Subrogated recoveries and a reminder of the Napier principles

Court of Appeal's decision in Textainer case serves as a reminder the principles of subrogation, as established in Napier – more than 30 years ago – will still prevail as a matter of common law

A recent Court of Appeal judgment affirms the longstanding ‘top-down’ approach applied to the distribution of monies among excess layer insurers, which have been recovered as part of a subrogated action

On May 22 the Court of Appeal handed down its judgment in the matter of Royal & Sun Alliance and others v Textainer Group Holdings and others (2024).

The respondents are part of the Textainer group, the largest container lessor in the world, and have been operating since 1979.

In upholding the first instance decision, the Court of Appeal affirmed the longstanding “top-down” approach applied to the distribution of monies among excess layer insurers, which have been recovered as part of a subrogated action. The decision serves as a helpful reminder of the Napier principles, which, unless varied by the parties to a contract of insurance, can apply to subrogations brought under any type of policy. The potential application and effect of the principles is therefore far-reaching.

Textainer benefitted from a container lessee default insurance programme, the terms of which consisted of a $5m retention, $5m of primary cover (in excess of the $5m retention) and a tower of five excess-of-loss policies, providing cover up to $80m, again in excess of the $5m retention.

Of central importance to the Court of Appeal’s decision was the fact that while the Hanjin settlement had the effect of reducing Textainer’s losses, those losses nevertheless remained well above the upper limit of the cover provided by the insurance tower.

In or around August 2016, one of Textainer’s lessees, Hanjin Shipping, had in its custody approximately 113,000 containers belonging to Textainer, under both finance and operating leases. However, Hanjin began to fall short with lease payments and on August 31, 2016 it applied to the Seoul Central District Court to be placed into receivership.

This constituted an “event” under the policies, which entitled Textainer to be indemnified for the loss of containers on-hire that were not recovered within 183 days, lease payments that had fallen due and remained unpaid, as well as the costs of retrieving and repairing recovered containers, to the extent possible. Following the subsequent determination of Hanjin’s bankruptcy in February 2017, Textainer’s losses were assessed to be in the sum of $101,856,624.

In total, insurers paid out $75.1m, which involved exhausting the first five policy limits (the primary and first to forth excess layers) and agreeing a discounted settlement in relation to the fifth excess layer in the sum of $25.1m, as against a limit of $30m excess $55m.

In return for accepting this sum, Textainer insisted on the assignment of insurers’ subrogation rights under the fifth excess layer policy and was also assigned similar rights under the fourth excess layer policy, pursuant to a settlement that was concluded in June 2019. This left Textainer with uninsured losses in the region of $21m, in addition to its $5m retention.

At the invitation of Hajin’s Bankruptcy Trust, Textainer subsequently claimed against Hanjin, which, by way of settlement, agreed in principle to pay approximately $26m in respect of Textainer’s claim for operating leases only. Thereafter, insurers sought to claim an entitlement to the monies recovered.

Napier principles

The case of Napier and Ettrick (Lord) v RF Kershaw and others (1993) sets out the principles for the distribution of monies received in a subrogated claim in what is known as the “pay up, recover down” model or the “top-down” approach.

The doctrine of subrogation gives insurers the right to “step into the shoes” of an insured following the payment of an indemnity. However, in practice, many policies contain provisions that allow the relevant insurer to commence a subrogated action before payment of the indemnity is finalised. This means the relevant insurer can exercise any rights available to the insured as a result of the insured event.

In short, the top-down approach means the insured will be fully indemnified before the insurer – or, in the present case, insurers – have any entitlement to the recovered sums that have been clawed back by the subrogated action. Monies received by the insurer in such circumstances will be distributed in the following order: first, the insured first recovers any uninsured losses, excluding the applicable excess; second, insurers then have the right to recover the amount paid by way of the indemnity, from the highest to lowest layer of cover; and finally, any remaining monies will go towards the insured’s excess.

In simple terms, distribution under the top-down approach effectively reverses the order in which monies are paid to an insured as part of the indemnification process. What this means, however, is insurers may find themselves unable to recover some of the monies paid out, depending on the delta between the total loss itself and the total amount recovered.

As a consequence, insurers of the primary and first to fourth excess layers brought proceedings against Textainer with the intention of clawing back some of the monies recovered from Hanjin. Insurers claimed to be entitled to 39.3% of those sums on the basis that, together, they had insured $40m of Textainer’s $101,856,624 total loss.

On October 5, 2022 the High Court dismissed insurers’ claim on three bases, including any recoveries made were to be applied following the top-down approach; this was not a case of underinsurance, meaning recoveries were not to be shared pro rata; and in any event, insurers had failed to prove the recoveries made in respect of the operating leases had been indemnified proportionately or at all by the primary policy and/or first three excess policies. Insurers were granted permission to appeal.

Issue on appeal

The key issue before the Court of Appeal was whether the insurers of the primary and first to fourth excess layers were entitled to a proportionate share of the $26m recovered from Hanjin or whether those monies should be distributed in accordance with the top-down approach as set out in Napier. The Court of Appeal unanimously upheld the first instance decision of the High Court and dismissed insurers’ appeal.

Of central importance to the Court of Appeal’s decision was the fact that while the Hanjin settlement had the effect of reducing Textainer’s losses, those losses nevertheless remained well above the upper limit of the cover provided by the insurance tower. Crucially, this was not – as the court pointed out – a consequence of being underinsured, in circumstances where Textainer’s risk was “undefined and indefinite”, in that it included, among others, the costs of the recovery and repair of containers as well as the loss of rental.

This decision serves as a comforting reminder the principles of subrogation, as established in Napier – more than 30 years ago – will still prevail as a matter of common law. While none of the findings of this decision seek to militate against this longstanding legal principle, it is important to remember the parties to a contract of insurance are still at liberty to vary the top-down approach as they see fit.

As at the date of this article, insurers’ leave to appeal has been refused and no appeal application has been lodged with the Supreme Court.

This article was first published by Insurance Day.