PI Insurance: Limits Of Indemnity

Insurers now face potential risks for costs above their limit of liability. In a recent case professional indemnity insurers were ordered to pay the claimant’s legal costs of up to £1m, in addition to the limit of indemnity of £2m. This is the first time that the court has exercised its power to award costs against a non-party in a PI context.

The insured was a firm of architects who was found negligent for £2.07m. Insurers paid the £2m limit of indemnity (their total liability under the policy). The claimant was also awarded its costs, which were estimated to be in the region of £1 million. The insured was insolvent and couldn’t pay. So who did pay? Insurers had paid up to their limit, so they were out of the picture, right? Unfortunately not.

Judge Thornton ruled that PI insurers had to pay the Claimant’s costs on the basis that:

• Insurers decided to defend the claim in an attempt to limit their own liability;

• Insurers funded and conducted the unsuccessful defence of the claim. (The insured’s cooperation in conducting the defence was irrelevant);

• Insurers fought the claim exclusively to defend their own interests;

• The claimant incurred and increased its costs in response to this defence; and

• The defence failed entirely.

• To protect themselves, insurers should be doubly careful in considering whether or not to defend a claim to trial, particularly one against a financially troubled insured, and should take care to investigate the insured’s excess layer cover.

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To protect themselves, insurers should be doubly careful in considering whether or not to defend a claim to trial, particularly one against a financially troubled insured, and should take care to investigate the insured’s excess layer cover.

An insured firm of architects is found negligent for an amount in excess of the limit of indemnity. Insurers pay the limit of indemnity, which is their total liability under the policy. A substantial costs award is made in the claimant’s favour. The insured are insolvent, so they can’t pay. So who does? Insurers have paid up to their limit, so they’re out of the picture, right? Unfortunately not. In a worrying development for PI insurers, the Technology and Construction Court has recently ordered insurers to pay out potentially up to £1 million for claimants’ costs in addition to the full £2m maximum liability already paid out under the policy. So what are the reasons for this decision? What can insurers do to prevent such an award being made against them?

In 2001 PSW commenced a claim against ASM for negligent architectural services. By August 2001 ASM had ceased trading. The company directors considered liquidating the company but their solicitors advised against this. While there was a pending legal action it would not be possible to assess the company’s assets and liabilities. ASM’s insurers defended the claim. In January 2006 judgment was given against ASM. Judge Thornton, in the Technology and Construction Court, ordered ASM to pay PSW damages of £2.07m and costs to be assessed but in the region of £1m. Five insurers each carried 20% liability under a PI policy. The policy was subject to a £2m limit of indemnity, which insurers paid over, leaving ASM liable to pay up to £1.07m. At this point ASM was declared insolvent and put into voluntary liquidation. PSW applied to the court for an order that insurers pay its outstanding costs.

The court’s decision and its rationale

The court ordered each insurer to pay 20% of PSW’s costs, in line with the proportion of risk that they each carried under the policy. Judge Thornton concluded that it was fair and reasonable to make the order because the following "exceptional circumstances" were present:

1. Insurers decided to fight the claim
   
   Insurers argued that the decision was a joint one. The court disagreed. ASM had ceased trading and its sole director had retired around the time that legal action began. ASM did not mind whether the claim was defended or not: there was no professional reputation to protect and it would have done whatever insurers advised. The court concluded that the claim would have been left undefended but for insurer’s involvement.
2. Insurers funded and conducted the defence of the claim
   
   Insurers argued that funding of the claim was a normal incidence of PI insurance and not "exceptional"; the court said this was irrelevant as insurers had funded the defence. Insurers also argued that they conducted the defence jointly with ASM. The court disagreed, finding that ASM’s assistance in both preparing the defence and with disclosure was merely a fulfilment of its duty under the policy to cooperate with insurers. Further, the court noted that insurers had appointed solicitors without consulting the insured and no evidence had been filed to support the case that ASM had helped to conduct the defence.
3. Insurers fought the claim exclusively to defend their own interests
   
   Insurers maintained that both parties had a mutual interest to preserve the assets, good name and trading position of ASM. The court concluded that there was no commercial reason for ASM to defend a £2m claim when it had ceased trading and would have been in liquidation but for the pending legal action.
4. The defence failed entirely
   
   The court rejected insurers’ argument that the defence had succeeded because damages awarded were only 2/3 of damages claimed.

The danger for insurers is that, whilst the features set out at (i) to (iv) above may not be extraordinary in the insurance industry, according to Lord Justice Phillips in Chapman v Christopher, "that is not the test. The test is whether they are extraordinary in the context of the entire range of litigation that comes to the Court. I have no doubt that they are."

The criteria for making a costs award against a non-party were first set out in Chapman v Christopher, an accidental damage insurance case. The courts have previously rejected the application of this reasoning in a PI context but this latest ruling increases the likelihood of new costs claims against insurers where their insured is insolvent.

PI Insurers are now clearly potentially at risk for sums over and above their limit of indemnity. There are however steps insurers can take to protect their position:

1. Find out as much as you can about the insured’s financial position.
2. If the insured is insolvent or has ceased trading, think twice about defending a claim to trial where the claim is likely to come close to or exceed your limit of indemnity. Think more than twice about defending a claim to trial where the only realistic goal is to reduce quantum.
3. Try to ensure that there is a reason for the insured to defend the claim. If the court believes that it is solely insurers that are causing the claimant to incur costs, there could be implications over and above the limit of indemnity.
4. Involve the insured in the decision making process as much as possible. Consider, for example, whether the insured wants to be involved in deciding which solicitors are instructed.
5. Look into the insured’s excess layer coverage (if any) at an early stage. Ensure that, if necessary, the excess layer insurers are involved as early as possible.

Further reading: [Plymouth & South West Co-Operative Society Ltd v Architecture, Structure & Management Ltd [2006] All ER (D) 248 (Dec)]

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

The original publication date for this article was 15/01/2007.