Practical restrictions on insurers' subrogation rights

It is remarkable how a matter which might be considered to be of no more than academic interest can suddenly assume practical significance. An example of this phenomenon is the recent decision in the matter of Ballast plc [2006] EWHC 3189 (CH) in which Lawrence Collins J (as he then was) had to decide, in the context of the application of provisions in the Insolvency Act 1986 ("the 1986 Act"), whether an insurer's rights of subrogation gave the insurer a proprietary interest in the insured's cause of action against a third party which was alleged to be responsible for the loss covered by the insurer.

Decision and practical implications

It was held that the insurer did not have a proprietary interest with the result that the insolvent insured's claim against a party against whom the insured might claim did not vest in the insurer. The decision highlights the fact that insurers can no longer assume that their general legal rights of subrogation will provide them with sufficient protection to enable them to proceed with recovery claims where their insureds become insolvent. Property insurers should re-consider their policy wordings in light of this decision and should seek to add to such rights by contractual provisions.

Legal background

The question of the nature of the insurer's interest in its insured's cause of action against a third party had been discussed by the House of Lords in Lord Napier and Ettrick v Hunter [1993] AC 713. One of the matters which had to be determined by the House of Lords in that case had been whether an insurer who was subrogated to the interests of the insured enjoyed a right of property in the proceeds of the insured's claim against third parties. In Lord Napier, the factual background was that Lloyd's Names personal stop loss insurers claimed an interest in the proceeds of recovery from an action brought by the Lloyd's Names against various members and managing agents who had been sued following the underwriting by the Outhwaite Syndicate of run-off reinsurance policies. It was alleged that the underwriting of those policies had been negligent. The House of Lords decided that the personal stop loss insurers held an equitable lien over the proceeds of the action (which were, at the time, being held by Richards Butler in their client account). There has been considerable debate about the correctness of that decision. Some of the Law Lords also considered the nature of the insurer's interest in the insured's cause of action. Lord Goff tended to the view that the insurers' interest would be in the nature of an equitable proprietary interest:

"Does the equitable proprietary interest of the insurer attach only to a fund consisting of sums which come into the hands of the insured in reduction of the loss paid by the insurer? Or does it attach also to a right of action vested in the insured which, if enforced, would yield such a fund? The point is not altogether easy. I can see no reason in principle why such an interest should not be capable of attaching to property in the nature of a chose in action… however since the point was not directly addressed in the argument before your Lordships I am reluctant to reach any conclusion upon it without a full examination of the authorities relating to the respective rights and obligations of insurer and assured, especially with regard to the conduct and disposal of litigation relating to causes of action of the relevant kind."

Lord Templemen also adverted to the point, albeit referring in general terms to the insurer's "interest" in the right of action. Ultimately he agreed with Lord Goff that the precise nature of the insurer's interest did not arise for consideration in that case.

Ballast – facts

The point arose directly for determination, however, in Ballast plc. Ballast plc ("Ballast") had been required to carry out repairs to remedy defects in works that it had carried out to a school in Wales. It was indemnified by its contractors all risks insurer, St Paul Travelers Insurance Company Limited ("St Paul"), against the cost of the repairs (apart from the deductible borne by it under the policy). An issue arose as to whether Mott MacDonald Limited ("MMD") was liable to Ballast in respect of the defects. MMD assisted in the carrying out of the repairs and delivered invoices to Ballast in relation to that assistance but had not received payment for the amount of the invoices. Before the differences between Ballast and MMD could be resolved Ballast went into administration, and later, into liquidation.

St Paul wished to pursue the subrogated claim against MMD but the liquidators had no interest in doing so. To the contrary, they wished to complete the liquidation quickly in order to secure funds from Ballast's parent. To that end, they agreed MMD's claim in the liquidation for the unpaid invoices, having previously disclaimed any interest in the claim against MMD. They did so by filing a notice of disclaimer pursuant to section 178 of the 1986 Act. St Paul sought to advance its claim by making an application under section 181 of the 1986 Act for a vesting order vesting it with Ballast's claim against MMD. Under the 1986 Act, the court has power to make an order for the vesting of disclaimed property in a person entitled to that property. MMD opposed the application which, potentially, raised a number of difficult issues. In the event it was determined by the judge by reference to the question of whether St Paul had a sufficient interest in Ballast's claim against MMD to justify the making of a vesting order.

Ballast – decision

The judge decided that St Paul's interest in Ballast's claim was not sufficient for the making of a vesting order. In doing so he had to consider the nature of an insurer's subrogated claim. He identified the following characteristics:

  1. Once it has indemnified its insured, the insurer is entitled to receive the benefit of all rights which diminish the loss.
  2. If the insured refuses to bring a claim against a third party in its own name, the insurer might bring the claim in its name and join the insured to seek an order that the insured should allow its name to be used.
  3. The insurer has a proprietary interest in the proceeds of a recovery action.
  4. The insured's cause of action against a third party does not vest in the insurer. It continues to be the insured's cause of action. The point was made succinctly by Kerr LJ in Smith (MH) (Plant Hire) Limited v Mainwaring [1986] BCLC 342, in these terms:
    "The right of subrogation does not have the effect of transferring to the insurers any cause of action which the assured may have against the wrongdoer. Such transfer can only be affected by a legal assignment to insurers".
  5. An insured may pursue the third party to recover its own uninsured losses even if the insurer has decided not to seek to recover the amount of the indemnity (for example, because it has already concluded an agreement with the third parties insurer not to do so).
  6. A settlement reached between the insured and the third party is binding on the insurer (although the insurer may have a claim against the insured).
  7. It is only the insured who can give a valid receipt and discharge to a third party in respect of the judgment against that third party.
  8. The insurer's right in respect of a subrogated claim is limited to the amount that it has paid to the insured and it enjoys no wider rights to the benefits of the claim as a whole (as it would if it took an assignment of the insured's claim against the third party).

Conclusion

The judge concluded that the characteristics referred to in 1 to 3 above were not clear indicia that the insurer's interests in the claim were property rights. Those referred to in 4 to 8 above were indicia that they were not and the judge so concluded. Having ruled that it was a requirement of section 181 of the 1986 Act that the relevant interest in property must be proprietary in nature, he concluded that an insurer's right of subrogation is not a sufficient interest for the making of a vesting order under the 1986 Act.