Section 156 of the Insolvency Act: A third party’s forgotten remedy?

February 1st, 2015

By Nicole Bell

The principle of subrogation is well established in South African law and allows an insurance company to litigate under the name of the insured for the recovery of damages incurred. Any judgment obtained for, or against, the insured is thereafter settled by the insurance company, subject to the terms and conditions of the agreement of insurance entered into between the parties.

Should an insurance company fail to uphold their contractual duties to the insured, the insured holds the applicable contractual remedies to enforce such a claim against the insurance company, however, the insured party shall remain liable to the third party.

As a general principle in South African law, a party instituting a claim for delictual damages must proceed against the person who has caused the harm, subject to specific circumstances where this principle has been altered through the enactment of legislation, for example the application of the Road Accident Fund Act 56 of 1996, as amended by Act 19 of 2005, among others.

Therefore, as a point of departure a third party will hold no such direct right of recourse against the insurance company and should execution against an insured commence and insufficient capital be raised. The third party holds little to no options in respect to obtaining their damages, save for the remedy contained in terms of s 156 of the Insolvency Act 24 of 1936.

Section 156 has a novel application in that it provides a remedy, on the insolvency of the insured, for a third party to ‘pierce the veil’ of the principle of subrogation and hold an insurance company directly liable for the damages incurred by the insolvent insured.

Where legislation has been effected to provide for the liability of a party not directly causing the harm it ordinarily provides for the substitution of that party for the wrongdoer and not for the joint and several liability of that party, as is the case in s 156, which provides as follows:

‘Whenever any person (hereinafter called the insurer) is obliged to indemnify another person (hereinafter called the insured) in respect of any liability incurred by the insured towards a third party, the latter shall, on the sequestration of the estate of the insured, be entitled to recover from the insurer the amount of the insured’s liability towards the third party but not exceeding the maximum amount for which the insurer has bound himself to indemnify the insured.’

The effect of s 156 was illustrated by the court in Coetzee v Attorneys’ Insurance Indemnity Fund 2003 (1) SA 1 (SCA) at para 19 – 20 where the court provided as follows:

‘In the absence of [the] section the insured’s creditor, upon the former’s sequestration, would have to prove a claim in his insolvent estate and be content with whatever dividend is paid to the concurrent creditors; whilst the insured’s rights under the policy would vest in his trustee, who would claim from the insurer for the benefit of the general body of creditors. The effect of the section, therefore, is that the creditor is granted the considerable advantage that he does not have to share the proceeds of the policy with other creditors. To that end he is given a direct right of action against the insurer. However … the section was not designed to confer any additional favour upon that creditor. He would have to prove not only his claim against the insured, but also that the insured would have succeeded against the insurer in his claim for an indemnity.’ (See also Unitrans Freight (Pty) Ltd v Santam Ltd 2004 (6) SA 21 (SCA) at para 7 and 8; Le Roux v Standard General Versekeringsmaatskappy Bpk 2000 (4) SA 1035 (SCA) at 1046J – 1047G; Canadian Superior Oil Ltd v Concord Insurance Co Ltd (formerly INA Insurance Co Ltd) 1992 (4) SA 263 (W) at 273H – 274B; and Woodley v Guardian Assurance Co of SA Ltd 1976 (1) SA 785 (W) at 759E – H.)

While the effect of the section is clear the precise nature of the liability imposed by this section bears further discussion and was established by the court in the Unitrans case at para 7 where the court found the following:

‘The section does not add to the contractual liability of an insurer. It merely allows a person, who is not a party to the policy of insurance, to recover directly from the insurer in particular circumstances. It entitles a person who has a claim against someone who is indemnified against such liability by an insurer to pursue the claim directly against the insurer if the estate of the indemnified person is sequestrated.’

In the case of Van Reenen v Santam Ltd 2013 (5) SA 595 (SCA) at para 17 the Supreme Court of Appeal provided further clarity on the application of the section as follows:

‘What may be gleaned from these authorities and indeed the clear wording of section 156, therefore, is that its provisions create a right which does not exist before insolvency. Whilst it allows the third party to exercise the insured’s rights against the insurer, it nonetheless confers upon the third party no greater rights than those enjoyed by the insured. And, importantly, the section does not transfer to, nor vest the existing rights of an insolvent in the third party (Gypsum Industries Ltd v Standard General Insurance Co Ltd 1991 (1) SA 718 (W) at 722D). … The section rather creates a new and distinct cause of action for the third party, on the sequestration of the insured, as a means to recover from the insurer precisely what the latter owes the insured under the insurance contract.’

Prior to the third party therefore being in a position to utilise the remedy provided for in s 156 certain requirements need to be met, which are as follows –

• there must be an obligation to indemnify the insured for the specific liability incurred to the third party; and

• the insured’s estate must be sequestrated or under sequestration.

In assessing whether the remedy provided to protect third parties is sufficient, one must first focus on the nature of the claim, the ordinary course of litigation and the extent to which the operation of the law would provide for further enhancement of the litigation.

It is important to note that this remedy is exceptional and a departure from the ordinary and general principles of both South African insurance and delictual principles. The importation of liability on the insurance company directly further departs from ordinary contractual principles, for example the principle of privity of contract.

Arguably the extent to which the third party would have to go to prove their claim would result in excessive legal costs often outweighing any advantage that they may obtain. These legal costs may furthermore not be covered by the eventual claim as the insurance company may only be held liable for those costs provided for in terms of the insurance contract.

It is, therefore, argued that as the nature of the remedy provides the third party with a claim separate from the remaining creditors of an insolvent estate, together with a concurrent claim against the estate for any damages not covered by the insurance company, that the extension of the remedy beyond that already provided for would give rise to additional and unfair liability on the insurance company. I submit that a fair balance has been obtained by the legislature in enacting this legislation.

Nicole Bell BA (Law) LLB (SU) is an attorney at Goldberg & de Villiers Inc in Port Elizabeth.

This article was first published in De Rebus in 2015 (Jan/Feb) DR 27.