Pay first rules

IT is increasingly becoming a habit in Spanish maritime claims for claimants to sue, simultaneously, a shipowner or carrier and its P&I club in order to obtain a judgement declaring them both jointly and severally liable. Claimants are seeking to ensure that, when judgement is entered, if the claim against the P&I club is admitted and the club held liable, the judgement will be easily enforced. The claimants can then proceed directly against the club’s assets and avoid the ‘pay first’ or ‘pay to be paid’ rule which requires the insured to pay the claim before the right to an indemnity from the P&I insurer arises.

The legal ground used by Spanish plaintiffs to defend the existence of a direct action against the P&I club is Article 76 of the 1980 Spanish Insurance Act (SIA). According to Article 76, a third party who has sustained a loss covered by an insurance policy may bring a direct action against the insurer. This use of Article 76 to support direct civil liability against a P&I club is made under the assumption that Spanish substantive law is applicable.

Anticipating the counter-argument - that P&I insurance contracts generally provide, that English law shall govern and that the ‘pay first’ rule as interpreted by English courts denies a third party from bringing a direct action against a club except in an insolvency or other specific cases - Spanish claimants have argued that the application of English law contravenes Spanish conflict of laws and public order principles.

For example, on occasions, opposition to the application of English law and the ‘pay first’ rule has been based on Article 78 of the 1992 State Ports Act, which provides that it is obligatory for a Spanish shipowner to insure against civil liabilities. Applying this provision, some claimants have argued that P&I club’s are, or need to be construed as, civil liability insurers. The ‘pay first’ rule, insofar as it contradicts an obligatory law and a principle of public order, is therefore null and void.

Another argument used by supporters of a direct action is that the application of English law is contrary to Article 107.1.(b) of the SIA which states that, when an insurance contract is the result of compliance with a Spanish obligatory law, such as Article 78 of the State Ports Act, Spanish law shall govern such a contract.

Perhaps surprisingly, so far most of the cases in which the complaint has been filed directly against the P&I insurer have been dismissed on other grounds. They have, therefore, not had to deal with the issue of third party rights against P&I clubs. The few cases in which the issue of whether third parties could attempt to recover directly has been the basis of the court ruling have all been decided against the claimants. Among those decisions are two Appellate Court judgements and one Supreme Court judgement in Spain.

It should be pointed out that, whereas in the cases before the Supreme Court and the Court of Appeal in Malaga the insureds have been foreign companies, in the one reported case before the Court of Appeal in Madrid the insured was a Spanish shipowner. Therefore, certain arguments which were valid for the Madrid case were not used in the other two cases. This explains the slight differences in the obiter dicta of the judgements.

Despite their small differences, however, in all three cases the Spanish courts defined P&I clubs as mutual insurance associations governed by English law that have no equivalent in Spanish law. According to the rules of the associations, as interpreted under English law, and apart from exceptional circumstances, the insured needs to pay first and only when the claim has been paid can it ask the club for reimbursement.

While the Supreme Court was the only tribunal to hold, quite correctly, that there was no reason for Spanish law or Spanish conflict of law provisions to apply to a contract between two foreign parties, all three courts acknowledged that, even if it were applicable, a stipulation by which English law, and consequently the ‘pay first’ rule, is to apply to an insurance contract between the insured and the P & I club is valid under the Spanish conflict of laws provisions and public order principles. In this sense, the courts have all agreed to deny the application of the previously cited Article 107.1.(b) of the SIA on two different grounds.

The first ground is that marine insurance is regulated by the Commercial Code and the SIA only applies secondarily, that is when there is no specific provision in the Commercial Code. Since the Commercial Code establishes that the parties to the contract can set up its terms freely, there is only one mandatory requirement to ensure that a choice of law provision is valid and does not contravene the general Spanish conflict of laws provisions. Article 10.5 of the Civil Code establishes that a contract shall be governed by the law of the country agreed by the parties if the contract has a connection with that country. In these cases, since the P&I insurance contract was born in the UK, the choice of English law was valid.

The second ground to reject the application of Article 107.1.(b) is that, in part 2 of the article, parties entering maritime contracts may choose freely the applicable law which will govern the contract. As in these cases the choice of law did not contravene other conflict of laws provisions, namely Article 10.5 of the Civil Code, the choice of law was valid.

Finally, the Court of Appeal in Madrid has held that the application of English law and the ‘pay first’ rule does not infringe principles of public order. The court accepted that the principle of public order could not be used to avoid the application of the law of another democratic country just because this country regulated certain issues differently.

It is clear that these three recent and more-or-less uniform judgements will be important to deter plaintiffs from attempting to sue P&I clubs directly in the future. However, the question of whether third parties have a direct action against the clubs will not be settled until there is a second Supreme Court judgement upholding the lack of direct action as two judgements are needed to create case law. Given the above precedents, though, it is likely that when this second Supreme Court judgement is entered it will follow the already established line of interpretation.