xs $750,000) where a line of 55% had been accepted).
926. Mr Broad's evidence was that Mr Smith should have drawn this to his attention; if a line of 90% was being written, then Mr Whitcombe was leading (in contravention of the terms of the binding authority). Mr Broad did not appreciate that Phoenix were one of his reinsurers under the internal programme (as set out at paragraph 673). He was, on the contrary, delighted that the binder had got off to such a good start.

(2) Instructions to obtain separate reinsurance

(a) Mr Whitcombe's understanding of the business by March 1997

927. Before setting out what had happened at the meeting on 21 March 1997 between Mr Broad, Mr Smith and Mr Whitcombe, it is necessary to set out Mr Whitcombe's evidence of his understanding of the business being written by Mr Henton.
928. His initial understanding was limited, but as set out at paragraph 793, Mr Henton had explained each of the five programmes to Mr Whitcombe before the programmes were confirmed.
929. Moreover, by March 1997 Mr Whitcombe had read the letter from the run-off agency of Syndicate 103 (set out at paragraph 514) which set out the problems (which had taken 3½ years to become manifest) in relation to the PA spiral. Mr Whitcombe accepted that this showed that, apart from the effect of a spiral in magnifying claims, serious problems could occur, particularly in relation to the period of run-off and to the cash flow effects. His evidence was that by March 1997 all he perceived was an impact on cash flow and he expected that the Names on Syndicate 103 would get their money back.
930. Although the business that EIU was writing was the same type of business as that which had been written by Syndicate 103, he did not stop writing the business; Mr Whitcombe's evidence was that the fact that Mr Bird had run into problems did not mean that Mr Henton would. Even though the position of EIU's business was dependent on reinsurers, he considered that the reinsurers were different and that they had been writing this business for years seemingly without any problems.
931. Mr Whitcombe never told Mr Broad about the cash flow problems encountered by Syndicate 103. Mr Whitcombe's evidence was that he did not necessarily see a similarity in the position between Syndicate 103's reinsurers and EIU's. He accepted however, that the letter made clear that there was an inherent problem with cash flow because claims had to be paid at once and reinsurance collected quarterly. Mr Whitcombe said that he continued with the business as it made money.

(b) The meal at the pub at Tadworth on 21 March 1997

932. Mr Smith's account was that Mr Whitcombe had seen SD's reinsurance cover notes and that he had been told by Mr Whitcombe that the reinsurance did not go far enough as it did not cover incidental LMX.
933. It was Mr Henton's evidence on the other hand, that either he or Mr Whitcombe was told, through a telephone conversation with Mr Smith on Friday 21 March 1997, that SD's reinsurance programme was not responding to the account that EIU had written. It was a worry, but he also knew that Mr Broad was meeting Mr Whitcombe for dinner that evening. Mr Whitcombe and Mr Henton did not tell Mr Broad of the consequences in writing, as he was well aware that it was potentially disastrous.
934. Mr Henton's evidence was that sometime after 21 March 1997, he was told by Mr McCarthy that the problem was caused by a treaty exclusion but when they saw the cover notes they appreciated that the reason that they were not covered was because of the exclusion of LMX business howsoever assumed. Mr McCarthy had told him that he had spoken to Mr Broad and had asked him as to why he had been so stupid.
935. On Friday 21 March 1997, Mr Smith recorded:

"I have been advised by Mr Vic Broad of [SD] that, contrary to his previous advice, their own reinsurance programme will not respond to this account. Can we please take necessary action. J Whitcombe informed."

Mr Smith's account was that this note was made after dinner that day at which Mr Whitcombe had discussed the classes and types of business and Mr Broad had agreed with Mr Whitcombe that his reinsurance did not go far enough.

936. There is no doubt that there was a meeting that Friday between Mr Broad, Mr Smith and Mr Whitcombe which took place over a meal at a pub at Tadworth. According to Mr Whitcombe, it was a meeting between Mr Broad and Mr Smith into which he crashed as he was again staying at Mr Smith's. He did not take Mr Henton along to the meeting for that reason. Mr Broad's recollection was that it was arranged because Mr Whitcombe was staying with Mr Smith for the weekend. It was difficult to keep Mr Broad to business matters; although the meeting lasted a few hours, they only discussed reinsurance for 15-20 minutes; there was a lot of discussion about personal matters. Mr Broad's evidence was that it was quite a "liquid" and convivial evening although he was not a heavy drinker.
937. There was clearly a discussion about reinsurance:

i) Mr Broad accepted that it was probable that there was a discussion about reinsurance. Mr Whitcombe had always suggested reinsurance and Mr Smith was keen on pressing for it to generate business for him.

ii) Although Mr Broad accepted, as set out at paragraph 681, that he had initially told Mr Smith that SD's own programme would cover the business written under the binder, he did not tell him in March 1997 that it would not. His position was that by March 1997 he felt that the binder business should have its own reinsurance programme because of the volume of premium written, even though he considered that SD's own reinsurance programme would respond. Mr Smith was pressing Mr Broad to get a reinsurance programme and, as the binder was earning sufficient premium, he felt that HHI should have the opportunity of placing a reinsurance programme for the binder and earning commission, rather than the brokers who had placed SD's own reinsurance programme but who had brought SD little by way of business.

iii) Mr Broad did not accept that Mr Whitcombe emphasised the importance of reinsurance but accepted that it was possible he had. He was definitely not told or given to understand that the account was only going to make money by writing against reinsurers; he would have recalled that as it was against his whole philosophy. There was also a discussion about the method of paying the premiums on the reinsurance.

iv) Mr Broad's evidence was also that he had been pressed by Mr Whitcombe and Mr Smith to place reinsurance and he was told that SCB and WFD would be able to place it for SD. He thought that the involvement of WFD might help SD as WFD were not using SD. If he had been aware of the fact that there was no reinsurance he would have panicked as there would have been the exposure without any protection.

v) It was Mr Whitcombe's evidence that the discussion over the meal on 21 March 1997 was on the basis that the reinsurance would not respond; he was horrified to learn that business had been written without reinsurance; it was frankly frightening. He told Mr Broad this and told him that it was exceptionally dangerous. Despite this Mr Broad went on cracking jokes as that was his manner. He could not believe that he had been let down in this way; his thoughts were about getting something done about the reinsurance and his mind was on that one thing. It was left on the basis that he would pull things together to get something put together quickly. The reinsurance was felt to be placeable. He rejected Mr Broad's account of the evening; Mr Broad was very worried.

vi) Mr Smith's account was that although he could recall Mr Broad and Mr Whitcombe agreeing that SD's programme did not go far enough (as I have set out at paragraph 934), he could not recall Mr Whitcombe saying that SD would face catastrophic losses or be blown out of the water. He did not know that EIU had subsequently ceased accepting business.

938. I am satisfied that there was a decision that Friday evening that a separate reinsurance programme would be obtained, as on the following Tuesday (25 March 1997), EIU instructed SCB and WFD to try and obtain a reinsurance programme – see paragraph 946. The probabilities are that there was some discussion as to the scope of the coverage but that it was vague. I am sure that Mr Broad was susceptible to the arguments of Mr Smith that he should have the opportunity to earn brokerage through a separate programme as on 21 April 1997 Mr Broad insisted that HHI received 20% of the brokerage – see paragraph 954 below; without a great deal of thought or enquiry (as was characteristic of the way in which Mr Broad dealt with the binder) he agreed that a separate reinsurance programme be purchased. I set out at paragraphs 1049 and following my conclusion as to his state of knowledge regarding the business being written and as to the consequences of the lack of reinsurance.
939. It was suggested to Mr Broad on the basis of Mr Smith's account, that Mr Broad wanted to discuss the bordereaux with Mr Whitcombe and that the purpose of the meeting was to discuss the first bordereau. Mr Broad disagreed.
940. Mr Whitcombe's evidence was that as the business so far written was all XL he was embarrassed at the level of commission that EIU was receiving; Mr Broad had said that that was not a problem as it would all balance out over time as direct business was written. Mr Broad's evidence was that he had no recollection of that; he had never got into such a discussion; had Mr Whitcombe been embarrassed at the level of his commission, they would have gone to an expensive restaurant and not to a pub. If Mr Whitcombe had spoken about XL it would not have been implicit that he was talking about XL treaty business as facultative XL business could have been written.
941. It was Mr Whitcombe's account that he made it clear at the dinner that no new business would be written until reinsurance was in place. Mr Broad did not agree he was ever told this. Mr Smith also denied this (as set out at paragraph 942 below). There was nothing in EIU's November 1997 report to SD (see paragraphs 1105 and following) to the effect that they had ceased underwriting. Mr Henton's evidence was that they had told Mr Smith of the problem and could not accept Mr Smith's account to the contrary.

(c) EIU cease to write business

942. A note written by Mr Henton in December 1997 recorded that EIU ceased underwriting on 21 March 1997. It was the evidence of EIU that they ceased because of what they had been told about the reinsurance position. EIU did not write any further contracts, save for one risk written in October 1997 (see paragraph 1025), until after they had been provided with reinsurance by Mr Brown in December 1997.
943. Mr Smith's account was that he had no recollection of being told that EIU had ceased to write business, but he did know and assumed that Mr Whitcombe had reached his premium income limit. Mr Broad was clear in his evidence that he was not told this and that he never knew it. Although the bordereaux showed that there was no new business, his evidence was that he had not seen any bordereaux between March and December 1997; he did see the bordereau for business written as at 30 April 1997 on 11 June 1997 and had initialled it; it was suggested to him that this bordereau was brought to him because there was a change to see. Even if he had known that there was no new business being written he would not have been concerned as all the business under the account might have written at the beginning of the year.
944. On 11 April 1997, Mr McCarthy made a manuscript note on the second sheet of the class bordereau for business written as at 28 February 1997, stating that the March business was mainly XL with a premium income of $1m and that Mr Bird's pro rata treaty would have an August inception. Mr Henton's evidence was that this was probably made during one of his discussions with Mr McCarthy and that it probably referred to business being written for WFD for Legion Insurance Company (Legion) (which was owned by Mutual Risk Management Ltd.) in March 1997; the reference to Mr Bird's treaty was a reference to what was in the business plan (see paragraph 628). There was no note in this document about not accepting new business because of the problem with reinsurance.
945. It was the submission of SCB that this had indicated to them that EIU were attempting to follow a proper net underwriting approach as EIU had stopped writing once the reinsurance position had become clear. I do not accept this. Mr Whitcombe and Mr Henton had stopped underwriting because they had nearly reached the premium limit and they knew that to write any more business without reinsurance would cause disastrous losses. As had occurred on other occasions (such as Mr Whitcombe's intervention in relation to Programme 16 (Unum) described at paragraphs 382 and following of Part II), I am sure that it was Mr Whitcombe who had decided that they should cease underwriting. Although he had never properly understood the business being written by Mr Henton, when he had appreciated the consequences of the business being written without reinsurance, he had decided that continuing underwriting was something that they should not do.

(d) The instructions given to SCB and WFD

946. As set out at paragraphs 779 and following, Mr Henton had asked WFD to obtain a quote for the layer $50,000 xs $10,000 and Mr Durling had quoted on 25 February 1997. Mr Broad instructed HHI to purchase a layer $50,000 xs $10,000 on 21 March 1997, though no firm order was given until 21 May 1997 – see paragraph 952.
947. On Tuesday 25 March 1997, following the discussions on Friday 21 March 1997 at the pub at Tadworth about reinsurance (as set out at paragraph 936), Mr Henton requested Mr Johnson of WFD and SCB to jointly place a reinsurance programme; he also scratched a note of the proposed reinsurance programme. WFD told him that they would do all that they could to get the reinsurance placed. According to Mr Henton's letter of 30 May 1997, it was anticipated that WFD would seek quotes on the top layers and SCB would seek quotes on the lower layers. SCB were optimistic and expected it to be placed easily. Mr Henton's evidence was that WFD were optimistic about getting reinsurance for them.
948. It is, however, difficult to see how Mr Johnson could have said this given his evidence as to the state of the market – that the market was hardening and that it was becoming increasingly difficult to place reinsurance in 1997. SCB remained optimistic until June 1997.
949. Mr Johnson's evidence was that when EIU suddenly realised that they did not have the benefit of SD's protection, they were concerned that they had written the business without reinsurance and had remained anxious about it.
950. Mr Butler's evidence was that he was told in late March 1997 that the reinsurance programme that EIU thought it had was not in existence; he was astounded at the news. SCB were asked to look for reinsurance and were told that EIU wanted a protection for the whole of the business under the binder. Mr Brown's recollection was that either he or Mr Butler were told that SD had said that the reinsurance programme that SD had claimed would accommodate the business was not available and that it would not be allowable for EIU to cede business to it.
951. Mr Butler did not then think that it would be as difficult to get reinsurance as it turned out to be; if he had been told to get reinsurance on 27 January 1997, he might have got it as there was reinsurance down to that sort of level at that time.

(e) The 20% line put down by American Reliable

952. On 1 April 1997, American Reliable put down a 20% line on the layer $50,000 xs $10,000. Mr Johnson said that there was no order until July 1997 and thus was unable to place it until then; this was not correct as an order had been given by Mr Broad earlier.
953. It was only on 21 May 1997 that Mr Broad gave a firm order for the layer $50,000 xs $10,000 with American Reliable and this was immediately passed to WFD; before the firm order was placed, SD had approved American Reliable as security. Mr Broad said that he was told when the reinsurance was placed with American Reliable and that he was also kept informed that little further progress was made in mid-1997. As set out at paragraph 985, no other insurers subscribed and in July 1997 American Reliable confirmed that it would write 100% of the reinsurance of SD at the layer $50,000 xs $10,000.
954. Mr Broad said that he did not appreciate that Mr Whitcombe had written a programme reinsuring American Reliable. Mr Whitcombe accepted that he should have told Mr Broad about this as the business would spiral back, but his evidence was that he did not put the two things together.

(f) Mr Broad's involvement on 21 April 1997

955. On 21 April 1997, Mr Broad wrote to Mr Smith and referred to "recent discussions concerning the XL protection that John Whitcombe wishes to purchase to protect the downside of the facility". The letter went on to deal with the broking arrangements for the placing of the reinsurance and with the split of brokerage – 20% to HHI and 80% to be split between SCB and WFD. Although the letter referred to Mr Smith's involvement being necessary to keep him informed, Mr Broad's evidence was that he wrote this to ensure that HHI received some commission. Mr Whitcombe apologised to WFD for letting this happen; he said that it was entirely for the benefit of Mr Smith who had not wanted to lose out on commission.
956. The letter showed no sense of urgency; Mr Whitcombe accepted that there was nothing in the letter to reflect the precarious position that he felt they were in; he did not want to get Mr Broad into trouble with Mr Watson.
957. Mr Henton accepted that at this time he knew that SD faced claims under the business written in excess of $10m – exceeding the whole of the premium income for 1997; they never wrote to Mr Broad to point this out as it had been Mr Broad's mistake and they were trying to sort it out.

(g) The information prepared for reinsurers on 4 April 1997

958. Mr Henton provided the information which WFD took the lead in presenting. A sheet was prepared by WFD and approved by Mr Henton on 4 April 1997 in the format used by WFD for this business. It gave the premium income as £5m written and £3m signed, the line size, and the breakdown of the account as:

60% international

35% proportional

5% LMX

It also stated (as mentioned at paragraph 646):

"The account is new for 1997 and therefore has no claims experience. The underwriter is John Whitcombe who has had many years of experience in Lloyd's."

Mr Johnson said that this was very good information for a startup and was the "bog standard" level of information required. The inclusion of 5% LMX was, it appears, based on the documents described at paragraphs 961 and 962.

959. There is no document that recorded what had happened between then and 13 May 1997 despite the fact that it was urgent that reinsurance was obtained; a note of Mr Henton's that was written on 30 May 1997 attributed the delay to the travelling commitments of Mr Brown and Mr Johnson. It was SCB's evidence that they were doing their best but without success; however, there was no detailed exploration of the position in their cross-examination. Given the clear urgency in dealing with the position which EIU were in, with substantial programmes having been accepted and there being no reinsurance to protect them apart from the 20% line on the bottom layer, the obvious inference is that there was no market or that SCB did not regard the matter as urgent given that they had dumped all the losses on SD and their reinsurers.

(h) Further activity: 13-14 May 1997 – LMX

960. On 13 May 1997, WFD sent to HHI a copy of the proposed slip, the information sheet and the proposed programme. The slip was a standard PA reinsurance slip; LMX was included in its description of the business that was written by the reinsured. Mr Smith and Mr McCarthy never queried the inclusion on the information sheet of the business being 5% LMX or of the inclusion of LMX on the slip. The proposed programme set out the lead line on the bottom layer from American Reliable and stated that information was awaited from SCB on all the other layers, save for the layer $5m xs $5m where ISA (acting on behalf of Manulife) had indicated terms.
961. Mr Whitcombe thought that the information sheet had not been shown to Mr Broad. Mr Broad said that he could not recall seeing it and that he was surprised at the document. He accepted that it looked like the account of Syndicate 103 with the direct business removed. He would have expected Mr Smith to show it to him, but it was quite possible that Mr Smith had withheld it from him as there were reasons why that might be so. Mr Broad's evidence was that he could not recall being shown the slip either. Mr Smith was a person who might not have paid proper attention to what had happened and had preferred to let the situation lie and not drawn to Mr Broad's attention.
962. On the following day, 14 May 1997, Mr Henton supplied further information about the business he had written up to that point to Mr Johnson. This explained where the figure for 5% LMX had come from. Mr Johnson was given a list of the programmes written which gave the aggregate exposure as it showed the maximum exposure for any single loss on the assumption that that loss affected each programme; this was done on a per occurrence basis ($7.2m) and on the basis where that loss occurred as part of a series of different losses (as unlimited reinstatements were given under most of the reinsurances written by Mr Henton) ($6.5m). The sheet showed that the retro exposure on Programme 2 (Phoenix) and Programme 3 (American Reliable) was 5%; however, the column for Programme 1 (John Hancock per JEH Re) was left blank; Mr Henton's evidence was that he did not know what the retro content of Programme 1 was; he had been told (as set out at paragraph 10 of Part II) that Mr Billyard was concentrating on the writing of direct writers.
963. Mr Henton also prepared a summary of the business written about this time. This showed that 27 contracts had been written; five reinsured direct writers (Programme 5 – John Hancock per Hackett and Programme 4 – Lincoln National), 14 reinsured the reinsurers of direct writers (Programme 1 – John Hancock per JEH Re, Programme 4 – Lincoln National and SRRF) and eight reinsured two US-based companies with a 5% retro involvement (Programme 3 – American Reliable and Programme 2 – Phoenix). Mr Henton's evidence was that although Mr Billyard had described Programme 1 as a reinsurance of LMX, he considered that there was only LMX where EIU were reinsuring a London domiciled company; as John Hancock were not a London domiciled company, they had not written any LMX business on that definition; he had therefore classified Programme 1 in his mind as international XL even though Mr Billyard had classified it as his LMX account. By international XL he meant business that was not LMX and which was not retro or spiral. Mr Henton's evidence was also that when he provided the figure of 5% for LMX business which was recorded on the information sheets for the business accepted by EIU, he could have been referring to retro or spiral business and he might have confused the two.
964. In my view, these two documents need to be treated with considerable caution because of the way in which Mr Henton dealt with his accumulation calculations – see paragraph 11.iv) of Part II.

(i) The meeting of 19 May 1997

965. On 14 May 1997, Mr Henton spoke to Mr Butler; Mr Henton's note of that conversation recorded Mr Butler stating that prices indicated for reinsurance were 50%-60% of net premium income. Mr Butler's evidence was that in comparison with the price of 25% which might have been available earlier, this was double; these may have been oral indications.
966. On 19 May 1997, there was a meeting at SCB's office between HHI (Mr Smith and Mr McCarthy), EIU (Mr Whitcombe and Mr Henton), SCB (Mr Butler) and WFD (Mr Johnson and Mr Davis) at which the difficulties in placing were discussed. These were attributed to the losses that had occurred in 1993/4 which were affecting the US market by then. Mr Henton's note of the meeting recorded that no London cover was available and that the prices quoted were extortionate; they were now in May and outside the normal time of the renewal season. Those attending the meeting were told that cover was definitely available. SCB and WFD wished to see if SD's reinsurance programme could be extended to include EIU's business as that would be cheaper than an entirely separate reinsurance programme. There was a reference to the possibility of Lincoln National covering it – Mr Butler did not know whether this was a reference to Mr Bird under the Big Ben facility or to Mr Dumenil at Lincoln National's London office; it is difficult to understand this as Lincoln National had decided that the Big Ben facility would not be used for LMX – see paragraph 740.i).
967. Some oral evidence was given about this important meeting. Mr Butler's evidence was that he could not recall saying prices were extortionate nor to speaking with anyone about any definite pricing; he could not recall details of the meeting. Mr Brown did not know why it was said that prices were extortionate; he did not believe that they had given any indications or quotes. Mr Butler could not recall the specific timing but there was a point in time when the 1993/4 losses had come through and people were saying that they had received losses they had not expected to receive. Mr Brown's evidence was that by the time of the meeting, some of the North American reinsurers participating in spiral business were suffering losses; he did not, however, know about the level and content of those losses. Mr Johnson could not recall attending the meeting.
968. It is clear to me that Mr Henton's note was accurate and that although EIU were told that reinsurance was available, SCB and WFD could not find anyone to write it. It is confirmation of the position that I have set out earlier at paragraph 746 that there was no market for this type of business in 1997.
969. I consider that the reference to the extension of SD's reinsurance programme was a reference to seeing if the LMX exclusion could be removed. Mr Broad's evidence was that this was never raised with him.
970. On 20 May 1997, WFD prepared a revised information sheet (with a reduction in the premium income written from £5m to £3.5m and the premium income accounted for from £3m to £2m, as well as a reduction in the line sizes) and sent it to HHI with a request that they obtain an order for the bottom layer. Although Mr Broad gave a firm order for the placing of the layer with American Reliable on 21 May 1997 (as set out at paragraph 952), Mr Broad's evidence was that what was said at the meeting on 19 May 1997 was not reported to him. He also denied seeing the information sheet prepared by WFD; SCB submitted that it would have been extraordinary if it had not been shown to him by HHI, as it was sent to EIU and HHI. There was no evidence that it was. Furthermore, given Mr Broad's inattention to paperwork which would have ordinarily interested a prudent underwriter, I am sure that he would not have looked at it even if it had been offered to him.

(j) SCB's approaches to Mr Billyard, Mr Cackett and others

971. On 21 May 1997, Mr Cackett was approached by SCB; the fax stated that there was only £2m of original premium income under the facility and that Mr Butler had thought that that was being optimistic; Mr Brown could not square this with other information that had been given about the amount of business that had been written. On 23 May 1997, Mr Butler reported to Mr Henton that Mr Cackett had expressed an interest in writing three of the layers.
972. On 28 May 1997, Mr Butler told Mr Henton that Mr Cackett had declined to provide reinsurance as he had reached his aggregates for that type of risk. Mr Butler's evidence was that this had surprised him at the time as Mr Cackett was a known arbitrageur and had bought down to extremely low retentions; I find this evidence surprising because, as I have set out at paragraph 742, Mr Cackett did not reinsure spiral business and, as set out at paragraph 983, Mr Cackett had told WFD that he had declined the reinsurance because of its LMX content.
973. In the same conversation Mr Butler suggested an approach to Lincoln National's London office (where Mr Dumenil was the underwriter); Mr Dumenil was writing LMX and the Big Ben facility was unable to accept whole account LMX. The only other suggestion which Mr Butler could make was to await Mr Brown's visit to Bermuda which was planned for 3 June 1997. Conversations with WFD disclosed that the best way of approaching Mr Dumenil was through Lloyd Thompson.
974. On 30 May 1997, Mr Henton wrote to Mr Brown, setting out his account of the position with a copy to WFD; he noted that Lincoln National had been proposed as a possible lead and that he was going to speak to Lloyd Thompson that day. When he spoke to Lloyd Thompson, they expressed the view that two of the accounts written had more retro business than the information suggested and they wanted a confirmation of EIU's understanding of the content before approaching potential reinsurers; this is referred to again at paragraph 1002.i).
975. Mr Brown was in Bermuda in early June 1997; his evidence was that he would have spoken to people about placing the reinsurance. On 10 June 1997, Mr Brown or Mr Butler approached Mr Billyard; Mr Henton's note recorded that on 11 June 1997 Mr Billyard did not want to do it, but they expected that he would write the layer $140,000 xs $60,000. Mr Brown could not recall what had happened at the meeting with Mr Billyard.
976. Mr Butler sought Mr Henton's permission to speak to Phoenix about the retro content of the account. Mr Butler accepted that through the reinsurances placed with SD, Phoenix and Mr Billyard had reduced their exposure to the spiral. However, he would not accept that they did not want to come back in.
977. On 16 June 1997, Mr Billyard declined to write the reinsurance. The reasons given to Mr Henton are important, partly because of the content of the account written by Mr Billyard, and partly because Mr Billyard did in fact, later in the year, provide a substantial amount of reinsurance for SD for 1997 (as set out at paragraphs 1131 and following). On 17 June 1997, Mr Henton received a call from Mr Butler; Mr Henton recorded that Mr Butler had told him that Mr Billyard had declined the reinsurance:

"due to the fact that he has no coverage for this business. We have written his r/i which states that no retro is to be written."

Mr Henton said that the first sentence of his note was a reference to what he was told; the second sentence was either a reference to what he was told or was a note he had written to himself. Mr Butler could not recall the conversation; he did not think it was right that he had said that no retro was to be written – Mr Billyard was writing it but was reducing his writing. Mr Henton accepted that this was correct and that Mr Butler had said to him that Mr Billyard was reducing his retro, not that no retro was to be written (see further paragraph 10 of Part II). Mr Butler could not recall what he told Mr Henton about Mr Billyard's coverage; his evidence was that he was told by Mr Billyard that he did not have the capacity – Mr Butler thought that that probably meant that Mr Billyard had not got enough vertical aggregate left to make sure he did not go out of the top of his programme. Mr Brown's evidence was that he believed that Mr Billyard had declined to write the reinsurance in June 1997 because he did not have enough aggregate to cover it; Mr Brown was sure that he would have discussed the position with Mr Billyard, but he could not recall.

978. Mr Butler also told Mr Henton that Clarendon had declined due to the old year cash flow problems they had experienced through the Lloyd's market (Mr Owen) and because their management agreement by that time excluded such business; Mr Henton said that he thought that the references to cash flow were to the problems with the 1994 year (to which I have referred at paragraphs 436 and 451). Mr Butler's evidence was that he did not know to what this referred, though he knew that there was a time when cash flow became a problem, but could not recall if that was in June 1997. As I have set out at paragraph 542, I am sure that he was aware of such problems by 1996.

(k) SCB's failure to place the reinsurance of SD

979. Mr Butler then made various suggestions as to approaches that could be made, including Mr Brian Traxler at Beach & Associates Ltd. (Beach) who had a binding authority for Dorinco Reinsurance Company of Midland, USA (Dorinco Re) (a Doctors company); Mr Traxler had previously worked for Crown Life and Hanover Re and had, according to Mr Butler, previously written LMX aggregate business. He was not able to help immediately as his management agreement was not finalised yet. Mr Butler told Mr Henton that SCB could not "help" further.
980. Mr Butler's evidence was that there came a point when they had nowhere else to go – they had spoken to the markets. Mr Brown's evidence was to the same effect.
981. Neither Mr Brown nor Mr Butler would accept the suggestion put to them in cross-examination that John Hancock (per JEH Re), Phoenix and American Reliable would not reinsure the business written by EIU because they would thereby lose the advantageous position they had had in using SD as a "dump" and in not having had to re-create the spiral that had existed in prior years. Mr Butler did accept that without reinsurance Mr Whitcombe and Mr Henton were in a pretty desperate position through the writing of low level business on the back of reinsurance that was not there.
982. Although there is a record that SCB had one or two conversations with Mr Henton about reinsurance after the end of June 1997, nothing of substance happened until Mr Billyard agreed with Mr Brown on 12 November 1997 that he would provide the reinsurance for 1997 – see paragraphs 1131 and following.
983. Mr Whitcombe's recollection was that it seemed virtually impossible to get reinsurance.

(l) WFD's placement for the period of 12 months at 1 January 1997

984. WFD continued to approach the market. They approached GIO on 26 June 1997 and 16 July 1997 and obtained a 50% line on two layers; however, this only provided for two free reinstatements and was subjected to a warranty of no known or reported losses as at 16 July 1997. GIO stated that they did not provide uncapped cover. WFD also tried Mr Cackett (who said that he had already declined the reinsurance because of its LMX content) and New Cap Re (a company new to the market, described at paragraph 1129).
985. On 3 July 1997, Mr Smith wrote to WFD, asking several questions about the reinsurance programme – confirmation as to the placement with American Reliable and information on the quotes obtained from GIO; he said that he needed the information as he was meeting Mr Broad on 4 July 1997 and Mr Broad wanted answers to the questions that Mr Smith had asked. WFD responded, reporting on the position on 4 July 1997. Mr Broad could not recall any such meeting though he plainly had a meeting on 5 July 1997, as that was the day on which he scratched the business plan prepared by EIU in November 1996.
986. On 11 July 1997, EIU were told that 100% of the layer $50,000 xs $10,000 was placed with American Reliable. Mr Johnson's evidence was that he could not recall marketing it to others; American Reliable had only agreed to write the full line in July 1997 – the slip being scratched by Mr Durling on 5 June 1997 and confirmed by American Reliable on 7 July 1997. Mr Johnson's evidence was that although Mr Durling was not particularly interested, Mr Johnson had persuaded him to write 100% of the risk on the basis that SD had given him a good chunk of aggregate and that the least he could do was to give them $50,000 in return. In fact, this made little difference to the position of American Reliable for the reasons set out at paragraph 843. A copy of the cover note was sent to HHI on 15 July 1997.
987. As set out below at paragraph 1008, HHI saw Mr Broad on 14 July 1997 when an increase in commission was agreed; Mr Broad had no recollection of this meeting.
988. On 11 July 1997, Mr Johnson faxed Mr Traxler of Beach with information about EIU that had been provided by EIU themselves; this included a summary of Mr Henton's career and the business plan for EIU (which contained the same type of phraseology as in the earlier plans). There was nothing in the business plan which stated that the business being written was gross loss making and that a profit would be made on the backs of reinsurers. Mr Johnson's evidence was that he did not study it; when he put it forward he did not consider it misleading; he had no reason to suspect that the proposal was misleading as it was on EIU-headed notepaper. The only relevance of this document was that it was similar to all other documents which described the business, in that the business being written was not honestly described and was calculated to mislead. Mr Johnson was cross-examined, on the basis of the passages that were put to him, that the document was obviously misleading; he did not agree. I did not find his answers truthful.
989. Mr Henton stated in the document summarising his career:

"I was responsible for underwriting and leading, which included rating, of the varied spectrum of Personal Accident business written by the syndicate. This covered Individual and Group PA Schemes (including sports), London Market Excess of Loss, International Excess of Loss, Occupational Accident, [EEII] and Travel Accident Insurance."

990. This was clearly untrue; he excused this by suggesting in his evidence that it was an attempt to oversell himself and that people did that in their CVs. This was a document sent to a reinsurer who was being asked to reinsure what Mr Henton was doing. I have no doubt that this was a calculated lie designed to give the impression that Mr Henton had the experience suggested whereas he knew that he did not have that experience and had intended to mislead potential reinsurers.
991. Mr Johnson asked Mr Traxler to quote; Mr Traxler quoted on behalf of Dorinco Re in 23 July 1997 and agreed to write a stop loss in August 1997.
992. WFD approached others, including more of the Australian market, Bimeh of Iran (through their London office), Phoenix and RGA, and had meetings from time to time with Mr Henton during the summer and early autumn.
993. Mr Broad thought that he had two to three meetings with Mr Smith in the second half of 1997; on 8 September 1997, he had a further meeting with Mr Smith about the reinsurance and the brokerage. He signed a letter acknowledging that SCB's contribution to the placement of the reinsurance had been minimal and that the brokerage should be split on all the reinsurances (except the bottom layer) on the following basis: 33.33% to HHI and 66.6% to WFD. Mr Whitcombe understood that SCB's contribution was minimal; they had tried their best, but had got nowhere.
994. By 1 October 1997 WFD had placed a very incomplete reinsurance programme with effect from 1 January 1997:

i) $50,000 xs $10,000, with unlimited free reinstatements: placed with American Reliable in June 1997;

ii) $150,000 xs $350,000, with two free limited reinstatements: placed 50% with GIO;

iii) $750,000 xs $500,000, with two free limited reinstatements: placed 50% with GIO; and

iv) a stop loss for 15% of net premium income xs 85% of net premium income: placed with Dorinco Re in August 1997.

995. On 31 October 1997, Mr Broad scratched the note showing what had been placed. At the same time he scratched the programme placed for 15 months at 1 October 1997 (see paragraph 1092). The sheets he scratched for both sets of reinsurances showed M&D premiums of over $600,000 for what was very incomplete cover; Mr Broad's evidence was that he could not recall why he had agreed to this amount but that he was sure that there had been a discussion as he would not have allowed the reinsurances to be placed without a discussion of cost.

(m) Enquiries by SD about the writing of LMX business

996. There can be no doubt that enquiries were made by SD at some stage in the first half of 1997 as to whether EIU were writing LMX business. According to Mr Tunstall's evidence (which I accept as truthful), Mr Philo had heard a rumour in the market that Mr Whitcombe was writing LMX business and that the SD account was full of it; Mr Philo had told Mr Tunstall that he was most concerned and had asked Mr Tunstall to find out, as Mr Broad was away at the time either on holiday or on business.
997. Mr Tunstall put the timing of this as March 1997 in his statement, but he could not be precise about this and he could not definitely say that it had not been later, in mid-May or June 1997; all he knew was that it had occurred during a time when Mr Broad was away.
998. Mr Tunstall's evidence was that he telephoned Mr Smith and told him of the rumour; Mr Smith told Mr Tunstall that he would find out and revert to him. Either later that day or on the following day, Mr Smith went to see Mr Tunstall and told him that he had spoken to Mr Whitcombe who had told him that no LMX was being written. Mr Tunstall was quite clear in his evidence that Mr Smith was adamant that no LMX was being written as Mr Tunstall had to report this to Mr Philo; Mr Smith had not told Mr Tunstall "None LMX, but some incidental". He reported this to Mr Philo, who discussed the issue with Mr Broad on his return.
999. Mr Broad's evidence was that he was told of this by Mr Tunstall and he then discussed it with Mr Philo; this probably happened in March 1997; he had told Mr Philo that it was not an LMX account. Although Mr Tunstall had made direct enquiries of Mr Smith and had been told LMX was not being written, Mr Broad decided to inquire Mr Smith himself and get confirmation. He was told that Mr Whitcombe had confirmed that he was not writing LMX business.
1000. In his statement Mr Broad referred to the undated manuscript note referred to in the next paragraph and stated that he was told that it was possible that some cedants might have very minor incidental LMX involvements or that there might be some purely incidental exposure. When cross-examined about this, he said that he had been told that there was no LMX. It was clear to me that Mr Broad was giving his evidence on this point by reference to the note; the finding I make is that his account was essentially the same as Mr Tunstall's – he was told that no LMX was being written, but something might have been said of some LMX being included incidentally.
1001. The undated manuscript note written by Mr Smith to Mr McCarthy recorded:

"Ring Vic. Firstly as far as XOL since spoken to John. He made clear none LMX as such. When raised, incidental. John has asked to be confirmed for Sterling Cooke. WFD 5%. Reiterated no Lloyd's or company market."

Mr Smith's account was that this was an accurate record and that the reference to LMX being incidental was to the reinsurance of John Hancock per JEH Re (Mr Billyard).

1002. Another of Mr Smith's undated manuscript notes recorded:

"J.H. Whitcombe

1. Requires copy of proposal form (PI policy)

2. Broker Coleman

3. Fax from Willis Faber confirming placed 100% first layer $50,000 xs 10S

4. Update on…

5. Ring Vic Broad this morning.

6. Confirmation from [SCB] 5% incidental LMX."

Mr Smith's account was that Mr Broad wanted confirmation from SCB in relation to the 5% incidental LMX risk. Coleman was the placing broker; it might have been relating to other business; Mr Whitcombe's evidence was that the note was jumbled up but that part of it referred to the same conversation as that which was referred to in the other undated note.

1003. Mr Whitcombe could not recall speaking to Mr Smith in March 1997. However, he suggested that Mr Smith's note probably related to a query that had arisen in relation to LMX in June or July 1997. The evidence relied upon in respect of that was:

i) As set out at paragraph 973 above, on 30 May 1997, Lloyd Thompson, who were trying to place the outwards reinsurance, expressed the view that two of the accounts written by EIU contained more retro business than the information supplied by EIU suggested.

ii) On 17 June 1997, Mr Whitcombe wrote to Mr Smith, enclosing an information sheet from WFD and two letters from SCB. The information sheet that was enclosed was that which was provided by American Reliable which showed that the PA including retro was 5.25%. In the first letter, SCB confirmed, although they had not heard from Phoenix, their understanding that there was minimal retro exposure from Phoenix (see paragraphs 97 and following of Part II for the original information on which this was written):

"As you are aware there is hardly any retrocessional underwritings in 1997 and I would therefore expect most of their accounts to be of direct/whole account underwritings."

In the second letter, SCB confirmed, again without confirmation from Phoenix, that the retro content was 5%.

iii) The evidence of Mr Broad and Mr Tunstall was that they had not seen these enclosures, though Mr Broad considered that the letters ought to have been shown to him.

iv) Mr Whitcombe's evidence was that he recalled speaking to Mr Smith about LMX when he had raised a query in June or July 1997; he did not think that he had used the word "incidental" – he would have said "international". Mr Smith was dyslexic as a youngster and he used to muddle words up; he may have misunderstood matters. He thought that Mr Smith's note referred to the matter which was raised by Lloyd Thompson. As far as he could recall, he was never asked about the amount of LMX or retro business in the account at any other time.

v) Mr Whitcombe accepted that it would have been untrue to say that there was no LMX and to say that there was merely incidental LMX.

1004. Although the LMX content of the account was raised with Mr Smith in June 1997 in connection with the placing of the reinsurance, I accept Mr Tunstall's evidence of his conversation with Mr Philo; I am sure that questions were asked of Mr Smith in March 1997 and that Mr Tunstall was told that no LMX business was being written; Mr Broad was told something very similar at the same time and was not told about it again in May or June 1997. I do not draw any adverse inference from the fact that Mr Philo was not called; Mr Tunstall was an honest witness who gave a clear account of these matters and whose evidence I accept.

(n) Further meetings between Mr Whitcombe and Mr Broad in 1997

1005. Mr Whitcombe's evidence was that there was a further meeting with Mr Broad over lunch at Gladwin's at Minster Court on 24 March 1997; Mr Smith was not present. There was a discussion about personal matters, about the commission HHI were getting and about getting WFD to place the reinsurance. Mr Broad had no recollection of any such meeting; this was an expensive restaurant and he had only been there on certain occasions.
1006. It was the evidence of Mr Whitcombe and Mr Henton that although there may have been meetings or casual encounters with Mr Broad at which other matters were discussed, nothing of significance in relation to the binder was discussed in the remainder of 1997 up until the Christmas Eve placements. Mr Whitcombe thought that he had seen Mr Broad on several occasions as he had diary entries for 16 July 1997 and 8 October 1997; Mr Whitcombe had sat next to Mr Broad at the IBRC dinner on 15 October 1997. Mr Whitcombe had also bumped into Mr Broad when he was out and about. In those meetings he would have told Mr Broad where they were on the reinsurance.
1007. Mr Whitcombe met Mr Smith quite regularly during 1997; he also saw Mr McCarthy as Mr McCarthy was Mr Smith's immediate boss and liked to know what was going on. Mr Smith and Mr McCarthy generally reported to Mr Whitcombe on their meetings with Mr Broad, but Mr Whitcombe could not recall any queries ever being raised.

(3) Relations between SD, HHI and EIU: commission and claims

(a) Increase in commission under the binder

1008. On 11 July 1997, Mr Henton wrote to Mr Smith to deal with a number of matters; he said that they were actively pursuing an increased level of direct business and asked for an increase in the commission level. Mr Broad's evidence was that he had not seen this letter before.
1009. On 14 July 1997, Mr Broad agreed to an increase in the commission from 40% (which had been agreed in January 1997 and is explained at paragraph 703) to 42.5%. Mr Broad's evidence was that he had agreed to this because he was told that there was to be more direct business and that had higher acquisition costs.
1010. Mr Henton's evidence was that HHI and EIU then reached an agreement that when there were higher deductions, he would create a special bordereau which showed when the extra 2.5% was used by EIU (see also paragraphs 295 and following of Part II in relation to the commission on Programme 13 – Gerber).
1011. According to Mr Whitcombe's evidence, there were possibly only two occasions when they took the extra commission, though HHI took it on every single risk.

(b) Offset of reinsurance premiums

1012. All the premiums were paid by EIU to HHI, which then used those premiums to offset the cost of the reinsurance; Mr Whitcombe thought that HHI also paid claims from the funds which they held. EIU never thought that they could hide the level of claims.

(c) Claims, including the Gianni Versace claim

1013. Mr Henton dealt with claims; he passed all the claims bordereaux to HHI and also dealt with the recovery on the outwards reinsurance.
1014. The first major claim related to an event which received much publicity – the shooting of Mr Gianni Versace on 15 July 1997 which gave rise to claims under insurances relating to him; his death was a conventional PA risk. American Reliable received a part of the claim which they passed on to EIU through SCB on 9 September 1997 for £239,400 under two layers of the reinsurances written under Programme 3. Mr Henton's evidence was that he put in a reinsurance claim under the bottom layer of the outwards reinsurance written by American Reliable, copying the documents to HHI; he also passed the claim to HHI who in turn also prepared a claim for collection on the reinsurance; Mr McCarthy endorsed this in manuscript on 24 September 1997 to the effect that this was not to be claimed under the reinsurance placed by WFD with American Reliable as there would be "a mini-spiral"; Mr Henton's evidence was that he was unaware of that note and was never told not to claim from American Reliable.
1015. HHI then passed the claim to SD; Mr Henton and Mr Whitcombe were unaware of this. When the claim was sent to SD's claims department, it was sent with documents that made it quite clear that it was a claim by American Reliable under their XL treaties. As set out at paragraph 993 above, the specific reinsurance for the binder had a gap between $60,000 and $150,000 and only 50% had been placed on the layer starting at $150,000. If SD had not claimed on their own reinsurance, they would have had to carry $275,000 net. A claim was made on SD's own reinsurance programme.
1016. It was the practice of SD's claims department to report large claims to the underwriters. Mr Broad's evidence was that he was unaware of the decision to claim on SD's own reinsurance programme; he thought that it was an accident.
1017. The claim made on SD's own reinsurance programme was queried by SD's reinsurers in early November 1997 as being LMX and therefore excluded; it was subsequently rejected by them on 7 November 1997. This rejection was notified to Mr Tunstall, who was unaware of the specific reinsurance for the binder; he reported the rejection to Mr Broad who said that it was "bollocks"; by that he meant that the claim was not LMX and should therefore be covered; Mr Broad then took over the running of the claim.
1018. It was Mr Broad's evidence that SD had taken the position that this claim was not LMX business as EIU did not write LMX business, but there was no point in disputing it as the claim should have been made under the specific reinsurance programme for the binder and not under SD's internal reinsurance programme. He was not concerned by the rejection on the ground that it was LMX as it appeared to be an individual risk. The claim was withdrawn from the internal reinsurance programme in December 1997.
1019. It was suggested by SCB that this claim ought to have at least given HHI "a clear understanding of the sort of account that the EIU defendants were writing – an account that was exposed to retrocessional business and tight spirals". Although it should have rung some alarm bells, this was a traditional PA risk and the spiral was only between American Reliable and SD at that stage; this claim did not give any real indication either of the true nature of the account or of the losses that were to be funnelled into SD on the reinsurance structure as it stood at the time.

(4) Changes at SD

(a) The internal review at SD and the business plan

1020. In 1997 SD decided to conduct a review of the international facultative and contingency account underwritten by Mr Broad's department. It was one of a series of internal reviews that SD carried out. The review team reported on 9 May 1997. Mr Broad made written comments on the report of the review team on 12 June 1997 and these comments were discussed at a meeting that day and an action plan was agreed. Apart from commenting on market conditions and the expansion of the account in the soft market, the review team expressed several concerns, including concerns about the keeping of files/records and the audits of holders of binding authorities. They reviewed the EIU binding authority and were critical of it in many aspects, including the lack of meaningful data held on record and the "worryingly high" level of deductions.
1021. Mr Broad's opinion of the review team was that they understood little of the facultative business that he wrote – he described them as "nerds". His comments made at the meeting on 12 June 1997 in relation to PA business were either that there was no retro reinsurance exposure, or that any aggregate exposure which existed was of a small value; his evidence was that this was because he assumed that it was a direct and facultative account.
1022. Mr Broad's evidence was that as a result of the review, he asked his staff to put the file in order; it was in these circumstances that Mr Broad scratched the business plan (see paragraphs 604 and 984).
1023. Mr Watson could not recall seeing the report of this review. He was not then aware of the concerns expressed in the report about the EIU binder and was unaware of the binder at this time. He was unaware of concerns about binding authority audits as he was engaged in the sale of SD to Fairfax Financial Holdings Ltd. (Fairfax) at the time.

(b) The acquisition of SD by Fairfax

1024. Fairfax, a Canada-based financial services group, owned a number of companies with the name of Odyssey Re in 1997. Odyssey Re had two relevant parts, both indirectly held by Fairfax – Odyssey Re Holdings and Odyssey Re Group Ltd. In June 1997, Fairfax acquired the ownership of SD through Odyssey Re Group Ltd. The announcement of the acquisition was made on 23 June 1997 and of the completion on 3 December 1997. After the acquisition, the SD companies adopted the name of Odyssey Re (though the London insurance and reinsurance company reverted to the name of SD in October 1999). No review of the binder was made during the due diligence for the acquisition.
1025. The Chairman of Odyssey America Reinsurance Corporation (based in Stamford, Connecticut) was Mr Andrew Barnard. He became its Chief Executive Officer, but he resigned this position in 2001. He was the Chief Executive Officer of Odyssey Re Holdings at the time of the trial; he began his career in the insurance industry in 1985; his early experience was in liability business. He had some experience of WC business. He gave his evidence very clearly and I am sure that he gave his evidence honestly and to the best of his recollection.

(5) Business written by EIU in October 1997

(a) WEB

1026. On 3 October 1997, Mr Henton accepted a participation on a reinsurance of WEB – Programme 6. Although there was no proper reinsurance programme in place, Mr Henton thought that there was nevertheless sufficient reinsurance for this programme. The programme is described at paragraphs 214 and following of Part II; for reasons set out in that Part, no serious criticism was made of this programme as it was written on the basis of an expectation of an underwriting profit and there was justification for that view. WEB played a role in subsequent events and programmes and it is therefore necessary to describe the company.
1027. WEB were an underwriting agency based in Connecticut who wrote under an MGA for All American Life Insurance Co (All American) and Trustmark Insurance Co (Trustmark). With effect from 1 January 1997, they had management agreements with All American and Trustmark under which a pool was operated with either All American or Trustmark fronting for the liabilities which they agreed to share equally regardless of which company fronted the business.
1028. The MGA was set up through John B Collins, an intermediary in the US. WEB specialised, according to a memorandum written by them, in occupational accident (30%), PA, carveout (10%) and related business. Two of WEB's principals were Mr Wright and Mr Ekwall who had been employed by Phoenix where they had written similar business (see paragraph 424.i); the other principal was Mr Chuck Bastan who had been employed in the Atlanta office of Duncanson & Holt (US). Mr Ekwall and Mr Bastan were the underwriters of WEB and Mr Wright was the actuary. WEB had a large book of US business.
1029. SCB had a 25% interest in WEB. SCB had lent WEB between $600,000-$750,000 for three years to help them get established.
1030. WEB subsequently gave a marketing agreement to Accident and Health Reinsurance Consultants (AHRC), a company described at paragraph 1080. AHRC employed Mr Durling to introduce business to them and through whom WFD did business with WEB.

(b) Presentations for special acceptance by Mr Broad

1031. In about October 1997, two risks were presented for special acceptance by Mr Broad:

i) Stuchbery: This was presented to Mr Broad and rejected; see further paragraph 67- 69 of Part III

ii) Aviation PA lineslip for Ian McCall International Ltd.: This was presented to, and rejected by, Mr Broad on 13 November 1997. Mr Broad asked questions. The business was not written. Mr Whitcombe accepted that this was straightforward in comparison to the carveout business; see further paragraphs 63-66 of Part III.

iii) It was SD's case that these were the only two risks that were presented for special acceptance. This is probably correct on the materials before the Court.

(c) Declinatures

1032. EIU relied strongly on the fact that they declined a significant number of risks as evidence that they were underwriting with proper regard for the interests of SD. I have set out at paragraphs 36-123 of Part III the contracts presented between May and December 1997 upon which EIU relied. As can be seen from the conclusions I have reached, brokers other than SCB presented contracts during this period, but very little was placed. I was able to determine in most cases the reasons; these were varied, but I was quite unable to draw the conclusion for the reasons set out that EIU's actions supported their contention.

(d) Other risks written

1033. As set out at paragraph 836, a few contracts were written for WFD, MRM Hancock and HHI; SD advanced no case on these.

(6) The change in Mr Bird's position

(a) The termination of the Lincoln National lineslip

1034. As set out at paragraph 740.i), Lincoln National ceased writing LMX retro business through the Big Ben lineslip for 1997.
1035. In April 1997, Lincoln National became concerned about losses made by LMX business which they had written in their home office account in 1993/4 (referred to at paragraphs 432 and 437), but not with business which was written under the Big Ben lineslip.
1036. There had also been a management change at Lincoln National though Mr Vollenweider was still employed; Mr Bird went to Fort Wayne in June 1997 and had discussions about Lincoln National's concerns which by then also included the business which had been written under the Big Ben lineslip. Lincoln National decided to look at the spiral in general. The Big Ben lineslip was suspended on about 14 July 1997. A management team came over to London to review matters and decided to cancel the Big Ben lineslip. Mr Bird could not recall detailed discussions about their complaints.
1037. Mr Brown's evidence was that after the establishment of Lincoln National's London office, brokers were getting quotes that were lower than those that were being given under the lineslip.
1038. When the Big Ben lineslip came to an end, SCB did not place further business with Lincoln National as they had lost their entry into Lincoln National. Mr Dumenil (of Lincoln National's London office) would only write to certain brokers.
1039. Lincoln National have subsequently sought to avoid many contracts; they reserved their rights on 14 July 1997 in respect of John Hancock and Phoenix and in June 1998 avoided the reinsurances written by their home office on the basis that there had been non-disclosure of the operation of the spirals; they took a similar position with regard to Phoenix the following year.

(b) CIGNA and the Aviary lineslip

1040. During 1997, SCB negotiated a lineslip from CIGNA Re Europe (CIGNA) which was known as the "Aviary lineslip". According to Mr Bird, the intention was for the Aviary lineslip to run alongside the Big Ben lineslip as there were premium income problems under the Big Ben lineslip. However, the Aviary lineslip eventually replaced the Big Ben lineslip with effect from 1 October 1997. Just as in the case of the Big Ben lineslip, the Aviary lineslip was open to all brokers. No evidence was called by anyone from CIGNA as to the events involving them, which it will be necessary for me to set out.
1041. The evidence before me was that CIGNA had started underwriting through a London office from 1 January 1993; amongst the principals were the underwriter, Mr Paul Minter (who had underwritten at Syndicate 478 (PAM), an aviation syndicate which also wrote PA) and Mr Chris Branch (who had been a broker with Greig Fester and the Benfield Group). The evidence was that the underwriting room was unconventional; it was lively with a wide screen TV with computer games and there was a general melee; it was all part and parcel of the underwriting room and was fairly close to where the underwriters worked. At first SCB only placed a small amount of CIGNA's reinsurance, but in the second year SCB placed the reinsurance of CIGNA's first $5m, though they had to share the brokerage with other brokers.
1042. Mr Bird's evidence was that it was intended that the business under the Aviary lineslip would all be WC carveout or WC related business and in that respect it was different to the Big Ben lineslip as CIGNA did not want to write EEII; they also did not want to write LMX as they already did that through their main account. The Aviary lineslip was essentially Section A of Lincoln National's Big Ben account without the international XL business to a great extent, as Mr Minter wrote that himself.
1043. It was Mr Bird's evidence that before CIGNA agreed to the lineslip they sent a team over from the US to review what had been written under the Big Ben lineslip; they reviewed some of the larger accounts and thought that it was worthwhile getting involved. CIGNA wanted to get more involved in the primary areas of carveout and they saw a lineslip as the best way of doing it because it saved on office expenses and administration costs. Mr Bird's evidence was that the arrangement had the approval of the President of CIGNA because of the prospective premium volume that would be written. CIGNA assigned Ms Tracy Stoltz to work with Mr Minter.
1044. Mr Bird's evidence was also that a lot of, but not all, the business previously written by Lincoln National was written by CIGNA, provided that it was WC carveout. CIGNA did not necessarily write the book that Lincoln National had cancelled; CIGNA made their own decision. There were some accounts that were renewed and some that were new. Mr Bird did not accept that the business was simply a renewal of the risks that Lincoln National had written.
1045. Mr Bird accepted that the Aviary lineslip contained a number of similarities with the Big Ben lineslip: the estimated amount of premium to be written, the underwriting limits, the account distribution (the Big Ben lineslip was 83% carveout, the Aviary lineslip was 95% carveout) and the layers of the reinsurance (which Mr Bird said was fairly standard structuring). Mr Bird's evidence was that CIGNA's intentions were different from Lincoln National's – CIGNA were looking to write a book that was predominantly carveout or carveout related whereas Lincoln National were prepared to look at other business. Mr Bird's evidence was also that CIGNA intended to try and achieve a gross profit; that could not have been the intention of the person who made the underwriting decision under the Aviary lineslip, given the fact that Mr Henton viewed Programme 11 (under which SD reinsured CIGNA) as one which he accepted on a net basis and given the 5,700% loss ratio that had eventuated by 2001; since then the losses have deteriorated still further – see paragraphs 263 and following of Part II.
1046. Mr Bird's evidence was that he only made recommendations and administered the business; risks were considered by Mr Minter at CIGNA and the decisions were taken by Mr Minter; risks were sometimes broked directly to Mr Minter; Mr Minter would then speak to Mr Bird and Mr Bird would then administer the risk; Mr Bird was used for his specialist expertise in WC business; Mr Bird prepared the presentation for Mr Minter and later for Ms Stoltz (though she was an experienced WC underwriter).
1047. Mr Christopher Kelly of SCB told WEB on 5 December 1997 that the majority, if not all, the account would, as regards QS, be SCB-produced; Mr Bird said that this was true for the QS section (80% of the account according to the information sheet), but other brokers such as Sedgwick, Crawley Warren and Gallaghers placed most of the XL business, as the lineslip was open to all brokers, just as the Big Ben lineslip had been.
1048. At paragraphs 265.i) and following of Part II, I set out the reasons for my conclusion that the business to be written was essentially intended to be the account which had been written under the Big Ben facility, with certain categories of risk excluded and some of the renewals declined. From paragraph 256 to paragraph 261 of Part II, I set out the reasons for my conclusion that the account was clearly an account over which Mr Bird had the decisive influence.
1049. Just as reinsurance for the Lincoln National lineslip was provided by SD through Programme 4, reinsurance was provided by SD for the Aviary lineslip under Programme 11 which was written on Christmas Eve 1997 in the circumstances explained below. The losses under Programme 11 were $29.898m at the end of the first quarter of 2001, on a net premium to SD of $525,000. Although figures were available for Programme 4 these were not realistic as there had been so many avoidances.

(7) Conclusion on SD's knowledge in relation to the business written

(a) Knowledge from the bordereaux

1050. The purpose of providing bordereaux was to enable SD to see what had been written so that the necessary control could be exercised over the cover holder. Mr Broad was entitled to trust Mr Whitcombe (for Mr Broad would not have granted the binder if he had any question about his trust in Mr Whitcombe), but ordinary prudence required that Mr Broad should have paid careful attention to the bordereaux.
1051. Mr Broad did not; if he had done so, it would have been obvious to him that treaty business was being written (as Mr Broad accepted – see paragraph 914) and that the business had very low excess points. It would not have been apparent that the business was rated cheaply as the bordereaux did not set out the loss record. Nor would it have been apparent that gross loss making business was being written on the backs of reinsurers, as the mere fact that there were low excess points did not show that.
1052. Mr Broad did ask questions but they were not of the probing kind. He was, in my judgment, grossly negligent in his conduct in not taking the most basic steps to satisfy himself of the nature of the business which was being written and which was generating (as he knew) significant premium income. Indeed in his evidence he referred to the bordereaux coming into the underwriting room like confetti and that he did not look at such documents as he was a director of the company; he simply scratched the bordeareaux. This was grossly negligent.
1053. I am sure that Mr Broad was not provided with the slips when the first bordereau was given to him, however, he did ask that the type of business be described. I have reached this conclusion because the slips are not mentioned in the accompanying letter, there would have been every reason not to send them, and the class bordereaux were produced to answer an enquiry as to the type of business being written.
1054. I am sure that Mr Broad was not provided with the placing information; there would be no reason to supply such information and there was only mention of slips in Mr Whitcombe's statement (with a mistaken reference to the occasion). I am sure that it was a matter subsequently invented in an attempt to try and fix Mr Broad with knowledge of the gross loss making nature of the business.
1055. I have concluded that at this stage in the history of the binder Mr Broad was content to see that the binder was generating significant income, but never bothered to go much further. He agreed to the premium increase on 14 March 1997 without proper enquiry, even though he knew that the premium income had grown rapidly and he himself had had difficulty in obtaining PA business. Again that was grossly negligent; no competent underwriter should have agreed to the premium increase without enquiry as to how the business had grown in such circumstances. I reject the submission that he was lying and that he appreciated the nature of the business being written; I am sure that he did not know that gross loss making business was being written. In reaching that conclusion I have considered his evidence as a whole (and to which I will refer in due course), but with facts of such complexity it is necessary to refer to this conclusion now. The fact that he scratched documents did not mean that he had read them; he scratched them because he was asked to do so; some of the bordereaux were scratched when Mr Broad was presented with other documents which he had to scratch – such as those on 14 March 1997 (see paragraphs 923 and following) and on 11 February 1998 (see paragraphs 1290 and 1295).
1056. I had the opportunity of observing Mr Broad when he gave his evidence over 10 days initially, and during the occasion on which he was recalled towards the end of the trial. There were three characteristics about him which were striking – (1) he did not read documents properly unless he was asked to (a matter to which I have already referred at paragraph 731.iii)), (2) he had a very volatile personality, and (3) he was very proud of his own abilities and of the traditional way of doing business in the London market as he perceived it.
1057. I have no doubt that brokers who regularly did business with him appreciated these characteristics; in particular I have little doubt that Mr Smith knew that Mr Broad would not read a document such as the business plan in any detail. Mr Broad would have listened to what was said and would have made his decision largely on the basis of the oral presentation and on the matters specifically drawn to his attention; I have no doubt that Mr Whitcombe made a good impression on him as someone which he could trust as having been a Lloyd's underwriter who understood and acted in accordance with the perceived traditions of the market.

(b) Was Mr Broad told that gross loss making business had been written?

1058. The evidence about the discussions over the meals on 7 February 1997 and 21 March 1997 was not satisfactory. It is clear that there was a discussion about the need for reinsurance and Mr Broad had agreed to a separate reinsurance programme.
1059. However, Mr Broad was never told that gross loss making business was going to be written on the backs of reinsurers prior to the binder being granted. Mr Whitcombe accepted as much in his cross-examination on behalf of SD (as set out at paragraph 729). However, Mr Whitcombe's evidence (referred to at paragraph 815.iv)) was that Mr Broad became well aware that a gross profit was not likely on the business as a result of the meeting at the pub at Tadworth on 7 February 1997; Mr Whitcombe was not suggesting that Mr Broad knew this before the binder was signed; he did not know that they would lose large sums on a gross basis.
1060. I do not accept Mr Whitcombe's evidence in relation to the pub meal at Tadworth, referred to at paragraph 815.iv); the phrases "net profit is the name of the game" and the account was "very volatile at the lower layers" were not set out in his statement where this meal was dealt with, nor was there any suggestion that he had said anything similar about the nature of the account on that occasion. Although I have taken into account EIU's position in relation to legal representation, I am sure that these matters were thought of by Mr Whitcombe much later and he had never said anything of the kind at the time. Furthermore, Mr Whitcombe accepted that he was not telling Mr Broad that EIU were deliberately writing gross loss making business on the backs of reinsurers, nor was he giving Mr Broad a true idea of the type of account being written; there was also the account of Mr Smith (as set out at paragraph 1322) that Mr Whitcombe and Mr Henton never told him that they were going to be writing gross loss making business or engaging in arbitrage. Had Mr Broad been told of the nature of the business, Mr Whitcombe would, if he had been acting faithfully in the interests of SD, have drawn the cash flow problems encountered by Syndicate 103 to Mr Broad's attention so that he could consider how best to deal with the problems; as set out at paragraph 930, Mr Whitcombe never told Mr Broad of the cash flow problems encountered by Syndicate 103.
1061. I also attach considerable importance to the finding I have made at paragraph 999 that Mr Tunstall was told (in answer to his enquiries about a market rumour) that no LMX business was being written by EIU; Mr Tunstall told Mr Philo this. If Mr Whitcombe and Mr Smith had been open with Mr Broad as to the type of business being written, then, unless Mr Broad was in league with them to deceive both his general manager and his assistant (with whom he had worked for years), there was no reason for Mr Whitcombe and Mr Smith to deny that the writing of LMX business that formed such a material part of the business written, small though in percentage terms it might be. I am sure that Mr Broad was not in league with Mr Whitcombe and Mr Smith (for the reasons I give at paragraph 1065 below). The evidence of Mr Tunstall, which was independent of Mr Broad's, adds confirmation to the conclusion I have reached that it was not drawn to Mr Broad's attention that LMX business was being written and that he was not told that gross loss making business was being written against reinsurers.
1062. I accept the evidence of Mr Broad that he did not tell HHI that SD's reinsurance programme did not cover the business; he did not know that LMX business was being written; he was persuaded to agree to a separate reinsurance programme by Mr Smith and had thought that he was doing Mr Smith a favour in earning brokerage. I am sure that Mr Whitcombe and Mr Henton had seen the cover notes by this time and that it was they who had reached the conclusion that there was no cover once they saw the terms. I therefore do not accept the accuracy of Mr Smith's account; the reason why SD's reinsurance did not cover the business written under the binder was because of the LMX exclusion, yet Mr Smith had told Mr Tunstall that no LMX business was being written. Mr Tunstall was an honest witness whose evidence I accept. Mr Smith's account was, in my judgment, self-serving. As I have noted, Mr McCarthy was not called to give evidence, but I have not drawn any adverse inference from that fact.
1063. EIU submitted that Mr Broad knew, from 21 March 1997, that there was a lack of reinsurance cover and that SD faced catastrophic losses; that it was his fault and that they had said nothing in writing about it or about the cessation of business as they had not wanted to get Mr Broad into trouble.
1064. I am sure that Mr Whitcombe did not tell Mr Broad on 21 March 1997 that SD faced the prospect of catastrophic losses as its own reinsurance programme did not cover the business; Mr Broad was wholly unaware of the position SD were actually in as a result of having no reinsurance cover. Given Mr Broad's highly volatile personality he would have become extremely angry and would have panicked. There is no evidence of that from anyone. As a reinsurance programme was not put in place until the end of the year, I do not think that he was capable of concealing from those he worked with at SD, the immense anxiety that this would have caused him.
1065. More importantly, I also do not consider that Mr Broad would have behaved with the calculated deception of SD that remaining silent would have entailed; he would have had to deceive his fellow directors and colleagues in his department for many months by concealing a very serious loss exposure to SD as business which would produce very serious losses had been written without any reinsurance. He would have had to lie at weekly meetings about the position of the business written through his department and would have had to make misleading reports to the board; it would have been gravely dishonest.
1066. If Mr Broad had known what was in fact being written by Mr Henton, his conduct towards the review (referred to at paragraphs 1019 and 1020) and his statements would have been deceptive and dishonest. I am satisfied that his conduct towards the review and the statements which he made were honest, even though his attitude to the keeping of records and the conduct of audits showed that he was acting very far below the standards to be expected of any prudent insurer.
1067. As set out above at paragraph 1023, SD was acquired by Fairfax in the summer of 1997; silence by Mr Broad during that time and during the due diligence that followed would have been a grave and calculated act of dishonesty. I am quite sure that he did not know.
1068. I am also sure that Mr Broad did not initiate or know of the changes to the class bordereau referred to at paragraph 906. Although, as set out at paragraphs 1104 and 1324, there could have been a clear motive for Mr Broad initiating other changes to the documents which were produced by EIU to disguise the fact that treaty and LMX business were being written (as Mr Broad had no authority to write treaty business), it is difficult to understand why this change was made, unless it was to conceal the fact that WC carveout (as opposed to PA business) was being written. The most likely motive for this change was a desire to conceal the fact that something other than PA business was being written; this was done by bringing the terminology into line with that used in the business plan where the term "occupational accident" was also used (as set out at paragraphs 620 and following). If it had been done with the knowledge of Mr Broad, his only motive would have been to conceal the true nature of the business being written from his fellow directors and colleagues; I am sure he did not act in this dishonest manner for the reasons I have set out in the preceding paragraph. The overwhelming probability is that the change was initiated by either EIU or HHI who wanted to ensure that the business being written was in apparent conformity with the plan. I have reached a similar conclusion with respect to the changes to the underwriting report submitted by EIU in November 1997 (as set out at paragraph 1104) and the alterations made in February 1998 to the class bordereau (as set out at paragraph 1323).
1069. SCB pointed out that the effect of Mr Broad's evidence in relation to his agreement to the increase in the premium income limit on 14 March 1997 (referred to at paragraph 923) (if it was to be believed) was that he was apparently unconcerned by this request, despite the fact that Mr Whitcombe was writing in a soft market, that the premium income limit had been £2m and that Mr Broad had had considerable difficulty in getting the business he believed that Mr Whitcombe was writing. Mr Broad's evidence was that he had attributed the success to the personal relationships that Mr Whitcombe had with brokers which had access to the business he wanted to write.
1070. Mr Broad's agreement was one which should not have been made without proper enquiry. None proper enquiry was made. As I have stated at paragraph 1054 in connection with the knowledge he might have obtained from the bordereaux, although he was grossly negligent, he was not lying.
1071. Mr Broad's conduct was similarly grossly negligent in the enquiries he made about the reinsurance. I am sure that Mr Smith did not draw to Mr Broad's attention (as he should have done) the references to LMX in the slip or the information sheet, nor did Mr Smith produce to Mr Broad the documents referred to at paragraph 1002.ii) which described the amount of LMX business written by American Reliable and Phoenix (as to do otherwise would be to draw attention to the inconsistency in the information he had provided earlier to Mr Tunstall and Mr Broad). I am also sure that Mr Broad did not look at the information sheet or the slip; this was undoubtedly grossly negligent, but Mr Broad was content to rely on Mr Smith telling him what he needed to look at and being content with assurances that every effort was being made. In making this finding, I have had regard to the letters referred to at paragraph 984 and to the meeting that Mr Smith had with Mr Broad on 5 July 1997; I am sure that Mr Broad was interested in whether progress was being made and not, as he should have been, in the terms of the reinsurance or in what was being written under the binder. Nor did he pay proper attention to the cost; it was submitted that Mr Broad only agreed to pay $600,000 for M&D premiums (referred to at paragraph 994) because he recognised that it was imperative to obtain cover in respect of the LMX business written. I do not accept that submission as he did not know that LMX business was being written. He had not properly applied his mind to the cost and had agreed because it had been well broked to him by Mr Smith (whom he trusted).
1072. I also accept Mr Broad's evidence referred to at paragraph 968 that, following the discussion at the meeting between the brokers and EIU on 19 May 1997, he was never asked to consider seeking to get the LMX exclusion removed; I am sure that no proposal was put to him. Quite apart from the fact that such a request would have contradicted the assurance given to Mr Tunstall, it would inevitably have led to questions from reinsurers about what had been written, as they would be being asked to provide retrospective cover and remove an exclusion they had put in. No insurer who was told what had happened would ever have granted cover once they were told of the effect of the arrangements made that funnelled the losses into SD; they would have been large and certain losses running into many millions of dollars, even though they may not have appreciated that their exposure would in fact have been in the order of $100m. I am sure that the point was raised at the meeting in the full knowledge that that was not an option open to EIU, as it would have involved disclosing what had been done and it would have been done in the knowledge that there was not the remotest prospect that any reinsurer told the truth would reinsure the business written. It was an example of the cynical behaviour of SCB who wished to appear to be trying to help EIU but who in truth cared not at all for the position in which EIU were placed or about the massive losses that they had funnelled into SD. It was suggested by SCB that any broker would be interested in trying to find reinsurance for EIU so that they could use them the following year; although I can accept that might be an approach to be expected of ordinary and honest brokers, the events of November and December 1997 demonstrate that SCB were not going to help EIU until it suited them.
1073. It was also submitted that Mr Broad must have appreciated that a spiral would arise from the fact that (1) EIU had written a reinsurance of American Reliable (as was clear from the bordereaux), and (2) that he had authorised the placing of reinsurance with American Reliable. In my judgment, he certainly should have appreciated the potential for a spiral if he had paid attention to the bordereau, the business written under the binder and the details of the reinsurance. I am sure, for the reasons given, he did not pay proper attention to any of the matters and through his own gross negligence did not appreciate the potential problem. I have no doubt, however, that this should have been drawn to his express attention by EIU; it was not.
1074. It was also suggested by SCB that Mr Broad must have been aware of the decision not to claim in respect of the Versace claim under the reinsurance placed with American Reliable; but Mr Henton's evidence was that he (Mr Henton) had put forward a claim and had not been told not to by HHI. It was also suggested that Mr Broad must have accepted that this was LMX business; there would have been no reason otherwise to withdraw the claim from SD's own reinsurers and carry it net in part because of the gaps in the specific reinsurance under the binder; indeed it was submitted that this fact was confirmed by an internal memorandum written by an employee of SD in June 1998 (see paragraph 1382.vi)). I do not accept that submission. Although a competent underwriter would have immediately caused the claim to be properly investigated, Mr Broad's reaction to Mr Tunstall was typical of his lack of attention to the binder; he knew that the binder had its own reinsurance and expected the claim to be made under that; he did not appreciate there would be a shortfall in the recovery; SD's internal procedures were such that the problem did not emerge until later in 1998 (as set out at paragraphs 1367 and following). It was in that context that the internal memorandum was written and I accept the explanation that Mr Broad gave about it. In withdrawing the claim and leaving it to be collected under the specific reinsurance for the binder, Mr Broad was acting negligently by failing to ask any relevant questions.

7. THE EVENTS LEADING TO THE YEAR END PLACINGS

(1) The attempted exclusive arrangement with WFD

(a) The possibility of reinsurance for15 months at 1 October 1997

1075. As set out at paragraphs 983 and following, WFD made efforts to place an outwards reinsurance programme for EIU for 12 months from 1 January 1997.
1076. In the course of October 1997, WFD then attempted to place an outwards reinsurance programme for 15 months from 1 October 1997. The circumstances in which this was attempted are significant, even though little by way of reinsurance was obtained.

(b) The discussion of an exclusive arrangement

1077. On 9 October 1997, Mr Henton had a conversation with Mr Johnson at which he discussed an arrangement which was to involve credit card business and Phoenix acting as reinsurers for the first $350,000. The manuscript note of the meeting recorded "Possible exclusive arrangement". Either at that meeting or at about that time, WFD produced a new reinsurance information sheet; Mr Henton provided the information and discussed the format. This showed that £5m of premium income had been written and £3m accounted for; it set out the line size, including the information:

"$500,000 a.o. contract LMX

$2,000,000 a.o. programme "

It also gave the anticipated breakdown of the account as:

"1. Direct PA 30%

2. PA Treaty XL Direct Writers 29%

3. PA Treaty XL Retro exc XL on XL 15%

4. PA Treaty XL Retro 5%

5. K&R XL Direct Writers 1%

6. Proportional Treaty 20%"

This information sheet showed a very significant increase in the LMX or retro content to 20% compared with 5% shown in the information sheet prepared in April 1997 and referred to at paragraph 957. Mr Henton's evidence was that the figures were based on the promise of significant support from WFD (as he noted in a document produced on 12 December 1997); that document also recorded that on 9 October 1997 WFD attempted to place the whole of the reinsurance programme from 1 October 1997 with Phoenix.

1078. The importance of the meeting was, however, the promise of significant support from WFD and a note in manuscript which referred to "possible exclusive arrangement".
1079. Mr Johnson's evidence in relation to Mr Henton's manuscript note was that the reference to an exclusive arrangement was surprising; he could not recall discussing potential levels of business with EIU; the retro market WFD had with which they could place business was, from September to December 1997, Phoenix, EIU and Keyport Life Insurance Company of Boston (Keyport). They would not have had an exclusive arrangement with EIU; they placed retro business for the Panter Syndicate, Gan and American Reliable without having any form of exclusive arrangement.
1080. His evidence on this point was contradicted by the following:

i) Mr Johnson's own evidence was that a retro market should be found and set up first as this enabled the broker to offer protections to direct writers at a given price; however, things did not always go in accordance with the plan as American Reliable's programme for 1995 was not placed until April 1995 and American Reliable's programme for 1996 was not placed until February 1996. What happened in 1997 has been set out at paragraphs 818 and following. That this was the way in which business was placed was supported by an internal minute of a "think tank" meeting at WFD on 17 August 1995 attended by Mr Johnson, Mr Davis and others. This minute recorded a discussion of potential new retro markets for PA or carveout business. Their plan was to put the retrocessions in place by mid-September of that year so that they could make early approaches to the direct market to offer them, on the basis of the retrocessions, unlimited reinstatement reinsurance placements in September/October rather than in December.

ii) Mr Henton's evidence was similar; his evidence was that what happened in the market was that the broker first put in place for the reinsurer he wished to use, an outwards retrocession for the inwards reinsurances of other insurers the broker wished to place with that reinsurer, on the understanding that the reinsurer would then write the inwards reinsurances of that broker's clients, as those inwards reinsurances would then use up the outwards retrocession programme and its aggregates. That reinsurer would write the business of other brokers, provided it did not aggregate with the business of the broker who had placed the outwards retrocession. The business that would aggregate and therefore be exclusively written to the broker would be that which was hardest to place – international XL business and all retro or spiral business. It was EIU's intention to enter into such an arrangement with WFD.

iii) The expert evidence of Mr Hines was that it was impossible to write prudently on a net basis without the reinsurance being in place.

iv) In the November 1997 underwriting report submitted by EIU to SD (see paragraphs 1109.ii) and 1110.v)), there was reference to an arrangement with WFD and the offer of significant support towards EIU's planned writing of £5m of business in 1998. Mr Johnson's evidence was that WFD would not have been able to offer EIU the volume of business referred to in the November 1997 underwriting report, though they were placing about £10m-£15m worth of business in 1997. Mr Brown accepted that the passage in the November 1997 underwriting report set out at paragraph 1109.ii) said it all as to how the market traded.

v) Mr Whitcombe's evidence was that he did not have much understanding, save that WFD wanted EIU to write at lower layers than those that had been written for SCB; WFD had proposed an even "heavier account" than the SCB account.

vi) When EIU obtained reinsurance from SCB, they did not write retro business for WFD – see paragraph 1269.

vii) The attempt to enter into an arrangement involving Keyport is described in the following paragraphs.

(c) Keyport and Mr Durling

1081. Mr Durling had formed another agency called RAD Underwriting Ltd. which operated in co-operation with AHRC, a company owned by Mr David Melvin and based in Long Island, New York, to which reference was made at paragraph 1029 in connection with its relationship to WEB. This agency was to introduce business to Keyport from 1 October 1997; the agency intended to write a PA XL book with a premium income in 1998 of $7.5m to $8.5m.
1082. To enable Mr Durling to do this, an arrangement with EIU was contemplated under which:

i) Keyport, a company within the Liberty Mutual group, were to write part of EIU's reinsurance. They would write the $140,000 xs $10,000 layer with Phoenix and possibly the backup layer to $350,000 xs $150,000 as well; a quote was to be obtained from Folksam for the layer $1.25m xs $1.25m. These steps were evidenced by an entry for 21 November 1997 which Mr Henton recorded in his note of 12 December 1997.

ii) Mr Henton was asked to write a reinsurance of Keyport for 15 months at 1 October 1997 for $2.5m xs $10,000 to be arranged in three layers; these were the same layers as Mr Durling had used when he had acted for American Reliable. Mr Henton indicated that he was prepared to do so for lines of between 25% and 50%, and recorded:

"subject to EIU/Sphere/Holman R/I programme completion for equivalent period."

This meant that he would write Keyport's reinsurance if Keyport would write EIU's.

iii) Mr Henton's evidence was that there was nothing unusual in this; he accepted there would be a spiral but he was not deliberately creating one.

1083. Mr Johnson could not recall this; if this had happened, then it was possible that EIU would have had to do the same for Keyport and Phoenix, but he would not accept that a "reciprocal" deal was under discussion. He said he could not remember anything about his discussion with Mr Henton – his memory was "a black hole".

(d) The failure of the arrangements with Keyport and WFD

1084. The arrangement, however, did not materialise. Mr Johnson's evidence was that the Liberty Mutual group had decided to set up a company in London called Liberty Re and did not want another Liberty company writing business in the same market. They therefore brought the arrangement with Mr Durling to an end very quickly; it appears that Keyport remained in the market, as on 17 December 1997 they were being approached through WEB by SCB along with EIU to write a line on Programme 9 – see paragraph 1127.iii).
1085. Mr Henton's evidence was that on 11 December 1997, Mr Johnson suggested that EIU exclude XL on XL from their plans, in other words, that they consider not writing the retro spiral content which was, under the arrangements proposed by WFD, to be written exclusively for the benefit of WFD. Mr Henton referred to this in his note of 12 December 1997 and added that this business had only been included for the benefit of WFD.
1086. On 12 December 1997, a memorandum from Mr Henton to Mr Whitcombe (which dealt in part with another attempt to get reinsurance for EIU through other brokers and was accompanied by a chronology) stated that Mr Johnson had said that he would be able to show them the level of business he had indicated if they could lead; if they could not, they would be left with the 'scraps on the table'. Mr Henton's evidence was that if WFD gave EIU outwards reinsurance for the retro spiral business, then they would have written that inwards business exclusively to WFD; as they were not going to get that, there was no reason to write exclusively to WFD.
1087. WFD were told in January 1998 that EIU would not be able to write retro business to WFD (see paragraph 1269).

(e) Conclusion on the arrangements

1088. SD alleged that these discussions were an attempt to negotiate an exclusive market for loss making reinsurance and retrocession business; EIU and WFD intended to create a tight spiral which would be a mechanism for passing the loss up to the unsuspecting; that this was intended to be a new collusive arrangement to replace that made between EIU and SCB which had so far failed to produce the outwards reinsurance.
1089. This is a very serious allegation against Mr Johnson and WFD; as I have pointed out at paragraph 858.iv), neither were parties to this action. I am therefore only prepared to make such findings as are strictly necessary for the decision in this action. In my view, it was very necessary to make some findings in respect of these matters; it is fair to do so as I have heard the evidence of Mr Henton and Mr Johnson on them.
1090. I am sure that Mr Johnson was attempting with Mr Henton to set up an exclusive arrangement with EIU under which WFD would provide outwards reinsurance for them on the understanding that WFD would provide all the inwards reinsurances that would have a spiral or retro content and would therefore count towards the aggregate under the outwards reinsurance. This would have resulted (as was intended by Mr Henton and Mr Johnson) in the spiralling of losses. This was consistent with the way in which Mr Johnson had tried to act in the past and with the contemporary documents; the motivation was clear – the provision of a market to WFD to place the reinsurance of gross loss making business for those who wished to write on this basis at a first tier. The arrangement was clearly reflected in the contemporary documents and in particular the internal memorandum of 12 December 1997 from Mr Henton to Mr Whitcombe.
1091. I reject as untruthful, Mr Johnson's evidence that he could not recall this; he was distinctly uneasy and unconvincing when cross-examined about the contemporary documents which clearly pointed to an attempt by him to create an exclusive arrangement of this type. He knew that the documents clearly pointed to that; he dishonestly pretended in his evidence to the Court that he could not remember.
1092. When this arrangement failed, EIU turned to SCB who were, as explained at paragraph 1122 below, in a position to take advantage of the position in which EIU had placed themselves, having written a significant amount of gross loss making business that had been funnelled into SD without there being any reinsurance in place.

(f) The programme placed for 15 months at 1 October 1997

1093. A very limited programme was placed as follows by WFD with the assistance of HHI. This was then supplemented when Mr Billyard agreed to provide reinsurance to fill some of the gaps by writing the programme described at paragraph 1223:

i) $350,000 xs $150,000 with two reinstatements: 25% with Auto-Owners Insurance Company of Michigan (Auto-Owners) (placed on 28 October 1997); 50% placed with GIO (placed by 15 December 1997) and 25% placed with Bimeh (placed on 3 November 1997).

ii) $750,000 xs $500,000 with two reinstatements: 25% with Auto–Owners (placed on 28 October 1997), 50% with GIO (placed by 15 December 1997) and 25% with Bimeh (placed on 3 November 1997).

iii) $1.25m xs $1.25m with three reinstatements; 25% with Auto-Owners (placed on 22 December 1997) and 25% with Bimeh (placed on 11 December 1997).

These reinsurances were of little use for the writing of gross loss making business as the reinsurance did not go to a low excess point and the reinstatements were limited.

1094. The total M&D premiums for these reinsurances and those for 12 months at 1 January 1997 were put to Mr Broad as being over $600,000; as set out at paragraph 994, Mr Broad was sure that he must have discussed the cost.

(2) EIU's business plan for 1998

1095. Before turning to explain how SCB provided reinsurance for EIU, it is necessary to set out the circumstances surrounding the preparation of EIU's business plan for 1998.

(a) Mr Watson's request to Mr Broad on 7 November 1997

1096. Mr Broad had answered a questionnaire for the purpose of preparing SD's 1998 business plan; some information related to the PA account, including a projected increase in the premium income on this part of the account to £3.2m. He gave an estimated gross loss ratio for the PA account of 80%. He just put this figure in without enquiry but believed it to be his target. Although this exhibited Mr Broad's total disinterest in prudent planning and control, the answer was not dishonest; he had no idea that the gross loss ratios in some of the business which had been written by Mr Henton would have run into at least several hundred per cent.
1097. On 7 November 1997, Mr Watson sent a memorandum to Mr Broad about the answers in the questionnaire. One of the questions asked how Mr Broad planned to grow PA business and how this fitted in with SD's strategy for participating in business where they could lead. He proposed a meeting to discuss the issues on 18 and 19 November 1997.
1098. The proposed meeting to discuss the business plans of SD's various departments took place on 18 and 19 November 1997. Mr Watson's evidence was that he spent two to three hours in a meeting with Mr Broad. When they discussed the growth of the PA account, Mr Broad had said that they were going to get the increase through a binding authority, but did not refer to it as the EIU binder. SD agreed to an increase in the PA account to £2m, which was to be achieved through a binder. Mr Broad's evidence was that he had no recollection of the meeting and that he had never had a long one-to-one meeting with Mr Watson; there were just the Monday morning meetings and the periodic meetings with the underwriters. Mr Broad could not recall any discussion with Mr Watson about the binder prior to 29 December 1997.

(b) The first underwriting report: 17 November 1997

1099. On 17 November 1997, an underwriting report written by EIU was delivered by HHI to Mr Broad. The report and the circumstances in which it was produced are important and were relied on by all the parties as supporting their respective cases.
1100. The report, which was the joint work of Mr Henton and Mr Whitcombe, was provided to Mr Broad by Mr Smith under cover of a letter from Mr Whitcombe dated 17 November 1997; the letter began:

"I understand from Graham Smith of [HHI] that you require what is, in effect, a review of activities covering this year. We were working on such a submission so, as usual, your timing was excellent!"

1101. Mr Broad recollected seeing the report and reading it but not the letter; his evidence was that he would either have read it very closely or that he would have read it quickly and honed in on the important points whilst the broker was highlighting the main points to him.

(c) The circumstances of its production: alterations to the text

1102. It was suggested that it was Mr Watson's memorandum of 7 November 1997 which caused Mr Broad to request Mr Smith in about mid-November 1997 to ask Mr Whitcombe to produce a report of what he had been underwriting, so that he could review the account in the light of the year-end and premium income pressures. Mr Broad did not accept this. It was his evidence that he called for the report as it was the appropriate time for a review of the activities; it was not his job as a director of the company to review bordereaux.
1103. More important, however, was the fact that alterations had been made to drafts of the report to delete references to "treaty" and "LMX".

i) A "post it" note in Mr Henton's handwriting stated:

"Amended LMX to read PA Treaty XL as per Graham Smith's request 11.11.97 on the understanding that it meant the same thing."

This was clearly a reference to the information sheet prepared by WFD in October 1997 to which reference has been made at paragraph 1076, the text of which was to be attached to the report.

ii) Another draft of the report (dated 17 November 1997) referred to "treaty" XL on a page and the information sheet (which contained the change referred to in the sub-paragraph above) made (as is apparent from the text set out at paragraph 1076), numerous references to "treaty". In each case, the word "treaty" was deleted and the word "contracts" substituted; the manuscript amendments to effect this change were in the handwriting of Mr McCarthy. This draft also contained a reference to EIU which was deleted.

1104. The evidence on these documents was as follows:

i) It was Mr Smith's account that he recalled Mr Broad reading the report and requesting the changes.

ii) It was Mr Whitcombe's and Mr Henton's evidence (though not raised in their initial statements) that the version of the report which had the word "treaty" in it was collected on 17 November 1997 by Mr McCarthy and Mr Smith, and brought back by them that day saying that Mr Broad had wanted to delete the reference to "treaty" and to substitute "contracts"; that Mr Henton was willing to make the changes on the basis that Mr Broad understood what the business was and did so. Mr McCarthy and Mr Smith subsequently took the revised report away and they then came back with a further request to delete the reference to EIU.

iii) It was Mr Broad's evidence that he did not request these changes; he did not know treaty business was being written. Although reluctant to condemn Mr Smith, he suggested that HHI had made the alterations as they did not want to bring to his attention the fact that they were writing treaties.

iv) Mr McCarthy was not called to give evidence about this by either SD or EIU.

1105. It is clear that those who had a part in the alteration intended the alteration to mislead at least those in SD to whom Mr Broad would pass the report. Was Mr Broad a party to that or was it intended that he be misled? Plainly he would have had a motive if he knew that treaty or LMX business was being written – a desire to conceal the fact that he had authorised the writing of an account that contained such business when he had no authority to write such business. I am sure that Mr Broad was not dishonest and that he did not set about deliberately deceiving his employers which would be the inevitable conclusion if I had found that he had initiated or had a part in the alteration. As I have already noted at paragraphs 731.iii), 1055 and 1056, it was obvious to anyone who had any regular contact with Mr Broad that he did not read documents properly and that that was abundantly clear from the way in which he looked at documents in the witness box. The overwhelming probabilities are that either EIU or Mr Smith and Mr McCarthy initiated the change as, although Mr Smith and Mr McCarthy had no idea that gross loss making business was being written on the backs of reinsurers, EIU, as Mr Smith and Mr McCarthy knew, was writing treaty business and LMX business and did not want to draw attention to that fact in a document that might be read by Mr Broad or his superiors. This conclusion is very similar to the one I have reached in relation to the earlier alterations to the class bordereau as set out at paragraph 1067 and the later alterations as set out at paragraph 1325.

(d) The description in the report of the business written in 1997

1106. A number of points emerged from the report:

i) Mr Whitcombe was stated to have started underwriting in the early part of 1997; that as a result of "discreet conversations with selected brokers", Mr Whitcombe had been able to accept several PA reinsurance contracts incepting at 1 January 1997 in line with the business plan submitted. There had been 'low key' marketing and concentration on a small number of brokers with whom EIU had long standing relationships.

ii) A very sound business relationship was said to have been developed with WFD which EIU were assured would develop further in 1998; business was being shown to EIU from several sources.

iii) A breakdown of the account showed a heavy bias of PA XL contracts; these amounted to 90%-95% of the account, but it was hoped to redress the account into line with the original forecasts.

iv) The reinsurance position was described, beginning with EIU's understanding that the business described in the plan would be covered by SD's reinsurance and the proposal that a lower layer of $50,000 xs $10,000 be purchased. The instruction to place a separate programme and the difficulties encountered were described.

v) The underwriting results attached were on HHI paper and the report stated that they were provided by HHI; these showed net premium booked of $2m, paid claims (net of reinsurance recoveries) of $278,000 and outstanding claims of $13,000. It recorded that reinsurance premium for the 12 months at 1 January 1997 was $605,763.

1107. It was EIU's case that the report was fair:

i) Mr Whitcombe thought it was, in a sense, true to say that he had started underwriting in the early part of 1997 and that the business, as he then saw it, was in line with the business plan.

ii) They were at that stage developing a sound business relationship with WFD (as described earlier at paragraphs 1074 and following).

iii) They had been shown a lot of bad business which they had declined; the other brokers who had shown them business were Buckenham and Monument; the business showed to them by Buckenham included some credit card business, PA insurance of refuse collectors in South Africa and school fees insurance – direct and conventional "man in the street" business.

iv) It was accepted that the report nowhere stated that business was not being written due to the absence of reinsurance, or of the desperate need for reinsurance. Mr Whitcombe's evidence was that this was because Mr Broad had done them an immense favour and EIU did not want to damage him. Mr Whitcombe accepted that he should have referred to his constant worry about the lack of reinsurance.

v) Nothing was said about the business being gross loss making business written on the backs of reinsurers; they wanted to protect Mr Broad. Mr Henton's evidence was that Mr Broad was aware of the position – that gross loss making business had been written deliberately and that there was no reinsurance. Mr Henton accepted that the report was misleading if someone did not know about what had happened, about the business which had actually been written and about of the lack of reinsurance.

1108. I am sure that the report, in dealing with 1997, was a document designed and carefully crafted to deceive anyone who read it who did not know what EIU had actually done:

i) The major programmes written were gross loss making business written on the backs of reinsurers. It was dishonest not to make that clear in the report.

ii) The figures were designed to mislead; it was dishonest not to have made significant provisions for the inevitable and substantial losses that must have been incurred but not yet reported. It was no excuse that they were provided by HHI as Mr Henton and Mr Whitcombe knew what the business was which had been written and that it was inevitably going to produce large losses for which there was no reinsurance.

iii) It was dishonest to say that a profit was anticipated without stating that it was dependent on reinsurance which was not yet in place; without it they knew that the losses would be catastrophic.

iv) It was dishonest to have omitted any mention of the cessation of business.

1109. I reject the explanation that EIU had acted to help Mr Broad; they had done no such thing as he was ignorant of the matters set out in the preceding paragraph. But their explanation was in any event consistent only with a dishonest intention; Mr Whitcombe and Mr Henton, by explaining the matters set out in the preceding paragraph as an attempt to protect Mr Broad, were in fact intending to deceive Mr Broad's superiors at SD.

(e) The description in the report of the plans for 1998

1110. The report then turned to 1998:

i) It began:

"The philosophy detailed in our 1997 Business Plan remains true for 1998. The intention is to develop the direct and proportional reinsurance element of our account with a target ratio of 35-45% which would account for approximately £3,000,000 in original gross premium if business develops as planned. The account will be a mix of traditional business with its sources being brokers' lineslips, direct open market risks and facultative reinsurance.

….We now intend to develop further this section of the account. We have been offered a share on some major Travel accounts that fit well within our acceptance criteria."

ii) EIU's intentions as regards what was described as the non-proportional part of the account were then set out:

"Our non-proportional account will for the present time form a significant proportion of our overall portfolio. For 1998 we expect to write an original gross premium of £5,000,000. It is this sector we are most able to access as stated in our original business plan. Consequently we are able to predict with a fair degree of accuracy its ultimate size. We do however expect to change the broker producing the majority of business. Following discussions with [WFD] we have secured an offer of significant support from them to write their [PA] Excess of loss account which will in most cases be within a life and in a few selected cases contain a small element of retro business including London market exposure. The estimated proportions are as detailed on the attached information sheet.

Indications are that several new insurers are looking to come into the market for 1998. Inevitably these underwriters will be looking to write reinsurance of Direct writers, an area that is already oversubscribed consequently increasing the downward pressure on already depleted rates. Our aim along with WFD is to construct a market that can withstand this pressure and insist on a reasonable return for our carriers' capacity. By concentrating our available capacity predominantly to a single broking source it is hoped that we will encourage a hardening of rates and at the same time prevent any inadvertent support being given to competing brokers on risks that are otherwise being quoted for within the Willis Faber Circle (emphasis added). With the arrangement that is being proposed we will be required to lead certain risks."

iii) The information sheet attached showed the information set out in the WFD document referred to at paragraph 1076, modified as described at paragraph 1102.i).

iv) The proposed reinsurance programme for 1998 was then described; this stated that WFD and HHI were seeking quotations for the 1998 account and for the last quarter of 1997; it was to be a pre-requisite that it be in place before any contracts were bound. The anticipated reinsurance programme was set out in a series of layers up to $5m xs $10,000; Keyport was mentioned as the expected leaders of the first two layers. It was anticipated that a comprehensive reinsurance protection (with unlimited reinstatements and stop loss protection) would be obtained for 30%-35% of net premium income; this was in comparison with an account excluding non-proportional business which could be placed at a rate of 15%-20%.

1111. EIU contended that the description was a fair one:

i) EIU said that the reference to the intention to develop the direct and proportional part of the account referred to the business they had hoped to get; the travel account was to come from Monument and Buckenham had also offered business which was to be part of the facultative direct and proportional element of the account. Mr Zuberi was the contact and they lost that contact when he left EIU in January or February 1998. They were also in discussion with Windsor about a sports account. The written criteria were reference books which Mr Henton had.

ii) There was no reference to SCB as EIU were then not dealing with them.

iii) Mr Henton said that the reference to the very sound business relationship with WFD was a reference to the exclusive arrangement that they were trying to develop with WFD (as set out at paragraph 1076). Mr Whitcombe's evidence was that this referred to a lower layer and an even heavier account that WFD wanted EIU to write. Mr Whitcombe accepted that this gave an impression of the account with WFD being reinsurance of direct writers; he thought that this reflected the discussions with WFD.

iv) EIU were saying (as their written submissions made clear) that the market for retro business was going to be tight for 1998; first tier underwriters needed to get their reinsurance protections placed before they wrote any business and therefore anyone writing in that area could expect to achieve much better rates than in previous years; the knock on effect would be that reinsurance rates would rise. By concentrating their capacity on a single broker, they would reduce the risk of supporting their competitors and losing business.

v) The reinsurance arrangements referred to were those that WFD were trying to arrange (as already described at paragraphs 1079 and following). Although there was no express reference to the spiral that was to be created, there was reference to retro business.

vi) Mr Whitcombe considered that it reflected the business plan and that there was to be a low to medium risk account.

1112. The part of the plan that described 1998 was also designed to deceive, in that the true nature of the intended arrangement with WFD and Keyport was not described; the report dishonestly omitted any reference to the reciprocal arrangement and the spiral that I have found was intended (as set out at paragraph 1089).

(f) Mr Broad's understanding of the report and his dealings with it

1113. Mr Broad accepted that the report stated that there was retrocessional and LMX business, though not treaty business; he had concentrated on the paragraph that referred to traditional business. Although he accepted that the attached information sheet showed 20% retro business, he had concentrated on the text that referred to it as being in a few selected cases and as small. He vehemently rejected the suggestion that the report made it clear that treaty business was being written and that he knew gross loss making business was being written against reinsurers.
1114. He maintained that he had read the report without giving it a great deal of analysis, that he had seen the reference to traditional business and the very good results attached; the account was broadly as he thought it was and that it was going forward for 1998 in the same way, but redressing some balances; he did not study it in the detail to which it was subjected in cross-examination; as far as he was concerned, reading it as he did in 1997, treaty business was not being written and there was nothing to alert him to what Mr Whitcombe was actually doing. Mr Broad was pleased that WFD was referred to as the broker intended to have a predominant role in the production of the business; having a predominant broker was quite usual.
1115. Mr Broad's evidence was that he did not consider the reinsurance cheap; he did not read this as a plan to write against their reinsurers.
1116. After reading the report, Mr Broad's evidence was that he did not tell Mr Smith that he did not want any of the business described; he accepted that he would have been expected to raise any doubts or concerns he had and would have assumed that the broker would have reported that he (Mr Broad) was content with the report.
1117. Although any proper reading of the report would have made any prudent insurer ask questions, Mr Broad did not read it properly and so did not ask any questions. This was undoubtedly a gross and culpable neglect of his duty, but that neglect must be understood in the context of a document that was intended to deceive any reader as to what was being done under the binder (for the reasons I have set out).
1118. Mr Watson's evidence was that he did not see the report and would not have expected Mr Broad to show him the report or the attached information sheet. He was certain he had not seen it at the time and was not told of its contents. If he had been shown it, lots of things would have concerned him about the information sheet; it looked like treaty business; if the word "treaty" had been there, it would have alarmed him as they did not write treaty business through a binder and he thought that the binder was for facultative business.

(3) The placing of shares in SCB

1119. As part of the expansion of the group described at paragraph 359, on 25 November 1997, a prospectus for an IPO of shares in SCB Holdings Ltd. on NASDAQ was issued with Goldman Sachs as the lead investment bank. It was anticipated that this would raise $65m. Mr Brown sold shares with a value of $4m and retained shares then valued at $20m. I have already referred at paragraph 305.iv) to the fact that there was no description in the prospectus of the fact that the reinsurance was placed on a basis that was gross loss making and that it was built on the risk that the reinsurance might not respond.
1120. Mr Brown's evidence in his statement was that SCB were fully open about their intentions. He stated in his oral evidence that he was aware of the obligations under US securities law; that the prospectus for the IPO had been put together with Mr Cooke and Mr George Jones (the Group Financial Director of SCB Holdings Ltd.) and that he did not have any large role. I have already referred at paragraph 163 to a passage in the prospectus dealing with the importance of reinsurance to SCB's business. As is usual, the prospectus also contained a section setting out risk factors. In the course of the cross-examination of Mr Brown, it was suggested to him that the prospectus was grossly misleading and that it did not tell the truth as nothing was said under this heading or elsewhere about the true nature of the business in which SCB were engaged; nothing was said of the fact that much of the reinsurance was done on a gross loss making basis and written on the back of other reinsurance, nor was anything said of the catastrophic effect that failure of the reinsurance business might have on the business of SCB. Mr Brown (having been advised by the Court that he need not answer such questions) made it clear that he did not consider the prospectus misleading and stated that Goldman Sachs had been a partner of SCB and had seen the group evolve.
1121. I have carefully considered whether in the circumstances it is necessary for me to make any finding in relation to the prospectus; as I made clear at the time, I could not investigate the knowledge of Goldman Sachs. I consider that I should make findings in the light of the case made by SD in relation to Mr Brown's honesty and the general issue that nothing was ever said about the true nature of the business and its risks. I am sure that the prospectus was grossly misleading in not properly describing the true nature of the reinsurance business and that Mr Brown knew it to be a grossly misleading document:

i) The true nature of many of the reinsurance arrangements that enabled SCB to compete more effectively in the US involved, for the reasons given in section 2 of this Part of the judgment, the transferring of losses on the back of reinsurance and through spirals rather than the transfer of risk.

ii) As the reinsurances that formed the basis of their business were so different to conventional insurance and reinsurance, that fact had to be pointed out specifically.

iii) The risks to reinsurers were substantial and are summarised at paragraph 191; as I have found at paragraph 542, Mr Brown was well aware of the risks and the problems that had manifested themselves, in particular those at Syndicate 103. Those problems had, by the end of 1996, affected the market (as I have described at paragraphs 739 and following), making it impossible to find anyone prepared to provide the retro cover essential to the provision of lower tiers of reinsurance. As set out at paragraphs 964, 965, 976, 977 and 979, their attempts to find reinsurance for EIU and their explanations of their failure confirmed this.

iv) The prospectus did point to the fact that:

"A lack of available reinsurance coverage could limit [SCB]'s ability to continue certain of its reinsurance programs."

It also pointed to the other difficulties that could be caused by the lack of reinsurance, but nowhere was the true nature of those reinsurances described; that true nature was essential to an understanding of the risks.

v) If the true nature of the reinsurances had been described and the real risks consequent on that nature had been set out, it would have had a serious adverse effect on the business of SCB.

1122. A dispute had arisen with D&H over alleged non-disclosure in relation to a contract reinsuring SCB business (that was written by Clarendon and CIRCL) which Mr Billyard had accepted whilst employed by D&H; an attempt was made to use the IPO to put pressure on SCB – see paragraph 362 of Part II.

(4) The offer of reinsurance from Mr Brown

(a) SCB's knowledge of the desperation of EIU

1123. EIU became increasingly desperate at the lack of reinsurance to protect the gross loss making business they had written. SCB obviously knew of the serious difficulty in which this placed EIU and were aware that EIU were becoming increasingly desperate; I reject as untruthful, Mr Butler's evidence to the contrary referred to at paragraph 980; he was far too acute a broker not to have appreciated their obvious desperation in June 1997 and did not have to wait to be told of this in the autumn. Mr Brown was, however, able to provide the reinsurance not only for 1998 but also for 1997 through quotations given by Mr Billyard. There was an important conflict of evidence as to how this came to be provided.

(b) The market for 1998

1124. There was an important factor in Mr Brown's thinking – the tightening of the market.
1125. It was SD's case that the market was extremely tight:

i) Phoenix was not writing for 1998. Mr Butler accepted that Phoenix were no longer writing LMX from 1 January 1998.

ii) Mr Butler's evidence was that Mr Ekwall at WEB was not in a position to write the type of business that he had written at Phoenix.

iii) American Reliable had left the market.

iv) Lincoln National had stopped writing.

v) Mr Billyard at JEH Re was the only writer; however notice of termination was given by John Hancock in or about early October 1997. As set out at paragraph 1540, this was to take effect on 1 October 1998.

vi) SD gave as an example, the reinsurance required by Syndicate 53 (Mr Crane (Programme 22) – see paragraphs 566 and 587 of Part II), where they submitted no one other than Mr Henton and Mr Billyard were prepared to write business that had been so consistently loss making.

vii) Mr Butler's evidence was that he could not think of others writing retro business at a low level; CIGNA were also writing PA carveout but would not write LMX, only direct or first tier reinsurance.

1126. SCB did not accept that the market was as tight as SD contended. Mr Butler's evidence was that the market was quite tight; although there was not a great amount of capacity, there was no dearth. Mr Billyard was writing as were CIGNA and Clarendon; Mr Brown's view was that there were other markets that others could access – Panter, D&H (Mr Bert Stratton and Mr Nigel Guillaume-Smith), Gan and a number of Lloyd's syndicates were still writing down to $25,000; Crawley Warren were still using Phoenix and Rattner Mackenzie were using Mr Cackett.
1127. Mr Johnson's evidence was that the market for retro in 1998 was only WEB (writing for All American and Trustmark), and Phoenix through their own underwriting office and through Mr Cackett/Centaur in Bermuda, but Mr Cackett did not usually write the reinsurance of spiral business (as I have set out at paragraph 742); as EIU correctly pointed out, he was primarily a person who wrote on the first tier.
1128. Independent evidence of the tightness and of the difficulties facing SCB was provided by:

i) The losses and the cash flow problems arising from spiral business written in earlier years continued to affect the market adversely; SCB had given this as an explanation for their inability to find reinsurance for EIU in May and June 1997 (see paragraphs 965, 966 and 977).

ii) The difficulties in placing the reinsurances of Unum – see paragraphs 365 and following of Part II.

iii) Realm National needed cover for the facility granted to B&S (see paragraph 177 of Part II); on 17 December 1997, Mr Mortley of SCB told SCB North America that JEH Re had covered it for 100% and was hoping to get lines from SD and from Keyport per WEB.

iv) Stop loss cover was needed for Mr Billyard's reinsurance of Bridgefield Employers Insurance Company (Bridgefield) (see paragraph 1246.v)c) below and paragraph 148 of Part II) as Mr Billyard had written on 19 November 1997 asking for such cover.

v) Cover was needed for Hallmark (see paragraphs 499 and following of Part II).

vi) It was difficult to find any one to write Programme 22. As set out at paragraph 566 of Part II, the lowest layer had been reinsured 100% by Mr Billyard who wanted his line reduced. It is hardly surprising that no one else was prepared to write it other than EIU; Mr Crane's evidence was that this low layer was bought as a means of making the syndicate a profit; this had been done by the syndicate for several years. He accepted that it was exactly as if the reinsurers had agreed to write him a cheque or he had given them £1 but had received £5 in return. Mr Butler's evidence was that he could not think of any other than these prepared to write the business at such a low layer.

vii) The considerable difficulties in placing reinsurance for Mr Billyard's LMX account – see paragraphs 1561 and following. As set out at paragraph 609 of Part II, New York brokers had pointed out that reinsurers were demanding an LMX exclusion on facilities.

1129. I am sure that the market was very tight and that there was no one other than Mr Billyard and Mr Henton who was generally prepared to write retro business for 1998; the only possible exceptions were WEB and New Cap Re; what WEB were prepared to write was fairly restricted as they did not have the capacity and were extremely selective in their approach as the circumstances of their involvement in some of the programmes described in Part II makes clear.
1130. The holding company of New Cap Re had been formed in September 1996 to write property and casualty insurance business; it was listed on the Australian stock exchange; initially, its Australian subsidiary traded; a further subsidiary incorporated in Bermuda – New Cap Re (Bermuda) started trading in January 1998. Mr Sparkes, who had been the underwriter at Gan (see paragraph 741.ii)) was to move to New Cap Re in January 1998 and be based in Australia; he was to underwrite a PA account for both the Australian New Cap Re company and for the Bermudan New Cap Re company; he would only write business on the basis of limited reinstatements, as he had done in the past.
1131. It was against this background that Mr Brown met Mr Billyard in November 1997 in Florida.

(c) Mr Billyard's quotation on 12 November 1997

1132. In his first witness statement, Mr Brown had said that in about early December 1997 EIU had come back to SCB and said that they were in desperate straits; it was at that point that Mr Brown spoke to Mr Billyard again when he was in Bermuda. Mr Billyard had told Mr Brown that he had looked at his aggregate writings vertically for the year and had not written as much as he had anticipated; he was therefore in a position to quote for SD. Mr Brown thought that this was due to the fact that risks had signed down. Mr Brown then telephoned Mr Henton or Mr Whitcombe from Bermuda and had told them that a quotation for SD's reinsurances had been given by Mr Billyard. The timing of this coincided with the evidence of EIU.
1133. Mr Brown then reviewed the evidence and in particular quotations by Mr Billyard for reinsurances of SD dated 12 November 1997.
1134. Following that review, Mr Brown said, in his fourth witness statement and in his oral evidence to the Court that:

i) SCB knew that EIU still wanted reinsurance; if they could do something to help, they would do so. EIU came back to SCB in late October or early November 1997 and asked for help.

ii) Quote documents were prepared by Mr Mortley or someone else at SCB's technical backup.

iii) He had been told by either Mr Henton or Mr Whitcombe that WFD and HHI had managed to make a partial placement for 1997 and that he had been asked to place a structure around that; he could not recall precisely what he was given, but they were schedules of either what had been placed or what EIU had wanted to place. Nor could he recall precisely when these documents were provided, save that they must have been provided either before Mr Billyard had quoted or during the quotation stage itself. When Mr Brown met Mr Billyard, Mr Brown had the information sheets and a schedule with a few losses on it.

iv) He had taken these documents with him when he went to the US for the roadshow for the IPO; he had met Mr Billyard at The Breakers Hotel at West Palm Beach, Florida where they spent a couple of days playing golf and doing business.

v) On Wednesday 12 November 1997, Mr Billyard scratched three quotations for the reinsurance of SD in respect of the risks written under the binder – a programme filling the gaps for the period from 1 January 1997, a programme from 1 October 1997 also filling gaps, and a programme from 1 January 1998.

vi) The rates inserted in manuscript were in Mr Brown's handwriting and were inserted when he was with Mr Billyard. All the reinsurances for which Mr Billyard quoted had unlimited reinstatements except for the layers written by GIO where the balance of the risk had not been subscribed.

vii) He did not know what had persuaded Mr Billyard to write the business then; he believed that Mr Billyard had kept his vertical aggregates under constant review to ensure that what he had written was fully covered; he might have put some in place in anticipation of renewal in October 1997 and these had not been used. He therefore had spare aggregate capacity. He was quite surprised that Mr Billyard had quoted 100% and Mr Brown did not expect it to sign down.

viii) Mr Brown did not think at that time that the market would be tight for 1998. He did not know when Phoenix had said that they would not be continuing into 1998 for retro and LMX nor did he know that Mr Durling might not be continuing. Although he was in touch with Mr Johnson from time to time and they discussed the market, Mr Brown was pre-occupied with the IPO and did not follow the market in detail.

ix) The quotes were headed "anticipated programme"; they were therefore not firm quotes. He was not authorised to release them until Mr Billyard had checked his aggregates; he understood that Mr Billyard would do that in Bermuda. Mr Billyard would have been back in Bermuda by about 15 November 1997. Mr Brown did not know how long it would take to check the vertical aggregates, but Mr Billyard would have to take into account the renewals he would want to write at 1 January 1998.

x) Although Mr Brown went to Bermuda for a roadshow in connection with the IPO, he did not see Mr Billyard on that occasion and next saw him in London on 22 December 1997. He was very busy with the IPO and he did not know whether Mr Billyard had specified a particular point at which the quotes were to be released or whether Mr Billyard had said that it must wait until he came over to England. If SCB had pressed Mr Billyard, he might not have provided the reinsurance.

xi) It is, however, clear from an e-mail sent by Mr Butler's secretary on 17 December 1997, that Mr Butler had been in Bermuda on Thursday 11 December 1997 and that Mr Billyard had written some 1997 business for him.

1135. Mr Butler's evidence was that although he believed he had not been in Florida at the time the quotes were given, he probably knew of the quotes at the time. In his first statement, he had said that SCB were approached in around December 1997 by EIU whom SCB then understood were desperate; SCB then spoke to Mr Billyard again who felt that he had enough capacity to quote as he had not written as much business in the year as he had expected or because, as a result of signing down, he had not got as much aggregate exposure as he had expected. Mr Butler did not think this evidence was inconsistent with the fact that Mr Billyard had already provided quotes on 12 November 1997, as Mr Billyard had not authorised the release of those quotes.
1136. EIU tested during the evidence, whether Mr Billyard had given a quote on 12 November 1997, though SD accepted that the quotes were given then. I have carefully considered the points made by EIU, but do not consider that they cast doubt on the dates set out on the quote or the other evidence that supported that.

(d) The conflict of evidence as to the time EIU were told

1137. Mr Brown's evidence was that he rang Mr Henton or Mr Whitcombe shortly after Mr Billyard had quoted; he told them that he had quotes from Mr Billyard but that he could not yet confirm them. He told them that there would be an element of "regurgitation of loss", meaning some spiral, but that this was the best that they could get.
1138. Mr Whitcombe denied that this had happened; his evidence was that he would have recalled it if it had happened; Mr Henton's evidence was to the same effect; he would have recalled if it had happened; he would have put it in his chronology of 12 December 1997 (referred to at paragraphs 755.i) and 1085) which set out the chronology of the attempts to obtain reinsurance. The first they knew of the quotations was on 22 December 1997.
1139. Mr Whitcombe's and Mr Henton's evidence was that as a last resort, they had arranged a meeting with SCB in early December 1997 in order to press them to arrange comprehensive reinsurance cover. Mr Henton telephoned SCB and was told that Mr Brown was away until 15 December 1997. That information was in fact correct as Mr Brown was doing roadshows for the IPO and was not back until 9 December 1997. No meeting took place until 15 December 1997.
1140. Mr Brown's evidence was that it was not in his interest to delay providing the quotes; he would have brought it forward if he could.
1141. There was evidence of a meeting between SCB and EIU in SCB's expense records which recorded a lunch at Langan's Brasserie on 22 November 1997 that was attended by Mr Whitcombe and Mr Butler. Both Mr Whitcombe and Mr Butler denied that it took place. I attach no significance to this in those circumstances.

(e) The meeting between EIU and SCB on 15 December 1997

1142. Mr Henton and Mr Whitcombe met with Mr Butler and Mr Brown on Monday 15 December 1997 at SCB's boardroom. I am sure that there was such a meeting. That was the evidence of Mr Whitcombe and Mr Henton, it was noted in the diaries of Mr Brown and Mr Butler and the document referred to in paragraph 1144 was annotated to the effect that it was provided to SCB that day.
1143. It was the evidence of Mr Henton and Mr Whitcombe that:

i) They wanted to explain to SCB how serious the position was and they asked if SCB could help; Mr Whitcombe had not dealt with them since June 1997 and there was a degree of desperation on their part.

ii) They gave SCB full details of their position and explained that they would need funds to pay the premiums.

iii) Inwards business was mentioned as, if the reinsurance was placed, then it had to be paid for; they had told SCB that they could not pay for much reinsurance so they would have to write more business; they anticipated that the quotes would probably be expensive and that they would need more inwards business to pay the M&D premiums that were going to be charged. Specific risks might have been mentioned.

iv) Mr Brown said that he would go away, review the position and come back, but no commitment was made.

v) They were not told of the quotes by Mr Billyard.

1144. Mr Brown could not recall the specifics of the meeting and Mr Butler could not recall the meeting. Mr Butler could not recall telling EIU of the quotes at that meeting or before; he did not know if they were allowed to release them; they could not have said anything if they were not allowed to release them.
1145. A copy of the losses on the layer $90,000 xs $60,000 with the words "Reinsurance collection as at 31^st December 1997" had been marked by Mr Henton, "Copy to SCB 15/12/97". Mr Brown accepted that he was probably given this, but his evidence was that he had been given a copy earlier; there was another version in the file which was different as it did not include the words in typescript: "Reinsurance collection as at 31^st December 1997".

(f) The events of 17 December 1997

1146. EIU's evidence was that on Wednesday 17 December 1997, Mr Brown called back saying that he would try and help. Mr Henton could not recall a meeting that day, but he and Mr Whitcombe recalled a telephone call; Mr Brown could not recall a meeting, though a meeting was noted in Mr Brown's diary kept by Ms Barnes. Mr Butler's diary also recorded a meeting with Mr Henton. Although Mr Butler could not recall in depth what was discussed at the meeting, and he could not recall them discussing the quotes given by Mr Billyard, they probably discussed Programme 19 (Hallmark) and other matters.
1147. There was certainly contact that day between SCB and EIU, either by telephone or at a meeting. The probability of there being a meeting that day is supported by the fact that an information sheet and a sheet setting out the existing reinsurances were annotated by Mr Henton as having been provided to SCB on that day. This information sheet is an important piece of evidence as it was different to that prepared by WFD in October 1997 (see paragraph 1076) and that annexed to EIU's report of 17 November 1997 (with the terminology modified); the percentage of retro XL (including and excluding XL on XL) to be written was reduced from 20% to zero and the percentage of XL reinsurance of direct writers was increased by 20% to 49%. It is difficult to understand the point of EIU providing this if they knew of the quote by Mr Billyard.
1148. There were three other significant matters that occurred on 17 December 1997:

i) SCB sent a fax to SCB North America in connection with the reinsurance of Realm National B&S (Programme 9) in which they stated that Mr Butler was marketing the layers and that further lines from SD and Keyport were anticipated. Although the outwards protection for Realm National B&S had not been fully placed, false promises to the contrary had been given (see paragraph 1246.v)a)).

ii) There was documentation in relation to Programme 19 (Hallmark) which suggested the involvement or intended involvement of EIU in providing a retrocession on 17 December 1997 – see paragraph 510 of Part II.

iii) There was also similar documentation in relation to Unum which suggested that Mr Brown was discussing asking EIU to provide cover on 17-18 December 1997 – see paragraph 367 of Part II.

1149. Mr Brown's evidence was that this business was discussed with Mr Henton at that time, but he could not have discussed it with Mr Henton unless Mr Henton had some idea of the availability of reinsurance. Mr Henton's evidence was that there was no such discussion until the reinsurance was offered on 23 December 1997.

(g) SCB's conversations with EIU on 22 and 23 December 1997

1150. It was the habit of Mr Billyard to come to England for Christmas and go to Yorkshire to visit his family prior to Christmas. On Monday 22 December 1997, Mr Brown met Mr Billyard at the offices of SCB and had lunch with him. It was Mr Brown's evidence that Mr Billyard confirmed the quotes previously given and authorised him to release them to EIU.
1151. That same evening, Mr Brown telephoned Mr Henton or Mr Whitcombe and gave them the news. Mr Whitcombe recalled being telephoned and told of the provision of reinsurance by Mr Billyard, as it saved the 1997 account and put EIU in business for 1998. He recalled discussing with Mr Henton the question of finding funds to pay for the reinsurance as it was quite expensive. Mr Henton's recollection was that he was telephoned by Mr Brown and was told to go to SCB the following day as SCB had been successful in their quest for reinsurance. It is not important to determine who was telephoned; the important matter is that it is common ground that Mr Brown telephoned and told them that he had obtained reinsurance.
1152. The following morning, Tuesday 23 December 1997, Mr Henton had a meeting with Mr Brown at SCB's offices at which he was given three typed quotation sheets for reinsurance programmes, one for 12 months at 1 January 1997, one for 15 months at 1 October 1997 and one for 12 months at 1 January 1998; for the first two, these referred to the existing reinsurances. The sheets set out the number of reinstatements, rates and the anticipated net premium income on which the quotes were based. For 1998, EIU's premium income was stated to be anticipated as being $7.5m-$10m.
1153. The new reinsurer was not identified. Mr Henton therefore asked Mr Brown, who told him that the quotes came from John Hancock per JEH Re; he was told that they were writing 100%.
1154. Mr Henton's evidence was that there was little chance by this stage of finding any other reinsurance; this would be the only way of getting them out of the mess into which SD had got them. They had no alternative choice.

(h) An assurance given about the spiral?

1155. Mr Henton's evidence was that he was concerned that if John Hancock (per JEH Re) provided reinsurance for 12 months at 1 January 1997, there was an obvious risk of a spiral through Programme 1; the outwards reinsurance of SD by John Hancock (per JEH Re) for 1997 might come back to SD through the inwards reinsurance of John Hancock (per JEH Re) by SD. Mr Billyard, by writing this reinsurance of SD, was going to be writing a retro account of a retro account. Mr Henton's concern was correct because the risk of a spiral was obvious.
1156. Mr Henton's evidence was that he had questioned Mr Brown, who had assured him that that would not occur; it was Mr Henton's further evidence that Mr Brown had said something to the effect that Mr Billyard had a separate treaty into which the reinsurance of SD would go. He had a very clear recollection of this as it was very important to know if there was to be a spiral.
1157. In his cross-examination, Mr Henton accepted:

i) That he did not know what the other treaty was as he did not ask; it would have had to have been another LMX treaty apart from Programme 1 as SD's business was LMX and John Hancock (per JEH Re) had a treaty for LMX business in Programme 1. He did not ask who had written this treaty, though if it had been written by Phoenix or American Reliable, it might have come back indirectly to SD and this would have had the same effect as if it had come back directly.

ii) He was content to have a spiral with American Reliable when American Reliable had written the bottom layer of the 1997 reinsurance, but his evidence was that he had little choice but to accept this; the same happened later in relation to New Cap Re for 1998 when EIU and New Cap Re wrote a reinsurance of each other (as set out at paragraph 1341.iv)).

iii) He had catered for Programme 1 within the vertical limits of his 1997 reinsurance programme and had taken it as a 100% loss.

iv) Because Mr Henton had catered for it in this way, he said he would probably have been happy with the position even if the reinsurance did come back; but he did ask the question and was told that there was a separate treaty. In any event, reinsurance from John Hancock (per JEH Re) was all that was on offer and the losses would be dissipated into the higher layers.

v) He did not ask for an exclusion from Programme 1 (to prevent EIU's reinsurance from returning to it) or make any contemporaneous note of the assurance that he maintained that Mr Brown had given to him.

1158. Mr Brown's evidence was that he could not recall saying that there was a separate treaty or mentioning the 95% QS (a treaty which had run for some years to protect the business written for John Hancock) which was placed from 1 January 1998 as Programme 28 and which was broked on New Year's Eve 1997 by Mr Butler to Mr Henton; Mr Brown did not know if the SD outwards reinsurances had been ceded to it but any reinsurance that was placed would inure to the benefit of that QS including the reinsurances written by SD which protected business written for John Hancock by JEH Re (Mr Billyard) or Hackett.
1159. Mr Brown's evidence was that he believed that Mr Billyard was not intending to cede LMX to the 95% QS for 1998 and therefore would not cede the outwards reinsurance of SD. Mr Brown thought that Mr Billyard was looking to renew what they would deem would be an LMX programme on 23 December 1997, but that it was Mr Billyard's belief that rates would harden and he could look on it on more of a gross basis than he probably had done in prior years – see paragraph 1555 as to what happened. As set out at paragraph 1608, John Hancock had stated that the SD outwards reinsurance for 1998 was in fact ceded to the QS.
1160. In his statement, Mr Whitcombe said that he had a vague recollection of Mr Brown having given assurances that there was no risk of a spiral – he being told by Mr Henton of an assurance at Mr Henton's meeting with Mr Brown on 23 December 1997, and one he was given by Mr Brown at a meeting on 30 April 1998 (see paragraph 1579 below). Mr Whitcombe had forgotten this when he gave his evidence and accepted that his recollection was vague.
1161. It was SCB's case that Mr Henton was untruthful and that he lied when he was in a corner. Mr Brown had said no such thing. I set out my conclusion at paragraph 1254. There was some evidence that the issue of a spiral was raised again on 29 December 1997 when the programmes written by EIU on Christmas Eve 1997 were confirmed – see paragraph 1198.

(i) The further meetings that day with HHI and Mr Brown

1162. After the meeting with Mr Brown, Mr Henton's evidence was that he went to see Mr Smith and Mr McCarthy for coffee at The Saigon Times. He showed them the quotes and told them that the security was John Hancock, but could not recall saying anything to them about a spiral. Mr Henton then went to see Mr Whitcombe; Mr Whitcombe had no specific recollection of what he had been told by Mr Henton; he was just pleased to get the quotation and wanted to get it as fast as possible to Mr Smith and get Mr Broad to agree it. He accepted that by this time it was very likely that he knew that the security was John Hancock; once he knew this, there was an obvious risk of a spiral because Programme 1 was the reinsurance of John Hancock's LMX account. He also accepted that it was highly material to tell Mr Broad of this.
1163. There was then a further meeting with Mr Brown that day which took place before Mr Broad was seen. Mr Henton believed that it was at that meeting that they discussed how the reinsurance would be paid for, as it was quite expensive for 1997 – about 60% of the premium income and just a little less for 1998.
1164. The quotation for 12 months at 1 January 1997 was stated on the quotation sheet to be on the basis of a net premium income of $5m-$6m; the M&D premiums had been calculated on that premium income. Mr Henton's evidence was that they had written $4.1m gross or after deduction of the commission, $2.5m net. They needed income to pay for the reinsurance and, according to Mr Henton, what they needed was the difference between the net premium income they had written ($2.5m) and the net amount of $5m-$6m, being the net premium indicated on the quote sheet.
1165. Mr Henton told Mr Brown that EIU had to get SD's specific approval for the acceptance of inwards business; he thought that he had worked out the amount of premium that was needed with Mr Brown and had got a rough idea of the inwards contracts that were available, but no documents were available then.
1166. The further events relating to the placement of the reinsurances are considered at paragraph 1228; it necessary before turning to that to describe the approaches to Mr Broad and the writing of the contracts on Christmas Eve 1997 and New Year's Eve 1997.

(5) The writing of the Christmas Eve programmes

(a) The proposal put to Mr Broad

1167. On the same day, Mr Whitcombe wrote a letter to Mr Smith about the new reinsurance programme. The letter referred to the negotiations with SCB for a comprehensive reinsurance programme for the business written in 1997. It attached the quotes and stated that they were:

"supported in full by various A rated companies for which [SCB] require a firm order. You will note from the net premium income limits shown that an increase is required to the slip gross premium income limit. The increase in income is essential to provide the necessary funds to pay the reinsurance premiums and will give a much better account breakdown to the one we have currently. We have obtained firm promises from [SCB] that they are able to provide the net income they have suggested. We have established that in gross terms this will be in the region of 7-8 million dollars, I believe that this would require an increase to the facility of £2,500,000 making the total gross premium limit of £6,000,000 using the existing rate of $2-£1. A bordereau of all business written will be provided in the normal fashion. As we have discussed, this business is predominantly Direct emanating entirely from their Occupational Accident account as described in our 1997 business proposal."

1168. The letter was grossly misleading and dishonest:

i) EIU knew that the reinsurer was John Hancock and that there was no prospect of getting any other company to write the reinsurance. However, the letter referred to "various A rated companies". The EIU Defendants could not explain this. They said that there was hope that John Hancock might sign down and get other companies on, but John Hancock did not know who the other companies were at that point. Mr Whitcombe's evidence was that he did not tell Mr Smith what the security in fact was nor did he tell Mr Broad when he met him later in the day.

ii) Nothing was said of the spiral that might be created. If an assurance had been given, nothing was said of that.

iii) The letter referred to the business being "predominantly Direct"; none was in the ordinary sense of the term. Mr Henton and Mr Whitcombe said that "direct" referred to the reinsurance of direct writers; even with the capitalisation of the initial letter, this term would not have been understood in this sense by anyone other than those familiar with PA carveout business. The use of that term was plainly intended to deceive. Furthermore even if the term "direct" was used in the sense of first tier reinsurance as was used in the PA market for writing gross loss making WC carveout business, the statement was dishonest as it was not predominantly first tier reinsurance.

iv) Nothing was said as to the real reason for EIU's desperation to obtain the reinsurance – that they had written a significant amount of business which was loss making on a gross basis and that the losses to SD would be enormous without reinsurance.

v) The request for an increase in the premium income limit to £6m (or on the agreed rate of exchange to $12m) was not justified; the quote had been on the basis of a net premium income of $5m-$6m or a gross premium of between $8.6m and $10.3m.

1169. Mr Whitcombe's evidence was that he asked Mr Smith to take the quotation sheets to Mr Broad at once, as it was essential that they had an acceptance in view of the Christmas break.
1170. Mr Smith went to see Mr Broad at once. He told him that a comprehensive reinsurance programme was available for 1997 and 1998 and that Mr Whitcombe was keen to agree it; Mr Broad was told that there was a package on offer and that the level of business that Mr Whitcombe wanted to accept under the binder required an increase in the premium income limit under the binder. Mr Broad's evidence was that he did not see Mr Whitcombe's letter.
1171. Mr Broad was shown the programme described on the typed quote sheets and saw at once that it was LOD. He therefore queried the reason for buying the reinsurance and said that he was not inclined to buy it as it did not seem to be required.
1172. Mr Smith returned from seeing Mr Broad and told him that Mr Broad had said that he did not want to buy the 1997 cover. Mr Whitcombe said that Mr Broad was wrong and that he must see him at once. A meeting was arranged at Balls Brothers, the branch of the wine bar at the London Underwriting Centre at 5.15 that evening.

(b) The meeting at Balls Brothers

1173. There was a conflict of evidence as to the short meeting that took place at Balls Brothers that evening:

i) It was Mr Whitcombe's evidence that he went to Balls Brothers with Mr Smith and Mr Henton. When Mr Broad arrived, Mr Whitcombe took him to one side and asked him why he would not buy the reinsurance. Mr Broad had responded by saying that he was told that the reinsurance was claims made and he did not see why he should buy it as there were only a few days left. Mr Whitcombe said that the reinsurance was LOD and Mr Broad immediately said that EIU should buy it. Mr Whitcombe then told Mr Broad that SCB had offered EIU a number of risks that would assist in paying for the reinsurance and that that would take them above the limits on the slip; his evidence was that he had probably told Mr Broad that EIU would have to lead on a number of risks. Mr Broad then asked to see a schedule of the risks before they reached any binding agreement. Mr Broad and he subsequently returned to where Mr Smith and Mr Henton were and he introduced Mr Henton to Mr Broad. He understood from Mr Broad that he (Mr Broad) needed internal approval of the increase in the limits. Mr Broad then rushed off, saying he was late for another engagement.

ii) Mr Broad accepted that there was a meeting at Balls Brothers; he maintained that he had always thought that there was no point in buying reinsurance on an LOD basis at the end of the year for a short tail account. He agreed to take the reinsurance. Mr Broad's evidence was that he was told by Mr Smith and Mr Whitcombe that the reinsurance for 1997 and 1998 were a package available together on a take it or leave it basis; he was also told that there was a possibility of other claims in relation to Versace and that there might be other unknown claims that had not been notified. He also understood that WFD were involved and wished to rebuild that connection. He was persuaded to buy it. He added that he was told that the reinsurers were prepared to backdate the cover to the beginning of the year and, as it was Christmas, he was feeling generous. He also accepted that there was another aspect to the package – taking on more 1997 risks, but he did not look on this as writing the risks to pay for the reinsurance.

iii) Mr Broad's evidence was also that he was told that it was good quality PA business and that the question of leading was not raised. He might have asked for a schedule to be provided. Mr Whitcombe denied that he said it was good quality direct business; his evidence was that that Mr Smith knew that it was a treaty account and that some of the business would be gross loss making.

iv) Mr Whitcombe accepted that he did not tell either Mr Smith or Mr Broad that the security on the reinsurance was John Hancock.

v) Mr Henton's evidence was that this was the first time he had met Mr Broad; Mr Whitcombe had spoken to Mr Broad alone and without Mr Smith being with him. Mr Whitcombe had then come back and told Mr Henton that Mr Broad had agreed the reinsurance and the increase in the premium income. Mr Broad had not been surprised to see him – he was introduced and there was a conversation for 5-10 minutes on social matters over a glass of wine.

1174. I am sure that Mr Broad understood that to get the reinsurance he would have had to increase the premium income limit. However, he did not question EIU closely as to what was involved; his agreement was given at Balls Brothers on an evening shortly before Christmas and he was in a rush to get to another engagement. As he said, he was feeling generous as it was Christmas. Although his actions again fell well below the standard of a prudent underwriter, he was not told about the nature of the business that was to be written to pay for it. The EIU Defendants lied as to the nature and quality of the business and concealed the true reason for needing the reinsurance; I am sure that Mr Broad did not know that what was to be written was more gross loss making business. However, Mr Broad, as I have said, behaved with gross negligence in signifying his assent to the arrangements without proper enquiry or reading the letter, but merely after a short conversation in a wine bar on his way to another engagement.

(c) The writing of the programmes

1175. With Mr Broad's agreement obtained by these deceptive means, SCB and EIU then completed the transaction.
1176. On the morning of Christmas Eve 1997, Mr Henton met Mr Brown to write a number of the programmes. There was some dispute as to whether Mr Whitcombe was present but, as nothing material was said to have happened in his presence, the dispute is immaterial.
1177. Mr Henton told Mr Brown that Mr Broad had given his oral approval to the premium income increase. They then went through the contracts that SCB had wanted Mr Henton to write. SCB had kept all the risks that they had not placed fully on the floor in Mr Butler's office; either Mr Butler or Mr Brown put those in Mr Brown's office for the meeting with Mr Henton and these were shown to Mr Henton. The meeting lasted 2½ to 3 hours.
1178. During that time, Mr Henton wrote 12 programmes which are described in Part II; they were:

P7 Clarendon (per Raydon) – IMC Truckers scheme

P8 Retrocession of JEH Re's participation in Bridgefield

P9 Reinsurance of Realm National and of JEH Re's participation in the B&S scheme

P10 All American per WEB

P11 CIGNA in respect of the Aviary Lineslip

P12 John Hancock (per JEH Re) "direct" account

P13 Gerber (B&S)

P14 Clarendon (per Raydon) – participation in MELEX scheme

P15 Clarendon (per Raydon) – EEII book

P16 Unum

P17 Clarendon Temps scheme

P26 Mr Cackett's specifics

1179. I set out my conclusions on each of these programmes in Part II. I am sure that there was no time for Mr Henton to do any more than listen to Mr Brown point out the more important matters. He did not consider any risk properly (which he had to do) as he had had no underwriting plan; even if he had one, it would have had to be carefully reconsidered in the light of the reinsurance programme he had obtained. It was SD's submissions that Mr Henton was not attempting to underwrite the programmes on a conventional basis or on a net basis; for the reasons I have given in Appendix 1, I did not consider it fair to permit such a case to be advanced against SCB. Further it was contended that the programmes written were obvious losers on a large scale (apart from Programme 13) and some were losers on a huge scale; even on a net basis, where information existed, they were mainly losers on a very large scale and those that might make a profit would do so on a very modest basis before cash flow costs. I set out my conclusions on each programme in Part II.
1180. Mr Henton then went back to see Mr Whitcombe and spent about ½ to one hour going through the risks with him. In his evidence to the Court, it was clear that Mr Whitcombe had no real understanding of the programmes written; I am sure that that was also the position when Mr Henton told him of them on Christmas Eve 1997. They both went out to a very good but not very sober lunch. Mr Whitcombe then took Mr Brown a bottle of Chateau Latour as Mr Whitcombe thought that Mr Brown had done an excellent job and was delighted.

(d) 29 December 1997: the further presentation to Mr Broad

1181. On Monday 29 December 1997, the first working day after Christmas, Mr Henton prepared the bordereau for the contracts he had accepted on Christmas Eve 1997, which was referred to at the trial as the "Christmas Eve bordereau". He continued to go through the programmes with Mr Whitcombe; Mr Whitcombe was happy with each of them and signed some of the confirmations before he went off to lunch. Again I am sure that Mr Whitcombe had no real understanding of the risks written by Mr Henton. They filled out as many of the confirmations as they could and then made photocopies of a blank page with Mr Whitcombe's signature on it. Mr Henton then filled these in and countersigned them. This thereafter became the procedure for the confirmation of many other programmes.
1182. At about 10 a.m., Mr Smith and Mr McCarthy collected the Christmas Eve bordereau; Mr Smith then took to Mr Broad:

i) an amendment to the slip increasing the estimated gross premium income to £6m for 1997;

ii) the Christmas Eve bordereau; and

iii) details of the three reinsurance programmes.

Mr Broad scratched these. They were then taken back by Mr Smith to Mr Henton by lunchtime.

1183. It is convenient to consider the position of each in turn.

(e) Mr Watson's authorisation of the increase in the premium income

1184. Mr Broad could not agree to the amendment to the slip as he did not have authority within SD's internal controls to authorise the increase of the premium income limit to £6m; the total premium would have been outside the business plan figure of £2m. He therefore had to seek the authority of Mr Watson. This was the first occasion in which Mr Watson was directly involved with the binder.
1185. The meeting between Mr Watson and Mr Broad was brief – not more than five minutes on Mr Watson's account and between 10-15 minutes on Mr Broad's. Mr Broad had put his head round the door as they were about to go to lunch and told Mr Watson that there was a binder on which he wished to increase the premium income. Mr Watson asked him about the business and was told that it was PA; he asked him if he was content with the quality of the business and was told he was – they had had exceptionally good results; that he was comfortable with Mr Whitcombe and that all had been going very well. Mr Watson asked Mr Broad why the increase was for 1997 and not for 1998. Mr Broad responded that the cover holder had been holding back business pending SD's agreement to the increase in the limit.
1186. Mr Watson's evidence was that he was asked to increase the amount by £1m-£2m; he could not recall a figure of £6m being mentioned. Based on Mr Broad's assurances, he agreed, but he never saw the endorsement. As the bordereau showed that the business was treaty business, he would have expected Mr Broad to show it to him.
1187. Mr Watson did not believe that reinsurance was mentioned, but it was Mr Broad's evidence that he assured Mr Watson that the business was reinsured and that the authorisation was given on the basis that comprehensive reinsurance was available down to $10,000.
1188. Mr Broad initialled the amendment increasing the 1997 premium income limit on 29 December 1997. This stated:

"Noted and agreed the Estimate Gross Premium under "Information" is amended to read: £6,000,000. This being in respect of the period 12 Months at 1^st January 1997."

His evidence was that he only scratched it after speaking to Mr Watson and added the initials "MW" to show that it had been authorised. There is, however, a copy of the endorsement without the initials "MW".

(f) The Christmas Eve bordereau

1189. It was EIU's case that the bordereau was provided for the purpose of seeking Mr Broad's approval to three specific matters – (1) the writing of 100% lines, (2) the increase in the premium, and (3) the backdating of the risks. I did not understand their case to be that he was being asked to approve the underwriting; he could not have been as it was not suggested that he was provided with any underlying information.
1190. The bordereau showed the name of the insured or reinsured, the period, the territory covered (USA or worldwide), the broker (SCB in each case), the inception date (each incepted earlier in 1997), the period, the limits, the type (direct XL, QS, aggregate, direct, international XL), the line to be signed and the premiums (which totalled $8.171m).
1191. Mr Broad had no specific recollection of the bordereau being presented and his evidence was contradictory:

i) In his cross-examination, he accepted that he had looked at it closely whilst it was being broked to him, but he had also said he did not look at it closely or examine it in any detail though he would have been extremely keen to see what the business was and from where it had come.

ii) The fact that lines were being written for 100% would not have been of any concern.

iii) He did not spot that some programmes went down to a low level excess point of which he disapproved.

iv) He did not look at the column which showed the type of contract written as his focus was on obtaining reinsurance.

v) He would have noticed the early inception dates and would have been keen to see that the reinsurance mirrored what he was accepting.

vi) It was broked to him on the basis that EIU had new business which was to be backdated; although he was content to approve the backdating, he said to Mr Smith that Mr Smith should go away and find out more about it and that whatever was accepted had to be subject to reinsurance. He therefore scratched the list "subject full reinsurance, noted further information to follow".

vii) Mr Broad did not believe he was ever provided with the further information.

1192. Mr Broad's examination of the bordereau was at best perfunctory; he plainly approved the writing of 100% lines and the increase in the premium to the extent shown on the bordereau. He did not pay any attention to matters beyond that and I am sure that he did not appreciate that this was treaty business and certainly had no idea that it was gross loss making business.
1193. Mr Smith then saw Mr Henton. According to Mr Henton, Mr Smith told him that the further information required was a full bordereau. Mr Whitcombe's evidence was to the same effect. It was Mr Whitcombe's and Mr Henton's evidence that they provided this in the bordereaux which were scratched by Mr Broad on 2 and 11 February 1998 – see paragraphs 1281 and 1295.
1194. Mr Broad's evidence was that he never removed the conditions to which he had made the reinsurance subject ("the subjectivities"); it was his practice to run his pen through them; it was not known if this was done as the original of the document had been lost. He did not agree that the bordereaux received in February 1998 contained the information he required as the bordereaux did not provide any underwriting information.

(g) Subject to reinsurance

1195. Mr Broad's evidence was that when he scratched the reinsurance quotations, he approved the reinsurance programmes and was placing a firm order to place the reinsurance on the understanding that the reinsurance desk had cleared it. He did not know what the security was. It was not until July 1998 that the cover notes were signed as accepted by SD. Mr Broad could not explain the delay.
1196. EIU accepted that they could not bind the risks without full reinsurance, but maintained that when they received the documents scratched by Mr Broad back, they had the reinsurance and so the subject was satisfied; their only other obligation was to provide the information by way of the bordereau which Mr Broad had wanted. It did not matter that there was no paperwork for the reinsurance.
1197. EIU contended that they had reinsurance as they had accepted the quotes, even though this was oral and there was nothing in writing other than the quotes. The other terms of the reinsurance were standard market terms unless the terms were qualified on the quote sheets; these were the terms set out on LMX PA1. Although the quote sheets did not specify the M&D premiums, these were between 80% and 100%, the standard being 90%.

(h) The confirmation of the Christmas Eve risks by EIU

1198. Finally on the same day, on 29 December 1997, Mr Brown and Mr Butler came round to EIU's offices, where Mr Henton confirmed the reinsurance and the risks written on Christmas Eve 1997, except Programme 15 (confirmed on 5 January 1998), Programme 17 (confirmed on 9 January 1998) and Programme 26 (confirmed on 24 February 1998).
1199. Mr Brown's evidence was that he recalled that they discussed the reinsurance provided by Mr Billyard for 1997 and, as John Hancock were reinsured by EIU, he had said that there would be regurgitation of loss. He recalled Mr Whitcombe saying that the risks would be dissipated after a while as they worked their way through the programmes. Mr Whitcombe's evidence was that he had made no such comment.

(6) The creation of a spiral for 1997

1200. As set out at paragraph 838, SD had been the funnel for the losses incurred under the business written, as a result of the arrangements made in February and March 1997; the position was not materially altered by the placing of the XL reinsurance for the layer $50,000 xs $10,000 with American Reliable (as set out at paragraph 843) because the loss eventually came back to SD. The effect of the reinsurance offered in December 1997 for the 1997 year was to make SD's position very much better, if they were prepared to participate in a spiral.
1201. The result of Mr Billyard writing the reinsurance was that a spiral was created with Mr Billyard for 1997. The operation of the spiral is most clearly set out in the chart produced by Mr Hunt showing the reinsurance position on the 1997 year as at 1 January 1998; this is annexed as Chart 3. The chart was based on a number of working assumptions. Principal amongst these were the assumptions that Mr Billyard had used Programme 1 to cede the reinsurance to SD, that four losses had exhausted the reinsurances that were put in place by WFD and HHI with GIO, Auto-Owners and Bimeh, all with limited reinstatements (as described at paragraph 993) (the first four losses had been reinsured with different reinsurers to those reinsuring the fifth and subsequent losses), that the leakage through Manulife and RGA as reinsurers of American Reliable was not reinsured indirectly back into the spiral, that those shown did not have higher layers, that there were no specific, aggregate or stop loss protections, and that what was shown on the chart was the totality of the reinsurances. Clearly it was not possible to know precisely where a particular loss would go without knowing the totality of the reinsurances.
1202. The important features of the spiral, as shown in the chart, were that:

i) All losses in excess of the combined retention of $50,000 of the four participants spiralled.

ii) The effect was that the losses spiralled round until either there was a leakage when the loss reached a layer reinsured by others outside the spiral or a programme reached its limit, when the participant whose programme had run out received the loss. As can be seen in the chart, the leakages were to RGA (identified on the chart as X) who wrote 20% of the layer excess of $500,000 and to Manulife (identified on the chart as Y) who wrote 70% of the layer excess of $1.25m; RGA and Manulife would have ended up bearing almost the entire loss, subject to whatever reinsurance arrangements they might have.

iii) After 100 turns of the spiral which, based on quarterly accounting, would take over 25 years; the following (calculated by computer) illustrated what would probably happen:

a) An inwards loss to John Hancock of $100,000 would be borne as to $49,983 by RGA; the participants would only pay their retention save in the case of SD and American reliable who would pay respectively $9 and $8 in addition to their retention.

b) An inwards loss to Phoenix of $200,000 would be borne as to $149,983 by RGA, with the others paying their retention with the small additions referred to in the preceding sub-paragraph.

c) An inwards loss of $1.075m to American Reliable would be borne as to $150,000 by RGA and $875,000 by Manulife; the participants would only pay their retention.

d) An inwards loss to John Hancock of $1.075m would be borne as to $150,000 by RGA and $637,805 by Manulife, as John Hancock would bear more if the loss spiralled out of the top of their programme. The other participants would only bear their retention.

e) An inwards loss of $1.075m to Phoenix would be borne as to $150,000 by RGA, $874,652 by Manulife and $10,348 by John Hancock. The other participants would only bear their retention.

1203. Mr Hunt's methodology was questioned by SCB, who pointed out that:

i) The ultimate financial sensitivity of a spiral depended less on the number of reinsurers involved in the spiral and more on the total size of the reinsurers' retentions. However, it was accepted by SCB that this, in turn, depended on which reinsurer was reinsuring whom and on the order of reinsurance.

ii) It was the amount of money that went out by way of retention or by way of leakage that mattered to the ultimate result, not the number of small retentions or cracks for leakage that found their way out. Mr Hunt accepted this.

iii) The calculations also depended on where the loss entered the spiral. Mr Hunt accepted this.

iv) The calculations depended also on which programme a loss happened to move through first, as the speed and efficiency of any particular reinsurer in making collections differed from one to the next. The movement might also be slowed down where an individual reinsurer was underwritten for by an agent, as the agent might not have had authority to settle losses.

v) The incidence of the operation of the spiral could be affected by an alteration in the reinsurances of the participants. Mr Hunt accepted this.

As a consequence of the above, Mr Hunt accepted that in general, the actual operation of the spiral could be extremely difficult to predict.

1204. However, I find that:

i) The reinsurance of EIU's book placed by SCB with John Hancock (per JEH Re) had a dramatic effect on the incidence of loss on SD; under the position as it had been at 31 March 1997 (after the placement of the first five programmes) and at 30 June 1997 (after the placement of the first layer of SD's 1997 programme with American Reliable), SD's potential retention had been up to $500,000 in the range of losses considered by Mr Hunt. The effect of the reinsurance was to reduce the retention to $10,000 in that range of losses.

ii) The chart did not allow for the effect of leakage on the first four losses or the fact that they might have come back into the spiral. The reinsurances with GIO, Auto-Owners and Bimeh gave limited reinstatements, but each of the reinstatements could be fully exhausted by any number of claims; this gave a total of $7.5m of original loss leakage. Mr Railton put the effect of leakages at over $11m but it was not clear why it was this larger figure rather than $7.5m; it was so limited because the policies had limited reinstatements.

iii) It was impossible to know how many losses would be contained within the retentions of the participants; below a certain size, losses would obviously not spiral.

iv) Exclusions could stop the spiral or affect it but it was not clear how much of a realistic effect this could have.

v) The quantum of the original loss that needed to be paid constantly remained the same.

vi) The effect of the spiral was to push the first four losses up to Bimeh, just as it was to push the subsequent losses up to RGA and Manulife.

vii) However, with respect to RGA and Manulife, as there were unlimited reinstatements, they were constant sources of leakage and therefore would bear the brunt of the losses over the net retentions of the four participants.

viii) After the first four total losses had been exhausted and subject to the effect of exclusions, the spiral operated substantially in the manner depicted in Chart 3, though its exact operation would have been subject to specific, aggregate and stop loss protections.

1205. A loss to RGA or Manulife would, on the assumption that they had an XL programme, be added to any other losses they had from the same occurrence and, assuming it exceeded the retention, go into their bottom layer (and layers above that depending on its size); as mentioned at paragraph 312, the premium would be miniscule as it would be, as Mr Hunt confirmed, a proportion of the premium on the higher layer of RGA or Manulife which had taken the working layer loss that had spiralled up to that higher layer; their reinsurers would take the losses at the bottom and therefore be getting in working layer losses for a premium rated on the basis of catastrophe losses.

(7) The premium and the losses

(a) The premium shown on the Christmas Eve bordereau

1206. The gross premium income for each programme was entered on the bordereau presented to Mr Broad on 29 December 1997 (as described at paragraph 1189) and it came in total to $8.171m; this was in addition to the $3m shown on the bordereau as at 30 November 1997; they were seeking Mr Broad's approval for a total of £6m or $12m.
1207. It was SD's case that the premium on the bordereau was deliberately understated. They contended that the total gross premium income should have been $21.017m if the proper figures had been used; they produced a schedule setting out the basis for their contention; this would have been a net premium to SD of approximately $14.2m. There were three matters which were relevant to this allegation: (1) the use of the M&D premium figures, (2) Mr Henton's evidence over the method of accounting for the premium, and (3) the specific disputes over certain programmes.
1208. On the first issue, Mr Henton's explanation was that the figures in the column for premium on the bordereau were taken from the M&D figures and not the estimated premium income. The effect of this had been to understate the estimated income by 11%. In Programme 13 (Gerber), it was greater; the gross premium was shown as $112,500 whereas the M&D premium was in fact $250,000 (see paragraph 293 of Part II).
1209. The second issue related to Mr Henton's evidence on his understanding of accounting under the binder. Mr Henton's general explanation was that the binder was a continuous contract, but that it was to be re-signed each year so that SD could account for the premium each year in the appropriate year of account. Where an inwards contract written under the binder ran for more than one year, it would also be re-signed each year and the premium attributed to each year of account under the binder. Where there were adjustment premiums under the contracts, these would be signed into the year of account in which the adjustments occurred and not into the year in which the contract was written. Such adjustments would, however, count against the income that could be written in that year and so reduce the amount of new contracts that could be written. On this basis, the Christmas Eve bordereau submitted to Mr Broad on 29 December 1997 set out the M&D premiums which would be attributed to the 1997 accounting year though they would not actually be paid until 1998.
1210. This explanation was difficult to reconcile with the reason as to why he could not have agreed to the additional premium request in relation to Programme 26 in August 1998 (see paragraphs 1747.ii) and 1771.xi)), where he had said that the reason he could not have agreed was that one contract was a 1997 contract and the other was a 1998 contract. In his evidence on that programme, he said that the premium for one of the contracts went into 1997 and the other into 1998 and he could not therefore swap one against the other.
1211. The third issue related to SD's allegation that that there were four programmes (the two parts of Programme 9, Programme 11 and Programme 12) where the premium had been grossly understated. A schedule setting out their contention was produced by SD during the course of Mr Henton's cross-examination; he was afforded time to respond. The four specific programmes where SD alleged that the premium was grossly understated were:

i) JEH Re's participation as a QS reinsurer of Realm National for B&S (part of Programme 9). Mr Henton had entered on the bordereau $1.5m; however the estimated premium income for this part of Programme 9 (based on the estimated premium income to the underlying scheme of $130m) and stated on the slips to be for the 12 month period at 1 July 1997 (see paragraph 188 of Part II) was $7.6m. Mr Henton's evidence was that he had entered onto the bordereau, the premium for the first year of the three year contract – the premium of $130m was he said a three year premium; he had been told and noted the premium for the first year as $1.5m (see paragraph 190 of Part II). Although he accepted that on the basis of the slips the figure should be $7.6m, he had put the figure of $1.5m in on the basis of what he had been told.

ii) Realm National's retention for the B&S scheme (the other part of Programme 9). Mr Henton had entered $500,000 on the bordereau (50% of $1m). However, the premium for this part of Programme 9 (based on the estimated premium income to the underlying scheme of $130m) was $2.5m based on what was stated in the slips to be the estimated premium income for the 12 month period at 1 July 1997 – see paragraph 189 of Part II. However, Mr Henton's evidence was that as in the case of the other part of Programme 9, he had been told that the premium was $1m and had entered his share of that – 50%. Although he accepted that on the basis of the slips the figure should have been $2.8m, he had entered his figure on the basis of what he had been told.

iii) CIGNA Aviary (Programme 11). The estimated gross premium income was $50m and based on that, the estimated gross premium income to SD for the programme was $2.92m (SD had written a 50% line for three layers and a 33.33% line on one layer, though these subsequently signed down). Mr Henton's evidence was that he had used the M&D premiums which were 16% of the total estimated premium income of $50m; he did not base the figure on the estimated premium income as he did not think Mr Bird would achieve the estimated premium income of $50m, even though he accepted Mr Bird was far more experienced than he was. This meant that he had put on to the bordereau a figure of $264,000 for the first layer whereas if he had used the full estimated premium income, the figure should have been $1.65m. Mr Henton's further evidence was that he had only put in the lower figures because all that would be signed against the 1997 year were the M&D premiums; the adjustments would be signed against the following years in annual adjustments and would therefore not count against the 1997 year income.

iv) JEH Re "direct" (Programme 12). There was a guaranteed minimum premium which was 90%; Mr Henton used the deposit premium which was lower. For example, on the lowest layer he put the figure $350,000 into the bordereau rather than $940,000 which was the minimum premium. Mr Henton said that he did this as the minimum premium would only be received when the adjustments were made and would therefore count against a different year.

1212. I am sure that Mr Henton acted dishonestly:

i) Mr Henton approached the figures that he was to show on the Christmas Eve bordereau on the basis that they had to fit in with a maximum premium income of $12m for the year.

ii) Although there is room for doubt as to Programme 9 (see paragraph 210 of Part II), I reject as dishonest, his explanations in respect of Programmes 11 and 12. In the light of Mr Bird's experience, Mr Henton can have had no honest belief that CIGNA would not write what Mr Bird had given as the estimated premium income; he was simply looking for a way of reducing the figure he had to show. There was no ground for failing to include the minimum premiums that would be received under Programme 12.

iii) His explanation of his understanding of accounting was an invention which had been made to try and explain his dishonesty; it was inconsistent with the explanations in respect of Programme 26 – see paragraphs 1747.ii) and 1771.xi) to which I have referred; he plainly knew that the purpose of the bordereau was to provide to SD an estimate of the income to be received in respect of the contracts written in 1997 and not the income that would be received in 1997. If adjustments under these contracts were to be taken into account in subsequent years, then such an allowance would have had to be made in 1998, but there is no evidence that EIU attempted to do this. Furthermore, I accept the evidence of Mr Jackson that it was contrary to market practice.

iv) There was a column for estimated premium income on his spreadsheet; he had taken a deliberate decision not to provide this to SD (as set out at paragraph 894). There was absolutely no justification for not including this figure on the Christmas Eve bordereau (which was intended to provide information as to programmes where a specific additional premium income allocation had been given).

1213. I am sure that the figure provided on the bordereau should have been at least $10.557m. This figure is calculated on the basis that there is room for doubt as to whether any greater figure than $2m should be included for both parts of Programme 9.

(b) The commission and the losses

1214. Mr Jackson calculated that on a premium of $21.287m, EIU's fee was $3.967m. On the figure which I have found to be the correct gross premium, giving EIU the benefit of the doubt on Programme 9, the fee to EIU would have been in the order of $2m.
1215. Mr Henton looked at the programmes (except Programme 7 (IMC Truckers), Programme 13 (Gerber), Programme 17 (Clarendon Temps) and possibly part of Programme 9 (B&S) and Programme 10 (All American per WEB)) on a net basis and accepted that he would not have been surprised if they had had a loss ratio of 400%-500%. The actual losses were far worse. On the figures as at 24 March 2003, the net premium income to SD (ignoring Programmes 16 and 26) was $6.22m against incurred losses of $73.493m – a loss ratio of over 1,000%.

(8) The New Year's Eve programmes

(a) The writing of the New Year's Eve programmes

1216. On Wednesday 31 December 1997, Mr Henton accepted five further programmes when he visited Mr Butler and had a meeting with him in Mr Brown's office; the meeting lasted somewhere between one to two hours; Mr Henton said that it was sufficient time to consider the risks.
1217. During the meeting, Mr Henton considered seven risks; the five accepted were:

P18 Clarendon (per Raydon) – "direct" generals programme

P19 the Hallmark scheme

P22 Syndicate 53's PA account

P27 CIGNA PA account written by Mr Minter and Mr Branch

P28 John Hancock (per Hackett/JEH Re) 95% QS

1218. Two smaller contracts were considered, but not accepted – First Allmerica and Catlin (see paragraphs 124 to 129 of Part III).
1219. On two of the programmes – Programmes 19 and 28, the information was extensive but indigestible and required a lot of work; but Mr Butler's evidence was that it was all properly considered. I am sure that there was no time for Mr Henton to have done more than look at some of the documents, flick through others and listen to Mr Butler broking to him. Mr Whitcombe's evidence was that he knew little about these programmes; he assumed that he had discussed them with Mr Henton when they were confirmed. It was SD's submissions that Mr Henton was not attempting to underwrite the programmes on a conventional basis or at all. Further it was contended that all of the programmes written were obvious losers on a large scale (apart from Programme 28 where the position was unclear) and some were losers on a huge scale; even on a net basis, where information existed, they were mainly losers on a very large scale (Programme 19 and Programme 22) and those that might make a profit (Programme 27) would do so on a very modest basis before cash flow costs. I set out my on conclusions on each programme in Part II.

(b) The premium income and the losses

1220. Mr Henton's evidence was that he had looked at these contracts on a net basis, except for Programmes 18 and 28 which he expected might make a gross profit; he did not consider a gross loss ratio, but accepted that it could have been anticipated in the order of 300%-400%.
1221. The total premium income for the programmes accepted was shown in the bordereau as $4.276m; Mr Jackson's calculation was that it should have been shown as being in the order of $10m on which the fee due to EIU would have been in the order of $700,000.
1222. The losses under these programmes total $20.46m as at 7 March 2002 against premium actually received of $2.5m; there has been further deterioration on Programme 28 – as at the second quarter of 2002, the incurred losses on Programme 28 were $10.756m, as opposed to $4.29m.

(9) The placing of the reinsurance programmes

(a) The programmes

1223. The outwards reinsurance was largely placed by SCB; the final programme for 12 months at 1 January 1997 was on an LOD basis in 14 layers excess of $10,000 up to $5m (three of the layers were only for nine months). The bottom layer was written by American Reliable for 100%, John Hancock (per JEH Re) wrote 11 of the other layers 100% and two for 50% with GIO taking the balance of 50%. The other reinsurances are identified at paragraph 993.
1224. The programme for 15 months at 1 October 1997:

i) This was very important as it, rather than the programme for 1998, covered, on an LOD basis, the losses between $150,000 and $2.5m that had occurred in 1998.

ii) Cover on a limited reinstatement basis had been placed by WFD and HHI as described at paragraph 1092. The layer $1.25 xs $1.25m had only been placed 50%.

iii) Mr Billyard wrote the balance of the limited reinstatement line for $1.25m xs $1.25m and then provided unlimited reinstatement for all the layers.

iv) Mr Henton was therefore covered under these programmes for losses occurring in 1998 between $150,000 and $2.5m.

1225. The programme for 1998 was complex. The vertical XL programme was written by Mr Billyard was on an LOD basis at 1 January 1998. Mr Billyard wrote 100% of:

i) A layer $40,000 xs $20,000; this was replaced by a backup layer for $50,000 xs $10,000 in the circumstances set out at paragraph 1237;

ii) a layer $90,000 xs $60,000; and

iii) layers of $500,000 xs $2.5m to provide cover up to $5m.

1226. The very significant feature was that there was a gap between $150,000 and $2.5m, though SD had the benefit of the protection for 15 months at 1 October 1997 which covered this gap. This gap is crucial to the understanding of the spiral that developed when Programme 33 was placed (as explained at paragraph 1607.iii)).
1227. In addition to this vertical programme, other reinsurances were placed as described in the following paragraphs.
1228. The cost of the programmes was:

i) For losses occurring 12 months at 1 January 1997: 55.2%.

ii) For losses occurring 15 months at 1 October 1997: 27.78% plus 4.25% of net for the stop loss.

iii) For losses occurring 12 months at 1 January 1998: 29% plus 14.25% of net for the stop loss.

(b) The placing of the programmes with Mr Billyard

1229. The history of the placing needs closer examination for several reasons, including the subjectivity of the Christmas Eve programmes.
1230. The quote sheets did not state that Mr Billyard was prepared to write 100%, but Mr Butler said that when they asked Mr Billyard to quote for something like that they generally asked him to write 100% to cover it.
1231. On New Year's Eve 1997, Mr Smith sent Mr Butler a fax in which he stated that Mr Henton had given him the quotes and had understood that orders had been given. He said that the confirmation of the orders should be subject to the approval of the draft slips, the definition of net premium income, the proposed security and the agreement of brokerage. He asked for confirmation that full coverage was in place in respect of all XL contracts. He also asked for confirmation that, whilst losses for the layer $90,000 xs $60,000 were excluded from the quotations for the period commencing 1 January 1997, further losses (such as the Versace claim) would be covered by the programme.
1232. On 7 January 1998, Mr Billyard signed quote sheets which mirrored the sheets given to Mr Broad but with the M&D premiums added.
1233. On 28 January 1998, Mr Mortley of SCB sent to Mr Henton a fax from Mr Billyard setting out the lines he would write with his stamp of 27 January 1998. These were the same as shown to Mr Broad but with the M&D premiums. These were for 100% lines save for two where the line was 50%.
1234. On 19 February 1998, cover notes were given to EIU; some were dated 29 January 1998 and the slips were dated 22 and 27 January 1998. Mr Whitcombe could not say if the terms had been agreed before the slips were signed. He thought that the reinsurance was in place at the end of 1997 as the offer of cover had there and then been accepted; however, they had no cover notes.

(c) The initial stop loss for 1998

1235. On 4 March 1998, WFD placed a stop loss for $1.2m (15% of the applicable net premium income) xs $5.4m (85% of the applicable net premium income) with Dorinco Re underwritten by Beach & Associates of Toronto; Dorinco Re has been referred to at paragraphs 978 and 993.iv).

(d) New Cap Re and New Cap Re (Bermuda)

1236. On 18 February 1998, New Cap Re (Bermuda) provided to WFD, quotes for two Reinstatement Premium protection reinsurances of SD for the contracts for 15 months at 1 October 1997 placed through WFD; contracts were placed on 10 March 1998 and these were placed.
1237. Thereafter, more complex arrangements were made:

i) On 30 April 1998, negotiations began with Mr Sparkes at New Cap Re (Australia) for an arrangement under which they reinsured SD and SD reinsured them at a lower layer – see paragraph 1341.iv).

ii) Negotiations began with Mr Henton for him to reinsure Mr Billyard for his LMX business written in 1998 (see paragraph 1570).

iii) On 10 June 1998, Mr Henton agreed to provide a reinsurance for Mr Sparkes who had agreed a little earlier to provide a bottom layer for him; Mr Henton was also seen about the placing of the reinsurance of Mr Billyard (Programme 33) but the agreement was not finalised that day (see paragraph 1588).

iv) Mr Henton agreed to provide the reinsurance of Mr Billyard (Programme 33) on 19 June 1998 (see paragraph 1591) and on 23 June 1998 (see paragraph 1598), Mr Billyard amended the scope of the lowest layer he had written, an agreement in principle having been made on about 3 June 1998.

1238. In the result, in June 1998 the lower layer for 1998 placed with JEH Re for $40,000 xs $20,000 was replaced by:

i) a layer for $50,000 xs $10,000 placed with New Cap Re (Australia) with 99 free reinstatements; and

ii) JEH Re cancelled the reinsurance of SD for $40,000 xs $20,000 and replaced it with a backup layer for this on the exhaustion of the reinstatements, by a cover $50,000 xs $10,000 xs $5m in the aggregate.

The inter-relationship between Programmes 32 and 33 was explored in the evidence, but no detailed exploration of the relationship between Programme 33 and the alteration to the reinsurance of SD was made, though it was relied upon in the submissions of EIU. In the circumstances I have made the principal findings in respect of the relationship between Programmes 32 and 33.

1239. Mr Broad's evidence was that he did not know anything about the replacement; if he had been asked about it he would have wanted to have known about the M&D premiums that were paid to the original reinsurers who would want to be paid for the time on risk. The original reinsurer was Mr Billyard who, as set out above, changed the terms of the reinsurance to fit in with New Cap Re (Australia)'s reinsurance after he had received confirmation of the placing of Programme 33.

(e) The reinsurances placed between September and December 1998

1240. On 23 September 1998, three layers of $1m upper layer stop loss protection beginning at $750,000 xs $2.8m were placed with New Cap Re (Australia).
1241. In October and December 1998, cessions covers in respect of Programme 33 were placed (see paragraphs 1652 and following).

(f) No spiral at first in 1998

1242. The effect of the reinsurance for the 1998 year was, on the assumption that the outwards reinsurance of SD was not ceded to Programme 28 (which was thought to be the case for much of the trial), that until SD provided a reinsurance to Mr Billyard under Programme 33 in June 1998 (see paragraphs 1570 and following), most of the losses were retained by John Hancock. There was no spiral for losses occurring during that year at first. The effect on the spiral of the cession of the outwards reinsurance under Programme 28 is considered at paragraph 1608.
1243. However, the position was known to have changed when Programme 33 was put in place and a limited spiral was created – see paragraph 1605; Programme 33 only covered losses occurring on risks attaching from 1 January 1998. Therefore the layers of reinsurance between $150,000 and $2.5m that covered losses occurring in 1998 which attached for 15 months at 1 October 1997 were not covered by Programme 33. Because of this, the spiral in 1998 which arose under Programme 33 between SD and Mr Billyard, was broken (as explained in more detail at paragraph 1607.iii)).

(10) Conclusion on the actions of EIU and SCB

(a) SD's case

1244. SD's case was that:

i) Mr Brown obtained the quotations from Mr Billyard on 12 November 1997.

ii) He obtained them because they might be useful in the future and agreed with Mr Billyard that they were to be kept from EIU until it was expedient for SCB to use them and until EIU would write such of SCB's and Mr Billyard's business as needed to be placed. He would keep them in his "back pocket".

iii) Mr Brown learnt that Phoenix and American Reliable were unlikely to be in the market in 1998; it was then expedient for Mr Brown to make use of the quotations because they needed EIU for their market for 1998 as the only other market then was Mr Billyard.

iv) It was also expedient to use the quotations to get Mr Henton to write business he would not otherwise have written as he was so desperate for the reinsurance.

v) If Mr Henton had not written the business, the reinsurance would have evaporated.

vi) The reinsurance would have been withdrawn had Mr Henton written business to WFD.

vii) It was in essence a case against Mr Brown akin to blackmail.

1245. SD's case was that Mr Henton could not have helped at all without reinsurance as he had made plain; a trap was laid for him by waiting until he was desperate; no proper consideration was given to the risks; as it was clearly gross loss making business, there was no point in giving it serious study:

i) Mr Henton rejected the suggestion that there had been any understanding that he had to write the business offered in order to obtain the reinsurance. It was Mr Whitcombe's evidence that it was not suggested to EIU that they would not get the reinsurance if they did not write the inwards business.

ii) Mr Whitcombe agreed that it was ridiculous that all of the business could have been written sensibly in the space of 2 to 2½ hours on Christmas Eve 1997 or 1 to 2 hours on New Year's Eve 1997. Mr Brown's evidence was that many underwriters wrote in that way and that this was business that had been placed for years.

1246. SCB's case was that this was entirely misconceived. There was no reason for Mr Brown to have held the quotes back. The evidence of Mr Butler and Mr Brown were as follows:

i) Mr Butler denied that there was an obligation to write the risks to obtain the reinsurance; risks would be presented to Mr Henton and Mr Henton would make up his mind. He was quite free to write business to WFD.

ii) Mr Brown's evidence was that it would have made no difference to the writing of the business if he had been free to release the quotes three weeks earlier; he had not kept the quotes back; it was in his interests to release them as soon as was possible; he would not hang on to it in case he lost the business. Although he did not know of the negotiations with WFD, that was the kind of thing that might have happened in the market.

(b) SCB secure EIU's subservience to their interests

1247. I am sure that Mr Brown acted ruthlessly in withholding the quotation until the last minute and in making it clear to Mr Henton that Mr Henton had to write the business offered or EIU would not get the reinsurance they desperately needed for 1997 and 1998. He put Mr Henton in the position where he had no real alternative other than to accept the offer to write the programmes presented in return for reinsurance; Mr Henton acquiesced in this.

i) I am sure that Mr Henton and Mr Whitcombe did not approach SCB for reinsurance in late October or early November 1997; they were then engaged in trying to obtain the exclusive arrangement with WFD.

ii) I am sure that Mr Brown did not tell EIU of the quotations until 22 December 1997; I reject his evidence that he had told them earlier. It is clear from the contemporary documents and from the actions of Mr Whitcombe and Mr Henton that they remained desperate until 22 December 1997. One of the most telling pieces of evidence is the chronology produced by Mr Henton on 12 December 1997 (see paragraphs 755.i) and 1137); it is wholly inconsistent with Mr Brown having told them earlier and I can see no reason for him to have omitted this from what was an internal contemporary document; this was not a document in respect of which there was any evidence it had been tampered with or brought into existence later.

iii) It cannot have taken Mr Billyard more than a very short time to check his aggregates on his return to Bermuda; this cannot have been the reason why there was a delay. It was submitted on behalf of SCB that the calculation of aggregates might have taken some time. I reject SCB's suggestion that this might have been because his aggregates were low or that there was some uncertainty as a result of the termination by John Hancock of JEH Re's authority in early October 1997; neither is a reason for the delay as Mr Billyard must have known from day to day what his aggregates were as these had to be carefully monitored. When Mr Butler visited Mr Billyard on 11 December 1997, Mr Billyard wrote some 1997 business for Mr Butler.

iv) Mr Brown kept the quotations until he was in the best position to make use of them; the more desperate Mr Whitcombe and Mr Henton were, the more likely they were to do his bidding. Given the state of the market, there was little risk that anyone would have been able to provide reinsurance that would have enabled another broker to set up the kind of arrangement contemplated by WFD that would have meant that EIU would have written retro business exclusively to that broker and not to SCB.

v) Mr Brown did so in part because there was no one except Mr Billyard prepared to write retro business for 1998 (see paragraph 1128) and in part because there was a significant amount of 1997 business that they needed to place, including by way of example:

a) Realm National in respect of B&S (Programme 9), where an assurance had been given, but the cover had in fact not been placed – see paragraph 1147.i) and paragraph 177 of Part II. Mr Brown's evidence, given after the slips signed by Mr Billyard had been found, was that Mr Mortley might well have spoken to Mr Billyard and had had the missing layers covered, though there was no note of this. Mr Billyard had undertaken a large exposure because Lincoln National had refused to write the risk while they reviewed the spiral situation; although Mr Brown denied that any assurances had been given to Mr Billyard about reinsurance when he agreed to take over the Lincoln National line, it was submitted by SD that it was highly likely that Mr Billyard had been given an assurance or at least some comfort that this was to be the case. I am sure that that was what had happened.

b) Unum (Programme 16), where it was very important to SCB that reinsurance could be found as part of an arrangement to settle a dispute between D&H and SCB. No one could be found to write the reinsurance at a price that was considered acceptable – see paragraph 365 of Part II.

c) Bridgefield (Programme 8), where Mr Billyard had requested reinsurance (see paragraph 1127.iv)); this had been discussed with Mr Brown at the Florida meeting on 12 November 1997.

d) Hallmark (Programme 19), where, as set out at paragraphs 501 and following of Part II, Mr Crane would not provide reinsurance without a retrocession that transferred away the losses and that enabled him to remove any real prospect of loss to his syndicate.

vi) Mr Brown's decision to tell EIU about the quotes only on the evening of 22 December 1997 was designed to put maximum pressure on EIU as there were then only 2 business days remaining before Christmas.

vii) I reject as untruthful, the evidence of Mr Brown, Mr Butler and Mr Henton that the reinsurance would still have been available had Mr Henton not agreed to write the programmes which he eventually wrote.

viii) Mr Henton's hand was forced as he could not have written any business in 1998 without reinsurance for that year; without reinsurance for 1997, it was only a matter of time before the losses that would flow from the programmes he had written would come through and their dishonesty revealed.

ix) In the November underwriting report (referred to at paragraph 1110.iv)), EIU had reported to Mr Broad that they had envisaged, in the arrangement with WFD, using the opportunity that the market presented to increase the rates. EIU were not able to implement any such strategy with SCB; they acquiesced in what Mr Brown wanted – reinsurances and retrocessions which would assist SCB in their competitive position in the US market.

x) As set out at paragraph 1214, Mr Henton's evidence was that he looked at most of the Christmas Eve programmes on a net basis; he knew that the business was likely to be gross loss making overall and that the losses would be on a very large scale; although his evidence was that he did not consider the overall loss ratio on a gross basis, he accepted that it could have been anticipated to be in the range of 400%-500%. On this basis he would have been exposing SD to gross losses of $36m-$40m on the premium on the Christmas Eve bordereau or gross losses of $42m-$53m on the estimated premium income properly calculated.

xi) As set out at paragraph 1219, Mr Henton considered the New Year's Eve programmes (except Programmes 18 and 28) on a net basis and accepted that the loss ratios could have been anticipated to be 300%-400%.

xii) Mr Henton and SCB were also aware that as SD's reinsurances for 1997 and 1998 were on an LOD basis, business written on an RAD basis would produce losses after the expiry of SD's outwards reinsurance for 1998; he must have realised the serious risk he was running in a market where the reinsurance he actually needed had been impossible to obtain (save on the terms imposed by Mr Brown); 10 of the programmes accepted on Christmas Eve and 2 of the programmes accepted on New Year's Eve were on an RAD basis. Mr Henton's evidence was that he had accepted these knowing that SD only had LOD reinsurance because he believed that he would have been able to sort the position out for 1999. He had also relied on Mr Jackson's evidence that it was quite common to write an RAD risk whilst only having LOD reinsurance; however, that was a remark in the context of writing conventional business and not deliberately gross loss making business. He also relied on Mr Greig's evidence to which I have referred at paragraph 933 of Part II, but for the reasons given I do not consider it relevant to the position at the end of 1997. In my judgment, no honest or competent person acting in the best interests of his capital provider could have contemplated, after the difficulties encountered and with Mr Henton's knowledge of the market, accepting so much gross loss making business on an RAD basis without matching outwards reinsurance. Was this due to incompetence on Mr Henton's part? I am sure that it was not for he was, as I have set out at paragraph 864.ii), an intelligent man with an acute trading instinct. He did so because he was effectively forced by Mr Brown and Mr Butler to write the inwards business on the terms offered as he would not have received the reinsurance on offer if he did not do that. He had acted dishonestly and SCB knew that he was dishonest in so doing; no honest agent acting in the best interests of his principal would have exposed his principal to such obvious risks for such a purpose or entered into so many contracts with such large lines which were advantageous to the various reinsureds who were obtaining the benefit of the inwards contracts.

xiii) I am sure that Mr Brown and Mr Butler fully appreciated the risks to SD of granting RAD cover but only having outwards reinsurance on an LOD basis; they must have appreciated that no honest agent would expose his principal to such obvious risk for such a purpose. Mr Butler's evidence was that LMX contracts were generally written on an LOD basis and that it was normal for underwriters to write inwards business on an RAD basis and place their reinsurance on an LOD basis. I do not accept that evidence. I have already referred to the evidence of Mr Greig and Mr Jackson. I am sure that it was obvious folly to write gross loss making business with such a major mismatch in the reinsurance in the then market; but even if that evidence was correct, it was obvious to Mr Brown and Mr Butler and they must have fully appreciated that the writing of a significant number of gross loss making contracts on an RAD basis whilst only having reinsurance on an LOD basis would inevitably expose SD to the massive financial risks I have described. Furthermore, Mr Brown must have appreciated (as a result of the matters relating to Unum – see paragraphs 345 and following of Part II) that, by proffering to Mr Henton and making Mr Henton accept business on an RAD basis to pay for outwards reinsurance on an LOD basis, this would inevitably expose SD to the risk that they would not be able to obtain outwards reinsurance to cover the losses that would occur after the expiry of the LOD reinsurance. The finding of knowledge by Mr Brown and Mr Butler is not dependent on their knowing how he underwrote the risk; they knew his reinsurance arrangements in full and they knew the terms of the risks he was accepting. There is one further consideration which reinforces the conclusion I have already reached. As I have set out at paragraph 887.v), it was in their interests to ensure that insurers should write contracts with an exposure for which they had no existing cover, as such insurers would need cover for the inevitable losses that would occur and for which there was no reinsurance; SCB could then offer to provide this reinsurance on the basis that the insurer continued to write the business. In this way they could lock insurers into writing gross loss making business, thus assisting their competitive position in the US. It was submitted by SCB that Mr Broad must have known which of the risks were RAD from the bordereau; however, he did not know that gross loss making business was being written and thus even if he knew that the programmes were on an RAD basis, an aspect of the dishonesty of SCB was to bring about a mismatch in gross loss making business as SD were deliberately exposed to inevitable losses which SCB and EIU knew would occur and for which there was no cover.

xiv) As set out at paragraph 301 of Part II, no agent acting honestly in the best interests of his principal would have agreed to pay SCB the commission of 50% which Mr Brown and Mr Henton agreed on Programme 13 – the one programme where SD was likely to make a substantial gross profit. Mr Brown knew that Mr Henton was not acting in the interests of SD and I reject his evidence to the contrary.

1248. For these reasons I am sure that Mr Henton acquiesced in the arrangement that Mr Brown's ruthless conduct gave him little alternative but to accept; he put aside the interests of SD and acted in a way that was subservient to the interests of SCB. I am sure that he acted dishonestly in writing all the Christmas Eve and New Year's Eve programmes and that SCB instigated that dishonesty and had dishonestly assisted him in that dishonest course of conduct:

i) As I have already set out at paragraphs 885 and 888, SCB knew from early February 1997 that EIU had no authority to write gross loss making business and had dishonestly assisted them in breach of fiduciary duty; as set out at paragraph 878, SCB had ruthlessly exploited the opportunity offered through the binder from the outset in order to further their interests and ambitions; SCB knew from then that EIU were acquiescing in their demands and acting contrary to the interests of their principal.

ii) SCB instigated that dishonesty in the way I have set out and did so in pursuit of their aim.

iii) I am also sure that Mr Henton was influenced to go along with SCB's plan by the very substantial fee that EIU earned; the information provided is summarised in Part II.

iv) I am also sure that, although Mr Whitcombe understood very little of the business, he knew that EIU had been forced into writing these programmes, that Mr Broad knew nothing of the circumstances and the fact that gross loss making business was being written against reinsurers; the letter of 23 December 1997 written by Mr Whitcombe to Mr Broad was grossly misleading and dishonest in the respects set out at paragraph 1167; Mr Broad was not told about the creation of the spiral, although it was highly material he should have been (as Mr Whitcombe accepted – see paragraph 1161); the dishonesty of Mr Whitcombe's conduct is also beyond doubt.

1249. What was Mr Billyard's role?
1250. SD contended that SCB's willingness to get Mr Billyard to grant cover and Mr Billyard's motivation to grant it must be viewed in the light of the fact that John Hancock had given notice of termination of the facility with Hackett in early October 1997 (as set out at paragraph 1540).
1251. I am sure that Mr Billyard was prepared to grant cover because it suited SCB to keep Mr Henton in business and without reinsurance EIU could not have remained in business; neither he nor SCB cared what the effect might be on John Hancock:

i) The relationship between Mr Billyard and SCB was close; it dated back to the time SCB itself was formed and Mr Billyard was the leader on the majority of business placed by SCB (see paragraph 414). According to the evidence of Mr Paul Riding of SCB, Mr Billyard used to telephone SCB once a day (see paragraph 1725.i)).

ii) As can be seen from the events of 1998, SCB envisaged using EIU in 1998 to reinsure carriers that they hoped would grant Mr Billyard a new facility (see paragraphs 1446 and following and paragraphs 1545 and following).

iii) It was therefore in the interests of both Mr Billyard and SCB to ensure that EIU were in business in 1998; it did not matter to them if the arrangements were such that they disadvantaged John Hancock.

iv) In the absence of documentation or evidence from John Hancock, it is not possible to calculate what the effect on John Hancock might have been of the provision of the reinsurance to EIU, particularly given the uncertainty in relation to programme 28. Nor is it possible in the absence of such evidence to understand why Mr Billyard wanted certain lines reduced. There are several possibilities, but I will not speculate.

v) Furthermore changing the reinsurance arrangements for 1997 might have disadvantaged John Hancock (in that SD were relieved of the position of being the funnel for the losses) and providing reinsurance for 1998 might also have done so for, as set out at paragraphs 1241 and 1608, the effect, depending on the use of Programme 28, might be to leave the loss with John Hancock until the arrangements were changed mid-year. Their motivation for that change is discussed at paragraphs 1563 and following.

vi) As I have mentioned at paragraphs 415 and 538, Mr Billyard was not called to give evidence and I have not held that fact against SCB. I have taken into account the fact that I have not heard Mr Billyard's explanation of these events, but for the reasons I have set out, I am also sure that Mr Billyard was a party to the dishonest arrangement that Mr Brown made to provide reinsurance to EIU in return for the writing of SCB's business.

(c) Was the subjectivity in respect of reinsurance satisfied?

1252. As set out at paragraph 1233, Mr Billyard did not sign the slips for the reinsurance until 22 January 1998; until that was done, there was no reinsurance in place and the subjectivity on the slip had not been satisfied.
1253. No written confirmation of the reinsurance was provided to Mr Henton until 28 January 1998 and cover notes were not provided until 19 February 1998. It was reckless of Mr Henton and Mr Whitcombe to have provided the confirmations of cover for any contracts until they had evidence of the reinsurance; as set out at paragraph 1197, they did so in all but one case; in that one case (Programme 26) there was a reason for the delay as the programme was restructured (as set out at paragraphs 1692 and following).
1254. Furthermore, as set out at paragraph 1246.xii), several of the programmes accepted were on an RAD basis; there was no outwards reinsurance in place for those and for that further reason the subjectivity was not satisfied in relation to those programmes.

(d) No assurance about the spiral for 1997

1255. As Mr Brown and Mr Henton were both witnesses who gave dishonest and untruthful evidence in relation to many matters, it was not easy to decide which of them was lying about the assurance that Mr Henton claimed had been given in respect of the potential spiral (as set out at paragraphs 1154 and following). Considering matters independent of both witnesses, I am sure that Mr Henton was giving untruthful evidence as to the assurance given by Mr Brown about Mr Billyard ceding the reinsurance of SD to a separate treaty. He made no note of such an important matter and did not attempt to exclude the business coming back by requesting an endorsement. He had been content to enter into a spiral with American Reliable. He had accepted a treaty from Mr Billyard for his LMX business and the outwards reinsurance of SD would be LMX business; it was highly unlikely that there was a second such treaty. The existence of any assurance was inconsistent with what Mr Henton told Mr Bentley on 16 July 1998 (as set out at paragraph 1468). I am sure that he invented this conversation to try and bolster the position he subsequently took in relation to the assurance about Programme 33 – see the conclusion at paragraph 1672.

(e) Appreciation of the effects of the spiral created for 1997

1256. As I have set out at paragraphs 533 and following, I concluded that the spirals in 1993-1996 were deliberately created and that Mr Bird, Mr Billyard, Mr Brown, Mr Butler and Mr Johnson understood that the effect of the spirals was to push working layer losses (particularly in 1995 and 1996) up to layers where catastrophe losses would ordinarily be experienced, and that they intended this to happen.
1257. Mr Henton's evidence was that he did not know of the effect of the spiral in passing small claims to the higher layers, as I have mentioned at paragraph 862.iii). He was aware of the spiral working party though. His evidence was that he did not know of these matters in 1996 even though he had been Mr Bird's deputy underwriter at Syndicate 103 and was going to emulate Syndicate 103's account at EIU. Mr Henton said that he did not expect EIU to have these difficulties as EIU had higher retentions, were concentrating on direct writers, and were looking to build up the rest of the account as well.
1258. I reject Mr Henton's evidence. He knew the way in which the spiral operated from his experience at Syndicate 103; he was thereafter employed by Eastgate, which managed the run-off of the syndicate. Mr Henton claimed that he was not directly involved in the run-off; I find it inconceivable that he did not find out from, or was not told by, a fellow employee in Eastgate about what was happening to the syndicate at which he had been the deputy; his diary entries indicated meetings about Syndicate 103. He also remained (as I have set out) in close contact with Mr Bird.
1259. Mr Henton invented the assurance which he alleged had been given by Mr Brown in relation to the spiral as he knew what its effects would be and had wanted to disassociate himself from them.
1260. SCB (through Mr Brown and Mr Butler) and Mr Henton were well aware that the effect of the writing of the Christmas Eve programmes would be to create more gross loss making business that would then be put into the spiral which was created as a result of the reinsurance with Mr Billyard; I am sure that they appreciated that this might have had the effect of delaying the ultimate payment for many years and of passing the loss to those in the higher layers.
1261. A document made available by SCB in July 2002 as a result of the e-mail search showed that Mr Butler had attended a meeting of the 1993 spiral working party in February 1998. When he gave his evidence, the only reference to the working party was contained in the report of Syndicate 103 which was published in April 1997 (referred to at paragraph 518). His evidence was that he became aware of the spiral working party for 1994 first and attended meetings of that working party. I am satisfied that he must have become aware of the 1994 working party by the end of 1997 at the latest.
1262. I reject Mr Brown's and Mr Butler's evidence that anyone who wrote higher layer reinsurances of this business must have known that they might be getting working layer losses passed to them through the operation of the spiral; for the reasons I have given in relation to the 1993-1996 spirals, they knew that one of the objectives of a spiral was to push working layer losses up to catastrophe layers which would not, in a conventional market, anticipate working layer losses. I will not, however, for reasons I have set out, make findings as to whether particular companies actually knew that they might receive working layer losses or whether they expected catastrophe losses.
1263. I am sure that Mr Brown and Mr Butler knew that the creation of this spiral would delay the payment of these losses for very many years and that this would enable them to continue to broke this gross loss making business.
1264. It was SD's submission that the 1997 spiral was very similar to what was created for 1993-1996; that this was no coincidence as without a spiral the participants would have been left to bear, between themselves, the losses which they knew would arise on their deliberate writing of gross loss making business; the construction of a spiral was the only way of moving the losses away from themselves.
1265. The construction of a tight spiral had the effect of reallocating working layer losses to reinsurers writing at what would ordinarily be catastrophe level layers protected by high excess points. I have set out at paragraph 300 my views on those who might have been prepared to write these layers.
1266. In the case of the spiral created at the end of 1997, I am sure that Mr Brown and Mr Butler had one interest – to provide reinsurance to Mr Henton so that he could write the risks that they had not placed in 1997 (or reduce Mr Billyard's line on others) and be able to write risks for 1998. That meant that SD could not continue to be the dump. The creation of the spiral had the advantage of moving the losses to those who would be reinsurers of the participants at higher layers as they knew that the participants (other than SD) were very likely to have higher layer excess of loss reinsurances because they had this in previous years, but if they did not, SCB did not care as Phoenix and American Reliable were of no further use to them as a market for their gross loss making business.

(f) Appreciation of the problems caused by the spiral

1267. As I have set out at paragraph 542, I am sure that by the end of 1996 at the latest, Mr Brown and Mr Butler were well aware of the serious adverse cash flow effects of writing spiral business. Over the course of 1997, their knowledge had been reinforced – see the letter to the Names on Syndicate 103 in March 1997 (referred to at paragraph 514) and the report of Syndicate 103 in April 1997 (see paragraph 518), the explanations given to EIU during the attempts to place the reinsurance in May 1997 (see paragraph 965) and in June 1997 (see paragraph 977), and the problems that had led to the suspension and cancellation of the Big Ben facility in 1997 (see paragraphs 1033 and following). I reject as dishonest, Mr Brown's evidence (referred to at paragraph 519) that he did not know of the cash flow problems of Syndicate 103; they were similar to those that had arisen in respect of Mr Owen and had been caused by the cessation of payments of Mr Owen's syndicate on reinsurances that were placed by SCB; furthermore, Mr Bird was a close colleague of Mr Brown's at SCB.
1268. I am also sure that Mr Henton was well aware of these risks by November 1997; he was bound to have learnt from Mr Bird or Mr Whitcombe what had happened to Syndicate 103 and in any event was told by SCB of the problems in May and June 1997 (referred to at paragraphs 965 and 977) when these were given as the reasons for the difficulty in securing reinsurance.
1269. EARLY 1998

(1) The business written in early 1998

(a) The position of WFD and the exclusive arrangements

1270. The market for 1998 has already been described – see paragraphs 1124 and following.
1271. The proposed exclusive arrangement with WFD (referred to at paragraphs 1076 and following) was not carried into effect for the reasons set out; as SCB summarised the position in their closing submissions, with the reinsurance in place, the need for the exclusive arrangement with WFD vanished. The position was made clear to WFD at a meeting, followed by a letter on 13 January 1998 which stated:

"A copy of the 1998 slip format will follow shortly. You will note that the slip does not contain an XL on XL exclusion clause. As explained however the aggregate exposure available to us for London Market business was limited and has been fully utilised. In any event our 1998 programme was geared to an XL of Direct Writers account as discussed with you prior to Christmas. We are covered for the reinsurance of an Occupational Accident account indeed we may be seeking some specific coverage on our own writings."

This paragraph was intended to make it clear that EIU would not write XL on XL to WFD; it was an excuse to tell WFD that EIU would not write WFD's business. Mr Henton's evidence, as set out at paragraph 1079.ii), was that if a broker put together a programme that allowed an underwriter to write XL on XL business, then the underwriter would look to write that broker's business into that section of the underwriter's account. As SCB had put together the programme that allowed EIU to write retro business, Mr Henton would write SCB's business and not WFD's business into that section of the EIU account. WFD's business could be written, but he was not going to.

1272. SCB accepted that such exclusive arrangements existed; but their evidence and that of Mr Henton's was that there were no such arrangements between SCB and EIU for 1998; it was open to EIU to take business from any source.
1273. The letter also sought stop loss quotes and resulted in the reinsurances that were provided by Dorinco Re and New Cap Re (Bermuda) – see paragraphs 1234 and 1235 above.
1274. Some business was offered by WFD to Mr Henton in 1998 but he did not accept it; the only contract written by EIU for WFD was a reinsurance of New Cap Re for $3m xs $2m which is briefly referred to further at paragraph 835 of Part II.

(b) The programmes written in early 1998

1275. Between 5 January 1998 and 4 February 1998, Mr Henton wrote five more programmes, all to SCB:

P20 Chiyoda

P21 Venton Syndicates 376 and 2376 and the run-off of Fenn Syndicate 1038

P23 CIGNA Aviary aggregate cessions

P24 Retrocession of JEH Re's reinsurance of Centaur (Mr Cackett)

P25 Republic Western

As set out in Part II, no criticism was made of Mr Henton's decision to accept Programmes 20 and 25.

1276. Unlike the other main acceptances, these programmes were accepted on different occasions. Their characteristics can be summarised as follows:

i) the weight of the business was reinsurance of WC carveout;

ii) Programmes 21 and 24 were reinsurances of gross loss making business; the information on programme 23 was totally inadequate to make any assessment; Programmes 20 and 25 may have been profitable, but the premiums under these two programmes were small;

iii) Mr Billyard was the co-reinsurer on most of the programmes;

iv) two of the programmes were on an RAD basis; and

v) all the programmes were backdated to 1 January 1998 (except for Programme 23 which was backdated to 1 October 1997).

I set out my conclusion in relation to these programmes and to the Unum programme described in the next paragraph at paragraphs 1536 and following.

(c) Programme 16 – Unum

1277. One of the risks accepted on Christmas Eve 1997 was a reinsurance of Unum expressed to be in respect of "losses occurring on risks attaching during the 36 month period commencing 1 January 1995".
1278. This is dealt with in detail at Part II, but the events are significant in that:

i) Mr Henton agreed on Christmas Eve to provide a reinsurance to SCB in order to enable them to settle a dispute with D&H and their principals (including Unum) which they had over alleged misrepresentations in relation to related 1995 reinsurances of gross loss making business which were placed by SCB with Mr Billyard whilst Mr Billyard was an underwriter at D&H.

ii) The terms on which Mr Henton had agreed to do this had been deliberately crafted to try and fit in with the authority under the binder and at a price which was determined solely by what SCB would pay. This was a collusive and dishonest arrangement.

iii) When Mr Whitcombe discovered what was agreed in early January 1998, he prevented the agreement being implemented.

iv) Thereafter Mr Henton and Mr Brown dishonestly colluded together to try and find (1) a formulation of terms acceptable to D&H that would enable the programme to be written under the binder, and (2) a means of meeting the requirement of D&H that the writing of the programme was confirmed by SD itself, as D&H were suspicious as to the authority of EIU.

v) I am sure that EIU would not go to Mr Broad to get confirmation of the cover because that would have involved explaining the risk that they had wanted to cover and SCB knew that they would not go and why they would not go. It is important to note that SCB did not also approach SD to obtain confirmation of authority to write Programme 24 when, shortly after this, a similar question was raised by the principals of Mr Cackett (see paragraph 1707).

vi) Their collusive course of conduct included writing letters that told lies, a request to Mr Henton on 26 February 1998 to "doctor" a document and the fraudulent alteration by SCB of a document sent to D&H on 4 March 1998.

(2) The information given to SD on 2 February 1998

(a) Internal discussions at SD on 8 January 1998

1279. Mr Watson attended an internal meeting at SD on 8 January 1998 which was called because of the angst between those responsible for reinsurance at SD and Mr Broad. Mr Broad, Mr Watson and others were present. This was a heated meeting as Mr Broad and Mr Watson had had a heated argument over reinsurance; Mr Watson was upset at the way Mr Broad was running the reinsurance for his department. The note produced recorded Mr Broad as saying that the binder was successful with $2m in premium income and $250,000 in claims; that WFD was involved in placing the business. The note also explained that the cover was not within the main reinsurance, but that there was specific reinsurance which left the account with a net retention of $10,000. Mr Broad was recorded as saying that cover notes and full documentation would be provided in the near future. He was also recorded as stating that he did not know the security, but that it was all 'A' rated. This was entirely consistent with the fact that he had not been told by Mr Whitcombe that the security was John Hancock (as set out at paragraph 1167.i)).
1280. The note also recorded that the writer had only seen one of the reinsurance cover notes and that he thought that they might therefore be left with £158,000 on the Versace claim.
1281. There was some documentation that indicated that a review of Mr Broad's account within SD was to be undertaken and that the business under the binder was to be reviewed; however, on the evidence available, it did not appear that much, if any, progress was made until about May 1998 – see paragraph 1367.

(b) 2 February 1998: HHI's meeting with Mr Broad

1282. On 27 January 1998, Mr Whitcombe sent to HHI, under cover of a letter, the written and paid bordereaux for the months of October, November and December 1997, a document setting out the current written position for 1998, the January claims received listing for the 1997 year along with all relevant documentation, and what he described as an addendum to his November 1997 underwriting report. This last document was a further report and it is convenient to refer to it as the January 1998 report as it was so inscribed; the fact that the report was sent then is important as regards the statements in the report about the reinsurance. These documents were presented to Mr Broad on 2 and 11 February 1998.
1283. On 2 February 1998, Mr Broad was presented by Mr Smith with an endorsement for the premium income for 1998 and the premium bordereau for 1997; Mr McCarthy had by then left HHI and had joined Moore Brown Barnes (as set out at paragraph 1544).

(c) The endorsement for the premium for 1998

1284. The endorsement for the 1998 premium income was presented on 2 February 1998 with the gross premium income figure shown as £7.5m.
1285. Mr Broad agreed only £6m as the gross premium income, as that was within his authority. He amended the slip to £6m and scratched it. Mr Henton and Mr Whitcombe had the impression that Mr Broad did not want to go back to Mr Watson for more; Mr Broad agreed that that was a fair understanding of the position.

(d) The premium bordereau for 1997

1286. There was also presented on that occasion, a single bordereau of all the risks that had been written in 1997 including the Christmas Eve programmes; it showed that the total premium was over $11.28m. Mr Broad scratched the bordereau. As set out at paragraph 1192, it was EIU's evidence that this bordereau and that submitted on 11 February 1998 supplied the further information that had been requested by Mr Broad when he scratched the Christmas Eve bordereau.
1287. Mr Broad's evidence was that he could not recall reading the bordereau whilst it was presented to him with the endorsement; it was not drawn to his attention that this included the Christmas Eve programmes and no further information had been provided. By scratching it, he did not approve it knowing what was in the bordereau, as what was in it had not been drawn to his attention; he was not approving the Christmas Eve programmes or the supply of the further information he had requested. He was merely agreeing to the fact that he had seen the document.
1288. SD's case was that the bordereau grossly understated the premium that had been written; it was not $11.28m but $26.5m. They produced a similar schedule to which they had produced in respect of the Christmas Eve programmes (see paragraph 1206) for the whole of 1997, adding in the risks written earlier in the year. Their case was that the premium reported to SD was $12.3m (or $11.7m, removing Unum), but it was in fact $26.5m (allowing for the removal of Unum and stating the premium on Programme 26 (the occupational accident specifics of Mr Cackett) on the basis that there was no increase as a result of the "all sources" endorsement). A similar schedule was produced for 1998 (see paragraph 1343).
1289. Mr Henton's response was:

i) As to Lincoln National (Programme 4), CIGNA per Aviary lineslip (Programme 11) and John Hancock per JEH Re "direct" (Programme 12), there were large adjustments of $3.5m which would not be attributed to 1997 and which would only come through in subsequent years of account; only the M&D premiums were properly attributable to 1997.

ii) On American Reliable (Programme 3), the estimated applicable premium in respect of the bottom layer should have been $7.5m rather than $10.5m because of the exclusion of the travel account from the bottom layer; that reduced the premium by $460,000.

iii) Taking into account the evidence he gave on the Christmas Eve programmes referred to at paragraph 1210, his explanations reduced the figure in the schedule to $13.8m.

1290. Mr Henton said that he believed that Mr Broad would have had no problem at all with the way in which they had dealt with the figures.
1291. Although for the reasons given there was some doubt about the position on Programme 9 and I accept Mr Henton's explanation in respect of American Reliable, I have rejected at paragraph 1211, his other explanations in respect of the Christmas Eve programmes; for the reasons I have already given at paragraph 1211.iii), I have rejected his explanation for the accounting of adjustments and have no doubt that this was another dishonest document.

(3) The documents presented on 11 February 1998

(a) Further amendments to the binder

1292. On 11 February 1998, Mr Broad was presented with:

i) two further amendments to the binder which he scratched;

ii) a class bordereau which he scratched;

iii) the January 1998 underwriting report which he scratched; and

iv) 4 information sheets used for placing the reinsurance (the one for 1998 being attached to the underwriting report, as set out at paragraph 1307 below); the one for 1998 gave the estimated applicable net premium income as $7m and gave the breakdown of the account as:

"Direct PA 25%

International 20%

International inc London, 10%

PA XL Contracts Direct Writers 5%

Proportional contracts 30%"

Mr Broad also scratched each of these.

1293. It is necessary to refer to the endorsements, class bordereau and underwriting report in more detail.
1294. The first endorsement to the binder amended the 'General Conditions'. It substituted the following:

"It is hereby noted and agreed that with effect from 1^st January, 1998,

That the General Conditions amended as follows: -

GENERAL CONDTIONS:

As per Wording T.B.A.

Original policy conditions on established Market Forms.

The Coverholder is authorised to sign collective/subscription policies and endorsements thereto, in respect of risks declared hereunder and shall retain a copy on file and forward a further copy to Underwriters with the bordereau to which it applies.

Mr. Chris Henton added to authorised persons to accept as Named Underwriter.

Built in Reinsurance protection hereon to be agreed through Horace Holman International Limited.

Conversion rate $2=£1."

1295. This was an important change as its principal effect was to add Mr Henton as a named underwriter and to remove the requirement to follow a recognised market lead. Mr Broad's evidence was that he agreed to dispense with the follow clause as he understood that one of the reasons why WFD were not supporting the binder was that they could not lead. Mr Broad's evidence was that he had met Mr Henton once at Balls Brothers and Mr Whitcombe had spoken very highly of him; he did not ask for a CV or make enquiries as that was not necessary. He had not known that Mr Henton was involved from the start.
1296. The second endorsement amended the cancellation clause so that the binder could not be cancelled until 30 June 1999; Mr Broad did this so that EIU would not have the ground cut from under their feet; he had not suggested this.

(b) The class bordereau

1297. The class bordereau was the one to which I briefly referred to at paragraph 904 as the class bordereau which he had scratched. This was the other document which EIU contended had supplied the information requested by Mr Broad by his scratch on the Christmas Eve bordereau (as set out at paragraphs 1190 and following). His evidence was that he did not read this.
1298. As set out at paragraph 907, a deliberate change had been made to the first class bordereau produced in March 1997. There was also a deliberate change to the one scratched on 11 February 1998. The bordereau as originally prepared referred, in respect of the JEH Re and Phoenix programmes (Programmes 1 and 2), to the inclusion of "London Market Excess of Loss", as was done in the bordereau submitted in March 1997 (see paragraph 905). On the revised version, all the references to "London Market Excess of Loss" had been deleted.
1299. However, both the bordereau as originally prepared and the one scratched by Mr Broad on 11 February 1998 contained descriptions taken from the Realm National slips which referred to workmen's compensation:

"[in respect of] Occupational Accident Death and Bodily Injury as determined by the regulatory authority, PTD, PPD, TTD, TPD inc medical expenses such benefits which are part of Section A of the Standard Workers Compensation Policies."

There was a similar reference in respect of Bridgefield. These references to WC remained, even though the bordereau submitted in March 1997 had been deliberately amended to delete the reference to WC.

1300. There was again a conflict of evidence as to who had initiated the changes:

i) Mr Henton's evidence was that he had prepared bordereaux in answer to Mr Broad's request for further information about the risks written on Christmas Eve (as set out at paragraph 1192); the bordereaux was in two documents – the bordereau with details of the premium and the class bordereau. Both had been given to Mr Smith, who had taken them to Mr Broad on 2 February 1998; Mr Broad had scratched the one with the premium details (as set out at paragraph 1284). Mr Smith had told him that Mr Broad had wanted the changes to remove the references to LMX in respect of the Phoenix and JEH Re programmes. Mr Henton had then deleted the references. He was given no reason by Mr Smith for Mr Broad wanting the changes. There had been references to LMX in the bordereaux for many months. The bordereaux did in any event make it clear that there was WC business.

ii) Mr Broad's evidence was that he did not know about the changes. He rejected the suggestion that the original bordereau was shown to him on 2 February 1998 and that he had asked for the changes.

iii) It was Mr Whitcombe's oral evidence that he had assumed that these changes were made at the request of Mr Broad; he did not know the reason. His evidence was also that he was told by Mr Smith that the changes were requested by Mr Broad. At the time he did not give any thought to the significance of this. They were not trying to conceal the fact that LMX was being written.

iv) Mr Smith's account was that he knew nothing of this.

(c) The second underwriting report: January 1998

1301. The report referred to the significant growth achieved in the last quarter of 1997 and that the total gross premium written (calculated by using the brokers' forecasts) was $12m. It continued:

"The account written now has a core of good quality direct Personal Accident business which includes the occupational accident product (emphasis added) we previously described in our Business Plan and was one of our objectives for the year. This line of business has traditionally been written in the Personal Accident market in London and abroad and categorised by both insurers and reinsurers alike as part of their 'Direct' account. The lions share of this business is placed by Stirling Cooke Brown in a carefully selected market. This is our source. As a class it is now producing a better loss ratio after reinsurance than many more traditional P.A. areas (emphasis added) which through market over capacity and strong competition for business have suffered some severe rate reductions. That is not to say that this class is without competition indeed several London brokers and many domestic insurers in the States provide a constant threat to established accountants. However by strict adherence to underwriting guidelines (emphasis added) and the continual development of new and innovative products within the field Stirling Cooke Brown are able to increase their premium volume whilst maintaining an attractive bottom line result (emphasis added)."

1302. Mr Whitcombe's evidence was that the reference to "Direct" was to direct in terms of the reinsurance of direct writers; the term could be confusing but the next sentence made it clear that it was reinsurance. At the time he thought that it was good quality business and that the loss ratio was good as the claims were minimal; he accepted, with hindsight, that they should have made clear that they were writing gross loss making business which they understood would make a net profit through reinsurance. He could not identify the "guidelines" referred to in the report, save to say that Mr Henton had books. Mr Whitcombe thought that he had discussed occupational accident business with Mr Broad over the meals on either 7 February 1997 (see paragraph 815.ii)) or possibly on 21 March 1997 (see paragraph 935) and that Mr Broad would have therefore understood that this referred to US WC business – WCA carveout was specifically referred to on those occasions.
1303. Mr Henton accepted that the business was all reinsurance but it was characterised as "direct" on his definition; he believed that it was good quality business.
1304. I am sure that in dealing with 1997, this report was a further document that was designed to deceive anyone who read it; this is a similar conclusion to that which I reached in respect of the first report prepared in November 1997 (see paragraph 1107):

i) It was dishonest to describe the account as having "a core of good quality direct Personal Accident business which includes the occupational accident product"; it had no direct business as that term was (and is) ordinarily understood; the word 'direct' was used to deceive a reader who was not familiar with PA carveout business. It was dishonest to describe gross loss making business as good quality business and dishonest not to state that the bulk of the business was in fact WC carveout.

ii) It was dishonest to describe the class of business as producing a better loss ratio after reinsurance than many more traditional PA areas, without making it clear that it was gross loss making and that profit was only to be made of the backs of reinsurers.

iii) The reference to strict adherence to guidelines was dishonest; it gave the impression of conventional underwriting rather than arbitrage; in any event there were no guidelines.

iv) It dishonestly stated that the premium income for 1997 was $12m; it was untrue as set out at paragraph 1212; it was a figure chosen to make it fit with the premium income limit agreed for 1997.

1305. The report confirmed that reinsurance was in place for 1997 and 1998 and drew attention to the fact that the retention for 1998 was $20,000, but expressed the hope that this could be reduced to $10,000; EIU's evidence was that they believed that this was true.
1306. This part of the report was also dishonest in its omission to mention the spiral that had been created for the 1997 account as a result of the reinsurance being written by Mr Billyard on behalf of John Hancock.
1307. The report then referred to the proposed 1998 account:

"We envisage that we will write an account with an ultimate size in region of $16,000,000 gross premium for 1998."

The report pointed out that a much smaller proportion of PA XL contracts were to be written because of factors which included:

"The expected renewal and expansion of the Direct account.

Market forces which were particularly negative on the placement of reinsurance for London Market reinsurers.

The level of support from [WFD] which is currently way below that which they had predicted to us. Due in part to the point above but also because we were unable to lead. We hope to develop our account with them during the year."

1308. This was dishonest as it did not describe what had already been written for 1998 and did not describe what the true position had been with WFD.
1309. The report drew attention to an information sheet which was attached and which Mr Broad had separately initialled (as set out at paragraph 1290 iv)) which showed the breakdown of the account; this was similar to that which was attached to the November report (see paragraph 1109.iii)).
1310. Mr Broad did not believe that he read the January 1998 underwriting report particularly closely as he was very comfortable with the binder. Although he scratched it, it was presented with the amendments to the binder and other documents (which he also scratched).

(4) Other events in February to April 1998

(a) 26 February 1998: the further endorsement

1311. On 26 February 1998, Mr Broad agreed a further endorsement which provided that some of the contracts protected had original policies for periods of up to 36 months. Mr Broad made this subject to reinsurance being obtained; he did not, however, inquire into the business being written that required this amendment.
1312. This endorsement was probably sought to cater for the business accepted under Programme 9 (see paragraphs 185 and following of Part II); this was also relied on in connection with the acceptance of Programme 34 (agreed on 29 June 1998).
1313. The endorsement also recorded the agreement to reduce commission by 13.75% on XL contracts with effect from business attaching at 1 January 1998. The effect was to reduce the commission to 28.75%. The level of commission was raised again in a letter written by Mr Henton on 23 April 1998, as set out at paragraph 1403 below, which resulted in a further endorsement on 20 May 1998.
1314. The endorsement also sought an increase in the premium income limit to £8m. Mr Broad refused to agree to it because the limit of his authority was £6m.

(b) The report to Mr Broad of Mr Zuberi's comments

1315. Relations between EIU and Mr Broad remained cordial; for example, in January 1998, EIU sought Mr Broad's help in trying to arrange a binder for D&O business from an associated French company. However, in February 1998, Mr Broad was told by Mr Andrew Thacker of JK Buckenham that Mr Whitcombe had written "a substantial retrocessional account with significant losses", and that the business written "was a load of rubbish … on a large scale". Premium income of $12m and losses of $30m were mentioned.

i) Mr Broad's evidence was that he was quite horrified and he either rang Mr Smith who told Mr Whitcombe, or he rang Mr Whitcombe direct, or he did both. Mr Broad was told that the allegations were "a nonsense" and were being made by Mr Zuberi because he had fallen out with EIU and Mr Whitcombe. On being told this, Mr Broad put it down to it being a vicious market rumour.

ii) Mr Whitcombe's evidence was that Mr Broad had spoken to him on 4 February 1998 and had told him of the allegations. Mr Whitcombe had told Mr Broad that it was a load of nonsense and that they had been reporting all premiums and claims.

1316. Although Mr Whitcombe had seen his lawyers about this at the time, he accepted in cross-examination that Mr Zuberi was making allegations that were pretty close to the truth as EIU had in fact written a retro account; he maintained that Mr Zuberi was wrong about the losses. The fact that Mr Zuberi was making such allegations in the market annoyed Mr Whitcombe. Mr Whitcombe did not accept that he should have told Mr Broad that he had written a retro account; he did not think that particularly germane as Mr Zuberi was bad mouthing EIU and he wanted to stop it; Mr Broad would have known what EIU were writing from the bordereaux supplied.
1317. Although Mr Whitcombe was very angry with Mr Zuberi and that dominated his thinking, I am sure that Mr Whitcombe acted dishonestly in telling Mr Broad that all the allegations were a load of nonsense and in not telling him that they were writing a retro account, when that had been one of the main allegations made by Mr Zuberi; it is some mitigation of the consequences of this further deception of Mr Broad that Mr Whitcombe, unlike Mr Henton, did not appreciate the seriousness of the gross losses to which SD were exposed.

(c) 11 March 1998: Mr Broad's request for details of Programme 28

1318. As mentioned at paragraph 917, on 11 March 1998, Mr Broad scratched the bordereau for business written as at 31 January 1998, requesting full details of the contract which was Programme 28. This was the first contract on the bordereau; his evidence was that he had either noticed that the original gross premium was $50m, or Mr Smith had drawn it to his attention. Mr Broad wanted Mr Smith to find out full details about it. His evidence was that he did not notice it was treaty business. It was Mr Broad's evidence that he had subsequently heard nothing more.
1319. Mr Henton's evidence was that he recalled getting this request and putting together the information. He gave Mr Smith, in response to this request, the documents he had on his file. His evidence was that these documents were about a dozen in number and were sent as an attachment to a letter he wrote to Mr Smith on 23 April 1998. That letter dealt with a number of other matters; these documents were referred to in the last paragraph of the letter. Mr Henton's evidence was that he told Mr Smith that this was a QS treaty reinsuring the JEH Re account, and he would have said that it was WC carveout. Mr Smith later said that he had passed the documents on and that it was all fine.
1320. There can be little doubt that the letter was sent to Mr Smith and taken by Mr Smith to Mr Broad. Mr Smith, in his interview, stated that he believed that he would have given the documents to Mr Broad.
1321. Mr Broad's evidence was that he did not see the documents. He could not recall Mr Smith bringing the file to him, but if Mr Smith had, Mr Smith would not have analysed the file in detail with Mr Broad but would have told Mr Broad that he had seen it and that it was all okay. Mr Broad's evidence was that he probably would not have gone through the file as he was not underwriting then and would not have looked at a detailed file.

(d) The request on 23 April 1998 for a claims fund

1322. Amongst the other matters raised in Mr Henton's letter to Mr Smith of 23 April 1998, Mr Henton raised the question of the establishment of a claims fund which was said to be becoming more pressing. His letter stated that:

"Some of the underwriters of the facultative reinsurance risks written have indicated their understandable desire for a simultaneous settlements clause. To comply with this request and settle other claims due as quickly and efficiently as possible we need this fund."

1323. No facultative business whatsoever had been written by EIU; it was all treaty business. Mr Henton's evidence was that requests had been made for the establishment of a claims fund in respect of a number of programmes; he could recall that these might have included Bridgefield (Programme 8) and Hallmark (Programme 19) and he considered that these could be described as facultative. I reject this explanation; the reinsurances were clearly treaties.

(5) Conclusion on Mr Broad's knowledge

1324. In each of his interviews with Clyde & Co, Mr Smith denied that he knew that EIU were deliberately writing gross loss making business on the backs of reinsurers or were arbitraging. I am sure that this was truthful, particularly in the light of Mr Whitcombe's evidence that he did not tell Mr Broad that they were going to be writing gross loss making business (as referred to at paragraph 729) and that he did not tell Mr Broad that over the pub meal at Tadworth (as set out at paragraph 815.iv)). Mr Smith did, however, know that treaty business was being written and I am satisfied that he must have known from the bordereaux that LMX and WC business was being written; it is unclear to me if he knew that LMX was being written other than incidentally; I do not consider it possible to make a finding on the evidence.
1325. It was submitted on behalf of SD that the motive for the changes to the bordereaux (set out at paragraphs 1296 and following) was an improper one as EIU knew that it would be untrue to say that no LMX had been written, or that only incidental LMX had been written. SD further contended that the purpose of these changes was to mislead Mr Broad and SD, in the light of the assurances that had been given to Mr Tunstall about no LMX being written.
1326. Again it can be seen that Mr Broad would have had a motive for altering the bordereaux as he had maintained that LMX business was not being written. However, I am also sure that Mr Broad did not ask for the changes to the class bordereau referred to at paragraph 1296 and did not know that LMX business was being written. As I have set out at paragraph 1067 in relation to the alteration to the class bordereau in early 1997 (see also paragraph 906) and in relation to the first underwriting report in November 1997 (paragraph 1104), I am sure that Mr Broad was not a person who had been engaged in a systematic deception of his colleagues and seniors; that deception would have, by this time, extended to the deceiving of all those present at the meeting of 8 January 1998 (to which I have referred at paragraph 1277).
1327. The overwhelming probability is that the change was initiated by either EIU or HHI for the same reasons as the first underwriting report had been altered (as set out at paragraph 1104) and was part of the same thinking that had led to the alteration to the first class bordereau (as set out at paragraph 1067).
1328. I am also sure that Mr Broad still had no idea that gross loss making business was being written on the backs of reinsurers, or that retro business was being written. There was little conflict in the evidence over what was said in relation to Mr Zuberi's allegations and those allegations were close to the truth; it was common ground that Mr Broad was told that the allegation that retro business being written was nonsense. That was entirely consistent with the finding I have made that Mr Broad did not know that retro or spiral business was being written and that EIU were continuing to deceive him.
1329. When Mr Broad looked at the bordereau shown to him on 11 March 1998 (as set out at paragraph 1316) and had seen that the original gross premium was $50m, either because he had noticed the entry or because his attention had been drawn to it, it ought to have been obvious to him that this was treaty business and that a detailed investigation should have been undertaken. However, I am sure, having regard to his volatile and impulsive personality and the view he took of his role as a senior underwriter which was so evident when he gave his evidence, that he did not look beyond the figure and had told Mr Smith to find out about it. Mr Broad behaved with gross negligence and dereliction of duty in failing to cause a proper investigation to be made or to follow up what he had asked Mr Smith to find out, but I am sure that he did not then appreciate what was being done. When the documents arrived, I am sure that Mr Smith gave him an assurance; he was satisfied with that and neglected to look at them; this was another gross dereliction of duty.
1330. It is beyond argument that an insurer should not scratch a document without reading and understanding it; the ordinary expectation from the fact that an insurer had scratched a document was that he had read and understood it. However, I am also sure that Mr Broad did not read the bordereaux submitted on 2 and 11 February 1998. He simply scratched the bordereaux on 2 and 11 February 1998 as they were just other documents presented to him on both occasions with amendments to the binder which he had to scratch. He was grossly negligent in scratching them without reading them. If he had considered them, he would have appreciated that treaty and WC business was being written. If he had known, as he should have done, that the outwards reinsurance of SD had been provided by John Hancock, he would have appreciated the potential spiral. Nor did he consider the underwriting report or the reinsurance information sheet submitted on 11 February 1998. Again he was grossly negligent. But as I have found at paragraphs 1302 and following, the report was a document that was designed to deceive the reader and was part of the continued deception of Mr Broad, further illustrated by the lies told in the letter of 23 April 1998 (set out at paragraph 1320) and in relation to Mr Zuberi's allegations (as set out at paragraph 1315).

9. THE EVENTS LEADING TO CESSATION

(1) The final programmes

(a) The developments at Syndicate 103

1331. I have set out at paragraphs 512 and following, the events of 1997 in relation to the cash flow difficulties that had been faced at Syndicate 103. Matters deteriorated very substantially in February 1998.
1332. Concern about the position of Syndicate 103 had increased substantially. SCB were involved. By way of illustration, on 23 February 1998, Mr Butler reported to Mr Brown that he had been asked to meet the solicitors to Syndicate 103. Mr Butler also attended the meeting of the 1993 spiral working party on 26 February 1998.
1333. On 27 February 1998, the Names on Syndicate 103 were sent a letter which enclosed a letter from the run-off agency dated 26 February 1998, explaining that a further cash call was possible due to the "unwelcome development" that Transamerica were seeking to avoid their reinsurance for 1993 on six layers of reinsurance and for 1994 on one layer of reinsurance:

"The alleged grounds for avoidance are that four participants in the so called PA spiral (among which was Syndicate 103) created an artificial situation which meant that even small losses were likely, eventually, to give rise to losses into the higher layers of reinsurance programmes, and it is alleged that this was known or ought to have been known to Alan Bird, the Underwriter of Syndicate 103 or, alternatively to the reinsurance brokers [SCB], and that the placing information given to reinsurers misrepresented the risk."

As set out at paragraph 383, the four participants in 1993 were Syndicate 103, Mr Billyard, Mr Owen and NAF&G through Raydon; the involvement of Transamerica is shown in Table A. .

1334. The 1997 accounts published on 31 March 1998 reported not only further on the spiral but also on "the unwelcome development outlined in our letter dated [27] February 1998". The report included the passage in the letter of 27 February. The accounts also set out the results as at 31 December 1997: the gross net premium was £9.3m, the reinsurance premium was £4.85m and the gross claims paid were £57.6m.
1335. Mr Henton's evidence was that he was aware of the avoidance by Transamerica as he had provided a statement for the arbitration. Mr Whitcombe could not recall seeing the letter or the report. Mr Whitcombe accepted that he knew of the avoidance and that he would have known of the involvement of SCB if he had read the letter.
1336. Mr Whitcombe nonetheless continued to do business with them as his opinion was that there were no real allegations against SCB. EIU also continued to do business with Mr Bird as Mr Whitcombe thought that Mr Bird might have learnt something from what had happened and could not think of any reason not to continue dealing with him.
1337. I am sure that Mr Whitcombe, Mr Henton, Mr Bird, Mr Brown and Mr Butler understood the nature of the allegations made against SCB and those who had participated in the spiral. It is inconceivable, given the fact that Mr Whitcombe was a Name on the syndicate and was working closely with Mr Henton, that he did not know; he must have then appreciated the very serious consequences to those insurers who had participated in this type of business. The knowledge of the others was reinforced by what had happened.
1338. Despite this, SCB presented seven further programmes to EIU which EIU wrote.
1339. The arbitration was determined in favour of Transamerica and against Syndicate 103, as set out in the 1999 accounts signed on 27 March 2000. This was a majority decision; SCB did not accept the result; Mr Butler's evidence was that the arbitration tribunal did not go into prior years or the fact that spirals occured knowingly and unknowingly.

(b) The last seven programmes

1340. The seven programmes in the period between March 1998 and 8 July 1998 which Mr Henton wrote were:

P29 CIGNA per Aviary lineslip reinsurance of US longshoremen and harbour workers' WC business, agreed in principle sometime between 1 and 10 March 1998 and confirmed on 30 March 1998.

P30 The retrocession of JEH Re's reinsurance of Mr Cackett's participation in WEB's variable QS, agreed in principle and confirmed on 5 May 1998.

P31 Realm National Monoline, agreed in principle and confirmed on 13 May 1998.

P32 New Cap Re (Australia), agreed in principle on about 28 May 1998 and confirmed on 10 June 1998.

P33 JEH Re QS of their non-proportional account, agreed in principle on 30 April 1998 and confirmed on 19 June 1998.

P34 Reinsurance of WEB's participation in the Unicare scheme, agreed in principle on 10 June 1998 and confirmed on 29 June 1998.

P35 Clarendon (per Raydon) – EEII and CSLI business, agreed in principle and confirmed on 8 July 1998.

Apart from Programme 33, these are all described in Part II. Programme 33 is described at paragraphs 1552 and following.

(c) Writing the business after the avoidance at Syndicate 103

1341. As set out above, by the time Programme 29 was written, I am sure that EIU and SCB were well aware of the allegations made in respect of Syndicate 103 and of the very serious consequences that would follow to anyone else writing such business.
1342. As EIU's business was modelled on Syndicate 103's, SCB and EIU had a clear example of what could happen. However, SCB carried on presenting business to Mr Henton and EIU accepted it on a large scale, both quite regardless of what had happened.
1343. They did so (as set out in more detail in Part II) because:

i) Programme 29 was written 100%; it was the only way in which the underlying programme operated by SCB to cover WC liabilities in respect of US longshoremen and harbour workers could be continued; one of the fronting companies needed reinsurance and CIGNA would not write it without protection for the first $20,000 of loss.

ii) Programme 30 was a variable QS and was thus a type of contract where WEB could 'cherry pick' what it reinsured; participation was accepted 11 months after the inception of the QS in June 1997 as a retrocession of Mr Billyard's reinsurance of Mr Cackett's participation as no one else could be found to write it.

iii) Programme 31 was written four months after inception in order to reduce Mr Billyard's line. It was a programme that protected a scheme put together by SCB and underwritten by SCB's own company, Realm National.

iv) Programme 32 was written 100%; it involved a reciprocal arrangement with New Cap Re (Australia) where Mr Sparkes, the arbitrage underwriter who had been at Gan, was now an underwriter. The reinsurance was written on the basis that New Cap Re (Australia) would provide the outwards reinsurance for SD referred to at paragraph 1236; this involved Mr Billyard altering his reinsurance of SD. The outwards reinsurance provided by New Cap Re (Australia) was limited to 99 free reinstatements and was on an LOD basis whereas the reinsurance provided by Mr Henton under Programme 32 provided unlimited reinstatements and gave cover for 12 months from May 1998 on an RAD basis.

v) Programme 33 was written 100% as Mr Billyard was desperate for protection for his LMX account (including the reinsurance of SD for 1998). Its placement was closely connected with Programme 32 and the with the outwards reinsurance of SD (as set out at paragraph 1236). It is more convenient to deal with this programme as one single account – see paragraphs 1554 and following.

vi) Programme 34 was written 100%; it was backdated by about five months; it was a very large contract protecting the entirety of WEB's participation save for a small retention in a low level XL reinsurance of Unicare which wrote WC business in California. It was accepted when EIU had already written more than the maximum gross premium income of $12m permitted under the binder, despite the fact that the estimated gross premium income was $6.2m and there was very little information.

vii) Programme 35 was written 100%; it protected SCB's EEII and CSLI business on information that showed that the EEII part of the risk was disastrously loss making; there was no premium information to assess the CSLI part of the risk, despite the fact that the SCB group plainly had such information as the business was SCB group business.

1344. My conclusion in respect of EIU and SCB's conduct is set out at paragraph 1537.

(d) The premium written for 1998

1345. It was SD's case that EIU were authorised to write £6m (the equivalent, on the rate of exchange agreed on the slip, of $12m); they eventually reported premiums of $16.3m to SD but had in fact written $24.6m; SD prepared a schedule similar to that prepared for 1997 (referred to at paragraph 1286) to explain the discrepancies.
1346. Mr Henton's response was that:

i) He believed that Mr Watson had authorised an increase in the premium income limit to $20m (as set out at paragraph 1375.v)); Programmes 32, 33, 34 and 35 were confirmed after that. He accepted that he had grossly overwritten if his evidence on the increase being authorised by Mr Watson was not accepted.

ii) The QS with ESG, referred to at paragraphs 1412 and following, would reduce the exposure to SD by 25% but not affect the limit under the binder.

iii) There was a double count for Hallmark (Programme 19) on the schedule; this would reduce the figure to $22m.

iv) No allowance needed to be made for 1997 premiums in the 1998 figures because the adjustments would not have significantly come through until 1999.

v) All the M&D premiums were fairly standard except, those on Longshoremen (Programme 29) and Unicare (Programme 34).

1347. However, accepting for these purposes the double count on Hallmark, I am sure that the premium income was exceeded and that Mr Henton had accepted programmes on the basis that he had expected the premium to be over $20m. Mr Henton knew that he was exceeding the premium income limit and did so, as I have set out at paragraphs 1535 and following, in order to earn commission and to benefit SCB by writing the very large lines on the programmes set out at paragraphs 1338 and 1341:

i) For the reasons set out at paragraph 1376, Mr Henton knew that no increase in the premium income limit had been agreed.

ii) I have already rejected (as set out at paragraph 1211) his explanations for the method of accounting he had adopted.

(2) The further attempts to obtain more from Mr Broad

(a) The request for an increase in the premium income limit

1348. The premium income limit for 1998 had been agreed at £6m (see paragraph 1283). Mr Broad had refused to increase it in February 1998 when he was presented with an endorsement – see paragraph 1312. In the underwriting report of January 1998, Mr Henton and Mr Whitcombe had proposed to underwrite $16m worth of premium in 1998 (see paragraph 1305).
1349. In the letter of 23 April 1998 (which has already been referred to at paragraphs 1317 and 1320 in other contexts) written to Mr Smith, Mr Henton had asked for the premium income limit to be reviewed. He had stated that he had currently written about $9m; this did not include premium from risks in 1997 (which, according to Mr Henton's evidence as to his method of accounting, should have been accounted for in 1998) and was the figure taken from the bordereau for business written as at 31 March 1998. He had asked for an increase to £7.5m or $15m. He had asked Mr Smith if Mr Broad had given any indication of the maximum figure with which Mr Broad might feel comfortable, as discussions with other brokers had led Mr Henton to believe that it might have been possible to reach a premium income of $30m in the current year and to increase it in 1999. This, he had said, would be achieved through the expansion of the current occupational accident account along with the further development of other PA classes.
1350. Mr Broad's evidence was that by May 1998 Mr Whitcombe had been pressing for some time for the premium income limit to be raised to £12m. Mr Broad's evidence was that that was totally unacceptable to him and at a meeting at Balls Brothers on 21 May 1998 (see paragraph 1352), he had pointed out that it was not in his authority to give an increase of that nature and had suggested that Mr Whitcombe have a meeting with Mr Watson instead.

(b) 20 May 1998: further amendments to the binder

1351. On 20 May 1998, Mr Broad agreed a number of amendments to the binder, including one which effected a change to the limits of the contracts that could be underwritten and one which provided that there was to be a minimum of 25% QS for the 1998 year; this QS was placed, as set out at paragraphs 1412 and following.
1352. More important was an alteration in the commission terms. There was some dispute as to whether this was agreed on 20 May 1998 or on 20 June 1998. It is clear from the sequence of events and other documents that it was agreed on 20 June 1998 and I therefore deal with it at paragraphs 1403 and following.

(c) Mr Broad's dissatisfaction with HHI's administration

1353. Mr Broad became dissatisfied with HHI's administration of the binder during 1998; he considered that Mr Smith was not on top of it and was unable to give figures. HHI were receiving 5% of the premium income (about $1m by then) and in his view, they should have acted as the "eyes and ears" of SD on the binder.
1354. Mr Broad "blew his top" on one occasion in May 1998 when Mr Smith visited him and asked for an increase in the premium income limit. It was Mr Broad's evidence that Mr Smith looked as if he had had a few drinks (as was often the case in the afternoon). Mr Whitcombe rang Mr Broad and Mr Broad expressed his frustration to Mr Whitcombe at a meeting at Balls Brothers on Thursday 21 May 1998.
1355. After that meeting, Mr Whitcombe saw Mr David Dansie, the Managing Director of HHI, and wrote to Mr Broad on 28 May 1998 to report on what he had done. The letter set out what Mr Whitcombe had done to remedy problems by speaking to Mr Dansie who also wrote to Mr Broad, setting out the improvements that HHI would make.
1356. Mr Whitcombe's letter of 28 May 1998 also referred to an offer by Mr Broad to him of a managing general agency. Mr Broad's evidence was that he had made no such offer; all he had done was to say to Mr Whitcombe that he was paying a large amount of commission to HHI and getting nothing for it whilst he could have dealt with EIU direct. He accepted that he had had a good understanding of Mr Whitcombe and had liked him. Mr Whitcombe's letter concluded:

"I promised you an updated appreciation of 1997 and 1998 and what I think our aims should be going forward. That document is enclosed. It is not a full blown 'glossy' as I don't think that is required. It is an accurate statement of affairs as they presently stand and should afford to you and Michael Watson information on which to base sound judgment."

(d) The third underwriting report: May 1998

1357. The document was a report was which was headed "Accident and Health Account". It dealt first with the 1997 year; it enclosed a summary of the performance of the account at 30 April 1998.

i) The summary set out the estimated gross written premium income as $12.34m for the 1997 contract year. This was the figure from the bordereau for the 1997 year and not the estimated premium income, as it was EIU's case that a portion of that would be accounted for in later years.

ii) The summary also set out the paid loss ratio as 9% and the incurred loss ratio as 21% for 1997.

iii) However, closer analysis of the figures showed that of the $12.3m premium written, $4.3m had been paid in commission. Reinsurance premium was $2.9m whereas claims recoverable from reinsurers (paid and outstanding) were $6.6m. This would have given to anyone who had studied the figures, an indication that the account was heavily reliant on reinsurance and, as it was put to Mr Broad in cross-examination, that the reinsurers had "taken a caning".

1358. The text of the report referred to the fact that the Versace claim accounted for more than £1m of the claims. It referred to cash flow and continued:

"When all is said and done there is little point in producing excellent figures if there is no money!

The account itself is developing as expected, at this stage however it would be unwise to predict anything other than a satisfactory outcome. The ultimate scenario should be viewed in the knowledge that the Stop Loss Reinsurance effected on this and the present year of account will be triggered if the loss ratio of net premium after reinsurance costs against net claims were to exceed 85%."

1359. Mr Henton's evidence was that this referred to the net position on development of the account. However, he accepted that although SD were supplied with the bordereaux, they could not tell that deliberately gross loss making business was being written. Mr Broad would have understood that EIU were talking about the net position and what was said was not misleading. Mr Whitcombe's evidence was that as far as EIU were concerned, all was progressing well and the general message was that the account was successful.
1360. The report next dealt with the 1998 year and attached figures showing that at 30 April 1998 the estimated gross written premium income was $9.64m. The text pointed out that:

"With the benefit of five months development we are pleased to report that [SCB] have shown and continue to show a good spread of business (emphasis added). They have indicated a continuing flow and on current estimates and underwriting acceptability we expect to be able to exceed the limit indicated in our original report."

The report also referred to 1999 and the expectation that the account would develop and grow to its optimum size of around $40m-$50m.

1361. The evidence of Mr Whitcombe and Mr Henton was that they did not think that it was misleading to describe the business as a good spread; Mr Henton said that SCB had shown EIU a good spread of SCB's account of PA carveout business. Mr Whitcombe's evidence was that they had wanted to write a broader book of business but could not do so as they had been stuck with not being able to write business for such a long period in 1997; Mr Broad had understood that they were writing for net profit; the gross results were worse than expected.
1362. I am sure that this report was another document which was produced by EIU with a design to deceive, just as the two earlier reports had done (as referred to at paragraphs 1107 and 1302); the report made no mention of the fact that gross loss making business was being written on the backs of reinsurers. As I have set out, it was discernible from the figures that the account was heavily reliant on reinsurance where the reinsurers had suffered very heavy losses, but there was nothing to show that gross loss making business was being deliberately written. In the light of the cash flow problems and of the avoidance at Syndicate 103 of which Mr Henton and Mr Whitcombe were well aware, their continued suppression of the truth was even more inexcusable.
1363. Mr Broad did not have a specific recollection of looking at the report; but his evidence was that if he had looked at it he would have been very pleased with the summary of incurred loss ratio of 21%. His evidence was that he would not have bothered to look at the figures with care once he had seen that the loss ratio was so good, as he had so much else to do. He did not appreciate that these results were achieved only because of the reinsurance; it was not obvious to him that the loss ratio was achieved only through reinsurance or that Mr Whitcombe was writing against his reinsurance. The report, in the way he looked at it, would have given him comfort.
1364. Again his attitude and actions were not those of a competent insurer; the report should have been considered, the figures analysed, the obvious questions asked and the documents examined. It was suggested that he must have reviewed them for, or in, the meeting with Mr Watson on 1 June 1998 (see paragraph 1371), but Mr Watson only understood the figures to show an incurred loss ratio of 21%.

(e) Misleading information about the stop loss reinsurances

1365. On 29 May 1998, Mr Whitcombe sent to Mr Broad, details of the aggregate horizontal stop loss reinsurances which were to protect the retentions. The letter set out four layers for 1997 and four for 1998; for 1997 only one had been placed – that with Dorinco Re referred to at paragraph 993.iv) and for 1998 only the bottom layer (WFD) had been placed – the reinsurance by Dorinco Re (see paragraph 1234). The rest had not been; they were considered further in the summer – see paragraph 1647.iii). Mr Henton's evidence was that he thought that the other reinsurances for 1997 and 1998 would be or had been placed on the basis of a conversation with SCB. There was no independent evidence of any such conversations. I am sure that Mr Henton and Mr Whitcombe knew that the stop loss reinsurances had not been placed and that their statement that it had been was known by them to be untrue.
1366. The letter concluded:

"I think that you will agree that we have taken a belt and braces approach in attempting to guarantee your worst case bottom line profit."

1367. It was suggested to Mr Broad that the letter was written in the light of the figures attached to the May underwriting report because he was concerned to see that the worst case net position was protected. Mr Broad could not recall why the question was asked.
1368. However, what is significant is that the letter was untrue and was designed to deceive Mr Broad; I am sure that far from showing someone who knew that gross loss making business was being written on the backs of reinsurers, it was a further attempt to reassure him of a prudent and careful approach, whilst concealing the fact that they were writing gross loss making business against reinsurers.

(3) The involvement of others at SD

(a) Renewed signs of concern within SD about the binder

1369. Although it appears that some concern was expressed about the binder at the meeting on 8 January 1998 (referred to at paragraph 1277), Mr Watson first became concerned about the EIU binder in about March or April 1998; this concern arose because problems in connection with recoveries from reinsurers in respect of the Versace claim had emerged. The first written record of his concern was on 29 May 1998.
1370. There was a meeting of senior management at Bordeaux in April 1998. Mr Broad had not initially been invited, but he was subsequently invited. Mr Watson's evidence was that if Mr Broad had been aware of the size of the EIU binder account, Mr Broad should have said something about it at the meeting, but Mr Watson had no recollection of it being discussed.
1371. By the end of May, relations between Mr Watson and Mr Broad had substantially deteriorated. It came to a head much later when Mr Broad was told that the binder was to be transferred to the American division which Mr Michael Mather had been appointed to run (see paragraph 1434).
1372. It is unclear on the evidence when Mr Watson began to take a detailed interest in the binder; the reason was clear as two matters coincided – Mr Whitcombe's desire for a greater premium income limit which Mr Broad had no authority to grant, and Mr Watson's growing concern about the binder and the failure to recover under the reinsurance on the Versace claim.

i) It was Mr Broad's evidence that it was his suggestion that Mr Whitcombe should meet Mr Watson in relation to Mr Whitcombe's wish for a greater premium income limit and be free to ask Mr Watson all the questions he wanted. Mr Broad's evidence was that if he had been concerned about the binder he would have never suggested a meeting with Mr Watson as he would have been providing an opportunity for Mr Watson to dismiss him; he was under no pressure to provide information to Mr Watson.

ii) On 29 May 1998, Mr Watson requested from within SD, further information about the recoveries on the Versace claim; the response was made to him that there was difficulty in identifying the reinsurers.

1373. There was a brief discussion about the binder between Mr Broad and Mr Watson when they met on 1 June 1998 to deal with a number of issues relating to a review being conducted by Mr Watson of other accounts written in Mr Broad's department. Mr Broad gave Mr Watson some background information. Mr Watson asked for papers, but all he saw prior to the meeting with Mr Whitcombe on 3 June 1998 were the figures sent with the May 1998 underwriting report for the 1997 and 1998 years. He understood the figures for 1997 to show an incurred loss ratio of 21% (as he subsequently reported to Mr Barnard on 3 June 1998). Although he accepted that the account was not, on an analysis of this document, profitable on a gross basis, it was not apparent to him then that that was the case.

(b) 3 June 1998: the meeting between Mr Whitcombe and Mr Watson

1374. Mr Watson's evidence was that he had agreed to meet Mr Whitcombe because of the request for an increase in the premium income limit and it was also his practice to meet the major producers of business.
1375. There was considerable common ground about the meeting which lasted about an hour at SD's offices:

i) Mr Whitcombe and Mr Watson discussed the nature of the business being written under the binder. Before the meeting, Mr Watson had been firmly of the opinion that the business was all facultative, both because SD had employed Mr Broad as a facultative underwriter and because SD had started to write a facultative PA account. It was his understanding that the same business was being written under the binder as was being written internally at SD.

ii) Mr Watson enquired of Mr Whitcombe how he had written so much facultative business; Mr Whitcombe laughed and told him that they did not do that but wrote treaties instead. Although this surprised him as Mr Broad should not have been writing treaties, he said nothing to Mr Whitcombe. Nor did he say anything subsequently to Mr Broad, though he ordered a full review (as set out at paragraph 1379).

iii) Mr Watson recalled discussing administrative problems and both he and Mr Whitcombe blamed HHI; Mr Whitcombe recalled that they discussed reinsurance, but only in so far as it related to net accounting – they agreed that that should not be done. Mr Watson could not recall this.

1376. There were differences between Mr Watson's and Mr Whitcombe's evidence about the meeting, first as to whether anything was said about the business being WC. Mr Whitcombe's evidence was that he told Mr Watson that the business being written was WC, but Mr Watson's evidence was that he was not told this but said that occupational accident might have been mentioned.
1377. Although it was common ground that Mr Whitcombe raised his request for an increase in the premium income limit, there was also a difference in the evidence as to what was said about it and whether anything was agreed:

i) Mr Whitcombe wanted an increase in the estimated premium income level EIU could write and he wanted to be provided with a fixed amount that EIU could write to the end of the year; he considered his current arrangement (where he had to go back to Mr Broad on a piecemeal basis) unsatisfactory; he wanted certainty and mentioned a figure of $20m.

ii) Mr Watson's evidence was that an increase in the premium income limit was a matter for Mr Broad; he told Mr Whitcombe that and that he (Mr Watson) would have to discuss the matter with Mr Broad; he also told Mr Whitcombe that SD would advise Mr Whitcombe of the decision as to whether the premium income limit would be increased.

iii) It was Mr Watson's evidence that the normal practice would be for any change in the terms to be effected by the insurer through an endorsement put to him. He believed that it was very clear to Mr Whitcombe that any agreement to an increase would be done in that manner and that it would follow his discussions with Mr Broad, who would then communicate the decision to Mr Whitcombe. Mr Whitcombe's view was that this was a large issue and that the CEO therefore wanted to be involved.

iv) It was Mr Whitcombe's evidence that Mr Watson was agreeable in principle to the increase to $20m as Mr Watson had said that SD would not be alarmed by such an increase. He was in no doubt that there was an agreement in principle to increase the premium income limit which Mr Broad was to sort out.

v) Mr Henton's recollection was that Mr Whitcombe came back and told him that the increase in the premium income limit to $20m had been agreed.

vi) Mr Whitcombe believed, as did Mr Henton, that EIU had had authority to write up to $20m as a result of the meeting; Mr Whitcombe wrote to Mr Watson in those terms on 9 June 1998 (see paragraph 1389).

1378. Mr Watson was a witness of undoubted integrity as I have stated at paragraph 547; he was also very methodical by nature and was keen that proper procedures be followed. I am sure that his evidence is to be preferred over that of Mr Whitcombe's. Quite apart from the fact that Mr Whitcombe was a witness who gave untruthful evidence on so many matters and who produced several dishonest documents to which I have referred in this judgment, Mr Watson was not the person who was to agree to a matter as important as an increase in premium income limit without that being formally agreed and documented. I am sure that Mr Watson had told Mr Whitcombe that the increase was a matter to be discussed with Mr Broad who would then advise Mr Whitcombe of the decision. Indeed, that is consistent with what was said by Mr Whitcombe in his letter of 9 June 1998 referred to below at paragraph 1389. When Mr Whitcombe left the meeting, he had hoped for an increase, but he knew that he had not obtained any agreement to it; he knew that the usual practice in the market was for that to be agreed in a slip and that that was the practice which had been followed with respect to the binder.
1379. I am sure that he never gave Mr Henton to understand that an increase had been agreed and Mr Henton knew that it had not when he confirmed Programmes 32, 33, 34 and 35 (referred to at paragraphs 1338 and 1341).
1380. I am also sure that Mr Watson's evidence that no mention was made of WC business is correct.

(c) The internal enquiries at SD about the binder and the reinsurance

1381. Mr Watson was surprised at being told on 3 June 1998 that the business written was treaty business. He was also sent a note that day by Mr Rayner and Mr Vassilides (who, as set out at paragraphs 548 and 561, headed the reinsurance desk) explaining why the Versace claim had not been paid; it set out a list of the reinsurers and explained that the premium had not been paid. Mr Watson asked that this be investigated and that there be an audit and review. Mr Robert Forness, the Chief Operating Officer of SD, was asked to conduct it, forwarding the note and expressing his view that to say there was a "**** mess is an understatement".
1382. On 1 June 1998, Mr Bentley joined SD as head of operations to run the back office (claims, premiums, underwriters' support for the capture of data onto SD's systems and administration); he had worked in the insurance market from 1978 and had worked as head of reinsurance in the Lloyd's Claims Office. He gave evidence and was an impressive witness, careful in his recollection and was clearly honest.
1383. Shortly after joining, he was asked by Mr Forness to look into the binder as there had been a large loss on the Versace claim but no reinsurance recoveries. It was thought that the reason for this was that no premiums had been paid by HHI to reinsurers.
1384. In the course of the enquiries, Mr Bentley and those responsible for the administration at SD became aware of a number of serious problems in relation to the binder:

i) All that there was on the SD system were the net amounts as Mr Broad had agreed to net accounting. SD had no idea of the premiums, claims or reinsurance positions. None of the outwards reinsurances were on the system.

ii) Reinsurance cover notes had not been supplied to SD's administrative back office at Brighton or to the reinsurance desk. The original debit notes had been kept by HHI and not sent to SD; the outwards reinsurance premiums had not been paid. That was why the recoveries on the Versace claims had not been paid by reinsurers.

iii) The cover notes had never been sent to the person responsible for approving reinsurers and had not been approved. Mr Bentley learnt that American Reliable and John Hancock were on the inwards and outwards reinsurance and that they were not approved security.

iv) The bordereaux had not been sent to Brighton, though it was commonplace that there had been no sharing of information within SD.

v) On 9 June 1998, an internal memorandum prepared for Mr Forness stated that "information on the built-in reinsurance was not passed on to any areas outside of the underwriting room". Mr Broad's evidence was that that was not true; he considered that it was the technical department not having received the documents from the reinsurance security division that had caused the problem. The memorandum also stated that no bordereaux or declarations had been received by the technical department. Mr Broad's evidence was that that was the fault of the brokers; those documents should have been sent by HHI to the technical department at SD.

vi) A further internal memorandum (prepared by Mr Snelling, a junior employee at SD) on 10 June 1998 for Mr Bentley and Mr Forness, stated:

"Initially all losses were advised to our general Reinsurance Program, these were queried as the policies exclude LMX business. After consultations with underwriters we were informed of the specific R/I and the original claims were withdrawn. It was stated the underwriters were aware of the LMX exclusion and this was the reason for the specific R/I being implemented."

Mr Broad's evidence was that this was wrong; he had never said that the LMX exclusion was the reason for the specific reinsurance; he had never spoken to Mr Snelling about this. He rejected the suggestion made by SCB that there was a late appreciation on his part that LMX was not covered and that he had lied about being aware in March 1997 that there was any LMX in the account.

1385. There was then an SD board meeting on 11 June 1998. Mr Watson was sure that the concerns which he had would have been discussed at the board meeting or at a meeting with Mr Broad sometime after 3 June 1998. The minutes for the board meeting on 11 June 1998 did not contain any reference to a discussion of the binder. Mr Watson had, however, made notes on a copy of the monthly report produced by Mr Broad's department for May 1998 that the business was treaty business, that the retention was $10,000 and that there was a spiral. Mr Broad had no recollection of discussing this with Mr Watson at any meeting in June 1998. No note of another meeting could be found.
1386. Mr Watson reached the conclusion that Mr Broad's review of the binder had been cursory; Mr Broad had few files and was not able to provide details of the reinsurance; he did not have the details at his fingertips. Mr Watson's recollection of his discussions with Mr Broad was that Mr Broad was not familiar with the business and did not know anything when asked questions about it. Before setting out the further action taken by SD to review the binder (see paragraph 1423), it is necessary to set out what had happened between SD and EIU.

(d) The meeting between Mr Broad, Mr Smith and EIU on 16 June 1998

1387. On 16 June 1998, Mr Whitcombe, Mr Henton, Mr Smith and Mr Broad met; Mr Broad thought it was at The Saigon Times, Mr Whitcombe and Mr Henton at The Captains' Room at Lloyd's. The meeting lasted for 30-40 minutes. The accounts of what happened differed:

i) Mr Broad's account was that he had been away and was anxious to find out how Mr Whitcombe had got on with Mr Watson. He did not believe that there was a discussion about commission.

ii) It was Mr Whitcombe's evidence that an increase in the premium income limit was discussed on the basis that it had been agreed in principle by Mr Watson; he believed that Mr Broad was willing to agree; Mr Whitcombe asked Mr Broad to agree to it. Mr Whitcombe and Mr Henton could not recall whether they had told Mr Broad that Mr Watson had said that "this is alright", or whether Mr Broad had confirmed that, or whether they had all proceeded on that basis from their own information.

iii) Mr Broad's evidence was that the increase in the premium income limit was not a matter for him but for Mr Watson; he could not recall being told that EIU had been given a premium income increase, but he got the impression that Mr Whitcombe had had a very positive meeting with Mr Watson.

1388. On 17 June 1998, Mr Whitcombe wrote to Mr Broad, referring to the meeting on 16 June 1998 and setting out what he believed had been agreed about the commission; the letter continued:

"You asked how an increased premium limit would impact on the spread of types of account and I can confirm what I then said, that irrespective of premium limit, it is the intention to adhere to the plan set out in our report of January 1998 give or take a few variations…

May I ask you to please confirm in writing the commission agreement and the premium limit for 1998…

The market potential for occupational accident coverage in the USA is immense. As I mentioned to you yesterday there is a contract about to come to the market for the first time with an outline premium of $500,000,000…"

Mr Broad did not believe he had seen the letter. The only available copy was an unsigned one in HHI's file that was not on EIU's note paper.

1389. Mr Whitcombe's evidence was that he was seeking confirmation of what he believed had been agreed with Mr Watson, namely that the premium income limit could be increased to $20m; Mr Whitcombe was expecting Mr Broad to confirm it. However, the terms of the letter are not consistent with an agreement having been reached with Mr Watson on 3 June 1998.
1390. It is more convenient to consider the issue on commission below at paragraph 1407 after completing the evidence in relation to premium income.

(e) The different positions on the premium income limit

1391. Mr Whitcombe had written to Mr Watson earlier on 9 June 1998, stating that it was his understanding that a controlled expansion of the premium income to $20m would not alarm Mr Watson; that he was aware that Mr Watson would be discussing their conversation with Mr Broad and that Mr Whitcombe would await Mr Broad's instructions. His evidence was that this had been written because he believed that he had had the go ahead to write $20m and that Mr Broad would do the necessary. However, the terms of that letter are entirely consistent with the finding I have made at paragraph 1376 that Mr Whitcombe and Mr Henton knew that Mr Whitcombe had not obtained an agreement to an increase; their evidence to the contrary was untruthful.
1392. Mr Watson's response on 17 June 1998 was that the expansion should be carefully controlled; before agreeing to this, he needed to understand:

i) The source of the new business.

ii) How it compared with the business mix that EIU initially provided to SD. It was Mr Watson's evidence that this was a reference to the meeting with Mr Whitcombe on 3 June 1998 where Mr Whitcombe had mentioned that a long-term business plan had been put to Mr Broad when the binding authority was being sought.

iii) That appropriate reinsurance was in place.

Mr Watson asked them to continue on a "business as usual" basis for the present. He also wanted the records, information and procedures updated by mid-July 1998. He informed Mr Whitcombe that Mr Barnard would be visiting on 8/9 July 1998 and that they would appreciate a meeting.

1393. The phrase in the letter "business as usual" was interpreted by Mr Whitcombe and Mr Henton, according to their evidence, as meaning that they could write to the increased premium of $20m. Their evidence was that they continued on that basis until they were told of the moratorium.
1394. By the phrase "business as usual", Mr Watson meant 'continue on the terms of the slip'; his view was (as set out above) that the next step was for an underwriting audit; he did not believe that he could unilaterally abrogate the binder; he considered that to the extent that he had authority, Mr Whitcombe was free to continue underwriting. Mr Watson wanted the audit to find out everything.
1395. I am sure, taking into account all the evidence including the three letters, that Mr Watson had not agreed to any increase in the premium income limit and that Mr Whitcombe and Mr Henton knew that. Their evidence to the contrary was untruthful. No agreement had been given by Mr Watson at the meeting and they knew in any event that there would be no increase until Mr Broad signed off on it. That was never done.
1396. In his letter of 7 January 1999 to Clyde & Co (referred to at paragraph 1829), Mr Broad stated:

"Indeed the largest premium increase to income was authorised by Watson after his meeting with John Whitcombe."

Mr Broad's evidence was that at the time he wrote the letter, his understanding from Mr Whitcombe was that Mr Whitcombe had been given the authority to increase his premium income; he subsequently learnt that that was denied by Mr Watson during the course of discussions with Clyde & Co.

1397. As set out at paragraphs 1338, Programmes 32, 33, 34 and 35 were written and/or confirmed by EIU after 3 June 1998; EIU knew that they had no right to agree to these programmes as accepting them would exceed a premium income level of £6m that had been agreed as the limit.

(f) The provision of a file by EIU to Mr Broad

1398. Mr Whitcombe's letter of 17 June 1998 to Mr Broad (referred to at paragraph 1386) also stated:

"I am enclosing what I feel you should have as the basis of your broking/underwriting file but please do ask for anything you would like; it would be provided."

1399. Mr Whitcombe's evidence was that Mr Broad had phoned him and had said that he was being chased by Mr Mather and that he needed a file as he was unable to find one; Mr Whitcombe did not want to tell HHI as they would think that Mr Broad was a clown. Mr Henton then put together a file of about two to three inches thick and Mr Whitcombe walked it round himself. It was Mr Whitcombe's evidence that the file contained the slips, a business plan, the underwriting reports, correspondence, the bordereaux and the cover note.
1400. Mr Broad could not initially recall receiving the documents, but he then recalled that he had received the file but not what was in it. Mr Broad's evidence was that this had nothing to do with Mr Mather wanting papers.
1401. Mr Henton's evidence was that the business plan, the underwriting reports, the slips and endorsements, correspondence, figures and the bordereaux which were contained within some of the dividers in what was in fact Mr Mather's file were the papers he had given to Mr Whitcombe to give to Mr Broad.
1402. Mr Watson recalled seeing Mr Broad's file; it was relatively thin but included various bordereaux. He believed that this was the file which Mr Broad had requested from EIU and that Mr Broad had brought it to him at one of their one-to-one meetings at which they discussed Mr Broad's accounts. Mr Broad had no recollection of speaking to Mr Watson about the file but he accepted that there might well have been a meeting during which the binder was discussed.
1403. On the evidence, I find that Mr Broad did request a file at this time and that the papers which Mr Whitcombe identified as provided, were indeed provided by EIU; SD accepted as much in their closing submissions. The internal investigations at SD made it clear that SD had virtually no paperwork on the binder; I am sure that Mr Broad was told to get the relevant papers; he turned to EIU for them and I am sure that these were the papers subsequently collected together in Mr Mather's file.
1404. As was obvious, anyone reading the bordereaux contained in the file would have appreciated that WC and treaty business were being written; they might also have seen the references to LMX contained in some of the bordereaux.

(g) Mr Broad's agreement to a change in the rate of commission

1405. As set out at paragraph 1311, in February 1998, a reduction in the commission was agreed. In his letter of 23 April 1998 to Mr Smith, Mr Henton returned to that subject as he had wanted a change; he stated that EIU were being shown QS contracts where there were deductions in excess of 35% or 37.5% whilst still maintaining a healthy loss record; he also stated that Mr Smith was aware that from 1 January 1998 they had elected to take no more than 12.5% from any risk written, including those risks where they previously would have been allowed to take up to 25%, and that they wanted the binder amended to provide for them to take 12.5% on each risk. Mr Henton's opinion was that HHI's brokerage should not exceed 2.5%.
1406. The 12.5% sought was very high; for example, Mr Cackett's Centaur received 7.5% from Sun Life Assurance Company of Canada and Phoenix (as set out at paragraph 1687.iii)) and Mr Billyard's JEH Re received 6% from John Hancock, though it is right to point out that the volume of business written by them was much greater.
1407. Mr Henton's evidence was that Mr Broad appreciated that there was a 'swings and roundabouts' approach; Mr Henton did not think that HHI were doing much for their money and that was why he thought that they should not receive more than 2.5% in brokerage.
1408. Mr Whitcombe's evidence was that he had suggested a flat rate commission of 12.5% for EIU at the meeting on 21 May 1998; Mr Broad could not recall that; Mr Broad had always thought that EIU were to receive 12.5%. Commission had only come up as he was angry with HHI then, but nothing could have been changed without the consent of HHI.
1409. Mr Whitcombe returned to the issue in his letter to Mr Broad on 17 June 1998 as one of the matters that had been discussed at the meeting of 16 June 1998 (described at paragraph 1385). In the letter, he stated:

"It is my understanding that the maximum commission to EIU is agreed at 12.5% and that you are in discussion with [HHI] concerning their brokerage. In reality I estimate the commission payable on the International XL and Fac account will be in the range of 10-12.5% but on the Quota Share account is 1.5-2.5%."

1410. Mr Henton's evidence was that they had discussed levels of commission and had agreed to reduce the level on the basis of the account which EIU were in fact writing; EIU were not trying to get levels of commissions increased. Although EIU charged a commission of 1.5% on Programme 28 (95% QS), they charged a commission of 12.5% on Programme 33 (the QS of John Hancock per JEH Re's non-proportional business), despite what Mr Whitcombe had stated in the letter. Mr Henton's explanation was that the level of commission charged on Programme 33 was justified as it was a QS of non-proportional business and there was no original rate on such business.
1411. The letter then asked:

"May I ask you to please confirm in writing the commission agreement and the premium limit for 1998."

By reference to "the commission", Mr Whitcombe was referring to the conversation he had had with Mr Broad the previous day on 16 June 1998; they had agreed that commission rates were too high and had reached an agreement on it.

1412. In his evidence, Mr Broad maintained that he did not know that treaty business was being written by EIU, but as the reference in the letter to commission on the QS account made it obvious that treaty business was being written, he accepted that this was a difficulty and that it did not sit easily with his evidence.
1413. Two further endorsements effected the change:

i) The first dealt with commission:

"Deductions: O.G.R. less original commissions and brokerage plus 12.5% management fee and overrider.

Information: Estimated average original overall commission for 1998 is 27.50%."

ii) By a separate endorsement there was a reduction in the brokerage to 3.75% of original gross rate for risks attaching on or after 1 January 1998.

(h) The quota share with ESG

1414. One way of enabling an increase in the premium income limit was for HHI to place a QS reinsurance of business that had been written under the binder. It was the evidence of both Mr Whitcombe and Mr Broad that this was a proposal on which HHI were keen and was being promoted by them; Mr Whitcombe's evidence was that EIU were not keen on it; they looked on it as a means of HHI earning more commission and were not initially involved with it. He never discussed this directly with Mr Broad save for mentioning to Mr Broad in his letter of 28 May 1998 (referred to at paragraph 1353) that he should only enter into the QS on the basis of a full follow clause.
1415. HHI approached ESG, the company that wrote for a pool of reinsurers and which had written the QS of Lincoln National when it had the premium income problems referred to at paragraph 441.iv) above; by 18 February 1998, HHI had interested ESG in a 33% QS, subject to ESG being provided with certain information including the claims experience and being made "to feel a little more comfortable about the exposure on spiral business".
1416. Mr Broad recollected being asked to agree to a QS with ESG; on 3 April 1998, a fax was sent by HHI to ESG saying that Mr Broad had given a firm order for a 25% QS on an estimated premium income of $5m, but Mr Broad's evidence was that Mr Smith had misunderstood him; he had never given a firm order but had said that he would be prepared to go along with this as a means of increasing the premium income limit provided that the security was approved. This did not proceed.
1417. On 15 May 1998, ESG asked a number of questions about the business being written. On 20 May 1998 (as set out at paragraph 1349) an amendment to the binder was agreed, stating that there was to be a minimum 25% QS in respect of the 1998 year of account. A draft response to ESG's questions was prepared by HHI and passed to EIU, but because of what was said, Mr Whitcombe would not agree to it. A response was provided to ESG (in answer to their questions on 26 June 1998) in a memorandum signed by Mr Smith. Mr Broad could not recall discussing this memorandum with either Mr Smith or Mr Whitcombe or being told anything about what was in the memorandum.
1418. The important questions asked by ESG, Mr Whitcombe's reaction, and the responses sent were:

i) ESG asked for a written guarantee that "P.A. X.L. Retro business" was not written in any form; the draft response sent to EIU stated that "P.A. XL contracts Retro is not written". The response actually sent stated that "Excess of Loss Retro could be written as incidental". Mr Whitcombe did not accept that it was incidental; the guarantee could not be given and it was untrue to say that it was incidental as Programmes 1 and 33 contained retro business that was more than merely incidental.

ii) A request that all business bound must have a five year sunset clause; the draft and final response confirmed that all would have a sunset clause, with the majority having a five year clause.

iii) A request for confirmation that XL on XL business was not on a "'going forward' basis to be sought or written"; the draft response stated that "XL on XL was not written or [sought] as such, however, some incidental Could be picked up from the Pro-Rata account". Mr Smith had said in his interview that he had been told this by Mr Whitcombe and Mr Henton. The final response was that "XOL on XOL not written as such, however some incidental could be picked up". Mr Whitcombe accepted that the answer was definitely untrue; he had told Mr Smith the true position. Mr Henton said that this statement and the one referred to in sub-paragraph i) were accurate for 1998 as EIU did not really write retro business (in the sense of spiral, LMX or international XL on XL business), they were concentrating on the reinsurance of direct writers; they had not written into the 1998 account, anything like the American Reliable or Phoenix programmes that they had written in 1997.

1419. It is clear from this document that the most that HHI were prepared to say about the writing of retro business was that some could be written as incidental. EIU submitted that it was inconceivable that EIU/HHI would tell ESG this but not Mr Broad; however, as I have set out, I am sure that Mr Broad was not told, particularly when the direct question was raised in relation to Mr Zuberi's allegations earlier in 1998.
1420. A presentation was also sent to ESG by HHI in June 1998. EIU's evidence was that they had not been involved in the preparation of this presentation but that it had been put together by HHI, who had included in it, part of another presentation on EIU note paper which EIU had sent to another company at about this time (the timing followed from the fact that the part of the presentation on EIU note paper referred to the figures as at 30 April 1998). The part of the presentation on EIU note paper had been put forward (as Mr Whitcombe accepted) to invite that other company to participate as a co-insurer with SD on business written under the binder.
1421. It described, in that part which was on EIU note paper, EIU's strategy as underwriting a "low to medium risk portfolio" and that the business was its accident and health reinsurance account. It stated that accident and health was a highly desirable product line which had proven to be highly profitable:

"EIU's underwriter has proven that with strict adherence to the agreed underwriting limits and prudent risk review against selective acceptance criteria substantial underwriting profits are possible (emphasis added).

The account has been written to offer the best opportunity for constructive long term development with consistent profit potential. The account includes proportional and non-proportional risk which are accepted on a world wide basis. The anticipated breakdown being as follows:-

Facultative Reinsurance 25%

Non Proportional Treaty 45%

Proportional Treaty 30%

The non proportional treaty account is predominantly International Excess of Loss which does include a small percentage (estimated 5%) of London market exposure. This exposure being predominantly from the accounts of direct writers only (emphasis added). Aggregate exposures are carefully monitored especially if they are those of fellow reinsurance underwriters regardless of their international address."

It stated that part of the account was "Occupational Accident", making clear that it included Section A benefits of standard workers' compensation policies. It attached the figures as at 30 April 1998 which had been attached to the May 1998 underwriting report (see paragraph 1355), as well as bordereaux and the January 1998 and May 1998 underwriting reports.

1422. This is a significant document:

i) The language in the passages on EIU note paper reflected some of the language used in the business plans and their antecedent documents, but the importance of the passages to which I have referred is the fact that they were repeated after this business had been written by EIU for over a year.

ii) It did not say that gross loss making business was being deliberately written on the back of reinsurance, though the presentation did, however, make it clear that spiral business was being written.

1423. On 1 July 1998, ESG signed the slip for a 25% QS from 1 January 1998; the slip recorded (as information provided) that the estimated premium income was $20m and that the estimated average original commission was 27.5%; ESG allowed, on top of the original commission and brokerage, a further 7.5% brokerage and overrider. Mr Broad's evidence was that he did not see either the slip or its draft. ESG's QS was subject to SD's approval of the security of ESG and of the companies for whom ESG underwrote.
1424. On 6 August 1998, HHI wrote to SD, seeking approval of ESG's security; approval was given on 11 August 1998 by Mr Forness in the circumstances described at paragraph 1500. The QS has been avoided by ESG (see paragraph 1850).

(4) The involvement of Mr Barnard

(a) The continuation of the internal enquiries after 16 June 1998

1425. Mr Bentley met Mr Broad on 17 June 1998 to introduce himself. He agreed with Mr Broad that the outwards reinsurance collections (which had not been monitored or controlled) should go through Brighton. He was told by Mr Broad that Mr Rayner had the cover notes; Mr Rayner had found these in a pile on his own desk. Mr Bentley's evidence was that Mr Broad was happy that Mr Bentley was sorting things out.
1426. Mr Bentley also met Mr Dansie and it was agreed that they should conduct a review of the position on claims, premiums and reinsurances; there was a meeting on 30 June 1998 between HHI and a team from SD led by Mr Bentley, at which these matters were reviewed and information was provided by HHI to SD. On Mr Bentley's evidence in relation to the enquiries he made (which I accept), it is clear that the files of HHI were all jumbled up; they could not even send a broker's file for the binder to SD; the position within SD was that there had been considerable confusion in getting the papers from the underwriting room.
1427. By 7 July 1998, Mr Bentley had established that:

i) no premium had been paid for the 1998 reinsurance;

ii) security on various layers had not been approved;

iii) the outwards reinsurance was on an LOD basis whilst some inwards business was on an RAD basis;

iv) the QS of John Hancock (Mr Billyard), the outwards reinsurance by John Hancock (Mr Billyard), the inwards reinsurance of American Reliable, and the outwards reinsurance by American Reliable gave rise to the risk of a spiral.

Mr Broad accepted that this was information he could have, but had not, discerned from reading the documents. His evidence was that none of this was brought to his attention at the time, but Mr Bentley's evidence was that Mr Broad might have mentioned the spiral and the non-approval of the security.

1428. Mr Forness recommended on 8 July 1998 that they put a moratorium on Mr Broad's account "regarding all "built in" reinsurance binding authorities". Mr Bentley was told by Mr Forness to report to him directly sometime after 8 July 1998.

(b) Mr Barnard's visit to London

1429. By the end of June 1998, Mr Watson had come to the view that although he had a good personal relationship with Mr Broad, Mr Broad would not change his way of doing business and Mr Mather and Mr John Coppinger should therefore take over (see paragraph 1437). Mr Watson was concerned that Mr Broad had stumbled into an area of business he ought not to have been involved in.
1430. Mr Barnard (whose experience was referred to at paragraph 1024) was made aware of the binder in June 1998 but he was not then told of the problems. He was told of the request for an increase in the premium income limit to $20m and that it was outstanding. He could not recall receiving materials prior to coming to London or of reviewing documents until after a meeting he had had with Mr Whitcombe over lunch on 9 July 1998.
1431. Present at the lunch with Mr Barnard were Mr Whitcombe, Mr Broad and Mr Smith. Mr Broad's evidence was that he considered that the purpose of the meeting was for Mr Barnard to get to know Mr Whitcombe (as Mr Whitcombe was an important supporter of SD) and for Mr Barnard to promote Odyssey Re in London; he only gave Mr Barnard a short briefing prior to the meeting.
1432. There was some common ground as to what was said over the lunch, which lasted about 1½ hours:

i) Mr Barnard asked Mr Whitcombe about the business and was told that much of his PA business was occupational accident; there was a discussion as to whether it was WC carveout business; it originated from the US. The discussion made it clear that the business was treaty business.

ii) Mr Barnard enquired about the tail of the business and was told by Mr Whitcombe that it was long tail (Mr Whitcombe denied telling Mr Barnard this), but that he expected that all the claims would be commuted after a few years.

iii) Mr Whitcombe told Mr Broad that his largest income producer was John Hancock (where the projected income was about $6m); there was a difference in recollection as to whether this was $6m over three years or that the adjustments would take three years to finalise.

iv) Mr Whitcombe said that the John Hancock business came through Bermuda and that the underwriter was Mr Billyard.

v) It was Mr Smith's recollection that Mr Barnard asked Mr Whitcombe if they had written Unicover; Mr Whitcombe replied that they had not but had written Unicare. Unicover Insurance Company were an MGA based in Chicago which wrote a large amount of WC business – see paragraph 1712; Unicare were a Californian insurance company in respect of which Mr Henton had written a very large reinsurance by way of retrocession of WEB (Programme 34) in June 1998 (as set out at paragraphs 1338 and 1341.vi) above, and at paragraphs 873 and following of Part II).

1433. Mr Whitcombe made it clear at the meeting that the business was WC carveout; there was a dispute as to whether this was the first time Mr Whitcombe had said this:

i) Mr Smith's recollection was that he did not know that it was WC carveout until 9 July 1998; he had thought that it was occupational accident.

ii) Mr Broad recalled the discussion about occupational accident business, but was not under the impression that WC business was being written and had no recollection of being told that it was carveout or treaty or that there were sunset and commutation clauses. He would have been very concerned if it had been mentioned. His evidence was that he did not know that occupational accident included carveout business.

iii) Mr Whitcombe's evidence was that this was not the first occasion he had referred to the business written as WC carveout, as he had told Mr Broad this on 7 February 1997 (see paragraph 815.ii)) and he had said this to Mr Watson on 3 June 1998 (see paragraphs 1374 and 1378).

1434. Mr Whitcombe perceived the lunch as becoming increasingly heavy going and he thought that SD would duck out of the binder; as the lunch progressed and as he told Mr Barnard more about the account, Mr Barnard became distinctly unenthusiastic. Mr Henton's evidence was that Mr Whitcombe had told him that he had had a hard time at lunch and that he had a feeling that the binder would be cancelled.

(c) Mr Barnard's actions after the meeting

1435. What he was told at the meeting and had learnt from a review of the papers gave Mr Barnard considerable concern and he wanted the account transferred to Mr Mather:

i) After the meeting, Mr Barnard asked Mr Broad if he was familiar with occupational accident business or with Mr Billyard; Mr Broad was not. Mr Barnard was concerned because it was a large account which had grown rapidly. Mr Barnard had no memory of Mr Broad reacting to being told that it was WC business, or that it was long tail business, or as to the involvement of John Hancock.

ii) The mention of Mr Billyard's name aroused Mr Barnard's concern as he recalled that Mr Billyard had been involved in prior problems.

iii) In addition, Mr Broad was not familiar with the business and the account had grown rapidly and was large.

iv) In his review of the file, he was concerned when he saw the names Clarendon and Legion as they wrote business as fronting companies and had a reputation of fronting for anyone for fees. His contemporary notes set out obvious and pertinent questions that required an answer. He reviewed the figures attached to the May 1998 underwriting report; they made clear to him that the business was unprofitable; he was concerned with the future as this was long tail business.

v) He expressed his concern about the nature of the business to Mr Watson and they looked at some of the bordereaux together. They discussed the fact that the market had begun to focus on the writing of severely underpriced WC carveout business in the US, particularly the Unicover programme.

1436. As set out at paragraph 1426, Mr Forness had recommended restricting Mr Broad's authority. On 10 July 1998, Mr Watson told Mr Broad of the decision to transfer the account to Mr Mather. Mr Broad was very annoyed as he believed this was a cream account. By that time Mr Broad was making contemporaneous notes as he feared that he would be dismissed. According to those notes, Mr Watson expressed concerns about the account, but neither Mr Broad nor Mr Watson could recall in their evidence what they were, other than that Mr Barnard had generally been concerned about WC business. Mr Broad's note records:

"He raised some examples which we discussed and I said that these were aspects which I had also queried. I reassured him that on the information I had been given he was putting the wrong interpretation on some of the issues. I stated that I had underwritten this class of business myself when I had my Lloyd's syndicate. Nevertheless this business was now being taken away from me without any prior discussion and I know that will create an adverse impression about me with my colleagues and my Broker connections. I can't really argue the point because Watson would use it as an excuse to dismiss me."

1437. I am sure that Mr Watson would have relayed Mr Barnard's concerns to Mr Broad as the worry that Mr Barnard had about the account had been conveyed to Mr Watson by that stage and he would have passed the concerns on.
1438. Mr Broad spoke to Mr Smith and told him that Mr Mather was going to handle the account; he also told Mr Smith about Mr Barnard's concern about WC business and Mr Smith expressed his concern about WC business too.

(d) The ordering of a review by Mr Mather and Mr Coppinger

1439. Mr Barnard also decided that there needed to be a full review so that SD could understand the business that had been written under the binder. He appointed Mr Mather and Mr Coppinger to conduct the review; Mr Broad was informed of this in writing by Mr Watson on 13 July 1998 and was told to tell HHI and Mr Whitcombe that there was to be a thorough underwriting audit and ask if there could be a meeting in Bermuda with the person who wrote the programme on which SD had a QS.
1440. Mr Mather was the senior underwriter and a director of the Odyssey Re Group. Mr Mather did not give evidence at the trial though SD had served a statement of his evidence; at the time the statement was served he was employed by SD and remained so employed until shortly before he was due to be called to give evidence. He left the employ of SD as he was due to be called and was not eventually called. His statement was not served under a hearsay notice; it was returned by the Court to SD as it formed no part of the evidence.
1441. Mr Coppinger joined Odyssey America in June 1998 as supervisor of the Alternative Risk Transfer (ART) division, reporting directly to Mr Mather; the ART account was written by SD in Bermuda; on the evidence, I am sure that the ART account was underwritten under him for a profit and the ART division did not engage in writing gross loss making business on the backs of reinsurers. Mr Coppinger had been an international treaty underwriter with the Continental Insurance Company, a domestic reinsurance underwriter with the Unity Group, a consultant to Marsh & McLennan, an underwriter with the Skandia America Group and an underwriter with TIG Reinsurance Company (where he had been the WC leader). His experience of WC went back to the late 1980s. He gave evidence at the trial with undoubted honesty and clarity; he was an impressive witness.
1442. When Mr Coppinger was asked to investigate, a number of names were mentioned to him by SD. Two of those mentioned were Hackett and Mr Billyard. He made an enquiry about them and received a response which stated that Hackett was an MGA in New Jersey which was run by Mr James Hackett Sr; he had a binder for carveout; when he died, John Hancock withdrew the authority; JEH Re was formed by SCB, Mr Hackett and Mr Billyard; JEH Re was then using Republic Western "paper [that was] thought to have been arranged by Mark [Cooke of SCB]"; it was suggested that they investigate New Cap Re as they were doing "cheap … WC carve-out business".

(5) The investigations by Mr Mather and Mr Coppinger

(a) The visit of Mr Mather and Mr Coppinger to Bermuda

1443. Mr Coppinger met Mr Mather in Bermuda; Mr Mather had brought with him the file that had been assembled and to which I have referred at paragraph 1401. On 14 July 1998, they met Mr Billyard. Although Mr Broad had been asked to make an introduction, none had in fact been made and they arrived at his offices without any explanation of the purpose of the visit. The meeting lasted 1 to 1½ hours; they discussed matters with Mr Billyard but did not see any files. Mr Coppinger's note of the meeting was one of the documents disclosed by SD during the course of the trial.
1444. Mr Coppinger's note recorded a number of matters including:

i) JEH Re (which was 39% owned by SCB) was the MGA for John Hancock and the facility with John Hancock was to terminate on 31 December 1998 as it was not being renewed; the gross written premium income for 1998 was $50m.

ii) The account was largely XL "occupational accident" business; the average commissions on reinsurance were 10%-15%.

iii) SD had written 12% on a 95% QS of John Hancock and John Hancock had provided many layers of reinsurance of SD in 1997 and 1998. There was therefore a spiral.

iv) Realm UM (owned 100% by SCB, as referred to at paragraph 453.i)) was the MGA for Republic Western (which wrote full conditions WC XL reinsurance) and Mutual Service Casualty Insurance Company (MSC); the facility with MSC appeared to be the replacement for the John Hancock facility; a 100% reinsurance was being provided by SD through SCB.

v) Although the facility with MSC was not to operate until 1 January 1999, it had written some (though very little) premium. In a letter written to HHI on 9 September 1998 (in circumstances described at paragraph 1648.i)), Mr Billyard denied that the facility was up and running or that it had been fed small amounts of premium.

vi) They were concerned about the spiral, the risk that the business was underpriced, the concentration of business from JEH Re and the relationship with SCB. They also wanted to find out what was to go into the MSC facility.

1445. Mr Mather's note described the meeting as cordial and candid and that Mr Billyard had believed that they were interested in discussing the 100% reinsurance of MSC by SD; he noted that Mr Billyard, as the leading underwriter of the reinsurance of SD, demonstrated little, if any, familiarity with the portfolio. He recorded in his letter of 20 August 1998 to HHI (referred to at paragraph 1640) that Mr Billyard had said that the MSC facility was expected to assume the $50m portfolio in January 1999.
1446. I am sure that Mr Mather was right. They had arrived unannounced and Mr Billyard had thought that Mr Mather and Mr Coppinger were coming to see him to discuss the reinsurance of MSC. That was why he was so candid and had told them so much which was so near the truth; SCB had not been able to warn him of the real reason for the visit.
1447. Before continuing the account of the investigation, it is necessary to explain the connection with MSC.

(b) MSC and the proposed reinsurance by SD

1448. The position in relation to the MSC facility is very important in the light of what had emerged during the trial. Almost all the documents were obtained by SD from MSC, whose provision of these documents was of the greatest assistance to the Court. It was the evidence of SCB that they could not locate their file on the facility, nor could any file on the facility be located amongst EIU's files.
1449. MSC and its associated companies were based in St Paul, Minnesota. Mr Butler's evidence was that they had wanted a "sit alongside facility" to the JEH Re facility and discussions had begun in February 1998. The documents produced by MSC showed that in April 1998 there were discussions through Mr Richard Standing of Delta Intermediaries (New Jersey brokers which acted for B&S which acted as an MGA for a very large programme that was reinsured under one of the Christmas Eve programmes – Programme 9 – see paragraph 167 of Part II) and SCB, the purpose of which was to get MSC to front a book of business that was to be written by Mr Billyard at Realm UM and reinsured by SD. Those involved for SCB included Mr Brown.
1450. The proposal that was sent to MSC was based on a proposal for First Reinsurance Company of Hartford which had not progressed; the significant points of the proposal were:

i) Mr Billyard was to underwrite predominantly occupational accident business produced by SCB's network in the US; MSC would front the reinsurance; it would get a 5% overrider and cede 100% of the risk.

ii) The estimated premium income was to be $25m and the income was largely to be derived from the reinsurance of SCB group products.

iii) The proposal contained phrases such as "[u]nderwriting to be undertaken by an International Lead Underwriter in the proposed classes", "access to an existing portfolio of business, which is profitable", "[a]n immediate and continued flow of quality business is available, which substantially reduces the risks normal inherent in a start up situation"; these were similar phraseology to those used in Mr Whitcombe's EIC business plan of August 1995 that was prepared with Julius Baer (see paragraphs 490.iv) and 490.v)), and in EIU's business plan sent by WFD to Mr Traxler in July 1997 (see paragraph 987).

iv) There was nothing in the document to indicate that this was gross loss making business that was to be written on an arbitrage basis. However, it did say that there would be a 10%-20% mark-up over the historic burn plus costs; it was intended to be an account written for a gross profit.

v) It was, according to Mr Butler, the usual type of arrangement, with an issuing company being written for by an agent with a QS behind them.

1451. On 17 April 1998, Mr Brown told MSC that he was intending to go into the market to place the QS reinsurance with effect from 1 May 1998 but that he might be able to backdate it to 1 March 1998.
1452. On 3 May 1998, Mr Brown sent to MSC what was described as supporting information that was to be provided to reinsurers on the QS. This was very similar to the proposal put to MSC; it included a statement that there was to be strict adherence to pricing "based on a 10-20% mark-up over the historic burn plus costs."
1453. On 12 May 1998, a slip was sent by SCB to MSC with the amendments said to have been discussed with Mr Brown; the slip provided for a 100% QS as MSC were going to front. It excluded LMX. Mr Brown's evidence was that he could not recall who the reinsurers were; it was intended for first tier reinsurances along the lines of the Bridgefield (Programme 8) and MELEX (Programme 14) programmes.
1454. On 25 June 1998, Mr Brown sent a fax to Mr Standing, confirming that he had London market security whom he believed would write a 100% QS for MSC; that security was SD. He wanted to know if MSC was happy with the security:

"Please speak with Don Gray as we would be very keen to do this deal and get [MSC] up and running with Reg as we have business we wish to cede."

1455. On 29 June 1998, MSC wrote to Mr Standing with a copy to Mr Brown and Mr Billyard, saying that SD were acceptable to MSC as reinsurers for the Realm National programme; they wanted to know more about EIU. It was evident that Ms Barnes of SCB had produced a memorandum about the role of EIU by 1 July 1998; this could not be found; however, it satisfied MSC who, after discussions with Mr Billyard, were prepared to proceed with the arrangement.
1456. Mr Butler's evidence was that he had forgotten about this and could not recall anything further. Mr Brown's evidence was that he had really no recollection of this, but that it was not the intention to write spiral business; it was a facility for SCB products and programmes similar to Bridgefield and MELEX; the statement as to rating in the proposal to reinsurers (set out at paragraph 1450) would support this as, if true, it would obviously evidence an intention to write on a gross basis.
1457. Mr Henton produced a manuscript list on 7 July 1998 which was described as a "wish list" for his reinsurance requirements; it was handed to SCB. On it there was, in the hand of Ms Barnes, some writing which stated "MSI deal – quote specific layer…". At the time of the trial, Ms Barnes was Mr Brown's partner and lived in Monte Carlo; she did not give evidence. Mr Brown knew of no reason why she could not give evidence.
1458. On 10 July 1998, there was a conversation between Mr Brown's secretary and Mr Henton. According to her note, she had, on Mr Brown's instructions, asked Mr Henton if it was alright to take the MSC QS back to 1 January 1998; Mr Henton was recorded as saying that that was okay. This document emerged towards the end of the trial and Mr Henton was not asked about it.
1459. On 20 July 1998, Ms Barnes sent a fax to Delta headed "MSI arrangement" which stated:

"We are awaiting confirmation from the reinsurer on the inception date of this treaty. I have been advised that we will be in a position to complete on Friday of next week at which point, we will advise the inception date and if all parties are happy we can commence with the flow of business."

1460. During the visit by Mr Mather and Mr Coppinger to EIU (see paragraphs 1469 and following), Mr Whitcombe denied any knowledge of MSC.
1461. On 18 August 1998, MSC e-mailed Mr Billyard, asking how things were going with SD; they stated that they had heard nothing from London other than that SD had settled on a 1 May effective date for the reinsurance agreement. On 26 August 1998, MSC enquired again and asked if there were any problems. No reply to these e-mails was available.
1462. Mr Henton denied that EIU had provided any reinsurance for the MSC facility. Mr Butler's evidence was that as far as he was aware, nothing was bound or agreed and no reinsurance had been provided by EIU on behalf of SD; Mr Coppinger's note (referred to at paragraph 1442.v)) which stated that the facility had been fed a small amount of premium was wrong.
1463. It was SD's case that SCB were withholding the documentation and that Mr Henton, Mr Butler and Mr Brown were giving dishonest evidence when they could not recall discussions about MSC. I set out my conclusions at paragraphs 1532 and following.

(c) The reaction to the visit by Mr Billyard, SCB and EIU

1464. Mr Billyard was, according to Mr Butler, not happy about the visit; he had thought that it was to be a courtesy call, but had viewed what happened as an audit; he expressed his unhappiness in a letter to HHI on 9 September 1998 (which Mr Brown had re-drafted, in the circumstances set out at paragraph 1645.ii)).
1465. Mr Brown learnt of the visit quickly as he understood that it had been a very hostile meeting; his evidence was that he had possibly spoken to Mr Henton about it. It was Mr Whitcombe's evidence that he had received a message through SCB that Mr Billyard was extremely annoyed about the visit and about Mr Mather's discourtesy. Mr Whitcombe then had a conversation with Mr Billyard though they had never met previously.
1466. Mr Broad's evidence was that he was not told of the results of the visit by SD, but Mr Mather did comment on it at one of Mr Watson's Monday morning meetings; Mr Mather had questioned whether SD should be writing the business. Mr Mather's style towards him was antagonistic.
1467. On 16 July 1998, Mr Broad spoke to Mr Whitcombe, probably at Balls Brothers. Mr Whitcombe expressed outrage about the visit made to Mr Billyard; Mr Broad told Mr Whitcombe that the business was to be taken over by the SD office in New York. Mr Broad was worried about SD's highhandedness and about the passing of the account to New York; he had found Mr Whitcombe and Mr Smith very sympathetic at what was happening to him. It was Mr Whitcombe's feeling that SD were going to get rid of Mr Broad.
1468. Mr Whitcombe wrote a letter that day to Mr Broad, expressing his sympathy to Mr Broad at having the account transferred away:

"Is it being suggested that you don't understand and cannot control this account. Certainly that is the obvious implication and as an underwriter and director your position is obviously lessened and demeaned."

1469. He also complained about the visit to Mr Billyard; he said that Mr Billyard had found Mr Coppinger a man ready to listen and understand the risk, but that Mr Mather had asked questions he should not have done and Mr Billyard had found Mr Mather untrustworthy. Mr Whitcombe complained in similar terms in a telephone call to Mr Watson.
1470. Also, Mr Bentley went to see Mr Henton on 16 July 1998 and discussed the reinsurance; there was some discussion about a spiral and, according to the note made by Mr Bentley, Mr Henton had told him that, apart from Programmes 2 and 3, there were exclusions of inwards reinsurance to stop spirals. Mr Henton's evidence was that there were no such exclusions save in the New Cap Re (Australia) programme (Programme 32), and that he had never said this to Mr Bentley; if he had, then it would have obviously been inconsistent with his evidence about Mr Brown's assurances in December 1997 and April 1998. I am sure that Mr Bentley's note was accurate; he was a careful and obviously honest witness; he took considerable care in his investigations. At the same meeting, Mr Henton told Mr Bentley that he had not written any programmes with original policies of up to 36 months as permitted by the endorsement made on 26 February 1998 (referred to at paragraph 1309). Mr Henton had in fact written the Unicare programme (Programme 34) which reinsured original polices of more than 12 months (as set out in at paragraphs 888 and following of Part II.

(d) Mr Mather's and Mr Coppinger's visit to EIU

1471. Mr Mather and Mr Coppinger visited EIU's office on 28 and 29 July 1998. EIU gave access to all the files and to anything that Mr Mather and Mr Coppinger required. Most of the discussion took place between Mr Coppinger and Mr Henton as Mr Mather was not there all of the time.
1472. Mr Coppinger reviewed eleven programmes – Programmes 11, 18, 19, 22, 24, 28, 29, 31, 32, 33 and 34.
1473. A number of issues were raised:

i) Mr Coppinger appreciated during the course of the audit that there was a lot of treaty business.

ii) Mr Coppinger told EIU that it appeared from the information on the files that the business was loss making; by that he meant that where there was information on the file as to losses and premiums, it showed that the business would produce losses that would exceed the premium, sometimes by a significant amount. In other words, he had concluded that EIU were writing gross loss making business. He was told by EIU that much of the business was loss making on a gross basis and that the business could not possibly be written without the benefit of reinsurance. He was told that the way in which PA business was carried out in the UK meant that EIU could not be selective and had to accept the whole portfolio. SD's position depended on the presence of reinsurance and they could not write profitably without it.

iii) Mr Coppinger concluded that there was insufficient placing information to enable EIU to understand and rate the business properly; there was nothing to show that the terms had been negotiated. He was told by Mr Henton that there was other information on the brokers' files which he could call for when he wanted them.

iv) Mr Coppinger was told that there were accumulations in the account and that EIU did monitor them; that the accumulations were contained within the reinsurance programme.

v) Mr Mather also raised the question of a spiral between Mr Billyard and SD; it was Mr Whitcombe's evidence that he had said that SCB had assured him that there was no spiral as they had been given an assurance on the placement of what was Programme 33 – see paragraphs 1579.ii) and 1617.

vi) Mr Whitcombe told them that he had given instructions to the broker to ensure that the business written by EIU would not spiral.

1474. At the conclusion of the review, Mr Coppinger told Mr Whitcombe and Mr Henton of their findings:

i) that the business which EIU accepted was loss making;

ii) that it was inevitable that the business would produce losses that would sometimes exceed the premium by a very significant amount; and

iii) that almost all of the inwards business was placed by SCB; it was coming from a concentrated source.

1475. Mr Coppinger left written questions that were to be answered in relation to Programmes 29, 28 and 33. The questions in relation to Programme 33 were very important; the questions and the circumstances leading to the responses are considered at paragraphs 1550 and following.

(e) Agreement of the moratorium

1476. Mr Henton and Mr Whitcombe agreed, on the first day of Mr Mather's and Mr Coppinger's visit, that they would write no more business from 28 July 1998. EIU accepted in their evidence that this meant that they could not write any more business or authorise any increases in premium income, although there might be adjustments of premiums. They sought to qualify this in their closing submissions by maintaining that it did not extend to endorsements and was not extended to all underwriting matters until 1999.
1477. EIU later confirmed (as set out at paragraph 1496) in letters to Mr Mather dated 11 August 1998 and 10 September 1998, that they had not written any more business since 28 July 1998.
1478. Mr Henton thought that this was a temporary measure and that they would be able to continue; they did not think differently until after the 4 January 1999 meeting with SD.
1479. The disputed question as to whether SCB knew of the moratorium is considered at paragraphs 1766 and following.

(6) The termination of Mr Broad's employment

(a) The debriefing meeting at SD on 29/30 July 1998

1480. I am sure that on 29 or 30 July 1998 there was a meeting which lasted about 1-2 hours and which was attended by Mr Watson, Mr Bentley, Mr Forness, Mr Coppinger, Mr Mather and Mr Broad, during which Mr Mather made a presentation of the results of his and Mr Coppinger's investigation. That was the evidence of Mr Bentley and Mr Coppinger; the meeting was also referred to in an e-mail drafted by Mr Coppinger on 30 July 1998.
1481. I am also sure that Mr Broad was present for the part of the meeting when Mr Mather went through the conclusions of their visit to EIU; that was the evidence of Mr Bentley; his presence was referred to in the e-mail sent by Mr Coppinger:

"I'm trying to forget Vic Broad's comment today that due to [HHI's] and his careful efforts, we are less cash negative than we otherwise would have been!…"

1482. I accept Mr Bentley's account of the meeting:

i) Mr Mather reported that the EIU account contained a significant amount of WC, that there was little evidence of underwriting or analysis by EIU, that the business was underrated, and that it was predominantly US business which was produced through SCB.

ii) Mr Broad said that he had been assured that the business was not WC business; he said that those present at the meeting did not understand the business, that it was London Market PA, and that they were panicking.

iii) Mr Bentley reported on his findings that the administration and accounting by HHI was poor, that much of the documentation was missing, and that there was a possibility of spirals. SD needed to pay the reinsurance premiums but he had difficulty in finding where the premium written had gone.

iv) Mr Broad agreed that the administration by HHI was "a shambles"; that he had told HHI that reinsurance premiums should be paid from the inwards premium received.

v) Mr Broad was very defensive and did not contribute very much; he gave the clear impression of being like a "rabbit caught in the headlights". Mr Broad treated with scepticism what he had been told and appeared to be willing to believe what he had been told by Mr Whitcombe and Mr Smith; Mr Broad contradicted Mr Mather's and Mr Coppinger's findings.

vi) After about 20 minutes, Mr Watson suggested that Mr Broad leave the meeting as the other attendees wanted to discuss how to take things forward and, as he would no longer be handling the account, that did not concern him.

vii) The meeting concluded with an agreement to form a group to deal with the problem and to refer the matter to lawyers. In the meantime, SD would pay the reinsurance premiums and would try to collect on the reinsurances.

1483. Mr Broad gave evidence on this meeting on two occasions:

i) When Mr Broad gave evidence in March 2002, he said that he was not told anything after the Monday morning meeting following Mr Mather's and Mr Coppinger's visit to Bermuda; he was not told of the result of the visit to EIU and was never told that the business written was WC. He thought that it was a good account when he left SD.

ii) When he was recalled to give evidence in July 2002 (as many more documents had since been disclosed by SD), he said, after reading Mr Bentley's statement about the meeting made in March 2002, that he recalled being at the meeting as he could remember being defensive. He had left the meeting after 20 minutes at Watson's invitation. He did not dispute Mr Bentley's evidence of the meeting.

1484. Mr Coppinger's evidence was that he was sure that he had reported at the meeting that gross loss making business had been written and that the account depended for profitability on reinsurance according to EIU. Mr Coppinger recalled outwards reinsurance being discussed as well as a discussion that Mr Broad had delayed the purchase of outwards reinsurance because SD were cash negative and; Mr Broad had contributed to that discussion; Mr Coppinger's e-mail (referred to at paragraph 1479) referred to Mr Broad's comments. I accept Mr Coppinger's evidence on these matters, but I prefer Mr Bentley's account as to the time at which Mr Broad left the meeting. I am sure that relations between Mr Broad and Mr Watson were such that Mr Watson wanted him out of the meeting as soon as it became clear that Mr Broad would not accept what Mr Mather had said and that he would have had nothing positive to contribute.
1485. After the meeting, Mr Bentley did not discuss the matter with Mr Broad as he was instructed not to. Mr Bentley felt uncomfortable about this as he had promised Mr Broad to keep him informed.

(b) The report of Mr Mather and Mr Coppinger

1486. On 30 July 1998, Mr Coppinger returned to New York and drafted an e-mail to Mr Mather which set out his considered views and his comments on certain key accounts. He emphasised (1) the lack of information provided to EIU and the lack of analysis by EIU where information was provided, and (2) the known and unknown spiral potential and:

"the rake off of major amounts of money by all the people involved in the chain (and "all of the people" are predominantly people who are employed by , or owned by, Sterling Cooke)."

After referring to his view, on detailed examination of the incoming business, as to how bad each programme was, he continued:

"My conclusion is that these guys are doing deals that certainly would have gotten me fired from Odyssey or anyplace else I've ever worked, and you probably would have been, too. And, even if the deals themselves didn't get me fired, if I did them in the way these guys have done them, that certainly would have done it!

…at the end of the day, I fell that there are just too many things about this deal that look not just stupid, but really idiotic, to even think about continuing as it is now."

1487. Mr Mather produced a first draft of a report and sent it to Mr Coppinger in New York. Mr Coppinger then went through it with Mr Barnard in New York on 5 August 1998. He showed him Unicare (Programme 34) and when the rating was explained, Mr Barnard was upset. Mr Coppinger's analysis of Programme 34 had demonstrated that it was grossly under-rated and that there was no loss development information. Mr Henton had told him that the existence of reinsurance protected SD and had made the business acceptable at the rates written.
1488. Mr Coppinger also showed Mr Barnard Programme 31 (Realm National Monoline); Mr Coppinger's note also showed that the excess point was too low, the limit was too high and the premium was not appropriate; there was no loss information or history. During the course of the discussion, Mr Barnard said that Mr Bruce Jones at SD's ART division had done something similar. Mr Barnard's evidence was that that was a throwaway comment; Mr Jones had underwritten aggregate XL business for a gross underwriting profit; EIU had underpriced the risk. His view was that the business written by EIU bore a superficial resemblance to the business that Mr Jones had written – only in relation to the premium charged; Mr Jones was not writing business known to be gross loss making. Information was provided to SCB about the risk written by SD's ART division. It was not contended by SCB that they wrote gross loss making business; as I have set out at paragraph 1439, I am sure that SD's ART division did not write that sort of business
1489. Mr Barnard had started to think about ending the contract.
1490. The final report was produced on 5 August 1998. It set out the adverse views formed. In summary, some of the main points made were:

i) It pointed out that the facility was described as a PA facility, but that in practice most of the business was assumed reinsurance protecting assumed reinsurance; from the information in EIU's files, it was not possible to verify what the business was, though they had learnt from Mr Billyard that the portfolio was largely XL protecting WC carveout.

ii) It set out in what had been learnt from Mr Billyard in relation to the spiral and MSC and the contradiction between the accounts given by Mr Billyard and Mr Whitcombe.

iii) It referred to the fact that Syndicate 103's prior years were open and that Mr Bird, as an employee of SCB, was binding business for CIGNA that was reinsured by EIU; years on syndicates underwritten by Mr Whitcombe were still open.

iv) Most of the business written by EIU came from SCB and they placed the bulk of the reinsurance; SD had no control over the reinsurance.

v) The commission was very high in the light of the fact that much of the business was XL.

vi) Commission-churning by SCB was transparent; SCB generated risk-free income by owning fronting companies and underwriting agents.

vii) EIU did not price the business or establish terms; they merely accepted and processed those provided by SCB.

viii) The facility provided a good deal for the reinsured, SCB and EIU but was a stupid deal for SD.

ix) Run-off cover would be very expensive.

1491. It concluded that:

"The deal looks and smells bad. If losses don't impact us, a negative market image will."

It recommended that legal advice be taken and that the binder be terminated at the contractual termination date – 90 days beyond 30 June 1999 or sooner if possible. It also recommended the continuation of a positive relationship with EIU, but with a more professional approach with specific matters listed. It recognised that the reinsurance placed by EIU was critical to SD.

1492. The report was sent to Mr Watson, Mr Barnard, Mr Bentley, Mr Forness and SD's in-house solicitor; it was not sent to Mr Broad.

(c) The decision that no more business would be written

1493. Mr Watson discussed with Mr Barnard as to what was to be done. They decided to assign the account to Mr Mather and to gain a better understanding of it. Mr Watson's evidence was that they did not decide to terminate, but instead decided to try and understand what had happened to the account; however, they only got a real picture of what happened to the account in about March 1999.
1494. On 6 August 1998, a decision was made to stop accepting any more business because of the way the business had been written; SD justified this on the basis that the premium income limit had been reached. After the account had been transferred to Mr Mather, Mr Barnard and Mr Mather took all the major decisions.
1495. On 7 August 1998, Mr Watson spoke to Mr Whitcombe. He enquired about the amount of premium that had been written; Mr Watson had understood from Mr Broad that $16m had been written and amounts as high as $28m were being spoken of; he was told by Mr Whitcombe that the figure of $28m was in line with the business plan and that he had envisaged, by agreement with Mr Broad, that he could write to that amount in a piecemeal fashion in order to increase the amount stated on the binder. Mr Watson made it clear that SD wanted to stick to the agreed figure which he mistakenly stated was £7.5m rather than the figure of £6m.
1496. Mr Watson also told Mr Whitcombe that the account had been transferred to Mr Mather because Mr Broad was a short tail facultative underwriter for property, contingency and "genuine" PA; the results of the review showed that this was long tail WC business or a variant. Mr Whitcombe told him that the ESG QS was not effective as SD had not accepted the security of the reinsurers.
1497. On 11 August 1998, SD wrote to HHI, expressing concern that the premium income limit had been exceeded and stressed that overwriting was not to continue.
1498. Also on 11 August 1998, Mr Whitcombe wrote to Mr Mather about the conversation with Mr Watson; he maintained that EIU were entitled to write the much larger amount of premium income, he nevertheless confirmed, as has been mentioned at paragraph 1475, that no business had been written since 28 July 1998. Mr Mather responded on 27 August 1998; after referring to the difference over the issue as to the premium income limit, he made it clear that the moratorium was to remain in place. Mr Whitcombe responded on 10 September 1998:

"… I confirm that no business has been written since 28^th July and will not be until such time as you and I agree events going forward."

His letter also referred to Mr Billyard's letter of 9 September 1998 (referred to at paragraph 1645.ii)); he noted that what Mr Billyard had said in his letter about the spiral was "not ideal" and had referred to MSC as being a "non-event".

1499. From July 1998 onwards, enquiries were made into low layer WC business and SD obtained a whole mass of information on matters such as Unicover and WEB.

(d) SD's knowledge of the losses

1500. As I have set out at paragraphs 1472 and 1482, it was clear that Mr Coppinger and Mr Mather understood that the account depended on reinsurance for its profitability; they had, however, no real appreciation of the extent of what had had been done by EIU. The evidence of Mr Bentley was that SD did not understand the extent of the business under the binder at the time; Mr Bentley believed that the XL contracts that had been written were XL contracts of direct writers. His view at the time was that EIU had written bad business, not that they had written on the backs of reinsurers. His understanding was that the business was severely under-priced; he did not at the time make the connection that the losses were inevitable or that it was hugely gross loss making. He only appreciated that after the analysis of EIU's files which was carried out in December 1998 and January 1999 – see paragraph 1789.
1501. It was Mr Bentley's evidence, as set out at paragraph 1784, that they only began to appreciate the nature of the losses that would be sustained in October 1998 when a very large number of small losses under the bottom layer of Programme 3 were presented in a bordereau from American Reliable.

(e) Approval by SD of the ESG quota share on 11 August 1998

1502. On 11 August 1998, the security on the ESG QS was approved by Mr Forness. At that time, SD wanted ESG to take $5m of premium income; SD did not tell ESG or HHI that Clyde & Co had been instructed, or that gross loss making business had been written against reinsurers. Their evidence was that they did not know enough then to make a judgment and were being told by Mr Broad and others that they simply did not understand the business; by the end of the year they were in a very different position and had decided that there had to be full transparency.
1503. Criticism was made of the decision by SD not to tell ESG of their concerns; it was submitted that it was difficult to see any justification for that decision. Although there was clearly a duty of disclosure to ESG as the QS had not been placed, and although I see very considerable force in the submission that the facts as by then known to SD were highly material to ESG's decision to enter into the QS, it would, however, not be appropriate for me to make any further findings in relation to this issue, in view of the fact that I have heard no evidence from ESG and the dispute with ESG is not before the Court.
1504. Mr Whitcombe obtained a binder from ESG in 1999 – only one Scandinavian risk was confirmed under it.

(f) Mr Broad's departure from SD

1505. Mr Broad's state of mind after the meeting on 29/30 July 1998 was evident from his contemporaneous notes:

i) His note of 7 August 1998 records:

"Michael Watson rang to say that the EIU account has been transferred to New York and will be controlled by Mike Mather. This is totally unjustified as the review did not reveal any problems. On the other hand Mather although accepting that there was nothing wrong with the Underwriting had questioned whether we should be in this business or not. I suppose that this will be another example of Mather making an excuse to get off a cover. John Whitcombe is horrified."

Mr Watson's evidence was that he recalled speaking to Mr Broad; he had told Mr Broad that it was treaty, WC and long tail business; it was better for the business be handled by Mr Mather. Mr Watson's view was that Mr Broad had perhaps never understood that it was treaty business; he had made it clear to Mr Broad that it was treaty business, but Mr Broad was relaxed and not fazed.

ii) A further note of 10 August 1998 set out Mr Broad's grounds for concluding that his position had been systematically undermined and that he had no future at SD. It referred to the changes in his areas of responsibility, his exclusion from key management decisions, his public humiliations by Mr Watson, and that he had been identified for removal as "a seat of the pants underwriter". He concluded:

"The above issues are highlighted by [SD]'s recent decision to remove responsibility for the largest client in my account, [EIU], to New York. That decision has been taken on the vaguest grounds and without any prior consultation with me. As you are aware the Managing Director of EIU has written on 16^th July 1998 to express his amazement at the decision."

1506. On 13 August 1998, Mr Broad left SD. There was a dispute as to whether he was dismissed or constructively dismissed, but it is not necessary to refer to the details.
1507. Mr Whitcombe's evidence was that he met Mr Broad on 4, 10 and 13 August 1998. The meetings were about Mr Broad's personal position; he was worried that he would be dismissed and he was in an extremely annoyed state. He recalled Mr Broad telling him and Mr Henton of a meeting where Mr Broad had been asked about the binder and the review had been discussed; Mr Whitcombe and Mr Henton asked Mr Broad about what he had said and Mr Broad told them that he had said that it was an occupational accident account, that it involved a high frequency of loss, and that reinsurance was the key to underwriting this kind of account. He described the business as WC carveout and explained what it was. Mr Broad never complained that they had been writing business that they should not have done. Mr Henton's evidence was to the same effect – he thought that Mr Broad was talking about a meeting when Mr Coppinger and Mr Mather were present; Mr Broad had said that he had explained the need for low level reinsurance. Mr Broad's evidence was that this had not happened.

(7) Conclusion

(a) Mr Broad's position and knowledge

1508. I am sure that Mr Broad continued with the way of dealing with the binder that he had followed earlier – not reading the documents and trusting Mr Whitcombe and Mr Smith; as set out at paragraph 1410, the letter of 17 June 1998 should have made it clear to Mr Broad that treaty business was being written, but he paid little attention to the letter and so did not pick that up.
1509. I am sure that shortly after the meeting between Mr Whitcombe and Mr Watson on 3 June 1998, Mr Watson told Mr Broad what he had learnt; the notes made on the copy of the monthly report (referred to at paragraph 1383) clearly shows that Mr Watson had learnt that the business included treaty business and that there was a risk of a spiral.
1510. Relations between Mr Watson and Mr Broad had been deteriorating for sometime:

i) There had been a heated argument at the meeting in January 1998 (see paragraph 1277).

ii) By the end of May 1998, the relationship had deteriorated significantly (see paragraph 1369).

iii) Mr Watson rightly did not approve of Mr Broad's lack of attention to procedures laid down by the company, though I am sure that he did not appreciate how serious Mr Broad's failures had been until after Mr Bentley's enquiries had been concluded.

iv) Mr Broad's note of the description of him being identified as a "seat of the pants underwriter" (referred to at paragraph 1503.ii)) correctly encapsulated Mr Watson's view of Mr Broad.

v) Mr Broad thought that the controls imposed on him were interference and he thought that Mr Watson was rather autocratic.

1511. When Mr Watson questioned Mr Broad, Mr Broad did not, as set out at paragraph 1384, know anything about the business and he had few facts or documents. Was Mr Broad lying to him? I am sure he was not. Mr Watson thought at the time that Mr Broad's examination of the business had been cursory. He was in essence right that that was what had happened, but Mr Watson considerably underestimated how grossly inattentive to his duties and negligent Mr Broad had been.
1512. It must have become clear to Mr Broad that his position within SD was untenable; the removal of the account from him on 8 July 1998 made that obvious as did Mr Watson's explanation to him of Mr Barnard's concerns (see paragraph 1435). Mr Broad was a man who, as I have said at paragraphs 731.vi) and 1055, was very proud of his own abilities; that pride was considerably hurt by the removal of the account; it was seen by him as creating an adverse impression on his colleagues. Mr Whitcombe was not slow to drive home the implication that it would be suggested that he did not understand the account. He became more volatile and emotional in his conduct.
1513. Mr Broad thought of Mr Watson as being "out to get him" and described what was going on as "the normal paranoid witch hunt that kept on happening in the company".
1514. This was made worse by his antagonistic relationship with Mr Mather; Mr Broad considered that Mr Mather had made up his mind that that he had not liked the way things had been done by Mr Broad and was only interested in the future. He described encounters with him as waiting for the Exocet to come in.
1515. I accept Mr Bentley's evidence that Mr Broad was "like a rabbit in the headlights" was an accurate description of Mr Broad's position by the time of the debriefing meeting at SD on 29 July 1998. Mr Broad had found, as he said, Mr Whitcombe and Mr Smith sympathetic to him in what was obviously an untenable position at SD; he disliked Mr Watson and Mr Mather; he preferred to believe Mr Whitcombe and Mr Smith over whatever Mr Mather was saying. It must have been obvious, in view of what SD believed had emerged from the audit, that Mr Broad had been responsible for allowing what had happened on the binder to occur, but it was also obvious that he was not prepared to accept what he was told by Mr Mather; I am sure that it was for such reasons and for those I have set out at paragraph 1482 that he was asked by Mr Watson to leave the meeting.
1516. Given Mr Broad's highly volatile and emotional state and his obvious pride in his own abilities, I was not surprised that his evidence at first was that he had been told nothing after the visit and that he only accepted that he had been present when he was recalled at the end of the trial and Mr Bentley's account was put to him.
1517. After he left SD, as set out below, he had meetings with Mr Whitcombe and made an introduction of Mr Whitcombe to Mr Jean Claude Chalhoub of Reass (referred to at paragraph 1778). Indeed, he wrote a letter to Clyde & Co on 7 January 1999 (as set out at paragraph 1830) stating that everything he had done was in accordance with his department's plan, approved by the board of SD.
1518. SCB submitted that Mr Broad lied when he gave evidence that he was not at the debriefing meeting on 29 July 1998; that when Mr Broad was told at that meeting of the conclusions reached by Mr Mather and Mr Coppinger, this was the culmination of mounting concern about the binder during 1998, and one would have expected him to have been outraged and for his relationship with EIU to have undergone a marked deterioration; the fact that there was no such reaction and that Mr Broad had maintained friendly relations with EIU was a further and very strong pointer to the fact that he knew what EIU had been doing all along.
1519. Mr Broad's explanation was, as I have set out, that he was told little about the investigations being made and that he only learnt that treaty business was written after he had left SD (when it was a surprise to him); he did not learn of the nature of the business actually written until he met with Clyde & Co (as described at paragraphs 1825 and following) in December 1998 and January 1999; it was at those meetings that he heard of the results of Mr Mather's and Mr Coppinger's investigations.
1520. As I have set out above, I reject Mr Broad's evidence that he was not told; it is clear that he was told by Mr Watson of his and then also of Mr Barnard's concerns; Mr Broad was present at the debriefing meeting. His evidence as to what he was told is wholly unreliable.
1521. There are a number of striking matters in relation to the contemporary documents which were produced by Mr Broad:

i) As set out at paragraph 1434, he recorded in his note of the meeting with Mr Watson on 10 July 1998, that he had written this class of business himself; he had not. The business which had been written in his syndicate (as set out at paragraphs 562 and following) had been written by Mr Thorogood and, when he had written PA business himself at SD (as set out at paragraph 566), the business was traditional PA.

ii) The comment of Mr Broad's that was recorded by Mr Coppinger in his e-mail (referred to at paragraph 1479 and referred to in Mr Coppinger's evidence which is summarised at paragraph 1482) could be seen either as demonstrating some knowledge on the part of Mr Broad of what had happened or as demonstrating Mr Broad's total ignorance of what business was actually being written (which resulted from his own gross negligence in failing to find out what was happening). I am sure that it was the latter; if he had understood that gross loss making business was being written, it was absolutely essential that reinsurance was in place and a comment that he was improving the cash flow by not buying it would have been folly.

iii) The notes which Mr Broad wrote in August 1998 showed that he did not think that Mr Mather had raised any questions about the underwriting.

1522. Was Mr Broad lying in his evidence and did he understand by the time he left the debriefing meeting at the latest, that gross loss making business had been written against reinsurers, or was he simply not accepting what he was told?
1523. If he was lying then this would be a powerful pointer to the fact that he had known this all along or that he had discovered it sometime during the course of the operation of the binder and was trying to cover up his position.
1524. I have concluded at paragraphs 1054, 1173, 1191 and 1326 that Mr Broad did not know that gross loss making business was being written and that he did not discover that fact during the course of the operation of the binder. In making those findings I have borne in mind the issue as to whether he was lying in relation to his knowledge in July 1998 and his conduct thereafter. It was Mr Whitcombe's evidence (as I have set out at paragraph 729) that he did not tell Mr Broad prior to the grant of the binder that they would write gross loss making business and that he did not tell him that on 7 February 1997 during the pub meal at Tadworth (see paragraph 815.iv)); Mr Smith's account (as set out at paragraph 1322) was that he did not know that EIU were writing gross loss making business on the backs of reinsurers. As I have set out, Mr Broad never bothered to look at matters himself.
1525. But Mr Broad was told about this at the latest by the time he had left the debriefing meeting. Did he then lie to cover up his own incompetence or would he just not accept what he was told? There are two explanations as to why he might not have accepted what he was told. It was submitted by SD that he saw himself the subject of a witch hunt and he distrusted everything that he was told; he thought that these were merely excuses to get rid of him. The other explanation is that he was a very proud man who would not admit his errors to himself, let alone to others; he therefore refused to accept the position because it would involve his acceptance of his own incompetence.
1526. I am, however, sure that he was in a highly volatile and unstable state of mind. I had the opportunity of listening to him and of watching the way in which he gave his evidence and the considerable emotion and tension that he exhibited. He was also a very angry man and that anger was directed at EIU and SCB; the latent anger that was present throughout his evidence was not only due to his indignation at the allegations most fairly and properly put to him by counsel for SCB and EIU, but was also due to the fact that he had genuinely felt betrayed by Mr Whitcombe, whom he had trusted as someone from Lloyd's like himself. I have also carefully considered the contemporaneous notes which he had made; they were self-serving in the sense and to the extent that they set out, as he had come to believe, that no criticism should attach to him; however, he was not engaged, as was suggested, in some devious planning.
1527. I also considered the points set out in the submissions which he made in January and February 2003 at my invitation (for the reasons I have explained at paragraph 60). In those submissions, whilst maintaining his lack of knowledge of what was being done, Mr Broad would not accept that his conduct and supervision of the binder was open to serious criticism.
1528. I am sure that because of his antagonistic relationship with Mr Watson and Mr Mather, he simply would not accept what they were saying; he thought that their purpose was to drive him out of the company and he would not admit the possibility that he had done anything wrong. I have no doubt at all that Mr Whitcombe played on his highly volatile and emotional state of mind and that Mr Broad believed Mr Whitcombe's assurances that EIU had done nothing wrong. As set out at paragraph 1856, Mr Whitcombe was still maintaining at a meeting with SD on 4 January 1999 that they were not writing on the backs of reinsurers.
1529. Mr Broad remained in this highly emotional state for some time and would not accept that gross loss making business had been written on the backs of reinsurers until he was taken through the documents by an experienced partner at Clyde & Co in and after January 1999 (as set out at paragraph 1826). It was only then that he appreciated what had actually been done by EIU under the binder. Even after the trial, as I have said, he would not accept that any criticism should attach to him for allowing that to happen.

(b) What an audit would have revealed

1530. It is evident that the review conducted by Mr Coppinger and Mr Mather revealed a substantial amount about the business being written; on the basis of what they had discovered, it was obvious that either the binder had to be terminated or the most stringent control had to be exercised over the business. Although it is clear that Mr Coppinger and Mr Mather considered that the binder was used to churn commission, that they appreciated that gross loss making business had been written, and that they had been told by Mr Henton that profitability depended on reinsurance, their audit did not reveal the real extent of the dishonesty of Mr Henton, Mr Whitcombe and SCB and of the massive losses that they had caused through their dishonesty.
1531. That review was assisted by two matters; firstly, Mr Coppinger was experienced in WC business, and secondly, Mr Billyard, in the unannounced visit to him, had revealed (1) that WC business was being written on an XL basis, and (2) the existence of the spiral.
1532. However, I am sure that had an audit been conducted by SD at an earlier stage, it would have confirmed, from the information obtainable from the bordereaux, that WC carveout was being written; it would have revealed the high preponderance of SCB business, the reinsurance arrangements which gave rise to the spiral, as well as many of the other matters discovered by Mr Coppinger and Mr Mather.
1533. This confirms the conclusion to which I have reached that the gross neglect of duty by Mr Broad in failing to arrange for an audit during 1997 enabled the dishonest activities of Mr Whitcombe, Mr Henton and SCB to continue into 1998. Although a properly conducted audit might well not have revealed their dishonesty, it would have revealed sufficient facts such that a prudent insurer would have immediately cancelled the binder or would have subjected the underwriting to the most stringent controls.

(c) MSC and the role of SCB

1534. Mr Billyard had clearly thought that Mr Mather and Mr Coppinger were coming to see him to deal with the proposed reinsurance to be written for MSC, which would have enabled him to continue to write the business which he had written for John Hancock. I am sure that that is the reason why he was so candid with them, as set out at paragraph 1444.
1535. I am sure that if SCB had been told of the visit they would have ensured that Mr Billyard was less candid. They were very concerned after the visit of Mr Mather and Mr Coppinger to Bermuda and were right to be so as Mr Mather and Mr Coppinger had immediately suspected that there were very serious problems.
1536. I am sure that SCB had reached an agreement in principle that (1) MSC would replace the facility with John Hancock, (2) the business to be written would be similar to that which Mr Billyard had written for years and which would enable SCB to further their WC business in the US, and (3) EIU would then reinsure the business under the binder. The motive was clear. The arrangement was to be a continuation of what SCB had been doing since Mr Brown joined them – using reinsurance in London to enable SCB to compete more effectively in the US market; this was in accordance with Mr Brown's and Mr Cooke's ambition (as set out at paragraph 353) to use these arrangements to build up SCB and to make SCB a full service insurance group.

i) No documentation in relation to MSC in EIU's or SCB's possession has survived; I am sure that there must have been documentation that EIU and SCB possessed and that its non-production was not due to the fact that it had been inadvertently lost or destroyed. In their closing submissions, EIU accepted that there must have been a discussion between SCB and EIU about a deal.

ii) The extent of the dealings with MSC were only revealed when MSC made relevant documents available to SD.

iii) Ms Barnes who clearly had relevant evidence to give was not called to do so. Mr Brown's and Mr Butler's evidence in relation to the arrangement was characterised by a lack of recollection that I am sure was untruthful and was designed to cover up what they had done.

iv) The documents show that at least an agreement in principle was reached under which EIU would reinsure MSC 100%; if there had been any different interpretation, Ms Barnes would no doubt have given evidence about it. She did not.

v) In the third underwriting report submitted by Mr Whitcombe to Mr Broad on 28 May 1998, EIU referred to the expectation that the account would grow to $40m-$50m in 1999 (see paragraph 1358); Mr Billyard had told Mr Mather (as set out at paragraph 1443) that he expected the MSC facility to have an income of $50m in 1999.

vi) Mr Billyard had expected confirmation of the arrangement from Mr Mather and Mr Coppinger and that was why he was so forthcoming; however, their discovery of the proposed arrangement brought it to an end.

vii) When questions were asked by SD during Mr Mather's and Mr Coppinger's review, EIU lied about it and pretended that there was no such arrangement.

viii) Subsequently when SD asked further questions (as set out at paragraph 1640), Mr Henton and Mr Brown acted together to co-ordinate an untruthful response (as set out at paragraphs 1642.ii) and 1645.ii)).

ix) I reject Mr Brown's evidence that the MSC facility was to be used for business that was different to that written under the John Hancock facility. It contained language that was reflected in earlier proposals and the one sentence that suggested an attempt to price in order to produce a gross profit was not the way such business had been written. I am sure that that was not the way Mr Billyard intended to write the business as he was an arbitrage underwriter. Indeed, as set out at paragraph 1443, Mr Billyard had told Mr Mather that the $50m John Hancock portfolio would be assumed by MSC on 1 January 1999.

(d) EIU's further subservience to the interests of SCB

1537. As I have already set out at paragraphs 885 and 888, SCB knew from early February 1997 that EIU had no authority to write gross loss making business and had dishonestly assisted them in breach of fiduciary duty; as set out at paragraph 878, SCB ruthlessly exploited the opportunity offered through the binder from the outset in order to further their interests and ambitions. As set out at paragraph 1247, Mr Brown's ruthless conduct gave Mr Henton little alternative but to acquiesce and act dishonestly in putting the interests of SCB over those of SD by writing the Christmas Eve and New Year's Eve programmes.
1538. I am sure that in accepting three of the five programmes written between early January and early February 1998 (listed at paragraph 1273), EIU and Mr Henton in particular had acted dishonestly in the respects set out in Part II. SCB dishonestly assisted them in the respects set out in Part II.
1539. I am sure that in accepting the seven programmes written between March and July 1998 (referred to at paragraphs 1338 and 1341), EIU and Mr Henton in particular had acted dishonestly in accepting each of these seven programmes in the respects set out in Part II. SCB dishonestly assisted them in the respect set out in Part II.
1540. I am sure that Mr Henton acted during 1998 in collusion with SCB. He did so because he had no regard for the interests of SD and wrote the programmes in order to earn commission for EIU and to further the interests of SCB. SCB did so to further their ambitions and their interests in WC insurance in the US:

i) SCB knew that EIU had no authority to write gross loss making business and that, as set out at paragraph 1247, he had been acquiescing and acting dishonestly in putting the interests of SCB before those of SD.

ii) SCB knew of further dishonesty and of breaches of fiduciary duty by Mr Henton in the respects identified; SCB had dishonestly assisted EIU in their dishonesty and in breach of their fiduciary duties in the respects set out above and in Part II.

iii) There were three clear further examples of the overall collusion and of the overall subservience of EIU to the interests of SCB:

a) The events relating to the Unum programme (Programme 16) summarised at paragraphs 1275 and following and considered in detail in Part II.

b) Mr Henton's willingness to write the reinsurance of the MSC facility in order to enable SCB to continue to place its business with Mr Billyard and thus maintain its business in the US.

c) Mr Henton's promise to renew Programme 9; as set out at paragraphs 202 and following of Part II, Mr Henton promised Mr Brown that he would renew the reinsurance on that part of the programme protecting JEH Re on 8 July 1998 without any information whatsoever being provided. If this was, as SCB and EIU asserted, a programme that required renewal, then information was needed as this was a programme that had been written on the basis that it was new in 1997; no honest underwriter would contemplate renewal without seeking information about what had happened in the first year; a broker obtaining renewal in such circumstances would obviously know that the underwriter was acting dishonestly and in fraud of his principal. SCB had been involved in setting up the underlying programme and the policy-issuing company, Realm National, was an insurance company that was within the SCB group. SCB could have easily obtained the information, but clearly knew that Mr Henton would do their bidding without any information whatsoever.

10. THE EVENTS OF AUGUST AND SEPTEMBER 1998

(1) The background

(a) The termination of the facility from John Hancock

1541. The agreement between Hackett and John Hancock (as set out at paragraph 424.ii)) had come into effect in 1991; by an amendment made on 4 November 1996, it was terminable on 12 months' notice. SCB had a copy of the agreement on their file.
1542. The agreement was in fact terminated by John Hancock in or about early October 1997 with effect from 1 October 1998; this information was provided to the Court by solicitors acting for John Hancock on 4 October 2002. Their letter explained that John Hancock had sold all of its accident and health business to a third party and that the business written by Hackett and JEH Re was a small proportion of this; after an evaluation of the business the buyer decided that the Hackett and JEH Re account was not part of its core business and so did not wish to continue with the agency agreement. As the agreement required a year's notice of termination and as John Hancock were parties to the agreement, they gave that notice in or about early October 1997. The identity of the purchaser was not disclosed by John Hancock; EIU submitted, on the basis of a manuscript note of that Mr Henton had recorded in connection with Programme 34 (Unicare), that the purchaser might be Unicare; no other evidence was put before the Court and the implications of any such purchase were not considered in the evidence; it would not, in the circumstances, be appropriate for me to make any further findings.
1543. Mr Butler did not know when he became aware that John Hancock had terminated the authority of Hackett and JEH Re; Mr Brown did not know when he first realised that Mr Billyard was having problems with John Hancock; he could not recall what he was told by Mr Billyard. It was their evidence that SCB were told that John Hancock had sold their group life company and that arrangements with MGAs would not continue.
1544. It was suggested to Mr Butler that that meant that SCB would lose their entire capacity for writing loss making business apart from SD. Mr Butler's evidence was that they had CIGNA and others.

(b) Mr Whitcombe's and Mr Henton's search for new capacity

1545. As set out at paragraphs 1447 and following, the termination of the facility from John Hancock had already led to SCB seeking to make an arrangement with MSC.
1546. EIU had begun looking for other carriers, in conjunction with Mr McCarthy (who had left HHI and had moved to Moore Brown Barnes, as mentioned at paragraph 1281) and Mr Brown. It was Mr Butler's evidence that these were to be additional to, and not replacement for, SD and John Hancock. Mr McCarthy was exploring the possibility of Zurich Re and Chubb Atlantic providing a facility. Others approached, according to EIU, were Trenwick, ESG 1999, Lumbermans and Utilities Mutual.
1547. By July 1998, an approach had been made to Lincoln General Reinsurance Company (Lincoln General) through Mr Standing for a lineslip to be provided by Lincoln General to SCB. By 10 July 1998 (as Mr Brown's secretary told Mr Henton), there was a positive response from Lincoln General about a lineslip. EIU chased SCB about progress on this on 10 August 1998 (when Mr Riding visited EIU, as described at paragraphs 1633 and 1728) and 25 August 1998.
1548. In October 1998 a proposal was produced; this envisaged EIU making "independent [risk] selection" principally of occupational accident and PA business produced by SCB, with Lincoln General making the underwriting decisions; the premium income was to be $50m-$75m. It contained passages similar to those in the MSC proposal (see paragraph 1448.iii)):

"An immediate and continued flow of quality business is available, which substantially reduces the risks normally inherent in a start up situation."

"Due to the specialised nature of the accounts that it is envisaged you will underwrite, it is essential to have a comprehensive reinsurance programme in place. EIU would insist that these programmes are purchased to maximise the profitability of this type of account."

It explained the need to reinsure down to $10,000 and recommended the use of SCB and other selected London brokers to arrange this:

"It may seem unnecessary to you to reinsure down to these retention levels however, this is standard practice in the current market and is therefore an essential factor to underwrite and compete on a level playing field with others in the marketplace."

"The strategy is to underwrite a low to medium risk portfolio, a combination that will be achieved through specialisation in the classes of business affording the highest growth potential and profitable returns."

Nothing was said as to whether the business was gross loss making or whether it would be written on an arbitrage basis.

1549. Mr Bird was asked to liase with Mr Henton and to help put the proposal together as the proposal was to be similar to the Big Ben and CIGNA Aviary lineslips in which he had participated.
1550. On 8 December 1998, it was reported to Mr Butler that Lincoln General was very interested but would not be able to respond until after 1 January 1999.
1551. It was SD's case that the document was dishonest and did not describe the business as loss making. Mr Bird did not know what Lincoln General intended to write; he thought that it was for business that was profitable on a gross basis, similar to CIGNA; it had no LMX section and he did not think it included arbitrage.

(2) SD's questions in July 1998 and the answers given

1552. During the course of their visit to EIU, Mr Mather and Mr Coppinger asked questions about Programme 33 and about a spiral with SD. They followed this up with written questions (as has been mentioned at paragraph 1473). The response to these questions was said by SD to be an attempted cover up by EIU and SCB acting in concert to deceive SD. It will be necessary to explain how Programme 33 was written before setting out the questions and the way in which they were answered.
1553. SD also asked a question about the reinsurances of Mr Cackett's underwriting for Phoenix/Sun Life; Programme 26 became important in August 1998 because there was a clear breach of the moratorium. It will be necessary to explain that programme also.

11. PROGRAMME 33: THE WRITING AND COVER UP

(1) Mr Billyard's need for LMX retrocession

1554. On 30 April 1998, Mr Brown presented a proposal to write a further reinsurance of JEH Re to Mr Henton; this was for a 66.6666% QS of Mr Billyard's non-proportional account, up to $2m any one person on an RAD basis for 12 months from 1 January 1998. It included LMX business and international XL on XL business, including LMX retro and international XL retro. Mr Henton agreed in principle to write the programme on certain terms and eventually wrote it. This was Programme 33 and is summarised in Diagram 33 (see paragraph 1.ii) of Part II).

(a) SCB's intention that Mr Billyard write LMX for 1998

1555. Hackett's and Mr Billyard's writings for John Hancock had been protected by a 95% QS that was renewable each year on 1 January; this had run for some years prior to 1998, reinsuring Hackett from its formation in 1991 and JEH Re from its formation. Mr Billyard's LMX writings had been protected under Programme 1 for 12 months from 1 January 1997 on an LOD basis and this had inured to the benefit of the QS in 1997. There were documents which suggested that D.W. Van Dyke and Company of Connecticut, Inc. (Van Dyke), which had placed the QS in prior years and which had been instructed to renew the QS for 1998, intended to exclude LMX – see paragraphs 609 and following of Part II; in November 1997, SCB were also instructed to place the QS; LMX was not excluded on their slip; this became Programme 28 – see paragraphs 612 and following of Part II. Mr Butler's and Mr Brown's evidence was that it was not the intention to cede LMX under that QS – see paragraph 1570.iii).
1556. It is clear that SCB had envisaged that Mr Billyard would continue to write a substantial volume of LMX business in 1998:

i) In a memorandum on 10 December 1997, Mr Mortley advised Mr Brown about the anticipated income from the LMX accounts for 1998; it attached a document (which was not found), in respect of which Mr Mortley advised that he assumed that Mr Billyard would write a maximum of $1m lines in most cases. Mr Mortley was assuming that many of the 1997 accounts would be renewed.

ii) The 1997 accounts were summarised in a document headed "Reg LMX file" dated 10 December 1997.

iii) SCB placed some of that business with Mr Billyard. They also placed the outwards reinsurance of SD for 15 months at 1 October 1997 (which covered losses in 1998) and SD's outwards reinsurance for 1998.

1557. Mr Brown's evidence was that by the time the Christmas Eve programmes were being placed, he knew, as I have mentioned at paragraph 1158, that Mr Billyard thought that rates would harden and that he could look to retaining more LMX on a gross basis, although he was looking to obtain an LMX treaty. Although that treaty would cover LMX, it would not have been only for LMX.
1558. The 95% QS (Programme 28) was still being placed in the early part of 1998 as SCB needed to increase EIU's line and to get Overseas Partners Re and New Cap Re (Bermuda) on to the slip for Programme 28; it seems clear that it was not until sometime in February or March 1998 that Overseas Partners Re and New Cap Re (Bermuda) agreed – see paragraphs 619 and following of Part II.

(b) Mr Billyard's LMX business in 1998

1559. Substantial business for the 1998 year that had been placed with Mr Billyard that was of an LMX nature included, as subsequent documents sent at the end of 1998 (when a number of risks were ceded to Programme 33 – see paragraphs 1662 and following) proved:

i) All American and Gan which was placed by WFD (on which SD did not participate).

ii) Catlin and a CIGNA contract (on which SD did not participate).

iii) All American placed by SCB (on which SD did not participate).

iv) Syndicate 53 (Programme P22), Venton (Programme 21), CIGNA PA account (Programme 27), Chiyoda (Programme 20); the M&D premiums on Programme 27 were about $6.84m – see paragraph 591 of Part II.

v) The outwards reinsurance of SD for 1998 and for 15 months from 1 October 1997.

The premium under these contracts (all with an inception date of 1 January 1998) totalled $11.2m on the basis of the M&D premiums.

1560. All these contracts except the protections of All American (per WEB) were cover noted prior to 20 March 1998.

(c) Attempts by SCB to obtain reinsurance for Mr Billyard

1561. Mr Brown believed that Mr Billyard was un-reinsured on the LMX writings until Programme 33 was placed with EIU; he did not know if John Hancock knew that Mr Billyard was un-reinsured until then. Mr Brown accepted that Mr Billyard was obviously very exposed, but did not accept that this was suicidal.
1562. Mr Brown's evidence was that he did not know if SCB had tried to renew Programme 1 in the period between December 1997 to March 1998. He denied that there were discussions as to how they would get Mr Billyard out of his un-reinsured position; his evidence was that Mr Billyard had written business and was just trying to purchase reinsurance. SCB had merely come into the market late.
1563. It was, however, obvious that active consideration must have been given to the renewal of Programme 1 (Mr Billyard's LMX programme) for several months. The documents produced by SCB were few, but I am sure that a very considerable effort by SCB must have been made without success:

i) I have already referred to Mr Mortley's memorandum which made it obvious that it was intended that Mr Billyard was to write significant LMX business and that he in fact did write such business.

ii) In his witness statement, Mr Brown stated that Mr Billyard asked him to renew Programme 1 in late 1997 or early 1998, but that SCB had told him that they could not do it because they did not feel that there was the XL capacity available for the required programme.

iii) By 23 February 1998 Mr Billyard was desperately pressing SCB to provide LMX reinsurance; it is clear that SCB must have been pressed to do this sometime before and had failed. An e-mail of that date from Mr Butler to Mr Brown, who was skiing at Aspen, dealing with a number of outstanding points, recorded:

"Just to remind you Reg [Billyard] and Mark [Cooke] are kicking my balls for LMX programme for him. Reg actually rang me and apologised for Mark getting involved, I think he has little to do at the moment. Reg also needs to get off the Cackett LMX covers as I mentioned yesterday."

This was retrieved on 27 July 2002 from the archive of SCB, but none of the surrounding documents could be found. Mr Brown's evidence was that it was not a problem with the market; it was just SCB being late in getting everything up and running. Mr Brown did not know what Mr Cooke's involvement was. As I have noted, Mr Cooke was not called to give evidence on this or on any other matter.

iv) Mr Butler's evidence (prior to the finding of the e-mail of 23 February 1998) was that a replacement was needed for Programme 1 and that this was eventually provided by Mr Henton's writing of Programme 33 on 30 April 1998. In early March 1998, he wrote a note recording a conversation with Mr Billyard:

"Advised that due to lack of capacity it would be worth looking at quota share. Reg advised expects income to be difficult to predict due to market conditions. Expects to get $2m plus but not too sure."

There was clearly a problem with capacity (as I have set out at paragraph 1127). Mr Brown's evidence was that he did not know any more about the note than this, but that there must have been conversations prior to this about switching from the XL basis (on which Programme 1 had been written) to a QS. XL capacity was very tight, but it might have been the perception that the presentation of the reinsurance as a QS might have helped to market it.

v) On 5 March 1998, Mr Billyard faxed a handwritten list of XL contracts which he had written; this was in his handwriting and contained 1997 and 1998 risks, including the SD reinsurances. Most of them were risks which had been placed with him by SCB. He had totalled the exposure at $20m and the premium income at $12.8m. The list set out reinsurances of Chiyoda, HIH, All American (per WEB), Syndicate 53, Catlin, Reliastar, CIGNA (several accounts) and SD; those incepting in 1997 included All American (per WEB), SD and CIGNA (per Aviary lineslip). These had been placed by SCB except for HIH, Gan and All American.

vi) Mr Brown believed that this was a pro forma document which had been prepared in order to allow Minet Burn Roche (MBR), brokers in Australia whom SCB were using to try and place the reinsurance with GIO of Australia, to look at the type of business; the same was true of the list subsequently typed as it had 1997 risks as well. Mr Brown did not know why the estimated premium income had been pitched so low at $2m in the light of the list that showed $10m; in his statement, he said that this was because Mr Billyard had wanted to use a conservative figure as he had thought that some of his existing participations might sign down, but Mr Brown accepted that they would need considerable signing down.

vii) On 17 March 1998, Mr Brown sent to MBR, a typed list of accounts and a risk profile of the accounts:

"written to date (emphasis added) which we (emphasis added) would like to cede to the proposed reinsurance."

Comments on those accounts were attached; some of these were 1997 accounts. The fax concluded:

"At present we have not approached any other reinsurers as the reinsured has written these risks and only just decided how he would wish to [reinsure] this part of the account.

I hope this has provided you with the information you required, but obviously we feel strongly that this account should run well and would very much like to begin our business partnership with you on this."

Mr Butler's and Mr Brown's evidence was that they thought that that list had been taken from Mr Billyard's handwritten list. Mr Brown thought that possibly Mr Mortley had decided what to take from the manuscript list, though the typed list still included 1997 risks. The total premium on the typed list was $11.457m. Mr Brown accepted, on the basis of the two lists, that he knew that Mr Billyard had written a very large amount of premium income.

viii) Mr Butler thought that New Cap Re had been tried as well.

ix) By 7 April 1998 there were difficulties with the placement. Mr Brown told MBR that he was running out of time and, as GIO wanted reinsurance, they suggested that MBR get a commitment from GIO and sort out the reinsurance for GIO later. Mr Brown thought that SCB were being pushed by Mr Billyard to get the QS in place; he had no recollection of trying to get any reinsurance for GIO. On 8 April 1998, GIO declined to reinsure Mr Billyard. The broker commented:

"If Hancock already had an established reinsurance protection on which they could look at the gross and the net results over a period of time, they may well have been more convinced."

Mr Billyard had had reinsurance protection for the LMX account written on an XL basis; the gross position can be seen in Programme 1 – see paragraph 8.iii)a) of Part II: it was disastrous.

x) Mr Brown did not think he had approached anyone else about the QS between 8 April 1998 and his approach to Mr Henton on 30 April 1998; Mr Billyard was pushing them and had wanted something done.

1564. I am sure that by the time Mr Brown had approached Mr Henton on 30 April 1998, he had discussed Mr Billyard's LMX reinsurance with him and was under very considerable pressure to obtain reinsurance, given Mr Billyard's very substantial exposure to LMX business and the importance of Mr Billyard to SCB. He had been trying to obtain reinsurance for a considerable time without success.

(d) Why was SCB attempting to get reinsurance for Mr Billyard?

1565. SCB had placed the outwards reinsurance of the business written by EIU with Mr Billyard for 1998 with the result that John Hancock might have sustained the losses (see paragraph 1241); I have concluded at paragraph 1250 that neither SCB nor Mr Billyard cared if this should happen.
1566. Indeed it was EIU's case, as the trial developed, that SCB had decided to make John Hancock the dump for their business in 1998.
1567. Nonetheless it is very clear from what I have set out at paragraph 1561 that Mr Billyard decided that he had to have cover for the LMX business for 1998 and Mr Billyard had put considerable pressure on SCB to find such cover.
1568. However, the cover that was sought from EIU was different to his earlier cover. That had been on an LOD basis. The cover that was put to SD was on an RAD basis without a run-in; it therefore meant that contracts which Mr Billyard had written in 1997, including protections that had incepted in October 1997, were not covered; this included the layers on SD's reinsurance between $150,000 and $2.5m which was in fact the only reinsurance at those layers that covered 1998 losses.
1569. Why did Mr Billyard seek cover and why, when he did so, did he make such a significant omission from the cover by failing to provide for a run-in period with such serious consequences, particularly as to the effect of the spiral with SD? Was it just a very serious error by a very experienced net underwriter or was it a calculated decision? Mr Brown appreciated (as set out at paragraph 1570.i)) that the effect would be to break the spiral and it was clear that when converting to RAD a run in provision was essential – see Programme 4 at paragraphs 24 and following of Part II and Programme 5 at paragraphs 55 and following of Part II, particularly the evidence of Mr Henton at paragraph 58.i). However, as Mr Billyard did not give evidence and as the information supplied by John Hancock was very limited, I cannot make any finding. There are again many possibilities, but I will not speculate.
1570. Whatever the reason, SCB were placed under very considerable pressure to obtain reinsurance; I am sure that Mr Brown gave Mr Billyard a promise that he would do so; Mr Billyard recorded such a promise in his letter to Mr Brown on 25 June 1998 (referred to at paragraph 1599), though Mr Brown denied that such a promise had been given.
1571. As I have set out at paragraph 1128, the market was very tight and by April 1998 it was clear that no one except for EIU was available for what was wanted; the pressure on SCB to obtain reinsurance for Mr Billyard was intense as the e-mail of 23 February 1998 from Mr Butler made clear. I also reject as untruthful, Mr Brown's evidence (set out at paragraph 1561.iii)) that SCB came into the market late; the difficulty was that the market was almost non-existent.

(2) EIU's agreement to provide retrocessional cover

(a) SCB's decision to approach to Mr Henton

1572. Mr Brown's evidence was that:

i) He could not recall a discussion with Mr Billyard as to whether he should approach Mr Henton; Mr Brown thought that there was no risk of a spiral with SD under the proposed reinsurance as it only covered risks attaching for 12 months from January 1998 and the 1998 programme of SD had a gap in it, at the layer xs $150,000, and so the spiral would be broken.

ii) He did not know why the figure 66.6666% was chosen by Mr Billyard.

iii) He did not discuss the relationship between Programme 28 and Programme 33 with Mr Billyard; he did not discuss Mr Billyard using Programme 28 to cover that proportion of the risk that could not be placed under Programme 33. As far as he was concerned, John Hancock were retaining 33.3334% net of what was ceded to this and this was not subject to Programme 28 (for the reasons set out at paragraph 638 of Part II) or any XL programme. In any event, it was up to JEH Re to decide what to cede to which treaty; he did not know the criteria.

iv) Mr Butler's evidence was that he did not know if Mr Billyard retained his 33.3334% or ceded it to Programme 28.

1573. However, a list dated 25 June 2001 that was obtained from John Hancock by SD (but only produced by SD to the other parties on day 75 of the trial) showed that what had been ceded under Programme 33 had also been ceded under Programme 28; this meant that 66% of all LMX risks were ceded under Programme 33 and the retention was ceded under Programme 28. That this had happened was confirmed by John Hancock's solicitors as set out at paragraph 639.iii) of Part II. As set out above, it was Mr Brown's evidence that it was not the intention to cede LMX under Programme 28. At paragraph 640 of Part II, I set out such conclusions as I could reach, as to the ability to make cessions of LMX business under Programme 28 and as to the time at which such cessions were in fact made.

(b) The assessment of Programme 33 by Mr Henton

1574. On 30 April 1998, Mr Brown approached Mr Henton. It is important to note, as I have already set out at paragraph 1236, that the approach was on the same day as the approach made on Programme 32 (see paragraph 839 of Part II) and that as a result of the negotiations which followed by the end of June 1998:

i) Mr Henton reinsured Mr Billyard under Programme 33.

ii) New Cap Re (Australia) was reinsured by Mr Henton under Programme 32.

iii) EIU's bottom layer of reinsurance for 1998 was altered so that:

a) New Cap Re (Australia) provided outwards reinsurance down to $10,000 (in place of the outwards reinsurance down to $20,000 which had been provided by Mr Billyard); however, this was limited to 99 free reinstatements; and

b) Mr Billyard amended the bottom layer he had provided to a backup layer of the New Cap Re (Australia) outwards reinsurance; this was with unlimited reinstatements.

1575. Programme 33, which consisted of a single contract taking effect from 1 January 1998 was first broked by Mr Brown to Mr Henton at a meeting on 30 April 1998 when Mr Henton endorsed the slip "Agree 100% of order in principle, subject R/I". Three issues arose:

i) the way Mr Henton had examined what was offered;

ii) whether Mr Henton had known that the SD outwards reinsurances were to be ceded, thus creating a spiral; and

iii) what had been said about the provision of specific reinsurance for Programme 33.

1576. No written information was provided apart from the slip and, if the evidence of Mr Brown is correct, lists of contracts to be ceded; there were no loss statistics.
1577. The enquiries made by Mr Henton and the extent of his assessment of the risk were as follows:

i) Mr Henton made no enquiry about the extent of LMX business. Mr Henton's evidence was that he did not think that there would be much retro as he vaguely recalled being told that Mr Billyard was going to write more on a gross basis (that is, writing for a gross profit) that year; he had been trying to concentrate on the reinsurance of direct underwriters in the previous year. It was, however, unclear whether the balance of the XL account could have been ceded under the Programme 28; Mr Henton's position was that LMX business could not be.

ii) Mr Henton was not provided with loss statistics then or later. His explanation was that this was because the account had not been reinsured on a QS basis before; that what was going forward was not reflective of what had been written in the past. His evidence was also that he would not have expected to have been provided with Mr Billyard's own loss records about the underlying accounts for 1996 and 1997 which had formed Mr Billyard's book, even though SCB had the list of accounts written in 1997 dated 10 December 1997 (to which I have referred).

iii) There was no warranty of no known or reported losses at the date he wrote the programme, even though he was providing the reinsurance at the end of April 1998 for a programme that incepted on 1 January 1998; instead a warranty of no known or reported losses was given as at 11 March 1998, but this was, as Mr Henton accepted, before the end of the first quarter and it was unlikely that there would be any known or reported losses. Mr Henton did not know why the date of 11 March 1998 was chosen, but his evidence was that he would have expected to have been told if the brokers knew of any losses when they approached him on 30 April 1998.

iv) The premium to be received was 66.6666% of Mr Billyard's applicable net premium income less 5% brokerage on the QS; Mr Henton believed that the original deductions would have been 10%-15%.

v) Mr Henton was told orally on 30 April 1998 that the premium income would be $2m, even though the handwritten and typed lists of contracts (see paragraphs 1561.v) and 1561.vii)) had much more on them. It was not disputed by SCB that he was told that the premium income would be $2m.

vi) Part of the broke to Mr Henton would have been Mr Billyard's retention.

(c) The cession of SD's outwards reinsurance; specific reinsurance

1578. The second and third issues relating to the meeting of 30 April 1998 were whether Mr Henton was told that the outwards reinsurance of SD that was written by Mr Billyard was to be ceded to the treaty, and about what was said in relation to the provision of specific reinsurance.
1579. Two matters are clear:

i) Mr Billyard was going to cede the outwards reinsurances of SD to the programme and SCB knew this. The slip provided under the heading 'Information':

"2. Lists of current contracts written by the Reinsured and provided by them is seen and noted by Reinsurers hereon. This list should not be regarded as final as the Reinsured may write further contracts that are to be ceded to this contract."

There were only the two lists to which I have referred:

a) The handwritten list of contracts in Mr Billyard's writing that sent by him by fax on 5 March 1998 (referred to at paragraph 1561.v)) included SD's outwards reinsurances.

b) The typed list of contracts that was sent to MBR on 17 March 1998 (referred to at paragraph 1561.vii)) showed, on the second page, some of the SD contracts and other contracts on which Mr Henton had also taken a line.

Both lists therefore made it perfectly clear that the outwards reinsurances of SD were to be ceded back to SD.

ii) Mr Brown noted in his handwriting on the slip:

"90 x 10 }

400 x 100 } Max rat 25%

833,200 x 500,00 }

Agg layer losses up to 10,000 }

Attached 50%-60% of net income } Max cost 5%"

This notation referred to the provision of three layers of XL reinsurance above a retention of $10,000 at a maximum rate of 25%, as well as an aggregate stop loss to take care of losses on the retention excess of 50%-60% of net premium income.

iii) There was a dispute on the evidence principally as to (1) what Mr Henton was told about SD's outwards reinsurance being ceded, and (2) whether, as mentioned on the slip, he had seen the list.

1580. Mr Henton's evidence was:

i) He thought that the coverage of Programme 33 included the same part of Mr Billyard's account that was covered by Programme 1 in 1997, but that it was to be by way of QS rather than an XL.

ii) He was told that five or six contracts were to be ceded under the programme. He made the link to the separate treaty of JEH Re to which Mr Brown had referred in December 1997 (see paragraph 1155); he had asked if this was the same treaty. Mr Brown had said it was not. Mr Henton followed up that question and asked if it included the reinsurance of SD. Mr Brown had said it did not. They then went ahead.

iii) He did not see the list and was not shown it, though he accepted that he should have seen it; Mr Brown had said that there were five or six contracts on the list but that he did not have the list with him. According to Mr Henton, he therefore did not know that the outwards reinsurance of SD was to be ceded under Programme 33.

iv) He made no note of what he was told. He accepted that he could and should have asked for an exclusion or something in writing which confirmed the assurance he had been given, but he did not think of that until after the visit of Mr Mather and Mr Coppinger in July 1998.

v) The proposed reinsurance programme noted on the slip was suggested by Mr Brown; Mr Henton wanted this to be a cessions treaty (though that was not noted). His view of the problem was that under the QS Mr Billyard could make different inwards cessions of $2m to SD which could accumulate and exceed the vertical limit of $5m in the outwards reinsurance; he would not have written Programme 33 if he had known that there would be a spiral. If there was a special cessions protection, each cession of $2m would go to that treaty and the vertical limit of $5m would not matter; there would be no accumulations. For example, if there were six contracts for $2m ceded under the treaty and there was a total loss, the amount of $12m would be recoverable under the cessions treaty. It did not matter that it exceeded the vertical limit of his XL programme. Cessions treaties had not been necessary on other programmes as the other programmes had their own specific reinsurances and had a vertical limit. The rate on the cessions treaty was cheaper than the reinsurance that he had.

vi) He accepted that a cessions treaty would also solve the problem of the spiral between Mr Billyard and SD.

vii) He was very confused as to whether the specific reinsurance was to be of both John Hancock (per JEH Re) and SD and placed by JEH Re, or of SD alone; it must have been of SD alone because the maximum limit noted by Mr Brown on the slip was $1.3333m – SD's 66.6666% of $2m, and not $2m which would have been the case if it was to be a reinsurance of both John Hancock (per JEH Re) and SD.

1581. Mr Whitcombe's evidence was:

i) He was present that day in his office, at his desk which was next to Mr Henton's. He listened to the conversation between Mr Henton and Mr Brown about a spiral as he knew that Mr Henton had wanted to bring up the subject of a spiral.

ii) The conversation touched on a spiral between Mr Billyard and SD; there was an obvious risk of a spiral in view of the fact that SD were also being reinsured by JEH Re; there was a discussion of reinsurance to make sure that SD did not get back what they had reinsured with JEH Re; that Mr Billyard would have a separate reinsurance for the account. This was the basis of Mr Whitcombe's comment to Mr Mather and Mr Coppinger during their meeting in July 1998 (see paragraph 1471.v)). Without that assurance from SCB, Mr Whitcombe accepted that to write the risk would have been reckless.

iii) He was sure that Mr Henton had seen some underwriting information even though Mr Henton had not seen the list.

iv) He could not explain why EIU wanted separate reinsurance if they were told that Mr Billyard had his own reinsurance for the SD risk.

1582. Mr Whitcombe's evidence was not clear and his recollection was vague. He accepted that the remark could have been made in respect of Programme 28 (as set out at paragraph 1617) where what he told Mr Mather and Mr Coppinger is described.
1583. Mr Brown's evidence was:

i) He could not recall the meeting on 30 April 1998, or to Mr Henton referring to a separate treaty. He also could not recall giving any confirmation that SD's outward reinsurances would not be ceded to Programme 33.

ii) He might have referred to five or six programmes being ceded to this, but he had the lists with him in any event as they were in the file and he showed one of the lists, probably the typed one, to Mr Henton. He accepted, however, that there was no list of the contracts that were to be ceded under the proposed reinsurance as both lists contained 1997 contracts and a proper list needed to be put together.

iii) Mr Brown and Mr Henton discussed the proposed programme noted in Mr Brown's handwriting on the slip as a means of reducing the spiral with Mr Billyard.

1584. It was EIU's case that they could not have been shown either list as (1) both contained 1997 risks which could not be ceded, (2) the premium was vastly greater than $2m, and (3) more than five or six contracts were detailed; the premium under the 1998 outwards reinsurance of SD was such that if there was a premium of $2m, there was no room for much other business to be ceded. SCB had not shown either list to Mr Henton because it would have exposed the lies that EIU had been told.
1585. Although SCB accepted that an estimated premium income of $2m would not have given room for much in addition to SD's outwards reinsurance to be ceded, they rejected that allegation. If EIU been concerned about the identity of the reinsurers to ensure that a spiral was not created, they would have sought the identity of the reinsurers on the SD programme from Mr Broad in 1997; there was a well known risk in the writing of this business that the business might come back from anywhere.
1586. Mr Henton accepted that if there was a spiral, SD would get 66.6666% and cede it back to JEH Re through SD's outwards reinsurance, JEH Re keeping 33.3334% before it was passed back and so on with the effect that JEH Re would keep 33.3334% each time it went into the spiral. He accepted that EIU were therefore not in a bad position as JEH Re were on the losing end; he saw that that was the position at the trial and he should have seen it at the time if he had appreciated the facts. Furthermore, because of the gaps in SD's reinsurance for 12 months at 1 January 1998, the spiral was in fact limited (for the reasons set out at paragraph 1607).
1587. Mr Brown's evidence was that he did not know what was in Mr Henton's mind on this but that that was the consideration at the time; however, Mr Brown did not think that this was an obviously loss making programme as Mr Billyard was retaining 33.3334%, even though this programme would pick up a lot of the loss making business that had been placed with SD for 1998. In their letter of 4 December 2001, SCB accepted that this programme was only writeable on a net basis.
1588. I am sure that it was obvious at the time:

i) To Mr Brown that Mr Henton, by making his acceptance subject to reinsurance, was trying to arbitrage – take on the risk and reinsure it out again for 30% of the premium received.

ii) To both Mr Brown and Mr Henton, given the market in 1998, that the specific reinsurance would have been as difficult, if not more difficult to place than the QS which Henton was accepting; Mr Henton wanted in effect to take only the bottom $10,000 and to reinsure the balance of the risk for 25% of the premium.

iii) That this was gross loss making business; I reject Mr Brown's evidence to the contrary as untruthful as the overwhelming evidence was that it was obviously gross loss making business.

iv) To Mr Brown, that if he had found no one to write the business other than Mr Henton, he was not going to find someone else to reinsure Mr Henton on terms that were even less favourable than those which Mr Henton had accepted, as the terms Mr Henton had wanted would involve that reinsurer taking on the greater part of the risk for less than a quarter of the premium.

(d) The further meeting on 10 June 1998

1589. As set out paragraphs 842 and following of Part II, negotiations had continued in relation to the reinsurance of New Cap Re (Australia) by SD and of SD by New Cap Re (Australia). By 3 June 1998, Mr Billyard had agreed to change the bottom layer of the 1998 reinsurance he had written for SD to a backup of the proposed New Cap Re (Australia) reinsurance which had the lower excess point of $10,000.
1590. On 10 June 1998, there was a further meeting between Mr Henton and SCB, the same day as the confirmation of the New Cap Re (Australia) programme (Programme 32) – see paragraph 851 of Part II. It was Mr Henton's evidence in relation to Programme 33, based on a very scrappy composite photocopy of a note found by SCB, that Mr Butler went to Mr Henton with the slip for Programme 33 in order to have it entered. Mr Butler had told him that the estimated premium income was $10m; Mr Henton had recorded in the note "must have built in r/i" because of his concern about the vertical limit in the programme. He recorded "xl on xl a/c, inc EIU" as a reference to confirmation that the outwards reinsurance of SD would not come back as he was concerned that it might be, in view of the much larger premium income which Mr Butler had mentioned – this figure was large enough to include SD's outwards reinsurance. He wanted confirmation again that they would not be ceded. Mr Henton's evidence was that Mr Butler did not know if the in-built reinsurances had been placed.
1591. It was SCB's case that the meeting was with Mr Brown and that the reference on the note to EIU showed that Mr Henton appreciated that it was coming back:

i) Mr Henton accepted that the writing on the top left corner of the note was that of Mr Brown's and that it showed how the reinsurance was to work.

ii) Mr Brown accepted that the income was bound to be more than $2m, but he could not recall if he had met Mr Henton on 10 June 1998.

iii) Mr Butler could not recall the meeting, but his evidence was that he would have known, at the time, the information about the premium, the details of the contracts to be ceded to the QS (as they were in the broking file), and the in-built reinsurances. He did not know that the premium income exceeded $2m until he saw a premium closing in late 1998 or early 1999.

1592. Although SCB accepted that Mr Henton had been told that the estimated premium income would be $2m (as recorded in the manuscript note made by Mr Butler in March 1998 – see paragraph 1561.iv), and as the figure was repeated by Mr Kelly in October 1998 – see paragraph 1653), they also accepted that the proportion of the premium income that would be ceded, as shown on the lists (after removing the 1997 risks), substantially exceeded $2m. Mr Brown's evidence was (as set out at paragraph 1561.vi)) that Mr Billyard thought that the risks might be signed down.

(e) The line put down on 19 June 1998

1593. It was common ground that on 19 June 1998, Mr Brown took the slip back to Mr Henton. EIU's line was put down and confirmation was given on the same date. The slip stamped by EIU contained no reference to the proposed reinsurance and was not made subject to reinsurance.
1594. However, a further manuscript note was added by Mr Brown to the copy of the slip on which the reinsurance requirements had been written (as described at paragraph 1577.ii)):

1595. It was Mr Henton's evidence that he was told by Mr Brown that the in-built reinsurances were in place and that that was the reason the slip did not contain any reference to it being subject to reinsurance. He was also told that the premium income was $2m and he considered that a cession of SD's outwards reinsurance could not, in view of its size, be within that amount. He had recorded this in two documents:

i) He had written on 19 June 1998: "confirmed when line entered" on the slip which he had scratched on 30 April 1998 (see paragraph 1573).

ii) He made a note dated 19 June 1998 which stated:

"Nick Brown confirmed that built in Reinsurances are in place as detailed on Promise lineslip. EPI confirmed as $2,000,000."

iii) The note disclosed by EIU was in fact produced in November 1998; this was determined after forensic tests had been carried out on behalf of SCB. Mr Henton's explanation for the note being made in November 1998 was that when copying EIU's files (as SD had requested in November or December 1998), he had badly damaged the manuscript note which he had made on 19 June 1998 which he said contained his record that Mr Brown had said that he had effected the reinsurance of Programme 33. Mr Henton had then re-written the file note but had not kept the damaged original. His evidence was that no other documents were damaged in photocopying.

1596. It was suggested to him that he could not have believed that reinsurance was in place as there were so many matters that were inconsistent with this; his further evidence was:

i) He did not check the rate as he thought that JEH Re were buying the reinsurance.

ii) He did not check the security for the reinsurance as he thought that that was a matter for Mr Billyard.

iii) He did not know the aggregate entry point on the stop loss – whether it was 50% or 60%, or the extent of the protection.

iv) He was not given any documentary evidence and did not ask for it, not even a quote sheet.

v) He had in mind a common account reinsurance being placed by JEH Re but accepted that as the line would be $2m and not $1.33m, the reference could not be to a common account reinsurance.

1597. Mr Brown's evidence was that:

i) The reference to "50,000 x 10,000" in the manuscript note he added was a reference to the XL reinsurance placed with New Cap Re (Australia) as a result of the reciprocal arrangement made and was not a cessions treaty (see paragraph 1236). Mr Brown could not say when he had written the remainder of the manuscript.

ii) He had spoken to Mr Murray at Raydon, which underwrote for Clarendon, about providing the specific reinsurances; he did this about the time of Mr Henton's original acceptance (30 April 1998), or just before or just after 19 June 1998. As best as Mr Brown could recall, Mr Murray had quoted and had said that he would write a line of 100% or at least lead with a line of 50%. At the time when Mr Brown gave his evidence, there was nothing at all in writing to or from Mr Murray that could be found. After he had given evidence, a fax dated 17 June 1998 from SCB to Mr Murray was found; it stated:

"Please find attached as requested Sphere Drake Information."

This provided some confirmation that Mr Murray had been approached. However, there was nothing in writing from Mr Murray or any draft slip or other documentation prepared for Mr Murray's acceptance of such reinsurance. Furthermore, Clarendon had withdrawn from the LMX market at the end of 1995 (as set out at paragraph 451), and in June 1997 (as set out in paragraph 977) Mr Butler had told Mr Henton that Clarendon's management excluded reinsurance of this type. Mr Murray worked at Raydon at the time of the trial but was not called to give evidence to confirm Mr Brown's account on this very important issue.

iii) Whilst he was keen to put something together on 19 June 1998, the obtaining of reinsurance was not made a subject in the slip and the purchase of the specific reinsurance was under negotiation with Clarendon. All that he had obtained for EIU was a promise of reinsurance which, if it materialised, would be purchased by SD and was not for the common account.

iv) He did not confirm to Mr Henton that the reinsurance was in place; he confirmed that he had a promise and that he did not think that it would be a problem.

v) He had no recollection of confirming the estimated premium income as $2m.

1598. SCB's case was therefore that the reinsurance of the bottom layer was in place and that Mr Brown had said that he had a promise of lead lines from Clarendon on the layers xs $60,000 but that this was not in place. Mr Henton's evidence was that he recalled the mention of Clarendon at some point and he might have translated the fact that there was a promise into a belief that the reinsurance was already in place.
1599. Mr Butler's evidence was that he might have been involved in discussions with Mr Brown about attempts to place the reinsurance, but he could not recall any details without help from something in a file (and there was nothing).

(f) The events after the signing of the slip; the fax to Mr Billyard

1600. On 23 June 1998:

i) Mr Billyard was sent the cover note for the reinsurance placed with SD.

ii) Mr Billyard also signed a slip for a backup reinsurance of the layer written by New Cap Re (Australia) ($50,000 xs $10,000), which he had agreed to provide in place of the XL he had written for $40,000 xs $20,000 (as set out at paragraph 1237).

1601. On 25 June 1998, Mr Billyard wrote to Mr Brown and Mr Butler, stating the fact that the QS that was placed with SD gave JEH Re no benefit whatsoever:

"As I write [SD]'s London programme, every time we cede 66.6666% to the Quota Share it is returned to me. I retain another 33.3334% and cede the balance back, which again is returned to me to retain a further 33.3334%. If you take this scenario to its final conclusion, I end up paying the whole claim under my share of the Quota Share, which is retained net.

The only way this can work is if [SD] agree to retain and not cede to the programme I write.

If this is not possible then either a new market, not a market already protected by me, or I retain the whole account and protect with a Stop Loss.

Please consider this urgently and contact me as soon as possible. I do need you to perform on this as promised."

The statement in this letter that Mr Billyard retained the risk net is, on its face, inconsistent with the position taken by John Hancock's solicitors in their letter of 29 October 2002 (from which it appeared that there had been a cession of LMX business, including the SD reinsurances, to Programme 28 – see paragraph 1608 below and paragraph 639 of Part II).

1602. Mr Brown's evidence was that the reference to "perform on this as promised" was a reference to the placing of the QS, however, he had not given a promise; things had not progressed as swiftly as was hoped. He had not given Mr Billyard a promise that he would obtain reinsurance for him when Mr Billyard agreed to write the loss making contracts that were set out in the list referred to at paragraph 1561.v); Mr Billyard had, in his days at Lloyd's, quoted and written without his reinsurances having been in place.
1603. Mr Butler accepted that the placing of the reinsurance in this way could cause a spiral; he had written, on the fax referred to at paragraph 1599, "No" against the paragraph where it was suggested that SD retain the risk, as he would not have expected SD to retain it. He might have had a discussion with Mr Brown about what to do, but he had no recollection of what had been discussed.
1604. Mr Brown spoke to Mr Billyard and responded the very same day (25 June 1998):

"Further to our conversation today, please be advised that [SD] per EIU have a separate programme to cede this account to that is not written directly by yourself and does not clash with the reinsurances you have for them."

1605. Mr Brown's evidence was that he had explained the position to Mr Billyard as he understood it, namely that he believed that they had obtained the agreement of Mr Murray of Raydon, on behalf of Clarendon, to write the specific reinsurance of SD; that he was confident on Mr Murray concluding the reinsurance and that he had committed to it. As Mr Billyard's office was about 20-30 feet from Mr Murray's, Mr Billyard could have easily checked with Mr Murray.
1606. Mr Butler's evidence was that he was not particularly involved, did not have a recollection of the fax, and had not seen anything to show that there was reinsurance at that time; he did not know to what Mr Brown was referring.

(g) The extent of the spiral

1607. Until Programme 33 was placed, and on the assumption that the outwards reinsurance of SD was not ceded under Programme 28, there was no spiral (as set out at paragraph 1241).
1608. The operation of the spiral in 1998 created by Programme 33 is most clearly set out in two other charts that were produced by Mr Hunt (Chart 4 Chart 4 Key and Chart 5 Chart 5 Key). In explaining the operation of the spiral in 1998, Mr Hunt made the following assumptions:

i) New Cap Re (Australia) had no reinsurance cover over the bottom-end franchise that was provided by SD, which came back into the spiral.

ii) JEH Re could have ceded the 1 January 1998 reinsurances of SD under Programme 33, but not under the 95% QS (Programme 28).

1609. In respect of JEH Re:

i) SD limited their loss to their retention of $10,000 and JEH Re ended up with significant losses.

ii) JEH Re were not able to recover 33.3334% of each loss under the QS, though the cessions treaties benefited JEH Re in that they stopped losses returning to JEH Re from SD. Any losses that could be claimed under Programme 33 would be subject to the 33.3334% retention of JEH Re. Thus as losses spiralled between JEH Re and SD, JEH Re would retain more and more.

iii) There was a break in the spiral:

a) JEH Re had no reinsurance under Programme 33 for losses in 1998 for risks attaching before 1 January 1998 as Programme 33 applied only to risks attaching in 1998 (RAD basis) and there was no run-in coverage in respect of previous risks.

b) There was a gap in the outwards reinsurance of SD written by JEH Re incepting at 1 January 1998 because there were no layers between $150,000 to $2.5m.

c) SD's losses which went into this layer as a result of the spiral were not therefore claimable under the outwards reinsurance incepting at 1 January 1998, but claimable only on SD's outwards reinsurance for 15 months at 1 October 1997 as that provided cover for losses occurring during 1998 in the layers between $150,000 and $2.5m.

d) However, SD's outwards reinsurance for 15 months at 1 October 1997 could not be ceded under Programme 33 as it had an attachment date prior to 1998.

e) Therefore the losses occurring in 1998 that were recoverable under the reinsurance of SD written for 15 months at 1 October 1997 could not come back to SD, and the spiral was broken at JEH Re.

iv) The spiral between SD and JEH Re was therefore limited in 1998 to $150,000 because of the gaps in SD's 1998 reinsurance at that point and the loss would therefore have stayed with JEH Re.

v) If declarations to the cessions treaties with New Cap Re and All American per WEB (referred to at paragraphs 1652 to 1658) were made, then in claims where the exclusions did not apply, the loss to JEH Re was reduced. However, there was no evidence that declarations were made to these treaties. Furthermore, it appears from a letter written on behalf of John Hancock on 4 October 2002, in response to a request from the Court, that Mr Billyard's reinsurances of All American were ceded to Programme 33; that may have meant that losses may have come back to the spiral if cessions had been made.

1610. However, the position may be much more complex:

i) In letters written on behalf of John Hancock on 4 and 30 October 2002, it was stated that there was no stop loss protecting the retention of 33.3334% under Programme 33 and that that programme inured to the benefit of Programme 28 (the 95% QS); that SD's outwards reinsurances incepting at 1 January 1998 had been ceded to Programme 28.

ii) If John Hancock were entitled to do this (and that is not a matter for me) and the cessions were made at the appropriate time (which they might not have been, in view of Mr Billyard's letter referred to at paragraph 1599), then there would be a further spiral.

iii) Mr Hunt's evidence was that the calculation of the effect of this would be very complex; SD had a 13.4% line on Programme 28 and the resulting spiral would be very complex. He had not worked it out, but there would be leakages to the other QS reinsurers (provided a loss did not come back through reinsurances written by Mr Billyard or by SD) and there was a possibility (though unlikely) that SD's aggregates might be exceeded.

1611. In respect of the New Cap Re spiral:

i) SD limited their losses to their retention; the balance of the losses went to New Cap Re or to New Cap Re's reinsurers.

ii) There was in fact no spiral between SD and New Cap Re between 1 January 1998 and 1 May 1998, because the outwards SD cover incepted on 1 January 1998 and the New Cap Re inwards reinsurance to SD incepted on 1 May 1998.

iii) The losses in the period before May 1998 exhausted the limited reinstatements on the New Cap Re cover.

iv) In addition, there was also an exclusion of "excess of loss on excess of loss with a known spiral content" which precluded New Cap Re from recovering any loss to them from their reinsuring SD, though Mr Henton might not have so understood the contract when he wrote it (see paragraphs 858 and following of Part II).

1612. Mr Brown accepted that there would be accumulations as the bottom layer of SD's outwards reinsurance was the XL written by New Cap Re.

(h) The losses under Programme 33

1613. The losses under Programme 33 as at 30 September 1999 were $21.2m against a net premium to SD of $7.75m. At 10 July 2002, the losses were $26.1m on a gross premium of $7.65m or a net premium of $7.27m.
1614. My conclusions are set out at paragraphs 1671 and following.

(3) The cover up

(a) The position at the end of July 1998: no specific reinsurance

1615. Mr Brown's evidence was that he became aware in late July or early August 1998 (before his meeting with Mr Henton on 7 August 1998) that Mr Murray would not provide the reinsurance he had promised; he was told by Mr Murray that Clarendon were unable to participate in the programme. He could not recall the circumstances.
1616. On 28 July 1998, Mr Butler wrote to MBR with a submission; he said that SD had in place, an aggregate protection for a layer $1.2m (15% of the applicable net premium income) xs $5.4m (85% of the applicable net premium income) (referred to at paragraph 1234), and he wanted $3m of additional cover on top of that layer. An internal list of matters at 31 July 1998 also referred to this. There was a follow-up on 31 July 1998. The annotations on the letter of 31 July 1998 are consistent with this.

(b) The questions posed by SD

1617. During the inspection of EIU on 28 and 29 July 1998, Mr Mather told EIU that Mr Billyard had said that JEH Re was in a spiral with SD.
1618. Mr Coppinger's evidence was that Mr Whitcombe had said to Mr Mather and Mr Coppinger that he (Mr Whitcombe) had given instructions to SCB to make sure that the business would not spiral. Mr Whitcombe's evidence was that he believed that his answer was true as he had been told by Mr Brown, on 30 April 1998 when Programme 33 was placed, that there would be no spiral (see paragraph 1579.ii)), and Mr Henton was told likewise by Mr Brown on 23 December 1997 when the outwards reinsurance was placed with JEH Re (see paragraph 1155).
1619. However, the report of Mr Mather and Mr Coppinger (which recorded Mr Whitcombe's answer that there was no spiral) probably referred to the 95% QS (Programme 28). As that was a 95% QS of the direct account placed on New Year's Eve 1997, it was suggested by SCB that if a question had been raised on that account, the answer would have been given that there was no LMX as it was a direct account; Mr Whitcombe seemed to accept that he was confused and that the assurance might have been given in respect of Programme 28.
1620. Mr Coppinger left Mr Henton with four questions about Programme 33. One question read:

"(2) Experience history of the account is not in the file… was it provided?

(4) XS protection issues are not finalised

Agg stop limit is not known

" " attachment point listed as "50-60%"

- who is the security?"

1621. On 31 July 1998, Mr Henton wrote two letters to Mr Butler; they were formal in tone. The first dealt with the matters that were urgent about Programme 33; the second set out Mr Coppinger's questions. He asked in the first letter:

"We/[SD] require written confirmation that our outwards reinsurance written by JEH Re does not come back into us via any of the inwards contracts written by EIU. I realise you have confirmed this verbally but [SD] have requested the statement in writing."

He also asked for details of the cessions treaty and the aggregate stop loss. In the second letter he passed on Mr Coppinger's questions about Programme 33 slightly re-formulated; these included:

"[(1)] Contract incepts 1^st January 1998 but was not bound by [EIU] until 19^th June 1998.

[(2)] Require statistical history of this account

[(4)] The common account reinsurance is detailed as $90,000 xs $10,000, $400,000 xs $100,000, $823,200 xs $500,000 and aggregate layers above 50-60% of nett income. For the aggregate protections what is the total aggregate limit and what is the exact attachment point? Also who is the security? Who will administer the collections?"

(c) The preparation of draft responses in early August 1998

1622. Mr Brown's evidence was that he had found the question in the first letter strange; he had annotated the letter and he had noted this fact in a note he dictated to Ms Barnes and which was in her handwriting; he thought that Mr Henton was confused as he knew that the SD programme came back under Programme 33. Mr Butler's evidence was that he was going on leave and could not recall discussing it until his return on 24 August 1998.
1623. On 6 August 1998, a letter to EIU in response was either prepared by Mr Brown or was done so on his instructions. Mr Brown thought that the letter had been sent to Mr Henton, but that seems unlikely as it was not in EIU's files. The draft stated that SCB were awaiting quotes from Clarendon in relation to cessions treaties for the aggregate writings and that Mr Brown wanted to discuss the top layer of the specific reinsurance. The draft stated that Mr Brown would provide the information but that there were a number of points which he might not be able to answer easily. Mr Henton's evidence was that he had not seen this draft.
1624. The draft did not state that the verbal confirmation had not been given; nor did it state that that the reinsurance about which questions were asked was not in place; when this point was put to Mr Brown in cross-examination, his evidence was that he was confused by Mr Henton's letter.
1625. Mr Henton also prepared a draft response dated 6 August 1998 to send to SD based, according to his evidence, on the information then available to him. In answer to the questions about the inception date and the loss record, he stated:

"The writing of this contract was first discussed with the broker in April 1998 at which point and as shown on the slip it was warranted that there were no known or reported losses as at 11^th March 1998.

"As a result of the continuous evolution of an account of this type and especially due to the radical changes that have occurred in the market the underwriting strategy currently adopted by the reinsured meant that the historical figures that were produced at placement bore little relation to the expected outcome of the account."

1626. The statement that there were historical figures at placement was untrue. As set out at paragraph 1575.ii), there were no figures produced at placement. A different but nonetheless still untruthful answer was given when the questions were answered on 9 September 1998 (as set out below).
1627. The draft also went on to deal with the question in relation to common account reinsurance and aggregate protection and gave the following answer:

"There have been some slight amendments to the excess placements as detailed in the file. The first layer is $40,000 xs $10,000 and is written by New Cap Re. The remaining exposure has been placed on a cession treaty basis as follows…"

Mr Henton's evidence was that he did not know when he drafted that letter; it was a working draft as evidenced by the word "complete" written against one of the paragraphs. The reference to the New Cap Re reinsurance was to the general account stop loss; the specific protection was to be excess of that; Mr Henton said he might have added that to the draft after the discussion with Mr Brown on 7 August 1998. It was undoubtedly inconsistent with Mr Henton's case.

(d) The meeting of 7 August 1998

1628. On 7 August 1998, there was a meeting between Mr Henton and Mr Brown, followed by a lunch at which Mr Whitcombe was present (though he could not recall anything about it). Ms Barnes was also present.
1629. Mr Henton's evidence was:

i) According to his statement and his evidence in his cross-examination on behalf of SD, Mr Brown told him that Mr Billyard had ceded SD's outwards reinsurance to Programme 33; that JEH Re had two QS treaties (Programmes 28 and 33), that there was no separate reinsurance for the SD treaty; that JEH Re had no separate reinsurance for SD's outwards reinsurance which they had written for the 1997 year, and that the outwards reinsurance for 1997 had probably been ceded to Programme 1.

ii) He was also told by Mr Brown that the specific reinsurance for Programme 33 was not in place; Mr Henton found it difficult to recall precisely what he was told at the lunch about what was to be done about the specific reinsurance for Programme 33; he was told that the only option was for the bottom layer to be the general account stop loss written by New Cap Re; the cessions treaty would be above that; Trustmark was also mentioned (as it was referred to in the letter that Mr Brown drafted during the meeting) as the "indicated reinsurer"; the letter was in Ms Barnes' handwriting.

iii) They also discussed using the cessions treaty to deal with the vertical limit on the reinsurance, though they might have also discussed a separate cessions treaty – his recollection was not clear. Mr Henton accepted that it was clear to him at the time of the trial that he was being offered only a single cessions treaty; he was wrong in thinking that there might be another. He also accepted that there was no reinsurance in place.

iv) Mr Brown's explanation of the position on 7 August 1998 demonstrated, according to Mr Henton's statement and cross-examination on behalf of SD, that Mr Brown had told him three serious lies:

a) the assurance that SD's outwards reinsurance would not be ceded to Programme 33;

b) that JEH Re had a separate account for 1997 and that the outwards reinsurance would not be ceded to Programme 1; and

c) that there was separate reinsurance for Programme 33.

However, in evidence given in his cross-examination on behalf of SCB, Mr Henton said that there might be "room for manoeuvre" in relation to the absence of separate reinsurance for Programme 33 as he might have misunderstood Mr Brown, but he confirmed, when cross-examined on behalf of SD, that he had been lied to about the fact that SD's outwards reinsurance would not be ceded to Programme 33 and about the fact that the specific reinsurance for Programme 33 was in place.

v) He was faced with a dilemma; if he had said that Mr Brown had lied, the meeting would have broken down; he was not prepared to do that without speaking to Mr Whitcombe. He felt, however, that his own underwriting of Programme 33 could have been better and he felt a little responsible for allowing the situation to occur. He told Mr Brown that this was not what he had been told before, but never at anytime did he say that Mr Brown had lied nor did he challenge Mr Brown further.

1630. In contrast to Mr Henton's detailed evidence, Mr Brown's recollection of the meeting was vague. He recalled a discussion about where they were at that point in time and about what they were trying to achieve. They also discussed the reinsurances they were trying to place. He said that the position was that they were trying to get reinsurance for SD. They were not colluding or singing from the same hymn sheet.
1631. The draft letter prepared by Mr Brown (referred to at paragraph 1627.ii)) suggested that Programme 33 should be subjected to the XL contract for $50,000 xs $10,000 that was written by New Cap Re (Australia) as part of the general reinsurance programme for SD; losses in excess of $60,000 would be protected by a separate cessions treaty with Trustmark/All American as the indicated reinsurer:

"As per our discussions and enquiries in the market, once we had made you aware that this non-prop cession treaty was available, it obviously made more sense to utilise this enabling you to write other non-prop business and not restrict yourselves to the common a/c reinsurance programme as originally proposed. This is of much greater benefit to you as you can use it for all non prop business as allocated at your discretion."

The letter concluded:

"Whilst the risk transfer between JEH and [SD] may exist to a limited degree, full risk transfer takes place once JEH and [SD] have eroded their retentions by virtue of the non prop specific reinsurance."

Mr Brown's evidence was that this was an answer to the question posed by SD that the outwards reinsurance did not come back; there was no way that assurance could be given, as it could come back from anywhere in the retro market.

(e) The discussion between Mr Whitcombe and Mr Henton

1632. Mr Henton accepted that, on his account of how Programme 33 had been placed, he had been deceived into writing that large reinsurance contract. That position was maintained in EIU's closing submissions. He wanted to discuss matters with Mr Whitcombe, which he did. His evidence was that they decided that "we would be better off solving the situation". They would not tell SD as that would create another problem. Mr Henton rejected the suggestion that they acted in their own personal interests; they thought that it would be better for SD to put the cessions treaty in place and to break the spiral.
1633. Mr Whitcombe accepted that being lied to was an extremely important matter but he did not tell SD as he had wanted to try and solve the problem. He had had no support from SD.
1634. Mr Henton accepted in his evidence that SD were entitled to be told of the lies Mr Brown had told them, and of the actual position on the reinsurance of Programme 33 so that they could decide what to do about the deception, but his evidence was that he did not appreciate this at the time.

(f) More discussions about the responses and attempts to find reinsurance

1635. On 10 August 1998, when Mr Riding went to see EIU about Programme 26 (see paragraph 1728), Mr Henton raised the question as to the position regarding a proposed stop loss with New Cap Re and the extension of the cessions treaty to include all writings. Mr Riding's evidence was that Mr Henton was more concerned with this and with the position in relation to Lincoln General (see paragraph 1545) than with Programme 26. Mr Riding reported this to Mr Brown who was in Bermuda.
1636. Mr Brown spoke to Mr Wright at WEB that same day and then sent a manuscript fax seeking a quote from WEB (who wrote for Trustmark/All American) that day itself, sending two draft slips for cessions treaties on an XL basis, one for $440,000 xs $60,000 and one for $990,000 xs $500,000; the fax stated that EIU had written an excess book of about $4m and that they wanted to carve some of it out from the general account; the fax also stated that there were no losses reported to SCB to date. Mr Brown could not recall from where he had obtained the figure of $4m; he would have probably worked out a minimum to Programme 33 and added a bit to the top. He could not recall sending Mr Wright any other information. He accepted that he knew then that the premium income on a 100% basis was about $11.5m and that 66% of that was therefore $7m-$8m; he thought that he had in mind the $2m spoken of originally.
1637. On 11 August 1998, Mr Henton wrote to Mr Coppinger to tell him that they had passed the questions to the producing brokers and were awaiting their detailed reply which was delayed by business travel and holidays:

"I explained to you that whilst we had seen adequate risk information we did not tend to copy that data but rather relied on its accessibility from the broker in line with Lloyd's/London market practice."

Mr Henton's evidence was that this was meant as an answer to all of Mr Coppinger's questions and not only in respect of Programme 33; they were trying to solve the problem that had arisen.

1638. Mr Whitcombe then went on holiday from 14 August to 1 September 1998.
1639. On 17 August 1998, Mr Henton prepared a letter to Mr Brown (about Mr Brown's draft letter to him which Mr Brown had provided at the meeting on 7 August 1998) as well as an alternative draft of the letter that was to be written by Mr Brown to him; Mr Henton's covering letter and the accompanying draft were not, however, sent until they were sent with the letter of 25 August 1998.

i) The letter of 17 August 1998 sought details of the cessions treaty (the rate for each declaration and the existence of exclusions) and of the aggregate stop loss; the letter stated that the assumption was that the cessions treaty would be on an RAD basis. Mr Henton accepted that the text of this letter reflected his thinking that the cessions treaty excess of $60,000 was not in place and that in asking for details of the aggregate stop loss he must have appreciated that it was not in place.

ii) Mr Henton's alternative draft of the letter for Mr Brown to send to him stated that the cessions treaty with Trustmark/All American was in place above the layer that was placed with New Cap Re and that all the necessary declarations had been made. Mr Brown's evidence was that the assertion in the draft that the treaties with Trustmark/All American being in place was not true; he had used the words "indicated reinsurer" in his draft.

iii) Mr Henton's alternative draft also stated that the reinsurers were prepared to extend the treaty to non-proportional accounts that SD wished to declare. Mr Henton's evidence was that the purpose of the draft was to help solve the problem for SD and not to help Mr Brown.

1640. On 19 August 1998, Mr Ekwall of WEB sent a fax to Mr Kelly of SCB for the layer $440,000 xs $60,000:

"I have discussed the above with Steve [Wright] and due to the lack of information on the business Steve came up with a rate of 45%. Understanding this may not be what you need, in order for us to come up with anything more competitive we will need a breakdown of the layers and their lines."

Mr Brown's evidence was that he did not know if any further information was sent, but he accepted that the quoted rate was a stab in the dark from WEB.

1641. On 18 August 1998, Mr Murray provided, in manuscript, an indication of aggregate cessions cover for the retentions below the aggregate stop loss on Programmes 7, 9, 15, 23, 30 and 31 were written on a cessions basis. There was no mention in this of any prior quote or indication. A lot of information was sought on the basis that he wanted to get a feel for the account. Mr Henton was provided with the quote on or about 19 August 1998, which he had endorsed to the effect that they were much more expensive than the reinsurance that he had written for Mr Bird (Programme 23) in February 1998 (see paragraph 1273).
1642. On 20 August 1998, Mr Mather wrote to HHI to ask them to obtain a response from Mr Billyard in relation to his comment on the operation of a spiral between SD and JEH Re (see paragraph 1442.iii)) and in relation to what they had been told by Mr Billyard as to MSC and its reinsurance by SD (see paragraph 1442.iv)). Mr Mather said that SD could find no trace of the MSC treaty. Mr Henton sent a copy of this letter to Mr Brown.
1643. Mr Henton and Mr Brown were, from that time, faced with covering up two matters – the MSC arrangement and what had happened in relation to Programme 33.
1644. On Tuesday 25 August 1998, Mr Henton again wrote to Mr Brown enclosing his letter of 17 August 1998 and the alternative draft letter with that, Mr Mather's letter to HHI dated 20 August 1998 and a draft response to that letter:

i) In relation to the spiral the draft response stated:

"Contrary to our understanding of this risk your conversation with Mr Billyard has raised the question of a potential spiral existing between [SD] and John Hancock. Prior to responding on this point several conversations were necessary with the broker and reinsured which were delayed longer than would have been our wish due to their holiday and business commitments. As a result of these conversations we have established that unbeknown to us a limited 'spiral' has occurred between the two parties. The term 'spiral' suggests a number of reinsurers passing around the same loss exaggerating its size with scant regard for their own reinsurers, this is not the case here as we are talking about a risk transfer process allowing two reinsurers to compete in a more cost efficient manner whilst at the same time providing low level reinsurance designed to enhance profitability in a very tough market…"

Mr Henton's evidence was this meant that the risk would go out to JEH Re, come back into Programme 33 and then go out on the specific reinsurance. It was not a spiral where the loss went round and round and got bigger and bigger. He accepted that after the exhaustion of the New Cap Re protection, low level losses would go to Mr Billyard and there would be a limited spiral. On a higher layer, the losses would go to All American and would not come back. Mr Brown's evidence was that there had been a potential for a spiral all along; that had been obvious and the suggestion in the letter to the contrary was incorrect.

ii) In relation to MSC, the draft stated:

"The risk referred to as [MSC] has not been written by [SD]. The broker has informed me that this risk has been written by another reinsurer."

Mr Henton's evidence was that he had told Mr Mather and Mr Coppinger that he had not written a reinsurance of MSC at the meeting on 28 and 29 July 1998, but he had not spoken to Mr Brown and was drafting what he thought was the answer.

iii) The letter of 25 August 1998 to Mr Brown (as set out at paragraph 1545) asked Mr Brown to progress further the introduction to Lincoln General; Mr Henton's evidence was that he had added this as they had hoped that Mr Brown could find them new capacity so that they could continue to work with SCB; despite what had happened, they wanted to do this and felt that they could trust SCB; he would make sure that the situation that had arisen would not occur again by ensuring that he saw the relevant documentation or information to support things that were said.

1645. On 3 September 1998, Mr Adam Hedley of MBR and Mr Sparkes of New Cap Re visited SCB on one of their regular visits to London. They were seen by Mr Butler (who had returned from his holiday on 24 August 1998) who gave Mr Sparkes a copy of the fax and slips that had been sent to WEB on 10 August 1998 with the notation "need $1m x $500k for 20-25% of NPI". Mr Sparkes and Mr Hedley then went to the Monte Carlo Rendezvous; Mr Kelly was there and Mr Butler got him to follow it up on 7 September 1998.

(g) Mr Brown's co-ordination of the responses

1646. By 8 September 1998, no specific reinsurance of Programme 33 had been obtained; Mr Brown was away from London for holiday and business at the Grand Hotel du Cap in the south of France.
1647. On 8 September 1998, Mr Brown faxed three draft letters to Mr Butler in London:

i) A letter to be written by Mr Brown to Mr Henton; he had dictated this to Ms Barnes and the draft was in her hand. The draft stated that details of the three additional aggregate stop loss layers and the cessions treaty were on the attached schedule. After dealing with the other questions posed by SD, the draft dealt with Programme 33:

"JEH Re were uncertain as to how they wished to protect this part of their account for 1998 and they only entered the market for reinsurance on this some months into the year. I would like to point out that as with your own reinsurances, we are only the broker and as such, decisions by reinsurers as to when, how and what reinsurance they buy is entirely theirs. My understanding is that JEH Re had not purchased a quota share of this nature on this account therefore statistical history would be difficult to provide. It was however pointed out by the JEH Re underwriter that they are retaining a significant proportion of each and every risk."

Mr Brown's evidence was:

(a) It was truthful to state that JEH Re had only entered the market some months into the year as Mr Billyard did not come into the market until March 1998, even though (as set out at paragraph 1561) it was clear that Mr Billyard was seeking reinsurance earlier than that.

(b) It would have been difficult to provide "as if" statistical information as Mr Billyard was retaining 33.3334% in 1998 and had not done that previously.

The letter continued, after dealing with the level of deductions:

"Again with regard to common account reinsurance, as per your request, we have provided quotations on an original cession basis (details on attached reinsurance quotation schedule). With regard to aggregate layers, following our conversations, with the additional aggregate cover purchased for your whole account, you stated this may not be necessary. We have therefore not pursued any quotations."

The reinsurance quotation schedule which was attached is considered at paragraph 1647.

ii) A letter to be written by Mr Billyard to HHI in response to Mr Mather's letter to HHI of 20 August 1998. This was a redraft by Mr Brown of a letter faxed by Mr Billyard to Mr Butler on 3 September 1998 and which dealt with the visit by Mr Mather and Mr Coppinger; Mr Billyard's letter stated, after dealing with other issues and stating that he had been peppered with questions about SD's participation in the "JEH Re pool":

"Turning to MSC, I understand you have various markets interested in this quota share including [SD]. No document has been signed, no cover issued, no commitment of any kind has been made on behalf of [SD]. It is not up and running and is not being fed by small amounts of 1998 premium.

May I suggest you contact Mr Batchelor and explain the circumstances to him. It would be nice if we could obtain their approval to commence as we have a few items of X/L suitable for this arrangement."

Mr Brown's evidence was that he had redrafted the letter from Mr Billyard because he had thought that it did not express how upset Mr Billyard was at the visit made to him in Bermuda; the passage referring to the seeking of HHI's consent to the MSC arrangement was also deleted because Mr Brown believed that no business had been written through that arrangement at all. Mr Brown's redraft stated:

"Turning to M.S.C., various reinsurers had been contacted with a view to participating in this quota share and EIU/[SD] may have been one of the reinsurers the broker had contacted. However, no document has been signed, no cover issued and no commitment of any kind has been made on behalf of SD. This facility is not up and running and is not being fed by small amounts of 1998 premium."

The draft letter was further redrafted by Mr Henton on 8 September (as set out at paragraph 1648.i)) and was then returned to SCB before it was sent by Mr Billyard to HHI with a copy to SCB.

iii) A copy of the draft letter which Mr Henton had prepared on 6 August 1998 (see paragraph 1623) that he was to write to Mr Coppinger, which had been sent out to Mr Brown on 7 September 1998.

Mr Butler was asked to get the two new drafts typed up and sent to Mr Henton and Mr Whitcombe for review; Mr Brown suggested a telephone conference.

1648. It is clear from documents retrieved by the e-mail search in July 2002 that the draft letter to be sent by Mr Brown to Mr Henton was typed and was sent to EIU. It was the evidence of Mr Henton that he had met Mr Butler, though Mr Butler's evidence was that he could not recall such a meeting taking place; the evidence of Mr Henton was that there was no conference call with Mr Brown; Mr Whitcombe and Mr Butler could not recall the conference call taking place.
1649. The reinsurance quotation schedule (which was attached to the draft letter from Mr Brown to Mr Henton and which was provided to EIU) showed for 1998:

i) A whole account QS (possibly to be placed with New Cap Re).

ii) Two cessions treaties (the first to be placed with Trustmark/All American); the first was the one in respect of which a quote had been given (see paragraph 1638) as the rate of 45% was set out in the schedule; the second was to be at a rate of "up to 25%". Mr Henton accepted that the description in the schedule showed that these were not in place, but he could not recall whether he thought that at the time.

iii) A whole account horizontal stop loss programme to protect the aggregate retention; SD had been told that this had been placed in May 1998 (see paragraph 1363), but as set out in that paragraph, only one layer for 1997 and one layer for 1998 had actually been placed.

iv) Two aggregate account protections (which were quotes that had come from Mr Murray (as set out at paragraph 1639)) to cover the retentions below the aggregate stop loss on Programmes 7, 9, 15, 23, 30 and 31 were to be written on a cessions basis.

(h) The explanation sent to SD on 9 September 1998

1650. On 9 September 1998:

i) Mr Billyard wrote to HHI; a copy was sent to Mr Butler under the cover of a letter which referred to a telephone conversation with him. The letter reflected Mr Brown's redraft in relation to MSC as set out above, but it had been redrafted by Mr Henton to deal with the spiral. Mr Henton wrote the following passage in manuscript on the draft and returned the draft to SCB. The version sent therefore incorporated the following addition that Mr Henton had made to Mr Billyard's original fax as redrafted by Mr Brown:

"Having now had a chance to review further and after taking into account my own reinsurance arrangements it would seem that only a residual proportion of the risk written for [SD] incepting as at 1.1.98 is retained with the JEH Re Quota Share account."

ii) Mr Henton wrote to Mr Coppinger with the answers to various questions that were posed. His evidence was that he did not discuss the terms of the letter in detail with Mr Butler or Mr Brown, although he agreed that some discussion did take place as answers were required to enable him to draft the letter. Mr Brown's and Mr Butler's evidence was to the same effect. No copy of the letter was provided to SCB.

1651. The letter from Mr Henton to Mr Mather stated in part (with numbering added):

"(1) Question. Contract incepts 1^st January 1998 but was not bound by [EIU] until 19^th June 1998.

Answer. The writing of this contract was first discussed with the broker in the early part of the year. As discussions reached a conclusion a warranty that there were no known or reported losses as at 11^th March 1998 was entered on the slip. The actual line was entered on 19^th June 1998.

(2) Question. Require statistical history of this account.

Answer. The account written under this quota share predominantly covers non proportional reinsurance of direct accounts and the reinsurance of those direct account writers. This is a new account for 1998 and whilst similar business has been written in the past within a larger and more varied grouping it was not possible to extract a truly reflective set of historical figures

(3) …

(4) Question. The common account reinsurance requires clarification.

Answer. The reinsurance purchased has been placed on a each and every original cession basis covering this account with limits of $440,000 xs $60,000 and $1,500,000 xs $500,000, thus alleviating the need for vertical coverage. Both the primary and stop loss areas are contained within the existing reinsurance arrangements covering the whole account."

The answer to question (4) did not accord with what was in the draft letter from Mr Brown, as that draft letter expressly referred to quotations.

1652. Mr Henton's evidence about the answers which he provided in the letter was:

i) In relation to the answer to question (1), Mr Henton accepted (as set out at paragraph 1572) that he had first seen the risk on 30 April 1998; the letter could be giving a false impression as an attempt to justify the 11 March 1998 date, but he had not intended to mislead.

ii) In relation to the answer to question (2), he said he had been told that the account was a predominantly non-proportional reinsurance of direct accounts, but he never saw a list. It was, he said, not possible to construct a truly reflective set of statistics.

iii) In relation to the answer to question (4), he said in his statement that he had been told by Mr Butler that the specific reinsurance was in place and the security used, prior to the writing of the letter to Mr Coppinger; his recollection was based on what he had recorded in his fax of 17 December 1998 to Mr Kelly (briefly referred to at paragraph 1658 below) where he had mentioned that the security on the lower layer of the cessions treaty was Clarendon. However, in cross-examination on behalf of SCB, he accepted that this must have been wrong and that the reference to Clarendon was either a reference to a conversation he had had with Mr Brown prior to 19 June 1998 about a promised lead line from Clarendon (see paragraph 1595.ii)), or he had confused the cessions treaties with the aggregate account protections referred to at paragraph 1647.iv) which were to be placed on a cessions basis. He had thought that the reinsurance was in place but accepted now that he had "jumped the gun" and that it was not in place. In cross-examination on behalf of SD, Mr Henton's evidence was that the details came from the schedule of reinsurance quotations referred to at paragraph 1647; he was prepared to pay 45% and 25% for the cessions treaties as this would still make a net profit; he thought that the cessions treaties had been placed as he had been told this by Mr Butler on either 8 or 9 September 1998. He had seen no documents and did not ask for any (despite what he said he had learnt on 7 August 1998 – see paragraphs 1627.iv) and 1642.iii). He did no double-checking but thought that the reinsurance had been placed with Clarendon. Mr Butler's evidence was that it was a possibility that he might have, in referring to the aggregate account protections (which were to be placed on a cessions basis), said that the cessions treaties were placed with Clarendon and that this had given rise to the confusion.

1653. Mr Brown's evidence was that the answer to question (4) was untrue and that Mr Henton must have known it; Mr Brown had used the phrase "indicated reinsurer" in his draft letter (referred to at paragraph 1629).

(4) The subsequent events

(a) The placement of the higher layers of the cessions treaty with New Cap Re

1654. SCB continued their attempts to persuade New Cap Re to underwrite various reinsurances, including the higher layer of the cessions treaty that Mr Henton wanted. A number of further questions were asked by New Cap Re; they were told that the premium was approximately $8m.
1655. On 15 October 1998, New Cap Re agreed to write the higher layer of the cessions treaty – excess of the $440,000 xs $60,000 to be covered by WEB, but with only 49 reinstatements. New Cap Re split the higher layer into two layers – $500,000 xs $500,000 and $330,000 xs $1m. The combined rate was 25%. The net premium income was shown as $8m. On 26 October 1998, Mr Kelly wrote to explain that an error had been made over the premium; they had given the figure for the whole account; it was $2m only for the specific QSand the slips were amended in manuscript accordingly.
1656. On 21 October 1998, Mr Henton sent a fax to Mr Butler (with a copy to Mr Smith) stating that he had been advised that firm orders had been given for the quotations for reinsurances: these were for two types – the cessions treaty programme in three layers for Programme 33 and a whole account stop loss programme in three layers above the layer placed by WFD with Dorinco Re (set out at paragraph 1234). The fax had been scratched; it was Mr Whitcombe's evidence that this was Mr Smith's signature; Mr Henton's evidence was that Mr Smith had told him that a firm order had been given. Mr Barnard accepted that either he or Mr Mather would have approved the actions of HHI in this regard. At paragraph 1501, I referred to the submission that the facts as by then known to SD were highly material to the QS with ESG. The same views as I expressed there must apply to the placement of these contracts.

(b) The placement of the lower layer of the cessions treaty with All American per WEB

1657. On 3 November 1998, Mr Kelly chased Mr Ekwall of WEB, who had quoted on 19 August 1998 (see paragraph 1638) for the lower layer ($400,000 xs $60,000); he enclosed a slip which had the rate of 45% typed onto it, and an information sheet:

"Hopefully you will recall, Nick Brown faxed Steve Wright on the 10^th August 1998 and Robin, you faxed your quote to me on the 19^th August 1998. Jeff Butler informs me that we gave you a firm order."

1658. On 16 November 1998, Mr Ekwall signed the slip for the bottom layer of the cessions treaty, but added exclusions in manuscript of (1) "Excess of Loss reinsurance underwritten by the Reinsured that covers any other Excess of Loss reinsurance", (2) business emanating from Unicover howsoever assumed, and (3) no known or reported losses at 16 November 1998.
1659. Mr Butler's evidence was that exclusion (1) did not prevent SD from recovering losses as the reinsurance was intended to protect Programme 33 which was not an XL contract but a QS; as to exclusion (2), although Mr Butler could not recall whether he knew this at the time, there were rumours that Unicover had written a huge account of underpriced business – Unicover had become a hot topic. Mr Brown's evidence was that he had thought that exclusion (2) was aimed at competition as WEB did not want to be seen to be supporting a rival.
1660. On 8 December 1998, SCB sent the cover note for the bottom layer to EIU; on 17 December 1998, Mr Henton sent a fax to Mr Kelly in which he sought to have the exclusions removed, particularly the one relating to the absence of known or reported losses at 16 November 1998. He did not, at that stage, know of Mr Cackett's involvement with Unicover (see paragraph 1712 below) or of the risk that in fact existed that Unicover might come back to EIU under Programme 33. Although SCB passed on the objection WEB did not change its position.

(c) Information given to SD about what had happened

1661. Mr Barnard and Mr Bentley were not aware of anyone at SD approving the reinsurances.
1662. Nothing was said by EIU to SD in any correspondence or in the fourth underwriting report submitted in October 1998 about the lies that EIU believed they had been told; EIU's evidence was that they had wanted to ensure that reinsurance was put in place. On the contrary, on 2 November 1998, Mr Whitcombe wrote a long letter to SD in which he praised SCB for placing the 1997 reinsurance; in his letter of 5 January 1999 to Mr Barnard (see paragraph 1820 below), Mr Whitcombe stated that SCB had acted with absolute probity.

(d) The increase in the premium income to $11m

1663. As set out at paragraph 1553, the way this programme related to Mr Billyard's other programmes was said to be uncertain, though it was made clear by John Hancock (in the letter written on their behalf on 4 October 2002) that they considered that the programme inured to the benefit of Programme 28.
1664. The slip provided for monthly reports which were to list individual risks bound, though these were not provided until the end of December 1998. However, in the autumn of 1998, closings sent by SCB (without a bordereau detailing the risks) showed that the premium income was well in excess of $2m. This closing, dated 27 October 1998, showed that the premium ceded under Programme 33 in the period January 1998 to July 1998 was $4.898m. Shortly thereafter it was clear that there was a massive increase.
1665. A fax sent to Mr Brown in Australia on 5 November 1998 from SCB's London office stated:

"Jeff [Butler] asked me to [mention] to you that Chris Henton has spoken to him about [Programme 33]. According to Chris, you told him that you anticipated approximately $2,000,000 of income. To date, there is $11,000,000 and Chris is very very uncomfortable with it and wants to know what we can do."

Mr Henton's discomfort was not mentioned to SD.

1666. It was not until 21 January 1999 that documents were provided to EIU which showed what had been done; SCB's letter of that date enclosed closings dated 31 December 1998 for the period to 31 October 1998. This showed an increase in the gross ceded premium to $7.14m with the 100% premium being $10.71m; the bordereau attached showed that 35 contracts had been ceded; amongst those listed were the bottom layers of the CIGNA PA programme (Programme 27) which had been written 100% by Mr Billyard on 10 December 1997 and where the gross business written under that programme was $4.07m; the other risks included Chiyoda, SD, All American, Eliot and Catlin. Mr Brown could not explain why these were not on either of the lists provided in March 1998 during the attempts to place the reinsurance (see paragraph 1577).

(e) The agreement in February 1999 to offset the income

1667. Mr Henton queried with Mr Butler the closings sent on 21 January 1999. Mr Butler visited EIU and told Mr Henton that although the actual income on Programme 33 was going to be $6m instead of the $2m indicated, the underlying income on Programme 28 would be $20m instead of the $50m indicated and SD's share would consequently be less than the $6.5m that was anticipated. This decrease on Programme 28 would offset the amount of the increase in Programme 33, resulting in a minimal net increase.
1668. On 5 February 1999, Mr Henton sent a fax to Mr Butler setting out what he had been told about the premium being $6m and about the proposed offset; he copied this to Mr Smith. Mr Henton discussed the position with Mr Smith and his evidence was that Mr Smith accepted the position that more could be ceded to Programme 33; he had not consulted SD as the relationship was not very good and he considered it just an offset between two accounts from the same reinsurer. SCB prepared a note which stated that the ceded premium under Programme 33 at 31 January 1999 was $10.88m and the ceded premium under Programme 28 at 30 September 1998 was $12.53m; this was annotated by Mr Henton "Higher than expected; JB confirmed [should be] $10.7m". Mr Butler's evidence was that this related to the 100% net premium figure which would bring the income down to $6m.
1669. As set out at paragraph 1746.v) below, it was SCB's case that they had agreed with EIU in September 1998 that more premium could be ceded under Programme 26 as there was to be less premium under Programme 28. Mr Butler's evidence was that he had forgotten what he had agreed on Programme 26; clearly if the shortfall had been taken into account in the alleged agreement on Programme 26, it could not be taken into account again in relation to Programme 33.
1670. On 9 February 1999, Mr Henton sought further information to enable him to claim on the cessions treaties; this was passed to Mr Billyard who provided in response on 10 February 1999, a bordereau covering the period 1 November 1998 to 31 January 1999. This showed that the 100% net premium was $16.32m, that the ceded participation was $10.88m and that much business was then coming from Clarendon and Realm National; Mr Butler's evidence was that he did not know why so much did, but a lot of it was SCB business.
1671. Mr Henton recorded the change on his computer system; the spreadsheet in the form of a bordereau for the 1998 business as at 31 January 1999 showed, in the version retained by EIU, that the premium income on Programme 28 was reduced to $2.546m and that the premium on Programme 33 was increased to $6m.
1672. As set out at paragraph 1790, on 18 December 1998, Mr Mather had told EIU to refer any endorsements or wordings to them for their approval. Mr Henton's actions were a clear breach of the moratorium and of the instructions in the letter of 18 December 1998.

(5) Conclusion

(a) The placing of Programme 33

1673. There were four principal points in issue

i) Was an assurance given that SD's outward reinsurances would not be ceded?

ii) What was said in relation to the existence of reinsurance for Programme 33?

iii) What was known about the premium income by SCB?

iv) Was the acceptance of the programme by Mr Henton dishonest, and did SCB dishonestly assist him?

1674. I am sure that no assurance was given by Mr Brown that the SD outwards reinsurance would not be ceded:

i) Mr Henton had given untruthful evidence in respect of a similar matter in December 1997– see paragraph 1254.

ii) Mr Brown knew from the lists that SD's outwards reinsurance would be ceded; the lists were available and were referred to on the slip as having been seen.

iii) The obvious need for the cessions reinsurance was to deal with the cession of SD's outwards reinsurance to Programme 33.

iv) Mr Henton could have excluded the outwards reinsurance of SD or made a contemporary note of any assurance; he did neither.

v) Mr Whitcombe's evidence provided no support; he had related the remarks to Programme 28 in his conversation with Mr Mather and Mr Coppinger.

vi) The giving of an assurance is inconsistent with the note Mr Bentley made of a conversation with Mr Henton on 16 July 1998 (see paragraph 1468); I am sure that Mr Henton had told Mr Bentley the matters which Mr Bentley had recorded; what Mr Henton had told Mr Bentley was an untrue improvisation to try and conceal what had been written.

vii) The story in relation to the assurance was then invented by Mr Henton in order to deal with what Mr Coppinger and Mr Mather had been told by Mr Billyard; SD had never been told that spiral business was to be or had been written. Indeed Mr Whitcombe had told Mr Broad that no retro business had been written in February 1998 when he told him that what Mr Zuberi had said was untrue (see paragraphs 1313 and following). EIU wanted to maintain the pretence that no retro or spiral business had been written.

1675. I am sure that on 19 June 1998 Mr Brown led Mr Henton to believe that he had reinsurance for SD and that it would be effected; I am sure that Mr Henton believed him. Mr Henton could not have been led to believe that reinsurance was actually signed up, but I am sure that Mr Brown spoke to him in such terms that made it clear that he had obtained a promise of reinsurance and that the contract would be effected quickly:

i) A few days later, Mr Brown told Mr Billyard in writing (as set out at paragraph 1602) that EIU had a separate programme to which Programme 33 would be ceded. This was an obvious lie; there was no such reinsurance. I reject Mr Brown's explanation that he explained the position to Mr Billyard in different terms as untruthful; he put in writing what he wanted Mr Billyard to believe and he knew it was untrue.

ii) There was no reason for Mr Henton to have waived the insistence on reinsurance unless he had been given such an assurance by Mr Brown.

iii) When it turned out that there was no such reinsurance in place and Mr Brown could not put it in place, Mr Henton lied to SD about its existence in the letter of 9 September 1998 (as he did on other matters) and fraudulently created the document which purported to record that promise. I reject Mr Henton's account of the original being damaged by the photocopier; it was wholly implausible and there was no reason for him to have thrown away the original had it existed.

iv) Nonetheless, even though Mr Henton had lied and had produced a forged document, Mr Brown had also lied to Mr Henton. There was no promise of reinsurance from Mr Murray. No written evidence of such a promise was produced. It appears that some enquiry was made of Mr Murray, but that is all. Mr Murray was employed by Raydon and could have been called as this was a very important issue in the trial; the obvious inference is that he did not support Mr Brown's version. Clarendon had withdrawn from writing LMX business sometime before. No proper placing information had been prepared for the placement of such business; when Mr Murray quoted for specific aggregate cession cover, he sent a fax requiring detailed information as set out at paragraph 1639. There was nothing similar from Mr Murray in relation to the contract that was said to have been promised in June 1998. No information or other documentation was prepared by SCB. If it had been prepared, such information would have been sent to them when WEB were asked to quote on 10 August 1998 (as set out at paragraph 1634), or when WEB made it clear that their quote was a stab in the dark without information (see paragraph 1638). Furthermore given the state of the market, Mr Brown knew that he could not get reinsurance at the rates of 8% and 10% noted on the slip; the rate quoted by WEB was 45% and the rate quoted by New Cap Re was 25%.

v) In his letter of 6 August 1998 (which may never have been sent), Mr Brown did not deny that a verbal confirmation had been given – see paragraph 1622.

1676. I am sure that Mr Brown deceived Mr Henton about the premium:

i) As I have already set out (see paragraph 1562), I am sure that Mr Brown had had discussions with Mr Billyard about the placing of the reinsurance of his LMX business.

ii) I am also sure that he knew that the premium income would be much greater than $2m.

iii) The negotiations on Programme 33 were proceeding at a time when EIU were trying to get an increase from SD and Mr Henton would have been interested in the amount and concerned about the level of premium.

iv) It is clear from the premium declarations made that the income was in fact in the region of $10m and I am sure that Mr Butler told Mr Henton that it might be this amount; the fact that this was brought to his attention was evidenced in the scrappy note referred to at paragraph 1588 that was found by chance by SCB in an unrelated file in the course of the trial.

v) However, Mr Brown told Mr Henton that it was $2m before the slip was signed and this was the information repeated to New Cap Re in October.

vi) I am sure that that figure of $2m was known by SCB to be untrue and that the premium income was in fact much greater; the explanation that Mr Brown understood from Mr Billyard that the contracts he had written might sign down was untrue. As set out at paragraph 1558, all but one of the programmes on the list had been cover noted by 20 March 1998. There was no prospect in the then market of anyone in June 1998 writing lines on the contracts that had been placed long before and the lines written by Mr Billyard, as Mr Brown asserted (see paragraph 1590), signing down.

1677. I am sure that in accepting this programme Mr Henton acted dishonestly:

i) As set out at paragraph 1575.i), Mr Henton made no enquiry into the LMX content.

ii) As set out at paragraphs 1574 and 1575.ii), he made no enquiry about loss statistics and made no attempt to obtain a proper warranty.

iii) He made no attempt to examine the list of contracts or obtain any proper information about the premium on those contracts.

iv) He did not care what loss he inflicted on SD and committed them without being sure that reinsurance was in place.

v) Although he was lied to by Mr Brown in the assurance given about reinsurance, that did not excuse his committing SD when he had not obtained proper confirmation and details of the terms.

1678. Mr Brown also acted dishonestly:

i) As I have set out, the reinsurance was obtained by the dishonesty of Mr Brown in relation to the assurance he had given on reinsurance and the lie about the premium income.

ii) He knew that this was gross loss making business; it was accepted against the background set out at paragraph 1538 above.

iii) He knew that Mr Henton would in any event not be concerned to protect the interests of SD in the way any honest and competent underwriter would have done and although it was necessary to deceive Mr Henton in relation to the reinsurance and the premium income, that would be a fairly easy task as he knew that Mr Henton did not care about the losses he inflicted on SD and so would not make the obvious enquiries that would have unmasked his lies.

1679. As I have set out at paragraph 1250, neither SCB nor Mr Billyard had any care for the interests of John Hancock; they were not going to be of any further use to them. It is clear, however, that John Hancock did carry out one or more audits at JEH Re during 1998 and that Mr Billyard needed cover for his LMX writings. It is also clear from Mr Brown's evidence referred to at paragraph 1570.i) that he appreciated that because of the way Programme 33 was written and because there was no run in provision, the spiral would be broken and, as it was his view that Programme 28 could not be used by John Hancock, the effect of Programme 33 would be to leave the bulk of the losses with John Hancock. That remained Mr Brown's position in 1998. As I did not hear from Mr Billyard and as the materials provided by John Hancock were insufficient, I will not express a view as to Mr Billyard's position.
1680. As I have set out at paragraph 1534, they were looking to an arrangement with MSC backed by a reinsurance through EIU with SD. It was therefore in their interests to maintain EIU in business; it is clear from the events surrounding Programmes 32 and 33 and the outwards reinsurances of SD written by New Cap Re and amended by Mr Billyard in June 1998 that there was a relationship between them (as summarised at paragraph 1236). That inter-relationship was not explored at the trial and I will not speculate on it, but it is clear that unless Programme 28 was used to cede the retention under Programme 35, the losses did not spiral back to SD under any of the arrangements because of the terms of the contracts.
1681. As set out at paragraphs 1536 and 1537, Mr Henton had written very large programmes between March and July 1998 and was content to acquiesce in subordinating the interests of SD to those of SCB. SCB, EIU and Mr Billyard looked forward to continuing to act together and would have done so had it not been for SD's decision to instigate an audit.

(b) The cover up in respect of Programme 33 and MSC

1682. I am sure that Mr Whitcombe and Mr Henton acted dishonestly and told SD lies in an attempt to cover up what had happened in relation to Programme 33:

i) On Mr Henton's evidence, it is clear that he had learnt on 7 August that he had been told lies by Mr Brown; after he had discussed the position with Mr Whitcombe, it was clearly their duty to tell SD. Far from doing this, EIU even went so far as to praise SCB for their work in connection with the binder (see paragraph 1660).

ii) It was also their duty to tell SD that there was no reinsurance in place. They covered that up. This cover up, which began on 7 August 1998, was first manifested in the letter to Mr Coppinger on 11 August 1998 (see paragraph 1635) and continued throughout the entire remainder of the binder; it included the lies in the letter of 9 September 1998 (see paragraph 1649):

a) Mr Henton dishonestly stated that discussions had started in the early part of the year; they did not start until 30 April 1998. The lie was to try and explain the warranty date and to avoid explaining why he had only been approached so late in the year.

b) His answer given in relation to the absence of statistics was a lie; if he had been interested in the loss history, the information could have been produced. He also knew that the programme was intended to reinsure LMX business.

c) It was grossly dishonest to state there were reinsurances, when he knew the reinsurances were not in place.

1683. SD alleged that SCB were involved in the cover up; they had been colluding and were engaged in covering up what had actually happened – Mr Henton's deliberate involvement in the creation of a spiral and his failure to get the reinsurance he had insisted on. They agreed not to tell SD the truth, but rather to "sing from the same hymn sheet".
1684. SCB denied that they were engaged in any cover up; they did not know that the nature of the business was being concealed from SD; Mr Henton was told on 7 August 1998 that there was no reinsurance and that SD's outward reinsurances had been ceded; and if he had been lied to, he would have accused Mr Brown of lying and had nothing further to do with him; instead he went out to lunch. He never complained to Mr Butler; he even went to SCB's motor racing day on 27 August 1998 (see paragraph 1740.iii)).
1685. I am sure that SCB colluded with EIU in the cover up:

i) I am sure that Mr Brown was prepared to help Mr Henton concoct his response to SD, even though Mr Brown knew from the questions being asked that they were susceptible of a simple answer.

ii) If Mr Brown had acted honestly, he would have written a letter to Mr Henton answering the questions in Mr Henton's letter of 31 July 1998 quite simply and setting out the true position. He would not have engaged in drafting a series of letters that Mr Billyard, SCB and EIU were to send.

iii) SCB and SD had a joint interest in covering up what had happened in relation to MSC. Mr Henton's initial instinct was to invent an explanation – see his draft letter of 25 August 1998 at paragraph 1642.ii). Mr Brown's approach was to allow Mr Billyard to deal with the matter, but to amend his letter and then send it to Mr Henton and allow Mr Henton to amend it before it was sent (see paragraphs 1645.ii) and 1648.i)).

iv) Mr Brown was prepared to lie to help Mr Henton where he considered that the lies helped SCB and that those lies could be told without much risk; the letter drafted by him at Grand Hotel du Cap and given to Mr Henton contained two clear lies – that Mr Billyard entered the market late and statistics were difficult to prepare. Both those lies helped SCB in that they negated criticism of the placement of the risk. He was also prepared to consider obfuscating the position on a spiral – his draft produced on 7 August 1998 (referred to at paragraph 1629) was cleverly drafted.

v) However he was not prepared to lie, unlike Mr Henton, about the existence of the reinsurance as that was not in his interests to do so. He set out the correct position on the reinsurance in his letter of 8 September 1998, though he was prepared to provide an answer on the spiral that obfuscated the problem; that did not matter to SCB as provided that SD were on risk, the non existence of the reinsurance or the operation of the spiral were not matters that affected SCB, given the position that Mr Brown had taken.

vi) It is clear that EIU hoped that they could continue the relationship with SCB; that was evident from their interest in progress with Lincoln General (see, for example, paragraph 1642.iii)).

vii) SCB were only prepared to act in their own interests and only where those interests were clear were they prepared to help Mr Henton in his cover up of what had happened.

1686. Mr Henton's conduct in agreeing to take the extra premium in February 1999 was dishonest; he knew that SD would never have accepted that additional premium. SD contended that Mr Butler must have known this as well. I have concluded at paragraph 1768 that Mr Butler knew of the moratorium; he therefore knew that no further business could be accepted and that to put through the very large increase under Programme 33 was a clear breach of the duties EIU owed to SD. I am sure that given the state of the relations between SD on the one hand and EIU and SCB on the other as explained below, he knew SD would never have accepted the additional premium and his conduct was dishonest in this further respect.

12. PROGRAMME 26 AND THE BREACH OF THE MORATORIUM

1687. The other very important event in August and September 1998 related to a breach of the moratorium that occurred when EIU agreed to an endorsement that permitted a very substantial amount of new business to be ceded to one of the programmes written on Christmas Eve 1997 – Programme 26 (the retrocession from JEH Re of specific reinsurance covering Mr Cackett's WC account). It is necessary to explain the placing of the programme before turning to the events of August and September 1998.

(1) The placing of the programme

(a) Mr Cackett and Mr Billyard

1688. One of the risks presented by Mr Brown to Mr Henton on Christmas Eve 1997 was Programme 26 – a specific reinsurance, on an RAD basis, of a WC and occupational accident account which Mr Cackett had written in Bermuda for Phoenix and Sun Life; it had an inception date of 1 October 1997 and was to run alongside the generals programme (Programme 24) for the period from 1 January 1998 which was subsequently placed on 30 January 1998 with Mr Henton – see paragraph 1273 above and paragraphs 720 and following of Part II.
1689. Mr Cackett was a well known arbitrage underwriter:

i) He had been the underwriter of Syndicate 957 from the mid-1980s to June 1996; he had written PA business and probably carveout business as well, and because of his apparent success and his position he had been known in the market as "the king of arbitrage". Both he and Mr Billyard had reinsurances with very low retentions and covered those retentions with aggregate stop loss reinsurances. Mr Hines' evidence was that he had been very successful in making profits for the Names on his syndicate by writing at a low level and transferring the losses to his reinsurers.

ii) On the evidence before me, it appeared that he developed strong links with Mr Steed and Mr Lockett of Crawley Warren, who then moved to Rattner Mackenzie; he held his spiral capacity for Rattner Mackenzie. Mr Cackett left when the management of Syndicate 957 was acquired by D&H.

iii) He then set up Centaur in Bermuda. Mr Cackett (through Centaur) entered into underwriting management agreements with Phoenix (through Mr Swanick) on 26 August 1996 and with Sun Life of Canada (through Ms Sue Benson) on 12 September 1996, both of which took effect on 1 October 1996. American Phoenix fronted. There was a business plan that envisaged a gross premium income in the first year of $100m on which Mr Cackett's agency was to be paid 7.5% plus a profit commission.

iv) It is clear that he continued his to write on an arbitrage basis; it was Mr Butler's evidence that when Sun Life pressed him to raise his retentions for 1998, he effectively forestalled that by getting SCB to renew a low level XL reinsurance – see Programme 24 at paragraph 722 of Part II.

1690. With effect from the inception of the account on 1 October 1996, Mr Cackett had bought a reinsurance programme with a vertical limit of $40m xs $10,000. Low layers (or a low layer) of that reinsurance had been placed with Mr Billyard and under the Big Ben lineslip with Lincoln National.
1691. When his reinsurance programme came to be renewed with effect from 1 October 1997, Mr Cackett told SCB that he had bought more vertical cover than he needed and asked SCB to try to get back some of his M&D premiums on the layers that were effectively unexposed; he had written primary quota shares and excess business, and when he accumulated his lines, he found he had bought too much reinsurance. He asked SCB to place the renewal with the terms made more specific.
1692. The renewal was led by Mr Billyard, who scratched the slips on 10 November 1997 for 100% to sign 50%. By Christmas Eve 1997, SCB had not been able to find other subscribers so as to enable Mr Billyard to be signed down to the 50% level he required.

(b) Christmas Eve

1693. When the renewal was first presented to Mr Henton on Christmas Eve 1997, it was presented as six layers of XL reinsurance up to $8m xs $35,000 of WC and occupational accident business (excluding LMX but not excluding international XL) on an RAD basis for 12 months from 1 October 1997. Mr Henton agreed to write a line of 25%, but not on the lowest layer (which, according to his evidence, he was not offered). The effect of Mr Henton's subscription was to reduce Mr Billyard's line.

(c) 23 February 1998

1694. It is not clear what then happened, but SCB were probably unable to find anyone else to subscribe a further 25% such that Mr Billyard's line could not be reduced to the intended level of 50%.
1695. In any event, the programme was discussed on 23 February 1998; according to Mr Henton's evidence, he was told that Mr Cackett did not want the coverage he had asked for on Christmas Eve 1997, but only for up to $500,000. Mr Henton scratched new slips; confirmation was given by EIU on 24 February 1998 when the lines were entered. Mr Cackett reduced the layers to three. Mr Billyard wrote 100% of the bottom layer ($25,000 xs $10,000); Mr Henton and Mr Billyard wrote 50% each on the next two layers ($65,000 xs $35,000 and $400,000 xs $100,000). This was summarised in Diagram 26 (see paragraph 1.ii) of Part II). The programme was written in such a way that there were separate contracts for Phoenix and Sun Life; for example, the layer $65,000 xs $35,000 were written as a reinsurance of Phoenix for $32,500 xs $17,500 and a separate reinsurance of Sun Life for $32,500 xs $17,500, giving a combined layer of $65,000 xs $35,000; for ease of explanation and as the split into two contracts for each layer makes no material difference, the two separate reinsurance contracts and the figures in respect of them have been treated as one contract for each layer.

(d) The information provided on presentation on Christmas Eve

1696. The information provided to Mr Henton was (1) a letter from Mr Cackett dated 12 August 1997, and (2) claims statistics as at 15 August 1997.

i) The letter stated that Centaur had begun underwriting on 1 October 1996 and had purchased a specific reinsurance programme to protect:

"it[s] portfolio of alternative workers compensation/occupational accident writings through [SCB]."

This was, in the light of subsequent events, an important provision; the obvious meaning of it (as both SCB and Mr Cackett had understood and intended) was that the programme covered business provided to Mr Cackett through SCB. Mr Henton's evidence was that he had read it as meaning that the reinsurance programme had been obtained through SCB. On the obvious meaning of this provision (which I am sure Mr Henton shared) it was quite clear that Mr Cackett needed Mr Billyard's and Mr Henton's permission if business produced through sources other than SCB was to be covered by this reinsurance.

ii) The letter also stated that the original premium income estimate for 1996/7 had been $10m, but Mr Cackett's current estimate of the actual premium for that year (after acquisition costs) was $15m-$20m. Mr Cackett gave a premium income estimate for 1997-8 of $17m-$24m which he described as a modest growth of 20%; those figures were calculated after all acquisition costs to Sun Life and Phoenix, including Centaur's fees, had been taken into account. Mr Henton's evidence was that he did not know the amount of the ceding commissions or Centaur's fee; he did not ask because the leader would have taken that into consideration when writing the reinsurance.

iii) The letter further stated that the actual accounted for premium as at 31 July 1997 was less than $900,000; the M&D premiums for the renewal were therefore to be based on a figure of $5m.

iv) The letter then stated that the portfolio consisted of 25 contracts – six QS and 17 non-proportional XL contracts, almost all with unlimited reinstatements; a list of contracts was attached; included on the list were John Hancock, John Hancock (per JEH Re), CIGNA, Trustmark and All American (per WEB), Lincoln National, Realm National and Alternative Risk Reinsurance Co. Ltd. (a company connected with Mr John Pallat III, the Chief Executive Officer of Unicover referred to below at 1712). This was in fact all SCB business which Mr Cackett was obviously arbitraging. Even though the business to be covered by the reinsurance was almost three months old by Christmas Eve, Mr Henton made no enquiry as to what had been written by Mr Cackett or about the underlying business or about the rating of those writing the original business or the rating applied by Mr Cackett; his evidence was that that was not the normal sort of information he would expect to be given.

v) The claims statistics were as at 15 August 1997 and showed that there were no losses for the 12 months from 1 October 1996; they were too raw to be of any value in December 1997 or February 1998. No up to date statistics were obtained by SCB; it was Mr Brown's evidence that this was simply not practicable during the renewal season. There was no copy of these statistics on EIU's file; Mr Henton's evidence was that he had not copied them as there were no losses.

1697. Apart from that written information, Mr Henton knew that Mr Cackett was, as set out at paragraph 1687.i), an arbitrageur who wrote on the back of his reinsurers; his evidence was that he did not know that Mr Billyard, who was leading the layers he wrote, was also writing the bottom layer.
1698. He did not seek up to date information on 23 February 1998 when the programme was re-written, even though by that stage there would be a further two months' development.
1699. The rate charged (on the terms agreed in February 1998) for the two layers was 9% of the maximum estimated gross premium income of $24m set out by Mr Cackett; if the underlying premium was achieved, the premium for SD's line was to be $2.16m gross with a net to SD of $1.4m. EIU's commission would have been $430,000 on these figures.

(e) The basis of acceptance

1700. Mr Henton considered that this was gross loss making business but he anticipated making a profit on a net basis. It was obvious to anyone that Mr Cackett was retaining most of the premium and ceding most of the losses.
1701. There was no information to calculate the number of anticipated losses; SCB suggested that the underwriter would have been able to make a judgment based on his experience and knowledge. It was the evidence of Mr Greig that a reasonable broker in the PA market would have regarded the information sufficient to make an underwriting assessment. Sir Alan Traill's evidence was that the information was inadequate and that there was nothing up to date. I cannot accept Mr Greig's evidence that the information was adequate in that SCB had made no attempt to bring the information up to date by February 1998 when the business was re-written; Sir Alan's evidence on this was unanswerable.
1702. Mr Henton's evidence was that he increased EIU's line in February 1998 as there was less exposure and there would be more premium to pay the net losses, as he was looking at it on a net basis.
1703. Mr Brown's evidence was that he knew Mr Cackett was arbitraging and that the reinsurers would be paying the losses; he was reinsuring down to very low layers as everyone else did.
1704. SCB accepted in their letter of 4 December 2001 that this was writeable only on a net basis; Mr Hines' evidence was that this would be gross loss making.

(f) The position on losses

1705. There was no information on losses because, as explained below, the programme as it was re-written had been avoided by CIGNA, who was brought in August 1998 to front the programme.

(g) Conclusion on the acceptance

1706. I am sure that Mr Henton acted dishonestly in accepting this programme:

i) This was one of the risks that Mr Henton accepted in the circumstances set out at paragraph 1246.

ii) He knew that very little about the reinsurance he was providing and asked no questions; the only matter he really knew was that he was reinsuring for a significant amount of business at a low layer a man who made profits on the backs of his reinsurers; that by accepting this programme, he was making SD a dump for these losses in the first instance and then passing them into the reinsurance programme with which Mr Brown had provided him in return for writing the Christmas Eve programmes.

iii) He provided cover on an RAD basis whereas the outwards reinsurance he was obtaining was on an LOD basis for 1997 and 1998; although it was Mr Henton's evidence that he expected to obtain reinsurance on an RAD basis in due course, it was not proper to expose SD to the mismatch in terms.

iv) He had the opportunity of considering the risk again on 23 February 1998; he asked no further questions, despite the fact that there was a further two months of experience. He plainly had no interest in obtaining proper information.

1707. Mr Brown knew that Mr Henton was acting in dishonest breach of duty and assisted him in this:

i) This programme was put before Mr Henton in the circumstances set out in paragraphs 1246 and 1247 above; this programme was included because no one else was prepared to reinsure Mr Cackett at this level and Mr Billyard had been promised that his line would sign down.

ii) He also knew full well that no up to date information was provided when the risk was written again on 23 February 1998; that Mr Cackett was an arbitrageur and was deliberately writing gross loss making business with the intention of making a profit by passing the losses to his reinsurers; he knew that he was making SD a dump for these losses in the first instance and then passing them into the reinsurance programme he had created.

iii) He knew the risks to which Mr Henton had exposed SD by granting RAD cover when he only had LOD reinsurance (see paragraph 1246.xiii)).

(2) Mr Cackett's wish for changes: Unicover

(a) Mr Cackett's wish to change the security

1708. Cover notes were sent by SCB to Mr Cackett on 27 February 1998, but he would not accept SD as security; it was not clear when Mr Cackett raised this question, but it was before 17 March 1998. On 17 March 1998, Mr Butler sent an e-mail to Mr Cackett asking him whether, after reviewing information on SD and EIU, he still wanted the security changed. Mr Cackett replied on the same day:

"[SD] in themselves are acceptable to Phoenix however the relationship with EIU has not been agreed by them since we have not received any information from you as yet. I think that since we are 5 months down the line that we should finalise the matter & that you should issue us with cover notes for 100% JEH Re as you suggested."

1709. This difficulty could easily have been overcome by SCB seeking Mr Broad's specific approval, but Mr Butler's evidence was that he did not consider asking Mr Henton to get approval from Mr Broad. His evidence was that it was not market practice to get approval from principals for the risks written by agents. It is important to note that this issue arose shortly after a similar issue had arisen in relation to Unum (as set out at paragraph 1276.v)). I am sure that SCB did not ask that the risk be put to Mr Broad as it would have involved the risk of explaining the nature of the business being covered under Programme 26.
1710. It was Mr Butler's evidence that it was only on receipt of a fax on 29 April 1998 that he definitely appreciated that he could not persuade them to change their minds and that he had to take SD off. Mr Butler did not tell Mr Cackett in response that he might not be able to get Mr Billyard to increase his line to 100%; he was quite confident that Mr Billyard, who had originally written 100%, would increase his line again. However, no steps were made to take SD off the risk; on the contrary, premium was paid to them on 4 June 1998 and on 28 July 1998.
1711. There were further conversations and correspondence in June 1998. In a fax dated 26 June 1998, Mr Cackett to Mr Butler, stated:

"I spoke to Chris Kelly this morning…

Firstly I understand that you have the addenda amending the security on our cover notes to just JEH Re since Sun do not accept [SD] per [EIU]."

1712. Mr Butler's evidence was that when he was in Bermuda in June 1998, he had spoken to Mr Billyard; Mr Billyard had agreed to write 100%, if SCB needed him to do so, but he (Mr Billyard) would probably have asked him (Mr Butler) to talk to the market first, saying that he would do it if no one else would; he therefore thought that SCB had had Mr Billyard's verbal agreement, but there was nothing signed. There was a note in an unidentified hand apparently of an employee of Mr Cackett's company dated 1 July 1998 on a copy of the fax of 26 June 1998 which stated:

"Phoned JB 1/7/98 – he has approached Reg Billyard and he is in turn approaching his reinsurers. [SD] addendum is agreed but awaiting technician to draft for us."

Mr Butler's evidence was that he did not know to what that referred and he could not recall the conversation.

(b) Mr Cackett's wish to add Unicover business

1713. Mr Cackett's fax to Mr Butler of 26 June 1998 then went on to state that he had only written one contract protected by the reinsurance – a protection of JEH Re; he wanted to broaden the terms and include non-SCB business:

"This would mean that the income [under the reinsurance programme] would increase from $17-24m to something in the order $160m based upon M&D's/Est. PI's. This figure is before specific facultative cover which would bring that figure down possibly quite dramatically.

If this is agreeable to JEH Re. It would be useful in that it would take a swathe of income out of our whole account which would reduce the income that they would receive on 1998 year and also Lincoln National on the 1997 year."

Mr Butler's evidence was that SCB were aware that the majority, if not all, of business that would be ceded would be business which came from Unicover.

1714. Unicover was an MGA based in Chicago which managed a pool that was created in the US in the mid-1990s; the pool comprised a number of companies which from time to time included Phoenix, Reliastar, Reliance National, Lincoln National and CIGNA. The underwriter was Mr Tom Dunn (who had been employed by Reliance in New York) and the Chief Executive was Mr John Pallat III, to whom I referred at paragraph 1694.iv) above. There was a very remote connection between SCB and Unicover in that Mr Dunn and Mr Pallat were directors of Alternative Risk Reinsurance Co. Ltd. of the Cayman Islands, a captive associated with the SCB group's business of renting captives; Mr Mark Cooke and Mrs Cooke were also directors of that captive. This connection was, on the evidence produced to the Court, of no materiality to the wish of SCB to include the Unicover business within Programme 26.

(c) The enormity of Mr Cackett's involvement in Unicover

1715. The Unicover pool became very large. The extensive reinsurances of the pool written by Mr Cackett for three years from 1 December 1997 were set out in a schedule provided to SCB on 12 August 1998. These reinsurances were not placed by SCB, but by Mr Chris Mays (of Aon and Rattner Mackenzie) and Mr Roger Smith (of Aon).
1716. Mr Cackett had, according to Mr Butler's evidence, been writing Unicover business for sometime as he had been doing so at Lloyd's. When Mr Cackett moved to Bermuda, he had committed his principals to Unicover in a very large way for a 36 month period commencing 1 December 1997; a spreadsheet sent by Mr Cackett to Mr Brown on 12 August 1997 showed that he had written 100% of 5 burning cost reinsurances and the following:

i) He had written 100% of a layer $40,000 xs $10,000;

ii) he had written 100% of a layer $50,000 xs $50,000;

iii) he had written 50% of a layer $150,000 xs $100,000; and

iv) he had written 50% of a layer $250,000 xs $250,000.

1717. These were three year contracts which ran from 1 December 1997. The estimated premium incomes were staggeringly large by any standards – from $655m to $1.515bn; there was a potential for them to reach $4bn in the third year.
1718. The brokerage and the commissions that were to be earned by Mr Cackett's company and the brokers were 17.5% on the minimum premiums and 7.5% on the swing (that is, the difference between the minimum and the maximum premiums). The information set out in this and the preceding paragraphs became known to SCB at the latest by 12 August 1998 (as it was set out in the fax of 12 August 1998 and in the accompanying document – see paragraph 1732); it was Mr Butler's evidence that he went through that fax with Mr Riding probably sometime in September 1998, but that he was unable to understand the figures.
1719. By the end of June 1998 at the latest, rumours began to sweep the market about the adverse nature of Unicover business as there was considerable interest in Unicover in the market by then. For example, Mr Barnard had asked Mr Whitcombe whether he had any involvement in Unicover on 3 June 1998 (see paragraph 1430.v)) and discussed Unicover with Mr Watson after that meeting (see paragraph 1433.v)). As set out below at paragraph 1725.ii), Mr Billyard was well familiar with Unicover by early August 1998. Mr Brown could not recall when he became aware of rumours surrounding Unicover, but I am sure that he must have known by the end of July 1998; he had a very considerable interest in competition in the market and given the widespread interest in the market, he must have known by then.

(d) Mr Billyard's agreement to the "all sources" endorsement

1720. Mr Cackett's wish to include the Unicover business under this reinsurance was a fundamental change to the reinsurance and needed the clear and specific agreement of the reinsurers to be obtained after full disclosure by SCB of all the material circumstances.
1721. Mr Butler's evidence was that he got Mr Billyard to agree to the change to include Unicover business when he was in Bermuda at the end of June 1998; he had told him that the reinsurance programme included Unicover risks, though a question was raised about this by Mr Billyard in February 1999; Mr Cackett maintained that he had also told Mr Billyard of the exposure on the Unicover account himself. The apparent dispute is not one for me to resolve.
1722. On 20 July 1998 Mr Riding joined SCB; he was an experienced broker who had begun his career in broking in 1983 and in 1998 had been made redundant as a director of WFD; when at WFD he had placed what he described as pure arbitrage contracts involving the LMX spiral. Mr Butler had known him for sometime and had recruited him to help Mr Butler out as Mr Butler not only had his work as a broker, but was effectively deputy managing director. He was asked to join quickly as Mr Butler was going on holiday at the end of July 1998 and he was to deal with outstanding matters whilst Mr Butler was away, including, in relation to Programme 26, the request to replace SD as security and getting an endorsement signed to include non-SCB business. Mr Riding was employed at the time of the trial by Hanover Re Services UK which was running off the SCB book of business assumed by Clarendon.
1723. Mr Riding's evidence was that he was told by Mr Butler that he should first try Mr Billyard to see if Mr Billyard would replace SD. Mr Riding read the file which included Mr Cackett's fax of 26 June 1998 from which it was obvious that there would be an enormous increase in the premium income, but his evidence was that he did not then know the nature of the business that would bring about the increase, though it was also his evidence that Mr Cackett (whom he had known at WFD) contacted Mr Riding and discussed the position with him a few days after he had joined SCB.
1724. On 21 July 1998, SCB prepared an endorsement which was intended to extend the reinsurance to cover the Unicover business which Mr Cackett had written:

"It is noted and agreed by Reinsurers hereon that with effect from inception this Reinsurance contract shall cover the Reinsured's portfolio of Workers Compensation / Occupational Accident business emanating from all sources.

All other terms, clauses, conditions and warranties remain unaltered.

…

21.07.98."

The reference in this endorsement to "all sources" meant that this endorsement became known as the "all sources" endorsement.

1725. The striking feature of the endorsement is its blandness and the fact that no reference was made to Unicover nor to the estimated amount of premium that was to be ceded, even though the cession of the Unicover business and the increase in premium income was the clear and obvious intention of SCB and Mr Cackett. It was Mr Riding's evidence that the endorsement did not state the increase in the estimated premium income as that was not contractual.
1726. Mr Riding formed the view that it was more important to get the "all sources" endorsement agreed first whilst everyone was on risk, rather than trying to change the security.
1727. It seems clear that Mr Billyard agreed the "all sources" endorsement, but when he did so was, on the evidence, unclear. The evidence can be summarised:

i) On some day before 10 August 1998, Mr Riding spoke to Mr Billyard when Mr Billyard made one of his daily telephone calls to SCB and he was introduced to Mr Billyard over the phone by a colleague. A few days later, Mr Riding telephoned Mr Billyard. His evidence about his conversation in relation to the replacement of SD as security was contradictory; when cross-examined by Mr Henton, his evidence was that he had asked Mr Billyard if Mr Billyard would write a 100% line on the reinsurance, but Mr Billyard would not agree; later in his evidence, when cross-examined on behalf of SD, he said that it was his belief that this was not discussed. The probability is that this was raised and Mr Billyard made it clear that he refused to increase his line to 100%.

ii) Mr Riding's evidence was that they discussed the "all sources" endorsement which he understood had been sent to Mr Billyard; Mr Billyard was not prepared to sign it as Mr Cackett had taken on Unicover and Mr Billyard was not prepared to take that on. Mr Riding's evidence was that Unicover meant nothing to him and so Mr Billyard explained to him that Unicover was a pool of business which had got a phenomenal premium income and that Mr Cackett was involved in the reinsurances. He agreed to check with Mr Cackett if what Mr Billyard had said was correct.

iii) Mr Riding telephoned Mr Cackett who told him that Mr Billyard was correct about Unicover; that he had wanted to reinsure some of it to Mr Billyard; that in any event Mr Billyard was to get more of it from the accounts he had already written protecting Mr Cackett; that it was really a question as to the best way in which Mr Billyard would take that income for Mr Cackett.

iv) Mr Riding then spoke to Mr Billyard again and told him what Mr Cackett had said; that Mr Billyard ultimately agreed to take the Unicover premium as he was going to get it anyway; that, as he had one retention, the greater income did not matter. By this he meant that he would only have to pay one loss and therefore the greater income would benefit him.

v) A calculation was later done (after the endorsement had been signed) to show which was the better route to take the income. Mr Riding's evidence was that Mr Billyard knew far more about Unicover than him and wrote on the basis of his (Mr Billyard's) own knowledge.

vi) On 7 August 1998, Mr Riding faxed the "all sources" endorsement to Mr Billyard who was at his house in Essex, England; it was scratched by Mr Billyard prior to 10 August 1998.

vii) There are a number of copies of the endorsement with different dates of acceptance. On one copy of the endorsement there was a note in the hand of Mr Daniel De Melo, an employee of SCB in London, that this was accepted by Mr Billyard with a date of 4 July 1998 – some days before the document was prepared. On another copy there was a date of "7.9.98". Another two versions had Mr Billyard's stamp and the date "7/4/98"; Mr Butler's evidence was that this was 7 April 1998 and not 4 July 1998 as Mr Billyard always used UK dates. The evidence of Mr Riding was that Mr Billyard was haphazard in signing and dating endorsements but that it was not signed until sometime before 10 August 1998 as John Hancock were looking at Mr Billyard's records in August 1998. On the evidence, I cannot conclude that there was any deliberate backdating of the endorsement

(3) EIU's acceptance of Unicover business

(a) The question raised in the audit

1728. Although Programme 26 does not appear to have been examined in the course of the audit by Mr Mather and Mr Coppinger, Programme 24, the generals programme, was; it was Mr Henton's evidence that Mr Coppinger mentioned to him that the ART division were reinsured by Mr Cackett and had said that he supposed there would be a spiral. Mr Henton said that he agreed to check it out and spoke to Mr Butler about it. In his letter of 31 July 1998 to SCB (considered in relation to Programme 33 at paragraph 1619), Mr Henton stated in relation to the reinsurance of Programme 24:

"[SD] made the observation that whilst the Centaur underwriting information was very comprehensive, so much so that they took a copy of it as a good example of what they would like to see as information, the third page, copy attached, would appear to be incorrect. Their reasoning being that Centaur write layer of $900,000 xs $100,000 covering [SD's] Occ Acc/WCA carve out book, the information sheet reflects a largest line anyone contract for this class of $450,000."

1729. Mr Brown's draft letter of 6 August 1998 (referred to in connection with Programme 33 at paragraph 1621) pointed out that this was incorrect, as did the letter drafted at the Grand Hotel du Cap and sent to EIU on 8 or 9 September 1998. As set out at paragraph 1756 below, Mr Butler obtained confirmation that there would be no spiral.

(b) SCB's approach to EIU on 10 August 1998

1730. On 10 August 1998, after Mr Billyard had agreed to the "all sources" endorsement, Mr Riding went to see Mr Henton to seek EIU's agreement. As I have already mentioned at paragraph 1633, various matters other than Programme 26 were raised by Mr Henton and Mr Whitcombe. As I have mentioned at paragraph 1633, Mr Riding's evidence was that Mr Henton was more concerned with the reinsurance for Programme 33 and with the position in relation to Lincoln General (see paragraph 1545) than with Programme 26. On that occasion, Mr Henton agreed to an endorsement amending Programme 23 – see paragraphs 713 and following of Part II. The evidence about what was said in relation to Programme 26 was as follows.
1731. It was common ground that the "all sources" endorsement was proffered by Mr Riding and rejected by Mr Henton at that meeting (although it was later agreed to by EIU in September 1998 as set out below):

i) Mr Riding's evidence was that he would have had with him his file which included the endorsements and the fax from Mr Cackett of 26 June 1998; he believed (as best as he could recall) that he showed him the fax from Mr Cackett and the endorsements. He told Mr Henton what was in the fax and about the very large income stream and also mentioned Unicover as he wanted to see Mr Henton's reaction. There was none. Mr Henton told him they could not take new income to be generated by Mr Cackett writing the Unicover programme into his bottom end. Mr Riding did not regard that as a final "no", as a first refusal was not unusual; a broker would have tried again and would have come up with ideas to help with income. Mr Henton did not mention the moratorium.

ii) Mr Henton's evidence was that Mr Riding asked for additional premium income to be covered and he mentioned that the underlying premium in respect of this was $150m-$160m; Mr Henton could not recall if Unicover was mentioned, but it would have meant nothing to him at the time. Mr Henton told him that EIU could not take it. He accepted that the proposal would have meant an extra $6m in premium income to EIU. Mr Henton did not tell Mr Riding that there was a moratorium. He just said no, though he may have told him that EIU were not writing any more business at that point or that they had run out of income.

iii) Mr Whitcombe's recollection was that he had told Mr Henton that they could not touch it. He could not recall Unicover being mentioned and it meant nothing to him in any event.

1732. There was a dispute as to whether the issue of SD's replacement was raised:

i) Mr Riding's evidence was that he passed on Mr Cackett's request for SD's participation to be replaced.

ii) Mr Henton had no recollection of that. His evidence was that he thought he first learnt of that in late August or beginning of September 1998.

1733. Mr Riding then reported to Mr Brown:

"Centaur (Cackett) [EIU] cannot take on the new income to be generated by JC writing the Unicover programme into his bottom end. I suggest we take them off the slip and give 100% to Reg. Can Reg carry this/What do you think?"

(c) Mr Cackett's request for more reinsurance

1734. On 12 August 1998, Mr Cackett sent to Mr Brown a fax headed "Unicover Specific Protection", enclosing a spreadsheet that listed the reinsurances which covered a 36 month period from 1 December 1997 (to which I have referred at paragraph 1714); it also referred to the premium income estimates (set out at paragraph 1715) which Mr Cackett stated represented a dramatic growth from the original estimates. Mr Cackett wanted, as a matter of extreme urgency, in addition to the coverage of this business under Programme 26, more cover to reduce its exposure on the burning cost protections and on the layers $50,000 xs $50,000 and $150,000 xs $100,000.
1735. Mr Riding's evidence was that he was asked by Mr Brown to think of markets where the specific programme that Mr Cackett wanted might be placed. As he understood the position, Mr Cackett wanted both to reduce the income on his treaties, where the reinsurers might otherwise be reluctant to accept additional premium, and to protect himself from losses. Although he had had many conversations with Mr Cackett, both Mr Riding and Mr Brown concluded in the end that no further reinsurance could be obtained, particularly because of the rumours in the market.

(d) The failure to get Mr Billyard to replace SD

1736. Mr Butler returned from his holiday on Monday 24 August 1998 and was told shortly thereafter by Mr Riding that Mr Henton had declined the "all sources" endorsement; Mr Butler's evidence was that he did not know that it was because of the premium moratorium.
1737. On Tuesday 25 August 1998, Mr Butler spoke to Mr Billyard; he asked Mr Billyard to write 100% of the risks with a facultative reinsurance from SD and sent him a fax which attached a worksheet that referred to Programme 24 (the generals) and to Programme 26; the worksheet suggested acceptance under Programme 26. Mr Butler's evidence was that he was under the impression that Mr Billyard had already agreed to write 100% of the risks, though, as he accepted, the fax did not read that way. The fax stated:

"You originally wrote 100% of these risks and were subsequently signed down. Due to difficulties between this client and your co-reinsurer we have been asked to remove them from these covers. By asking you to write 100% of these risks we obviously ask you to increase your exposure/premiums, and would therefore suggest that we offer FAC RI with your co-reinsurer who you already do business with ([SD]). This once again leaves you in an identical situation with no more exposure or premium and I can confirm that they have in principle agreed to this (emphasis added) as once again this leaves them in no different situation."

1738. Mr Butler's explanation was that that he knew a team from John Hancock were at JEH Re at the time doing an audit; that Mr Billyard had possibly told him that he had had the John Hancock people there and that he wanted it to come as if it was a new approach because he had not got anything previously; Mr Riding's evidence was that he recalled Mr Butler saying that he had spoken to Mr Billyard, who had asked Mr Butler to provide a more formal request.
1739. Mr Butler's evidence was that his statement in the fax that SD had agreed in principle was that was probably a "bit of broker licence" as; although EIU had not agreed, he expected them to do so. Mr Riding's evidence was that he did not know if there was an agreement with EIU; Mr Butler may have seen Mr Henton and Mr Whitcombe to discuss this as SCB saw Mr Henton and Mr Whitcombe daily, if not two or three times a day. Mr Riding's evidence was that he did not know if Mr Butler had seen Mr Henton or Mr Whitcombe separately.
1740. Mr Billyard refused to do as he was asked. It is not necessary to set out the evidence on this save to say that Mr Butler was upset and had an argument with Mr Billyard as Mr Butler felt that he had had an agreement with Mr Billyard to write 100% and to replace SD and he had been let down.
1741. Mr Cackett was informed on 27 August 1998 that Mr Billyard had not done as SCB had hoped in a fax sent by Mr Riding. He stated in it he had not been able to speak to Mr Brown or Mr Butler; this was not true. It was Mr Butler who had the conversation with Mr Billyard and who must have told him of the refusal; furthermore although Mr Butler and Mr Brown were, as set out below, at a client entertainment day, they were clearly contactable and I am sure that this problem was discussed.

(e) The agreement of CIGNA to front for SD

1742. After Mr Billyard's refusal, there was discussion between Mr Bird, Mr Butler and Mr Riding as to who could write "big" and front for SD. It was agreed that CIGNA was the obvious choice and that they would seek from CIGNA an oblige line as a front.

i) Mr Bird said that it could not be put under the lineslip and Mr Riding was asked to speak to Mr Minter at CIGNA to see if he would take on Centaur's bottom end, though they anticipated that this would be difficult, as they believed that Mr Minter did not like writing reinsurances of Mr Cackett.

ii) On Wednesday 26 August 1998, Mr Riding saw Mr Minter; Mr Minter refused to write the risk, using some "anglo-saxon" and telling Mr Riding to go away.

iii) On Thursday 27 August 1998, Mr Henton, Mr Butler and Mr Brown were at SCB's client entertainment day at a motor racing circuit.

iv) On Friday 28 August 1998, Mr Butler went to see Mr Minter as Mr Riding was away attending a CIGNA client event in Monte Carlo. In the result Mr Minter agreed to front for SD. There was a very substantial dispute between Mr Minter and Mr Butler as to whether Mr Butler had told Mr Minter about Unicover and about the size of further premium. As Mr Minter did not give evidence, it is not appropriate for me to make any finding. I will however set out Mr Butler's evidence which was that:

a) he told Mr Minter that he needed a favour;

b) he asked Mr Minter to step in as a front;

c) he was not going to go away until Mr Minter did;

d) Mr Minter then agreed to replace SD, but on the basis that it was administered under the lineslip;

e) Mr Minter had no difficulty with fronting but had a difficulty with the size of the premium; and

f) he then informed Mr Cackett of what he had done.

v) Early in the following week, on Mr Riding's suggestion, Mr Butler made a note of the circumstances in which Mr Minter had made the agreement.

1743. On 28 August 1998, Mr Cackett was sent a fax by Mr Butler's secretary on his instructions:

"As you are now aware due to circumstances beyond our control JEH Re Bermuda have changed their mind about replacing [SD] on the above mentioned treaties. As you know, I have previously been given the impression that this was not going to be a problem and it is only when finalising the documentation that this situation has arisen. In order to alleviate your problem with [SD] I have this morning replaced their lines with CIGNA Re Europe (Paul Minter)."

(f) A lunch at Willy's Wine Bar in September 1998?

1744. It was common ground that EIU agreed in September 1998 not only to cancel the original programme under which they directly reinsured Mr Cackett and rewrite it as a retrocession of CIGNA thereby giving effect to the front, but also agreed the "all sources" endorsement which Mr Henton had declined on 10 August 1998.
1745. It was EIU's case that they only agreed the "all sources" endorsement on the basis that the estimated underlying premium income would remain $17m-$24m as had been stated when the reinsurance was written on Christmas Eve 1997 (see paragraph 1694.ii)). SCB's case was that the true effect of the "all sources" endorsement was properly explained to them and their consent obtained at a lunch at Willy's Wine Bar (Bill Bentley's); that Mr Henton agreed to change his mind because there was a corresponding reduction in the premium income under another programme.
1746. It was Mr Riding's and Mr Butler's evidence that the lunch at Willy's Wine Bar was probably in the first week of September 1998 and that they had been present with Mr Henton and Mr Whitcombe. It was at this lunch that Mr Henton and Mr Whitcombe had agreed in principle to write the "all sources" endorsement and to being fronted for by CIGNA. Mr Whitcombe and Mr Henton denied that there was any such lunch.
1747. Mr Butler first mentioned the lunch in his fourth witness statement dated 6 March 2002, but he could not give an exact date; his diary gave a date of 3 September 1998, but that day he was having lunch with Mr Hedley of MBR (see paragraph 1643). Mr Riding thought that the lunch was on 3 September 1998, though his diary did not contain any entry for this; there was nothing in SCB's expenses sheets and the entries in other diaries conflicted.
1748. Mr Butler and Mr Riding's evidence as to the meeting was:

i) Mr Butler arranged the lunch and asked Mr Riding to go along; they felt it a good idea to see where EIU were coming from on their premium income.

ii) Mr Riding was sure in his recollection as to what had happened. It was early in his time at SCB; the sums involved were so much larger than the conventional PA insurance he had seen; in his time at WFD he had lived a different lifestyle as he had never been asked to go to a football match in Monaco or take a trip in a helicopter from Nice to Monaco on the occasion (referred to at paragraph 1740.iv)).

iii) They may have met Mr Whitcombe first at The East India (a pub across the road from Willy's Wine Bar), where they had met with Mr Henton and Mr Whitcombe before in the same way as they had met with them at Balls Brothers. The lunch, according to Mr Riding, lasted 1½ to two hours.

iv) At that lunch, SCB mentioned again the increase in the premium income from a change to all sources would be up to $160m in the underlying cover and mentioned the endorsement to permit that; Mr Butler's evidence was that he explained the increase was primarily due to Unicover, but Mr Whitcombe and Mr Henton made no further enquiry about the nature of the business. Mr Riding's evidence was that he did not think Unicover was mentioned at the lunch.

v) SCB stated that the premium income for the 95% QS of JEH Re for John Hancock (Programme 28) was much less and would be $20m (as Mr Butler had been told this by Mr Billyard at some point prior to the lunch); this reduction would have cancelled out the increased premium in Programme 26. They had put this matter forward as they thought that EIU would be over their income.

vi) Mr Butler accepted that this was the same reduction on Programme 28 that was discussed in February 1999 in relation to Programme 33 (as set out at paragraph 1665); when he asked Mr Henton in February 1999, he had overlooked that the reduction had been taken into account under Programme 26.

vii) They mentioned the proposal for CIGNA fronting for SD on Programme 26.

viii) Mr Henton and Mr Whitcombe asked Mr Butler to check and, if he was right about the premium income on Programme 28, then they would accept the increase on Programme 26. EIU had no difficulty with the front.

ix) They did not describe the underlying business, as that was not the way the market worked.

x) After the lunch, Mr Butler checked the premium income position with Mr Billyard in respect of Programme 28 and was told that it was only in the region of $20m. Mr Riding told Mr Henton this and Mr Henton agreed to accept the $160m underlying premium under Programme 26; Mr Riding said that he would be preparing the documents.

xi) Mr Riding did not make a note of the agreement at the lunch because they had got on to the subject immediately; Mr Whitcombe had signed the slip shortly thereafter; the discussions with EIU were not of the stony nature or of the animosity that there had been with Mr Minter.

1749. Mr Henton's and Mr Whitcombe's evidence was that the lunch had not taken place and that the evidence of SCB was untrue:

i) Mr Whitcombe did not recall the lunch. He had returned from holiday on 1 September 1998 and looking at his diary, it was very full between then and 10 September 1998.

ii) Mr Henton had no recollection of the lunch. He had had no discussion about the decrease in the premium on Programme 28 until February 1999 when it was raised in connection with the increase on Programme 33; he was then told that the underlying reduction was to $20m from the estimate of $72m-$77m, provided in the materials presented when Programme 28 was broked (see paragraph 623 of Part II). This would have produced a reduction in the premium under Programme 28 for EIU by about $8.5m (EIU's written line was 15%). Although Mr Henton accepted that this would be more than enough to compensate for the increase in Programme 26, this did not matter. Programme 26 was a 1997 risk and Programme 28 was a 1998 risk. As EIU had separate premium income limits each year, the reduction in premium for Programme 28 could not have helped as this was attached to the 1998 year whereas Programme 26 was attached to the 1997 year. However, Programme 33 was a 1998 programme and he was prepared to consider an increase in the income on a 1998 contract in return for a reduction on another 1998 contract. Mr Henton also relied on the fact that there was no change between the 31 August 1998 and 30 September 1998 bordereaux which EIU had submitted to SD, but that a change on Programme 28 had been recorded in the 31 January 1999 bordereau.

(g) The signing of further slips and endorsements

1750. On Thursday 10 September 1998 (the day Mr Henton went on holiday) Mr Whitcombe initialled in pencil "C&R" (cancel and replace) three slips interposing CIGNA on the layers that comprised Programme 26. Neither Mr Henton nor Mr Whitcombe had any difficulty with CIGNA fronting for SD as the front did not cost SD anything as brokerage was not paid. Mr Whitcombe's evidence was that this was merely interposing a front on which the risk was on the books; it was not a breach of the moratorium.
1751. It is unclear whether Mr Whitcombe also scratched the "all sources" endorsement that day.
1752. After EIU had signed off the slip endorsements and a set of facultative reinsurance slips, Mr Riding's evidence was that he went to see Mr Minter to get Mr Minter's agreement; Mr Minter was very annoyed and told Mr Butler that it was nothing to do with him; he said that Mr Bird would put it through the lineslip: "Give it to Birdy, Birdy will do it". Mr Riding gave the slips to Mr Bird who then dealt with them. Mr Bird's evidence was that his involvement was as a "hod carrier" (a bricklayer's labourer); he simply took the slips down for Mr Minter to sign off, but was not involved in reviewing the risk. The declaration page under the lineslip was taken to Mr Minter by Mr Bird. Mr Riding told Mr Minter that these were the slips that he (Mr Minter) had discussed with Mr Butler about Mr Cackett.
1753. Mr Riding's evidence was that the "all sources" endorsements had still not been signed by Mr Minter; he went to see Mr Minter again on Monday 14 September 1998; Mr Minter took the endorsements and scratched two of them in pencil "via L/S". Mr Minter later scratched them in pen when he was in a better mood.
1754. Mr Henton returned from holiday on 24 September 1998. At the end of September 1998, Mr Henton was seen again by SCB.

i) Mr Henton put his stamp on the new fronting slip showing CIGNA as the reinsured.

ii) Mr Henton unstapled the old confirmation notes dated 24 February 1998 from the old slips and put them with the new slips.

iii) Mr Henton scratched the "all sources" endorsement to the old slips (showing Phoenix and Sun Life as the reinsured) which had been signed by Mr Minter on 14 September 1998. Mr Henton's evidence was that he was told by someone from SCB (he could not remember whom) that SCB had not produced as much business to Mr Cackett as they had wanted and Mr Cackett would therefore not achieve his target; Mr Cackett therefore wished to include business from other brokers to achieve the estimate premium income originally intended. He was not told that the premium would be any greater than originally represented. He would never have agreed if he had realised that this was an attempt to put through the proposal mentioned on 10 August 1998 for the increase in the underlying premium income of up to $160m. Mr Henton's evidence was that the purpose of the endorsement was to open the reinsurance to other business, but that the income was to remain within the original limit; that he could not recall asking any questions as to the source of the new business (though he did not normally expect to see that sort of information) or as to its loss history; he could not say why he had not and he did not know that the business was coming from Unicover.

iv) Mr Henton's evidence was that he believed that all he was doing was allowing the original income target to be achieved and that that had already been accounted for; he did not look on it as increasing the premium.

v) Mr Butler's evidence in his original statement was that as EIU had seen all the material information on the placing of the risks when they directly reinsured Mr Cackett, it was not necessary to show it to them again. It may well have been Mr Riding who took the slips on this occasion, but it does not appear that he provided any further information when the slips were signed.

vi) Mr Henton removed the old slips. His evidence was that he did so as they had been replaced; that he was not concealing anything.

1755. On 8 October 1998, an "all sources" endorsement attaching to the new contract with CIGNA was scratched.
1756. Mr Henton's evidence was that he did not then know of the problems surrounding Unicover, though it later came into the exclusions in the cessions treaty from WEB (see paragraph 1656) and in the reinsurance offered by WEB for 1999 (see paragraph 1793).
1757. It was SD's case that as Mr Cackett had rejected SD as security, the risk had not been taken up and that therefore this was a new risk which EIU had no authority to write. Mr Henton did not agree. Mr Butler viewed them on risk as they had not been taken off.

(h) SD were not told

1758. As set out at paragraph 1726, a question had been raised by Mr Mather and Mr Coppinger in relation to Programme 24, the other programme protecting Mr Cackett's business though as a retrocession of Mr Billyard. On 8 September 1998, one of Mr Cackett's assistants sent to Mr Butler a fax which confirmed that a cession would not be made to the occupational accident specifics – a reference to Programme 26. It was not clear on the evidence as to whether there had been a further enquiry in relation to Programme 26 or that the reference to Programme 26 was an error. There was no evidence as to when this information was conveyed to SD.
1759. SD were not told of the fronting or of the "all sources" endorsement.

(i) The repudiation by CIGNA

1760. By December 1998, there were many rumours in the market about Unicover to the effect that they had taken a large part of the market which covered middle size employers by undercutting the competition, and that they had written a staggering quantity of business.
1761. On 2 December 1998, Mr Cackett visited Mr Minter; there were recriminations about the premium income. There was then a meeting between Mr Cackett and SCB; it was put to Mr Cackett that the premium under Unicover was $1bn; he would not agree or disagree. This led SCB to conclude that they had underestimated the amount of premium and that it was more than $1bn. CIGNA repudiated cover on 12 January 1999.
1762. An arbitration ensued in which CIGNA were successful.

(4) Conclusion

1763. There were two factual issues in dispute on which I did not hear the evidence of the other parties; the first was whether Mr Billyard had promised to assume 100% of the reinsurance in place of SD and then reneged on that promise; the second related to the basis on which CIGNA agreed to front. I did not hear evidence from Mr Billyard or Mr Minter; although the dispute involving Mr Minter has been the subject of an arbitration which has been concluded, I do not consider that it would be right to make any findings, particularly any adverse to Mr Butler, when I have only heard one side of the evidence and it is not strictly necessary for me to make findings to resolve the dispute before me.
1764. I shall therefore proceed on the assumption most favourable to Mr Butler that Mr Billyard did renege on his promise and that Mr Butler's version of events relating to Mr Minter is correct and in particular that he told him about Unicover.

(a) Was there a breach of the moratorium?

1765. It was clear that the writing of the "all sources" endorsement was a breach of the moratorium agreed between SD and EIU (as explained in the evidence set out at paragraph 1474); this was SD's case and not disputed by SCB, though SCB submitted that EIU's breach was not dishonest.
1766. Mr Henton's evidence was that they understood that no new or renewal business could be written and that they could not authorise increases in original premium income estimates on contracts they had previously written. EIU therefore contended that there was no breach because there was no increase in the premium income beyond that originally envisaged; Mr Henton's evidence was that he thought that allowing business from brokers other than SCB up to the original limit was merely allowing Mr Cackett to write what he had originally intended.
1767. I cannot accept that contention or the submission made by EIU and referred to at paragraph 1474 has any basis. Mr Henton and Mr Whitcombe understood that SD did not want any further business of the type EIU had written. Without the "all sources" endorsement further risks and the additional premium could not have been ceded; the "all sources" endorsement permitted new risks to be ceded, as without it the further business could not be ceded. That was known by Mr Whitcombe and Mr Henton to be contrary to what they had agreed.

(b) Did SCB know of the moratorium?

1768. During the course of the trial I gave SD leave to amend to plead that SCB knew of the moratorium and that by obtaining the "all sources" endorsement they were assisting EIU in breach of their fiduciary duties to SD.
1769. There was a conflict of evidence as to whether SCB knew of the moratorium:

i) Mr Whitcombe gave his evidence on this issue in cross-examination on day 29 of the trial; his initial response was to assert that Mr Brown and Mr Butler did not know, but he stated during the course of that cross-examination that he had told Mr Riding of SCB that no more business could be written; that that there was "a fair chance" and "it was very likely" that he had told Mr Brown and Mr Butler that they would not be doing any more underwriting. He added he was sure that they would have known.

ii) Mr Henton's evidence was given in cross-examination by SD on day 33 of the trial. He could not remember telling Mr Brown and Mr Butler of the moratorium. In September 1998 there was certainly a discussion with SD about the moratorium being lifted to deal with the question that had arisen as EIU had promised to renew all the layers on the Realm B&S programme (Programme 9) on 8 July 1998 (see paragraph 1538.iii)c)); at the end of September 1998 SCB would have been aware of the position. He would, however, not have used the word moratorium, but it is likely he would have said at that point that they did not have any more income so that they were not writing any business. He accepted the suggestion put to him on behalf of SD that he may well have told Mr Brown in early August that they could not write any more premium until SD let them start again.

iii) Neither Mr Whitcombe nor Mr Henton gave any evidence as to the occasion on which Mr Butler and Mr Brown might have been told.

iv) Mr Riding's evidence was that he was not told that there was a moratorium.

v) Mr Brown could not recall being told by Mr Henton that there was a moratorium.

vi) Mr Butler's evidence was that he was not aware that there was a moratorium.

1770. In view of the findings I have made elsewhere about Mr Henton and Mr Whitcombe and the fact that they would have an interest in implicating SCB, I have approached their evidence with a great deal of caution. I accept that there is an important distinction between SCB being told by EIU that they were not writing further business because they had used their premium income capacity (which is an ordinary incident of underwriting) and being told that they had been told to stop writing by SD. However, I am sure that Mr Brown and Mr Butler were told not merely that EIU were not writing new business but that EIU had been told by SD not to write any more business:

i) SCB knew that SD had visited Bermuda and asked Mr Billyard a number of questions; he had understood that it had been a hostile meeting – see paragraph 1463; that SD had conducted an audit at EIU and asked a number of questions, including one in relation to Mr Cackett's Programme 24 (see paragraph 1726) and the question of a spiral. They also knew that Mr Mather was still probing (see his letter of 20 August 1998 in relation to Programme 33 which was forwarded to SCB – see paragraph 1640); Mr Mather was also dealing with reinsurance for the account – Mr Riding had a meeting with him on 11 September 1998 – see paragraph 1776.

ii) As set out at paragraphs 1633 and following, EIU were chasing SCB in respect of the outwards reinsurances that they needed; in the first week of September 1998 SCB had obtained the agreement of Mr Sparkes of New Cap Re to write a QS.

iii) As set out at paragraphs 1543 and following, SCB and EIU were engaged in the search for further capacity; it would have been extraordinary if EIU had not told Mr Brown and Mr Butler of the position with SD and in particular that Mr Broad had left, that Mr Mather had taken over the account and that they were not permitted to write any more business.

iv) As set out at paragraphs 1706 and 1709, the difficulty that Mr Cackett's principals had with SD was the fact that the placement was through EIU. It was very clear when Mr Billyard refused to write 100% of the programme that SCB were in so difficult a position that they went to ask Mr Minter for a big favour. Why did they need to do it when the obvious course at that time was to approach SD to approve the risk direct and so overcome the objection of Mr Cackett's principals? The only explanation for not doing so was either because it would have meant running the risk of telling SD about the nature of the business (as I have concluded was the case in respect of Unum and the decision not to approach SD in March in relation to Programme 26 – as set out at paragraph 1707) or because of the moratorium. If it was the former, then although that would not have shown knowledge of the moratorium, that would show knowledge that SD would not approve the business in whatever form it was written. I raised, in a letter to the parties on 21 March 2003, the fact that this specific point was not put to Mr Butler or Mr Brown; it was submitted by SD that the issue was put to Mr Butler in relation to the position in March on this programme and in relation to Unum, as indeed it was. In the circumstances I consider it entirely fair to consider the matter. I am sure that Mr Butler would never have gone to the lengths he went to with CIGNA as he set out in his evidence and which I have summarised above, unless he knew that he could not go to SD because they would not agree to what he wanted either because of the moratorium or because he knew the business was written without their authority.

v) There was no dispute that Mr Henton and Mr Butler agreed in February 1999 that more premium income could be written to one programme (Programme 33) as there was a reduction in another – Programme 28; thus irrespective of the dispute over Programme 26, there was agreement between Mr Butler and Mr Henton on a solution to a problem faced by EIU. What was the nature of that problem – a simple excess of premium income or the moratorium? In my view this is equivocal as to whether they knew about the moratorium.

vi) The fact that Mr Whitcombe and Mr Henton did not identify a time at which they told Mr Brown or Mr Butler of the moratorium is a factor, but there were many occasions on which Mr Whitcombe or Mr Henton could have told SCB. Mr Riding's evidence referred to at paragraph 1737 was that SCB saw EIU daily if not two or three times a day.

(c) What were EIU told about the "all sources" endorsement?

1771. SCB contended that:

i) Mr Riding was an honest witness who gave his evidence convincingly and would have every reason to recall the lunch because he was new to SCB; he had not concocted a story with Mr Butler and, as he had told EIU about the increase in premium income under the endorsement on 10 August 1998, he would not have suppressed the truth at a subsequent meeting.

ii) The justification that EIU relied upon for accepting the "all sources" endorsement with no increase in the income applied equally to the endorsement with an increase in income; as there was a corresponding decrease in Programme 28, there was no overall increase.

iii) EIU had a motive for lying, given the terms of the moratorium.

iv) It would be extraordinary having refused to do what Mr Riding had asked on 10 August 1998 that they should thought that this was something different.

v) The original slip for the business was not on the file.

1772. On the other hand:

i) The shortfall in income was in fact used subsequently to deal with the income under Programme 33 (see paragraph 1665).

ii) There were no vouchers for the lunch.

iii) There was nothing on the endorsement to show that premium income would be increased.

1773. I am satisfied on the evidence that EIU were not told:

i) As I have set out at paragraph 1723, the "all sources" endorsement did not state the true purpose of what was intended; nor was any underwriting information available save the fax of 26 June 1998 from Mr Cackett which was wholly inadequate.

ii) Mr Butler had originally asked Mr Riding to persuade Mr Billyard to agree to the "all sources" endorsement without explaining to him the significance of the Unicover involvement; that was discreditable conduct on the part of Mr Butler. Mr Riding was thereby put in the position of having to broke a risk with the material information withheld from him.

iii) Mr Riding discovered the true nature of the Unicover account when he was told of it by Mr Billyard when he broked the change to him; he learnt then that the fact that Mr Cackett was exposed to Unicover was the reason for Mr Billyard's refusal. Mr Billyard had then only agreed to accept the Unicover business as he was going to get it anyway.

iv) No honest person could have approached EIU to accept the business without detailed information about Mr Cackett's exposure to Unicover and without explaining the full facts surrounding Unicover, as by that time I am sure that Mr Brown and Mr Butler fully understood the size and nature of the Unicover account and Mr Cackett's role. A proper presentation was required.

v) It was dishonest to have told Mr Billyard on 25 August 1998 that SD had in principle agreed to reinsure him; his description of it as "broker's licence" does not disguise the fact it was a deliberate lie. On the assumption that I have made that Mr Billyard had promised Mr Butler that he would take back the risk 100%, it was dishonest of him to have complied with Mr Billyard's request to draft his fax so that it appeared to be a new approach. The only purpose was to deceive John Hancock's team that were present in Bermuda, just as his lie about SD's agreement in principle was also designed to deceive them.

vi) Mr Brown and Mr Riding had concluded that they could not place the additional protections for Unicover which Mr Cackett had asked for on 12 August 1998 because of the rumours in the market about Unicover. I am sure that Mr Butler was concerned that if he explained the true effect of the endorsement and the involvement of Unicover, there was a risk that Mr Whitcombe (who had not been as ready to fall in with SCB's dishonest conduct as has Mr Henton) would not have agreed, particularly in the light of the scrutiny being applied by SD.

vii) The justification put forward by SCB for the ability of EIU to do this was the decrease in income under Programme 28; it is common ground that that was used to offset the increase in Programme 33. If an agreement had been made to use this in August 1998, it seems incredible that both Mr Butler and Mr Henton had forgotten by February 1999.

viii) The computer record kept by EIU showed the offset in premium between Programmes 28 and 33 was reflected – see paragraph 1669. No such record was made of change to Programme 26. As these were Mr Henton's internal records, they lend some support to the fact that no similar arrangement was made to Programme 26

ix) No notes of the meeting over lunch at Willy's Wine Bar were made by either Mr Riding or by Mr Butler or of the subsequent conversation with Mr Billyard, notwithstanding the fact that it was Mr Riding's and Mr Butler's evidence that, by virtue of his experience at WFD, Mr Riding was the sort of person who made notes of such important events and a note was made of the meeting on the related meeting with Mr Minter.

x) No expense claim form for this lunch could be found, nor was there any such entry on the SCB expense sheets that were disclosed. This is not that significant as a factor, as there SCB's expense records were not kept in as good an order as they should have been and there is the possibility that Mr Whitcombe or Mr Henton paid; however, it is a factor.

xi) It made little sense for EIU to agree to an offset in premium between Programme 26 (which was a 1997 risk) and Programme 28 (which was a 1998 risk), though this is difficult to reconcile with the evidence given by Mr Henton in relation to the premium on the Christmas Eve bordereau – see paragraph 1209.

xii) I regret to conclude that I cannot rely on Mr Riding's account or his independence. He was not in his behaviour or the way in which he gave his evidence an impressive witness; for example in the contradictory evidence he gave in relation to Mr Billyard referred to at paragraph 1725.i), he was most uncomfortable. He should have explained the full impact of Unicover when he went to see Mr Henton and Mr Whitcombe on 10 August 1998, particularly when, according to his evidence, he mentioned it, Mr Henton did not react. He knew then Mr Henton did not understand the significance of Unicover. It was clear that he was a man prepared to do Mr Butler's bidding, although I am sure that he was not told more than he needed to know. I therefore reject his evidence as untruthful and find he gave that untruthful evidence in an attempt to help Mr Butler.

1774. If I had found that EIU had been told of the purpose of the endorsement, Mr Butler had mentioned Unicover in the way Mr Butler explained in his evidence and that SCB did not know that there was a moratorium, I would nonetheless have concluded that in accepting this endorsement EIU acted dishonestly and manifestly contrary to the interests of SD and that SCB knew this and acted dishonestly.

i) As set out at paragraph 1768.iv), there can be no explanation for the failure to go to SD to get the risk approved unless they knew SD would not approve risks of this type or because they knew of the moratorium. If they did not know of the moratorium, then they did know that SD would not approve risks of this type.

ii) SCB knew that SD were asking questions and that Mr Mather was taking a keen interest; once anyone was told either of the increase in the premium or the involvement of Unicover, questions would have been asked by SD and enquiries made by them about this risk. These would have revealed the reason why Cackett wanted a replacement, the reason for the involvement with CIGNA and no doubt in due course the size of the business being written by Unicover. If the truth had emerged, there was no prospect that SD would have approved the risk.

iii) The omission of any information on the endorsement as to its true purpose was deliberately designed to conceal from anyone reading it the true purpose of what was to be done. If SD had called for the file, there was nothing to alert them to the very serious implications of the endorsement and what its true purpose was.

iv) I am sure that Mr Butler and Mr Riding knew that no honest underwriter acting in the interests of his principal could have taken on such a commitment by way of increase in income without proper underwriting information; they came with none.

13. THE AFTERMATH

(1) Events of the autumn of 1998

(a) SD instruct lawyers

1775. On about 11 August 1998, Clyde & Co were instructed on behalf of SD and in early December 1998, US lawyers were instructed.

(b) Attempts by SD to obtain co-insurance or reinsurance

1776. On 12 August 1998, HHI were informed by SD formally that responsibility for the account had been transferred to Mr Mather.
1777. After SD had imposed the moratorium, they discussed obtaining co-insurance or if that was not possible, reinsurance.
1778. Among companies that were considered were Bimeh and New Cap Re, but no further reinsurance or co-insurance was obtained. SCB was approached, according to the evidence of Mr Riding, by EIU to see if they could obtain more reinsurance. In September 1998, SCB put to Mr Sparkes of New Cap Re, a proposal to write a 25% QS of SD's business; he put a line down on a copy slip. That line was put down during a visit which must have been in the first week of September 1998, as on 3 September Mr Butler met them for lunch. EIU were told. A meeting between Mr Riding and Mr Mather took place on 11 September 1998 to put the proposal to him. Mr Mather decided in mid October not to proceed with New Cap Re.

(c) Mr Broad's actions after leaving SD

1779. After leaving SD, Mr Broad set up an underwriting agency, Holt UK, of which he was the Managing Director and a shareholder; he was joined there by Mr Tunstall.
1780. Sometime thereafter Mr Broad met Mr Whitcombe and Mr Smith and wanted to acquaint them with his future plans. He introduced Mr Whitcombe to Mr Chalhoub of Reass in the hope that EIU might get authority from Fidelity Security Life Insurance Company. It is obvious from this, as SCB rightly submitted, that Mr Broad's good relations with Mr Whitcombe were unimpaired by what had happened at SD. It was Mr Broad's evidence that he did not then know of the allegations and was trying to help Mr Whitcombe. Mr Whitcombe's evidence was that he was going to pay Mr Broad a commission of 2.5% and he discussed this with Mr Broad; this discussion was at an early stage so that Mr Broad knew where he was. Mr Broad denied this.
1781. A proposal was submitted to Mr Chalhoub on 16 December 1998 by Mr Whitcombe; it was to involve the creation of a lineslip for which the brokers were to be SCB. The covering letter set out the profile of the account to be written; the proposal did make clear that the business was occupational accident including WC carveout and that reinsurance was essential "[d]ue to the specialised nature of the accounts" and that the retention would be $10,000. It stated that EIU's "raison d'etre" was to afford insurers the opportunity to access profitable business they would otherwise not see; that the strategy was to write "a low to medium risk portfolio, a combination that will be achieved through specialisation in the classes of business affording the highest growth potential and profitable returns". It also explained that the business was "good quality business" and would be "extremely cost-effective". Nowhere did the proposal state that they were to write gross loss making business on the back of reinsurers.
1782. It was Mr Broad's evidence that after he had been shown the files of EIU's underwriting by Clyde & Co (see paragraph 1826), he telephoned Mr Chalhoub and told him to have nothing to do with Mr Whitcombe.

(d) Further investigations by SD

1783. On 28 September 1998, Mr Whitcombe wrote to Mr Mather seeking permission to recommence underwriting, given the renewals at 1 October and the renewal season for contracts incepting on 1 January 1998
1784. In October 1998, Mr Henton prepared a draft underwriting report; it was Mr Henton's evidence that it was not finalised; in the circumstances, it would not be apposite to draw any conclusions from it.
1785. Until October 1998, it appeared that there were a few large claims.
1786. In October 1998, SD were sent a bordereau by American Reliable totalling $16m in claims on the bottom layer of the Programme 3 which had been placed as a result of the deal between WFD, SCB and Mr Henton made in February 1997 (described at paragraphs 818 and following). Until then, according to Mr Bentley, the losses that had been claimed were, for the most part, catastrophe types losses such as Versace and the Korean Airlines claim.
1787. However, the bordereau from American Reliable contained a large number of claims that were almost all of small value. SD were not expecting this and it caused them a great deal of concern. They wanted to understand it. They had a meeting at the High Wycombe offices of American Reliable's parent (attended by the Deputy Chairman of WFD) on 4 November 1998; Mr Bentley was told that the losses resulted from an adventure which they had got into for a number of years in the London market which they had closed down. It then took some time to get an agreement to review the files of American Reliable; it was only in January 1999 that they examined the files of American Reliable and they discovered that the spiral was hugely greater than either they or American Reliable had expected.
1788. SD also decided to undertake their own review at EIU. On 19 October 1998, Mr Mather wrote to HHI answering Mr Whitcombe's request to commence underwriting again by stating that he had the gravest concerns about the account and about the loss development on the 1997 year. The letter set out in some detail a number of concerns including the dependence of the account on SCB. It stated that SD wanted more information before deciding to lift the moratorium, including reviewing and copying the files and visiting some of the cedants. It pointed out the mismatch between accepting business on an RAD basis and reinsuring it on an LOD basis, with the exposure this entailed for 1999; SCB had suggested they could provide run-off cover if SD stayed involved in the business for 1999, but SD were not at that time prepared to do that. A refutation in forceful terms was sent by Mr Whitcombe on 2 November 1998 and on 25 November 1998, he wrote with suggestions for visits to some of the cedants.
1789. On 2 December 1998, Mr Mather wrote to Mr Whitcombe to inform him that they wanted quotations for a run-off of the 1997 and 1998 accounts, that they would not lift the moratorium and everyone should act on the assumption that no further business would be written under the binder.
1790. On 7 December 1998, WEB on behalf of Trustmark and All American requested letters of credit for about $4.25m to cover IBNR (incurred but not reported) in respect of business written through WEB, including Unicare.
1791. On 11 December 1998, Mr Bentley visited Mr Whitcombe and Mr Henton to see all their files on the binder. The files were not voluminous and Mr Henton confirmed that the files that had been copied were all the underwriting files. SD then reviewed the files and were very concerned to discover that the business that had been accepted had very poor loss records. According to the evidence of Mr Bentley, it was then that they had very, very grave concerns about the nature of the underwriting.
1792. On 18 December 1998, Mr Mather wrote to EIU telling them that all endorsements and wordings must be submitted to SD for approval. On 30 December 1998, Mr Mather recorded in his letter to HHI that they were deeply disturbed by what they had so far seen from their review of the files.

(e) Quotations for reinsurance for 1999

1793. On 23 December 1998, HHI sent to SD, quotes that SCB had obtained for stop loss reinsurance from New Cap Re and Credit General; the one from New Cap Re was on an RAD basis for 14 months from 1 November 1998 with a run-in cover for risks attaching prior to that period excess of $100,000 in layers up to $2m; it had 99 free reinstatements. This was based on a premium income for the new business of $12m. The quote from Credit General was on an RAD basis from 1 January 1999 and contained different provisions on reinstatements for different layers. The accompanying letter from EIU stated that they looked to SD to make the decision on reinsurance and pointed out that:

"We are also advised that the market having started late, there is now an immense pressure for capacity and that presently available may not be for too long."

1794. On 24 December 1998, Mr Bentley spoke to Mr Whitcombe and told him that SD had very grave doubts about the quotations for the reinsurance, as, amongst other things, the quotations were based on the assumption that the account would be written for 1999. SD were not prepared to allow EIU to continue. SD were also concerned about coverage, security and disclosure.
1795. On 30 December 1998, Mr Bentley was rung by Mr Whitcombe and received a fax from HHI with alternative quotes from Trustmark which provided for cover for 1999 on business written earlier than that on an LOD basis and cover on an RAD basis for 1999 based on a premium income of $12m for that year. This excluded LMX business and Unicover business (which had been reinsured under Programme 26 in September 1998); the reinstatement provisions varied across the layers. This offer was conditional on the letters of credit requested being provided.
1796. Mr Brown telephoned Mr Bentley the same day and enquired about the letters of credit; in so doing he was acting as broker to WEB and bound to put WEB's case as forcibly as he could. He made clear that if they were not provided, then WEB would lose its management agreement and this could open up a lot of problems in the US for SD including bad faith claims. It was likely that WEB would not provide the reinsurance from Trustmark. They discussed the obligation to provide letters of credit. Mr Brown told Mr Bentley that he could not understand the attitude of SD, as SCB had "saved their bacon" when they had no reinsurance protection on the account; Mr Brown told him that SD did not understand the account and were asking ridiculous and unhelpful questions. SD refused to provide the letters of credit.
1797. A meeting was then organised for 4 January 1999 and a list of files which SD wished to discuss was provided by SD ahead of the meeting.

(2) The meeting of 4 January 1999 between SD, EIU, SCB and HHI

(a) Arrangements and attitudes

1798. On 4 January 1999, there was a meeting at the offices of SD between Mr Barnard, Mr Bentley, Mr Whitcombe, Mr Henton, Mr Brown, Mr Dansie and Mr Smith. In advance of the meeting EIU's files on five selected risks (three relating to Phoenix (Programme 2) and two to JEH Re (Programme 1)) had been circulated by SD under cover of a letter from Mr Mather which noted that SD were deeply disturbed about its review of EIU's underwriting files and that the five selected risks might be typical of the account as a whole. The letter enquired whether HHI, as coverholder, would have been happy that the risks be bound under the binder.
1799. It is clear that, by 4 January 1999, Mr Barnard thought that the Unicover and WEB facilities had come about because of a market that had been set up behind them whereby each participant would pass on the business to a subsequent participant at even cheaper prices; no one really thought that they were keeping a risk. His view was that that was inherently fraudulent. He wanted to know how EIU could justify the acceptance of such business as being in the interests of SD; the business was such that it was bound to generate enormous losses for SD.
1800. Mr Bentley intended the meeting to be a constructive meeting, but it became hostile because of the opposing views as to the nature of the account and the way in which it had been written.
1801. Mr Whitcombe described it as the most awful meeting he had been to in his life; he was exceptionally annoyed at the way he was treated by Mr Barnard whose behaviour he considered appalling. Mr Henton and Mr Brown agreed that it was hostile. I have no doubt that it was a very tense and hostile meeting.
1802. A number of topics were covered. A note of the meeting was made by each of HHI and SD.

(b) The Unicare programme (Programme 34)

1803. Mr Barnard asked Mr Whitcombe how the Unicare programme (Programme 34) could have been written as it was so obviously loss making. Mr Whitcombe asked Mr Henton to deal with the question. Mr Henton said that the risk had been broked in the ordinary way and that the nature of the account had changed before it was accepted by EIU; Mr Barnard's evidence was that he did not recall Mr Henton giving a more detailed account. Mr Brown said that he believed that the account had changed dramatically and that the loss record on EIU's files was not necessarily a good indication of the potential exposure. Mr Whitcombe said that it was EIU which did the underwriting and they did it properly.
1804. Mr Barnard then questioned Mr Dansie about the underwriting; Mr Dansie's response was that Mr Broad was aware of the account and that he had seen all the bordereaux; that Mr Broad knew everything and that the business had been written in accordance with the business plan; that the losses should be looked at on a net basis. According to the HHI note, Mr Barnard said that Mr Broad did not know the basis on which the cover had been accepted and that he did not understand the business; Mr Whitcombe strongly disagreed. Mr Whitcombe promised to revert with the complete file for the programme within 24 hours.
1805. Mr Smith was sitting next to Mr Dansie at the meeting and did not correct him. In a letter of 17 March 1999, Mr Dansie wrote to SD to maintain the position which he had taken at the meeting that the underwriting carried out by EIU was in accordance with the original business plan and that was supported by the bordereaux; the plan and the bordereaux had been countersigned by SD.

(c) Arbitrage

1806. There was a discussion as to whether the business had been underwritten by EIU on the backs of reinsurers. HHI's note recorded:

"This suggestion that the business had effectively been "arbitraged" was strongly refuted by both [Mr Whitcombe] and [Mr Brown]."

1807. Mr Bentley's evidence was that he recalled a discussion about the account being written on the back of reinsurance, but there was no mention of the word 'arbitrage' by Mr Barnard. Mr Barnard's evidence was that he could not recall using the word 'arbitrage', but the concept being discussed was knowingly accepting loss making business on the back of reinsurance. Mr Smith's account was that the word 'arbitrage' was used, and that he understood this to mean knowingly accepting loss making business on the back of reinsurance. Mr Whitcombe's evidence was that he thought that he had used the word 'arbitrage'; it was Mr Henton's recollection that the word 'arbitrage' was used.
1808. Mr Henton accepted in his evidence that at the meeting SD were complaining that the book had been written on the back of reinsurers; he noted that the notes of the meeting said that this was denied, but he did not have a very good recollection of the meeting as his second son had just been born and he had only just come in for the meeting. He accepted that Mr Whitcombe knew that the business was being underwritten net.
1809. Mr Whitcombe's evidence was that the book was always intended to be written on a net basis, that the inwards business was not sustainable without reinsurance and that the account could not be run net.
1810. Mr Brown's evidence was that he did not recall the word 'arbitrage' being used; he did not think he would have commented on the allegation that the business was written on the back of reinsurance as that was not a matter for him, as a broker, to comment on, but he accepted that the account had been arbitraged. He found the meeting fairly hostile and there was no attempt to discuss what had happened.
1811. The evidence about the meeting was that Mr Barnard said that Mr Broad did not understand the business, but Mr Whitcombe had said that he did and knew that it had to be written with reinsurance.
1812. Mr Whitcombe wrote on 5 January 1999 to make the position clear – see paragraph 1820.
1813. I am sure that at the meeting Mr Barnard made it quite clear that he was suggesting that the account had been written on the backs of reinsurers and that this was denied by those representing SCB and EIU.

(d) The spiral

1814. Mr Barnard asked Mr Whitcombe about a spiral; Mr Whitcombe confirmed that there was an element of spiral with John Hancock, but that he did not perceive this to be a problem. Mr Barnard referred to the spiral with American Reliable; Mr Whitcombe acknowledged that the spiral existed and said that he wished that the business had not been written. Mr Brown said that it was not the place of the broker to concern himself with spiral issues.
1815. Mr Brown said that SCB had been approached to place the outwards reinsurance programme for SD in 1997 late in the day and had done so to help Mr Whitcombe and Mr Henton as they had done business together before; they had done their best, but, as it was late in the day, the reinsurance was expensive; an increase in premium income was necessary to pay for the reinsurance and SCB was in a position to generate the necessary premium income.

(e) Quotations for reinsurance on losses occurring on or after 1 January 1999

1816. Mr Bentley's evidence was that SD wanted EIU to give them advice. SD was very concerned that there was no reinsurance in place for losses occurring on or after 1 January 1999. Mr Barnard was not so concerned as he thought that the business was LOD and there had been a moratorium since 28 July 1998; there was therefore little exposure into 1999.
1817. Mr Whitcombe suggested that SD should continue for 1999 and that reinsurance should be purchased to protect 1997 and 1998 losses; if SD would not do it, then the business could be written through one of SD's associated companies and disguised in that way.

(f) Unicover

1818. SD raised the exclusion in the reinsurance quotations provided by WEB of Unicover business. Mr Brown explained that Unicover were a WC facility in Chicago and were active in the reinsurance market. WEB viewed them as a competitor and did not want to give capacity to a competitor. Mr Brown told the meeting that he did not think that this would be problem for SD. In the light of the "all sources" endorsement to Programme 26 under which SCB had arranged to pass a large amount of Unicover business to SD, this was an obvious lie, though because of the avoidance of the contract by CIGNA, that source of Unicover business has not in fact been a problem.

(g) Disclosure to reinsurers

1819. Mr Barnard emphasised the importance of full and proper disclosure to prospective reinsurers; if full disclosure was given, then he did not believe that anyone would write the reinsurance. Mr Barnard's evidence was that Mr Whitcombe said that it was the role of the broker to determine the level of disclosure required and that SD should leave it to the broker. Mr Barnard said that SD would wish to meet with any potential reinsurer to make sure that there was full disclosure. There was also a discussion of the possibility of a portfolio transfer.
1820. Mr Whitcombe thought that the involvement of SD would be detrimental to getting the deal done; full disclosure would have to be made, but it did not help for the client to go with the broker. He did suggest that they wrote a small account for 1999 to ameliorate the situation – it was an attempt to dress it up in a slightly better fashion than trying to place a run-off. A run-off was a terrible thing to try and place.

(h) Follow-up correspondence

1821. On 5 January 1999, Mr Dansie sent a fax to SD, noting that in declining the reinsurance, SD had acted contrary to HHI's advice.
1822. On 5 January 1999, Mr Whitcombe wrote to Mr Barnard, recording that Mr Barnard had said the previous day that the account was "essentially arbitraging":

"That is not the case. Reinsurance is purchased to protect you against catastrophe exposure and volatility of attritional losses. The providers of that reinsurance are well versed in the type of business and doubtless carry their own protections."

1823. Mr Whitcombe's evidence was that he had not used the expression "arbitraging"; that was a banking term for discounting bills and taking a price between the two; EIU was retaining a risk, though bottom end protected; they hoped to make gross profits on some risks; it was not an arbitraged account. Mr Henton had seen this fax when he returned to the office. Mr Henton's answers in cross-examination were equally disingenuous.
1824. On 6 January 1999, Mr Barnard wrote to Mr Whitcombe stating that he understood Mr Whitcombe's response to mean that that the inwards business was intended to be profitable in its own right and that the reinsurance was intended to cover catastrophic accumulations and unexpected levels of attritional loss. SD did not understand from the files they had seen how the inwards business could be profitable in its own right. He also made it clear that he wanted the reinsurers to know what the account was and that it was a pure run-off; they were not prepared to "disguise" anything as Mr Whitcombe had suggested.
1825. On 6 January 1999, Mr Brown wrote to Mr Whitcombe seeking to explain EIU's acceptance of Unicare on the basis that it was profitable on a gross basis; he questioned how a professional reinsurer could have misunderstood the position. This was sent on to Mr Bentley who asked on 2 February 1999 whether this set out the basis on which they had underwritten the risk; in response Mr Whitcombe stated the explanation was wrong in a letter to SD on 11 February 1999, but that the programme was written in the light of assurances given about re-underwriting. Mr Brown accepted in his evidence that the letter was wrong and Mr Henton accepted that Unicare was written on a net basis.
1826. There was further correspondence, but it is not necessary to refer to it.

(3) Mr Broad's letter of 7 January 1999

(a) The meetings between Clyde & Co and Mr Broad

1827. Mr Broad was first seen by Mr Monroe of Clyde & Co on 20 November and 15 December 1998. He was shown one of the early programmes at the first or second meeting and was told that it was WC business; he was also told of Unicover. His evidence was that he found Mr Monroe aggressive.
1828. He was seen again, but this time by Mr Nigel Brook, on 5 January 1999. He was shown documents but he could not recall what these were. When he initially gave evidence on day 12 of the trial, Mr Broad was not aware of the precise dates. Mr Broad's evidence was that matters were gradually revealed to him and it slowly dawned on him what had been written. He may have been a little disinterested at first and was very suspicious because the meetings were antagonistic. As he was shown documents, he gradually accepted what they said and the meetings became less confrontational. He was not sent files to look at.

(b) An initial meeting at The Saigon Times

1829. Mr Broad's evidence was that after he had been told by Clyde & Co about what had been written, he saw Mr Smith and told him that a lot of carveout business had been written. His evidence was that Mr Smith was shocked; he thought that he had told Mr Smith this at The Saigon Times at Leadenhall Market. Mr Whitcombe had been present and denied that he had written Unicover.
1830. Mr Whitcombe's evidence was that Mr Broad never complained in this way. Mr Whitcombe's and Mr Henton's evidence was that they had met Mr Broad at The Saigon Times in December 1998 (though they could not recall the date); Mr Broad had told them of the meeting with Clyde & Co and that he had told Clyde & Co that he was sure there was a reason why Mr Whitcombe had written the risks. Mr Broad's evidence was that he could not recall that, but at that stage he did not believe that Mr Whitcombe had done anything wrong.

(c) The meeting at The Saigon Times on 7 January 1999

1831. On 7 January 1999, there was a meeting between Mr Whitcombe, Mr Smith and Mr Broad at The Saigon Times that led to Mr Broad writing a letter to Clyde & Co the same day.
1832. In the letter, Mr Broad referred to the meeting he had had with Clyde & Co, to his discussions with Mr Smith and to what he had been told of the meeting on 4 January 1999:

"On a more serious matter, I should like to draw your attention to a clause in my leaving agreement (no slagging clause) which clearly states that no party would disparage the other.

In this context I have been shown minutes of the meeting compiled by [HHI] in which Andy Barnard said "AB stated that their original underwriter of this business, Vic Broad had advised them since his departure that he "did not know the basis on which the EIU cover was originally accepted" and "did not understand the business". He also said that "Coppinger had "more knowledge of this class than Vic Broad" but intimated that even this knowledge was limited in expertise.

Firstly let me say that I find these statements to be completely outrageous. For the record when I ran my own Lloyd's syndicate I controlled an income in excess of that which is currently in dispute.

Secondly whatever subsequent interpretation is made in Andy Barnard's remarks they quite clearly give a completely false impression to David Dansie and others present. Nick Brown of [SCB] has seen fit to robustly respond to Barnard in a fax of the 7 January 1998 in which he states that it is not his concern that Barnard is dissatisfied with the decision made by Officers of his company.

I should like to place on record that all decisions I made both before and after [SD's] involvement were done so entirely in accordance with my departments business plan agreed at Board level. Any deviation from that plan was only done so after specific authorisation by Michael Watson. Indeed the largest increase to income was authorised by Watson after his meeting with John Whitcombe."

1833. The letter was written after Mr Broad had been told of the meeting on 4 January 1999 with SD and shown some form of note of the meeting; there was a dispute over what he was shown. Mr Broad's evidence was that he was shown a manuscript note by Mr Smith and Mr Whitcombe and told that SD were "slagging him off". He was furious and wrote out a draft letter at EIU's office which he gave to Mr Whitcombe for typing; his evidence was that the letter contained the views he held at the time, though he could not recall precisely what documents he had seen at the time. Mr Whitcombe accepted that Mr Broad was very angry. Mr Dansie and Mr Smith had been telling Mr Broad what had happened before Mr Whitcombe got there and Mr Broad was in an absolute fury.
1834. The letter contained two phrases from the note of the meeting of 4 January 1999, but Mr Broad's evidence was that he had not seen the note. It was Mr Whitcombe's evidence that he showed Mr Broad the whole of the note; they told him of the horrendous meeting and what was said about him; Mr Broad was incensed.
1835. I am sure that when Mr Broad wrote this letter he was displaying the volatile emotions that had festered since he had left SD and were characteristic of his personality; he was made angry very quickly. The letter reflects that anger. He had not by that time understood what business had in fact been accepted by EIU under the binder.
1836. In the letter to Clyde & Co, he said he would not help further; but changed his mind later. His evidence was that that was because of what he had learnt about the underwriting under the binder.
1837. Mr Broad's evidence was that Mr Whitcombe tried to get him to sign a letter in either January or February 1999 which stated that everything was in accordance with the business plans and that he knew what was being written and how it was written. He refused. Mr Whitcombe said that this was a fabrication.

(4) The final events

(a) Further discussion of reinsurance

1838. On 8 January 1999, SD wrote to SCB, asking them to consider obtaining outwards reinsurance on the basis set out.
1839. On 19 February 1999, a quote which had been provided by Alwen Hough & Johnson (to which Mr Johnson had moved), was sent by HHI to Mr Bentley. The quote was given by New Cap Re (Bermuda) on the basis that no new business would be written in 1999; the SCB quotes were on the basis that there would be ongoing business.
1840. The quotation obtained by Alwen Hough & Johnson was for 12 months at 1 January 1999 for risks that had attached prior to 1 January 1999. It was for $2m xs $25,000 with 99 free reinstatements on the bottom two layers and 49 free reinstatements on the remaining three layers; the premium was 41.5% on an adjusted premium of $6m which Mr Henton had calculated would come in during 1999. The slip excluded temporary staff agencies, staff leasing agencies and Unicover business howsoever assumed. It also excluded any losses from participation in New Cap Re's reinsurance.
1841. The exclusions were not considered satisfactory and Mr Henton therefore tried to get them amended; he wanted the entire run-off covered; losses might occur in 2000; he also wanted a backup for the reinstatements and for vertical coverage of up to $5m; none of the exclusions to which I have referred to were acceptable as he had written Programme 17 (Clarendon Temps), two layers of New Cap Re reinsurance and Unicover might come in from anywhere. The amendments were refused on 24 February 1999, but EIU were told that New Cap Re (Australia) and New Cap Re (Bermuda) had ceased underwriting.
1842. On 10 March 1999, there was a discussion of a portfolio transfer.

(b) Termination of the binder

1843. On 12 March 1999, SD formally terminated the binder; they had by then reviewed the files of EIU, HHI, Realm, American Reliable and JEH Re.

(c) Commencement of proceedings in New York

1844. On 29 March 1999, SD commenced proceedings in the US District Court for the Southern District of New York against EIU, SCB, Raydon, JEH Re, Mr Billyard and WEB. SD alleged that the defendants had engaged in an international conspiracy fraudulently to induce SD to reinsure drastically unprofitable WC business. Three counts were asserted against the Defendants:

i) common law fraud;

ii) violation of the Racketeer Influenced & Corrupt Organizations Act ("RICO"), 18 USC § 1962(c); and

iii) violation of RICO's conspiracy provision, 18 USC § 1962(d).

Considerable publicity was given to the proceedings which had a devastating effect on the personal positions of Mr Butler and Mr Brown.

1845. On 31 March 1999, SD wrote to the reinsureds and avoided the covers.
1846. On 21 February 2000 Judge Buchwald dismissed the proceedings on the grounds of forum non conveniens because this was at its heart a case between British companies and the action could be tried more conveniently in the UK. That decision was affirmed by the Second Circuit Court of Appeals on 18 January 2001.
1847. The proceedings in this court were commenced on 29 February 2000.
1848. The position against HHI was reserved; HHI are claiming brokerage and hold funds in escrow.

(5) The losses

(a) The gross position

1849. The gross losses on the account written reported to SD have deteriorated from $203.77m in June 2001 to $230.68m in March 2002 and to $258.55m in September 2002; although these were the best figures that SD could produce, they probably do not reflect the losses that have been incurred to date; this is because there are a number of disputes and other problems. Between September and December 2002, a further $3.2m was reported on one programme – Programme 10. SCB provided a helpful statement from Mr Pearson, their claims director; as a result of further work done in the course of the trial they accepted that the figures for gross losses are correct within a broad range.
1850. No claims have been passed on to reinsurers. On some programmes, because of disputes in the chain, losses have not been reported to SD. No IBNR is included in the figures. No account has been taken of spirals. The position is still deteriorating and might do so for some time yet.

(b) The effect of the reinsurance purchased

1851. SD calculated that on the position as at 28 February 2002 (based on incurreds of $201.6m), the net position would be about $44m on the assumption that the reinsurances were effective; SD submitted that this net position will not improve but instead will deteriorate. SCB were correct in their submission that it was difficult to comment on this figure. One of the difficulties was that this figure included all the losses in 1999 which should have been reinsured if the account had been conducted on the basis that reinsurance had to be in place for all losses. Furthermore there were difficulties in calculating the effect of other reinsurances.
1852. The assumption that the reinsurances were effective was questionable; ESG had avoided its cover, New Cap Re (Australia) and New Cap Re (Bermuda) were in liquidation and John Hancock had reserved its rights.
1853. Loss figures that were produced by SD showed the following (after accumulation within the programmes, but before accumulation across the programmes):

i) Contracts incepting 1997: 5,038 losses, of which

1997 LOD - 1,624

1998 LOD - 1,672

1999 LOD - 1,931

2000 LOD - 77

2001 LOD - 4

ii) Contracts incepting 1998: 2,176 losses, of which

1998 LOD - 1,806

1999 LOD - 336

2000 LOD - 34

1854. After accumulation across programmes had been taken into account, the figures on an LOD basis were 6,079, of which:

1997 - 1,169

1998 - 2,807

1999 - 2,007

2000 - 93

2001 - 3

1855. Various other calculations were done of accumulations between various different programmes. Although SCB were provided with the information on which these were based, no corrections were suggested.
1856. The calculations show that, whilst there was accumulation within the book (likely to be considerable on a gross basis), there were also large volumes of individual losses, the largest of which were on Programme 3 (1,001 losses), Programme 11 (1,988 losses), Programme 17 (691 losses), Programme 24 (998 losses), Programme 33 (660 losses) and Programme 34 (484 losses).

(c) The block reinsurance with Swiss Re

1857. A block reinsurance with Swiss Re New Markets (a member of the Swiss Re Group) was arranged by Fairfax in or around May 1999. The coverage related to claims or uncollectible reinsurance of Fairfax's insurance and reinsurance companies relating to business written before 1 January 1999; this included business that was written under the EIU binder.

(6) Conclusion

1858. I am sure that at the meeting on 4 January 1999, both Mr Brown and Mr Whitcombe made it clear that they were not writing the business on the backs of reinsurers.
1859. This was made abundantly clear by Mr Whitcombe's fax of 5 January 1999 in which he lied in his denial that the account was written on an arbitrage basis.
1860. I am sure that Mr Henton and Mr Whitcombe never made clear, either at the meeting of 4 January 1999 or in the follow-up correspondence, to SD that what had been written was gross loss making business that was written on the back of reinsurance. Mr Whitcombe's letter was obviously untrue and was known by him to be so.
1861. SCB and EIU relied heavily on the assertion by Mr Dansie at the meeting on 4 January 1999 and maintained in the letter of 17 March 1999 that what was underwritten was in accordance with the business plan and that Mr Broad had known about it. They submitted that in the light of that it was impossible to accept Mr Smith's denial in his interview with Mr Langley (to which I have referred at paragraph 1322) that he did not know that EIU were writing gross loss making business. I am sure that the position taken by Mr Dansie does not in any way undermine that statement or my conclusion that neither Mr Smith nor Mr Broad knew gross loss making business was being written on the back of reinsurance. My reasons appear from my findings in this judgment, but it may be useful to highlight two of the principal reasons why what happened in relation to Mr Dansie on 4 January 1999 cannot assist EIU and SCB:

i) Mr Dansie's statement was made at a meeting where EIU were denying that they had written gross loss making business on the backs of reinsurers.

ii) If Mr Dansie was asserting that the business plan or the bordereaux showed that gross loss making business was being written on the back of reinsurance, he was wrong; neither the plan nor the bordereaux showed that.

1862. It was suggested by Mr Greig that he was sure that a reasonably competent broker could and should have obtained run-off cover. On the evidence I am sure that SD were correct in the view they took that full disclosure of the matters that had led them to suspend the binder should have been made; if such disclosure had been made, there was no prospect of any reinsurer granting cover, even if there had been a market at the time for such reinsurance cover. In any event, as I have set out, the quotes from New Cap Re were very limited and they went into liquidation shortly thereafter.

14. OVERALL CONCLUSIONS

(1) General

1863. For those reasons I therefore conclude:

i) Mr Brown: He was the driving force in the dishonest enterprise which I have described in this judgment. He was motivated by ambition to make SCB a full-service insurance company and by greed in earning large sums of money through the brokerage of the business provided; the diagram from the prospectus which I have set out amply demonstrates those opportunities. He set about achieving his ambition with ruthlessness and where it suited his purpose, with singular dishonesty.

ii) Mr Butler: He had also acted dishonestly; characteristic of his attitude to the conduct of reinsurance was his description of a lie as "broker's licence".

iii) Mr Henton: It was submitted on EIU's behalf that Mr Brown was dishonest and that his dishonesty had permeated SCB; that if there was a dupe in this business, it was EIU. I accept in part the accuracy of that submission; I am sure, as I have said, that Mr Brown was a man of singular ruthlessness and dishonesty and that his dishonesty corrupted others; he fully exploited the position in which EIU were in and made them subservient to the interests of SCB in the way I have described; to that extent they were victims, but Mr Henton was intelligent and acute enough to know what he was doing and that it was dishonest to acquiesce as he did.

iv) Mr Whitcombe: Although he had acted dishonestly, it is right to point out that he never properly understood the business into which SCB had led him. When he understood enough to appreciate the very serious position into which he had put SD, he was in too deep to extricate himself; his actions became dishonest as he continued to conceal the disastrous position in which SCB and Mr Henton had placed SD. However, he did not act with the same degree of dishonesty as Mr Henton; he deserves credit for acting to restrain Mr Henton and Mr Brown in relation to Unum and in relation to continuing underwriting when they appreciated that they had no reinsurance cover in March 1997 (see paragraph 944).

1864. My findings of fact can be summarised as follows:

i) I accept that Mr Brown and Mr Butler, like many others in the PA market, considered that it was an ordinary incident of that market to place gross loss making business with others in that market on the basis that the losses would be paid by reinsurers who had reinsurance programmes that would pass those losses on to others. As I have set out, this practice was unobjectionable provided that each participant was a knowing participant in the sense that a fair presentation of the risk was made and full disclosure was given. Even though many may have disapproved of this practice, it was a practice of the market; it was not either objectively or subjectively dishonest to place or write such business provided that full disclosure was made.

ii) The programmes placed with SD were in general terms no different to the business that had been placed in this market by many brokers including Mr Brown and Mr Butler; if SD had been knowing participants, there would, in general terms, looking at the programmes one at a time, have been no dishonesty on the part of EIU in accepting modest lines on a small selection of the programmes.

iii) By 1993 the market had contracted. SCB, for the purpose of benefiting the group by making it more competitive in the WC market in the US and to earn large amounts of commission, pursued a strategy of providing cheap reinsurance by enabling certain underwriters to write reinsurance of WC carveout and related business at wholly uneconomic rates by passing the inevitable enormous losses to others by means of reinsurance; this involved SCB and those underwriters who, like Mr Bird and Mr Billyard, were knowing participants in the deliberate creation of artificial spirals which transferred these losses to high layers. I am sure that Mr Brown and Mr Butler knew that this was dishonest.

iv) By the end of 1996, the market for placing this business was dead.

v) I am sure that SD were never told that business Mr Henton intended to write was to be accepted in the knowledge that it would create gross losses that would be passed on to reinsurers. They were therefore dishonestly brought into this market to provide capacity without being told what they were actually being asked to write; if they had been told of the true nature of the market they would not have entered it. No rational person told of what was intended would have written such business, particularly given the scale and volume presented by SCB to Mr Henton.

vi) When EIU obtained the binding authority from SD, EIU agreed to write the programmes offered to them without SCB having to place reinsurance for them; EIU, having misled SD as to the nature of the business to be written, were content that the losses should be dumped on SD or on their reinsurers whom they knew must similarly have been unaware of the true nature of the business to be written.

vii) Mr Henton accepted in his evidence that he knew exactly what he was doing when he accepted the programmes; it was not a case of naivety or incompetence on his part. He was an intelligent man with an acute trader's instinct. When the circumstances surrounding the entirety of the business accepted by EIU in the 35 programmes placed are looked at as a whole (in the sense of the scale of the gross losses being assumed, the lines being written, the brokerage being allowed and the nature of the reinsurance cover obtained), I am sure that no person acting honestly, however imprudent, would have ever accepted those programmes.

viii) By late February 1997 when the deal was done to avoid the risk having to be approved by Mr Broad, SCB were aware that SD did not know that SD had become participants in writing gross loss making business on the back of reinsurance; the placing of Programmes 2 and 3 with EIU and all subsequent placings were therefore effected by SCB when they knew that SD had not approved the writing of this type of business.

ix) Both SCB and EIU were content that SD remain the dump for the losses until the end of 1997. For their own purposes, SCB procured reinsurance that re-created a spiral and that EIU were to write gross loss making business that they had been unable to place in 1997 and that they were continue to write such business in 1998. SCB and EIU were both fully aware that SD had no knowledge this was being done and that what was being done was wholly contrary to their interests and dishonest.

x) I am sure that all the Defendants acted in collusion; the particularly important examples are: the way in which Programmes 2 and 3 were written, Unum, the writing of the Christmas Eve 1997 and New Year's Eve 1997 programmes, the cover up in relation to Programme 33, and the meeting of 4 January 1999.

xi) Mr Henton (and through him EIU), Mr Brown and Mr Butler (and through them SCB) all knew that writing gross loss making business on the back of reinsurance could only be achieved through a scheme involving either the deception of capacity (as for example in the case of SD) or of reinsurers who would ultimately have to pay the losses. They each fully understood that this was dishonest.

xii) As set out in Part II, some of the programmes written were not likely to produce gross losses; however, that did not matter. The overwhelming amount of the business was gross loss making and it is the totality of the arrangements that mattered.

xiii) Throughout I have endeavoured to test the credibility of each witness whose credibility was in issue against the objective facts, the contemporary documents and the overall probabilities. I have had the advantage of seeing each of the main witnesses undergo long and searching cross-examinations that have also afforded me the opportunity to judge their credibility. I am sure that Mr Brown, Mr Butler, Mr Bird, Mr Henton and Mr Whitcombe were witnesses who had given untruthful evidence in the respects which I have set out.

1865. I therefore find that the claims for dishonest breach of fiduciary duty succeeds against Mr Whitcombe, Mr Henton (from February 1998) and EIU (from September 1997) and the claim for dishonest assistance succeeds against EIU (for matters before September 1997), Mr Henton (for matters before February 1998), SCB, Mr Brown and Mr Butler.
1866. I also find that the claim for fraudulent misrepresentation succeeds against Mr Whitcombe and Mr Henton. EIU also fraudulently understated the premium to SD on the occasions identified in the judgment.
1867. As to the claim for conspiracy:

i) I am sure that there was a collusive arrangement between SCB and EIU, the objective of which was to enable gross loss making business to be placed with SD; SCB's purpose was to find a source of reinsurance for their US business which they could ruthlessly exploit and earn commission. EIU's purpose was to earn commission.

ii) There were, as I have set out, numerous breaches of fiduciary duty; it is not necessary for me to decide whether those breaches amounted to unlawful means for the purpose of a claim in conspiracy, but I see no reason why these breaches of fiduciary duty do not constitute unlawful means.

iii) I am sure that SCB and EIU deliberately embarked upon a course of conduct from early February 1997, the obvious consequences of which they appreciated would damage SD and any reinsurers they had; at that time they believed that they had found a dump for the gross loss making business (SD and its reinsurers) which enabled them to restart the business described, with the intention that the losses should be dumped there. Although they may not have positively sought to injure SD as they did not care who paid the losses, they appreciated that the probable consequence was that SD and their reinsurers would suffer those enormous losses.

iv) Very serious loss was caused to SD.

1868. I am sure that Mr Broad did not know that gross loss making business was being written on the backs of reinsurers and that he was the victim of the dishonest and collusive conduct I have described. However, his conduct fell well below the standards of a competent underwriter and he acted with gross negligence and dereliction of his duties.

(2) Alternative findings in relation to Mr Broad

1869. It was SD's case that Mr Broad was never told that EIU were writing gross loss making business or deliberately participating in reinsurance spirals and that what he was told was meagre in the extreme. As set out, I have essentially accepted that case.
1870. However, if I had concluded that he had known that gross loss making business was being written on the backs of reinsurers, then I would have been sure that he had concealed this from all his colleagues and fellow directors at SD who had no knowledge that gross loss making business was being written on the backs of reinsurers. Such concealment would have entailed a course of conduct that was dishonest, involving a consistent course of concealing documents, requiring EIU to misstate the true position and systematic lying to his board about the business being conducted by his department over a period of a year and a half.
1871. It was submitted by SCB that EIU could not have known that by agreeing to their writing gross loss making business against reinsurers they were acting in fraud of their principals; SCB also submitted that the changes to the first underwriting report and the changes to the bordereaux, although odd, were in fact merely cosmetic and would not in isolation support a finding that EIU knew that Mr Broad was defrauding SD.
1872. I have no doubt that if Mr Broad had known of the true position, Mr Whitcombe and Mr Henton would have known that he must have been deceiving his colleagues and the board of SD; they clearly knew that no director or employees of a company would have authority to write the business accepted by EIU and so, if Mr Broad knew what was being done, they knew that he had no authority to commit SD. If the changes to the bordereaux and reports had been initiated by Mr Broad, it was obvious that they were not cosmetic and therefore it was obvious that Mr Broad was concealing from SD what was being done. Furthermore, as the reports sent to Mr Broad, far from setting out what was being written, in fact misrepresented it, they must have known that he was concealing the fact that EIU were writing gross loss making business on the back of reinsurance and incurring losses on a gross basis of tens of millions of dollars.
1873. I am also sure that, if Mr Broad had known gross loss making business was being written by EIU on the backs of reinsurers, SCB would have known that and appreciated that he would have had to deceive his colleagues and the board of SD:

i) They clearly knew that no director or employees of a company would have authority to write the business accepted by EIU in the circumstances set out in this judgment and so, if Mr Broad knew what was being done, they knew that he had no authority to commit SD.

ii) Mr Brown and Mr Butler both knew that no one was prepared to accurately describe the business that was written.

1874. As to Mr Smith, the position is the same. It was submitted that as SD had made no claim against HHI and as there was no case against HHI that they had acted dishonestly, I ought to be slow to conclude that they had acted dishonestly. Although I have concluded that the overwhelming probabilities are that the changes to the November 1997 report and the class bordereaux were made at the instigation of either Mr Smith or Mr McCarthy or EIU, the essential issue was whether HHI knew that EIU was writing gross loss making business on the backs of reinsurers. As I have set out at paragraph 1322, Mr Smith consistently denied in the interviews with Mr Langley that he knew that EIU were writing gross loss making business; Mr Whitcombe accepted, as I have set out, that he never informed Mr Smith that EIU were deliberately writing gross loss making business; the fact that Mr Dansie of HHI took the side of EIU at the meeting of 4 January 1999 was of no assistance to EIU or SCB because at that meeting SCB and EIU were denying that they had written gross loss making business.
1875. If Mr Smith had known, contrary to the finding I have made, then I am sure that EIU and SCB knew that that was being concealed from SD for very much the same reasons as I have given in respect of Mr Broad; SCB clearly knew that what was being done was outside the scope of the binding authority for the reasons I have given.