Legal Briefing

Do strangers to an insurance contract have a right to claim against the insurers?

The In-House Lawyer Logo

Insurance | 01 November 2010

Imagine the situation: your company has a significant claim against a supplier for breach of contract and/or negligence. Following the original tender process you are aware that the supplier has the benefit of liability insurance, you know the identity of the insurers and the levels of cover available. You suspect that the supplier itself is in financial difficulties or, worse still, it is in fact insolvent. In what circumstances can you circumvent the insured wrongdoer and proceed directly against the insurers? The purpose of this article is to compare and contrast the position under English and French law.

English Law

The main obstacle to a third party claiming rights under a contract, in this case a contract of insurance, is the concept of privity of contract, whereby only the parties to the contract or an assignee have the ability to enforce its terms. There is a statutory exception to this principle, as set out in the Contracts (Rights of Third Parties) Act 1999 (the 1999 Act), but this falls outside the scope of this article. For present purposes, we shall assume that the 1999 Act has no part to play.

Readers will no doubt be familiar with the Third Parties (Rights Against Insurers) Act 1930 (the 1930 Act).

Subject to certain requirements, the 1930 Act provides potential claimants with a direct right of claim against the insurers of an insolvent insured. Broadly speaking, insolvency means – in the case of an individual – bankruptcy or the making of a composition or arrangement with creditors. If the insured is a company, insolvency involves a winding-up or an administration order, or a resolution for a voluntary winding-up, or the appointment of a receiver or manager. If no insolvency takes place, no direct right of action exists against the insurers. The 1930 Act has always been problematic, because there was doubt as to when the rights of the insolvent insured, under the insurance contract, were transferred to the claimant.

The main hurdle of the 1930 Act is the requirement that the potential claimant has to bring proceedings against the insolvent insured to establish the insured’s liability before being able to issue proceedings against the insurers. In the most extreme scenario, where the insured was insolvent and had been struck off the Register of Companies (a defunct insured), the claimant would be involved in three separate legal actions:

  1. proceedings to restore the defunct insured to the Register of Companies;
  2. proceedings against the newly restored insured company to establish its liability; and
  3. proceedings against the insurers to establish the insurers’ liability under the policy to its insured or the claimant.

Not unexpectedly, insurers used the 1930 Act as a shield to deflect requests for disclosure of insurance documentation, on the basis that an entitlement to such documentation existed only after the insured’s liability had been determined and not before, and/or to deflect the claims themselves, which were widely thought to be premature unless or until the insolvent insured’s legal liability had been determined. Many commentators and litigants argued that this placed an onerous and unnecessary procedural and cost burden on the claimant (which may, in many cases, have been subrogated insurers exercising rights of recovery under the claimant’s own policy).

First National Tricity Finance Ltd v OT Computers Ltd [2004] provided welcome clarification. In OT Computers, the insurers declined the claimant’s request to provide a copy of the relevant insurance policy (to establish that cover was available for the loss) on the basis that the transfer of rights did not occur when the insured became insolvent (as defined by the 1930 Act), but only when the claimant had established that the insolvent insured was actually liable for the loss. The claimant made an application for disclosure. The court found that the rights were transferred to the claimant when the insolvency took place, which meant that the insurers were obliged to provide a copy of the policy and could not withhold disclosure until after the insolvent insured’s liability had been established.

If the insurers in OT Computers had succeeded, it would have had serious costs consequences for potential claimants and, in many cases, would have deterred claimants from pursuing claims at all. The claimant would have to bring two or potentially three sets of legal proceedings and there was nothing to compel the insurers to divulge any information to the claimant until after the claimant had obtained a judgment against the insolvent insured.

On 25 March 2010, the new Third Parties (Rights Against Insurers) Act (the 2010 Act) received Royal Assent. In many respects, the 2010 Act codifies the OT Computers decision and places it on a statutory footing. The 2010 Act is not yet law and there is still some way to go before it makes its way through the legislative process. It is intended that the new law will come into force during the first half of 2011.

The aim of the 2010 Act is to simplify and improve the rights of potential claimants and, where possible, to reduce the need for litigation (and overall to minimise costs and delay). The major changes are outlined below.

A clearer trigger for the cause of action

The 2010 Act transfers the rights under the policy to the claimant when the insolvency takes place. The need for multiple proceedings will be removed because the claimant will only be required to bring one set of proceedings against both of the insurers to obtain a declaration that the insurers have incurred a liability under the contract of insurance and against the insolvent insured, determining its liability to the claimant (and, accordingly, the insurers’ liability to indemnify the insolvent insured by way of a direct payment to the claimant). The claimant will be in no better position than the insolvent insured, and the insurers will be entitled to raise the same policy limits, exclusions and defences (subject to certain exceptions).

Rights to information and documentation

Following the insolvency, the claimant is entitled to request certain information, such as the identity of the insurer, the terms and conditions of the policy, and whether there has been a dispute between the insolvent insured and the insurer relating to the liability under the policy of insurance. This information and documentation can be requested from several different parties, including the personal representative of a defunct insured, the administrator, the insurers (if their identity is known), the brokers, loss adjusters and surveyors.

Any party receiving a request for information must provide it within 28 days of receipt. If the details cannot be given, the recipient must say why and supply another contact who might be able to help. The 2010 Act provides for an enforcement mechanism, whereby the claimant can make an application to the court for an order compelling compliance. In such circumstances, it is expected that the court, in most cases, will award the claimant its costs of having to make the application.

Insurers’ defences

As already noted, the claimant will be in no better position than the insolvent insured, and the insurers will be entitled to raise the same policy limits, exclusions and defences. To this general proposition are three new exceptions set out at s9 of the 2010 Act, namely:

  1. If the policy contains a condition requiring the insolvent insured to take a certain step (eg to give notice of a claim within a certain time frame), but the insolvent insured fails to do so, as long as the claimant itself has satisfied the requirement the insurer will not be able to rely on the insolvent insured’s non-compliance.
  2. The insurer will not be able to rely on the breach of any policy condition requiring the insolvent insured to provide the insurer with information and assistance, if it is impossible for the insolvent insured to comply (eg because the insolvent insured, in the case of an individual, has died, or in the case of a company, has been dissolved (and therefore no longer exists)).
  3. If the policy includes a ‘pay-to-be-paid’ clause, requiring the insolvent insured to have discharged its liability to the claimant before being entitled to an indemnity from its insurers, such clauses will no longer be enforceable against the claimant (except in marine insurance contracts, where such clauses will still apply to claimants (save in respect of claims for death or personal injury)).

French Law

The position in France is, in some respects, much simpler. The Insurance Code previously provided that a liability insurer is not entitled to pay any sum to its insured, unless the person who has suffered the loss has already been indemnified (Article L124-3). This provision was construed as early as 1926 by the Cour de Cassation (Supreme Court) and provides the claimant with the right of direct action against a liability insurer.

This right was reformed on 17 December 2007 and has been expressly codified. The first paragraph of Article L124-3 now reads as follows:

‘The third-party victim [the claimant] shall have a right of direct action against the liability insurer of the person responsible [for the loss].’

There is no need for the insured to be insolvent to trigger the right of direct action (as in England). The right to sue the liability insurer is autonomous and is a common feature of most litigation cases in France.

It has also been established (after much debate in and out of court on this question) that the claimant does not need to sue the insured responsible for the loss (Cour de Cassation, 7 November 2000). Instead, the claimant may simply bring an action against the liability insurer alone. If so, the court will rule, in the context of the direct action, not only on the insurer’s liability under the policy, but also on the liability of the insured (even if the latter is not a party to the proceedings).

As in England, the question arises as to which policy defences may be raised by the insurer against the claimant. Article L112-6 of the Insurance Code provides that the insurer may oppose, against the holder of the policy or against any claimant seeking to rely thereon, all defences that would be available against the original insured. The position is therefore, in principle, relatively clear and the Cour de Cassation has, on several occasions, upheld this provision, holding for example that:

‘The victim’s right against the insurer of the party liable for the damage originates from and is limited to the contract of insurance.’ (1 October 1980, First Civil Chamber.)

There are some obvious exceptions to this general principle. For instance, defences that would be available to the insurer, resulting from events occurring after the date of loss (itself the source of much debate), cannot affect the claimant’s right to recover under the liability policy.

There are, nevertheless, some more controversial exceptions. In particular, where an insured has failed to pay the premium, can the liability insurer deduct a sum – equivalent to the outstanding premium – from the indemnity that is owed to the claimant? If Article L112-6 were to be applied literally, the claimant would have no better rights than the insured and the level of unpaid premium should be set off against that of the indemnity. For a long time this was the position adopted by the French courts.

The Cour de Cassation stepped away from this position in a 1993 judgment. It held that the set-off between debts could only apply between the same parties. Since the claimant exercising a right of direct action is not the insurer’s debtor, it cannot be prejudiced by any claim that the insurer would have against its insured.

This judgment therefore suggests that the rights of the claimant may, in some circumstances, be greater than those of the insured under the policy. This position is also more consistent with the view that the right of direct action is autonomous and thus is not entirely derived from the policy itself (notwithstanding pronouncements relating to Article L112-6). Debate continues on this issue, although it is fair to say that French courts are generally more protective of the rights of the insured, and a fortiori of the claimant, than of the insurer.

Conclusion

The concept of privity of contract is still alive under English law and, unless the insurance contract expressly confers a benefit on third-party claimants, in accordance with the 1999 Act, only the parties to the contract or an assignee can sue on it, except in the limited circumstances prescribed under the 1930 Act, and shortly, under the 2010 Act.

To the English common lawyer, in whose psyche the concept of privity is deeply embedded, the French approach might seem a little alien, but the obvious equity in the French approach is clear to see. Readers should also bear in mind that matters inevitably become more complicated where a direct action is brought in France against a foreign liability insurer. In such cases there are several preliminary issues that will need to be considered, including jurisdiction and applicable law, before deciding the substantive defences on which the insurer may be allowed to rely.