Insurance Case Note August 2008

• What is not covered
• We do not cover any of the following Claims (or losses):
•  6.1  Known Claims and Known Circumstances
  • (a) . . .
  • (b) Claims (or losses) arising from a Known Circumstance, or
  • (c) Claim (or losses) directly or indirectly based upon, attributable to, or in consequence of any such
• KnownCircumstance or known Claims (or losses) . . 
• “Known Circumstance” is defined in section 11 of the policy as:
• 11.12 Known Circumstance
• Any fact, situation or circumstance which:
  • (a) an Insured knew before this Policy began; or
  • (b) a reasonable person in the Insured’s professional position would have thought, before this Policy began,
• might result in someone making an allegation against an Insured in respect of a liability, that might be covered by this Policy.

Brief history of proceedings

The events which gave rise to Mr Porthouse’s claim for indemnity occurred in 2001. On 17 April 1999 Mr James Bahmad sustained an injury while performing work pursuant to a community service order under the supervision of the Probation and Parole Service. In May or June 2001 Mr Porthouse was briefed by Mr Bahmad’s solicitors to advise whether Mr Bahmad had a claim under the Workers Compensation Act 1987 (NSW) (the Act) or a claim in respect of negligence against the Department of Corrective Services. In a memorandum of advice dated 12 June 2001, Mr Porthouse advised wrongly that the Act did not apply to Mr Bahmad’s claim and did not refer to the Crimes (Administration of Sentences) Act 1999 (NSW) which governed Mr Bahmad’s potential claim and set limits on common law damages for injuries to offenders undertaking community service. 

From about June or July 2001, as part of a comprehensive programme of tort reform, the New South Wales Government foreshadowed proposed restrictions on damages claims for injuries governed by the Act. The proposed amendments included transitional provisions having the effect that proceedings brought before the commencement date of the legislation would not be affected by the restrictions. The commencement date of the amendments to the Act was 27 November 2001.

On 6 December 2001, Mr Porthouse provided a draft statement of claim, which was filed on 11 December 2001, naming the State of New South Wales as the defendant. On 30 October 2002 the Crown Solicitor’s Office wrote to Mr Bahmad’s solicitor and for the first time raised the point that the Act was applicable to Mr Bahmad’s claim and that as his injury did not reach the 15% threshold required by the 2001 amendment to the Act, he was not entitled to an award of damages. 

On 4 November 2002, Mr Bahmad obtained an award at arbitration for the sum of $120,687.15, plus costs. Following an application by the State, the matter was listed for re hearing in the District Court of NSW.

On 29 August 2003, Graham DCJ delivered judgment in favour of Mr Bahmad on the basis that his claim was covered by the provisions of the Act as it stood prior to the 2001 amendment. The State appealed to the Court of Appeal.  Senior Counsel, subsequently retained to appear for Mr Bahmad in the appeal, conferred with Mr Porthouse and concluded the State had reasonable prospects of success in the Court of Appeal.

On 20 May 2004, Mr Porthouse completed a “Barcover Professional Indemnity Proposal Form” (Proposal) for the period 30 June 2004 to 30 June 2005. The Proposal inquired as to whether Mr Porthouse was aware of any circumstances, which could result in any claim or disciplinary proceedings being made against him, to which he replied, no. The Proposal contained a statement that the policy did not provide cover in relation to “facts or circumstances of which the insured first became aware prior to the period of cover, and which the insured knew or ought reasonably to have known had the potential to give rise to a claim under the policy.

On 27 August 2004, the Court of Appeal allowed the State’s appeal and set aside the verdict in favour of Mr Bahmad. On 3 March 2005, Mr Bahmad commenced proceeding in the District Court against his former solicitors and Mr Porthouse, alleging negligence. Mr Bahmad alleged that had his legal representatives acted with reasonable diligence and filed a statement of claim earlier, his claim would not have been caught by the 2001 amendment to the Act, which commenced on 27 November 2001 and reduced his damages entitlement to nil. CGU Insurance, which had since declined Mr Porthouse’s claim for indemnity, under the Barcover Policy, was joined by Mr Porthouse to the proceedings by way of cross-claim. 

The matter came before Balla DCJ in the District Court of NSW who found both the solicitors and Mr Porthouse had been negligent. Her Honour entered judgment in the sum of $170,000, plus costs (to be apportioned equally). Her Honour further decided that the exclusion upon which CGU replied in section 61 of the Policy did not apply.

Of particular significance to the Court was evidence of Mr Porthouse’s state of mind as at 20 May 2004, when he completed the Barcover Proposal.  This was elicited during his cross-examination before the Judge Balla. Mr Porthouse gave evidence to the effect that he did not then believe he had done anything wrong with respect to Mr Bahmad’s case and accordingly, as at 20 May 2004, had no belief that a claim would be made against him regardless of the outcome in the Court of Appeal.

With respect to the first limb of the definition of Known Circumstance in the policy Judge Balla found that Mr Porthouse did not know, before the policy commenced, that

Mr Bahmad might bring a claim against him in negligence which might fall for coverage under the policy. Her Honour accordingly found that the first limb of the definition pertaining to the exclusion did not apply. As to the second limb of the definition under Known Circumstance, her Honour accepted the submission advanced by Mr Porthouse that the clause does not impose an entirely objective test, since it requires consideration of whether Mr Porthouse’s actual state of mind was unreasonable. Judge Balla accordingly found CGU Insurance liable to indemnify Mr Porthouse under the Policy.

Court of Appeal

CGU appealed to the Court of Appeal against the order requiring indemnity.  The Court of Appeal, by majority, dismissed the appeal by CGU.

The essential issue, as framed before the Court of Appeal, was whether the primary judge erred in considering the subjective state of mind of Mr Porthouse when construing and applying section 11.12(b) of the Policy.

The Court was therefore required to consider the question of what a reasonable person in the position of Mr Porthouse would have thought before the Policy began.  This in turn required consideration of what Mr Porthouse did think before determining whether this was unreasonable.

The Court of Appeal ultimately held that Judge Balla had not fallen into error by assessing whether Mr Porthouse’s actual state of mind was unreasonable.  By majority, the Court of Appeal dismissed CGU’s appeal.

High Court

CGU then appealed to the High Court.

The grounds of appeal required the Court to consider 2 primary issues of construction.  Firstly whether a proper interpretation of the phrase “a reasonable person in the Insured’s professional position”, was confined to taking into account the insured’s experience and knowledge to the exclusion of the insured’s actual state of mind as to whether any fact, situation or circumstance known to the insured might give rise to an allegation relevant to the Policy.

The second issue of construction involved the correct interpretation to be given to the conditional expressions when determining whether the hypothetical reasonable person would have thought (any fact, situation or circumstance known to the insured) might result in someone making an allegation against the insured.  A third and subsidiary issue in the appeal concerned the correct application of clause 11.12(b) and specifically, whether evidence of what the insured person actually thought, should be taken into account when determining what the hypothetical reasonable person would have thought.

Both parties agreed that the second limb (clause 11.12(b)) provided an objective standard of a reasonable person.  Where the parties differed was on the meaning to be given to the additional words describing what constitutes a reasonable person under the Policy.

The statutory test for disclosure is found at section 21 of the Insurance Contracts Act 1984 (Cth) which is focussed on the reasonable insured and not the prudent insurer.  The section therefore operates by reference to the actual knowledge of the insured (section 21.1(a)) and by reference to what a reasonable person in the circumstances could be expected to know (section 21.1.(b)).  The latter phrase has been interpreted as meaning that one should take into account only factors which are extrinsic to the insured, such as the circumstance in which the policy was entered into, rather than intrinsic factors such as individual idiosyncrasies of the insured.  Whilst it is possible to take into account circumstances pertaining to the individual insured, the ultimate question under section 21.1(b) turns on consideration of a reasonable person’s state of mind, not the insured’s state of mind. 

Section 11.12 of the Policy does not replicate section 21 of the Insurance Contracts Act.  Instead it employs a technique for identifying a known circumstance made familiar by section 21 in that it defines a subjective test in the first limb (clause 11.12(a)) together with an objective standard in the second limb (clause 11.12(b)). The objective standard thereby moderates a purely subjective test and the difficulties of proof which a wholly subjective test might enliven.

The High Court upheld CGU’s appeal.  In a joint judgment the Court found that, given the nature and object of the policy, there could be no real doubt that a reasonable barrister knowing of the potential effect on his client’s case of the 2001 amendments and who knew of the pending appeal and his causative role in creating the legal issues in the appeal, would have anticipated a real possibility that an allegation would likely be made in respect of a liability contemplated by the Policy.

The Court further held that the primary Judge, with whom the majority of the Court of Appeal agreed, was in error by giving no independent consideration to the alternative, additional and objective standard stated in clause 11.12(b) of the Policy; namely what “reasonable a person … would have thought”.  The Court found no clear basis for the initial finding that Mr Porthouse’s knowledge coincided with what a reasonable person in the insured’s professional position would have thought and concluded.  This essential criteria in the policy was viewed by the High Court as an important practical protection for insurers where an insured’s disclosure is inadequate, by introducing a necessary element of objectivity into the final determination.

Summary

The High Court has delivered a significant “win” for Australian insurers.

In holding that clause 11.12(b) seeks an objective standard, whether or not an individual insured held a particular subjective belief will not operate to overturn the policy exclusion.  A Court must instead have objective regard to the insured’s professional experience, while an actual knowledge of known circumstances must now be considered with reference to what a reasonable person in the Insured’s professional position would have thought.  It does not inquire about certainties.  The High Court held that when considering the issues which arose in clause 11.12, whilst it is permissible to take into account the insured’s subjective belief as evidence which may have some relevance, the standard to be applied is an objective standard and a question of fact to be determined independently of the insured’s actual state of mind.

This decision obviously highlights the importance of disclosure by an insured to an insurer, particularly in the context of known circumstances.  It is no longer sufficient for a prospective insured to assert a subjective belief (genuine or not) that he/she did not believe a claim would be brought.  Rather, the test to be applied requires objective consideration of whether a reasonable person in that position would have held the same view.


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