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SUBROGATION PRINCIPLES AND PRACTICE PAUL HANDY – CRAWFORD & CO BRENDAN MCCARTHY – BEACHCROFT LLP Introduction
We have split this paper into 5 sections: 1. Basic Principles
2. Causes of Action and Obtaining Information 3. Limitations and Defences
4. Distribution of Recovered Monies 5. Negotiating Sharing Agreements Basic Principles
What is subrogation?
Subrogation is the right of insurers, once they have paid the insurance money due, to exercise any rights or remedies of the insured arising out of the insured event to recover their outlay from a culpable third party.
That right is almost invariably enshrined expressly in the wording of the insurance policy but, even if not written in to the policy, applies in any event.
There are two key underlying principles to bear in mind when dealing with subrogation.
The first is that subrogation is a doctrine founded on the indemnity principle, namely that an insured has a right to be indemnified against his loss but cannot make a profit from it by getting paid his insurance money as well as obtaining compensation from a third party.
By way of example therefore and as illustrated by one of the leading subrogation cases, Castellain v Preston  11 QBD 380, if an insured vendor of a property suffers fire damage between exchange and completion and is indemnified by his insurers, the insured must then account back to insurers when the sale of the house is completed and he receives the full purchase price to which he was entitled in spite of the fire.
There are qualifications to this principle. For example, a gift from a third party, intended as extra compensation, will not be taken into consideration when accounting to insurers. Also, an insured can retain any surplus sum received from a third party once it has accounted to insurers. In Yorkshire Insurance Co. Ltd v Nisbet Shipping Co. Ltd  2 QB 330, insurers had paid the insured for the total loss of his ship in a collision. The insured then sued the owner of the other ship responsible for the collision. The damages were recovered in Canadian dollars but by the time the damages had been paid, the pound sterling had been devalued and as a result, the damages, when converted back to sterling, exceeded the insurance money paid. The High Court held that, once the insured reimbursed insurers in full, it was entitled to retain any surplus. Therefore windfalls belong to the insured.
Secondly, insurers cannot pursue a claim in the name of their insured until the insured has been fully indemnified, unless agreed otherwise.
The majority of policies will include an express condition permitting insurers to commence a subrogated claim in the insured's name even if negotiations over the extent of the entitlement to an indemnity have not been concluded. If not, such terms may need to be specifically agreed if urgent action needs to be taken in pursuing the recovery.
Insurers must, of course, agree to indemnify the insured in respect of costs associated with bringing a subrogated claim.
It is also likely that the policy will include an express term giving insurers the right to control any legal proceedings brought against a third party.
In the absence of a specific term or agreement to that effect, if the insured has suffered a loss over and above the amount for which they have been indemnified, the insured is entitled to control the proceedings and can settle the claim without reference to the insurer. However, the insured must still act in good faith, which means including both insured and uninsured losses and not compromising any claim insurers may have when negotiating a settlement. Should the insurer's claim be prejudiced, the insurer would be able to seek reimbursement from the insured.
It is important to remember that, following a loss, there can only be one claim made in the name of the insured, only 'one bite at the cherry', so it is important to ensure that all insured and uninsured losses are included.
It is a settled rule of law that only one claim for damages can be made arising from one cause of action (a “cause of action” being defined as the set of facts or circumstances that give rise to a claim in
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law). The reasons for this are based in public policy. There is a public interest in avoiding any possibility of two courts reaching inconsistent decisions on the same facts and issues, in there being finality in litigation and in protecting citizens from being “vexed” more than once by what is really the same claim.
The significance of this rule is that a second claim arising out of the same cause of action will be regarded as an abuse of process and will be struck out.
Hence the importance of making sure that both insured and uninsured losses are included in the claim. If a claim for either proceeds in isolation and results in a settlement or a judgment, a separate subsequent claim for the other will be prejudiced.
The Courts in cases such as Buckland v Palmer  1 WLR 1109 andHayler v Chapman  1 Lloyds Rep 490 (where, unbeknownst to insurers, the policyholders had sued for their uninsured losses) have refused later attempts by insurers to set aside the judgment or overturn the settlement so that they could bring a subrogated claim for the insured losses.
That said, and provided of course the Defendant is willing to agree, there is nothing to prevent settlement of the insured element of any claim, but care must be taken in drafting the settlement agreement so as to ensure that the uninsured loss claim is preserved and there can be no argument that it is in full and final settlement of all causes of action by the insured against the third party.
Causes of Action and Obtaining Information
When considering whether there may be a recovery against a third party, it is necessary to consider all possible causes of action. These may include:
Breach of contract Negligence Nuisance
Defective Premises Act 1972 Rylands v Fletcher
Consumer Protection Act 1987
Water Resources Act 1991 and related legislation This is not an exhaustive list.
consideration. What is crucial is establishing as a matter of fact what terms apply as well as any relevant limitations and exclusions and whether they are valid under the Unfair Contract Terms Act 1977.
Where, as will be very likely, the contract involves the sale of goods and/or the supply of services, some very important terms are implied into the contract by statute law. Of particular importance where the contract involves the supply of goods is the term implied by section 14 of The Sale of Goods Act 1979 to the effect that the goods must be “of satisfactory quality and fit for their purpose”.
So far as the supply of services is concerned, a term is implied by section 13 of The Supply of Goods and Services Act 1982 to the effect that the services must be carried out “with reasonable care and skill”.
For negligence, there needs to be a duty of care owed, which has been breached, the breach of which has caused the damage and the damage can be demonstrated as not being too remote.
Nuisance is the wrong done to a person by unlawfully disturbing them in the enjoyment of their property. This cause of action needs to be borne in mind, for example, in cases where there is damage by tree roots.
The Defective Premises Act 1972 imposes duties on builders and others who do work on dwellings to ensure that work is done in a professional manner with proper materials so that the dwelling will be fit for habitation.
There are also some helpful causes of action which involve strict liability.
Where the loss occurs in the context of activities that might be regarded as high risk or inherently dangerous, a claim under Rylands v Fletcher  UKHL 1 may be a possibility. The requirements for a claim under Rylands v Fletcher are that a person brings some substance onto his land for his own purposes which is likely to do harm if it escapes. The substance must be accumulated on the land, the use of the land must be ‘non-natural’ and the substance must escape causing actual damage.
Section 1 of the Consumer Protection Act 1987 imposes strict liability on the producers of defective products which cause damage to property intended for private use. Possible defendants include the manufacturer, any importer and, in certain circumstances, suppliers.
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water undertakings and the rivers authorities respectively where there is an escape of water from their pipes or equipment.
As soon as the possible causes of action have been identified, it is vital to gather all relevant evidence as soon as possible. Time is of the essence for a number of reasons. Firstly, the fresher the insured's memory, the more they will be able to remember and the more weight their evidence will carry. Secondly, you do not want any documentation to be lost or destroyed. Thirdly, the reality is that an insured is going to be a lot less helpful once it has received its indemnity, whatever the policy conditions requiring co-operation may say. Fourthly, relevant documentation may highlight limits or restrictions on the rights of the insured to bring a claim against the third party and, if so, it is best to know that at the outset.
In particular, but not exclusively, for contractual claims, all relevant documentation, whether express contracts, purchase orders, invoices, exchanges of correspondence, records of telephone conversations or photographs need to be sought.
As a generalisation, there can be a presumption that a contract is some magical ringbound document with the word "Agreement" written in capitals on the front. Policyholders need to understand that agreements can be made informally and orally and all that information may be vital.
If any more reason is needed to ensure that all electronic documents are sought, a new Electronic Disclosure Practice Direction (Practice Direction 31B) comes into force on 1 October. According to Kroll Ontrack (Summer 2008), 93% of information is now held in a digital format and 70% of that data is never printed. In any scenario therefore, there may be crucial documents that have only existed in electronic format and will not come to light if electronic searches are not conducted. In order to assist with gathering all relevant documents, it may be worth asking an insured the following questions: Who are the relevant people involved in the transaction?
What is the relevant time frame?
In what format is the relevant information likely to be kept? May there be relevant deleted files?
Relevant emails, even deleted ones, text messages and any other data retained in electronic formats should specifically be asked for. The key media are computers, laptops, mobiles, blackberrys and the like. It is a misconception to think that electronic disclosure only applies to big ticket, document heavy claims.
information, whether those documents assist or adversely affect the case.
Quantum information should also be compiled and assembled at this stage. Where quantum may be an issue, it is prudent to notify the third party at an early stage so that their adjuster can be kept informed of the adjustment as it progresses.
Limitations and Defences
As the insurer stands in the shoes of the insured, the most important restriction on the doctrine of subrogation is that insurers can be in no better position than the insured would have been themselves. If the insured is therefore prevented from making a claim, the insurer falls with him.
No Right of Claim
This can arise in many ways.
If the insured's claim is out of time, either by way of a contractual provision or by virtue of the Limitation Act, insurers' right of subrogation is lost as well.
If immunity is granted by the policy itself in the form of a subrogation waiver, then that is the end of that.
If the insured no longer exists and cannot exercise its rights, then insurers cannot do so either. In Smith (Plant Hire) Ltd v Mainwaring  2 Lloyds Rep 244, insurers had issued subrogation proceedings in their insured's name but later found out that the insured had been wound up some time previously. No assignment of rights had been taken prior to the liquidation and accordingly the Defendant was successful in getting the claim struck out as the claimant simply did not exist.
If an insurer seeks to exercise subrogation in the name of an entity that has suffered no loss because it has already been fully indemnified under a contract with a third party, the claim will fail. In HSBC Rail (UK) v Network Rail Infrastructure  1 WLR 643, the claimant was the owner of railway rolling stock which was leased to a train operating company. The rolling stock had been damaged in a train derailment. By virtue of arrangements under the lease, the claimant had been fully indemnified by the train operating company. Insurers later commenced subrogation proceedings in the claimant's name against Network Rail who were responsible for the upkeep of the rail infrastructure. The claim was dismissed as the claimant had, in the eyes of the law, suffered no loss as it had already been fully indemnified by a third party under contract.
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Another example, as we have seen above, is where there has already been a claim made in the insured's name arising out of the incident which has been prosecuted to judgment or settlement. Any subsequent attempt by or on behalf of insurers to launch a subrogated claim will be struck out as an abuse of process.
Persons against whom subrogation is unavailable The Insured
An insured has no right of action against himself and nor do his insurers. In Simpson v Thompson  3 App Cas 279 two ships in the ownership of the same insured collided. Having indemnified the owner in respect of one ship, insurers attempted to subrogate against him by virtue of his ownership of the other vessel but the House of Lords dismissed the claim as an insured has no right of action against himself.
Persons for whose benefit insurance has been procured
One specific area of importance which is well known is where, under a contractual arrangement, the insured may have agreed that the insurance should enure to a third party's benefit. This is a frequent issue in relation to leases, as seen in Mark Rowlands Ltd v Berni Inns Ltd  1 QB 211. In that case, a landlord leased a building to a tenant and the property was subsequently damaged by fire through the tenant's negligence. The property was insured by the landlord and once indemnified, the issue was whether a subrogated action could be brought against the tenant. The answer was no. The Court of Appeal took the view that the contractual arrangements between landlord and tenant as encapsulated in the lease were such that the landlord had taken out buildings insurance for the benefit of himself and his tenant and that in the event of fire the landlord and tenant had intended to look to the buildings insurers to cover the loss.
The following factors were relevant, namely that:
The landlord was required to insure the premises against fire.
The tenant was required to pay part of the cost of the insurance (called an "insurance rent") taken out by the landlord.
The tenant was required to keep the property in good repair, but that obligation did not extend to repairing fire damage.
In the event of a fire the landlord was required to use the insurance proceeds to repair the property.
Where more than one party is insured under a composite policy (typically, contractor and sub-contractor, landlord and tenant, bailor and bailee, etc) and a loss is caused through the negligence of one party, the question arises whether subrogation rights can be exercised against that co-assured. The answer in most cases is no.
Many contracts contain risk allocation and insurance clauses and these often require one party to take out joint names insurance.
The question which invariably arises following a loss is whether the obligation on one of the parties to take out joint names insurance operates to exclude the liability of the other party and instead require that party to look only to the insurers for any loss.
The answer to that question is found by construing the true meaning and effect of the contract.
The first question to ask is whether there is an intention that the joint names insurance is designed to render the party against whom proceedings have been commenced a co-assured.
In Tyco Fire Solutions v Rolls-Royce Motor Cars Ltd  EWCA Civ.286 there was a co-insurance clause in a construction contract which required the employer to maintain in the joint names of himself, “the Construction Manager and others, including but not limited to, contractors, insurance of existing structures… against… Specified Perils”. Construing the contract as a whole, the Court held that the clause was not one under which the employer was required to make the contractor a co-assured but was simply a promise by the employer that there would be cover in place in respect of existing structures. The clause did not therefore render the contractor a co-assured and therefore he was not immune from subrogation in respect of the cause of the loss.
If the effect of the joint names clause is to render the party in question a co-assured, the question then is whether, properly construed, the co-insurance clause operates to discharge that party from a liability they would otherwise have faced.
In Co-operative Retail Services v Taylor Young Partnership Ltd  48 BLR 108, the Co-op engaged a contractor to construct new office premises for them and the contract required the contractor to take out a joint names policy covering the employer, the main contractor and the sub-contractor against damage by fire to the contact works. The contract also contained an indemnity by the main contractor to the Co-op in respect of damage caused to their property by negligence but that
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indemnity specifically absolved the main contractor from responsibility for damage to the contract works caused by insured risks prior to practical completion. On a proper construction of the contractual arrangements, the House of Lords was satisfied that the effect was to exclude all liability to the Co-op for fire damage and that any such damage was to be made good by the insurance.
The Co-operative Retail decision was followed by the Court of Appeal in Scottish & Newcastle plc v G D Construction (St Albans) Ltd  Lloyds Rep I.R. 821.
However subrogation is excluded only where the co-assured has an insurable interest in the damaged subject matter. In National Oilwell (UK) Ltd v Davy Offshore Ltd  2 Lloyds Rep 582, certain works under construction were insured by the contractor and sub-contractors under a joint names policy. All of the parties had an insurable interest in the entire works so that each could have potentially insured the entire works. The contract between the contractor and the relevant sub-contractor obliged the sub-contractor to insure only in respect of losses occurring before goods had been delivered to the contractor by the sub-contactor. The losses which actually occurred were post-delivery losses. As such, the High Court held that the sub-contractor was a co-assured only in respect of pre-delivery losses and accordingly was found not to be immune from subrogation in respect of post-delivery losses.
Distribution of Recovered Monies
Where a subrogation recovery is successful, the general principles of how to deal with the distribution of recovered monies between an insurer and their insured are set out in the House of Lords decision in Napier and Ettrick (Lord) v R F Kershaw Ltd and Others  1 All ER 385.
The following hypothetical example was used in that case to explain the general principle: Insured's loss - £160,000
Settlement monies - £130,000 Policy outlay - £100,000
Policy excess - £25,000
It was held that the insured was entitled to be fully indemnified for his loss of £160,000 although the recovery of the excess should come last in the chain of priorities. This is commonly summarised as "pay up and recover down" and is best illustrated by the following diagram.
Accordingly from the settlement monies of £130,000, the first payment is £35,000 to the insured (their uninsured loss claim other than the excess) with the balance of £95,000 going to the insurer, towards the £100k they had paid the insured. If the recovery had been anything over £135k, that extra would have gone to the insured, towards their excess.
However the rules are different where there is underinsurance and the policy is subject to average. In those circumstances, the insurer and insured are deemed to be co-insurers of the loss which means that any subrogated recovery proceeds are apportioned between them on a pro-rata basis.
The position is different again where the policy is a valued policy.
If a policyholder under a valued policy (which is not subject to average) is insured to the full agreed value of the subject matter (say, £80,000) but the agreed value is less than its actual value (of, say, £100,000) and the recovery from the third party is only £70,000, it appears that the entire £70,000 would be payable first to the insurers and the policyholder would recover nothing.
The reason is that, by virtue of see 27(3) of the Marine Insurance Act 1906, the valuation agreed between the insurer and the insured is conclusive. Accordingly the insured is fully indemnified under a valued policy when he receives payment of the agreed value. Therefore the principle underpinning Napier and Ettrick(i.e. that the insured must receive a full indemnity before the insurer has any rights over the proceeds) does not apply to valued policies.
Negotiating Sharing Agreements
In the interest of avoiding disputes and misunderstandings and to facilitate the efficient conduct of a recovery action, it is advisable to agree a sharing arrangement between insurers and insured at an
£35k uninsured loss
£100k policy outlay
Recover down Pay up
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At the heart of such sharing agreement would be an agreed formula for distribution of monies recovered so as to avoid any disagreements at the conclusion of the claim.
The conventional and, in most cases, the most equitable approach is to agree a pro-rata split of any monies recovered.
However, a particular difficulty that can arise with the pro-rata approach is where the uninsured losses are excessive/unsubstantiated. We have all encountered cases where insureds have been insistent on including, for example, very substantial claims for management time.
Therefore, it is advisable to include in the sharing agreement a mechanism for resolving any disputes as to the recoverability of heads of loss as well as a dispute resolution mechanism to resolve swiftly any differences of opinion as to whether a settlement offer should be accepted or not.
Other important matters to include in a sharing agreement are how the costs of the action are to be shared as well as co-operation clauses and agreed channels of communication.
Experience shows that sharing agreements make recovery actions much simpler and easier to conduct, avoid disputes and encourage greater 'buy-in' by the insured in the overall recovery effort. Conclusion
In summary therefore, and finishing off where we started, when considering a subrogated recovery it is worth bearing in mind the following checklist:
1. Has the insured been fully indemnified so that the right of subrogation is triggered. If not, a special agreement may need to be drawn up, expressly granting subrogation rights.
2. What evidence is available, both in hard copy and electronically. 3. What causes of action may apply?
4. What limitations are there to any recovery? This will include consideration of contractual terms between the parties and in the insurance policy. Be aware of notification/litigation time limits as well.
5. What are the heads of claim? This must include insured and uninsured losses.
6. How will any recovery be shared? This requires agreement both in terms of the recovery monies and own and other party costs.
This paper is published on a general basis for information only and no liability is accepted for errors of fact or opinion it may contain. Professional advice should always be obtained before applying the information to particular circumstances.