The Full Court of the Federal Court of Australia has recently handed down a decision confirming that an advancement extension in a management liability policy does not prevent the underwriter from avoiding the policy for alleged fraudulent non-disclosure.
The decision provides helpful guidance to underwriters who handle matters involving advancement obligations where the claim against the insured person involves serious allegations of dishonesty or criminal conduct occurring before the policy was entered into, including with respect to public policy considerations.
The recent decision of Onley v Catlin Syndicate Ltd  FCAFC 119 (Onley) concerned a Labour Force Liability Insurance Policy (Policy) issued by certain Lloyd's Underwriters to Synep Pty Ltd (Synep). The type of insurance provided was described as "labour industry and host employer insurance" and it included a management liability section. The policy included a number of fairly standard provisions which provided for the advancement of defence costs in criminal or civil penalty cases pending final establishment of the criminal or dishonest conduct of the insured person. The key aspects of the Policy in that regard were:
- It included cover for "Defence Costs", which broadly comprised the necessary and reasonable costs incurred in defending a "Claim".
- It included an exclusion titled Dishonest or Criminal Intent/ Improper Conduct (the Wrongful Conduct Exclusion). Generally speaking, the Wrongful Conduct Exclusion excluded "Loss" resulting from "Claims" arising directly or indirectly in respect of any "Wrongful Act" committed by an insured with "willful, reckless, dishonest, fraudulent, malicious or criminal intent". Not unusually however, the exclusion only applied where the relevant conduct was established "by admission by the Insured, judgment, or other adjudication".
- It included an extension of cover which provided that if a Claim alleged conduct as described in the Wrongful Conduct Exclusion, underwriters would nevertheless advance Defence Costs "until it is found by way of an admission by You, judgment or adjudication that such Insured did in fact commit such Wrongful Act…." (the Advancement Extension).
- It provided that if the Wrongful Conduct Exclusion ultimately applied, underwriters could recover Defence Costs advanced under the Advancement Extension.
On 17 May 2018 two directors of Synep (or its subsidiaries) were charged under the Criminal Code Act 1995 (Cth) with the crime of conspiring with other persons with the intention of dishonestly causing loss to the Australian Taxation Office. They sought cover under the Policy for the costs of defending the charges.
It was not disputed by underwriters that the claim fell within the scope of coverage of the Policy. Instead, underwriters sought to avoid the Policy on the grounds of fraudulent non-disclosure, or alternatively, to reduce their liability to nil on account of non-disclosure under Section 28 of the Insurance Contracts Act 1984 (ICA).
Among other things, underwriters alleged that the insureds had failed to disclose that the entity they controlled had conducted a dishonest enterprise in misappropriating funds which the entity had received for external payroll services it provided (which was the alleged conduct that also supported the charges).
The directors challenged the avoidance of the Policy and the declinature on the basis that:
- the Policy included the Wrongful Conduct Exclusion and the Advancement Extension;
- those provisions required the alleged conduct against the directors to be established by judgment or adjudication; and
- in the circumstances, underwriters were not permitted to avoid the Policy or decline the claim.
The Court did not accept the directors' submissions on the proper construction of the Policy.
The Court considered that the effect of the directors' preferred construction was such that the advancement provisions should be read as an agreement of the insurer to forgo, or to temporarily forbear from, exercising its statutory remedies for non-disclosure. In the Court's opinion, this construction encountered significant difficulties, including the following:
- First, it was noted by the Court that there was no suggestion that prior to entering into the Policy there was any agreed alteration to the insureds' duty of disclosure and nothing to suggest that underwriters offered the Policy terms to the insureds otherwise than on the basis that they had complied with their disclosure obligations.
- Second, the directors' construction inverted the ordinary process of the formation of insurance contracts, as it would result in an insurer being required to cover a claim which the insured ought to have disclosed prior to entry into the contract and which, had it been disclosed in the ordinary course, would likely have been specifically excluded.
- Third, a construction which provided for an insurer to have agreed to provide cover for risks which were not disclosed in breach of the insured's duty of disclosure would need support by clear words. No such words existed here.
- Fourth, the directors' construction did not construe the terms of the Policy as a whole, and resulted in an unusual and unbusinesslike interpretation of the Policy which further supported finding against the directors.
In the circumstances the Court was not prepared to find that the proper construction of the Policy was such that underwriters were prevented from avoiding the Policy under Section 28 of the ICA.
As the construction ground did not succeed, it followed that the waiver, election and good faith arguments raised by the directors also did not succeed.
Further public policy issue
Underwriters further submitted in the proceeding that, even if the directors' construction was to be preferred, public policy would prevent cover from being afforded to the directors because they would be benefitting (if even only temporarily) from their allegedly fraudulent non-disclosure.
On this issue, after considering the relevant authorities, the Court concluded that "[t]he construction advanced by the [directors] would mean that they would be relieved of the consequences of their own fraudulent non-disclosure even if the insurer can provide it, albeit on a temporary basis during receipt of the advanced costs. The public policy… means that such a construction cannot be accepted".
Further, the Court considered that, to require the insurer to advance defence costs whilst the question of whether the directors committed the Wrongful Conduct is adjudicated could give the directors the benefit of their own fraud. To accept that proposition "would be to undermine the common law's historical abhorrence of such conduct" in the eyes of the Court.
While each case must be considered on its own facts, and each policy on its own terms, the decision in Onley supports the view that the presence of an advancement of defence costs extension in a policy will not prevent the insurer from relying on its non-disclosure remedies under Section 28 of the ICA (in the absence of clear words to the contrary).
Accordingly, in circumstances where the claim against the insured person concerns allegedly dishonest or criminal conduct occurring before the policy was entered into, insurers should carefully consider whether such conduct (if proved) could give rise to a right to avoid the policy or decline the claim on the grounds of non-disclosure.
That is particularly important where the failure to disclose the matters could be considered fraudulent. In such circumstances, if fraudulent non-disclosure is proved, the Court may consider that advancement of defence costs under the policy was ultimately unlawful.
The Court's comments regarding this public policy consideration should therefore be carefully observed and kept in mind when considering claims where serious dishonest or criminal conduct is alleged to have occurred before policy inception.