Strangers no more - Taking action against an insolvent defendant's insurer

In brief

The High Court of Australia has decided that a third party claimant can join an insolvent or potentially insolvent defendant's insurer to proceedings to seek a declaration that the insurer is liable to indemnify the defendant. Partner Andrew Maher and Lawyer Shelley Drenth discuss the decision and its implications. 

Background

It is well-established that, except in limited circumstances¹, an insurance contract may only be enforced by a party to, or a third party beneficiary of, that contract. Consequently, a third party claimant with a successful claim against an insured defendant cannot recover compensation directly from the defendant's insurer. This will usually be inconsequential because a solvent defendant will be motivated and able to procure the release of the insurance proceeds to pay the claimant.

However, where a defendant is insolvent or potentially insolvent, the third party claimant is vulnerable to any contentious denial of indemnity or reservation of rights by the defendant's insurer because the insured is unlikely to be motivated or able to challenge the insurer's decision. The prospect of a hollow judgment for the third party claimant is significant.

Over time, third party claimants have sought to join insolvent defendants' insurers to their proceedings to establish the insurers' obligations to indemnify their insureds for their liability to the claimants. Those attempts have been met with varying degrees of success in intermediate appellate courts throughout Australia. This case is the first time the issue has been heard and determined by the High Court.

The facts

In this case², the liquidators of Akron Roads Pty Ltd commenced an insolvent trading claim against Trevor Crewe, an Akron director, and Crewe Sharp Pty Ltd, a de-facto director of Akron. The defendants' insurer, CGU Insurance Limited, denied indemnity for the insolvent trading claim under their professional indemnity policy (the Policy). Crewe Sharp went into liquidation, Mr Crewe had insufficient assets to satisfy any judgment against him.

Akron's liquidators then sought and obtained leave from the Victorian Supreme Court to join CGU to the proceeding and to seek a declaration that CGU was liable to indemnify Crewe Sharp and Mr Crewe under the Policy. CGU's appeal to the Victorian Court of Appeal was unsuccessful and it appealed to the High Court.

The decision

Akron's liquidators' ability to join CGU to the proceeding for the purpose of seeking a declaration on indemnity depended on the existence or otherwise of a 'justiciable controversy' (one in which the applicant has a real interest and is not directed to answering a 'purely hypothetical' question³) between them and CGU.

CGU argued that there was no such justiciable controversy, saying that, as a 'stranger' or non-party to the Policy, Akron's liquidators did not have a sufficient interest in determining the meaning and effect of a contract between other parties who are not themselves in dispute, and where CGU retained the right to deny liability under the Policy were a dispute between the parties to arise subsequently.

The court decided that there was a justiciable controversy in this case because of the legal consequence of s562 of the Corporations Act 2001 (Cth) and s117 of the Bankruptcy Act 1966 (Cth). Those provisions, in effect, confer on Akron a right to receive from the liquidators of Crewe Sharp and from the trustee in bankruptcy of Mr Crewe (were Mr Crewe to be declared bankrupt) the proceeds of the Policy payable to cover their liability to Akron's liquidators. In those circumstances, it was Akron's liquidators, rather than Crewe Sharp and Mr Crewe, which would benefit if the declaration were made. The court said:

It would be distinctly to ignore this reality if the liquidators' interest in this regard could be defeated by reason of inaction on the part of Crewe Sharp and Mr Crewe against CGU given that the statutory provisions … deprive Crewe Sharp and Mr Crewe of all incentive to pursue a claim under the Policy.

 

The court also decided that in circumstances in which the relevant insureds were also parties to the proceeding, it was unlikely that they or CGU would be permitted to relitigate the indemnity issue in subsequent proceedings.

The implications

This decision has important ramifications for the Australian insurance industry as it confirms that third party claimants can directly involve the insurers of insolvent and potentially insolvent insured defendants in the resolution of their disputes⁴. This direct accountability of insurers of insolvent insureds to third parties was also reflected, albeit in different circumstances, in last year's High Court decision in Selig v Wealthsure Pty Ltd [2015] HCA 18 (reviewed here), where an insurer of an unsuccessful, impecunious defendant was ordered to pay the third party claimant's legal costs.

Following this decision, applications to access insolvent or potentially insolvent defendants' insurance policies and for joinder of insurers to proceedings against those defendants are likely to increase. Third party claimants should now be better able to assess their recovery prospects in these proceedings and, thereby, reduce the risks of hollow judgments. The overall time and cost of litigation may decrease with insurance coverage issues 'front and centre' from an early stage.