Court of Appeal finds against insolvent insurer policyholders in FSCS appeal

In the case of R. (on the application of Manchikalapati) v Financial Services Compensation Scheme [2023] EWCA Civ 1006, the Court of Appeal reinstated a refusal by the FSCS to compensate policyholders for an insolvent insurer’s failure to meet its liabilities for post-judgment interest and litigation costs. The Court of Appeal held that those costs are not within the scope of the compensation scheme under the Policyholder Protection Rules (PPR).

Background

The appellant policyholders owned long leases in a residential development, and had been issued upon purchase with an insurance policy by Zurich Insurance plc (Zurich) which intended to cover structural defects. The development suffered serious defects, leading the policyholders to make substantial claims under the polices, which Zurich rejected.

During the resulting proceedings against Zurich, there was an insurance business transfer scheme in Ireland under which Zurich transferred its liabilities to East West Insurance Company Limited (EWIC).In that litigation, the Court of Appeal decided in favour of the policyholders, providing a consent order in their favour for approximately £9.7 million (excluding VAT), and a costs award of 92.5%. EWIC paid the consent order sum, but went into administration without meeting the sums due for VAT, statutory interest on the judgment debt, or (apart from a sum paid on account) costs.

The policyholders sought compensation from the FSCS, which agreed that the VAT element was covered by the PPR. However, it declined to issue compensation for the costs and post-judgment interest defaults, on the basis that these claims were not covered by the policies, but made pursuant to statute (s. 17 Judgments Act 1838) and a court order respectively.

The unpaid costs were estimated at approximately £3,283,000.

The unpaid costs were estimated at approximately £3,283,000. In litigation brought by the policyholders in the High Court, the FSCS’s decision was quashed.

Decision

On appeal by the FSCS, the Court of Appeal focused on the proper construction of the PPRs, specifically whether:

• The costs and interest were owed “under” a contract of insurance, such that they fell within the definition of “claim” under PPR 1.2;
• The claim for costs and interest fell within the concept of a “protected claim” under PPR 9.1; and
• The claim for costs and interest fell within PPR 3.1(2) because it was “in respect of” a protected claim, even if it was not itself a protected claim.

Falk LJ found in favour of FSCS on all three points, concluding that:

• Costs and interest were not owed “under” a contract of insurance as they were instead amounts due pursuant to a court order and statute;
• As the costs and interest were not so owed, those amounts could not fall within the definition of “protected claim”; and
• The words “in respect of” in PPR 3.1(2) meant “for” or “for the payment of”, and not “integral to, part and parcel of or sufficiently connected to” as found by the judge in the High Court.

The Court of Appeal was sympathetic to the policyholders, and noted that if the insurance claim had not been litigated before EWIC’s insolvency occurred then the FSCS may have been involved earlier and determined the amount due under the policies for the purposes of calculating compensation. Any dispute might then have been litigated against the FSCS rather than EWIC, and if the policyholders succeeded they might have been awarded costs against the FSCS for wrongly declining compensation, with the FSCS potentially paying interest for any delay under PPR 18.6.