Sections 28(2), 28(3) and 40(3) of the ICA consideredJul 2021 | Insurance
On 2 July 2021 the NSW Court of Appeal (Meagher JA, Bathurst CJ and Bell P) handed down judgment in P & S Kauter Investments Pty Ltd v Arch Underwriting at Lloyds Ltd.1
In upholding the primary judge’s decision that Underwriters had no liability to the appellants under a professional indemnity policy, the Court of Appeal discussed the operation of s 40(3), s 28(2) and s 28(3) of the Insurance Contracts Act 1984 (Cth) (ICA), including that:
- section 40(3) of the ICA requires notification of objective ‘facts that might give rise to a claim’ rather than mere possibilities; and
- although Underwriters bear the burden of proof, s 28(2) and s 28(3) can operate to reduce Underwriters’ liability to nil (for innocent misrepresentation or non-disclosure) or to entitle Underwriters to avoid a policy (for fraudulent misrepresentation or non-disclosure).
In January 2006, Moylan Retirement Solutions Pty Ltd (MRS) obtained an Australian Financial Services Licence (AFSL). Mr Moylan was the sole principal of MRS. He acted as an authorised financial services representative under MRS’s AFSL.
Four family group self-managed superannuation funds (appellants) received financial advice from Mr Moylan. Between 2006 and 2009 the appellants made various investments in projects or entities in which Mr Moylan had financial interests. This included making unsecured loans to Moylan Investments Group Pty Ltd (MIG). Mr Moylan was MIG’s sole director and shareholder. Further, some of the appellants’ moneys were misappropriated and treated by MRS as funds available to MIG. No payments of interest, repayments of principal, dividends or distributions were received by the appellants in relation to any of these investments after late 2009. MIG was wound up in September 2010.
MRS obtained professional indemnity insurance from certain Lloyd's underwriters (Underwriters) for two relevant policy periods, 5 February 2012 to 5 February 2013 (2012/2013 PI Policy) and 5 February 2013 to 5 February 2014 (2013/2014 PI Policy).
Significantly, in January 2013 Mr Moylan wrote to his broker seeking to renew the 2012/2013 PI Policy. He attached a completed policy renewal proposal and notification of circumstances. He stated that MRS only had 26 clients, of which 15 have their own self-managed superannuation fund. Mr Moylan’s letter went on to say that in relation to the potential claim ‘at this stage it is just a possibility and no action has been brought’. In response to a specific set of questions on the notification of circumstances form (particulars of the relevant contract, name of potential claimant, amount claimed, estimate of potential monetary liability), Mr Moylan answered ‘unknown’. However, Mr Moylan did specify that the relevant work was performed in 2008-2011, that there was no verbal claim or intimation of a claim, and that he became aware of the circumstance in August 2011. Attached to the notification form was an appendix in the following terms:
‘A small number of clients have invested/lent funds to property investments and/or companies that have to date been unable to repay those funds in total.
At the time of the investment all appropriate disclosures were made and clients invested/lent funds with full knowledge of the circumstances at the time.
At this stage no loss has been crystallised and no claim or complaint has been formally lodged.
We wish to advise the insurance company that there is a chance of a claim against Moylan Retirement Solutions in relation to any loss that may be incurred.’ (purported notification)
MRS was deregistered in August 2014.
The appellants commenced three separate proceedings against Underwriters under s 601AG of the Corporations Act 20012 alleging they were entitled to recover MRS’s liability for negligent financial advice, misleading and deceptive conduct and breach of fiduciary duties from Underwriters. The appellants alleged that MRS was indemnified against those liabilities under either the 2012/2013 PI Policy or the 2013/2014 PI Policy. The appellants’ proceedings were commenced and notified to Underwriters during the 2013/2014 PI Policy Period.
The three proceedings brought by the appellants were heard together before Justice Slattery in the Supreme Court of NSW. Justice Slattery accepted that MRS was liable to the appellants for losses sustained as a result of its misleading or deceptive conduct, negligent advice and breaches of fiduciary duty. He held MRS’ total liability, exclusive of interest and costs, to be $4,630,000. However, he determined that the appellants’ claims against Underwriters failed since:
- The 2012/2013 PI Policy either:
- did not respond on the basis that the purported notification was not sufficient to engage s 40(3) of the ICA4 as it did not notify ‘facts that might give rise to a claim’. It notified only ‘bare possibilities’ which did not point towards any particular claim; or
- did respond but Underwriters’ liability was reduced to nil under s 28(3) of the ICA5 due to MRS’s material non-disclosures; and
- The 2013/2014 PI Policy did not respond because:
- MRS had made fraudulent misrepresentations and non-disclosures (in the purported notification) which entitled Underwriters to avoid the 2013/2014 PI Policy under s 28(2) of the ICA;6
- alternatively, MRS’s innocent non-disclosures would entitle Underwriters to reduce their liability to nil under s 28(3) of the ICA; and
- in any event, Underwriters were entitled to rely on four exclusion clauses (fraud and dishonesty, conflict of interest, statement of advice and unregulated loans) to exclude cover for some or all of the liability.
The appellants appealed.
The NSW Court of Appeal (Meagher JA, Bathurst CJ and Bell P) unanimously dismissed the appeal and upheld the findings of the primary judge, Justice Slattery. We discuss the significant findings bellow.
Was the purported notification notice ‘of facts that might give rise to a claim’ as required by section 40(3) of the ICA?
Relevantly, s 40(3) of the ICA provides:
‘Where the insured gave notice in writing to the insurer of facts that might give rise to a claim against the insured as soon as was reasonably practicable after the insured became aware of those facts but before the insurance cover provided by the contract expired, the insurer is not relieved of liability under the contract in respect of the claim, when made, by reason only that it was made after the expiration of the period of the insurance cover provided by the contract’. (our emphasis)
In order to trigger s 40(3) of the ICA there needs to be sufficient connection between the facts notified and the claim subsequently made. It is not necessary that the notified facts identify the likely claimant or claimants. The notification may be of a problem or circumstances which may give rise to a claim or claims by persons or entities having particular characteristics.7
The requirement that the notification is of ‘facts’ indicates that s 40(3) of the ICA is concerned with objective matters that have a bearing on the possibility of a claim being made, rather than a mere belief or opinion as to that possibility. The reference to the possibility of a ‘claim’ rather than ‘liability’ includes claims which may not have significant prospects of success.
The Court of Appeal determined that the purported notification (see details above) did not suggest any sort of claim, did not include any fact which made a loss more than a possibility and did not identify any defect in advice given or disclosures made by MRS. It merely informed that should any investors suffer a loss of invested funds, there was a ‘chance’ they may make a claim against MRS.
The Court of Appeal upheld Justice Slattery’s finding that the purported notification did not notify ‘facts that might give rise to a claim’. It followed that s 40(3) of the ICA did not apply and there was no notification under the 2012/2013 PI Policy.
Was there a material non-disclosure in relation to the 2012/2013 PI Policy?
The primary judge determined that Mr Moylan had misappropriated client money and used it (unbeknown to clients, including the appellants) for MIG’s benefit and other purposes. Underwriters pleaded that if they been aware that Mr Moylan had misappropriated client money they would have not issued the 2012/2013 PI Policy or the 2013/2014 PI Policy. This was supported by affidavit evidence from a senior underwriter and underwriting expert evidence.
The Court of Appeal held that the non-disclosure was material and that even if the 2012/2013 PI Policy was engaged Underwriters’ liability was reduced to nil under s 28(3) of the ICA.
Were Underwriters entitled to avoid the 2013/2014 PI Policy or reduce their liability under that policy to nil?
The primary judge determined that the purported notification constituted fraudulent non-disclosure and misrepresentation, which entitled Underwriters to avoid the 2013/2014 PI Policy.
The Court of Appeal agreed and held that the misstatements made by Mr Moylan in the purported notification could not have been negligent or accidental. Mr Moylan knew the basis which underpinned his statements to be incorrect. The primary judge was justified in the conclusion that fraudulent misrepresentations were made in relation to the 2013/2014 PI Policy entitling Underwriters to avoid the 2013/2014 PI Policy, as they did.
Further, with respect to the question of whether Underwriters’ liability under the 2013/2014 PI Policy was reduced to nil due to innocent non-disclosure, for the same reasons as articulated in relation to the 2012/2013 PI Policy, the Court of Appeal held there was an innocent non-disclosure which entitled Underwriters to reduce their liability to nil.
Implications of this decision
This decision provides useful guidance as to what the courts will consider to be a valid notification of a claim or circumstance. It is not uncommon for insureds to make broad, blanket notifications of circumstances which might give rise to a claim, particularly in the lead up to policy renewal. Such notifications are not necessarily sufficient to amount to effective notifications of claims and require consideration with reference to the requirements of s 40(3) of the ICA when claims arise.
In addition, this decision highlights the manner in which s 28(2) and s 28(3) of the ICA can operate if there is a material non-disclosure or misrepresentation by an insured to reduce insurers’/Underwriters’ liability or to avoid a policy if there is evidence of fraud. It is noteworthy that in this matter evidence in support of the materiality of the non-disclosures and misrepresentations was adduced from a senior underwriter (as a factual witness) as well as an expert underwriter.
1  NSWCA 136; BC202105739.
2 Section 601AG of the Corporations Act 2001 operated to place the insurers in the shoes of MRS in relation to the underlying causes of action and the appellants in MRS’s position in relation to the relevant insurance contracts.
3 Esined No. 9 Pty Ltd v Moylan Retirement Solutions Pty Ltd (No 2)  NSWSC 359.
4 Section 40(3) of the ICA states ‘where the insured gave notice in writing to the insurer of facts that might give rise to a claim against the insured as soon as was reasonably practicable after the insured became aware of those facts but before the insurance cover provided by the contract expired, the insurer is not relieved of liability under the contract in respect of the claim, when made, by reason only that it was made after the expiration of the period of the insurance cover provided by the contract’.
5 Section 28(3) of the ICA states ‘If the insurer is not entitled to avoid the contract or, being entitled to avoid the contract (whether under subsection (2) or otherwise) has not done so, the liability of the insurer in respect of a claim is reduced to the amount that would place the insurer in a position in which the insurer would have been if the relevant failure had not occurred’.
6 Section 28(2) of the ICA states ‘if the relevant failure was fraudulent, the insurer may avoid the contract’.
7 DIF III – Global Co-Investment Fund LP v DIF Capital Partners Ltd  NSWCA 124 .
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The material contained in this publication is in the nature of general comment only, and neither purports nor is intended to be advice on any particular matter. No reader should act on the basis of any matter contained in this publication without considering, and if necessary, taking appropriate professional advice upon their own particular circumstances.