A recent decision of the High Court has ended an insurer’s fight to avoid being joined to insolvent trading proceedings. This decision confirms the ability of liquidators to directly pursue proceeds of insurance policies held by insolvent insured defendant directors and has important ramifications for insolvency practitioners as well as insurers and litigation funders.

Summary

CGU Insurance Limited v Blakeley & Ors [2016] HCA 2 has opened the door for liquidators to join third party professional liability insurers to directors’ duties proceedings where those directors are prima facie indemnified under a relevant policy. The insurer will be entitled to raise any dispute in respect of its obligation to indemnify in the substantive proceedings.

The High Court reached this decision without offending the key principle of privity of contract, which in the ordinary course prevents a party from having standing to proceed against a party with whom it does not have a contractual relationship.

This decision highlights a further potential source of funds available to liquidators and is particularly relevant in circumstances where the director being pursued is or may be bankrupt or an insolvent corporation. Indeed, the decision may prompt a liquidator who has a substantial claim against directors who are covered by a considerable D&O insurance policy to seek to join the insurer at a formative stage of proceedings, particularly in circumstances where it is apparent that the directors will be unable to satisfy a judgment.

Background

The first respondents were appointed liquidators (the Liquidators) in the winding up of Akron Roads Pty Limited (Akron). The Liquidators commenced proceedings against various Akron directors in 2013 (the Proceedings) for breaches of the s588G insolvent trading provisions and sought orders for compensation under s588M(2) of the Corporations Act 2001 (Cth) (the Act).

Amongst those directors were Trevor Crewe (Mr Crewe) and Crewe Sharp Pty Limited (Crewe Sharp), a company of which Mr Crewe was a director and which the Liquidators alleged was a shadow director of Akron.

Mr Crewe and Crewe Sharp made a claim on a professional indemnity policy held by Crewe Sharp with CGU (the Policy). CGU denied indemnity on account of various exclusions under the Policy.

Defendant directors’ ability to meet judgment or costs orders

During June 2014, Crewe Sharp was placed in a creditors’ voluntary liquidation. Whilst Mr Crewe was not at that time a bankrupt for the purposes of the Bankruptcy Act 1966 (Cth), on the basis of undisputed evidence it appeared unlikely that he could satisfy any judgment made against him in the Proceedings.

Neither Mr Crewe nor Crewe Sharp cross-claimed against CGU, sought to join CGU to the Proceedings or otherwise formally challenged its denial of indemnity under the Policy.

Orders sought by the Liquidators

In August 2014, during the interlocutory stages of the Proceedings, the Liquidators sought:

  1. an Order pursuant to Rule 9.06(b) of the Supreme Court (General Civil Procedure) Rules 2005 (Vic) that CGU be joined to the Proceedings as a defendant; and
  2. leave of the Court to seek a declaration that CGU was liable to indemnify Mr Crewe and Crewe Sharp under the Policy in respect of any judgment and consequent costs order made against them.

The Liquidators submitted that they had a sufficient interest in the determination of CGU’s liability on the grounds of s562 of the Act, which when applied to the circumstances of the Proceedings, provided that as a third party, the Liquidators were entitled to the proceeds of the Policy insofar as it related to the liability arising as against Crewe Sharp. The Liquidators also relied upon an analogous provision in s117 of the Bankruptcy Act 1966 (Cth) insofar as it related to any liability to be owed to the Liquidators by Mr Crewe as an insolvent party.

Decisions of the lower courts

At first instance, the Supreme Court of Victoria1 made the orders sought by the Liquidators, on the basis that in the particular circumstances of the Proceedings, the Liquidators had a sufficient interest in the proceeds of the Policy.

CGU sought leave to appeal to the Court of Appeal2 on the grounds that the Liquidators were strangers to the Policy and that no party to the Policy challenged the denial of indemnity.

The Court of Appeal dismissed CGU’s application on two grounds:

  1. the Liquidators had a “real interest” in the resolution of the insurance issue; and
  2. it would be akin to an abuse of process for any of CGU, Mr Crewe or Crewe Sharp to be allowed to re-litigate any questions dealt with in the Proceedings (such as the liability of CGU to indemnify Mr Crewe or Crewe Sharp).

CGU’s appeal to the High Court

Special leave for CGU to appeal to the High Court was granted for determination of the following questions:

  1. whether the Supreme Court had jurisdiction to effect the joinder and grant declaratory relief, given that the Liquidators were not parties to the Policy and the insured parties had not challenged CGU’s denial of indemnity; and
  2. whether there was a justiciable controversy between CGU and the Liquidators in that there was no “matter” which enlivened federal jurisdiction.

CGU’s primary argument was two-fold:

  1. first, the claim against CGU involved federal jurisdiction which state courts were unable to exercise; and
  2. secondly, as it had denied indemnity and Mr Crewe and Crewe Sharp did not pursue a claim against CGU, the Liquidators were in no position to do so, in accordance with the privity rule.

In respect of the second limb of this argument, CGU took objection to the Court of Appeal’s finding that s562 of the Act and s117 of the Bankruptcy Act “operate as an exception to the privity rule and provide the basis upon which an outsider may seek declaratory relief about the meaning and effort of a contract”.

The High Court’s decision

In February 2016, the High Court dismissed CGU’s appeal, holding that there was a justiciable controversy for determination which fell within the federal jurisdiction vested in and exercisable by the Supreme Court of Victoria.

Question One: Did the Supreme Court have the power to make the declaration sought by the Liquidators?

CGU submitted that the principle of privity of contract prevented the Liquidators, as strangers to the Policy, from seeking declaratory relief in respect of the Policy. CGU’s position was that s562 of the Act did not create substantive third-party rights capable of overriding this key contractual principle and that, accordingly, the Supreme Court had no right to grant the declaration.

The High Court accepted that the Liquidators’ ability to join CGU for the purpose of seeking the declaration was dependent upon establishing that the Supreme Court had jurisdiction to make the declaration.

The High Court held that the declaration sought by the Liquidators against CGU involved a question arising under federal legislation and, accordingly, the claims to be made by the Liquidators against CGU (if the joinder was granted) were of a federal nature.

For this reason, the Court held that the Liquidators’ claim fell within the Supreme Court’s federal jurisdiction vested by s39(2) of the Judiciary Act 1903 (Cth) and/or s1337B of the Act. Particularly:

  1. the Liquidators relied upon s562 of the Act as their basis for joining CGU insofar as Crewe Sharp was concerned;
  2. the Liquidators relied upon the broadly analogous s117 of the Bankruptcy Act 1966 (Cth), which vests in a bankruptcy trustee the right of a bankrupt to indemnity under a current insurance policy against all liabilities to third parties, insofar as Mr Crewe was concerned; and
  3. in its defence, CGU relied on s21(1) of the Insurance Contracts Act 1984 (Cth) in alleging that Mr Crewe and Crewe Sharp had breached their disclosure duties owed to CGU.

The Supreme Court had an overarching discretion to make the declaration sought by the Liquidators under s36 of the Supreme Court Act 1986 (Vic) whilst exercising state jurisdiction. By virtue of the operation of s79 of the Judiciary Act 1903 (Cth), the High Court found that discretionary power was conferred equally whilst the Court was exercising federal jurisdiction.

Thus, the High Court found in favour of the Liquidators on the first question.

Question Two: Was there a justiciable controversy?

The High Court considered CGU’s contention that on a proper reading of s562, no right of action is conferred against a defendant’s insurer in a manner that represents an incursion upon principles of contract law or privity of contract. It also noted that had Mr Crewe been declared bankrupt, s117 of the Bankruptcy Act 1996 (Cth) would have provided a similar remedy to that under s562 of the Act.

Importantly, the High Court relied upon the legal consequence created by each of s562 of the Act and s117 Bankruptcy Act 1996 (Cth) in the event that CGU was liable to indemnify Crewe Sharp and Mr Crewe (if he was in fact declared bankrupt) respectively, being the bringing into existence in favour of the Liquidators of a right to the proceeds of the Policy payable to Crewe Sharp in respect of its liability.

The High Court held that even without a direct “right of action” under legislation, a “sufficient” interest in favour of the Liquidators arose as a practical matter from this right.

The Court referred to, first, the reality that the Liquidators (rather than Crewe Sharp or Mr Crewe) stood to benefit from the Policy and, secondly, CGU’s unchallenged denial of liability under the Policy as being the factors which ultimately created a justiciable controversy involving a question under a federal law. The Court held that it “would be distinctly to ignore this reality if the liquidators’ interest in this regard could be defeated by reason of inaction on the part of Crewe Sharp and Mr Crewe against CGU given that the statutory provisions themselves deprive Crewe Sharp and Mr Crewe of all incentive to pursue a claim under the policy”.

Accordingly, the High Court held that the Supreme Court had not erred in granting the Liquidators leave to join CGU to the Proceedings.

Summary of key take-away points

  • Where a liquidator has commenced proceedings against an insolvent or bankrupt director or shadow director under the insolvent trading provisions of the Act, the court may allow the joinder of the director’s insurer to the proceedings where, first, the liquidator can show that there is a real interest in the proceeds of the insurance policy and, secondly, that there is practical utility in the joinder.
  • Subject to any order by the relevant court upholding an insurer’s denial of indemnity under the applicable insurance policy, the joinder of the director’s insurer may facilitate a direct claim by a liquidator of an insolvent director to the proceeds payable by the insurer to the insured insolvent defendants under the insurance policy. Indeed, the CGU decision arguably represents an encouragement for a liquidator who has a substantial D&O claim against a director who is insured under a D&O insurance policy but lacks the assets to satisfy a judgment, to join the insurer at a formative stage of the proceeding.
  • Liquidators will avoid the need for a multiplicity of proceedings prior to recovering a judgment debt from an insolvent director. In turn, we expect this will naturally reduce the costs involved in that recovery and consequently increase the funds available for distribution to creditors in the liquidation.
  • More broadly, the outcome of this judgment may in some instances serve to assist unfunded liquidators in securing funding from third-party funders to pursue insolvent trading claims against directors of an insolvent company, where the proceedings may otherwise have not been attractive from a risk/reward perspective.