The Full Court of the Federal Court of Australia has confirmed the Federal Court's decision that section 54 of the Insurance Contracts Act 1984 (Cth) (ICA) applied to nullify a clause that suspended cover under certain conditions.1
This decision confirms that the essential characteristics of a policy are a key consideration in determining whether section 54 will apply to a claim. It is, therefore, imperative for insurers to carefully consider the scope and intent of cover when drafting policies, particularly the effect of exclusions or conditions and how those terms impact that intent, as they may be prevented from relying on such terms to refuse to pay a claim.
In its first decision of 2016, the Federal Court looked at section 54 of the Insurance Contracts Act 1984 (Cth) (Act) and found that it nullified a clause that suspended cover under certain conditions. The Court also found that the second insurer (Watkins) was, therefore, required to contribute to the claim for damage to a yacht that was covered by the first insurer (Pantaenius). For full details of the original Federal Court decision please see our earlier article.
Watkins appealed this decision and the Full Court was asked to consider the operation of section 54 in circumstances where:
- the Pantaenius policy (without any effect on its operation by section 54) responded fully to the claim by the insured; and
- Pantaenius sought to recover a proportionate share of its liability from Watkins in a contribution action, where the Watkins policy would not respond to a claim made by the insured unless the insured invoked section 54.
In a joint judgment, the Full Court endorsed the approach taken by Meagher JA in Prepaid Services Pty Ltd v Atradius Credit Insurance NV2 (Prepaid) and the Primary Judge's decision on the operation of section 54.
Issues considered on appeal
The appeal considered three fundamental issues:
- Was section 54 engaged in the circumstances?
- If it was, did its operation mean that Watkins would not have been able to refuse to pay a claim by the insured if made?
- Could Pantaenius set up putative liability of Watkins to the insured as a basis for a claim for contribution by it?
Was section 54 engaged in the circumstances?
In FAI General Insurance Co Ltd v Australian Hospital Care Pty Ltd3 (Australian Hospital Care), the High Court held that consideration of whether section 54 is engaged must proceed on the basis of the claim actually made by the insured, and the section cannot operate to relieve an insured from the inherent restrictions or limitations of that claim as made.
The significance of the Australian Hospital Care approach was analysed by Meagher JA in Prepaid and endorsed by the Full Court in this appeal. The key factors of that approach require:
- consideration of the effect of the contract (as a matter of construction) in the way in which it responds to the claim actually made by the insured;
- that section 54 is enlivened when an insurer may not refuse to pay a claim "by reason only of" the relevant act or omission, and that it does not permit the reformulation of a claim so that the claim is one in respect of an insured event;
- that the insured's claim has the characteristics of the "event of the kind insured" and, if it does not, there are "restrictions or limitations" inherent in that claim, and matters of form are not to dictate the outcome in considering the effect of the contract;
- that section 54 does not relieve against those restrictions or limitations, as it is not the purpose of the section to do so; and
- compliance with the intention of section 54, namely to prevent reliance on temporal exclusions or other provisions to suspend or decline cover, irrespective of whether the insurer suffers any prejudice, because of an act or omission occurring after the insurance was entered into.
The Full Court held that the process of determining the essential character of a policy requires a broad construction and will be influenced (but not dictated by) the drafting of the policy wording. It will also involve identification of the nature and limits of the risks intended to be accepted, paid for, and covered.
Watkins submitted that the essential character of its policy was that it provided cover within 250 nautical miles of the Australian coast, as long "as the yacht had not cleared customs for the purpose of leaving Australian Waters and not re-cleared customs and immigration on return". The Full Court did not agree, finding that the essential character of the policy was that it provided cover for occurrences within a 250 nautical mile range of the coast of Australia. The term that suspended cover from the point at which the yacht cleared customs when leaving Australia to the point that it cleared customs on return, was seen as a temporal suspension, collateral to the essential character of the policy.
Accordingly, the Watkins policy provided cover to yachts that suffered damage within the stated geographic limits of the policy and this physical dimension was the inherent restriction or limitation on the claim. The fact that the incident (the subject of the claim) was within that essential characteristic, meant that the act of the insured in clearing customs on departure and the omission (at the time of the incident) to clear customs on return, were acts or omissions to which section 54 could apply, and did apply because:
- the acts occurred after the policy was entered into, during the period of cover, and also within the geographic limit (i.e. within the essential character) of the policy; and
- the effect of the temporal suspension was that it entitled the insurer to refuse to pay the insured's claim.
Does section 54 prevent refusal in paying the claim?
In finding that section 54 prevented insurers from refusing to pay the claim, the Court rejected Watkins' argument that the use of the word "only" in section 54(1) required the "act" to be the sole cause of the insurer's refusal to pay and that the dual aspect of (clearing on leaving and not clearing on returning) meant that the requirement of sole causality of the act was not satisfied.
Their honours found that the acts of clearing on leaving and not clearing on returning were related and not to be treated separately. They also confirmed that the word "only" was used because there may be an independent basis for refusing to pay that is unrelated to the "act".
Watkins argued that section 54 should not apply to require contribution to another insurer, as it was only intended for the benefit of the insured. The Full Court disagreed, noting that if section 54 were to be engaged for the benefit of the insured only, the insurer would not be able to refuse to pay the claim.
The Full Court found that the obligations of both insurers were the same in their nature, extent, and function, and thus the principles of contribution applied to require Watkins to contribute to the claim.
Bottom line for insurers
This decision affirms the approach set out by Meagher JA in Prepaid, that the essential characteristics of a policy are a key consideration in determining whether section 54 will apply to a claim. It is important that insurers carefully consider the scope and intent of cover when drafting policies, particularly the effect of any exclusions or conditions, and how those terms impact that essential character, as they may be prevented from relying on such terms to refuse to pay a claim.