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Your are here: Home >> Bulletins The Problem For some considerable time, English law has accepted the doctrine of privity of contract. As far as back as Tweddle -v- Atkinson [1861] 1B&S 393 it was acknowledged that third parties cannot sue upon contracts to which they are not party. There has been some judicial discomfort at this proposal and it has been recognised that contracts may be for the benefit of third parties. However, the doctrine was affirmed by the House of Lords in Scruttons Limited -v- Midland Silicones Limited [1962] A.C. 446 in a shipping context. (Interestingly, that case is also cited as an example of how the judiciary have attempted to overcome the injustices caused by the privity of contract rule.) In terms of liability insurance, the injustices caused by the rule are quite clear. In a transit situation, it is often the case that the forwarder will have insufficient funds to meet a claim, particularly if high value goods are being moved. As such, logistics contracts, sub-contracting schemes etc often include requirements for liability insurance. When a large claim arises, this is often sufficient to bankrupt the forwarder. On many occasions, one finds that the forwarder is bankrupt before the claim is presented! There are two potential injustices which used to occur in such circumstances. The first is that the forwarder has no interest in pursuing his insurers given that the business is now insolvent. Prior to 1930 the claimant was simply left to prove in the insolvency and had no rights against the insurers. The second problem arose where the forwarder (or, more probably, its liquidator) did pursue the insurers. There was a risk in these circumstances that the insurance proceeds would simply fall into the pot of money to be distributed between creditors. As a consequence, the owner of the damaged cargo might receive a percentage (and this was usually a very small percentage) of the damages due. As the contract of insurance is between the forwarder and the insurance company, the cargo owner had no right to enforce the contract and no right to the proceeds under the policy. This effectively removed the purpose of the insurance and no matter how prudently the shipper acted in ensuring that his appointed forwarder had insurance, he would be left out of pocket on most occasions. The Third Parties (Rights Against Insurers) Act 1930 To overcome this problem, the 1930 Act was passed. Section 1 of the Act provides that where, under a contract of insurance, a person is insured against liabilities to third parties which they may incur then, in the event of the insolvency of that person (or company): "if, either before or after that event, any such liability as aforesaid is incurred by the insured, his rights against the insurer under the contract in respect of the liability shall, notwithstanding anything in any Act or rule of law to the contrary, be transferred to and vest in the third party to whom the liability was so incurred." The Act expressly provides that any attempt to contract out of these provisions or alter the rights of the parties upon the happening of an act of insolvency shall be null and void. Under Section 2, the person responsible for administering the liquidation/bankruptcy is obliged to provide information to any person claiming that the insolvent debtor is under a liability to him. The information must be reasonably required for the purposes of ascertaining whether any rights have been transferred to and vested in that person by the act. Again, any provision within the contract of insurance which attempts to avoid this provision of information shall be null and void. The intention of the Act is, therefore, reasonably clear. The wording of the Act, on the other hand, has given rise to some difficulties. Problems of Interpretation Any hopes that the Act overcame all of the difficulties outlined above have been dashed by a restrictive interpretation of its terms. As can be seen from the wording of the Act it transfers the rights of the original insured to the creditor. However, the Act makes it quite clear that the creditor assumes no better rights than the original insured. Thus, the insurer is still entitled to take any defences which were open to it vis-a-vis the original insured. Whilst, on the face of it, this might appear to be a reasonable enough position, in practice it can work in a rather harsh manner against the creditor. As will be appreciated, insurance contracts contain many conditions requiring the insured to undertake certain acts, provide notice of certain events etc. Obviously, an insolvent insured is not in a position to comply with these conditions. Moreover, an insured who is likely to become insolvent often has little interest in ensuring that the insurance claims of third parties are adequately protected by the provision of adequate notice etc. Thus, if the original insured fails to comply with a condition precedent, the third party debtor may find that any claim against the insurer has been lost. Other conditions precedent have caused considerable difficulties. A clear example is the "Pay to be Paid" condition which is often found in the terms of P&I Club membership. These clauses demand that the insured (or the member) pays the claim before there is any right to an indemnity. As will be appreciated, if the insured is insolvent it will not be in a position to pay the claim. In the decision of The Fanti and The Padre Island [1991] 2 AC 1 the House of Lords considered whether a Pay to be Paid clause operated in such a way as to derogate from the terms of the 1930 Act. The House of Lords decided that the Pay to be Paid clause established a condition precedent. As such, the insured had to pay the claim before it was entitled to any indemnity under the insurance policy. The 1930 Act had not intended to put the third party in a better position than that of the original insured. As such, the insurers (or the P&I Club in this case) were able to avoid a claim under the 1930 Act. This was the case even though the insured's liability had been incurred and established. Another problem which has received a mixed reception from the courts concerns the provision of information under the 1930 Act. On the face of the wording, it would appear that a third party is entitled to details of the insurance policy. However, the time at which that entitlement arises has been the cause of some lively debate. Litigation can be an expensive and time consuming exercise. There is always a degree of uncertainty as to whether a recovery will be made. When one is against an insolvent defendant, this uncertainty is magnified. As a consequence, a number of claimants have sought to argue at the outset that they are entitled to disclosure of details of any liability policies before embarking upon litigation against the insured. There are various aspects of a policy which are relevant in this regard. For example, a claimant will wish to know firstly whether a policy exists at all. Once this is established, the claimant will want to know the extent of cover, the monetary limits and any exclusions which may operate. The Courts have, however, taken a rather restrictive approach towards the question. An example is Nigel Upchurch Associates -v- The Aldridge Estate Investment Co Ltd [1993] 1 Lloyd's Rep 535. The claimant, Nigel Upchurch, was an architect who was suing the Aldridge Estates Investment Company for unpaid fees. The Aldridge Estates Investment Co counterclaimed for damages for negligence. Nigel Upchurch had entered into an individual voluntary arrangement for the benefit of his creditors. This was supervised by a Mr Robert Hewitt. The counterclaim was disputed. The Aldridge Estates Investment Company made an application at the beginning of the proceedings to establish whether or not Nigel Upchurch had insurance and, if so, what the terms of that insurance were. The matter was heard before an Official Referee, Mrs Barbara Dohmann QC. She held that the application was premature. The rights under the 1930 Act, including the right to information, did not arise until and unless the existence and amount of the liability of Nigel Upchurch to Aldridge Estates had been established by a judgment of the court or an award at arbitration or by an agreement between the two parties. As none of these had occurred, no right to claim an indemnity from the insurer could have been transferred to Aldridge Estates. Consequently, they had no right to information under the 1930 Act. Doris Bradley had worked at the mill of Dartmill Limited for some considerable period of time. She was diagnosed with byssinosis and she wished to bring a claim against Dartmill and their insurers. However, Dartmill was dissolved in 1976. Eagle Star insured Dartmill. Doris Bradley brought a claim against Eagle Star under section 1 of the 1930 Act. The House of Lords made it clear that, under the liability policy, the insured could not sue for an indemnity from the insurers unless and until the existence and amount of his liability to a third party had been established (by action, arbitration or agreement). The 1930 Act transferred the rights of that insured to the third party. Consequently, if no rights of action against the liability insurers have been established (because the liability of the insured had not been established) there is nothing to transfer. Mrs Bradley's problem is one which is all too familiar to practitioners. The insured, Dartmill Limited, had ceased to exist as a company because it had been removed from the register. Unfortunately for Mrs Bradley, due to the effluxion of time she was not able to reinstate Dartmill Limited. As Dartmill Limited did not exist, she was unable to obtain a Judgment against that company (thereby establishing its liability). This in turn meant that Eagle Star Insurance was able to avoid liability. In the transport and forwarding industry it is common to find that companies have been removed from the Companies Register. On occasions this is because the company has been wound up and the assets distributed. The Registrar of Companies will often remove companies from the register if they fail to file accounts, returns etc or fail to comply with other procedural requirements. This adds yet a further hurdle (and thus layer of expense) to litigation under the 1930 Act. It is beyond the scope of this paper to go into detail about company law but there are restrictions on the reinstatement of companies (although the period for resurrecting a company has been greatly extended by an amendment to the relevant legislation). If it is still possible to reinstate the? dissolved company to the Companies Register, an application to the Companies Court is needed before one can even consider the issue of liability. However, Lord Brandon of Oakbrook made it clear that the 1930 Act was not passed to remedy any injustice which might arise as a result of the dissolution of a company. In November of 2007, insurers tried to stretch this argument even further. They argued that where a bankrupt individual had been discharged from bankruptcy, the claimant could not establish liability against the bankrupt. As a consequence, it was said, a claim could not be established under the 1930 Act. However, in Law Society -v- Dixit Shah & Others [2007] EWHC 2841 Mr Justice Floyd found that the liability of the bankrupt insured could be established - even if the bankrupt insured had been discharged. The discharge only operated to prevent a recovery against the bankrupt insured. It did not prevent the establishment or quantification of liability. As a consequence, recovery against the insurers under the 1930 Act was still possible. A different approach? Recent cases suggest that we may have seen the first tentative steps by the Courts to adopt a rather more flexible approach, at least insofar as the provision of information is concerned. In Curzon Insurance Limited -v- Centre Reinsurance International Co [2006] 1 BCLC 187, Blackburne J considered that the insolvency of an insured could (by reason of the 1930 Act) confer contingent rights against the insurer upon third parties. These contingent rights would not crystallize until the third party had established and quantified the insured's liability. Thus, where an insured had liability cover of ?500 million in excess of ?690 million, the 1930 Act could still transfer rights and obligations under the policy such as, for example, those arising under a claims control clause. Blackburne J took his authority for this proposition from the judgment of Lord Justice Saville in Cox -v Bankside Members Agency Limited [1995] 2 Lloyd's Rep 437, where he said: "It is common ground that the obligation of the E&O Underwriters to pay under their insurances only arises when the liability of their insured is established and quantified by judgment, arbitration award or settlement: see Post Office -v- Norwich Union [1967] 2 QB 363 and Bradley -v- Eagle Star [1989] AC 957. Under the Act the rights of the insured against the insurer are transferred to the third party on (in the case of an insured company) the making of a winding up order etc: see section 1(b) of the Act. It follows from this that a statutory transfer can take place before the obligation of the insurer to pay arises i.e. before the liability of the insured has been established. In such an event, since it is clear from the authorities that the third party is to be put in no better position than the insured, the third party does not obtain the right to immediate payment until the liability of the insured is established." Thus, there has been an indication that perhaps some rights are transferred before the liability of the insolvent insured is established and quantified. However, it would seem that that these rights are, at present at least, rather restricted. The Court of Appeal appeared to take a more generous view of the wording of the Act in In re OT Computers Limited [2004] 2 All ER (Comm) 331. OT Computers sold computers under an extended warranty scheme. Its customers were able to obtain credit facilities from a finance company (which, according to Section 75 of the Consumer Credit Act 1974, became jointly and severally liable for breaches of contract by OT Computers). OT Computers went into administration and was sold free of its liabilities under the warranty scheme. This meant that the finance company was left with the liabilities under the scheme. The administrators advised the finance company that OT Computers had taken out insurance to cover such liabilities. The finance company would, according to the Consumer Credit Act 1974, stand in the shoes of the customer if it indemnified that customer. Consequently, it claimed to have an interest in the insurance policies by reason of the fact that it would be making a claim against OT Computers for any liabilities incurred under the extended warranty scheme. It would then seek to enforce any liability on the part of OT Computers against the insurers. Both the insurers and the administrators refused to provide any details of the insurance. Two questions arose. Firstly, it was argued on behalf of the insurers that the 1930 Act applied only to tortious liability or contractual liability arising in circumstances which were equivalent to a tort. Lord Longmore gave the leading Judgement (with which the other two Court of Appeal Judges agreed). He said: "The words are (to repeat them again) "insured against liabilities to third parties which he may incur". These words are perfectly general (as I have already observed) and are apt to include liabilities in debt just as much as liabilities in damages". Thus, where liability insurance covers a contractually accepted liability, it will still fall within the 1930 Act. He went on to say: "that is not to say that the insurance policy itself may not specifically provide that the insured liability is to be a liability in damages or even a liability for damage; in such a case the policy will not apply to a contract debt since liability for such a contract would not be a liability in damages and it will probably not be a liability for damage either (although we heard no argument on the point)". Thus, Lord Justice Longmore's decision does not extend the cover of liability under the policy and provide for claims where they would not ordinarily arise. However, it is important to note that the 1930 Act is not restricted in the type of liability to which it applies. The second question was whether, under section 2 of the 1930 Act, the administrators were obliged to give disclosure of the insurance policies with the underwriter (in this case AXA). Within this question, Lord Justice Longmore identified a third question, namely when are the insured's rights transferred to the third party? In the opinion of Lord Justice Longmore, it was more natural to read the 1930 Act as envisaging that the transfer of the rights of the insured to a third party occurs on the insured's insolvency (whether the establishment of liability occurs before or after the insolvency). He said: "The rights so transferred may be contingent or inchoate in the sense that the rights may not give rise to legal liability on the part of the insurer until the existence and amount of the liability is established but the transfer nevertheless takes place on the insolvency." As the rights are transferred on insolvency, the right to information about the insurance arrangements also arises at that stage. This still, however, leaves potential claimants with a difficulty in circumstances where the potential defendant is not yet insolvent but, nevertheless, is unlikely to be able to satisfy a judgment. As a third party to the contract, the potential claimant has no right to see the insurance contract. Moreover, in the absence of an insolvency, no rights under the policy are transferred. However, the gamble taken by the claimant in pressing on with litigation against an impecunious (but technically solvent) party in such circumstances is unlikely to be significantly less than it would be were the defendant insolvent. This position was considered in one of the most recent of the authorities, Harcourt -v- FFG Griffin & Others [2007] EWHC 1500. This is a decision of Mr Justice Irwin in the Queen's Bench Division of the High Court. The claim concerned an unfortunate accident whereby the claimant (at the time aged 16) suffered severe spinal injuries whilst in the gymnasium of the defendants. The accident resulted in serious disability and it was anticipated that an award for damages could be as high as £8 million or so. The first defendant was an unincorporated association responsible for the provision of gymnastics coaching at the club. The second and third defendants were coaches employed by the first defendant. The parties had reached an agreement on liability and the question of quantum remained outstanding. It was quite clear, however, that the defendants would not be in a position to satisfy a judgment of this size from their own pockets. The claimant therefore sought disclosure of information concerning the defendants' liability policies under the Civil Procedure Rules, Part 18. (Part 18 of the CPR allows a court to order that a party should clarify any matter which is in dispute or give additional information in relation to any such matter.) Mr Justice Irwin accepted that the nature and extent of the defendants' insurance was not, in itself, a matter in dispute in the proceedings. Proper quantum of damages could be determined without assessing whether or not the defendants could actually pay those damages. Nevertheless, the claimant's lawyers were concerned that a full assessment of damages was likely to be an expensive exercise (requiring considerable medical evidence etc). As the defendants had no funds to pay for the costs of such an exercise, this was likely to result in a substantially reduced recovery for the claimant. Mr Justice Irwin decided that the wording of CPR Rule 18 should be interpreted liberally. He could see no reason why the wording should not be interpreted so as to allow the application for information. That having been said, Mr Justice Irwin warned of the limits to be placed upon such applications. He said "I also agree that it would be highly regrettable if application and cross application for information of this kind became a standard piece of tactical manoeuvring in litigation, even in the case of personal injury litigation where the periodical payment consideration comes into play. This is a valid argument against any general practice of ordering disclosure along these lines. It seems to me that, setting aside any other point, disclosure of this kind should only be ordered where a claimant (or where the situation arises any other party) can demonstrate that there is some real basis for concern that a realistic award in the case may not be satisfied." Mr Justice Irwin listed some of the key facts which caused him to reach the conclusion that disclosure should be ordered. The claim was very large (in personal injury terms). Considerable costs had already been incurred and it would seem that both parties anticipated a much larger costs bill yet to come. A certificate of insurance (indicating a limit of ?5 million) had already been disclosed. If the limit indicated in that policy represented the totality of the insurance cover in place, the claimant's lawyers contended that it would be better to accept such a sum than waste costs (and thus reduce the money available to the claimant) by fighting for the balance of the claim. Since the introduction of the Civil Procedure Rules in 1998, the Courts have expressed a preference for avoiding wasteful litigation. The general scheme of the Civil Procedure Rules is to encourage an early exchange of information between the parties so that they can properly asses their rights and obligations at an early stage. Both the OT Computers decision and the Harcourt decision are in line with such an approach. Having said this, there are legitimate reasons for both insurers and insureds not wanting to disclose information concerning liability policies to third parties (and particularly potential claimants). Thus, it is important that the warning of Mr Justice Irwin in the Harcourt decision is carefully noted. Other potential courses of action It is possible that since 1999, an alternative route might be available to third parties seeking to enforce rights directly against an insurer under another party's policy of insurance. The inability of third parties to enforce rights for their benefit arising from contracts was recognised as a shortcoming of English law and the Contracts (Rights of Third Parties) Act 1999 was passed to amend this. This Act provides that a third party may enforce rights under a contract (in his own right) if the contract either expressly provides that he may or purports to confer a benefit on him. It has long been recognised within the insurance industry that there may be additional loss payees noted on a policy and that they may make a claim under the policy directly. This, in itself, does not cause too much of a problem. However, where liability policies are concerned, it is possible that the cover does, in effect, confer a benefit upon a third party even where that third party is not named as a loss payee. To take the benefit of the Act: "the third party must be expressly identified in the contract by name, as a member of a class or as answering a particular description but need not be in existence when the contract is entered into." The full implication of this wording has not yet been hammered out in this context. In the case of a forwarder, for example, it is possible that its customers may qualify as a "class" or as "answering a particular description". Some liability policies are taken out or extended to take into consideration particular projects or particular contracts. It may be stretching the definition too far to suggest that all potential claimants are included (although the policy wording will have to be considered carefully). However, where particular uplifts are in place for specific third parties or particular contracts are mentioned, third parties may be able to claim a specific benefit. That having been said, the Act states that rights are not conferred on third parties where, on a proper construction of the contract, it appears that the parties did not intend the term to be enforceable by the third party. Many contracts of insurance (in particular liability policies) expressly state that they are not to be enforceable by third parties. Such a provision would stop any application by a third party to enforce rights under the policy in its tracks. Potential amendment In 2002, the Law Commission completed its review of the 1930 Act and the Government announced its acceptance of the proposals for reform. However, to date, these proposals have not been implemented (allegedly due to a lack of Parliamentary time). Some of the principal reforms have already been addressed in the most recent decisions. For example, there were several proposals for reform concerning the provision of information. Lord Justice Longmore's decision in OT Computers appears to address many of these without the need for reform of the 1930 Act. Similar considerations apply to the earlier concern that the 1930 Act might only apply to tortious (or the equivalent) liabilities. Again OT Computers appears to deal with this The Law Commission's proposed amendments to the law attempt to address some of the procedural hurdles that occur with regard to company law. For example, where a company is dissolved, it is proposed that it would no longer be necessary to reinstate it and sue it before pursuing the insurer. This should, hopefully, save considerable costs and time. There is also a proposal to remove or limit the insurers' ability to rely upon technical defences. Thus, the Pay to be Paid clause would no longer allow an insurer to avoid liability. Furthermore, technical breaches of a policy (such as a failure of an insolvent (or even dissolved) insured to give notice of a claim against an insurer) would no longer allow the insurer to avoid liability. It is also proposed to clarify the operation of the Act in cases where assets, insured or insurers are based overseas. If the Government takes much longer about the implementation of the Law Commission's proposals, it is probable that the matter will have to be referred back to the Law Commission for further review. Whilst the legislation may not be high on the Government's list of priorities, to the practitioners and those involved in the insurance industry generally it is of considerable importance. As can be seen from recent decisions, the judiciary appreciates the urgency of the matter and the injustices caused by defects in the 1930 legislation. It is clear that the position has moved on somewhat since 2002! Although it is not necessarily an entirely satisfactory method of pursuing the matter, it is, perhaps, possible for further judicial interpretation to alleviate some of the current problems. For example, if it is accepted that rights transfer to the third party upon the insolvency, can the decision in The Fanti and The Padre Island be questioned? It could, perhaps, be argued that the contingent right under a "Pay to Paid" policy is transferred to the third party. Once the third party has suffered the loss it has "Paid" and can then recover. However, the requirement to pay is an obligation of the insured as opposed to a right and it must be questioned whether a third party is entitled to satisfy a condition precedent of this nature. It would take a visit to the House of Lords to have the decision overturned. Conclusion The 1930 Act was designed to overcome the specific injustice of proceeds of a claim under a liability insurance being placed within the general melting pot of an insolvency distribution of assets. Whilst it may have achieved this, various other injustices were overlooked. This has become apparent since the 1930 Act was passed and, understandably, the judiciary has found itself unable to address all of those concerns by inventive interpretation of the Act. Recently, the Courts have adopted a more liberal approach to the interpretation and application of the Act. Certainly with regard to the provision of information, the Courts have recognised that a considerable amount of time and costs can be wasted pursuing actions which really are fruitless. Moreover, it can hardly be doubted that insurers were able to hide behind a lack of information. Third parties had to decide whether or not to pursue an action without any knowledge of the contract upon which they would be suing. As a consequence, it is almost certain that many meritorious cases have been abandoned at the outset. Certain administrative and technical difficulties remain, however. It is just as important that these are addressed. If you have any queries arising out of the above please do not hesitate to contact Christopher Chatfield. February 2008 Return to Bulletins |
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