Insurance in MOtion – When can an insurer refuse to advance payment of defence costs?

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In the recent case of Onley v Catlin Syndicate Ltd as the Underwriting Member of Lloyd’s Syndicate 2003 [2018] FCAFC 119 the Full Court of the Federal Court of Australia permitted an insurer to refuse to advance defence costs, even it had agreed an Automatic Extension in the Policy providing for payment of Defence Costs which required the insurer to meet the cost of the proceedings until criminal or dishonest conduct is established by judgment or adjudication.

The Insured had undertaken to provide payroll services for clients, whereby it would receive PAYGW amounts which it transferred to related companies. Rather than forwarding the PAYGW payments to the ATO, the companies transferred the payments to Mr Cranston and Mr Onley. The consequence of the arrangement was that the ATO could only enforce the taxation obligations against the companies, which were straw companies. As a result, proceedings were commenced against Mr Cranston and Mr Onley for dealing in the proceeds of crime.

Mr Cranston and Mr Onley sought an advancement of defence costs under the automatic extension from the Insurer. However, the Insurer denied this on the basis of non-disclosure, and sought to avoid the policy. Mr Cranston and Mr Onley attempted to argue that the insurer could not rely on the remedies in the Insurance Contracts Act where it had agreed to cover defence costs for wrongful conduct up to the time of judgment or adjudication.

The Court disagreed with this construction. It considered that it is the insured’s duty of disclosure which informs the terms on which an underwriter might assume a given risk, including by extending defence costs in instances of alleged wrongful conduct. Therefore, in circumstances where the Insured had not complied with its duty of disclosure, the insurer was entitled to rely on the facts and avoid the policy all together.

The decision clearly turned on the specific facts in this matter. At the outset, the Court was eager to state that: “Despite the outcome in this particular case, it 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. This is not an issue in this case, where there is no suggestion of disclosure, and the relevant facts of the charges, if true, must have been known to the Applicants, and the merits of the charges are sufficient to support the commencement of a prosecution.” [7]

However, the case is a reminder for Insurers to look behind alleged wrongful conduct to ascertain if there are circumstances which should have been disclosed prior to the parties entering into the insurance contract, and if so, whether such risk would have been underwritten.

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