This article was written by Peter Yeldham and Georgia Cowley
The Full Court of the Federal Court of Australia recently considered the relationship between the Advancement of Defence Costs extension commonly found in Directors & Officers and Professional Indemnity liability insurance policies, and the available remedies for insurers arising out of non-disclosure.
Upholding the primacy of an insured’s disclosure obligations, the Full Court in Onley v Syndicate Ltd as the Underwriting Member of Lloyd’s Syndicate 2003  FCAFC 119 (“Onley”) held that the Respondent, Catlin Syndicate (“Insurers”) was not precluded from relying on section 28 of the Insurance Contracts Act (“ICA”) in refusing to advance monies for legal representation expenses and defence costs (“Defence Costs”) to Jason Onley and Adam Cranston (“Applicants”), two of the ten syndicate members alleged to be embroiled in the $130 million Plutus tax scandal.
Section 21 of the ICA requires an insured to disclose to an insurer, before a policy of insurance is entered into, a matter the insured knows is relevant to the insurer’s decision to accept a risk, or any matter a reasonable person in the circumstances could be expected to know to be relevant. If an insured fails to comply with its duty of disclosure as laid out by section 21, section 28 allows the insurer to avoid the contract (if the failure was fraudulent) or reduce its liability for a claim by the amount it would be had the failure not occurred (if not fraudulent). Section 28 does not apply where the insurer would have written the risk regardless of the failure to disclose.
The Applicants were directors of the company Synep Pty Ltd (“Synep”), which, from 1 June 2016, owned all of the shares in Plutus Payroll Australia Pty Ltd (“Plutus”). Both Synep and Plutus were named insureds under a policy taken out on 1 July 2016, underwritten by Insurers,that provided retroactive cover (under one section) for Management Liability and Professional Indemnity (“Policy”) from 1 June 2016.
In May 2017, the Applicants were charged for conspiring together (from at least 1 June 2016) with the intention of dishonestly causing loss to the Australian Tax Office, and are also the subject of proceedings brought by the Australian Federal Police under the Proceeds of Crimes Act 2002 (Cth).Together, the Applicants ran a business that involved a scheme in which Plutus (an outsourced payroll firm), received Pay As You Go Witheld (“PAYGW”) amounts from its clients and transferred those amounts through a corporate structure. The Applicants set up “straw companies” with impecunious directors to absorb the tax obligations, meaning the ATO was unable to recover its lost tax revenue, and personally profited from amounts withheld.
Both Applicants separately sought defence costs under the Management Liability and Professional Indemnity section of the Policy, seeking indemnity for liabilities arising out the proceedings. Insurers denied cover on the basis that the Applicants breached their obligations under s 21 of the ICA by failing to disclose their involvement in a “dishonest enterprise involving the misappropriation of funds” which had been running for some months prior to the inception of the Policy.
Insurers alleged that the non-disclosure was fraudulent in that the information was deliberately withheld knowing the business activities would be relevant to Insurer’s assessment of risk and purported to avoid the Policy.
The Applicants’ arguments
In response, the Applicants argued that Insurers were unable to rely on any non-disclosure because it had promised to advance Defence Costs pursuant to an Advancement of Defence Costs and Representation Expenses extension in the Policy (“Advance Costs Extension”). The Applicants contended that under the Advance Costs Extension, Insurers agreed to advance Defence Costs in respect of a Claim, even where the Claim alleged Improper Conduct that was otherwise excluded, until such Improper Conduct was determined by way of admission or judgment. In short, the Applicants argued the construction of the Advance Costs Extension contractually postponed Insurers’ entitlement to rely on section 28.
The Full Court, of Allsop CJ and Lee and Derrington JJ, found in favour of Insurers and held that none of the arguments advanced by the Applicants could succeed. In a brief judgment, the Court held:
- the Advance Costs Extension did not, in any way, limit or contractually exclude Insurers rights under the ICA. To do so, the Policy would need to have used clear and express terms stripping Insurers of their entitlement to decline indemnity on all grounds until the Improper Conduct had been finally determined, which in this case, the Full Court considered it did not;
- Whether or not the business activities constituted Improper Conduct for the purposes of the exclusion or the Advance Costs Extension is not relevant to the denial of cover, which was based on non-disclosure and not reliant on the Improper Conduct itself
- further, and in any event, the Applicant’s proposed construction of the Advance Costs Extension meant it would be necessary to conclude that Insurers agreed to defer its reliance on s 28 of the ICA until after admission or judgment and agreed to continually fund the Applicant’s defence of proceedings, costs it will need to claw back at the conclusion of proceedings. This was inconsistent with the terms of the Policy as a whole, which was clear in its refusal to indemnify the Applicants for conduct prior to the policy’s inception (for example, the Policy contained an exclusion for Known Claims and Circumstances as well as a Retroactive Date of 1 June 2016);
- as a matter of public policy, the Courts will not permit a contracting party to exclude liability for his or own fraud in inducing the making of a contract. The Court relied on the old principle that “fraud unravels all” in stating that to require Insurers to defer acting upon a fraudulent non-disclosure would reward the Applicants (even if only temporarily until final determination) for their fraudulent conduct; and
- even if the information was not withheld intentionally, the Applicants and any reasonable person in the circumstances could be expected to know that the Applicant’s risky business activities would be a matter relevant to Insurers in considering the risk.
The Court found no basis to conclude that Insurers would have accepted to cover the Applicants if it had known of the nature of the Applicants’ business.
What does this mean for insurers?
The decision in Onley provides continued support for the (uncontroversial) position that a contractual agreement to indemnify does not limit or exclude a party’s right to rely on statutory remedies (including for non-disclosure) unless the terms of the contract clearly and expressly purport to do so.
It is also useful to note the Court’s observation that insurers are reminded that a simple allegation of non-disclosure is insufficient to escape its obligations to pay. The Court observed that to satisfy their obligation of utmost good faith, insurers do not need all necessary evidence but must have a real or substantial ground for alleging non-disclosure.
What does this mean for directors and insureds?
In this case, Insurers argued that as Synep provided the proposal form and entered into the Policy as agent for all insureds, the Policy was avoided against all of them. This presents a danger for directors insured under D&O and Professional Indemnity policies where the company (or one director) acts as agent for the remainder of the directors and officers in entering into the policy without properly disclosing all relevant matters. Directors should properly consider whether there is any pre-policy conduct that should be disclosed before the policy is taken out, and should take an active role in reviewing any proposal form.