In an eagerly anticipated decision1, the High Court of Australia yesterday reversed a string of decisions to hold that an objective test is applicable when considering the operation of "known circumstance" exclusions.
While this result was not unexpected, the decision clarifies the effect of such exclusions, common in claims made policies (e.g. professional indemnity and D&O), that generally require the disclosure of "known circumstances" prior to the inception of a policy and exclude cover for subsequent claims arising from such circumstances.
The decision emphasises the need for the diligent consideration, disclosure and notification of circumstances that could give rise to claims against an insured as an honest failure to appreciate the potential for a claim will provide no excuse.
Setting the scene - the barrister
Mr Porthouse was a barrister who provided incorrect advice to his client in relation to important and well known legislative amendments. This ultimately precluded his client from receiving an award of damages for personal injury.
Mr Porthouse's client initially obtained a significant award at arbitration which was affirmed before the District Court. However, Mr Porthouse was aware that the other side maintained an arguable appeal.
The Court of Appeal ultimately set aside the verdict and Mr Porthouse was successfully sued by his client. He then sought indemnity under his professional indemnity policy.
The insurance policy and exclusion clause
Following the provision of the negligent advice and success at trial, but prior to the appeal judgment against his client, Mr Porthouse obtained professional indemnity cover from CGU. He explicitly stated in his insurance proposal form that he was not aware of any circumstances which could result in any claim or disciplinary proceedings being made against him.
CGU denied indemnity on the basis that Mr Porthouse ought to have disclosed the possibility of a claim against him. Professional indemnity and D&O policies often contain a clause to the effect that an insured shall not be covered for "known claims" or claims arising from "known circumstances", in this instance 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.
Ultimately subclause (b) was the focus of attention as at the time of completing the proposal Mr Porthouse did not know the result of the appeal and did not actually think that his client would sue him.
So far so good
Mr Porthouse's claim was upheld at first instance and by the NSW Court of Appeal.
Two of the three judges in the Court of Appeal construed subparagraph (b) against CGU for contrasting reasons. Justice Hodgson considered that the phrase "in the Insured's professional position" required a subjective enquiry into the insured's state of mind. Justice correctly applied an objective test, however the clause was considered ambiguous due to the terms would and thought and ultimately the clause was construed narrowly to require a reasonable person to have "believed that the circumstances might, as a realistic possibility, result in an allegation" being made.
In a rather circular approach, the Court of Appeal considered whether it was unreasonable for the insured to think that a claim was not a realistic possibility. This approach was ultimately rejected by the High Court.
In dissent, Justice Hunt construed subparagraph (b) to establish an objective test and to find that a reasonable person in the insured's professional position would clearly have, at the relevant time, contemplated the real possibility that an allegation of negligence might result against them based on the facts, situation and circumstances.
No more surprises
In a unanimous decision, the High Court overturned the Court of Appeal's decision and held that the insured's claim was precluded by the "known circumstances" exclusion.
The High Court provided the following primary reasons for the decision:
- Paragraph (b) set an objective standard, with the modification that the insured's professional experience and knowledge of facts and circumstances are imputed to "a reasonable person in the insured's profession". Such consideration is independent of the insured's state of mind but rather involve a reasonable person's state of mind.
- The inferences to be drawn from the undisputed facts and circumstances known by the insured were so obvious that the Court is able to evaluate for itself the correct application of the objective standard.
- There can be no real doubt that a reasonable barrister with the knowledge and experience of the insured would have thought that there was a real (not a fanciful or remote) possibility (not a certainty) that an allegation might be made.
The High Court concluded that subparagraph (b):
...sets an objective standard, with the modification that the insured's professional experience and the insured's knowledge of facts and circumstances are imputed to "a reasonable person in the Insured's professional position". An enquiry about what a reasonable person "would have thought" enquires about real (not remote or fanciful) possibilities; it does not enquire about certainties. ... it is not wrong to take into account what an insured thought, as a piece of possibly relevant evidence, but the standard ... is an objective standard, and a question of fact to be determined independently of the insured's state of mind.
What it means for insurers
The High Court's decision provides welcome certainty in relation to the operation of "known circumstance" exclusions and the adoption of an objective standard is likely to be welcomed by insurers.
However, the decision involved a particular clause (albeit a reasonably standard formulation), and there remains scope for differently worded clauses to give rise to a different result. Insurers would therefore be well advised to ensure that their "known circumstance" exclusions sufficiently prescribe an objective test.
What it means for insureds
The decision also highlights the importance of the considered and timely notification of circumstances by insureds. An honest failure to appreciate that a circumstance may give rise to a claim will be no excuse if a "reasonable person" in the same circumstances would have appreciated the risk.
The decision is also closely tied to an insured's duty of disclosure and emphasises the importance of a considered response to policy proposal forms.
Insureds are often reluctant to notify circumstances for fear of increased premiums. However, insurers generally prefer the diligent notification of circumstances and insured's run the far greater risk of not having cover when they need it if they do not duly notify circumstances.
While continuous cover clauses (allowing cover for claims arising from late notified circumstances where an insured has continuously insured with the one insurer) can provide additional comfort, there is no substitute for full disclosure and timely notification.
1. CGU Insurance Limited v Porthouse  HCA 30 (30 July 2008)
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This publication is provided to clients and correspondents for their information on a complimentary basis. It represents a brief summary of the law applicable as at the date of publication and should not be relied on as a definitive or complete statement of the relevant laws.