The Court of Appeal has upheld a decision to make a non party costs order against an insurer who defended its insured in proceedings. The case provides a reminder of the risk insurers face when defending proceedings on behalf of an insured. It also summarises the key factors the Court will consider when deciding whether or not to make such an order against an insurer. In this case, the decisive factor was whether or not the insurer was acting exclusively or predominantly in its own interests
In Legg and others v Sterte and Aviva  EWCA Civ 97, the claimants owned properties on the same road as a garage company, Sterte. In 2003, the claimants started to notice an unpleasant diesel smell. It transpired that there had been a spillage of around 300 litres of diesel in August 1997 from the above ground tank at the garage. Several reports were undertaken by the local authority to ascertain the origin and timing of the contamination. All concluded that the most likely origin was the above ground tank.
Sterte was insured by Aviva under a public liability policy which excluded cover for pollution save to the extent that it was “caused by a sudden identifiable unintended and unexpected incident which occurs in its entirety at a specific time and place during the period of insurance”.
In preaction correspondence the insurer argued that the spill in August 1997 was not the cause of the contamination, and therefore the claim was not within the scope of the policy.
The claimants' case, as set out in the Particulars of Claim, was that the spill of oil from the tank in August 1997 was the sole cause of their loss. The insured passed the claim on to its insurer on the basis that, as pleaded, it would be covered by the policy (even though the loss adjustor did not agree with the basis on which the claim had been formulated). The insurer instructed solicitors to defend the claim.
The insurer applied to strike out the claim on the basis that it was time-barred. As part of the application, the claimants relied on expert evidence which introduced for the first time an alternative possible cause of the damage to the claimants’ land – long term leaks from the insured’s underground storage tanks or pipework.
The strike out application was dismissed, and the claimants then amended their Particulars of Claim to add the alternative case that the pollution was caused by long term leaks from the underground storage tanks or pipework. The original claim that the damage was caused by the spill in August 1997 remained in the pleading.
Following this, the insurer withdrew representation for the insured. Judgment in default was entered and the insured went into creditors’ voluntary winding up. An order was made that the insurer pay the claimants’ costs on two separate grounds:
- First, in the exercise of the Court’s discretion to order costs to be paid by a non-party pursuant to section 51(3) of the Senior Courts Act 1981. The Court found that the insurer had taken over defence of the action, determined that the claim would be contested, funded the defence of the claim up to the point when it withdrew representation, had effective conduct of it and conducted the claim for its own benefit.
- Secondly, on the basis that the insurer was liable under the policy to indemnify the insured against its liability for costs to the claimants and, as a result of the insured’s liquidation, the claimant succeeded to the insured’s rights under the Third Party (Rights Against Insurers) Act 1930.
The insurer appealed against the decision on both grounds. In respect of the non-party costs order it raised a number of arguments:
- the insurer argued that it had repeatedly made clear that the policy did not provide cover for gradual pollution damage and in its view the claims being made would not be covered by the policy;
- the insurer only participated in the defence because it was pleaded solely on the basis of the spill in August 1997 which, if successful, would fall within the cover provided by the policy;
- the insurer’s defence of that claim was substantially successful in that the claimants effectively abandoned that claim in favour of their alternative case;
- insofar as there remained a claim based on the spill in August 1997, the judge should have decided the issue of fact that the damage to the claimants’ property was not caused by that incident;
- the insurer acted in the interests of the insured as well as its own in defending the claim and if it had not funded the defence, the insured itself would have done so; and
- the insurer had no choice but to defend a claim which, on its face, fell within the policy cover and the insured would have had legitimate grounds for complaint if it had not taken steps to defend the claim.
Court of Appeal decision
Nonparty costs order
The Court considered TGA Chapman Ltd v Christopher  in which the features necessary to justify making a costs order against an insurer were set out:
- the insurer determined that the claim would be fought;
- the insurer funded the defence of the claim;
- the insurer had conduct of the litigation;
- the insurer fought the claim exclusively to defend its own interests; and
- the defence failed in its entirety.
Palmer v Palmer  refined this test so that the critical issue became whether or not the insurer was motivated either exclusively or at least predominantly by its own interest in the manner in which it conducted the defence.
The Court of Appeal decided that there was “ample material” which supported the contention that the insurer in this case was acting predominantly or exclusively in its own interest. The insured was unable to meet any judgment if it was not covered by the policy. The Court found that there was no doubt that the claimants’ property had been damaged by the presence of diesel oil and no real grounds for doubting that it was caused by leaks from the insured’s property. The insured asserted no grounds for defending the claims against it. The insurer was not defending the claim to protect the insured against an award of damages which it would be unable to meet, but to defeat a claim which, as pleaded, fell within the narrow class of pollution incidents covered by the policy. To the extent that the claim was outside the cover of the policy, the insurer had no interest in defending it, as evidenced by its withdrawal of support for the defence once the Particulars of Claim were amended.
The Court noted that the insurer would have had a good answer to the claim for a nonparty costs order against them if, following the new expert evidence, the claimants had abandoned their original claim based on the 1997 spill. In substance then the insurer would have funded the successful defence of such a claim. However, the claimants did not abandon that claim.
There was no foundation for the contention by the insurer that had it not funded the defence, the insured would have done so. The insured failed to defend the claims once the insurer withdrew its support. It therefore appeared that, had the insurer not defended the claim, the claimants would not have had to incur the bulk of their costs.
In order to challenge successfully the judge’s exercise of his discretion to make a costs order, the insurer would have had to show that he had regard to irrelevant considerations, failed to take into account relevant considerations or made a decision which was not justified by the material before him. The Court of Appeal held that none of these were the case and the decision was justified.
Claim under the policy
In light of the decision on the nonparty costs order, it was not strictly necessary for the Court of Appeal to consider this issue but did so as it had been fully argued. The question for the Court was whether the insurer was liable to indemnify the insured for costs in circumstances where the insurer denied that an insured risk had occurred.
On the policy wording in this case, the Court of Appeal found that the insured was entitled to be indemnified against the costs order in favour of the claimants, and by reason of the 1930 Act, that right vested in the claimants. In coming to its conclusion, the Court of Appeal noted that the alternative conclusion would mean that the insurer would not be liable to pay costs incurred with its consent if the claim against the insured failed and found that this could not have been what the parties intended.
The decision in Legg does not alter the position as set out in TGA Chapman Ltd v Christopher, Cormack v Excess Insurance Co Ltd and Palmer v Palmer. It is unusual for a third party costs order to be made, but the conduct of defences by insurers is one of the contexts where the Courts have been willing to do so. Both Cormack v Excess Insurance and Palmer v Palmer emphasised the importance of the insurer having acted primarily or exclusively in its own interest, and this appears to have been the decisive factor in Legg as well.
The case is a reminder to insurers of the risk that an order for costs may be made against them when they are funding the defence of an insured. It may be possible to mitigate this risk by being careful to avoid acting exclusively or predominantly in the insurer’s own interests. For example, in Cormack v Excess Insurance, an order for costs was not made on the basis that the insurer had been acting in the best interests of the insured party. In particular, it did not act contrary to the instructions or wishes of the defendant in the conduct of the litigation, and its own interest in defending the professional negligence claim coincided with the defendant’s wish to maintain his professional reputation. The involvement of the insurer had not added to the costs of what would have been a reasonable defence. This reasoning was upheld in the Court of Appeal.
Insurers should therefore consider, at each stage of the defence, whether or not they are acting in the best interests, and in line with the instructions, of the insured party. In particular, care should be taken to avoid a situation where the claimant is incurring costs because of a defence pursued and conducted by the insurer, and which is likely to benefit solely or primarily the insurer.
All that said, there may be compelling reasons why an insurer may wish to conduct the defence of its insured, even an insolvent one. In deciding how to proceed the insurer needs to consider a number of things including any risk it runs of having a costs order made against it. The case is a timely reminder of this.