Factual and Procedural Background
This appeal arises from a decision of Judge Davis dated 4th March 2003 concerning the scope of the Financial Services Compensation Scheme's (the Scheme) obligations under sections 6(4) and (5) of the Policyholders Protection Act 1975 (the 1975 Act). The respondents, referred to as Company A, held an insurance policy with Independent Insurance Company Limited (Independent) that provided both compulsory employers' liability insurance and other non-compulsory cover. Independent became insolvent, triggering the Scheme's indemnity obligations.
Company A sought indemnification from the Scheme for damages and costs arising from a claim by an employee. While there was no dispute that the Scheme was liable for damages and costs payable to the employee, the contested issue was whether the Scheme was also liable for Company A's legal costs of defending the claim prior to Independent's liquidation. The trial judge held the Scheme liable for these defence costs and granted permission to appeal.
The policy in question was a composite "Business Liability" policy covering multiple areas including employers' liability, public liability, and products liability. The claim was defended by solicitors instructed by Company A, with Independent involved in the conduct of the defence. Independent entered provisional liquidation during the litigation. Company A paid pre-liquidation legal costs and sought recovery from the Scheme, which denied liability for these defence costs. Consequently, Company A initiated judicial review proceedings seeking declaratory relief and payment from the Scheme.
Legal Issues Presented
- Whether the Financial Services Compensation Scheme is obliged under sections 6(4) and (5) of the Policyholders Protection Act 1975 to indemnify a policyholder for legal costs incurred in defending a claim where the insurance company has become insolvent, specifically costs of defending the claim as opposed to costs payable to the claimant.
- The proper construction of the phrase "arising otherwise than in respect of a liability of the policyholder which is a liability subject to compulsory insurance" in section 6(5) of the 1975 Act.
- Whether the indemnity obligation extends beyond liabilities that are statutorily required to be compulsorily insured, including costs associated with defending claims under a composite insurance policy.
Arguments of the Parties
Appellant's Arguments (Company A)
- The Scheme's indemnity obligation under section 6(4) of the 1975 Act includes legal costs incurred in defending claims, not only damages and claimant's costs.
- Section 6(5) should be interpreted so that "in respect of" means "in connection with," thus covering defence costs incurred in relation to liabilities subject to compulsory insurance.
- The policy provides indemnity for both claimant's costs and defence costs with the insurer's consent, and the Scheme should honor this indemnity despite the insurer's insolvency.
- The phrase "liability subject to compulsory insurance" describes the type of liability covered by the policy rather than limiting indemnity to only those liabilities strictly required by statute.
Appellee's Arguments (The Scheme)
- The Scheme's obligation under section 6(4) and (5) is limited to liabilities that the policyholder is statutorily required to insure against (i.e., compulsory insurance liabilities).
- The phrase "in respect of" should be narrowly construed to exclude liabilities such as defence costs which are not themselves compulsory insurance liabilities.
- Statutory provisions, including the Employers' Liability (Compulsory Insurance) Act 1969 and related regulations, demonstrate that compulsory insurance covers damages and claimant's costs but not necessarily defence costs.
- Costs payable to solicitors defending claims are not "liabilities subject to compulsory insurance" and thus are outside the Scheme's indemnity obligation.
Table of Precedents Cited
| Precedent |
Rule or Principle Cited For |
Application by the Court |
| Paterson v Chadwick [1974] 1 WLR 890 |
Interpretation of the phrase "in respect of" in statutory context |
The court accepted Boreham J's view that "in respect of" has a wide meaning implying some connection or relation between subject matters, supporting a broad interpretation in the present statutory context. |
| Trustees Executors & Agency Co Ltd v Reilly [1941] VLR 110 |
Explanation of "in respect of" as having the widest possible meaning of connection or relation |
The court found this interpretation helpful in understanding the ordinary meaning of the phrase within the statute under consideration. |
| Commonwealth Holdings Plc v Barclays Bank Plc [1996] 1 WLR 1 |
More restrictive meaning of "in respect of" in certain statutory contexts |
The court noted that some authorities favored a narrower construction depending on statutory context, but found these less persuasive here. |
| Rodan International Ltd v Commercial Union Insurance Company Plc [1999] LLR 495 |
Construction of "in respect of an occurrence" in insurance policy wording |
The court recognized that "in respect of" requires a liability to relate to the identified occurrence, not merely to have some connection, but this did not support a narrow construction in the present statutory context. |
Court's Reasoning and Analysis
The court began by examining the statutory language of sections 6(4) and (5) of the 1975 Act. Section 6(4) imposes a duty on the Scheme to pay the full amount of any liability of an insolvent insurer to a policyholder under a policy subject to compulsory insurance. Section 6(5) excludes liabilities "arising otherwise than in respect of a liability of the policyholder which is a liability subject to compulsory insurance."
The court rejected the narrow construction urged by the Scheme, which would limit indemnity strictly to liabilities that the policyholder was statutorily required to insure against. Instead, the court interpreted "in respect of" as meaning "in connection with" or "in relation to," consistent with the ordinary meaning and relevant authorities. This interpretation allows for indemnity to extend to liabilities connected with compulsory insurance liabilities, even if not themselves strictly compulsory.
The court considered the composite nature of the policy, which included coverage for claimant's costs and defence costs incurred with the insurer's consent. Since the policyholder would have been entitled to recover defence costs if the insurer had remained solvent, the Scheme's indemnity should similarly cover these costs.
The court further reasoned that if the Scheme's indemnity was limited only to liabilities statutorily required to be insured, subsection (5) would be redundant, as subsection (4) could have been drafted to that effect alone. Therefore, subsection (5) serves to clarify that indemnity extends beyond strictly compulsory liabilities but remains connected to them.
Statutory provisions such as the Employers' Liability (Compulsory Insurance) Act 1969 and related regulations were examined. While these statutes mandate insurance against bodily injury liabilities and claimant's costs, they do not explicitly require insurance against defence costs payable by the policyholder. Nonetheless, the court found that the policy wording and statutory context support the inclusion of defence costs within the indemnity.
The court also considered the policy terms, which expressly provide indemnity for claimant's costs and defence costs incurred with the insurer's consent. Given that the Scheme steps into the insurer's shoes upon insolvency, it should honor these policy obligations.
Holding and Implications
The court DISMISSED THE APPEAL, affirming the trial judge's decision that the Financial Services Compensation Scheme is liable under the Policyholders Protection Act 1975 to indemnify the policyholder for legal costs incurred in defending a claim, including defence costs payable to solicitors, where the insurance company has become insolvent.
The direct effect of this decision is that the Scheme must pay the pre-liquidation defence costs incurred by the policyholder. The court did not set a new precedent beyond the statutory interpretation in this specific context, and no broader legal implications were explicitly discussed beyond the possible application to similar cases involving other insolvent insurers and policyholders with comparable insurance arrangements.