Payments from foreign insurers to insolvent insureds - Who gets what?

Thursday 9 July 2015

Authors: Murray Tingey, David Friar and Tim Fitzgerald

​​​​What happens if a claimant is injured by an insured person, and the insured becomes insolvent?

A recent High Court decision confirms that the answer depends on where the insurer is based. If the insurer is based overseas, the claimant is not entitled to receive the insurance money even if that money is paid to the insured person in New Zealand.

Section 9 of the Law Reform Act 1936

Section 9 of the Law Reform Act says that any insurance money that is payable to the insured in respect of its liability to the claimant are charged in favour of the claimant. This means that the claimant, and not the insolvent insured’s creditors, gets the benefit of the insurance money. The charge is intended to address what has been called the “obvious unfairness” of insurance money being shared between the insured person’s creditors along with the insured’s other assets, in circumstances where the money is only available because of the loss suffered and claim made by the claimant.

It is clear that s 9 applies to insurance payments made by New Zealand-based insurers. The more difficult question – which has been considered in four cases in the last five years – is how s 9 operates when the insurer is based offshore. The Courts have held that the section does not apply to offshore insurers, no matter how strong the connection between the claim and New Zealand. As a result, injured third parties can never rely on s 9 to reach overseas and claim against insurers who were not in the jurisdiction.

The issue was considered most recently by the High Court in McCullagh v Underwriters Severally [2015] NZHC 1384, where the claimant argued that the charge applies to insurance money once it is paid to the insolvent insured in New Zealand. Does the charge created by s 9 cease to exist when the money is paid to the insured? Did Parliament intend to address the “obvious unfairness” by changing the insurer’s obligations, but not the insured’s?

The High Court held that the insured’s obligations are not charged. Section 9 provides that the charge applies to insurance money “upon the happening of the event giving rise to the claim for damages” – that is, at the moment that the insured incurs liability to the claimant. The Court held that if the charge does not descend at that time (because the insurer was overseas) then it does not descend at all. This sits uneasily with the Court of Appeal’s reasoning in FAI (NZ) General Insurance Co Ltd v Blundell & Brown Ltd [1994] 1 NZLR 11, which was premised on a charge attaching to money payable under a policy that came into effect years after the relevant event took place. The High Court also held that the charge is only enforceable against the insurer, and not against the insured. Once the insurance money is paid to the insured, it forms part of the insured’s pool of assets, and is available for distribution to general creditors in the usual way.

The consequences

In practical terms, this means that:

  • If the overseas insurer accepts its liability and pays the insured, there is a windfall gain for the insured’s other creditors. The insurance money will be distributed to creditors along with all the insured’s other assets, in accordance with the usual rules of priority. The injured claimant will rank alongside all other unsecured creditors.

  • If the insurer is local, then s 9 applies and the injured claimant is incentivised to pursue the insurer. However, if the insurer is based overseas, there is no reason (or ability) for the claimant to do so. The insured, or its receiver or liquidator, is incentivised to pursue the insurer and apply any proceeds to the creditors generally.

  • Although it is theoretically possible for a claimant to obtain the benefit of an insurance payment, this will require two sets of proceedings and the agreement of the insured party. The claimant would need to establish its liability against the insured person (typically by suing them), and then fund a claim by the insured against its insurer. In those circumstances, the claimant is entitled to retain the proceeds of the recovery action against the insurer (up to the value of their debt and their costs incurred). Although this is possible in theory, the process is convoluted, time-consuming, and relies on the agreement of the insured, in circumstances where there will often be no real incentive for the insured to agree.


Disclaimer

This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.

For more information
  • David Friar

    Partner Auckland
  • Tim Fitzgerald

    Partner Auckland
Related areas of expertise
  • Insurance
  • Restructuring and insolvency