Policyholders of insolvent insurer lose in FSCS appeal

Overview

While expressing great sympathy for the policyholders an insolvent insurer, the England and Wales Court of Appeal has nonetheless reinstated a Financial Services Compensation Scheme decision declining to compensate the policyholders for post-judgment interest and litigation costs on a judgment rendered against an insurer that has since entered administration.

Background

The Policyholders owned long leases in a development known as New Lawrence House in Hulme, Manchester (the "Development"). On purchasing the leases the Policyholders were each issued with an insurance policy by Zurich Insurance plc ("Zurich") which was intended to cover structural defects (the "Policies"). The Development suffered from serious defects which led to the Policyholders making substantial claims under the Policies. Zurich declined the claims.

Proceedings were issued against Zurich in March 2015. During the proceedings, in March 2018, there was an insurance business transfer scheme in Ireland under which Zurich's liabilities were transferred to another entity, East West Insurance Company Ltd ("EWIC"). The litigation culminated in a Court of Appeal decision in favour of the Policyholders resulting in a consent order in favour of the Policyholders for £9,728,420.63 (exclusive of VAT) and a costs award of 92.5% of the Policyholders' costs.

EWIC paid the £9,728,420.63 but then itself went into administration without paying the VAT, statutory interest on the judgment debt or (apart from a sum paid on account) costs. The Policyholders sought compensation from the FSCS, which agreed that the VAT element was covered by the PPR but declined to pay compensation for EWIC's other defaults. The FSCS's final decision was made in a letter dated 6 May 2021 (the "Decision"). The basis for the Decision was that the claims for interest and costs were not claims "under" the Policies but were claims pursuant to statute (s.17 of the Judgments Act 1838) and a court order respectively. The Decision quantified the interest at £784,331.88. The unpaid costs were estimated to be approximately £3,283,000. The Policyholders were granted permission for judicial review and succeeded before the judge, who quashed the Decision. The FSCS appealed.

The Court’s Decision

The appeal focused on the proper construction of the concept of a “protected claim” in rule 9.1 of the PPR, the term "in respect of" in rule 3.1(2) of the PPR and the definition of "claim" in rule 1.2 of the PPR. Specifically, the appeal considered whether:

• the costs and interest were owed "under" a contract of insurance, such that they fell within the definition of "claim" under rule 1.2;

• the claim for costs and interest fell within the concept of “protected claim” under rule 9.1; and

• the claim for costs and interest fell within rule 3.1(2) because it was "in respect of" a protected claim, even if it is was not itself a protected claim.

Lady Justice Falk writing for the Court of Appeal ruled in favour of FSCS on all three points, finding that:

• the judge was right to conclude that the costs and interest were not owed "under" a contract of insurance – they were amounts due pursuant to a court order and pursuant to statute;

• as the costs and interest were not owed "under" the policies, those amounts could not fall within the definition of "protected claim"; and

• when used in rule 3.1(2), the words "in respect of" mean "for" or "for the payment of", and not "integral to, part and parcel of or sufficiently connected to" as found by the judge.

While rejecting the Policyholders’ arguments, Lady Justice Falk nonetheless emphasised the great sympathy she felt for the position they had been put in:

“I have a great deal of sympathy for the Policyholders, who have been placed in a very difficult position. They have been involved in very lengthy litigation including three trips to the Court of Appeal. Their rights under the Policies were finally vindicated in a judgment where Coulson LJ deprecated the approach of the insurers … only for EWIC to become insolvent and for the FSCS not to cover the sums left outstanding, much of which represented expenditure which the Policyholders had to incur to establish that the insurers were in the wrong. In the meantime the Development remains unusable.”

Later in her concluding remarks, Lady Justice Falk remarked that, had the timing of events worked out differently, any dispute might have been litigated against the FSCS rather than EWIC:

“As I have already said, I have a great deal of sympathy for the Policyholders, who have been placed in a very difficult position. It is additionally unfortunate that their predicament appears to have been worsened by the timing of Zurich's insurance business transfer to EWIC and the latter's insolvency. If the insurance claim had not been litigated before the insolvency occurred then the FSCS may well have been involved at an earlier stage and itself determined the amount due under the Policies for the purposes of calculating compensation. Any dispute might then have been litigated against the FSCS rather than EWIC, and if the Policyholders succeeded they might have been awarded costs against the FSCS for wrongly declining compensation and the FSCS might have paid interest for any delay under rule 18.6.”

Nevertheless, the Court allowed the appeal and reinstated the FSCS’s Decision.

Judges: Lord Justice Popplewell, Lady Justice Andrews and Lady Justice Falk

Counsel: Richard Handyside KC, James Cutress KC and Laurentia de Bruyn of Fountain Court Chambers (instructed by Dentons UK and Middle East LLP) for the Appellant, the Financial Services Compensation Scheme

James Drake KC and Douglas Grant of 7 King’s Bench Walk (instructed by Walker Morris LLP) for the Respondents, the Policyholders