In the recent case of MS Amlin Marine NV v King Trader Ltd, the Court of Appeal confirmed that onerous, draconian or unusual clauses in commercial contracts will be effective and enforced, so long as it is clear that the party whose rights are restricted by the clause was given sufficient notice of it. Whether notice is deemed sufficient or not will depend on the facts of the case, but includes whether the clause was the type a reasonable person would have read, or taken legal or other appropriate professional advice about, before entering into the contract.
This article summarises the Court of Appeal’s decision about the red hand clause doctrine in a commercial context.
Amlin, the claimant, was the insurer of the charterer of a ship under a marine insurance policy. The ship was owned by King Trader. Following damage to the ship when it went aground in the Solomon Islands, King Trader obtained an award of damages in an arbitration against the charterer for around US$47 million.
The charterer failed to pay the award and was wound up in 2024. King Trader believed the charterer was insured and hoped to be able to recover the unpaid award from Amlin. It started a claim against Amlin, on the basis the insolvent charterer’s rights under the policy had vested in King Trader under the Third Parties (Rights against Insurers) Act 2010.
Amlin, as the charterer’s insurer, contested the claim that the charterer had any right to be indemnified under the policy that could vest in King Trader under the Act. It relied on its ‘pay first’ clause in the policy which said this:
| ‘It is a condition precedent to the Assured's right of recovery under this policy with regard to any claim by the Assured in respect of any loss, expense or liability, that the Assured shall first have discharged any loss, expense or liability.’ |
Amlin said that on a proper interpretation, the pay first clause in the policy meant that it did not have to indemnify the charterer in respect of the award because the charterer had not paid it, and now, because of its insolvency, could not pay it. The non-payment of the award by the charterer meant that Amlin had no liability to the charterer under the policy to pay the award, so there was no right to payment that could vest in King Trader under the Act.
King Trader argued that the requirement in the pay first clause for the charterer to actually pay the award before its right to be indemnified under the policy arose was particularly unusual, draconian and onerous for a policy of insurance, and was therefore unenforceable. The Court of Appeal rejected King Trader’s argument, and agreed with Amlin that the pay first clause was effective. Under that clause, the charterer’s payment of the award was a condition precedent to its right to be indemnified under the policy, and since the charterer had not paid the award, King Trader could not itself claim the award sum from Amlin under the policy.
The red hand clause doctrine, also known as the onerous clause doctrine, arises where one party to a contract tries to escape the effect of a particularly restrictive, draconian or unusual clause on the grounds it was not aware of it and could not reasonably have been aware of it, because it was not fairly and reasonably brought to his attention at the time the contract was entered into. A red hand clause will only be enforceable if adequate warning of its effects was given, or, given the nature of the contract, a reasonable party could be expected to read it carefully from beginning to end, or take legal or other professional advice as to its meaning and effect. Construction contracts, like marine insurance policies, can be complex documents, and are the sort of contract where it would be reasonable to expect the party whose rights are restricted or excluded would take advice before entering into them.
As Lord Justice Male said in the Court of Appeal, it is ‘difficult to see how this doctrine could ever apply to a contract of marine insurance in which the insured was represented, as will usually be the case, by specialist brokers who can be expected to familiarise themselves with the terms available in the market’.
In reaching their unanimous decision, the three Court of Appeal judges agreed with Amlin that its pay first clause was enforceable, because a marine insurance policy is the type of contract where the insured could reasonably be expected to take professional advice (for example, from its insurance broker). It followed that King Trader could not rely on the red hand doctrine to defeat the effects of the pay first clause.
On the question of sufficiency of notice, Denning LJ said in J Spurling Ltd v. Bradshaw :
| ‘I quite agree that the more unreasonable a clause is, the greater the notice which must be given of it. Some clauses which I have seen would need to be printed in red ink on the face of the document with a red hand pointing to it before the notice could be held to be sufficient.’ |
In an earlier case, Goodlife Foods Ltd v. Hall Fire Protection Ltd, the Court of Appeal held that an exclusion clause in a contract for the installation of a factory fire prevention system was effective. It rejected the claim that the exclusion clause should not apply to prevent the buyer’s claim. Although onerous, the buyer, whose rights were restricted by the exclusion clause, had been given sufficient notice of it.
In the Amlin case, the Court of Appeal followed the same approach. It emphasised that where parties to a commercial contract are of equal bargaining power and negotiating at arms’ length, the courts will respect their right ‘to contract on terms they choose, to allocate risks as they see fit’. Avoiding the clear words of the contract by reliance on the red hand doctrine is only likely to work if there is an obvious failure to give sufficient notice of its effect before the contract was entered into.
For further information or advice, please contact our construction team.
