This article is the second in our series in relation to potential means of recourse for claimants against insolvent counterparties beyond the typical proof of debt process. In this article, we consider what recourse is available to access insurance held by insolvent counterparties to satisfy any claims for unmet liabilities of the insolvent party, including how to find out, in the first place, whether there is a policy that could respond to potential liabilities and how the proceeds of that policy can be segregated from other unsecured creditors.
Major contractors are commonly a party to policies of professional indemnity, public liability or other policies of insurance to cover unexpected losses and damage that may occur throughout the life of a project. But what happens when those contractors become insolvent? Can third parties access the proceeds of an insolvent counterparty’s insurance to recoup losses that would otherwise have been met had the insolvent remained solvent?
In this article, we consider:
- first, when a third party may have access to proceeds of insurance policies held by their insolvent counterpart to meet liabilities other than as an unsecured creditor through the usual external administration process; and
- second, how a third party can determine whether there is a policy of insurance that responds to such a liability for the purpose of bringing a claim against its insolvent counterparty, or in some instances its insurer directly (separate from the external administration process).
Mechanisms available to third parties against insolvent contractors
The law has not always recognised the right of a third party to access proceeds of insurance to which the third party is not itself an insured. The availability of such claims by the third party against the insurer, directly, has only arisen following the introduction of statutory mechanisms permitting such claims.
In the case of an insolvent counterparty in external administration, s 562 of the Corporations Act 2001 (Cth) (Act) permits the proceeds of an insurance policy that would have been payable to the insolvent company which is payable on account of its insured liability to be paid directly to the third party before any priority payments are made to creditors under s 556 of the Act.
Of course, where there are limited assets available for distribution to an insolvent company’s creditors, the regular external administration process would require that the insolvent company’s secured creditors be paid in priority to any unsecured creditors.[1] Any claims by creditors to pursue their losses from an insolvent company are otherwise prohibited during external administration.[2]
However, s 562 of the Corporations Act 2001 (Cth) provides an exception to the general external administration procedure that otherwise prohibits such claims. It permits claims to be made by third parties in respect of losses for which the insolvent counterparty was insured and are indemnified under that insurance.[3]
This has the practical effect of segregating the insurance proceeds from the general pool of proceeds available for distribution to unsecured creditors, and makes available to the third party a pool of proceeds to satisfy its own loss and damages, to the extent covered by insurance proceeds, in priority to other creditors.
As a starting point, how then can a third party (being an otherwise unsecured creditor) identify whether there is an insurance policy held by the insolvent counterparty against which indemnity may be available to meet third parties’ claims?
Step 1: Claims only permitted with leave of the Court
As indicated above, the external administration process does not permit claims to be brought by creditors against their insolvent counterparts during the external administration process. Such claims may only be brought with the Court’s leave by s 471B of the Corporations Act 2001 (Cth).
Accordingly, in the case of a third party’s claim against its insolvent counterparty (or the insolvent counterparty’s insurer) for amounts payable under an insurance policy for which the relevant liability is insured, the third party cannot bring such a claim without first obtaining the Court’s leave to proceed.[4]
In considering a third party’s application for leave to pursue such recoveries from an insolvent counterparty or its insurer, the Court may consider the merits of the third party’s claim.[5] Those merits cannot typically be assessed, however, without first determining whether a policy exists against which the third party is entitled to claim (and to which the relevant liability responds). But it is not in the interests of an insolvent counterparty’s creditors for funds to be expended on identifying whether there is a policy of insurance against which a third party is entitled to claim.
How then can a claimant ascertain whether there is a responsive insurance policy against which it is entitled to claim for the purpose of seeking leave to proceed against the insolvent counterparty or its insurance?
Step 2: Identifying a responsive policy of insurance
In circumstances where it is unknown whether the insolvent company held an insurance policy to which the claimant’s liability responds (or where the terms of its cover remain unknown) and the potential claimant has not been assisted by the external administrators to establish such matters, the Court may grant an application for preliminary discovery enabling the third party claimant to ascertain whether a policy exist and its terms. Such information is critical to a third party determining whether to bring a claim against its insolvent counterpart or the counterpart’s insurer.
The Federal Court Rules 2011 (FCR) (and typically the civil procedural rules that apply in each State and Territory) provide a mechanism for access to insurance documents from a prospective insolvent defendant and/or respondent insurer by way of preliminary discovery. FCR 7.23, for example, permits a party to apply to the Court for insurance documents held by a ‘prospective respondent’, where:
- the ‘prospective applicant’ reasonably believes that it has a right to obtain relief in the Court from the prospective insurer/respondent;[6]
- where the prospective applicant has made reasonable inquiries and still does not have sufficient information to inform whether it should commence proceedings against the prospective insurer/respondent;[7] and
- where the prospective applicant reasonably believes that the prospective insurer/respondent has, in their control, relevant policy documents that will inform the applicant’s entitlement to relief, and inspection of those documents will inform whether to commence proceedings.[8]
An originating application may be made by a prospective applicant for preliminary discovery of insurance documents from a prospective respondent under FCR 7.23, to inform whether it should seek leave under s 471B of the Corporations Act 2001 (Cth) to bring a proceeding against the prospective respondent. The prospective application should expect to have to pay the reasonable costs of the external administrator of the insolvent party to facilitate the reasonable searches necessary to comply with any such order.
The relevant authority demonstrates that FCR 7.23 is to be beneficially construed and given ‘the fullest scope that its language will reasonably allow’ in determining whether to order preliminary discovery.[9] The Courts have routinely ordered preliminary discovery of insurance policies held by insolvent companies to determine whether claimants’ losses are indemnified by the insolvent company’s insurance policies. The Courts have recognised that a refusal of preliminary discovery of such documents might otherwise preclude a claimant’s statutory entitlement to insurance proceeds under s 562 of the Corporations Act 2001 (Cth).[10]
The rules permitting access to preliminary discovery for the purpose of obtaining insurance documents from a prospective defendant differ between jurisdiction, but are utilised for the same purposes. By illustration, the Supreme Court of Victoria recently permitted preliminary discovery of insurance policies following a major contractor’s voluntary administration to inform the claimant whether alleged defects in the respondent’s construction of a shopping centre were indemnified under the builder’s insurance (Wadren Pty Ltd v Probuild Constructions (Aust) Pty Ltd [2023] VSC 348 (Wadren)).
Step 3: Commencement of proceedings and distribution of proceeds
Following successful application for preliminary discovery and discovery of relevant insurance documents (once satisfied that the prospective applicant has a claim against the insolvent counterparty, and that its claim responds to an insured liability for which proceeds may be available under the policy), the prospective applicant may seek leave to proceed against the insolvent counterparty or seek joinder of its insurer under s 471B of the Corporations Act 2001 (Cth).
If granted, the third party’s claims (if successful, and to the extent they are covered by the insurance policy) will be treated separately from payments to any unsecured creditors that are payable during the external administration process.
In practice, it remains the case that any insurance proceeds payable to third parties following successful proceedings against the insurers of insolvent counterparties must nevertheless be paid into the pool of assets to be distributed to creditors by a liquidator (subject of course to the caveat that the insured third parties will be entitled, prior to any unsecured creditors, to be paid the amount of proceeds of that insurance for which they are covered).[11]
Accordingly, there remains a role during the external administration process for the ‘getting in’ of insurance proceeds payable to third parties. For example, if the insurer of the insolvent counterparty denies liability under the insurance policy, the third party may seek to join the insurer to its proceeding against the insolvent counterparty and seek a declaration as to the insurer’s liability under the insurance policy.[12]
The process accommodates the possibility that more than one insured party is entitled to share in the pool of available insurance proceeds. In that circumstance, a liquidator may be tasked with determining what proportion of insurance proceeds are payable to which insured parties and may recover their reasonable expenses of distribution.[13]
Key takeaways
- In the case of an insolvent contractor in external administration, s 562 of the Corporations Act 2001 (Cth) permits the proceeds of any insurance payable to the insolvent counterparty on account of an insured liability to be paid directly to a third party whose liability is covered by that insurance.
- Where it is unknown whether an insolvent counterparty held a policy of insurance for which liability to a third party claimant may be insured, the Federal Court and State and Territory civil procedure regimes allow preliminary discovery of insurance policies by the insolvent counterparties to determine whether a policy exists for which its liability is covered. The Courts afford a beneficial construction of those provisions, enabling third parties to inform themselves whether to bring a claim against the insolvent counterparty in the first place.
- Although claims by a third party against an insolvent counterparty or its insurer (separate from the external administration process) are only permitted with leave of the court, the preliminary discovery process allows third parties to determine not only whether it has a claim, but also whether there are realistic prospects of that claim being satisfied. Such considerations will inform whether to seek leave to bring a claim against the insolvent contractor.
- If it is successful in seeking leave (and has a viable claim against the insolvent counterparty’s insurance), the third party will be entitled to the proceeds of any insurance paid to the insolvent counterparty before any payments are made creditors as part of the external administration process. Any uninsured losses will be the subject of the usual proof of debt processes.
Corporations Act 2001 (Cth) s 556.
Corporations Act 2001 (Cth) s 471B.
The Queensland Court of Appeal confirmed in Interchase Corporation Ltd (in liq) v FAI General Insurance Co Ltd [2000] 2 Qd R 301 (Interchase v FAI) that the effect of s 562 is to modify the priority payment procedure to permit liquidator, during a company’s winding up, to deliver to third party plaintiffs payment of any insurance proceeds to meet liabilities for which the insolvent company was insured.
Corporations Act 2001 (Cth) s 471B: such proceedings may not be commenced, ‘except with the leave of the Court and in accordance with such terms (if any) as the Court imposes.’
That is one of many considerations that the Court may take into account in determining whether to grant leave to proceed against an insolvent counterparty. The relevant considerations are usefully set out in Gilmour J’s decision in Swaby v Lift Capital Partners Pty Ltd (2009) 72 ACSR 627 at [29].
Federal Court Rules 2011 r 7.23(1)(a).
Federal Court Rules 2011 r 7.23(1)(b).
Federal Court Rules 2011 r 7.23(1)(c)(i) and (ii).
Shorey v One Key Workforce Pty Ltd (in liq) [2020] FCA 1750 at [32].
Lopez v Star World Enterprises Pty Ltd [1997] FCA 454 and Wadren Pty Ltd v Probuild Constructions (Aust) Pty Ltd [2023] VSC 348 at [126]
In Interchase v FAI (referred to above), McPherson JA confirmed that proceeds of insurance only become payable to third parties under s 562 of the Corporations Act 2001 (Cth) upon receipt by the liquidator of such amounts. In other words (per Martin J in Godden v Queensland [2018] QSC 018, following McPherson JA): ‘the point at which s 562 can have application is if [the company] falls into liquidation, incurs a liability …, and an amount in respect of that liability is received by it or its liquidator.’
CGU Insurances Limited v Ross Blakeley, Michael Ryan and Quentin Olde as joint and several liquidators of Akron Road Pty Ltd (In Liquidation) [2016] HCA 2.
Re Morgan; Brighton Hall Securities Pty Ltd (in liq) (2013) 96 ACSR 232 at 268-270.
