Defence costs and duty of disclosure: A tussle between insureds and insurers
The much-publicised prosecution of Adam Cranston, the son of former Deputy Commissioner of the ATO, charged with criminal conspiracy to defraud the ATO, recently spilled into the insurance world, as Mr Cranston and others sought a declaration that they were entitled to the advancement of defence costs incurred in defending the criminal proceedings under their insurance policy. The Full Court of the Federal Court of Australia held that insurers could rely on non-disclosure to deny the claim, notwithstanding that there was no finding or admission of the conduct underpinning the non-disclosure, and were therefore not required to advance defence costs.
In Onley v Catlin Syndicate Ltd as the Underwriting Member of Lloyd’s Syndicate 2003  FCAFC 119, Mr Cranston and others (applicants), sought a declaration against certain underwriters at Lloyds (Underwriters) that they were entitled to the advancement of defence costs under a directors’ and officers’ liability insurance policy (Policy) in respect of two criminal proceedings against the applicants stemming from their alleged conduct in defrauding the ATO.
Underwriters asserted that the applicants had not disclosed certain dishonest conduct, being the conduct the subject of the criminal proceedings, prior to the inception of the Policy, in breach of their duty of disclosure contained in section 21 of the Insurance Contract Act 1984 (Cth) (ICA). Underwriters’ position was that this allowed them to either avoid the Policy on the ground of fraudulent non-disclosure or reduce their liability to nil if the non-disclosure was not fraudulent.
The applicants submitted that the defence costs extension in the Policy required Underwriters to advance defence costs until the criminal or dishonest conduct was established by judgment, adjudication or admission. They argued that Underwriters could not rely on the alleged dishonest conduct for any purpose (including to deny cover because of the applicants’ breach of their duty of disclosure) before such judgment, adjudication or admission.
The applicants issued Federal Court proceedings seeking declaratory orders that they are entitled to the advancement of defence costs under the Policy.
The Court found in favour of Underwriters, holding that there was nothing in the defence costs extension that diminished or contractually qualified Underwriters’ rights to rely on statutory remedies available under section 28 of the ICA for non-disclosure. There was no need for the dishonest conduct to be subject of a prior determination or admission to enable Underwriters to exercise their statutory rights.
Observing the primacy of an insured’s duty of disclosure, the Court stated that, if the applicants’ contention was allowed, then an insurer would be forced to indemnify an insured that, had there been proper disclosure, it would not have insured in the first place.
The Court went on to hold that Underwriters’ position did not leave the defence costs extension without work to do because, had the dishonest conduct occurred during the currency of the Policy, and not prior, Underwriters would be required to advance defence costs until there had been a requisite determination or admission. That interpretation was consistent with both a “businesslike” and “purposive” interpretation of the Policy.
A further ground in support of Underwriters’ position was the Court’s recognition that public policy considerations would preclude “contracting parties excluding liability for their own fraud”.
Finally, the Court made an interesting observation as to the impact of an insurer’s duty of utmost good faith when taking a non-disclosure point:
[I]t ought to be observed that an insurer may not escape its obligation to advance defence costs until relevant facts are established by a simple allegation of non-disclosure. Consistent with its obligation of utmost good faith under s 13(1) of the ICA, an insurer must have a real or substantial ground for alleging non-disclosure. That does not mean the insurer must then have all necessary proof of the insured’s conduct to establish the ground for the exclusion. However, sufficient grounds must then exist which can be relied upon consistently with the obligation of utmost good faith.
The insured’s duty of disclosure prior to the inception of a policy of insurance takes primacy over any obligation within the policy to advance defence costs. Whilst a large number of insurance policies contain a “Conduct” exclusion that is not triggered until there is determination or admission as to that conduct, the existence of the exclusion clause does not undermine insurers’ statutory remedies for non-disclosure if the same dishonest conduct that might trigger the exclusion was not properly disclosed prior to the insurer coming on risk.
14 August 2018