Where a policy insures a number of insureds, can the insurer indemnify one co-insured for a loss and then use its rights of subrogation to recover that loss from another co-insured?
The Court of Appeal (the Court) considered this, and a number of other issues, in Rathbone Brothers Plc & Michael Paul Egerton-Vernon v Novae Corporate Underwriting Limited & Ors .
The Court’s conclusions are instructive for insureds, their brokers, and insurers regarding structuring insurance arrangements involving more than one insured.
Rathbones plc (Rathbones) is an international group whose trust business includes the management of family trusts for wealthy clients. A dispute arose over the construction and effect of its excess layer professional indemnity policy (the Policy) in the context of litigation before the Jersey courts regarding a discretionary trust set up by the late Jack Walker, the former chairman of Blackburn Rovers FC.
The beneficiaries of the trust allege that the trustees, including Paul Egerton-Vernon (PEV), who acted as an employee and subsequently a consultant to Rathbones’ Jersey subsidiary, made poor investment decisions in breach of their professional and fiduciary duties.
Rathbones had entered into 'An Instrument of Release and Indemnity' (the Rathbone Indemnity) a separate indemnity agreement between Rathbones and PEV under which Rathbones agreed to indemnify PEV from liability up to £40million per event in connection with liabilities arising from the performance of his duties.
Issue 1 – Which came first the Rathbone Indemnity or the Policy?
Clause 5.14 of the Policy provided that:
“Insurance provided by this policy applies excess over insurance and indemnification available from any other source.”
Excess insurers (Insurers) contended that this clause meant that if PEV were covered by the Policy, they were only liable for the excess after the Rathbones Indemnity had been exhausted.
PEV argued that the Rathbone Indemnity, as a non-insurance indemnity, was not caught by the clause; but if it were, it did not apply to indemnities given by one co-insured to another.
The Court decided that as a matter of language it plainly covered both insurance and non-insurance indemnities as confirmed by the conjunction “and” within the clause. However, the phrase “available from any other source” did not include an indemnity given by one co-insured to another.
The Court concluded that if Insurers could take advantage of an indemnity given by one co-insured to another “this would significantly undermine the protection afforded by the policy”and that it would frustrate the purpose of professional indemnity insurance to interpret the policy so as to exclude Insurers from liability in the very circumstances where that insurance is most likely to be needed.
It was clear where the clause referred to other insurance cover it meant insurance from a source independent of Rathbones and the other insured companies and it was reasonable to construe the clause so that the non-insured indemnity also needed to come from a source external to Rathbones.
Issue 2 – Could Insurers exercise a right of subrogation against a co-insured?
Clause 5.13 of the Policy provided that:
“The insurer shall be subrogated to all insureds’ rights of recovery, contribution and indemnity before or after any payment under this policy. The insured shall do nothing to prejudice such rights.”
As the Court held that the Policy responded ahead of the Rathbone Indemnity, it raised the issue of whether, once the Insurers had paid out under the Policy, the Insurers could be subrogated to the rights of PEV against Rathbones under the Rathbone Indemnity.
It is well established as a general principle that insurers who have paid out to an insured for loss or damage cannot bring a subrogated claim against a co-insured who is himself both insured and liable in respect of the same loss or damage. However, here Rathbones faced no liability for any loss suffered by the beneficiaries of the Walker Trust, but only a contractual claim by PEV under the Rathbone Indemnity.
The right of subrogation could therefore only be excluded by waiver of the right in the insurance policy itself; or, by the terms of an underlying contract between the insured and a third party denuding it of any substance and precluding it from being exercised.
Rathbones sought to argue that both ways applied here: it contended that there was an implied waiver in the Policy; and that the Rathbone Indemnity was intended to treat the Policy as the primary indemnity rather than take its place.
Rathbones argued that if Insurers were allowed rights of subrogation in respect of the Rathbone Indemnity it effectively meant that the Rathbone Indemnity was the primary source of indemnity and the Policy was the indemnity of last resort. This was contrary to both common sense and to the commercial realities; the result was nonsensical and could not have been what was intended.
The Insurers argued that the supposed commercial purpose of a contract could not override the clear and unambiguous terms of the Policy. The starting point was the wording of the Policy itself and the principle that the parties who agreed the wording intended the words used to mean what they say in setting out the parties’ respective rights and obligations. This meant that if there are two possible constructions of the document a court is entitled to prefer the construction which is more consistent with “business common sense” if that can be ascertained. It did not elevate business common sense to an overriding criterion of construction and the parties should not be subjected to the Judge’s notion of what would be a sensible solution to the parties’ dispute. Accordingly, it did not provide a basis to preclude the right of subrogation conferred under clause 5.13.
In addition, Insurers relied on the dicta of Lord Justice Rix in Tyco Fire & Integrated Solutions (UK) Ltd v Rolls-Royce Motor Cars Ltd  EWCA Civ 286;  Lloyd’s Rep IR 617 (Tyco) that there was nothing in the doctrine of subrogation to prevent an insurer suing an employee in the name of the employer to recover the insurance proceeds which the insurer has paid in the absence of any express “ouster” of the right of subrogation.
The Court however decided that the dicta of Rix in Tyco was not of universal application and that there was an implied term that Insurers would not seek to be subrogated to PEV’s right against Rathbones under the Rathbone Indemnity.
The Court relied on the test for implying a term set out in Attorney General of Belize v Belize Telecom Ltd  UKPC 10 of whether such a provision would spell out in express words what the document read against the relevant background would reasonably be understood to mean: that is to say, it must “go without saying” that was what was intended.
On this basis the Court was satisfied that it could not have been the intention of the parties that Insurers should be able to enforce rights of indemnity against a co-insured where the co-insured was indemnifying the very same risk as Insurers. This was for the same reason that the Policy was not found to sit above the Rathbone Indemnity: the effect would be to seriously undermine the purpose of the Policy because allowing Insurers to subrogate would deny Rathbones the very benefit the Policy was intended to confer.
It might be said, that in the light of the express wording of clause 5.13, and Rix’s comments in Tyco, Insurers had a strong case. However, the Court appeared to be influenced by the opportunistic nature of Insurers’ position: as the Court observed, it was “pure happenstance” that the indemnity was in place and the Court considered that, if Rathbones had asked in advance whether they could enter into the indemnity with PEV without jeopardising their right to recover under the Policy, they would have been told they could do so.
Issue 3 – Was the exercise of a right of subrogation precluded by the terms of the underlying contract i.e. the Rathbone Indemnity?
Rathbones relied on the decision in Mark Rowlands v Berni Inns Ltd  1QB 211 (Berni Inns) to argue that the terms of the Rathbone Indemnity itself could prevent Insurers being subrogated to it for the purpose of pursuing Rathbones.
In Berni Inns a landlord insured premises which were destroyed by fire caused by the tenant’s negligence. There was fire insurance in place and the premiums had been paid out of the rental income from the tenant. The Court held that the fire policy was intended to enure for the benefit of the tenant and that the landlord and tenants’ intention was that any loss suffered by the landlord would be recouped from the insurance moneys, which would discharge the tenant’s obligations. In this situation the landlord had been fully indemnified in the manner envisaged by the lease and therefore he could not recover damages from the tenant.
Insurers argued that in Berni Inns there was a clear link between the lease and the fire policy. However, there was no link of any kind between the Policy and the Rathbone Indemnity and the Rathbone Indemnity did not state that PEV should first look to his insurance before having recourse to the indemnity.
The Court observed that if there were an express clause linking an underlying contract with a policy of insurance, it could be seen that the insurance is intended to be the primary source of indemnity; but, nevertheless, it still might be the appropriate inference to draw from the facts where there is no explicit link between them.
The relevant question to ask in this case was whether PEV would naturally have understood that his claim under the Rathbone Indemnity had been exhausted once his liability had been fully met under the Policy: i.e., was the Policy the primary source of indemnification discharging Rathbone’s liability. The lack of an express term did not mean that there was no intention the Policy should come first: it was clear enough that this was the intention and, in these circumstances there was no right under the Rathbone Indemnity to which Insurers could be subrogated.
Lessons for the Insured and its broker
It is common for parties to a contract, such as landlord and tenant, or contractor and sub-contractor, to agree that one party should obtain insurance for both of them. In order to avoid the risk of an insurer subsequently seeking to exercise subrogation rights against one of those parties following a loss, they both ought to be named as co-insureds on the policy.
It is also common for an employer to provide an indemnity to an employee or consultant separate from any professional indemnity arrangements. In the light of this decision:
- any separate indemnity should make clear with express provisions within it the intended relationship between the indemnity and any insurance cover potentially available; and
- the insured (and its broker) ought to make sure these provisions do not conflict with the express language of the policy.
The failure to do so might lead to the separate indemnity inadvertently supplanting an insured’s professional indemnity policy, or at least allowing an insurer to pursue a subrogated claim against it.
Lessons for the Insurer
It might be observed that clause 5.14, which provided that the Policy applied over both other insurance and indemnification from any other source was clearly drafted in wide terms to protect the Insurer’s position. Similarly, clause 5.13 of the Policy was clear regarding the Insurer’s rights of subrogation.
The Court however appears to have perceived the Insurer's position as an opportunistic stance designed to avoid covering a claim in a manner that defeated the commercial purpose of the Policy. The Court appears to have bent over backwards to ensure that such a stance would not succeed.