In a significant decision for marine insurers, the Court of Appeal has agreed with the Commercial Court that a pay first provision in a marine insurance policy was valid and effective. Consequently, the insurer of an insolvent assured could rely on this provision to avoid liability to third parties seeking to bring a direct claim against the insurer under the Third Parties (Rights against Insurers) Act 2010.
This is a significant decision for marine insurers and reaffirms the common understanding that pay first provisions in marine insurance policies are prevalent. The market understands their effect but is content to contract on such terms.
The background facts
King Trader Ltd (Owner) time-chartered the vessel to Bintan Mining Corporation (Charterer/Insured) by a time charterparty dated 29 May 2017. In February 2019, the vessel grounded in the Solomon Islands.
On 14 March 2023, the Owner and its P & I Club (Club) obtained an arbitration award against the Charterer in LMAA arbitration in Hong Kong. The award against the Charterer, together with interest and costs, exceeds US$47 million.
The Charterer was wound up in the BVI on 25 March 2021 and in London on 24 April 2024. On 28 March 2018, the Charterer had been issued a marine insurance policy by MS Amlin Marine NV (Amlin/Insurer) in respect of the Charterer’s liability. The cover was for 12 months from 1 April 2018. The Charterer was represented throughout the placement of the policy by a professional insurance broker.
In October 2022, the Insurer had issued English Court proceedings seeking declarations that: (i) the pay first clause in the policy was enforceable by the Insurer against the Charterer in respect of its liability under the arbitration award; and (ii) the pay first clause survived the transfer of rights to the Owner and the Club under the Third Parties (Rights against Insurers) Act 2010 (2010 Act).
The Insurer argued that pursuant to the pay first clause in the policy, it did not have to indemnify the Charterer against its liability under the award. The Charterer had not paid and could not pay the award because of its insolvency. As a result, the Insurer argued that it had no liability to the Owner and the Club even if the Charterer’s liabilities had passed to the Insurer under the 2010 Act.
The 2010 Act
The 2010 Act provides for the rights of third parties against insurers of insolvent assureds against whom the third party has a claim which is covered by the insurance policy in question.
Pursuant to s.9(5), such transferred rights are not subject to a condition requiring the prior discharge by the insured of its liability to the third party. However, in marine insurance cases, s.9(5) only applies if the liability in question is in respect of death or personal injury.
Therefore, under the 2010 Act, pay first clauses are invalid but there is a carve out for marine insurance policies where the liability covered is not death or personal injury.
In this case, pursuant to s.1, the Charterer’s rights under the policy transferred to the Owner and the Club, who could then bring a direct action against the Insurer to enforce those rights, which had been established for the purposes of the 2010 Act by the award.
However, the pay first clause in the policy, if upheld, would effectively exclude the Insurer’s liability to the Owner and the Club.
The Commercial Court decision
Briefly, the Court made the declarations sought by the Insurer. It held that:
- the pay first clause was incorporated into the policy;
- the pay first clause was enforceable against the Charterer;
- the true interpretation of the policy meant that no indemnity was payable by the Insurer in respect of any liability that the Charterer had not discharged; and
- the pay first clause survived any vesting of the Charterer’s rights under the policy in the Owner and the Club under the 2010 Act.
The Owner and Club appealed. They argued primarily that the pay first clause should not be given effect because it was inconsistent with the insuring clause and the Certificate of Insurance and/or it was an onerous or unusual clause that had not been brought fairly and reasonably to the Charterer’s attention and was, therefore, ineffective.
The key policy terms
The Certificate referred to “Charterers’ Liability including Liabilities for damage to Hull – Class 1.”
The Policy Booklet was incorporated by the Certificate and contained:
- in Part 1, the insuring clause, which provided for indemnification of the assured against liability arising out of a final, unappealable arbitration award or court judgment arising from events occurring during the period of cover;
- in Part 5, the General Terms and Conditions, including the pay first clause;
- the hierarchy clause, the effect of which was that the specific terms of the Charterers’ Liability clauses in Part 1 of the Booklet should prevail over the General Terms and Conditions in Part 5, including the pay first clause, in the event of any conflict.
The Court of Appeal decision
The Court of Appeal dismissed the appeal.
Inconsistency
The Court of Appeal found that there was no inconsistency or conflict between the insuring clause and the pay first provisions. Specifically:
- The pay first clause did not negate the insuring clause. It qualified and supplemented it, albeit in a significant way. A qualifying provision is not inconsistent or repugnant just because it limits or modifies a wide and absolute provision.
- The indemnity fell due when the award was made but could not be enforced until the Charterer had paid the claim. That was a qualification, not a negation of the indemnity.
- Pay first clauses were long-established contractual provisions in the insurance and reinsurance industry and it would go against business common sense to find that they deprived the insurance clause of all practical effect or that they were inconsistent with the main object or purpose of the insurance.
The Court of Appeal concluded that the two clauses could be fairly and sensibly read together.
Onerous clause argument
The Court of Appeal held that the pay first clause was not onerous or unusual. Pay first clauses were commonly deployed by both P & I Clubs and in marine insurance generally. While such a clause had a serious and significant effect in the event of the insolvency of the insured, it did not amount to a clause that was so onerous it should be treated as ineffective.
The Court of Appeal highlighted that the Charterer had been advised throughout by a professional insurance broker, who ought to have drawn the Charterer’s attention to the pay first provision. Even if the Charterer had not been so represented by a professional broker, it should have appreciated that a pay first provision would likely form part of the General Terms and Conditions of a marine insurance policy.
The Court of Appeal concluded that it should be slow to intervene in a commercial contract between parties of broadly equal bargaining power.
Comment
The Court of Appeal has made it clear that, notwithstanding some industry criticism of pay first provisions, they are not unusual in marine insurance contracts and will not, therefore, be considered so onerous that they risk being struck down in normal circumstances.
As the Court of Appeal highlighted, whether pay first clauses in marine liability policies should be rendered ineffective as against third parties is not a matter for the English courts. It is for the UK Parliament to decide whether the 2010 Act should be amended in this respect.
Source: Hill Dickinson LLP
