DLA Piper's Practical Guide for Claims Managers in 2022 – Part 7

Introduction

In this edition of our monthly series of Practical Guides for Claims Managers in 2022, we discuss how a third party with a claim against an insured who is covered by an insurance policy can claim directly against the insurer of the policy if the insured becomes insolvent. The right is provided under the Third Parties (Rights Against Insurers) Act 1930 (1930 Act) and the Third Parties (Rights Against Insurers) Act 2010 (2010 Act).

This guide might be useful to you, in particular, if you are dealing with third party claims against an insured under a third party liability insurance policy such as a professional indemnity, employer’s liability or directors and officers policy, and your insured is or may become insolvent.

We anticipate that third party claims will likely increase if the number of insolvencies rises as a result of the current and anticipated adverse economic environment, and so this guide is intended to provide an overview and some practical tips for understanding how the 1930 and 2010 Acts apply to allow a third party to make a direct claim against insurers.

The 1930 Act – what did this do?

Before the 1930 Act came into force, if a third party had a claim against an insolvent insured only the insolvency office holder could claim under the insured’s insurance policy and any money paid out under the policy formed part of the insured's assets which would then be distributed to creditors. The third party would be left as an unsecured creditor with no direct claim to that money, other than amongst the pool of other creditors.

To address this situation, the 1930 Act introduced an automatic transfer of the insured's rights to claim against the insurer to the third party. This allows the third party to step into the insolvent insured's shoes and make a claim directly against the insurer so long as certain conditions are met. For example, if a firm of accountants provided negligent accounting advice to a client, and the accounting firm subsequently became insolvent for any reason, the client would have the right to claim directly against the accounting firm's professional indemnity policy.

The 1930 Act also created a duty on insolvency office holders of insolvent insureds, as well as insurers, to provide certain information to third parties to allow them to determine if they might have a covered claim.

In order to realise any claim under the 1930 Act, the third party must establish that the insured is liable to it for whatever loss the third party has suffered before it can establish a right to claim directly against the insurer. If the third party is successful, the court will usually give judgment against the insurer for a particular amount.

The 2010 Act: what did this do? – Key differences between the 1930 Act and the 2010 Act

In the landmark decision in OT Computers in 2004¹, the Court of Appeal overruled previous decisions and held that establishing the liability of the insolvent insured to the third party claimant was not a prerequisite for the claimant’s claim direct against the insurer of an insolvent insured.

The Court also decided that the duty to provide certain information to the third party also applied before the third party had established liability against the insured. It was this decision that eventually led to the 2010 Act being introduced.

The 2010 Act was introduced to clarify, modernise and simplify the 1930 Act. Importantly, the 2010 Act streamlined the process for third parties to make direct claims against insurers and updated and broadened the scope of insolvency situations to which it applies.

It may be important to bear in mind that the 2010 Act only came into force on 1 August 2016 and does not have retrospective effect. This means that if both the insured’s insolvency and the date when it incurred the relevant liability to the third party claimant occurred before 1 August 2016, the provisions of the 1930 Act still apply (although the scenarios in which this will be the case will naturally diminish with the passage of time).

Both the 1930 Act and the 2010 Act apply to all types of third party liability insurance. They do not apply to contracts of reinsurance. It is not possible to contract out of the Acts, with certain exceptions.

Below is a summary of the most important changes the 2010 Act made to the law:

• Removal of need to restore insured to register

1930 Act: Under the 1930 Act, if the insolvent insured has been removed from the Company Register, the third party first has to apply to have it restored to this Register before the third party can establish the insured's liability. This could be done by applying under section 1030 of the Companies Act 2006 for a declaration that the company be restored to the Register.

2010 Act: Under the 2010 Act this requirement has been removed.

• Information rights

1930 Act:

The 1930 Act imposes a duty on the insolvency office holder to provide, on the third party's request, whatever information the third party reasonably needs to ascertain whether any rights have been transferred to them and to enforce those rights.

If the information provided by the office holder shows that there are reasonable grounds for believing that the insured's rights have been transferred to the third party, then the insurer is under the same duty to provide that information. Specifically, the 1930 Act states that this duty includes a duty to allow all contracts of insurance, premium receipts and other relevant documents, to be inspected and copies taken. However, it is unclear under the 1930 Act exactly what is meant by "other documents".

In the OT Computers case, which was decided under the 1930 Act, the court said that this disclosure requirement applies from the outset, even before the third party has established liability against the insured.

2010 Act:

Under the 2010 Act, the third party can request information:

a. From the insured or insolvency office holder, if the third party reasonably believes that the insured has incurred liability to the third party; or

b. From the insurer, if the third party reasonably believes that the insured has incurred liability to the third party AND the insured is covered by an insurance policy and their rights have been transferred to the third party.

The third party should request information by giving notice in writing and providing the reasons why the third party believes it is entitled to the information.

The information which the third party is entitled to under the 2010 Act is as follows:

a. whether there is an insurance policy which covers or might reasonably be considered to cover the alleged liability,

b. who the insurer is,

c. what the terms of the insurance policy are,

d. whether the insured has been informed that the insurer has denied liability under the policy for this alleged liability,

e. whether there are, or have been, proceedings between the insurer and insured regarding the alleged liability, and if so, details of these proceedings,

f. if there is a policy limit in respect of claims, how much of this has been eroded, and

g. whether there is a fixed charge which any sums paid out under the policy would be subject to.

Within 28 days of receiving the notice, the recipient of the notice must then:

a. provide the information requested if they are able to (privileged information does not have to be provided); and

b. if they cannot provide some of the information requested:

i. give the third party any details available about the information or where it might be held; and/or

ii. explain why.

If the recipient of the notice fails to respond within the 28-day time frame, the third party can apply for a court order requiring them to do so.

It is worth noting, however, that the courts have held that the third party can make a claim without first establishing that there is a relevant policy in place providing cover. The third party only has to make a claim that there is a policy which covers its loss.²

• Number of proceedings required

1930 Act: Under the 1930 Act, the third party may have to go through two sets of proceedings. First, it may have to issue proceedings to prove it has a valid claim against the insolvent insured. It then has a choice: it can either apply to substitute the insurer as the defendant under CPR 19 or bring separate proceedings against the insurer to claim payment under the insurance policy.

2010 Act: The 2010 Act allows the third party to initiate a single set of proceedings against just the insurer. The third party will still need to establish the insured’s liability to it, but it does not need to do this before bringing proceedings against the insurer and it does not need to add the insured as a party to the proceedings either. The third party also still has the option of using the existing method under the 1930 Act if it prefers. This change reflected the OT Computers decision, summarised above, where the court held that establishing the insured's liability was not a prerequisite to the third party making a claim against the insurer.

• The broader scope of the 2010 Act

1930 Act: The 1930 Act was concerned with the insolvency procedures of the time, so it is nearly a century out of date. The insolvent insured could be an individual, but for the purposes of this article we will focus on the situation where this insured is a company. For companies, the 1930 Act applies where:

a. a winding-up order is made,

b. a resolution for a voluntary winding-up is passed,

c. a receiver or manager of the company's business or undertaking is appointed, or

d. the holder of a debenture secured by a floating charge takes possession of property subject to the charge.

2010 Act: The 2010 Act applies in a broader range of insolvency procedures, to reflect the changes in insolvency law since the 1930s. For companies, the insured will be a "relevant person", meaning an insolvent insured for the purposes of the 2010 Act, if:

a. the insured has a compromise or arrangement with its creditors in force,

b. a company voluntary arrangement is approved,

c. the insured goes into administration,

d. a receiver or manager of the insured's property is appointed,

e. a provisional liquidator is appointed,

f. the insured is being wound up either voluntarily or following a winding-up order by the court, or

g. the insured is dissolved.

We explain the process for claiming under each of the Acts more fully below.

Key questions we are often asked

In our experience, key questions that typically arise include the following:

1. Which Act applies?

As mentioned above, the 2010 Act came into force on 1 August 2016, and repealed the 1930 Act.

The 2010 Act does not apply retrospectively.³ For the 2010 Act to apply, either:

a. the insured must have become a "relevant person"⁴  after 1 August 2016, or

b. the liability must have been incurred after 1 August 2016.

If neither of these criteria is met, the 1930 Act will apply (before 1 August 2016).

2. What is the procedure for a third party to make a claim under the 1930 Act?

The following are the steps which a third party must take in order to claim under the insurance policy in circumstances where the 1930 Act applies:

a. If the insured’s liability to the claimant was incurred before the insured became insolvent, the rights to claim under the insurance are automatically transferred to the third party on the insured becoming insolvent. If the liability was incurred after the insured became insolvent, the rights are transferred automatically at that point.

b. If necessary, the third party can request information from the office holder and/or insurer in order to consider whether it has a claim.

c. If the insolvent insured has been removed from the Company Register, the third party must make an application for the insolvent insured company to be restored to the Company Register.

d. If necessary, the third party can then bring proceedings against the insolvent insured, in order to establish that the insured is liable to the third party, for example for negligent advice causing a financial loss. This can usually be done by seeking declaratory relief.

e. If necessary, the third party can then bring proceedings against the insurer to establish cover under the insurance policy for the claim.

3. What is the procedure for a third party to make a claim under the 2010 Act?

a. Rights are automatically transferred to the third party where the insolvent insured is a "relevant person" (see The broader scope of the 2010 Act above) who has incurred liability to the third party. If the liability was incurred before the insured became insolvent, the rights are transferred on the insured becoming insolvent. If the liability was incurred after the insured became insolvent, the rights are transferred automatically at that point.

b. If necessary, the third party can request information from the office holder and/or insurer in order to consider whether it has a claim.

Then the insured can either:

c. Follow the steps required under the 1930 Act as set out above; or

d. Bring proceedings against the insurer alone and establish both:

i. the insured's liability, by requesting a declaration from the court; and

ii. cover under the policy,

within the same proceedings.

Note: the third party can join the insured as a defendant in these proceedings as well. The third party may wish to do this if the insured's liability exceeds the amount recoverable from the insurer, in which case the third party can still claim the additional amount from the insured.

4. What protection does an insurer have against the third party claim, under the 2010 Act?

Conditions to be fulfilled

• If transferred rights are subject to a condition which the insured has to fulfil in order to claim against the insurer (for example under the insurance policy), the third party can step in and fulfil that condition so it can make a claim. For instance, if the insolvent insured does not notify the claim to the insurer within a specified period required by the policy, the third party can satisfy that condition by notifying the insurer.
• A condition requiring the insured to provide information / assistance to the insurer does not apply to the transferred rights if it cannot be satisfied because the insured company has been dissolved.
• Also, a condition requiring the insured to discharge its liability to the third party before making a claim under the policy (sometimes known as a "pay to be paid" provision) does not apply, except in respect of marine insurance policies.

Defences

• The third party cannot be in a better position than the insured would have been, against the insurer. This has two aspects:

• Any defences which would have been available to the insured in defending the claim by the third party, are also available to the insurer.
• Any defences which would have been available to the insurer against the insured in making a claim under the policy (eg coverage defences, or defences based on breach of policy terms and conditions, or of other legal obligations such as the duty of fair presentation) are still available against the third party, with some modifications, including the above where the third party can step in and fulfil conditions.

• The insurer is also entitled to apply any relevant policy limits or sub-limits to the third party claim.

Other rights

• If the insured would have been liable to the insurer under the insurance policy (eg for unpaid premium), and if the insured was not insolvent the insurer would have been entitled to set off the insured's liability to them against the insurer's own liability, the insurer can still exercise that right of set-off against the third party's claim.
• The third party will also be bound by any dispute resolution clauses in the policy. For example, a clause requiring arbitration will apply to mean the third party is required to arbitrate with the insurer.
• The insurer is also entitled to claim contribution against other liable parties, such as other insurers or parties connected to the insolvent insured. It is now possible for insurers to apply to restore an insured company to the Company Register (even if it has been dissolved for over 6 years) to allow it to claim contribution.

Practical takeaways for insurers

• Here are some key practical points for insurers to remember when dealing with third party claims under the Acts:
• The Acts only apply to insurance policies, they do not apply to reinsurance policies.
• It is not possible to contract out of the Acts, including through "pay to be paid" provisions (except in the case of marine insurance policies).
• In most scenarios, and increasingly so, it will be the 2010 Act regime that will be relevant - but not if both the insured's liability and insolvency pre-date 1 August 2016.
• The insured’s right to claim directly against the insurer under a policy of insurance does not transfer to a third party until the insured becomes insolvent (under the 2010 Act, until the insured becomes a "relevant person"), in one of the ways identified above.
• However, the insurer may be required to provide certain information to a third party under the 2010 Act if the third party reasonably believes that the insured has incurred a liability to it, that there is insurance that would respond, and that the insured has become insolvent. The information the insurer may need to provide will include whether there is insurance that covers or might reasonably be regarded as covering the alleged liability, and if so certain material details relating to the cover, but there is no requirement to produce a copy of the contract of insurance itself.
• A similar obligation on the insurer to provide information to the third party arises under the 1930 Act (in pre-1 August 2016 scenarios), if there are reasonable grounds for supposing that rights have been transferred to the third party (ie upon an insured’s insolvency). The obligation here extends to allowing the third party to have a copy of the contract of insurance as well as other relevant documents.
• If you are defending a third party claim on behalf of the insurer, with few exceptions, you should be able to rely upon all coverage and other defences the insurer would have had against the insured and all defences the insured would have had against the third party.
• If the liability of the insured to the third party is greater than the liability of the insurer to the insured (eg because of an uninsured deductible), the third party cannot claim against the insurer for the larger amount. The third party must claim the difference against the insured.
• Settlements between insurers and insureds after liability to the third party has been incurred do not affect the rights transferred to the third party.
• If an insurer has paid out to a third party, they can apply to restore an insured company to the Company Register (even if it has been dissolved for over 6 years), in order to claim a contribution from other liable parties.

DLA Piper UK LLP

Rebecca Hopkirk is a Partner and Charlotte Marks is an Associate in the Insurance and Reinsurance Disputes team in the UK. The UK Insurance and Reinsurance Disputes team forms part of DLA Piper's leading, multi-disciplinary, global insurance sector, consisting of over 400 lawyers representing major insurance and reinsurance companies internationally on all aspects of their business, including claims, disputes and investigations, transactional, regulatory and all forms of commercial advisory work.

To find out more about DLA Piper's insurance capabilities in the UK and globally, please click here.

This publication is intended as a general overview and discussion of the subjects dealt with under English law at the time of original publication and does not create a lawyer-client relationship. It is not intended to be, and should not be used as, a substitute for taking legal advice in any specific situation.

¹ Re: OT Computers Limited (In Administration) [2004] All ER (D) 361 (May)
² BAE Systems Pensions Trustees Limited v Royal & Sun Alliance Insurance Plc [2017] EWHC 2082 (TCC)
³ As confirmed in Redman v Zurich Insurance Plc [2017] EWHC 1919 (QB).
⁴ See above under ‘The broader scope of the 2010 Act’ for when an insured company will be a ‘relevant person’ for these purposes.