Baron Napier and Ettrick & Others v Kershaw & Others

Queen's Bench Division (Commercial Court)




HEARING-DATES: 12 June 1992

12 June 1992



A Boswood QC and N Warren and S Moriarty for the Plaintiffs; J Thomas QC and J Gruder for the First, Third and Fourth Defendants; P Taylor QC and J Child for the Second Defendants


PANEL: Saville J





SAVILLE J: In the first judgment I gave in these proceedings I decided, contrary to the submissions of Lloyds Society, that no part of the money paid in settlement of the litigation between certain Names at Lloyds and their respective Members and Managing Agents in respect of allegedly negligent underwriting for Syndicate 371/661 of risks attributed to the 1982 year of account had to be paid into the trust funds constituted under the Lloyds Premium Trust deeds executed by the Names. I now turn to consider a quite separate claim to part of the settlement money which is advanced by certain Stop-Loss Underwriters who have made payment to some of the Names under Stop-Loss policies covering or including the 1982 year of account.


The claim of the Stop-Loss Underwriters is based upon the principles of subrogation and raises two quite separate questions. The first of these relates to the nature of subrogation while the second relates to when and to what extent subrogation applies.


As to the first of these questions, the Stop-Loss Underwriters submit that when the right of subrogation arises, it gives the holder of that right an equitable proprietary interest in everything to which the right applies: in other words, that the party indemnified holds everything subrogated in trust for the holder of the right. (I should note that it was not suggested that subrogation gave rise to any common law proprietary right in this case). The Stop-Loss Underwriters further submit that in consequence, third parties who hold anything subject to this trust may, given due notice of the trust, be or become liable themselves as constructive trustees, so that if they deal with the subject-matter otherwise than in accordance with the trust, they incur liability as trustees.


The Names concerned dispute these submissions, as do their solicitors, who presently hold the settlement money pursuant to the terms of the settlement agreement. In the submission of these parties, rights of subrogation are personal rights arising out of the relationship created by a contract of indemnity and that in the absence of express agreement to the contrary, no such trust arises in respect of anything to which the right of subrogation applies.


To my mind, the basis and reason for the doctrine of subrogation is that it would be wholly contrary to the spirit and intent of an ordinary contract of indemnity for the person entitled under that contract to be able to obtain or retain more than an indemnity from his bargain. As between himself and his indemnifier, to allow that person to obtain or retain a payment under his contract which, together with other recoveries in respect of the loss, would mean that he is more than indemnified for his loss, would indeed be unjust enrichment, for the indemnifier has agreed to make good the loss or part of the loss, not to make a payment which, with other recoveries, would over-compensate the person sustaining the loss. It is for this reason that if a person indemnified receives anything that diminishes his loss, then the amount to which he is entitled under his contract of indemnity must be adjusted so as to avoid that person recovering more than his loss through payments under the contract of indemnity ie so as to avoid turning the contract to indemnify into a contract to over-indemnify.


This right of adjustment is called subrogation. It arises out of the very nature of ordinary contracts of indemnity, out of the bargain made by the parties, which is to make good the loss (or part of the loss) but no more than the loss. It follows, of course, that the parties can of course agree to modify or exclude the right of subrogation, and if and to the extent they do so, they change their bargain from one of simple indemnity.


It is clear that this right of adjustment existed at common law. The indemnifier could recover from the person indemnified as money had and received the amount of any over-payment ie the amount by which the sum paid by way of indemnity exceeded the loss sustained by the person indemnified. As Diplock J as he then was, pointed out in Yorkshire Assurance Co v Nisbet Shipping Co Ltd [1962] 2 QB 330 at 341, it is immaterial in what way the loss has been reduced or whether it has been reduced after the casualty but before the actual date of payment; if the insurer (the indemnifier) has paid more than the actual loss, he can recover from the assured (the person indemnified) as money had and received, the amount of the over-payment. In ordinary language, in such circumstances, the indemnifier can say simply: "My bargain with you was to indemnify you against a loss. It now turns out that my payment gives you more than an indemnity, so you must repay me the excess, for otherwise I will have paid to you more than I agreed to do". Similarly, if the recovery is made before the indemnifier pays, the latter can again simply say: "My bargain is to indemnify you against loss. It now turns out that your loss has been reduced, so my payment must be reduced so that you are not over-compensated for the loss, for otherwise I will be paying more than I agreed to do".


So far, this analysis has dealt with actual receipts which have reduced or extinguished the loss in respect of which the person concerned has contracted for an indemnity. The same considerations apply to my mind to cases where the person who has contracted for an indemnity has the means of reducing or extinguishing the loss, for example if he has a right to sue a third party for causing the loss. Again, in those circumstances it would seem quite contrary to the spirit and intent of the contract of indemnity, and unfair to the indemnifier, if he could not require the person indemnified to take all available steps to seek to obtain such recoveries so as to reduce or extinguish the loss and thus to reduce or extinguish the amount otherwise payable under the contract of indemnity.


It is at this point, however, that the common law was found wanting, for as Diplock J also pointed out in the case cited, there were no means by which common law could compel the person indemnified to sue to reduce or extinguish the loss. Thus before the fusion of law and equity it was necessary for the indemnifier to go to a court of equity for an order compelling the person indemnified to allow an action to be brought in his name. Of course, the use of that name would have, at least in the ordinary case, to be at the risk and expense of the indemnifier, for were this not so, the party indemnified might expend money for no recovery and thus increase rather than decrease the loss, which again would be against the spirit and intent of an ordinary contract of indemnity.


On the basis of the foregoing analysis, it follows that the idea behind and the reason for subrogation, is that the indemnifier has rights under his contract to adjust the amount he has to pay or has paid so as to ensure that as between himself and the other party to the contract, he does not pay more than the loss. In short, subrogation is a right to avoid or recover over-payments under contracts of indemnity arising implicitly out of the nature and intent of such contracts.


In my view, that this is the correct analysis is demonstrated by the judgments in Castellain v Preston [1883] 11 QBD 380, a case long regarded as the locus classicus on the subject of subrogation. As Brett LJ said (at p 386) the contract is one of indemnity only and means that the assured shall be fully indemnified but never more than fully indemnified, so that any proposition that involves the assured obtaining more (or less) than a full indemnity must be wrong. In like terms, Cotton LJ at p 393 said that since the policy is really a contract to indemnify the person insured for the loss he has sustained, it is only to pay that loss after taking into account those benefits or sums of money which the assured may have received in diminution of the loss.


To my mind this analysis is also supported by the fact that in valued policies of insurance, the value agreed is taken to be the measure of the loss for the purposes of subrogation, and by the fact that if a windfall is made from the loss, as in Yorkshire Assurance v Nisbet, then once the indemnifier recovers what he has paid, it is not he but the other party to the contract who is entitled to that windfall.


If this analysis of subrogation be correct, then it also follows that subrogation is on the face of it a right relating to actual or possible over-payments under the contract of indemnity rather than a right to recoveries from others which reduce or extinguish the loss. As Cotton LJ said in Castellain v Preston, (at p 393) subrogation means that in order to ascertain the loss, everything must be taken into account which diminishes the loss. In that sense it can of course be said, as indeed Brett LJ did say in the same case (at p 388), that as between the underwriter and the assured, the underwriter is entitled to the advantage of every right of the assured by which the loss insured against can be or has been diminished. The words used, however, are not "entitled to the right" but "entitled to the advantage of the right", clearly in the sense of taking advantage so as to reduce or extinguish the loss and thus correctly to calculate the amount, if any, of the indemnity contractually due.


In these circumstances, I find it difficult to see how, or indeed why, as a result of the contract of indemnity, the indemnifier could come to own recoveries or rights of recovery available to the person indemnified. Indeed, as a matter of common law, it is quite clear that he does not. The indemnifier cannot sue for such recoveries in his own name (see Simpson v Thompson [1877] 3 AC 279). Indeed, it is for that very reason that equity intervened to order the party indemnified to allow his name to be used. The party indemnified can effectively waive or abandon his rights against third parties (provided perhaps he does not do so in concert with the third party in order to defraud his indemnifier) though if he does so he has to answer to his indemnifier personally for any amount by which the loss would otherwise have been reduced (see West of England v Isaacs [1897] 1 QB 226). The indemnifier, it would seem, cannot himself waive or abandon any such rights (see Morley v Moore [1936] 2 KB 359). Thus it is only the person indemnified who can give a good discharge in respect of such rights.


Finally, there is a clear distinction in law between subrogation and abandonment, the latter applying in cases of total loss where indeed it is clear that the subject matter insured becomes the property of the insurer: see Section 9/79 of the Marine Insurance Act 1946, which reflects the law as it then existed.


Standing against this analysis is the undoubted fact that there are plenty of cases, and a number of textbooks, which describe subrogation in terms of recoveries or rights of recovery belonging to the indemnifier, or as impressed with an equity in favour of the indemnifier, or indeed as being held on trust for the indemnifier by the person indemnified. It was some of this material which led Wynn-Parry J in Re Miller, Gibb [1957] 2 All ER 266, [1957] 1 WLR 703 to decide that such recoveries were held on trust for the indemnifier so that they were not available for the general body of creditors when an assured became insolvent; and indeed, the learned editors of Goff & Jones on Restitution, second edition, at p 548, to say in terms that it is settled that money received by the assured to which the insurer is entitled to be subrogated is held by the assured as trustee for the insurer.


I have, of course, considered this material as carefully as I am able, but in the end I consider that none of it is binding on me. The early case of Randall v Cockran [1748] 1 Ves Sen 98 is difficult, if not impossible, to understand, it not being clear even who the defendant was or what relief was granted. Later cases assume, without it being necessary to decide the point, that there is an equity or trust, or proceed upon a concession to that effect, or use such terms in a general rather than a technical sense, while cases such as Morris v Ford [1973] QB 792, [1973] 2 All ER 1084, are readily explicable on the basis that equity puts limits on the right to use the name of the party indemnified, which in no way implies or requires the existence of an equitable proprietory right of the kind suggested. What is noteworthy, to my mind, is that in Castellain v Preston (supra), the leading case of subrogation, where Brett LJ expressly set about describing the doctrine in the widest terms he could, there is nothing to suggest or imply that the indemnifier owned recoveries or rights of recovery in equity or otherwise.


In my judgment, the party indemnified does not hold such recoveries or rights of recovery in trust for the indemnifier or, which is to say the same thing, that the indemnifier has any equitable proprietary right in any such recoveries or rights of recovery. Despite the material to which I have been referred, I am simply not persuaded that such a proprietary right either exists or indeed ought to exist under our law.


In the first place, if the reason for subrogation is that which I believe it to be, then as I have already observed, it is a right designed to prevent or cure over-payment by the indemnifier which arises from the very nature of an ordinary contract of indemnity. The right, therefore, attaches to the actual or potential over-payment, not to the things that result or might result in over-payment.


In the second place, it seems to me that if a recovery is owned in equity by the indemnifier, he could hardly simultaneously have a personal right to claim for money had and not received. Yet this right is clearly established in our law. In his skeleton argument Mr Clarke QC for the Stop-Loss Underwriters submitted that the indemnifier has both remedies. To my mind this cannot be so. If an assured holds a recovery as trustee for an insurer, then on ordinary trust principles he would be excused from his obligations as trustee if through no fault of his own, the subject-matter of the trust was lost in his hands. If, on the other hand, he has received something which reduces or extinguishes the loss, so that the indemnifier has paid more than an indemnity, it would be nothing to the point in an action for money had and received that the party indemnified had subsequently, through no fault of his own, lost what he had received. Indeed, if there was a trust, this would to my mind provide a defence to a personal action for money had and received, for the party indemnified could say, simply and correctly, that he had in truth received nothing, for that which he had recovered belonged in equity to the indemnifier.


As I understand him, Mr Clarke finally accepted that the party indemnified would not be liable if the recovery he had received was lost through no fault of his, but this to my mind would, if correct, mean the abolition or at least the substantial modification of the personal common law right to money had and received, for which proposition there is simply no authority at all.


In the third place, if a trust exists, it must, as indeed Mr Clarke submitted was the case, be a bare trust. There would be only one beneficiary absolutely entitled to the subrogated right. If so, then under ordinary trust principles (the rule in Saunders & Vautier) the equitable owner could dictate what was to be done with the subject-matter of the trust. Yet in Morley v Moore, (supra) the Court of Appeal was adamant that the indemnifier lacked the power to direct the party indemnified not to enforce the subrogated chose in action -- in other words, that the suggested owner in equity could not deal with his property as he chose.


It might, of course, be suggested that an answer to this particular problem could be to treat the trust as only applying to actual recoveries coming into the hands of the person indemnified and not to rights of recovery, but such a suggestion would be wholly inconsistent with Castellain v Preston, (supra) for there the Court of Appeal clearly took pains to draw no distinction at all between recoveries and rights of recovery.


In the fourth place, it is accepted, indeed asserted, that the suggested trust only arises after the indemnifier has made payment under his contract of indemnity. This is because it has been said that rights of subrogation only arise when the indemnifier has paid. In one sense this is true. The right to recover an overpayment ex hypothesi can only arise when the over-payment has been made and the right to use the name of the person indemnified only arises after payment under the contract of indemnity. But in truth, the doctrine of subrogation does apply to recoveries made before the indemnifier has paid, as both Brett LJ and Cotton LJ said in Castellain v Preston, (supra) and as indeed Diplock J said in Yorkshire Assurance v Nisbet (supra) in the passages to which I have already referred. If the assured obtains a recovery before payment by his indemnifier, then by subrogation the loss, and thus the amount of the indemnity, is adjusted so as to avoid over-indemnification. This adjustment is made because it is the bargain of the parties that the indemnifier is to pay the loss (or an agreed part of it) but not to over-compensate for the loss. If, however, subrogation involves equitable proprietary rights, then there would seem to be no good reason to distinguish between the position before and after payment, with a trust arising only in the latter event.


In the fourth place, once a trust does arise, then again on ordinary principles of trust law, there are likely to be effects on third parties. Indeed, in the present case it is asserted that the Names' solicitors would be liable as constructive trustees if they did not account to the Stop-Loss Underwriters for subrogated amounts. Presumably the same would follow with regard to other third parties given notice of the trust, such as the Defendants in the Outhwaite litigation, or their solicitors if they received the settlement money, as indeed happened in this case.


Now there may well be defences to any such claims, (such as the discharge given by Section 15 of the Trustee Act 1925) but the fact remains that if recoveries and rights of recovery belong to the indemnifier in equity, then the ramifications of this cannot be confined to the two parties to the contract of indemnity. For my own part it would seem to be highly undesirable to complicate ordinary commercial transactions like indemnity insurance by importing concepts of trust and equitable ownership unless there are good reasons for doing so.


I can see no good reason for such trusts or concepts of equitable ownership. The argument is, as I understand it, that if an indemnifier is paid, then it is only fair and equitable that he should own recoveries or rights of recovery which reduce or extinguish the loss, so that these should not be available for other creditors if the party indemnified becomes insolvent. But leaving aside the possible problem that in a case of a company this might perhaps be regarded as a registrable charge, why should the indemnifier have such a right? There is of course a close connection between the indemnity and a recovery which reduces or extinguishes the loss, but so too is there between a bank lending money for the purpose of enabling the borrower to buy something and the article then bought, yet in the absence of special agreement, the bank has no rights in the article but only a personal right to recover the loan. The indemnifier likewise has a personal right to recover an over-payment (or adjust the amount payable), but why should the latter be favoured with proprietorial rights when both the insurer and the bank could, and indeed frequently do, contract expressly for such rights by stipulating for a charge or an assignment of interest.


For the reasons set out in this judgment, therefore, I consider that the Stop-Loss Underwriters have no actual or contingent equitable proprietary interest arising from subrogation in any of the money paid in settlement of the litigation between the Names and their Members and Managing Agents. It follows, of course, that there is no question that by virtue of subrogation, the Names' solicitors Richards Butler & Co are in any way constituted or liable or contingently liable as constructive trustees to the Stop-Loss Underwriters.


Finally, before leaving this question of subrogation, I should briefly mention the case of Stearns v Village Main Reef Gold Mining Co [1905] 10 Comm Cas 89, which the Names and indeed some of the text books rely upon as authority for the proposition that no trust exists. In that case the assured sustained a loss but before payment under the insurance, recouped, as the Court of Appeal held, part of that loss. Ignorant of this, the insurers paid the original loss, but on discovering what had happened claimed, to summarize the headnote, what had been recouped. It was argued that a trust existed in relation to the over-payment made by the insurers (see p 92 of the report) so that trust interest was recoverable from the date of the over-payment to the date of trial. It seems that only Stirling LJ dealt with this particular aspect of the case. He rejected the claim for trust interest on the basis that the obligation to correct the over-payment was simply one arising from a relationship of debtor and creditor and not a relationship of trustee and beneficiary.


In one sense this case does not assist with the present problem because the argument was (apparently) not that the recovery was impressed with a trust, but that the over-payment produced a trust, presumably in relation to that part of the money paid by the insurers that exceeded the net loss. However, the case is an example of the courts applying the doctrine of subrogation in the way I have described above, to recoveries made before payment under the contract of indemnity -- ie so as to adjust the amount paid or payable under the contract -- and, at least so far as Stirling LJ is concerned, a demonstration of reluctance to import trust concepts into this sort of bargain.


The second question which I am asked to answer has been described as the "top down" point and I arises in the following way. In general terms the Stop-Loss covers in question were contracts of indemnity made by certain Names with Stop-Loss Underwriters to cover the risk of underwriting losses. There are various differences between the contracts in question, but the parties were agreed that these were not relevant to the point at issue, which can be illustrated by taking an example of a Stop-Loss cover against underwriting losses in excess of £25,000 with a limit of £100,000, underwriting losses of £160,000; a payment of £100,000 under the stop-loss cover; and a later net recovery under the settlement of £130,000.


The Stop-Loss Underwriters submit that through the correct application of the principles of subrogation, the recovery should be apportioned so that the assured keeps the "top slice"; that is to say, so much as is needed to compensate him for the losses above the limit in the cover. In the example this is £35,000, the loss being £160,000 and the limit of the cover being £125,000, (ie £100,000 in excess of £25,000). The Stop-Loss Underwriters submit that the next slice, which they describe as the "indemnity slice", goes in or towards reimbursement of the £100,000 paid under the cover. Since the recovery less the top slice is only £95,000, there is nothing further left over for the assured, who has of course borne the first £25,000 of the loss. The net result is that the Stop-Loss Underwriters have paid £5,000 under the cover.


The Stop-Loss Underwriters seek to support this argument by taking the same example but assuming that payment under the settlement is made before payment under the Stop-Loss cover. In this case, they say, the original loss of £160,000 is reduced to £30,000 by the recovery of £130,000. Accordingly, the assured can only recover £5,000 under the Stop-Loss cover because of the £25,000 excess. This, submit the Stop-Loss Underwriters, is the same result as in the first case, whereas if the assured was entitled to keep more in that case, this would produce the absurd result that what the assured could claim or retain differed upon whether the recovery was made before or after payment under the policy.


In my judgment this ingenious argument is fallacious for it proceeds upon premises that are the antithesis of the principles of subrogation. The assured sustains an underwriting loss of £160,000. The Stop-Loss Underwriters' argument involves the proposition that they can take account of the recovery before the assured has been reimbursed for his loss. As Brett LJ said in Castellain v Preston (supra) at p 386, subrogation has two sides. The assured must not receive more than a full indemnity but equally he must not receive less. The Lord Justice said this:


"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 the assured more than a full indemnity, that proposition must certainly be wrong".


I have underlined the words relevant in the present connection. The assured in the example has received in respect of the loss £100,000 from his insurers and £130,000 from the settlement. He has therefore been over-compensated by £70,000, or in other words, the underwriters have overpaid £70,000 and the assured must repay this amount. To my mind, no question of "top down" or dividing the matter into slices arises, and certainly not if it results in the assured ending up with less than a full indemnity, as would be the case if the underwriters argument were accepted.


In my view, exactly the same result is achieved whether the recovery is made before or after payment under the cover. The question to be asked, whichever it is, is whether the recovery together with the indemnity will more than compensate the assured for the loss. If it will, then if this arises before payment, the amount of the indemnity will be reduced so as to avoid over-compensation, while if it occurs after payment, the assured will have to repay the amount of over-compensation to his indemnifiers. I can only repeat that any approach which does not achieve this result but instead leaves the assured over- or under-compensated must be wrong, since it offends the very reason why subrogation exists in our law.


In the consent order joining the Stop-Loss Underwriters to these proceedings, the parties identified certain issues to be determined, including the two with which I have dealt in this judgment. As to these two, I shall accordingly make appropriate orders.



Judgment accordingly



Richards Butler; Oswald Hickson Collier & Co; Solicitor, Society of Lloyds; Clyde & Co