FORMER DIRECTORS OF TRIO CAPITAL LTD v ACE INSURANCE LTD

MEMORANDUM

1. My instructing solicitors act for GSA Insurance Brokers Pty Limited (GSA). GSA was the broker involved in the issuing by Ace Insurance Limited (Ace) of certain Investment Management policies to Astarra Capital Limited in respect of the period 15 September 2009 to 15 March 2011.1 The cover provided by the policies includes professional indemnity cover. 2. Astarra Capital Limited, later known as Trio Capital Limited (Trio) carried on business as a funds manager. However, it failed and has gone into liquidation. ASIC commenced an investigation into the failure of Trio, and a number of former directors of Trio made claims (as Insured Persons) under the policies in respect of their legal expenses. Ace initially provided such cover, but has recently indicated that, in reliance upon certain admissions made by Mr Shawn Richard, a former director and senior executive of Trio, of fraudulent conduct in relation to managed funds, it is declining indemnity under the policies to Trio and its directors, officers and employees. In so doing, Ace relies upon on Exclusion 4.1(d) the Prior Known Fact exclusion. 3. Ace contends that Mr Richards dishonest conduct amounts to a Prior Known Fact as defined in the policies, and, further, that it is entitled to deny indemnity in respect of any claims where the relevant Loss is one which is directly or indirectly caused by, or arising out of, or in any way connected with such conduct. According to Ace, the claims made by ACT Super Management Pty Limited on 7 March 2011 fall into this category, as will any claims that may be made in the future which arise from such conduct.

The terms of the policies do not differ in any respect which is material to the issues about which I have been asked to advise.

4. GSA has challenged Aces position. It has suggested to Ace that various former directors of Trio deny all knowledge of Mr Richards activities and so should get the benefit of General Condition 6.9 (Proposal Disclosure) which prevents certain information being imputed to Insured Persons. GSA says that this has the effect of overcoming the Prior Known Fact exclusion.

5. My advice has been sought as to whether reasonable grounds might exist upon which to challenge the basis of Aces denial of indemnity. I provided my views on this question in conference on 7 June. In summary, I advised that Aces position on the policy construction issue was stronger than that advanced by GSA. However, there may be a reasonable argument available to the effect that the Prior Known Fact exclusion is in substance concerned with failures by the insured to disclose matters prior to the contract being entered into, and hence cannot operate to exclude indemnity because to do so would be to provide a remedy in respect of such a failure which stands outside the exclusive code found within Division 3 of Part IV of the Insurance Contracts Act (the Act).

6. The purpose of this Memorandum is to briefly set out the reasons for that advice. Before doing so, I set out below the salient provisions of the policies.

7. Insuring clause 1.3 relevantly provides that Ace will pay to or on behalf of the Insured all Loss arising from any Claim2 first made against the Insured in the Policy Period for Wrongful Acts3 of the Insured .. while performing or failing to perform Investment Services.4

8. I note in passing that the demands made on behalf of ACT Super Management on 7 March 2011 seem to constitute Claims which satisfy the requirements of insuring clause 1.3, and Ace has apparently treated them as such.

2 3

Any Claim must be for a Wrongful Act or series of related or continuing Wrongful Acts. Wrongful Act is defined in clause 3.49. 4 Investment Services is defined in clause 3.22.

9. Exclusion 4.1(d) provides that Ace will not pay for any Loss directly or indirectly caused by, arising out of or in any way connected with any Prior Known Fact.

10. Prior Known Fact is relevantly defined to mean any fact which:

(a) an Insured was aware of after the Continuity Date [15.3.08] but prior to the commencement of the Policy Period [15.9.09], and

(b) the Insured knew, or a reasonable Insured would have considered, at any time after the Continuity Date but prior to the commencement of the Policy Period

might result in an allegation against an Insured of a Wrongful Act or might result in an Investigation.

11. The Prior Known Fact exclusion must be read in the light of Extension clause 2.8 (Continuous Cover), which relevantly provides: Notwithstanding Exclusion 4.1(d) Prior Matters ..Ace will pay Loss for any Claim first made against the Insured during the Policy Period..arising from a Prior Known fact provided that:

(a) the Claim would be covered under this Policy but for the operation of Exclusion 4.1(d) Prior Matters; and

(b) the Insured has maintained without interruption Investment Management Insurance with Ace or another insurer from the Continuity Date up until the date this Policy commenced; and

(c) the Insured would have been indemnified under such policy in force at the relevant time if the Prior Known Fact had been notified to the applicable insurer when the Insured first became aware of it; and

(d) neither the Claim nor the Prior Known Fact has been notified to Ace or to any other insurer under any other policy; and

(e) there

has

been

no

fraudulent

non-disclosure

or

fraudulent

misrepresentation to Ace in respect to such Prior Known Fact; and

(f) cover under this Extension will be in accordance with the terms, conditions, exclusions and limitations. of the policy in force at the time the Insured first became aware of the Prior Known Fact, but only where such earlier policy affords no broader cover in respect of the Claim than the provisions of this Policy. 12. Ace has asserted that this Extension does not apply because each of the provisos of the extension are not satisfied. This may well be correct, but it seems to me that this is an issue which needs to be considered further in the light of details of any relevant cover which was in place during the period 15 March 2008 to 15 September 2009.5

13. Leaving that matter aside, and assuming that Mr Richard had the knowledge described in Aces letters of 13 April 2011 by which they decline indemnity, there seems little doubt that an Insured (being Mr Richard) was aware of facts after 15 March 2008 but prior to 15 September 2009 which might give rise to an allegation of a Wrongful Act against an Insured, and a reasonable Insured would have considered at any time after 15 March 2008 but prior to 15 September 2009 that such facts might give rise to an allegation of a Wrongful Act against an Insured. Accordingly, it seems that the definition of Prior Known Fact is satisfied in relation to Mr Richards knowledge of such facts.6

There are some difficult construction issues involved with this provision, including what is meant by the expression when the Insured first became aware of it in paragraph (c) see also the expression the policy in force at the time the Insured first became aware of the Prior Known Fact in paragraph (f). 6 Mr Richards acquired knowledge of at least some of those facts before 15 March 2008. However, I think that paragraph (a) of the definition is unlikely to be read as requiring that the relevant Insured only become aware of the facts after 15 March 2008. It is enough if the Insured was aware of the facts at some time during the period 15 March 2008 to 15 September 2009.

14. It would follow that, subject to the possible effect of other provisions of the policy, exclusion 4.1(d) would operate so that Ace would not be bound to indemnify in respect of any Loss which arises out of or is connected with any such Prior Known Fact.

15. I think it is unlikely that General Condition 6.9 would operate to bring about a different result. That condition deals with a number of matters in relation to the proposal. It states that the declarations and statements in the proposal have been relied upon by Ace, are the basis of the coverage provided by the policy and are incorporated in and form part of the policy. It then goes on to state that the proposal is to be construed as a separate proposal by each of the Insureds and that with respect to statements made and particulars provided in the Proposal no statements or particulars and no information possessed by an Insured Person shall be imputed to any other Insured Persons, and only certain statements or knowledge is imputed to the Insured Organisation.

16. I am instructed that the relevant proposal was signed by the then managing director of Astarra Capital Limited (not Mr Richard). Question 13(b) asked whether the Applicant, or any director, officer or employee was aware, after enquiry, of any fact, circumstance, act or omission which may give rise to a claim. The answer given was No. So, at least in so far as the proposal was construed in accordance with General Condition 6.9 as a separate proposal by Mr Richard as an Insured, the statement in answer to the question 13(b) would be regarded as a misrepresentation. General Condition 6.9 then provides that neither such statement nor any information possessed by Mr Richard would be imputed to any other Insured Person.

17. However, the operation of exclusion 4.1(d), which concerns knowledge, does not require any knowledge to be imputed to an Insured. In its terms, exclusion 4.1(d) requires that an Insured must be aware of a certain fact which might result in an allegation against an Insured of a Wrongful Act (or an Investigation), and either the Insured must know or a reasonable Insured would have considered that such fact might result in an allegation against an Insured of a Wrongful Act (or an Investigation). 5

18. It is of course necessary for the exclusion to be read in the context of the policy as a whole (see Selected Seeds Pty Limited v QBEMM Pty Limited (2010) 85 ALJR 1 at [29] & [34]). However, bearing in mind that the exclusion and General Condition 6.9 perform somewhat different functions it seems unlikely that exclusion 4.1(d) would be held to have no application to innocent directors merely because the knowledge of Mr Richard (which is the subject of the Prior Known Fact and could have been disclosed on the proposal in answer to question 13(b)) cannot, by reason of General Condition 6.9, be imputed to them. 19. In order to counter Aces reliance upon exclusion 4.1(d) an argument could be raised to the effect that the exclusion, viewed as a matter of substance, operates in relation to matters which the insured was under a duty to disclose prior to the making of the contract of insurance (see s21 of the Act) and provides a remedy in respect of a failure to so disclose which goes beyond the remedies provided in the Act, thereby infringing s 33 of the Act.

20. Section 33 provides that the provisions of Div 3 of Part IV are exclusive of any right that the insurer has otherwise than under the Act in respect of a failure of the insured to disclose a matter to the insurer before the contract was entered into. (It should also be noted that by s52 of the Act a provision is void if it would have the effect of restricting or modifying, to the prejudice of a person other than the insurer, the operation of the Act.)

21. I am not aware of any cases in which it has been held that a provision of a contract of insurance governed by the Act purports to give remedies wider than those given to insurers under Div 3 of Part IV. However, the argument has been put in relation to provisions similar to exclusion 4.1(d), and such arguments have not been dismissed.

22. In Permanent Trustee Australia Limited v FAI General Insurance Company Limited (1998) 153 ALR 529 the argument was put in relation to a limitation on retroactive cover. The policy provided for unlimited retroactive 6

liability omitting claims or circumstances which are known to the insured prior to the inception of this insurance. Hodgson CJ in Eq at 568 held that as a matter of construction the provision only applied where the insured knows the circumstances as circumstances which might give rise to a claim. On the facts the provision did not apply but at 589 his Honour stated: If the retroactive clause had the effect of excluding liability for something which was in substance a non-disclosure, then I think s33 would in any event prevent the retroactive clause excluding liability.

23. It is not known whether the earlier case of Pech v Tilgals (1994) 94 ATC 4206 was cited to Hodgson CJ in Eq. In that case, Dunford J took a different approach in relation to a provision which excluded claims arising from any circumstances of which the insured was aware prior to the commencement of the insurance and which a reasonable accountant in the insureds position would at any time prior to the commencement of cover have considered may give rise to a claim. His Honour held that the exclusion did not apply on the facts, but went on to state that the exclusion was not void under s52 for modifying the operation of the Act relevant to non-disclosure because it was not concerned with non-disclosure and the claims specified are excluded whether the circumstances are disclosed or not so the remedies in s28 are not excluded or modified.

24. The above cases were referred to by Conti J in Permanent Custodians Limited v ARMA Pty Limited (2006) 14 ANZ Ins Cas 61-707 at 75,636-7 in relation to an exclusion which excluded claims arising from circumstances of which the insured was aware prior to the Insurance Period and which the insured or a person in the insureds position ought reasonably to have realised to be circumstances which might result in a claim. On appeal, in Macquarie Underwriting Pty Limited v Permanent Custodians Limited [2007] FCAFC 60 Allsop and Buchanan JJ at [28] stated that the contention of the insured that the exclusion was in substance a non-disclosure provision which offended s33 of the Act was arguable. They went on to note that insurers of claims made policies often attempted to identify the notification of a claim within the policy period as an essential attribute of the cover, rather than a 7

contractual condition of the policy regulating the conduct of the insured. Some similarity with the case before them was discerned, where the insurers by the exclusion were attempting to exclude from cover matters which would otherwise be disclosable. Their Honours said: The aim may readily be seen to be definitional, but it is arguable that s33 is engaged.

25. This issue is without doubt difficult. It plainly raises important issues, touching as it does upon the ability of liability insurers, in contracts governed by the Act, to restrict the extent to which retroactive cover is given (that is, cover for claims which arise from acts which occur before the making of the contract). Nonetheless, as matters currently stand, the point must be regarded as reasonably arguable.

26. Of course, even if exclusion 4.1(d) was not available to Ace in this case, it may well be able to rely, as against innocent directors, upon failures by the insured to comply with the duty of disclosure. Even if no fraudulent nondisclosure was established Ace would be in a very strong position to contend that had Mr Richards activities been disclosed it would have either declined to give any cover at all, or imposed a specific exclusion, such that any liability it would otherwise have for claims arising out of such conduct should be reduced to nil (see s28(3) of the Act). The question whether such defences would be available as against innocent directors is beyond the scope of that which I have been asked to consider, but I note that it may depend upon whether they are regarded as parties to the contract (or merely persons with rights under s48 of the Act7), and upon the effect of General Condition 6.9.

10 June 2011

Chambers

RJH DARKE SC

Liability limited by a scheme approved under Professional Standards Legislation

See CE Heath Casualty & General Insurance Limited v Grey (1993) 32 NSWLR 25.