Court dismisses challenge to pay to be paid clause in charterers’ liability insurance

MS Amlin Marine NV on behalf of MS Amlin Syndicate AML/2001 -v- King Trader Ltd & others (Solomon Trader) [2024] EWHC 1813 (Comm)

In a dispute over whether third parties were prevented by a “pay to be paid” clause from bringing a claim against insurers under a charterers’ liability insurance, the Court has confirmed that, in the context of marine insurance, such clauses are valid and will be upheld.

The decision is also generally useful for the Court’s reminder of how it will deal with potentially inconsistent contractual provisions.

The background facts

By a time charterparty dated 29 May 2017, the Owners fixed the vessel to the Charterers, BMC. Pursuant to a policy dated 28 March 2018, BMC took out charterers’ liability insurance with MS Amlin, with cover incepting for 12 months from 1 April 2018.

On 4-5 February 2019, the vessel grounded in the Solomon Islands. On 25 March 2021, BMC went into insolvent liquidation in its seat, the British Virgin Islands.

In March 2023, LMAA arbitrators found BMC liable to the Owners and their P & I Club in respect of the grounding. The total amount awarded, taking into account accruing interest and costs, exceeded US$47 million.

In April 2024, BMC was wound up under the Insolvency Act 1986.

The issue in these proceedings was the extent to which there was validly incorporated into the policy a “pay to be paid” clause and how this affected an indemnity claim by the Owners and their P & I Club, as third parties claiming under the policy.

Pay to be paid clauses

The “pay to be paid” (aka “pay as may be paid” or “pay first”) clauses incorporated into P & I Club rule books have the effect that a member’s right to indemnity for liability risks is limited to circumstances in which the member has first discharged the relevant liability.

The effect of such clauses on a third party was confirmed by the House of Lords in The Fanti and the Padre Island in 1991: the third parties acquired no greater rights under the contracts of insurance than the Club’s members had and the “pay to be paid” provision would, therefore, defeat their claim if the member’s claim would have failed.

That case was litigated while the Third Parties (Rights Against Insurers) Act 1930 was in force, but it provided part of the background to the updated legislation, the Third Parties (Rights Against Insurers) Act 2010.

While generally speaking under s.9 Act 2010, the transferred rights of third parties are not subject to a condition requiring the prior discharge by the insured of the insurer’s liability, the Act 2010 has a carve-out in this respect for contracts of marine insurance, except where the liability is for death or personal injury. That is for all contracts of marine insurance (not confined to cover provided by P&I Clubs).

The legislators made this carve-out decision on the basis that “pay to be paid” clauses were justified in the context of mutual insurance. For P&I Clubs, members were both insureds and insurers, exposed to a liability to supplemental calls to the extent that contributions were not sufficient to cover paid claims. More generally, there was also a reluctance to interfere in the sphere of marine liability insurance and propose provisions that might conflict with international measures.

The policy

The marine insurance policy consisted of the insurance certificate, attaching MS Amlin’s wording for “Charterers’ Liability: Marine Liability Policy 1-2017” (the booklet).

The “Conditions” section in the certificate stated “as per Marine Liability Policy for Charterers 1-2017”, but there was also express reference to various specific conditions.

The booklet was divided into five parts, with parts 1 to 4 each dealing with different types of cover. Pursuant to the certificate, only parts 1 (charterers’ liability) and 4 (war risk protection) formed part of the policy.

The opening of Part 1 provided:

“The Company shall indemnify the Assured against the Legal Liabilities, costs and expenses under this Class of Insurance which are incurred in respect of the operation of the Vessel, arising from Events occurring during the Period of Insurance as set out in sections 1 to 17 below”.

In the definitions section, “Legal Liability” was defined as “Liability arising out of a final unappealable judgment or award from a competent Court, arbitral tribunal or other judicial body”.

Part 5 was the “General Terms and Conditions.”

Section 25 of Part 5 stated:

“Any contract of insurance effected pursuant to the Marine Liability Policy for Charterers shall incorporate the general terms and conditions and the terms and conditions of Class of Insurance 1, Class of Insurance 2 or Class of Insurance 3 as the case may be. The terms and conditions set out in each Class of Insurance in this policy shall prevail over the general terms and conditions in the event of a conflict between them, but any terms appearing in the Certificate of Insurance shall prevail above all others.”

The “pay to be paid” clause was at Section 30, headed “Claims”:

“It is a condition precedent to the Assured’s right of recovery under this policy with regard to any claim by the Assured in respect of any loss, expense or liability, that the Assured shall first have discharged any loss, expense or liability.” (Section 30.13).

The arguments

Owners and their P&I Club argued that either the “pay to be paid” clause did not form part of the policy, or that as a matter of construction it should be interpreted as not applying where they sought to enforce the policy as third parties, or the assured was unable to discharge the liability or was insolvent, or that a term should be implied into the clause to this effect.

The reasoning of Owners and their P&I Club was as follows:

This was a liability policy in which the (sole) insured contingency was the ascertainment of a legal liability by a final judgment, not the ascertainment of a legal liability by a final judgment and the discharge of that liability by payment by the assured.
The “pay to be paid” clause was repugnant to or inconsistent with that main purpose, and also inconsistent with the clauses creating the obligation to indemnify and should be struck out.
The policy did not sufficiently highlight the second contingency that the “pay to be paid” clause created.
A subsidiary clause, such as the “pay to be paid” clause, should not be allowed to negate or deny the effect of a clause with a higher contractual status, in this case the obligation to indemnify, particularly where the indemnity clause formed part of the main purpose of the contract.

The Commercial Court decision

The Court summarised the applicable principles where there are two apparently inconsistent contractual provisions as follows:

Where the alleged inconsistency is between a bespoke clause specifically agreed for the contract in question, and a standard provision in an incorporated set of pre-existing printed terms, the Court can conclude that the standard term is not incorporated at all, or, if it is, its scope can be limited.
Where the alleged inconsistency is between two clauses which appear in a single document (whether a bespoke document or a set of pre-existing terms), the Court is unlikely to find that one of the clauses was not incorporated at all and will be more likely to conclude that the clauses were intended to be read together and to interpret them accordingly.
In determining whether and to what extent two clauses can co-exist, it is relevant to consider whether giving effect to the subsidiary and supposedly repugnant clause will still leave the more substantive clause with a real and sensible content, and, if the subsidiary clause is to be read down or limited in scope, whether it will be left with a meaningful and sensible content.
The Court will be more willing to limit or, if necessary, read out a subsidiary clause which is inconsistent with a provision which forms part of the main purpose of the contract, or which is inappropriate to the main contract into which it is to be incorporated.

Applying these principles to the arguments raised by the third parties, the Court found that the “pay to be paid” clause was not inconsistent with the terms of the certificate, nor with the main purpose of the policy. There was no inherent inconsistency between an insurer’s promise to provide liability cover and a clause making enforcement of the obligation to pay the indemnity conditional on prior discharge of that liability by the insured. S. 9 of the Act 2010 expressly acknowledged that “pay to be paid” clauses could co-exist with all types of marine insurance.

The “pay to be paid” clause was also not inconsistent with the provisions allowing MS Amlin to terminate the policy on BMC’s insolvency while preserving BMC’s rights to indemnity in respect of events occurring prior to termination. The fact that an assured becomes insolvent does not deprive it of its rights under the policy unless and to the extent that the policy so provides. There was no good reason to deprive Section 30.13 (the “pay to be paid” clause) of its clear effect.

The Court concluded that the “pay to be paid” clause was not inconsistent with the certificate and should neither be read down nor ignored. Nor was there any good reason to imply wording to limit the scope of the “pay to be paid” clause such that it would not apply except where the assured could pay a claim before receiving the insurance money, or where it would not apply in cases of insolvency or where a third party was seeking an indemnity.

Comment

In the Court’s view, English law on this issue is not particularly satisfactory because “pay to be paid” clauses reduce the efficacy of insurance protection when it is most needed. Nonetheless, pursuant to the Act 2010 and case-law, they are a recognised and well-established element of marine insurance.

Source: https://www.hilldickinson.com/insights/articles/court-dismisses-challenge-pay-be-paid-clause-charterers-liability-insurance