Insured’s duty of disclosure and waiver by underwriters – important recent Australian decisions

In the closing months of 2024, the Federal Court of Australia delivered three important decisions concerning an insured’s pre-contractual duty of disclosure, the remedies available to insurers should an insured breach that duty and how such remedies may be lost by underwriters.

Justice Halley’s decisions in Carter v Chubb  Insurance Australia Ltd [2024] FCA 1312 (Carter No 1) and Carter v Chubb Insurance Australia Ltd (No 2) [2024] FCA 1464 (Carter No 2) illustrate what is required to establish a breach of an insured’s duty of disclosure in Australia, the remedies available for non-disclosure and the need to act  promptly when seeking to recover advanced defence costs.  His further decision in J&J Richards Super Pty Ltd ATF The J&J Richards Superannuation Fund v Nielsen [2024] FCA 1472 (J&J Richards) illustrates how an underwriter writing Australian business may be found to have waived an insured’s duty of disclosure.

While addressing D&O policies, Justice Halley’s decisions apply equally to all classes of general insurance governed by Australian law[1] and provide important guidance concerning underwriting practice for Australian risks and the framing of any denial of a claim for non-disclosure. 

The Insurance Contracts Act

In Australia, the insured’s duty of pre-contractual disclosure and an insurer’s remedies for any breach of that duty are governed by sections 21 and 28 of the Insurance Contracts Act 1984 (Cth)(the Act).

Section 21 of the Act addresses an insured’s duty of disclosure and provides:

1. Subject to this Act, an insured has a duty to disclose to the insurer, before the relevant contract of insurance is entered into, every matter that is known to the insured, being a matter that: 

1. the insured knows to be a matter relevant to the decision of the insurer whether to accept the risk and, if so, on what terms; or 
2. a reasonable person in the circumstances could be expected to know to be a matter so relevant, having regard to factors including, but not limited to: 

1.  the nature and extent of the insurance cover to be provided under the relevant contract of insurance; and 
2.  the class of persons who would ordinarily be expected to apply for insurance cover of that kind. 

2. The duty of disclosure does not require the disclosure of a matter:

1.  that diminishes the risk; 
2. that is of common knowledge; 
3. that the insurer knows or in the ordinary course of the insurer's business as an insurer ought to know; or 
4. as to which compliance with the duty of disclosure is waived by the insurer. 

3. Where a person: 

1. failed to answer; or 
2. gave an obviously incomplete or irrelevant answer to; 
3. a question included in a proposal form about a matter, the insurer shall be deemed to have waived compliance with the duty of disclosure in relation to the matter. 

Section 28 of the Act addresses the remedies available to insurers for breach of an insured’s duty of disclosure and provides: 

1. This section applies if a relevant failure occurs in relation to a contract of general insurance, but does not apply if the insurer would have entered into the contract, for the same premium and on the same terms and conditions, even if the failure had not occurred. 
2. If the relevant failure was fraudulent, the insurer may avoid the contract. 
3. If the insurer is not entitled to avoid the contract or, being entitled to avoid the contract (whether under subsection (2) or otherwise) has not done so, the liability of the insurer in respect of a claim is reduced to the amount that would place the insurer in a position in which the insurer would have been if the relevant failure had not occurred.

The Carter decisions

Carter No 1

John Carter, the insured (former) chief executive officer and managing director, sought indemnity under a D & O policy for defence costs he incurred in defending criminal charges brought by the Director of Public Prosecutions and civil proceedings brought by the company for breach of directors’ duties surrounding the payment of bribes and the provision of illegal inducements to the company’s customers.[2]  The criminal proceedings did not proceed.

Mr Carter had signed a proposal which stated:

Q: Is the Company, or any director, officer or employee aware, after enquiry, of any fact, circumstance, act or omission which may give rise to a claim that may be covered under a Directors & Officers Liability Insurance policy?

A:  No (the Declaration)

The insurer denied indemnity on the basis of fraudulent non-disclosure and misrepresentation for failing to mention the payment of bribes and the provision of illegal inducements and, amongst other things, sought to reduce its liability to nil pursuant to section 28(3) of the Act.  The insurer also sought the recovery of defence costs advanced prior to the denial of indemnity.

It was found that:

1. Mr Carter knew of the bribes and illegal inducements prior to the signing of the Declaration, with his Honour stating: 

“Mr Carter’s various denials of his knowledge of the payment of bribes and provision of illegal inducements are implausible given the extent of his involvement in the impugned transactions as demonstrated by the contemporaneous documents and the inherent logic of events. There is little, if any, ambiguity in the [relevant] emails … concerning the impugned transactions both as to their content and their purpose in promoting the commercial interests of [the company]. The contention that [another employee]  was seeking to deliberately implicate Mr Carter in the emails he sent to Mr Carter is fanciful. On no plausible view was Mr Carter a peripheral observer who did not have any real or substantive appreciation of the payment of bribes and provision of illegal inducements to [the customers]. Further, it can readily be inferred from the nature of the payments made in response to the requests made by [one of the customers] that Mr Carter knew that the payments had not been authorised by [the customer’s employers].”;[3]

2. Mr Carter was at least recklessly indifferent to the truth of the Declaration, he could not have had any real belief as to the truth of the Declaration; Mr Carter dishonestly signed the proposal and Mr Carter knew of matters that may give rise to a claim covered under a D&O policy or was recklessly indifferent as to what might give rise to a claim covered by a D&O policy;[4]

3. the insurer was successful in establishing that Mr Carter had personal knowledge of the matters set out in the Declaration to be matters relevant to the decision of the insurer whether to accept the risk and, if so, on what terms thus satisfying the duty of disclosure as set out at section 21(1)(a) of the Act.  However, the insurer was unsuccessful in establishing a breach of section 21(1)(b) of the Act - that a reasonable person in the circumstances could reasonably be expected to know matters to be relevant to the underwriter’s decision to accept the risk - as the insurer had not properly pleaded reliance upon that provision in its defence;

4. the relevant underwriters’ evidence to the effect that they would not have offered the insurance on any terms had the payment of bribes or the provision of illegal inducements was accepted and the underwriters were found to be “inherently plausible and persuasive”[5];

5. in the circumstances, the insurer was entitled to deny indemnity pursuant to section 28(3) of the Act and reduce its liability to nil; and

6. the insurer was also entitled to repayment of sums already advanced.

Carter No 1 is unusual in the sense that there was such strong evidence against the insured’s director.  It illustrates the need for strong underwriting evidence.  Significantly – and what is often overlooked - it also provides a salutary reminder to expressly rely on section 21(1)(b) of the Act in appropriate circumstances.  This did not ultimately matter in Carter No 1 as the insurer was able to establish that Mr Carter personally had the requisite knowledge and thus satisfy 21(1)(a) of the Act.  However, there may be circumstances where an insured is not available[6] or as Justice Halley put it citing the High Court in the Porthouse[7] decision:

“The statutory test for disclosure now to be found in s 21 of the Insurance Contracts Act focuses on the “reasonable insured”, not the “prudent insurer”, and operates, first, by reference to the actual knowledge of the insured (s21(1)(a)), and secondly, by reference to what “a reasonable person in the circumstances could be expected to know” (s21(1)(b)). The latter statutory phrase has been interpreted as meaning that one should take into account only factors which are “extrinsic” to the insured, such as the circumstances in which the policy was entered into, rather than “intrinsic” factors such as the individual idiosyncrasies of the insured. Whilst it is possible to take into account the circumstances of the insured, the ultimate question under s 21(1)(b) turns on consideration of a reasonable person’s state of mind, not the insured’s state of mind.

A test of disclosure, which operates by reference to both the insured's actual knowledge and the knowledge of a reasonable person in the same circumstances, is calculated to balance the insured's duty to disclose and the insurer's right to information. The insurer is protected against claims where the insured's disclosure is inadequate because the insured is unreasonable, idiosyncratic or obtuse and the insured is protected from exclusion from cover, provided he or she does not fall below the standard of a reasonable person in the same position.”[8]  

Carter No 2

Justice Halley delivered his judgment in Carter No 2 a few weeks after Carter No 1.  In Carter No 2,  the insurer was not awarded its full pre-judgment interest on returned advanced defence costs as there was a three and half year delay between proceedings being issued for indemnity by the ultimately unsuccessful insured and the insurer issuing a cross claim against the insured in those proceedings seeking the return of advanced defence costs.  This illustrates that the return of defence costs advanced should be sought when denying any relevant claim for indemnity and, in litigated claims, a cross claim against an insured for the return of defence costs should be filed when an insurer files its defence.

J&J Richards

The insured’s managing director completed and signed a proposal on behalf of the insured advisory firm.  The proposal was completed with a view to obtaining quotations from an underwriting agency for a full suite of insurance products, including D&O insurance. The proposal asked the insured whether it was aware of any facts or circumstances which might lead to future investigations, inquiries, regulatory proceedings or other claims against the insured.   The insured’s managing director answered ‘Yes’.  The underwriting agent then issued a D&O policy to the insured but did not seek further particulars of these future claims from the insured. 

The insured’s D&O policy was later transferred to the respondent insurer.  At the time of accepting the risk, the relevant underwriter accepted the insured’s original responses contained in the original proposal, rather than asking the insured to complete a new proposal on the new insurer’s form in accordance with the insurer’s own internal policies.  The insurer’s own proposal notably contained prompts which could have elicited further details from the insured as to how and/or why future claims of the kind described in the original proposal could materialise.  It appears from the contemporaneous records that the underwriter intended to seek a new proposal from the insured in a form that complied with the insurer’s own guidelines but did not.  His Honour accepted that the failure to do so was not deliberate and there were significant time pressures placed on the underwriter.[9]

A class action was later brought by investors against the directors of the insured advisory firm in circumstances where the directors had clearly breached their director’s duties by making improvident loans without adequate security and contrary to representations to investors. The applicants joined the insurer to the proceedings seeking the third party benefit of the insurance. The insurer denied indemnity on the basis of innocent non-disclosure.  

Justice Halley found that both limbs of section 21(1) of the Act were engaged.[10]  In terms of establishing a remedy under section 28(3) of the Act, the underwriter understandably had little recollection of the risk and gave evidence largely by reference to their usual practice.  While conceding that they had departed from the internal guidelines and their own usual practice at times, they gave evidence to the effect that that they would not have written the risk had full disclosure been made.  The underwriter was accepted on this.[11] However, the real emphasis was on whether the insurer had waived the duty of disclosure – especially with reference to clauses 21(2) and 21(3) of the Act.

 Justice Halley found that, while the matters not disclosed in the insured’s proposal were clearly material to the insurer’s decision to bind cover,  the insured’s proposal form nonetheless presented a fair representation of the future risks to which the insurer could be exposed.[12]  However, Justice Halley held that the insurer had a responsibility to probe further into these risks before binding the policy.  This omission constituted a waiver of the insurer’s right to rely on the insured’s non-disclosure under sections 21(2)(d)[13] and (3)[14] of the Act. As a result, the policy was held to respond to the claims brought against the directors.

The J&J Richards decision illustrates the need to follow internal underwriting guidelines, keep robust underwriting notes and ensure that proposals contain complete, clear and relevant answers.

Lessons

The lessons from the Carter and J&J Richards decisions for insurers writing Australian risks are:

1. insurers should expressly address both sections 21(1)(a) and (b) of the Act when assessing the insured’s duty of disclosure
2. the actions of the relevant underwriter will come under close scrutiny.  Good underwriting notes and the following of internal protocols, guidelines and procedures will be critical;
3. any claims for the return of costs paid must be taken promptly and should not wait until the courts have assessed any challenge to a declinature;
4. care must be taken by underwriters in assessing proposals and they must act upon any incomplete or irrelevant answers so as not to waive an insured’s duty of disclosure.    

 

[1] Except certain statutory lines

[2] The underlying facts are somewhat salacious and have been the subject of wide spread media attention – see for example “ORIX executive John Joseph Carter fails in $4.5 million lawsuit against insurance company Chubb”, Kate McClymont, the Sydney Morning Herald, 2 December 2024

[3] [44]

[4] [739], [740] and [805]

[5] [872]

[6] For example, third party claims directly against an insurer under section4 of the Civil Liability (Third Party Claims Against Insurers) Act 2017 (NSW)

[7] CGU Insurance Ltd v Porthouse (2008) 235 CLR 103

[8] [810] with footnotes omitted

[9] [330]

[10] [266]

[11] [272]

[12] [336]

[13] [338]

[14] [351]