The need for a physical loss in All Risks cargo policies
Author: Anna Budgett
In Engelhart CTP (US) LLC v Lloyd’s Syndicate 1221 for the 2014 Year of Account & 6 others the court has confirmed that construction of an All Risks cargo policy does not extend cover to paper losses unless specifically provided for in the policy itself.
The insured, part of a large trading group, shipped copper ingots to a purchaser in Hong Kong. On arrival the containers were found not to contain the copper ingots but slag of a nominal commercial value. It was agreed that no copper ingots had, in fact, been shipped in the containers and no such cargo ever existed. The bills of lading, packing lists and quality certificates were therefore fraudulent.
The insured claimed for the loss under its cargo policy on the basis it provided All Risks cover of the very broadest kind. This was declined by insurers who argued that none of the clauses in the policy provided cover for economic losses resulting from acceptance of fraudulent documents for a nonexistent cargo.
“Something must exist to be physically lost”
With reference to various authorities from both the English and New York courts Sir Ross Cranston observed that, when construing an All Risks cargo policy, one starts with the presumption that the purpose of All Risks cargo insurance is to cover physical loss of or damage to goods. In this case, there had been no physical loss or damage to the goods on account of the fact they had never existed – “something must exist to be physically lost”. As a result, the losses suffered by the insured were economic losses through the acceptance of fraudulent documents.
The question then was whether the policy as a whole could be construed more widely to include cover for paper losses. In particular, the policy included a provision stating that “the broadest coverage shall apply”. On the facts, and by giving the clauses in the policy their ordinary meaning, Sir Ross Cranston acknowledged that there were significant extensions to cover included in the policy beyond what is contained in a standard, entry level All Risks policy. However, ultimately, he was unconvinced that such extensions went so far as to displace the presumption previously stated.
Sir Ross Cranston made it clear that, where there is an intention to extend cover under an All Risks cargo policy beyond physical loss of or damage to goods there must be clear words stating the intention to do so. It is not clear yet whether this decision will be appealed; however, it provides some helpful clarification to both insurers and insured alike when it comes to considering the scope of cargo cover for anything beyond physical losses.
VAT recovery for brokers and “offshore looping”
Author: Andrew James
Insurers and brokers are generally unable to recover VAT incurred on their costs, as the supply of insurance services is exempt for VAT purposes. However, some insurers have developed arrangements whereby brokerage operations are based in the UK, but the risk is written offshore, even if the insured is UK based. HMRC see this as “offshore looping” and may argue that this is established to give rise to an input tax recovery where, if the insurer were in the UK, no recovery would be possible.
Such an arrangement was recently the subject of an appeal before the UK courts. In Hastings Insurance Services Ltd v HMRC  UKFTT 27 (TC) a UK insurance service provider was successful in arguing that it should be able to recover input VAT that was attributable to supplies of broking, underwriting support and claimshandling services supplied to a related non-EU insurance company, which then provided supplies of insurance to UK customers.
Although HMRC have indicated that they intend to appeal that decision, the UK Government has decided to legislate to put the issue beyond doubt and to prevent the use of such arrangements in the future. As a result, on July 26, 2018, the UK Treasury published a draft order for consultation.
The UK Budget 2018 announces that changes to tackle this type of arrangement will be brought into effect (although in a more targeted manner than in the original draft order). From March 1, 2018, a company supplying insurance intermediation services will only have a right to recover VAT on its costs if the transaction which is being intermediated is itself an exempt supply of insurance services to a consumer of the insurance services that does not belong in the UK.
The UK Treasury has indicated that, following the decision in Hastings, some insurers made it clear that, if the competitive “distortion” arising from this type of arrangement was not addressed, those other insurers would themselves have to adopt similar practices.
Insurers which have “offshore looping” or similar intermediary arrangements in place will be impacted by these changes, and they are advised to review their activities in order to assess the impact on their businesses.
Can a breach of a performance guarantee be subject to insurance under Quebec law? The Superior Court takes a stand
Author: Charles A. Foucreault
On May 17, 2018, Justice Danye Daigle of the Superior Court of Québec dismissed a Wellington motion filed by LeProhon Inc. against its insurer, Federated Insurance Company of Canada (Insurer). The Superior Court of Québec’s decision in 9071-3975 Québec inc. v Leprohon inc.1 gives guidance on whether coverage under a commercial general liability policy (CGL Policy) and a professional liability/errors and omissions policy (E&O Policy) applies when the essence of the claim arises from a breach of the insured’s obligations under a letter of performance guarantee.
Nature of the underlying claim and denial of coverage
The plaintiff 9071-3975 Québec Inc. (Lucyporc) operates in the pork processing industry. After LeProhon performed work on behalf of Lucyporc, the latter filed an action against LeProhon mainly alleging a breach of the obligations set forth in a letter of performance guarantee attached to the agreement entered into between LeProhon and Lucyporc.
After receiving a notice of the action, the Insurer refused to take up LeProhon’s defense pursuant to the issued insurance policies. The Insurer determined that the grounds of Lucyporc’s claim, which was based on LeProhon’s failure to satisfy the performance guarantee, did not trigger application of the insurance policies’ coverage.
Coverage not applicable
After going over the general principles that apply in the context of Wellington motions, the Court reviewed the insurance policies that the Insurer issued to LeProhon to determine whether the coverage could apply.
The E&O Policy
The Court concluded that Lucyporc’s claim was explicitly subject to the exclusions set forth in the E&O Policy, more specifically the “manufacturer’s express warranty” exclusion, because it referred to delays, refusals to complete work and the breach of the performance guarantee.
The CGL Policy specifically provided that property damage should result from an occurrence in order for insurance coverage to be triggered. The CGL Policy defined occurrence in the usual manner, which is “[translation] an accident, including continuous or repeated exposure to substantially the same risks.”2
Relying on the Supreme Court of Canada’s teachings on the notions of “occurrence” and “accident” in Progressive Homes, the Court determined that the breach of a performance guarantee does not constitute an accident or repeated exposure to certain conditions, despite giving a broad and liberal interpretation to the CGL Policy. Consequently, the Court ruled that the insurance coverage under the CGL Policy was not triggered by the claim.
In sum, this decision emphasizes that insureds can’t offer co-contractors a performance guarantee in the belief that they can fall back on their insurance coverage in the event of a breach. The courts must examine the reasons for which insureds breach their obligations under a contract to determine if the loss is attributable to an insured risk, otherwise insurers would be bound by every single one of their insureds’ undertakings. As the Court so carefully summarized, “[translation] this would distort both the nature and the objectives of insurance contracts.”3
This decision has not been appealed.
The author wishes to thank articling student Sandrine Raquepas for her help in preparing this legal update.
Fraudulent non-disclosure, avoidance and refusal to advance – Australian Federal Court decides insurers can avoid advancing defense costs to Cranston and Onley
The full court of the Federal Court has considered a question that by some has been considered a “sleeper issue” which had not previously received judicial attention. The question was whether a final adjudication clause in a conduct exclusion prevents underwriters from relying on their statutory right to avoid a policy for fraudulent non-disclosure. If the answer was “yes” underwriters would be required to advance defense costs until a finding was made which triggered the conduct exclusion.
The Federal Court decision of Onley v Catlin Syndicate Ltd as the Underwriting Member of Lloyd’s Syndicate 2003 (the Insurer) determined that the answer to that question is “no” and the Insurer is not prevented from avoiding the policy.
Indemnity proceedings were brought by Adam Cranston and Jason Onley (who are being pursued by the ATO in one of Australia’s biggest cases of tax fraud), against their management liability insurer. The Insurer had exercised its statutory right to avoid the policy under Part IV of the Insurance Contracts Act, refusing to advance Cranston & Onley’s costs of defending ongoing civil and criminal proceedings against them by the Australian Federal Police and the ATO.
This case is particularly noteworthy given that the facts which were the subject of the non-disclosure (and which the Insurer relied on to avoid the policy) i.e. corporate arrangements that would facilitate the fraud, hold similarities to the facts that are the subject of the proceedings for which Cranston and Onley sought funding of their defense costs.
The separate question
The separate question issue was whether the final adjudication clause in the dishonesty exclusion meant that underwriters had somehow waived their entitlement to avoid the policy on the basis of fraudulent non-disclosure.
Cranston and Onley argued that
- The interaction of these provisions precluded the Insurer from exercising its statutory right to avoid.
- The Insurer had agreed to “pay now” and “claw back later” and that by avoiding the policy, it was pre-judging the outcome of the proceedings which were unproven until the proceedings were resolved.
- The substance of their nondisclosure could not be determined until wrongful conduct (as defined under the policy) had been established.
In response, the Insurer agreed that the exclusion comes into play if the policy is validly on foot. But in circumstances where its existence is based on fraudulent non-disclosure, the Insurer argued that the exclusion cannot apply because the policy is avoided at inception.
The Insurer argued that it wasn’t necessary to await final adjudication as there was sufficient information available about the business model of Plutus Payroll, of which Cranston and Onley were allegedly the masterminds, to establish a real risk that the ATO would come after those involved in the business, including Cranston and Onley, to recover any unpaid tax. As has been much-reported, that business model involved Plutus Payroll (another Insured under the policy) being set up in a way which enabled Cranston, Onley and others to benefit from payments which were due to the ATO, leaving the ATO no option to recover the tax debt but from a string of phoenix companies with straw directors.
The Insurer argued that this business model, which wasn’t disclosed prior to policy inception, was material to their decision to underwrite the policy. The Insurer therefore exercised its statutory right to avoid the policy.
The Federal Court’s Decision
The court agreed with the Insurer, answering the separate question in the negative.
The court held that “there can be little doubt” that there were “matters which were fraudulently non-disclosed” and also that “one need only set out the business model in these basic terms to appreciate that it is fraught with the risk that the ATO may seek to recover its lost tax revenue from those involved in the scheme.”
The full court held that underwriters did not have to extend payment for defense costs to Cranston and Onley in accordance of the defense costs extension because
- As a matter of construction, the defense costs extension does not diminish or contractually qualify the Insurer’s statutory right to avoid the policy consequent upon Cranston and Onley’s non-disclosure.
- As a matter of public policy, courts will not allow a party to contract out of the consequences of his/her own fraudulent conduct.
Public policy considerations
Clearly, the court was not prepared to allow the insureds to obtain a benefit from their alleged fraud. It held that if the separate question was determined in Onley and Cranston’s favour, it would risk a situation of the duo benefiting from the fraud, stating: “even to require the insurer to defer acting upon its claim of fraudulent non-disclosure whilst the question of whether the Applicants committed Wrongful Conduct is adjudicated could give the applicants the benefit of their own fraud. To accept such a proposition would be to undermine the common law’s historical abhorrence of such conduct.”
Implications for insurers
Courts won’t limit the statutory right of insurers around fraudulent nondisclosure without express language in the policy. The presence of a final adjudication clause in a dishonesty exclusion is not enough to waive insurers’ statutory rights to avoid. The court also emphasized that it won’t read a policy in a way that risks giving insureds who have fraudulently induced an insurer to enter a policy by reason of non-disclosure a way to benefit from that fraud.
2018 QCCS 3434.
Ibid, para. 48.
Ibid, para. 60.