In industries such as construction contractual arrangements often involve complex multi-party commitments. Parties often choose to settle disputes out of court for a number of reasons: it can be less costly, it can be less time-consuming, it is a private process and not subject to media attention and, most of all, it often allows the parties to continue to work together amicably in the future. Settlement is also an underlying objective of the Rules of the High Court and Rules of the District Court following the Hong Kong Civil Justice Reforms. However, when relations turn sour and parties commence litigation, there will inevitably be varying attitudes towards settlement. Despite the many benefits of settlement, settling the dispute in a multi-party action can be fraught with difficulties.

Generally if a third party caused the damage, the third party will have to compensate the losing party following a judgment against the losing party. However, this is less straightforward where a settlement has occurred between the winning and losing parties. The party at fault may, for example, argue that the contractor should not have settled or that he settled for too large a sum in the knowledge that the third party will have to pick up the bill. The question for the courts is: in such circumstances, when can the losing party succeed in a claim against the third party to recover sums paid in settlement? This client alert answers the question by analysing the recent case of Siemens Building Technologies FE Ltd v Supershield Ltd [2009] EWHC 927.

The Facts of Supershield

The dispute arose following the failure of a nut-and-bolt connection on a water tank float valve. As a result of the failure, water from the storage tank overflowed and flooded the basement of a new office building in London. This led to extensive damage to electrical equipment. Proceedings were issued against the contractor who had constructed the building (Skanska) by the lessee, owner, and occupier to recover the cost of the damage.

The installation of the sprinkler system had been subcontracted through several tiers of contractors. The resulting contractual chain necessitated that each contractor be joined as a party to the action. Skanska joined its subcontractor Haden Young. Haden Young joined Siemens Building Technologies FE Ltd (Siemens). Siemens joined Supershield. The litigation and contractual chain can be expressed simply in diagrammatic form.

In June 2008, mediation took place and was attended by all parties. Siemens settled the claims with the other parties for its liabilities under the contractual claim but maintained a claim against its sub-contractor, Supershield, on the basis of breach of contract and under an indemnity clause. The settlement represented 48% of the total sums claimed in the dispute.

Supershield refused to pay Siemens for the cost of the settlement. Their claim, in effect, boiled down to the assertion that Siemens had settled for too large an amount given the alleged weakness of the claim and Supershield should therefore not be obliged to indemnify the cost of the settlement. The court was asked to determine whether Supershield was liable to Siemens for the sum paid in settlement of the claims against Siemens.

The Law in Supershield

The question was whether a defendant to a claim (Siemens) can recover sums paid to claimant(s) in settlement of a claim (Haden Young and others) from a third party (Supershield). To find any liability on behalf of the third party the following 3 stages have to be satisfied as a prerequisite:

Stage 1 - the third party must be liable to the defendant, typically for damages for breach of contract or for payment of a sum under an indemnity;

Stage 2 - the third party must be liable to pay the defendant damages in respect of the same issue; and

Stage 3 - the third party must be liable to pay the original claimant(s) the money paid to him in settlement by the defendant.

Once the first stage is satisfied and it is clear that the third party is liable to the defendant, the issue of whether the third party can be made liable for the settlement under stages 2 and 3 becomes relevant. The two point test derived from the case of Biggin v Permanite [1951] 2 KB 314 can be used to evaluate this:

a. had the claimant acted reasonably in settling the claim; and

b. if so, was the amount of the settlement reasonable in the circumstances.

The analysis of the reasonableness of a settlement is a discretion-based process. In his judgment Mr Justice Ramsey put forward 6 principles of interpretation of ‘reasonableness’ which he derived by summarising and applying past case law:

1. For a third party to be liable to a defendant, in respect of the defendant’s liability to the original claimant(s) which was the subject of a settlement, it is not necessary for the defendant to prove that he was or would have been liable to the original claimant.

This means that the defendant only has to show an arguable case. However, the strength of the case remains relevant to the reasonableness of the amount of the settlement.

2. For a third party to be liable to a defendant in respect of the settlement at common law, the defendant must show that the breach of contract by the third party caused the loss for which the settlement was paid in satisfaction and that the loss is not too remote. This is on the basis that it is not covered by the claimant’s indemnity. For example, case law has shown that damage to reputation is too remote. Conversely, a person put in the position of Siemens cannot usually be said to be acting unreasonably simply by incurring costs defending a claim.

3. The claim must be of sufficient strength to reasonably justify a settlement and the amount paid in settlement must be reasonable in regard to the strength of the claim. If not then it cannot be shown that the loss has been caused by the relevant eventuality or breach of contract.

In assessing the strength of the claim, unless the claim is so weak that no reasonable party would take it sufficiently seriously to negotiate any settlement involving payment, it cannot be said that the loss attributable to a reasonable settlement was not caused by the eventuality or the breach.

It should be noted however that there may be cases where a settlement of an intrinsically weak claim might be considered reasonable in order to avoid the uncertainties and expense of litigation.

4. In general if, when a party is in breach of contract, a claim by another party is in the reasonable contemplation of the parties as a probable result of the breach, then it will generally also be in the reasonable contemplation of the parties that there might be a reasonable settlement of any such claim by the other party.

5. The test of whether the amount paid in settlement was reasonable is whether the settlement was, in all the circumstances, within the range of settlements which reasonable people in the position of the settling party might have made. Such circumstances will generally include:

  1. The strength of the claim;
  2. Whether the settlement was the result of legal advice;
  3. The uncertainties and expenses of litigation;
  4. The benefits of settling the case rather than disputing it.

The judge in his judgment also noted that the advice was provided by a reputable firm of lawyers. This analysis suggests that the reputation of the legal advisers is relevant. To put it in its proper perspective it should also be a competent and experienced firm of lawyers, which the learned judge affirmed by citing the remarks of Goff LJ in Comyn Ching & Co (London) Ltd v Oriental Tube Co Ltd [1979] 17 BLR 56. This is of particular importance where the proceedings entail “long and complex litigation which was bound to be costly, and the outcome of which [the defendant] could not foresee with any certainty”.

6. The question of whether a settlement was reasonable is to be assessed at the date of the settlement (and not based on subsequent facts that come to light).

The Decision in Supershield

For Supershield to be liable to Siemens for sums paid by Siemens in settlement of the claims, it was not necessary for Siemens to prove the claims would have been successful. Siemens merely had to show that there was a good arguable case against them and that either the breach of contract between Siemens and Supershield caused the loss (and that it was not too remote), or the indemnity given by Supershield covered the settlement.

The court held that Supershield was liable to Siemens under the terms of the indemnity. The court further held that, in any event, Supershield would have been liable on breach of contract for the resulting losses caused by the faulty installation of the nut-and-bolt connection that caused the flooding. On the facts, the settlement was a reasonable one. Legal advice had been sought prior to the settlement and the case against Siemens was strong. The settlement of approximately 50% of the claim was reasonable in the circumstances as it was within the range of settlements which reasonable people in Siemens’ position might have made. Siemens was entitled to recover the full £2.72 million it had paid out.

The Significance of Supershield

This case is a useful summary of the law relating to the recovery of monies from a third party where the claim is based on an earlier claim against the claimant by another party. This case is especially important because it affirms the post-Civil Justice Reform stance of encouraging mediation and settlement.

From the perspective of a settling contractor, this case provides it with comfort on when it may recover from its lower tier subcontractor. For the lower tier subcontractor, it will be to its advantage if it provides its input to the settlement proceedings so that if a recovery action is brought against it, it can cite reasons that the sum settled is not reasonable (e.g. its valid views and input were ignored by the settling contractor, etc). Ultimately each case depends on its own facts and the principles of this case provide guidance.