The recent NSW Supreme Court judgement of Martin John Green in his capacity as liquidator of Arimco Mining Pty Ltd (in liquidation) v CGU Insurance Limited & Ors [2008] NSWSC 825 addresses the need for companies and their directors to provide full disclosure of their financial standing to their insurers before entry into a policy of insurance.

In mid-December 1998 the directors of Arimco Mining Pty Ltd (Arimco) provided a signed proposal form to its D&O insurer, CGU, when arranging a renewal of the D&O policy. Amongst other things, the proposal made representations to the effect that Arimco was a financially strong company with a strong profit and cash balance of over AUD12 million. On the basis of the proposal, CGU issued a D&O policy to Arimco. However, the financial representations in the proposal were incorrect. At the time the directors provided the proposal to CGU, Arimco was in fact in financial trouble and had a negative cash balance, and the directors were aware of a proposed claim against Arimco for approximately AUD15 million.

Shortly after CGU issued the policy, Arimco was placed into liquidation and the liquidator issued proceedings against the directors pursuant to s558M of the Corporations Act 2001 that the directors pay the liquidator the amount of debt incurred by Arimco when it was allegedly insolvent. The directors settled the claim and a judgment was entered against each direction for AUD15 million. The directors then sought indemnity under the CGU policy for the settlement amounts. CGU denied liability for the settlement pursuant to s21 of the Insurance Contracts Act 1984 on the basis that the directors failed to disclose and misrepresented the financial situation of Arimco in the proposal form. CGU maintained that had the directors fully disclosed the correct financial status of the company then CGU would have insisted on the inclusion in the policy of an exclusion clause for insolvency. The liquidator disputed this, saying that at best CGU would have included an exclusion for any damages arising from the proposed claim (which did not make up part of the settlement).

The NSW Supreme Court accepted CGU's argument and found that, on the balance of probabilities, it would not have renewed the Policy without imposing the insolvency exclusion if all material facts had been disclosed. On this basis the Court found that s28 of the Insurance Contracts Act reduced CGU's liability to the directors to nil. The Court held the view that it is a matter of commonsense that the financial soundness of a company and its ability to continue to operate for the period of insurance is a matter of fundamental importance to insurers when determining whether or not to insure the company. Importantly for insurers, the Court found that the relevant consideration for determining whether ss21 and 28 of the Insurance Contracts Act apply is what the particular insurer would have done in the circumstance rather than what a "prudent insurer" would have done.

Given that the current economic climate is resulting in more companies going into liquidation, the possibility of claims being brought against directors of companies by liquidators for insolvent trading is increasing. It is therefore important that underwriters retain good records of their underwriting decisions and in the event of a non-disclosure similar to that by the directors of Arimco, are able to demonstrate that they would not have issued the policy on the terms that they did if full disclosure had been made.

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.