In the decision of Petersen1 in June this year, the Federal Court of Australia confirmed that an appropriately worded “adverse costs” or “after the event” (ATE) insurance policy could constitute sufficient security for a defendant’s costs, but ruled that the policy in question was insufficient.

Implications for litigants

The Court left open the possibility that an ATE insurance policy could be adequate security if a plaintiff can establish that the likely coverage response and enforceability is sufficiently certain for defendants.

In the circumstances, both plaintiffs and defendants should take care when negotiating security. In particular, defendants should be prepared to challenge the offer of such security if it provides insufficient certainty of recovery.

What the Court decided

Security for costs is often sought in class actions – it is an important tool for defendants to ensure recovery of legal costs (which can be significant) from plaintiffs in the event the claims are unsuccessful. Typically, security is provided in the form of payment into Court or an unconditional bank guarantee. Plaintiffs are increasingly offering security by way of ATE insurance (which commonly covers their exposure to adverse costs orders, among other things).

In Petersen, the Federal Court held that the ATE insurance policy, which indemnified the applicant for defence costs, did not satisfy the threshold for security due to the potential obstacles the respondents might face in recovering their costs under the policy. Importantly:

  1. The respondents were not identified as insureds under the policy, and therefore had no contractual rights to recover their costs.
  2. The respondents did not have the ability to compel the applicant to sue on the policy if the insurer refused to meet any legitimate claim. It was insufficient that the applicant’s directors gave undertakings to the Court that it would make claims on the policy to meet any adverse costs order. The Court found there was no evidence that those undertakings, of themselves, would provide the respondents with sufficient security.
  3. The policy contained a significant number of exclusions from liability, which had the potential to affect the applicant’s legal entitlements under the contract.
  4. The provisions of the policy allowed the insurer to reduce its liability, or even cancel the policy, including on the basis of non-disclosure. The respondents were not privy to (nor could they control) the information which had been or would be provided to the insurer. There was a risk the policy could be cancelled before a costs order was made in the proceeding.
  5. The applicant was impecunious. In the circumstances, the Court found that there was a real question as to whether the insurance proceeds would be available to the respondents in the event the applicant was placed in external administration.

Accordingly, the Court ordered security to be provided in the traditional form (payment to the Court or bank guarantee).