Mind the Gap: Why Disclosure Due Diligence is a Non-Negotiable

The duty of disclosure, a cornerstone of insurance underwriting.  Last month, the Federal Court of Australia delivered a significant judgment in a directors and officers (D&O) indemnity dispute, finding that an insurer waived its right to rely on the insured’s non-disclosure by failing to address a conspicuous gap in the insured’s proposal form. This oversight left the insurer liable under its D&O policy and exposed it to the financial fallout of a sizeable class action.

Background

In J&J Richards Super Pty Ltd ATF The J&J Richards Superannuation Fund v Nielsen [2024] FCA 1472 (J&J Richards Super v Nielson), the applicant / super fund trustee, commenced a representative proceeding against two companies and their directors for alleged breaches of the Corporations Act 2001 (Cth) and the Australian Securities and Investment Commission Act 2001 (Cth).  The class action was initiated on behalf of a large ‘class’ of investors who suffered losses under the companies’ management investor schemes.  One of the company respondents to the proceeding, Linchpin Capital Group Limited (in liq), is the relevant insured.

The Proposal

Before the claim’s inception, the insured’s managing director (also a respondent to the proceeding) completed and signed an insurance proposal form on behalf of the insured.  The proposal form was completed with a view of obtaining quotations from an underwriting agency for a full suite of insurance products, including D&O insurance. The proposal form asked the insured to confirm whether it was aware of any facts or circumstances which might lead to future investigations, inquiries, regulatory proceedings, or other claims against the insured.[1]   The insured’s managing director answered this affirmatively.  The underwriting agent subsequently issued a D&O policy to the insured but did not probe the insured for further particulars of these future ‘claims’.

The insured’s D&O policy was later transferred to another insurer where, at the time of accepting the risk, the underwriter accepted the insured’s original responses contained in the original underwriters’ proposal form, rather than asking the insured to complete a new proposal.   The new insurer’s 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. 

The class action ensued, and so too did the insured’s claim under the D&O policy (lodged by the respondent directors in their capacity as third party beneficiaries to the policy).

Subsequent insurer’s joinder and non-disclosure

Given the insured’s insolvency, the applicant successfully joined the subsequent insurer as a respondent to the proceeding (in its capacity as the D&O insurer for the director respondents).[2]  This led to the director respondents being excused from the proceeding, leaving the subsequent insurer as the sole active respondent.[3]

The subsequent insurer sought to resist the claim brought by the applicant, arguing that the insured breached its duty of disclosure under section 21 of the Insurance Contracts Act 1984 (Cth) (ICA).  The insurer specifically argued that, at the time the D&O policy was issued, the insured’s managing director had actual knowledge of the matters relied upon by the applicant in the class action proceeding.  Such knowledge was, purportedly, not disclosed in the insured’s proposal.  The insurer attempted to rely on sections 28(3) and 48(3) of the ICA and the Court of Appeal decision in C E Heath Casualty & General Insurance Ltd v Grey (1993) 32 NSWLR 25,[4]  to reduce its liability to nil under the D&O policy.  

The Court’s Finding

Justice Halley found that, while the matters not disclosed in the insured’s proposal were clearly material to the subsequent insurer’s decision to bind cover,[5]  the insured’s proposal form nonetheless presented a fair representation of the future risks the insurer could be exposed to.  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 subsequent insurer’s right to rely on the insured’s non-disclosure under section 21(3) of the ICA to absolve itself of liability.  As a result, the D&O policy was held to respond to the claims brought by the director respondents.

Lessons

The judgment underscores the need for underwriters to diligently review proposal forms – their own and previous insurer’s proposals if they wish to rely on those for assessing their risk. In circumstances where an insured’s proposal form contains gaps - whether glaring (such as a disclosure made of a potential risk or subtle (a question unanswered) - underwriters should proactively seek clarification from insureds and their brokers at the earliest opportunity.  If there has been an omission or not fulsome information, claims teams will need to consider whether there has been the requisite disclosure.

 

[1] J&J Richards Super Pty Ltd ATF The J&J Richards Superannuation Fund v Nielsen [2024] FCA 1472 at [253].

[2] J&J Richards Super Pty Ltd ATF The J&J Richards Superannuation Fund v Nielsen [2024] FCA 1472 at [7].

[3] Ibid [10].

[4] C E Heath Casualty & General Insurance Ltd v Grey (1993) 32 NSWLR 25 at [47].

[5] J&J Richards Super Pty Ltd ATF The J&J Richards Superannuation Fund v Nielsen [2024] FCA 1472 at [322].