Manchikalapati & Ors, R (on the application of) v The Financial Services Compensation Scheme

Compensation under an insurance policyholder protection scheme is confined to claims for liabilities owed under the contract of insurance, unless the scheme rules clearly extend it further. Costs awarded by a court and statutory judgment interest are not liabilities owed under the policy merely because they arise from litigation about an insured claim. The phrase “in respect of” must be read in the context of the scheme as a whole. Rules governing protected claims, compensation limits, calculation and payment confirmed that the scheme covered contractual policy benefits, not every amount connected with them. An earlier decision under materially different legislation did not justify a broader interpretation. Hardship and sympathy could not authorise the court to enlarge the scheme beyond the rules.

Policyholders held building guarantee insurance issued by Zurich Insurance plc. After Zurich declined claims for serious structural defects, the policyholders obtained judgment and a costs award. Zurich’s liabilities were transferred to East West Insurance Company Ltd, which paid the principal judgment sum but entered administration without paying VAT, statutory interest or most of the costs.

The Financial Services Compensation Scheme accepted that VAT was covered but refused compensation for the unpaid interest and costs. The High Court, Mr Dexter Dias KC sitting as a Deputy High Court Judge, granted judicial review and quashed that decision: [2022] EWHC 2228 (Admin). The FSCS appealed. The central questions were whether the claim for compensation was “in respect of” a protected claim, whether the unpaid amounts were themselves protected claims, and whether they were owed “under” the insurance policies.

1. Appeal allowed. The FSCS’s decision was reinstated. The court had no discretion to award compensation outside the Policyholder Protection Rules (“PPR”).
2. The PPR are legally enforceable rules made by the PRA under the Financial Services and Markets Act 2000 (“FSMA”). They should be construed broadly like statutory provisions, but with the rule-maker’s objective intention substituted for Parliamentary intention. The words used, the rules read as a whole, the statutory framework, the scheme’s practical operation and its funding by levies are relevant. The rules are intended to be workable and comprehensible to non-lawyers.
3. “Under” a contract of insurance means under its terms. It does not include liabilities arising from another source, such as a court order or statute. The unpaid costs and judgment interest therefore were not claims under the Policies and were not “protected claims” under PPR 9.1. The reference to “civil liability” in the definition of “claim” did not enlarge that meaning.
4. The phrase “in respect of” in PPR 3.1(2) meant “for” or “for the payment of” a protected claim in this scheme. The context supplied by PPR 6, 17, 19 and 20 showed that compensation was calculated by reference to benefits or liabilities due under the insurance contract. PPR 19.3 confined the overall claim to protected claims of the same category, while PPR 20.2 required calculation under the contract’s terms. A broader “integral to” or “sufficiently connected” test was inconsistent with the scheme.
5. Geologistics was not determinative. It concerned materially different legislation and costs expressly recoverable under the insurance policy. The Barras principle did not apply because the statutory and regulatory contexts and the subject matter were materially different. The 2020 Statement supported only an increase from 90% to 100% cover for building guarantee insurance, not an extension to costs and interest.
6. The court expressed sympathy for the policyholders and recognised the possible practical disincentive to litigate against a recalcitrant insurer. Those considerations could not distort the rules or supply a full indemnity which the scheme was not designed to provide.

1. Court of Appeal (Civil Division): appeal allowed and the FSCS decision reinstated, on the basis that unpaid litigation costs and statutory judgment interest were outside the PPR compensation scheme. [2023] EWCA Civ 1006
2. High Court of Justice, Queen’s Bench Division, Administrative Court: judicial review granted and the FSCS decision quashed. [2022] EWHC 2228 (Admin)