03 October 2008
An insurer who provides indemnities against paid losses may be legally insolvent if it is unable to pay liabilities which have been incurred but which are not yet payable.
Background
New Cap Reinsurance was a reinsurer. Its policies provided an indemnity to insurers for losses paid by the insurers once those losses had exceeded a threshold sum.
As at 31 December 1998, reinsureds had notified New Cap of the occurrence of insured events and provided estimates of their liability in relation to those events. In April 1999 New Cap went into liquidation. The liquidator filed a number of claims in the NSW Supreme Court. These claims related to alleged voidable transactions in the period leading up to the liquidation. To establish these claims, the liquidator had to prove (among other things) that New Cap was insolvent at various points in the six months before his appointment.
The statutory test for determining insolvency is whether a company is able to pay all its "debts" as and when they become due and payable (section 95A of the Corporations Act).
There was evidence suggesting that New Cap would have been unable to pay up once the reinsureds formally claimed on their policies. However, were those future liabilities "debts" within the meaning of section 95A?
Initially, it appeared that the answer to this question would depend upon whether a claim for unliquidated damages would be a "debt" under section 95A. That was because there are many court decisions to the effect that the liability of a insurer under a policy of indemnity insurance is a liability to pay unliquidated damages.
Claim for unliquidated damages
The Court began by noting that there are conflicting authorities as to whether a claim for unliquidated damages is a "debt" under s 95A:
Normally, the High Court is taken to prevail over any other Australian court. However, the Supreme Court held that it was bound to follow its own Court of Appeal decision, rather than the High Court, because the Court of Appeal decision had been handed down after the High Court decision.
It followed that a liability to pay unliquidated damages was not a debt. However, that was not the end of the matter.
Claims on indemnity insurance
The Court then looked at the legal authorities which have held that a claim on a policy of indemnity insurance is a claim for unliquidated damages. It found that the reasoning in those cases was not applicable to situations in which the indemnity relates to losses paid by the reinsured (which was the case here).
Essentially, it noted that, if the insurer has to indemnify the reinsured for amounts that the reinsured has already paid, the amount payable by the insurer is not really at large (ie. is not unliquidated). It followed that a claim under such a policy would be a claim in debt, rather than for unliquidated damages.
Based on this reasoning, New Cap's liabilities in respect of the reinsureds' paid losses were to be taken into account in determining whether it was able to pay its debts as and when they fell due.
Comment
The Court appears to have been determined to avoid what it described as the "absurd" suggestion that "an insurer's solvency should be determined without reference to its insurance liabilities".
It may be noted that the Court was dealing with a voidable transaction claim. This decision may also be of concern to the directors of insurance companies insofar as it may impact on their liability for insolvent trading.
Directors may be personally liable for debts incurred while their company is insolvent if a reasonable director would have suspected that the company was insolvent at the time. In the case of New Cap, reinsureds had lodged notifications of the occurrence of insured events and estimates of claims. This court decision raises the problem of directors of indemnity insurers who have not been formally notified of the occurrence of insured events but who are aware that the events have occurred. If this situation arose in relation to an insolvent trading claim, a court may have to decide whether a reasonable insurance company director in this position would have suspected that the company would be unable to meet claims arising from the event.
