As any insurer underwriting risks in Spain will know, there is always a risk in any policy coverage dispute that insurers might be ordered to pay penalty interest pursuant to Section 20 of the Spanish Insurance Contract Act (“SICA”), if the court decides there has been an unjust delay in them paying an indemnity. The quantum of any penalty interest award will be calculated on the basis of the legal interest in force, plus 50% for the first two years after the occurrence of the loss and a rate of, at least, 20% from the second year onwards until payment of the indemnity.

Paragraph 8 of Section 20 SICA stipulates that penalty interest will not be payable in certain circumstances, namely "…when the failure to indemnify or to pay the minimum sum known to be due, is founded in a justified reason or in a reason which is not attributable to the insurer". However, what constitutes a "justified reason" has been the subject matter of a number of different judgments issued by the Spanish Supreme Court and as a result the position remains far from clear.

The Supreme Court previously allowed insurers to avoid paying penalty interest under Section 20 SICA, if they were able to show a variety of reasons, including: (i) a dispute between the parties about the loss or its causes; or (ii) an ongoing discussion about policy coverage; or (iii) the need for judicial intervention in light of discrepancies between the parties; or (iv) an exaggerated claim.

This position has however gradually changed and the attitude of the Supreme Court has hardened, narrowing the bases upon which insurers can legitimately refuse to indemnify an insured. For example, the mere existence of a dispute is no longer considered a “justified reason” for insurers not to indemnify. This stance has been reinforced by the most recent judgment of the Supreme Court on this issue dated 1 July 2016. In this decision, the Supreme Court upheld the position that the existence of ongoing judicial proceedings (alone) does not suffice as a legitimate basis for insurers to refuse to indemnify the insured. The Supreme Court held that in such circumstances, the appropriate course was for insurers to make a payment of the claimed loss, pending resolution of any dispute.

The consequences of this decision are significant. As matters stand, if Insurers are disputing cover, the only sure fire way to avoid a potential award of penalty interest is for insurers to pay the sum demanded by the insured under the policy to the insured (even if the amount claimed is (in insurers’ view) exaggerated) and then to challenge the position. Insurers will therefore be required to initiate an action against the insured to dispute cover and to recover the monies paid over to the insured. This course of action is clearly unattractive and causes obvious problems in circumstances where an insured becomes insolvent. In such a situation, there is a distinct possibility that insurers would not be able to make any recovery.

Furthermore, in the recent case, the Supreme Court also ordered that penalty interest should be calculated from the date of the loss, rather from the date when the Court of Appeal overturned the judgment at First Instance and decided that the loss claimed was covered. This decision ignores three key issues: (i) the fact that the Court at First Instance initially decided the loss was not covered and as such insurers were not obliged to make any payment to the insured; (ii) the fact that under Spanish law, a party is entitled to rely upon a judgment until it is revoked by a superior court; and (iii) insurers should not be liable for any delays caused by administrative delay.

This recent Supreme Court decision is an unwelcome development for insurers and has put them in an invidious position in circumstances where they are disputing policy coverage. Either they must pay the claim and then seek to challenge cover, running the risk that if their challenge is successful, they may have difficulties in recovering the monies paid, or alternatively they must reject cover and then run the risk that if their position is challenged successfully, they will be required to pay penalty interest. Whilst the Supreme Court’s focus may be to encourage insurers only to take valid policy coverage arguments, its stance has arguably put insurers at a distinct disadvantage.