This briefing is the second in a series of 3 briefings about the Third Parties (Rights Against Insurers) Act 2010 which we will be publishing on the run-up to it coming into force on 1 August 2016.
Click here if you would like to read the first briefing in the series.
The pros and cons every claims professional needs to know
In order to understand how the Third Parties (Rights Against Insurers) Act 2010 (2010 Act) changes the tactics insurers use when handling claims involving an insolvent defendant, it is helpful to look back at how the Third Parties (Rights Against Insurers) Act 1930 (1930 Act) works currently to consider the perceived flaws to both claimants and insurers. We do this by way of two case studies, looking at how the 2010 Act might bring about change to certain tactics used by the insurers in our case studies.
In summary: The pros and cons for insurers
Click here to view the table.
The 1930 Act allows a claimant to stand in the defendant insured's position in relation to a claim on its liability insurance. The right of a defendant to an indemnity from its insurer is transferred to a claimant when a defendant becomes insolvent which prevents the insurance money from becoming an asset in the insolvent estate and being used to increase the amount paid to other creditors.
However, prior to bringing proceedings against the insurer in relation to those rights, the claimant has to “establish” the claim against the insolvent defendant, which it must do by obtaining a judgment, arbitration award or settlement of the claim in its favour.
The main flaw in the 1930 Act for a claimant is that it generally does not know whether a prospective defendant has any liability insurance, and if it does, whether it will respond to the claim. So it does not know whether it is worth pursuing the defendant until it has already gone through the process of establishing the claim against the defendant which may involve restoring a defunct defendant to the company register in order to be able to sue it. If the defendant is insolvent and turns out to have no liability insurance, or none that will meet the claim, the claimant is left with no way of recovering its damages or costs.
The way the 1930 Act works can also be expensive and cumbersome for insurers. For example, insurers are aware of a potential claim against them as soon as they know that their insured is being sued, but it can take a long time for that liability to be established, which means they may have to carry reserves for a long time. Alternatively, insurers may have to spend money on legal advice considering tactics such as whether they should try to intervene in the insured's dispute.
The following two case studies identify some of the issues that insurers currently have to address when faced with a situation under the 1930 Act.
Case Study 1
Bond Dickinson was appointed by Insurers to conduct the defence of a claim made against a firm of surveyors (the Insured) by an institutional mortgage lender (the Claimant). The Claimant made 12 mortgage loans totalling around £27 million, to a number of individuals in the same family, secured over properties in a buy-to-let portfolio. The Insured provided mortgage valuations in respect of 5 of these 12 transactions.
When the borrowers defaulted and the properties were repossessed, the Claimant became aware that there would be a serious shortfall on the borrowers’ accounts, and brought claims against the firm of solicitors who acted in all 12 transactions (the Solicitors), and the Insured. It appeared highly likely that the borrowers were fraudulent, that the Solicitors and surveyors were complicit in this fraud, and that one of the Claimant's private banking partners who initiated and helped to authorise the loans, was also involved.
Insurers did not become aware of this claim until a judgment in default was obtained against the Insured, by which time it had ceased trading and was in liquidation. Proceedings were however still continuing against the Solicitors. So we had the judgment in default set aside and took up conduct of the defence of the claim to protect the Insured’s position. Insurers instructed a separate firm of solicitors to advise on coverage issues, and our instruction was made on a strict reservation of rights pending the outcome of the separate coverage investigation.
Meanwhile the Solicitors had ceased trading and the partners in the firm were no longer contactable. Their lawyers therefore became unable to take instructions and had applied to be taken off the record. The Solicitors’ indemnity insurer (the Solicitors' Insurer) then successfully applied to be joined to the proceedings as a defendant. The Solicitors' Insurer’s position was that the two partners in the Solicitors had been fraudulent and/or dishonest, or had condoned such fraud or dishonesty, and as a result it had no liability to indemnify the Solicitors in respect of these claims (since the insurance policy essentially replicated the SRA’s Solicitors' Indemnity Insurance Rules and Minimum Terms and Conditions of Cover). However, the Solicitors' Insurer was concerned that, as the Solicitors’ lawyers had come off the record, the Claimant’s claim would go undefended and the Claimant would be able to obtain judgment in default for the full sum claimed. The Claimant would then be likely to seek to enforce that judgment against the Solicitors' Insurers under Section 1 of the Third Party (Rights Against Insurers) Act 1930 (the 1930 Act).
Whilst the Solicitors' Insurer did not dispute the liability of the Solicitors, it wished to be joined to that action to ensure that potential defences or issues relating to quantum were raised on behalf of the Solicitors, and also issued a counterclaim, seeking declarations to the effect that it was not required to indemnify the Solicitors, and that in the event that it was required to provide such an indemnity, this would be regarded a single claim “arising from similar acts or omissions in a series of related matters or transactions” and therefore subject to an indemnity limit of £2 million, rather than twelve separate claims subject to an indemnity limit of £12 million.
In so doing, the Solicitors' Insurer had the benefit of potentially disposing of the claim without the additional cost and expense of a separate and further claim under the 1930 Act, and would also be able to ensure that relevant defences to the Claimant’s claim against the Solicitors were not simply by-passed by way of procedural default. However, despite this advantage, the Solicitors' Insurer would not be able to avail itself of any of the defences or arguments open to the Solicitors, most notably in relation to contributory negligence, and if the Court disagreed with its analysis of coverage points it would potentially be required to indemnify the Solicitors for the full quantum claimed. Contributory negligence was a significant factor in this claim, and advice from counsel suggested that it was potentially as high as 70-80%.
By contrast, whilst continuing to act for the Insured under a reservation of rights, we did not inform the Claimant of the insurance position (a declinature was likely) at any stage prior to a mediation. While Insurers had strong arguments in favour of declining the policy, there were certain perceived weaknesses, at least until further investigations had been carried out. As such, the approach taken by the Solicitors' Insurer was unlikely to be appropriate given the scrutiny that would be put on any decision to decline cover. Instead, we/Insurers chose to continue to run a robust defence of the claim against the Insured (insofar as this was possible given that almost no documents were recovered from the Insured on which to base our conduct of the claim), relying on the contributory negligence points (which became apparent from the Claimant’s disclosure) that were not open to the Solicitors' Insurer, and indicating to the Claimant that cover was likely to be declined. With no formal requirement to inform the Claimant of the nature of policy concerns, it was left with a difficult decision as to whether to challenge the repudiation without sufficient knowledge of the basis on which it was made and lose a good chance to settle at mediation, or alternatively to accept a deal which factored in Insurers’ repudiation arguments. As such, it was possible to agree a commercial settlement at mediation which reflected this significant risk to the Claimant.
Case study 2
We acted for the liability insurer of a broker who was being sued for negligence for allegedly failing to disclose to motor insurers the nature of modifications to a vehicle on the placing of motor insurance. The insured was involved in a road accident as a result of which his passenger sustained extremely serious injuries. The passenger was claiming against the insured, whose motor insurers were trying to avoid the policy for non-disclosure, but who also threatened to bring proceedings against the broker who was by now in liquidation.
The motor insurers wanted the broker’s liquidator to admit into the liquidation a proof of debt which they had submitted. The danger there was that the admission of the proof of debt by the liquidator would be seen by a Court to amount to “an agreement” by which the broker’s liability to the motor insurers had been established and ascertained. This would allow the motor insurers subsequently to pursue a claim directly against our client, the broker’s liability insurer, under the 1930 Act. Our client would then cease to have any liability defence available to it and would be left to defend purely on policy coverage points. The difficulty for our client in seeking to have an influence on any liability defence was that it had already repudiated cover on the broker’s liability policy so had to take care not to act inconsistently with its repudiation of the broker’s policy so as to avoid waiving the repudiation. It was decided in the end that the only available tactic was to emphasise to the liquidator that if by admitting the proof of debt into the liquidation this might be found to amount in the future to an acceptance of liability on the broker’s part, so as to prevent it disputing that it was liable to the motor insurers, then such conduct would be in breach of the broker’s liability policy such that it would be a further ground on which to repudiate and/or decline cover under the policy.
The liquidator would then have to decline to admit the proof of debt, and the motor insurers would have to appeal to the Court under the Insolvency Rules to have it admitted. The appeal would most likely be allowed, but the tactic was to put the motor insurers to additional expense and difficulty (by having to go through an appeal process) to try to persuade it that pursuit of a claim against our client under the 1930 Act was not worthwhile.
A change in tactics?
Using our knowledge about the 2010 Act which we covered in our first article in this series (click here to read it again) we now look back at our two case studies and analyse whether different tactics might be necessary once the 2010 Act comes into force.
You can access a copy of the 2010 Act itself by clicking here.
Case study 1 revisited
Instead of the Solicitors' Insurer having to choose whether to apply to be joined to the action against the Solicitors, the likelihood is that the Claimant would have brought a claim directly against the Solicitors' Insurer under Section 2(2)(b) of the 2010 Act, to seek a declaration as to the insurer’s potential liability to the Claimant. This would allow the Solicitors' Insurer still to meet its objective of trying to ensure that potential defences or issues relating to quantum were raised on behalf of the Solicitors, and would allow it to put forward favourable arguments on aggregation. The Solicitors' Insurer would be saved the costs of having to apply to join in those proceedings and the cost of taking advice on whether or not to pursue that tactic. So the 2010 Act would improve the situation for the Solicitors' Insurer, making the process marginally easier, quicker and cheaper.
By contrast, the 2010 Act could take away the tactical advantage our own client had as Insurers of the surveyors, which was to remain quiet on any question of fraud in order to rely on contributory negligence arguments in order to obtain a commercial settlement. The 2010 Act would require Insurers to provide details of the cover, including whether they were repudiating cover, within 28 days of the Claimant serving a notice for information and disclosure on them. Even though Schedule 1 of the 2010 Act does not specifically require the insurer to say why it claims not to be liable under the policy, the disclosure may have alerted the Claimant to the option of alleging fraud by the Insured, meaning that contributory negligence arguments would no longer be sustainable. This might have encouraged the Claimant to bring proceedings against Insurers under Section 2(2)(b) of the 2010 Act and during those proceedings they may well have obtained further disclosure about coverage investigations. This would certainly have weakened our ability to obtain a good settlement for Insurers.
Case study 2 revisited
Under the 2010 Act the motor insurers would not need to try to prove that admission of a proof of debt into a liquidation “establishes” liability because they will no longer need to establish an insured’s liability in order to make a claim on an insured’s liability insurers. The motor insurers would be able to sue our client directly and seek a declaration from the Court (under Section 2 (2)(a)) that liability against the insured has been established. So the motor insurers save time and money and our client is denied the tactic of making things more difficult for them; however, if the motor insurers do bring proceedings against the broker’s E&O insurer, a huge positive is that the E&O insurer can now defend liability allegations without risk of waiving its repudiation of the policy.