In June 2017, the New South Wales Parliament introduced the Civil Liability (Third Party Claims Against Insurers) Act 2017 (NSW Act), designed to clarify the rights of claimants to proceed directly against insurance companies. But in the context of insolvent corporations, has it created more problems than it has solved?

Below, we offer an overview of what the NSW Act does, and outline three key issues it raises for claimants, creditors and insolvency practitioners. We also outline our observations on the other aspects of the Act we feel require further consideration.

What does the NSW Act do?

At a high level, the NSW Act provides for direct claims by creditors against insurers - sidestepping the need to sue the insured party or the beneficiary directly.

Under the NSW Act, a system of first past the post priority seems to exist – meaning the creditor who obtains judgment first does not have to share with other creditors in an insolvency scenario according to the literal scheme of the Act.

Also of note is that fact that there is a possible inconsistency between the NSW Act and the Corporations Act 2001 (Cth) (Corporations Act) in relation to insolvency scenarios – the Corporations Act calls for creditors with the same types of claim to be treated equally, rather than first come first served.

3 key issues arising from the introduction of the NSW Act

1. Priority issues

There is a chance that the inconsistency between the NSW Act and the Corporations Act in regards to priority issues may result in the NSW Act being ineffective or held invalid.

In an insolvency scenario, there are numerous priority issues in relation to the application of policies of insurance. Usually, under the Corporations Act, any proceeds of an insurance policy are paid to creditors who have a claim under that insurance policy, and if insufficient funds exist then the shortfall is shared equally amongst creditors with insured claims.

The NSW Act purports to create a special, entirely independent right to sue insurers without involving the insured or beneficiary under a contract of insurance. This has the potential to create a situation where the proceeds of the insolvent companies insurance policy do not come into the insolvent estate and there is correspondingly no scope for the Corporations Act provisions relating to rateable sharing to operate.

However, a successful claim under the NSW Act clearly impacts on the insolvency administration of an insolvent insured or beneficiary. Section 9 of the NSW Act purports to specifically provide that where a payment is made to a claimant, it reduces the liability of the insurer to the insured. This reduces the property available to the insolvent estate. Further, section 8 provides that a claimant who sues the insurer directly may still make a claim against the insured or beneficiary except to the extent that their claim is discharged by payment from the insurer.

From a policy perspective, there is an open question as to why a creditor who obtains judgment first should both receive the proceeds of what they recover (without having to share) and still have a right to claim against the insolvent insured/ beneficiary. This question is particularly acute because the net effect of the NSW Act (if it works) is that other creditors will receive less with respect to equally deserving claims of the same kind.

Moreover, the inconsistency between the NSW Act and the Corporations Act gives rise to a question about whether the NSW Act is ineffective on constitutional grounds. In particular, it seems arguable both that:

  • the provisions in the Corporations Act dealing with the application of proceeds of contracts of insurance in an insolvency context are altered, deterred or impaired by the operation of the NSW Act[1] - in so far as rateable treatment is effectively abolished and a system of special preference is introduced and on that basis the NSW Act; and

  • there is no scope for state or territory laws to, as a matter of fact, vary the order of priority that exists with respect to the distribution of the property of insolvent corporations[2].

What does all this mean?

For creditors (and those standing behind litigation) looking to definitively establish priority by being the first mover, there is a possible uncertainty as to whether the NSW Act is effective. If the NSW Act is effective, then it will pay to be first. If it is not effective, then there is a possibility of rateable distribution.

For liquidators and creditors who are not first in time in establishing a claim, there is a difficult and complex case to consider in relation to whether the NSW Act does truly create an exception to the usual principles of equal treatment. In a large insolvency, with many creditors, this issue will potentially be significant enough to warrant litigation.

2. Settlement issues

The NSW Act makes early settlements between insolvent corporations and insurers less likely, because Section 10 provides that any compromise between the insurer and the insured does not prevent a further claim under the NSW Act by a potential third party claimant.

Given section 10 of the NSW Act means that a settlement will never (absent a scheme of arrangement) be definitive of the insurer’s liability, one unintended consequence of the NSW Act may be to make settlements between insolvent corporations and insurers potentially unworkable unless the proceeds of the settlement exhaust the insurance policy (but then why would an insurer settle on that basis).

3. Choice of law issues

The NSW Act does not deal with choice of law and choice of forum issues in insurance contracts.

The NSW Act provides that the insurer is entitled to deny liability based on any defence that would be available had the proceedings being commenced by the insured.

The NSW Act does not deal with any of the issues that are likely to arise in relation to claims against offshore insurers, including choice of law clauses where the effect of the choice of law forums mean that the law of the contract is not NSW and the proper forum to commence proceedings is outside of Australia.

If the Courts construe the provisions of the NSW Act strictly, then insurers may be able to draft around the effect of the NSW Act in any case. If the NSW Act is not read in that way, then the enforcement of judgements in some jurisdictions may be very difficult.

What else do you need to know?

Below are five further key points to note:

  1. Under the NSW Act, the Court’s leave is required to proceed against an insurer. Leave will be refused if the insurer can establish that it is entitled to disclaim liability under the policy. Unlike under section 6, leave may be sought before or after the commencement of proceedings against the insurer. There are a number of threshold issues which we expect to be hard fought in the initial case law.

  2. The NSW Act enables a plaintiff to recover from an insurer where the defendant is a third party beneficiary under the policy of insurance. This differs to the position under section 6, which arguably applied only to the person who entered into the contract of insurance.

  3. Under the NSW Act, the limitation period for commencing an action against an insurer is the same as against the insured/beneficiary.

  4. The NSW Act does not deal with the difficulties faced by plaintiffs in ascertaining the identity of the defendant’s insurer and the terms of an insurance policy. However, Rule 5.2(1) of the NSW Uniform Civil Procedure Rules (which enables preliminary discovery in circumstances where the applicant cannot identify a person for the purpose of commencing proceedings against them) will likely assist in this regard.

  5. The NSW Act may also create further complications in the context of multiple class actions arising out of corporate failure (a topic for separate consideration).