England and Wales High Court (Technology and Construction Court) Decisions

IN THE HIGH COURT OF JUSTICE
Technology and Construction Court

		St Dunstan's House, 131 – 137 Fetter Lane, London, EC4A 1HD
		18 December 2006

JUDGMENT (No 2)

Introduction

1. This application seeks to join five insurance companies as non-parties to this litigation for the purposes of costs only and for orders that these insurance companies pay the costs which PSW is entitled to recover from ASM. PSW is entitled to a costs order in its favour following the trial and a judgment in favour of PSW which ordered ASM to pay PSW £1,392,088 and interest of £684,244. Thus, the judgment in PSW's favour totalled £2,076,332.
2. PSW's action was for damages for professional negligence arising out of ASM's negligent performance in relation to its professional engagement to carry out architectural services for the redevelopment of PSW's principal shop and trading premises in Plymouth. The judgment is now reported. ASM has not met, and will not be able to meet, any of the costs it has been ordered to pay. It is an incorporated architects' practice, is not trading and it ceased to trade in August 2001, prior to the action being started. The five insurance companies provided professional indemnity insurance to ASM with a limit of £2 million. To date, PSW has been paid £1,999,000 and ASM's insurers through their solicitors, Kennedys, have agreed to pay PSW the remaining £1,000 of the insurance cover. As a result, PSW has recovered all but £76,332 of the judgment but has not recovered, and will not recover anything towards, the costs. The costs have not yet been assessed but are estimated to exceed £1 million. An interim payment of £250,000 on account of costs was ordered to be paid by ASM but no part of that sum has yet been paid.

The Law

3. The application is made against the insurers who are liable to indemnify ASM under a policy of professional indemnity insurance. The application is made under section 51 of the Supreme Court Act 1981 and CPR 48.2. Each of the five insurers agreed under the policy to accept liability to indemnify ASM for 20% of the overall indemnity liability incurred by the insurers under that policy. Section 51 provides that:

"(1) … the costs of and incidental to all proceedings in … the High Court … shall be in the discretion of the court. …

(3) The court shall have full power to determine by whom and to what extent the costs are to be paid."

4. Recent case law has identified the factors which a court should take account of when considering whether to exercise its discretion to order a section 51 costs order against non-party insurers where those insurers have agreed to indemnify the defendant, wholly or partially, for its professional liability. These cases were referred to in argument and it was common ground that what must be established by PSW in order to recover its costs from the insurers may be summarised in this way:

(1) The insurers have agreed to indemnify ASM and ASM has been found liable to pay damages to PSW in circumstances in which that liability is covered, in whole or in part, by the insurers' liability to indemnify ASM.

(2) ASM will be ordered to pay to PSW some or all of PSW's costs incurred in pursuing the action that led to the liability to pay damages.

(3) ASM is unable to discharge its costs liability wholly or in part and PSW will, in consequence, fail to recover that undischarged liability.

(4) There must be exceptional circumstances present making it reasonable and fair for a non-party costs order to be made. The features justifying such an order include:

(i) The insurers determined that the claim would be fought;

(ii) The insurers funded the defence of the claim;

(iii) The insurers had the conduct of the claim;

(iv) The insurers fought the claim exclusively to defend their own interests; and

(v) The defence failed in its entirety.

(5) The insurers' conduct complained of caused loss to PSW in the sense of occasioning or increasing the costs which PSW incurred in the action in question.

5. These principles are derived from Aiden Shipping Co Ltd v Interbulk Ltd [1986] A.C. 965, HL; Murphy v Young & Co's Brewery [1997] 1 WLR 1591, CA; Chapman Ltd v Christopher [1998] 1 WLR 12, CA; Bristol & West plc v Bhadresa (No 2), Chancery Division, unreported 13 November 1998, Lightman J and Cormack v The Excess Insurance Company Limited [2002] 1 Lloyd's Rep 398, CA.
6. In this application, the dispute concerns the application of the facts to these principles. In particular, the insurers contend that none of the five factors identified as having to be present to make the case an exceptional one are present and, in particular, the fourth factor is absent. In other words, the insurers in this case contend that they did not fight ASM's defence or fund or otherwise control that defence exclusively for their own interests.

The Facts

7. CWS was an architectural practice based in Bristol. It had had a longstanding professional relationship with PSW and, in 1985, Mr John Mitchell, who was in charge of the CWS Bristol office, took over those offices when CWS split up and formed the Bristol practice of CWS into a new incorporated architectural practice, ASM. Mr Mitchell was a director of ASM and he ran the business from day to day. About one third of its turnover was derived from PSW in the early and mid 1990s. Mr Gibbs joined ASM in April 1985 and worked for ASM until 2001 when he left to form Digby Gibbs Architects Limited. Mr Mitchell and Mr Gibbs were the two fully qualified architects that undertook the great majority of the work undertaken by fully qualified architects for ASM in the period it was trading from 1985 until 2001.
8. Mr Nicholls worked with ASM as a quantity surveyor for most of the time ASM was trading. This work was undertaken through a separate quantity surveying company, QSM Limited which was formed in the late 1980s and which had as its directors both Mr Nicholls and Mr Mitchell. It was intended that QSM would undertake the quantity surveying work for the commissions being undertaken by ASM. Mr Nicholls was never a director of ASM. QSM was dissolved on 22 April 2003.
9. Mr Mitchell retired from practice as an architect in 2000 and, in the same year, many of ASM's employees left ASM to form and run their own company. In August 2001, all of ASM's remaining employees were made redundant at about the time that Mr Gibbs left to form his own company. ASM ceased trading. Two replacement directors were subsequently appointed, being Sylvia Potter, an executrix of Mr Mitchell's estate, and Mr Michael Mitchell. Neither director has sought to activate the trading activities of ASM or to do anything in relation to the running of the company.
10. The situation since August 2001 in relation to the activities of ASM is best summarised from this extract from the Directors' Information to Creditors prepared for the First Meeting of Creditors of ASM held on 21 March 2006 after ASM sought a voluntary winding up in February 2006:

"[In August 2001 when ASM ceased trading] the company was by then subject to a large-scale legal negligence claim in respect of the construction of [the subject-matter of this action]. The director [Mr Mitchell] sought advice about whether the company was solvent. He was advised by both the company's solicitors and insurers that whilst there was a pending legal action, the company's liabilities and assets were uncertain. Therefore, they recommended against entering into liquidation and the company's insurers defended it against the claim by [PSW].

In June 2002 Mr Mitchell died and two new directors were subsequently appointed on 8 July 2002, being Mr M Mitchell and Mrs S Potter.

In January 2006, the High Court gave its judgment in respect of the litigation started in 2001. The judge ruled that the company was negligent on the majority of matters claimed. The value of the judgment has been calculated by the company's legal team to be in the region of £1.5 million. On top of this there will be an award for interest that has been estimated to be in the region of £890,000. The claimant's costs will also have to be paid and have been estimated to be in the region of £1 million. The total liability that the company faces is therefore in the region of £3,390,000. This amount may vary subject to a possible appeal by the company's solicitors.

The company's insurers have a £2 million limit in respect of such claims. Consequently, the company is liable for any excess, which is potentially in the region of £1,390,000. It is therefore clearly insolvent.

On the 2 February 2006, the company's accountants sought insolvency advice on behalf of the directors. Having had the benefit of this advice the directors concluded that the company should be placed into liquidation."

11. The summary of assets set out in the Directors Information to Creditors showed that the only assets of ASM were cash in the bank of £42,975 and a director's loan account of £54,258. The relevant director was Mr Mitchell and the only means of obtaining repayment of that loan was from his estate. The evidence did not show whether the estate had realisable assets still under the control of the executors of his will covering any or all of this liability to repay the loan. Apart from a small contingent Inland Revenue tax liability that would only accrue if the director's loan is repaid, the only creditor of ASM is PSW.
12. The claim leading to the liability arising from the judgment in this case was first intimated in a letter before action sent on 11 February 2002. This had followed nearly two years of pre-claim correspondence about the losses incurred by PSW on the redevelopment project. The claim form was issued on 23 April 2002 and was served on 9 August 2002. The insurers instructed Kennedys, Solicitors, to act for ASM and it was that firm that signed the disclosure statement served on ASM's behalf. Kennedys also act for the insurers in this application for an order for costs against non-parties.
13. ASM applied for permission to appeal the judgment but, on 2 August 2006, permission to appeal was refused by a single Lord Justice on paper and the application was not renewed to the full court.

Background to the Application

14. There are several matters which form the essential background to my consideration of this application.
15. Insurance contract. The terms of the policy under which the insurers agreed to provide an indemnity to ASM against professional liability was in conventional form for such insurance. In particular, the terms provided that the insurers would indemnify ASM against loss arising from any claim for breach of duty in its professional capacity. The insurers would meet the costs, charges and expenses of legal representation at any proceedings which gave rise to a claim. The insurers were entitled to nominate a solicitor and, if appropriate, a barrister to represent the insured. It would appear that it was by virtue of these contractual provisions that Kennedys were instructed by the insurers, having been notified of the claims being made against ASM by ASM as provided for by the terms of the policy. From the outset, Kennedys stated that they were acting for ASM.
16. Third Parties (Rights Against Insurers) Act 1930. As is well known, this Act was passed so as to enable a successful judgment creditor of an insolvent company to recover direct from an insurer who had provided an indemnity by way of an insurance policy against all or part of that liability the sum that the insurer was contractually obliged to pay to the insolvent insured by way of indemnity. Before the Act was passed, the third party had no means of recovering that sum and the only party who could recover the relevant sum was the liquidator on behalf of all the creditors. However, before a third party can claim direct from an insurer, that party must first obtain a judgment against the insured, even if the insured is insolvent. The corollary of that requirement is that if a judgment has been obtained, it is no longer possible for the insurer to contest liability or quantum. If the insurer wishes to preserve its position, it must ensure that the insured defends the action brought by the third party. The insurer is able to ensure that this is done where, as in this case, the relevant policy entitles the insurer to nominate solicitors to act and provides that the costs and fees involved will be met by the insurer. Any policy containing such provisions also contains express or implied terms that require the insured to provide all reasonable assistance to the insurer nominated legal team in relation to the conduct and presentation of the insured's defence.
17. Evidence. It is noteworthy that the insurers have not filed or adduced any evidence directly from ASM or those involved on behalf of the insurers who instructed Kennedys in the first place to act on ASM's behalf or with whom Kennedys subsequently dealt or communicated. Furthermore, no instructions, in either written or oral form, were placed in evidence and no communications with Kennedys were disclosed. This was because privilege was claimed. However, no detailed disclosure statement listing each document for which privilege was claimed was served despite an order directing disclosure of all documents material to the section 51 application. Given the evidence served by the representative of Kennedys and the insurers, grounds of defence, it is at least arguable that much of the relevant documentation relating to the conduct of the defence by Kennedys was disclosable or that privilege otherwise attaching to these documents had been waived. However, PSW elected not to seek specific disclosure of any of this documentation. Overall, however, in the light of the absence of direct evidence from ASM or their insurers in either witness statement or documentary form, it is very difficult for the court to make positive findings in relation to ASM's state of mind in relation to the pursuit of a defence to PSW's claims or in relation to the extent to which the insurers pursued that defence on behalf of ASM and ASM's perceived interests.

Insurers' Liability to Indemnify ASM

18. It is not in dispute that the insurers had agreed to indemnify ASM and that ASM has been found liable to pay damages to PSW in circumstances in which that liability, to a limit of £2 million is covered by that obligation to indemnify ASM. In monetary terms, the insurers' liability to indemnify ASM amounts to almost 100% of ASM's liability to pay the judgment sum and interest and there is, in consequence, no further liability to meet any part of ASM's costs liability to PSW. The insurers have now agreed to pay out the entire amount it is liable to pay under the policy, being the total of £2 million and that sum has now been received by PSW save for the sum of £1,000 which remains outstanding. The reality is that the balance of the judgment sum and interest, being a sum of £76,332, and no part of the costs liability can or will be paid by ASM. This is because it has very limited remaining realisable assets. The remaining assets will, in part, be needed to fund essential professional fees and expenses. The balance of its assets are unlikely to be recovered since they represent an unrecovered director's loan which must be recovered, if at all, from Mr Mitchell's estate following his death some 4 ½ years ago.

Exceptional Circumstances

19. The insurers determined that the claim would be fought. It is accepted by Kennedys that that firm was instructed by the insurers to defend the claim brought against ASM. At the time that that firm entered an appearance on behalf of ASM, if not long before then, both the insurers and Kennedys knew, or must have known, that ASM had ceased to trade, had no employees or active directors and was, at least until the claim had been successfully defended, insolvent.
20. The insurers contended that at the time they were first instructed in March 2000, ASM still had an active director, in Mr Mitchell, and it was still trading. Mr Thomas, a partner of Kennedys who served a witness statement on behalf of the insurers, stated in that witness statement that his firm was instructed by ASM's accountant, a Mr Groves, to liaise with Mr Nicholls and Mr Gibbs in order to defend the claim and to protect ASM's interests generally. Thereafter, Kennedys reported to Mr Groves as to the progress of the claim, albeit in far less detail than Kennedys reported to the insurers. Mr Thomas went on to assert that:

"my clients do not waive privilege in communications with my firm".

In this context, the reference to Kennedys' clients is a reference to both ASM and the insurers since the witness statement states that Kennedys has the conduct of the case on behalf of ASM and also that the firm was nominated to act on behalf of ASM's professional indemnity insurers and was further instructed to act on behalf of the insurers in the non-party costs application.

21. Mr Mitchell had retired before, or soon after, Kennedys were first instructed and it is clear that he was never in direct communication with Kennedys about the claim or the arrangements for pursuing ASM's defence to that claim. Many of ASM's employees left in 2000 and the remaining employees were made redundant in August 2001 when the company ceased trading. For at least a year before ASM actually ceased trading, its trading activities were clearly very limited and probably amounted to little more than responding to requests for information about the claim addressed to it by Kennedys to enable Kennedys to respond to the pre-action correspondence that took place. The letter before action was finally sent on 11 February 2002.
22. In those circumstances, and given the terms of the Directors' Information to Creditors settled in March 2006, I conclude that it was the insurers alone who determined that Kennedys should be instructed and that the claim should be defended using funds solely provided by them. Had that decision not been taken, I also conclude that the claim would have been left undefended and would have gone by default once proceedings had been started.
23. The insurers funded the defence of the claim. It is accepted by the insurers that they funded the entirety of the defence to the claim. They contended that that was a normal incidence of professional liability insurance and that therefore that factor did not make this case an exceptional one since insurers funded most defences where, as is frequently the case, the defendant's liability is covered by insurance. However, the question of whether or not the insurers funded the defence is not strictly relevant in relation to the question of whether the insurers' interest is sufficiently unusual to allow a costs order to be made against them. The question is a threshold one so that, unless the insurers did fund the defence, they cannot be made liable however exceptional their involvement might otherwise be considered to be.
24. The insurers had the conduct of the claim. It was accepted by Mr Thomas that the insurers had the conduct of ASM's defence. He also accepted that this was an inevitable feature of any policy providing professional indemnity cover for the insured's potential liability to third parties.
25. The insurers did, however, contend that the defence was put forward and pursued on the basis of joint instructions received by Kennedys from ASM and the insurers or that both ASM and the insurers were separately instructing Kennedys. Mr Thomas stated in his witness statement that Mr Nicholls and Mr Gibbs gave very detailed instructions as to the content of the defence and both were closely involved in the disclosure process. This statement is self evidently true given the content of the witness statements served in the litigation by both men and of the detail relied on by ASM during the trial. However, when asserting that these representatives "instructed" Kennedys, Mr Thomas is using the word "instruct" in the strict sense used by solicitors to mean "provided the detail" or "assisted by providing information". When used in that sense, the acts and statements of both men are equally consistent with ASM's employees and representatives enabling ASM to comply with its contractual obligation to the insurers to assist the insurers in their prosecution of ASM's defence for the insurers' interests and with the same individuals assisting ASM in pursuing its decision to defend the action for its own interests. On the basis of all the evidence, I conclude that both Mr Nicholls and Mr Gibbs were instructing Kennedys in the first, and more limited, sense of assisting ASM to fulfil its contractual obligation to provide assistance to the insurers to conduct ASM's defence in the insurers' interests.
26. The insurers fought the claim to defend their own interests. The insurers contended that ASM's defence was mounted and PSW's claim was fought exclusively, or predominantly, or even in part, in the interests of ASM. In reality, so it was contended, the interests of ASM and the insurers coincided. Both wanted to preserve ASM's assets and to reduce ASM's potential exposure to PSW's claims, both wanted to protect the good name and trading position of ASM and both were pursuing these goals in good faith and on the basis of legal advice.
27. On the basis of the evidence adduced in this application, these submissions are untenable. ASM had no continuing professional reputation to preserve, it had ceased trading and had lost its entire work force before the claim was even started. The principal had retired at about the time that a possible claim was first intimated and he died within a few weeks after proceedings were issued. Neither Mr Gibbs or the quantity surveyor Mr Nicholls gave further evidence in connection with the current application so that there was no evidence that enabled it to be concluded that their professional reputation in their new professional roles and firms were being preserved by the prosecution of ASM's defence. The evidence also shows that those responsible for ASM in early 2002 wanted to put ASM into liquidation at that time and were only stopped from doing so because they were informed that the insurers wished to pursue ASM's defence in their interest. The then directors of ASM clearly did not regard the pursuit of ASM's defence as being in ASM's or their own personal interests.
28. It is true that there was a very limited sum available within ASM and an outstanding asset in the form of an outstanding director's loan made some years earlier to Mr Mitchell but it would have made no commercial sense for ASM to seek to pursue its defence, even if funded by the insurers, to enable it to realise or preserve these limited assets in circumstances in which it was facing a liability of at least £2 million. There is no evidence, either from the personnel whose interests might have been affected by preserving ASM's assets or from any other source that supports a finding that there was any other interest being pursued than the insurers' wish to limit their liability to meet the claim under the Third Party (Rights against Insurers) Act.
29. It follows that ASM's defence was pursued solely, or predominantly, in the insurers' interests and would not have been pursued at all had the insurers not insisted that this course be taken at their expense.
30. The defence failed in its entirety. The insurers accepted that the defence failed in its entirety so far as liability was concerned, but contended that it did not fail in relation to quantum since the ultimate recovery was about two-thirds of the sum originally claimed.
31. It is important to take account of the nature of the claim, the reasons why it succeeded in full save for a reduction in the recovery when compared with the sum claimed and the reasons for that reduction. These are set out in detail in the first judgment in this case. In summary, PSW contended that there had been an avoidable cost overrun in the redevelopment project due to a series of significant acts of negligence at each stage of the project leading to avoidable costs. These costs were incurred because the design was incomplete at the time of contract, because of the procurement method adopted, because of serious and repeated failures to detail the work sufficiently, to programme the work or the design development, to detail and instruct variations, to cost and value the work or to advise on appropriate cost-saving measures that could have been implemented as work proceeded had its true cost been ascertained on a regular basis and reported to PSW.
32. These errors were compounded by ASM's almost complete failure to bring into existence appropriate documentation that should have been brought into being but was not which would have enabled an accurate cost overrun to be ascertained. In the absence of this documentation, the task of accurately assessing the cost overrun associated with ASM's defaults was not possible.
33. No reasonable criticism can therefore be made of the apparent reduction of the overall size of PSW's recovery given its comprehensive success in relation to liability and its equally overwhelming success in establishing the basis for assessing damages.
34. In short, PSW's claim for a non-party costs order should be considered on the basis that it succeeded in full in the judgment that it recovered against ASM. In other words, ASM's defence is to be taken to have failed in its entirety.

The Insurers' Conduct Caused PSW's Loss

35. PSW must show that the insurers' conduct it complains of caused its loss in the sense of it occasioning or increasing the costs which it incurred in the action.
36. PSW was readily able to demonstrate that it was the insurer's decision to instruct solicitors and counsel to conduct ASM's defence of PSW's claim and to fund that defence in its entirety that caused PSW to incur the costs which will be irrecoverable from ASM but which ASM will be ordered to pay.
37. It is clear that PSW's claim would have gone undefended had the insurers not insisted that it should be defended and then provided the costs needed to provide that defence. Had the claim been left undefended, PSW would have been able to enter judgment against ASM with a modest outlay in costs and would then have been able to execute that judgment, up to a limit of £2 million, against the insurers using the Third Party (Rights Against Insurers) Act and without the insurers being able to defend the substance or quantum of the claim. Thus, given PSW's virtually complete success in the action and its ability to recover all but a tiny part of its entitlement to principal and interest under the judgment, it is clear that PSW's loss represented by all its costs being irrecoverable from ASM was occasioned or increased by the acts of the insurers in funding and instructing the defence of PSW's claim.

Form of Judgment

38. The insurers contended that each of them should only be liable for 20% of the costs PSW succeeds in obtaining a cost judgment for and that that costs judgment should be severely limited given the irresponsible manner in which PSW prepared and presented its claim, thereby significantly and unreasonably increasing the costs it incurred.
39. Since each insurer is only liable for 20% of the insurers' collective liability under the policy, it is fair and reasonable that each should only be 20% liable for ASM's liability to pay PSW's costs. Since each insurer is able to meet that liability, I do not need to decide the more difficult question of whether, if there is a shortfall in overall recovery due to an inability by any of the insurers to meet its notional liability, that shortfall can or should be redistributed amongst the remaining solvent insurers or whether PSW should be left funding it in the sense of not being able to recover it. I do not need, and therefore do not propose, to provide an answer to this theoretical question.
40. As for the suggested unreasonable conduct of PSW leading to a reduction in the insurers' liability, I decline to give effect to that suggestion. I have already found that PSW's overall conduct was reasonable in the way it prepared and presented its claim. If any part of the significant sum in costs it incurred in pursuing its claim were unreasonably incurred, that unreasonable expenditure will be capable of being identified and eliminated during the detailed assessment of PSW's costs by the costs judge. I will, however, direct that the insurers have permission to intervene in the detailed assessment of PSW's costs.

Conclusion

41. I therefore conclude that PSW has permission to join each of the five insurers in question as non-parties for the sole purpose of claiming costs from each of them under section 51 of the Supreme Court Act 1981 and that each insurer is liable to pay PSW direct a sum representing 20% of the overall recoverable sum from ASM following a detailed assessment of those costs. I also conclude that the insurers should be entitled to intervene in the costs assessment process.

HH Judge Thornton QC

18 December 2006