This article is the second in a series with a focus on problematic commercial contract issues and considers insurance clauses when drafting and general insurance issues.
Insurance is a key part of risk management and is therefore a vital component of the risk and liability matrix of any contractual relationship.
A contract of insurance is a legally enforceable contract between two parties under which the insurer agrees to indemnify the insured in return for payment of the premium by the insured. A policy which aims to return the insured to its pre-loss position, but not to allow the insured to make a profit out of the loss, is called an indemnity policy. The insured is entitled to recover any loss it has suffered provided that it is covered by the insurance contract.1
Sources of insurance law
There are two sources of insurance law: common law and statute law including the Insurance Contracts Act 1984 (Commonwealth) and the Insurance (Agents and Brokers) Act 1984 (Commonwealth).
The doctrine of utmost good faith (Uberrimae Fidei)
As a general principle under the common law, contracting parties are not obliged to disclose material facts to each other, even though each party is aware that complete disclosure to the other would affect that person’s willingness to enter into the contract. An exception to this principle is contracts of insurance, as they are deemed to be contracts of the utmost good faith (Uberrimae Fidei). This is where the insured must disclose all material facts that can be reasonably discovered, and go to the question of risk, whether asked about them or not. The onus of proof lies on the insurer and the standard of proof is on the balance of probabilities.
Section 28 of the Insurance Contracts Act 1984 limits remedies to an insured where an insured has failed to comply with the duty of disclosure, or made a misrepresentation prior to the contract of insurance being entered into. Section 28(3) expressly allows an insurer’s liability to be “reduced to the amount that would place the insurer in a position which the insurer would have been in if the failure had not occurred or the misrepresentation had not been made”.
In two recent cases (one in Queensland4 and the other in New South Wales5) the Courts closely scrutinised the insurers’ underwriting guidelines, practices and procedures in making an assessment as to whether they would have issued a policy had they been provided with full and frank disclosure from an insured before the policy was issued. In both cases, the insurer’s liability was reduced to nil, but not without considerable effort in meeting the insurer’s onus. These two cases act as a reminder to insureds that it is critical to make complete and proper disclosure when entering into a contract of insurance, and to insurers to maintain comprehensive underwriting guidelines, practices and procedures so they are in a position to meet the necessary onus of proving what they would have done had complete and proper disclosure been made on behalf of the insured prior to the policy being issued.
In the Michails case,6 Mr Michail, who had a poor driving history, insured his Aston Martin. He was in an accident and wrote his car off and sought to claim $250,000 on the policy. The insurer investigated the claim and refused it stating that, had Mr Michail revealed the true state of his driving history, the insurer would not have issued the policy. Both at first instance, and at the Court of Appeal, the court dismissed the insured’s claim and found that the insurer would not have issued the policy had it been provided with complete disclosure, and thus was entitled to reduce its liability to nil by virtue of Section 28(3).
Under the common law the insured bears part of the loss in cases of underinsurance. Where a contract of insurance has included in it a “subject to average” clause, the rule is that the insured bears a pro rata proportion of any loss. For example, a person has shop inventory worth $200,000 but only insures it “subject to average” for $100,000. Say $25,000 is lost in a fire thus the insurer will only be liable to pay $12,500, being the $25,000 damage multiplied by the underinsurance of 50%. Relief is available for homeowners who find it difficult to assess the value of their property, as long as the property is used primarily and principally as a place of residence of the insured and as long as the sum insured is 80% or more of the value of the insured property.7
Behaviour that may affect a claim
Care needs to be taken to ensure that no admission of fault (or part fault) is made as such an admission normally prejudices the terms of an insurance policy, as it reduces the ability of the insurer to contest the case. Care should also be taken in the “heat of the moment” that apologies made do not seem to be, or in fact do not contain, an admission. To reduce the risk of this occurring better practice is to say nothing and seek immediate legal advice. If there is a claim, or a potential claim the insurer must be advised according to the terms of the policy, normally as soon as possible (and in any event by a certain date) and, as described above, without making any admissions to the other party.
What to look for
Ordinarily a buyer obtains the vendor’s insurance details by asking for a copy of the vendor’s certificate of currency (CoC). If this is not forthcoming then the purchaser seriously should consider not engaging the vendor. Upon receipt of the CoC the purchaser should check the following:
- Is the counterparty, and not an associated party, listed on the certificate? Check name and ABN of the insured.
- Is the insurance current? Check the start and end dates.
- Is the type of insurance correct to cover the risk(s)? For example: public liability, professional indemnity.
- Is the geographic cover of the insurance correct?
- Check that the policy limits are adequate to suit the nature of the work or the products sold. For example with public liability ensure that the public liability policy is unlimited in the aggregate and product liability is capped in the aggregate. Aggregate is the total amount that cannot be exceeded no matter how many claims are made.
- Is the cover from a recognised insurance company (perhaps one regulated by APRA and what is its credit rating ie A+)?
- If the information is available on the CoC, what are the policy exclusions and are they relevant to the work being done (eg asbestos / working near or on water / consequential loss / third party claims etc)?
- How large is the deductible and where will the vendor fund that from if needed?
What you will ordinarily not find on the CoC
Ordinarily you will not find in a CoC the policy inclusions and exclusions. If the risk is significant you should ask to see the original policy. Often larger organisations will refuse to provide the full policy, but if there are concerns this should be pressed. Where there is non-cooperation in cases of high or extreme risk, especially by smaller vendors without good reason, then you could consider excluding that vendor from consideration. Insurers often place a warning on the face of the CoC to remind readers that the insured can cancel the cover at any time, the terms and conditions between the insured and the insurer are in the policy not on the CoC, and therefore for full policy details including details of exclusions a copy of the policy will be necessary.
How then do you know if the vendor is insured?
There are a number of ways to determine whether a party is insured:
- Ask the counterparty if it is currently insured (they may or may not give you a truthful answer).
- Ask for your interest as purchaser to be noted on the counterparty’s policy, as this allows you to make a claim on the policy, but this will not give you the right to be notified if the policy is varied or cancelled.
- The purchaser can purchase insurance on behalf of the vendor and charge the vendor for this insurance, or cover the counterparty as part of its master policy.
- The insured can expressly authorise its broker to provide currency and other policy information to the counterparty.
How insurance cover can be reduced or eliminated
The insurer may reduce or eliminate cover in a number of situations including:
- The insured voluntarily assuming contractual liability. For example this is where an insured vendor contractually assumes liability for damages that would not have applied in the absence of the contract, for example under an indemnity clause. Understandably, the insurer does not want to cover situations that its insured would not have been liable for, but for the voluntary assumption of the risk under the contract.
- The insured voluntarily agreeing to a waiver of subrogation. Subrogation is the substitution of one person for another and allows the insurer to “step in the shoes of the insured” thereby giving it all the legal rights that the insured had over the asset insured, including the right to take legal action in the insured’s name.8 The insurer can then pursue whatever claim its insured could assert against other parties for that same loss. If however there is a waiver of the right to subrogation, the insurer then cannot recover the money paid to or on behalf of their insureds when such waivers apply. The result is that the insurance company bears more loss than it should have due to the insured agreeing to such waiver in the contract. The acceptance of a waiver of subrogation by any party without the prior agreement from an insurer can render the currency of the entire insurance policy null and void, so any request for waivers by any party should first be agreed and noted by the respective insurers.
Ensure that where you are giving a broad indemnity that is not triggered by a legal liability, but is instead triggered by the fact of a loss, that the insurer agrees to it. If the insurer is not aware of it, or does not agree to it, there is a good chance that the insurance will not cover any claim under an indemnity.
Typical types of insurance cover
Examples of typical cover include:
- Directors and officers – covers claims from allegations against directors and officers of a company of wrongful acts whilst acting in their capacity as a director or officer, but normally does not cover fraud or dishonesty.
- Fire – covers damage to property or premises by fire.
- Loss of profits – covers any loss of profits that occurs due to a defined event occurring.
- Motor vehicle – compulsory third party and, depending on the needs, comprehensive or extended third party cover.
- Product liability – covers damage or injury caused to another organisation or person by the vendor’s product.
- Professional indemnity – covers civil liability for breach of a duty owed in a professional capacity in connection with the organisation’s activities.
- Public liability – covers third party loss arising from death or injury, loss or damage of property or “pure economic” loss resulting from the organisation’s negligence.
- Worker’s compensation – this is employee protection, and ordinarily is compulsory for employers under legislation.
Checklist of insurance issues to consider for a purchaser when engaging a vendor:
- Do we need insurance to mitigate or eliminate risks in the contract?
- Are key risks coved by the type of insurance (public liability, professional indemnity etc)?
- Is the right party on the certificate? Check organisation name / ABN.
- Is the cover current?
- Are the insurance start and end dates correct?
- Is the geographic cover of the insurance correct?
- Are the policy limits adequate to suit the nature of the work or the products sold?
- Is the cover from a recognised insurance company?
- Do you want your organisation to be named on the other party’s policy so you can claim on their policy?
- Is there a voluntary assumption of contractual liability that may invalidate the policy?
- Is there a waiver of subrogation that may invalidate the policy?
- Should the buyer control the insurance?
- What are the exclusions?
- What is the excess?
Key insurance law takeaways
- The purpose of insurance is to reduce risk.
- Insurance is a creature of contract that has been modified by legislation.
- Make complete and proper disclosure when entering into an insurance contract.
- Understand inclusions/exclusions, aggregation and averaging.
- Use a checklist to ensure that all key issues are considered (see sample checklist).
- Care must be taken to ensure that the contractor has current and relevant cover.
- Where necessary look beyond the Certificate of Currency.
- Care must also be taken when voluntarily assuming contractual liability and when facing a waiver of subrogation clause.
- Do not accept an indemnity unless your insurer agrees to provide cover.
Co-authored by Dr Cyril Jankoff (The Risk Doctor)