1. Subrogation and indemnity1
An insurer cannot refuse to pay merely on the ground that the insured has a claim against a third party: the insured ‘does not receive [money from the insurers] because of the accident, but because he has made a contract providing for the contingency’.2 Equally, the third party cannot deny liability on the ground that the insurer has or will indemnify the insured.3 Yet it is also the case that the insured cannot recover a sum greater than the loss suffered:
The very foundation, in my opinion, of every rule which has been applied to insurance law is this, namely, that the contract of insurance contained in a marine or fire policy is a contract of indemnity, and of indemnity only, and that this contract means that the assured, in case of a loss against which the policy has been made, shall be fully indemnified, but shall never be more than fully indemnified. That is the fundamental principle of insurance, and if ever a proposition is brought forward which is at variance with it, that is to say, which either will prevent the assured from obtaining a full indemnity, or which will give to the assured more than a full indemnity, that proposition must certainly be wrong.4
Subrogation is one means by which the insured is prevented from obtaining more than a full indemnity.5 The rights that the insurers acquire through subrogation were summarised by Brett LJ in Castellain v Preston:6
[A]s between the underwriter and the assured the underwriter is entitled to the advantage of every right of the assured, whether such right consists in contract, fulfilled or unfulfilled, or in remedy for tort capable of being insisted on or already insisted on, or in any other right, whether by way of condition or otherwise, legal or equitable, which can be, or has been exercised or has accrued, and whether such right could or could not be enforced by the insurer in the name of the assured by the exercise or acquiring of which right or condition the loss against which the assured is insured, can be, or has been diminished.
In the same case, Cotton LJ said that since an indemnity policy is designed ‘only to pay for that loss which the assured may have sustained’, then, ‘In order to ascertain what that loss is, everything must be taken into account which is received by and comes to the hand of the assured, and which diminishes that loss.’7 This means that the insurers are entitled to be subrogated to the insured’s rights of action against a third party,8 but the insurers are also entitled to other benefits, such as compensation, received by the insured that relate to the loss.9 In Castellain v Preston,10 a house was damaged by fire after a contract of sale had been signed but before the date of completion. The vendor was paid by his insurers for the loss. The purchase was then completed and the price paid to the vendor. The insurers were allowed to recover their payment out of the sale proceeds of the house. If the insured has received a benefit in a form other than money, the insurers will be entitled to claim its value up to the amount of the claim paid: so, where a lessor insures the leased property and the tenant has a duty to repair, then if the property is damaged and the tenant repairs, the insurers may recover the value of the benefit which the lessor has received from those repairs up to the amount paid out by the insurers.11 Of course, where the benefit handed over by the wrongdoer is for losses not covered by the insurance contract this may be retained by the insured.
In Lord Napier and Ettrick v Hunter,12 the House of Lords asserted the equitable origins of subrogation and, broadly, rejected Lord Diplock’s view that it is the result of an implied term in the insurance contract.13 Nevertheless, in insurance the rights of subrogation rest on the contract of indemnity and the parties may in that contract agree to alter or waive it.14 Policies relating to construction projects routinely include a term by which insurers waive rights of subrogation against certain parties, such as subcontractors. It is also common for contracts to include the right for the insurers to control proceedings against a third party even before they have indemnified the insured, or to require that the insured not admit liability without the consent of the insurers.15 Less common is a requirement that the insured assign rights against third parties to the insurer,16 although it is worth noting that in practice insurers, who have paid on a loss, require the insured to sign a letter of subrogation, which assigns the insured’s rights of recovery against the third party.17
Following the judgments in Castellain v Preston,18 and in the earlier case of Darrell v Tibbits,19 it would seem that the right of subrogation confers three rights on the insurer. First, having met their liability under the policy through the payment of money or the reinstatement of the property, the insurer is entitled to take over any right of action that the insured has in relation to the loss. Secondly, where benefits relating to the covered loss were given by a third party to the insured before payment of the claim, then the insurer is entitled to recover the amount by which the total benefits received by the insured (ie the payment from the insurer plus the benefit from the third party) exceed the loss up to the amount paid by the insurer. Thirdly, where a benefit has been received from a third party in compensation for the covered loss after the claim has been met, then the insurer has a right over those benefits to the extent that they exceed the amount of the loss suffered up to the amount paid by the insurer. Mitchell has cogently argued that only the first constitutes subrogation.20 In the second situation the payment by the insurer is made under a mistake of fact, namely, the belief that the insured has not been indemnified. Here the means of recovering the excess is an action for money had and received. In the third situation the insurer has an equitable lien over the money in the hands of the insured.21 While accepting the logic of this view, it is perhaps too late to retrieve the limited and more exact definition of subrogation in the face of more than a 120 years of judicial bad habits, so these three aspects will be dealt with together in this chapter.
Subrogation rights are not independent rights that the insurers can exercise against a wrongdoer, they merely mean that, ‘the insurer and the insured are one’.22 They arise only in relation to a contract of indemnity. As Lord Cairns put it:
I know of no foundation for the right of underwriters, except the well-known principle of law, that where one person has agreed to indemnify another, he will, on making good the indemnity, be entitled to succeed to all the ways and means by which the person indemnified might have protected himself against or reimbursed himself for the loss. It is on this principle that the underwriters … can assert any right which the owner of the ship might have asserted against a wrongdoer for damage for the act which has caused the loss.23
There are no subrogation rights in the case of a contingency policy,24 so that if a life policy names the insured life as beneficiary and that person is killed by another’s negligent act, the insured’s estate will be able to claim under the policy and keep any damages received from the wrongdoer. Not surprisingly, no right of subrogation exists if the insurance contract is void. A marine policy in which no proof of an insurable interest is required (a ppi contract) is void under the Marine Insurance Act 1906, section 4(1) and (2) and will not, therefore, give rise to the right of subrogation because any payment made by the insurer is not pursuant to an obligation to indemnify the insured.25
To avail themselves of the right of subrogation, the insurers must have discharged their liability under the policy to the insured26. As one judge put it:
[T]he principle of subrogation is ever a latent and inherent ingredient of the contract of indemnity, but…it does not become operative or enforceable until actual payment be made by the insurer. It derives its life from the original contract. It gains its operative payment from payment under that contract. Not till payment is made does the equity, hitherto held in suspense, grasp and operate upon the assured’s choses in action. In my view the essence of the matter is that subrogation springs not from payment only but from actual payment conjointly with the fact that it is made pursuant to the basic and original contract of indemnity.27
In Page v Scottish Insurance Corporation,28 Mr Forster’s car was involved in an accident as a result of the negligent driving of Mr Page, a mechanic. Both Forster’s car and a car owned by a Mr Stobart were damaged. Forster’s insurers agreed to let Page undertake the repairs to Forster’s car, but failed to pay him. Page sued and the insurers responded by suing Page, as the wrongdoer, for a sum equivalent to the cost of the repairs. The Court of Appeal held that the insurers had no right to be subrogated to Forster’s rights of action because they had not settled in full all the claims under the policy relating to the accident, including those brought by Stobart against Forster and Page jointly. Similarly, in Scottish Union & National Insurance Company v Davis,29 when a Bentley car owned by Mr Davis was damaged by a coping stone falling from a building, the insurers agreed that the car should be repaired by a particular firm. The firm failed to carry out the repairs, but submitted a bill which the insurers paid. Davis then received a sum of money in settlement of a claim against the owner of the building and his insurers sought to recover that money. The Court of Appeal held that the right of subrogation only arose when the insurers settled the claim, and in this case, although they had paid out money, they had not settled because the car had not been repaired as the policy required.
The right of subrogation arises when the insurers have paid out for the loss to the extent required by the policy, even if the actual loss exceeds that figure.30 The insurers will also acquire the right of subrogation where they have made a payment for a loss even if it is not covered by the policy, as long as that payment was ‘honestly and reasonably’ made. In King v Victoria Insurance Co Ltd,31 an alleged tortfeasor sought in vain to defend an action by arguing that the insurers were not liable under the terms of the policy to meet the claim, and therefore they had no title to sue: ‘[I]f, on a claim being made, the insurers treat it as within the contract, by what right can a stranger say that it is not so?’32 Moreover, the insurer’s right of subrogation is not affected by the fact that the premium was paid by someone other than the person who benefits under the insurance contract.33
Although the insurers cannot bring an action until they have settled the insured’s claim, it seems far-fetched to suppose that, pending this, there is any implied duty on an insured to commence an action against the wrongdoer, particularly since one of the reasons people take out insurance is to avoid the need to litigate. The insurers must not reach a settlement that unreasonably prejudices the interests of the insured: for instance, the insurers are required to keep in mind the insured’s interest in obtaining compensation for any uninsured loss. It is not uncommon for insurers to elect not to exercise the right of subrogation: until 1995 in motoring cases where both motorists were comprehensively insured, insurers operated the so-called ‘knock-for-knock’ agreement, which in essence meant that insurers met the losses of their own insured without arguing about liability.34 Similarly, insurers have informally agreed that they will not normally pursue claims against the employees of an insured firm.35 If the insurers decide not to pursue the third party, the insured can sue and might well decide to do so if the insurers are only liable for part of the loss, as, for instance, would be the case where there is an excess clause in the policy (ie the insured pays for part of the loss up to an agreed amount) or the insured’s loss is not fully covered (ie the subject-matter is not insured to its full value).36 A policy may, however, include an express term empowering the insurers to instruct the insured to cease an action against the wrongdoer
Where the insured has suffered no loss, rights of subrogation do not arise. In HSBC Rail (UK) Ltd v Network Rail Infrastructure Ltd, 37 HSBC leased rolling stock to GNER, a train operator, on terms that GNER was to assume all risk of loss. The contract required GNER to take out all risks property insurance in the names of both itself and HSBC; the proceeds were payable to HSBC and would be applied in discharging GNER’s obligation to HSBC. The rolling stock was damaged due to the admitted negligence of the defendant. The insurers indemnified HSBC, and the insurers then sought to exercise subrogation rights against the defendant. The Court of Appeal held that it could not. The court held that HSBC, as a bailor, could sue only for damage to the reversionary interest, and there had been no loss. Although HSBC argued that they have suffered no loss only because they had been compensated by the insurance, the court held that it was GNER that was indemnified under the policy, not HSBC.38 It was,’ unrealistic to regard an insurance policy which insures the respective rights and liabilities of both HSBC and GNER as indemnifying HSBC rather than GNER’.39 Longmore LJ summarised: ‘The reality of this case is that HSBC, as lessor, has in the event suffered no damage to its reversionary interest because GNER has fully indemnified it, not because it has been indemnified by insurance.’40
A different issue arises where the insured becomes insolvent. In Re Ballast plc,41 a civil engineering firm appointed M to undertake work on a project that B was constructing. Out of that work there arose an alleged claim against M for breach of contractual duty of care, but B was in liquidation. B’s insurer, S, requested that the liquidators notify S before concluding the liquidation because S’s subrogated claim could only be brought while B existed. The liquidator, however, believed that B’s claim against M lacked merit and applied under the Insolvency Act 1986, section 178, to disclaim interest in B’s claim against M. S argued it had a proprietary interest in the fruits of the claim and might even have its own right of action, so that it had sufficient interest to apply for a vesting order (under section 181), which would vest property disclaimed by the liquidator in the applicant. This was refused because an applicant for a vesting order must have a proprietary interest and the court concluded that S had, at most, a proprietary interest in the proceeds of a claim and not in the insured’s cause of action against M.
The insurer must bring the action in the name of the insured and so needs the insured’s consent. However, the court may compel a reluctant insured, subject to the insurer providing an indemnity as to costs.42 There is some doubt whether a court has any discretion to refuse to compel the insured. In Morris v Ford Motor Co Ltd,43 Morris was an employee of a firm that undertook cleaning work for Ford. Under the contract between Ford and the cleaning firm, Ford was indemnified in respect of liability for injury caused by the negligence of the employees of either company. Morris was injured by the negligent act of Roberts, one of Ford’s employees. Morris sued Ford as Roberts’ employer, Ford sought an indemnity from the cleaning firm, and this in turn led to the argument that since the cleaning firm was obliged to provide an indemnity, there was a right to sue Roberts. The case for the cleaning firm seemed fairly strong in view of the decision of the House of Lords in Lister v The Romford Ice and Cold Storage Co Ltd.44 Lord Denning MR in Morris did not really bother to conceal his distaste for Lister, which he called ‘an unfortunate decision’, and he duly proceeded to ignore it. Since the two cases were not precisely similar, in that Lister involved two people employed by the same firm and Morris two people employed by different firms, he was technically able to distinguish them, although the distinction does not really stand up to scrutiny. In any event, Lord Denning formulated a very broad principle: ‘[W]here the risk of a servant’s negligence is covered by insurance, his employer should not seek to make that servant liable for it. At any rate, the courts should not compel him to allow his name to be used to do it.’45 His justification was simple:
Everyone knows that such risks as these are covered by insurance. So they should be, when a man is doing his employer’s work, with his employer’s plant and equipment, and happens to make a mistake. To make the servant personally liable would not only lead to a strike. It would be positively unjust.46
He suggested that since subrogation rights were equitable the court had discretion, and in circumstances such as these Ford would not be compelled to lend its name to an action against one of its employees. Ford expected the cleaning firm to insure and it had; the insurance company had received premiums and everyone would have expected the insurers not the employee to bear the loss. In addition, it was ‘not just and equitable’ to endanger industrial relations by forcing Ford to sue its own employee.47 This approach was without convincing precedent. It is not clear that the courts have a discretion, but leaving that matter aside, it seems odd to have looked not at the relationship between the insured and the insurers, but at the broader context of the impact on industrial relations. On the other hand, as the facts of the case show, there is much to be said for the flexibility of Lord Denning’s approach.48 James LJ avoided these difficulties by concluding that the rights of subrogation were excluded by an implied term in the insurance contract.
Since the insurers step into the shoes of the insured, they can have no greater rights than the insured and cannot pursue actions that could not have been undertaken by the insured.49 This means that if the insured’s right of action is barred by rules of court,50 or the insured caused the loss, the insurers will not be able to exercise rights of subrogation. In Simpson v Thomson, Birrell,51 the insurers were precluded from exercising rights of subrogation where two ships owned by the insured collided. The wrongdoer can use any defence available against an action by the insured:52 so, for example, the third party can allege the insured’s contributory negligence, or volenti non fit injuria, or that the action has become time-barred. 53 The insured may have reached an agreement with the wrongdoer before the claim under the policy is met, and this will bind the insurers because they have no independent right of action against a wrongdoer. When a motorist sued for his uninsured loss and was compensated, that action precluded his insurers from recovering the amount they had paid out for the insured loss.54 In Sousa v London Borough of Waltham Forest,55 the claimant under the policy was required to use a specified firm of solicitors with whom the insurers had a collective conditional fee agreement, which included a success fee. The claim was settled on the basis that the defendant paid the claimant’s cost, but the defendant refused to pay the success fee on the ground that it had not been reasonable for the claimant to have entered into a conditional fee agreement (CFA) because he had the benefit of a full indemnity against costs provided by the insurers under the terms of the policy. The Court of Appeal held that that the success fee was recoverable by the insurer exercising rights of subrogation. Ward LJ held that the question of whether the success fee is recoverable:
depends on the application of the rules to the facts of the case. The court always has to ask whether the costs have been unreasonably incurred or are unreasonable in amount. In considering that, the court must take all the circumstances of the case into account and in particular must have regard to the Practice Direction which requires the court in deciding whether a percentage increase is reasonable to take into account the other methods of financing the costs that were available to the receiving parties.56
Thus, he said ‘If one is looking at the realities, one has to look at the position of the insurer and consider the reasonableness of the insurer entering into this CFA.’57 Following Campbell v MGM (No 2),58 he held that CFAs are open to all and stated:
I do not see how the Court can possibly conclude that if CFAs are open to all, they are nonetheless unreasonable by virtue of the fact only that they will also be open to rich and powerful insurance companies who accept the price of litigation as a necessary incident of their business. If the law permits it, it must be reasonable for rich as well as poor to take advantage of that which the law permits.59
Further, he held that the fact that the claim was being controlled by the insurers under their subrogation rights and that the insured would be indemnified was irrelevant.60 Thus, the decision confirms that the insurer when exercising their rights of subrogation has the same rights as an insured: the insured would have been able to enter into a CFA and therefore the insurer can compel the insured to do so.61 In Bee v Jenson (No 2),62 the assured’s vehicle was damaged in a motor accident caused by the defendant. The assured’s policy allowed the hire of a replacement vehicle at the expense of the insurer. The insurer sought to recover the hire charge from the defendant by way of subrogated claim. It was argued, first, that the insurer should have deducted an introduction fee from the car hire because this represented an unjustified profit at the defendant’s expense, and, second, that the defendant’s insurer could have obtained a replacement vehicle more cheaply by utilising corporate rates available to it. Morison J confirmed ‘that contractual subrogation (as in insurance cases) and subrogation as a remedy to prevent unjust enrichment are two distinct institutions and must not be confused’.63 Citing Diplock J,64he said the principles of law are clear:
‘[S]ubrogation’ is concerned solely with the mutual rights and liabilities of the parties to the contract of insurance. It confers no rights and imposes no liabilities upon third parties who are strangers to that contract. It vests in the insurer who has paid a loss no direct rights or remedies against anyone other than the assured. He cannot sue such parties in his own name; he is bound by any release given by the assured to a third party. The insurer’s rights against the assured cannot be affected by any subsequent contract, or dealings between the assured and a third party.
He held that the assured was entitled to a hire a replacement car and obtain cover for it;65 what concerned the insurers was that it was ‘at a reasonable rate and for a reasonable period, he is without the more entitled to recover those hire costs from the tortfeasor’.66 Thus the defendants need only be concerned with the reasonableness of the charges. Further he said the decision is not affected by whether the claimant insurers have made ‘a large profit or a profit on their insurance arrangements’.67 The amount recoverable by the insurers was based on the assured’s loss, and the fact that collateral benefits had been received by the insurers was irrelevant, particularly as contractual subrogation was not governed by principles of unjust enrichment. Morison J also rejected the argument that insurers could have obtained a lower rate as had the claimant, as it would be tantamount to saying that in ‘reality the insurers’ claim and that the insurers are to be treated as parties to the action. That is not the law; on the contrary, the law is blind to insurance arrangements and recoveries in claims such as this.’68 Therefore, the claimant could not be confined in his claim to the cost of hiring a car on corporate as opposed to spot rates.
The courts have formulated a broad principle requiring the insured not to act to the prejudice of the rights of the insurers.69 The insured must not reach any agreement, whether before or after indemnification, which undermines the rights of the insurers. If the insured abandons a claim against the wrongdoer, that may amount to a breach of the insurance contract which will entitle the insurers who have not paid to refuse to do so and the insurers who have paid to recover from the insured damages for the prejudice suffered.70 Likewise, if the insured reaches a settlement with the wrongdoer which prejudices the insurers’ rights, the insured incurs personal liability to the extent of that prejudice.71 There is no breach of contract if the insured acted in good faith, although what amounts to a bona fide settlement is not clear.72 It may simply be that if there is no collusion between the insured and the wrongdoer and, in the circumstances, the settlement is reasonable, the insurers may find it difficult to show they have been prejudiced. Since the subrogated action is that of the insured, the insured may proceed against the tortfeasor, not only before the insurer has paid, but if the insurer, having paid in full, refuses to proceed or, indeed, even if the insurer wishes to do so. It seems unlikely that an insured, who sues the wrongdoer, would succeed in claiming that, because any recovery reduces the payment due under the policy, the insurer should pay part of the legal costs.73 In Horwood v Land of Leather Ltd, 74 the claimants commenced proceedings against the assured for personal injuries. The assured became insolvent and the claim proceeded against the assured’s product liability insurers under the Third Parties (Rights against Insurers) Act 1930. Clause 3 of the policy, which was a condition precedent, was a claims control clause under which the assured was not to
except at his own cost, take any steps to compromise or settle any claim or admit liability without specific instructions in writing from the Insurer nor give any information or assistance to any person claiming against him, but the Insurer shall for so long as they shall so desire have the absolute conduct and control of all proceedings (including arbitrations) in respect of any claims for which the Insurer may be liable under this policy, and may use the name of the Insured to enforce for the benefit of the Insurer any order made for costs or otherwise or to make or defend any claim for indemnity or damages against any third party or for any other purpose connected with this policy.
At the end of 2007, and following complaints about allergies, the assured decided to stop selling products provided by Linkwise, and it was agreed that Linkwise would provide compensation of US$900,000 although the court found that there was no agreement as to how and when the money should be paid. The release provided that ‘[the assured] also confirm they will make no further claim on Linkwise in respect of alleged allergic reactions to their products though no proof exists that the cause was Linkwise products’. The insurers contended that the release contravened the claims control clause. The court ruled that the claims control clause applied not just to claims made against the assured but also to claims made by the assured, and accordingly it had been broken. In regard to the formation and breach of an implied term relating to an insurers’ subrogation rights, Teare J stated that:
The implied term arises because the insurer has a right to be subrogated to the rights of the insured when he indemnifies him pursuant to the policy of insurance. If the insured acts without regard to that contingent right he may harm the value of that right to the insurer. The most obvious harm occurs where the insured settles a claim he may have against a third party for an indemnity and so deprives the insurer of its benefit in whole or in part. But in principle harm may be caused to the insurer’s rights of subrogation where the claim against the third party is not lost or reduced in value by settlement. For example, the documents necessary to establish such claim may be destroyed. I therefore consider that the implied duty must be one which obliges the insured to act in good faith and reasonably with regard to the interests of the insurer.75
Thus, had the point arisen, the court would have found that there was an implied term in the policy that the assured would act in good faith and reasonably with regard to the interests of the insurers so as to preserve the insurers’ subrogation rights and by entering into a settlement contract that implied term had been broken.
In practice, some—although plainly not all—of these problems are resolved by the inclusion in most policies of a term permitting the insurer to take control of any proceedings or even abandon them, irrespective of their having indemnified the insured, and typically there are various stipulations as to what the insured may or may not do (eg not admit liability or not settle without the consent of the insurer). In a consumer contract such a term may be assessed against the standards of good faith in the Unfair Terms in Consumer Contracts Regulations 1999. The problem is that, in blissful ignorance of the niceties of this fairly obscure branch of insurance law and in confident possession of a comprehensive motor policy, the insured may enter a binding agreement not to pursue a claim unaware that this raises the possibility of an action by the insurers. It is not necessarily reassuring that the insurers may not regard it as worthwhile to pursue the insured because of the adverse publicity or because the insured does not have the resources to pay.
2. Joint insurance and co-insurance
As has been seen, the insurer, who pays a claim, cannot seek reimbursement where the insured caused the loss,76 but what happens where two or more parties are covered by the same policy and only one is responsible for the loss? There are three main contractual relationships involved in these types of policy: first, joint insurance, which strictly speaking only applies if the parties covered by the policy have the same interest in the insured property; secondly, where the parties have different interests in the property, as with a lessor and lessee; thirdly, co-insurance or composite insurance, where some of the parties do not have an interest in the property, but the policy purports to cover them.