Insurer’s Right Of Subrogation Upon Payment 

1. Introduction To Subrogation

Subrogation is a concept with a wide application within and outside contracts of insurance. It has its foundations in Roman law.

Subrogation is largely an equitable (as opposed to a common law) doctrine, although there appears to be some support for the view that there is an implied term in insurance contracts allowing the insurer to exercise rights of subrogation.

In the context of insurance contracts, the doctrine of subrogation allows the insurer who has indemnified the assured to ‘take advantage of any means available to the assured to extinguish or diminish the loss for which the insurer has indemnified the assured’. 

The purpose of the doctrine of subrogation is therefore to permit the insurer to diminish or extinguish the loss he or she has had to pay to the assured. If, prior to receiving an indemnity from the insurer, the assured receives a benefit from a third party which operates to diminish the indemnifiable loss, the assured is permitted only to recover from the insurer his or her net loss (i.e. after taking into account the benefit received); this is the principle of indemnity (Burnand v Rodocanachi Sons & Co, Castellain v Preston, Goole and Hull Steam Towing Co Ltd v Ocean Marine Insurance Co Ltd. 

After the insurer has paid the assured his or her indemnity, the insurer may exercise the rights of the assured to diminish his or her loss and any recoveries will inure to the benefit of the insurer with a view to diminishing his or her loss.

2. The requirement of payment

Before the insurer can exercise any rights of subrogation, the insurer must have paid an indemnity to the assured in respect of the insured loss in accordance with the terms of the policy.

It appears that the insurer will acquire a right of subrogation only if he or she pays the assured whatever the assured is entitled to in full.

If the insurer pays something less than the assured’s full entitlement, it has been suggested that the insurer is not entitled to exercise his or her rights of subrogation. It may be thought that there is no reason why the insurer should be deprived of a right of subrogation in such circumstances, although it will complicate the apportionment of any recoveries as between the assured and the insurer.

It is sufficient that the insurer has paid a claim in honest satisfaction of a potential liability under the policy, even if the claim is not strictly covered by the policy. In such cases, the insurer will acquire rights of subrogation, unless the policy is void by reason of illegality or being contrary to public policy (King v Victoria Insurance Co; BUPA Australia Pty Ltd v Shaw).

It has been held that it is not open to the parties to agree contractually that rights of subrogation can be exercised prior to payment under the policy: Rathbone Brothers plc v Novae Corporate Underwriting. 

3. The categories of subrogation rights

The rights available to the insurer by reason of the doctrine of subrogation are:

a) In the case of a total loss, the right to take over the assured’s interest in the subject-matter of the insurance (section 79(1) MIA).

b) The insurer has the right to exercise the assured’s rights of action against third parties to seek compensation for the assured’s indemnified loss (section 79(2) MIA).

c) The insurer has the right to use any benefit received by the assured in respect of his or her loss to diminish the indemnified loss (section 79(2) MIA).

i. The right to take over the subject-matter insured

In the event of a total loss, upon payment of the claim, the insurer is entitled to take over the assured’s interest in the subject-matter insured as from the date of the casualty (section 79(1) MIA; compare section 63 MIA)

This principle is often referred to as the principle of ‘salvage’. It is very similar to the doctrine of abandonment provided for under section 63 MIA (i.e. ‘a cession or transfer of the ship to the underwriter’), which occurs upon the insurer’s agreement to accept a claim for a total loss and to accept the abandonment. The purpose of this principle is to ensure that the assured is not over-indemnified. If the assured has been paid for a total loss, it follows that he or she has received in money terms the value of the asset insured so that any residual interest in that asset might operate to put the assured in a better position than he or she had been in before the casualty. In the circumstances, such salvage is designed to ensure that the assured is left with nothing more than the indemnity for a total loss.

Some commentators prefer not to treat salvage as an instance of the doctrine of subrogation. However, it is significant that this right of salvage falls within the general statement of the right of subrogation referred to above and that section 79(1) MIA which provides for salvage is a provision under the heading ‘right of subrogation’.

ii. Rights of action against third parties

Upon payment of an indemnity to the assured, the insurer is entitled to exercise the assured’s rights of action against those third parties who are responsible for the loss suffered by the assured.

The insurer exercises such rights in the following way:

a) The insurer must bring any proceedings against the third party in the assured’s name, not in the insurer’s name. As far as the third party is concerned, this is an action brought by the assured, not the insurer. This is in contrast to the position adopted in other jurisdictions, where there is an assignment of the assured’s cause of action against the third party to the insurer. Indeed, under English law, if the assured assigns his or her cause of action against the third party to the insurer, the insurer then will be permitted to sue in his or her (e. the insurer’s) own name (see Compania Colombiana de Seguros v Pacific Steam Navigation Co).

b) The insurer, however, is not entitled to sue the third party in the assured’s name without the assured’s consent. If the assured does not consent, the insurer may bring proceedings against the assured to compel the assured to lend his or her name to any proceedings against third parties.

c) The assured is still permitted to bring proceedings against third parties in his or her own name. Until payment of the indemnity by the insurer, the assured is entitled to control the proceedings. However, after the insurer pays the assured, the insurer is entitled to take control of the proceedings upon the insurer undertaking to indemnify the assured in respect of the costs of the proceedings.

The rights of action which may be exercised are only those rights of action which are available to the assured. Therefore, if the assured has no right of action, or if the assured could not pursue a right of action against a third party, the insurer cannot benefit from subrogation by instigating a suit against that third party.

The insurer cannot exercise subrogation rights against co-assureds (provided that the loss in question could form the subject of a valid insurance claim by the co-assured) or against other persons for whose benefit the insurance contract was entered into.

Occasionally, the policy will include a ‘waiver of subrogation’ clause which is a promise by the insurer not to pursue subrogation rights against a specified class of persons. Such clauses were at common law enforceable only by the assured, not by the third party (compare the position in Australia: Woodside Petroleum Development Pty Ltd v H & R-E & W Pty Ltd; and in Canada: Fraser River Pile & Dredge Ltd v Can-Dive Services Ltd).

However, since 2000, the third party may be able to enforce the waiver of subrogation clause pursuant to the Contracts (Rights of Third Parties) Act 1999.

If the co-assured is not covered for the same loss, the insurer can exercise rights of subrogation against that co-assured, unless there is an express or implied term to the contrary in the insurance contract or unless there is an express or implied term in the underlying contract between the co-assureds that no right of action can be pursued if there is cover available under the relevant insurance policy (Rathbone Brothers plc v Novae Corporate Underwriting; Gard Marine & Energy Ltd v China National Chartering Co Ltd; Cape Distribution Ltd v Cape Intermediate Holdings plc).

iii. Benefits recovered

If the assured recovers a benefit in respect of his or her loss prior to receiving an indemnity from the insurer, the assured’s indemnifiable loss will be reduced by the amount of the recovery. If, however, the benefit was paid to the assured with the intention of benefiting the assured and of not benefiting the insurer, the assured is entitled to retain the benefit as a gift and recover an indemnity from the insurer (i.e. in addition to the gift).

If, after the assured receives an indemnity from the insurer, the assured receives a benefit from a third party, the assured holds the benefit subject to an equitable lien in favour of the insurer in respect of his or her share (Ettrick v Hunter). Although the subrogated insurer has a proprietary interest in the proceeds recovered by the assured, the insurer does not have a proprietary interest in the assured’s cause of action against a third party in respect of the loss which has been indemnified by the insurer: Re Ballast plc, St Paul Travelers Insurance Co Ltd v Dargan & Anor.

If the insurer recovers a benefit from a third party, the insurer will hold any sums in excess of the insurer’s own share in trust for the assured. If the assured recovers from third parties more than the indemnity received from the insurer, the insurer is entitled only to reimbursement of the amount of the indemnity paid; the assured is entitled to the excess. However, if the cause of action is assigned to the insurer, the insurer is entitled to retain any excess (subject of course to the terms of the assignment) (see Compania Colombiana de Seguros v Pacific Steam Navigation Co). Where the assured receives a benefit which, together with the indemnity received from the insurer, is less than the loss sustained, the general principle appears to be that the assured is entitled to retain the benefit to the exclusion of the insurer.

However, there are three exceptions to this, particularly in the context of marine insurance on property:

a) Under an agreed value policy in which the value of the subject-matter insured is agreed, the assured and the insurer are bound by that valuation as representing the value of the subject-matter Therefore, if the assured receives an indemnity in respect of the total loss in the amount of the insured value, but as a matter of fact, the assured’s loss is greater, the assured is bound to pass on to the insurer any amounts received, because the assured is deemed to have been fully indemnified by the insurer.

b) Where the assured has under-insured the subject-matter insured, any recovery received by the assured is to be shared proportionately between the assured and the insurer, because the assured is deemed to be a co-insurer in respect of the uninsured element (section 81 MIA).

c) Where the insurance and any uninsured element or other insurances are structured in layers, any recoveries will be applied in accordance with the ‘top down’ principle (Lord Napier and Ettrick v Hunter). For example: if the insurance is for £100,000 in excess of £25,000, there is a loss of £160,000 and there is a recovery from a third party of £140,000, the recovery is to be applied ‘top-down’ (e. to the benefit of the person who assumed responsibility for each of the insured layers, the top layer first, the second top layer next, and so on). Therefore:

The top layer of £35,000 is the assured’s layer (being £160,000 less £125,000). The assured will receive the first £35,000 of the £140,000 received, leaving £105,000. 

The second top layer is the £100,000 in excess of £25,000 (i.e. the layer between £25,000 and £125,000). This £100,000 layer is the insurer’s layer; so the insurer receives £100,000, leaving £5,000.

The bottom layer (i.e. the excess layer) is the assured’s layer. The assured receives the remaining £5,000.

Of the £140,000 received, £100,000 goes to the insurer and £40,000 goes to the assured.

iv. Other types of subrogation rights

The insurer is entitled to exercise his or her rights of subrogation over any receipts or rights of the assured which may be attributed to the indemnified loss with a view to extinguishing or reducing that loss. The above examples are the most commonly encountered examples of the exercise of rights of subrogation. 

There may be other rights. For example, there is a form of statutory right of subrogation under section 5 of the Mercantile Law Amendment Act 1856, which might be exercised by the insurer against the assured’s other insurers of the same property. However, the insurer’s right of contribution will often avail the insurer in such circumstances.

4. Prejudice to the insurer’s right of subrogation

There is probably an implied term in the insurance contract that the assured will take no steps which would prejudice the insurer’s right of action against third parties. See Boag v Standard Marine Insurance Co Ltd, Yorkshire Insurance Co Ltd v Nisbet Insurance Co Ltd, Napier v R F Kershaw Ltd).

If the assured does act so as to prejudice the insurer’s rights of subrogation, the insurer is probably entitled to damages for breach of the implied term.

In BUPA Australia Pty Ltd v Shaw, the Court awarded equitable compensation by reason of theprejudice of the insurer’s rights of subrogation.

It is uncertain (but probably unlikely) that there is any implied term that the assured is obliged to take positive steps to preserve rights of action against third parties. Of course, it is open to the parties to agree in the policy that the assured is subject to such a duty. See clause 16 of the Institute Cargo Clauses (1/1/82) and (1/1/09) (the Bailee Clause).

If the assured does act so as to prejudice the insurer’s rights of subrogation, the insurer is probably entitled to damages for breach of the implied term. In BUPA Australia Pty Ltd v Shaw, the Court awarded equitable compensation by reason of the prejudice of the insurer’s rights of subrogation.

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