Should Insurance Money Be Ring-fenced for Clients of an Insolvent Insured?

Desai v Wood¹ arose from a claim under a professional indemnity policy where the insurers had exercised their rights to pay the limit of indemnity prior to the insured’s liability for the underlying claim being established, leaving the insured to defend the claim. 

After receiving the insurance proceeds, the insured entered voluntary liquidation, having been insolvent for some time and was therefore not in a position to pay damages to the claimants. The claimants, who were unable to claim under the Third Parties (Rights Against Insurers) Act 2010 in these circumstances, tried unsuccessfully to argue before the Court of Appeal that the insurance money should be ring-fenced for them and not form part of the insured’s liquidation estate.

Background

This case relates to a professional negligence claim against Boscolo Limited (“the Company”) who provided the claimants with interior design and project management services. The claimants claimed in excess of £700,000, alleging that the Company negligently told them that they did not need Listed Buildings Consent for works carried out at their property. 

The Company had professional indemnity insurance with insurers as required by the British Institute of Interior Design (the “Policy”). The limit of indemnity was £250,000 and there was a £500 excess per claim.

As is common in professional indemnity policies, there were claims conditions in the Policy whereby insurers could take over the defence of any claim against the Company covered under the Policy, but insurers were also entitled to pay the Company the limit of indemnity for any claim, and relinquish control of the claim and any defence proceedings arising from it.

Although insurers initially instructed solicitors in relation to the claim, insurers decided to exercise their right to pay the Company the full policy limit and to cease to be involved in the defence. Later that month, the Company entered into voluntary liquidation.

If insurers had not paid the policy limit to the Company, the Company’s rights under the Policy would have transferred to the claimants under the Third Parties (Rights Against Insurers) Act 2010. Thus, had the Company’s liability to the claimants been established, the claimants would have been entitled to an indemnity under the Policy. 

As it was, the insurance money became part of the Company’s assets to be divided amongst creditors. The only other creditor of the Company was its sole director and sole person with significant control who was said to be owed £250,000. The only asset of the Company was the sum of £246,000 which was the remains of the insurance proceeds.

To get around this difficulty, the claimants submitted that they had a proprietary interest over the insurance monies by way of an express or implied term in the contract between the Company and the claimants that insurance monies would be held on trust, or a constructive trust necessary to prevent unjust enrichment.

At first instance, HHJ Paul Matthew rejected both arguments. He found there was no constructive trust because the Policy was not expressed to be held by the insured for the benefit of its clients or others. Further, HHJ Paul Matthew did not agree it was a term of the design contract that the clients should have a proprietary interest in the insurance proceeds. He held that it was not so obvious that an implied term was required to give business efficacy to the contract.

The claimants appealed. 

Submissions

The appellants filed an appeal on two bases:

1. There was an implied term in the interior design contract and also in the Policy, such that if the Company believed that it might be unable to pay the claim from its available resources (referred to as the “Relevant State of Mind”), the Company would not dissipate or use the insurance money for other means or use it in any way that was in conflict with its “Paramount Purpose”. 
   
   The “Paramount Purpose” was that of ensuring the Company was financially secure to compensate its clients.
   
   In other words, the submission was that the Company could use the money for its own purposes until it had reasonable grounds to suspect or believe that it might be unable to meet a client’s claim from other resources. This term was said to be implied on the basis that the professional indemnity insurance had been entered into by the Company for the benefit of its clients.
   
   In support of this, the appellants relied upon Impact Funding Solutions v Barrington Support Services Ltd².
2. Alternatively, there was a constructive trust over the proceeds of the Policy because it would be unconscionable for the Company to retain the insurance money if it had the “Relevant State of Mind”.

Court of Appeal decision

Lord Justice Zacaroli gave the leading judgment with which Lord Justice Arnold and Lord Justice Moylan agreed.

Zacaroli LJ noted that the appellants would need to be successful in their arguments that there was an implied term giving rise to a trust over the insurance proceeds; a simple contractual right to the proceeds would add nothing to the appellant’s existing rights to any assets in the liquidation if they were successful in their professional negligence claim.

Zacaroli LJ agreed that the condition under the interior design contract to obtain and maintain liability insurance had some benefit to the clients. However, the direct purpose of the insurance was to the Company to provide it with the monies to meet claims made against it without diminishing its own resources. Any benefit to the Company’s clients was indirect. There was no need to imply a term into the contract to recognise this indirect benefit.

He was sympathetic to the circumstances that the appellants found themselves in, but this was not enough to imply a term into the contract or Policy as submitted:

• The implied term did not meet the legal requirements for necessity and certainty.
• An implied term requires identifying what the parties would have agreed with sufficient clarity to meet the “notional bystander” test and also to give business efficacy to the design contract. The former requires the party seeking to imply the term to prove that the notional bystander would have no hesitation in assuming what the parties had intended. In this case there were any number of possible options as to what may have been agreed as to the timing of when a trust would arise from the implied term, both in relation to the state of the Company’s finances and the state of mind required of its directors.
• Similarly, the Judge rejected the submission there was an implied term in the Policy because an insurer’s obligations under the Policy ended upon payment of its limit to the insured. There was no reason why a policy would be ineffective without a restriction on the insured as to the use of the funds, and hence such an implied term was not necessary.
• The parties could have made it an express and specific term of the interior design contract that the appellants/clients would have had a proprietary right or security interest over the Company’s rights under the Policy or any other assets of the Company. However, they did not do so, and thus the appellants/clients assumed the “ordinary risk” of dealing with a company/professionals who later could and did become insolvent.
• Even if there were an implied term, the Judge did not agree that this gave rise to any trust. A trust requires certainty of intention, subject matter and object. The argument that the “Paramount Purpose” of the insurance monies was to ensure the Company could financially compensate the clients itself fell short of requiring the insurance proceeds to be ringfenced for the claim. The appellants had accepted that the Company could use the monies in its defence of the appellants’ claim. This was inconsistent with the application of the trust, as this permitted the Company to use some of the money for purposes directly opposed to the interests of the supposed beneficiary. 

As to the second ground regarding a constructive trust, Zacaroli LJ did not agree that it would be unconscionable for the Company to retain the insurance monies, given that they could be used for the Company’s defence. He perceived this as an attempt to “resurrect” the type of constructive trust recognised in Neste Oy v Lloyds Bank plc³ which was rejected by the Supreme Court in Angove’s Pty Ltd v Bailey⁴. There was no limitation on use of the money based on the circumstances of its payment. 

Takeaways

The judgment is perhaps unsurprising given the law that terms are only to be implied where they are essential for certainty and clarity, and the resulting general reluctance of the courts to imply terms. Here it was neither clear nor certain that the Company had agreed to use insurance proceeds as contented for by the claimants.

The Court of Appeal’s decision makes it very clear that, in the absence of clear, specific wording in a contract between a client and a professional relating to the proceeds of professional indemnity insurance, no term ringfencing the proceeds in favour of the client will be implied. This applies even in unfortunate circumstances such as those in this case.

It is also unfortunate for the claimants/appellants that they were not afforded the protections under the Third Parties (Rights Against Insurers) Act 2010 due to the timing of the specific insolvency steps taken in this case. In other circumstances the Act may have applied and may have assisted with their claim to the insurance monies.

Footnotes

1. [2025] EWCA Civ 906
2. [2017] AC 73
3. [1983] 2 Lloyds Rep 658
4. [2016] UKSC 47