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Limelight 04/20

Insolvency exclusions: what are they and when do they apply?

Insolvency exclusions are common in directors’ and officers’ liability (D&O), professional indemnity (PI) and management liability (ML) policies issued in Australia and elsewhere.

The unfortunate economic and commercial consequences of the COVID-19 pandemic will likely result in these exclusions requiring more frequent and closer consideration when assessing claims.

To that end, we now discuss some issues that may arise when assessing whether an insolvency exclusion applies, together with some observations on strategy in relation to such claims.

What is an insolvency exclusion

The wording of insolvency exclusions in the market varies significantly, but, broadly speaking, a standard insolvency exclusion will seek to exclude cover for claims and/or loss that arise from, or are otherwise sufficiently related to, the insolvency of an insured organisation.

Insolvency exclusions typically include three limbs:

  1. a description of the cover excluded. This is worded differently in different policies and could include “liability under this policy”, “Loss” and/or “loss, costs and expenses”;
  2. the ‘causal’ limb. This describes the required connection or relationship between the insolvency or insolvency event and what is excluded. The wording used may require a close causal connection, such as “caused by”. Alternatively, words that require less of a direct connection may be used, such as “arising from”, “relating indirectly” or “in any way whatsoever connected with”; and
  3. a description of the event that triggers the insolvency exclusion. Commonly the trigger may be the “insolvency of the insured”. It could, however, be broader, and refer to bankruptcy, receivership, administration or liquidation of the insured or some other organisation. It may also refer to the inability of the insured to pay its debts as and when they are due.

Please see some example insolvency exclusions in the Annexure below, with each limb of the exclusion unpacked.

Common issues that arise

The causal connection

One issue that often arises is the assessment of the required connection between the insolvency event and the loss or claim in light of the ‘connecting words’ used in the ‘causal’ limb.

For example, the words “arising from” in the context of an insolvency exclusion have been held to require “some causal connection between the claim and the specified matter”, but that the connection could be satisfied by “a less proximate relationship than that required by the phrase “caused by”[1].

Of course, what constitutes a causal connection that is less than a proximate relationship, but sufficient to meet the term “arising from”, can be difficult to determine. In the context of a liability claim against an insured, the cause of action has been said to “arise from” a set of material facts, proof of which found the cause of action. Similarly, a claim has been said to “arise from” the underlying facts that, if established, justify the claim[2].

Other exclusions use wider connecting words than “arise from”. For example, the use of the word “indirectly” to qualify the causal link has been said to reduce the causative effect downwards from a proximate cause. Further, the use of connecting words such as “relating to” may only require a mere connection or relation[3]. However, a mere “ancillary connection” may still not be enough[4].

What must be causally connected

The description of the cover excluded in the first limb will often be relevant in determining whether an insolvency exclusion applies. For example, the exclusion may exclude all “loss, liability, costs and expenses” that are causally related to the insolvency trigger. Conversely, the wording might provide that the exclusion only applies if the claim is causally related to the insolvency trigger.

The recent Full Court of the Federal Court of Australia decision in Kaboko[5] considered this issue. In that case, the policy excluded cover for

Loss in connection with any Claim arising out of, based upon or attributable to the… insolvency of the Company…

The Full Court in that case held that the wording required the insurer to demonstrate that the Claim (as defined) arose out of, was based upon or attributable to the insolvency of the Company. The exclusion was not satisfied by only the Loss having the requisite relationship to the insolvency of the Company.

Allocation

There may be instances where an insolvency exclusion applies only in part to a claim. Indeed, while the Full Federal Court in Kaboko found that the insolvency exclusion did not preclude cover for the entire claim, it was capable of applying in respect of certain claims made by the plaintiff[6].

Where an insolvency exclusion applies to only part of a claim, consideration will need to be given to any allocation clause in the policy to determine whether and to what extent cover is available.

Some strategic considerations

There are also a number of broader strategic matters that may need to be considered when assessing a claim that potentially triggers an insolvency exclusion.

A common issue that arises is whether any dispute about the application of an insolvency exclusion should be, or is capable of being, determined as a preliminary or separate question in the underlying proceedings brought against the insured.

In cases where it is possible for the insurance issue to be determined before primary liability of the insured is determined, careful consideration should to be given as to the potential benefits and risks associated with that course. An early successful determination could potentially extricate the insurer from any exposure by validating its position on the exclusion; however, if the determination is unfavourable, it could inflate the plaintiff’s expectations in respect of any potential settlement by exposing the availability of funds to meet any judgment. The appeal of any determination could also delay the proceedings generally and increase costs.

A further issue arises where an insurer is joined directly to proceedings and the insolvent insured is unable to fund its defence. In these cases, consideration will need to be given as to whether and to what extent it is appropriate to run a positive defence on liability in addition to the coverage defence, and if so, how the insurer is to obtain relevant documents and access to witnesses to run the liability defence.

Conclusion

Although insolvency exclusions in D&O, PI and ML policies are fairly common, they differ greatly in wording and scope. Careful consideration of the precise words used and relevant case law should be carried out before making a final determination as to whether any particular insolvency exclusion applies.

Moreover, given the unique situations presented by the insolvency of an insured in defending a liability claim, it is important to carefully consider broader strategic issues relating to the resolution of any dispute on coverage, together with the common interest an insurer and insured might have in defending the claim on primary liability in any event.

Annexure – Example insolvency exclusions

Complete exclusion Cover excluded Causal description Insolvency trigger
PI Policy A

‘We will not pay for any amounts insured under the Policy for or arising out of…the insolvency, receivership, administration, bankruptcy or liquidation of the Insured’

‘amounts insured under the Policy’ for or arising out of’ the insolvency, receivership, administration, bankruptcy or liquidation of the Insured’
PI Policy B

‘[The Insurer] will not be liable under the Policy to make any payment for Loss directly or indirectly caused by, arising out of or in any way connected with… the insolvency, bankruptcy or liquidation of any person or entity, including an Insured’

‘any payment for Loss’ ‘directly or indirectly caused by, arising out of or in any way connected with’ ‘the insolvency, bankruptcy or liquidation of any person or entity, including an Insured’
PI Policy C

‘This Insured section excludes and does not cover any claims, liability, loss, costs or expenses… arising out of or relating directly or indirectly to the insolvency or bankruptcy of the Insured or of any insurance company, building society, bank, investment manager, stockbroker, investment intermediary, or any other business, firm or company with whom the Insured has arranged directly or indirectly any insurances, investments or deposits’

‘claims, liability, loss, costs or expenses ‘arising out of or relating directly or indirectly’ the insolvency or bankruptcy of the Insured’

or

‘the insolvency or bankruptcy of… any insurance company, building society, bank, investment manager, stockbroker, investment intermediary, or any other business, firm or company with whom the Insured has arranged directly or indirectly any insurances, investments or deposits’

PI Policy D

The Underwriters shall not provide indemnity in respect of any Claim… arising from:

a)      the insolvency of any insurer or reinsurer…’

‘indemnity in respect of any Claim’ arising from ‘the insolvency of any insurer or reinsurer’
D&O Policy A

‘The Insurer shall not be liable under any Cover or Extension for any Loss in connection with any Claim arising out of, based upon or attributable to the actual or alleged insolvency of the Company or any actual or alleged liability of the Company to pay any or all of its debts as and when they fall due’

‘any Cover or Extension for any Loss in connection with any Claim’ ‘arising out of, based upon or attributable to’ ‘the actual or alleged insolvency of the Company’

or

‘any actual or alleged liability of the Company to pay any or all of its debts as and when they fall due

D&O Policy B

‘The Insurer shall not be liable for Loss in respect of any Claim… based upon, arising from or attributable to the insolvency, liquidation, bankruptcy, winding-up, receivership or administration of the Organisation or its actual or its actual or alleged inability to meet any or all of its debts as and when they fall due’

‘Loss in respect of any Claim’ ‘based upon, arising from or attributable to’ ‘the insolvency, liquidation, bankruptcy, winding-up, receivership or administration of the Organisation’

or

‘[the Organisation’s] actual or its actual or alleged inability to meet any or all of its debts as and when they fall due’

ML Policy

‘We will not cover the insured for or in connection with… any claim arising from or in any way whatsoever connected with the insolvency, liquidation, bankruptcy, receivership or administration of the company, any subsidiary or any associated company, its actual or alleged inability to meet any or all of its debts as and when they fall due’

‘cover… for or in connection with any claim’ ‘arising from or in any way whatsoever connected with’ ‘the insolvency, liquidation, bankruptcy, receivership or administration of the company, any subsidiary or any associated company’

or

‘it’s actual or alleged inability to meet any or all of its debts as and when they fall due’

 

 

[1] Quintano v B W Rose Pty Ltd & Ors [2008] NSWSC 793 at [7] citing GIO (NSW) v R J Green & Lloyd Pty Ltd (1966) 114 CLR 437.
[2] Quintano v B W Rose Pty Ltd & Ors [2008] NSWSC 793 at [8].
[3] Crowden & Anor v QBE Insurance (Europe) Ltd [2017] EWHC 2597.
[4] Kyriackou v ACE Insurance [2013] VSCA 150 at [109].
[5] AIG Australia Limited v Kaboko Mining Limited [2019] FCAFC 96.
[6] AIG Australia Limited v Kaboko Mining Limited [2019] FCAFC 96 at [60].

 

This publication constitutes a summary of the information of the subject matter covered. This information is not intended to be nor should it be relied upon as legal or any other type of professional advice. For further information in relation to this subject matter please contact the author.