Australia: "Dishonesty And Fraud Exclusion In PI Policy: Court Affirms Wayne Tank Principle And As To Defence Costs Entitlements": Mccarthy -v- St Paul International Insurance Co Ltd [2007] FCAFC 2

McCarthy -v- St Paul International Insurance Co Ltd
[2007] FCAFC 28

Kiefel, Stone and Allsop JJ

• The Full Federal Court has confirmed the Wayne Tank principle, which denies indemnity for a loss arising from both insured and excluded events.

• An excluded cause of a loss need not be the only or the proximate cause of the loss for the loss to be excluded from indemnity. Although each case will differ in its particular facts, fraud will give rise to a loss where that fraud is a material fact in the third party’s claim.

• Where particular costs of investigation and defence relate to both insured and excluded causes, the Insured is entitled to indemnity for these costs.

• Where an Insured succeeds in proceedings for indemnity against its Insurer, it is prima facie entitled to its costs on a party-party basis only. The costs of bringing indemnity proceedings do not fall within the insurance indemnity.

• The Appellants were the members of a firm of solicitors ("the Insured") insured against professional liability by the Respondent ("the Insurer") under a claims-made policy. The policy excluded liability to third parties brought about by dishonesty or fraud. The Insured’s subsequent insurer, QBE, was a party at trial, but was not involved in the appeal.

• The Insured offered investment schemes to investors. The Insured's Loans Manager (a Mr Blackadder) prepared an "investment summary" for each proposed investment. The investment summary was then circulated among the Insured’s partners before a decision was made to issue the summary to potential investors.

• In the investment scheme sued on, Blackadder’s investment summary dishonestly stated that the developer was in a strong financial position. Blackadder’s representations, both dishonest and merely negligent, induced 39 investors to invest in a land development scheme.

• The 39 investors brought proceedings in the Federal Court against the Insured, who cross claimed against the Insurer, seeking indemnity with respect to the investors’ claims and the cost of defending the claims.

• The Trial Judge found the investment summary to have been fraudulently prepared within the terms of the policy exclusion.

• The Trial Judge found the Insured liable to 36 of the investors based on Blackadder's fraud, one on another basis and two claims not to have been made out.

• In relation to the Cross Claim, the Trial Judge ordered:

• The Insured appealed to the full Federal Court on the bases that:

• Both the Insured and the Insurer appealed against the cost orders.

• Kiefel J dealt principally with the issue as to whether Blackadder's conduct was fraudulent, agreeing with Allsop J as to the extent of indemnity available to the Insured. Allsop J dealt with the indemnity questions, agreeing with Kiefel J as to Blackadder's fraud. Stone J agreed generally with both Kiefel and Allsop JJ.

• The Insured's appeal, as it related to Blackadder's fraud, contended that the Trial Judge erred in that he:

• The evidence said to have been wrongly rejected was evidence of Blackadder's supervisor at the Insured, Mr Ryan. Ryan gave evidence that, of the 150 mortgage investment schemes the Insured had promoted over four or five years, the rate of default by borrowers was relatively low. This evidence was originally sought to be led in a Cross Claim against QBE on the issue as to whether the Insured had made proper disclosure to QBE with respect to the claims the subject of these proceedings. The Insured sought to lead this evidence to negative the inference that Blackadder was dishonest, on the basis that the Insured's mortgage schemes, overall, were honestly and competently conducted. Kiefel J found that the overall conduct of the Insured's mortgage brokerage business was not relevant to Blackadder's conduct with respect to this scheme.

• Secondly, the Insured argued that dishonest conduct in terms of the policy must be deliberate. That is, Blackadder must have had an intention to deceive. The Insured contended that it was necessary to find that Blackadder considered his conduct deceitful. Keifel J rejected this argument. The person is guilty of deceit if they know or believe what they say to be false: Derry v Peek (1889) 14 App Cas 337. Whether a statement is dishonest is to be assessed by reference to standards of ordinary honest persons: McCann v Switzerland Insurance Australia Ltd (2000) 203 CLR 579. It was therefore immaterial whether Blackadder had the motivation to cheat or to injure the investors.

• In Keifel J’s view, the Trial Judge properly found Blackadder's representation to have been fraudulent.

• The Insured also argued that the loss had not been "brought about" by Blackadder's dishonesty. Rather, it was "brought about" by the decision by the Insured’s partners to issue the investment summary. However, the Trial Judge found that Blackadder's fraudulent conduct included making the misrepresentative investment summary and failing to draw the inaccuracies to the attention of the partners of the Insured. Dishonest conduct can "bring about" a loss if the dishonest breach of duty puts the monies at risk, notwithstanding that there were intervening or additional causes: McCann v Switzerland Insurance.

• In relation to its defence costs of the 36 claims arising from the fraudulent conduct, the Insured argued that these claims were based on both fraudulent and merely negligent misrepresentations. Only one of which (Blackadder's fraud) was subject to the exclusion. On this basis, the Insured argued that the Insurer should indemnify it for its defence costs on the 36 claims arising from fraud, except the extent that they related to the one fact of fraud.

• Allsop J rejected this argument. The argument relied on characterising each of the constituent facts of each claim as a "claim". The policy did not support this construction. In particular, as a claims made policy, it contemplated a "claim" as a set of circumstances potentially giving rise to third party liability.

• The investors had each been misled by a number of representations. It was the collection of representations, and the investors' resulting loss, that constituted each claim. Therefore, in respect of the 36 claims in which Blackadder's fraudulent misrepresentation formed an element, the Insured was not entitled to indemnity for its defence costs.

• It is a settled principle of insurance law that where a loss falls within the terms of the insuring clause, but also those of an exclusion, the Insured is not entitled to indemnity: Wayne Tank and Pump Co Ltd v Employers' Liability Assurance Corporation [1974] QB 57. Therefore, since the claims of the 36 investors arose both from insured and excluded circumstances, the Insured was not entitled to recovery of its defence costs with respect to those claims.

• However, should particular investigation and defence costs be referable both to indemnified and excluded claims, the Insured was entitled to recover those particular costs. Each of these particular costs, since they were referable to claims for which indemnity was available, were properly the subject of the indemnity for defence costs.

• The Insured was entitled to the legal costs of the Cross Claim against the Insurer, to the extent that these costs related to the one claim on which liability was found other than Blackadder's fraud and the two unsuccessful claims. The Insured argued that it was entitled to those costs on an indemnity basis, as its liability for such costs was part of a loss recoverable under the policy. Allsop J rejected this argument. He found that such a claim for costs was not a loss contemplated by the policy of insurance: BNP Paribas v Pacific Carriers Limited [2005] NSWCA 72.

• Losses arising from both insured and excluded events will, subject to the terms of the policy, be excluded from indemnity.

• An excluded event need not be the sole or proximate cause of a loss. Depending on the terms of the policy and the circumstances of the loss, it will be sufficient that it constitutes a material fact in a third party’s claim.

• Where particular costs of investigation and defence relate to both insured and excluded causes, the Insured is entitled to indemnity for these costs.

• Insureds are entitled to costs of successful indemnity claims on a party-party basis only, subject to the ordinary rules of legal costs.

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