Out-Law / Your Daily Need-To-Know

The terms of a settlement agreement entered into by the insured breached a condition precedent in its product liability policy. Claimants proceeding directly against the insurer under the Third Parties (Rights against Insurers) Act 1930 consequently had no claim.

Clare Horwood & Others v Land of Leather Limited (In Administration); Zurich Insurance PLC & others 

  • [2010] EWHC 546 (Comm) 

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Facts

In 2007, customers complained that leather sofas they had bought from Land of Leather were causing skin complaints.

Land of Leather identified the supplier and stopped selling their products. Costs were incurred in handling returned stock and finding alternative products. The company also had to deal with the reputational damage caused by the media coverage.

Land of Leather sought compensation for these costs from the supplier and a settlement was reached whereby the supplier agreed to pay US$900,000. On 8th November 2007, Land of Leather issued an invoice in terms approved by its insurer, which stated:  

"Compensation for damage to reputation, unsold stock, increased cost of working and cost of testing commission by the Company arising from reported allergic reactions to product supplies, as agreed: US$900,000".

On 18th November, the supplier issued a credit note for US$900,000 "in relation to agreement between [Land of Leather] and [the supplier]".

No date for payment was mentioned. The court heard conflicting evidence about whether the parties had agreed to instalment payments or to payment being made by credit note against future orders. The judge concluded these details had been left "in the air".

When Land of Leather next ordered some sofas, no credit was given. By his time, the company was in serious financial difficulties. New Year sales had been disastrous and its share price had fallen by 50% or more. 

In February 2008, a further agreement was reached. This stated: "in return for a credit note from [the supplier] of US$900,000 payable in six instalments of US$150,000 Land of Leather will undertake to buy US$20, 000, 000 of products from [the supplier] in 2008.

"Land of Leather also confirm they will make no further claim on [the supplier] in respect of alleged allergic reactions to their products although no proof exists that the cause was [the supplier's] products". 

In January 2009, Land of Leather went into administration. Customers who had suffered skin complaints sought to bring their personal injury claims directly against the company’s product liability insurer under the Third Parties (Rights against Insurers) Act 1930.

The insurer, however, argued that, because of the terms of the February agreement, it was under no liability to indemnify Land of Leather and so could not have any liability to the claimants under the Act.

Policy terms

Condition 3 of the policy said the insured "shall not, except at his own cost, take any steps to compromise or settle any claim or admit liability without specific instructions in writing from the Insurer," and that the insurer would have:

"the absolute conduct and control of all proceedings … in respect of any claims for which the Insurer may be liable under this policy, and may use the name of the Insured to enforce for the benefit of the Insurer any order made for costs or otherwise or to make or defend any claim for indemnity or damages against any third party or for any other purpose connected with this policy".

Condition 1 provided that the due observance of the terms and conditions of the policy was a condition precedent to any liability of the insurer to make any payment.

The insurer said the wording of the February agreement extended the original settlement to cover any claims Land of Leather might have against the supplier, including claims arising from its liability to customers for personal injuries. This was a breach of condition 3.

Alternatively, the insurer argued that Land of Leather had breached an implied term in the policy that the insured would act reasonably and in good faith with due regard to the insurer's interests and rights of subrogation.

The claimants maintained that a reasonable person with all the background knowledge available to the parties would have understood that the February agreement referred back to the earlier invoice. The words "no further claim" effectively meant "no further claim of the type identified in the invoice". 

Judgment

The Judge agreed with the insurer. The commercial purpose of the February agreement was to sort out, once and for all, the problems that had arisen between the two parties. Had it dealt only with claims relating to cost and reputational damage, the personal injury claims would have been left unresolved.

Instead, the parties had chosen to use general words of release ("no further claim") which were broad enough to include all claims arising from alleged allergic reactions. In addition, Land of Leather committed itself to ordering £20 million of products in 2008. The consideration for this new deal was a fixed timetable for payment of the settlement sum.

Under pressure to secure any payment at all, Land of Leather must have considered this a price worth paying.

Was the February agreement a breach of condition 3? The judge concluded it was, rejecting the claimants' argument that the condition only applied to settlements of claims brought against the insured. In his view, the wording was wide enough to include claims the insured might have against third parties, which (as the second part of the condition made clear) the insurer could pursue in the name of the insured.

Condition 1 made condition 3 precedent to the insurer's liability. Since condition 3 had been breached, the insurer could have no liability to the claimants under the 1930 Act.

This made it unnecessary to consider whether there had been a breach of an implied term or what the scope of such a term would be. The judge, however, agreed that the insured was under an implied term to act reasonably and in good faith with due regard to the insurer's interest and rights of subrogation under the policy.

If, on its true construction, the February agreement did not extend to include claims arising from Land of Leather's liability for personal injury, there would have been no breach of the duty. If it did cover those claims but was unenforceable for lack of consideration, there would have been a breach, but it would not have caused the insurer any loss.

Commentary

There is no English authority that deals directly with the scope of an insured's implied duty not to prejudice the rights of its insurer.

The judge commented that the implied term arose because of the insurer's right of subrogation – the right to pursue a third party in the name of the insured. An insured who settles a claim by a third party harms the insurer's interest because it deprives the insurer of its right of subrogation against that third party.

But he rejected the claimants' argument that only settlement of a claim would amount to breach of the implied term. In principle, an insurer's rights may be harmed by something other than settlement – if documents necessary to establish the claim are destroyed, for instance.

The case is also a reminder that third party claimants claiming directly against insurers under the 1930 Act will only have the same rights as the insured would have had. This will remain the position once the 2010 Act comes into force (see: The Third Parties (Rights against Insurers) Act 2010, an OUT-LAW Guide).