Court of Appeal upholds Pay-to-be-Paid clauses in marine insurance

This case review was co-authored by Mallory Pradel-Weisz, Litigation Assistant.

In this recent decision, the Court of Appeal considered the application of a Pay-to-be-Paid clause in a marine insurance policy, including questions around incorporation, interpretation and the onerous or unusual nature of such clauses.

Background 

This dispute concerned a Charterer’s liability Policy issued by MS Amlin Syndicate AML/2001 (the Insurers) to Bintan Mining Corporation (the Charterers). The Policy consisted of two documents: A Policy Booklet, which contained the detailed provisions of the Policy; and the Certificate, which contained the details of the subject matter insured. 

The Certificate incorporated the terms of the Booklet.  It also included an “hierarchy clause” which provided that, in the event of a conflict, the terms of the Certificate would prevail.  The Policy provided cover for the insured for liability arising out of final unappealable judgments (the insuring clause). The Policy Booklet also contained a Pay-to-be-Paid Clause. Paid-to-be-Paid Clauses are reasonably common in P&I Rules and related marine insurance contracts and they require the insured (or member) to pay any liability before it is entitled to be indemnified.

In May 2017, the Charterers time-chartered the Solomon Trader from King Trading Ltd (the Owners), who were members of the Korea Shipowners’ Mutual Protection & Indemnity Association (the P&I Club). In February 2019, the Solomon Trader grounded in the Solomon Islands. 

The initial proceedings

The Owners and P&I Club started LMAA arbitration proceedings in Hong Kong against the Charterers and obtained an award in March 2023 in the region of USD 47 million including interest. However, the Charterers commenced insolvency proceedings before the award could be enforced. 

The Owners and the P&I Club presented their claim against the Insurers under the Third Parties (Rights against Insurers) Act 2010 which gives a claimant a direct right of action against liability insurers in the event of the defendant’s insolvency.  However, the Insurers rejected that claim, relying on the Pay-to-be-Paid Clause in the Policy given that the Charterers had become insolvent before paying their liability under the award.

The Insurers issued proceedings in the High Court seeking a declaration that they had no liability under the terms of the Policy.

At first instance, the  judge found for the Insurers.  The Owners and the P&I Club appealed.

The appeal decision

The P&I Club and Owners’ appeal revolved around three grounds.

1. The Pay-to-be-Paid Clause within the Policy Booklet was inconsistent with the insuring clause in the Certificate. Consequently, the hierarchy clause meant that the Certificate’s wider terms should prevail over the limiting Pay-to-be-Paid Clause.
2. The Pay-to-be-Paid Clause was an onerous or unusual clause that was not brought fairly and reasonably to the Charterer’s attention and should therefore be set aside under the onerous clause doctrine.
3. The Pay-to-be-Paid Clause was not properly incorporated.

The Court of Appeal ruled unanimously on all three grounds of appeal.

Regarding the first ground, the Court of Appeal confirmed a long line of case law and explained that the court was required to see whether the two clauses can be read together fairly and sensibly so as to give effect to both. In this case, the Pay-to-be-Paid Clause was found not to negate the Insuring clause but, instead, qualifies it (albeit very significantly). The Court of Appeal highlighted that “there is a distinction between a printed term which qualifies or supplements a specially agreed term and one which transforms or negates it.” 

The Court of Appeal considered whether Pay-to-be-Paid Clauses had the effect of depriving contracts of marine insurance of their main purposes and found that they did not. In doing so, the Court considered the fact that the Third Parties (Rights against Insurers) Act 2010 specifically carved out their use in marine insurance policies from the general exclusion under the Act so Parliament clearly approved of their use in marine insurance policies! Moreover, Pay-to-be-Paid Clauses are only relevant  when an Insured becomes insolvent, as was now the case, so the Clauses do not jeopardize the business efficacy of marine insurance policies.

On the second ground, the Court of Appeal held that the Pay-to-be-Paid Clauses were not onerous or unusual in marine insurance.  They are commonly used in this context and this is recognised in the Third Parties (Rights against Insurers) Act 2010.  Moreover, these Clauses have been considered in earlier judgments so they are well recognised and discussed in that industry.

Additionally, the Court of Appeal rejected the argument that the Pay-to-be-Paid Clause had not been properly brought to the Charterer’s attention.  The Charterer was a commercial entity which had been represented by a professional marine insurance broker.  Moreover,  the Court of Appeal considered that, in the context of a marine insurance policy a Pay-to-be-Paid Clause  “cannot fairly be described as a bolt from the blue” even where that Clause appeared in a separate document - provided the relevant wording had been properly referred to within the Certificate.

The Court of Appeal dismissed the third ground on lack of incorporation due to inconsistent arguments made by the Owners and P&I club and obvious evidence of incorporation of the terms of the Policy Booklet within the Certificate.

The appeal was dismissed on all three grounds and the Insurers were entitled to rely on the Pay-to-be-Paid Clause to avoid liability.

Comment

The judgment recognises the common use of Pay-to-be-Paid Clauses in marine insurance.  It also confirms the position (which is longstanding) that the use of these Clauses will be upheld by the courts provided that they have been properly incorporated within the relevant insurance policy. 

Whilst the case contains a useful review of the importance of drawing attention to any unduly onerous terms (often referred to as the “red hand test”) the Court of Appeal did not consider the Pay-to-be-Paid Clause to be unduly onerous or to need any such attention.