The known knowns and unknown knowns in PI policies

Prospective insureds under professional indemnity policies are often asked about "known circumstances" when applying for cover - but what is a "known circumstance"? What must the insured know or think? The NSW Court of Appeal has just provided some guidance in CGU Insurance Ltd. v Porthouse [2007] NSWCA 80.

Making the policy

The insured was a barrister who was sued for negligence. He had not ascertained the effect of legislative amendments upon a client's claim; the client won at trial, but the other side appealed.

Between the success at trial and the appeal which found against his client, Mr Porthouse filled in a proposal form with CGU for professional indemnity cover.

Question 4 on the proposal form was: "Are you aware of any circumstances, which could result in any Claim or Disciplinary Proceedings being made against you?", to which he answered "No". The form also pointed out his duty of disclosure under section 21 of the Insurance Contracts Act. CGU issued a claims made policy.

At the time of filling in the proposal form, Mr Porthouse knew that the other side had an arguable appeal point based on the legislative amendments. He did not know the result of the appeal. He did not think that his client might sue him for negligence. When his client did precisely that, he turned to his insurer, who pointed to the exclusion clause.

The exclusion clause

The claims made policy under which Mr Porthouse was insured did not cover "known claims" or claims arising from "known circumstances", defined as:

"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."

The relevant part is (b), since Mr Porthouse didn't have the actual knowledge of a claim by his client as provided for in (a). Did Mr Porthouse have knowledge in this sense?

What did he know and when did he know it?

The Court of Appeal said Mr Porthouse did not have knowledge within the meaning of clause (b):

• the combination of the words "thought" and "might" covers a spectrum from something like "believed that the circumstance might as a realistic possibility result in an allegation" down to "fleetingly thought that the circumstance might as a remote possibility result in an allegation"
• since CGU drafted it, the clause should be interpreted against CGU, meaning that (b) requires something like the insured "believed that the circumstance might as a realistic possibility result in an allegation"; and
• it is appropriate to ask what Mr Porthouse's actual state of mind was at the time, and then if that was unreasonable, since (b) asks what "a reasonable person in the Insured’s professional position would have thought". This is acceptable so long as the ultimate question is asked: what would a reasonable person in the insured's position have thought?

That of course is a question of fact: on the facts, the Court decided that a reasonable person in Mr Porthouse's position would not have believed that the pending appeal in his client's case, coupled with his role in the creation of the problem that gave rise to it, was a circumstance which could, as a matter of realistic possibility, result in a claim. The policy therefore responded.

The Court added that "this result has some support from the consideration that the Insurance Contracts Act discloses an intention that an insured under successive claims-made policies should not be precluded from claiming under both of them." A reasonable person in Mr Porthouse's professional position, it said, may well have believed it appropriate to give notice under section 40(3), but would not have believed it appropriate to do so.

What does this mean for PI policies?

The issue of notification and disclosure by insureds is often contentious, and these sorts of clauses are very common in claims made policies. For insurers therefore this could mean a redraft of their exclusions and proposal forms is required to spell out clearly what type of knowledge is required.

Notwithstanding that it turned upon the terms and conditions in the contract, this case also shows that the Insurance Contracts Act is never far away.