The application of "Pay to be Paid" clauses in the context of a claim under the 2010 Act

The dispute in MS Amlin Marine NV v King Trader Limited [2024] EWHC 1813 (Comm) concerned a claim by the Owner of a vessel under a charterers' liability insurance (the Policy) taken out by the charterer.  The claim was brought under the Third Parties (Rights Against Insurers) Act 2010 (the 2010 Act) which enables a third party to pursue an insurance claim against an insolvent insured's liability insurer, seeking a determination of the insured's liability, and whether there is a valid insurance claim, in one set of proceedings. The insurer succeeded in avoiding liability due to the application of a "pay to be paid" clause in the Policy which required the liability to be first discharged by the insured (which was insolvent).  A specific carve out under the 2010 Act means that "pay to be paid" clauses are effective in marine insurance policies.  The judgment also serves as a reminder of the key principles governing the construction of contracts containing conflicting clauses.

BACKGROUND

In May 2017 King Trading Limited (the Owner) time-chartered a vessel to BMC.  On 28 March 2018, BMC took out the Policy with insurer MS Amlin which provided cover for 12 months. 

The vessel grounded in the Solomon Islands in February 2019, following which BMC went into insolvent liquidation. 

On 14 March 2023, an LMAA Arbitration Tribunal found BMC liable in damages to the Owner and its Protection and Indemnity Club (P&I Club) in respect of the grounding and made an award of over US$47 million, including interest and costs in favour of the Owner and the P&I Club. Subsequently BMC was wound up. 

It was common ground that the Owner and the P&I Club were both "relevant persons" under the 2010 Act and were therefore entitled to bring a direct claim against MS Amlin as BMC's rights under the Policy had been transferred to and vested in them pursuant to section 1 of the 2010 Act.

The key issue in dispute was whether the Policy validly incorporated a “pay to be paid” clause and. if so, how this affected the claim brought by the Owner and the P&I Club under the Policy.  

The Policy

The Policy took the form of an insurance certificate and wording entitled "Charterers' Liability: Marine Liability Policy 1 – 2017".  The type of insurance was described as "Charterers’ Liability including Liabilities for damage to Hull Class 1". The Policy wording was divided into 5 parts: Parts 1 to 4 related to different types of cover and Part 5 was headed “General Terms and Conditions"

Relevant provisions under Part 5 included:

• Section 25 – which provided that 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.
• Section 30 – which was a "pay to be paid" clause as follows:

“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."

"Pay to be paid" clauses

It was explained in the judgment that the genesis of "pay to be paid" clauses lies in mutual marine insurance, where members of an association such as a P&I Club are both the insured and the insurer. Accordingly, with a view to providing protection to their members, P&I Clubs have for a very long time included provisions in their rules which limit a member's right to indemnity by a condition requiring members to first discharge the relevant liability ("pay to be paid clauses").  The justification behind such clauses lies in the manner in which P&I Clubs operate (i.e. through mutual insurance) and the nature of the marine business wherein P&I Clubs frequently, amongst other things, undertake direct liability to third parties in the form of guarantees.

The effect of such clauses in circumstances where a claim is brought by a third party under the provisions of the Third Parties (Rights Against Insurers) Act 1930 (the predecessor to the 2010 Act) was confirmed in the 1991 House of Lords decision of The Fanti and the Padre Island [1991] 2 AC 1.  This decision held that third parties acquired no greater rights under the contracts of insurance than the Club’s members and the "pay first" provisions defeated the third party claims.

The drawbacks of "pay to be paid" clauses having such an effect under the 1930 Act was recognised and as a result section 9 of the 2010 Act (the successor act to the 1930 Act) deals with the situation where “transferred rights are subject to a condition (whether under the contract of insurance from which the transferred rights are derived or otherwise) that the insured has to fulfil”. Section 9(5) provides that the transferred rights “are not subject to a condition requiring the prior discharge by the insured of the insured’s liability”.  However, there is a carve out under section 9(6) for contracts of marine insurance. This carve out is not limited to cases of mutual marine insurance (from which it is derived) but to all contracts of marine insurance. In other words, "pay to be paid" clauses will remain effective for claims made under the 2010 Act.

As a result the dispute concerned, not whether the "pay to be paid clause" was effective in a claim under the 2010 Act, but whether the "pay to be paid clause" ought properly to be construed as such under the Policy itself.

Owner and P&I Club's position

The Owner and P&I Club advanced the following points to argue that the Policy should respond:

1. 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.
2. The “pay to be paid” clause was inconsistent with that main purpose, and with the clauses creating the obligation to indemnify.
3. The policy gave no "fair warning" of "the second contingency" that the “pay to be paid” clause created and therefore operates as a "wolf in sheep's clothing".
4. A clause occupying "a lower place in the contractual hierarchy" should not be allowed to negate the effect of a clause with a "higher contractual status", being the obligation to indemnify here. 

As such, it was submitted that the "pay to be paid" clause did not form part of the Policy, or that as a matter of construction it should not be read as applying where a third party sought to enforce the Policy or where the insured was unable to discharge the liability (due to its insolvency in this case). 

DECISION

Mr Justice Foxton found against the Owner and P&I Club.  In doing so, he set out the relevant considerations that arise in circumstances involving potentially inconsistent and conflicting terms: 

1. "Typed" or bespoke terms (drawn up specifically for the contract in issue) will usually take precedence over "printed" or "boilerplate" terms (terms prepared independently of the transaction in issue) in that the Court may find that the latter is either not incorporated or limited in its effect.
2. Where the inconsistency is between two clauses which appear in a single document, the Court will be more likely to conclude that the clauses were intended to coexist.
3. In determining whether and to what extent two clauses can co-exist, it is relevant to consider whether giving effect to the 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, whether it will be left with a meaningful and sensible content.
4. There will be greater readiness to read out or read down a subsidiary clause which is inconsistent with a provision which forms part of the main purpose of the contract.

Applying these principles, the Court found that the "pay to be paid" clause in the Policy was not inconsistent with either the terms of the certificate or the main purpose of the Policy.  An obligation to provide indemnity was not inconsistent with a condition requiring the prior discharge by the insured of that liability. This was further supported by the position under section 9 of the 2010 Act evidencing that a "pay to be paid" clause could co-exist in marine insurance contracts. 

Nor was there an inconsistency between sections of the Policy that allowed MS Amlin to terminate the Policy on insolvency but preserve BMC’s rights to indemnity in respect of events occurring prior to termination, and the "pay to be paid" clause requiring an insolvent insured to first discharge its liability.

The Court also observed that the "pay to be paid" clause was not “hidden away in the thickets of the Policy”, appearing clearly within a section of the policy imposing a number of the obligations and being wholly unambiguous. The clause was not therefore “in the nature of a fox in the henhouse (or a wolf in the flock)”.

COMMENT

The decision reinforces that the Court is usually reluctant to interfere with unambiguous wording in an insurance contract.  This was particularly so here in light of the provisions in the 2010 Act (giving force to the implementation of the "pay to be paid" provisions in marine insurance contracts) and long-standing industry practices.  The Court was however sympathetic to the unintended effect the provisions could produce and emphasised the unsatisfactory "state of English law on this issue in the light of the 2010 Act" which could leave a range of third parties looking to make good their loss and damage without any recourse. 

The case is a useful reminder to policyholders to review policy wordings carefully and to avoid provisions that might potentially conflict.