Case No: 0008467
BAILII Citation Number: [2002] EWHC 9007 (Costs)
IN THE HIGH COURT OF JUSTICE
SUPREME COURTS COST OFFICE
Supreme Courts Cost Office
Clifford Inn
Fetter Lane
London
EC4A 1DQ
Date: 18 September 2002
Before :
Master Campbell, Costs Judge
 
Between :
 	Alan Robert Miskin 
Jennifer Miskin 	Claimant/s
Appellants 	
 	- and - 	 	
 	St John Vaughan 	Defendant/
Respondent 	

Mr Morgan (instructed by Field Fisher Waterhouse) for the Appellants
Mr Lawrence (Kennedys) for the Respondent
Hearing dates : 29 August 2002

Judgment

Master Campbell :
1.	On 29 August 2002 I heard an appeal by the Claimants/Appellants, Mr & Mrs Miskin against the decision of Chief Costs Officer Ryan dated 10 April 2002 given in detailed assessment proceedings whereby the learned Costs Officer ordered the Miskins to pay VAT on the costs claimed against them by the Defendants/Respondents in this action. In their Notice of Appeal the Appellants contended that the Chief Costs Officer was wrong to allow VAT on the costs assessed. The Appellants also raised the indemnity principle by way of an additional ground of appeal, a point which had not been argued before the Chief Costs Officer. It was common ground before me that the appeal was a re-hearing (CPR 47.23(a)) and accordingly no point was taken by the Respondents that because the indemnity issue had not been raised before Mr Ryan it was now too late to do so. At the conclusion of the appeal I reserved judgment. 
2.	The Appellants' liability for costs arose pursuant to a judgment of Mr Stephen Tomlinson QC sitting as a Deputy Judge of the High Court (as Tomlinson J then was) on 13 February 1998, which provided as follows: 
"It is adjudged that the Defendant do pay the Plaintiffs £41,096.24 and their costs of the action up to 6th day of June 1991 and that the Plaintiffs do pay the Defendants costs from the said date. The costs recoverable by the Defendant to be set off against the sum of £41,096.24 and the Defendant do pay the Plaintiffs the balance of the costs, such costs to be taxed if not agreed."
3.	The Defendant was a firm of estate agents against whom the Appellants had intimated that they would make a claim in negligence as long ago as 1986. At that time the Defendant notified its insurance brokers of the claim, who in turn informed their professional indemnity underwriters. When the matter eventually came to trial on 13 February 1998 the Appellants obtained judgment for £41,096.24, but as this sum was less than the value of a payment into court made seven years earlier, the learned Deputy Judge ordered the Appellants to pay the Defendants its costs from the last date upon which the payment in could have been accepted. 
4.	On 25 August 2000 the Defendants served notice of commencement pursuant to the CPR 47.6. In their bill they claimed the sum of £55,016.64 (including VAT) which the Chief Costs Officer reduced on detailed assessment to £33,946.72 plus VAT on vatable items. As I have said, it is against his decision to allow VAT that the Appellants appeal. 
5.	Prior to the hearing of the detailed assessment, both sides had engaged in lengthy correspondence with HM Customs & Excise between December 2000 and December 2001 in the hope and expectation that the UK revenue assurance officer could resolve the issue between the parties as to whether the Defendant could recover VAT (in which case it would not be payable by the Miskins) or whether it could not (in which case the Miskins would be liable to meet the Defendant's VAT liability on the costs assessed). When the issue did not prove capable of a solution in this way the parties restored the matter before the Chief Costs Officer for adjudication. 
6.	During the course of the correspondence with Customs & Excise it came to the notice of the Appellants' solicitors, Messrs Field Fisher Waterhouse, that bills rendered by the Defendants' solicitors during the litigation had been invoiced not to the Defendant but to its insurers. 
7.	At the appeal the Appellants were represented by Mr Jeremy Morgan of Counsel and the Defendant by Mr Michael Lawrence of Kennedys, both of whom had lodged skeleton arguments and various documents including the exchange of correspondence with Customs & Excise. It was Mr Morgan's case that this correspondence revealed a breach of the indemnity principle, in which case as a matter of law the Appellants would cease to have any liability for payment of the Defendants' costs and any VAT thereon. 
8.	It is convenient to deal first with the indemnity principle. 
9.	The indemnity principle means that a party cannot recover any costs from his opponent if he is under no liability to pay any costs to his own solicitors (see Gundry v Sainsbury [1910] 1 KB 215). It follows that absent any contractual obligation upon the Defendant to pay costs to Kennedys, there are no costs for the Appellants to indemnify, and accordingly the Defendant would be unable to recover anything from them. 
10.	The indemnity principle has been considered in a long line of cases since the decision in Gundry v Sainsbury. In Adams v London Improved Motor Coach Builders [1919] 1 KB 495 the Court of Appeal considered the position which pertained where a successful litigant had been funded by a third party such as an insurance company or trade union. Banks LJ at page 500 said this: 
"It is said here that the plaintiff is not in a position to claim an indemnity, for two reasons, as I understand: one is that the firm who purported to act as his solicitors were not his solicitors at all; all they were were the solicitors for the union, and their only instructions were to act as solicitors for the union. The other is that, assuming the union instructed the solicitors to act as solicitors for the plaintiff, yet it was upon the terms that the solicitors should look solely to the union and not to the plaintiff for payment of their costs. Sankey J [the Judge below] held that neither contention was well founded upon facts. He came to the conclusion that the solicitors were engaged to act as solicitors for the plaintiff by the union and that in so engaging the solicitors, the union were acting as agents of the plaintiff. In my opinion that view is correct. The learned Judge also found that there had been no arrangement either by the union or by the solicitors or by the plaintiff, that the solicitors should not under any circumstances, look to the plaintiff for payment of their costs. With that conclusion upon the facts I also agree."
11.	Then at page 501 Banks LJ said this: 
"When once it is established that the solicitors were acting for the plaintiff with his knowledge and assent, it seems to me that he became liable to the solicitors for costs and that liability would not be excluded merely because the union undertook to pay the costs. It is necessary to go a step further and prove that there was a bargain, either between the union and the solicitors or between the plaintiff and the solicitors, that under no circumstances was the plaintiff to be liable for costs."
12.	In a concurring judgment at page 505 Atkin LJ said this: 
"In these circumstances I think that it is highly probable, though the matter has not been discussed, that the solicitors have a personal right against the trade union to receive a proper remuneration for their services. It has not been discussed, and we do not know the precise terms of the relationship between the trade union and the solicitors, but I assume there exists such an obligation. Nevertheless there is nothing inconsistent in that obligation co-existing with an obligation on the part of the plaintiff to remunerate the solicitors."
13.	In Davies v Taylor (No.2) [1974] AC 225 it was argued in the House of Lords that no costs had been incurred by the successful defendant as he was insured and the insurance company was bound to pay the costs. That argument was rejected. Viscount Dilhorne on page 30 at G said this: 
"In this case the solicitors, no doubt first instructed by the insurance company, were the solicitors on record as solicitors for the respondent. They acted for him, and in the absence of proof of an agreement between him and them, or between them and the insurance company that he would not pay their costs, they could look to him for payment of the work done and his liability would not be excluded by the fact that the insurance company had itself agreed to pay their costs."
14.	In his judgment in R v Miller & Glennie [1983] 1 WLR 1056 Lloyd J referred to the judgments in Adams and Davies. On page 1061 at C he then said this: 
"I would hold, following Adams and the other cases I have mentioned, that costs are incurred by a party if he is responsible or liable for those costs, even though they are in fact paid by a third party, whether an employer, insurance company, motoring organisation or trade union and even though the third party is also liable for those costs. It is only if he has agreed that the client shall in no circumstances be liable for the costs that they cease to be costs incurred by him, as happened in Gundry v Sainsbury. In practice, of course, the taxing officer will have before him on the taxation the whole of the solicitors file. If it appears to the taxing officer that there is doubt whether there is an express or an implied agreement, binding on the solicitors, not to seek to recover the costs from the client the taxing officer should ask for further evidence. It must then be for the taxing officer to come to a conclusion on the whole of the facts presented to him. Unless those facts establish a clear agreement express or implied that in no circumstances will the solicitor seek to obtain payment from their client then the basic presumption stands ..."
15.	Mr Morgan's primary submission involved an analysis of the contract of insurance between the Defendant and its professional indemnity insurers which Mr Lawrence had commendably made available to him and to the court. Clause 5 of the insuring clauses provided as follows: 
"The liability of the insurers shall not exceed for any one claim under this policy the sum specified in item 4 of the schedule except as provided for under insuring clause 4 but the insurers shall in addition indemnify the assured in respect of all costs and expenses incurred with their written consent in the defence or settlement of any claim which falls to be dealt with under this policy ..."
16.	General condition 1 then provided: 
"The assured shall not admit liability for, or settle any claim, or incur any costs or expenses in connection therewith, without the written consent of the insurers who shall be entitled at their own expense at any time to take over and conduct in the name of the assured or the said firm as the case may be, the defence or settlement of any such claim ..."
17.	Mr Morgan's principal submission was that the policy thereby gave insurers two different means of providing cover. Under insuring clause 5, the insured was indemnified against costs and expenses incurred with insurer's consent and retained conduct of the defence. It followed that although in these circumstances the insurer would pay the solicitor, the insured would still retain a residual liability for the solicitor's costs and in these circumstances, in accordance with the Miller principle, there would be no breach of the indemnity principle. 
18.	The position would be different if the insurer took over the conduct of the litigation in its absolute discretion and without reference to the insured. This is what had happened here and was plain from the following: 
i.	The Defendant has ceased business some time before 1989 (see Kennedys letter to Customs & Excise dated 19 December 2000). 
ii.	Bills rendered by Kennedys could not have been submitted to the partners in the Defendant firm because they disappeared (see letter 3.10.01 Kennedys to Customs & Excise). 
iii.	The solicitor and own client bills were rendered on 28 April 1993, 5 March 1999 and 21 January 2000. Two were addressed to "underwriters at risk c/o Aon Group" and one to "Halifax Property Services formerly St John Vaughan – St John Smith". (See Customs & Excise letter 14.08.01.) 
iv.	As the Defendants ceased business some time before 1989 instructions could subsequently have come only from insurers not from the former partners themselves. 
19.	It followed that the solicitors could only have taken their instructions from the insurers who conducted the case in their own interests and at their own expense. Thus the only entity liable for the solicitor's costs was the insurer. Such a situation was inconsistent with the insured retaining a residual liability for costs of the sort contemplated in Adams and Miller. Indeed, it was implied that solicitors would not look to the Defendant for any costs because the business was dissolved and the partners had disappeared. Accordingly, there was nothing against which the defendant required an indemnity and by the operation of the indemnity principle, nothing for the Appellants to pay. 
20.	Mr Morgan further sought to distinguish the decision in Davies. In his submission, the House of Lords had found in favour of the receiving party because the paying party had been unable to establish that there had been an agreement between the Claimant and the solicitor that he, the Claimant, should not pay the solicitor any costs. The most that the Law Society (which was paying costs) could rely on was: 
"A letter from the Respondents solicitors in which it was stated that the terms of the Respondents policy of insurance was such that the insurance company concerned would not in any circumstances have looked to the Respondent for payment of costs." (per Viscount Dilhorne page 230 at A)
21.	The position here was different in that the insurance policy was before the court and the insurer had elected to take over the litigation at its own expense, thereby effectively becoming the client. 
22.	The point could be tested further by postulating what would have happened had the insurers become insolvent. In that event Kennedys could have looked only to the insurer's liquidator and not to the insured for the firm's costs. 
23.	For the Defendant Mr Lawrence stressed that the insurance contract was a contract between the insured and his insurer. The fact that the insurer can elect to take over conduct of the litigation does not affect the right of the solicitor to look to his client, the insured, for costs. Unless there is a specific agreement between the insured and the solicitor, that the solicitor will not require the insured to pay his costs, the indemnity principle is not breached. Absent such a specific agreement, the insured remains residually liable to the solicitor for costs. 
24.	Mr Lawrence further dismissed the suggestion that because the Defendant was dissolved, the partners had no liability to pay Kennedys costs of the defence of the claim. Whilst it was correct that the partnership as a legal entity no longer existed, the insured parties were individual partners who remained liable for their own acts and omissions and for those committed or omitted during the life of the partnership. There was no suggestion that the firm had been dissolved prior to the date of first notification of the claim to insurers in May 1986. It followed that had the insurers become insolvent (the scenario postulated by Mr Morgan) his firm would have looked to the former partners for their costs. Accordingly there had been no breach of the indemnity principle and the Appellants were liable to meet his clients costs of defence. 
25.	The first point for decision is whether or not the Defendant retained Kennedys as its solicitors in the litigation, or whether the retainer was between Kennedys and the insurers who had exercised their right to conduct the litigation at their own expense. 
26.	In my judgment the evidence supports the view that both insured and insurers were liable for Kennedys' costs. At least until the bill of 28 April 1993, it is clear that Kennedys looked to the insurers for their profit costs and disbursements and to the insured for the VAT. This is evident from interim bills made available for inspection by the court. They do not support the view that in no circumstances would the insured be responsible for any costs. On the contrary, in my judgment they demonstrate that the solicitors expected their costs to be met from two sources, namely insurers as to profit costs and disbursements and insured as to VAT. 
27.	Such an arrangement does not infringe the indemnity principle. I repeat what Atkin LJ said in Adams (see judgment 505): 
"... there is nothing inconsistent in there being a co-existing obligation on the part of the insured and its insurers to remunerate the solicitors." 
In my view that is exactly the situation here.
28.	I am not persuaded, either, that where insurers take over a claim and conduct it "at their own expense" that this creates a liability only between the insurer and the solicitors that is sufficient to exclude a liability on behalf of the insured to the solicitor. The contract of insurance is between the insurer and the insured and the solicitor is not a party to the policy. Whilst I accept that Banks LJ in Adams and Lord Dilhorne in Davies v Taylor did not consider the agreement to relieve the client of costs could only be made with the client himself (an agreement with the third party (the trade union or insurer) would suffice), this point was addressed by Lloyd J in Miller. On page 1061 at F the learned Judge said this: 
"But Lord Cross in Davies v Taylor (No.2) [1972] 1 AER 959 at 965 to 966 ... refers only to an agreement with the client and it was Lord Cross' speech which was adopted by Lord Diplock in O'Brien v Robinson (No.2) [1973] 1 AER 969."
It follows that where, as here, the Defendant did not agree expressly that Kennedys should look only to insurers for their costs, it remained jointly liable to meet them.
29.	I conclude therefore, that not only was there an agreement between the Defendant and Kennedys under which insured and insurer would be liable for the costs, the fact that insurers may have taken over the claim did not affect the co-existing obligation on the Defendant to pay Kennedy's costs. Therefore I reject Mr Morgan's submission on this point. 
30.	Mr Morgan's advanced a subsidiary submission that even if (as I have found) a co-existing obligation existed between the Defendants and the insurers to meet the solicitor's costs, there was an implied agreement under which the Defendant was released from that liability. 
31.	I reject that argument too. First, as I have said, the solicitors, at least until 28 April 1993, looked exclusively to the insured for payment of the VAT. Whilst it is correct that thereafter the underwriters paid the VAT, to my mind such conduct does not imply any agreement that, years after the policy was created, in no circumstances would the solicitor look to the insured for any costs. 
32.	Second, there is the judgment of Lord Denning in Lewis v Avery (No.2) [1973] 2 AER 229, cited by Lloyd J in Miller. At 231 Denning MR said this: 
"Counsel suggest that in this case the costs were not incurred by Mr Avery but were incurred by the Automobile Association because the Automobile Association undertook the appeal and instructed their solicitors and paid them. I cannot accept this suggestion. It is clear that Mr Avery was in law the party to the appeal. He was the person responsible for the costs. If the appeal had failed, he would be the person ordered to pay the costs. If the costs had not been paid, execution would be levied against him and not against the Automobile Association. The truth is that the costs were incurred by Mr Avery, but the Automobile Association indemnify him against the costs ... that is sufficient to satisfy the requirement that the costs were "incurred by him"."
33.	In this case the Defendants instructed Kennedys in the defence of the Appellants' claim. They, not insurers, were liable for the costs awarded to the Appellants by Tomlinson J up to 6 June 1991. Although in practice the insurers would indemnify them for those costs, in the event of the insurer's insolvency the Defendant would have remained liable for any unsatisfied costs. 
34.	Third, there is the submission by Mr Lawrence that if the insurers had become insolvent his firm nonetheless would have looked to the insured for his costs. This is at variance with any arrangement under which his firm impliedly released the insured from their co-existing obligation to meet Kennedy's costs. For that reason, Mr Morgan's alternative submission fails also. 
35.	Mr Morgan advanced a third argument on the indemnity principle which was that if, contrary to his other submissions, sums were potentially recoverable from his clients, then that sum should not be the £33,946.72 awarded by Mr Ryan but a lesser figure. The reason for this was that the Respondent had claimed a higher amount from the Appellants than had been billed by Kennedys and their predecessors, and accordingly there was a breach of the indemnity principle as to quantum. 
36.	Having viewed the solicitor and own client bills (in respect of which Mr Lawrence did not waive privilege) I calculated that profit costs billed to the Defendants were £38,618. Accordingly Mr Morgan's submission was correct, and the certification on the inter partes bill by Kennedys, so far as compliance with the indemnity principle was concerned, was wrong. 
37.	Mr Morgan did not suggest that this was in any way improper conduct, a view with which I concur. Having said that, doing the best I could on the material before me, and having had regard to the submissions of Mr Morgan and Mr Lawrence, I concluded that the amount the Chief Costs Officer would have allowed had the full facts been laid before him, as they had been before me, was £28,700. Subject to the VAT point this is the sum which should be substituted in the bill. 
VAT
38.	The issue is whether or not the costs payable by the Appellants should include VAT on the legal services provided to the Defendant. 
39.	The general rule is that a party does not have to pay VAT on another party's legal costs where that other party is able to recover VAT as input tax (see Costs Practice Direction 43 at paragraph 5.3). 
40.	Regulation 111 of the Value Added Tax Regulations ("The Regulations") provide: 
"(5) Subject to paragraph (6) below if a person who has been but is no longer a taxable person makes a claim in such manner and supported by such evidence as the Commissioners may require, they may pay to him the amount of any VAT on the supply of services to him after the date with effect from which he ceased to be, or to be required to be, registered and which was attributable to any taxable supply made by him in the course or furtherance of any business carried on by him when he was, or was required to be, registered. 
(6) Subject to paragraph (7) below, no claim under paragraph (5) above may be made more than 3 years after the date on which the supply of services was made.
(7) Paragraph (6) does not apply where:
(a) The person ceased to be, or ceased to be required to be registered before 1 May 1997; and 
(b) the supply was made before that date."
41.	A taxable person is "a taxable person for the purposes of this act while he is, or is required to be registered under this act" (Clause 3 of the Value Added Tax Regulations 1984). 
42.	The competing submissions of the parties are these; for the Defendant, it is pointed out that the Defendant no longer exists, is not registered for VAT and cannot recover VAT. As insurance companies are not generally registered for VAT, because they make exempt supplies of insurance, the insurers in this case cannot recover the VAT element either. In these circumstances, consistent with CPD 43 paragraph 5.3, VAT is payable by the Miskins on the assessed costs. 
43.	Not so say the Appellants. They contend (skeleton at paragraph 14) that: 
"As regards the Defendant it will be able to recover the VAT as input tax so the Claimant should not be expected to meet costs that can be recovered elsewhere. To allow otherwise would be to enable the VAT on legal services to be recovered twice: once from the Claimants and then again from Customs & Excise. 
Should the position be any different where the insurer has paid the whole of the Defendants legal costs (ie, the VAT and inclusive costs)? In my submission it should not be because for the purpose of claiming an input tax credit, the focus of the legislation is on the recipient of the supply and it is irrelevant who actually pays for the service ... The fact that the Defendant is not now registered for VAT does not affect the position. Regulation 111(5) of the 1995 Regulations makes it plain that a person who ceases to be registered can still make a claim for input tax."
44.	Mr Morgan recognised that there was an inconsistency between his arguments on the indemnity principle and VAT. If, as was his primary case, the client was the insurer, then it was not open to St John Vaughan as the nominal Defendant in the case to reclaim the VAT as an input. In these circumstances the Appellants would be liable to pay the VAT. 
45.	For the reasons I have given, I have found that there was a co-existing obligation on the Defendant and the insurers to pay Kennedys' costs. The issue I have to decide therefore is whether the Defendant can recover VAT as input tax and if it can, VAT should not be included in the claim for costs (see CPD 43 at paragraph 5.3). 
46.	I was told by Mr Lawrence that his client ceased to be registered in 1989, although this fact did not come to light until much later. The Appellants liability for costs did not begin until June 1991. By that date the Defendant was no longer registered for VAT and the insurers have met this liability. As they cannot make reclaim this sum as input tax it follows that this is a liability which the Appellants must meet. 
47.	In my judgment, the Appellants must pay the VAT. Presumably in ignorance of the deregistration, until the bill of 28 April 1993, Kennedys had looked to the Defendant for payment of the VAT. When the VAT remained unpaid on that bill and the reason came to light, the insurers agreed to discharge the VAT liability. Those insurers cannot recover the tax as an input and therefore the Appellants must pay it under CPD 43. Regulation 111(5) would not assist, since no "taxable person" as defined in the Act has existed during the period for which the Appellants are liable for costs, who would be capable of making an application under Regulation 111. In these circumstances I do not consider any application for a refund would succeed. The sum I have assessed will have VAT added to it and I uphold the Chief Costs Officer's decision (his last after 41 years in service) on this point. It follows that the appeal must be dismissed. 
48.	Both parties at the conclusion of the appeal submitted schedules of costs for summary assessment. They were for the Appellants and for the Defendant respectively £9,260 and £8,713.80. In my view both figures are wholly disproportionate. Subject to any submissions which the parties may wish to make I would propose that there should be no order as to the costs of the appeal. Whilst Mr Morgan succeeded in demonstrating that there had been a breach of the indemnity principle, he failed in his contention that this meant nothing was payable. In my view the fair order would be for each side to bear their own costs. However the parties have liberty to apply if they wish to contend for a different order. In respect of permission to appeal their time for applying to me is extended until seven days after receipt of this Reserved Judgment.