The Full Court of the Federal Court of Australia has recently confirmed that an insurer is not precluded, by virtue of an advance defence costs extension in a management liability policy, from relying upon its statutory entitlements under Part IV of the Insurance Contracts Act 1984 (Cth) (ICA) to avoid a policy of insurance on the basis of the insured’s non-disclosure.
The applicants, Jason Onley and Adam Cranston, were directors of Synep Pty Ltd (Synep) which, on 1 June 2016, became the sole shareholder of Plutus Payroll Australia Pty Ltd (Plutus). On or about 1 June 2016, the respondent, Catlin Syndicate Ltd as the underwriting member of Lloyd’s Syndicate 2003 (insurer), issued a liability policy to various companies, including a number of which Onley and Cranston were directors (policy). Pursuant to the ‘Management Liability and Professional Indemnity’ section of the policy, cover, including the provision of advance defence costs (advance costs extension), was provided to each director.
In separate proceedings, charges were laid against Onley and Cranston for conspiring with the intention of dishonestly causing loss to the Australian Taxation Office (ATO) under the Criminal Code Act 1995 (Cth) and for recovery from them under Proceeds of Crime Act 2002 (Cth) (proceedings).
Onley and Cranston sought indemnity in relation to their defence costs associated with the proceedings. In seeking to avoid the policy, the insurer claimed that the conduct that was the foundation of the proceedings was dishonest conduct that had occurred, at least in part, prior to the policy’s inception, that Onley and Cranston were aware of its materiality and that they had failed to disclose its existence. In particular, the insurer relied upon the insured’s failure to disclose that in the 14 months prior to June 2016, Plutus had conducted a dishonest enterprise in misappropriating pay as you go withheld (PAYGW) funds that it had received from entities for which it provided payroll services.
The applicants sought declaratory relief to the effect that they were entitled to indemnity under the advance costs extension, pending the determination of the proceedings. On 12 April 2018, Chief Justice Allsop ordered that this question be heard separately by the Full Court.
Decision of the Full Federal Court
In a unanimous judgment, the Full Federal Court (Allsop CJ, Lee and Derrington JJ) determined, on two grounds, that the arguments advanced by Onley and Cranston could not succeed. First, the advance costs extension in the policy did not diminish the insurer’s entitlement to rely upon the remedies available to it in relation to an insured’s non-disclosure under Part IV of the Insurance Contracts Act 1984 (Cth) (ICA). Secondly, as a matter of public policy, the Court would not allow a party to contract out of the consequences of its own fraudulent conduct.
The applicants’ primary submission was that, when a claim of Wrongful Conduct was made against an insured in any proceeding, the effect of the advance costs extension was that the insurer was prevented for any purpose, from relying upon the nature of the allegations until that question had been answered by an admission, judgment or adjudication. The submission was founded in part upon the construction of the unequivocal terms of the advance costs extension, which construction was said to be supported by the desirability to protect the insured’s common law privilege against self-incrimination.
The Court confirmed that the duty of disclosure remained the essence of the insured’s obligation of utmost good faith and that the terms of a policy of insurance were generally agreed to by an insurer on the common understanding of the insured’s having disclosed all relevant facts which are, or ought reasonably to be, known to it, and which are relevant to the risk insured. In the present case, the Court stated that there was no basis to believe the insurer would have agreed to cover the risk if it had been fully informed of its details. Moreover, a promise could not be implied, indirectly from the wording of the advance costs extension, that the insurer would cover a risk that had been wrongly undisclosed.
In the Court’s view, the construction of the policy as a whole also militated against the applicants’ proposed construction, noting that in both the policy schedule and the general terms and conditions, it was clear that cover applied to claims (as defined) provided that the insured was not aware at any time prior to policy inception of circumstances that would have put a reasonable person on notice that a claim might be made.
Moreover, the Court found that it was unnecessary for the insurer to characterise the undisclosed conduct as being dishonest, or falling within the policy definition of Wrongful Conduct. It was sufficient for the insurer to rely upon the non-disclosure of the underlying business transactions and business model as being relevant matters that were fraudulently not disclosed. In the present case, at the time of entering into the policy, the facts surrounding the manner in which the payroll business was operating, by the payment of PAYGW amounts to related companies of straw, for distribution to the applicants, was relevant to the insurer’s decision whether to accept the risk and, if so, on what terms. This would have been apparent to a reasonable person.
The Court noted that, even on the construction proposed by the insurer, the advance costs extension had work to do. This included in circumstances where the insured was not aware of the qualitative nature of the relevant prior conduct, which would have made it material to an insurer (in such a case, it may not be necessary for the conduct to be disclosed and the advance costs extension may still provide cover). Alternatively, if such conduct had been properly disclosed, cover pursuant to the advance costs extension would remain part of the insurer’s promise, albeit subject to an exception in respect of the disclosed conduct.
Unsurprisingly, the Court emphasised that public policy reasons precluded the applicants from benefiting from their own fraudulent non-disclosure. Importantly, the Court stated that, in the absence of clear or unmistakable words, the position was no different where a fraudulent agent entered into a policy on behalf of a non-fraudulent insured.
It is useful to have the Full Federal Court confirm the centrality of the insured’s pre-contractual obligation of disclosure to the insurer’s offer of policy terms. It is also a timely reminder that, without clear and unmistakeable words, the contract of insurance does not derogate from a party’s statutory entitlements under the ICA, including those relevant to non-disclosure.
For insurers, the decision is relevant where there is Wrongful Conduct ‘of a material quality’, alleged to have occurred prior to the formation of the contract of insurance, which has not been disclosed. The allegation of non-disclosure must be real or substantial, in accordance with an insurer’s obligations of good faith under s 13(1) of the ICA. The corollary of this is that an insurer is unlikely to escape its obligation to advance defence costs until relevant facts are established, by a simple allegation of non-disclosure.
For directors, the decision highlights the potential danger where the company (or another director) acts as agent for the insureds in entering into a policy, without complying with its disclosure obligations.