A claim under a Directors and Officers liability policy for investigation, defence and settlement costs has ended with the New South Wales Supreme Court1 allowing some claims but denying others. The decision is a reminder of the importance of robust internal insurance reporting processes, and of carefully managing notifications and claims where multiple insurance policy years may be available as options.

BACKGROUND

The underlying events

Construction giant CIMIC (the policyholder) was structured in various business divisions, each with its own Chief Operating Officer (COO). In November 2010 (during FY11 policy period), a divisional COO (the Author), who at the time was CEO elect, made a file note of a conversation with another COO which:

  • suggested that the policyholder had won a tender in Iraq by way of an unlawful payment;
  • noted that there was opportunity to win another tender by way of a similar payment; and
  • recorded that the Author and the then CEO had agreed that they were not comfortable with winning the further tender by such methods and ‘if he can’t win without this, then we don’t want the work.’

The Author became the CEO from January 2011 to August 2011.

The file note was identified in November 2011 (during the FY12 policy period) by external solicitors, as part of the response to an ASIC document production notice. The policyholder then referred the file note to the AFP for investigation and resolved to internally investigate the issues raised in it.

The policyholder also notified its FY12 insurers of the potential for a claim to be made against it by regulators and by a class action associated with the disclosure of the relevant conduct. No notifications were made to (or claims advanced under) the FY11 policy, notwithstanding that the Author acquired the knowledge of the matters in the file note during that earlier policy period.

Policies, notifications and amounts claimed

The FY11 and FY12 insurance policies were relevantly similar in their terms. Both policies involved a ‘tower’ consisting of a primary policy and 9 excess layers, with a total limit of $200 million. Most of the layers were insured by the same insurers across the 2 periods, though there were some differences.

Importantly, cover under the FY11 policy had already been eroded by $75 million. This meant that different insurers would be exposed to the liability, depending on which policy responded.

Combined, the policyholder claimed a total of $45.7 million for the defence costs of the AFP and ASIC investigations and for the defence and settlement of the shareholder class action. The total value of each category was to be determined by way of a separate hearing, but at least $32 million of this was the settlement sum for the shareholder class action.

The key controversy

Among the many issues the key questions were: what did the policyholder know and when, and what were the legal consequences of this knowledge under each policy? That is, whether the policyholder:

  • was prevented from recovering under the FY12 policy because it failed to disclose the information in the file note on renewal; and
  • could (and should) have notified the FY11 insurers when the Author created the file note (such that it might be able to recover under the FY11 policy, with the assistance of s54 ICA).

While the Court could not determine what cover might be available under the FY11 policy (as no claim had been made under that policy), the policyholder’s relief included a declaration that it had become aware of notifiable circumstances (being the content of the file note) during the FY11 period.

Claim under FY12 policy – AFP and ASIC investigation costs

The Court held that:

  • the policyholder had failed to disclose the file note prior to renewal, such that (on the basis of the demonstrated prejudice – discussed below in the context of the shareholder class action settlement) insurers would have been entitled to reduce their liability to nil.
  • However, a clause in the FY12 policy – which stated that the insurer waived its remedies for innocent non-disclosure in respect of Side B cover – applied here, so the 2011 insurers were liable for the Side B costs.

The Court also considered limitation issues raised by the insurers, given the historical nature of some of the costs claimed. Section 14 of the Limitation Act 1969 (NSW) provides that, for claims in contract, a claim must be brought within 6 years after the cause of action accrued.

In relation to the FY12 policy, the Court determined that:

  • the cause of action accrues when the insurers breached the policy;
  • importantly, notification of a loss was a condition precedent to the insurers’ liability;
  • the relevant breach of contract occurred when insurers failed to promptly advance the costs after receipt of invoices; and
  • prompt payment required payment within 1 month of insurers being provided invoices.

Therefore, the causes of action accrued 1 month after presentation of invoices (or 1 month after the policyholder paid invoices given the denial of indemnity made it pointless to present them to insurers). As a result, any payments made prior to 8 May 2014 were statute barred and could not be recovered from insurers.

Claim under FY12 policy – shareholder class action defence costs and settlement

There was no similar proviso for the Side C cover so, having clearly not disclosed the file note prior to renewal, the question became: what prejudice has the insurer suffered due to the non-disclosure?

The Court concluded that there was insufficient evidence to prove that the policyholder had paid bribes or that bribes caused the policyholder to win the tender (i.e. that the matters in the file note were true) but concluded that the Author:

  • did not know whether what the COO was saying was true or not;
  • understood the COO to mean that the policyholder was making improper payments; and
  • knew that, if true, the statements could have significant consequences for the policyholder.

This knowledge was attributable to the policyholder according to the conventional principles regarding attribution of knowledge for insurance purposes – in essence, the Author was sufficiently senior (either in his COO or CEO role) for the knowledge to be attributed.

The Court further concluded that a hypothetical person in the position of the policyholder would have considered that the allegation by the COO of such serious matters which were ultimately reported to the AFP was a matter relevant to the risk insured by the insurer (regardless of whether they were ultimately true).

Each insurer argued that, had the file note been disclosed, they would have still insured the policyholder but would have ‘in some way’ excluded liability for claims arising from the file note.

Historically, it has been difficult for insurers to prove what they would have done had disclosure been made through lay evidence alone (as Courts are naturally sceptical about evidence influenced by hindsight). In this case, two aspects seemed to have carried weight in convincing the Court that insurers would have excluded liability:

  • first, the insurers were able to point to other, less serious matters, that had been disclosed them prior to the inception which caused them to offer materially different terms; and
  • second, the insurers were able to point to what they actually did after the file note had been disclosed, namely the primary insurers included an express exclusion at the FY13 renewal for claims arising from the file note and the excess insurers’ evidence was that they would have followed suit.

Position under FY11 policy

The policyholder also sought a declaration that ‘the plaintiff was, during the period 30 June 2010 to 30 June 2011, aware of circumstances reasonably expected to give rise to a Claim…’ (reflecting the circumstance notification provisions in the FY11 policy).

Having already concluded that the policyholder’s level of knowledge during FY11 policy period was sufficient for it to have breached its duty to disclose the file note prior to renewal of the FY12 policy (see above), the Court swiftly concluded that the policyholder did have sufficient knowledge of circumstances such that it could have notified the file note under the FY11 policy, and therefore granted the declaration.

However, the Court made clear that it was not resolving whether the policyholder was entitled to indemnity under the FY11 policy, so if the policyholder brings a claim the relevant insurers may run additional defences.

Additional issues of interest: coverage for settlements

Although the Court did not need to decide whether the class action settlement was otherwise covered (as the FY12 policy non-disclosure defence was successful), the case contains some useful commentary on this issue, which arises frequently for policyholders.

The key points to take from the judgment are:

  • At least where the insurers have breached their obligation to indemnify, there is a good basis to argue that the entry into a settlement will in and of itself establish the policyholder’s legal liability – the policyholder need not prove that it would have been the subject of a legal liability by way of a judgment.
  • What then remains is for the policyholder to prove the settlement was reasonable. In this case, there had been a series of settlement offers in relation to the class action proceedings, including an offer by the class to settle for $38 million, which some of the insurers essentially endorsed in the context of telling the policyholder that it had to act as a prudent uninsured.
  • The policyholder did not accept that offer but instead sought to (successfully) strike out parts of the statement of claim, and subsequently were then able to settle for $32 million.
  • In finding that the settlement was reasonable the Court made a number of useful observations:
  • the fact that the policyholder achieved a better settlement than the amount that the sophisticated and legally advised insurers had endorsed pointed in favour of the settlement being reasonable;
  • the decision not to settle at $38 million, but rather to seek to strike out arguments, demonstrated that the policyholder was conducting its defence with due care and skill;
  • it was not necessary for the policyholder to provide the legal advice it had received in relation to whether it should settle for $32 million. However, it was clear from correspondence to the insurers that the policyholder was mindful of the risk that it could receive a less favourable outcome at trial (which assisted in showing the settlement was reasonable); and
  • the class action proceedings were being conducted on an open class basis, but the settlement discussions were being conducted on a closed class basis (in other words, the potential exposure at trial could become far larger). This also pointed towards the settlement being reasonable (albeit only marginally).

WHAT DOES THIS MEAN FOR POLICYHOLDERS?

This case does not substantially change the law – rather, it is a useful practical illustration of how issues which policyholders commonly face in relation to notification and non-disclosure can play out and result in lengthy and costly court battles.

The case therefore highlights the importance of:

  • a robust process for identifying circumstances that ought to be notified prior to renewal;
  • actively managing insurance issues from an early stage in relation to investigations and disputes more generally, particularly where there may be multiple policy years that could respond; and
  • developing a strategy for dealing with insurance recovery issues in parallel with any underlying proceedings (in particular to avoid cost recovery being time-barred).