July 05 2005
The decisions of the High Court in Rich v CGU Insurance Ltd, Silbermann v CGU Insurance(1) and Wilkie v Gordian RunOff Ltd(2) illustrate the court's strict approach to the construction of policy terms. This update explains why insurers and insureds alike should ensure that policies clearly identify the cover provided.
In Wilkie v Gordian RunOff Limited,(3) Rich v CGU Insurance Ltd and Silbermann v CGU Insurance Ltd(4) the courts held that insurers were entitled to refuse to advance defence costs to insureds under directors and officers liability insurance policies that excluded loss arising from the dishonest or fraudulent conduct of the insureds. Although the relevant exclusions applied where there was a judgment or final adjudication on the issue of dishonesty, the insurers were able to refuse advance payment of defence costs before that judgment or adjudication had taken place.
The insureds appealed these decisions to the High Court, with contrasting results. The words used in the policy were carefully analyzed by the High Court. The decisions highlight the need for both insureds and insurers to choose their words carefully.
The insureds in Rich and Silbermann were former directors of One.Tel Ltd (in liquidation). The Australian Securities and Investments Commission commenced proceedings against them in relation to the collapse of One.Tel. The insureds sought indemnity and advance payment of the defence costs in respect of the investigation conducted by the commission and other proceedings under the directors and officers liability insurance policy issued by CGU. CGU denied indemnity on the basis of fraudulent non-disclosure and fraudulent misrepresentation, and the application of an exclusion for losses arising from dishonest or fraudulent acts. The insureds applied for summary judgment as to whether they were entitled to receive advance defence costs prior to the determination of the other issues.
At first instance Justice McLelland held that CGU was entitled to rely on the exclusion clause in relation to the former directors' claims.(5) McLelland's decision was affirmed by the court of appeal.(6) The High Court granted special leave to Rich and Silbermann to appeal the court of appeal decision.(7)
At first instance Justice Nicholas relied on the reasoning of the court of appeal in the Silbermann Case in his decision to refuse to make the orders sought by Wilkie.(8) The High Court granted Wilkie special leave to appeal this decision.
Wilkie was an officer of FAI General Insurance Company Limited. Criminal proceedings were commenced against him in the local court in relation to the collapse of the HIH Insurance Group, of which FAI was a part. Wilkie made a claim for the payment of advance defence costs as and when they were incurred under Extension 9 of the directors and officers indemnity insurance policy issued by GIO Insurance Ltd (now Gordian RunOff Limited).
As in Silbermann, the insurer relied on a term excluding liability for loss arising out of dishonest or fraudulent conduct of the claimant. However, in contrast to the Silbermann Case, the insurer made no allegations of misrepresentation or non-disclosure against the claimant.
The High Court unanimously allowed Wilkie's appeal.
The relevant terms of the GIO policy considered by the High Court were as follows.
Extension 9 provided that:
"If [the insurer] elects not to take over and conduct the defence or settlement of any claim, GIO will pay all reasonable defence costs associated with that claim as and when they are incurred, provided that (i) GIO has not denied indemnity for the claim, and (ii) the written consent of GIO is obtained prior to the insured incurring such defence costs.
GIO reserves the right to recover any defence costs paid under this extension from the insured or the organization severally according to their respective interests, in the event and to the extent that it is subsequently established by judgment or final adjudication, that they were not entitled to indemnity under this policy."
Exclusion 7 provided that:
"This policy does not insure loss arising out of any claim...based upon, attributable to, or in consequence of (i) any dishonest, fraudulent, criminal or malicious act or omission, or (ii) any deliberate breach of any statute, regulation or contract where such act, omission or breach has in fact occurred."
The words 'in fact' were defined to mean "that the conduct referred to in those exclusions is admitted by the insured or is subsequently established to have occurred following the adjudication of any court, tribunal or arbitrator".
The High Court rejected GIO's argument that its denial of indemnity based on Exclusion 7 relieved it of its obligation to advance defence costs under Extension 9. It held instead that Exclusion 7 had not been triggered as the alleged wrongful conduct had not "in fact" occurred - that is, it had not been admitted by Wilkie and no adjudication had been made in relation to his conduct. The majority noted that the findings of the Royal Commission did not satisfy the Exclusion 7 requirement for the conduct to be established "in fact" (ie, admitted by the insured or established by adjudication of any court, tribunal or arbitrator).
The majority noted that the policy specifically contemplated the possibility of advancement of defence costs before all issues relevant to entitlement to indemnity were resolved. By reason of Extension 9, GIO reserved its right to recover defence costs advanced to the insured if it was subsequently established that the insured was not entitled to be indemnified.
The majority held that this construction was compatible with the commercial purpose of the GIO policy (ie, to provide advance funding for legal costs in the absence of a final adjudication of disqualifying conduct on the part of the insured) and observed that "it would require clearer exclusionary language than appears [in the GIO policy] to deprive the insured of the benefit of the policy for which the premium has been paid".(9) The court viewed the advance payment of defence costs until any relevant fraud or dishonesty was proven as an important benefit provided by the policy. The insurer runs the risk that the insured may have insufficient funds for it to recover what it paid if fraud is ultimately proven.
In contrast to the policy wording in Wilkie, which stated that the insurer "will pay all reasonable defence costs", the policy wording in Silbermann granted the insurer a discretion regarding the payment of defence costs. However, the relevant exclusion for dishonesty was similarly expressed to apply "to the extent that the subject conduct has been established by judgment or other final adjudication".
The majority judgment was given by Chief Justice Gleeson and Justices McHugh and Gummow. They considered that, as the appeal did not extend to the positive answer given by the court of appeal to the question of whether the insurer could seek final adjudication adverse to the insured and thereby exclude liability under the relevant exclusion clause, summary judgment on entitlement to defence costs could not be given without enabling the insurer to raise issues of fraud or dishonesty. Therefore, they revoked the grant of special leave to appeal and did not consider questions of policy interpretation.
Justices Callinan and Kirby gave separate reasons in which they favoured the insured's interpretation of the policy. They stated that, having regard to the words used and the reality that directors against whom dishonesty is alleged may otherwise have no means of defending themselves adequately, the policy was intended to provide up-front cover for defence costs in such circumstances.
These decisions demonstrate that the court will have regard to the policy wording as a whole and will carefully analyze the words used. The difficulties associated with adducing evidence in proceedings of the commercial purpose of a policy mean that the policy wording must be chosen very carefully. However, the court did not completely disregard evidence that the insured in Wilkie had sought to adduce how similarly worded policies had been construed in the United States. Those cases supported the commercial purpose of the policy as being to afford assistance with defence costs when an insured is faced by allegations of wrongdoing, including criminal wrongdoing.
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