Neil Beighton explains the impact of the Sphere Drake case

In a damning judgment in the Commercial Court, Mr Justice Thomas has found that broker Stirling Cooke Brown (SCB) and underwriting agent Euro International Underwriting (EIU) defrauded Sphere Drake.

When EIU started underwriting for Sphere in early 1997, it was expected to write traditional personal accident business. Instead, it wrote a large volume of workers' compensation carveout reinsurance, a product which enabled US workers' compensation exposure to be underwritten by the life and personal accident markets. The judge found that EIU had dishonestly accepted huge volumes of this business, exposing Sphere to losses of up to $250m. It was either hoping to recover those losses from retrocessionaires, or was reckless as to whether retrocession was available.

In doing so, EIU had become subservient to the interests of SCB, a major broker of this business, whose driving force, Nick Brown, was described by the judge as "singularly dishonest". Spirals that circulated losses around the market had been deliberately created by SCB, which earned huge amounts in brokerage. These spirals could be sustained only by capacity being misled. Sphere itself had been serially misled, although its underwriter, Vic Broad, had been grossly negligent in supervising the binder.

Sphere has not obtained any immediate remedy, other than an entitlement to costs. It does not necessarily follow that it will be entitled to avoid inwards contracts. That entitlement will be determined in separate arbitrations, although this decision will strengthen Sphere's hand. The judge found that spirals in earlier years, 1993 to 1996, were deliberately created by SCB.

The decision will have a major impact on many existing disputes, but the judge was careful to distinguish the unusual features that made this type of business improper. Those features included the virtual certainty of losses, very low excess points, unlimited reinstatements, substantial underpricing, lack of information and tight, deliberately created spirals. Those features could arise elsewhere, but only rarely. The case demonstrates the massive damage an uncontrolled agent can cause, and highlights the need for close supervision. Finally, questions must also be asked of regulators as to how a high-profile Lloyd's broker could have been allowed to base a substantial part of its business over many years on a dishonest structure.

Sphere Drake Insurance & Anr v Euro International Underwriting Ltd [2003] EWHC 1636 (Comm) is available at
http://www.bailii.org/ew/cases/EWHC/Comm/2003/1636.html

Neil Beighton is a senior lawyer in the insurance and reinsurance group of Cameron McKenna