The Law Lords overturned a damages award of pounds 1m - plus as much again in interest - against Eastern Counties Leather, a tannery company, which had been sued by Cambridge Water Company for polluting a well.
Insurers had warned that if the decision had gone the other way they would have severely curtailed pollution liability cover. Banks had said that some firms in potentially polluting businesses would have found it harder to borrow.
Legal experts warned that the cost of the decision for water companies and their customers could be high. Glen McLeod, who advises banks on environmental law for the solicitors Denton Hall, said the decision could allow companies to escape paying millions of pounds to clean up environmental pollution they cause.
He added that it would have profound implications for water company profits and share prices in the UK because the companies would have to bear these costs instead. They would almost certainly be forced to pass them on to consumers in the form of higher bills.
The insurance industry regarded the Eastern Counties Leather case as important because it concerned liability for activities that come to be labelled as pollution only after subsequent legislation raises environmental standards. The pollution occurred before 1976 but the well was not closed until after standards were tightened six years later.
ECL's case was funded by General Accident. The total legal costs of both sides, which must now be paid by Cambridge Water, exceed pounds 500,000.
The Association of British Insurers said that if the decision had gone the other way, insurers would have had to consider excluding all pollution risks under standard liability policies. Pollution cover would then have become restricted and expensive.
Paul Taylor, senior partner of Berrymans, the insurance solicitors, said it was a good day for the insurance industry. The House of Lords ruling that any pollution must have been foreseeable for any liability claim to succeed would discourage many historic pollution claims.
'It's going to make claimants very much more cautious because they're going to have to prove both causation and foreseeability,' he said. 'There will be fewer claims against people who might then pass their claims on to their insurers. Historic pollution will become a lot easier to defend.'
A Royal Insurance spokesman said it was good news that the judgment clarified that claimants cannot establish retrospective liability. 'It just supports the general view that most insurers have that environmental pollution claims in the UK are a world apart from anything in the US,' he said.
Tony Baker, the ABI's spokesman, said an adverse decision 'would have had a detrimental psychological effect on both businesses and insurers which would have been in no-one's best interest'.
Mike Pummell of Barclays Bank, chairman of the British Bankers' Association's specialist body on environmental risks, said the judgment was 'fair and equitable' and laid to rest some concerns about responsibility for contamination.
The banks are worried that customers could be driven out of business by large pollution claims and that they could find themselves liable for past pollution if they take possession of polluted land held as security.
The Confederation of British Industry also welcomed the decision. John Cridland, CBI environmental director, said employers were 'very encouraged' by the judgment.
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