If your subcontractor or supplier turns turtle you have a major problem, but all may not be lost. Here’s how you can jump the insolvency queue …

When a subcontractor or supplier that owes you money runs into financial difficulties you will generally be in for a rough ride. Anyone in the construction industry who has tried to recover money from an insolvent party will know that there is hardly ever a happy ending for creditors.

But what if the insolvent party had specifically insured against its liability to you? If so, an act dating back to 1930, the Third Party (Rights Against Insurers) Act, may entitle you to bypass the insolvency process and claim payment directly from the insolvent party’s insurer.

The act applies where A has insurance to cover potential liabilities owed to B. If A becomes insolvent, then the benefit of the insurance is, under the act, transferred directly to B from A (and away from its other creditors). The act also gives a right to obtain information about A’s insurance arrangements from the receiver, administrator or liquidator and the insurer. But does the act cover any insured liability and, if so, when does B receive the benefit of the policy? And when is B entitled to ask for the information?

For many years there has been a belief, based on old case law, that the transfer, and the right to the information, arose only after A’s liability to B had been ascertained by judgment, award or agreement. The reasoning applied was that if liability is not established, then rights under the act in respect of that liability cannot have arisen.

This is crucial since nobody is likely to run the risk of incurring costs in pursuing an insolvent party, obtaining a judgment and then finding out that there is no insurance. The act was therefore thought to have only limited value.

These questions were reconsidered in the recent Court of Appeal case, First National Tricity Finance Ltd vs OT Computers Ltd.

OT offered its customers extended warranties. First National Tricity Finance (FNTF) provided credit facilities to OT’s customers, under which FNTF took on liability to the customer for any warranty claims. Before the insolvency, FNTF was then compensated by OT. OT had taken out insurance with Axa specifically to cover these repayments.

OT went into administration, leaving FNTF in the firing line. FNTF met its own obligations at considerable cost but had a worthless claim against OT. FNTF therefore asserted its rights under the act against AXA.

FNTF sought a court order to obtain the policy information. OT maintained that the act did not cover contractual liability and that there was no obligation to give policy details until OT was proved to be liable to FNTF, for instance by FNTF obtaining a judgment.

The court disagreed with OT on both issues.

On the first issue it pointed out that the wording of the act is simply “… liabilities to third parties which he may incur”. These words, it said, were “very general” and to restrict them would be to put a “considerable gloss” on the act.

On the second issue FNTF claimed the right to the information arose as soon as the insured becomes insolvent, that is, that the old case law was incorrect. OT argued that FNTF first had to obtain a determination of its rights against OT.

The Court of Appeal said that “what a third party claimant needs to know is whether the person against whom he is making a claim is insured and, if so, on what terms”. It looked at the terms of the act and was satisfied that this was what the wording intended.

It is now clear therefore that a third party is entitled, much earlier than was previously thought, to obtain the information it reasonably requires to enable it to determine whether it can claim directly from the insurer. The rights under the policy are transferred to the third party, and the right to obtain policy information arises, as soon as the insured becomes insolvent. The liability of the insured and the insurer must of course later be established by judgment, award or agreement, before the insurer has to pay out.

So, should a contracting party become insolvent, consider finding out whether it was insured against its liability to you. You are entitled to information about a policy after the insolvency even though the liability of the insured to you has not yet been established.

Richard Williams is an insolvency lawyer with expertise in construction at Pinsent Masons