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.
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
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:
in a 1907 case, the High Court held that a liability to pay
unliquidated damages was a debt; but
in 2006, the NSW Court of Appeal held that a liability to pay
unliquidated damages was not a debt (the Court of Appeal
was apparently unaware of the High Court ruling).
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
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.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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The failure of a party to call a witness does not necessarily give rise to an adverse inference being drawn in accordance with Jones v Dunkel (1959) 101 CLR 298. An unfavourable inference is drawn only if evidence otherwise provides a basis on which that unfavourable inference can be drawn.
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