In Napier City Council v Local Government Mutual Funds Trustee Limited 1 the High Court recently found that a weathertightness exclusion in professional indemnity cover excluded indemnity for both weathertightness and non-weathertightness defects. While not strictly an insurance policy, Justice Grice's decision is relevant to the wider insurance community.
The Local Government Mutual Funds Trustee Limited (RiskPool) is a mutual fund. Local authority members make annual contributions in return for Riskpool providing indemnity cover for members, including for civil liability. Riskpool operated much like a commercial insurer. It issued “Protection Wording” which was similar to a commercial insurance policy, but Riskpool also had “absolute and unfettered discretion” whether or not to indemnify.
Napier City Council (NCC) was a member of RiskPool in 2014 when the owners of Waterfront Apartments (Waterfront) brought a claim in negligence against it.
The claim alleged both weathertightness and non-weathertightness defects. NCC provided the building consents, inspections, and granted Code Compliance Certificates for the apartments.
NCC settled Waterfront's claim at mediation for a global figure for all defects and negotiated contributions from the other defendants.
NCC notified RiskPool of the claim. RiskPool refused cover on the basis that exclusion clause 13 of its Protection Wording excluded the entire claim, as it involved weathertightness defects. NCC sued RiskPool for breach of contract.
Exclusion clause 13
Exclusion clause 13 provided that “liability for claims alleging, arising directly or indirectly out of, or in respect of … [weathertightness defects]” were not covered under the Protection Wording.
The decision turned largely on how “claim” was interpreted in this specific wording; whether it meant one, albeit mixed claim, or whether it could be subdivided into its constituent parts for the purpose of indemnity.
The Court found the use of the word “claim” in other exclusion clauses, provided little assistance due to the inconsistent way it was used.
Submissions on the meaning of “claim”
NCC submitted that exclusion clause 13 only excluded liability for claims (or parts of claims) that related to weathertightness defects. It said non-weathertightness defects should still be covered even if they were found as a result of investigating weathertightness defects.
This interpretation arose from the natural and ordinary meaning of the words, in part because the plural “claims” is used and because non-weathertightness defects had no causal relationship to the exclusion. If RiskPool did intend to exclude non-weathertightness defects it should have done so explicitly.
NCC also submitted it could produce absurd results if a very small weathertightness defect tainted a larger unrelated building defect (e.g. $1,000 to fix a leaky window, excluding cover for $10 million of structural defects, if included in a claim). Finally, NCC argued that the ambiguity in clause 13 should be construed contra proferentum against the drafter, RiskPool.
RiskPool submitted that a claim was excluded in entirety if it is tainted by weathertightness defects because the liability the scheme was intending to avoid was building defects and failures which were the result of the building industry's systemic failure.
RiskPool submitted that a literal interpretation of the exclusion clause should be adopted. In particular, it said the “claim” is “the demand for compensation” for NCC's negligence in undertaking its statutory processes as a whole, so the weathertightness defects tainted all of the complaints contained in the “claim”. Additionally, the claim excluded all complaints arising “directly or indirectly out of or, in respect of” weathertightness issues. The non-weathertight defects were found when investigating weathertightness defects, so were excluded.
In support of its argument, RiskPool pointed to the original demand for compensation which made no distinction between types of defects or claims. Further, settlement was negotiated in a lump sum and there is no authority for dividing the claim into its constituent parts for the purpose of assessing indemnity. The principle of de minimis could be read into the contract to prevent absurd results raised by NCC and the plural and singular of “claims” is interchangeable.
The Court's finding on “claim”
Justice Grice applied the accepted approach to contractual interpretation, recognising the text remains “centrally important”. If the text has a natural and ordinary meaning, construed in the context of the policy as a whole, that is a powerful indicator of what the parties intended.
The Court considered how “claim” has been interpreted in other cases (i.e. a single mixed claim, or multiple or composite claims).
NCC relied on Murphy v Swinbank2where the New South Wales Supreme Court determined where the loss or damage is separate or distinct, it weighs in favour of multiple claims.
RiskPool cited Thorman v New Hampshire Insurance Co (UK) Ltd3 where the England and Wales Court of Appeal considered that an original notification letter, which included problems arising “inter alia” with general defects, allowed other issues to be particularised as part of the claim later, even if not originally mentioned.
It's the underlying facts that determine what is part of the claim, not the pleadings. Where the defects and damage are separate, it is more likely to be a distinct claim. If several regulatory failings are alleged, they are more likely to fall under the same claim.
Grice J preferred Thorman, particularly as its facts were more analogous to Waterfront's claim.
In AIG Australia Ltd v KabokoI4, the Federal Court of Australia suggested that defined terms should be read into the provision in which they apply. Justice Grice found that when the definition of “claim” is inserted into the exclusion clause 13, the “liability for claims” governs the exclusion, and on its plain reading, weathertightness defects do taint the whole “claim”.
The Court accepted Riskpool's submission that the de minimis doctrine could be applied to avoid the absurd outcomes raised by NCC. It may apply as an implied term, operation of law, or as a general principle. This should be assessed objectively. Riskpool's overarching discretion to accept or decline a claim for indemnity could also be used to avoid absurd outcomes.
This resulted in the exclusion clause effectively excluding all complaints, including those relating to non-weathertightness defects, so NCC had no cover from RiskPool.
Extrinsic evidence & mutual intention
Of course, while the text is “centrally important” the Court's job is to decide what the parties intended the contract, here the Protection Wording, to mean.
NCC submitted that the effect of RiskPool's interpretation was not the mutually intended meaning of exclusion clause 13 and, further, the exclusion would be commercially unrealistic or absurd if the Court relied on it.
The Court considered it needed extrinsic evidence on the mutual intention of the parties. Grice J analysed years of communications between Riskpool and NCC, including annual reports explaining the genesis and evolution of exclusion clause 13.
The exclusion clause was a replacement of an earlier clause that was titled “Multi-Unit Building Defects Claims Involving Moisture Ingress” which placed a $50,000 sublimit on damages . This clearly included all defects. Riskpool had communicated its difficulties with the increasing volume and quantum of building defects claims. A reasonable person would understand that RiskPool wouldn't have intended to increase its liability when introducing exclusion clause 13, removing the sublimit, but no longer including all defects.
Additionally, in 2012 RiskPool had declined another NCC claim involving weathertightness and non-weathertightness defects because the weathertightness defects “infected” the whole claim. NCC had been explicitly informed of the intended meaning and application of exclusion clause 13 when that claim was declined. Despite this, NCC renewed its membership with RiskPool anyway in 2013 and 2014.
The Court found it was in fact the mutual intention of both parties to exclude non-weathertight defects, because NCC was regularly informed of Riskpool's approach to non-weathertightness building defects, was put on notice of this interpretation, did not object to it and continued to enter into the scheme annually.
Justice Grice went further and found that NCC owed Riskpool a duty of good faith under the Trust Deed (also noted to be a feature of insurance relationships). If it did not accept Riskpool's meaning of the exclusion when the previous claim was declined, the duty of good faith meant NCC had a duty to disclose this when it renewed its annual scheme membership. It could not silently disagree and wait for a better case to argue for its interpretation. This is effectively “speaking silence” – the party remaining silent will be bound by the other party's terms as if they intended to agree unless they explicitly object.
Contra proferentum was found not to apply because the meaning of exclusion clause 13 was clear. Nor was there a risk of commercial absurdity because people negotiate insurance contracts on balance of risk every day and both parties had agreed to the terms.
Approach if RiskPool was liable
Presumably in anticipation of an appeal, the Court considered the approach it would have taken if RiskPool was liable.
The first consideration is whether the settlement paid by NCC to Waterfront falls within the scope of general indemnity cover. In general, legal liability does not have be shown. Rather, it is the demand or claim that is to be indemnified.
The insured, NCC, would have had to show it acted reasonably in reaching settlement at mediation. The reasonableness of the settlement should be judged at the time settlement was reached and is a question of fact. If NCC had acted reasonably, the measure of damages is the settlement amount paid in damages and costs.
As a global settlement was reached, the damages would then need to be apportioned depending on what was a weathertightness defect or not. RiskPool would only be liable for the reasonable amount of damages related to non-weathertightness issues. Damages arising from mixed weathertightness and non-weathertightness defects would be excluded, based on Arrow International Ltd v QBE Insurance.
Determination of value can be supported by expert evidence. In this case, if it had been liable to indemnify NCC, RiskPool would only have had to pay for the fire safety compliance defects.
It seems that the longstanding relationship between the parties and their historical communications, were centrally important to Justice Grice's reasoning and ultimate decision. Whether the same outcome would follow in a commercial insurance arrangement remains to be seen.
An appeal has been lodged, so we await the Court of Appeal's decision with interest.Footnotes
1 Napier City Council v Local Government Mutual Funds Trustee Limited  NZHC 1477
2 Murphy v Swinbank  NSWSC 934
3 Thorman v New Hampshire Co (UK) Ltd  1 Lloyd's Rep 7 (CA)
4 AIG Australia Ltd v Kaboko Mining Ltd  FCAFC 96,  20 ANZ Insurance Cases 62-205
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