Insurance update

March 2012

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Introduction

This edition of Norton Rose Australia Insurance Update provides insight into recent decisions dealing with litigation funding in a representative proceeding, a bank fee class action, proportionate liability, double insurance and many more. The new Occupational Health and Safety legislation is outlined, as well as its impact on directors and officers and their liability insurers. We report on developments across a spectrum of other areas of insurance including regulatory and corporate. Finally, we provide some interesting highlights from our international offices. We hope you enjoy!

General: Do litigation funders need an AFS licence?

International Litigation Partners Pte Ltd v Chameleon Mining NL and Anor [2011] 276 ALR 138

Tricia Hobson, Marnie McConnell, Natalie Dickson

The NSW Court of Appeal has delivered the most recent challenge to the Australian litigation funding industry, finding that a funding agreement was unenforceable on the basis that the litigation funder was dealing in a ‘financial product’ without an Australian Financial Services licence.

Background

On 28 October 2008, Chameleon Mining NL (Chameleon) entered into a litigation funding agreement with a Singaporean litigation funder, International Litigation Partners Pte Limited (ILP), in respect of proceedings commenced in the Federal Court of Australia by Chameleon against Murchison Metals Ltd and others.

ILP was entitled under the funding agreement to the repayment of its legal costs and the payment of a percentage of the proceeds from the litigation. The funding agreement also gave ILP the right to a multi-million dollar Early Termination Fee in the event of termination.

Following a change in control in Chameleon resulting from a merger, Chameleon purported to rescind the funding agreement on the basis that, contrary to the Corporations Act 2001 (Cth) (the Corporations Act), ILP was providing a financial service without an Australian Financial Services (AFS) licence. The impact of this challenge was that if this rescission was effective, the contract with ILP would be unenforceable and ILP would not be able to recover the Early Termination Fee or any other benefit under the funding agreement.

Decision at first instance

Hammerschlag J rejected the proposition that the funding agreement was a “financial product” issued by a non-licensee and concluded that ILP was entitled to the Early Termination Fee.

Court of Appeal

The Court of Appeal, in determining whether the funding agreement was a “financial product”, was required to resolve whether the funding agreement was a facility through which Chameleon “managed financial risk” as required by section 763A(1) of the Corporations Act. At trial, Hammerschlag J had found that while the funding agreement minimised Chameleon’s defence costs enabling it to pursue Murchison, on no realistic view could it be said that the funding agreement was a facility through which Chameleon managed its financial risk.

On appeal, Chameleon submitted that his Honour wrongly confined attention to the payment of Chameleon’s defence costs without reference to the risk of an adverse costs order or the risk that the proceedings could not go ahead without the provision by Chameleon of security for costs, both of which also featured in the funding agreement.

The Court of Appeal unanimously held that the Funding Agreement was a “financial product”.

This Court however was divided as to whether the exception contained in s 763E of the Corporations Act applied. This exception permits dealing without an AFS licence where managing financial risk was not the main purpose of the “financial product”. The majority concluded that managing risk was the main purpose of the facility while Hodgson JA found that this aspect was incidental to the main purpose which was the provision of funding.

The result was that ILP was found to have provided “financial services” without an AFS licence contrary to the Corporations Act which meant that the funding agreement could be rescinded by Chameleon.

High Court - Special Leave

The High Court has granted special leave to ILP to appeal this decision. During the Special Leave Application, Gummow J observed that the question of licensing litigation funders was an important one that needed to be addressed.

Implications

The litigation funding industry will be watching closely this High Court appeal which is expected to take place this year.

ASIC has, since the Court of Appeal judgment, issued class order 11/555 which extends class order 10/333 to exempt all litigation funding arrangements, including single member arrangements, from the requirement to hold an AFS licence.

The Federal Government has also released details of a proposed Corporations Amendment Regulation which, amongst other things, seeks to carve out funded class actions from the definition of a “financial product” in the Corporations Act.

Thus it appears that whatever the outcome of the High Court appeal, litigation funders will not in future require AFS licences as the issue is being dealt with by ASIC and the Federal Government.

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General: Proportionate Liability under the microscope

Mitchell Morgan Nominees Pty Limited Pty Ltd v Vella [2011] NSWCA 390

Katherine Czoch, Randall Walker

Introduction

On 15 December 2011, the New South Wales Court of Appeal handed down its decision in Mitchell Morgan Nominees Pty Limited Pty Ltd v Vella [2011] NSWCA 390 (Vella). In doing so, the Court clarified how proportionate liability operates in New South Wales pursuant to Part 4 of the Civil Liability Act 2002 (CLA). In short, it is now more difficult to successfully reduce a defendant’s liability due to the requirement that, for the proportionate liability provisions to apply, any alleged wrongdoers must have each caused the plaintiff to suffer the same loss or damage. The New South Wales situation is now confirmed as similar to that in Victoria.

Facts of the case

Messrs Vella and Caradonna formed a joint venture in 2005 for the purpose of selling tickets to a boxing match between Anthony Mundine and Danny Green. The income from the joint venture was to be put into a joint account opened with the ANZ bank.

During this time, Mr Vella decided to consolidate all his loans. To that end, he attended his solicitor’s office to collect his property title certificates. Mr Caradonna also attended this meeting. While the loan consolidation did not proceed, at some stage Mr Caradonna came into the possession of Mr Vella’s certificates of title.

Without the knowledge of Mr Vella, Mr Caradonna forged Mr Vella’s signature on mortgage documents and used the certificates of title to borrow money from Mitchell Morgan Nominees Pty Ltd and Mitchell Morgan Nominees (No 2) Pty Ltd (together, Mitchell Morgan). Mr Caradonna’s solicitor cousin, Mr Flammia, misrepresented to Hunt & Hunt, solicitors for Mitchell Morgan, that Mr Vella had signed the mortgage documents before him. The forged mortgage was registered and Mitchell Morgan paid $1,001,748.85 into the joint ANZ account. Mr Caradonna subsequently forged Mr Vella’s signature again and withdrew these funds.

The Court of Appeal overturned the earlier decision in Vella v Permanent Mortgages Pty Ltd [2008] NSWSC 505 in which the Supreme Court held that Mr Vella was not liable to Mitchell Morgan. While the forged mortgage had gained indefeasibility of title upon registration, as it was worded to secure money payable by Mr Vella to Mitchell Morgan, and no such money existed, the mortgage was to be discharged. Hunt & Hunt, and Messrs Flammia and Caradonna, were found to be concurrent wrongdoers in negligence and fraud respectively.

By virtue of the operation of s 35 of the CLA, Hunt & Hunt’s liability was reduced to 12.5 per cent. However, as Messrs Flammia and Caradonna had since become bankrupt, an appeal was commenced to increase the proportion for which Hunt & Hunt was liable. The Court of Appeal increased Hunt & Hunt’s liability to 100 per cent.

Discussion

The key issue for the Court of Appeal was whether Hunt & Hunt and Messrs Flammia and Caradonna were concurrent wrongdoers under section 34(2)A of the CLA. Section 34(2)A provides that a concurrent wrongdoer is “a person who is one of two or more persons whose acts or omissions (or act or omission) caused, independently of each other or jointly, the damage or loss that is the subject of the claim.” Thus, the question was whether the acts of Messrs Flammia and Caradonna caused the loss which was the subject of Mitchell Morgan’s claim against Hunt & Hunt.

The Court of Appeal found that, in the claim against Hunt & Hunt, Mitchell Morgan’s loss arose because its money could not be recovered from the security, and not because it was lent in the first place. Therefore, Hunt & Hunt were not concurrent wrongdoers with Messrs Flammia and Caradonna.

In finding that they were not concurrent wrongdoers for the purposes of an apportionable claim, the Court of Appeal approved the Victorian case of St George Bank v Quinerts [2009] VSCA 245 (Quinerts). By way of background, Quinerts established that it is necessary to analyse the part played by each potential wrongdoer in causing the plaintiff’s loss. Only then can the Court establish, for the purposes of the proportionate liability regime, whether they are a concurrent wrongdoer.

The Court found assistance in the case of Hurstwood Developments Ltd v Motor and General & Andersley & Co Insurance Services Limited [2001] EWCA Civ 1785, in which Lord Hope of Craighead stated, “the mere fact that two or more wrongs lead to a common result does not of itself mean that the wrongdoers are liable in respect of the same damage. The facts must be examined more closely in order to determine whether or not the damage is the same.”

In light of this, Giles JA made the important distinction between damage and damages. Giles JA noted that “damage” was the actual injury suffered, while ”damages” were the compensation paid as a result.

This distinction helps in determining whether parties are concurrent wrongdoers. Two or more parties will not be found to be concurrent wrongdoers merely because they are liable to pay the same amount of damages in compensation. They must instead be liable for the same loss or damage. In this way, it is the underlying reason why the damages are being paid that is paramount.

In Vella, the Court of Appeal found that the damage, or loss, caused by Hunt & Hunt on the one hand, and Messrs Flammia and Caradonna on the other, did not match. Hunt & Hunt was liable for negligently failing to secure Mitchell Morgan’s loan with a valid mortgage. Messrs Flammia and Caradonna were liable for inducing Mitchell Morgan to pay the money through fraud. For this reason, the parties were not concurrent wrongdoers and liability could not be apportioned.

In finding Hunt & Hunt liable for the entirety of damages, the Court of Appeal established that a person who negligently acts and protects another person from fraudulent behaviour by a third party cannot reduce their liability by pointing towards the wrongdoer and arguing for the loss to be apportioned.

It is important to note that where the loss is not the same and there can be no proportionate liability, one party compensating the victim does not lessen the liability of the other wrongdoer. An equitable remedy can be sought should the victim receive double recovery.

Conclusion

The Court of Appeal decision in Vella provides clarification as to the operation of the proportionate liability regime in New South Wales. The implication is that legal practitioners must pay close attention when advising insurers and pleading proportionate liability. Practitioners and insurers alike may need to reassess their potential share of liability if it was previously assessed taking into account another liable concurrent wrongdoer. This is because proportionate liability can now only be used to reduce a party’s liability where they have caused the same loss or damage as the other party. As has been seen, professionals must be alert to the fact that a party may now be liable for the entire loss even where another party is involved. Concurrent wrongdoer defences will need to be considered carefully in light of this case.

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General: Who is liable – the lender or the broker?

Perpetual Trustee Company Ltd v Milanex Pty Ltd (in liquidation) [2011] NSW CA 367

Barry Richardson, Lona Naoum

A recent decision of the NSW Court of Appeal has clarified the liabilities of mortgage brokers.

At first instance, Mr Alexander Kotevski (Mr Kotevski), a 74 year old pensioner, was described by the primary judge as being “an unsophisticated man with very little formal education and virtually no business experience … had some knowledge of spoken English ... [but] … no capacity to understand more than very simple concepts…”

In 2005, Mr Kotevski was encouraged by a friend to take out a loan, secured by a mortgage over his property and repayable over a period of 30 years.

The preparation and completion of Mr Kotevski’s loan application was the responsibility of Good Home Loans Pty Ltd (GHL), following referral from Milanex Pty Ltd (Milanex), a mortgage broker.

Upon preparation and completion of the loan application, GHL forwarded the loan application to Calibre Financial Services Pty Ltd (Calibre), pursuant to a Mortgage Origination and Management Agreement (MOMA). Calibre was the agent of the lender, Perpetual Trustee Company Ltd (Perpetual). Calibre forwarded the loan application to Perpetual for approval.

In January 2006, following approval of the loan application, Perpetual advanced Mr Kotevski the sum of $221,935 (the Loan). The Loan was secured by a registered mortgage over Mr Kotevski’s home. Mr Kotevski initially made payments to reduce the Loan. Later he defaulted, and Perpetual took steps to enforce the mortgage.

In his defence, Mr Kotevski sought relief under the Contracts Review Act 1980 (NSW) (the CRA), claiming that the basis on which the loan agreement was formed was unjust.

A cross-claim was brought by Perpetual against Milanex for damages pursuant to section 52 of the former Trade Practices Act 1974 (Cth) and section 42 of the Fair Trading Act 1987 (NSW), on the basis that it had been misled by Milanex in relation to Mr Kotevski’s loan application and personal circumstances.

At first instance, Patten AJ found that Mr Kotevski had been pressured by his friend to enter into the loan agreement. It was noted by the Court that Mr Kotevski entered into the loan agreement for the sole purpose and benefit of his friend. Although Mr Kotevski sought independent legal advice from Mr Kevin Lo (Mr Lo) prior to entering into the loan agreement, His Honour found that Mr Lo could not have been satisfied that Mr Kotevski understood the requirements of the loan agreement, and that if Mr Kotevski had, he would not have entered into it.

Milanex was found liable for misrepresentation for verifying Mr Kotevski’s identity and income prior to referring Mr Kotevski to GHL. Mr Kotevski was a 74 year old retired builder whose sole income was his Centrelink pension. Patten AJ concluded that the loan contract between Perpetual and Mr Kotevski was unjust at the time it was made and, pursuant to the CRA, the loan and mortgage over the property were void. As a result, Perpetual was found to have suffered loss and damage.

However, Perpetual was unable to recover the funds it had advanced to Mr Kotevski. The Court confirmed that not only was the loan deemed void from the beginning, but that Perpetual, through its agent GHL, should have made the relevant enquiries to confirm the details apparently provided by Mr Kotevski in support of his loan application.

Milanex contended that it had done nothing more than pass information on, without adopting or endorsing it and as such had not made any representations. This argument was rejected, the primary judge finding that Milanex was not acting as a mere “conduit” or “post box.”

On appeal, Perpetual challenged the trial judge’s finding that it had not relied upon the representations made by Milanex. Perpetual submitted that, in considering reliance, the trial judge should have included in Milanex’s contravening conduct its continued involvement on behalf of Mr Kotevski in the process of the loan being advanced.  Macfarlan JA, with whom Campbell and Young JJA agreed, found that Perpetual had relied on the representations, at least in part, and that they did not rely solely on the representations “is not to the point”. His Honour referred to the comments of Wilson J in Gould v Vaggelas [1985] that “the representation need not be a sole inducement. It is sufficient so long as it plays some part even if only a minor part in contributing to the formulation of the contract.” Accordingly, his Honour rejected Milanex’s submission that the fact that GHL sought to verify some information it had received from Milanex meant that it wasn’t relying on the representations.

Macfarlan JA also found that the actions of GHL, having acted in some respects carelessly or having departed from the operations manual Calibre had directed it to comply with, were not significant to the case. His Honour went further and applied the approach laid down by Gaudron, Gummow and Hayne JJ in I & L Securities v HTW Valuers [2002]:

“It can be said of each of those events (the misrepresentation being one event and the carelessness of the lender the other), that had it not happened, the loan would not have been made and the lender would, therefore, have suffered no loss…but to show that if either of the two events had not occurred, a loss which has been suffered would not have been suffered, does not demonstrate that the one rather than the other event was the cause of the loss, any more than it demonstrates that neither was a cause of that loss. But the fact is that both did happen and both contributed to the decision to make the loan.

The MOMA between Perpetual and GHL provided Perpetual with a contractual right to compel GHL to take over the loan where there was a failure to comply with the operations manual. On this basis, Milanex attempted to plead that Perpetual failed to mitigate its loss. However, the point was only raised in closing submissions at first instance and Milanex was not permitted to raise the issue on Appeal.

Judgement was also entered against Mr Lo by consent on Mr Kotevski’s cross claim. Milanex successfully argued that Mr Lo was a concurrent wrongdoer and that Perpetual’s claim should be reduced to take into account Mr Lo’s share of responsibility. Although there was no contractual relationship or duty of care between Mr Lo and Milanex, Milanex argued that Mr Lo engaged in misleading and deceptive conduct in making representations to Perpetual to the effect that he had provided independent legal advice to Mr Kotevski and that he was satisfied “Mr Kotevski freely and voluntarily signed the loan and mortgage.” Their Honours apportioned the liability 65 per cent to Milanex, 35% to the solicitor (Young JA dissenting and apportioning liability of 75 per cent to Milanex).

Comments
The Court of Appeal rejected Milanex’s argument. Their Honours referred to the case of Butcher v Lachlan Elder Realty [2011] and noted:

… [i]f the circumstances are such as to make it apparent that the corporation is not the source of the information and that it expressly or impliedly disclaims any belief in its truth or falsity, merely passing it on for what it is worth, we very much doubt that the corporation can properly be said to be itself engaging in conduct that is misleading or deceptive.

Justice Macfarlan has provided a significant win for mortgage lenders. His Honour considered:

… that a mortgage broker who communicated to a mortgage lender or mortgage manager that it had a client who wanted to borrow money and who signed a loan application and associated documents would reasonably be understood to have been representing the truth of those matters, they being fundamental to the existence of the relation of the lender and Mr Kotevski that the mortgage broker was proposing to create.”

Traditionally, a mortgage broker’s role in the granting of a loan is the preparation and gathering of relevant documents and materials in support of the application, which is forwarded to the lender and/or it’s agent for processing.

This decision broadens the scope of the mortgage broker's liability in the loan application process. A mortgage broker will be held liable for loss or damage caused to a lender, following any representations made, however minor they might be, if they are relied upon by the lender in granting the loan.

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General: Arbitrating against companies in administration

Katherine Czoch, Riaan Piek, Rachel Page

On 5 October 2011, the NSW Supreme Court upheld an application pursuant to s 440D(1) of the Corporations Act 2001 (Cth) (the Corporations Act) for leave to bring and continue proceedings against a defendant under voluntary administration. In Larkden Pty Limited v Lloyd Energy Systems Pty Limited [2011] NSWSC 1305, Hammerschlag J found that the discretion granted under the Corporations Act was not limited by the assumption that it would be rarely exercised and, further, that the exceptions to recognition and enforcement of awards under s 36 of the Commercial Arbitration Act 2010 (NSW) (the Arbitration Act) were narrow and specific so as not to include the voluntary administration of an arbitrating party.

The facts

Larkden Pty Limited (Larkden) and Lloyd Energy Systems Pty Limited (Lloyd) were parties to arbitration proceedings in July and August 2010 that had arisen out of a dispute about the ownership of patent applications the subject of an earlier licence agreement. In what were described by the arbitrator as “draft reasons”, the arbitrator found in favour of the plaintiff, Larkden. Whilst the parties were preparing consent orders, the directors of Lloyd resolved that the company enter into voluntary administration. Shortly thereafter the arbitrator published further reasons and orders in favour of Larkden (the Award).

The enforcement proceedings

The issue for determination before Hammerschlag J was whether or not to provide Larkden leave under s440D(1) of the Corporations Act to pursue orders for the recognition and enforcement of the Award pursuant to s35(1) of the Arbitration Act.

Reasons

His Honour found in favour of Larkden for the following reasons:

  • Arbitral proceedings are not a “proceeding in a court” as contemplated by, and within the meaning s 440D(1) and accordingly no stay of orders is brought about by the appointment of an administrator: Auburn Council v Austin Australia Pty Ltd (2004) 22 ACLC 766.
  • An arbitral award may only be refused in the circumstances defined within s 36 of the Arbitration Act. Neither the administration of an arbitrating party, nor a stay of proceedings against an arbitrating party, are considered within the prescribed circumstances allowing for refusal of an award under the Arbitration Act.
  • The distraction value and cost to the administrators is minimal.
  • Larkden was seeking to vindicate rights of an essentially proprietary nature and the interests of unsecured creditors should not be a barrier to Larkden seeking to vindicate those rights. Further, it was held that Larkden “would not steal a march over any other creditor or potential creditor” by the court recognising and enforcing the Award.

Implications

The decision creates greater prospects for enforcement and recovery to arbitrating parties in the face of an existing risk of other parties to the arbitration entering into administration. The traditional position to rarely exercise the discretion to lift a stay on proceedings has been replaced with the view that the discretion is one at large, and should be exercised on a case by case basis. Section 36 of the Arbitration Act which sets out the circumstances where recognition and enforcement of an award may be refused reflects article 36 of the UNCITRAL model law on International Commercial Arbitration. This decision demonstrates a trend across Australia to ensure consistency in relation to international arbitration rules and arbitration awards and secure their enforceability. This is, however, in contrast to the current position in the UK, where the effect of moratoria under the UK Insolvency Act 1986 appears to be broader than the s440D Corporations Act stay on proceeding. It appears that if a similar application were adjudicated upon by the UK courts, the enforcement of the award would not have been sustained. 

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General: Duelling Indemnities: HIH continues to have impact

Nicole Wearne, Renee Gorenstein

HIH Insurance Ltd was notorious for its claims management approach to third party claims litigation with a fierce reputation for not being afraid to test the boundaries of legal principle. As a result the law reports are replete with significant superior court decisions in which HIH companies or their insureds feature in the development and understanding of Australian law and insurance law in particular. The group in liquidation has continued to add to the development of legal principle in the areas of insolvency law, reinsurance law, directors’ duties, shareholders rights: the list goes on. Its most recent contribution arises out of the remnants of the Dragon Scaffolding case following the Federal Government’s bailout of the HIH group. In the latest High Court case, HIH Claims Support Scheme (HCSL) has sought to extend the law in relation to equitable principles of dual insurance. 

The decision of the High Court in HIH Claims Support Ltd v Insurance Australia Ltd [2011] HCA 31 (the HCSL case) provides a useful statement of the principles of equitable contribution and when the obligations of two or more parties may result in coordinate liabilities.

HCSL was created by the Commonwealth Government to assist insureds affected by the collapse of the HIH group of insurance companies, by providing a partial or complete indemnity for third party and first party losses, subject to specified criteria being satisfied.

In general terms, dual insurance exists where two insurance policies insure the same entity against the same risk. The insured entity is entitled to call upon either policy to the value of the agreed indemnity. Under the principles of dual insurance, the indemnifying insurer is entitled to claim an equitable contribution from the other insurer.

The HCSL case involved an appeal by HCSL against a unanimous decision of the Court of Appeal of the Supreme Court of Victoria (Warren CJ, Mandie JA and Beach AJA). The Court of Appeal held that, for the principles of dual insurance to apply, the liabilities of the relevant insurers must be ‘coordinate’ or ‘of the same nature and to the same extent’. The Court found that the liabilities of HCSL and an insurer are not coordinate and therefore HCSL cannot rely on the principles of dual insurance to seek an equitable contribution from an insurer.

The High Court in the HCSL case unanimously dismissed the appeal.

Gummow ACJ, and Hayne, Crennan and Kiefel JJ found that the assignment of the insured's rights, which was central to the HCSL Scheme, did not place HCSL in the same position as HIH either ‘effectively or “in substance”’. Under the Scheme, HSCL did not step into the shoes of HIH and become exposed to all claims under HIH policies or to contribution claims from co-insurers of HIH. Rather, HCSL stepped into the shoes of the insured, who assigns his/ her rights to HCSL thereby entitling HCSL as assignee creditor to lodge a proof of debt in HIH's liquidation. That aspect of the Scheme, which applied to all eligible insureds, was fundamental to maximising recovery of public funds utilised for the purposes of the Scheme.

Further, the High Court found that the obligations of HCSL to the insured under the Scheme ‘were not "of the same nature and to the same extent" as the obligation of’ the respondent insurer (IAL) in that:

  1. there is no common interest or common burden between HCSL and IAL because, if IAL had paid the insured under its insurance policy before HCSL formed the contract between it and the insured, the insured would not have satisfied the eligibility criteria for assistance under the Scheme. The insured and HCSL would never have entered into contractual obligations with each other and the possibility of double indemnification in respect of the insured’s loss would not have arisen
  2. since HCSL undertook no enforceable obligations under the Scheme until a payment was made, IAL would never have had an opportunity to bring a claim for contribution against HCSL
  3. the offer of assistance under the Scheme was conditional upon the insured’s assignment of rights under the HIH policy, covering events which had already occurred. This means that the risk undertaken by HCSL could not be described as the same risk undertaken by IAL. It could not be said that HCSL’s contract to indemnify the insured, made after the HIH Group's insolvency and coming into existence upon payment, and IAL’s contract of insurance covering the insured ‘were the "one insurance"’.

The High Court held that IAL’s ability to claim the benefit of satisfaction, because of HCSL’s payments in respect of the insured, does not give rise to a common burden. The High Court found that ‘a "community of interest" between obligors is not a sufficient condition for the operation of an equity to contribute in circumstances where the obligations in question are qualitatively different’.

On the basis of the above, the High Court concluded that the obligations of HCSL and IAL ‘are not "of the same nature and to the same extent"’ and are not co-ordinate liabilities.

In a separate written judgment, Heydon J was somewhat critical of the situation in which HCSL found itself, identifying what he calls a number of ‘striking’ features of the case. Namely, that:

  1. whereas HIH was unable to pay but willing to do so, IAL was able to meet its liability to indemnify but has been unwilling to do so
  2. normally, where a person is insured by two insurers, the liquidation of the first operates adversely to the interests of the second by rendering it liable to indemnify the insured completely, without contribution. IAL does not dispute that, if HIH had not gone into liquidation but had indemnified the insured, IAL would have been liable to make contribution to HIH
  3. IAL has, despite its ‘stroke of good fortune in the Federal Government's intervention’, resisted paying anything towards alleviation of HCSL’s burden of indemnifying the insured, which, but for that intervention, it would have had to bear.

Notwithstanding the above, Heydon J concluded that the reasoning of the majority was correct and the appeal must be dismissed.

Heydon J confirmed that ‘contribution is a remedy which rests on a type of mutuality’ and found that mutuality did not exist. If the insured had proceeded against IAL, IAL would not have had contribution rights against HCSL because HCSL was not an insurer of the insured and IAL was not eligible to claim under the Scheme.

Heydon J noted HCSL’s argument that, if it lost the appeal, this would result in a ‘windfall’ to IAL. However, Heydon J considered that HCSL had presented no reason for developing the doctrine of contribution to overcome this difficulty. He considered that to develop the law to benefit HCSL in these circumstances ‘would not be to develop the law relating to contribution, but to revolutionise it’ and ‘it would be a revolution having the tendency to produce idiosyncratic and uncertain results’.

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D&O: OHS Developments

Drafted by Siobhan Flores-Walsh, Insurance contact Katherine Czoch

In January 2012, important changes to Australian Occupational Health & Safety (OHS) laws came into effect in NSW, Queensland, the Commonwealth, the ACT and the NT. Those changes are likely to be implemented in other States and Territories over the next 12 months. Directors and Senior Managers need to be aware of the potential personal and professional consequences of these changes. These include fines of up to $600,000 and/or jail sentences of up to five years.

What are the OH&S changes that Directors and other Officers need to be aware of?

The changes in Australian OHS laws are the most significant for over 30 years. The new laws represent a trade-off, that is: the acceptance of vastly increased criminal liability for corporate and individual decision-makers in return for the promised reduction in OHS compliance costs, which it is claimed will flow from having a “single” OHS system across Australia. The ideal is that businesses that operate across State and Territory boundaries will have less jurisdictional differences to manage.

The references in the media to a “single” or “uniform” OHS system in Australia are, however, misleading. We do not have a single national system from 1 January 2012 - we still have nine different OHS systems (one for each State, Territory and the Commonwealth). However, each system is based on model provisions for a principal OHS Act and model provisions for regulations and codes of practice. Importantly however, we have nine different regulators, nine different prosecutors and nine different first instance courts – these differences are not insignificant, and over time, the likelihood is that further jurisdictional differences will emerge; sabotaging the promised reduction in OHS compliance costs.

What are the main features of the so called ‘common legislation’?

There are four main features.

First, the “employer” is no longer the primary OHS duty holder - it is now, the “Person Conducting a Business or Undertaking”, which is commonly referred to as the “PCBU”. A PCBU can be an individual or a corporation and a PCBU can operate a business or undertaking alone or with others (i.e. with other PCBUs).

Second, the duty of care held by the primary PCBU is broader than that currently held by employers. The duty is to keep safe to the extent “reasonably practicable” a vastly increased group of people, which now includes all workers (a much broader concept than employees) and “any other person” who is put at risk by the activities of the business that is being run by the PCBU.

The definition of “worker” picks up everyone from an employee through to a volunteer (and everyone in between) and “any other person” means literally anyone else who is affected by the business (they do not have to have any connection with the PCBU’s workplace). This means that activities that may once have only been actionable under public liability laws and negligence laws will also be a breach of OHS laws.

Third, an issue directly relevant to Directors and other Officers is the imposition of a positive and personal obligation on persons who are classed as ‘officers’ under the new OHS laws (the category ‘officers’ replaces the director and manager liability under the “old” OHS legislation).

Under the new OHS laws “officers” have a personal and proactive duty to exercise due diligence to ensure that their organisation complies with its duty under the new OHS legislation. There are six elements of due diligence defined in the legislation. Those elements include taking reasonable steps to:

  1. Acquire and maintain up to date safety knowledge
  2. Gain an up to date understanding of business risks
  3. Provide and use appropriate resources
  4. Consider incidents, hazards and risks
  5. Ensure legal compliance
  6. Verify compliance with (1)-(5) above (audit and review).

The point here is that the elements of due diligence are quite specific, quite onerous and personal to each “officer” – leadership in OHS is not about good intentions, it is about doing very specific things. Importantly, this will be a criminal jurisdiction, so even low level breaches could result in a criminal record, with all the personal and professional consequences that entail.

Fourth, a new duty has been placed on concurrent duty holders. Essentially, if more than one person has an OHS duty in respect of the same matter, each person with the duty, must, so far as is reasonably practicable, consult, cooperate and coordinate activities with all other persons who have a duty in relation to the same matter. This duty requires duty holders to ensure that they have policies and procedures in place to provide for compliance with this new duty.

What should companies be doing now to prepare themselves for these changes?

First, companies need to ensure there is a high level of awareness at executive and board level about the new laws and how they will affect them as individuals and the operation of corporate governance systems – clearly, OHS will be a key corporate governance issue in 2012.

In terms of practical steps, there are two major streams of work: the OHS management stream and the due diligence stream.

The OHS management stream requires companies to perform a gap analysis of their current system to identify what needs to be done to comply with the new legislation. This audit should identify rectification actions including the need to revise OHS policies, review contracts, develop new consultation procedures with different groups of workers and new approaches to union right of entry for OHS purposes.

The due diligence stream is about developing mechanisms that ensure that the organisation’s officers can comply with the detailed and onerous officers’ duty discussed above. Individuals will not typically be able to meet those obligations, unless there is an organizational due diligence framework established to assist them with compliance. Accordingly, companies should audit their existing corporate governance systems to determine the extent to which they need to be amended to accommodate OHS in decision-making.

Do companies have any discretion as to whom they appoint as ‘officers’ for OHS purposes?

No. The term “officer” has the same definition as it has in the Corporations Act. This includes any director (formal or shadow director), company secretary, and any person who makes or participates in making, decisions that affect the whole or a substantial part of the business of the corporation. The identification of officers will be a question of fact.

Importantly, the term ‘officer’ may include parent companies that have extensive influence on the operation of subsidiary companies (i.e. the parent may be a shadow director for the subsidiary company and therefore an officer for it). Equally, it should be noted that the fact that an ‘officer’ is located overseas will not diminish in any way their duty of care as an officer.

What should Directors and Officers be doing about this now?

Directors and officers must ensure their OHS management systems are audited, that the required rectification work is undertaken and that training is undertaken in relation to the changes. This task is generally simple, although time consuming.

More challenging, but necessary, is the need to develop and implement a due diligence framework that identifies officers (not always easy) and ensures that they are assisted in the fulfilment of their new and onerous duty of care.

Impact on Directors and Officers Liability Insurance

Directors and officers liability insurers need to appreciate that the jurisdiction previously regulating OHS was generally regarded as quasi-criminal and one jurisdiction was a civil jurisdiction. Whereas before the company needed to have breached its duty before the director or officer could be liable, this is no longer a pre-requisite as there is now a positive duty on directors/officers to comply with due diligence obligations. The likelihood of directors being prosecuted and held liable for breaches is expected to increase under the new legislation. It is imperative for directors and officers insurers to ensure that their company’s OHS management system is audited to account for the changes in legislation and that gaps are rectified. This risk management step is the best way to safeguard directors and officers against OHS claims.

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D&O: Third party access to D&O policies

BOS International (Australia) Ltd v Babcock & Brown International Pty Ltd [2011] NSWSC 1382

Tricia Hobson, Andrea Garratt, Ross Whalebelly

On 11 November 2011, the Supreme Court of New South Wales handed down a decision ordering the defendant (BBIPL) to produce to the plaintiff (BOSI) copies of directors’ and officers’ insurance policies held by BBIPL or any other company within the Babcock & Brown group (of which BBIPL was a part) which would respond to a claim made during the period 1 January 2006 to 1 January 2011.

This case raised an interesting question as to the interaction of conflicting disclosure and confidentiality requirements under different agreements. However, the decision may be of limited use as precedent as it was very much based upon the construction of the particular terms of a particular agreement within its own factual matrix.

Background

BOSI managed a facility on behalf of a number of lenders who lent to BBIPL AUD3 billion pursuant to a syndicated facility agreement on 4 December 2008 (the Agreement). The Agreement provided at clause 10.1(l) that BBIPL was obliged to:

“provide [BOSI] with any other information the [BOSI] or a Lender requests relating to the assets, operations, accounting methods or financial position of [BBIPL] or any other member of the [Babcock & Brown Group] promptly on being requested to do so”.

The Agreement further provided that BBIPL was to:

“insure, and maintain insurance in relation to, its business and assets against those risks and to the extent as is usual for companies carrying on the same or substantially similar business”

Throughout the relevant period, BBIPL was an insured under directors’ and officers’ insurance policies (the D&O Policies) each containing a confidentiality clause which provided:

“The Insureds shall make all reasonable efforts not to disclose the existence of this policy to any person except to professional advisers or as required by law or court order and shall only state within the Company’s annual report that the Company has agreed, or otherwise, to pay a premium for this policy but shall not publish the nature of the liability covered by this policy, the name of the Insurer, the Limit of Liability or the Premium paid for this policy.”

A number of entities within the Babcock & Brown Group, including BBIPL’s parent company, were placed in liquidation. Although this did not include BBIPL, BOSI wanted to ascertain whether BBIPL’s policies would respond to claims which some of the companies might subsequently have brought against their directors and officers and to quantify the prospects of recovering the value of such claims. It therefore sought copies of all insurance policies in respect of BBIPL’s directors and officers and other members of the group which would respond to claims notified between 2006 and 2010 and certificates of currency for all such policies.

In light of the confidentiality clauses contained within the D&O Policies, BBIPL refused to produce them, and BOSI brought proceedings in the Supreme Court of New South Wales to compel their production.

Whether the D&O Policies were assets for the purposes of the Agreement

BOSI argued that clause 10.1(l) of the Agreement provided for access to the D&O Polices on the basis that:

  • a claim by BBIPL against its directors and officers was a chose in action
  • a request for copies of the D&O Polices was a request for information relating to an asset, as the worth of the chose in action may be dependant upon whether any judgment against the directors and officers would be met by the insurer
  • a request for copies of the D&O Polices therefore fell within clause 10.1(l).

BBIPL, in response, argued that, in the context of sophisticated parties which should be aware of the confidentiality provisions contained within insurance policies:

  • the term “asset” as used in clause 10.1(l) could not mean insurance polices as insurance policies are forms of protection obtained in respect of an asset, and so would fall outside of the term “asset”
  • in any event, the rights under an insurance policy are merely contingent rights or assets, which are dependent on a circumstance giving rise to a claim which falls within the terms of the policy (no such circumstance existing in this case)
  • the natural meaning of “asset” does not include a contingent asset.

Judgment in favour of BOSI

Justice Rein ruled in favour of BOSI, stating that a request for the D&O Polices was a request for information relating to the assets or financial position of BBIPL. On this basis, clause 10.1(l) of the Agreement required BBIPL to produce copies of the D&O Policies to BOSI. His Honour’s reasoning was as follows:

  • the rights associated with the D&O Polices were a chose in action, and accordingly an asset within the ordinary meaning of the term (“asset” not having been defined in the Agreement)
  • the fact that the asset was contingent on an event which may never occur (and which BOSI had not contended had occurred) was irrelevant
  • any claim against BBIPL’s directors and officers would also amount to a chose in action
  • such assets being intangible, the D&O Polices were the best source of information about them, and a request for their production was properly to be classified as a request for information about assets as opposed to a request to produce the assets themselves
  • further and alternatively, if a claim were made against BBIPL, the existence of any policy which may cover a portion of that liability would be information relevant to the financial position of BBIPL, and so would fall within clause 10.1(l) of the Agreement
  • BOSI could not be presumed to have been aware of the practice of including confidentiality provisions in directors’ & officers’ policies because the practice was not sufficiently “notorious” within the banking sector. In light of this, the practice could not form part of the factual matrix relevant to the construction of clause 10.1(l) of the Agreement.

His Honour was clear in his judgment that both the size of the loan facility in place and the fact that BBIPL’s parent company, along with various other Babcock & Brown companies, had been placed in liquidation had influenced his thinking. He noted that in that context the request did “not arise out of idle speculation on the part of the lenders”.

Conclusion

It is settled law that the bundle of rights that an insured has under a policy of insurance is a chose in action and is assignable at law. This was not disputed by BBIPL; the operative question in this case was whether the contingent nature of the asset took it outside of the meaning of clause 10.1(l) of the Agreement. It is unlikely that any general principle could be drawn from the court’s conclusion that, on the wording of the Agreement, the chose in action was an asset as contemplated by clause 10.1(l).

This is however an important case in that it shows that boilerplate clauses in other contracts can trump confidentiality clauses contained in policies of insurance despite the potential consequences of breach of those confidentiality clauses (such as potential loss or reduction of coverage under the policy should any prejudice be suffered by underwriters). It is notable that in this case the confidentiality clause allowed disclosure “as required by law or court order”.

It is also interesting in that, to a degree, this appears to have been a court sanctioned fishing trip to ascertain the depth of the pockets of potential targets for litigation. His Honour did, however, comment that the motivation behind the request was irrelevant to whether or not BOSI should be granted access to the documents in accordance with the Agreement. 

As a general proposition, companies entering into significant debt agreements should be aware that the terms of any such agreement may well require that they disclose the existence of and / or provide details of insurance policies of which they are beneficiaries despite any confidentiality obligations imposed by those policies. However, as shown in this case the context of the request for disclosure and the precise wording of the obligation will likely be determinative of the outcome of any proceedings brought to compel disclosure. 

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D&O: Shareholder access to the ambit of cover

Barry Richardson, Riaan Piek, Rachel Page

A recent decision of the Federal Court in London City Equities Limited v Penrice Soda Holdings Limited [2011] FCA 674 illustrates the trend set by the courts in recent years to exercise the discretion under s247A of the Corporations Act in favour of shareholder claimants.

Facts

On the basis that it held 8% of the issued share capital of Penrice Soda Holdings Limited (Penrice), London City Equities (LCE) sought authorisation to inspect Penrice’s books under ss 247A(1) and 247A(3) of the Corporations Act 2001 (Cth) (the Act). The books that LCE sought to investigate related to three areas of concern, namely:

  • the potential non-disclosure or misleading disclosure of certain financial information and whether Penrice or one or more of the directors of Penrice was responsible for the said conduct
  • whether in 2008 Penrice paid dividends other than from profits
  • whether Penrice funded the defence of two of the directors of their positions on the board. 

In order to decide whether to bring proceedings against the directors or against Penrice, LCE needed to assess whether it was capable of sustaining a claim against the directors (and which directors), as well as whether the directors would be able to satisfy a judgment in favour of LCE. LCE expressed concern as to whether the directors were covered for a claim against them and the monetary limit of such coverage.

LCE applied to the Federal Court for access to 15 categories of documents that dealt with the transactions and periods of time in which the directors exercised judgment relating to the areas of concern LCE sought to investigate. Included in the application was a reference to all documents "recording, referring or relating to Penrice’s Directors and Officers insurance policies for the periods from 1 July 2008".

Sections 247A(1) and 247A(3) of the Act and recent common law trends

Pursuant to s247A of the Act, shareholders are entitled to apply for orders authorising them to inspect the books of a company provided the application is made in good faith and for a proper purpose.

Robertson J affirmed that the test for this requirement was whether there was a “case for investigation”. He also noted that his discretion to make an order for inspection included discretion as to which of the books should be made available for that purpose. His Honour relied on Re Style Ltd; Merim Pty Ltd v Style Ltd (2009) 255 ALR 63 which enounced that books inspected should be limited to those that bear on, and are particularly relevant to, the purpose for which the inspection is sought.

His Honour further observed that where the case to investigate rests largely on the position of directors and their knowledge at certain points in time, it is not appropriate to merely confine the ambit of documents to be inspected to the results evidencing decisions of directors.

Penrice contended that the discretion under s247A of the Act should be exercised only where the inspection of documents concerns the investigation of the facts potentially in issue and not merely the financial position of the potential defendants.

In reliance on the decisions in Re Style Ltd; Merim Pty Ltd v Style Ltd (2009) 255 ALR 63 and Snelgrove v Great Southern Managers Australia Ltd (in liq) (receiver and manager appointed) [2010] WASC 51, where shareholders were given access to inspect D&O policies, His Honour considered the scope and nature of the cover as relevant factors in any decision as to whether to initiate proceedings against the directors. As Le Miere J explained in Snelgrove, it is consistent with modern case management objectives that litigation not be wasteful and found that obtaining an understanding of the scope of liability cover available to directors and officers constituted a proper purpose under s247A.

Findings

Notwithstanding the challenging breadth and varying dates of the subject matter of the categories of documents sought to be inspected, His Honour found that the s247A application had been made in good faith and for a proper purpose.

Following a meticulous assessment of each of the 15 categories of documents requested by LCE, the Court found that 11 of those listed within the originating process bore on and were relevant to the purpose submitted by LCE. His Honour amended the scope of all of the categories of documents for which he made orders other than one which was not in issue, and further limited the time frames of the categories to ensure they were closer in proximity to the transactions and events the subject of LCE anticipated proceeding.

As to inspection of D&O policies, whilst judicial cognisance had been taken of Penrice’s contention with the trend set in Re Style Limited and Snelgrove, the Court remarked that unless the approach was clearly wrong, consistency demanded an application of earlier decisions. Accordingly, orders were made authorising access to, and the inspection of Penrice’s D&O policies.           

Implications

This decision cements the trend in favour of shareholder claimants seeking to gain access to D&O insurance policies and in so doing exposes insurers to a magnet effect of litigants and litigation funders.

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D&O: Expansion of personal liability of directors

Ashley Jones, Daniel Davison

Australian law recognises that a company is a separate legal entity from its directors, officers and shareholders, and that directors are not generally liable for the debts of companies. The law will pierce the “corporate veil” only in limited circumstances, such as where directors breach their duties to the company or cause the company to trade while insolvent. The recent Supreme Court of Queensland decision of Phoenix Constructions Queensland Pty Ltd v Coastline Constructions Pty Ltd and McCracken [2011] QSC 167 has potentially widened the scope for creditors to claim damages against a director personally for a contravention of the Corporations Act 2001 (Cth) (Act). 

The Court held that a creditor is entitled to damages against a director personally if the claim falls within section 1324 of the Act. Section 1324 provides that where a person has engaged in conduct that constitutes a contravention of the Act, any person affected, including creditors or a member of the insolvent company, may apply to the Court for an injunction restraining the director from engaging in that conduct. The Court also has the power under section 1324(10) to order that person to pay damages to any other person.

The Court awarded damages, including interest of approximately $2 million against the defendant, Mr McCracken. This decision is subject to appeal.

Background

The third defendant, Mr McCracken, was the sole director of Coastline Constructions. In August 2004, the first defendant, Coastline Constructions, entered into a joint venture agreement (JV Agreement) for the development of land owned by the second defendant, the wife of Mr McCracken. Coastline Constructions then entered into a construction management agreement with the plaintiff, Phoenix Constructions. Coastline Constructions breached the construction management agreement, causing Phoenix Constructions to institute proceedings against it. Subsequently, Coastline Constructions became insolvent and Mrs McCracken became bankrupt.

In February 2007, a Deed of Amendment (Deed) was entered into by Coastline Constructions and Mrs McCracken. The Deed amended the JV Agreement so that Coastline Constructions abandoned its rights in much of the remaining land in favour of Mrs McCracken.

Amendment of JV Agreement in breach of section 182 of the Act

Phoenix Constructions alleged that Mr McCracken had engaged in “improper” conduct, in breach of section 182 of the Act. That section requires directors to exercise their position and discharge their duties in good faith, in the best interests of the company and for a proper purpose.  The Court accepted Phoenix Constructions’ submission and held that Mr McCracken had used his position as director to gain an advantage for his wife. The Court held that the effect of entering into the Deed was to deprive Coastline Constructions of a beneficial contractual interest in six units. This denied Phoenix Constructions recourse against the assets of Coastline Constructions, so far as those six units were concerned. The court noted as relevant, evidence of an earlier threat made by Mr McCracken to Phoenix Constructions that he would “not be paying anything” and could “close the company down” if he needed to.

Entitlement to damages under section 1324 of the Act

Phoenix Constructions applied under section 1324 of the Act for injunctive relief, and in the alternative, or in addition to, damages, as a person whose interest had been, or would be, affected by Mr McCracken’s actions. The question for the Court was whether the Court had power to award damages under section 1324(10).

The Court held that, the fact it had jurisdiction to grant an injunction under section 1324 to restrain Mr McCracken, was sufficient to enable the plaintiff to claim for damages. Significantly, the court held it was not necessary for Phoenix Constructions to prove that it was likely an injunction would have been granted or otherwise refused on discretionary grounds. The court cited with approval the principle established in Wentworth v Woollahra Municipal Council (1982) 42 ALR 69 that a discretionary defence to a claim for equitable relief, such as injunction, cannot operate as a defence to a claim for common law damages for infringement of the right on which the equitable relief was based.

Accordingly, the Court was satisfied that the terms of section 1324 of the Act were met and ordered Mr McCracken to personally pay damages to Phoenix Constructions.

Conclusion

This decision potentially broadens the category of persons who may claim against directors personally for breach of duties owed to the company. Whether this case marks the beginning of a new line of authorities widening the personal liability of directors will depend on the outcome of the pending appeal. Central issues that will be raised include whether section 1324(10) confers a right to damages on a creditor for loss suffered from a breach by a director of a duty imposed by section 182 and whether the Court has power to award damages in substitution for an injunction that has no prospect of being granted. 

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D&O: Board papers in the cloud

Authors: Tim Woodforde, Kathryn Martin Contact: Katherine Czoch

Introduction

It is impossible to ignore the trend towards increased use by boards, in Australia and elsewhere, of cloud-based information technology services to create paperless board rooms, reducing the need for traditional email and paper-based communications. These services allow board papers and other information to be securely uploaded by management and then accessed remotely by directors through dedicated applications and the use of mobile devices, such as laptops and iPads.

Evolving concepts of communications

Efficient and effective communication has become an increasingly difficult task at the board level, where companies and their directors are expected to manage complex and voluminous quantities of information.

Recent Australian cases, such as Centro1, have demonstrated the need for directors to have continual access to company information and be able to analyse the information presented to them. In Centro, the Court provided little comfort to the company’s directors, who relied on the quantity and complexity of the information supplied to them as a defence to allegations of negligence, reasoning that the board could control the amount and format of information received. Consequently, the standard of information oversight now expected can create problems for companies and their directors, and highlights the growing importance placed on managing the manner in which information is provided to directors, not only in terms of content but also in terms of presentation and accessibility.

Cloud-based information technology services will potentially revolutionise the manner in which management communicate with directors and directors communicate with each other. Depending on the services provided, there are many advantages associated with using the more popular devices, such as iPads, to distribute board papers to directors. For example, there are cost savings and efficiencies associated with reduced paper consumption, courier fees and time spent on document preparation. Directors have immediate access to current documents, regardless of their location. Further, with documents being stored in a central document repository (ie, the cloud), there is a corresponding reduction of physical storage space.

These services can vary substantially from a customised service developed to meet the needs of a particular company, to an ‘off-the-shelf’ service where a company has no control over the hardware or software that provides the service. Accordingly, given these technologies are relatively new and continuously evolving, it is important for companies to remain vigilant, to:

  1. ensure that any chosen cloud service is compatible with their corporate governance and operational policies; and
  2. take all appropriate actions to minimise risks associated with a variety of new legal and regulatory challenges arising from the use of cloud services.

Some of the more apparent legal and regulatory issues are discussed in detail below.

Confidentiality and security

When talking about confidentiality and security, there are a number of questions that must be asked of service providers. First, is your confidential information more secure by being hosted online with other companies or offline on the company’s own local network? What harm would it cause your company if confidential information fell into the wrong hands? Consider what type of, and how much, information you want to upload to these services – this is sensitive information and it is important to ensure that you have control over, and can restrict access to, that information.

Ownership concerns also need to be considered and appropriately addressed. In Kriewaldt2, the Court considered whether board papers become the property of a director when provided to that director. Justice de Jersey held that when the company provided board papers to directors it was to be taken as surrendering its right to them. His Honour reached this decision because the company had not reserved its rights to recall the papers when sending them to the directors, the papers had never been recalled by the company, the directors had been free to mark and annotate the papers, and the papers had been sent without any conditions attached to their disposal. However, importantly, his Honour stated that “this is apparently not a case, I would add, where at the end of meetings, the papers are recalled.” Consequently, you should consider whether you wish to implement policies to ensure that board papers are recalled at the end of meetings – discuss these options with your information technology service provider before rolling out the services at a board level.

You also need to consider whether it is appropriate to place restrictions on whether board papers may be printed or saved locally (ie, to the memory of the device), or annotated with notes. While personal notes made by directors on board papers can serve as useful reminders to busy directors, directors’ notes can be requisitioned as evidence in court. This may be helpful if the notes show that the directors adequately informed themselves, appropriately questioned and considered issues, and used proper care and diligence; however, this practice can also create risk if the notes are ambiguous, incomplete or inconsistent with other records, such as the formal minutes of meetings.

Directors’ duties

These issues can lead to tensions between a company and its directors. While a company will naturally be concerned with confidentiality and security issues, directors will be motivated to ensure that their access to board papers, as well as their ability to annotate the board papers with notes, will enable them to satisfy their duties as directors, particularly their duty of care and diligence.

For a start, the board papers must be presented in a manner which allows the directors to review them to a level required to discharge their duties. From a practical perspective, it may be difficult for directors to view lengthy documents (such as financial reports) on a mobile device (where, for example, they cannot have multiple pages in front of them, as they could with hard copies). Further, those directors who are not very computer literate may find using a mobile device difficult, and until they become comfortable with the technology, it may be more time consuming and less efficient for them to review board papers using mobile devices.

Privacy

Australian privacy laws generally require personal information (or other sensitive information such as health information) collected by certain organisations to remain within Australian borders unless, among other exceptions, the individual consents to the transfer or the organisation believes the recipient of the information is subject to laws that are substantially similar to the National Privacy Principles. Therefore, it is important to be aware of the types of information which directors will have access to online, as well as to consider whether or not that information will be held or accessed overseas by either the service provider or directors.

The company should also consider the risk that their data may be disclosed to the government of the jurisdiction in which their data is held by the service provider, possibly without their knowledge or consent. For example, the United States government is permitted under the USA Patriot Act3 to seek a court order for disclosure of electronic records, often without permitting notice to the user.

Reliability of access

Timely access to information is vital for directors. It is important to remember that directors have both general law and statutory rights of access, and may also have contractual rights of access, to certain company documents, including board papers, which may be primarily accessible through your chosen technology.

At common law, directors have rights of access to company documents in order to facilitate the performance of their duties, together with corresponding rights to make copies.4 Directors also have a statutory right of access to certain documents (including board papers) in the circumstances afforded under sections 198F and 290 of the Corporations Act 2001. A contractual right of access may also have been granted to directors under a Deed of Access, Indemnity and Insurance with the company, together with a corresponding right to make copies.

Technology isn’t always reliable. Accordingly, it is important to not only ensure that you meet the general law, statutory and contractual rights of access, but that you also implement appropriate standards of data protection, security, back-up, redundancy and disaster recovery processes – these standards should be documented both internally within the company as well as by agreement with the relevant information technology service provider.

Document retention

Subject to individual company document retention policies, some cloud services also offer the ability to permanently purge documents upon deletion. This includes the ability to irrevocably purge email messages uploaded on cloud servers, or electronic notes made by directors on uploaded documents, such as board papers.

Take the time to ensure that your document retention policies are up to date. If documents are held online by service providers, consider adopting and maintaining a robust records management policy to ensure that you are aware of what and where documents are located.

While most people engaged in business activities understand the need to keep proper records, many are unaware of the plethora of Federal and State laws that impose document retention and production obligations. This is particularly important given the emerging trend, in Australia and elsewhere, to criminalise poor document management practices. Organisations which destroy documents relevant to a Court hearing may be prosecuted for obstructing justice or be held in contempt of Court. Potential penalties include fines for the company and the individual, and in extreme cases, gaol for the individual.

Concluding remarks

There is no doubt that the use of paperless board rooms by Australian companies is increasing – numerous services are being marketed which provide better ways to manage board processes in an environment where a company’s compliance responsibilities are continually evolving.

The issues raised in this update are not intended to be exhaustive, although companies must ensure that they stay alert to critical issues, such as confidentiality, security, directors’ duties, privacy, access to information and document retention. This means that, before making the decision to move towards a paperless board room, you should take a few moments to consider your company’s risk profile as well as its corporate governance and operational policies, so that you continue to protect your company’s information and are well prepared to incorporate these technological changes into your business practices.

1ASIC v Healey & Ors [2011] FCA 717.
2Kriewaldt & Ors v Independent Direction Ltd (1995) 14 ACLC 73.
3Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT ACT) Act of 2001.
4Edman v Ross (1922) 22 SR (NSW) 351

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D&O: Proposed directors’ liability reforms

Authors: Tim Woodforde, Kathryn Martin Contact: Katherine Czoch

Introduction

On 27 January 2012, David Bradbury (the Parliamentary Secretary to the Treasurer) released for public consultation the first tranche of proposed amendments to Commonwealth legislation to implement principles approved by the Council of Australian Governments (COAG) to harmonise derivative liability for corporate fault across Australian jurisdictions. The proposed amendments are contained in the Personal Liability for Corporate Fault Reform Bill 2012 (Bill).

Directors’ liability reform project

At present, there are hundreds of Australian laws that impose personal liability on directors and other corporate officers for contraventions of the law by their companies. Often these laws impose strict liability, making directors and other corporate officers automatically liable if their companies contravene the law, even where they may not be aware of, or have the ability to prevent, the contravention. In many cases, the usual burden of proof is reversed, obliging corporate officers to prove their own innocence. Consequently, there has been growing concern in recent years about the consistency and fairness of these laws, which unnecessarily create significant burdens for corporate officers, particularly their own personal compliance, as well as recurring issues of criminal justice and equality.

Accordingly, the directors’ liability reform project of COAG is designed to harmonise the imposition of personal criminal liability for corporate fault across federal, state and territory legislation by reference to an agreed set of principles which aim to ensure that, where derivative liability is considered appropriate, it is imposed in accordance with principles of good corporate governance and criminal justice and in a manner that will promote responsible entrepreneurialism and economic growth.

The Bill relates only to Treasury (non-taxation) portfolio legislation. In other words, it appears that we are to be drip-fed amendments to Commonwealth legislation, potentially on a portfolio by portfolio basis rather than on a whole-of-government basis, which does not auger well for a harmonious approach within the Commonwealth Government, let alone between the various Australian Governments. At this stage, there has been limited progress by the States and Territories in releasing draft legislation, and it is now over two years since COAG approved the principles (COAG Principles) developed by the Ministerial Council for Corporations.

COAG Principles

The COAG Principles are as follows:

  1. Where a corporation contravenes a statutory requirement, the corporation should be held liable in the first instance.
  2. Directors should not be liable for corporate fault as a matter of course or by blanket imposition of liability across an entire Act.
  3. A ‘designated officer’ approach to liability is not suitable for general application.
  4. The imposition of personal criminal liability on a director for the misconduct of a corporation should be confined to situations where:
    1. there are compelling public policy reasons for doing so (e.g. in terms of the potential for significant public harm that might be caused by the particular corporate offending);
    2. liability of the corporation is not likely on its own to sufficiently promote compliance; and
    3. it is reasonable in all the circumstances for the director to be liable having regard to factors including:
      1. the obligation on the corporation, and in turn the director, is clear;
      2. the director has the capacity to influence the conduct of the corporation in relation to the offending; and
      3. there are steps that a reasonable director might take to ensure a corporation’s compliance with the legislative obligation.
  5. Where principle four is satisfied and directors’ liability is appropriate, directors could be liable where they:
    1. have encouraged or assisted in the commission of the offence; or
    2. have been negligent or reckless in relation to the corporation’s offending.
  6. In addition, in some instances, it may be appropriate to put directors to proof that they have taken reasonable steps to prevent the corporations’ offending if they are not to be personally liable.

Since the COAG Principles were adopted on 29 November 2009, the Business Regulation and Competition Working Group, comprising representatives from Commonwealth, State and Territory Governments, developed supplementary guidelines (BRCWG Guidelines) and then each Government proceeded to separately audit their own legislation against the COAG Principles and BRCWG Guidelines. On 11 February 2011 the Reform Council of COAG published a performance report1 which identified serious concerns about the progress of reforms relating to derivative liability and the failure to implement any inter-governmental process to ensure there will be nationally consistent outcomes relating to those reforms.

Given the long period of gestation, the Bill itself has remarkably little substance.

Corporations Act 2001

Proposed amendments include:

1. Responsibilities of the company secretary:

Section 188 designates responsibility to a company secretary for certain administrative functions of the company. It is proposed this section be amended by reducing the liability imposed on company secretaries so that a breach of section 188 is subject to a civil penalty, rather than constituting an offence. Further, the Courts will become entitled to make a declaration of contravention if a company secretary has contravened section 188. However, their ability to order a company secretary to pay a pecuniary penalty will be limited to $3,000 for breaches of these responsibilities.

2. Location of registers:

The responsibilities of a company secretary will be extended under section 188 to purportedly include section 1302, which requires that a register of charges be kept, subject to certain exceptions, at the registered office or at an office at the principle place of business in Australia.

However, section 1302 was repealed by the Personal Property Securities (Corporations and Other Amendments) Act 2010, effective 30 January 2012.

3. Duties of responsible entity:

Section 601FC(1) sets out the considerations of a responsible entity of a registered scheme when exercising its powers and carrying out its duties. Section 601FC(6) currently extends personal liability for intentional or reckless involvement in the breach of these duties – this section will be repealed, although the standard legal principles regarding accessorial liability for those involved in the commission of offences would remain.

4. Penalties:
Schedule three lists the penalties available for breaches of relevant provisions. Amendments have been proposed to increase the severity of certain penalties listed in the Schedule.

Examples of the proposed increases include:

 

ProvisionProposed penalties
Failure by a company to have a registered office in Australia, or to lodge notice of a change of address of its registered office with ASIC not later than 28 days after the date on which the change occurs (sections 142(1), (2))60 penalty units*
Failure of the registered office of a public company to be open to the public within specified hours, or to lodge notice of a change in the opening hours of its registered office with ASIC before the day on which a change occurs (sections 145(1), (3))60 penalty units*
Failure to lodge with ASIC notice of a change of the address of a company’s principle place of business not later than 28 days after the date on which the change occurs (section 146(1))60 penalty units*
Failure to notify ASIC of change to member register or share structure by proprietary company (see sections 178A(1), 178C(1))60 penalty units*
Failure to notify ASIC of the personal details of a director, alternate director or secretary on their appointment, when their personal details change, or when cease acting as a director or secretary within 28 days after the date on which the change occurs. (sections 205B(1), (2), (4), (5))60 penalty units or imprisonment for one year, or both**
Failure to notify ASIC of share issue within 28 days after issuing shares, or attend to additional lodgement requirements for shares issued for non-cash consideration under a contract (sections 254X(1), (2))60 penalty units*
Failure to lodge annual report with ASIC (section 319(1))60 penalty units or imprisonment for one year, or both***

 * Currently five penalty units.
** Currently 10 penalty units or imprisonment for three months, or both.
*** Currently 25 penalty units or imprisonment for six months, or both.

Other Commonwealth legislation

The Bill also contains some fairly minor amendments to the Foreign Acquisitions and Takeovers Act 1975,the Insurance Contracts Act 1984 and the Pooled Development Funds Act 1992.
Submissions on the exposure draft of the Bill close on 30 March 2012.

Mr Bradbury’s press release indicated that a further exposure draft bill covering the second tranche of proposed amendments to Commonwealth legislation is expected to be released for public comment in the first quarter of 2012.

1Titled “National Partnership Agreement to Deliver a Seamless National Economy”.

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D&O: Bridgecorp decision

Marnie McConnell

A primary benefit of Directors & Officers (D&O) cover is the costs protection it provides for directors and officers. The recent High Court of New Zealand case of Steigrad v BFSL puts this cover at risk when a company collapses and a third party claimant seeks a charge over the insurance proceeds of the D&O policy.

The facts

The Bridgecorp group collapsed and was placed into receivership owing investors nearly $500 million. The directors of Bridgecorp faced numerous criminal and civil claims following the collapse.

The Bridgecorp companies held D&O cover with QBE. The directors also held separate defence costs cover which had been fully eroded by the defence costs incurred to date. The directors were therefore relying on the cover available under the D&O policy to cover their defence costs going forward. Significantly for the directors, the D&O policy responded to the directors' legal liability to third parties and the limit of indemnity under the D&O policy was inclusive of defence costs.

The investors of Bridgecorp who had lost their money in the collapse claimed a charge over the monies payable under the D&O policy pursuant to section 9 of the New Zealand Law Reform Act 1936 (the NZ Act) which is written in substantially similar terms to section 6 of the New South Wales (NSW) Law Reform (Miscellaneous Provisions) Act 1946 (the NSW Act). Section 9 of the NZ Act relevantly provides as follows:

  1. If…the insured has, whether before or after the passing of the Act, entered into a contract of insurance by which he is indemnified against liability to pay any damages or compensation, the amount of his liability shall, on the happening of the event giving rise to the claim for damages or compensation, and notwithstanding that the amount of such liability may not then have been determined, be a charge on all insurance money that is or may become payable in respect of that liability.
  2. If, on the happening of the event giving rise to any claim for damages or compensation, the insured…is being wound up, the provisions of [subsection (1)] shall apply notwithstanding the…insolvency…of the insured.
  3. Every charge…shall be enforceable by way of an action against the insurer in the same way and in the same Court as if the action were an action to recover damages or compensation from the insured…

Section 9 of the NZ Act (and section 6 of the NSW Act) creates a charge in favour of a claimant over insurance proceeds enabling the claimant to directly access these funds in certain specified circumstances. The purpose of this statutory charge is to ensure that enforcement of a claimant's entitlements is not frustrated by, relevantly, the insolvency of the insured.

The charge having being claimed, QBE advised the directors that it could not make any payments under the D&O policy in respect of their defence costs until the directors and the investors agreed on an allocation of the funds available under the D&O policy. When the parties were unable to agree on this allocation, the directors approached the court seeking a declaration that the charge did not prevent QBE from funding their defence costs.

The High Court's ruling

The High Court determined that the payment of the directors' defence costs could not be permitted to reduce the pool of funds that would otherwise be available to meet claims to which the charge applied. The NZ Act (and the NSW Act) charged "all insurance money" that was or may become payable in respect of "liability to pay damages or compensation". According to the High Court, this meant that where the level of cover was less than the amount of a notified claim, the entire cover under the policy was subject to the charge. As the investors' claim was significantly greater than the limit of indemnity under the D&O policy, QBE was obliged to keep the insurance proceeds intact for the benefit of the investors. The High Court noted that the position would be different in circumstances where the amount of the claim was well within the amount of cover available under the policy. In that case, an insured director may be able to gain access to the policy to meet defence costs.

The High Court warned that the risk to QBE in meeting the directors' defence costs where a charge had been claimed was that it could become liable to restore that amount to the pool of money available under the policy to meet the investors' claim.
While observing that this ruling produced unsatisfactory consequences for the directors, the High Court commented that this outcome was party a consequence of the decision by the Bridgecorp companies to take out a policy that provided cover for both defence costs and claims for damages and compensation.

Implications

In NSW, where the limit of indemnity under a traditional D&O policy is costs-inclusive, directors are at risk of losing their defence costs protection should the company become insolvent. It was accepted in Steigrad that the separate defence costs cover held by the directors, which had already been eroded at the time of this action, would not have been subject to the statutory charge as it did not indemnify the directors for damages or compensation - it covered only defence costs. This decision has caused debate in the industry as to whether new language in D&O products can be devised to prevent this outcome or whether it is necessary to take out separate defence costs cover to ensure that this protection will be in place for directors when they need it.

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Financial Institutions: What bank fees constitute penalties?

Authors: Alison Deitz, Alison Castle Contact: Tricia Hobson

Bank fee Class Action

Judgment was handed down late last year by Gordon J in John Andrews & Ors v Australian and New Zealand Banking Group Limited [2011] FCA 1376. This judgment dealt with the declarations sought by the applicants that the arrangements between ANZ and the applicants in relation to ANZ charging an exception fee on the accounts in question are void and unenforceable as they amount to a penalty, and required the determination of Separate Questions which identified certain specific Exception Fees charged by ANZ to account holders in relation to an identified ANZ account.

The applicants in the proceedings were customers of ANZ seeking declarations that Honour Fees, Dishonour Fees, Over-limit Fees, Non-Payment Fees and Late Payment Fees (Exception Fees) charged by ANZ on a variety of accounts, could constitute a penalty and as such were unenforceable or void.

Gordon J found that of these Exception Fees only the Late Payment Fees could constitute a penalty. Her Honour based her reasoning on an analysis of the contractual and regulatory framework which underpins each of the Exception Fees and found that only the Late Payment Fees which were charged in respect of late payments in respect of consumer credit cards could be characterised as a fee charged as a result of a breach of contract and were therefore the only category of the Exception fees that was capable of being characterised as a penalty. In making that finding Her Honour pointed out that it was accepted that the Exception Fees did not constitute a genuine pre-estimate of damage. However, consideration of the quantum of the Exception Fees and, in particular, whether that Exception Fee was out of all proportion to the likely damage suffered by the ANZ was deferred to a later hearing.

Law of Penalties

The case provides an excellent summary of the development of the law on penalties in both England and Australia. Her Honour made the observation at the outset that “the law of penalties is a narrow exception to the general rule that the law seeks to preserve freedom of contract, allowing parties the widest freedom, consistent with other policy considerations, to agree upon the terms of their contract. Equity, however, continues to play a role in the law of penalties, a law which is confined to payments for breach of contract.”

In their assertion that the Exception Fees constituted a penalty, the applicants sought to construct an argument that the law of penalties was not confined to payment made upon breach of a contract, but also applied to payments made upon conditions or events lying within the areas of obligations of the party required to make the payment. They referred both to past decisions and the historical origins of penalties.

After extensive and careful analysis of the law of penalties, Gordon J in rejecting this characterisation or broad definition of a penalty, made the following conclusions with respect to the law of penalties:

  • The law of penalties is a narrow exception to the general rule that the law seeks to preserve the freedom of contract.
  • To the extent that there are judicial statements to the effect that breach is not an essential element, this is limited to the applicability of the law of penalties to lease and hire purchase agreements governing the consequences of termination of these agreements. The state of the current authorities in respect of contractual payments upon termination is that the law of penalties is only applicable where the agreement is terminated for breach of contract.
  • Where the contract has provided for a sum or amount to be paid upon breach of the contract, the question as to whether the sum is a penalty is a question of construction to be decided upon the terms of and inherent circumstances or each particular contract.
  • A sum will be a penalty in circumstances where it is considered to be extravagant and unconscionable in amount by comparison to the greatest loss that could conceivably be proved to have followed from the breach or could not be considered a genuine pre-estimate of loss that would flow from the breach.

Whether the Exception Fees Constituted a Penalty

In rejecting the applicant’s assertion that Honour Fees, Dishonour Fees, Over-Limit Fees and Non-Payment fees were penalties, Gordon J first characterised the relationship of a saving or deposit account as being, in law, a loan to the bank whereby the bank borrows the money and proceeds from the customer who undertakes to repay them on demand.

On the other hand, where an issue of a cheque by a customer or the giving of a payment instruction to the bank would have the effect of overdrawing the customer’s account, Gordon J construed this as a request by the customer for an advance or loan from the bank, which the bank has the discretion to approve or disapprove.

Accordingly, Her Honour found that:

  • The action of overdrawing an account is not a unilateral action by the customer. It is an action that requires the consensual conduct of both the bank and the customer and as such, cannot be construed as conduct constituting a breach of some contractual obligation. In other words, if the bank agrees to and approves a transaction with the effect of overdrawing a customer’s account, the customer cannot then be in breach of its contract with the bank.
  • Similarly, in circumstances where the bank exercises its discretion and refuses to approve a payment instruction that would have the effect of overdrawing the customer’s account and in doing so charges the customer a Dishonour Fee, this is not a case of a breach of contract as no advance or loan is made and the account is not overdrawn.

In these circumstances the Honour and Dishonour fee are not payable on breach of a term or condition of the contract. Instead they are payable by a customer in response to a request for credit.

Her Honour reached similar conclusions in respect of Over-Limit Fees (charged in respect of credit card accounts) and Non-Payment Fees (charged in respect of an authorised Periodical Payment that is not made because there are insufficient funds in the account).

By contrast, her Honour held that the Late Payment Fees were charged to the customer as a result of the customer’s breach of their contract, that being their failure to pay within the required time-frame of 28 days. Unlike the requests for loans, which are at the discretion of the bank, the failure to comply with the payment obligations within the stipulated time-frame is not at the discretion of the bank and therefore, constitutes a unilateral breach of the contract.

Accordingly, the Late Payment Fee could constitute a penalty if the amount being charged was not a genuine pre-estimate of damage or was out of all proportion to the likely damage caused to the bank should payment not be made within the required time-frame. This specific factual issue was deferred for hearing at a later date.

Implications

Her Honour’s judgment is a good outcome for the banks given that Her Honour found that 13 of the 17 fees were not capable of being characterised as a penalty. However, in respect of those fees that her Honour found were not penalties, the applicants are not precluded from persisting with their claims for damages in respect of those fees being unconscionable.

The case provides a detailed analysis of the law of penalties in Australia and provides banks with a useful framework which can be applied to similar fees and charges being made to their customers and in light of this decision, other potential defendants should now analyse fees levied in the event of late payment to ascertain whether on a construction of the relevant contracts those fees can be construed as payable as a consequence of an event of default under the contract. The case also highlights the importance of being able to establish if necessary that these fees do in fact constitute a genuine pre-estimate of damage or that the fees charged are not out of all proportion to the damage caused.

An important question that arises from this decision is whether the applicants will obtain leave to appeal Her Honour’s judgment direct to the High Court. The applicants have filed a special leave application. However, it remains to be seen, in circumstances where a significant number of issues remain unresolved in these proceedings, whether the High Court will entertain such an appeal at this stage, or whether the applicants will be required to conduct the whole of the current litigation before any appeal to the High Court can be entertained. Given that an appeal now would not resolve the controversy between the parties, we consider it likely that the High Court will deny an application for special leave at this stage.

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Regulatory: New financial requirements for Responsible Entities

Author: Fadi Khoury Contact: Tricia Hobson

ASIC has introduced new financial requirements for responsible entities of managed investment schemes. The measures include many (but not all) of ASIC’s proposals in its 2010 consultation paper.

This alert outlines some of the key new requirements that will apply to responsible entities, which will be effective from November 2012. Responsible entities will need to start to plan for the new (generally, higher) financial requirements as well as put in place appropriate processes in order to meet the associated reporting requirements.

1. Cash flow projection for at least 12 months

It is proposed that a responsible entity must prepare a projection of its cash flows over at least 12 months based on the responsible entity’s reasonable estimate of what it is likely to happen over the period.

The aim is to further encourage responsible entities to plan their financial resource requirements on an ongoing basis. The current three month projection period is considered too short as it is unlikely to provide directors with the opportunity to identify potential cash flow risks at a sufficiently early stage to allow them to take corrective action.

Responsible entities will be required to be able to demonstrate, based on the cash flow projection, that over the 12 month projection period it will have:

  1. access to sufficient resources to meet its liabilities; and
  2. sufficient resources to comply with the cash or cash equivalents component of its net tangible assets (NTA) requirement (see below).

The projections need to be approved at least quarterly by the directors and must be updated in certain circumstances including when there is a ‘material change’.

2. Net tangible assets (NTA)

The proposed new measures require that a responsible entity must at all times hold minimum NTA of the greatest of:

  1. $150,000; and
  2. an amount of up to $5million, being 0.5 per cent of the average value of scheme property operated by the responsible entity; and
  3. 10 per cent of the average RE revenue of the responsible entity (with no maximum).

The proposed changes reflect ASIC’s view that the current minimum NTA requirements, which start at $50,000 (depending on the circumstances), do not provide a responsible entity of any size with a sufficient buffer to meet its compliance requirements.

Average value of scheme property and average RE revenue

The base amount of scheme property applied to calculate the required NTA will potentially become a more fluid figure. ‘Average value of scheme property’ will require the responsible entity to apply the greater of the actual current value and an adjusted amount. The adjusted amount, broadly speaking, is derived from averaging the actual monthly value of scheme property for up to the last two preceding financial years (starting from when the RE is first authorised to operate a registered scheme) and the monthly forecast value of the scheme property for the remainder of that financial year.

ASIC also states that the inclusion of a revenue based test in the proposed NTA requirement is a better indicator of a responsible entity’s overall operating risk. The reference to ‘average RE revenue’ includes payments out of scheme property that relate to fulfilling a responsible entity’s obligations, even if some of those obligations are outsourced to a separate management or custodial entity. There is an exception for audit costs covering statutory audit requirements. The stated aim is to ensure that responsible entities maintain NTA that cover all aspects of scheme operations. Broadly, the average RE revenue is to be calculated by the responsible entity by reference to the actual RE revenue over certain previous financial years and the forecast RE revenue for the remainder of that current financial year. Note, for the second financial year and going forward, responsible entities do not take into account their revenue for the first financial year.

Liquid assets and cash or cash equivalents

The NTA would be required to be in the form of ‘liquid assets’ (extending to assets that can be realised for market value within a six month period). The purpose of this is to enable responsible entities to have access to liquid assets to address short-term to medium-term issues. Half of the required NTA would need to be in the form of ‘cash or cash equivalents’, subject to a minimum of $150,000. The intention here is to ensure that responsible entities have adequate cash reserves to address immediate and unexpected expenses.
The NTA requirement that would apply if a responsible entity has custody of scheme assets would become the greater of $5million and 10 per cent of average RE revenue (explained above).

Adjusted liabilities and eligible undertakings

There are arrangements that responsible entities have entered into that would need to be reviewed in light of the amended definitions of ‘adjusted liabilities’ and ‘eligible provider’ categories, otherwise responsible entities risk inadvertently breaching the minimum NTA requirements.

3. Audit opinion

The responsible entity must lodge with ASIC a report by a registered company auditor, for each financial year of the responsible entity and any other period that ASIC directs. Among other assurances, the opinion must state that for every part of the period for which the responsible entity was authorised to operate a registered scheme, it complied with certain provisions regarding the cash needs requirements and NTA requirements. This would need to include an opinion relating to the reasonableness of the assumptions underlying the 12 month cash flow projections.

What proposals were rejected?

ASIC did not adopt certain of the proposals in its original consultation paper. In particular, it originally proposed to prohibit responsible entities from providing certain guarantees and indemnities. The majority of respondents disagreed because, amongst other reasons, the nature of operations of a responsible entity requires the provision of certain guarantees and indemnities in the ordinary course.

What does this mean for responsible entities next year?

The proposed reforms are to commence on 1 November 2012. Entities that will have difficulty meeting this deadline should consider applying to ASIC for an extension.

In the meantime, it is important that responsible entities review their current financial resources and ensure that they meet the revised requirements above. It may be the case that restructuring or recapitalisation will be needed to ensure that responsible entities are in compliance with the new reforms.

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Regulatory: Future of Financial Advice Reforms

Marnie McConnell, Amie Crichton

The Future of Financial Advice reforms are placed to take effect from 1 July 2012. The impetus for the changes is improved transparency and increased access to financial advice. Both were concluded to be necessary by the Federal Government’s 2009 ‘Ripoll Inquiry’. Following the introduction into Parliament of Bills seeking to implement the reforms, the question is whether the legislation will be enough to meet the ‘Ripoll Inquiry’s’ focus of rehabilitating the public perception of the industry.

In our June 2011 Insurance & Financial Services Bulletin, we outlined the Federal Government’s proposed Future of Financial Advice (FOFA) reforms. Since then, the Federal Government has released, in two separate tranches, Bills seeking to implement these reforms. On 13 October 2011, the Corporations Amendment (Future of Financial Advice) Bill 2011 was introduced into Federal Parliament. This was followed on 24 November 2011 by the introduction into Parliament of the Corporations Amendment (Further Future of Financial Advice Measures) Bill 2011. Both Bills have since been referred to the Parliamentary Joint Committee on Corporations & Financial Services.

The FOFA reforms were largely driven by allegations of conflict of interest which featured in a number of the high profile Australian corporate collapses arising out of the GFC. The underlying objective of the reforms is cited in the Explanatory Memorandum as “building trust and confidence in the financial planning industry”.

To this end, the FOFA legislation proposes key amendments of a ‘best interests’ duty, 'opt-in' disclosure requirements and increased watchdog powers for the Australian Securities and Investments Commission (ASIC).

Best Interests

Currently, the Corporations Act 2001 (Cth) (the Act) does not require a financial adviser to act in the best interests of the client or to prioritise a client’s interests over their own. In practice, this has meant that an advice need only meet the requirement of appropriateness (s 945A) and that the necessary disclosures be made by the “providing entity” (the licensee) (Part 7.7). These necessary disclosures are currently limited to issues such as the provision of a Financial Services Guide (s 941B) and Product Disclosure Statement, the requirement to warn that a general advice does not take account of a client’s objectives (s 949A) and also to warn where an advice is based on incomplete or inaccurate information (s 945B(1)).

The new legislation introduces a more onerous framework requiring obligations for all individuals who provide personal advice to “act in the best interests of the client in relation to the advice” (s 961B(1)). Relevantly to basic banking and general insurance products, this can be established through compliance with the first three of the following seven steps:

  • identifying the objectives, financial situation and needs of the client;
  • identifying the client's circumstances relevant to the subject matter of the advice sought – being termed in the industry as the “know your client rule”;
  • making reasonable inquiries to obtain complete and accurate information;
  • assessing whether the provider has the expertise to provide the advice sought and, if not, declining to provide the advice;
  • conducting a reasonable investigation into and assessing any financial products it considers recommending – the “know your product rule”;
  • basing all judgements in advising the client on the client's relevant circumstances; and
  • taking any other steps that would reasonably be regarded as being in the best interests of the client, given the client's relevant circumstances.

It is acknowledged in the Explanatory Memorandum that these steps are based on the current regime and what is expected of licensees. Under the new legislation, whether a provider has acted in the best interest of the client will also be tested according to what would “objectively and reasonably” be considered appropriate for the client (s 961G) – this is also the current test relevant to “appropriateness” under s 945A.

In addition to the ‘best interests’ duty, s 961J of the new legislation will also require the provider to give priority to the client's interests when providing the advice. There is no existing statutory duty to do so.

Ongoing fee arrangements

The current regime allows advisers to obtain ongoing ‘trail fees’ from their clients’ investment portfolios in lieu of a higher initial commission or fixed fee for service. Despite receiving ongoing remuneration for these services, an adviser has no corresponding obligation to provide an ongoing service. This has led in some instances to disengaged clients paying ongoing fees for little or no service.

Notwithstanding public criticism, the Federal Government acknowledges in the Explanatory Memorandum accompanying the Bills that trail commissions have a role to play in the financial services industry and subsequently, these have not been entirely abolished. The legislation does however seek to redress the adviser/consumer imbalance by imposing two separate disclosure requirements on advisers providing advice to a retail client and proposing to charge an ongoing advice fee:

  1. an annual fee disclosure statement to the client (s 962G) detailing advice fee and service information for both the previous and upcoming 12 months (s 962H); and
  2. an additional 'opt-in' renewal notice to the client every two years (s 962K).

For ongoing fee arrangements, the client is also entitled to ‘opt-out’ or terminate the arrangement at any time (s 962E). Significantly, in the case of the renewal notice, where the client opts not to renew (s 962M) or simply does not respond to the renewal notice (s 962N), the arrangement ceases and an ongoing advice fee can no longer be charged to the client. The opt-in will apply to new clients from 1 July 2012.

ASIC powers

The legislation also enhances the regulatory powers of ASIC to supervise the financial services industry through changes to its licensing and banning powers.

Under the current legislation, the threshold for entry into the licensing regime is relatively low whereas the threshold for cancelling licences was acknowledged in the ‘Ripoll Inquiry’ to be comparatively high. The laws contained in the first of the two Bills will enable ASIC to refuse or cancel a licence if it believes a licensee is “likely to contravene its obligation" (s 915C(1)(aa) rather than the current requirement to establish that a licensee “will not” comply. The Explanatory Memorandum refers to these provisions as "an enhancement of ASIC's powers to deal with unscrupulous operators."

The legislation will also give ASIC the capacity to act at an earlier stage if it has concerns about either individuals or a licensee (as opposed to only a licensee), enabling it to ban a person who it "has reason to believe" is "not of good fame or character" or "not adequately trained or not competent to provide a financial service" (s 920A(1)(c ). While the legislation sets out a limited number of circumstances that would tend to suggest a person is "not of good fame or character", including the conviction of an offence, suspension or cancellation of an Australian Financial Services licence or the making of a banning or disqualification order under Division 8 of the Act, the proviso "any other matter ASIC considers relevant" makes it clear that ASIC's powers under the new regime are intended to be broad-sweeping. In fact, the legislation is now being criticised by some industry bodies as giving ASIC too much discretion. There have also been demands for more certainty as to how ASIC intends to prove a licensee is ''likely to'' breach its obligations.

Implications

The reforms seek to expand the regulatory framework in which financial providers are currently operating. Insofar as the ‘best interests’ component has not previously been codified and the new legislation targets individuals as opposed to licensees which are currently regulated, these reforms could lead to increased levels of exposure. However, the ‘best interests’ threshold does not appear unduly high, requiring compliance in some cases with only the first 3 of 7 steps which are based on current practice, calling into question the extent of the claims impact which will be felt.

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Professional indemnity: Setback for Timbercorp Investors

Marcus O'Brien, John Tesarsch

On 1 September 2011, Justice Judd of the Victorian Supreme Court handed down judgment in the long-running class action issued by investors against various companies in the failed Timbercorp group, as well as directors of those companies. In the proceeding, thousands of investors had sought to be released from their ongoing liability to make loan repayments to Timbercorp Finance totalling several hundred million dollars, and other compensation.

Although the judgment related only to a preliminary trial of certain agreed common issues, His Honour’s decision was so adverse to the interests of the investors that it effectively dismissed the claims of the class.

The representative plaintiff alleged that Timbercorp had failed to disclose information about risks that it was required to disclose in accordance with its statutory obligations. At trial, his counsel sought to argue that the Timbercorp group had a “fragile business model” which made its capital management particularly sensitive to market conditions, including the onset of the global financial crisis. This differed from his pleaded case, which was that the group’s business model had a “structural risk” and that the group might fail because of insufficient cash, with a consequential risk to the viability of managed investment schemes.

His Honour ruled that the plaintiff should be confined to his pleaded case, because evidence had been directed to the pleadings rather than the new allegations raised at trial, and because experts had not been briefed to express an opinion on whether Timbercorp’s business model was fragile, unusual or inherently risky.

The central reasons for His Honour’s judgment were as follows:

  • Under the Corporations Act, Timbercorp was required to issue Product Disclosure Statements (PDSs) to retail investors which included information about any “significant” risks associated with investing in Timbercorp products. It was also required to provide retail investors with any up-to-date information that might have a material influence on their decision to invest.
  • The pleaded “structural” risks of the Timbercorp group were not significant so long as the group’s financiers supported it, as while they supported it there was no real threat to its cashflow, and banks continued to support the group until shortly prior to its collapse.
  • The only category of risk which was a “significant” risk of the sort that must be disclosed by Timbercorp was its so-called “performance risk”, being that it may fail to discharge its contractual obligations due to financial incapacity. This was a risk that “went without saying” and was well understood and accepted by business people. In any event, the PDSs did include sufficient information about this performance risk by referring to it in general terms. 
  • The representative plaintiff failed in his personal claims, because:
    • His evidence was implausible, when he attempted to diminish the importance of the tax benefits that he derived in favour of an alleged long-term investment objective;
    • His Honour was not persuaded that the representative plaintiff relied upon any PDS when deciding to make his investments, and noted that a Court ought to be sceptical of protestations of reliance on financial representations leading to an investment in a tax-driven scheme.

In summary, Justice Judd applied a practical and commercial approach in his judgment, exhibiting little sympathy for investors in tax-driven schemes seeking to justify their investment motives after the event.

The group members have appealed the decision to the Victorian Court of Appeal.

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Professional indemnity: When an insured is insolvent…

Marcus O'Brien, Natalia Kepa

Introduction

In Genworth Financial Mortgage Insurance Pty Ltd v KCRAM Pty Ltd (in liq) (No 2) [2011] FCA 1124, the Federal Court considered the point at which an “event giving rise to the claim for damages or compensation” occurs for the purposes of section 6(1) of the Law Reform (Miscellaneous Provisions) Act 1946 (NSW) (the Act).

Facts

Genworth provided mortgage insurance to lenders. KCRAM was a property valuer. When four security properties were sold below their valuation price following default by the borrowers, Genworth sued KCRAM claiming that the valuations were prepared negligently.

After KCRAM went into liquidation, Genworth sought leave, under s 6(4) of the Act, to join the valuer’s professional indemnity insurer, International Insurance Company of Hannover Limited (Hannover), as a second respondent to the proceeding. Leave would have given Genworth, pursuant to s 6(1) of the Act, the possibility to enforce a charge over insurance funds payable by Hannover to KCRAM. There was also an application by Genworth under the Federal Court Rules to join Hannover so Genworth could seek a declaration about Hannover’s liability to indemnify under the professional indemnity policy.

Decision

Section 6(1) of the Act provides that a charge will arise in relation to insurance money payable on the happening of an “event giving rise to the claim for damages or compensation”.

The “event giving rise to the claim”

Hannover submitted that the “event giving rise to the claim” was the time at which the loss became readily ascertainable, because recoupment of the loan amount was not possible through sale of the properties.  Conversely, Genworth contended that the “event” for the purposes of the Act happened when it paid out the insured lender’s claim.

The Court accepted Hannover’s submission that the “event giving rise to the claim,” for the purposes of the Act, happened when it became readily ascertainable that Genworth would suffer a loss.

The timing

Hannover submitted that, in order for 6(1) of the Act to apply, the relevant insurance policy had to exist at the time of the “event” giving rise to the claim. The court accepted this submission. Accordingly, the Court refused Genworth leave to join Hannover as a respondent under section 6 of the Act in respect of those properties where the relevant “event” occurred before the inception of Hannover’s insurance policy. The Court did, however, permit the joinder of Hannover under the second limb of the application, so that Genworth could seek a declaration as to Hannover’s liability to KCRAM under its PI policy (because Hannover had relied upon an endorsement to deny indemnity).

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Professional indemnity: Construction - limitation period and recovery

Katherine Czoch, Eve Ormond

Introduction

In Vero Insurance Ltd v Kassem [2011] NSWCA 381, the NSW Court of Appeal recently held that where a breach of statutory warranty is established under the Home Building Act 1989 (NSW) (“the HBA”), the limitation period does not necessarily commence on the date of practical completion, but may commence on the earlier date of completion of the specific works or part of the works to which the dispute relates.

As the limitation periods provided for under the HBA were legislatively reduced in 2011 to six years for structural defects and two years for non-structural defects, home owners seeking to claim under home warranty policies of insurance need to act quickly to avoid the expiration of the relevant limitation period, bearing in mind that time may have begun to run before the date of practical completion of the residential building works.

The Court of Appeal also examined a home owners warranty insurer’s right to subrogated recovery against the developer.

Background

Ungul Properties Pty Ltd (“the Developer”) contracted with Lusted Pty Ltd (“the Builder”) for the development of seven residential units in NSW in June 1999. As the construction work was ‘residential building work’ within the meaning of the HBA, certain statutory warranties were implied as part of the contract for works.

In accordance with the HBA, it is compulsory for insurance covering any potential breach of the implied statutory warranties to be obtained by the Builder. Relevantly, clause 42 of the Home Building Regulation 1997 requires the beneficiary of the insurance contract to be the person on whose behalf the work was being done, along with any successor in title to that person. The developer is not required to be a beneficiary.

On 24 June 1999, Vero Insurance Pty Ltd (“Vero”) issued seven certificates of insurance in relation to the residential units. The insurance was addressed to the Builder, however, the Developer was named as the sole beneficiary of the insurance.

The building’s strata plan was registered on 14 December 2000. Throughout 2001, five of the seven units were sold. The Developer retained two of the units. Defects in the building became apparent in 2002 and by mid 2003, a number of the unit-holders had made claims on the insurance issued by Vero. Vero rejected the claims.

Following the commencement of litigation by the Owners Corporation against the Builder and Vero, the Builder went into liquidation. In June 2007, Vero admitted liability for the defects and settled the dispute with the Owners Corporation.

Vero then commenced an action against the Developer in the name of the Owners Corporation and the owners of the five units for recovery of the settlement sum. Vero asserted that the litigation was brought in exercise of its right of subrogation under the policies.

Voluntary administrators (“Kassem”) were appointed over the Developer’s affairs on 6 May 2009 and the proceedings against the Developer were stayed in accordance with section 440D of the Corporations Act 2001 (“the Corporations Act”). Vero lodged a Proof of Debt with Kassem on 21 May 2009. However, it was not accepted by Kassem.

Vero applied to the Supreme Court to terminate the Deed of Company Arrangement (“DOCA”) between the Developer and its creditors. In order to consider the application, it was necessary for the Court to assess whether the claim against the Developer was statute barred by virtue of the limitation provisions of the HBA and, further, whether Vero was prevented from exercising subrogated rights against the Developer due to ‘circuity of action’.

At first instance, the trial judge held that, although Vero’s claim against the Developer arose by way of subrogation, Vero had an unliquidated claim against the Developer sufficient to define Vero as a ‘creditor’ of the Developer within the meaning of the Corporations Act. This was not challenged on appeal. Further, it was held that Vero had not established sufficient grounds for the DOCA to be terminated.

The grounds of appeal to the New South Wales Court of Appeal were twofold. It was submitted on behalf Vero that the Court erred by neglecting to address Vero’s application to terminate the DOCA on the basis that Vero was a substantial creditor, as opposed to Vero being a creditor for a nominal amount. Further, Vero submitted that the trial judge had given inadequate reasons for the finding that Vero had failed to establish sufficient grounds for terminating the DOCA.

The Limitation Argument

Section 18E of the HBA statute barred any proceedings for breach of statutory warranty from the date seven years after “the completion of the work to which it relates”.1 The Developer argued that the claims were statute barred as the works were completed prior to 8 October 2000, whereas the proceedings were not commenced until 8 October 2007 (one day late).

The Court of Appeal concluded that “the limitation period concerning any particular item of damage would commence to run when the work to which the damage relates was completed”. This was not necessarily the date of practical completion. The Court of Appeal accepted that the date of completion may therefore be the date that specific work by a particular contractor or subcontractor was completed.

The Court of Appeal noted that there was likely to be room for debate on the issue of whether the claims were statute barred. However, it was unnecessary for the Court to consider the factual circumstances as there was no indication that such defences would ultimately be made out. Further, given that (for other reasons) the Court found that there was no basis to terminate the DOCA, it was unnecessary to decide the limitation point.

The Circuity Argument

The Developer argued that, as it was listed as a beneficiary under the home warranty insurance policy (which extended cover to any successors in title), and the owners of the units were successors to the Developer’s title, Vero could not exercise its right of subrogation against the Developer as it was a co-insured under the Policy. The Developer asserted that any subrogated action brought by Vero would be “bound to be dismissed so as to avoid circuity of action.”

The rule against circuity of action is designed to prevent an insurer from bringing a subrogated action against a third party, if that third party is a co-insured under the insurance policy.

Although the Vero policy listed the Developer as a beneficiary, it also specifically excluded coverage to the Developer, stating: “we have no liability to you whatsoever if you are a developer (as defined in the Act) in relation to the work”. While this resulted in an “oddity”, the purpose of the legislation was to ensure that there was insurance in place when the units were eventually purchased. As the units had not been purchased when the insurance was issued, the Developer was the only entity to which the insurance could be issued.

As such, the Court of Appeal found that the Developer was not an insured under Vero’s policy and Vero was entitled to exercise its rights of subrogation against it.

Conclusion/Implications

The limitation period under the HBA for claims for breach of statutory warranty may begin to run in relation to different parts of the same residential building works at different times.

Consequently, a beneficiary of a home warranty insurance policy covering breach of statutory warranty may have less than seven years after practical completion to identify defects arising out of such breaches, before the limitation period expires. As the Court of Appeal did not fully canvass all of the potential issues arising out of this decision, it is likely that this issue will become the subject of future litigation.

The decision also confirms that an insurer will be at liberty to bring a subrogated action against a developer in the name of an owners corporation for breach of statutory warranties, even if the individual members of the owners corporation have the benefit of cover under the relevant policy. 

1The Home Building Amendment Act 2011 has further the limitation period from seven years for all work, as follows :

  1. six years for structural defects; or
  2. two years for non-structural defects; or
  3. if the defect was discovered in the last 6 months of a relevant period, the relevant period is extended by a further six months
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Professional indemnity: Westport Insurance Corporation v Gordian Runoff Ltd

Professor Rob Merkin

Gordian wrote professional indemnity insurance. One of the policies written by Gordian was in favour of FAI Insurance. In the latter part of 1998 FAI was taken over by Winterthur, and FAI negotiated a run-off policy with Gordian, under which Gordian would for a period of seven years indemnify FAI for all claims arising out of wrongful acts committed before 31 May 1999.

The run-off policy was entered into on 23 December 1998 and attached on 1 January 2000. Up to December 1998 Gordian was reinsured under an excess of loss treaty subscribed to by Westport. In the renewal negotiations in December 1998 Gordian indicated that it had written policies for two or three years and sought the reinsurers’ approval to include in the renewed treaty capacity to write multi-year contracts. Westport said that it would do so and that “up to three years is acceptable”. Westport then renewed the reinsurance treaty with Gordian, and this applied to claims made on policies attaching from 1 January 1999 to 3 March 2000.

The Gordian-Westport treaty contained an arbitration clause under which disputes were to be determined by arbitration in NSW. Claims were made against Gordian under the FAI run-off treaty and these were notified to Westport. At this point Westport became aware of the seven-year FAI insurance, and it contended that it faced liability only under policies which ran for a maximum of three years. In fact, all but one of the claims made under the FAI insurance fell within three years from the date of the policy, but Westport nevertheless denied liability for all claims under the FAI insurance on the ground that the treaty did not apply to any underlying policy capable of lasting longer than three years.

The arbitrators held that the FAI insurance fell outside the treaty but that the effect of section 18B of the Insurance Act 1902 was to allow Gordian to recover for any claims falling within three years, on the basis that its breach of the treaty had not caused Westport any loss. The High Court by a majority overturned the award, holding that the arbitrators had not given full reasons so that there was manifest error on the face of the award and there was also error of law in applying section 18B to a case where there was no coverage. Heydon J, dissenting, upheld the award but on the basis that the arbitrators had erred in holding that the treaty did not include the FAI insurance in the first place.

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Product liability: Federal Court allows Vioxx appeal

Toby Biddle

On 12 October 2011, the Full Court of the Federal Court delivered its judgment in the appeal of the representative (class) action brought on behalf of certain consumers of the arthritic drug, Vioxx. Vioxx was alleged to have caused adverse cardiovascular side-effects in several arthritis patients. The Full Court allowed the appeal against the earlier damages award against the supplier of Vioxx.

Facts

Vioxx is an anti-inflammatory drug prescribed to treat the effects of arthritis. It was manufactured by a US company, Merck & Co Inc, and distributed by its Australian subsidiary, Merck Sharpe and Dohme (Australia) Pty Limited (MSDA) (collectively Merck). The drug was marketed on the basis that, unlike most anti-inflammatories on the market, it did not carry with it gastrointestinal side effects.

In late May 1999, Vioxx was approved by the United States Food and Drug Administration and was registered on the Australian Register of Therapeutic Goods in mid-January 2000.

In early 2000, the results from a clinical trial known as the VIGOR Trial were revealed. The trial suggested that the rate of serious cardiovascular complications was significantly lower in patients receiving an alternative medication to Vioxx.

In mid-October 2000, Merck provided the USFDA with a safety update report on Vioxx, taking into account the cardiovascular test results from the VIGOR Trial. The product information for Vioxx was subsequently amended on a number of occasions with the Australian Register of Therapeutic Goods, but Vioxx remained on sale.

In September 2004, the results of a further clinical trial (the APPROVE Trial) which had commenced in early 2000 were released. The results of the trial suggested that the rate of cardiovascular adverse events amongst patients taking Vioxx was approximately double that of patients taking a placebo.

Shortly afterwards, Merck voluntarily withdrew Vioxx from the market.

Graham Peterson had commenced taking Vioxx in May 2001. It was prescribed by Dr John Dickman for back pain attributed to osteoarthritis.

Mr Peterson suffered a heart attack in December 2003 but continued to take Vioxx until its withdrawal from the market in late 2004.

Mr Peterson initially commenced proceedings in the Supreme Court of Victoria, but the proceedings were transferred to the Federal Court in 2006 as a representative action on behalf of all patients who had been prescribed Vioxx after 1999 and had suffered from myocardial infarction, thrombotic stroke, unstable angina, transient ischaemic attack, or peripheral vascular disease.

First instance judgment

A trial took place before Jessup J of the Federal Court. In the trial, Mr Peterson alleged causes of action against Merck in negligence and under the Trade Practices Act 1974 (TPA).

In the negligence action, Mr Peterson alleged that the Merck entities failed to conduct sufficient research into the side effects of Vioxx, failed to adequately consider the outcome of clinical trials (in particular the VIGOR trial) and failed to provide adequate warnings concerning the potential adverse side-effects of Vioxx. For the first 2 allegations, Jessup J found that Merck’s research and consideration of the VIGOR trial was in fact adequate. However, he found that Merck was negligent in failing to take adequate steps to inform Mr Peterson’s doctor of the results of the VIGOR trial, finding that changes to the product information and other steps undertaken by Merck were insufficient.

Despite this, Mr Peterson’s claim in negligence failed on causation, his Honour finding on the evidence that even if Merck had taken adequate steps, Dr Dickman would still have prescribed Vioxx and Mr Peterson would have taken it.

In Mr Peterson’s claim under section 52 of the TPA, Jessup J found that Merck was guilty of misleading conduct through its sales representatives conveying a broad message of safety in relation to Vioxx, in circumstances where the VIGOR trial had suggested otherwise. Again, however, the action failed on causation, as Jessup J found that Dr Dickman would still have prescribed Vioxx, and Mr Peterson would have taken it, had the misleading conduct not occurred.

Mr Peterson also brought a claim pursuant to the defective good provisions in section 75AD of the TPA on the basis that the safety of Vioxx was not such as persons were generally entitled to expect. Jessup J found that Vioxx was indeed defective within the meaning of section 75AD. Again, however, the cause of action failed, this time on the basis of the “state of the art defence” in section 75AK of the TPA. Jessup J found that it was not until the results of the APPROVE trial were available that the state of scientific knowledge was sufficient to enable the defect to be discovered.

However, Mr Peterson was successful in his action against MSDA under the fitness for purpose (section 74B) and merchantable quality (section 74D) provisions of the TPA. Jessup J found that Vioxx was not fit for the purpose made known by implication by Mr Peterson (treatment of arthritis), nor was it of merchantable quality, having regard to the cardiovascular side-effects. Jessup J found that Mr Peterson’s heart attack occurred by reason of the Vioxx supplied by MSDA not being fit for purpose or of merchantable quality.

Appeal

MSDA fought the appeal strongly on the issue of causation. Its arguments on causation were accepted by the Full Court.

The Full Court held that Mr Peterson was obliged to show that his consumption of Vioxx was a necessary condition of his heart attack. In relation to this, the first instance judgment had relied heavily on epidemiological evidence that Vioxx consumption doubled the risk of myocardial infarction.

On this issue, the Full Court found that while it was certainly possible that Vioxx consumption was the cause of Mr Peterson’s heart attack, there were several other possible causes, in particular age, gender, hypertension, hyperlipidemia, obesity, left ventricular hypertrophy and a history of smoking.

The Full Court also noted that a small absolute risk may be doubled without making it a likely source of injury – doubling a low absolute risk may produce an absolute risk which still remains low.

Noting this, while careful to state that the finding did not preclude other group members from establishing causation, in the circumstances of Mr Peterson’s case the Full Court did not consider that it was more probable than not that the consumption of Vioxx was a necessary condition of the heart attack.

Accordingly, the Full Court found that Mr Peterson could not establish that his heart attack was “by reason of” the consumption of Vioxx (a requirement to establish liability pursuant to both section 74B and section 74D).  As to section 74B (fitness for purpose), the Full Court also found that it could not be implied that Mr Peterson had made known that he required a medication with an absence of side effects. The Full Court noted that almost all medications have some side effects.

MSDA also appealed Jessup J’s finding of breach of duty (given the potential relevance of this to the claims of other group members). MSDA was also successful in this aspect of the appeal. The Full Court considered that evidence that Dr Dickman had in fact been made aware of the amended TGA product information containing the results of the VIGOR trial, rendered irrelevant any failings by MSDA to make Dr Dickman aware of the results of the trial through other means.

Conclusion

The appeal judgment will be welcomed by manufacturers and suppliers of products, in particular pharmaceutical products.

However, we may not have seen the last of the case. The Full Court was careful to point out that its findings in relation to aspects of Mr Peterson’s claim would not necessarily follow in the circumstances of other group members. Lawyers for other group members will now need to carefully consider the individual circumstances of each of their clients to determine whether any case differs from Mr Peterson’s in that Vioxx was a necessary condition to the occurrence of the particular adverse cardiovascular event suffered by the group member. The lead applicant’s lawyers in the representative action, Slater & Gordon, have indicated that cases of some group members may still be pursued on this basis. However, given the Full Court’s comments concerning the use of epidemiological evidence, causation is still likely to be a difficult hurdle for any such group members who choose to continue with their actions.

Slater & Gordon have also indicated that a High Court appeal is being contemplated. The High Court’s recent treatment of causation cases (eg. Adeels Palace Pty Limited v Moubarak (2009) 239 CLR 426, Amaca Pty Limited v. Ellis (2010) 240 CLR 11 and Tabet v. Gett (2010) 240 CLR 537) suggests that a successful appeal might be difficult.

Despite the outcome, the Vioxx case illustrates the importance of manufacturers and suppliers of products, in particular pharmaceutical products, being constantly vigilant about not only the adequacy and timeliness of information supplied about their products, but also the adequacy of the means by which that information is supplied. Mere compliance with a regulatory regime concerning registration of products and product information will rarely be sufficient in itself to defend a product liability action.

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Life: Fiduciary duties of Superannuation Trustees and TPD definitions

Manglicmot v Commonwealth Bank Officers Superannuation Corporation Pty Ltd [2011] NSWCA 204

Ganga Narayanan, Steven Donley

Introduction

In Manglicmot v Commonwealth Bank Officers Superannuation Corporation Pty Ltd [2011] NSWCA 204, the NSW Court of Appeal examined the scope of the fiduciary duties owed by superannuation trustees to members when changing over group TPD insurance policies. In the judgment, the appeal court provides guidance on the construction of TPD coverage clauses and conducts a useful analysis of the due diligence process to be followed by trustees when evaluating alternate insurance arrangements.

Facts

The respondent (the “Trustee”) was the trustee of a superannuation fund (the “Fund”) established for the benefit of employees of the Commonwealth Bank of Australia (the “Bank”). The Trustee annually obtained, from an insurer, a group insurance policy providing, among other things, TPD benefits for Fund members.

Prior to 30 June 2003, the group policy was provided by Hannover Life Re (the “Hannover Policy”). In 2003 the Trustee, after taking advice from its solicitors, negotiated and entered into a replacement policy with CommInsure, which took effect from 1 July 2003 (the “CommInsure Policy”).

The appellant, Manglicmot, was a Bank employee and Fund member between 1998 and 2003. Manglicmot suffered injuries in 2000 that limited him to working part time from November 2002 onwards. The Bank subsequently offered redundancy, which Manglicmot accepted in August 2003.

Manglicmot sought alternative employment for a year following redundancy, without success, and in 2004 claimed TPD benefits of $120,000 under the CommInsure Policy. CommInsure refused the claim on the basis Manglicmot was not totally and permanently disabled within the meaning of the CommInsure Policy.

Manglicmot sued the Trustee, taking issue with the Trustee’s substitution of the CommInsure Policy for the Hannover Policy. Manglicmot contended that the Hannover Policy provided TPD benefits in circumstances where the member was fit for part-time work, whereas the CommInsure Policy provided benefits only where the member was unfit for any work. Thus, Manglicmot argued, he would have been entitled to TPD benefits under the Hannover Policy had the Trustee not changed to the more restrictive coverage under the CommInsure Policy.

Manglicmot alleged the Trustee had breached its general law fiduciary duties to Fund members to act in their best interests, as well as similar duties inserted into the trust deed by sections 52(2)(b) and 52(2)(c) of the Superannuation Industry (Supervision) Act 1993 (Cth) (the “SIS Act”).

First Instance

The trial judge dismissed Manglicmot’s claim.

The trial judge accepted that the Trustee owed a general law fiduciary duty to its members to act in the members’ best interests and to exercise reasonable care. The trial judge ruled that, in obtaining substitute insurance, the Trustee had discharged its duties by exercising its discretionary power under the trust deed in good faith and by taking comprehensive legal advice during the insurance substitution to the effect that there was no material difference in coverage.

Regarding the SIS Act provisions, the trial judge accepted that the scheme of section 52 was to insert mandatory covenants into the trust deed requiring the Trustee to observe its basic fiduciary obligations. Subsection 52(2)(b) required the Trustee to exercise the same degree of care, skill and diligence as an ordinary prudent person would exercise in dealing with property of another for whom the person felt morally bound to provide, and Subsection 52(2)(c) required the Trustee to ensure its duties and powers were exercised in the best interests of the beneficiaries.

The trial judge ruled the SIS Act provisions did not impose a higher standard on a trustee than the general law. As the Trustee was found to have discharged its general law duties, it necessarily followed that the Trustee had complied with the trust deed covenants inserted by sections 52(2)(b) and 52(2)(c) of the SIS Act.

The trial judge regarded the construction and application of the TPD coverage terms in the Hannover and CommInsure policies as an issue of causation – Manglicmot suffered no loss unless the CommInsure Policy removed coverage previously existing under the Hannover Policy.

The Hannover and CommInsure Policies both contained typical (but substantially different) TPD coverage clauses, providing a benefit to a member who, among other things, had missed six months of work due to illness or injury and was unable to ever work again in any other occupation.

The Hannover Policy coverage clause relevantly provided that the benefit was payable only where the member was:

“incapacitated to such an extent as to render the [member] unable ever to engage in or work for reward in any occupation or work for which [he] is reasonably capable of performing by reason of education, training or experience”.

In contrast, the CommInsure Policy paid a benefit where, among other things, “the member will not ever be able to resume any Occupation, whether or not for reward”. “Occupation” was defined as “an occupation that the person can perform, on a full time or part time basis, based on the skills and knowledge the person has acquired through previous education training or experience”.

Given Manglicmot’s failure to establish liability, the trial judge did not decide whether the Hannover Policy provided TPD benefits if the fund member could engage in part-time employment.

Appeal

Manglicmot’s appeal was dismissed.

Trustee's Review Process

The trial judge’s rulings regarding the existence and scope of the Trustee’s general law fiduciary duties were not challenged on appeal, with argument focusing instead on the breach or discharge of the duty.

The appeal court found the Trustee had intended benefits under the CommInsure Policy to match or better those provided under the Hannover Policy, and that the Trustee believed it had obtained equivalence. The Trustee’s policy review process was carefully examined and found to have discharged the Trustee’s duties, with the following factors deemed determinative:

  1. The catalyst for the policy substitution was the poor performance of the Hannover fund, with the insurer insisting on a 130 per cent premium increase effective at renewal. A quote was obtained from CommInsure offering a significantly lower premium.
  2. A draft of CommInsure’s proposed replacement policy was reviewed by the Trustee’s in-house legal counsel for compliance with the trust deed obligations and equivalency with the Hannover Policy.
  3. Coverage gap advice was obtained from external solicitors to the effect there was no material gap in TPD benefits, however it was not clear whether the advice was obtained before or after execution of the policy.

Scope of the Implied SIS Covenants

The appeal court reviewed the legislative history and intent of section 52, concluding the section was enacted to preserve the general law rules by preventing superannuation trustees from abrogating general law fiduciary duties through provisions in the trust deed.

Thus, the appeal court affirmed the trial judge’s finding that sections 52(2)(b) and 52(2)(c) did not impose a more onerous duty than the general law:

Section 52(2)(b) does not in my opinion materially add to breach by the respondent of its general law duty to exercise reasonable care...The respondent was obliged to exercise the care, skill and diligence in insuring pursuant to the powers in [the trust deed] and obtaining insurance on terms and conditions acceptable to it under [the relevant trust deed rule]. The former were acknowledged as discretionary powers, the latter was of the same kind. The exercise of a discretionary power is approached through the s 52(2)(b) covenant in no different way from its exercise in accordance with the respondent's general law obligation.

Nor in my opinion does s 52(2)(c) materially add to breach by the respondent of its general law duty to act in the best interests of members of the Fund. The respondent's general law obligation could be expressed, in the language of s 52(2)(c), as an obligation to perform and exercise its duties and powers in the best interests of the beneficiaries. The words "to ensure" add nothing; an obligation is an obligation. Again, the respondent was exercising a discretionary power, and "to ensure" does not turn the question of exercise of a discretionary power into one of strict liability. There is liability if the discretionary power is exercised improperly, but otherwise there is not.

TPD Coverage

The appeal court gave detailed consideration to whether the TPD coverage clause in the Hannover Policy contemplated the payment of benefits where the member was still capable of working part-time. The court applied the rule of construction from Chammas v. Harwood Nominees Pty. Ltd. (1993) 7 ANZ Ins Ca 61-175 and related cases, namely, when interpreting a TPD coverage clause making incapacitation for further employment a precondition for payment of a benefit, a reasonable construction of “employment” must be given, having regard to the wording of the clause and the circumstances of the case.

In ruling that the Hannover Policy TPD coverage clause did not provide benefits to injured members capable of part-time employment, the court stated:

“The Hannover TPD clause defines total and permanent disablement. It is quite emphatic: the member must be unable ever to engage in or work for reward in any occupation or work. As further context, the member must have been absent from work for six months. Introduction of full time employment or part time employment into the wording, notions which themselves carry uncertainty (what is the standard for full time employment?) is in my view not warranted. The clause requires unfitness to work, without distinction between full time work and part time work other than by regard to the work which the member is reasonably capable of performing by reason of education, training or experience.

There is nothing inherently unfair or unreasonable in the Hannover TPD clause as so construed. A member who can not work even part time has a need; a member who can work part time has a different need, and one which will vary according to the work the member can perform. The premium will be struck according to the need to be met, and that is found in the terms of the policy of insurance.”

Causation

As there was found to be no material change in coverage due to the policy substitution, the court found causation was not made out.

The appeal court further noted that Manglicmot was not entitled to benefits under the either policy because he ceased work due to redundancy and not due to injury, so causation was negated on this second basis also.

Implications

  • Trustees – the covenants incorporated into the governing rules of a superannuation fund by virtue of section 52(2)(b) and (c) of the SIS Act do not materially extend the general law fiduciary duties owed by a trustee to fund members;
  • Insurers – TPD coverage clauses should be interpreted strictly. In the absence of clear language to the contrary, when construing a TPD clause that has similar terms to the Hannover policy, a claimant who is able to work part-time is unlikely to satisfy the definition of TPD.
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Life: Fraud Doesn’t Pay

Paul Baram, Kate Benjamin

Summary

In a recent decision of Supreme Court of Queensland in Syddall v National Mutual Life Association of Australasia Ltd [2011] QSC 389, the Court examined the provisions of the Insurance Contracts Act 1984 (Cth) and the circumstances in which the right of an insurer to avoid paying a claim under an income protection insurance policy, due to the misrepresentation and fraudulent conduct of an insured, will be enlivened.

Background

Eric Albert Syddall, the plaintiff, held an income protection policy with Australian Casualty & Life (ACL), whose life insurance business was assumed by the defendant in November 2002.

At the time of taking out his income protection policies in 1993 and 1995 Mr Syddall stated that he was employed as a computer programmer and insurance agent. 

Mr Syddall made a claim on his income protection policy on 16 January 2011 in respect of a back and shoulder injury that occurred on 27 November 2000 during the course of his employment as a plumber. ACL made interim disability payments to Mr Syddall’s whilst his claim was being determined.   

On 9 April 2011, ACL advised Mr Syddall that his claim for income protection was denied on the basis that the plaintiff’s treating doctor and ACL’s medical assessors considered Mr Syddall was fit to perform the duties of a computer programmer/database administrator. 

Mr Syddall commenced proceedings against ACL for breach of contract on the basis that he was at liberty to change his means of earning income at any point in time without any adverse effect on his income protection policy. ACL argued that Mr Syddall was not entitled to cover under his income protection policy on the basis that he was not totally disabled within the meaning of the insurance policy. Coverage was also denied on the basis that Mr Syddall made misrepresentations to ACL prior to taking out his income protection policy with ACL in 1993 and 1995 which entitled ACL to avoid the insurance policy pursuant to s29(2) of the Insurance Contracts Act 1984 (Cth) (ICA).

Decision

The Court firstly considered whether Mr Syddall’s representations on his 1993 and 1995 income protection application forms (the application forms) constituted misrepresentations for the purposes of s29 of the ICA. The Court found the plaintiff was evasive and his evidence lacked credibility and considered that the plaintiff made misrepresentations on the application forms with respect to his past income, his primary and second occupation, and his psychiatric history.

At the request of ACL, the Court then considered whether Mr Syddall’s misrepresentations fell within s26 of the ICA. Given the significant discrepancy between the information provided by Mr Syddall on his application form and the information contained in contemporaneous tax records, hospital records and the oral evidence provided by various witnesses at trial, the Court held that Mr Syddall was not protected by s26(1) of the ICA, as a reasonable person in the circumstances of Mr Syddall at the time of making the insurance application would have seen his responses as positively untrue.

With respect to s26(2) the Court held that given the purpose of the income protection policy was to provide financial protection to an insured in the event of the insured being unable to work, a reasonable person in the circumstances of Mr Syddall would certainly be expected to know that ACL’s decision to take on the risks associated with an income protection policy would be affected by statements as to his earnings, occupation and medical history.

The Court then turned to consider whether, under s29(1)(c) of the ICA, ACL would have issued the income protection policy even if Mr Syddall had not failed to comply with the duty of disclosure or had not made any misrepresentations. ACL gave evidence that if the plaintiff had declared his second occupation was as a “plumber”, he would not have been offered the income protection policy he applied for as that policy was designed for white collar workers. ACL gave further evidence that if the plaintiff had been truthful with respect to the disclosure of his earnings or the fact that he was in receipt of social security payments, he would not have been offered the income protection policy as his income level was below ACL’s minimum annual income requirement. Finally, had Mr Syddall declared the true extent of his pre-existing psychiatric history, his application would have been rejected. Accordingly, the Court held that if ACL had been provided with the correct information on Mr Syddall’s application form, ACL would have rejected the plaintiff’s application.

The Court further considered that Mr Syddall’s representations on his application form were “demonstrably and completely untrue” and were made purely for the purpose of obtaining the benefit of the income protection policy. The Court held that the nature of Mr Syddall’s conduct and misrepresentations was such as to be considered fraudulent for the purposes of the ICA.

Given the Court’s findings regarding Mr Syddall’s fraudulent misrepresentations, the Court held that it followed that ACL was entitled to avoid the contract of income protection insurance under s29 of the ICA as a result of the plaintiff’s fraudulent failure to comply with the duty of disclosure and his fraudulent misrepresentations. 

The Court then considered whether, even if ACL did have a right to avoid the policy, it could use its discretion under s31 of the ICA to disregard the avoidance. The Court considered not only should the discretion only be exercised “if it would be harsh and unfair not to do so,” but that the discretion may only be exercised if the defendant has not been prejudiced by the failure or misrepresentation, or if such prejudice was minimal or insignificant. The Court held that ACL suffered clear prejudice as a result of Mr Syddall’s misrepresentations, on the basis that the policies of insurance would never have been entered into had Mr Syddall told the truth, and accordingly ACL was entitled to avoid the policy pursuant to s29 of the ICA.

Finally the Court turned to consider whether Mr Syddall was entitled to the indemnity he sought under the income protection policy in the event that the Court erred in holding that ACL was entitled to avoid the policy of insurance. The Court considered that on the basis of the medical evidence and the surveillance videos obtained by ACL, Mr Syddall was not suffering from a ‘total disability’ as required under the policy. Given Mr Syddall had not satisfied all of the necessary elements required for payment under the policy, Mr Syddall was not entitled to make a claim under the policy. Additionally , the Court considered that as Mr Syddall’s claim was dishonest and fraudulent, ACL was entitled to refuse to pay Mr Syddall’s claim for lost income.   

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Corporate: Transaction liability insurance for negotiated M&A transactions

Shane Bilardi, Steven Torresan

Warranty and indemnity insurance (W&I Insurance) continues to be an increasingly common instrument used by merger parties to manage deal risk in Australian M&A transactions.

In broad terms, W&I Insurance involves the underwriter indemnifying the insured for any loss arising out of a breach of warranty or a claim under the tax indemnity in the relevant sale and purchase agreement. The insured can either be the buyer (a “buyer-side” policy) or the seller (a “seller-side” policy) but will most often be the buyer. Both policies will also cover reasonable legal costs incurred by the insured in defending certain claims.

We expect that buyer-side policies will continue to dominate whilst M&A parties are willing to structure the transaction and policy to ensure that there is little or minimal residual liability for the sellers. Under a buyer-side policy, the insurer waives its right to subrogate against a seller other than in the case of a seller’s fraud and an insured buyer will also typically agree not to make a claim against the seller for an insured matter.

While the market for W&I Insurance has evolved rapidly over the last 5 years, there is still a great deal of expertise required to underwrite this product. Underwriting teams are inevitably advised by experienced M&A practitioners from leading law firms to familiarise underwriters with the process and structure of an M&A transaction to properly assess risk. 

Policy documentation is also becoming more standardised but is still evolving gradually to reflect changing M&A trends and risk appetites in the market. Each policy also has to be tailored to reflect the particular terms of each transaction and there is always scope for some negotiation of policy terms with insurers depending on the needs of the insured.

Whilst other forms of transaction liability insurance (eg. environmental liability insurance, litigation insurance, tax liability insurance, contingent risk insurance and prospectus liability insurance) are available, they are usually separate and distinct from the cover available under a W&I Insurance policy and have not gained as much traction in Australia as the W&I Insurance product.

Australia is seen globally as an attractive growth proposition for the transaction liability insurance market, particularly because of its relatively high M&A deal flow (by number and value), continued strong economic growth, low geo-political risk and its robust legal system. This, combined with strong market penetration, awareness and acceptance of the W&I Insurance, has led to the Australian market for this product being roughly similar in size to the UK market, and has meant that the Australian market has become a focus for brokers and insurers/underwriters specialising in these transaction risk insurance products.

As a result, we have seen a marked increase in the number of international brokers and insurers/underwriters seeking to participate in W&I Insurance deals in Australia in the last 12 months. Given the up-take of the product in Australia, many international brokers and insurers/underwriters have also decided to send experienced team members to Australia to establish a physical presence to enable them to more properly service the Australian M&A market.

The market for W&I Insurance in Australia continues to remain competitive, particularly as a result of the increased competition between brokers and insurers/underwriters. The effect of this has been that:

  • premium costs have decreased significantly over the last 5 years, presenting an even better value proposition for a potential insured; and
  • insurers/underwriters have been willing to offer greater flexibility in the policy wording and insurance coverage being provided (eg. full or partial tipping retention structures, cover for specific indemnities or specific known issues and more limited exclusions from policy coverage).

While competition is still increasing, we expect that there is very little room for further depreciation in premium costs and we think that the increased competition is instead likely to drive further product innovation.

Based on our experience, we expect the use of W&I Insurance to increase further as the product continues to become more widely known and accepted beyond the private equity industry which was, and still is, the biggest buyer of the product. In particular, we are seeing strong growth in take-up of the product by corporates, particularly those involved in cross-border transactions.

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International: Contract law in the UK

Laura Hodgson

There will be few people working in the London insurance market who have not been keeping an eye on the progress of the Law Commissions’ (of England and Wales and of Scotland) proposals to reform insurance contract law in the UK. Although obviously a matter of importance to the London market, should these reforms be of any interest or significance to those outside the UK? These proposed changes to English law should not be overlooked in terms of their international significance for the insurance market. Given the significance of the London market (the third largest in the world, largest in Europe and 28 per cent of UK net premium coming from overseas), understanding the UK changes may be an essential part of legal risk planning for international business.

Why reform?

The current proposals for reform to insurance contract law in the UK (and for this article I will limit discussion to the law of England and Wales only) have in part been prompted by international pressure. It has been argued by proponents of law reform that a modernised insurance contract law will better equip the UK Government in any negotiations held in Europe about the introduction of an optional European insurance contract law. As the law currently stands, the UK may have limited capacity to persuade European colleagues to adopt principles found in UK national law. In an increasingly globalised commercial market, the current law with all its complexities and uncertainties can fail to meet the expectations of both policyholders and insurers, potentially damaging the UK as a favoured jurisdiction for insurance disputes.

So, what is wrong with the current law? In short, some argue that it is archaic, overly complex in some areas and can be harsh on the unwary insured. Further, the letter of the law differs considerably from market practice - especially for consumer insurance where FSA regulation and the decisions of the Financial Ombudsman mitigate the sometimes draconian outcomes of the law.

Progress so far

The Law Commissions began their review of insurance contract law in 2006. The Commissions published a series of issues papers to consider the main areas of the current law that were thought to be problematic. Areas included misrepresentation and non-disclosure, the status of intermediaries, warranties, insurable interest, damages for late payment, post-contractual good faith and the requirements contained in statute for a formal marine policy. Following public consultation on the issues considered suitable, the first bill to implement the reforms was laid before Parliament in December 2009. This bill addresses the law of misrepresentation and non-disclosure in consumer insurance policies (the Consumer Insurance (Disclosure and Representation) Bill).

The Bill tackles the long criticised application of the principle of utmost good faith in consumer policies. The Marine Insurance Act 1906 (MIA), which applies in certain areas to non-marine insurance, requires prospective insureds to volunteer information about the risk they are seeking insurance for. MIA requires insureds to disclose those “material circumstances which would influence the judgement of a prudent insurer in fixing the premium, or determining whether he will take the risk”. Failure to do so can allow the insurer to avoid the contract. Similarly, MIA also allows the insurer to avoid where the prospective insured has made a material representation. At present, there is no obligation in law for the insurer to ask for information about facts they wish to know in order to underwrite.

The Bill proposes to change the nature of the parties’ pre-contractual negotiations so that insurers are obliged to ask those questions about the risk they wish to know. In response, consumers will be under a new duty to take reasonable care to answer the questions asked by the insurer fully and accurately.

Where a consumer has made a mistake in answering the insurer’s questions, the Bill makes a distinction between “careless” and “deliberate or reckless” misrepresentations; innocent misrepresentations have no negative consequences for the insured. The remedy which an insurer will have available to him in the event of a misrepresentation will depend upon what the underwriter would have done had they had the information when underwriting the risk. The Bill is expected to come into force for consumer policies during 2013.

In December 2011, the Law Commissions began the next stage of the reform proposals by publishing a consultation on post-contractual duties. The consultation covers insureds’ remedies for late payment, insurers’ remedies for fraudulent claims, the nature of insurable interest, and policies and premiums in marine insurance.

It is worth considering what the Commissions propose and why the reforms matter in an international context.

Damages for late payment

The normal position in general contract law is that where one party suffers loss because the other party has failed to meet its contractual obligations, the innocent party may claim damages for consequences suffered (Hadley v Baxendale (1854) EWHC J70). The English courts have, however, held that insurance contracts fall outside this rule. In English law, an insurer is not liable for any loss caused by its delay or failure to pay a valid claim. This is based upon the legal fiction that the insurer’s contractual obligation is to prevent the loss occurring (or to “hold the insured harmless”), rather than to pay out a claim. As a result, claims money is considered to be damages. Where payment is late, there can be no remedy (other than interest on the amount outstanding) as English law does not allow damages for late payment of damages (as decided in The President of India v Lips Maritime Corporation (The Lips) [1988] AC 395).

The Law Commissions believe that there is a strong case for reform and their main proposal is to re-characterise the insurer’s primary obligation not as a duty to prevent loss but to pay valid claims after a reasonable time. At the same time, the Law Commissions accept that insurers require enough time to investigate claims fully. For business insurance, an insurer should be able to use a contractual term to limit or exclude its liability to pay damages for late payment, provided that an insurer acts with good faith. Conversely, in consumer insurance, insurers should not be able to exclude liability for failure to pay valid claims within a reasonable time.

Insurers’ remedies for fraudulent claims

Fraudulent claims are a serious and expensive problem and the law is currently unclear as to the penalties for fraud. Since the nineteenth century, the courts have recognised a common law rule that a person who fraudulently exaggerates a claim forfeits the whole claim. This rule, however, is inconsistent with the duty of utmost good faith set out in section 17 of MIA. Section 17 states that the penalty for failing to observe good faith is avoidance of the contract ab initio. This means that, in theory, insurers could require policyholders to repay all claims already paid under the policy, including genuine and legitimate claims paid before the fraud arose.

To address this confusion and to ensure the UK has a robust and clear approach to insurance fraud, the Commissions propose a number of changes. Statute should clarify that a policyholder who commits fraud should forfeit the whole claim to which the fraud relates. Further, the policyholder should also forfeit any claim which arises after the date of the fraud. However, the fraud should not affect any previous valid claim where the loss arises before the fraud takes place, whether or not the claim has been paid. The insurer should also have a right to claim the costs reasonably and actually incurred in investigating the claim, provided that these costs are not offset by savings from legitimate, forfeited claims which have occurred after the fraud.

The Law Commissions provisionally propose that in commercial contracts, express fraud clauses setting out remedies should be upheld, provided that they are written in clear, unambiguous terms and specifically brought to the attention of the other party.

Insurable interest

In English law, contracts of insurance require the insured to have an “insurable interest” in the subject matter of the policy. Put simply, the insured must stand to gain from the preservation of what is insured or suffer a disadvantage from its loss or destruction. For insurance to be valid, the insured must possess an interest capable of being insured. Unfortunately, the English law of insurable interest is not particularly straightforward and has been described as “a confusing and illogical mess” with definitions and requirements scattered across legislation and case law. The nature of the interest, when it must be shown and the consequences of not possessing an interest vary depending on the type of insurance concerned whether marine, indemnity or life (and other non-indemnity policies which the Commissions label “contingency”).

A number of commentators now question whether the requirement for insurable interest - originally introduced as a concept to protect against gambling - retains any practical merit. In Australia for example, legislation has removed the need for insurable interest altogether. Nevertheless, a majority of respondents to an earlier issues paper published by the Commissions were in favour of retaining the concept in the UK to ensure against moral hazard, especially in life insurance. There was however, strong support for revision of the law as it stands to meet modern commercial expectations.

The Commissions’ proposals for indemnity and “contingency” insurance differ. For indemnity insurance, the Law Commissions propose to provide a clear statutory basis for the requirement of insurable interest, and clarify that the insured must have an interest at the time of the loss. Further, they propose that a policy will be void unless there is a real probability that a party would acquire some form of insurable interest at some stage during the duration of the policy. The consultation considers whether a statutory definition of insurable interest would be of benefit.

For life and other forms of “contingency” insurance, the Commissions suggest that the current law is unduly restrictive. For example, whilst people can insure the life of their spouse (or civil partner) for an unlimited amount, they cannot insure the life of a cohabitant, child or parent. Policies can also be based on the fact that the insured will suffer financial loss on another’s death, but this is restricted to “a pecuniary loss recognised by law” (and requires a legal right to payment).

The Commissions propose a new statutory requirement for an insurable interest for life policies, which will replace that in the Life Assurance Act 1774. This would state that without an insurable interest, a policy is void but not illegal (as it is at present). The Law Commissions’ main proposal is to widen the test of economic dependency. They propose that it will be sufficient for there to be a real probability that the proposer will retain an economic benefit on the preservation of the life insured, or incur an economic loss on death. The new test will enable people to insure the lives of family members where they are dependent on them and would suffer a loss if they died.

The Commissions also suggest that parents should be entitled to take out insurance on the life of a child under 18. In addition, cohabitants should be entitled to insure each other’s lives without evidence of economic loss if they have lived in the same household as husband or wife (or as civil partners) for at least five years before the policy is taken out.

Other proposals

The remaining proposals in the Commissions’ latest consultation are on anomalous aspects of the law relating to marine policies. One area is the requirement for all marine insurance contracts to be “embodied in a marine policy”. Without a policy, the insured will have no evidence of the contract and therefore will not be able to make a claim. The requirement, contained in section 22 of MIA, dates from a time when stamp duty was imposed upon all marine policies. This was abolished in the UK in 1970 and the formal requirement for a written policy as evidence of the agreement is widely ignored by the market. The Commissions propose removing section 22 and leaving the form of policies to the market and regulation.

In addition, the Commissions propose to reform section 53(1) of the Marine Insurance Act which currently makes brokers, rather than policyholders, primarily liable to the insurer for the payment of marine premiums.

Reform in a global context

Reform of English insurance law and the form it will take will be relevant to any commercial business insuring in the UK. London is a major international centre for commercial insurance and reinsurance, not least in terms of marine underwriting. Some elements of insurance contract law in the UK currently fail to meet the demands of the modern market, but the proposals set out in the latest consultation aim to ensure that the UK remains a suitably flexible and commercial jurisdiction for international underwriting.

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International: China’s more open insurance market

Lynn Yang, Ai Tong

In November 2011, the Chinese Insurance Regulatory Commission (CIRC) published a short note on its website with respect to the implications of China’s recent opening-up of its insurance industry. According to the note, fifty-five companies supported by foreign investment (with around 1,300 branches) have now been established in China. Foreign investment backed insurance companies are concentrated in the large cities of Shanghai, Beijing, Shenzhen and Guangzhou, with respective market share estimated at between 6 to 11 per cent.

In addition to introducing foreign investment into the Chinese insurance market, the CIRC has gradually applied its “going global” strategy for Chinese insurers wishing to enter the international insurance market. As at the end of November 2011, eight Chinese insurers had established legal entities overseas for the purpose of engaging in international business, with another six Chinese insurers setting up their overseas representative offices for the purpose of exploring offshore markets.

In 2000 the CIRC joined the International Association of Insurance Supervisors (IAIS) and later became a member of the executive committee in 2008, followed by the audit committee in 2010. These appointments greatly improved the CIRC’s international influence in the global insurance market. In addition to its greater role in international supervision, the CIRC has signed up to a number of bilateral cooperation agreements with insurance regulators in a number of jurisdictions, including the United States of America, the United Kingdom, Hong Kong, and Japan. The CIRC has also established an insurance dialogue mechanism with insurance regulators in the US and the UK, with a particular focus on sharing supervisory information and developing the commercial pension insurance market. As a representative of a developing country, the CIRC has actively participated in drafting the Supervisory Framework for International Insurance Groups. This active involvement of the CIRC has largely mitigated the impact of the overhaul of the international supervisory rules upon China’s insurance industry.

According to the note, the CIRC will continue its policy of opening up the Chinese insurance industry, focusing on attracting further foreign investment in the health and pension sectors as well as increasing the establishment of branches in the Mid-West of mainland China. However, given the existing international financial environment, the CIRC requires that all insurance companies regularly assess the risks resulting from the internationalisation of the insurance industry, particularly taking care to avoid unnecessary transfer of risk from foreign owners to their Chinese subsidiaries.

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International: European progress towards Solvency II

Laura Hodgson

Now long in the pipeline, the Solvency II Directive edges ever closer to becoming a reality in Europe. However, recent legislative delays have concerned those in the insurance market who seek certainty as soon as possible in terms of an implementation timetable and the detail of the new regime. 

Solvency II will radically change the supervision of insurers and reinsurers across the European Union. The Solvency II Directive amends existing European insurance directives in order to introduce a consistent, risk-based, solvency regime which better reflects modern solvency and reporting requirements. The original implementation date for the new regulatory regime was 31 October 2012.

A “framework directive”, setting out the high level principles of the regime was agreed in November 2009. However, for the law to come into full effect further, more detailed, legislation and guidance needs to be agreed in Brussels. This more detailed legislation is to take the form of what is known as Level 2 implementing measures; in effect the nuts and bolts of how the regime will operate for both insurers and reinsurers.

Unwieldy at the best of times, the legislative process required to agree to the detail of Solvency II has been unusually convoluted and considerably delayed, much to the dismay of the insurance market that has spent a phenomenal amount of time and money in preparation for the new regime. The delays have been caused by an administrative piece of legislation called Omnibus II. Omnibus II makes various amendments to European legislation, including to the Solvency II framework directive. The changes will allow European supervisory authorities greater powers of intervention, introduce certain transitional provisions to allow more time for Solvency II measures to take effect and importantly, change the date on which the directive comes into effect to 1 January 2013. Significantly, the all important Level 2 measures can only be published once Omnibus II has been agreed.

The delay in agreeing Omnibus II and the resulting delays to the publication of the detailed Level 2 measures will push back the timetable for implementing Solvency II. It is now commonly understood that, although Solvency II goes live for supervisors on 1 January 2013, insurers and reinsurers will not be subject to the rules for another year. 

Industry frustrations with these delays are now being widely voiced. In a recent newsletter from the Association of British Insurers, Hugh Savill, Director of Prudential Regulation, states that European policymakers must aim to end 2012 with full certainty on when the regime will come into force. Furthermore, the body with responsibility for design of the new regime, the European Insurance and Occupational Pensions Authority (EIOPA) has recently written to the European Commission to express concern about the delays that negotiating the Omnibus II Directive will have on the Solvency II timetable. EIOPA argues that any further delays will lead to supervisors adopting national solutions in order to prepare for Solvency II, something that will undermine the very aim of a single European rulebook for insurance supervision.

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