Two recent Australian cases of interest – one overturns a PI claim declinature, the other upholds a PI claim declinature by applying the aggregation clause
Certain Underwriters at Lloyd’s v Aquagenics Pty Limited (in liquidation) (Click here for the decision)
The insured (Aquagenics) was a water treatment-engineering firm. It contracted with a local council to design and build a wastewater treatment plant. It held a design and construct professional indemnity policy with Lloyd’s Syndicates.
As part of that contract, the insured was required to pre-commission the plant at a certain point in the construction process. In order to do this the council had to provide what the contract referred to as ‘seed sludge’ to the plant.
A dispute arose when the insured wished to start the pre-commissioning. It requested the council to supply the seed sludge. The council refused because it believed the plant wasn’t ready to be pre-commissioned. The insured disagreed and would not proceed further until the council provided the seed sludge. A stalemate arose. Eventually, the insured left the site and never returned.
The council contracted another engineering firm to complete the construction and commissioning of the plant. The council then pursued the insured for losses arising from what it alleged was a breach of contract by the insured. The parties arbitrated the dispute.
The arbitrator found against the insured. He found that due to its own default, the insured had failed to undertake the pre-commissioning work. The arbitrator rejected the insured’s argument that it had satisfactorily completed the work required to enable the pre-commissioning to commence. The arbitrator also found design flaws in the insured’s construction work that existed before the dispute with the council arose, and which the council was unaware of at the time.
The arbitrator ordered damages against the insured of approximately $1.5M. Most of that sum related to remedying the design defects rather than the costs arising from the insured leaving the site.
The insured went into liquidation and the liquidator made a claim against the company’s design and construct professional indemnity policy. The underwriters declined the claim. The liquidator sued the underwriters successfully in the Supreme Court. The underwriters appealed to the Full Federal Court in Australia.
Grounds of declinature
On appeal, the underwriters relied on four grounds to justify their declinature:
- Was it a ‘claim’?
The underwriters wished to withdraw a concession made in the lower court that a letter from the council to the insured saying the following was a valid notification of a claim:
… [the council] would be exercising [its] rights to claim damages/compensation in respect of [the insured’s] breach of contract …
The definition of ‘claim’ in the policy included a written demand received for money or compensation.
The Full Federal Court refused to grant the underwriters leave to withdraw the concession. They said that despite the above quotation being in the future tense:
… as a matter of language and characterisation the letter is a demand for compensation.
- Did it arise out of a ‘wrongful act’?
The underwriters argued that the insured had made a commercial decision to abandon the contract and this was an intentional act, which is not the type of act that comes within the definition of ‘wrongful act’. Effectively, the underwriters were arguing that the policy does not cover intentional acts, errors or omissions. However, the definition in the policy for ‘wrongful act’ did not contain the word ‘intentional’ before the words ‘act, error or omission’. The court refused to imply that word, as there was no basis at law for doing so.
- Was the wrongful act committed in the course of professional activities?
The underwriters argued that ‘just walking off the site’ was not a wrongful act in the course of professional activates.However, the arbitrator found that the insured’s failure to properly complete the pre-commissioning work amounted to the breach of contract for which it was liable, not the fact that it left the site. The pre-commissioning work was in the course of the insured’s professional activities.
- Did the liability assumed by agreement exclusion apply?
The court gave this short shrift and said the insured’s actions did not amount to it assuming a liability contractually that it did not otherwise have.
The appeal failed; the court held that the claim was valid under the design and construct professional indemnity policy.
Reading between the lines, there seems to have been an element of desperation by the underwriters to decline this claim. All of the four grounds of declinature set out above had their difficulties.
The action of the insured in walking off the site and never returning was unusual and, at first appearance, gave the impression of the insured deliberately breaching the contract.
However, the difficulty the underwriters always faced was that the findings of the arbitrator dictated the policy response, and the arbitrator found the insured breached the contract before this by not pre-commissioning the plant correctly. The insured’s action of walking off the site was simply a by-product of that breach, based on its refusal to accept (incorrectly) that it was in breach.
Further, the arbitrator found most of the council’s damages arose from the preceding design flaws, not the lack of readiness for the pre-commissioning to take place. In the light of this, the insured walking off the site was of little relevance.
The Bank of Queensland Limited v AIG Australia Limited (Click here for the decision)
The purpose of aggregation clauses is to alter the application of the deductible and sometimes the sum insured in a policy. They achieve this by deeming linked losses covered under the policy to be one loss so that only one deductible applies instead of several. This makes sense when losses occur separately in time, but they all arise from a common cause covered by the policy.
Where a policy has a very high deductible, both the underwriter and the insurance broker must take great care to ensure the words used in the aggregation clause achieve the intended outcome.
The Bank of Queensland Limited (Bank) had a $2M deductible under its PI policy. In the particular circumstances of its claim, the application of the aggregation clause meant it was entitled to either $4M plus defence costs, or nothing. In the light of this situation, it is, perhaps, unsurprising that a dispute arose that ended up in court.
192 investors in a financial product lost their money when their funds were misappropriated. It transpired that the product was a ‘Ponzi’ scheme. The fraudster operated the scheme through an account set up with the Bank. The 192 account holders alleged that the Bank breached the terms of this account by allowing unauthorised withdrawals, or withdrawals when it knew or ought to have known that a fraud was occurring.
The 192 brought a single court proceeding against the Bank in a representative action. In accordance with the terms of that representative action, each investor agreed to distributing the proceeds of the proceedings in accordance with his or her respective losses. The proceeding against the Bank settled for $6M. The Bank claimed this amount under its PI policy with its insurer.
That policy’s deductible clause applied a deductible of $2M for each ‘Claim’. The definition of ‘Claim’ had an aggregation clause. It said:
For the purposes of this policy all Claims arising out of, based upon or attributable to one or a series of related Wrongful Acts shall be considered to be a single Claim; conversely where a Claim involves more than one unrelated Wrongful Act, each unrelated Wrongful Act shall constitute a separate Claim.
The word ‘Claim’ was defined as:
(i) Any suit or proceeding … brought by any person against an Insured for monetary damages or relief …;
(ii) Any verbal or written demand from any person that it is the intention of the person to hold an Insured responsible for the results of any specified Wrongful Act
In the light of there being only one court proceeding against the Bank, the court first considered whether there was more than one ‘Claim’ against the Bank. If there wasn’t the aggregation clause wasn’t engaged at all.
Although there was only one proceeding, each of the investors had incorporated their separate losses in that one proceeding and the court found the distribution agreement between them to be a separate written demand by each of them for each of their respective losses. Accordingly, there were 192 ‘Claims’ and not just one ‘Claim’.
The court then looked to several recent English authorities on the application of aggregation clauses. These cases refer to losses being aggregated when there is a ‘unifying factor’ between the losses.
Applying the same approach to this aggregation clause, the court found the unifying factor required by it was the ‘Wrongful Acts’. The court found on the facts that each withdrawal from the account in breach of its terms was an individual ‘Wrongful Act’ by the Bank. Therefore, there were multiple ‘Wrongful Acts’.
As there was more than one, the next question in applying the aggregation clause was whether they were ‘… a series of related Wrongful Acts …’. One of the English cases defined ‘related’ as implying some:
Interconnection between the matters or transactions
Critically, the court found that although the withdrawals were similar in nature and had characteristics in common, each was a separate act, made on a different occasion, from a different sub-account, causing loss to a different party in response to different and separate instructions. The court didn’t think each withdrawal had a sufficient degree of similarity or integral relationship with the others to be considered a ‘series’.
This meant there was no aggregation and there were 194 ‘Claims’. This was good news for the insurer as no individual ‘Claim’ exceeded the $2M deductible and nothing was payable under the policy.
As class and representative litigation continues to develop in Australia and New Zealand, the importance of Aggregation Clauses is likely to increase. As this case demonstrates, it is important to draft the clause with precision.
This case also demonstrates that it is not only the Aggregation Clause that needs to be drafted carefully. If that clause relies on the definition of ‘Claim’ then the interplay between the two definitions is also critical.
We won’t be surprised if the Bank appeals the decision. If it does, we will keep you posted.
Please feel free to contact us if you require any further information.