The NSW Supreme Court has handed down a significant decision regarding Directors and Officers (D&O) insurance highlighting the importance of clearly expressed intent, particularly when modifying well-accepted policies and where statutory rights are being waived.
The court’s decision, handed down by Her Honour Justice Peden, calls into question some sought-after policy features such as continuity clauses and non-rescindability, while testing the definition of a ‘reasonable settlement’ in the absence of express requirements.
It also squarely points to the effect of the plaintiff’s chosen strategy of suing consecutive D&O insurance towers.
The plaintiff, CIMIC Group Limited (CIMIC), previously known as Leighton Holdings Limited, was a construction contractor, with D&O liability policies issued by the defendants (comprising the insurers for the relevant policies during FY 2010/2011 and FY 2011/2012).
The claims arose from various criminal and civil proceedings brought against Leighton and its officers for alleged bribery offences after the discovery and disclosure of a file note (Iraq File Note) relating to the Leighton’s bid for a crude oil export facility project in Iraq.
CIMIC sued its 2011 insurers for their failure to indemnify it for the costs incurred by the proceedings totalling more than $45 million. CIMIC sought a declaration that the 2011 insurers were severally liable to indemnify CIMIC for the costs and damages associated with the investigation required and the defence of company securities claims.
In addition, CIMIC sought a declaration that it could claim under its 2010 policy.
The non-rescindability clause
Depending on its terms, a non-rescindability clause may prevent an insurer from exercising its statutory right to avoid a policy if an insured has been found responsible for a non-disclosure or misrepresentation prior to entering the policy.
In CIMIC Group Limited v AIG Group, Limited  NSWSC 999, the court considered whether a non-rescindability clause in the CIMIC Group’s 2011 policy applied to CIMIC’s securities claims.
The court’s decision-making process highlights the importance of clear drafting, especially when statutory rights are being waived.
The non-rescindability clause 7.1 of the policy provided that:
‘This policy is not avoidable or rescindable in whole or in part and the Insurer shall have no other remedy with respect to any pre-inception misrepresentation or pre- inception non-disclosure by any Insured in connection with this policy, except with respect of Insurance Cover 1.2 (“Company Securities”).
‘If the Insurer has a right to reduce its liability under Section 28(3) of the Insurance Contracts Act 1984 (Commonwealth) for any fraudulent misrepresentation or fraudulent non-disclosure of a matter or fact established by final adjudication of a judicial or arbitral tribunal, or any formal written admission by or on behalf of any Insured, the Insurer will only exercise such right against that Insured.’
CIMIC argued that according to the construction of the clause, the 2011 insurers had waived their right to rescind the policy with respect to any misrepresentation or non-disclosure except for company securities claims where the conduct was committed fraudulently.
By contrast, the insurers held that they retained their rights (including for non-fraudulent conduct) relating to company securities claims.
Justice Peden found that the non-rescindability clause operated to exclude all rights arising from any pre-inception misrepresentation or non-disclosure, other than for company securities claims, for which there was a specific carve-out.
Influenced by the insurers’ conscious decision to use the wording, ‘Insured’ in the clause, rather than ‘Policyholder’, Her Honour held that such an interpretation would provide a ‘harmonious’ interpretation of the policy.
Interestingly, this interpretation seems to suggest that for securities claims, the insurers in this case might have had greater rights for innocent misrepresentations or non-disclosures than for fraudulent ones.
While the issue did not affect the outcome of this case, the insurers could have reduced the sum paid (potentially to nil) for innocent misrepresentation or non-disclosure and canceled the policy for all insureds.
However, they could have only done the same for a particular insured if there had been a fraudulent misrepresentation or non-disclosure proven by a final adjudication or admission.
This apparent anomaly was one reason CIMIC decided to argue that the 2011 insurers’ rights should only be preserved in the event of fraud.
It is noteworthy that non-rescindability clauses are commonly intended to preclude all remedies except in the event of fraud. The difficulty in this case arose from the way ‘securities claims’ were carved-out in the wording.
Proper construction of the continuity clause
Another important aspect of the case was the interpretation of ‘limitations’ under the continuity clause in the 2011 policy, because it determined whether CIMIC was entitled to claim for a circumstance that should rightfully have been notified under the Group's 2010 policy.
The main controversy was over whether or not claims made under this continuity clause should be paid out of the 2010 policy (which had been eroded) or the 2011 policy limit.
The 2011 insurers argued that the word ‘limitation’ could only refer to the limit of liability and that the purpose of the clause was to enable insureds to notify a claim late without taking advantage of the new liability limit under the 2011 policy.
The continuity clause provided that a claim that was notified late in the 2011 policy was to be dealt with in accordance with the ‘terms, conditions, exclusions and limitations’ of the 2010 policy.
CIMIC argued however, that the purpose of the clause was to provide cover under the 2011 policy for any claim that could have been notified under an earlier policy but hadn’t been.
CIMIC also asserted that the insurers’ intention was to permit the Group to make a claim under the terms of previous policies but to be paid pursuant to the 2011 policy.
Justice Peden determined that the intention of the clause was that a claim made under the 2011 policy could have 2010 policy terms applied (including its limit of liability), without regard to any payments made under the 2010 policy limit.
As a result, it was immaterial that the 2010 policy limit had been eroded and CIMIC was entitled to enforce both the 2010 and 2011 terms.
This interpretation satisfied the language in the continuity clause requiring that the claim be ‘dealt with’ in accordance with the ‘limitations’ of the 2010 policy and that the claim be paid under the 2011 policy.
In our view, this interpretation may not align with the common industry understanding of such clauses. Rather, the policy in place at the time the circumstances should have been notified would apply, with its terms and in its condition at the time (including any erosion of the limit).
Disclosure of the Iraq File
Having dealt with the policy interpretation issues, the main proposition in the 2011 insurers’ case was that CIMIC breached its duty under s 21 of the Insurance Contracts (IC) Act 1984, as it failed to disclose the allegations in the Iraq File Note prior to entering the 2011 policy.
The 2011 insurers argued that they were entitled to reduce their liability to nil under s 28(3) of the IC Act. Justice Peden held that a breach under s 21(1) of the IC Act had been established.
The evidence indicated the relevant Leighton officer (whose knowledge was imputed to Leighton) was sufficiently informed of the alleged conduct contained in the Iraq File Note even though he was unsure of its factual truth.
Furthermore, a reasonable person in Leighton’s position would have known that the possibility of the allegations being true would be relevant to the 2011 insurers’ decision to grant cover.
To support their argument for reducing their liability to nil, the insurers pointed out that the renewed version of CIMIC’s D&O policy in the FY 2012/2013 year, expressly excluded losses attributable to the Iraq File Note.
CIMIC responded by arguing that the exclusion of those events in subsequent policies did not prove that the insurer would not have entered the 2011 policy on the same terms, had the Iraq File Note been disclosed.
The company pointed out that to suggest otherwise was an assumption made after the fact, and that the exclusions in the later policy could not necessarily be attributed to the Iraq File Note.
Justice Peden however, thought otherwise and held that the insurers had succeeded in their argument without requiring the presentation of the relevant liability exclusions.
Her Honour held that on the facts, it was sufficient that some action was taken in relation to the notification of the Iraq File Note. Consequently, the 2011 insurers were permitted to reduce their liability to nil for the majority of losses claimed.
Requirement for a ‘reasonable’ settlement
The CIMIC v AIG decision also provides guidance on the requirement for settlement sums to be ‘reasonable’.
While policies often stipulate that settlements should be ‘reasonable’, CIMIC’s policy did not. Therefore, a dispute arose as to whether reasonableness should be implied in the wording.
In determining this issue, Her Honour followed the construction of similarly drafted clauses in Weir Services Australia Pty Limited v AXA Corporate Solutions Assurance  and NSWCA 100 and Vero Insurance Ltd v Power Technologies Pty Ltd . NSWCA 226.
Essentially, Weir and Vero both provided that although their respective settlement clauses did not expressly require being reasonable, it was nonetheless required.
Therefore, despite no express requirement in the policy wording, CIMIC had to demonstrate that the relevant settlement sum was ‘reasonable’ in order for the company to be indemnified for costs incurred.
Ultimately, Justice Peden held that the settlement amount was reasonable, as it was a bona fide attempt to settle the dispute and CIMIC’s exposure at trial was likely to be greater than the settlement amount.
The right to notify
As part of its strategy, CIMIC brought an alternative claim against its 2010 insurers and asked the court to make a declaration as to Leighton’s state of mind concerning the facts of the Iraq File Note.
The intention here was to address the potential for a differently constituted court to come to a different conclusion about what CIMIC knew about the Iraq File during the 2010 policy year. This approach was not without resistance.
To decide, the court firstly had to determine whether CIMIC should be prevented from bringing an alternative claim against its 2010 insurers.
The 2010 insurers argued that CIMIC had elected to notify the 2011 insurers at various points in time and therefore had chosen to seek indemnity from that tower rather than their own.
Based on that argument, CIMIC was not entitled to make a claim against the 2010 insurers.
Her Honour rejected the 2010 insurers’ argument, holding that CIMIC could bring an alternative claim against the 2010 insurers, and that it had an equal right to notify under either policy.
She pointed out that requiring CIMIC to elect a specific tower of insurers to notify would create an inconsistency in the policy terms. It was also held that the notification clauses in both policies conferred the right to notify the 2010 and 2011 insurers respectively.
In addition, the right to notify differed between the 2010 and 2011 polices. In the 2010 policy, the clause was permissive (stating that the ‘Insured may notify’), whereas the wording in the 2011 policy effectively made notification mandatory.
Notifying both 2010 and 2011 insurers
Justice Peden also held that CIMIC’s non-notification during the Iraq File Note’s creation did not indicate an election not to notify the 2011 insurers.
Furthermore, CIMIC’s subsequent notification of the Iraq File Note to the 2011 insurers did not in itself preclude it from claiming against the 2010 insurers, given that the non-disclosure came about through CIMIC’s silence rather than a specific communication with the 2010 insurers.
Her Honour pointed out that s 54 of the IC Act contemplates the possibility that parties might notify claims late, and this prevents any potential inference that CIMIC abandoned its right to notify the 2010 insurers.
It was held that CIMIC could properly notify both the 2010 and 2011 insurers of the Iraq File Note circumstances.
Accordingly, the court made a declaration that CIMIC was aware of the circumstances of the Iraq File Note during the 2010 policy period so that this could have been a notifiable event under the 2010 policy.
However, the court did not go as far as to confirm the effect of the notification and deeming clauses in the context of s 54 of the IC Act.
The insured is yet to prove that s 54 assists it to late notify the claim under the 2010 policy for the claim to be deemed ‘made’ under that policy.
The erosion of the 2010 policy limit may also be an obstacle if the continuity clause isn’t relied upon, which may explain why the primary claim was made against the 2011 insurers.
Some final thoughts
Not all clauses are created equal. This decision highlights the importance of clear drafting, particularly when modifying well-accepted policy forms. Insurers and insureds alike should take care to ensure the intent of a policy is clearly expressed, especially where statutory rights are being waived.
Continuity clauses are a common feature of D&O insurance policies (and other policies written on a claims-made basis) and often influential in convincing officers to stay with their existing insurers.
It is extremely important such clauses effectively set out their operation, especially in relation to the relevant limits that might apply. Insurers and insureds may wish to check the current wording of their policies to see if the appropriate drafting is in place and the policy operates as intended.