The Full Court of the Federal Court in the last couple of weeks considered a question that by some has been considered a “sleeper issue” which had not previously received judicial attention. The question was whether a final adjudication clause in a conduct exclusion prevents Underwriters from relying on their statutory right to avoid a policy for fraudulent non-disclosure. If the answer was “yes” Underwriters would be required to advance defence costs until a finding was made which triggered the conduct exclusion.

The Federal Court decision of Onley v Catlin Syndicate Ltd as the Underwriting Member of Lloyd’s Syndicate 2003 (the Insurer) determined that the answer to that question is “no” and the Insurer is not prevented from avoiding the policy.

Norton Rose Fulbright Australia acted on behalf of the Insurer in the proceedings.

Background

Indemnity proceedings were brought by Adam Cranston and Jason Onley (who are being pursued by the ATO in one of Australia’s biggest cases of tax fraud), against their Management Liability insurer. The Insurer had exercised its statutory right to avoid the policy under Part IV of the Insurance Contracts Act, refusing to advance Cranston & Onley’s costs of defending ongoing civil and criminal proceedings against them by the Australian Federal Police and the ATO.

This case is particularly noteworthy given that the facts which were the subject of the non-disclosure (and which the Insurer relied on to avoid the policy) i.e. corporate arrangements that would facilitate the fraud, hold similarities to the facts that are the subject of the Proceedings for which Cranston and Onley sought funding of their defence costs

The Separate Question

The Separate Question issue was whether the final adjudication clause in the dishonesty exclusion meant that Underwriters had somehow waived their entitlement to avoid the policy on the basis of fraudulent non-disclosure.

Cranston and Onley argued that:

  • the interaction of these provisions precluded the Insurer from exercising its statutory right to avoid,
  • the Insurer had agreed to “pay now” and “claw back later” and that by avoiding the policy, it was pre-judging the outcome of the Proceedings which were unproven until the Proceedings were resolved, and
  • the substance of their non-disclosure could not be determined until Wrongful Conduct (as defined under the policy) had been established.

In response, the Insurer agreed that the exclusion comes into play if the policy is validly on foot. But in circumstances where its existence is based on fraudulent non-disclosure, the Insurer argued that the exclusion cannot apply because the Policy is avoided at inception.

The Insurer argued that it wasn’t necessary to await final adjudication as there was sufficient information available about the business model of Plutus Payroll, of which Cranston and Onley were allegedly the masterminds, to establish a real risk that the ATO would come after those involved in the business, including Cranston and Onley, to recover any unpaid tax. As has been much-reported, that business model involved Plutus Payroll (another Insured under the policy) being set up in a way which enabled Cranston, Onley and others to benefit from payments which were due to the ATO, leaving the ATO no option to recover the tax debt but from a string of phoenix companies with straw directors.

The Insurer argued that this business model, which wasn’t disclosed prior to policy inception, was material to their decision to underwrite the Policy. The Insurer therefore exercised its statutory right to avoid the policy.

The Federal Court’s Decision

The Court agreed with the Insurer, answering the Separate Question in the negative.

The Court held that “there can be little doubt” that there were “matters which were fraudulently non-disclosed” and also that “one need only set out the business model in these basic terms to appreciate that it is fraught with the risk that the ATO may seek to recover its lost tax revenue from those involved in the scheme.”

The Full Court held that Underwriters did not have to extend payment for defence costs to Cranston and Onley in accordance of the Defence Costs extension because:

  1. As a matter of construction, the Defence Costs Extension does not diminish or contractually qualify the Insurer’s statutory right to avoid the policy consequent upon Cranston and Onley’s non-disclosure.
  2. As a matter of public policy, Courts will not allow a party to contract out of the consequences of his/her own fraudulent conduct.

Public policy considerations

Clearly, the Court was not prepared to allow the insureds to obtain a benefit from their alleged fraud. It held that if the separate question was determined in Onley and Cranston’s favour, it would risk a situation of the duo benefiting from the fraud, stating: “even to require the insurer to defer acting upon its claim of fraudulent non-disclosure whilst the question of whether the Applicants committed Wrongful Conduct is adjudicated could give the Applicants the benefit of their own fraud. To accept such a proposition would be to undermine the common law’s historical abhorrence of such conduct.”

Implications for insurers

Courts won’t limit the statutory right of insurers around fraudulent non-disclosure without express language in the policy. The presence of a final adjudication clause in a dishonesty exclusion is not enough to waive insurers’ statutory rights to avoid. The Court also emphasised that it won’t read a policy in a way that risks giving insureds who have fraudulently induced an insurer to enter a policy by reason of non-disclosure a way to benefit from that fraud.