This article was written by Travis Toemoe, Peter Yeldham, Riana Cermak.
In a significant decision for the insurance industry, the Federal Court of Australia has granted leave to shareholders to bring a direct action against a company’s insurers where the (insured) company was in liquidation. This is one of the earliest cases to make use of the new Civil Liability (Third Party Claims Against Insurers) Act 2017 (NSW) (Third Party Claim Act), and provides some useful guidance for the industry on how this new legislation will be applied.
The decision impacts plaintiff lawyers, policyholders and insurers alike. Importantly:
plaintiff lawyers potentially have a new, direct route to insurance funds;
policyholders are likely to see increased premiums (and less appetite for securities litigation or “Side C” cover); and
insurers may wish to review the co-operation obligations imposed on policyholders.
In December 2014, Rushleigh Services Pty Ltd (Rushleigh) commenced a representative proceeding against Forge Group Limited (in Liquidation) (Forge) and two former directors. This was a garden-variety formulation of a shareholder class action, turning on Forge’s alleged failure to comply with its continuous disclosure requirements, misleading or deceptive conduct, and that Forge made false representations.
Rushleigh was required to seek the Court’s leave to proceed against Forge because it was in liquidation. In December 2016, the Court (Foster J) refused leave, meaning Rushleigh could only proceed against the directors and not against Forge.
Joining of insurers
In July 2017, Rushleigh sought leave under section 5 of the Third Party Claim Act to join Forge’s D&O insurers (the Insurers) to the proceedings as Respondents.
This relatively untested legislation was introduced in June 2017, and replaced some earlier provisions in the Law Reform (Miscellaneous Provisions) Act 1946 (NSW). The Third Party Claim Act allows a claimant to pursue litigation directly against a third party insurer (but not a reinsurer) in certain circumstances. Indeed, section 4(3) of the Third Party Claim Act provides that in a proceeding brought by a claimant against an insurer, the insurer stands in the place of the insured person as if the proceeding were a proceeding to recover damages, compensation of costs from the insured person. This is quite different to the Law Reform (Miscellaneous Provisions) Act 1946 (NSW) which allowed a court to impose a “statutory charge” on all possible insurance monies pending the outcome of litigation against the policyholder.
The Insurers submitted that leave should not be granted for the following reasons:
if leave to proceed were granted, the Insurers would suffer irreparable prejudice: first, because of the cost they would incur in defending the proceeding; and, secondly, because of the forensic disadvantage to them which arises because they are “strangers” to Forge (and to the facts and circumstances underlying the claims). It was submitted that, whilst the Insurers accepted they would bear the cost of Forge’s defence of the proceeding in any event, if they were to be joined as respondents, they would incur additional costs and prejudice;
there is no utility in granting leave to join the Insurers as parties as they had already agreed to indemnify Forge and the directors; and
the application to join the Insurers would circumvent the proof of debt process, thus circumventing the decision at first instance (Foster J), in circumstances where there was no appeal from that decision. The Insurers contended that it was implicitly held that there was no good reason warranting departure from the proof of debt process.
Justice Markovic was unconvinced by these submissions, and granted Rushleigh leave to proceed against the Insurers. The Insurers were also ordered to pay Rushleigh’s costs of the application.
Analysis of decision
In exercising the Court’s discretion to grant leave, Justice Markovic did not consider that she ought attribute “significant weight” to the additional costs or prejudice to be borne by the Insurers in the balancing exercise she had to undertake.
With respect to prejudice, her Honour considered that an insurer would “always” be a stranger to the proceedings when joined under the Third Party Claim Act and would inevitably suffer a degree of forensic disadvantage. The Court considered that if the additional cost an insurer might incur in defending a claim because it is a third party is a relevant factor in exercising judicial discretion, it could undermine the intent behind the Third Party Claim Act (as these costs would inevitably be incurred by Insurers joined). Moreover, her Honour considered that the disadvantage which would be suffered by the Insurers would be mitigated by the obligations of co-operation and assistance imposed on Forge by the relevant policy (and Forge was not relieved of those obligations).
With respect to utility, the Court held that there was utility in granting leave as Rushleigh was unable to proceed against Forge directly. As Forge was not an active participant in the proceeding and the claims against the directors would not necessarily succeed. Leaving aside the question of availability of funds under the policies, her Honour considered there was clearly utility in granting leave to join the insurers to stand in the shoes of the company.
Finally, her Honour found that the decision at first instance and the emphasis on a claimant pursuing the proof of debt process did not preclude Rushleigh from applying for joinder of the Insurers under the Third Party Claim Act. The Court considered that as Forge was in liquidation and no longer trading, Rushleigh was unable to sue it directly and therefore if the leave application failed, Rushleigh would have no ability to pursue its claim. Whilst in some circumstances, the availability of the proof of debt procedure might be a relevant factor in the exercise of the discretion to grant leave to join insurers, it is not a factor that would weigh against the exercise of the discretion. Her Honour emphasised that there was no evidence about the prospect of the liquidators calling for proofs of debts and if the liquidators were to call for proofs, it would be more efficient to grant leave at this stage of the proceedings anyway.
This decision potentially raises a number of issues for plaintiff lawyers, policyholders and D&O insurers. These include:
Plaintiff lawyers: rather than seeking leave to pursue a company in liquidation, the easier route may be to seek leave to pursue the company’s insurer directly. The claims that can be advanced are the same as against the company, the balance sheet of the insurer is available to meet the claim (up to policy limits) and the insurer is unlikely to be as well placed as the company to defend the claim.
Policyholders: are likely to see continued premium increases for D&O insurance and reduced availability for securities litigation (or “Side C”) cover. The D&O market in Australia has tightened significantly over the last year with significant increases in premium – this change has been driven by the perception amongst D&O underwriters that the risk of large claims is high because of the significant class action activity. Allowing a plaintiff to pursue an insurer directly where previously the Court had not allowed the company to be pursued is hardly likely to reduce the risk to insurers of defending large claims.
D&O insurers: insurers can expect to be joined directly to actions such as this in the future. In order to best position themselves to defend those claims, insurers should review the policy wording imposing access, co-operation and assistance obligations (and how they survive liquidation). Where “Side C” cover is provided, insurers may wish to consider imposing additional specific co-operation obligations on the company to deal with access to books and records etc where the company is placed in liquidation.