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No knowledge, no power: Section 54 and deeming provisions

Insurance Law & Litigation

Section 54 of the Insurance Contracts Act 1984 (Cth) (ICA) is a powerful remedial provision which may excuse a lack of proper notification where a policy has a deeming provision. However, this power is not unfettered.

The recent New South Wales Court of Appeal decision in DIF III [1] demonstrates that Section 54 will have no work to do where the insured fails to demonstrate knowledge of the relevant facts or circumstances which could reasonably be anticipated to give rise to a future claim.

Background

DIF III was a limited partnership established under the laws of Delaware with its affairs managed by a general partner, DIF III GP Limited (General Partner).

In September 2007, DIF III entered into a management agreement with DIF Capital Partners Limited [2] (the Manager) where the investment committee of the Manager would consider and approve investments presented to it by the Manager’s investment officers after they had undertaken due diligence (the Investment Committee) and recommend it to DIF III.

On the recommendation of the Manager, DIF III invested US$25 million in November 2007 in a transaction by which Babcock & Brown LP acquired control of Coinmach Service Corporation (Coinmach). Coinmach was a publicly listed Delaware corporation and the leading provider of outsourced laundry equipment services for American multi-family or multi-dwelling housing properties. DIF III's investment was part of a much larger investment by other B&B Group companies.

This investment coincided with the Global Financial Crisis and was not a success. DIF III received some deferred profits but ultimately commenced proceedings in the Supreme Court of NSW seeking damages for the bulk of the lost investment.

DIF III pursued a number of causes of action against the Manager, including for damages for breach of the Management Agreement. DIF III also sued individual members of the Investment Committee of the Manager, Directors and Officers Insurers and the Manager’s Professional Indemnity Insurers (PI Insurers). The PI Insurers undertook the defence of DIF III’s claim against the Manager, but were also sued directly by DIF III pursuant to s 4(1) of the Civil Liability (Third Party Claims Against Insurers) Act 2017 (NSW).

First instance decision

Relevantly, the PI Insurers' position was as follows:

  • Causation: The PI Insurers admitted the Manager had breached the Management Agreement, but denied the breach had caused DIF III any loss or damage.
  • Deeming provision and section 54: The PI Insurers denied they were obliged to indemnify the Manager under the professional indemnity policy (the Policy) on the following grounds.
    • Whilst the Policy provided that written notice of particulars of an actual or potential Claim within the policy period from September 2008 to 2009 was a condition precedent to cover, the Policy had a deeming provision which provided that a third party Claim "is considered to be made" when the insured's management (including directors, the managing director and members of executive committees established by the board) become "aware of any fact, circumstance or event which could reasonably be anticipated to give rise to a Claim at any future time."
    • DIF III commenced the underlying proceedings against the Manager in 2018. No written notice of that claim or of any "fact, circumstance or event" which could reasonably be anticipated to give rise to a Claim under the Policy, was notified to PI Insurers by B&B or the Manager before the proceedings were commenced.
    • The effect of Section 54 is that PI Insurers could not refuse to pay the Manager's indemnity claim by reason only of its omission to give written notice of it having become aware of relevant matters during the Policy period.
    • However, PI Insurers denied section 54 operated to excuse the lack of written notice on the basis that the management of the Manager had not become aware of any “fact, circumstance or event which could reasonably be anticipated to give rise to a Claim” against the Manager during the policy period.

At first instance, the trial judge (Ball J) dismissed DIF III’s claims against all parties and, relevantly, held that DIF III had not established the admitted breach of the Management Agreement had caused it any loss.

His Honour also held that the Manager had not been put on notice of any potential claim within the policy period, and so, the Policy did not respond. In that latter respect, his Honour concluded that the evidence did not establish that any director or member of the senior management of the Manager had become aware of such circumstances during the policy period. Notably, the evidence provided by the two directors, Mr Topfer and Mr Green, did not establish such awareness, and the other two members of senior management, Mr Nicholson and Mr Neilson, were not called to give any such evidence. The trial judge also held that none of the nine communications relied on suggested DIF III might make any claim against the Manager or members of the Investment Committee.

DIF III appealed the trial judge's decision.

Appeal decision

There were three grounds of appeal. DIF III was unsuccessful on the first two grounds and the Court of Appeal decided it was not necessary to determine the third.

The first issue on appeal was causation. Having undertaken a detailed analysis of the evidence at trial, President Bell (with whom Bathurst CJ and Meagher JA agreed) concluded DIF III failed to demonstrate the trial judge erred in finding that DIF III had failed to establish loss or damage for breach of contract. This was dispositive of the appeal, but the Court went on to consider the second ground of appeal in relation to the deeming provision.

Meagher JA (with whom Bathurst CJ and Bell P agreed) concluded that DIF III again failed to demonstrate the trial judge had erred in finding that the Policy did not respond. We analyse below the Court of Appeal's reasoning.

Section 54 and the deeming provision

On appeal, DIF III only relied on three "notification" communications dated 13 November 2008, 17 November 2008 and 5 February 2009, which post-dated the conclusion of the Coinmach transaction in November 2007. Those communications appear to have come to the attention of Mr Nicholson but, on their face, did not come to the attention of other Investment Committee members.

DIF III submitted all three communications had to be considered together and indicated the following:

  • 13 November 2008 email: this email recorded the views of Mr Stahel of BBGP [3] that in late 2008, the investment was "distressed" and the original investment strategy [4] was no longer feasible. However, there was no suggestion in this email that the Manager might be held responsible for third party losses if the investment ultimately failed.
  • 17 November 2008 email: this email from Mr Stahel of BBGP to Mr Nicholson referred to an earlier exchange between Ms Talintyre of the Coinmach Deal Team and RBS which recorded that in November 2007, Ms Talintyre had regarded the Coinmach deal as "uncommercial" but that it should go ahead "purely for the reason of collecting a substantial fee from BBGP and other satellite fund investors".
  • 5 February 2009 email: this email contained a draft valuation of Coinmach as at October 2008 undertaken by KPMG, which assessed the value of Coinmach's equity, and, accordingly, DIF III's investment, to be nil.

Having analysed the substance of these communications, Meagher JA concluded that:

  • The 17 November 2008 email did not provide any basis for thinking a claim of some sort may be brought against the Manager because of the conduct of Ms Talintyre (as leader of the Coinmach Deal Team).
  • The 13 November 2008 email and 5 February 2009 emails concern Coinmach's financial position in October and November 2008. Whilst Coinmach's distressed position made it likely that there were persons or entities, including DIF III, who would suffer loss as a result of its failure, that was not of itself a matter which could reasonably be anticipated to give rise to a claim against the Manager. There was nothing in those communications which suggested DIF III or any other party had a basis for making a claim arising out of conduct of the Manager in relation to the DIF III investment.

In light of the above, DIF III failed to establish the required knowledge of the Manager under the deeming provision (awareness of any circumstance that could give rise to a claim), with the consequence that Section 54 did not operate to provide the insured with a remedy and cover was not available under the Policy.

Implications

Whilst Section 54 is a broad remedial power when applied to a deeming provision, it is not an absolute panacea and cannot cure every failure to properly notify. The DIF III appeal decision and reasoning by Meagher JA is a reminder that in order for an insured to successfully invoke section 54 and the deeming provision, there has to be evidence of the insured's knowledge of circumstances which might reasonably be anticipated to give rise to a claim, or a "problem" which might of itself result in claims.

Another takeaway from this case is that the PI Insurers made the forensic decision to undertake the defence of DIF III's claim against the Manager (as noted by the Court), in addition to defending the coverage dispute.

When sued directly by a third party pursuant to s 4(1) of the Civil Liability (Third Party Claims Against Insurers) Act 2017 (NSW), insurers have a choice to simply fight the coverage dispute or undertake to fight both the liability and coverage issues. The benefit of the latter strategy is that if the insurers step in to undertake the defence of the liability issues and succeed, then the third party would never be able to put the coverage issues into play and have a chance at accessing the insurance because there would be no "Loss". The PI Insurers' success on the liability issue in this case was dispositive of the entire appeal.

The downside of this strategy is, of course, costs. However, such a strategy would be most attractive for insurers where the case against the insured is defensible, the insured lacks the resources to put on a strong defence and the stakes (quantum) are relatively high.


[1] DIF III - Global Co-Investment Fund LP v DIF Capital Partners Limited [2020] NSWCA 124. Unanimous decision of Bathurst CJ, Bell P and Meagher JA https://www.caselaw.nsw.gov.au/decision/172ea4572e815a34bc8cc594

[2] Formerly known as Babcock & Brown Direct Investment Fund Limited

[3] Another B&B entity investor in Coinmach

[4] to hold equity interest to realise value through EBITDA growth

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Melissa Tan

Special Counsel