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THE LAW COMMISSION

AND

THE SCOTTISH LAW COMMISSION

Item 9 of the Law Commission's Seventh Programme of Law Reform: Third Parties' Rights Against Insurers

THIRD PARTIES – RIGHTS AGAINST INSURERS

To the Right Honourable the Lord Irvine of Lairg, Lord High Chancellor of Great Britain,
and the Scottish Ministers

PART 1

INTRODUCTION

1 The 1930 Act

1.1      The scheme of the Third Parties (Rights against Insurers) Act 1930^[1] is to give a person who is owed money a direct claim against an insurer of the debt. In this report we refer to the person who is owed money as the "third party", the person who owes the money as the "insured" and the insurer of the debt as the "insurer". The 1930 Act performs its function by effecting what we shall refer to as a "statutory transfer" of certain of the insured's rights under the insurance policy to the third party.^[2]

1.2      One of the circumstances in which the 1930 Act effects a statutory transfer is if the insured is declared insolvent. If it did not, the third party would not receive all the insurance proceeds. Instead, these would be treated as an asset of the insured and would be distributed pro rata under insolvency legislation to the general creditors, of whom the third party would be one. As a result, the third party would be likely to recover at most only a small proportion of the insurance proceeds. The balance would increase the dividends of the other creditors.^[3]

1.3      In the absence of the 1930 Act, the third party might also be disadvantaged if the insured's freedom of action was lost for some reason other than insolvency. For example, a corporate insured might be wound up while solvent or might become subject to a receivership.^[4] The 1930 Act aims to relieve the third party of the potentially serious delay and expense involved in dealing with such an insured by effecting a statutory transfer. Commenting on the rationale for the 1930 Act's operation in such circumstances, Bingham LJ said:

The legislative intention was, I think, that ... the provisions of the 1930 Act should apply upon an insured losing the effective power to enforce its own rights and dispose of its own assets.^[5]

1.4      As we pointed out in our consultation paper,^[6] direct claims under the 1930 Act are now made by third parties under a wide range of insurance policies.^[7] In addition to its use in court and arbitration proceedings brought by third parties against insurers, the 1930 Act lies behind many claims settled without recourse to litigation. By disentangling insured debts from insolvency procedures, the 1930 Act plays an important commercial role. It is also worth noting that third parties who use the 1930 Act are often vulnerable members of society - for example, injured former employees of defunct companies.^[8]

2 The need for reform

1.5      Unfortunately, the 1930 Act does not work as well as it should. Its basic operation in the context of insolvency has provoked criticism over a number of years from academics, lawyers, the judiciary and litigants.^[9] Owing to the way the 1930 Act has been applied by the courts, third parties are often not assisted by it at all or are unnecessarily required to expend substantial time and money enforcing their rights.

1.6      A number of respondents to the Law Commission's consultation paper on privity of contract^[10] argued that the 1930 Act should be amended. As we explained in the subsequent report,^[11] such proposals raise significantly different issues from those we were then considering. Accordingly, we were pleased to be asked to examine, as a separate exercise, the operation of the 1930 Act in the light of current law and the market practices of the insurance industry.^[12]

1.7      Respondents to our consultation paper, published in 1998, overwhelmingly confirmed that the deficiencies of the 1930 Act were not merely theoretical but caused real hardship. In addition, it became clear, both from consultees' responses and from our further work, that the 1930 Act is seriously out of date in a number of ways. The drive towards clarifying and improving insolvency law which began with the publication of the Cork Report in 1982,^[13] and which resulted in the Insolvency Act 1985, the Insolvency Act 1986 ("IA 1986") and most recently the Insolvency Act 2000, has added significantly to the range of circumstances of the kind to which Bingham LJ was referring, in which an insured may lose effective control of its rights and assets.^[14] Although the 1930 Act has been periodically updated,^[15] some developments in insolvency law have been ignored^[16] and others have not been properly addressed.^[17] In this report we consider these shortcomings.

1.8      It is possible that, in England, third parties may in the future derive some benefit from the Contracts (Rights of Third Parties) Act 1999.^[18] If the insurance contract in question is drafted so that it complies with the requirements of that Act, the third party may be able to enforce some of its terms. But there is no obvious reason for insurers to draft third party liability insurance contracts in this way and we are not aware of any cases in which this has been done.^[19] Even were such a contract to come about, this would not necessarily improve the third party's position from that under the 1930 Act. In particular, it would not improve the third party's ability to obtain information about the insurance position;^[20] nor would it necessarily remove the requirement that the third party establish the insured's liability before becoming entitled to proceed against the insurer.^[21] The need for fresh legislation to deal with these two problems, and the others which we identify in this report, is, in our view, as strong as ever.

3 Principal reform recommendations

1.9      The draft Bill appended to this report would, if enacted, remedy the problems which have prevented the 1930 Act from working well in the past and accommodate recent developments in the fields of insurance and insolvency. By removing the need for multiple sets of proceedings, it would also reduce costs for both litigants and the courts. We set out briefly below the principal reforms in the draft Bill.

4 Third party entitled to a remedy in one set of proceedings^[22]

1.10      The third party cannot issue proceedings against the insurer under the 1930 Act without first establishing the existence and amount of the insured's liability. This may require the third party to issue a number of separate sets of proceedings.

1.11      The draft Bill would give the third party a right to issue proceedings against the insurer before the liability of the insured has been established. The third party would then establish the existence and amount of the insured's liability in those proceedings.

5 Third party not required to sue the insured^[23]

1.12      Under the 1930 Act, if the insured is a dissolved company which has been struck off the register of companies, the third party may first have to take proceedings to restore it to the register in order to be able to sue it.

1.13      The third party would not have to do this under the draft Bill under which it would not be necessary for the third party to proceed against the insured at all.

6 Third party would have improved rights to insurance information^[24]

1.14      Although the 1930 Act gives the third party a right to obtain information about the insurance policy, in practice that right is often worthless. The main difficulties are:

(1) It has been held by the courts that a right to information does not arise until the liability of the insured is established.^[25] This may not be until some time after the insured's insolvency. Until then, the third party may have to conduct litigation in ignorance of whether any rights have been transferred by the 1930 Act or, if they have, whether they are of any value. As a result, time and money may be wasted pursuing a worthless claim or a worthwhile claim may be abandoned in the belief that there would be no funds to pay a judgment.

(2) Even after the third party's right to obtain information arises, the third party is only able to exercise it against a limited list of people. These may not include the person who in fact has the information, for example an insurance broker.

(3) It is unclear what information the third party is entitled to receive and the information provided in accordance with the 1930 Act may omit critical details.

1.15      The draft Bill would remedy these deficiencies. In relation to the particular problems highlighted in the previous paragraph:

(1) A person who believed on reasonable grounds that he had received a transfer of rights under the draft Bill would be entitled to obtain information about those rights so as to enable a sensible decision to be taken on whether to pursue or continue litigation.

(2) The draft Bill would entitle the third party to require the information from anyone in control of it.

(3) The draft Bill specifies the information which would have to be provided to a third party exercising rights under the draft Bill.

7 Developments in company and insolvency law reflected^[26]

1.16      There are a number of surprising omissions from the list of circumstances in which the 1930 Act effects a statutory transfer. For example, no transfer is effected if the insured is struck off the register of companies under section 652 or section 652A of the Companies Act 1985 ("CA 1985") and no mention is made of the orders which may be made against an insolvent partnership.^[27]

1.17      The draft Bill takes account of the wide variety of procedures to which individuals, companies and other bodies may now be subjected and which might adversely affect a third party. It also contains a power of amendment which would enable the Secretary of State to ensure that a new Act could be updated without the need for fresh primary legislation.

8 Voluntary procedures properly catered for^[28]

1.18      Since the publication of the consultation paper, two reported cases^[29] have raised serious concerns over the interaction between the 1930 Act and "voluntary arrangements".^[30] The value of the third party's claim against the insurer may be reduced by such an arrangement. The third party may only be able to avoid such a result by making, and involving other creditors in, expensive and time consuming applications to court. Similar problems arise in cases in which the insured enters into other forms of voluntary procedure falling short of a formal bankruptcy or winding-up.

1.19      The draft Bill contains provisions which prevent these problems from arising. Under the draft Bill, a third party with rights against an insurer would not be bound by a voluntary procedure to the extent of those rights.

9 Legal expenses and health insurance covered^[31]

1.20      In Tarbuck v Avon Insurance plc,^[32] it was held that the 1930 Act does not enable a solicitor with unpaid fees to claim directly on the legal expenses insurance of an insolvent client. The same reasoning appears to apply to health insurance or car repairs insurance. In Tarbuck, Toulson J remarked that this result was unfortunate and called for reform.

1.21      Under the draft Bill this restriction would no longer apply. A third party would be able to make a direct claim against an insurer even if the insurance covered liabilities voluntarily incurred by the insured to the third party.

10 Insurers' rights to rely on some technical defences removed^[33]

1.22      Under the 1930 Act, a third party's claim may fail because the insurer successfully relies on the defence that the insured did not give notice of the claim, even where the third party had personally told the insurer of the claim within the prescribed period.

1.23      This would not be possible under the draft Bill. If the insurance policy specified that a particular thing should be done by the insured, and if, after a transfer of rights under the draft Bill, the third party did that thing, the insurer would not be able to rely on the non-performance of the policy condition.^[34]

11 Third party generally protected from pay-first clauses^[35]

1.24      The House of Lords has decided^[36] that rights transferred to a third party by the 1930 Act are useless if the insurance contract contains a clause requiring the insured to pay the claim before the right to an indemnity arises (a "pay-first" clause).

1.25      By contrast, in most cases under the draft Bill,^[37] the third party's claim would not be adversely affected by such a clause.

12 Operation in cases with a foreign element clarified^[38]

1.26      In cases with a foreign element (where, for example, the incident giving rise to the alleged liability of the insured happened abroad, or where the law governing the insurance contract is not English or Scots law), it can be unclear whether the 1930 Act applies. It may also not be certain whether a court in Great Britain has jurisdiction to hear the third party's claim. This is likely to be an increasingly serious problem as cross-border insurance activity grows.

1.27      The draft Bill sets out clearly the occasions on which it would apply. In many cases jurisdictional questions will be settled by the Brussels Convention.^[39] However, in a case in which a third party domiciled in one part of Great Britain faces an insurer based in another part of Great Britain, or in Northern Ireland,^[40] we recommend that third parties should be given the choice of suing in their own domicile, or in that of the insurer. In cases in which the insurer is based outside Great Britain, and in which the Brussels Convention does not allocate jurisdiction, we are recommending a minor amendment to the rules of court in England and Wales to enable the courts to exercise jurisdiction over claims against insurers based abroad.

13 The structure of this report

1.28      The arrangement of the main text of this report is as follows. In Part 2 we consider the scope of the draft Bill, including the range of insurance policies to which it applies, and the occasions on which it will confer rights on third parties. In Part 3 we explain the nature of the rights under the insurance contract which are conferred on the third party by the draft Bill, and how the procedural problems which beset the parties under the 1930 Act would be avoided. In Part 4 we discuss the rights to disclosure which we recommend the third party should receive. In Part 5 we set out our recommendations for limited restrictions on the ability of insurers to rely on defences against third party claimants.

1.29      We have allocated an entire part, Part 6, to the important issue of the operation of the draft Bill in the context of voluntary procedures. In Part 7 we review the effect of the draft Bill on various rights of the insurer, the third party and the insured. In Part 8 we illustrate the way in which the draft Bill would work in cases with a foreign element. We conclude, in Part 9, with a summary of our reasons for declining to make special provision in the draft Bill to cater for multiple claimants against a limited fund.

14 Draft Bill

1.30      Appendix A contains a draft Bill to give effect to our recommendations. For ease of reference we set out the 1930 Act in Appendix B. As the draft Bill is appended to a joint report, we wish to record that it is the opinion of the Scottish Law Commission that the subject matter of the draft Bill is not within the legislative competence of the Scottish Parliament, as it relates to the reserved matter of insurance.^[41]

15 Amendments to rules of court

1.31      We recommend below three amendments to the rules of court in England and Wales, and one in Scotland, to improve the operation of the draft Bill once it is enacted.^[42]

16 Acknowledgements

1.32      We thank the many individuals and organisations, listed in Appendices C and D, who commented on our consultation paper or who helped us with specific advice. We are grateful, in particular, for the assistance of the Law Reform Advisory Committee for Northern Ireland whom we consulted on the application of these reforms in Northern Ireland.^[43]

Note 1    Referred to in this report as the “1930 Act”.    [Back]

Note 2    Section 1(1).    [Back]

Note 3    This was the situation before the 1930 Act was passed. See In re Harrington Motor Co. Ltd ex parte Chaplin [1928] 1 Ch 105; Hood’s Trustees v Southern Union General Insurance Co. of Australasia [1928] 1 Ch 793.    [Back]

Note 4    The long title to the 1930 Act is “An Act to confer on third parties rights against insurers of third-party risks in the event of the insured becoming insolvent,and in certain other events.” (emphasis added).    [Back]

Note 5    The Fanti and The Padre Island [1989] 1 Lloyd’s Rep 239 at p 247 in a passage approved on appeal by Lord Goff of Chievely [1991] 2 AC 1 at p 38.    [Back]

Note 6    Third Parties (Rights against Insurers) Act 1930 (1998) Law Com No 152; Scot Law Com No 104, referred to in this report as the “consultation paper”.    [Back]

Note 7    Consultation paper, paras 2.8-2.11.    [Back]

Note 8    See the consultation paper, Appendix C, for statistics from the Association of British Insurers indicating that around 30% of litigation relating to the 1930 Act related to claims against employers.    [Back]

Note 9    See, in particular, Jonathan Goodliffe “What is left of the Third Parties (Rights against Insurers) Act 1930?” [1993] JBL 590, Sir Jonathan Mance “Insolvency at Sea” [1995] LMCLQ 34, Professor Robert Merkin “Liability insurance - the rights of third parties” [1997] P & I Int 178 and Robert Purves “Claims Against Insolvent Insureds” [1998] CFILR 98.    [Back]

Note 10    Privity of Contract: Contracts for the Benefit of Third Parties (1991) Law Com No 121.    [Back]

Note 11    Privity of Contract: Contracts for the Benefit of Third Parties (1996) Law Com No 242;Cm 3329, para 12.20.    [Back]

Note 12    Our original terms of reference are set out in the Law Commission’s Sixth Programme of Law Reform (1995) Law Com No 234 and the Scottish Law Commission’s Fifth Programme of Law Reform (1997) Scot Law Com No 159.    [Back]

Note 13    Report of the Review Committee on Insolvency Law and Practice (1982) Cmnd 8558.    [Back]

Note 14    See para 1.3 above.    [Back]

Note 15    See para 2.6 below.    [Back]

Note 16    For example, the application of insolvency procedures to partnerships by the Insolvent Partnerships Order 1994 (“IPO 1994”). See paras 2.26-2.29 below.    [Back]

Note 17    For example, the procedures for company and voluntary arrangements in the Insolvency Act 1986. See Part 6 below.    [Back]

Note 18    Which was enacted largely in the terms of the draft Bill included in Privity of Contract: Contracts for the Benefit of Third Parties (1996) Law Com No 242; Cm 3329.    [Back]

Note 19    The 1999 Act may, by contrast, have an important effect in the context of reinsurance contracts with “cut-through” clauses by allowing direct claims by the insured against the reinsurer. As we explain in para 2.45 below, reinsurance is outside the scope of the 1930 Act and that of the draft Bill. For a review of the likely relevance of the 1999 Act to insurance law generally, see Professor Andrew Burrows, “The Contracts (Rights of Third Parties) Act 1999 and its implications for commercial contracts” [2000] 4 LMCLQ 540 and Anthony Menzies, “Rights of third parties against insurers” 30 November 2000, Insurance Day, p 6.    [Back]

Note 20    See paras 4.5-4.10 below.    [Back]

Note 21    See paras 3.4-3.10 below.    [Back]

Note 22    See Part 3 below.    [Back]

Note 23    See Part 3 below.    [Back]

Note 24    See Part 4 below.    [Back]

Note 25    Woolwich Building Society v Taylor [1995] 1 BCLC 132.    [Back]

Note 26    See Part 2 below.    [Back]

Note 27    Under the IPO 1994.    [Back]

Note 28    See Part 6 below.    [Back]

Note 29    Re Greenfield [1998] BPIR 699 and Sea Voyager v Bielecki [1999] 1 All ER 628.    [Back]

Note 30    That is to say, Individual Voluntary Arrangements (governed by IA 1986, Part VIII) and Company Voluntary Arrangements (governed by Part I).    [Back]

Note 31    See Part 2 below.    [Back]

Note 32    [2001] 2 All ER 503.    [Back]

Note 33    See Part 5 below.    [Back]

Note 34    In practice, the third party is only likely to be in a position to comply with terms which require the insured to take procedural steps.    [Back]

Note 35    See Part 5 below.    [Back]

Note 36    The Fanti and The Padre Island [1991] 2 AC 1.    [Back]

Note 37    We do not recommend, as part of this project, any change in the treatment of pay-first clauses in the context of marine insurance, unless the claim is for personal injuries or death. See para 5.37 below.    [Back]

Note 38    See Part 8 below.    [Back]

Note 39    The Brussels Convention on Jurisdiction and Enforcement of Judgments in Civil and Commercial Matters 1968, applied by Civil Jurisdiction and Judgments Act 1982. With effect from 1st March 2002 revised rules will come into effect in the form of an EC Regulation. See Part 8 below.    [Back]

Note 40    See para 2.52 below for the position in Northern Ireland.    [Back]

Note 41    Scotland Act 1998, Sched 5.    [Back]

Note 42    See paras 3.52-3.56, para 4.47 and paras 8.32-8.35 below.    [Back]

Note 43    See para 2.52 below.    [Back]