Sublimits a case of ‘each to their own’ in rectified D&O insurance programme
The Federal Court of Australia has recently handed down a decision concerning a claim for rectification of a Side C sublimit under a multilayered directors’ and officers’ liability programme (D&O Programme).
In Quintis Ltd (Subject to Deed of Company Arrangement) v Certain Underwriters at Lloyd’s London Subscribing to Policy Number B0507N16FA15350 Justice Lee upheld the insured’s claims for rectification against one of three subscribing insurers on the first excess layer, and one of seven insurers on the second excess layer of the 2016 to 2017 D&O Programme, but the claims against the other subscribing insurers, including the primary insurers, failed.
This judgment highlights the high evidentiary threshold to be met to successfully effect rectification of an insurance policy. It also highlights that, where there is a multilayered insurance programme, rectification may be assessed separately for each insurance contract comprising the programme. Further, ‘follow form’ excess insurers will not automatically be required to follow the rectified terms of the underlying contracts.
A shareholder class action was brought against Quintis Ltd (Subject to Deed of Company Arrangement) (Quintis). Following disclosure of documents relating to the 2016 to 2017 D&O insurance programme held by Quintis, a claim was brought against Quintis’ D&O insurers seeking rectification of the policies that comprised its primary, first and second excess layers so that the $10 million sublimit for Side C cover recorded in the policy schedules would instead provide a $50 million sublimit.
One programme, many separate contracts
In order to succeed on the rectification claim, Justice Lee noted that it was necessary to establish by evidence on the balance of probabilities that it was the common intention of the parties to include a $50 million Side C cover sublimit, as opposed to the $10 million sublimit that was recorded in the policy schedules.
In that regard, it was accepted that it was the intention of Quintis and its Australian producing broker to secure $50 million in Side C cover when placing its 2016 to 2017 D&O Programme. However, as the programme was placed with Lloyd’s, it was also necessary to establish that this intention was also held by the placing broker and each subscribing syndicate within the primary, first and second excess layers (Common Intention Question).
In assessing the Common Intention Question, his Honour noted the following:
- both the local producing broker and the placing broker were agents of the insured and that it was the placing broker who was the contracting agent for the insured;
- the slip method of placing insurance, by signing the Market Reform Contract (MRC) and stating the proportion of the risk that the underwriter is prepared to subscribe, results in the conclusion of separate contracts between the insured and each subscriber of the slip; and
- while there may be one primary policy and multiple excess policies, there are in fact multiple separate contracts between the insured and each subscribing syndicate.
Establishing common intention
His Honour also restated the well-established rules for contractual rectification, namely that it must be demonstrated that, at the time of the execution of the written contract sought to be rectified, that there was an “agreement” between the parties in that the parties had a “common intention” and that the written contract was to conform to that agreement. It must also be demonstrated that the written contract did not reflect the “agreement” because of a common mistake.
As to ascertaining the common intention of the parties, clear and convincing proof of the actual common intention of the parties is required. Evidence of that intention may be drawn from the external or outward expressions of the parties (such as their objective words or conduct) and also from evidence of their subjective states of mind.
Follow form and binding excess insurers
It was submitted that only the 2016 to 2017 primary layer policy was required to be rectified in order for the $50 million sublimit to take effect across the programme. That was said to be because the excess policies were said to ‘Follow Form’ with respect to the primary layer policy, such that rectification (which takes effect from contract inception) would have an automatic follow-on effect for the excess layer policies.
His Honour did not accept this submission for two principal reasons:
- to have the rectified primary policy “run through” the excess policies in circumstances where there was no relevant common intention established between the parties to the excess policies, would “turn established principle on its head”; and
- his Honour would not grant equitable relief that impacted the excess insurers in this way, because they would be bona fide third parties (with respect to the primary policy) whose rights would be adversely impacted by such relief. In other words, where the excess insurers acted in reliance on the primary policy in its unrectified form and would have done so to their detriment if the primary policy were rectified, his Honour would refuse to grant rectification in a way that automatically impacts upon the excess policies.
Accordingly, it was necessary for the common intention of each excess layer insurer to be established in order for rectification to apply to the first and second excess layer policies.
Application to placing broker and subscribing insurers
The relevant insurers did not serve any substantive affidavits or call any lay witnesses in defence to the claim for rectification. Further, neither party served an affidavit establishing, or called any witness to give evidence of the placing broker’s actual intention. Accordingly, the intention of the relevant insurers and the placing broker was to be ascertained from discovered documents and documents produced under subpoena.
His Honour conducted a detailed and extensive analysis of the relevant communications and documents, concluding that a common intention of a $50 million sublimit for Side C cover could be established for:
- The placing broker, because it was told that Quintis wished to maintain its current amount of cover, which included up to $50 million in Side C cover, and because subsequent discussions with the producing broker were conducted on this basis.
- One of three first excess layer insurers, on the basis that:
- it was sent a diagram of the structure of the expiring programme, which included the $50 million Side C Cover together with an email that confirmed that Quintis was looking to maintain its current levels of cover;
- it was also sent post-contractual correspondence expressing concern about becoming the primary carrier for Side C cover in an extended period of insurance; and
- the responsible underwriter was not called as a witness to give evidence, which gave rise to an adverse (Jones v Dunkel) inference drawn against the insurer.
- One of the seven second excess layer insurers, on the basis that:
- it was sent the same a diagram of the structure of the expiring programme and the email as to maintaining the current levels of cover; and
- a similar Jones v Dunkel inference was also drawn due to a lack of evidence from the responsible underwriter.
In respect of all other subscribing insurers to the primary, first and second excess layers, his Honour was not satisfied those insurers held the requisite common intention with respect to Side C cover. In other words, the required ‘clear and convincing proof’ had not been established.
Having found two contracts where rectification was appropriate, his Honour invited the parties to provide written submissions on the specific questions of the form of relief that should be granted and the form of orders made. This will be complicated given that, as noted above, while two of the insurance contracts in the programme will be rectified, this will not increase the limit of liability of all the other insurers whose contracts are not to be rectified, including those excess insurers who follow form.
Rectification disputes can be complex, expensive and uncertain. Naturally, preventing a dispute by recording the terms of the agreement is invariably better than seeking an equitable cure.
For those involved in preparing policy documentation, the accuracy of this documentation can be particularly critical for multilayered programs where excess insurers may rely on the terms of an underlying contract presented to them in quoting and binding the risk.
Even if rectification is available in respect of a primary layer policy, it will likely be immaterial for the available excess cover unless the relevant common intention can also be proved against the excess insurers.
This decision also reiterates that there is a high evidentiary threshold to be met in any rectification case. This was exacerbated here by circumstances common to the insurance industry, where there are producing and placing agents involved and a plethora of separate underwriters. Careful forensic decisions will also need to be made as to whether and to what extent any lay underwriting evidence should be served when preparing to litigate such a dispute.