Insurers take note: Australian court limits the application of insolvency exclusions

AIG Australia Limited v Kaboko Mining Limited [14.06.19]

The recent decision of AIG Australia Limited v Kaboko Mining Limited [14.06.19] confirms that an insolvency exclusion in a directors’ and officers’ (D&O) policy will not automatically apply to claims against former directors of an insolvent company.

The decision serves as a reminder that there are no special rules of construction to be applied to exclusion clauses. Exclusion clauses should be given their natural and ordinary meaning and regard must be had to the language of the exclusion clause and context in which the insurance clause appears. While this approach appears to be applied across jurisdictions, the application has led to different results in England and Wales – as discussed below.

AIG Australia Limited v Kaboko Mining Limited

The facts

  • In or about July 2012 Kaboko Mining Limited entered into a prepayment agreement with Noble Resources Limited, where Noble advanced Kaboko approximately US$6 million as prepayment for manganese ore.
  • In July 2014, Noble issued a default notice to the directors of Kaboko for breach of the terms of the prepayment agreement.
  • In August 2014, Noble issued a statutory demand for the US$6 million, which was subsequently set aside by the Supreme Court of Western Australia.
  • In 2015, a monetary default occurred on the prepayment agreement and Kaboko’s directors appointed administrators. The administrators’ report identified possible breaches of directors’ duties based on allegations by Noble and the Noble default notice.
  • In 2016, Kaboko commenced the proceedings against four current and former directors alleging breaches of sections 180 and 181 of the Corporations Act 2001 (Cth) and a breach of the general law duty to act in good faith in the best interests of Kaboko and for a proper purpose.
  • The directors sought indemnity under their AIG D&O Policy. AIG denied cover, relying on the insolvency exclusion.
  • The insolvency exclusion endorsement provided:
    • The Insurer shall not be liable under any Cover or Extension for any Loss in connection with any Claim arising out of, based upon or attributable to the actual or alleged insolvency of the Company or any actual or alleged inability of the Company to pay any or all of its debts as and when they fall due.
  • The dispute between AIG and Kaboko’s directors was determined in the Federal Court as a preliminary question.
  • AIG argued that the proceedings, “arose out of, was based upon or was attributable to” the insolvency of Kaboko or its inability to pay its debts (i.e. there would be no claim unless Kaboko was insolvent).
  • Kaboko rejected AIG’s position and submitted that the insolvency exclusion is only triggered if insolvency was one of the underlying facts that, if established, would justify the claim or loss claimed (i.e. the insolvency or Kaboko’s inability to pay its debt caused the loss claimed).

The primary judgment

His Honour Mckerracher J, found that the insolvency exclusion was not triggered because the relevant loss did not arise out of, originate in, spring from nor have its foundation in Kaboko’s insolvency. Rather the loss arose through Kaboko losing the opportunity to develop the manganese mines. In reaching its decision, the court considered the purpose of the policy (i.e. to protect directors and officers from those customary risks borne by them in performing their role) and found that AIG’s interpretation would defeat the indemnity granted by the policy and make it “practically illusory”.

AIG appealed the decision to the Full Federal Court of Australia (FCAFC).

The key question before the FCAFC

The FCAFC had to consider the extent to which Kaboko’s insolvency arose “in connection with any claim”. In doing so, the FCAFC considered whether:

  1. The subject matter of the claim had the “specified insolvency link”.
  2. The link is also established where, by reason of the circumstances that have led to the bringing of the claim, it can be said that the claim arises out of, is based upon or is attributable to the insolvency of Kaboko or its inability to pay its debts”.

The decision

AIG’s appeal was dismissed. The FCAFC found that, as the claims against Kaboko’s directors did not originate from any allegation of insolvency (i.e. the claim could be advanced irrespective of Kaboko’s insolvency, as ultimately it is the directors’ breaches that created the circumstances, which could lead to insolvency), the insolvency exclusion is not triggered.

Further, the court held for the insolvency exclusion to apply to a loss in connection with a claim, the insolvency must have caused the loss complained. In this case, except for Kaboko’s claim for the costs of the receivers, managers and the administrator, no other loss was caused by insolvency. Kaboko’s claim for costs would not have been incurred had Kaboko not been insolvent and were therefore excluded.

Implications for insurers

The FCAFC took a narrow approach to the construction of the insolvency exclusion. While the decision is fact sensitive, and will turn on the language of the particular exclusion clause in question, it is clear that Australian courts will not look behind the substance and nature of the claim itself to consider whether the claim “arises out of, is based upon or attributable to” an insured’s insolvency or inability to pay its debts and thereby triggering an insolvency exclusion. Insurers are limited to the subject and nature of the claim and cannot rely on the intention or motivation of a claimant in pursuing a claim to determine whether an insolvency exclusion is triggered or not.

For insurers, the key issue now is therefore when will an insolvency exclusion apply? It is clear that this will now only be in circumstances where there is a specific insolvency link with the subject matter of the claim, such as allegations of insolvent trading, breaches of the Corporations Act or of directors’ fiduciary duties arising out of insolvency or an inability to pay debts.

Differences in England and Wales

The approach taken by the Australian court, so far as it relates to taking into account the nature and purpose of the policy is consistent with the United Kingdom’s approach in recent years. For example, in Impact Funding Ltd v AIG Europe Insurance Ltd [2016] the Supreme Court held that the insurer could rely upon the trading debt exclusion in the policy and was not liable for loans that a funder had advanced to a law firm to pay disbursements under Conditional Fee Agreements. It held that the extent of the insurer’s liability was to be ascertained by reading the insuring clauses and exclusions together and in the context of the policy, having regard to the overall purpose of the policy.

This approach was followed by the High Court in Crowden v QBE Insurance [2017], (which was cited in Kaboko), where the High Court confirmed that exclusions should be considered against the factual matrix and in the context of the policy, bearing in mind the scope of cover. However, in Crowden the language of the insolvency was wider than that in Kaboko (“arising out of or relating directly or indirectly to the insolvency or bankruptcy of the Insured…” (emphasis added)) with the use of “directly or indirectly” along with the connecting words indicating that the causative link “need not be as strong or efficient so as to constitute a proximate cause”. Even so, the High Court found that for the exclusion to apply the insolvency must be “specifically accountable as a cause” and be a contributing factor of the claim or loss, taking a similar approach to the Federal Court in Kaboko. In Crowden, however, the exclusion was triggered because the claim, liability or loss associated with the two investment products was caused by the insolvency.


As in Australia, the recent authorities in England and Wales are a reminder that these cases are fact sensitive. However, it appears that in light of the decision in Kaboko the Australian courts are taking a narrower approach when interpreting insolvency exclusions. The courts of England and Wales will not, on the other hand, normally take such a narrow approach to the interpretation of exclusion clauses (unless the language is ambiguous) and the principles of construction that apply to exemption clauses are not appropriate when considering exclusion clauses designed to define the scope of cover under the policy.

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