Insurance companies won't be rejoicing at the Full Federal Court's recent decision AIG Australia Limited v Kaboko Mining Ltd  FCAFC 96, which dismissed an appeal from an insurer seeking to expand the operation of an insolvency exclusion in a directors' and officers' (D&O) liability insurance policy. Insureds, on the other hand, should take some measure of comfort from it, as it brings greater certainty to the scope of their cover, and their right to make a claim. Clayton Utz acted for the successful respondent, Kaboko Mining Ltd (Subject to a Deed of Company Arrangement).
The Claim, the D&O policy, and the insolvency exclusion in Kaboko
Kaboko brought a civil claim against four former company officers for alleged breaches of the Corporations Act 2001 (Cth) (the Claim), and the four former directors sought indemnity pursuant to their D&O policy. The insurer declined indemnity, arguing that because the former directors' alleged breaches of the Corporations Act also led to the insolvency of the company, the "insolvency exclusion" clause in the D&O policy applied.
The insolvency exclusion provided that the insurer shall not be liable "for any Loss in connection with any Claim arising out of, based upon or attributable to the actual or alleged insolvency of [Kaboko] or any actual or alleged liability of [Kaboko] to pay any or all of its debts".
Justice McKerracher in Kaboko Mining Limited v Van Heerden (No 3)  FCA 2055 rejected the insurer's argument, taking into account the commercial purpose of the D&O policy and the mischief sought to be excluded by the insolvency exclusion.
The insurer appealed Justice McKerracher's decision to the Full Court, arguing that on the basis of events leading up to Kaboko bringing the Claim, the Claim arose out of, was based upon or was attributable to the insolvency of Kaboko or its inability to pay its debts.
The insurer submitted that there would have been no Claim if Kaboko had been able to repay a certain creditor, and that the reason the proceedings had been brought was because of the insolvency of Kaboko.
Conversely, Kaboko argued that for the insolvency exclusion to apply, the merits of the Claim itself or the causal pathway for the loss claimed must depend upon demonstrating the insolvency of Kaboko or its inability to pay its debts.
Motivation for bringing the claim isn't relevant
The Full Court surmised that the key question was whether it was the subject matter of the Claim that must have the requisite link to insolvency, or whether that link can be established where, by reason of the circumstances that led to the Claim being brought, it can be said that the Claim arises out of, is based upon or is attributable to the insolvency.
The Court held that for the purposes of this insolvency exclusion, a Claim does not arise out of, is not based upon and is not attributable to insolvency unless the subject matter of the Claim has that character.
The exclusion could not apply on the basis that insolvency motivated or led to bringing the Claim, for reasons including:
- there was no language in the definition of "Claim" or in the insolvency exclusion that directs attention to the reasons why the Claim was brought;
- there is no commercial rationale for the extent of coverage to be dependent upon the motivations behind bringing the Claim;
- to accept the insurer's argument, there would need to be an objective or subjective inquiry into the state of mind of those bringing the Claim – which would likely result in complexity in other cases; and
- the words used in the insolvency exclusion, especially "arising out of" and "based upon" indicate a focus on the subject matter of the Claim, not the motivations behind bringing the Claim.
Insolvency link not established
Ultimately, the Full Court found that Kaboko's Claim against the former directors was not founded upon any allegation of insolvency, and could be advanced irrespective of whether Kaboko was in administration. Accordingly, it could not be said that the breaches were of a character that they arise out of, are based upon or are attributable to Kaboko's insolvency, and the appeal was dismissed.
What the decision means for directors, officers – and their insurers
In a market where insurers are pressing for wider exclusions and limitations, this decision brings some comfort to insureds with similar exclusion clauses in D&O policies, and avoids creating an uncertain area of law where people's motivations for bringing legal action could be called into question when determining insurance coverage.
Further, the decision confirms that an insolvency exclusion in a D&O policy will not automatically apply to claims against former directors of an insolvent company.
The decision serves as a reminder to be aware of the precise wording of your insurance policies, to consider seeking advice when entering into D&O policies, and to seek advice if your insurer declines indemnity on the basis of an exclusion clause.