By Danny Joffe
It has become common in primary insurance policies for Insurers to insert what we call “pay as paid” clauses. This often occurs where the Insurer is concerned about the credit risk of the reinsurer being used or where the policy holder insists on a specific reinsurer being used by the Insurer to reinsurer the risk and who may not be on the Insurer’s panel. Another example is where the reinsurer is fronting the risk highly and the underlying insurer would not want to have high reserves on their books when large claims come in. The clause in essence states that the Insurer would only be liable to pay the claim if the reinsurer agreed and paid the insurer first. Its not a simple legal issue and for an Insurer to rely on a court allowing this clause is a risk with very high stakes.
In July of this year, the English High Court gave a judgment as to whether or not the insurers under a charterer’s liability policy were obliged to settle third party claims, even though their Insured could no longer force the claim because they had gone insolvent, and their policy demanded they pay the liability claim first before insurers would reimburse them. Insurers often simply advise third parties to sue the Insured directly with very little risk knowing that a third party cannot do that and it gets them as insurers out of the third party claim. The court actually found that insurers were not obliged to pay any third party claim because there was a apay as paid clause in the liability policy and gave a view on the interpretation of policies and justified the way it wished to explain the policy’s intention with the provisions of the Third Party’s (Rights against Insurers) Act of 2010 (the 2010 Act) which deals with the effect of “paid to be paid” clauses. The Act was passed to make provision about the rights of third parties against insurers of liabilities to third parties in the case where the insured is insolvent, and in certain other cases.
The case involved the following details: King Trader had time chartered its vessel the mv Solomon Trader to the insured which took out a charterer’s liability policy from the insurers covering various charterer’s liabilities to a limit for US$50 million. In February 2019, the vessel grounded on one of the Solomon Islands. In March 2021 the insured went insolvent and was placed into liquidation. The insurers commenced the English High Court proceedings in October 2022 seeking a declaration that they were not liable to pay the claim to the third parties and the Insurer got off scott free effectively from such liability claims which would not have been the case had their Insured not gone insolvent and had been able to pay the claims first. In March 2023 and January 2024, the arbitration tribunal made awards against the insured for US$47 million but the Insured was unable to make these payments. A key part of the liability policy was that the Insured would have to pay first and then recover its liability from Insurers. Pay as paid.
It was accepted that the claimants were entitled under section 9 of the 2010 Act to pursue the claims for indemnification arising out of the Arbitration awards directly against insurers. Under South African law that right of direct recourse against a liability or other insurer only arises if the insured is insolvent in terms of the Insolvency Act but would not exist otherwise.
Given the amount involved and the effect of this decision, it is likely to be taken on appeal. Pending the outcome of an appeal or a statutory intervention, parties to liability policies and third party claimants who rely on those policies for financial comfort will have no comfort if the underlying policy states that the Insured must pay first before the Insurer has a duty to pay which makes it impossible often for Insureds to comply with if the amount is high enough to put the Insured into liquidation. The case is going on appeal but it seems the courts do give effect to the provisions of policies if agreed as part of the policy, almost no matter how unfair it may be. It is for this reason I would submit a pay as paid clause concerning reinsurers in the underlying policy would be upheld specifically where there is UK jurisdiction. There has not been any discernible case law though regarding pay as paid clauses.
The reinsurance pay as paid clause as discussed is of a similar nature. It goes tot heart of the agreement, with the contracted insurer delegating their right to a third party who is not a party to the contract but courts in the UK appear to give effect to the meaning of the contract unless statute says otherwise. This should not be seen or construed as legal advice but just looking at the issues that would be at play if this were to go to court.