Folgate London Market Ltd v Chaucer Insurance Plc

The appellant is Folgate London Market Limited (‘Folgate’), an insurance broker. It was formerly known, and was sued, as Towergate Stafford Knight Company Limited. The respondent is Chaucer Insurance Plc (‘Chaucer’), a Lloyd’s syndicate. Folgate’s appeal is against an order dated 20 May 2010 made by Sir Edward Evans-Lombe sitting as a High Court Judge in the Chancery Division.

The issue before the judge was one of law arising on undisputed facts. It turned on whether a clause in a settlement agreement relieving the paying party from its obligation to make payment to the receiving party in the event of the latter’s insolvency infringed the so-called anti-deprivation principle that prevents the making of a valid contract by which a man’s property is to remain his until bankruptcy but is on such event to pass to someone else and so be taken away from his creditors.

The judge held that the relevant clause infringed the principle and made an order accordingly. Folgate, represented by Mr Knowles CBE QC, challenges his order. Chaucer, represented by Mr Zacaroli QC, seeks to maintain it. Both counsel also appeared before the judge.

I take these gratefully from the judge’s judgment. On 26 September 2001 Justin Mayhew suffered severe personal injuries when a load carried by a lorry driven by Phillip King and belonging to Milbank Trucks Limited (‘Milbank’) slipped and struck his car. Milbank was insured by Chaucer, but Chaucer declined to indemnify it against Mr Mayhew’s claim on the ground that the claim fell within an exception in the policy. On 14 September 2004 Mr Mayhew sued Mr King and Milbank in Cambridge County Court for damages. On 14 July 2005 he obtained judgment against Milbank for damages to be assessed.

Milbank, by a separate action in the Commercial Court, sued Folgate for damages for negligence in arranging Milbank’s insurance cover with Chaucer. That claim was, however, settled by an agreement made on 25 August 2006 (‘the agreement’). By the agreement, Folgate was to pay Milbank on the defined ‘Due Date for Payment’ £99,646.69 (being 85% of the payments that Milbank had to date paid out under Mr Mayhew’s judgment of 14 July 2005) and to indemnify Milbank in respect of its liability to Mr Mayhew for damages, interest and costs subsequently assessed to the extent of (a) 85% of any sum payable by Milbank by way of damages and costs up to £1m, and (b) 100% of any sum payable by Milbank by way of damages and costs in excess of £1m (whether my summary in (a) and (b) should also include a reference to Milbank’s interest liability depends on the correct construction of clause 4.2 of the agreement, but that question is not before us). Certain terms of the agreement are central to the issue before us and so I will break off the account of the facts to set them out.

Clause 1.5.1 defined the ‘Due Date for Payment’ as meaning:

Clauses 5, 9 and 11 provided:

Milbank entered into administration on 4 November 2008. It is insolvent. On 19 January 2009 Mr Mayhew joined Chaucer as the third defendant to his claim, as the insurer liable to meet any judgment by Mr Mayhew against Milbank under section 151 of the Road Traffic Act 1988. On the same day, in consideration of £5,000, Milbank’s joint administrators assigned to Chaucer its interest in the agreement of 25 August 2006. It is agreed that the assignment gave Chaucer the like right to challenge the validity of clause 11 as would have been open to Milbank’s administrators.

On 12 February 2009, in Mr Mayhew’s proceedings, Chaucer commenced a CPR Part 20 claim against Folgate to enforce the agreement and, in particular, its provisions for the indemnification of Milbank (and now, by the assignment, itself) against Mr Mayhew’s claim. Folgate filed a defence to that claim on 19 March 2009 relying on clause 11 as releasing it from all indemnification liability to Milbank by reason of Milbank’s supervening insolvency. If that assertion was correct, Chaucer, as Milbank’s assignee, could be in no better position than Milbank.

On 3 June 2009 Mr Mayhew’s claim against Mr King, Milbank and Chaucer was stayed on terms that Chaucer – on behalf of all defendants – paid him damages of £640,000 and £75,000 on account of costs. That meant that the ‘Due Date for Payment’ under the agreement was 21 days later, 24 June 2009. On 16 June 2009 the Part 20 proceedings in Mr Mayhew’s proceedings were transferred from Cambridge County Court to the Chancery Division, following which the trial of the issue between the Part 20 parties – Chaucer and Folgate – came on before the judge on 19 and 20 April 2010. The outcome of this issue has no impact upon Mr Mayhew’s position. Chaucer has satisfied his claim pursuant to its liability referred to in paragraph [8] above. The only question is whether it is entitled to be indemnified by Folgate to the extent of the obligation imposed on Folgate by clause 4 of the agreement.

The question for the judge was, therefore, whether clause 11 of the agreement validly achieved what it purported to achieve: namely, that Milbank’s insolvency released Folgate from its clause 4 payment obligation. The judge said that it was a longstanding principle of insolvency law that a court will refuse to give effect to provisions in a contract which achieve a distribution of the insolvent’s property running counter to the principles of insolvency legislation, i.e. other than equally in proportion to their provable debts. He referred to British Eagle International Air Lines Limited v. Compagnie Nationale Air France [1975] 1 WLR 758, per Lord Cross of Chelsea, at 779E; Perpetual Trustee Company Limited v. BNY Corporate Trustee Services Limited [2010] BCC 59, per Lord Neuberger of Abbotsbury MR at [32], [43] and [44], and Patten LJ at [113]. Paragraphs [44] and [113] both made it clear that no insolvent person may at any time contract for its property subsisting at the date of the insolvency to be dealt with or disposed of otherwise than in accordance with the Insolvency Act 1986. ‘Put another way’, said Patten LJ, ‘it is not possible to contract out of the Act.’ The judge referred to Ex parte Mackay (1873) LR 8 Ch App 643, where James LJ in this court, at 647, made an observation to the same effect; and to Money Markets International Stockbrokers Limited (in liquidation) v. London Stock Exchange Limited and Another ]2001] 2 BCLC 347, a decision of Neuberger J (as he then was).

Mr Knowles’s submission for Folgate to the judge was that the anti-deprivation principle did not apply where the relevant asset of the insolvent is a chose in action such as an agreement to indemnify and the clause operating as a defeasance is part of that agreement. All that clause 11 did was to put a time limit on the clause 4 indemnity. There was no reason why a time limit fixed by reference to a date could not have been validly provided for in the agreement. It instead chose to limit its operation by reference to an event, namely the onset of Milbank’s insolvency. There was, it was said, no reason to treat such a limit differently from a specific time limit.

The judge explained in [27] why, in the light of the authorities, he was unable to agree. It was accepted that the clause 4 indemnification agreement was an asset of Milbank which, absent clause 11, would have been available to be realised by Milbank’s administrators for the benefit of its creditors. There was an essential difference between a simple time limitation and a limitation by reference to the event of the commencement of an insolvent administration when considering the application of the anti-deprivation principle. He considered that a limitation by reference to a time period in circumstances leading the court to conclude that the period had been fixed deliberately to remove the asset from proving creditors in an impending insolvency administration might also persuade a court to strike down such time limitation by applying the anti-deprivation principle. If the argument were right, it would provide a means for the avoidance of the principle in many cases where in the past it has been applied. It could, for example, have been argued that the relevant provisions in Ex parte Mackay were nothing more than mere time limit provisions. In particular, Mr Knowles’s submission could not stand with the judgment of Neuberger J in the Money Markets case with which, although not bound by it, the judge respectfully agreed.

Mr Knowles’s skeleton argument in support of the appeal was dated 8 June 2010. It sought to meet the judge’s reasoning head on, in particular his point that it had not been in issue that Folgate’s clause 4 indemnification obligation was an asset of Milbank which, absent clause 11, would have been available for Milbank’s creditors. Mr Knowles’s submission was that that was to misstate the nature of the asset. The asset was in the nature of a promise and was thus one that by its very nature comprised the clause 11 limitation, which the judge did not recognise. The judge was also wrong to apply the authorities in the way that he did.

It is unnecessary to summarise the written argument further because in his oral argument Mr Knowles tacitly abandoned most of it and advanced a brand new argument that was not advanced to the judge. It was inspired by observations of Briggs J in Lomas and Others v. JFB Firth Rixson, Inc and Others [2010] EWHC 3372 Ch, in which judgment was handed down on 21 December 2010. The focus of the new argument was on clauses 5 and 9.1 of the settlement agreement, to which the judge did not refer in his judgment because they had played no part in the argument before him.

The new argument was to this effect. Clause 5 entitled Folgate to take over from Milbank the conduct of the defence of Mr Mayhew’s claim; and by clause 9.1 Milbank was to provide Folgate with all the assistance it reasonably required in conducting such defence (it was not suggested that clause 9.2 was material to the argument). Thus, said Mr Knowles, there was an apparent commercial link between Milbank’s obligation towards Folgate under clause 9.1 and the release of Folgate’s payment obligation under clause 11. The commercial justification for clause 11 was that Milbank’s required assistance was foreseen as likely to evaporate upon the occurrence of any of the triggering events it there described; and so the purpose of clause 11 was to release Folgate from a payment obligation in circumstances in which Milbank would not be in a position to continue to furnish assistance under clause 9.1. The termination of a payment obligation in circumstances in which the full consideration for such obligation is not going to be provided does not infringe the anti-deprivation principle.

It is sufficient to understand why the Lomas case was the inspiration for that argument by citing from three paragraphs from Briggs J’s judgment:

Taking that distinction at face value, I regard it as plain that it is not one that can lend succour to Folgate. The proposition that clause 11 can or must be interpreted as inspired by and linked to the thought that, in the particular events there described, Milbank would be unable to provide continuing assistance under clause 9.1 so that Folgate should in turn be released from its payment obligations under clause 4 is, it seems to me, and with respect to Mr Knowles’s careful argument, fanciful.

First, whilst the provisions in clauses 5 and 9.1 were perfectly reasonable ones to include in the agreement, and Folgate was potentially better off with them rather than without them, the clause 9.1 obligation was foreseeable as being in practice to be likely to be of little real value. By the time of the agreement, Mr Mayhew had already established liability against Milbank and all that remained was the assessment of his damages. It is far from clear what practical assistance, if any, it was perceived that Milbank might have been able to lend to that inquiry. There is of course no evidence as to whether, or when, Folgate ever so much as asked Milbank to provide any such assistance. Nor is there any evidence that, at the time of the agreement, Milbank was, or was perceived to be, in a position to give continuing assistance. If the intention of the agreement was to release Folgate from its obligation if Milbank were, upon request, to fail to provide any assistance reasonably required by Folgate, it could easily have so provided expressly. It did not purport to do that.

Secondly, whilst that last point is accepted, it is said that it achieved the like commercial result by clause 11. But, for four reasons, that is an improbable commercial objective to attribute to clause 11. First, there is no warrant for an inference that the onset of a Milbank insolvency event would automatically bring the shutters down on the giving of clause 9.1 assistance. Second, if this was the commercial objective of clause 11, it sought to achieve it by a considerable measure of overkill. In practice, it was foreseeable that all possible assistance might be provided well in advance of any determination of the damages assessment. If so, Milbank would have fully performed its clause 9.1 obligation, yet it would still forfeit the clause 4 payments if an insolvency event should ensue before payment was made. That scenario cannot be fitted into Briggs J’s second category. Third, it is tolerably obvious that clause 11 was not directed at meeting an incomplete performance of the clause 9.1 obligation. What triggers clause 11 is an insolvency event before the ‘Due Date for Payment.’ That is 21 days after the ‘full and final determination’ of Mr Mayhew’s outstanding claims. Nothing more can be asked of Milbank under clause 9.1 during that 21 day period, yet if it suffers an insolvency event during its currency, Folgate is let off the payment hook. How is that provision linked to the need to ensure that Milbank continues to provide the requested assistance?

Fourth, it is obvious that the commercial reality of the settlement agreement is that what Milbank and Folgate were agreeing to was that, if Milbank would stay its claim against Folgate, Folgate would pay it the clause 4 sums and take over the conduct of the defence of the Mayhew claim. That is what clause 3 of the settlement agreement says. It is true that clause 9.1 imposes upon Milbank the assistance obligation that it does. But to regard clause 11 as linked to a contemplated breach of that obligation is fanciful. Clause 9.1 is a minor collateral obligation, likely in practice to be of little commercial value. There is no evidence before us that it was of any value at all. The big guns of clause 11 were not deployed to deal with any contemplated breach of it.

What was the commercial objective of clause 11? Save for the suggestion that it was linked in the way described to clause 9.1, Mr Knowles was unable to explain it. As it seems to me, it was apparently a naked attempt to provide that, whilst Milbank’s right to payment and Folgate’s obligation to pay were to survive so long as the payment would accrue exclusively to the benefit of Mr Mayhew, they were to be extinguished if such payment would instead be available for Milbank’s creditors generally in the event of its insolvency. This is not a commercial purpose so much as a collateral device to avoid the consequences of the insolvency legislation.

Once the argument based on clause 9.1 is rejected, which is what I would do, Mr Knowles’s cupboard of arguments was bare. The case then becomes a straightforward one in which, as I consider the judge rightly held, clause 11 infringed the anti-deprivation principle. The main submission advanced in Mr Knowles’s written argument, although not one that I understood him to seek to develop orally, was that it is fallacious to regard Milbank’s right to payment under the agreement as an asset available for creditors, because it was of the essence of that asset that it was a chose in action in respect of which the clause 11 condition prevented its being so available. This argument, sometimes called ‘the flawed asset’ argument, invited the conclusion that clause 11 therefore involved no infringement of the anti-deprivation principle. The creditors were not deprived of the asset because it was not one to which they ever had a right.

If the condition resulting in the non-availability of an asset to creditors in the event of the subsequent insolvency of the asset holder is unrelated to such insolvency, it may well be that the anti-deprivation principle has no role to play. In this case, however, the relevant condition was Milbank’s insolvency. The agreement entitled Milbank to a chose in action in the nature of a debt that was to be released upon its insolvency. The reason for the release was not because the debtor would not receive continuing consideration for the performance of his obligation that, but for the insolvency, he would have received. The effect of the release, if valid, was simply to remove the asset from the creditor’s debtors generally.

The authorities show that a condition of that nature infringes the anti-deprivation principle. The basic principle is illustrated by Whitmore v. Mason (1861) 2 J & H 204, which concerned the validity of a provision in a partnership deed under which, in the event of a partner’s bankruptcy or insolvency, his share in a mining lease forming part of the partnership property should accrue to his co-partners. The provision was held to be void. Sir W. Page Wood V-C said, at 212:

Ex parte Mackay (1873)LR 8 Ch App 643 is much closer to the present case. Jeavons entered on the same date into three linked agreements with Brown. By the first, he sold a patent to Brown in consideration of the payment of royalties for six years. By the second, he charged to Brown a lease to secure the repayment of 12,500 lent to him by Brown. By the third, the parties agreed that Brown should not press for payment of the loan or enforce the security, but should retain half the royalties, as they became payable, towards the satisfaction of his debt. They further agreed that if Jeavons became bankrupt or made an arrangement with his creditors, Brown might retain the whole of the royalties in satisfaction of his debt. But for that last provision, half the royalties would, on the occurrence of the relevant insolvency event, have been available for Jeavons’s general creditors (who would have included Brown). The purport of the provision was to give a preference to Brown over Jeavons’s creditors generally.

The court held that the third agreement constituted the creation by Jeavons of a valid charge or lien in favour of Brown in respect of half the royalties, but that the attempt to give him a charge on the other half in the event of Jeavons’s bankruptcy failed as being in fraud of the bankruptcy laws and so void. James LJ said, at 647:

That authority appears to me to provide a clear pointer to the answer to the present case. Under the arrangements in Ex parte Mackay Brown was required to pay half the royalties to Jeavons until the latter’s bankruptcy, whereupon Brown would be released from that obligation and was instead given a lien or charge over that half enabling him to apply it in or towards satisfaction of his debt. In the present case, Folgate was obliged to make the clause 4 payments to Milbank by a particular date conditionally upon Milbank not having entered an insolvency regime by that date, upon the occurrence of which condition Folgate was to be released from its payment obligation. The case appears to me an even more blatant example of the relevant vice than was Ex parte Mackay, in which Jeavons and his creditors were only purportedly deprived of the royalties that Brown contracted to pay up to the limit of the debt due from Brown to Jeavons. In this case, the Folgate debt was wholly released.

The basis of the principle underlying the decision in Ex parte Mackay is that a purported ‘contracting out’ of the insolvency legislation is contrary to public policy, as Lord Cross of Chelsea explained in his speech in the House of Lords (the main speech of the majority) in British Eagle International Airlines Ltd v. Compagnie Nationale Air France [1975] 1 WLR 758, at 780. British Eagle shows that Ex parte Mackay was rightly decided. That was also accepted by the minority, with Lord Morris of Borth-y-Gest delivering the main dissenting speech. The minority view was based on its assessment that the commercial arrangements in issue, unlike those in Ex parte Mackay, could not be regarded as a device for defeating the bankruptcy laws. The majority’s view was that a purported contracting out of the bankruptcy laws was nevertheless their effect. I have no doubt that all members of the House would have regarded clause 11 of the agreement in the present case as being void.

I would dismiss the appeal.

I agree.

I also agree.