• In the latest, and possibly final, instalment of the Prepaid Services v Atradius Credit Insurance NV saga, the Supreme Court of New South Wales has again allowed Atradius to reduce its liability to nil for innocent misrepresentation pursuant to section 28(3) of the Insurance Contracts Act 1984 (Cth) (the Act).
  • After the New South Wales Court of Appeal found that his Honour’s initial consideration of the issue was incomplete, McDougall J had to make the hypothetical inquiry as to whether Atradius would have issued the policy had proper disclosure been made and Prepaid given the opportunity to provide further information (the likely result of full disclosure).
  • The decision provides guidance on the extent to which a court will engage in hypothetical enquiry to determine what may have been the outcome if full disclosure had been made at the outset.  Insurers are not required to meet a limitless array of hypothetical circumstances in which they might possibly have considered coverage.
  • For insurers, who bear the onus of proof, the decision highlights the importance of clear and documented underwriting guidelines and procedures designed to support the insurer’s notional position.  An insurer must prove a causal link between the presentation of the risk and the acceptance or otherwise of the risk.
  • The decision also demonstrates the difficulties insureds face in establishing that a misrepresentation has made no difference to an insurer’s decision.

Returning to the scene

At first instance [1] McDougall J held that Atradius was entitled to avoid a trade credit insurance policy due to fraudulent misrepresentation by Prepaid Services and, even if the misrepresentation was not fraudulent, reduce its liability to nil.

However, the New South Wales Court of Appeal [2] held that the evidence was insufficient to establish fraud.  On the question of whether the insurer could alternatively rely on section 28(3) of the Act to reduce its liability to nil, the Court of Appeal held that McDougall J had inadequately considered whether Atradius would have issued the policy if proper disclosure had been made, including on the hypothesis that further information might have been provided to Atradius.  This question was therefore remitted for his Honour’s further consideration. 

It is this further hearing that is the subject of this article.  In light of the outcome, it now seems unlikely that an appeal to the High Court on the fraud issue will progress thus depriving insurance lawyers of clarification of this issue by the High Court.

For a more detailed examination of the facts and circumstances of the case please see our previous article entitled ‘The Radius of Atradius: The Limits of Fraudulent Non-Disclosure and Section 54’ found here.

The devil is in the detail

The Court of Appeal was unconvinced that McDougall J’s first attempt to determine what Atradius would have done had the proper disclosures been made was complete.  If Bill Express’ payment history had been disclosed and Atradius requested more information about that history, what information would Optus have given and how would Atradius have responded to that information?

The burden of proof was borne by Atradius to demonstrate that, had the facts not been misstated or withheld by Prepaid, it would not have written the risk at all (Atradius did not assert that a different policy would have been issued).  This duty extended to Atradius adducing evidence from senior people within its organisation with authority to approve the relevant insurance applications, or producing underwriting guidelines touching upon such issues.  In addressing this question, McDougall J reviewed the evidence of four key employees from Atradius’ London and Sydney offices.  These individuals were subject to different approval limits according to seniority and involved in Atradius’ two separate underwriting processes – both credit and policy requirements.

Much of the cross-examination consisted of putting to Mr Mark Magee, senior manager of Atradius’ special products analysis team, what further inquiries and assessments he might have caused to be undertaken.  This was in particular reference to a hypothetical credit analysis prepared by Mr Stephen Naven, general manager of credit management at Optus.  Mr Naven was asked to assess Bill Express’ credit worthiness as at August 2007 and prepare a document he might have composed in an attempt to deal with Atradius’ concerns.  Prepaid’s counsel made submissions to the effect that Mr Magee had been:

‘crippled in the evidence he had given’ because it was based on a ‘deracinated’ version of events on which, in the counterfactual universe they would have been required to reach a conclusion.[3]

However, following a thorough analysis of the evidence adduced, McDougall J was satisfied that even if Atradius had requested further information and that information had been provided nothing could disguise that Bill Express was, at the relevant time, an unappealing credit risk.  His Honour was satisfied that on the balance of probabilities, however the hypotheticals manifested, Atradius would not have issued the policy had proper disclosures been made.

Hypothetical questions get hypothetical answers

McDougall J made clear that in ruling on hypothetical questions a court must be in a position to insist upon a proper foundation being laid before it allows the question to be answered.  The premise as stated by Prepaid’s counsel was devoid of any assumption as to evidence, pointing to responses Prepaid would have made to any hypothetical inquiries of Atradius so that the conclusion called for would be pure speculation and conjecture.  As McDougall J commented:

[T]he process envisaged by Optus would involve further exchanges of evidence with Atradius responding hypothetically to the hypothetical further information that Optus said it would have supplied, Optus responding hypothetically to each further response from Atradius, and so on until, at some point, the parties or the Court cried “enough”.[4]

When weighing the conflicting testimony, the Court identified the failings of hypothetical questions in practice and in swearing to legal conclusions.  McDougall J further states:

I do not think that it is necessary to consider what further inquiries might have been made, what responses might have been given, what if any further inquiries those responses might have provoked, and so on through an ever-branching maze of hypothetical inquiry and response.[5]

In evaluating Atradius’ evidence, McDougall J was mindful that it was necessarily hypothetical and that hypothetical evidence by its very nature lends itself to exaggeration and embellishment in the interests of the party on whose behalf it is given.  For this reason, such evidence has to be rigorously tested by reference to logical self-consistency (ie Atradius’ internal underwriting processes) and to such independent evidence as may be available.  This is so as to avoid the hazard of any biased retrospective underwriting.

Addressing the hypothetical universe

Insurers can take some comfort from this decision that they need not anticipate an endless hypothetical universe when seeking to defend their underwriting decisions.

Nevertheless, the decision highlights the importance of comprehensive underwriting guidelines and procedures to help resist challenges to an insurer’s asserted position. 

The decision also demonstrates the difficulties insureds face in establishing that an insurer’s decision was not affected by any established non-disclosure or misrepresentation.  As these matters are peculiarly within the knowledge of the particular insurer, difficulties in challenging the insurer’s stance are inevitable.