Over their dead bodies

"In this world nothing can be said to be certain, except death and taxes," said Benjamin Franklin. He may be right on a general level but I suggest two further certainties – that people will screw up and that people will go bust. Worse still, some people will do both, leaving their victims in a difficult position.

One way we manage the risk of screw ups is through insurance, especially professional indemnity insurance. A client with a team of consultants and contractors may take comfort in the thought that their PI insurance will enable them to meet any damages if their design for the building is negligent. All well and good – so long as they renew their insurance. But what if one of them goes bust?

Under the legal insolvency rules, the client would be in a weak position. If it establishes that the contractor or consultant is negligent and that it is entitled to damages as a result, it would have to stand in line with the other unsecured creditors, and might end up recovering only a few pence for every pound awarded. However, the Third Parties (Rights Against Insurers) Act 1930 comes to the rescue. It transfers to the client the right to claim an indemnity from the failed company's insurers, bypassing other creditors whose claims are not covered by insurance.

Back in 1930, nobody had even thought of adjudication (happy days!) but Galliford (UK) Ltd vs Markel Capital Ltd has just told us how the act can work in relation to adjudication awards. Galliford engaged a structural engineer to convert the Wellesley Hotel in Leeds into flats. It alleged that the engineer had been negligent in carrying out this work. An adjudicator agreed and ordered the engineer to pay £722,586 compensation. In the meantime, the engineer went into liquidation. Galliford invoked the 1930 act and sued the engineers' professional indemnity insurers for the amount of the adjudicator's award.

The action failed. Looking at the wording of the policy and the act, there was no transfer of rights on which Galliford could sue. In the usual way, the PI policy covered legal liability for damages. It had even been extended to include damages "consequent upon an adjudicator's award". However, the judge noted that the adjudicator's award did not create a liability for damages. It only created a contractual obligation to make a payment that was enforceable through the courts. Galliford would have to begin enforcement proceedings and only once these were upheld by a judge or an arbitrator would the engineer be legally liable, creating a right to be indemnified by insurers – which would then transfer to Galliford under the 1930 act.

If the client is entitled to damages it would have to stand in line with the other unsecured creditors

There were other issues that the engineer (and, in turn, its insurer) would have wanted aired during an enforcement hearing. First, it disputed that its contract with Galliford was in writing. If it was not, the Construction Act would not apply and the adjudicator would have no jurisdiction to order payment.

Second, the insurer would have argued that the engineer had not complied with the policy term requiring the prompt notification of claims. If so, this would defeat any claim by the engineer to be indemnified. It would kill off the direct claim from Galliford in the same way.

The Law Commission has published a number of consultation documents proposing reform to the 1930 act. It recommends that claimants should be able to sue the insurers direct without suing the insolvent consultant first, and that issues about jurisdiction would be dealt with at the same time as the underlying claim was assessed. In addition, where there are procedural requirements such as prompt notification of claims, the claimant would be entitled to deal with these instead of the insured engineer, giving it control over the whole process.