Silbermann v CGU Insurance Ltd

[2003] NSWCA 203

Reported Decision: 57 NSWLR 469
(2003) 12 ANZ Insurance Cases 61-571
(2003) 21 ACLC 1425

Court of Appeal

CITATION:	Silbermann v. CGU Insurance Limited; Rich v. CGU Insurance Limited; Greaves v. CGU Insurance Limited [2003] NSWCA 203 revised - 31/07/2003
HEARING DATE(S):	23 May 2003
JUDGMENT DATE:	25 July 2003
JUDGMENT OF:	Beazley JA at 1; Hodgson JA at 2; Tobias JA at 63
DECISION:	1. In each matter, leave to appeal granted. ; 2. In each matter, appeal dismissed with costs.
CATCHWORDS:	INSURANCE - Liability insurance policy - Exclusion clause - Dishonesty and fraud - Requirement of judgment or final adjudication - Whether insurer can resist giving indemnity prior to judgment or final adjudication.
CASES CITED:	Baldry v. Jackson [1976] 2 NSWLR 415 Darlington Futures Pty. Ltd. v. Delco Australia Pty. Ltd. (1986) 161 CLR 500 Distillers Bio-Chemicals (Aust) Pty. Ltd. v. Ajax Insurance Co. Ltd. 91974) 130 CLR 1 Fire & All Risk Insurance Co. Ltd. v. Powell (1966) VR 513 Hammer Waster Pty. Ltd. v. QBE Mercantile Mutual Ltd. [2002] NSWSC 1006 MGICA Ltd. v. United City Merchants (Australia) Ltd. (1986) 4 ANZ InsCas 60-729 Provincial Insurance Aust. Pty. Ltd. v. Consolidated Wood Products Pty. Ltd. (1991) 25 NSWLR 541 Sherry v. FAI Insurance Ltd. (In Liq) [2002] SASC 3
PARTIES :	John David Rich - claimant Mark Silbermann - claimant John Huyshe Greaves - claimant CGU Insurance Limited - opponent in each matter
FILE NUMBER(S):	CA 40066/03; 40065/03; 40076/03
COUNSEL:	Mr. D.L. Williams for Rich and Silbermann Mr. A.J.L. Bannon SC for Greaves Mr. C.G. Gee QC with Mr. A.W. Street SC and Mr. E. Romaniuk for CGU Insurance
SOLICITORS:	Joanne Kelly, Darlinghurst for Rich and Silbermann Watson Mangioni, Sydney for Greaves Collins Biggers & Paisley, Sydney for CGU Insurance

LOWER COURTJURISDICTION:	Supreme Court - Equity Division
LOWER COURT FILE NUMBER(S):	SC50141/01; 50096/02; 50150/02
LOWER COURT JUDICIAL OFFICER :	McClellan J

CA 40065/03
CA 40066/03
CA 40076/03

BEAZLEY JA
HODGSON JA
TOBIAS JA

Friday 25 July 2003

SILBERMANN V. CGU INSURANCE LIMITED

RICH V. CGU INSURANCE LIMITED

GREAVES V. CGU INSURANCE LIMITED

Judgment

1 BEAZLEY JA: I agree with Tobias JA.

2 HODGSON JA: These are three applications for leave to appeal, raising identical questions. In each of three cases brought in the Commercial List of the Equity Division by the claimants against the opponent, McClellan J ordered the separate determination of three questions, namely:

1. Whether, on the true construction of Directors & Officers Liability Insurance Policy No 01 DO 0298798 ("the Policy"), issued by the Defendant absent an existing judgment, order or other final adjudication adverse to the Plaintiff, the Defendant can rely on Exclusion Clause 3.1 in answer to the Plaintiff's claim for indemnity under the Policy;

2. Whether, on the true construction of the Policy issued by the Defendant the Defendant itself is entitled to seek a judgment, order or other final adjudication adverse to the Plaintiff and, thereby, exclude liability for a claim under clause 3.1 of the Policy in the same proceedings in which the Plaintiff makes a claim for indemnity against the Defendant.

3. Whether, on the true construction of the Policy issued by the Defendant, exclusion clause 3.1 of the Policy operates to exclude liability on the part of the Defendant to pay claims by the Plaintiff for indemnity for Defence Costs under
(i) Clause 2.1 of the Policy;
(ii) Clause 2.6 of the Policy;
(iii) Insuring Agreement A of the Policy; and
(iv) Insuring Agreement B of the Policy.

3 On 18 December 2002, the primary judge answered questions 1 and 2 and each paragraph of question 3 “Yes”. Each of the plaintiffs below seek leave to appeal. The applications for leave have been argued on the basis that, if leave is granted, the appeal will be determined without further argument.

CIRCUMSTANCES

4 Each claimant is a former director of One.Tel Limited (One.Tel) which is in liquidation. Each of them has brought proceedings against the opponent CGU Insurance Limited claiming a declaration that the opponent is obliged to indemnify him for and advance to him the costs of defending himself in an investigation by the Australian Securities & Investment Commission (ASIC), two proceedings brought by ASIC in the Equity Division of this Court, examinations under the Corporations Act, and other proceedings; and also claiming associated and consequential orders.

5 The opponent is defending these proceedings. One of its defences relies on cl.3.1 of the Policy on which each claimant relies; and the separate questions were intended to be determinative of whether the opponent can rely on that particular defence.

6 In order to understand the issues, it is necessary to set out the relevant provisions of this Policy.

PROVISIONS OF POLICY

7 Section 1 of the Policy is entitled “Operative Clause”, and it provides as follows:

Directors and Officers Liability
Insuring Agreement A
The insurer will pay on behalf of the Directors and Officers any Loss for which the Directors and Officers may not be legally indemnified by the Corporation arising out of any Claim, by reason of any Wrongful Act committed by them in their capacity as a Director or Officer, first made against them jointly or severally during the period of Insurance and notified to the Insurer during the indemnity Period.

Corporate Reimbursement
Insuring Agreement B
The Insurer will pay on behalf of the Corporation any loss payment which it is legally permitted to make arising out of any Claim, by reason of any Wrongful Act, committed by any Director or Officer in their capacity as a Director or Officer, first made against the Director or Officer during the Period of Insurance and notified to the Insurer during the Indemnity Period.
The total amount payable in respect of all Claims under Insuring Agreement A and/or Insuring Agreement B of this Policy shall not in the aggregate exceed the limit of aggregate liability as stated in Item 5 of the Schedule

8 Section 2 is entitled “Extensions”, and it commences with the following paragraph:

Unless specified otherwise to the contrary the cover granted by these extensions is subject to all the terms and conditions of this Policy.

9 Under the heading “Automatic Extensions” are a number of relevant clauses. First, there is clause 2.1 which is as follows:

2.1 Advancement of Defence Costs
Where the Insurer elects not to take over and conduct the defence or settlement of any Claim in the name of any Director or Officer, the Insurer shall meet the Defence Costs of any Director or officer in defending or settling any Claim made against them as they are incurred and prior to the finalisation of the Claim provided always that indemnity in respect of such Claim has been confirmed in writing by the Insurer.

Where the Insurer has not confirmed indemnity and it elects not to take over and conduct the defence or settlement of any Claim, it may, in its discretion, pay Defence Costs as they are incurred and prior to the finalisation of the Claim, provided that It has consented in writing to such Defence Costs prior to their being incurred, such consent not to be unreasonably withheld.

The Insurer reserves the right to recover any Defence Costs from the Directors or Officers and/or the Corporation severally according to their respective interests in the event and to the extent that it is subsequently established by judgement or other final adjudication that the Directors and Officers and/or the Corporation were not entitled to the Defence Costs so advanced.

10 Next, there is cl.2.5, dealing with “Insured vs Insured Cover”, which provides that “the Insurer will pay on behalf of the Directors and Officers any Claim brought by” (inter alia) other directors or officers arising out of such matters as discrimination, unfair dismissal, workplace harassment, unfair demotion, and defamation.

11 Next, there is cl.2.6, which provides as follows:

2.6 Attendance at Official Investigations or Inquiries
The Insurer will pay Defence Costs incurred with its prior written consent by or on behalf of a Director or Officer in attending any official investigation, examination, inquiry or other proceedings ordered or commissioned by any official body or institution, where a Director or Officer is legally compelled by such body or institution to attend such investigation, examination, inquiry or proceeding and which involves an allegation of a Wrongful Act against a Director or Officer which is the subject of indemnity under this Policy.

12 Section 3 of the Policy is entitled “Exclusions”, and it commences as follows:

This Policy does not provide an indemnity against any Claim made against any Director or Officer:

There follow a number of clauses, the most relevant of which is cl.3.1, which provides as follows:

3.1 Dishonesty & Fraud
brought about by, contributed to by or which involves:
(1) the dishonest, fraudulent or malicious act or omission or other act or omission committed with criminal intent of such Director or Officer,
(2) such Director or Officer having improperly benefited in fact from securities transactions as a result of information that was not available to other sellers and/or purchasers of such securities; or
(3) such Director or officer having gained in fact any personal advantage to which he/she was not legally entitled.

However, this exclusion shall only apply to the extent that the subject conduct has been established by a judgement or other final adjudication adverse to the Director of Officer.

13 Other exclusions concern matters such as “Prior Claims and Circumstances”, “Breach of Professional Duty”, “Insured vs Insured”, “Prospectus Liability” and “Bodily Injury, Property Damage, Pollution, Nuclear Risks and War”. Unlike the other clauses, the clauses relating to prospectus liability and bodily injury etc. commence with the words “for Loss”, in the first case continuing “arising from the issue of initial public offering of securities of the Corporation”, and in the second case, continuing with the words “arising from”, these being followed by a number of paragraphs, the first of which commences with the words “bodily injury”.

14 Section 4 of the Policy is entitled “General Conditions”. Clauses 4.4 and 4.5 are as follows:

4.4 Claims Co-operation
The Directors and Officers shall use due diligence and do and concur in doing all things reasonably practicable to avoid or diminish any Loss hereunder, and shall immediately give all such information and assistance to the Insurer as it may reasonably require to enable it to investigate and to defend the Claim and/or to enable the Insurer to determine its liability under this Policy.

The Insurer may, on request from the Directors and Officers for indemnity under this Policy, take whatever action that it considers appropriate to protect the Directors' and Officers' position in respect of the Claim and such action by the Insurer shall not be regarded as in anyway prejudicing its position under this Policy and no admission of the Directors' and Officers' entitlement to indemnity under this Policy shall be implied.

4.5 Allocation
In the event of a Claim which is made against Directors and Officers or the Corporation and which is covered only partly by this Policy, the Insurer will use its best efforts to ensure a fair and proper allocation of the claim for insured and uninsured portions.

The Insurer will also advance Defence Costs on a similar basis, which will apply to all Defence Costs unless otherwise agreed by all parties.

15 Clauses 4.15 and 4.16 are as follows:

4.15 Q.C. Clause
Neither the Directors and Officers nor the Insurer shall be required to contest any legal proceedings unless a Queen's Counsel or Senior Counsel (mutually agreed upon by the Directors and Officers and the insurer or in default of such agreement, selected by the Chairman or President of the local Bar Council) shall advise that such proceedings should be contested. In formulating his or her advice, Counsel shall take into consideration the economics of the matter, having regard to the damages and costs which are likely to be recovered by the plaintiff, the likely Defence Costs and the prospects of the Directors and Officers successfully defending the action.

The costs of such Counsel's opinion shall, for the purpose of this Policy, be regarded as part of the Defence Costs. In the event that Counsel advises that, having regard to all the circumstances, the matter should not be contested but should be settled, providing settlement can be achieved within certain limits which, in Counsel's opinion, are reasonable, then the Directors and Officers shall not object to any such settlement and shall co-operate with the Insurer to effect such settlement in accordance with this Policy.

4.16 Settlement Procedure
Subject otherwise to the provisions of the Insurance Contracts Act 1984 the Directors and Officers shall, as a condition precedent to the right to be indemnified under this Policy, not admit liability for or settle any Claim or incur any costs or expenses in connection therewith or enter into settlement without the written consent of the insurer who shall be entitled to at any time to take over and conduct in the name of the Director or Officer the defence or settlement of any Claim. However, if the Director or Officer shall refuse to consent to any settlement recommended by the Insurer and shall elect to contest or continue any legal proceedings in connection therewith, the Insurer's liability for the Claim shall not exceed the amount for which the Claim could have been so settled plus the Defence Costs incurred up to the date of such refusal.

16 Section 5 of the Policy is entitled “Definitions”. The most important definitions for these proceedings are those contained in cls.5.1, 5.3, 5.8, and 5.15. The section opens with the following words:

Whenever appearing in this Policy the following terms shall be interpreted only in the manner described below:

The clauses I have mentioned are in the following terms:

5.1 Claim
"Claim" shall mean:
(1) any writ, summons, application or other originating legal (criminal, civil or otherwise) or arbitral proceedings, cross claim or counter-claim issued against or served upon any Director or Officer alleging any Wrongful Act; or
(2) any written demand alleging any Wrongful Act communicated to any, Director or Officer under any circumstances and by whatever means.

5.3 Defence Costs
"Defence Costs" shall mean:
all reasonable costs, charges and expenses (other than regular or overtime wages, salaries or fees of any Director or Officer) incurred with the prior written consent of the Insurer in defending, investigating, attending or monitoring any Claim or proceedings, including but not limited to official investigations, examinations, inquiries and the like, or appeals therefrom, together with all reasonable costs of bringing any appeal,

5.8 Loss
"Loss" shall mean:
the amount payable in respect of a Claim made against the Directors and officers for a wrongful Act and shall include damages, judgements, settlements, interest, costs and Defence Costs. In respect of Section 2.5 (Insured vs insured Cover) and 2.20 (Entity Cover for Employment Practices Liability) this Policy will include back-pay where reinstatement by a court is ordered but excludes any amount which the insured is or was required to pay pursuant to a specific obligation imposed under a contract of employment, employment agreement, statute, award or otherwise.

"Loss" excludes a Claim arising from or by reason of or directly or indirectly caused by or arising from fines and penalties imposed by law, punitive, exemplary or aggravated or multiple damages, income tax, customs duties, excise duty, stamp duty, sales tax or any other State or Federal tax or duty.

5.15 Wrongful Act
"Wrongful Act" shall mean:
any actual or alleged breach of duty, breach of trust, neglect, error, misstatement, misleading statement, omission, breach of warranty of authority or other act done or attempted by or any other matter claimed against any Director or Officer or any of them wherever or whenever while acting in their individual or collective capacities as Directors or Officers.
DECISION OF PRIMARY JUDGE

17 On the third question, the primary judge held to the effect that, without the exclusion in cl.3.1, the opponent’s obligation was to indemnify a director or officer with respect to any “Loss”, this being defined to include “Defence Costs”, which in turn are one of the amounts payable “in respect of a Claim”. Accordingly, when cl.3.1 excludes “indemnity against any Claim”, it thereby excludes indemnity in relation to “Defence Costs” associated with that “Claim”.

18 On the first and second questions, the primary judge held that the third paragraph of cl.3.1 did not exclude the opponent from pleading the exclusion in the present proceedings, and doing so without a relevant finding having been made in other proceedings. He noted that there are a variety of circumstances in which adverse findings may be made in relation to the conduct of a Director or Officer, including a Royal Commission or official investigation, or other similar proceedings; and the primary judge held that cl.3.1 did no more than make it clear that such findings, not amounting to a final judgment, would not be sufficient to allow the opponent to deny indemnity.

GROUNDS OF APPEAL

19 Each claimant seeks leave to appeal on the following two grounds:

1. His Honour erred in answering each of the preliminary questions of construction in the affirmative.
2. His Honour ought to have answered each of the preliminary questions of construction in the negative.

20 Fortunately, these grounds have been amplified by submissions. It is convenient to deal first with the third question, and then with questions 1 and 2.

STATUTORY PROVISIONS

21 The only relevant statutory provisions in this matter are ss.13 and 14 of the Insurance Contracts Act 1984 (Cwth), which are as follows:

13. A contract of insurance is a contract based on the utmost good faith and there is implied in such a contract a provision requiring each party to it to act towards the other party, in respect of any matter arising under or in relation to it, with the utmost good faith.

14(1) If reliance by a party to a contract of insurance on a provision of the contract would be to fail to act with the utmost good faith, the party may not rely on the provision.
(2) Subsection (1) does not limit the operation of section 13.
(3) In deciding whether reliance by an insurer on a provision of the contract of insurance would be to fail to act with the utmost good faith, the court shall have regard to any notification of the provision that was given to the insured, whether a notification of a kind mentioned in section 37 or otherwise.

THIRD QUESTION
Submissions

22 Mr. Williams for the claimants Silbermann and Rich submitted that the Policy provides for two distinct types of indemnity: first, indemnity against Claims as such, that is claims by third parties against the insured; and second, against Defence Costs, that is the insured’s own costs of meeting such claims, payable to the insured’s own lawyers. The opening words of Section 3 were focused on the former: those opening and governing words refer to “indemnity against any Claim”, and do not refer either to “Defence Costs” or “Loss” (which is defined to include “Defence Costs”). The further words “against any Director or Officer” confirm that it is what is claimed against the insured which is being referred to here. If it had been intended to exclude Defence Costs, these words would have referred to Defence Costs or at least to “Loss”, using the words used in the principal insuring clauses in Section 1. This was confirmed by the express use of the word “Loss” in cls.3.5 and 3.6. The definition of “Claim” is plainly not such as to extend to Defence Costs.

23 The contrary view adopted by the primary judge was against the ordinary meaning of the words used, and involved reading into the provision words that were not there. Even if there were any ambiguity, this should be read strictly against the insurer.

24 Mr. Williams provided the following notes on the applicable principles of construction:

1. Exclusion clauses are to be construed according to their natural and ordinary meaning, read in light of the contract as a whole, thereby giving due weight to the context in which the clause appears, including the nature and object of the contract and, where appropriate, construing the clause contra proferentum in case of ambiguity: Darlington Futures Pty Limited v Delco Australia Pty Limited (1986) 161 CLR 500 at 510; Provincial Insurance Australia Pty Limited v Consolidated Wood Products Pty Limited & Ors (1991) 25 NSWLR 541.

2. Exclusion clauses in insurance policies are construed strictly against the insurer: Sutton, Insurance Law in Australia , 3rd ed 1999 para 9.97. If liability is to be excluded in any particular circumstance then that circumstance and the exclusion must be clearly expressed in the policy.The principle is an application of an established doctrine that insurance policies are to be construed contra proferentum: Hammer Waster Pty Ltd v QBE Mercantile Mutual Ltd & Anor (2002) NSWSC 1006 at paras 25-27.

3. An insurance policy must be read in its commercial setting in such a way as to fulfil and not restrain its commercial purpose: MGICA Limited v United City Merchants (Australia) Limited (1986) 4 ANZ Ins Case 60-729 at 74,349.

4. There is an implied obligation imposed upon an insurer to have regard to more than its own interest when exercising its rights and powers under a contract of insurance. There is an implied covenant of good faith and fair dealing that neither party will do anything which would injure the right of the other to receive the benefits of the agreement. This principle is applicable to policies of insurance, but the rights of the insured go deeper than the mere surface of the contract written for him by the defendant and implied obligations are imposed based upon those principles of fair dealing which enter into every contract: Distillers Bio-Chemicals (Australia) Pty Limited v Ajax Insurance Co Limited (1974) 130 CLR 1 per Stephens J at 31.

5. There is no rule of construction that general words are to be read subject to an implied exception of loss caused by the insured's wilful act or wilful misbehaviour (as distinct from loss intentionally caused by him): Fire and All Risk Insurance Co Ltd v Powell (1966) VR 513.

6. The principle that an insured does not, as a general rule, intend to cover loss deliberately created by an insured, particularly where it amounts to the commission of a crime or fraud, is not a principle of universal application. It is necessary to examine the nature of the contract and the type of indemnity provided. Effect must be given to the terms of the contract: Sherry & Ors v FAI Insurance Limited (in liq) (2002) SASC 3 (18 January 2002).

25 Finally, Mr. Williams submitted that, even if the exclusion was otherwise applicable, it would not apply to cl.2.6, which contained no reference to a Claim.

26 Mr. Williams’ submissions were adopted by Mr. Bannon SC for the claimant Greaves.

27 Mr. Gee QC for the opponent submitted that “indemnity against any Claim” in Section 3 must mean indemnity against the consequences of a Claim, and thus must include Defence Costs associated with any Claim. He submitted also that exception clauses in insurance policies would be construed contra proferentem only if there were an ambiguity, and there was none here: see Delco at 510.

Decision

28 In my opinion, the Policy does not draw a sharp distinction between an indemnity against a Claim and an indemnity against Defence Costs, as suggested for the claimants.

29 It is true that the definition of Claim does not refer to Defence Costs; and the definition of Defence Costs is not limited to costs incurred in connection with any Claim, but rather extends also to costs incurred in respect of “proceedings”, which are said to include official investigations and the like. But the primary indemnity is against “any Loss … arising out of any Claim”; and “Loss” is defined to include amounts payable in respect of a Claim, including Defence Costs. That is, the two types of loss or liability, said for the claimants to be clearly distinct, are bracketed together in the definition of “Loss”.

30 The words “indemnity against any Claim” in Section 3 cannot mean that only indemnity against what is defined as a “Claim” is excluded, because a Claim as defined is only a document. The words must at least exclude an indemnity against so much of any amount claimed in a Claim, as defined, as is established or (with the insurer’s concurrence) accepted. But if it is limited to that, this would separate out one of the two elements which are combined in the definition of “Loss”; and it would mean that Section 3 would have no application at all to those Claims which do not involve a claim for money by a third party, in particular those in par.(2) of the definition of “Claims”.

31 In my opinion, the words “indemnity against any Claim” in Section 3 must be read as meaning indemnity against the consequences of any Claim; and there is in my opinion no basis for considering those consequences as being narrower than the “Loss arising out of any Claim” referred to in Section 1. This is strongly confirmed by cl.2.1. The third paragraph of that clause plainly refers to a circumstance contemplated by the concluding paragraph of cl.3.1, that is, where a judgment establishes that the relevant claim was brought about by dishonesty or the like; and it provides that in those circumstances Defence Costs can be recovered by the insurer. That could only be the case if cl.3.1 does apply to Defence Costs.

32 On the other hand, cl.2.6 is not expressed as being limited to Defence Costs in respect of a Claim; and it could be said that, since this is an extension, it does not have to apply only where the principal insuring provision in Section 1 is engaged.

33 However, the concluding words of cl.2.6 show that it applies only if there is involved “an allegation of a Wrongful Act … which is the subject of indemnity under this Policy”. I think this means that the Defence Costs covered by cl.2.6 must be within the principal insuring provision in Section 1, and I think it means that the allegation in question must be a “Claim”, that is, it must be within par.(2) of the definition of “Claim” as being a “written demand alleging any Wrongful Act”. On that approach, the Defence Costs referred to in cl.2.6 are also caught by the exclusions in Section 3.

FIRST AND SECOND QUESTIONS
Submissions

34 Mr. Williams submitted that the last paragraph of cl.3.1 included the words “has been established”. He submitted that the past tense there meant that the opponent was obliged to provide indemnity unless and until a judgment to the effect stated had been given. Such a judgment was a condition precedent to reliance on the particular exclusion, and accordingly, unless and until there was such a judgment, the exclusion could not be pleaded and relied on in a defence to proceedings claiming the indemnity. The defence as pleaded involved an assertion that the insurer had a presently existing right to disclaim: in fact, there was no existing defence, so that matter could not be pleaded or supported by evidence.

35 Mr. Williams submitted that the clause contemplated that it would be left to a third party to formulate the way a claim was made against the insured; and it prevented the insurer from saying that the insured might have been found liable on another basis.

36 Mr. Williams submitted that the insured was entitled to expect that the insurer would assist the insured against persons making claims against the insured, not that it would support and try to prove the case of the person making the claim against the insured. It would be particularly offensive to good faith if the insurer could make a claim against the insured which was not being made by a third party.

37 Mr. Bannon submitted that “Claim” included criminal proceedings. He submitted that it would be repugnant to the Policy if, when such proceedings were brought, the insurer could simply wait to see what happens in an inadequately funded defence to such proceedings; let alone itself seek to make out the same case, in advance and on the balance of probabilities. Similarly, the Policy covered many different types of liability for intentional or malicious conduct: for example, par.1(g) of cl.2.5 relating to defamation could involve malice. It could not have been intended that, whenever some intentional or malicious or dishonest conduct was alleged, the insurer could decline indemnity and simply wait and see what happens or else seek to prove the conduct itself.

38 Mr. Bannon submitted that the words “to the extent that” in the last paragraph of cl.3.1 suggested that this clause is not dealing with a claim brought by an insurer against the insured over which the insurer would have control: indeed, the detailed words in the three numbered sub-clauses of cl.3.1 had plainly been selected so as to include various characterisations of conduct likely to be alleged by third parties, over which the insurer has no control. Otherwise, the clause could simply refer to dishonesty. Furthermore, if the last paragraph were given the meaning contended for by the insurer, it would be entirely useless and otiose.

39 Mr. Gee pointed out that, for the decision of the separate questions, the allegations of dishonesty made by the insurer should be assumed to be true. He submitted that the claimants’ submissions meant that, even if those allegations were true, the insurer would be helpless to deny indemnity.

40 Mr. Gee submitted that the words “has been established” are neutral: the words “in the insurance proceedings or otherwise” could be added without violence being done to those words.

41 Mr. Gee submitted that it must be open to the insurer to agitate in insurance proceedings the defences which it considers it had available. The third paragraph of cl.3.1 would not then be otiose; at the very least, it would remove any doubt that might otherwise exist that the insurer could rely on anything less than a judgment to resist indemnity.

42 Mr. Gee also submitted that the claimants’ submissions would have the unreasonable result that, where third parties formulated their claims so as to avoid allegations of dishonesty with a view to ensuring that their defendants had insurance cover, the insurer would be helpless to rely on dishonesty as a defence.

43 In any event, Mr. Gee submitted, the claimants’ submissions overlooked the circumstance that the Policy did not guarantee the advance of Defence Costs: the first paragraph of cl.2.1 applied only where the insurer has confirmed the indemnity in writing; and the second paragraph of cl.2.1 plainly left the insurer with a discretion whether to advance Defence Costs. Under cl.2.6, Defence Costs would be paid only if they were incurred with the insurer’s prior written consent.

44 Mr. Gee submitted that, in any event, leave to appeal should not be granted. The decision of the separate question did no more than permit the pleading of these matters. Even without them, there would still be major and live issues in the case. There had to be reasons justifying leave to appeal where there had been a decision of separate questions, including consideration of the practical consequences of granting leave and allowing the appeal.

Decision

45 In my opinion, the construction and effect of cl.3.1 has to be considered in the light of the apparent commercial purpose of the Policy, namely to provide the insured with Defence Costs to fight Claims, not excluding Claims which allege dishonesty, and to provide indemnity against liability to third parties, at least where this liability is not contributed to by dishonesty. In cases where dishonesty is established by judgment and Defence Costs have been advanced, the Policy by the third paragraph of cl.2.1 contemplates that they will be refunded.

46 In my opinion, if the opponent were wholly correct about the final paragraph of cl.3.1, it would either be entirely otiose or else operate solely to the benefit of the insurer. To have the benefit of the exclusion provided by cl.3.1, the insurer has to prove that it applies; and if the final paragraph were not there, the insurer would have to obtain a final adjudication to that effect in the insurance proceedings themselves. Plainly, it would not be sufficient merely to point to allegations, or to a finding of another tribunal not amounting to a judgment or final adjudication. The only thing additional that the paragraph could do, on the construction suggested by the opponent, would be to provide, in the insurer’s favour, that it could rely on a judgment or final adjudication in other proceedings, and then not otherwise itself have to prove the application of cl.3.1 in the insurance proceedings themselves.

47 In my opinion, the final paragraph of cl.3.1 was intended to confer a benefit on the insured, a benefit consistent with the general purpose of the Policy to assist in defence against allegations, at least until such time as allegations involving dishonesty and the like were proved. In my opinion, this is confirmed by cls.4.4, 4.5, 4.15 and 4.16. I think effect should be given to the words “has been established”, so that cl.3.1 cannot prevent the contract requiring the insurer to provide indemnity, unless and until the requisite judgment or adjudication has been obtained.

48 It is true that one would not readily read the Policy as protecting dishonesty. But questions of honesty of conduct of Directors and Officers of companies are often difficult and marginal; and a finding of dishonesty should generally be made only after natural justice has been given to persons against whom allegations of dishonesty are made. Part of the apparent commercial purpose of this Policy is to assist insured Directors and Officers to have that natural justice, by way of provision of costs for the defence of such allegations.

49 The insurer is purportedly given some discretion in relation to the advancing of Defence Costs. However, cl.2.1 is expressed as an extension and not as a qualification to the indemnity given in Section 1, and that indemnity includes indemnity against Defence Costs. Once Defence Costs have actually been incurred (either with the insurer’s consent or where that consent has been unreasonably withheld) and paid, there is Loss; and thus the indemnity given by Section 1 is engaged and the insurer has no discretion to refuse indemnity. In my opinion, cl.2.1 only gives the insurer a discretion in relation to the timing of payment of Defence Costs, and it permits the insurer in its discretion to withhold payment until Defence Costs have actually been so incurred and paid.

50 On the other hand, the contract does not say that the insurer cannot attempt to establish the exclusion in cl.3.1 in proceedings between insurer and insured, and I do not think there is any implication to that effect. If cl.3.1 provided the only defence, then, until that defence was established by judgment, the insurer would be in breach in not providing indemnity. But this does not mean it is a breach of contract to plead cl.3.1 and to attempt to establish it, nor is there any principle, analogous to that in Baldry v. Jackson [1976] 2 NSWLR 415, which would prevent the pleading of defences which will only take effect at some future date; and the effect of establishing this defence would be to relieve the insurer from any liability to provide any future indemnity and to entitle the insurer to a refund of money already paid. In my opinion, the only relevant implied term is that the insurer should not rely on cl.3.1 in any way which would be a breach of its obligation of good faith.

51 In my opinion, the obligation of good faith means that the insurer can rely on any defence only if it has reasonable grounds to do so; and generally this would require legal advice given on the basis of full instructions as to facts and evidence known to the insurer. Of course, because of privilege, the insured and the Court will not generally be able to put that to the test, so to some extent this must depend upon the integrity of the insurer. Otherwise, the only real sanction is the possibility of striking out defences which are shown to have no reasonable chance of success.

52 If cl.3.1 is the only defence, and the insured has incurred Defence Costs (either with the insurer’s consent, or where that consent has been unreasonably withheld) and has actually paid those costs, then in my opinion the insurer has no defence to the claim in so far as it relates to the situation which applies until such time as the last paragraph of cl.3.1 is satisfied. The insured could apply for some kind of summary judgment, either for part of the damages claimed or possibly for an order for specific performance requiring payment of Defence Costs when they are incurred (with consent, or consent being unreasonably withheld) and paid, until such time as judgment is given on the cl.3.1 defence. If the insurer considered its defence under cl.3.1 to be sufficiently strong for it to obtain a summary judgment on it, then it could respond by seeking such a judgment. Otherwise, the insurer would have no defence to such a summary judgment, except on the question of the reasonableness of withholding consent to the incurring of costs and discretionary considerations relating to the grant of that kind of judgment. The insurer could seek an urgent final hearing of the issue raised by the cl.3.1 defence; and it would then be a matter for the Court as to whether or not it would require the insurer to comply with its contract until that issue is heard, and whether or not it would expedite the hearing of that issue.

53 If there are other defences, and if the issues raised by those other defences are intertwined with issues raised by the cl.3.1 defence, then in my opinion there is no basis on which the insured could seek any relief until all issues are heard and determined.

54 If there are other defences, but those defences raise issues entirely distinct from issues raised by the cl.3.1 defence, then in my opinion it could be open to the insured to apply for a separate hearing of those other defences. If those defences could be dealt with quickly, it might be appropriate for the Court to exercise its discretion to deal with them first; and then, if the insured was successful on those defences, the position would be the same as if cl.3.1 were the only defence.

55 To my mind, there is some analogy here with the position which arises when an impecunious plaintiff has a money judgment in a complex case, and the defendant appeals and seeks a stay of that judgment. The plaintiff then contends that it cannot have a fair hearing of the appeal unless it has access to at least some of its judgment in order to pay for its legal representation, while the defendant says that, if it is required to pay, the money would be irrecoverable and its appeal rights would effectively be lost. In those circumstances, it is a matter of a discretionary judgment as to what, if any, stay should be granted.

56 In cases such as the present, an insured can say that, if it does not have funding for its defence, there will not be a fair decision as to whether or not there was dishonesty; and the insurer can say that, if it is compelled to fund the defence, the money will be irrecoverable and it will lose the benefit of the dishonesty clause.

57 In my opinion, the resolution of this difficulty in cases dealing with the subject Policy must have regard to the following:

1. If the only defence is cl.3.1, then, until there is a judgment, the insurer is plainly in breach if it does not pay Defence Costs once they have been incurred and paid (subject to reasonableness questions).
2. However, whether or not such payment would be ordered is subject to discretions, in particular discretions concerning the granting of an appropriate summary judgment and discretions concerning the timing of hearing of issues.
3. If there are other reasonable defences, and the issues raised by those defences are intertwined with the issues under cl.3.1, then generally there is no way in which the insured can compel the funding of its defence in advance of a final determination of the insurance proceedings.
4. If there are other reasonable defences, and the issues raised by those defences are severable from issues under cl.3.1, then there will be case management questions and other discretionary questions which may arise in determining whether issues are severed, and if so when and in what order they are heard.
5. I would add also that there may be a further question of case management, as to whether a dishonesty allegation brought by third parties should or should not be heard together with the cl.3.1 defence raised by the insurer. If cl.3.1 is the only defence and there is a summary judgment relating to Defence Costs paid during the period until that defence may be established, then the insured would be funded in relation to that combined hearing.

58 In my opinion, that approach conforms to the words of the Policy, and it does maximum possible justice to the requirement of good faith, and also to the competing considerations flowing from the general obligation of the insurer to fund the insured’s defence unless and until dishonesty is proved, and the right of the insurer to refuse indemnity in circumstances referred to in cl.3.1.

59 On the question of leave, in my opinion determination of these questions was appropriate in order to do justice between the parties. In my opinion it is appropriate to address these questions at this time.

CONCLUSION

60 It follows that the answers to questions 2 and 3 given below are correct. The answer to question 1, however, could be misleading. It is true that the cl.3.1 defence can be relied on in the sense that it can be raised as a defence in insurance proceedings; but it cannot be relied on in the sense that cl.3.1 does not provide a valid justification for refusal of indemnity unless and until the fourth paragraph is satisfied. So I would propose that question 1 be answered yes, but only in the sense and subject to the qualifications set out in my reasons.

61 Accordingly, I would propose that leave to appeal be granted, and that the appeal be upheld to the extent that I have indicated but otherwise dismissed.

62 As regards costs, the result gives some success to both parties, both in relation to the original hearing and in relation to the appeal. One possible costs order would be that each party pay its own costs of the hearing below and of the appeal. Another would be to make the costs of both the hearing below and of the appeal costs in the proceedings. A third alternative, which is the one I prefer, would be to make the costs of both the hearing below and the appeal costs in the proceedings, unless a judge in the meantime makes an order which has the effect of providing Defence Costs to the claimants in advance of the final determination of the insurance proceedings, in which case one might expect that there would be a costs order for the hearing below and the appeal in favour of the claimants.

63 TOBIAS JA: In this matter I have had the advantage of reading in draft the judgment of Hodgson JA. I agree with his Honour’s conclusion at [59] that the affirmative answers to Questions 2 and 3 given below were correct and I do so substantially for the reasons his Honour has given. However, with respect, I am unable to agree with his Honour’s affirmative answer to Question 1 which he has subjected to the qualification that a clause 3.1 defence cannot be relied on as providing a valid justification for refusal of indemnity with respect to Defence Costs unless and until the relevant conduct referred to in that clause has been established by a judgment or other final adjudication adverse to the relevant director. In my opinion, Question 1 was correctly answered in the affirmative without qualification.

64 The relevant provisions of the Policy are set out in the judgment of Hodgson JA and need not be repeated. Where I refer hereafter to words or expressions which are defined in Section 5 of the Policy, I do so upon the basis that they bear their defined meaning. Further references to the “insured” are intended to encompass the Directors and Officers who are the subject of the indemnity which the Policy provides.

65 Subject to the terms and conditions of the Policy including clause 3.1, there is no doubt that Insuring Agreement A in Section 1 thereof provides indemnity against, inter alia, the incurring by the insured of Defence Costs. Accordingly, if such costs are incurred by an insured he or she may seek payment of them by way of indemnity from the insurer.

66 However, the insurer is entitled to refuse indemnity and, therefore, payment of Defence Costs where the Claim which caused those costs to be incurred by the insured was brought about by, contributed to or involved, inter alia, a dishonest act or omission on the part of the insured. As Hodgson JA has held, the insurer may defend any claim for indemnity under Section 1 of the Policy by pleading the exclusionary provision of clause 3.1. If it is successful in that defence in the sense that the “subject conduct has been established by a judgment” within the meaning of clause 3.1 adverse to the insured, then the insurer is no longer bound to indemnify the insured against loss including Defence Costs otherwise duly incurred.

67 However, with respect to Hodgson JA I cannot agree that clauses 4.4, 4.5, 4.15 and 4.16 of the Policy confirm that the final paragraph of clause 3.1 was intended to confer a benefit on the insured to assist in his or her defence against the allegations made in a Claim unless and until such time as any allegations involving dishonesty and the like have been established in the required manner. The provisions referred to seem to me to be essentially neutral. Furthermore, it may be noted that clause 4.16 expressly provides that the insured, as a condition precedent to the right to be identified under the Policy, is not to incur any costs or expenses in connection with a Claim without the written consent of the insurer who is entitled at any time to take over and conduct in the name of the insured the defence of the Claim. This provision is consistent with the terms of clause 2.1 and, importantly, with the second paragraph of that clause and, as will appear, it is that provision which I regard as central to the resolution of Question 1.

68 It is true, as Hodgson JA points out at [48] of his judgment, that clause 2.1 is expressed as an extension to the indemnity given in Section 1 of the Policy and that that indemnity includes indemnity against Defence Costs. However, with respect, I cannot agree that the clause only gives the insurer a discretion in relation to the timing of payment of Defence Costs and only permits the insurer in its discretion to withhold payment of those costs until they have actually been incurred and paid.

69 By definition, Defence Costs are confined to all reasonable costs, charges and expenses “incurred with the prior written consent of the insurer in defending, investigating, ….any Claim”. In other words, costs do not become Defence Costs until, with the prior written consent of the insurer, they have actually been incurred. The second paragraph of clause 2.1 empowers the insurer, where it has not confirmed indemnity and elects not to take over and conduct the defence of any Claim, to pay those costs as they are incurred. In my opinion, if the insurer has a discretion to pay such costs in the circumstances postulated it also has a discretion to refuse to pay them. The construction adopted by Hodgson JA, it is respectfully suggested, would mandate the exercise of the insurer’s discretion only in favour of payment of Defence Costs notwithstanding a denial or non-confirmation of indemnity.

70 In my opinion, the scheme or structure of the Policy is clear. Insuring Agreement A in Section 1 requires the insurer to pay any Loss arising out of any Claim which Loss includes Defence Costs. However, that prima facie entitlement to indemnify is subject to the terms and conditions of the Policy including clause 3.1. The latter excludes indemnity against the financial consequences of any Claim including any Defence Costs incurred in defending the Claim. Clause 2.1 is an extension of the indemnity in Section 1 in that it provides for the payment of Defence Costs (or, more accurately, their advancement subject to the right of the insurer to recover them pursuant to the last paragraph of clause 2.1) at the discretion of the insurer notwithstanding that indemnity under Insuring Agreement A has been denied on the ground, inter alia, that clause 3.1 excludes it. In other words, clause 2.1 extends the indemnity set forth in Section 1 to advancing Defence Costs pro tem even where a Section 1 indemnity is in dispute as a consequence of the insurer invoking the clause 3.1 exclusion. That this is so is confirmed by the fact that the occasion for any such advancement is that the insurer has not confirmed indemnity (under Section 1) and elects not to take over and conduct the defence of any Claim.

71 In paragraphs 52 and 56.3 of his judgment Hodgson JA accepts that if the insurer raises a clause 3.1 defence to a claim for indemnity under the Policy and, in addition, raises other defences such as (as in the present case) non-disclosure or misrepresentation, then there would be no way in which the insured could compel the insurer to fund its Defence Costs in advance of the final determination of the proceedings in which those defences are litigated. However, with respect, I can find no reason in principle or as a matter of construction of the Policy to justify a distinction between an insurer being entitled to refuse indemnity for Defence Costs where it denies Section 1 indemnity on the grounds of non-disclosure or misrepresentation on the one hand but being required to indemnify those costs where it denies Section 1 indemnity only on the basis of the insured’s dishonesty or fraud within the meaning of clause 3.1 on the other. On the approach adopted by his Honour, the insurer would be entitled to exercise its discretion under clause 2.1 of the Policy to refuse to pay Defence Costs where it has declined Section 1 indemnity on the basis of defences other than one invoking clause 3.1 but would be obliged to advance those costs notwithstanding the clear words of clause 2.1 where the only ground upon which it has declined that indemnity is on the basis of dishonest conduct within the meaning of clause 3.1.

72 In my opinion, consistency requires that the second paragraph of clause 2.1 should be given effect to according to its terms which I regard as clear and unambiguous. True it is that under the third paragraph of clause 2.1 the insurer reserves the right to recover any Defence Costs advanced by it where it is subsequently establishes by judgment or other final adjudication that the insured was not entitled to the Defence Costs so advanced. That paragraph provides a necessary protection to the insurer in the event that it exercises its discretion to advance Defence Costs, in whole or in part, pursuant to the second paragraph of clause 2.1. The wording of the third paragraph has obvious similarities to that part of clause 3.1 which provides that the exclusion therein contained is only to apply to the extent that the subject conduct has been established by a judgment or other final adjudication.

73 In my opinion, there is nothing in the second paragraph of clause 2.1 or otherwise in the terms of the Policy which excludes its discretionary operation where Section 1 indemnity is refused by the insurer solely in reliance upon the clause 3.1 exclusion. By its terms it extends to or contemplates a refusal (or non-confirmation) of indemnity on any ground including, for example, non-disclosure and misrepresentation. If this be so, then it must follow that there is no justification to construe the second paragraph of clause 2.1 so as to confine the exercise of the discretion therein provided to refuse to advance Defence Costs where indemnity is declined on one basis rather than another.

74 It was submitted by the claimants and accepted by Hodgson JA that the concluding words of clause 3.1, “has been established”, were intended to require the insurer to provide indemnity for Defence Costs unless and until the requisite judgment or final adjudication had been obtained. This is so in the sense that unless such a judgment or final adjudication is obtained the insurer will be unable to rely upon clause 3.1 to ultimately refuse indemnity. As the primary judge said in [45] of his judgment,

All that the final paragraph does is make plain that CGU can only sustain its denial of indemnity if the relevant final determination is made.

75 However, clause 3.1 not only excludes indemnity against amounts payable in respect of a Claim but also against the incurring of Defence Costs in defending the Claim. Both elements of the financial consequences of a Claim are encompassed in the definition of Loss. If it be correct that indemnity under Section 1 of the Policy with respect to Defence Costs cannot be refused unless and until a judgment or other final adjudication establishes dishonest conduct in accordance with the concluding paragraph of clause 3.1, then it would also follow that unless and until that occurs the insurer would be required to not only indemnify the insured against Defence Costs but also against any other amounts payable in respect of a Claim where the liability to pay such amounts is determined in proceedings between the insured and the third party claimant before the insurer obtains a judgment against the insured establishing clause 3.1 conduct.

76 Thus if proceedings were brought by a third party against the insured in which, as would be likely, dishonest conduct by the insured is not alleged and those proceedings are finalised and a judgment obtained in favour of the third party against the insured before the finalisation of proceedings between the insurer and the insured, then on the approach adopted by Hodgson JA it logically must follow that the insurer would be required to indemnify the insured not only against the Defence Costs incurred by it in defending the third party claim but also against the requirement to pay any amount determined to be payable in respect of that Claim. In other words the Section 1 indemnity would operate in respect of all the financial consequences of the successful Claim unless and until the insurer managed to establish by a judgment or other final adjudication that the insured was guilty of dishonest conduct in accordance with clause 3.1. In the event that subsequently the insurer obtained a judgment or other final adjudication adverse to the insured within the meaning of clause 3.1, then it may be too late for the insurer to be able to recover the amount payable in respect of the Claim in respect of which it has already provided indemnity.

77 In my opinion, the Policy was not intended to provide a form of “up front” indemnity for the Defence Costs to the insured in the circumstances postulated. The clear structure of the Policy entitles the insurer to refuse indemnity in respect of any part of any Loss including Defence Costs where it asserts dishonest conduct within the meaning of clause 3.1 provided only that it will be ultimately required to indemnify the insured against that Loss unless it establishes by a judgment or other final adjudication that the relevant conduct was dishonest. In my opinion, neither the Policy nor its commercial purpose requires the insurer to advance to the insured either Defence Costs or any other amount payable in respect of a Claim where it has denied indemnity upon any proper ground including that provided by clause 3.1.

78 The construction which I have adopted is not inconsistent with the obligation of good faith which the insurer owes to the insured. I agree with what Hodgson JA has written in [51] of his judgment in this regard. Any defence by the insurer which invokes clause 3.1 must be based on reasonable grounds. In other words, the insurer cannot raise a defence based on clause 3.1 or any other ground for that matter for the purpose of frustrating or delaying the insured’s defence of a Claim brought by a third party. Of course, there would be little incentive for the insurer to do this as it might result in a judgment against the insured by default which is then enforced by the judgment creditor and in respect of which indemnity would be claimed by the insured. The insurer would still need to prove (either in proceedings instituted by it or in the third party proceedings) that it has a real defence to the insured’s claim to indemnity.

79 For these reasons there may well be cases where it is in the ultimate interest of the insurer to advance Defence Costs pursuant to the discretion vested in it by the second paragraph of clause 2.1 of the Policy so as to ensure that the Claim is properly defended by the insured where it might otherwise be regarded as weak and/or where the potential to successfully sustain its refusal of indemnity based on alleged dishonesty, non-disclosure or misrepresentation is not guaranteed. But it is not obliged to do so irrespective of whether its refusal of indemnity is based on alleged dishonesty or fraud of the insured within the meaning of clause 3.1 of the Policy or upon the basis of non-disclosure and/or misrepresentation by the insured which, although outside the terms of the Policy, would, if established, entitle the insurer, subject to the provisions of the Insurance Contracts Act 1984, to refuse indemnity.

80 For the foregoing reasons, I would propose that leave to appeal be granted but that the appeals be dismissed with costs.

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Last Modified: 07/31/2003