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Litigation Property Preservation Liability insurance (LPPL) is a uniquely Chinese specialty insurance line that has grown strongly over the last few years. However, as more insurers have come into the LPPL market, premium rates have begun to fall sharply with pricing now frequently inadequate compared with the risk exposure.
Worryingly, many insurers believe that LPPL is relatively risk-free because there have been very few large losses in the course of its short existence. In fact, because of the inherently long-tail nature of LPPL insurance, it can easily take more than two years after a policy is issued for claims of wrongful preservation to be reported.
The loss picture is developing, however, with several large LPPL claims on insurance underwritten in 2015 and 2016 being reported throughout 2018. At the same time, many new situations and problems have emerged that require corresponding countermeasures from LPPL underwriters.
To summarize the problem in a nutshell, while premium rates have been falling, loss control has been getting less strict.
The development of Litigation Property Preservation Liability (LPPL) insurance in China was driven by the increasing level of civil litigation taking place.
According to the Civil Procedure Law of China, before or during civil litigation, the plaintiff can apply to the court to preserve the defendant’s assets to ensure the plaintiff gets its money should they win the suit. To secure approval from the court, the plaintiff is required to provide the guarantee for the property preservation in case there is wrongful preservation which causes the economic loss of the defendant or any other party.
Traditional methods of the involved party providing its own guarantee (letters of guarantee from commercial banks and sponsor’s guarantees, etc.) often fell short, and failed to meet the demands of judicial practice.
The insured liability of LPPL relates to the damages that a court orders to be borne by the insured as a result of the loss incurred by the respondent due to a wrongful application for litigation property preservation by the insured.
The China Insurance Regulatory Commission authorized the first pilot trial of LPPL insurance in Yunnan Province in 2012. Since then, LPPL products have become available from insurers in several provinces and cities across China.
At the same time, more courts in China are recognizing LPPL as an acceptable litigation property preservation guarantee method, boosting the market for an insurance product that cannot be found anywhere else in the world.
On November 7, 2016, the Supreme People’s Court formally established the legal status of LPPL insurance across the country. Since then, LPPL insurance has been developing much faster than before and has become an important new liability product in China.
One of the most common sources of cases involving LPPL have to do with equity disputes. They can be divided into four main dispute categories: shareholder capital contribution; equity ownership confirmation; equity transfers; and shareholder rights.
As stated, the use of property preservation is more commonly seen in equity dispute litigation. Often the value of the preserved property is relatively high, especially in confirmation of equity ownership and equity transfer cases. At the same time, the preserved property does not necessarily have to be the equity itself. Bank deposits and real estate are more common.
Corporate Law is the main applicable law for equity dispute cases, which tend to be much more complicated than general civil cases. They often involve multiple parties, and the legal risks of the cases are frequently hard to identify. Also, since the value of the preserved property is relatively high, it is easier to cause wrongful preservation and significant losses in these cases.
To date, around ten large LPPL claims have been reported in the market, all from equity dispute litigation cases, with claim amounts ranging from 10s to 100s of million yuan. The largest settled case for wrongful preservation in history is reported to be the Tort Liability Dispute between Qingdao Zhongjin Company and Qingdao Yuneng Company.
This case was finalized by the Supreme People’s Court on December 8, 2017 (Judgement No.: (2017) Supreme Court Civil Final No. 118): Zhongjin Industrial Company shall compensate Qingdao Yuneng Company for the loss of nearly 66.7 million yuan caused by the application for wrongful property preservation. The property preservation involved in this case arose from equity transfer litigation.
The properties preserved mainly included deposits, pre-sale commodity housing, and land use rights. The loss caused by wrongful preservation, which was supported by the Supreme Court, consists of two aspects. One is the loss of interest on 120 million yuan, caused by the replacement fund being frozen for half a year. The second is the loss of interest on sales from the real estate development project, following it being delayed for one year due to the property preservation.
The legal risks contained in LPPL insurance are more complicated than those associated with traditional liability insurance lines in China. The insurer needs to comprehensively assess the insurance subject, the preservation subject, and the nature of the basic litigation case.
However, owing to the low reported loss ratio of LPPL business and a competitive environment stimulating demand for faster insurance underwriting, the risk review methods adopted by insurance companies have become increasingly simplified.
Frequently, the review is inadequate, as illustrated in the following three situations:
This kind of risk review doesn’t just expose insurance companies to claims – it could create a moral hazard. When a respondent is unable to repay the debt or intends to seek extra benefits, the applicant and the respondent could collude with each other and invent an erroneous preservation, or exaggerate the loss due to the preservation, to cheat insurance companies out of money.
LPPL insurance is a relatively long-tail business. It quite often takes several years from the issuance of a letter of undertaking to the filing of a claim. This requires insurers to properly track cases and to implement risk management after underwriting. However, according to our observations, many insurers have not established an ideal “post-insurance risk management” mechanism.
Once underwriting is completed, the development of a case is often ignored. This can create the hidden danger of subsequent wrongful preservation and deterioration of loss. In practice, this mainly includes the following two situations:
According to Article 23 of Provisions of the Supreme People’s Court on Several Issues Concerning Handling Cases of Property Preservation by People’s Courts, after the People’s Court adopts property preservation measures, the applicant shall apply for removing of preservation in a timely manner in any of the following circumstances:
If the applicant for the preservation fails to apply to the People’s Court to remove the preservation in time, they will have to compensate the loss suffered by the preserved due to the property preservation.
Based on our analysis of a large number of previous cases of wrongful preservation, the most common high-risk scenarios include the following situations:
In order to address the new issues discussed above and develop LPPL insurance in a sustainable and healthy way, we recommend insurers take the following risk management countermeasures:
Insurance companies should take the legal risk review process for LPPL business seriously, selecting and training risk reviewers through multiple channels. They should focus on developing their internal professional capabilities, but also consider using external resources to properly handle LPPL business under the premise of balancing costs.
LPPL business involves cases with complicated subjects and legal relationships. The diversity and complexity of the risks determine not only that the risk review of LPPL business rely more on the professional initiative of specialists, but also that the risk reviewers have relevant legal expertise and experience.
At present, many insurance companies use internal legal personnel to conduct their LPPL business risk reviews. This is problematic for several reasons. First, the internal legal personnel are not full-time underwriters. They have to undertake another company’s legal work and cannot be in two places at once.
Secondly, the basic legal cases involved in LPPL business are usually various types of civil and commercial cases. Legal personnel in insurance companies are more exposed to insurance cases rather than civil and commercial cases. A lack of direct experience will affect the accuracy and efficiency of the risk review.
The party most suited to conducting risk reviews should be lawyers or judges with many years of experience in civil and commercial cases. In this regard, insurance companies should consider establishing a risk review legal team specialized in LPPL business, selecting and hiring through open tendering or competitive negotiation. We recommend: increasing the number of law firms in the pool; freezing fees by signing cooperation agreements, and; clarifying risk review requirements and accountability to make the best use of external review lawyers.
Of course, in the long run, as the business grows, insurance companies should build their own LPPL risk reviewer teams. We have found several insurance companies in the market that have successfully established one of the following two risk review models which deserve our encouragement and strong recommendation.
First, personnel with legal backgrounds can be introduced to engage fully in the risk review of the liability insurance, with their review ability improving continually through case study and accumulated review experience.
Secondly, responsible lawyers or retired civil and commercial case judges and arbitrators can be introduced into the company to manage LPPL risk review cases.
Insurers should establish and improve the post-insurance risk management framework of LPPL insurance as soon as possible to prevent unforeseen losses, or any increase in losses due to a significant rise in the level of risk after policy inception. Improvements should include:
We understand the implementation of such a risk management mechanism needs time and people and it may not be realistic for all LPPL policies. However, we believe that it is an important undertaking for insurance companies, particularly for large and/or complex cases.
At present in judicial practice, the court requires insurance companies to issue an Insurance Policy Letter of Undertaking or a Letter of Guarantee, which requires unconditional joint liability for wrongful preservation. The legal nature of the Insurance Policy Letter of Undertaking or the Letter of Guarantee essentially equals the “Independent Letter of Guarantee” in the insurance industry; therefore, insurance companies should not invoke the agreement of the insurance contract against the respondent’s claim for damages.
In order to protect its own rights and interests, an insurer should list in the insurance clauses the obligations that the insured (i.e., the applicant for preservation) should perform. If the insurer is liable for compensation because the insured fails to perform these obligations (or performs them insufficiently), after paying compensation to the respondent, the insurer has the right to request the insured pay the corresponding indemnity.
The obligations include, but are not limited to:
In addition, there is a trend in the market for LPPL clauses to be used to underwrite the risk of property preservation under arbitration. Here, the insurer needs to be reminded that the current LPPL policies of many companies are generally defined by the insurer as “civil litigants or interested parties” who apply for property preservation to the court due to civil disputes, but do not include the parties of the arbitration. Similarly, with LPPL, the source of the insured property preservation is also limited to pre-trial preservation or in-litigation preservation and does not include pre-arbitration preservation and in-arbitration preservation.
If the risk of arbitral property preservation is directly underwritten within LPPL insurance clauses, there will be a problem of inconsistency between the insurance clauses and the underwritten risk. This will involve a considerable compliance risk and cause reinsurance recovery problems. We have noticed that some insurers have developed and are marketing separate “Arbitration Property Preservation Liability Insurance (APPL)”. With these products, proper risk control measures should be taken against high-risk factors inherent in the arbitral procedures, such as foreign-related arbitration and invalid arbitration, which are different to litigation procedures.
Establishing a comprehensive full-process legal risk management mechanism is crucial to the healthy long-term development of LPPL insurance. This requires the involvement of LPPL professionals who can ensure that insurers properly understand and manage their risks. Only then will LPPL better meet the needs of judicial practice and thus make a positive contribution to building a society ruled by law.
