The Law Society of England and Wales & Ors v Shah & Ors

This case raises a question of some importance in relation to the rights of injured third parties to claim on the insurance of a bankrupt wrongdoer under the Third Parties (Rights against Insurers) Act 1930 when the wrongdoer has obtained his discharge from bankruptcy.

Between November 1998 and mid-2000 Dixit Shah acquired a number of firms of solicitors (or sole practitioners’ practices). Following these acquisitions it is alleged that the firms traded in an association of firms under the name “the BJ Brandon Group”. On 22^nd September 2000 the Office for the Supervision of Solicitors (“the OSS”, now known as the Solicitors Regulation Authority) intervened on each of the firms. The Law Society alleges that the OSS discovered that a total of around £12.5 million had been misappropriated from the client accounts of the firms by Mr Shah. Shortly after the intervention it appears that Mr Shah left the jurisdiction.

The Law Society maintains a fund under section 36 of the Solicitors Act 1974 (“the 1974 Act”) from which payments by way of compensation can be made to victims of misappropriation by solicitors. This fund has made payments to clients of the firms of solicitors who were victims of the alleged misappropriation by Mr Shah. As at November 2006 it had made payments of around £12.5 million.

By sections 36(4)-(6) of the 1974 Act the Law Society is subrogated to the rights and remedies of the victims in relation to the acts or defaults in respect of which payments have been made by the fund. So the Law Society has the rights of the victims, and can pursue those rights against the alleged wrongdoers, for what they are worth.

The Law Society has accordingly, at various dates from 30^th August 2005, issued 12 sets of proceedings by way of claim form (“the Main Proceedings”). The Claimants are the Law Society and the injured parties. The Defendants to these proceedings are alleged to have been partners in one or more of the firms prior to or following the acquisition. In each case the list of Defendants includes, but is by no means limited to, Mr Shah. The Law Society has made clear that it makes no allegation of dishonesty in any of the proceedings against any of the non-Shah Defendants.

It is not necessary to rehearse in any detail the nature of the claims made in the Main Proceedings against the non-Shah Defendants. They are in essence claims that the partners in question were in breach of contract or fiduciary duties or duties as trustees or duties of care, by failing to notify the clients of the acquisition by Mr Shah, failing to account to the clients for their monies, failing to obtain their consent to the transfer of their contracts of retainer and failing adequately to protect their interests.

Three of the Defendants in the Main Proceedings are discharged bankrupts. They are Raymond Barda, Marcus Graziani and Zaheda Aziz (“the Discharged Bankrupts”). There are 8 actions (out of the total of 12) in which one or other of them is a Defendant. They were made bankrupt on various dates between February 2001 and January 2002. They were discharged from bankruptcy under section 281 of the Insolvency Act 1986 (“the 1986 Act”) on various dates between February 2004 and May 2005. In the Main proceedings, the Discharged Bankrupts plead their discharge from bankruptcy as a complete defence to the actions. Raymond Barda is a defendant in only one set of proceedings, which has been referred to as “the Barda Proceedings”.

The Law Society now concedes that the effect of the discharge from bankruptcy is that they cannot succeed in the Main Proceedings against the Discharged Bankrupts. To that extent, it is accepted by the Law Society that the application by the Discharged Bankrupts to strike out the proceedings in their current form as against them succeeds.

Since 1976, solicitors have been required by law to take out and maintain Professional Indemnity insurance. None of the Discharged Bankrupts had the benefit of such compulsory insurance. In such circumstances, cover for such firms is provided by the Law Society’s “Assigned Risks Pool”. That cover is underwritten by all qualifying insurers who provide cover for firms who insure through commercial providers. St Paul Travelers Insurance Company Limited acts on behalf of the qualifying insurers subscribing to the Law Society’s Assigned Risks Pool in the relevant year, which is 2000/2001. I will refer them as “the Insurers”. On these applications, the Insurers and the Discharged Bankrupts were represented by the same solicitors and counsel. No point is taken on the fact that the insurance cover for the acts and defaults of the Discharged Bankrupts arises in this particular way.

Recognising that it has no prospect now of succeeding in its subrogated claim against the Discharged Bankrupts, the Law Society wishes to take advantage of the Third Parties (Rights against Insurers) Act 1930 (“the 1930 Act”). The 1930 Act provides so far as material

“(1)

Where under any contract of insurance a person (hereinafter referred to as the insured) is insured against liabilities which he may incur, then –

(a)

in the event of the insured becoming bankrupt...

if, either before or after that event, any such liability as aforesaid is incurred by the insured, his rights against the insurer under the contract in respect of the liability shall, notwithstanding anything in any Act or rule of law to the contrary, be transferred to and vest in the third party to whom the liability was so incurred.

(2)

Where the estate of any person falls to be administered in accordance with an order under section 421 of the Insolvency Act 1986, then, if any debt provable in bankruptcy …. is owing by the deceased in respect of a liability against which he was insured under a contract of insurance as being a liability to a third party, the deceased debtor’s rights against the insurer under the contract in respect of that liability shall, notwithstanding anything in any such order, be transferred to and vest in the person to whom the debt is owing.

...

(4)

Upon a transfer under subsection (1) or subsection (2) of this section, the insurer shall...be under the same liability to the third party as he would have been to the insured...”

The central issue between the parties on these applications is whether it is possible for the Law Society to claim payment from the Insurers under the 1930 Act in respect of their claims against Messrs Barda, Graziani and Aziz after those individuals have not only been made bankrupt but have also been discharged.

The following applications are before the court:

Insurance for liability to third parties could in principle take a number of different forms. At one extreme the insurer could agree to indemnify the insured only when the insured has been found liable to pay and in fact paid the third party’s claim. Examples of contracts including a requirement for payment of the claim are the “pay to be paid” clauses to be found in some contracts of marine insurance on which the courts have had to adjudicate in the past: see for example Firma C-Trade v Newcastle Protection and Indemnity Association (“The Fanti” and “The Padri Island”) [1991] 2 AC 1. In such cases it has been held that payment by the insured to the third party is a condition precedent to recovery by the insured under his contract of insurance. Unless and until that condition was fulfilled, the insured could not recover against the insurance company. Upon the insolvency of the insured, therefore, the third party acquired no rights against the insurer unless and until the third party was paid.

At the other extreme would be a form of insurance where indemnity is provided against all claims by third parties. Under such a form of insurance the insurer becomes liable to the insured at the point when the insured becomes liable to the third party, in the sense that the third party has a cause of action against the insured. It matters not that the cause of action had not matured into a judgment or otherwise been ascertained. Accordingly the insured can look to his insurer for an indemnity whenever a claim is made. This type of insurance would operate on the basis that the insured has suffered an indemnifiable loss as soon as a claim is made against him, although the claim has neither been admitted nor adjudicated upon.

A middle line between these forms of insurance is to provide indemnity to the insured only when his legal liability to the third party has been established in some way. That was the view taken by the Court of Appeal in Post Office v Norwich Union Fire Insurance Society Limited [1967] 2QB 363 of a contract of insurance which provided indemnity for “all sums which the insured shall become legally liable to pay as compensation in respect of loss of property”. The claim was by the Post Office against a contractor, Potters, for damaging one of their cables which in consequence the Post Office had to repair. Before the Post Office had sued Potters, Potters went into liquidation. The Post Office sued the insurance company direct purporting to make use of the 1930 Act, but before the Post Office’s claim against Potters had been the subject of adjudication or agreement. Lord Denning MR said at 373G:

“It seems to me that the insured only acquires a right to sue for the money when the liability to the injured person has been established so as to give rise to a right of indemnity. His liability to the injured person must be ascertained and determined to exist, either by judgment of the court or by award in arbitration or by agreement. Until that is done the right to an indemnity does not arise. I agree with the statement by Devlin J in West Wake Price & Co v Ching [1957] 1 WLR 45, 49. “The assured cannot recover anything under the main indemnity clause or make any claim against the underwriters until they have been found liable and so sustained a loss”

In that passage Lord Denning MR says that the liability must be “ascertained and determined to exist”, and that this may be achieved by judgment, arbitration award or agreement. At page 375 BC he added this:

“In these circumstances I think the right to sue for these moneys does not arise until the liability of the wrongdoer is established and the amount ascertained. How is this to be done? If there is an unascertained claim for damages in tort, it cannot be proved in the bankruptcy; nor in the liquidation of the company. But nevertheless the injured person can bring an action against the wrongdoer.”

In that passage Lord Denning does seem to countenance the possibility that one way of ascertaining the claim and establishing the loss would be through the procedure of proving the claim in the bankruptcy of the individual or the insolvency of the company. The difficulty to which he refers, namely that an unascertained claim for damages in tort could not be proved in the bankruptcy was then, but is not now, an obstacle to proving such a claim. That is important, because the proof of debt route is now the principal mechanism by which the Law Society submits that it can establish the claim in the present case.

Salmon LJ agreed with Lord Denning. He explains that when the liability is established, it dates from the date when the cause of action arose. At 377E he said:

“The case really resolves itself into this simple question: Could Potters on June 17, 1965, have successfully sued their insurers for the sum of £839 10s 3d which they were denying they were under any obligation to pay the Post Office? Stated in that way, I should have thought the question admits of only one answer. Obviously Potters could not have claimed that money from their insurers. It is quite true that if Potters in the end are shown to have been legally liable for the damage resulting from the accident to the cable, their liability in law dates from the moment when the accident occurred and the damage was suffered. But whether or not there is any legal liability and, if so, the amount due from the Potters to the Post Office can, in my view, only be finally ascertained either by agreement between Potters and the Post Office or by an action or arbitration between Potters and the Post Office.”

Accordingly in Post Office the Post Office was required to commence and pursue an action against the insolvent Potters in order to establish the existence of its claim against Potters, and thereby create an indemnifiable loss within the policy of insurance. Although Potters could be said to have incurred a liability, it was not one which gave it any rights to claim under the insurance. A condition precedent to the creation of those rights was the establishment of the claim against it. Only then could the Post Office proceed against the insurers making use of the transferred rights under the 1930 Act.

Twenty years later the decision in Post Office came under attack in the House of Lords in Bradley v Eagle Star Insurance [1989] 1 AC 957. Mrs Bradley was employed by Dart Mill for various periods between 1933 and 1970 and acquired byssinosis from inhaling cotton dust. The company was wound up in 1975 and dissolved in 1976. In 1984 she applied to the court for pre-action disclosure under section 33(2) of the Supreme Court Act 1981 and RSC Ord. 24 rule 7A. She wanted to see the terms of Dart Mill’s insurance contracts so that she could, if appropriate, bring a claim under the 1930 Act. The House of Lords (Lord Templeman dissenting) dismissed her appeal. Lord Brandon, who gives the leading speech, appears to treat the question of what is needed to establish a claim under a contract of liability insurance as one of pure law – he had to do so as the insurers were declining to provide the contracts in question. Be that as it may, at 966 B he concluded:

“In my opinion the reasoning of Lord Denning MR and Salmon LJ contained in the passages from their respective judgments in the Post Office case set out above, on the basis of which they concluded that, under a policy of insurance against liability to third parties, the insured person cannot sue for an indemnity from the insurers unless and until the existence and amount of his liability to a third party has been established by action, arbitration or agreement, is unassailably correct”.

In contrast to the position in Post Office, the consequences for Mrs Bradley were not merely procedural. As the company no longer existed and could no longer be resurrected, it was not possible for her to pursue any action against it. She was left without any means of establishing her claim against Dart Mill, and, in consequence, without any means of establishing an indemnifiable loss under the policy.

In the present case the policy of insurance provided by the Assigned Risks Pool provided as follows:

“1.1

Civil Liability

The insurer will indemnify each Insured against civil liability to the extent that it arises from Private Legal Practice in connection with the Firm’s Practice, provided that a Claim in respect of such liability is first made against an insured

(a)

during the Period of Insurance; or

(b)

during or after the Period of Insurance and arising from Circumstances first notified to the Insurer during the Period of Insurance.”

It is clear that this is not insurance against “claims” in the broad sense indicated above. Indeed Mr Edwards QC, who appeared on behalf of the Law Society with Mr Lloyd Tamlyn, made it clear that he accepted the two stage process of creating liability under the policy in favour of a third party, namely ascertainment of the claim against the insured, and subsequent enforcement of the rights under the 1930 Act against the insurer. He directed his submissions to what would amount to sufficient ascertainment of the claim.

A contract of insurance is one that indemnifies the insured against loss of a kind defined by the contract. It seems to me that the effect of construing contracts of indemnity in the way indicated in the cases of Post Office and Bradley is to limit the definition of the indemnifiable loss to those circumstances where a claim has been elevated from a mere disputable claim to one which has been accepted by agreement or adjudicated upon in favour of the third party. The intention of the parties to the contract is that while the claim remains disputable, it is not established that the insured has suffered a loss. Once the claim is settled or adjudicated on, it is clear that he has suffered a loss because he has come under an indisputable obligation to pay. Although it might be said that the insured was always under an obligation to pay from the moment the cause of action arose, once the claim is agreed or adjudicated on that obligation acquires a different quality. It is only where there is an established obligation to pay that an indemnifiable loss comes into being and that the indemnity under the contract arises.

It is important to bear in mind that the purpose of the requirement for the claim to be established is not so that the value of the claim is precisely quantified. Even once the claim is established in one of the ways mentioned by the Court of Appeal in Post Office, the insurer is not bound by any valuation of the claim by the court, or the sum agreed by the insured. What is necessary to establish an indemnifiable loss is that the claim be elevated to one which is no longer disputable as between the third party and the insured.

In their written submissions the Law Society suggested they could establish the claim in the present case by amending their pleadings (as sought by the Amendment Application) to seek declarations that, prior to the discharge from bankruptcy, the Discharged Bankrupts were liable to the Law Society. In oral submissions Mr Edwards QC recognised that the declaration sought was not on its own going to be sufficient for the Law Society’s purpose. A declaration that throughout the period up to their discharge the Discharged Bankrupts could have been successfully sued by the Law Society would not be adequate to establish that the Discharged Bankrupts had suffered an indemnifiable loss. It was for this reason that Mr Edwards, without formally abandoning the amendment application, focussed his submissions on the Bankruptcy Application.

I have set out the material parts of section 1 of the 1930 Act above. The Act was passed in order to remedy a situation which had arisen in In re Harringtons Motor Co. Ltd; ex p Chaplin [1928] Ch 105 and elsewhere. In that case a victim had recovered judgment against a company for damages for personalinjury following a motor accident. The company was insured. The insurance company had conducted the defence of the claim and paid the company the amount of the claim less certain deductions. The company had gone into liquidation. Eve J held that the victim had no claim to the proceeds of the policy, which fell to be distributed by the liquidator as part of the company’s assets for the benefit of the creditors as a whole. This result was thought to be manifestly unjust, as it subverted the primary purpose of insurance for third party liability.

It is clearly established that, upon transfer, the third party steps into the shoes of the insured party, and can emerge in no better position as against an insurer than that of the insured himself. As Lord Brandon said in The Fanti and the Padri Island (supra) at 29F

“It is abundantly clear from the express terms of the Act of 1930 that the legislature never intended .. to put a third party in any better position as against an insurer than that of the insured himself.”

The statutory transfer to the third party (for that is what it is) of the insured’s right against his insurer takes place at the moment of his bankruptcy: see Cox v Bankside Members Agency [1995] 2 Lloyd’s LR 437 at 442, Re OT Computers Limited [2004] Ch 317 at [46]; FSCS v Larnell [2006] QB 808 at [12]. If, at that point, the third party’s rights against the insured remain to be established, then the third party’s right against the insurer will be contingent or inchoate, and will remain so until the insured’s liability to the third party becomes established.

It is, of course, relevant to consider the background of bankruptcy law against which the 1930 Act was passed. At that time there was no automatic discharge of the bankrupt, or even automatic review: he had to apply for his discharge after his public examination was complete. Many bankrupts did not bother to apply for their discharge. It was not until the Insolvency Act 1976 that automatic review to determine whether or not discharge was appropriate was introduced. The 1986 Act, as originally enacted, provided for automatic discharge after 3 years, reduced to one year by the Enterprise Act 2002. The Insurers and the Discharged Bankrupts pray this in aid. They say there would be nothing surprising if the 1930 Act did not protect victims where the insured was discharged from bankruptcy. Given the length of time before discharge might occur, if it was to occur at all, it is unlikely to have been in the minds of the framers of the 1930 Act as a situation likely to arise.

Equally it might be considered a somewhat harsh and surprising result if the effect of discharge from bankruptcy is now to provide a cut off period of 12 months from bankruptcy during which a claim must be brought.

It is against this background that I have to determine whether the effect of discharge is as the Insurers and the Discharged Bankrupts contend.

Mr Sheldon QC, who appeared on behalf of the Insurers and the Discharged Bankrupts with Mr Stephen Robins, submitted that the effect of the discharge of a bankrupt was to “extinguish” his debts. By this he meant that the discharge had the effect not simply of releasing the bankrupt from the remedy of an order for payment, but also extinguishing the cause of action on which the obligation to pay is founded. If he is right about this then it provides a short-cut to success for his clients, because nobody can claim on insurance in respect of an obligation which has been wholly extinguished. It would be, as he put it, as if the Law Society had themselves signed a release of their underlying claims and thereby destroyed their underlying cause of action.

The distinction between remedy and underlying cause of action is a familiar one from the law of limitation. A limitation defence normally bars the remedy and not the right. When the effect of the expiry of a limitation period is to extinguish the underlying right and not merely the remedy it is spelt out in the statute: see e.g. Limitation Act 1980 s 3 and 17. Mr Sheldon contended that discharge from bankruptcy extinguishes the underlying cause of action as well.

The starting point is section 281(1) of the 1986 Act:

“Subject as follows, where a bankrupt is discharged, the discharge releases him from all the bankruptcy debts, but has no effect –

(a)

on the functions (so far as they remain to be carried out) of the trustee of the estate, or

(b)

on the operation, for the purposes of carrying out those functions, on the provisions of this Part;

and, in particular, discharge does not affect the right of any creditor of the bankrupt to prove in the bankruptcy for any debt from which the bankrupt is released.”

This language, which preserves the right to “prove … any debt from which the bankrupt is released”, suggests to me that the underlying cause of action remains, so that it can be proved in the bankruptcy after discharge. It is only the remedy of enforcement as against the bankrupt which is extinguished, the creditor being left to the collective enforcement procedure under the 1986 Act to secure satisfaction of the underlying cause of action out of the estate in the hands of the trustee in bankruptcy, perhaps only to the limited extent that he can.

It is true to say that in Professor Fletcher’s “The Law of Insolvency”, 3^rd Edition at paragraph 11.023 he says:

“Where discharge had been effective to release a debt, the creditor’s right of action is totally lost and is not revived because after discharge the creditor may utter a promise to pay”

The authority cited in support of this proposition is Heather & Son v Webb (1876) 2 C.P.D. 1. In that case it was alleged that subsequent to the discharge of the debtor, he had uttered a fresh promise to pay the debt. The decision turned on the proper construction of section 49 of the Bankruptcy Act 1869. Previous statutes had made express provision making subsequent promises to pay of no avail to the creditor. That section was not in the same terms, but released the debtor from any proceedings in respect of any debt from which he is released”. Lord Coleridge CJ said at page 6-7

“The plaintiffs’ counsel was driven to say that this was not only not an action brought for the old debt, but not a proceeding in respect of the old debt…. It is in vain to say that this is not a proceeding in respect of a debt provable under the liquidation, and which was discharged by the order of discharge”.

In Wight v Eckhardt Marine [2004] 1 AC 147; [2003] UKPC 37 the Privy Council was concerned with the effect of a winding up. Lord Hoffmann said at [27]:

“The winding up leaves the debts of the creditors untouched. It only effects the way in which they can be enforced. When the order is made, ordinary proceedings against the company are stayed… The creditors are confined to a collective enforcement procedure that results in pari passu distribution of the company’s assets. The winding up does not either create new substantive rights in the creditors or destroy the old ones. Their debts, if they are owing, remain debts throughout. They are discharged by the winding up only to the extent that they are paid out of dividends. But when the process of distribution is complete, there are no further assets against which they can be enforced. There is no equivalent of the discharge of a personal bankrupt which extinguishes his debt”. [emphasis added]

I do not consider that Heather v Webb or Wight v Eckhardt provides support for Mr Sheldon’s proposition. Heather v Webb simply did not decide that the underlying cause of action was extinguished by the discharge: it simply held as a matter of statutory interpretation that the new proceedings based on the subsequent promise to pay was an action “in respect of” the old debt, and accordingly released by express statutory provision. Of course, Professor Fletcher is right in the sense that the creditor’s “right of action” is lost against the debtor, in the sense that he can no longer recover against the debtor, but that is not to say that the underlying cause of action is totally destroyed. In Wight v Eckhardt Lord Hoffmann was merely referring to the fact that there is no equivalent of discharge in corporate insolvency. The company can be dissolved, but if restored the company still faces the debts which it had at the date of dissolution. He was not considering whether, although released from the obligation to pay, the underlying cause of action remained.

Accordingly, in my judgment, the short cut does not work. It is necessary to go further and examine in more detail the Law Society’s argument. Before doing so it is necessary to consider the decision of the Court of Appeal in Financial Services Compensation Scheme Limited v Larnell Insurances (in liquidation) [2006] QB 808; [2005] EWCA Civ 1408 (“Larnell”).

In Larnell a group of investors claimed that their financial adviser, the defendant insolvent company, had given them negligent advice. The action was brought as a preliminary to claiming against the defendant’s insurers under the 1930 Act, in the way made necessary by the Post Office and Bradley cases. The judgments are mainly concerned with the limitation defences which were deployed with a view to striking the action out. The claimant had put in a proof of debt in the liquidation, but the liquidator had neither admitted nor rejected it (see Lloyd LJ at [6]). At [11] Lloyd LJ refers to Post Office and Bradley as deciding that establishment of liability by action, by arbitration or agreement between the insured and the third party, was a prerequisite. He then points out that agreement will not always be possible, for example where the policy prohibits it. He goes on

“If proceedings are necessary, they may take one of a number of forms. The obvious instance is a claim such as the present. Because the company is in voluntary winding-up it is unnecessary to obtain consent before starting such a claim. If the winding-up were compulsory the court’s permission would be needed, and the court might regard it as more appropriate for the third party to prove for its debt. If the liquidator were to reject that proof, the third party could appeal against that rejection under rule 4.83 of the Insolvency Rules 1986. That would lead to a judicial determination which would also be sufficient establishment of the liability of the insured. Nothing turns on the particular procedure adopted. It makes no difference whether the proceedings themselves are brought within the bankruptcy or winding-up proceedings or outside them, as is the present claim.”

Moore-Bick LJ at [63] was also of the view that an appeal by the claimant against the refusal of the liquidator to admit the proof would, if successful, “complete its cause of action against the insurers under the policy”.

It is right to point out that the observations of Lloyd and Moore-Bick LJJ were obiter. The case concerned an ordinary Part 7 claim, not a proof of debt; and the case involved the winding up of a company, not a discharged bankrupt. Moreover it cannot always be the case that the proof of debt will be an adequate substitute for a Part 7 claim to trigger the policy. As the Insurers and Discharged Bankrupts point out, contingent claims which could not be pursued to judgment under Part 7 because the contingency never arose are admissible in bankruptcy.

Nevertheless it does seem to me that the Court of Appeal in Larnell was contemplating that, in an appropriate case, it would be sufficient for the purposes of the 1930 Act for the third party to prove his claim in the bankruptcy without the need to proceed directly against the bankrupt by means of a Part 7 claim. If the Court of Appeal was right, then it is not a pre-condition of establishing a claim in the relevant sense that agreement be achieved with, or judgment or arbitration award be obtained against, the bankrupt himself: it suffices if the third party obtains a decision admitting the claim in the bankruptcy.

Mr Sheldon submits that admission of the claim in the bankruptcy is not sufficient to establish a loss covered by the policy. He says that the loss to the bankrupt is caused by the vesting of his estate in his trustee in bankruptcy, and that is not a loss covered by the policy. In a case where there is no surplus for the payment of a dividend, there is no loss by the admission of the claim because there are no assets to deplete. Even in a case where there is a surplus, the surplus is not diminished by civil liability: it is diminished by the fact that there are more claims.

I think these submissions miss the point. As I have concluded earlier, what is required to establish an indemnifiable loss under the policy is that the third party’s claim is raised to the status where it is established, in the sense that it no longer merely a disputed claim. The effect of its admission in bankruptcy is, in my judgment, to give it that elevated status. It matters not that it has not been accurately quantified according to strict rules of law, any more than it matters were the claim to be agreed by the bankrupt himself at a sum higher or lower than the third party’ strict entitlement. It matters not that there is no money in the estate, any more than it would matter if any other insured was unable to pay. It matters not that the loss to the bankrupt can be said to have been caused by the vesting of the estate in the trustee in bankruptcy: that will always be the case where liability is established after insolvency, so cannot be an answer here.

Mr Sheldon sought to make something of section 1(2) of the 1930 Act, which makes specific provision for what is to happen in the case of a deceased bankrupt. He says that is one situation in which specific provision is made for debts which have been affected by a subsequent event. He says that if the Law Society are right then a similar provision would be required to deal with the effect of discharge: but there is none. I am not persuaded by this. Section 1(2) specifies what is to happen notwithstanding anything in an order made under the Insolvency Act provision referred to. There is no corresponding need for such a provision here.

Mr Sheldon also submitted, on the basis of Larnell, that if, contrary to his primary submission, admission of the debt in bankruptcy was sufficient, only a judicial decision so admitting the debt would do. I think this is too literal a reading of Larnell. Lloyd and Moore-Bick LJJ were focussing on the case where no admission or agreement was obtained (see also [33]). In such cases an application to the Court and a judicial decision would be necessary. But I cannot see any logic in the contention that in the case of bankruptcy proceedings a judicial determination is necessary, when that is not the case outside the bankruptcy proceedings. So to hold would elevate the requirement for “establishment” of a claim yet further, and in a way which has no support from the policy of insurance itself. The passages in Larnell implicitly accept that where the debt is admitted, that is enough.

Of course I accept, as Mr Sheldon submitted, that Larnell was a case where the admission of the debt in bankruptcy would equiparate, as he put it, with the Part 7 claim. The Court of Appeal were dealing with an insolvent company, so no question of the release of the bankrupt from his debt could arise. That is correct, but it remains the case that the Court of Appeal considered, and I agree, that admission of the claim in bankruptcy was adequate establishment of a claim against an insured to enable them to say that the insured had suffered indemnifiable loss under the policy of insurance.

Mr Edwards submitted that this was clearly the position prior to the bankrupt’s discharge from bankruptcy. He went on to say that it is also the position after discharge provided, as the Law Society accepts it is obliged to establish in order to be able to prove in the bankruptcy, that the bankrupt was liable to the Law Society up to the date of his discharge.

In my judgment the Law Society is right. Once it is accepted, as I have done, that admission of the debt in the bankruptcy is adequate establishment of the Law Society’s claim to give rise to indemnifiable loss and a claim under the policy, then it seems to me that the release of the bankrupt from the obligation to pay (or more accurately the remedy of payment) is irrelevant. As Mr Edwards put it graphically, the admission of the bankruptcy claim hits the insured in the pocket in just the same way as the Part 7 claim: in neither case does it matter that there are no funds in the pocket to pay. And that is so just as much before discharge as after.

Does this result offend against the principle that the third party can acquire no better rights against the insurer than those possessed by the insured against the insurer? I do not think it does. The principle does not require there to be a moment in time when the right to claim under the policy and the indemnifiable loss are coincident in the insured. If that were so the indemnifiable loss could never be established after the insolvency, for it is at that point that the statutory transfer takes place. The requirement is that the insured should suffer an indemnifiable loss. The insured does suffer an indemnifiable loss at the point at which the debt is proved in his bankruptcy. Of course at that point he cannot himself make a claim under the policy, because his inchoate rights have already been transferred to the third party: but that is simply the effect of the 1930 Act. Upon the debt being admitted, the inchoate rights which were transferred to the third party are made good.

The law in this area has been the subject of a Law Commission Report: Third Parties – Rights Against Insurers; Cmnd 5217/2001. The Commissioners were Carnwath J, as he was then, Professor Beale and Partington and HHJ Wilkie QC as he then was. Their views are entitled to great respect.

Paragraphs 5.47 of the Report considers the effect of the insured’s discharge from bankruptcy on the third party’s right against him. It is not directed specifically to the question considered in this judgment of whether the third party’s rights against the insurer are lost by discharge, even if the liability is subsequently established by proof in the estate. Paragraphs 5.49 and 5.50 consider proposals for reform, a topic on which the Commission had not consulted. They concluded that discharge should have the effect of discharging the insurer from claims where no proceedings to enforce the liability (against insurer or insured) had been commenced at the moment of discharge, but not otherwise. The authors of the Report conclude paragraph 5.49 by saying “…we were concerned not to confer on the third party a right to issue proceedings against the insurer at a time when the insurer no longer owed any money to the third party”

Mr Sheldon relies on that paragraph. How he asked, could the Law Commission have put it in that way if the law already conferred on the third party the right to establish his debt for the first time after the discharge of the bankrupt? Whilst I appreciate the force of the submission, it does not in the end persuade me that the route propounded by the Law Society is unsound. The Commission did not have the benefit of the Court of Appeal’s decision in Larnell. Once it is recognised that proof of the debt in the bankruptcy (something which can be done both before and after discharge) is adequate to establish it for the purposes of a claim against the insurers, the discharge, as it seems to me, loses its significance. Whether the Law Commission’s policy conclusions (which are expressly stated to have been arrived at without consultation) are correct is not a matter for me.

The Law Society submitted that one appropriate means of determining the validity of the Law Society’s proof (which it has lodged) is for Mr Barda’s trustee (or in the case of the other two Discharged Bankrupts, the Official Receiver) to be joined to, and for the validity of the proof to be determined in, the present proceedings. It is suggested that the court has power to do this under section 363(1) of the 1986 Act. Under this mechanism it is suggested that there is no need for the trustees to consider or reject the proofs.

Alternatively, it submits that Mr Barda’s trustee and the Official Receiver can be allowed to reject the proof (as at least Mr Barda’s trustee has said he intends to do) and the Law Society’s “appeal” under paragraph 6.105 of the Insolvency Rules can be determined in the present proceedings. Either way, the insurers will be party to the proceedings and able to conduct Mr Barda’s defence.

Initially the Insurers and the Discharged Bankrupts submitted that the trustees had no power to consider the proofs at all except in the context of a creditors’ meeting or the payment of a dividend. In their oral submissions they modified this position and submitted (supported by counsel for the Official Receiver, Ms Anna Markham) that the trustees had a power but no duty to consider the proofs. Both Ms Markham, and Mr Jonathan Brettler who appeared as counsel for Mr Barda’s trustee, Mr Earp, emphasised the fact that there was no money in any of these estates. That being so the trustees were concerned not to incur costs.

So far as costs are concerned, the Law Society has indicated that it would not seek any order for costs against Mr Barda’s trustee or the Official Receiver and would indemnify them against any order for costs made against them at the suit of any other party provided that the trustees remained nominal parties to the proceedings.

The stance of the trustees in the present case is as follows. Mr Barda’s trustee is happy to act as a facilitator of the mechanism proposed by the Law Society, subject to the court being of the view that it would be proper for him to reject the proof without properly considering it. The Official Receiver’s view is that he ought to hold the proofs over. He considers it “well nigh impossible” to conduct the exercise required by section 322(3) of the Act and decide affirmatively whether to accept or reject the proofs.

The Insolvency Rules provide for a procedure by way of proof of debt, and for an application to the court by a dissatisfied creditor. In summary the procedure works as follows, borrowing heavily from the skeleton argument of the Insurers and Discharged Bankrupts:

Section 363(1) of the 1986 Act provides

“ 363.-(1) Every bankruptcy is under the general control of the court and, subject to the provisions in this Group of Parts, the court has full power to decide all questions of priorities and all other questions, whether of law or fact, arising in any bankruptcy.”

Section 303(1) provides:

“303.

-(1) If a bankrupt or any of his creditors or any other person is dissatisfied by any act, omission or decision of a trustee of the bankrupt's estate, he may apply to the court; and on such an application the court may confirm, reverse or modify any act or decision of the trustee, may give him directions or may make such other order as it thinks fit.”

On its face section 363(1) is in wide terms. The admission of the Law Society’s proof of debt is undoubtedly a question of fact arising in a bankruptcy. Can the court decide that question without the anterior decision of the trustee as anticipated by the Act and Rules? The trustees are neutral on the question, but Mr Sheldon submits that the right of any person to invoke that section must be found elsewhere in the Act. He stresses the words “subject to the provisions in this group of Parts”, points to section 303 and says that, if section 363 has the width contended for by the Law Society, section 303 would be unnecessary.

In Osborne v Cole [1999] BPIR 251, Registrar Baister (now Chief Bankruptcy Registrar) held at 255H that a person who challenges a trustee’s conduct under s 303 must show that the trustee is acting “in bad faith or so perversely that no trustee properly advised or properly instructing himself could so have acted, alternatively if he has acted fraudulently or in a manner so unreasonable and absurd that no reasonable trustee would have acted in that way”.

The Chief Registrar’s view was followed by Warren J in Supperstone v Hurst (No 3) [2006] BPIR 1263 and by the Deputy Judge (Gabriel Moss QC) in Shepherd v Official Receiver [2007] BPIR 101.

Mr Sheldon argues that the stance of the trustees in the present case cannot be brought within section 303, so section 363 should not provide a jurisdiction either.

I agree that the conduct of the trustees in the present case cannot be brought within section 303(1) if it is necessary to show conduct of the kind described in those cases. Indeed their stance is a pragmatic one: they simply do not have the resources to investigate the proofs, and, unless and until the court directs them in the exercise of their powers, they are under no duty to do so.

However I do not consider that section 363 is constrained in the way in which Mr Sheldon contends. In my judgment it is wide enough to give the court jurisdiction to decide a question properly arising in a bankruptcy, notwithstanding that other mechanisms might have existed for determining it. So to hold is not to disapply substantive provisions, as was the case in Re BCCI SA No 10 [1997] Ch 213. That would be the case if the Court were to sanction a procedure in which the proofs were not adjudicated on at all, but that is not what is proposed here.

The procedure proposed here is unusual. The proof of the debt in the bankruptcy is not sought for the usual purpose of obtaining a right to vote or a dividend. I was told, at least by the Official Receiver, that trustees are anxious about opening up the wide collateral use of the proof of debt procedure if this is permitted here. I can understand the concern, but in the present case the use for which the procedure is being used, though in a narrow sense collateral, is directed to satisfying the claim of a legitimate creditor without any possible harm to any other creditor.

It was not suggested that, if I came to the conclusion that I had the power to order a determination in this way (and that it would otherwise be effective to establish the claim), it was a power that I should not exercise in my discretion. Further, it seems to me that in the circumstances of this case it would be highly convenient if the issue of the admission of the proof should be decided at the same time as the actions against the non-Shah parties.

Accordingly, in my judgment, the Bankruptcy applications succeed to the extent that they seek determinations of the question of whether the Law Society’s proofs should be admitted in the bankruptcy.

It is not strictly necessary for me to decide, therefore, whether in a case such as this it would be appropriate for the trustee to reject the proof, not on its merits, but for the pragmatic reason that this would assist in obtaining a decision of the Court, enabling an “appeal” under the Rules. Whilst this approach has obvious attractions, I am not persuaded that it can be reconciled with the trustee’s obligation to examine the proof in a quasi-judicial capacity. I therefore say no more about it.

The Amendment application fails. The Strike Out applications succeed. The Bankruptcy Applications succeed. If the parties cannot agree, I will hear them on the appropriate form of order to give effect to these findings.