On 28 January 2021, Justice Lee, sitting in the New South Wales registry of the Federal Court, decided an application for rectification of Investment Management Insurance policies (the Policies) against two Lloyd’s syndicates.
The decision highlights:
- how insurers may face significantly higher exposures (in this case, an additional $11.25 million) as a result of a claim for rectification of the insurance contract, despite attempts to achieve contract certainty;
- risks for insurers arising from the use by the Australian courts of ‘inferential reasoning’, where insurers do not lead oral evidence from the responsible underwriter at trial; and
- the ‘mind-numbing’ and ‘tedious’ attention to detail (and significant costs) involved in litigating rectification claims involving multiple Lloyd’s syndicates and large volumes of documents.
The application was made by the applicants in two securities class actions against Quintis Ltd, the failed sandalwood investment company, formerly headquartered in Perth, Western Australia (Quintis).
The applicants contended that the Policies provided up to $50 million in “Side C” cover, by way of an Entity Securities Liability optional extension, either because the Policies were to be construed that way (the Construction Claim) or because the court should order the Policies to be rectified (the Rectification Claim).
The Policies comprised a primary layer policy (the Primary), a first excess layer policy (the First Excess), a second excess layer policy (the Second Excess) and a third excess layer policy (which was not relevant because it included a retrospective endorsement excluding liability for Side C cover). The application was made against 10 Lloyd’s syndicates.
Insurers argued that the Policies provided $10 million only of Side C cover and that there was no basis for rectifying them.
Lee J decided the Construction Claim in favour of insurers. It was clear enough on the face of the Primary schedule and wording that the Entity Securities Liability cover was subject to a sub-limit of $10 million which was part of and not in addition to the specified $10 million D&O Limit of Liability.
Further, as the Excess policies included a “Full Follow Form” condition, any cover available under those Excess policies was similarly limited, and that conclusion was supported by terms in the Excess policies specifying how the Excess policies would respond in the event that a specified sub-limit of liability provided for in the Primary was or was not exhausted.
Despite those findings, Lee J decided the Rectification Claim against two of the insurers. He found the placing broker, Price Forbes, and Argo and Vibe, held the necessary common intention that the D&O cover was to include $50 million of Side C cover, resulting in an increase in the exposure for those insurers of $11.25 million.
Key points of interest
- Lee J confirmed that ordinary principles of contractual interpretation apply to insurance contracts. The terms must be considered in the context of the whole policy and surrounding circumstances. The objective theory applies – while evidence of subjective intention was relevant to the Rectification Claim, it was not relevant to the Construction Claim. Extrinsic material is not relevant unless ambiguity is found in the contract (which was not the case here).
- Rectification is an equitable remedy, the purpose of which is to make a contractual instrument conform to the true agreement of the parties, based on the existence of a common intention, where the writing by common mistake fails to express the agreement accurately.
- There is no requirement for communicating the common intention by express statement, but there must be convincing evidence of the parties’ actual intentions, viewed objectively from their words or actions, and the common intention must be held by each party.
- The judge had to be satisfied that the relevant common intention was shared by Quintis and each relevant insurer. The issue was complicated by the use of a Perth based producing broker, PSC, who was in direct contact with Quintis, and a London based broker, Price Forbes, who was in direct contact with the insurers. Applying established principles for placing insurance at Lloyd’s, the judge found that both PSC and Price Forbes were agents of the insured and their knowledge was to be attributed to Quintis.
- Accordingly, the applicants were required to show the common intention was held by Price Forbes and each individual Primary insurer and Excess insurer. The ‘Full Follow Form’ condition in the Excess policies did not avoid the need to prove each individual insurer’s intent.
- The existence of the common intention was determined by reference to documentary evidence (which was incomplete) and ‘inferential reasoning’ (where there was no direct evidence of the underwriter’s intent).
- The Judge found it was possible to establish the common intention for Argo, a First Excess insurer, and Vibe, a Second Excess insurer.
- That conclusion was based on documentary evidence that each of those insurers had received not only a copy of the expiring wording, but also a copy of the structure diagram of the expiring programme for the previous year, which made it clear that there was A$50 million of Side C cover, and an email from PSC that Quintis was seeking to maintain its current limits of cover.
- In Argo’s case, the Judge’s conclusion was also based on Argo’s post contractual conduct. After inception, Argo expressed concern at being the primary carrier for Side C claims that were unrelated to the Quintis securities class action claim. The Judge interpreted this as a concern that in the event of a new securities claim, Argo would be liable for Side C cover in excess of A$10 million.
- In the absence of witness evidence from the responsible underwriter, the Judge drew adverse inferences about insurers’ intention from the available documents, using a process of ‘inferential reasoning’. In short, he inferred that the uncalled evidence would not have assisted Argo or Vibe.
- In dealing with the Rectification Claim, the Judge described the nature of the detailed analysis of volumes of contemporaneous documents ‘mind numbing’ and ‘tedious’, given the need to canvass the evidence both in depth and chronologically. His comments are a reminder of the complexities of managing rectification claims involving multiple parties and large volumes of documents.
- Argo and Vibe have appealed the judgment. Their appeals have yet to be determined.