- The New South Wales Court of Appeal has clarified that where insurers allege fraudulent misrepresentation or non-disclosure, the court must inquire into the subjective state of mind of the maker of the statement. Analysis of whether a person’s conduct is careless or reckless from an objective viewpoint is insufficient.
- In doing so, the Court of Appeal has arguably re-set the bar for fraud in its proper place by correcting the first instance decision which in effect held that honest but careless errors amounted to fraud.
- The decision also addresses a raft of other issues including sections 21, 27, 28 and 54 of the Insurance Contracts Act 1984 (Cth) (the Act). The decision supports a broad interpretation of s 54 (despite finding that s 54 did not apply in this instance), in line with the approach adopted in Maxwell vHighway Hauliers.1The decision provides clarity regarding the conceptual difficulties faced in determining the application of the section.
- The decision also provides useful guidance on the steps to be taken when completing insurance proposals and the correct approach to construing an insured’s answers.
‘A day late and a dollar short'
On 27 August 2007, the respondent insurer, Atradius Credit Insurance N.V. (Atradius) issued a trade credit insurance policy in favour of the appellants, Prepaid Services (PPS), Optus Mobile (Optus Mobile) and Virgin Mobile (Australia) Pty Limited (Virgin Mobile). The policy insured against the failure of Bill Express Limited (BXP) to pay amounts due to any of the appellants.
Optus and Virgin Mobile operate telecommunication networks within Australia. PPS acts as an agent for Optus Mobile by selling access to its telecommunication network.
BXP controlled more than 14,000 point of sale terminals. Customers would purchase pre-paid cards through BXP’s terminals and were issued ‘e-vouchers’ allowing customers to access the corresponding telecommunication networks.
BXP subsequently became insolvent and the appellants claimed under the policy. BXP was allegedly indebted to the appellants for amounts in excess of $62 million. Atradius’ potential exposure was $27 million (being 90% of the $30 million limit of indemnity). However, Atradius asserted that the losses potentially falling within cover could be reduced by almost $16 million as direct supplies by Optus Mobile were not made on terms contemplated by the policy.
Atradius also claimed that it was entitled to avoid the policy for fraudulent non-disclosure and misrepresentation, or alternatively was entitled to reduce its liability to nil in the absence of fraud. Atradius asserted that Mr McQuade, the senior commercial manager of PPS, on behalf of the appellants, made three representations in the insurance proposal form. These were:
- BXP ‘has traded 7-10 days from the due date on occasion’ (late payment statement).
- The difficulties in payment delays experienced were ‘in reducing payment terms from 28 to 21 days’ (payment terms statement); and
- Answering ‘no’ to whether BXP had been put on a payment plan (payment plan statement).
McDougall J, the primary judge, held that the answers in the first and third questions were wrong and concluded that Mr McQuade was recklessly indifferent as to the truth of those answers. Those misrepresentations were therefore fraudulent1 entitling Atradius to avoid the policy under ss 28(2) of the Act. The primary judge also held that the answer in the second question was wrong, but not fraudulent2.
If fraud was not established, the appellants also asserted that Atradius had sufficient information (BXP’s management accounts as at April 2007) as to the financial position of BXP before it went on risk. The information showed that BXP was trading well over 7 to 10 days late, the high extent of the delays in payment, and payment terms for PPS were 21 not 28 days. The appellants asserted that Atradius was precluded, pursuant to ss 21(2)(c), 21(2)(d) and 27 of the Insurance Contracts Act, from relying on the plaintiff’s answers as Atradius already possessed information providing accurate answers to the questions.
For similar reasons, the appellants contended that Atradius was not entitled to reduce its liability to nil pursuant to s 28(3) of the Act.
The primary judge also held that Optus Mobile was not entitled to an indemnity because the obligations in respect of which BXP defaulted were not obligations arising under the supply contract insured under the policy. Consequently, section 54 did not prevent Atradius from refusing indemnity on that basis.
Honesty is the best policy: re-setting the bar for fraud
On appeal, the appellants were successful on three of the four issues dealt with.
The principal issues, as framed before the Court of Appeal, were whether the primary judge was correct to conclude that Atradius was:
- entitled to avoid the policy for fraudulent misrepresentation; and
- if fraud was not established, to reduce its liability under that policy to nil for innocent misrepresentation under s 28(3) of the Act.
On the key issue of fraudulent misrepresentation, Meagher JA (with Emmett JA and Macfarlan JA agreeing) found the primary judge had misdirected himself as to what was necessary to justify a finding of fraud based upon ‘reckless indifference’. The primary judge found that Mr McQuade acted recklessly in the way that he checked, printed and signed the proposal form. Four main reasons were provided by the primary judge supporting this conclusion, as follows:3
- his failure to review the final version of the proposal form carefully that it reflected prior changes.
- paying more attention to the matter of form over substance, for example, correcting typographical errors but not substantive errors.
- failing to make proper checks regarding BXP’s payment history.
- potentially being influenced by the desire of his superiors to secure cover.
However, the Court of Appeal disagreed with the primary judge’s formulation by stating that the four reasons given in support of a finding of fraud were concerned with an objective assessment of Mr McQuade’s conduct as ‘careless, excessively lax and, indeed, reckless’.4
Borrowing from the dicta espoused in the recent High Court decision of Forrest v Australian Securities and Investments Commission5, the Court of Appeal considered the primary judge’s ‘objective considerations were evidence of Mr McQuade’s not caring that the answers may not be true, but were not determinative of that question’. Meagher JA stated relevantly:
The primary judge gave no consideration in his reasons to the ultimate question, which was whether Mr McQuade was consciously indifferent to the truth of the answers given. The second is that in addressing that question it would have been necessary for the primary judge to consider Mr McQuade’s intention and state of mind in participating in the completion of the proposal form. Two of those findings are consistent with Mr McQuade caring that the answers were correct.6
As such, the Court of Appeal found that Atradius was not entitled to avoid the policy for fraudulent misrepresentation. Having recognised the mischief that a mere objective assessment of recklessness could amount to fraud (a low threshold), the decision broadens the test to take into account more subjective considerations.
This is a welcome result for insureds as the formulation at first instance could arguably result in honest but careless answers amounting to fraud.
In relation to Atradius reducing its liability to nil under s 28(3) of the Act, the Court determined that the primary judge’s conclusion should be set aside. This was on the basis that Atradius was not entitled to a remedy with respect to the three representations (canvassed above) because it was aware of the true position in relation to each of them or would still have issued the policy.
In his analysis, Meagher JA addressed the scope of s 27 of the Act which addresses when a person is taken not to have made a ‘misrepresentation’. His Honour made clear that the provision is directed to misrepresentations which arise solely because there has been either a failure to answer or an ‘obviously incomplete’ or ‘irrelevant answer’ given. Such misrepresentations would include those made by a ‘negative answer’ which is inferred only from the fact of the incomplete or partial answer.7 His Honour stated that neither of the misrepresentations contained in questions one or two arose solely from the fact that those answers were obviously incomplete or irrelevant.
Meagher JA then turned his mind to the operation of s 28(3) of the Act. This provision requires an inquiry as to the position the insurer would have been in if the relevant misrepresentation had not been made. After a detailed analysis of the evidence given by Atradius’ employees, Meagher JA rejected the primary judge’s findings that, had the proposal form disclosed the payment plans, Atradius would not have issued the policy.
However, the proceedings were remitted back to the primary judge for consideration of the evidence in order to determine the true underwriting position. The retrial is to take into account the reasons stated in the Court of Appeal.
Not surprisingly, given the findings regarding fraudulent misrepresentation, the Court of Appeal upheld that there was also no fraudulent breach of the duty of disclosure and similarly no entitlement to reduce Atradius’ liability to nil on that basis.
Barracking for Western Australia: adopting a broad approach to s 54
The Court of Appeal endorsed the primary judge’s conclusion that s 54 of the Act did not apply to prevent Atradius from refusing to pay Optus Mobile’s claim. However, unlike the primary judge’s cursory treatment of s 54, the Court of Appeal undertook a comprehensive examination of the issues and corresponding case law.
Significantly, this is the first New South Wales decision addressing the judicial tension between the Queensland Court of Appeal decision in Johnson v Triple C Furniture & Electrical Pty Ltd8 and the Western Australian Court of Appeal decision in Highway Hauliers. Following a careful analysisof the relevant dicta contained in both cases, Meagher JA was decisive in approving the broad interpretation enunciated in Highway Hauliers. His Honour held:
In my respectful opinion, … [the primary judge in Johnson v Triple C Furniture & Electrical Pty Ltd] proceeded other than in accordance with the principles and approach stated in Australian Hospital Care and applied in Maxwell v Highway Hauliers.9
However, despite the broad application of s 54, the Court of Appeal held that the effect of the policy was that Atradius may refuse to pay Optus Mobile’s claim because it is in respect of a payment default falling outside the insuring provisions of the policy. The reason for Atradius’ refusal to indemnify Optus Mobile was not its act in contracting with BXP on different terms or omission to do otherwise. The Court of Appeal also held that there was no basis for disregarding the agreement of the parties as to the description of the relevant contract on the basis that to do otherwise would be to prefer form over substance.
Lessons to be learned
A welcome decision for insureds, the Court of Appeal has re-set the bar to clarify that honest but careless errors (even if reckless when viewed objectively) will not amount to fraud. Where insurers allege fraudulent misrepresentation or non-disclosure, the court must inquire into the subjective state of mind of the maker of the statement. Analysis of whether a person’s conduct is careless or reckless from an objective viewpoint is insufficient.
The decision may evidence a more insured focused manner of resolving disputes in relation to questions of misrepresentation and non-disclosure.
The Court of Appeal decision further supports a broad interpretation of section 54 of the Act, in line with the approach adopted in Highway Hauliers. In doing so, the decision provides clarity regarding the conceptual difficulties faced in determining the application of the section.
The decision also provides guidance on the scope and application of sections 21, 27 and 28 of the Insurance Contracts Act. In particular, the judgment addresses how these sections operate in a finding of misrepresentation and confirms that reducing liability to nil may not be readily accepted.