Case Study Two Firma C-Trade S.A. v Newcastle Protection and Indemnity Association (The Fanti) [1991] 2 A.C. 1

Case Study Two

Firma C-Trade S.A. v Newcastle Protection and Indemnity Association (The Fanti) [1991] 2 A.C. 1

Insurance—Marine—Protection and indemnity risks—Third party liability—Liability incurred by members of P. & I. clubs to cargo owners—Club rules containing 'pay to be paid' provision—Members wound up—Whether valid claim by cargo owners against clubs—Third Parties (Rights against Insurers) Act 1930 , s. 1(3)

In the first appeal a cargo claim had arisen in respect of the loss of cargo on board a motor vessel whose owners had entered it in the P. and I. club of which they were a member. The club rules provided by rule 4:

'a member shall be protected and indemnified against all or any of the following claims and expenses which he shall have become liable to pay and shall in fact have paid . . . (q) for loss or damage caused to . . . property . . . carried on board a ship entered in this class . . .'

The member did not defend the cargo owners' action against it and a default judgment was obtained for damages with interest. The judgment was not satisfied and subsequently the member was ordered to be wound up by the Companies Court. Thereupon the cargo owners instituted arbitration proceedings against the club in which they claimed an indemnity against them under the Third Parties (Rights against Insurers) Act 1930. The umpire made an award in favour of the club. On appeal by the cargo owners, Staughton J. allowed the appeal.

In the second appeal the vessel in relation to which a cargo claim had arisen was entered by the owners in the P. and I. club of which they were a member. The rules of the club included rule 2 under which they undertook to:

'Protect and indemnify members in respect of losses which they as owners of the entered vessel shall have become liable to pay and shall have in fact paid.'

The cargo owners asserted claims against the member arising out of voyages in the later part of 1965. Those claims were litigated in Florida and in 1975 the cargo owners obtained judgment against the member for damages including interest. The judgment was not satisfied and in April 1982 the Companies Court ordered the member to be wound up. Subsequently the cargo owners began two actions against the club in which they claimed a direct indemnity for their losses under the Act of 1930. Leggatt J. dismissed the actions on the ground that the rules in force at the relevant time contained a Scott v. Averyarbitration clause. In subsequent arbitration proceedings, the arbitrator found in favour of the club. On appeal Saville J. affirmed his decision.

On an appeal by the club against the decision of Staughton J. and an appeal by the cargo owners against the decision of Saville J., both appeals being heard together, the Court of Appeal affirmed the decision of Staughton J. and reversed the decision of Saville J.

On appeals by the clubs to the House of Lords:-

Held, allowing the appeals,

(1) that on the ordinary and natural construction of the 'pay to be paid' provisions of the clubs' rules payment by the members to the third parties, namely, the cargo owners, was a condition precedent to payment by the clubs to the members, and that there was no principle of equity which enabled those express provisions to be disregarded or overridden (post, pp. 23A, 27F-H, 28C-E, 30C, D, 31F-32A, 39G).

Collinge v. Heywood (1839) 9 Ad. & E. 633 considered.

(2) That the 'pay to be paid' provision being the terms of the contracts of insurance made between the members and the clubs did not purport, either directly or indirectly, to avoid those contracts or to alter the parties' rights under them upon the members being ordered to be wound up, so as to render those provisions to that extent of no effect under section 1(3) of the Third Parties (Rights against Insurers) Act 1930 (post, pp. 23A, 29A-B, 30C, D, 39G).

(3) That in the circumstances the members admittedly having no accrued rights to be indemnified by the clubs, the cargo owners could not, in consequence of the statutory transfer of rights under section 1(1) of the Act of 1930, have transferred to them any better or larger rights against the clubs than those which the members previously possessed; and that accordingly, the cargo owners' claims against the clubs failed (post, pp. 23A, 29D-F, 30C, 39G).

Staughton J. and the Court of Appeal were both correct in holding that if a member of the club had not paid a third party claim, then the only right which was capable of being transferred to a third party under section 1(1) of the Act of 1930 was, at best, an inchoate or contingent right to be paid. The member had no existing rights against the club prior to payment of the third party by the member.

The Act of 1930 makes it clear that, subject to section 1(3), the contractual rights, as between the insured and the insurer, will govern the rights of a third party after the transfer of rights has taken place under section 1(1). The effect of the arguments of the cargo owners is to put the cargo owners in a better position than the insured member. This was not the object of the Act of 1930. It's object was simply (a) to avoid the liability insurance moneys going into the pool of assets for the benefit of creditors generally and (b) to prevent the parties to the contract of insurance from seeking in their contract to alter or abrogate contractual rights which would (but for the stipulated events) continue to exist.

Rule 2 of the club's rules provides that the member is to have no claim on the funds of the club unless and until he has become liable to pay a loss or claim and is actually out of pocket. Three issues are raised by this appeal in connection with this rule. (i) Does the 'pay to be paid' provision apply at all if the member is insolvent? The respondents argued that on its true construction this rule had no application where the member lacked the means to pay or where the effect of making payment before reimbursement by the club would be to drive them into insolvency. They also argued that in equity the member was entitled to indemnity under the rule without first having paid the loss or claim: Bingham L.J. [1989] 1 Lloyd's Rep. 239, 244-246 and Stuart-Smith L.J., at pp. 259-260, correctly rejected those arguments.

My Lords, these two appeals, which have been heard together, raise the same important question of law in the field of marine insurance. It is a question which has been long debated but never until now come before the courts for decision.

The question arises in this way. It is the long-established practice of shipowners to enter their ships in Protection and Indemnity Associations ('P. & I. Clubs') for the purpose of insuring themselves against a wide range of risks not covered by an ordinary policy of marine insurance. By so entering one or more of their ships in a P. & I. Club shipowners become members of that club. P. & I. Clubs operate on a system of mutual insurance under which the successful claim of one member is paid out of the contributions of, and the calls made on, all the members including himself. Each member is accordingly both an insurer and an insured. Among the wide range of risks covered by P. & I. Clubs is liability incurred by members to cargo owners for loss of or damage to cargo carried in an entered ship.

P. & I. Clubs have bodies of rules governing the relationships between the club and its members and between one member and all the other members. When shipowners enter one of their ships in a P. & I. Club there comes into being a policy of marine insurance relating to that ship on the terms of the club's rules.

In the first appeal the ship in relation to which a cargo claim arose was the motor vessel Fanti, owned by a Ghanaian company called Central Shipping Lines ('the member') and entered by it in the Newcastle Protection and Indemnity Association ('the club'). The rules of the club in force at the material time provided:

'4. The member shall be protected and indemnified against all or any of the following claims and expenses which he shall have become liable to pay and shall in fact have paid . . . (q) For loss or damage caused to . . . property . . . carried on board a ship entered in this class . . .'

In March 1983 the Fanti left Rostock on a voyage to Nigeria with a cargo of cement in bags owned by Firma C-Trade S.A. ('the third party'). About eight days later the ship developed serious leakage resulting in the entry of sea water into certain of her cargo holds and other spaces. A distress call was sent out and the Fanti was escorted into Portuguese waters off Cascais by a salvage tug. Subsequently both ship and cargo were abandoned to the salvors. Soon after the casualty the third party began an action against the member in the High Court here claiming damages for loss of its cargo. The member did not defend the action and in due course the third party obtained a default judgment against it for $748,953 including interest. The judgment was not satisfied and on 30 July 1984 the Companies Court, on the petition of the third party, ordered the member to be wound up. The third party then instituted arbitration proceedings against the club claiming an indemnity against them under the Act of 1930. The umpire made an award in favour of the club against which the third party appealed by leave to the Commercial Court. The appeal came before Staughton J. [1987] 2 Lloyd's Rep. 299 by whom it was allowed.

In the second appeal the ship in relation to which a cargo claim arose was the steam tanker Padre Island, owned by Steam Tanker Padre Island Inc. ('the member') and entered by them in the West of England Ship Owners Mutual Insurance Association (London) Ltd. ('the club'). Under rule 2 of its rules the club undertook to:

'Protect and indemnify members in respect of losses or claims which they as owners of the entered vessel shall have become liable to pay and shall have in fact paid . . .'

A long list of losses and claims followed, including (j) cargo claims.

Before I state the reasoning on which the decisions of Staughton J. and Saville J. were founded, it is necessary for me to set out the material provisions of the Act of 1930 as applicable at the material time. In its long title the Act of 1930 is described as 'An Act to confer on third parties rights against insurers of third party risks in the event of the insured becoming insolvent, and in certain other events.' Section 1 provided at the material time [see above]

There were appeals to the Court of Appeal both by the club against the decision of Staughton J. and by the third party against the decision of Saville J. The two appeals were heard together in July 1988 by a court consisting of O'Connor, Bingham and Stuart-Smith L.JJ. On 30 November 1988 reserved judgments were delivered by which the court unanimously dismissed the club's appeal against the decision of Staughton J. and allowed the third party's appeal against the decision of Saville J.: [1989] 1 Lloyd's Rep. 239.

The reasoning on which the judgments in the Court of Appeal proceeded can be summarised as follows. First, no cause of action against either club was transferred under section 1 of the Act of 1930, because neither member at the time of winding up had a cause of action. Such contingent rights, however, as the members had in respect of the third party claims concerned were so transferred: those contingent rights would only grow into effective rights of immediate indemnity upon payment by the members of those claims: see p. 248, col. 2, and p. 249, col. 1, per Bingham L.J.

Secondly, under the rules of the two clubs it was the members who were subject to the burden of making payment and entitled to the benefit of the right to be indemnified. Upon the statutory transfer taking place it was more natural to treat both burden and benefit as being transferred to the third parties. The bundle of rights and duties which were transferred included the right or duty to arbitrate, the right of payment and the condition of prior payment. However, the condition of prior payment was impossible to perform once the statutory transfer had taken place and was therefore ineffective, leaving the third parties with immediate rights against the clubs for an indemnity: see p. 250, col. 1, per Bingham L.J. and p. 258, cols. 1 and 2, per Stuart-Smith L.J.

Thirdly, so far as section 1(3) of the Act of 1930 was concerned, the condition of prior payment expressed in the two insurance contracts did not have the substantial effect of avoiding the contracts upon the winding up of the members. Nor could it be said that this condition had the substantial effect of altering the rights of the parties upon the members being ordered to be wound up. What was affected or altered by the members being ordered to be wound up was the ability of the members to enjoy their rights, and not the rights themselves. Those rights remained the same before and after the event save that, upon the order for winding up being made, they were transferred to the third parties: see p. 251, cols. 1 and 2, per Bingham L.J., p. 260, col. 2, per Stuart-Smith L.J., and p. 264, col. 1, per O'Connor L.J.

Both clubs now appeal to your Lordships' House against the decisions of the Court of Appeal with the leave of that court.

My Lords, it is not in dispute that the 'pay to be paid' provisions in the rules of the two clubs which I set out earlier were terms of the contracts of insurance made between the members and the clubs. That being so, it seems to me that it is necessary, in order to determine these appeals, to pose and answer three questions.

First, immediately before the members were ordered to be wound up, what rights, if any, did the members have against the clubs under their contracts of insurance in respect of the liabilities which the members had previously incurred to the third parties?

Secondly, did the 'pay to be paid' provisions, being terms of the contracts of insurance made between the members and the clubs, purport, whether directly or indirectly, to avoid those contracts, or to alter the rights of the parties under them, upon the members being ordered to be wound up, so as to render those provisions to that extent of no effect under section 1(3) of the Act of 1930?

Thirdly, having regard to the answers to the first and second questions, what rights against the clubs, if any, were transferred from the members to the third parties upon the members being ordered to be wound up?

With regard to the second question, it was contended for the third parties that section 1(3) of the Act of 1930 rendered the 'pay to be paid' provisions in the clubs' rules of no effect, on the ground that they purported, directly or indirectly, to alter the rights of the parties under their contracts of insurance upon the members being ordered to be wound up.

With regard to the third question, there are two views as to what rights against the clubs, if any, were transferred from the members to the third parties upon the members being ordered to be wound up. The first view, which was taken by Staughton J. and the Court of Appeal, is that the third parties had transferred to them rights to be indemnified by the clubs, subject to a condition precedent that they, the third parties, first paid to themselves the amounts of the liabilities to them which had been incurred by the members; that such a condition precedent was impossible for the third parties to satisfy because a person cannot pay money to himself, and that it therefore became ineffective or inapplicable; and that, in the result, the rights transferred to and vested in the third parties were accrued rights to be indemnified by the clubs.

My Lords, having regard to the answers which I have given to the three questions discussed above, I am of opinion that the clubs' appeals against the decisions adverse to them made by the Court of Appeal should in both cases be allowed. On that basis certain other points in the second appeal, which were raised before the courts below and dealt with by them; do not require to be dealt with by your Lordships.

My Lords, I have had the advantage of reading in draft the speeches of my noble and learned friends, Lord Brandon of Oakbrook and Lord Goff of Chieveley. I agree with them and for the reasons given I, too, would allow the appeals.

My Lords, I agree that the appeals of the two clubs should be allowed for the reasons stated by my noble and learned friend, Lord Brandon of Oakbrook. I only add a few words of my own out of respect for the arguments of counsel, which I found to be of the greatest assistance in elucidating the questions at issue in these appeals.

This point was, to my mind, the central point in the two appeals before your Lordships' House. However, litigation at the pitch of intensity at which these cases have been conducted acts as a catalyst, from which new ideas can well arise; and here we have seen the emergence of two new arguments never before advanced in the present context. The first, which I shall call the 'futility point,' was taken by the third party (whom I shall refer to in each case as 'the cargo owners') for the first time before Staughton J. in Firma C-Trade S.A. v. Newcastle Protection and Indemnity Association (The Fanti) [1987] 2 Lloyd's Rep. 299; this found favour with Staughton J. in that case, though not with Saville J. in Socony Mobil Oil Co. Inc. v. West of England Ship Owners Mutual Insurance Association Ltd. (The Padre Island) (No. 2) [1987] 2 Lloyd's Rep. 529, and proved in due course to be the decisive point against the clubs on both appeals.

The second, which I shall call the 'equity point,' was first taken by the cargo owners before the Court of Appeal. It was rejected by them, but it re-appeared before your Lordships' House, refurbished and really transformed in an argument addressed to your Lordships by Mr. Sumption, who had not appeared in the courts below.

I turn first to the point which in the Court of Appeal proved to be decisive against the clubs, which I have called the futility point. In brief, the point is this. A member's right of indemnity in respect of any relevant claim or expense under the rules of either club is conditional upon his having first paid such claim or expense. The statutory transfer of that right of indemnity to a third party carries with it transfer of the term that the member must first have paid such claim or expense. The third party cannot however pay himself; accordingly that term becomes, upon such transfer, of no effect, either (1) because it has become impossible of performance; or (2) because it is futile to require a person to pay himself, and the law does not require the performance of futile conditions; or (3) because there is a merger of interests. It was the second of these two reasons which attracted Staughton J. [1987] 2 Lloyd's Rep. 299, 307; the first attracted Bingham L.J. in the Court of Appeal [1989] 1 Lloyd's Rep. 239, 250; Stuart-Smith L.J. at p. 258 was attracted by all three; O'Connor L.J. at p. 263 agreed with both Bingham L.J. and Stuart-Smith L.J. on this point.

I do not deny that I was from the beginning startled by the point, and closer acquaintance did not make me any better disposed towards it. It is, to my mind, fundamentally flawed. I start from the position that what is transferred to and vested in the third party is the member's right against the club. That right is, at best, a contingent right to indemnity, the right being expressed to be conditional upon the member having in fact paid the relevant claim or expense. If that condition is not fulfilled, the member has no present right to be indemnified by the club. Here the relevant claim or expense was never paid, by the member or indeed by anybody else on his behalf. That condition not having been fulfilled, the member had no present right to indemnity, and the statutory transfer of his right to a third party cannot put the third party in any better position than the member. It is as simple as that. The fundamental flaw in the argument, as I see it, is that it assumes that the statutory transfer of the contingent right to the third party has the effect that the third party has then to pay himself. This appears from the brief passage in the judgment of Staughton J. [1987] 2 Lloyd's Rep. 299, 306, which embodies his conclusion on this point, in which he said:

'I therefore conclude that, as Mr. Clarke contends, upon the winding up of the members in this case there were transferred to the claimants all the contractual rights of the members, so far as they concerned this claim, even though the members as yet had no cause of action. Among those rights was the term that the members must have paid the claim before they had a remedy against the association. After the transfer, that became a term that the claimants must have paid themselves. Such a term makes no sense. I do not consider that, in the ordinary or legal meaning of payment, a person can pay himself. At any rate it would be a futile exercise to do so.'

Likewise Bingham L.J. [1989] 1 Lloyd's Rep. 239, 250 concluded:

'Under the rules it is the same party (the member) who is subject to the burden of making payment and entitled to the benefit of enjoying the right to be indemnified. Upon the statutory transfer taking effect it is, I think, more natural to treat both burden and benefit as being transferred to the third party transferee so that both still attach to the same party.'

'would be to read section 1(1) as having the effect, not of transferring and vesting in the third party 'the insured's rights against the insurer under the contract in respect of the liability,' but of creating in the third party a right to an indemnity which the insured never possessed and which accordingly never could be transferred and vested in the third party.'

For this reason alone, I am unable to accept the futility argument. I wish however to add that (1) the argument of the cargo owners raises, in my opinion, a question not of futility but of impossibility. Furthermore I know of no general rule that the mere fact that a condition becomes impossible of performance renders the condition of no effect. Whether it does so or not must depend on the construction of the contract; and it may well be that, as here, the fact that it cannot be performed will simply mean that it is never fulfilled. (2) I can see no room for the operation of the doctrine of merger in the present cases, which are concerned with a non-promissory condition and not with circumstances in which the right and liability arising out of an obligation become vested in the same person in the same right.

In reaching his conclusion, Bingham L.J. was influenced by the decision of Leggatt J. in The Padre Island [1984] 2 Lloyd's Rep. 408, that the right (or obligation) to arbitrate against the club is one to be enjoyed by (or imposed on) the third party transferee when the statutory transfer takes effect. In my opinion, however, that case is to be distinguished from the present cases. The agreement to arbitrate is one which regulates the means by which the transferred right is to be enforced against the club. As such, it is inevitable that such an agreement must be treated as transferred to the statutory transferee as part of, or as inseparably connected with, the member's rights against the club under the rules in respect of the relevant liability: see section 1(1) of the Act of 1930. No such consideration applies however in respect of the condition of prior payment.

I turn next to the second of the two arguments which emerged in the course of this litigation, viz. the equity point. Before the Court of Appeal the argument ran as follows. At common law, it was held that an indemnity does no more than protect the indemnified person against actual loss; but equity went further and was prepared to require the indemnifier either to pay the creditor direct or to pay the indemnified person before he had paid the creditor. This equitable doctrine was invoked by the cargo owners before the Court of Appeal in the present cases [1989] 1 Lloyd's Rep. 239, 245 'both as an aid to construction of the rules and as a principle of law denying effect to the condition of prior payment.' However, the argument of the cargo owners was rejected on three grounds by Bingham L.J. (with whom, on this point, both O'Connor and Stuart-Smith L.JJ. agreed): first, in so far as the equitable rule was invoked as an aid to construction, the draftsman of the rules had shown a clear intention to exclude it; second, because there was no principle upon which a court of equity could, without more, override the clearly expressed contractual agreement of commercial parties; and third, if the case was one in which a court of equity could relieve a party from a clearly expressed contractual obligation, it would be necessary for that party to seek equitable relief by the setting aside of the offending provision, and no such relief was sought from either arbitral tribunal who alone (in the exercise of their discretion) could grant it.

Before your Lordships' House, however, the argument assumed, in the hands of Mr. Sumption, a more elaborate form and a more formidable aspect. The basic elements in his submission may be summarised as follows.

(1) The purpose of the condition of prior payment was to prevent a member from making a profit from his insurance cover by receiving payment from the club but failing to pay the third party. This problem does not however arise if a member is being wound up, because upon a winding up the assets are held for the creditors; nor does it arise if the club makes payment direct to the third party.

(2) If a club (as it may do) makes payment direct to the third party, it thereby discharges the member's liability to the third party and so fulfils the condition that the member (on whose behalf the club has paid) must have paid the third party's claim. In such a case, the club cannot rely on the circular argument that payment has not already been made. If payment direct to the third party will satisfy the condition of prior payment, it follows that the club is contractually bound either to pay the member who has in fact paid the claim, or simply to pay the claim direct to the third party.

(3) If however the club is not so bound, and the condition of prior payment operates at law to exclude the club's obligation to pay a member who has not in fact paid the third party's claim, equity will resolve the deadlock by requiring the club either to pay the third party direct, or to pay the member for the purpose of his paying the third party, thereby ensuring that both the condition precedent and the club's obligation are satisfied. The basis on which equity intervenes is as follows:

(a) At common law, a contract of indemnity gave rise to an action of assumpsit for unliquidated damages for failing to prevent the indemnified person from suffering damnum by paying the third party. A condition of prior payment was implicit in the nature of the contract.

(b) Equity, though recognising the existence of the condition, would not allow reliance on it when the effect would be to defeat the indemnity altogether rather than to achieve the object of the condition, i.e. to ensure that the liability in respect of which the indemnity existed was indeed discharged. This is because equity looks to the substance rather than to the form of a transaction.

(c) The mere fact that the contract contained a condition of prior payment cannot displace the equity. On the contrary, the condition is a pre-requisite of the operation of the equitable doctrine.

(d) Although the equity may be displaced by language which reveals the parties to have intended the result which applying the condition will have, it will not be excluded by words directed to another problem, e.g. preventing the member of a club from making a profit from the club's payment by receiving it and yet not paying the third party's claim.

(e) Procedurally, it was never necessary to invoke the equity by applying for specific equitable relief. It originally operated by a decree of specific performance of the contract of indemnity. Nowadays, following the Chancery Amendment Act 1858(Lord Cairns' Act) (21 & 22 Vict. c. 27) and the Supreme Court of Judicature Act 1873 (36 & 37 Vict. c. 66), relief can take the form of a judgment for the relevant money sum.

I found Mr. Sumption's argument most impressive; but on consideration I am unable to accept his submissions, for the following reasons.

First of all, I take his submission that the club is contractually bound to pay the third party direct, as an alternative to paying the member who has in fact paid the third party. For my part, I assume it to be correct that, as your Lordships were told, clubs do on many occasions make payment direct to third parties. I am also prepared to accept that, if a club does so, its payment to the third party is expressly or impliedly authorised or ratified by the member, and so operates to discharge the member's liability to the third party. But further than that point, I am unable to accompany Mr. Sumption's reasoning. First, it appears to me that the club's payment does not at the same time operate to fulfil the condition of prior payment. On the contrary the club, by paying the third party direct and so discharging the member's liability to the third party, indemnifies the member against that liability although he has not fulfilled the condition of prior payment; accordingly the club, by so doing, waives the requirement that the member should first have paid the third party. Second, even if it were the case that the club's payment did operate to fulfil the condition of prior payment, the most that can be drawn from this fact is that it may be consistent with the rules that the club may, if it wishes, pay the third party direct and so fulfil the condition of prior payment. I can see no basis for concluding that, as a matter of construction of the rules, the club is under any obligation to indemnify the member by paying the third party direct.

Turning to Mr. Sumption's propositions on the equitable doctrine itself, I see great force in his submission that it has never been necessary to invoke the equity by seeking specific equitable relief in the form of an order setting aside the offending condition. On the contrary, equity appears to have operated by means of what is effectively a decree of specific performance of the contract of indemnity. It follows that I am unable to accept the third ground upon which Bingham L.J. rejected the more limited submission on this point advanced before the Court of Appeal. Even so, I find myself in agreement with Bingham L.J. [1989] 1 Lloyd's Rep. 239, 245, that equity will not override 'the clearly expressed contractual agreement of commercial parties,' and that the condition of prior payment in the present case constitutes such an agreement. I do not consider that Mr. Sumption has been able to overcome this difficulty, for two reasons.

First of all, I am unable to accept his submission that a condition of prior payment is, at common law, implicit in a contract of indemnity. I accept that, at common law, a contract of indemnity gives rise to an action for unliquidated damages, arising from the failure of the indemnifier to prevent the indemnified person from suffering damage, for example, by having to pay a third party. I also accept that, at common law, the cause of action does not (unless the contract provides otherwise) arise until the indemnified person can show actual loss: see Collinge v. Heywood (1839) 9 Ad. & E. 633. This is, as I understand it, because a promise of indemnity is simply a promise to hold the indemnified person harmless against a specified loss or expense. On this basis, no debt can arise before the loss is suffered or the expense incurred; however, once the loss is suffered or the expense incurred, the indemnifier is in breach of contract for having failed to hold the *36 indemnified person harmless against the relevant loss or expense. There is no condition of prior payment; but the remedies available at law (assumpsit for damages, or possibly in certain circumstances the common count for money paid) were not efficacious to give full effect to the contract of indemnity. It is for this reason that equity felt that it could, and should, intervene. If there had been a clear implied condition of prior payment, operable in the relevant circumstances, equity would not have intervened to enforce the contract in a manner inconsistent with that term. Equity does not mend men's bargains; but it may grant specific performance of a contract, consistently with its terms, where the remedies at law are inadequate. This is what has happened in the case of contracts of indemnity. As a general rule, 'Indemnity requires that the party to be indemnified shall never be called upon to pay' (see In re Richardson [1911] 2 K.B. 705, 716, per Buckley L.J.); and it is to give effect to that underlying purpose of the contract that equity intervenes, the common law remedies being incapable of achieving that result.

Next, I am unable to accept Mr. Sumption's submission that a condition of prior payment in the contract is not effective to displace the equity. As I have already stressed, if the condition is in sufficiently clear terms, it would be contrary to principle that equity should grant specific performance of the contract inconsistently with the terms of the contract. In the present cases, the condition of prior payment is perfectly clear. The clubs are only bound to indemnify a member against claims or expenses which he shall become liable to pay and shall in fact have paid. The reason why this provision was included in the rules seems to me to be immaterial. I should record that Mr. Boyd, for the West of England Club, put forward a rather different reason for its inclusion from that proposed by Mr. Sumption. He suggested that, in a mutual insurance association such as a P. & I. Club, it is essential that members should be able to assume the financial probity of other members, because all of them are insurers as well as insured. To that end, it is customary to require each member to discharge his own liability before he can be indemnified against it by the club. Each member is, after all, running his own business; it is up to him to make sure that a claim against him is well founded, and the best way of ensuring that is to require him first to pay the claim before seeking indemnity from the club. I must confess that I was much attracted by this submission. Your Lordships do not however have to choose between Mr. Sumption's and Mr. Boyd's submissions on this point, especially as it is not inconceivable that they are both correct. For the fact remains that the rules provide unambiguously that there is no present obligation on the club to indemnify the member unless the condition of prior payment has been fulfilled; and for equity to grant specific performance of the contract, inconsistently with that condition, would, as I have said, be contrary to principle.

For these reasons there is, in my opinion, no room for the operation of the equitable principle in the cases before your Lordships. There remains, however, what I consider to be the central question in these cases. This is whether the condition of prior payment is rendered of no effect by section 1(3) of the Act of 1930. Since however I find myself to *37 be in complete agreement on this point with the judgment of Saville J. in the Padre Island (No. 2) [1987] 2 Lloyd's Rep. 529, with which I understand the Court of Appeal also to have been substantially in agreement, I can deal with the point briefly.

The question is whether the condition of prior payment in the club rules purports, directly or indirectly, to avoid the contract or to alter the rights of the parties upon the happening to the member of any of the events specified in paragraphs (a) and (b) of section 1(1). Here we are not concerned with the possibility of the contract being avoided, only with the possibility of the rights of the parties being altered. For present purposes, the only event specified in section 1(1) which could conceivably be of relevance is an order for winding up of the member.

Saville J. [1987] 2 Lloyd's Rep. 529, 534, having pointed out that the member has at best a contingent right under the rules to be reimbursed on payment, observed that that right was totally unaffected by a winding up order. He said:

'in the words of section 1(3) nothing in the contract, directly or indirectly, purported to alter (i.e. had the effect of altering) that right - for it remained exactly as it had been throughout. After the winding up order, as before, the owners had the same contractual right as they always had, namely, that which I have stated.'

He then identified what he saw as fatal flaws in the submissions advanced on behalf of the cargo owners. In particular, he considered that the argument confused the rights conferred by the club rules with the personal ability of the member to exercise or enjoy those rights. With that criticism I, like Bingham L.J. in the Court of Appeal, find myself to be in complete agreement. Following the insolvency of the member, or a winding up order, his contractual rights remain the same; there is a contingent right of reimbursement as before, though it is one which the member is, in the new circumstances, less able to exercise. Saville J. went on to identify two further flaws in the argument: first, that it treated as one and the same thing the member's inability to pay the cargo owners, and the winding up order, though they are separate and distinct; and second, that the argument led to the proposition that any monetary obligation of the insured under the contract of insurance upon which his rights against the insurer are wholly or partly dependent, is struck down by section 1(3) upon the happening of a winding up order by reason of insolvency. To these criticisms also, I can see no answer. Indeed, the judgment in The Fanti [1987] 2 Lloyd's Rep. 299of Staughton J., who formed a different view, identified the relevant event specified in paragraph (b) of section 1(1) as being insolvency, rather than winding up, which is inconsistent with the words of the subsection, and further did not confront the fact that, even if the relevant event was insolvency, the contract did not purport to alter the rights of the parties upon the happening of that event - the rights remained the same, the effect of the event being simply to render the condition of prior payment more difficult to perform.

Before your Lordships Mr. Clarke, for the cargo owners in The Fanti, submitted that the contract altered the rights of the parties thereunder directly upon the making of a winding up order, because whereas before the winding up the member had a right to pay and be paid, after winding up he did not have that right because payment by him would be unlawful. I am however unable to accept this submission, for the simple reason that the mere fact that the member could not lawfully pay after the winding up did not mean that the contract purported to alter the rights of the parties in that event. The rights of the parties remained exactly the same; all that happened was that, following the member's insolvency, and a fortiori following the winding up, the member was no longer able to fulfil the condition of prior payment which, as both Saville J. and Bingham L.J. pointed out, is quite different.

Mr. Sumption urged upon your Lordships that section 1(3) is not limited to cases where the legal substance of the right is altered; on the contrary, it extends to cases where the legal substance is unchanged, but the practical effect is altered. Indeed he went so far as to suggest that section 1(3) is directed not to the form of the contract term, but to the result. This submission I do not feel able to accept, because in my opinion it is inconsistent with the words of the subsection.

For the reasons I have given, I too would allow the appeals of the clubs in both cases.

Appeals allowed with costs.

“The Legal Costs”

This clause sets out the parameters of the insured/assured contractual relations vis-à-vis the payment of the legal costs in defending an action for damages by the assured. It does not, however, deal with the assured’s legal costs in making a claim against third parties. The following case deals with the predecessor of the current ¾ Collision Clause, which incidentally did not cover legal costs.

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