Federal Court holds Opal Tower defendant not entitled to be paid defence costs prior to determination on exclusion clause

In brief 7 min read

The Federal Court has rejected an insured's argument that the insured was entitled to be paid defence costs as and when those costs were incurred in defending a third party claim made against it, prior to a court determining whether or not an exclusion clause applied to the third party claim.¹

The insurer had refused to pay, relying upon an exclusion clause. The Federal Court held that under the policy in issue, the insurer was not obliged to pay the insured's defence costs unless and until there had been a judicial determination as to whether or not the exclusion clause applied.

Key takeaways

• It is common in the Australian market – even absent an advancement of defence costs provision in an insurance policy – for the insurer to reimburse the insured for defence costs during the course of the defence of a third party claim against it.
• It is also often the case that defence costs are paid by the insurer even where the third party claim against the insured may enliven an exclusion clause, depending upon the ultimate outcome of the case to which the third party claim relates.
• This decision clarifies that unless a policy contains an advancement of defence costs provision (and subject to the particular terms of the policy), an insured should not assume it will be entitled to be reimbursed for defence costs as and when they are incurred if there is a debate with the insurer about the operation of an exclusion clause in respect of the third party claim brought against the insured.
• Where an insurer refuses cover in respect of a third party claim and related legal costs, but an insured needs its legal costs met in order to defend a third party claim made against it, the insured may need to bring proceedings against the insurer prior to the conclusion of the third party claim.

The facts

The applicant (Evolution) is a cross-defendant in two proceedings in the Supreme Court of New South Wales arising out of damage sustained to the Opal Tower in Sydney. Evolution provided pre-cast concrete works for the construction of the tower.

Evolution was insured by the respondent (Chubb) under a Broadform Liability Insurance policy. Chubb accepted that the cross-claims against Evolution fell within the policy's insuring clause, but asserted that the professional liability exclusion clause applied to deny Evolution's claim. This dispute over the operation of the exclusion clause is still before the court.

Separate question

Evolution claimed advance payment of defence costs from Chubb under the policy. Before Justice Derrington, the parties argued a separate question as to whether Chubb was obliged to pay those defence costs before a judicial determination as to whether the exclusion clause applied.

The policy did not specifically contain an advancement of defence costs provision. Relevantly, the policy provided:

2.7 Defence Costs means

All reasonable legal costs and expenses incurred by Chubb or by the Insured with the written agreement of Chubb:

1. in defending or appealing a claim against the Insured; and
2. for legal representation of the Insured at any coronial inquest or other fatal accident inquiry.

[…]

4.1 Defence Costs

In respect of any liability for Compensation indemnifiable under this Policy, Chubb will pay Defence Costs, subject to the following:

1. Chubb is not obliged to pay any Defence Costs or to defend any suit after the Limits of Liability has been exhausted;
2. If a payment exceeding the Limits of Liability has to be made to dispose of a claim, the liability of Chubb for Defence Costs is limited to the proportion that Chubb’s liability to indemnify the Insured for Compensation under this Policy bears to that payment; and
3. In the event of a claim being made against the Insured in any Court or before any other legally constituted body in the United States of America, Canada or their respective protectorates and territories, the total amount payable by Chubb in respect of any one Occurrence including Defence Costs will not exceed the Limit of Liability.

Evolution argued that this clause required Chubb to pay its defence costs until a court determined that an exclusion clause applied. Chubb argued that the clause only required it to pay when the relevant claim both fell within the insuring clause and the exclusion clause did not apply.

Indemnifiable claim

The issue for determination was thus when, if at all, Chubb was obliged to pay the costs and expenses incurred by Evolution in defending the claims against it, which turned on the meaning of 'indemnifiable' in clause 4.1.

Chubb submitted that 'indemnifiable' referred to a liability that is both within the insuring clause and is not excluded by the operation of an exclusion clause.

Evolution accepted that for a claim to be indemnifiable, it required consideration of the effect of the professional liability exclusion clause. However, Evolution submitted that until a court had determined whether the exclusion clause applied, Chubb was liable to pay defence costs. Evolution submitted that its construction was consistent with the onus on an insurer to establish the operation of an exclusion clause.

Justice Derrington rejected this argument, and held that this onus does not create a free-standing obligation on an insurer who wishes to rely upon an exclusion.

When is an insurer is liable to pay defence costs?

Evolution also submitted that the definition of Defence Costs in the policy implied that Chubb was obliged to pay costs while the third party action against Evolution progressed, and that this obligation remained until a court determined an exclusion applied.

Justice Derrington accepted that under clause 4.1, Chubb was liable for Evolution's defence costs as Evolution incurred liability for them, and that Chubb would not be entitled to await the outcome of proceedings to ascertain whether Evolution is liable to a third party. If Chubb were mistaken in denying cover, it would be liable to pay the costs that should have been paid, and also damages for any loss caused by its breach. However, the temporal operation of the clause did not suggest that Chubb was obliged to pay defence costs when it had no obligation to do so.

Wilkie v Gordian Runoff

In support of its position, Evolution relied on Wilkie v Gordian Runoff Ltd (2005) 221 CLR 522, where the High Court held an insurer liable to pay an executive officer's defence costs pending a determination of whether a dishonesty exclusion applied. However, Justice Derrington noted differences between the policy in Wilkie and the present case, including:

• the exclusion clause in Wilkie only operated where dishonesty had in 'fact' occurred, which required either an admission or a determination by a court – the present policy did not require a court to determine liability before the exclusion operated;
• the policy in Wilkie made reference to 'advance' defence costs – the present policy did not include this wording, which Justice Derrington observed is a commonly used method of providing for the payment of defence costs whilst a dispute between insurer and insured over coverage is ongoing; and
• the policy in Wilkie required the insured to reimburse the insurer for defence costs if the exclusion clause was ultimately applicable – the present policy did not have this clause, so on Evolution's construction it would receive defences costs it had no entitlement to, and then no express obligation to return them.

Conclusion

Ultimately, Justice Derrington held that Chubb's obligation to pay defence costs is conditioned on a liability by a third party against Evolution, which if established would be indemnifiable under the policy. That requires establishing:

• that the manner in which the claim is formulated, or its substance, is in respect of a liability that falls within the policy's insuring clause; and
• that claim is not the subject of an exclusion.

The insurer will bear the onus of establishing that an exclusion applies. However, this does not mean the insured is entitled to receive payments in respect of a liability that is disputed pending a court determination that the liability is not covered.

Implications

• When obtaining insurance that includes cover for defence costs, insureds should check to see whether or not the policy contains an advancement of defence costs provision, and if so, the circumstances in which defence costs will be advanced.
• Depending upon the terms of the policy in issue, absent an advancement of defence costs clause, where a third party claim alleges subject matter that is excluded from cover, and the insurer denies indemnity on the basis of those allegations, then it may be open to the insurer to refuse to cover defence costs.

If an insurer denies cover at an early stage during the defence of a third party claim, the insured will need to decide whether to join the insurer to the proceedings brought against the insured by the third party or otherwise proceed against the insurer to contest the denial. The onus will be on the insurer in those proceedings to demonstrate that the exclusion clause applies.