P&I Clubs’ “Paid to be paid” rule and Insolvency

The incorporation of the “Pay to be paid” or “Pay First” provision into the Protection and Indemnity (P&I) Clubs’ rules is a fundamental practice. Basically, the legal effect of this provision is the imposition of a duty on the assured, to fulfill all his obligations to the injured third party, as a condition precedent, to any payment of the Club to its member, when incurring in liability, cost or expenses as a consequence of a shipping casualty or accident affecting third parties.

The issue arises where the assured had become insolvent and is not able to pay the indemnity to the injured innocent third party. It is argued that the “Pay First” rule annuls any possible claim under the policy which consequently would cut off any claim by the injured third party.

  • What is exactly the “paid to be paid” rule?

The P&I insurance is an indemnity type of insurance. Therefore, the payment by the assured is necessary prior to the insurer’s involvement. This is not required under liability insurance. The member’s liabilities discharge duty, before seeking payment of the Club, is incorporated into the policies as the “Pay to be paid” clause. Moreover, this is expressed in the Clubs’ Rules as a “condition precedent” to the right of a member to recover his payment from the Club.1 The Clubs’ rules have their legal authority in The UK Marine Insurance Act 1906, in its section 85 (3).

A classic example of a “Pay to be paid” provision, can be found in Rule 5 (A) of the “UK P&I Club” providing: A) Payment first by the Owner: Unless the Directors in their discretion otherwise decide, it is a condition precedent of an Owner’s right to recover from the funds of the Association in respect of any liabilities, costs or expenses that he shall first have discharged or paid the same out of funds belonging to him unconditionally and not by way of loan or otherwise”(…)

  • What is the law on this matter?

UK Third Parties (Rights Against Insurers) Act 2010 and “The Fanti” and The “Padre Island”

The act entered into force on the 25th March 2010, revoking the 1930 Act,4 and is the current statutory authority on this matter. When the third party has brought an action against the insurer, in order to get a declaration of the liability of the assured, according to Section 2 (4) of the 2010 Act, the insurer is able to rely on any defence that the assured would have been able to rely on. Additionally, the 2010 Act, maintains the provision that the claiming rights of the third party are the same of the insolvent assured might have had against the insurer. However, Section 9 of the Act provides exceptions to this rule.

At first instance, the provision in Section 9 (5) provides that, the transferred rights to the third party are not subject to any condition that requires the prior discharge by the assured of his liabilities to the third party. Consequently, it is believed that subsection 5 annuls the rule in “The Fanti” and “The Padre Island” the case authority, that confirms the payment of the claim by the member as a condition precedent to the reimbursement to the member by the club.5 However, as a transcendental provision, the subsection 6 limits the effect of subsection 5, providing that in cases of marine insurance, this exception is only applicable to liability of the assured regarding death or personal injury cases.

  • I am the injured innocent third party, what should I do?

0915138-300x200In the presented escenario, the third parties are obliged to find alternative ways of dealing with this issue. It is suggested that the main alternative is to begin an arrest process of the member’s ship as security for the claim. This is viable initiating an in rem (against the ship) action under ss. 20 (2) and 21 (4) of the UK Supreme Court Act. 1981. In the arrest scenario, the owner will need to release his ship for commercial purposes; therefore, he can ask his Club the issuing of a letter of undertaking for the release. Accordingly, the club may waive the “Pay to be Paid” rule to issue this letter of undertaking, which will guarantee the payment of the club to the third party, if the member is found liable. It is believed that, due to the fact of the lack of protection of the 2010 Act and the court’s decision, for the third party, this is the most effective method of dealing with the issue.

  • Conclusion

The “Paid to be Paid” Rule is transcendental and beneficial for the P&I Clubs, and is potentially harmful for the injured innocent third parties. It is believed that the UK should start to be closer with the international trend of forbidding, via public policy, the application of the “Pay to be paid” clauses by P&I Clubs, towards the achievement of a reliable source of indemnification to the third parties and to build a more equal future, between P&I Clubs’ and injured innocent third parties’ interests. In the meantime, rely on the right legal advisor, he will know what to do with your specific case.