Welcome to the fifth edition of Herbert Smith Freehills’ Policyholder Insurance Highlights. In this publication, we have pulled together the learning opportunities for insurance policyholders from the most relevant insurance cases and market developments over the last 12 months. Consistent with the trends we identified in last year’s Policyholder Insurance Highlights publication, the key messages this year are: ••The insurance market continues to harden: Australia has not seen a ‘hard’ insurance market for over a decade. Key indicators of a hard market are an increase in premiums, a reduction in capacity and scope of coverage offered by insurers and increased delays and difficulties in the payment of claims. We anticipate the trend will continue throughout 2020 as insurers deal with the economic slowdown, increased losses from natural disaster events (such as the recent tragic bushfires) and shifts in the liability landscape resulting from increased activities by regulators and litigation funders. ••The volatility of the Directors’ & Officers’ insurance market: consistent with the above, the D&O insurance market has experienced particularly significant continued hardening and volatility during the course of 2019. There are growing concerns within corporate Australia regarding the ongoing availability and cost of ‘Side C’ insurance within D&O policies to cover companies for shareholder class action claims, and the longer term impact of the heightening focus upon director’s liability on the affordability of D&O insurance. In a post-Hayne regulatory enforcement environment, it is more important now than ever that directors ensure their D&O cover is fit for purpose. ••Major insurance claims are more commonly delayed and often disputed: our observation is that insurance coverage disputes for major claims (in particular) are increasing, as insurers’ underwriting profit (premium received less claims paid) becomes more important as investment profit (returns on invested premium) slows with the economy. In light of this trend, it is even more important for policyholders to: (1) give very careful consideration to their policy wordings at renewal and seek to preserve the broadest and most appropriate cover available for their operations on clear terms, and (2) engage specialist advisers at an early stage to assist with claims notifications, preserve legal privilege, engage experts and advocate claims coverage issues so as to maximise entitlements under their insurance assets – be assured, insurers will ‘lawyer up’ early in major claims. We hope that you enjoy this year’s edition of Policyholder Insurance Highlights. Please contact a member of our Insurance team (details at the back of this publication) if you would like to discuss any of the cases or trends and how they may impact your business in more detail. Our insurance practice Our global insurance and reinsurance practice advises insurers, brokers and policyholders on all aspects of insurance and reinsurance matters, whether corporate, regulatory or contentious claims. Herbert Smith Freehills’ insurance practice in Australia is focussed upon representing the interests of our clients as policyholders in major claims. We work with corporate policyholders on a range of matters including: ••assisting policyholders with major claims, including advice on coverage, preparation of claims submissions, and claims advocacy to secure payment of the claim using the full range of dispute resolution processes; ••advising clients in relation to issues flowing from critical business events including environmental incidents; property damage; personal injury claims; corporate manslaughter charges and health and safety investigations; ••representing insured directors and officers and major corporates in defending claims covered by their insurance policy where they have rights to nominate their choice of legal representation; and ••advising clients on insurance and risk in the context of major transactions, projects and insolvency. We also advise brokers on the full spectrum of issues that emerge from the role of the broker, including defence of professional negligence allegations. Mark Darwin Partner T +61 7 3258 6632 M+61 412 876 427 [email protected] Guy Narburgh Special Counsel T +61 2 9322 4473 M+61 447 393 645 [email protected] 02 POLICYHOLDER INSURANCE HIGHLIGHTS 2019 HERBERT SMITH FREEHILLS Facts A series of transactions undertaken by a financial planner, independent of the bank, defrauded bank customers, with the bank acting upon each email the financial planner had sent the bank. The customers brought a class action against both the financial planner and the bank, alleging that the bank ought to have identified the fraud. The bank ultimately settled the claim for $6 million. The bank’s liability policy had a $2 million deductible for ‘each and every Claim’, so lodged a claim for $4 million with its insurer. The insurer argued that each of the claims forming part of the class action proceeding related to separate transactions for each of the 114 individual customers, and therefore each attracted a separate deductible. The policy’s aggregation clause provided that: ‘all Claims arising out of, based upon or attributable to one or a series of related Wrongful Acts shall be considered to be a single Claim’. ‘Claim’ was defined to include: ‘(i) any suit or proceeding, including any civil proceeding… against the insured… or (ii) any verbal or written demand… of any specified Wrongful Act.’ At trial, the Supreme Court agreed with the insurer and held that there were at least 3 separate ‘Claims’, therefore wiping out the entire $6 million settlement. Decision The Court of Appeal unanimously overturned the trial judge’s decision, concluding that the Claims could be aggregated and that only a single deductible applied. While each transaction was a separate alleged ‘Wrongful Act’ within the meaning of the policy, the determinative issue was whether they were sufficiently ‘related’. The Court noted that the aggregation clause did not expressly refer to a causal relationship between the acts or Claims (as may sometimes occur in such clauses). Instead, the unifying factor required by the aggregation clause was that the alleged ‘acts’ were claimed to be ‘wrongful’ on the same basis. For each claim, the basis of the allegation against the bank was the same – namely they were all based on its alleged knowledge of the financial planner’s actions. As a result, even though the claims related to separate transactions for individual clients and there was no causal relationship between each of the claims, the claims were held to be ‘related’ because they were advanced on a common series of Wrongful Acts. This finding meant that the multiple claims could be aggregated and treated as a single ‘Claim’ for the purpose of the policy’s deductible (or excess), so the bank recovered the $4 million claimed. Class aggregation Bank of Queensland Limited v AIG Australia Limited  NSWCA 190 Lessons for Policyholders This decision is a welcome outcome for policyholders, particularly given the increasingly high premiums they are being charged for class action risks (both in professional indemnity and D&O policies). While it represents a commercially common sense outcome, as the decision notes, the application of aggregation clauses will be heavily dependent on the particular facts and policy wording in question. Policyholders and their brokers should carefully consider the class action risks to which the policyholder is exposed and, where possible, negotiate aggregation clauses tailored to provide the most favourable outcome to the class action scenario most likely to face the policyholder’s business model. HERBERT SMITH FREEHILLS POLICYHOLDER INSURANCE HIGHLIGHTS 2019 03 04 POLICYHOLDER INSURANCE HIGHLIGHTS 2019 HERBERT SMITH FREEHILLS Lessons for Policyholders Whilst the outcome of this case may be somewhat surprising, it represents the current state of thinking of the NSW Court of Appeal (albeit by a 3-2 majority). Policyholders should be aware that the 6 year limitation period to commence proceedings against an insurer for a coverage dispute starts to run when the damage is suffered, and should take appropriate steps to protect their position, either by negotiating a ‘standstill’ of the limitation period in the context of a claim or by filing Court proceedings before 6 years has passed. Facts Globe Church was legally responsible for a number of church properties which were insured under an industrial special risks policy (property damage/business interruption) for the period 2007 to 2008. In 2007, a severe thunderstorm caused property damage to the church. Globe Church made a relatively small claim under the policy for property damage and business interruption as a result of the storm, which was settled with insurers. In 2009, Globe Church discovered further structural damage had been caused by the 2007 storm, and made a further claim under the policy. In 2011, the insurer declined cover for the further claim. Negotiations ensued but failed to resolve the claim. In 2016 Globe Church commenced Court proceedings against insurers seeking cover. In their defence, insurers contended that Globe Church’s action was statute barred, alleging that the 6 year limitation period began when the property damage occurred in 2007/8. Globe Church contended that its cause of action was not statute barred because it arose (and the limitation period began) in 2011 when insurers declined its further claim, or alternatively upon the lapse of a reasonable time for the insurers to make payment following the claim. Decision The issue (which was determined as a separate question before trial) was heard by a five-Judge bench of the Court of Appeal, which was split 3 to 2 on the decision. The majority concluded (consistent with the English law position) that absent any specific provisions in a policy to the contrary, the promise to indemnify (or “hold harmless”) in the context of a property damage insurance policy (and therefore the right to sue for breach of that promise) arises when the underlying property damage is suffered. Globe Church’s claim was therefore statute barred. While this approach creates the peculiar scenario where an insurer can be in breach of contract at a time when it may be completely unaware of the property damage (or knows of the claim and has not refused cover), the majority noted it is open to the parties to a contract of insurance to negotiate the terms, including (if so intended) stating in no uncertain terms that the making of a claim is a condition precedent to the insurer incurring liability (which was not the case here). The dissenting judges took a “business-like” approach to the construction of the policy - under the express terms, the insurers’ obligation was to indemnify by paying a sum of money ascertained in accordance with the policy (including basis of settlement, progress payments, and policy limits), and there was no obligation to, in some unstated way, “hold the insured harmless”. The undertaking was to make good the insured loss after it had occurred by payment, that being a well-accepted sense in which the term “indemnify” is used, and the only sense in which such a promise to indemnify could be performed by the insurer. As to the timing of the obligation, the ordinary rule is that where the contract does not stipulate a timeframe for the obligation, it must be done in a reasonable time. The dissenting minority added that neither the reasonable commercial expectation of the parties nor the language of the policy suggested that the payment obligation is to be performed immediately upon the happening of the damage. Furthermore, it was plain on the terms of the policy that the parties contracted on the basis that the event of loss would be followed by a period of adjustment to assess the insurers’ payment obligations. Justice Leeming also added that he saw no reason to displace ordinary principles of construction of contracts with some “fundamental” principle about the nature of indemnity insurance, especially one which he regarded as “absurd”. Fact v Fiction Globe Church Incorporated v Allianz Australia Insurance Ltd (2019) 20 ANZ Insurance Cases 62-207 HERBERT SMITH FREEHILLS POLICYHOLDER INSURANCE HIGHLIGHTS 2019 05 Facts Kaboko Mining agreed to sell Zambian manganese to Noble Resources. An advance of $10 million was paid by Noble Resources with a condition that the money only be used for specified purposes. The money was not used for the specified purposes, and so Noble sought repayment of the advance. When Kaboko was unable to repay, it went into receivership, and then administration (and entered into a Deed of Company Arrangement). The administrators brought an action against the directors of Kaboko alleging that they breached their duties in failing to use the money for the specified purposes. The directors sought indemnity under their D&O liability policy with AIG. However, AIG denied indemnity on the basis of the following insolvency exclusion: ‘[AIG] shall not be liable under any Cover or Extension for any Loss in connection with any Claim arising out of, based upon or attributable to the actual or alleged insolvency of [Kaboko] or any actual or alleged liability of [Kaboko] to pay any or all of its debts as and when they fall due.’ The primary judge found that the insolvency exclusion did not preclude cover under the policy for the claims made by Kaboko. AIG appealed, arguing that the exclusion applied where there was any loss in connection with any claim arising out of, based upon or attributable to an insolvency event. Decision The Full Court of the Federal Court dismissed AIG’s appeal, and construed the insolvency exclusion so that the directors were not deprived of cover. The Court noted that the definition of ‘Claim’ related to a demand or a civil proceeding for a ‘specified act, error or omission’. The term was not defined by reference to the motivation for the demand or proceedings. As a result, the Court concluded that the focus of the definition of ‘Claim’ was on the content, source and nature of any such demand or proceeding – not the motivation for it being brought. As used in the insolvency exclusion, this meant that the insolvency had to be linked to the content, source and nature of the claim against the former directors. The basis of Noble’s claims against Kaboko related to the failure to use the $10 million for the specified purposes, not for insolvent trading or because Kaboko was insolvent. The claims could in fact have been made even if Kaboko was solvent. Therefore, the Court concluded that the insolvency exclusion did not apply. It’s about the journey, not the insolvency AIG Australia Limited v Kaboko Mining Limited  FCAFC 96 Lessons for Policyholders This decision has proved an important reminder for policyholders that it is not enough for your insurer to invoke an insolvency exclusion where the insolvency merely motivated, or was the occasion for, a claim being brought. Careful consideration should be given to coverage debates before policyholders walk away from or settle claims. 06 POLICYHOLDER INSURANCE HIGHLIGHTS 2019 HERBERT SMITH FREEHILLS Facts The navy patrol vessel, ‘HMAS Bundaberg’, was destroyed by fire in August 2014 following a welding accident during repairs to the vessel by a sub-contractor to the policyholder. The policyholder’s contract with the Commonwealth required it to ‘replace or otherwise make good’ the loss. There was some debate about how to value the 8 year old destroyed navy vessel, for there was no second hand market in which to acquire a replacement, and its depreciated book value would not have been enough to enable the Commonwealth to replace the vessel. Following negotiations on the insurance claim, RSA entered into an indemnity settlement agreement which ceded responsibility for the settlement negotiations to the policyholder on terms which included that: ‘The parties agree that settlement of the Commonwealth Claim shall not be determinative of the amount to which [the policyholder] is entitled to be indemnified for the HMAS Bundaberg Fire Claim under the Insurance Policies. Such amount to be indemnified shall be determined in accordance with the terms of the Insurance Policies alone.’ The policyholder subsequently received a settlement offer from the Commonwealth for $31.5m, being the cost of a similar replacement vessel, which the Commonwealth had commissioned and planned to finance by a chattel lease. RSA refused to consent to the settlement as being reasonable, and denied the policyholder’s entitlement to prove its entitlement to indemnity via even a reasonable settlement. The policyholder accepted the offer and sued RSA for indemnity. At first instance, the Supreme Court found in favour of the policyholder, and RSA appealed. It did so on the basis of various arguments, but essentially the dispute came down to two key arguments: ••that the obligation to ‘replace or otherwise make good’ the loss did not require the policyholder to pay for a replacement vessel, but could be satisfied by paying for the cost of leasing the replacement vessel; and ••that the above extracted clause in the indemnity settlement agreement meant that the policyholder was not entitled to establish its entitlement to indemnity from RSA by proving that the settlement was reasonable. Fire in the Hull: a ship, a flame and a reasonable settlement Royal and Sun Alliance Insurance Plc v DMS Maritime Pty Limited  QCA 264 HERBERT SMITH FREEHILLS POLICYHOLDER INSURANCE HIGHLIGHTS 2019 07 Lessons for Policyholders The case represents a significant victory for policyholders and reinforces the principles on which a settlement can be used as a basis for coverage under a policy. It also highlights the importance of securing coverage for specific underlying contractual obligations to a third party if that be an integral part of the policyholder’s business operations which are intended to be insured. Decision The Court of Appeal held that the obligation to insure (and the obligation to mitigate loss) must always be viewed in the context of the underlying contractual obligation and the particular loss in question. In this case, the obligation to ‘otherwise make good’ required the policyholder to replace the vessel or pay for a functional equivalent. Simply reimbursing the Commonwealth for the costs of leasing a replacement, even if for the remainder of the HMAS Bundaberg’s service life, would not fulfil the obligation to replace a vessel which had been owned by the Commonwealth until it was lost. Further, steps taken by the Commonwealth to address its loss (namely leasing a vessel) were not relevant to DMS’ liability under the underlying contract. In other words, just because the Commonwealth had leased a replacement vessel, it did not mean that offering payment for the cost of the lease would be sufficient to discharge the policyholder’s obligation. The Court further held that the indemnity settlement agreement confirmed the insurer’s obligation to indemnify DMS in accordance with the terms of the Policies, and nothing in it altered the general proposition that a policyholder may establish its entitlement to indemnity by reference to a reasonable settlement. As the settlement was reasonable, the policyholder was entitled to indemnity calculated by reference to its settlement agreement with the Commonwealth. 08 POLICYHOLDER INSURANCE HIGHLIGHTS 2019 HERBERT SMITH FREEHILLS HERBERT SMITH FREEHILLS POLICYHOLDER INSURANCE HIGHLIGHTS 2019 09 Key developments: D&O insurance and class actions D&O insurance Predominantly as a result of the “double whammy” of continued proliferation of shareholder class actions and increased regulator activity during 2019, we have observed the following developments in the Australian D&O insurance market: ••a general reduction or withdrawal of capacity (amount of insurance available) for ‘Side C’ cover (being the cover which responds to a company’s costs and liability in respect of a shareholder class action). In some cases, insurers are refusing to offer terms for any Side C cover at all; ••significantly increased premiums are being charged by those still prepared to offer Side C cover (and also increased premiums for director only cover), particularly on primary and lower excess layers where the risk of a claim is greatest; ••increased deductibles; and ••broad exclusions such as exclusions for exposures arising from the Royal Commission into Financial Services or insolvency. Public Offering of Securities Insurance (POSI) (also referred to as IPO insurance), which offers similar protection to D&O insurance specifically in relation to a public offering of securities, has been similarly impacted. While, at the time of writing, IPO insurance is still available, it has become very expensive and insurers will generally not participate in a company’s D&O program as well as issue IPO insurance (which makes it increasingly difficult for companies with large, diverse D&O programs to purchase IPO insurance). This has left some companies to rely on their annual D&O program, with the attendant risks that claims arising from capital raisings may impact the annual limits of the D&O program, and that cover for capital raising claims may be withdrawn at future D&O renewals (in circumstances where IPO insurance traditionally applies for a fixed period of 7 years). Shareholder class actions There have also been a number of significant developments in the class action landscape which will impact the Australian D&O insurance market going forward. In brief summary: ••2019 has seen the settlement of a number of shareholder class actions, generally for amounts exceeding $30 million; ••the first judgment in a securities class action has been handed down in the Myer class action, providing support for the “fraud on the market” theory of causation and judicial guidance on issues such as continuous disclosure obligations and quantum. A further judgment in the WorleyParsons class action is anticipated in 2020; and ••the High Court handed down a decision in the BMW and Westpac class actions regarding the Court’s power to make “common fund orders” (where litigation funders were entitled to deduct a commission from the “common fund” of damages settlements, despite some members of the claim not having agreed to a funding arrangement). The decision may have implications for the business models of litigation funders in Australia. Further information on these issues and Herbert Smith Freehills’ market-leading class actions practice is available at: https://www.herbertsmithfreehills.com/ our-expertise/services/class-actions. Case law developments There were numerous cases in 2019 concerning the ability of plaintiffs to gain visibility over a defendant’s D&O insurance as part of a class action. Simpson v Thorn Australia Pty Ltd (t/as Radio Rentals) (No 4) Facts The applicant in the class action against Thorn Group (the ASX-listed parent company of Radio Rentals) claimed damages of more than $100 million for the company’s “Rent, Try, $1 Buy” program. Thorn’s D&O insurer (AIG) was joined to the proceeding by order of the Court in a separate judgment which found that, in circumstances where AIG had declined cover to the former CEO of Thorn (Mr Marshall, who was the second respondent) there was a real possibility that, if judgment were obtained, he would not be able to meet it.