Protection and Indemnity Clubs - Article Example

Protection and Indemnity Clubs (hereinafter “PI protect shipowners from unlimited liability. These clubs, the first being Shipowners Mutual Protection Society, established in 1855, limited liability for shipowners. Before these clubs were established, shipowners were unable to obtain insurance for the entire value of the vessel, only three-quarters of the vessel, and the shipowner had to cover the other quarter on his own. Membership in one of these clubs, however, entitled the ship owner to turn to the club to cover the last one-quarter. (Finnern, 2007, p. 4). Ninety percent of shipowners in modern times are a part of one of these clubs. These clubs also cover the shipowner from liability to third parties, as well as coverage against injury or death of the crew-members. (Finnern, 2007, p. 5). The shipowner becomes both the insured and the insurer, because claims are paid out of the Clubs funds, and these funds are collected from all the members of the Club. (Finnern, 2007, p. 6). A normal clause of most, if not all, of the PI Clubs is the “pay to be paid” rule. This rule states, in a nutshell, that if a shipowner has a claim for which he wants the club to reimburse him, he must first settle the claim with the injured party on his own, with his own means. (Hawkins, p. 3). He can then seek reimbursement from the Club for the money he spent out of pocket. (Finnern, 2007, p. 7). The reason for the “pay to be paid” rule is that the PI Clubs only provide indemnification for their members, as opposed to regular insurance. The difference between regular insurance and indemnification is that, with regular insurance, all claims against the insured are paid, whereas, with indemnification insurance, only the claims for which the insured has already paid are covered. With regular insurance, the insured does not have to suffer an actual financial loss to collect, and advanced payment is not necessary; with indemnification, the insured does have to suffer an actual financial loss to collect, advanced payment is necessary, and the amount that he collects from the indemnity insurance is only as much as he has already paid out. (Finnern, 2007, pp. 8-9). Further, the third party generally has to have a judgment against the insured, otherwise the PI does not kick in. In other words, if the insured gives money to a third party to settle the claim, but the third party did not first obtain a judgment, the PI may not pay the claim, even though the insured has fulfilled the requisite requirement of payment of claim. If the insured pays the third party an amount over and above a judgment, the PI is only liable to the dollar amount of the judgment. (Finnern, 2007, p. 11). The “pay to be paid” clause is a bargained-for clause – the shipowners are aware of the clause before they become a part of the Club, and they can either choose or not choose a certain Club, depending on whether the Club has the clause or not. (Finnern, 2007, p. 9). This rule presents a problem when the shipowner becomes bankrupt and, therefore, cannot settle the claim on his own. This could certainly result in an injustice to the third party, for he or she may not get paid for his or her claim against the insured in such a case. England attempted to rectify this situation with the “Third Parties (Rights Against Insurers) Act of 1930 (hereinafter “The Act”). (Third Parties Rights Against Insurers Act of 1930). In a nutshell, The Act states that, if an insured goes bankrupt, then the third party steps into the insured shoes, in that any right the insured had against the insurer vests with the third party. (Third Parties Rights Against Insurers Act of 1930 (1)(1)(a-b)). Similarly, if the insured dies, his rights against the insurer also vest in the third party (Third Parties Rights Against Insurers Act of 1930 (1)(2)). The Act further provides that any clause in an insurance contract that contradicts The Act is considered void. (Third Parties Rights Against Insurers Act of 1930 (1)(3)). The Act also provides that, in the event the total liability to the third party is over and above the limits of insurance, the third party can still proceed against the insured for the excess, and the insurer does not have to pay the excess. (Third Parties Rights Against Insurers Act of 1930 (1)(4)). The Act does not apply where the Workers Compensation Act of 1925 applies. (Third Parties Rights Against Insurers Act of 1930 (1)(6)). Basically, the 1930 Act would seem, on its face, to address the situation with the PI Clubs and their pay or be paid clauses. It states that a third-party stands in the shoes of the insured, with respect to the insurer, in cases where the insured is insolvent or dead. Since the pay or be paid clauses specifically contradict this rule, in that, if a shipowner is bankrupt then he is not entitled to claim against the PI, as he himself has not lost any money out of his pocket, it would seem as if the pay or be paid clauses would be deemed void under the 1930 Act. However, this was not the case, as decided by the courts in two cases that were consolidated – the Padre Island and Fanti cases. The courts in Socony Mobil Oil Co. Inc. et al v. West of England Ship Owners Mutual Insurance Association Ltd. ([1987] 2 Lloyds Rep 529) (hereinafter “Padre Island”) and Firma CF-Trade S.A. v. Newcastle Protection and Indemnity Association ([1987] 2 Lloyds Rep 299) (hereinafter “Fanti”) were conjoined in one appeal ([1990] 2 Lloyds Rep 191), and this single appeal made a consideration as to the applicability of the Third Parties (Rights Against Insurers) Act 1930 (hereinafter “1930 Act”) to the facts at hand. These facts were as follows. The Fanti case involved an expedition, in which the vessel Fanti started to drown and was rescued by a pick up tug. Later the vessel and the tug were cast off to the salvors. Since no amount was paid to the salvors by the holders of the vessel, the salvors filed a petition for a closing order against the holders and also against the P and I club as per the 1930 Act. The insurers denied paying the amount. In the Padre case, the vessel Padre Island was entered into the West of England Shipowners Mutual Insurance Association club, which had a pay to be paid clause. The claimant had several claims against the ship owner, claims that he pursued in Florida and won a judgment totalling US $238,315. (Finnern, 2007, p. 24). The ship owners did not pay a dime of this judgment. The shipowners were then ordered to wind up, due to the fact that they did not pay this judgment. The claimant then attempted to claim against the P and I Club as per the 1930 Act. For a second time the insurers declined to pay. In the lower court, the claimants prevailed in the Fanti case. This was because, in the Fanti case, the court decided that, if the third party acceded to the insurers rights that there can be no condition precedent that the PI will not pay unless the insured pays the claims because of the absurdity that would result in that the third party would effectively be required to pay himself in order for this condition precedent to take effect. Because this is futile, the claimant appeal was allowed. ([1987] 2 Lloyds Rep 299 at 306). However, in the Padre Island case, the PI prevailed. Therefore, the PI Club appealed the Fanti case, while the cargo owners appealed the Padre Island case. The court of appeals consolidated the two causes of action, ([1989] 1 Lloyds Rep 239), and decided that there was no transfer of rights from the insured to the third party, because the insureds rights were not fully vested, as the insured did not pay. According to the court of appeals reasoning, the rights of the insured against the PI do not vest until the insured actually makes a payment. Before he makes a payment, the rights are contingent. Because the rights are not vested until the insured makes a payment, only contingent, the insured has no rights to transfer to the third party under The 1930 Act. ([1989] 1 Lloyds Rep 239, 241). The court therefore found that the 1930 Act was not appropriate “to avoid the stipulations of the respective insurance contracts by virtue of the winding-up of the shipowner. Nor was a Pay to be Paid rule itself able to modify members actual right. It was rather the members ability to enjoy their rights and not the rights themselves.” (Finnern, 2007, p. 26). On this basis, the cargo-owners appeal was allowed, and the PI Clubs appeal was dismissed. The PI Clubs on both cases then brought their appeals further to the House of Lords ([1990] 2 Lloyds Rep 191). This court decided that the cases turn on three different issues. The first is what rights did the insureds have before they became insolvent as against the PIs, with respect to the paying the liabilities incurred to third parties. The second is whether the pay to be paid clauses purported to avoid contractual terms or alter the rights of the parties under the contract, thus becoming void under the terms of the 1930 Act. The third question is, after considering the answers to questions one and two, what rights were transferred to the third parties as to the rights against the Clubs. ([1990] 2 Lloyds Rep 191, at 196). As to the first question, the court approached it with equitable principles. This was necessary, because, under legal principles, it is pretty cut and dry – the insured must pay the third party before seeking indemnity. The legal principles thus could only yield one result. Under equitable principles, the third party may proceed directly against the insurer. (Finnern, 2007, p. 26). By using equitable principles, the court was able to analyze the situation according to what result would be equitable, as opposed to legal. In other words, what would be fair? By using equitable principles, the court decided the first question by stating that the insured is only entitled to be paid by his Club when the “existence and the amount of the liabilities had been established.” ([1990] 2 Lloyds Rep 191, 197). In other words, the court decided, as the earlier court of appeals had decided, that the insureds rights against the PI were only contingent until he performed the condition precedent of paying the third party. As to the second question, the court had to decide if the pay to be paid clauses were avoiding the contractual terms or were altering the rights of the parties to the contracts. The court decided that, just because the PI is able to discharge its liability when a member is insolvent is not enough to alter the members contractual rights with the PI, therefore the pay to be paid rule “did not purport, either directly or indirectly, to avoid those contracts, or to alter the rights of the parties under them, upon the members being ordered to be wound up, so as to render those provisions to that extent of no effect under s. 1(3) of the 1930 Act.” ([1990] 2 Lloyds Rep 191, 198). In other words, there was no alteration of contractual obligations or rights, therefore the pay to be paid provision was deemed to not be voided by the 1930 Act. The third issue that had to be decided was what rights were transferred to the injured party under the 1930 Act. Remember, the 1930 Act states that an injured party effectively stands in the shoes of an insured who is insolvent or deceased. The court decided that the injured party was not entitled to more rights than the insured was prior to winding up. Therefore, any defence that the PI Club had against the insured, it also had against the aggrieved third party. ([1990] 2 Lloyds Rep 191 at 198). This enabled the PI Clubs to defend the claims from the third parties in the same manner that they were able to do with the insured. The court also stated that the 1930 Acts intentions was not to place a third party in a better position than the insured, and, if the pay to be paid clause was invalidated as to the third party, the third party would effectively have more rights than the insured. ([1990] 2 Lloyds Rep 191, at 193). Therefore, the PI Clubs prevailed. Analysis When one looks at the situation from a strictly legal point of view, the decision by the House of Lords court in regards to these cases make a certain amount of sense. After all, the pay to be paid clauses are bargained-for contractual obligations. The insured or member knows about these clauses before he signs on with a certain Club, and can either still decide to sign on with the Club or not, and seek a Club that does not contain the clause. Therefore, it is assumed that the terms of the pay to be paid clause is a part of the overall contractual bargain – maybe a Club that does not have this provision will charge more to members, and this is because a certain member might be willing to pay a premium to avoid this clause. And vice-versa – Clubs who have the clause may charge less because of the existence of the clause. Therefore, the member bargained for this clause, and this is where the analysis generally ends. However, it becomes more complicated when dealing with third parties. They did not bargain for these clauses, yet these clauses are used against them. This is where the particular injustice lies – by using the 1930 Act as a basis for its decision, the House of Lords court in the Padre and Fanti cases decided that the third partys rights were no better than the insureds rights when it came to contractual terms. This seems to yield an injustice, because, as stated before, the insured bargained for these terms and the third party did not. It seems unfair to hold the third party to contractual terms for which he did not bargain. However, this is what the Padre and Fanti court effectively did. Of course, their reasoning is understandable, in that the 1930 Act stated that the aggrieved third party effectively stands in the shoes of the insured in claims against insurers. However, it seems as if the logic is a bit twisted. The 1930 Act was designed to protect third parties. This is why third parties are able to stand in the shoes of the insureds when the insured is insolvent or dead. If the 1930 Act were not put into place, then third parties might not have any rights against insurers in cases where the insured is insolvent or deceased. Although that does not really make much sense, either, because, in typical insurance cases that are not indemnity-based, the aggrieved third party does have a right to proceed against the insureds insurance policy, and whether the insured is insolvent or dead is irrelevant. Take, for instance, the classic case – two cars get into an accident. The insured is insolvent, or killed in the accident. Does the third party have a right to proceed against the insurance company? Of course he does. So, it seems as if the 1930 Act was created to expressly protect the rights of third parties when there is indemnification, as there is here. Indemnification assumes that the insured will pay the third party then seek reimbursement from the insurer, as with the pay to be paid clauses. Only in these cases, where the insured is expected to pay up front, would the issue of insolvency even be relevant. Therefore, the 1930 Act would seem to explicitly cover situations such as those presented to the Padre and Fanti cases. It makes no sense to assume otherwise. Further, as one of the lower courts pointed out, requiring the conditions precedent of paying before being paid is absurd when applied to third parties. By requiring this condition precedent to transfer to the aggrieved party is effectively requiring the aggrieved party to pay himself before he can be reimbursed. As this is an impossibility, this condition precedent can never be satisfied. Therefore, the PI clauses will prevent all aggrieved third parties from prevailing because the courts effectively imposed a duty upon them that is impossible to perform. It seems that the courts reasoning in the Padre and Fanti cases was lacking and reaching for an absurd result. First, it assumed that the 1930 Act did not give greater rights to aggrieved third parties than that of the insured. However, this cannot be so – the 1930 Act appears to be written explicitly for indemnification situations, and indemnification situations require, by their very nature, that a payment is made before reimbursement. Therefore, it would seem that the 1930 Act would have, logically, intended that the the aggrieved third parties would have more rights than the insured. After all, the third parties cannot pay themselves, therefore this condition precedent would have to be voided for the result to be equitable and effectuate the 1930 Acts intentions. This would necessitate that the third parties rights would be greater than the insureds rights. This would be a better reading of the 1930 Act than what the court actually determined was the purpose of the 1930 Act. Conclusion Pay to be paid clauses are widespread in the English shipping industry. The limit the liability of these Clubs, and are a bargained-for exchange, therefore would be effectuated, without question, in a typical case. However, when the shipowner is insolvent and cannot pay the claims of the third party, it becomes less cut-and-dry and much more complicated. On the one hand, the Clubs claim, and courts seem to agree, that the aggrieved third party cannot accede to more rights than those afforded the insured. On the other hand, this creates an impossibility for the aggrieved third party. He cannot pay himself, therefore he cannot accomplish the condition precedent for being paid by the Club. It is unfair to hold the third party to a standard that he cannot perform, just because the insured was held to this standard. The insured is able to perform the condition precedent, therefore, holding him to this clause makes perfect sense. Holding the third party to the same clause makes no sense. Moreover, the 1930 Act would seem to be written specifically in situations where there is a pay to be paid clause, otherwise the insolvency or death of the insured would be of no consequence and irrelevant. Therefore, it would seem that the courts in Padre and Fanti subverted the very intention of the 1930 Act when it stated, in effect, that the 1930 Act would still require that a third party must perform conditions precedent that are impossible for him to perform. It would seem that the 1930 Act has taken into consideration that in indemnification cases the aggrieved third party cannot completely step into the insureds shoes because of this impossibility and The 1930 Act was written with this mind. That the courts in Padre and Fanti virtually ignored The 1930 Acts intentions and ascribed an absurd result to The 1930 Act seems preposterous and a violation of equitable principles. Sources Used Finnern, C. (2007), “The Pay to be Paid Rule,” available at: http://web.uct.ac.za/depts/ shiplaw/theses/c-finnern.pdf Firma CF-Trade S.A. v. Newcastle Protection and Indemnity Association, [1987] 2 Lloyds Rep 299. Firma CF-Trade S.A. v. Newcastle Protection and Indemnity Association and Socony Mobil Oil Co. Inc. et al v. West of England Ship Owners Mutual Insurance Association Ltd. [1989] 1 Lloyds Rep 239. Firma CF-Trade S.A. v. Newcastle Protection and Indemnity Association and Socony Mobil Oil Co. Inc. et al v. West of England Ship Owners Mutual Insurance Association Ltd. [1990] 2 Lloyds Rep 191. Hawkins, T. “Pay to be Paid Wording in Marine Insurance Policies,” available at: http://www.bernardpartners.com/images2005/pdfs/PaytobePaid.pdf Socony Mobil Oil Co. Inc. et al v. West of England Ship Owners Mutual Insurance Association Ltd., [1987] 2 Lloyds Rep 529. Third Parties Rights Against Insurers Act of 1930. Read More