CATCHWORDS

INSURANCE LAW - Liability policy - claim for contribution by insurer - whether evidence establishes that co-insurer would have been liable under its policy to indemnify insured - whether settlement by claimant insurer of principal claim against insured was reasonable.

- Assessment of extent of contribution - whether "maximum potential liabilities test" or "independent liabilities test" should be applied.

INSURANCE LAW - Claims made and reported policy - what constitutes a "claim" - whether s.54 of the Insurance Contracts Act 1984 (Cth) applies if claim reported outside period of insurance - meaning of "omission" in s.54 - whether election by insured not to report claim constitutes "omission".

INSURANCE LAW - Professional indemnity policy - insured's business included providing advice as an accountant and investment adviser - whether insured's liability incurred "in connection with" practice as an accountant.

INSURANCE LAW - Liability policy - insurer wrongfully repudiates liability to indemnify - insured settles claim without consent of insurer - insurer not entitled to rely on provision preventing settlement without insurer's consent.

Federal Court of Australia Act 1976 (Cth), s 51A

Insurance Contracts Act 1984 (Cth), s 54

Albion Insurance Company Ltd v Government Insurance Office of New South Wales (1969) 121 CLR 342

Antico v C E Heath Casualty & General Insurance Ltd (unreported, NSW CA 30 January 1996)

Antico v C E Heath Casualty & General Insurance Ltd (1995) 8 ANZ Ins.Cas. 61-268

Boag v Economic Insurance Company Ltd [1954] 2 Lloyd's Rep 581

Burswood Management Ltd v Attorney-General (Cth) (1990) 23 FCR 144

Captain Boyton's World's Water Show Syndicate (Limited) (1895) 11 TLR 384

C E Heath Underwriting and Insurance (Australia) Pty Ltd v The State Government Insurance Commission (SA) (1983) 34 SASR 1

Distillers Company Bio-Chemicals (Australia) Pty Ltd v Ajax Insurance Company Ltd (1974) 130 CLR 1

East End Real Estate Pty Ltd t/as City Living v C E Heath Casualty & General Insurance Ltd (1991) 25 NSWLR 400

FAI General Insurance Co Ltd v Perry (1993) 30 NSWLR 87

General Omnibus Company Limited v London General Insurance Company Ltd [1936] IR 596

Government Insurance Office of New South Wales v Crowley [1975] 2 NSWLR 78

Government Insurance Office of New South Wales v Royal Exchange Assurance of London (1965) 82 WN (NSW) (Part 1) 468

G.R.E. Insurance Ltd v QBE Insurance Ltd [1985] VR 83

Thorman v New Hampshire Insurance Co (UK) Ltd [1988] 1 Lloyd's Rep.7

Triden Properties Ltd v Capita Financial Group Ltd (unreported, NSW CA, 15 November 1995)

Walton v National Employers' Mutual General Insurance Association Ltd [1973] 2 NSWLR 73

WILLIAM JOHN DRAYTON & ORS v JOHN LESLIE MARTIN & ORS

NG 377 of 1993

 

 

 

SACKVILLE J.

SYDNEY

24 MAY, 1996

IN THE FEDERAL COURT OF AUSTRALIA)

NEW SOUTH WALES DISTRICT REGISTRY)    NG 377 of 1993

GENERAL DIVISION                  )

 

 

                        BETWEEN:

 

                        WILLIAM JOHN DRAYTON, NANCY MAE DRAYTON, BRUCE WILLIAM DRAYTON, ROSS DRAYTON

                        Applicants

 

                        AND:

 

                        JOHN LESLIE MARTIN

                        First Respondent

 

                        THE NATIONAL MUTUAL LIFE ASSOCIATION OF AUSTRALASIA LIMITED

                        Second Respondent

 

                        ROGER BUDD AGENCIES PTY LIMITED

                        Third Respondent

 

                        FAI GENERAL INSURANCE COMPANY LIMITED

                        Cross Claimant on the Seventh Cross Claim

 

                        HIH CASUALTY AND GENERAL INSURANCE LIMITED (formerly C E HEATH CASUALTY AND GENERAL INSURANCE LIMITED), AMP GENERAL INSURANCE LIMITED, SWITZERLAND GENERAL INSURANCE CO LIMITED, SUN ALLIANCE AND ROYAL INSURANCE AUSTRALIA HOLDINGS  LIMITED (formerly SUN ALLIANCE AUSTRALIA LIMITED)

                        Cross Respondents to the Seventh Cross Claim

 

CORAM:    SACKVILLE J.

PLACE:    SYDNEY

DATE:     24 MAY 1996

 

                      MINUTES OF ORDER

 

IN RELATION TO THE SEVENTH CROSS CLAIM THE COURT ORDERS THAT:

 

1.   The cross respondents pay to the cross claimant the sum of $134,686.34.

2.   The cross respondents pay the costs of the cross claimant.

NOTE:Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

IN THE FEDERAL COURT OF AUSTRALIA)

NEW SOUTH WALES DISTRICT REGISTRY)    NG 377 of 1993

GENERAL DIVISION                  )

 

 

 

                        BETWEEN:

 

                        WILLIAM JOHN DRAYTON, NANCY MAE DRAYTON, BRUCE WILLIAM DRAYTON, ROSS DRAYTON

                        Applicants

 

                        AND:

 

                        JOHN LESLIE MARTIN

                        First Respondent

 

                        THE NATIONAL MUTUAL LIFE ASSOCIATION OF AUSTRALASIA LIMITED

                        Second Respondent

 

                        ROGER BUDD AGENCIES PTY LIMITED

                        Third Respondent

 

                        FAI GENERAL INSURANCE COMPANY LIMITED

                        Cross Claimant on the Seventh Cross Claim

 

                        HIH CASUALTY AND GENERAL INSURANCE LIMITED (formerly C E HEATH CASUALTY AND GENERAL INSURANCE LIMITED), AMP GENERAL INSURANCE LIMITED, SWITZERLAND GENERAL INSURANCE CO LIMITED, SUN ALLIANCE AND ROYAL INSURANCE AUSTRALIA HOLDINGS  LIMITED (formerly SUN ALLIANCE AUSTRALIA LIMITED)

                        Cross Respondents to the Seventh Cross Claim

 

CORAM:    SACKVILLE J.

PLACE:    SYDNEY

DATE:     24 MAY 1996

 

                    REASONS FOR DECISION

 

 

I.   INTRODUCTION

 

This is a claim for contribution by one insurer against another.  The claimant insurer, FAI General Insurance Company Limited ("FAI") issued a professional indemnity policy to John

Leslie Martin ("Mr Martin"), who, at the relevant time, performed work both as an accountant and investment adviser.  Mr Martin was also insured under an Accountant's Professional Indemnity Policy underwritten by a group of insurers (the "accounting underwriters").  FAI paid out $292,000 in settlement of a claim against Mr Martin by former clients of his, William and Nancy Drayton and their sons, Bruce and Ross Drayton ("the Draytons").  FAI says that the accounting underwriters are liable to contribute to the settlement sum paid to the Draytons.

The claim by the Draytons arose out of a recommendation made by Mr Martin, and accepted by them, that they should invest in certain endowment policies issued by National Mutual Life Association of Australasia Ltd ("National Mutual").  The Draytons instituted proceedings in this Court against Mr Martin, National Mutual and Roger Budd Agencies Pty Ltd ("Budd Agencies"), a National Mutual agent, claiming relief by reason of losses incurred by them in taking out the endowment policies.  The proceedings were set down for a hearing in this Court, to commence on 30 April 1996, and estimated to last 12 days.  At a mediation held on 29 March 1996, the Draytons' claims against each of the three respondents were settled. 

Notwithstanding the participation of the accounting underwriters in the mediation, the claim by FAI against them for contribution could not be resolved.  This was despite the fact that the claim is for a relatively modest amount. 
Consequently, FAI's claim for contribution had to proceed to a hearing and is the subject of the present judgment.  As the number of issues dealt with in the judgment suggests, there has been no lack of ingenuity displayed by the accounting underwriters in resisting the claim.

II.  THE FACTS

 

Background

Mr Martin has professional accounting qualifications and a Diploma of Financial Planning.  From 1988 until September 1989, he was managing director of Matheson PFC Australia Ltd ("Matheson").  His responsibilities at that time included providing investment advice to clients.  Matheson was a licensed investment adviser, which meant that it was authorised under the Securities Industry (New South Wales) Code then in force to conduct a business of advising other persons about "securities", as defined in the Code.  It is not entirely clear whether Mr Martin was himself licensed under the Code.  In any event, he held what he described as a proper authority from Matheson, authorising him to provide advice on Matheson's behalf in relation to securities.

From about 1979 Mr Martin had performed some accounting work, on a part-time basis, for his own clients.  This activity continued during his period at Matheson (with the approval of that company).  After he left Matheson, in September 1989, Mr Martin continued to conduct his accounting practice from his home.  However, after a short time he joined Mr Roger Budd in the latter's Bankstown office.  There was no ongoing financial arrangement between Mr Martin and Mr Budd, other than for the sharing of rent and expenses.  Mr Martin was not listed in directories as an accountant, but relied on personal referrals for work. 

Mr Budd, and, it would seem, his company, Budd Agencies, were agents for National Mutual.  In September 1990 Mr Martin signed an agreement to become an "Associate Agent" of National Mutual.  Mr Budd was nominated in the agreement as the agent and Mr Martin was described as a "sub-agent" of Mr Budd.

 

The Policies

After Mr Martin left Matheson he took out an Accountant's Professional Indemnity Policy, through Minet Professional Services Ltd ("Minet").  The initial policy was issued for the period 7 May 1990 to 31 December 1990.  Thereafter, policies were issued for the periods 26 February 1991 to 31 December 1991; 1 January 1992 to 31 December 1992; and 1 January 1993 to 31 December 1993. 

FAI asserts that the policy in force for the 1992 calendar year renders the accounting underwriters liable to indemnify Mr Martin against the claims made by the Draytons and therefore liable to contribute to the settlement sum paid by FAI.  I refer to this policy, the relevant terms of which are set out later, as the "Accountant's policy".  It is enough at present to note that it indemnified the insured, up to a maximum of $250,000 in respect of each claim, against loss (including any claimant's costs) arising from any claim first made against the insured and reported during the period of insurance.  The indemnity related to claims "in respect of any description of civil liability whatsoever incurred in connection with the Practice".  The "Practice" was defined to mean the professional business of practising as an accountant. The "assured firm" was identified as John L. Martin.  The premium, including stamp duty, paid by Mr Martin for the Accountant's policy was $448.95.

Mr Martin subsequently was issued with a policy of professional indemnity insurance underwritten by FAI.  The policy (the "PI policy") identified the insured as John Leslie Martin trading as John L. Martin and Moneymart Investments (the latter being one of the business names he used).  The period of cover was 18 February 1991 to 31 March 1992.  The PI policy indemnified the insured against any claim or claims for compensation first made against him and reported during the period of cover for breach of professional duty in the conduct of the "practice".  The PI policy also indemnified the insured against a claim made outside the period, if the insured became aware during the period of any incident which might give rise to a claim and gave notice to the insurer of the incident.  The practice was defined, in effect, to include the sale and service of life bonds and published investment products of life insurance companies and the sale or service of investment-related products.  The limit of indemnity was $1,500,000 for any one claim and $3,000,000 in the aggregate.  The premium, including stamp duty and administration fee, was $296.50.

 

Mr Martin and the Draytons

In early 1989, while Mr Martin was still at Matheson, he was contacted by William Drayton.  Mr Drayton sought advice concerning the investment of about $1.5 million, which he and his wife had received in consequence of the sale of their interest in a family business.  In February 1989, Mr Martin, in his capacity as investment manager for Matheson, prepared a personal financial report for William Drayton.  In early March 1989, William Drayton and Nancy Drayton appointed Matheson to establish an investment portfolio in accordance with the recommendations contained in the financial report.  Thereafter, Matheson received the sum of approximately $1.5 million from the Draytons, which was invested on their behalf.

Mr Martin monitored the investment portfolio and prepared quarterly reports for the Draytons.  He also spoke to Mr Drayton on a fortnightly basis on what Mr Martin described as a "range of issues".  This pattern continued after Mr Martin had left Matheson in September 1989, quarterly reports being prepared by Mr Martin at least until June 1992.  From September 1989, Mr Martin had an arrangement with Matheson, whereby he received 70 percent of fees or commissions payable to Matheson in respect of business he introduced or cared for himself.  He thus received 70 per cent of Matheson's fees in respect of the quarterly reports prepared for William and Nancy Drayton.  Mr Martin retained his proper authority from Matheson after he left that company's employment.

In the first half of 1990, Mr Martin also obtained a proper authority from a company known as Inscorp Financial Services Group Ltd ("Inscorp").  Mr Martin had no shareholding in Inscorp.  He had a similar arrangement with Inscorp as he had negotiated with Matheson, namely, that he would receive a commission in respect of business introduced or handled by him.  Mr Martin often wrote letters on Inscorp's letterhead.

In about February 1989, William Drayton asked Mr Martin to prepare taxation returns for the Drayton family.  In April 1989, Mr Martin visited the Draytons' home at Mt View to discuss one of the investment reports prepared through Matheson.  At that meeting, William Drayton asked Mr Martin to undertake accounting work for a farm equipment supply business he was proposing to start.  Thereafter, until January 1992, Mr Martin prepared income tax returns and financial statements for

l    William and Nancy Drayton and Bruce and Ross Drayton;

l    a trustee company known as Ederside Pty Ltd, which owned a vineyard;

l    the partnership consisting of William, Bruce and Ross Drayton, which operated the vineyard; and

l    a farm equipment retail business, known as the Hunter River Tractor Company, which operated from April 1989 until mid to late 1991.

From early 1989 to late 1991, Mr Martin attended about six meetings with William Drayton and the manager of the tractor business, Mr Eyb.  These meetings took place at the premises on which the business was conducted at Raymond Terrace, near Newcastle.  On those occasions Mr Martin reviewed financial reports of the business; assisted in preparing records relating to group tax and workers' compensation premiums; and advised in relation to maintaining accounting and financial records of the business, including a computer package.  Mr Martin advised William Drayton to run the tractor business through a company.  Mr Drayton accepted the advice and Mr Martin purchased a shelf company, known as Redwater Pty Ltd ("Redwater"), for this purpose.

 

 

The Cash Flow Management Plan and the National Mutual Policies

In late 1989, Mr Martin was told by Mr Budd of a product known as the "Cash Flow Management Plan" (the "cash flow plan") developed for National Mutual by A M Corporate Services Pty Ltd ("AMCS").  In December 1989 Mr Martin obtained a document headed "Cash Flow Management Program", prepared by AMCS.  The document, while short on detail, made it clear that the plan involved taking out an investment policy and using the policy as security for loans for a business, with interest on the loans being tax deductible:

 

 

     "To maintain normal business operations every company is faced with the payment of a range of normally recurring expenses such as, wages, rent, payroll, tax, staff superannuation, leasing etc.

 

     While these expenses are normally tax deductible they nevertheless represent a considerable strain on a companies [sic] cash flow and they also tend to increase each year due to the impact of inflation.

 

     Although being essential business outlays they do not directly increase the net value of the company in terms of increased asset value.

 

 

     A.M. Corporate Services have developed a cash flow management strategy which addresses two fundamental areas of concern for business's [sic].  The strategy allows a business to progressively reduce cash flow strain while at the same time build the asset base of the business.

 

 

                      BUSINESS EXPENSES

 

     The Aims

 

     1.   To peg the costs of annual expenditure items within a company structure.  (i.e. provide a hedge against inflation).  These items may include salaries and wages, rent, superannuation, payroll tax etc., and other items which have an inflationary trend.

     2.   Create a substantial company asset/cash reserve.

 

     3.   Reduce the strain on the companys [sic] cash flow position.

 

 

 

                      HOW DOES IT WORK?

 

     To fund the expenses mentioned a company must source these from direct cash flow or most commonly through use of an overdraft facility.

 

     The core of the strategy is to establish an investment contract and interpose this as the vehicle from which the expense item is paid.

 

     The investment policy in effect becomes the overdraft facility.

 

     Payment of the expenses is made by accessing the investment policy.  Any interest charged is tax deductible as in the case of overdraft interest.

 

     By adopting this strategy because there is a margin between the growth of value in the investment policy and the after tax cost of borrowings there is a steadily increasing asset value.  As the company owns this value the companies [sic] asset value therefore also increases.

 

     The extra asset may then be converted to cash to replace funds currently borrowed to finance projects.

 

     An alternative strategy is to fund for increasing expenses at a pre determined inflation rate.

 

     The annual contribution to the investment account is fixed at 30% higher than existing expenditure.

 

     This allows for an annual withdrawal indexed for inflation at 8% per annum.

 

     The result is to produce considerable cash flow savings as well as increasing the asset base."

 

This document was accompanied by some projections as to the returns that might be expected by a participant. 

Shortly after receiving the document from AMCS, Mr Martin visited the Draytons' home to discuss their investments with Matheson.  At that time, he showed William Drayton a copy of the document and explained to Mr Drayton the way in which the program would work.  A further discussion on the same topic took place at the Draytons' home in late February 1990.

In May 1990, Mr Drayton told Mr Martin to go ahead with the cash flow plan.  Mr Martin sought further information from AMCS.  In an undated fax, presumably sent about that time, Mr Martin noted that William Drayton "owned" two business ventures.  One was the tractor business, which Mr Martin said (somewhat inconsistently) was owned by Redwater.  The business was said to have an approximate turnover of $1,200,000 per annum; a gross profit of $300,000; and expenses of $200,000, comprising wages of about $120,000, and the balance made up of rent and advertising.  The second business was that of a property development company called Fisa Pty Ltd ("Fisa"), which was undertaking a building project in Coffs Harbour.  The fax recorded that the Drayton family had a 50% interest in Fisa, but did not refer to the likely profits, if any, to be earned by Fisa from its property ventures.  In any event Mr Martin suggested that

 

 

     "we should invest two lots of $200,000.  One lot for the Tractor Company and one lot for the building company."

Shortly thereafter, AMCS sent Mr Martin cash flow projections, based on premiums of $400,000 per annum for policies with terms, respectively, of 15 and 20 years.  I shall extract some of these cash flow projections and refer to the assumptions underlying them later.  At a meeting with the Draytons at their home on 30 May 1989, Mr Martin showed William Drayton the cash flows and briefly explained them.

In due course, Mr Martin assisted the Draytons to complete proposal forms for National Mutual Business Security Plan policies.  In the result, four policies were issued, each with a commencement date of 12 June 1990.  The premiums payable totalled $400,000 per annum.  The policies were as follows:

 

 

Policy No. Policy Owner         Life Insured        Policy       Annual

                                                     Term         Premium

 

2047.862/4   William J Drayton   Ross Drayton         20 years    $160,000

2047.861/6   Nancy M Drayton     Bruce W Drayton      20 years    $160,000

2047.863/2   Bruce W Drayton     Nancy M Drayton      15 years    $ 40,000

2047.860/8   Ross Drayton        William J Drayton    15 years    $ 40,000

 

 

The policies provided for a cash or surrender value, if terminated prior to maturity.  However, this value was available only if the policyholder paid at least two years' premiums.  The policy terms recorded that, since the cash value had to allow for costs associated with the issue and administration of the policy, that value might, for a number of years, be less than the premiums paid.  The terms also noted that the policy would cease and all moneys paid would be retained by the insurer, if the total of all debts due in
connection with the policy was greater than the cash value.

 

Subsequent Events

In June 1990, Mr Martin withdrew a total of $400,000 from the investment portfolio of William and Nancy Drayton, at their direction, to meet the first year's premiums on the four policies.  In June and August 1990, after having paid the first year's premiums, the Draytons borrowed some $200,000 from National Mutual, presumably under the terms of the plan.

In July 1990, Mr Martin received a commission of $54,750 for his role in causing the Draytons to enter into the National Mutual policies.  It appears that National Mutual paid a commission of $60,000 to Mr Budd and he in turn paid Mr Martin a cheque for $54,750.  In any event, Mr Martin did not tell the Draytons of the commission he had received in consequence of recommending that they participate in the cash flow plan.

In December 1990, construction on the development at Coffs Harbour, in which the Drayton family had invested through Fisa, was completed.  On 24 March 1991, Mr Martin wrote to William Drayton, referring to delays and cost overruns that had been experienced with the project.  The letter noted that Mr Martin himself had contributed $72,500 to the project.  Mr Martin estimated that, on the assumption that completed units could be sold at the anticipated prices, the project would still produce a gross profit of about $78,000.

On 4 July 1991, Mr Martin wrote to William Drayton advising him of the need to pay the second premium in respect of the National Mutual policies "in order to protect your interests".  The letter observed that the expected sales of units at Coffs Harbour had not taken place.  It also referred to the losses from the tractor company and described that investment as an "unpleasant experience".  (Management accounts for what was described as the Hunter River Tractor Company, prepared by Mr Martin, showed a nett loss of $67,413 for the year ended 30 June 1990.  Mr Martin indicated his willingness to "help us [viz. the Draytons] out" by personally buying one unit in the development for $110,000.

Mr Martin's letter of 4 July 1991 suggested alternative means of paying the second set of premiums.  The preferred alternative involved the Draytons receiving $86,000 due to them under their loan accounts with Fisa (the cash to be provided by Mr Martin's purchase of the unit) and borrowing the remainder from National Mutual.  However, this allowed only for payment of about $160,000 of the $400,000 in premiums.  The letter did not explain how the balance of the premiums would be paid.  The second alternative contemplated the payment of the full $400,000 in premiums, but required the Draytons to borrow (from a source other than from National Mutual), or to fund from their own resources, a total of $63,000.  It is not clear from the letter why all premiums could not be borrowed from National Mutual, as the projections had suggested could be done.

The letter asserted, without any explanation, that the surrender value of the National Mutual policies would be $580,000 after payment of the second year's premiums in full.  The letter also said that this sum would partially be offset by loans from National Mutual totalling $326,000.  Again, no explanation was given for the loan figure.  It appears substantially to understate the likely extent of the borrowings from National Mutual, bearing in mind that, by early July 1991, before payment of any part of the second year's premiums, the Draytons had already borrowed approximately $200,000 under the cash flow program.

In the event, the Draytons paid $80,000 in premiums in July 1991, in substance utilising moneys paid by Mr Martin for the purchase of the unit at Coffs Harbour.  This payment fully met the second year's premiums due in respect of the two smaller policies.  The Draytons elected to pay the premiums due in respect of the two larger policies by quarterly instalments (each instalment being slightly more than one quarter of the year's premium).  For this purpose, Ross and Bruce Drayton borrowed $120,000 against the security of the two smaller policies. This enabled payment of the first quarterly instalment of $84,803 to be made in July 1991.  Part of the remainder was used to pay interest due on the loan from National Mutual.  In October 1991, the Draytons paid the second quarterly instalment of $84,803.  The evidence does not indicate the source of this payment.

The documentary evidence shows that the Draytons paid a total of $649,606.64 in premiums over the sixteen months from June 1990 to October 1991.  The payments were as follows:

     Date          Policy No.         Amount

                                         $

 

     14.6.90       2047860/8          40,000.00

     14.6.90       2047861/6          160,000.00

     14.6.90       2047862/4          160,000.00

     14.6.90       2047863/2          40,000.00

     16.7.91       2047860/8          40,000.00

     16.7.91       2047863/2          40,000.00

     22.7.91       2047862/4          42,401.66

     25.7.91       2047861/6          42,401.66

     20.10.91      2047861/6          42,401.66

     20.10.91      2047862/4          42,401.66

                   Total Premium      649,606.64

 

 

The documentation also shows that, over the same period, loans totalling $320,519.20 were made by National Mutual under the cash flow plan.

     Date          Policy No.         Amount

                                         $

 

     24.6.90       2047862/4          99,915.00

     24.6.90       2047862/4              346.20

     9.8.90        2047861/6          99,911.80

     9.8.90        2047861/6              346.20

     18.7.91       2047860/8          60,000.00

     22.7.91       2047863/2          60,000.00

                   Total Borrowed     320,519.20

The borrowings were by the members of the Drayton family personally.

In January 1992, the solicitor for the Draytons advised Mr
Martin that they no longer wished to retain him.  Nonetheless, Mr Martin wrote to Mr and Mrs Drayton in March 1992, reminding them that it was a condition of the policies that at least two years' premium should be paid.  He expressed the view that it was in their interests to pay the final two instalments of the premiums due in respect of the two larger policies, plus accrued loan interest.  Mr Martin noted that the overdue premiums were attracting interest at 14% per annum.  He also expressed the view that the surrender values should comfortably exceed the loan debts, although he offered no figures to support this assertion.  In the event, the Draytons paid no further premiums in respect of the policies, although there was no direct evidence as to why they adopted this course of action. 

On 2 October 1992, the solicitors for the Draytons sent to Mr Martin a copy of an unfiled summons, drafted in a manner appropriate for proceedings in the Commercial Division of the Supreme Court of New South Wales.  The summons, to which further reference will be made later, identified the defendants as National Mutual, Inscorp, Budd Agencies and Mr Martin.  The covering letter to Mr Martin stated that the summons was not to be filed at that stage, as negotiations were taking place with National Mutual.

A fax from National Mutual to the Draytons' solicitor, dated 22 March 1993, showed that the surrender value of the two smaller policies (on which a total of $160,000 in premiums had been paid) was $42,982.  The same document showed that the two larger policies had no surrender value.

 

The Settlements

On 11 June 1993 the Draytons instituted proceedings in this Court.  As I have indicated, the respondents named in the proceedings were Mr Martin, National Mutual and Budd Agencies.  The relief sought included damages for alleged breach of duty by Mr Martin and National Mutual; orders under the Trade Practices Act 1974 (Cth) declaring the policies void and ordering a refund of premiums; and an account of profits as against Mr Martin and Budd Agencies.

As previously noted, the claim against Mr Martin was settled on terms that he pay the Draytons $292,000.  That sum was apportioned as to $224,615.40 on account of the claim and $67,384.60 on account of costs. 

The terms of settlement as between the Draytons and National Mutual and Budd Agencies were filed in Court prior to the commencement of the present hearing, but no evidence was led before me as to the contents.  However, the parties subsequently indicated that they had no objection to my taking into account the terms of settlement in determining any issue on the claim for contribution.  The Draytons' claim against National Mutual was settled on the basis that it agreed to pay them the sum of $60,000, together with $18,000 on account of costs.  The Draytons were also released from any claim National Mutual might have had against them.  It is not clear from the terms filed in Court whether the Draytons had repaid any part of the moneys advanced to them by National Mutual prior to the settlement.  Budd Agencies agreed to pay to the Draytons $15,384.60, together with $4,615.40 on account of costs, a total of $20,000.

Following the settlement of the principal claims and the resolution of certain cross claims, the only part of the proceedings left on foot were claims between FAI and the accounting underwriters.  To simplify matters, FAI filed an amended cross claim against the accounting underwriters' contribution from them, in respect of the sum of $292,000 paid by FAI in settlement of the Draytons' claim.  The accounting underwriters duly filed a defence to that cross claim.

 

The Accountant's Policy

As the provisions of the Accountants' policy are central to FAI's claim for contribution, it is convenient to set out the relevant clauses here:

            'ACCOUNTANTS' PROFESSIONAL INDEMNITY

                  CERTIFICATE OF INSURANCE

 

     ...

     SECTION A: LEGAL LIABILITY

 

     1.   Interpretation

 

          ...

          (b)  'The Practice' means the professional business of practising as an account undertaken by the Assured or the Assured's predecessors in business alone or with others including but not limited to acting as Trustees, Receivers, Liquidators, Directors or Secretaries or Registrars of Companies, or any activity declared by the ethical pronouncements or code of ethics of either the Institute of Chartered Accountants in Australia and/or the Australian Society of Certified Practising Accountants and/or the National Institute of Accountants and/or the Australian Association of Taxation and Management Accountants Ltd, to be appropriate to be undertaken as part of an Accountant's practice, provided that any fees or other income which accrue from any activities described above inure to the benefit of the Assured.

          ...

          (c)  The words 'professional business' are understood to apply to advice given or services performed of whatsoever nature undertaken by or on behalf of the Assured provided always that any fee accruing for such work shall inure to the benefit of the Assured or alternatively if work is done without fee, that such work is undertaken in the name of or on behalf of the Practice.

          ...

     2.   Insuring Clauses

 

          On the terms and conditions herein contained the insurers shall indemnify the Assured up to an amount not exceeding the Sum Insured and Related Costs against all loss to the Assured (including claimants' costs) whensoever occurring arising from any claim or claims first made against the Assured during the Period of Insurance and reported to the insurers during such period, in respect of any description of civil liability whatsoever incurred in connection with the Practice other than loss arising out of any circumstance or occurrence with [sic.] has been notified under any other insurance attaching prior to the inception of this Certificate of Insurance, or of which the Assured was aware at the
commencement of the Period of Insurance.

     ...

     4.   General Conditions

 

          (a)  (i)  The Assured shall not admit liability for, or settle, any claim falling within the Insuring Clauses hereof or incur any costs or expenses in connection therewith without the consent of the Insurers (such consent not to be unreasonably withheld), and subject to (ii) below the Insurers shall be entitled at their own expense at any time to take over the conduct in the name of the Assured of the defence or settlement of any such claim.

              ...

          (b)  The Assured shall give notice in writing to the Insurers as soon as practicable of any claim the subject of the Insuring Clauses hereof made during the Period of Insurance (or within 14 days following the Period of Insurance provided subsequent renewal or replacement insurance continues with the Insurers) against the Assured or of the receipt of notice from any person of any intention to make a claim against the Assured.  The Assured may also give notice in writing to the Insurers of any circumstances of which the Assured is or shall become aware during the Period of Insurance which may give rise to such a claim.  If notice is given to the Insurers under this paragraph any claim subsequently made (whether before or after the expiration of the Period of Insurance) pursuant to such an intention to claim or arising from circumstances so notified shall be deemed to have been made at the date when such notice was given.  Upon request, the Assured shall give to the Insurers all such information and assistance as the Insurers may reasonably require."

III.THE ISSUES

 

The Principle of Contribution

In order to understand the issues in the case, it is necessary to refer to the doctrine of contribution between insurers.  The principle of contribution applies where a person is insured against the same risk by two independent insurers.  It was authoritatively explained in the judgment of Barwick CJ, McTiernan and Kitto JJ in Albion Insurance Company Ltd v Government Insurance Office of New South Wales (1969) 121 CLR 342, at 345-346:

     "There is double insurance when an assured is insured against the same risk with two independent insurers.  To insure doubly is lawful but the assured cannot recover more than the loss suffered and for which there is indemnity under each of the policies.  The insured may claim indemnity from either insurer.  However, as both insurers are liable, the doctrine of contribution between insurers has been evolved.  It began in the second half of the eighteenth century with Lord Mansfield's decisions with respect to marine insurers and there is no doubt that it now applies generally to insurance which provides the insured with an indemnity.  There is no reason why the doctrine should not apply to insurance against liability to third parties and there is every reason in principle that it should.  The doctrine, however, only applies when each insurer insures against the same risk, although it is not necessary that the insurances should be identical.  Thus one insurer may insure properties A and B against fire and the other insurer may only insure property A against fire.  Again, one policy may be for a limited amount and the other may be for an unlimited amount.

     One policy may cover the risk of a whole voyage and the other may cover only part of the voyage.  Differences of this sort may affect the amount of contribution recoverable but they do not bear upon the question whether or not each insurer has insured against the same risk so as to give rise to some contribution.  The element essential for contribution is that, whatever else may be covered by either of the policies, each must cover the risk which has given rise to the claim.  There is no double insurance unless each insurer is liable under his policy to indemnify the insured in whole or in part against the happening which has given rise to the insured's loss or liability."

See also the judgment of Kitto J. (with whom Windeyer J. agreed), at 350-352.  Kitto J's exposition was described by Wells J. in C.E. Heath Underwriting and Insurance (Australia) Pty Ltd v The State Government Insurance Commission (SA) (1983) 34 SASR 1 (S Ct SA), at 7, as "combin[ing] scholarship, clarity and precision".

An insurer under an indemnity policy seeking contribution from a co-insurer must establish that

l    it is liable to indemnify the insured under its own policy;

l    it has paid out sums in respect of that liability;

l    the co-insurer is also liable under its policy to indemnify the insured; and

l    the co-insurer has not paid out moneys to meet its liability to the insured.

See Boag v Economic Insurance Company Ltd [1954] 2 Lloyd's Rep 581 (QBD/McNair J.), at 583.

FAI's Liability

In the present case, subject to one qualification, there is no dispute that FAI was liable to indemnify Mr Martin under the PI policy.  I have referred to the terms of that policy earlier in this judgment.   Mr Williams, who appeared on behalf of the accounting underwriters, did not suggest that, in the circumstances which had occurred, FAI was not liable to indemnify Mr Martin if he was liable to the Draytons by reason of a breach of his professional duty to them.  Although the evidence did not indicate when Mr Martin had notified FAI of an "incident" or a claim, there was no suggestion that the PI policy did not apply to any liability incurred by Mr Martin to the Draytons.

It is also clear that the accounting underwriters have paid nothing in respect of any liability they may have under the Accountant's policy.  On 1 March 1994, the underwriters denied liability under the policy.  In a later letter to Mr Martin, the ground for denying liability was stated to be that

 

     "your liability in these proceedings was not incurred in connection with your practice as a professional accountant but rather in connection with your practice as a professional investment adviser.  Accordingly, your claim does not fall within the insuring clause of the Policy."

 

The qualification to which I have referred is that the accounting underwriters put in issue whether FAI had established that Mr Martin had breached his professional duty to the Draytons so as to incur a liability to them.  They also put in issue whether the settlement of the Drayton's claim was reasonable, having regard to any losses sustained by them in consequence of Mr Martin's alleged breach.

The Issues

The principal question arising on the claim for contribution is whether the accounting underwriters are liable under the Accountant's policy to indemnify Mr Martin against any liability he has incurred to the Draytons.  The underwriters relied on a number of contentions:

(i)       FAI had failed to establish that Mr Martin had acted in breach of his professional duty to the Martins and that the amount paid to the Draytons in settlement of the claim was reasonable.   (This contention, as I understood it, was raised in relation to both the Accountant's policy and the PI policy, but it was not suggested the issues were any different in each case.)

(ii)      The Accountant's policy was a claims made and reported policy.  The period of insurance for the policy was 1 January 1992 to 31 December 1992.  No claim was made against Mr Martin during the period of insurance.  During that period Mr Martin had merely become  aware of circumstances that might have given rise to a claim by the Draytons in the future.  In any event, even if a claim had been made, it had not been reported within the policy period.  Section 54 of the Insurance Contracts Act 1984 (Cth) (the "IC Act"), which was relied on by FAI to excuse Mr Martin's failure to report the claim within the policy period, was not available in the circumstances of the present case.  Thus Mr Martin was not entitled to an indemnity under the policy.

(ici)     Any civil liability incurred by Mr Martin was not incurred in connection with his professional practice as an accountant.  This provided an independent reason why he was not entitled to be indemnified under the policy.

(iv)      The Draytons' claim was settled without the consent of the accounting underwriters.  This constituted a breach of cl.4(a)(i) of the Accountant's policy. The accounting underwriters were therefore entitled to refuse indemnity under the policy, and had done so.

Finally, the accounting underwriters submitted that if, contrary to their submissions, contribution was appropriate, the "maximum potential liabilities" test was a more appropriate measure of the extent of contribution required than the "independent liabilities" test supported by FAI.  I shall refer to these tests later in the judgment.

IV.  PROOF OF LIABILITY AND LOSS

 

The Principles

The onus is on FAI to establish that it is liable to indemnify Mr Martin under the PI policy and that he is entitled to be indemnified under the Accountant's policy.  If there has been no judicial determination of the insured's liability, the insurer against whom contribution is sought is entitled to put in issue whether the insured was liable to be the claimant and whether the amount paid in settlement of the claim was excessive.  The settlement does not, of itself, demonstrate that the insured was liable; nor does it show that the amount paid by way of settlement was not excessive.  Evidence is required to show that the insured was liable to the claimant and that the amount paid to compromise the claim reflected a genuine assessment of the claimant's loss.  See Derrington and Ashton, The Law of Liability Insurance (1990), 735, 745-746.  These principles were applied in Government Insurance Office of New South Wales v Royal Exchange Assurance of London (1965) 82 WN (NSW) (Pt 1) 468 (S Ct NSW/Myers J.).   There were, however, other reasons in that case for rejecting the claim for contribution, including the fact (unlike this case) that the other insurer was denied any opportunity to participate in the settlement.

The Evidence

It must be said that the evidence adduced on the question of the insured's liability to the Draytons and the quantum of their claim was not very satisfactory.  Mr Martin gave evidence and was cross-examined, but the Draytons did not give evidence.  Thus there no direct evidence from the Draytons themselves as to their motivation in taking out the National Mutual policies and in refusing to pay the last instalments of the second year's premiums due in respect of the larger policies.  No experts were called to assist in assessing whether Mr Martin had departed from the standard of care to be expected of either an accountant or an investment adviser.  Documents were tendered which allowed inferences to be drawn as to the payments made by the Draytons by way of premiums in respect of the insurance policies and the sums they had borrowed from National Mutual.  The evidence did not clearly establish, however, whether or not the Draytons had repaid or were required to repay the amounts borrowed by them from National Mutual.

In substance, there was no challenge to the accuracy of the two statements prepared by Mr Martin.  In particular, he was not challenged on the following evidence in his second statement:

     "I did not explain the Program to the Draytons in any more detail than that which is set out in those paragraphs [in the first statement], as I did not expect them to fully understand how the Program worked.  As I was their accountant and financial advisor, I expected that the Draytons would rely upon my recommendation to enter the Program.  I believe that they did rely upon my advice concerning the Program in determining to enter into the Program in May 1990."

I infer from this evidence that:

l    the only explanations about the cash flow program given to the Draytons by Mr Martin were those set out in his first statement;

l    Mr Martin was aware that the Draytons, despite their considerable assets, would not fully understand how the Program worked; and

l    the Draytons relied on Mr Martin's recommendation in entering the Program.

It is to be noted that Mr Martin's statement contains a non sequitur.  The fact that an adviser recognises that his clients will not fully understand an investment that requires them to contribute $400,000 per annum might be thought to be a very good reason indeed for explaining the program and any attendant risks in considerable detail.  Yet Mr Martin gave the Draytons' lack of understanding as a reason for not giving a fuller explanation.

In his first statement, Mr Martin gave evidence that he had explained to William Drayton the cash flow projections which had been provided by AMCS.  One of the projections was based on a policy in force for a term of 15 years, at an assumed annual premium of $400,000.  This document was as follows:

A number of features emerge clearly enough from these projections:

(i)       The projections assume that the entirety of the interest payable on the loans from National Mutual will be deductible from assessable income, producing a saving on gross interest payments of 39% (the assumed rate of taxation).  The gross interest payable on the loans rises from $42,706 in the second year, to $181,026 in the fourth year and $260,141 in the fifth year.

(ii)      The net termination values at the end of the first, second and third years indicate that the surrender of the policy within that time frame produces a loss for the policy holder, even assuming that all interest payments made in the intervening period are fully deductible from assessable income.

(iii)     It is not until the end of the fourth year that a "profit" on the policy holder's initial investment of $124,478 is obtained.  The profit is $23,023 ($147,501 less the initial payment by the policy holder of $124,478).  This profit is plainly dependent on the accuracy of the assumptions underlying the "gross asset value for termination".  While the interest rate on loans from National Mutual to the policy holder is assumed to be 15.5% per annum, the assumptions underlying the calculation of gross asset values for termination are not specified.  In the absence of some further explanation, the inference to be drawn is that if the assumed rate of growth of the gross asset value is overstated, the internal rate of returns may be very different from that suggested in the projections.  (It is to be noted that the actual surrender balance of the two smaller policies, after two years premiums, about 27% of premiums paid, a proportion substantially less than suggested by the projections.)

(iv)      By the end of the fourth year, when the policy holder is projected to receive a profit if the policies are surrendered, the indebtedness to National Mutual of the policy holder (if he or she chooses to borrow all premiums other than the original contribution) is $1,837,018.

(v)       The projections do not reveal that, if the policy is surrendered before payment of the first two year's premiums in full, the surrender value of the policy is nil.

Mr Martin gave the following account of his conversation with William Drayton on 30 May 1989, in which he explained the projections, including the one extracted above:

     "I showed Mr Drayton the cash flows and explained the documents to him in words to the following effect:

          'The people in Melbourne have produced 2 models; one based on a 15 year policy and one based on a 20 year policy.  They assume an interest rate on borrowings of 15½% and that you will be paying tax at a rate of 39%.'

     I then said (referring to the first table of 15 year policy projections):

          'It works like this.  Look at the first column.  You pay premium of $400,000 each year.'

     I then indicated the second and third columns entitled 'Agreed out of pocket investment' and 'Shortfall to be geared' and said 'In one year you can borrow back from National Mutual up to $275,522.  That means that in year 1 you have to invest $124,478 of your own money.  From year 2, after the payment of 2 years premiums, you can borrow an amount equal to each year's premium.

     I then indicated the column entitled 'Loan debt before interest calculation'.  This column shows the loan debt for the policy year before adding interest.

     I then indicated the three columns under the heading 'Interest'.  I said:-

          'These columns show the estimated interest, the tax saving and the net cost of interest after tax.'

     I then indicated the columns in the second table under the heading 'Cumulative total loan debt' and said:-

          'The first column shows the loan at the beginning of that year and the second column shows you the position at the end of the year after adding the real cost of interest.'

     I then indicated the column entitled 'Gross asset value for termination' and said:

          'This column shows the estimated value of the policy.  At the end of the second year, the policy has an estimated value of $801,124.  However, as the borrowings have to be repaid, the amount payable to you would only be $33,218.00 as shown in this column (indicating the column 'net termination value').  As you
can see (indicating the last two columns on the second table) as time goes on your asset value increases.

     He replied: 'That looks good.'"

The following exchange took place in a later conversation with either Ross or Bruce Drayton:

     "'Can you get out early?'

     I said:

          'Yes, but you have to pay at least the first two years premium.  Like a lot of investments the longer you maintain it the better.'"

These explanations do not make it clear that the projections depend on all interest payments being wholly deductible from assessable income.  In his oral evidence Mr Martin stressed that the major attraction of the program was its "integration" with the tractor business, this being the means of minimising the Draytons' exposure to income tax.  He said that it was an "essential part" of the product that the policy holders had to be in business.  It clearly follows that his perception was that the tractor business was to be the source of assessable income from which interest payments on borrowings could be deducted.

Mr Martin gave no warning to the Draytons that, if the tractor business was unprofitable, or if it simply ceased to operate, there would be no relevant assessable income from which payments of interest could be deducted.  (Nothing in the evidence suggested that interest payments could be deducted from any other assessable income of the Draytons or that Mr Martin adverted to any other business as the borrower, except for the reference in correspondence to Fisa.)  The absence of such a warning was somewhat remarkable, since Mr Martin had prepared the accounts for the tractor business for the year ended 30 June 1989 and for the six months ended 31 December 1990.  The first set of accounts showed a loss of $12,536 on a small turnover, while the second showed a loss of $11,066 on a turnover of $300,902.  (In the event, the business showed a net loss of $67,453 for the 1989/90 year, on a turnover of $964,283.  The commencement date for the National Mutual policies was 12 June 1990.)

In February 1990, Mr Martin wrote a letter to Inscorp concerning the Draytons' proposed participation in the program.  The letter suggested that the tractor business would provide a net profit in 1989/90 of $80,000 on a turnover of $1,000,000 and a net profit in 19990/91 of $120,000 on a turnover of $1,200,000.  As late as May 1990, Mr Martin wrote a letter suggesting that the tractor business would have a turnover of approximately $1,200,000 and a net profit of $100,000.  These estimates were said by Mr Martin, in his evidence, to have been supplied by the manager of the tractor business.

By early 1990 Mr Martin had completed for the tractor business accounts for the six months to 31 December 1989.  At the very least this must have suggested to Mr Martin that the Draytons needed to take account of the serious risk that the tractor business might not become profitable and indeed (as in fact occurred) might not survive.  Despite this, Mr Martin gave no warning to the Draytons of the consequences of not having a profitable business with which the cash flow plan could be "integrated".  In particular, he gave no warning that, if there was no relevant business income against which to offset interest payments (which actually increased in each of the first few years of the program by $60,000 to $80,000 per annum), they would have to be met out of after-tax income or from the Draytons' assets.  Nor did he warn them that, if the tractor business failed and interest had to be paid out of after-tax income, the projections would be rendered grossly inaccurate.

Similarly, the explanation provided by Mr Martin failed to advise the Draytons that the assumptions underlying the calculations of gross asset values might not be achieved in practice.  If this occurred, the investment might not produce a positive return, even after the payment of four or more years of premiums and interest on borrowings.  Mr Martin did tell Bruce or Ross Drayton that at least two years premiums had to be paid, but he did not explain that if this were not done the surrender value of the policy or policies would be nil.

Findings

In my opinion, the evidence, despite its deficiencies, justifies the following findings:

(i)       Mr Martin, in his capacity as the Draytons' accountant and investment advisor, owed a duty of care to the Draytons in making investment recommendations to them.

(ii)      The Draytons relied on Mr Martin's advice to participate in the cash flow plan and take out the National Mutual policies.  But for Mr Martin's advice they would not have done so.

(iii)     Mr Martin breached his duty to the Draytons by providing inadequate and incomplete explanations of the cash flow plan and by failing to warn them of risks of which he knew or should have known.  In particular, he failed to warn them of the risk that the projection would not be met if the tractor business failed to produce profits against which interest payments could be offset for tax purposes and that the ever-escalating interest payments might have to be met out of after-tax income or from capital.  Consequently, so I infer, the Draytons (whom Mr Martin did not expect fully to understand the plan) did not appreciate that a deterioration in their financial position might make it impractical for them to continue making payments under the plan.

Extent of the Loss

The evidence establishes that the Draytons paid at least $329,000 out of their own moneys by way of premiums ($649,606, less $320,519 borrowed from National Mutual).  In addition, they paid interest on the loans from National Mutual, although the evidence does not allow me to quantify the interest payments actually made (as opposed to being capitalised as part of the National Mutual loans).  The evidence does not make it clear whether the Draytons were released, under the settlement with National Mutual, from all their obligations under the National Mutual loans.  The documentary evidence is, however, consistent with the Draytons not having repaid any portion of those loans prior to the settlement of their claim against National Mutual.  In the absence of evidence that the loans had been repaid, the appropriate course is to proceed on the basis that the settlement released the Draytons from their obligations to repay the loans.

The surrender value of the two smaller policies, approximately $43,000, must be offset against the amount of $329,000 paid by way of premiums.  (The two larger policies were valueless.)  However, account must also be taken of the Draytons' entitlement to interest under s.51A of the Federal Court of Australia Act 1976 (Cth), which they sought in their application in the Federal Court.  (Of course, if proceedings had been instituted in the Supreme Court, an equivalent entitlement would have arisen under s.94 of the Supreme Court Act 1970 (NSW).) Interest on $329,000 from 20 October 1991 (the last date premiums were paid) until 29 March 1996 (the date of settlement), calculated at rates specified in the New South Wales Supreme Court Rules, amounts to approximately $170,000.  If the calculation is made on the figure of $286,000 ($329,000 - $43,000), interest amounts to about $148,000.   Thus the total losses sustained by the Draytons (leaving out of consideration any indebtedness to National Mutual) was at least $434,000 ($286,000, plus interest of $148,000).  To that figure must be added the costs incurred by the Draytons in the Federal Court proceedings, for which Mr Martin would be liable.  (The PI policy indemnified Mr Martin against any liability to pay claimants' costs.)   The evidence does not enable me to quantify precisely the costs incurred by the Draytons in relation to those proceedings, although the settlements apportioned a total of $90,000 under that head.  On any view, the Draytons would have incurred substantial costs in connection with the Federal Court proceedings, which were settled only shortly before the scheduled 12 day hearing.

The Draytons' claim against Mr Martin was compromised for $292,000 (inclusive of costs assessed at $67,384.60).  The claim against National Mutual was settled for $78,000 (inclusive of costs assessed at $18,000 and, as I have found on the evidence, a release from the advances made by National Mutual to the Draytons).  The claim against Budd Agencies was settled for $20,000 (inclusive of costs assessed at $4,615.40).

It is clearly appropriate, in considering the reasonableness of the settlement as between the Draytons and Mr Martin to take account of the benefits obtained by the Draytons by reason of the settlements reached with National Mutual and Budd Agencies.  Taking these benefits into account, in my view, the settlement reached between Mr Martin and the Draytons genuinely reflected an assessment of the actual losses, including costs, sustained by the Draytons.  Their losses, after allowing for the payments made by National Mutual and Budd Agencies amounted to approximately $400,000 (that is, about $500,000, if $60,000 to $70,000 is allowed for costs, less the payments of $98,000 made by National Mutual and Budd Agencies).  The settlement figure between the Draytons and Mr Martin was $292,000.  I find that the settlement reached between the Draytons and Mr Martin genuinely reflected an assessment of the losses sustained by the Draytons and was a reasonable settlement for Mr Martin (or FAI on his behalf) to reach in the circumstances of the case.

Mr Williams submitted that the failure of the Draytons to make the last two quarterly instalments of premiums in respect of the larger policies meant that the loss they had sustained was, in part, their own fault.  However, the last two instalments totalled approximately $170,000.  Having regard to the surrender value of the smaller policies (about 27% of premiums paid), I would not be prepared to infer, in the absence of other evidence, that the surrender value of the larger policies would have been substantially greater than $170,000, even if the instalments had been paid.  I place no weight on the unsubstantiated estimate of $580,000 in Mr Martin's letter of 4 July 1991, which contains omissions and inaccuracies.  Furthermore, there is no reason to think that the Draytons, if they could have been assured of obtaining $580,000 from National Mutual within six months simply by paying $170,000, would have refused to take that course.

In the result, I think that FAI has established that Mr Martin was in breach of his professional duty to the Draytons and was liable to them in respect of any losses sustained by them by reason of their taking out the National Mutual policies.  The terms of settlement of the Draytons' claim against Mr Martin genuinely reflected an assessment of their losses and was reasonable in the circumstances.

V.   THE TERMS OF THE ACCOUNTANT'S POLICY: CLAIMS MADE AND REPORTED

 

The Questions

On the assumption that Mr Martin had been shown to be negligent, and that he had incurred a civil liability in connection with his accounting practice, the accounting underwriters maintained that they were nonetheless not liable to indemnify Mr Martin against the liability he incurred to the Draytons.  Mr Williams argued that

l    no claims had been made against Mr Martin within the period of insurance; and

l    even if it had, the claim had not been reported within that period.

Accordingly, so it was said, cl.2 of the Accountant's policy was not satisfied.  It will be recalled that cl.2 indemnified Mr Martin against loss

     "arising from any claim or claims first made against the Assured during the Period of Insurance and reported to the insurers during such period...".

Mr Donaldson, who appeared on behalf of FAI, submitted that the letter of 2 October 1992 from the Draytons' solicitors to Mr Martin, which enclosed an unfiled summons, constituted a "claim" against Mr Martin for the purposes of cl.2 of the Accountant's policy.  Mr Donaldson accepted that Mr Martin had not reported the claim to the accounting underwriters until after the expiration of the period of insurance.  However, he contended that this failure did not avail the accounting underwriters, because of s.54 of the IC Act.  That section provides as follows:

     "54.(1)  Subject to this section, where the effect of a contract of insurance would, but for this section, be that the insurer may refuse to pay a claim, either in whole or in part, by reason of some act of the insured or of some other person, being an act that occurred after the contract was entered into but not being an act in respect of which subsection (2) applies, the insurer may not refuse to pay the claim by reason only of that act but his liability in respect of the claim is reduced by the
amount that fairly represents the extent to which the insurer's interests were prejudiced as a result of that act.

     (2)  Subject to the succeeding provisions of this section, where the act could reasonably be regarded as being capable of causing or contributing to a loss in respect of which insurance cover is provided by the contract, the insurer may refuse to pay the claim.

     (3)  Where the insured proves that no part of the loss that gave rise to the claim was caused by the act, the insurer may not refuse to pay the claim by reason only of the act.

     ...

     (6)  A reference in this section to an act includes a reference to:

     (a)  an omission; ... ."

 

The Letter and Summons

As I have noted, the summons forwarded by the Draytons' solicitors on 2 October 1992 nominated four defendants: National Mutual; Inscorp; Budd Agencies; and Mr Martin.  The plaintiffs claimed a declaration that they were entitled to rescind the National Mutual policies and an order that the defendants pay to the first and second plaintiffs (William and Nancy Drayton) the sum of $480,000, plus interest.  The sum of $480,000 was apparently claimed because this was thought at the time to be the total of premiums paid to National Mutual.

The nature of the dispute was described in the summons as follows:

     "The plaintiffs' claim is in relation to negligent misrepresentations and/or advice by the fourth defendant [Mr Martin] by himself and as servant or
agent for the first, second and third defendants as a result whereof the plaintiffs were induced to pay premiums totalling $480,000.00 for policies of pure endowment which are now of little or no value to the plaintiffs."

The plaintiff pleaded that

l    Mr Martin had been an accountant and financial adviser to the first and second plaintiff;

l    he had proposed that the plaintiffs take out policies of pure endowment as a tax effective way of investing money;

l    as a consequence of Mr Martin's representations, the plaintiffs took out endowment policies with National Mutual;

l    the policies were completely inappropriate to the known and reasonably foreseeable needs of the plaintiffs;

l    Mr Martin had made the representations negligently; and

l    the policies had become worthless.

The plaintiffs identified their causes of action against Mr Martin as follows:

     "11.The fourth defendant is liable to the plaintiffs for negligent misrepresentation and/or negligent advice.

      12.Further or alternatively the representatives made by the fourth defendant constituted misleading or deceptive conduct for the purposes of Section 42(1) of the Fair Trading Act, 1987 (NSW) and the fourth defendant is liable accordingly."

The accompanying letter, dated 2 October 1992, addressed to Mr Martin, was in the following terms:

 

     "Re:Drayton and National Mutual

 

     We enclose copy of summons.  We are not filing it at this stage as we have been negotiating with National Mutual.  Could you please contact us."

Was a 'Claim' Made?

The word "claim", when used in an insurance policy, can have different meanings depending on the context: Transport Industries Insurance Co Ltd v NSW Medical Defence Union Ltd (1986) 4 ANZ Ins.Cas. 60-736 (NSW CA), at 74,411, per Kirby P; at 74,416 per Glass JA.  Nonetheless, the starting point, in a claims made and reported policy, is the dictionary definition:

     "1.  to demand by or as by virtue of a right; demand as a right or as due.  2. to assert, and demand the recognition of (a right, title, possession, etc); assert one's right to." (Macquarie Dictionary).

The cases have generally adopted this meaning as applicable to liability policies.  In Walton v National Employers' Mutual General Insurance Association Ltd [1973] 2 NSWLR 73 (NSW CA), at 82, Bowen JA referred to the "primary sense" of the word "claim" in a liability policy as

     "a demand for something as due, an assertion of a right to something. It imports the assertion, demand or challenge of something as a right."

See also Dwyer v Long (1992) 58 SASR 102 (S Ct SA/Prior J.), at 108; Thorman v New Hampshire Insurance Co (UK) Ltd [1988] 1 Lloyd's Rep. 7 (CA), at 11, per Donaldson MR ("the assertion by a third party against the insured of a right to some relief because of [the insured's professional negligence]"; Antico v C E Heath Casualty & General Insurance Ltd (1995) 8 ANZ Ins.Cas 61-268 (S Ct NSW/Giles CJ. Comm.D.), at 75,999 (an issue not dealt with on appeal: see Antico v C E Heath Casualty & General Insurance Ltd, unreported, NSW CA, 30 January 1996).

In Triden Properties Ltd v Capita Financial Group Ltd (unreported, NSW CA, 15 November 1995), Sheller JA (with whom Clarke and Powell JJ.A. agreed) adopted the test propounded in Thorman.  His Honour rejected (at 55-56) a contention that a claim had to be a positive assertion of a legal right to claim damages for breach of duty and had to "be indicative of a real and unequivocal intention to pursue legal rights communicated to the insured".  Sheller JA applied (at 57) observations in a Canadian case that the words "claims made" in a solicitor's liability policy

     "ought to be construed in accordance with the ordinary plain meaning of those words, which, simply stated, denote a claim that is 'made' by being notified to or otherwise brought to the attention of the person against whom it is asserted.  However that is done, the essence of the making of the claim is that the substance of the claim is in fact 'brought home to' that person."

See Re St Paul Fire & Marine Insurance Co and Guardian Insurance Co of Canada [1983] 1 DLR (4th) 342 (Ont. CA), at 357.  I agree with this approach.

In my view, the summons sent by the Draytons' solicitors very clearly asserted their right to relief against Mr Martin by reason (inter alia) of his alleged negligence.  The document asserted that Mr Martin, along with the three other nominated defendants, was liable to the Draytons in the sum of $480,000 plus interest.  The substance of the claim was brought home to Mr Martin.  Indeed, Mr Williams conceded that, if the summons had stood alone, it constituted a claim for the purpose of cl.2 of the Accountant's policy.

Mr Williams argued, however, that the position was different by reason of the covering letter.  The letter stated that the summons was not being filed "at this stage as we have been negotiating with National Mutual".  This, so it was said, meant that the Draytons were merely exploring their rights and were not positively making a claim.  Thus the letter and summons merely amounted to "circumstances of which the Assured is or shall become aware during the Period of Insurance which may give rise to...a claim": see cl.4(b) of the Accountant's policy.

This argument stretches the meaning of the covering letter well beyond a fair reading of its terms.  The letter merely stated that the summons was not being filed at that stage, because of negotiations with National Mutual.  It did not suggest that Mr Martin should or could ignore the entitlement to relief against him asserted and pleaded in the summons.  Nor did the letter suggest that the negotiations with National Mutual were likely to obviate the need for proceedings to be instituted against Mr Martin.  The letter invited Mr Martin to contact the solicitors.  There was no evidence to suggest that such contact had been made during the policy period, nor that Mr Martin had been told that the assertion of rights in the summons was not to be pursued.

The letter meant what it said.  The enclosed copy summons asserted rights against Mr Martin, but the summons was not being filed at that stage because of negotiations with National Mutual.  This is very different from a letter which simply identifies matters of concern to the author or the author's clients and advises that further investigations are to be undertaken, pending which rights are reserved: compare Antico, at 75,999.

I appreciate that the Accountant's policy adopts a threefold classification concerning claims which have been or might be made.  The policy refers to a claim made against the assured (cl.2); notice of an intention to make a claim against the assured (cl.4(b)); and circumstances of which the assured becomes aware which may give rise to a claim (cl.4(b)).  This classification does not require or suggest that the phrase "claims... made", as used in cl.2 of the policy, should receive a construction different from its usual meaning.  The construction I have adopted allows ample scope for the operation of cl.4(b) of the policy, in circumstances different to those of the present case. 

Mr Williams pointed to events outside the policy period as indicating that the Draytons were simply investigating their rights and did not intend to make a claim in October 1992.  In particular, he relied on a letter of 24 March 1993 from the Draytons' solicitors to Mr Martin, in which the solicitors requested inspection of certain documents to ascertain whether their clients had rights to relief.  Even if that letter had accompanied the letter of 2 October 1992, I think it unlikely that I would have reached a different conclusion as to whether a claim had been made against Mr Martin at that time.  Be that as it may, I do not think that a letter sent by the Draytons' solicitors three months after the expiration of the policy period can affect the question of whether the letter of 2 October 1992 and the enclosed summons constituted a claim made against Mr Martin at that time.

The Contentions Relating to s.54

Mr Donaldson submitted that s.54(1) applied in the present case, so that Mr Martin's failure to report the Draytons' claim within the period of insurance did not justify the accounting underwriters in declining to indemnify Mr Martin.  He relied on East End Real Estate Pty Ltd v C E Heath Casualty & General Insurance Ltd (1991) 25 NSWLR 400 (NSW CA), as establishing the proposition that s.54(1) of the IC Act precludes an insurer from refusing to pay a claim under a claims made and reported policy by reasons only of the insured's failure to report the claim during its period of insurance.

Mr Williams contended that s.54(1) did not prevent the accounting underwriters declining to indemnify Mr Martin under the 1992 Accountant's policy.  He formally submitted that East End was wrongly decided, but acknowledged that, although I was not bound by the decision, I would follow it, at least unless I though it was clearly wrong: see Australian Securities Commission v Marlborough Gold Mines Ltd (1993) 177 CLR 485, at 492; Gye v Davies (1995) 131 ALR 723 (NSW CA), at 737, per Cole JA; R. v Yates (1991) 102 ALR 673 (NSW CA), at 679-680, per Priestley JA.  I do not think that East End is clearly wrong; on the contrary, with respect, I think it was correctly decided.

On the assumption that I would not refuse to follow East End, Mr Williams relied principally on FAI General Insurance Co Ltd v Perry (1993) 30 NSWLR 89 (NSW CA), which distinguished East End.  Some of Mr Williams' arguments were based on the proposition that the Draytons had not made a claim against Mr Martin during the currency of the Accountant's policy.  Since I have found that such a claim was made, I need not consider all of Mr Williams' arguments.  He did contend, however, that even if a claim had been made by the Draytons in October 1992, there had been no relevant "omission" by Mr Martin for the purposes of s.54, because he had consciously "elected" not to make a claim under the Accountant's policy.

A Preliminary Question: Was the Claim Ever Reported?

It was common ground that Mr Martin did not report the claim to the accounting underwriters until at least 12 July 1993, outside the period of insurance specified in the Accountant's policy.  On 12 July 1993, Mr Martin sent a fax to the Claims Division of Minet.  He indicated that his impression had been that the matter would be covered by the PI policy issued by FAI.  However, he had become aware that not all claims would be covered by the PI policy and, accordingly, he was advising Minet of the "matter".  This was a reference to the fact that FAI's solicitors had advised him that a claim based on breach of fiduciary duty was not covered by the PI policy, a view subsequently reiterated by the solicitors in a letter of 2 September 1993.

Mr Williams submitted that the fax of 12 July 1993 did not constitute a reporting of the claim to the accounting underwriters, within the meaning of cl.2 of the Accountant's policy.  This submission was not developed, but appears to have been based solely on the fact that Mr Martin identified the subject of the fax as "POTENTIAL CLAIM.  MY POLICY NO. 20573/93".  That policy came into effect on 1 January 1993 and remained in force until 31 December 1993.  The underwriters for the 1993 policy were three of the underwriters of the 1992 Accountant's policy.  The submission appeared to assume that the failure of Mr Martin to report the Draytons' claim at all would prevent s.54 of the IC Act applying.  It is not necessary to express a view on the validity of the assumption.  See Seery v John R. Carr and Associates Pty Ltd (unreported, S Ct NSW/Giles CJ CommD, 15 November 1995) at 7.

In my opinion, the fax of 12 July 1993 constituted a report by Mr Martin of the claim first made against Mr Martin in October 1992.  The fax advised that the "potential claim" previously notified to FAI had become "a real one".  It enclosed documents relevant to a "hearing" of the proceedings instituted by the Draytons (presumably a first return date), which had been set down for 15 July 1993.  I infer that Mr Martin sent to Minet a copy of the application and statement of claim which, by that time, had been filed by the Draytons in this Court.

In these circumstances, it is clear that Mr Martin made known to Minet, on behalf of the accounting underwriters, the details of the claim made by the Draytons.  What the Accountant's policy required Mr Martin to report was the claim first made in October 1992; he was not required correctly to identify the policy under which he was entitled to indemnity: see cll.2, 4(b) and (d).  Mr Martin complied with this requirement, no less because he identified the 1993 policy rather than the 1992 Accountant's policy as the subject of the communication.

Omission vs. Inaction

In order to understand Mr Williams' submission concerning the construction of s.54 of the IC Act, it is necessary to appreciate the distinction between an "omission" (on the one hand) and "inaction" (on the other), drawn in Perry.  As Giles CJ Comm D noted in Antico at 76,011, the distinction might be thought to be "elusive".  The topic has been the subject of divergent views within the New South Wales Court of Appeal: see the judgment of Kirby P. (who dissented in Perry) in the Court of Appeal Antico v C.E. Heath, which affirmed the decision of Giles CJ Comm D, but on different grounds.

In East End, a policy of professional indemnity insurance indemnified the insured against claims for breach of professional duty first made within the relevant period (31 December 1989 to 31 December 1990) "and which shall first be notified to underwriters during the period of cover".  A claim for breach of duty was made against the insured.  The client obtained judgment against the insured in February 1991, outside the period of cover.  The insured then notified the insurer of the claim and sought indemnity.  The insured acknowledged that, but for s.54(1) of the IC Act, the insurer was entitled to deny liability.  He argued, however, that s.54(1) applied because his failure to give notice of the claim was an "omission", but for which the effect of the contract of insurance was that the insurer could refuse to meet the claim.

The insurer sought to answer this argument, inter alia, by arguing that s.54(1), has nothing to say concerning acts or omissions which form part of the definition of the risk insured.  Gleeson CJ (with whom Clarke JA agreed "generally") rejected the argument, declining to read the language of s.54 narrowly.  His Honour said this (at 403-404):

     "In my view, by choosing words of generality and avoiding reference to the particular type of contractual provision that might produce the result that the insurer may refuse to pay a claim, the legislature has evinced an intention to avoid the result that the operation of s.54 depends upon matters of form.  As a matter of ordinary language, it is perfectly appropriate to say in the present case that the effect of the contract of insurance is such that, but for s.54, the respondent may refuse to pay the appellant's claim.  The circumstance that this comes about because of the language of that part of the contract of insurance which defines the risk rather than by reason of a breach of a condition of the policy does not seem to me to be material.  The case falls within the general words of the section and I see no justification for reading them down.

     The Act, in its long title, is described as an Act to reform and modernise the law relating to certain contracts of insurance so that a fair balance is struck between the interests of insurers, insureds, and other members of the public and so that the provisions included in such contracts, and the practices of insurers in relation to such contracts, operate fairly.  It would hardly be consistent with the purposes thus described to construe the language of s.54 in such a way as to make its operation depend upon the choice that is made between various
available drafting techniques."

Mahoney JA reached a similar conclusion (at 407):

     "Section 54(1) looks, in its terms, not to the provisions of the contract of insurance but to 'the effect' of it.  This, in my opinion, means the effect which the contract of insurance would, apart from the section, have in the relevant factual context.  In the present case, a claim has been made on the insurer and it has refused to pay that claim.  It has, for present purposes, refused to pay it 'by reason of' the fact that, within the terms of the policy, the claim is for a loss which is not within the cover.  But the reason why the loss is not within the cover is that the claim upon the insured was not 'notified' to the insurer within the period of insurance.  In my opinion, upon the construction of the words 'by reason of', the effect of the policy in the factual context would, apart from s.54(1), have been that the insured might refuse to pay the claim by reason of the fact that the claim upon the insured had not been 'notified' to the insurer."

His Honour also addressed the question of whether the absence of notification to the underwriters was an "omission" within s.54(6).  He answered this question as follows (at 408):

     "I am inclined to the view that 'omission' in this context includes merely the failure to do something, for example, to notify the insured of a claim.  But, however that be, in the present case the conditions of the policy imposed a contractual obligation upon the insured to give notice 'of any claim made against him' (condition 4).  The failure to perform a contractual obligation of this kind is, in my opinion, an 'omission' within the subsection."

On the face of it, East End is precisely in point in the present case.  The Accountant's policy provided coverage in respect of claims made and reported within the policy period.  A claim was made within that period.  Clause 4 of the policy required the insured to give notice in writing of any claim made during the period of insurance.  The failure to do so was therefore a breach of a contractual obligation in the policy. 

Mr Williams contended, however, that East End had been modified by the subsequent decision in Perry.  The facts in Perry were different from those of East End.  A professional indemnity policy was issued to the insured in respect of the period 26 October 1988 to 26 October 1989.  The policy provided coverage in respect of any claim made and reported during the period of insurance.  In addition, condition 3 stated that should the insured, during the subsistence of the policy, become aware of an occurrence that might subsequently give rise to a claim and give notice of the occurrence, then any claim subsequently made against the insured was to be deemed to have been made during the subsistence of the policy.  The insured acted negligently and caused loss to a third party before 26 October 1988.  He became aware of his negligence (and perhaps the loss caused) during the period of insurance.  A claim was made against him outside that period and he notified the insurer after receiving the claim.

Gleeson CJ (at 92) declined to apply a distinction between provisions defining the scope of cover and conditions affecting the entitlement of an insured to claim.  Such a distinction would allow the case to be determined by the skill of the draftsman and thus represent a triumph of form over substance.  The issue was whether the effect of the contract of insurance was that, but for s.54, the insurer could refuse to pay the insured's claim by reason of some act or omission of the insured, or of some other person.

His Honour saw the answer as resting on the distinction between an omission and mere "inaction".  He pointed out (at 93) that, in East End, the claim was made during the period of cover and there was a condition requiring prompt notification of claims.  Gleeson CJ continued (at 93):

     "Here the primary cover afforded by the policy is cover against claims made and reported during the relevant period.  An insured who, during the relevant period, becomes aware of an occurrence and hence the possibility of a future claim, is entitled, if he or she chooses to do so, to notify the insurer and thus extend the scope of the cover to future claims in respect of occurrences discovered and notified during the relevant period.  There could be reasons why an insured would choose not to do so.  The possibility of a future claim might, for a number of possible reasons, be regarded as remote.  Notification might indirectly affect future premiums.  When one is dealing with claims that are mere future possibilities, a decision not to elect to expand the scope of the cover to include such claims does not seem to me to constitute an omission of the kind with which s.54 is concerned.  Condition 3 is intended to relieve an insured (in a way that is similar but not identical to the relief given by s.40 of the Act) against a certain practical problem that can arise in liability insurance.  It does that by giving the insured a choice.  The insured may choose not to follow the course made available by condition 3.  In that event I am unable to conclude that the absence of liability on the insurer is by reason of an omission on the part of the insured within the meaning of s.54."

Clarke JA also concluded that s.54 did not apply, but relied on somewhat different reasoning.  He took the view that s.54 applies only where there is a pre-existing right which is lost by virtue of the insured's failure to notify the insurer.  He considered that there was no right in the insured to claim under the policy in Perry until the insured notified the insurer.

In Antico, Kirby P. declined to follow the reasoning of Clarke JA in Perry.  (The remaining members of the Court of Appeal, Priestley and Powell JJ.A., did not need to address this issue.)  Kirby P., although not resiling from his dissent in Perry, followed the reasoning of Gleeson CJ.  However, his Honour confined Gleeson CJ's reasoning to the case where the insured has a choice whether or not to notify the insurer of circumstances which might, in the future, give rise to a claim against him.

The Present Case

Mr Williams sought to apply Perry to the circumstances of the present case, by contending that Mr Martin had exercised a choice not to make a claim under the 1992 accountants' policy within the period of cover.  The submission was based on this part of Mr Martin's cross-examination:

     "Can I ask you to turn in the bundle to tab 6.  Is that a proposal form that you filled out in about December 1992 in respect of your accountant's policy?---Yes.

 

     You see in answer to question 8 you have said this:

 

          No claims have been made in regard to accounting or tax work.  A claim is in progress re investment advice but not on this policy.

 

     ---That's what I stated, yes.

 

     And that was your understanding at the time, was it?---It was.

 

     ...

 

     But in any event, the answer to question 8 was a reference to the claim that has now been brought by the Draytons?---Yes.

 

     You, in 1992, turned your mind to it and took the view that that claim was covered by your FAI policy, did you not?---Sorry, could you repeat that?

 

     You, in 1992, turned your mind to it and thought the claim by the Draytons would be covered by your FAI policy?---I thought that way, yes.

 

     For that reason you elected to notify FAI about the claim in 1992 but not the accounting underwriters?---Correct."

 

    

It seems to me that to describe Mr Martin as having made an "election", in the sense of an informed choice about his course of action, overstates what occurred.  As Mr Martin's fax of 12 July 1993 made clear, he had assumed, in October 1992 and thereafter, that he was wholly covered by the PI policy against the Drayton's claim.  He learned for the first time, in about July 1993, that this was not, or might not, be the case.  He thereupon reported the claim to Minet.  Moreover, Mr Martin was not asked in cross-examination if he had considered whether the Accountant's policy also indemnified him against the Draytons' claim.  The evidence is consistent with Mr Martin simply not adverting, until July 1993, to whether the Accountant's policy also provided him with indemnity against the whole or part of the Draytons' claim.  If it were relevant, I would not be prepared to find that Mr Martin had made a conscious decision not to claim on the accounting underwriters, in the knowledge that he was entitled to do so.

In any event, even if such a finding were made, it would not avail the accounting underwriters.  The choice referred to by Gleeson CJ in Perry was an election under the terms of the policy to expand the scope of cover to include future claims that might be made.  Even if Gleeson CJ's reasoning is not to be confined in the manner suggested by Kirby P, his Honour was not referring to the motivation underlying an insured's failure to comply with a contractual obligation to report a claim.  The judgments in East End do not suggest that a different result would have been reached had the insured deliberately decided not to report the claim during the period of cover.  Mahoney JA's reasoning expressly links the word "omission" in s.54 to a failure to perform a contractual obligation, and does not suggest or imply that the motive for the failure is in any way relevant.  Indeed, although no finding was made as to the motivation underlying the insured's failure, it would hardly seem to have been inadvertent.  The claim was made against the insured during the period of cover, resulting in a judgment only six weeks after the end of that period.

More importantly, to accede to the accounting underwriters' arguments would undercut the objectives of the legislation.  Gleeson CJ in East End (at 404) cited the Explanatory Memorandum accompanying the Insurance Contracts Bill.  In relation to s.54, the Memorandum said this:

     "The existing law is unsatisfactory in that the parties' rights are determined by the form in which the contract is drafted rather than by reference to the harm caused.  The present law can also operate inequitably in that breach of the term may lead to termination of the contract regardless of whether or not the insurer suffered any prejudice as a result of the insured's breach.  The proposed law will concentrate on the substance and effect of the term and ensure that a more equitable result is achieved between the insurer and the insured."

A reading of the report of the Australian Law Reform Commission, Insurance Contracts (ALRC 20, 1982) confirms that the policy underlying s.54 is that, in a case of what the Commission described as a "condition subsequent", the insured should have a remedy only where the breach by the insured prejudices its interests.  Even then, the insurer is to have relief only to the extent it can demonstrate prejudice: see para.241.

The present s.54 of the IC Act follows precisely the form of cl.54 of the Draft Insurance Contracts Bill 1982, appended to the Commission's report. In adopting cl.54, the Commission specifically adverted to, but declined to adopt, the model provided by s.27 of the Instruments Act 1958 (Vic).  That section is limited to cases where the insured failed to give notice required by the policy "by reason of accident, mistake or other reasonable cause".

For these reasons, I think that, at least where an insured, under a claims made and reported policy, fails to comply with a contractual obligation to report a claim made within the policy period, there is an "omission" for the purposes of s.54 of the IC Act.  That is so whether the failure is due to a deliberate "election" by the insured not to make the notification or report, or to some other reason, such as mistake or inadvertence.  Accordingly, in my opinion, s.54 of the IC Act applied in the present case to prevent the accounting underwriters refusing to indemnify Mr Martin by reason only of his failure to report the claim made by the Draytons until after the period of insurance specified in the Accountant's policy.

 

Can an Insurer Claiming Contribution Rely on s.54?

Mr Williams somewhat faintly suggested that an insurer could not rely on s.54 in a claim for contribution against a co-insurer.  However, the relevant issue is whether the accounting underwriters are liable to indemnify Mr Martin under the Accountant's policy.  The fact that a statutory provision prevents the underwriters relying on an act or omission that otherwise would justify them in refusing the claim, does not detract from the proposition that they are liable to indemnify the insured under the policy.  Nor does it detract from the proposition that the accounting underwriters have covered the same risk as FAI under its PI policy.

There is authority that an insurer can not necessarily rely on s.18 of the Insurance Act 1902 (NSW) in contribution proceedings against a co-insurer: Thimm v Commercial Union Assurance Co Ltd [1979] 2 NSWLR 847 (NSW S Ct/Yeldham J.), at 850-853.  But that case depended on the particular wording of s.18(1), which is very different from that of s.54 of the IC Act.  Furthermore, the decision in Thimm has been doubted: Workers Compensation Board of Queensland v Workcover Authority of New South Wales (1995) 36 NSWLR 732 (NSW S Ct/Rolfe J.), at 743-746.  In the absence of similar language to that employed in s.18(1), provisions such as s.54 should be read as intended to operate within an existing commercial and legal network of insurance relationships: GRE Insurance Ltd v QBE Insurance Ltd [1985] VR 83 (S Ct Vic/FC), at 98, per McGarvie J.  That network includes the entitlement of an insurer who has paid an indemnity to claim contribution from another insurer who is freed from liability to the insured by reason of the first insurer's payment: GRE at 98-99.  Thus FAI is entitled to invoke s.54 in its contribution claim against the accounting underwriters.

VI.  WAS THE CLAIM WITHIN THE ACCOUNTANT'S POLICY?

 

The Submission

Mr Williams submitted that any liability incurred by Mr Martin to the Draytons did not arise from any claim "in respect of any description of civil liability whatsoever incurred in connection with the "Practice", within cl.2 of the Accountant's policy.  It will be recalled that the term "Practice" was defined to mean "the professional business of acting as an accountant...".   Mr Williams distinguished between Mr Martin's practice as an accountant and his practice as an investment adviser.  He contended that any liability incurred to the Draytons arose because of Mr Martin's activities as an investment adviser and was not incurred in connection with his accountancy practice.

The wording of cl.2 is very broad.  The coverage extends, relevantly, to any loss arising from any claim in respect of any description of civil liability whatsoever in connection with the practice.  Of course, the meaning of the phrase "in connection with", whether used in a statute or in a contract, must depend on the context: Burswood Management Ltd v Attorney-General (Cth) (1990) 23 FCR 144 (FCA/FC), at 146.  Nonetheless, the width of the ordinary meaning of the phrase is indicated by a passage from the judgment of Wilcox J. in Our Town FM Pty Ltd v Australian Broadcasting Tribunal (1987) 16 FCR 465, at 479-480:

     "The words 'in connection with' have a wide connotation, requiring merely a relationship between one thing and another.  They do not necessarily require a casual relationship between the two things: see Commissioner for Superannuation v Miller (1985) 8 FCR 153, at 154, 160, 163.  They may be used to describe a relationship with a contemplated future event: see Koppen v Commissioner for Community Relations (1986) 11 FCR 360, at 364; Johnson v Johnson [1952] P.47 at 50-51.  In the latter case the United Kingdom Court of Appeal applied a decision of the British Columbia Court of Appeal, Re Nanaimo Community Hotel Ltd [1945] 3 DLR 225, in which the question was whether a particular court, which was given 'jurisdiction to hear and determine all questions that may arise in connection with any assessment made under this Act', had jurisdiction to deal with a matter which preceded the issue of an assessment.  The trial judge held that it did, that the phrase 'in connection with' covered matters leading up to, or which might lead up to, an assessment.  He said, [1944] 4 DLR 639:

          'One of the very generally accepted meanings of 'connection' is 'relation between things one of which is bound up with or involved in another'; or, again 'having to do with'.  The words include matters occurring prior to as well as subsequent to or consequent upon so long as they are related to the principal thing.  The phrase 'having to do with' perhaps gives as good a suggestion of the meaning as could be had.'

     This statement was upheld on appeal"

Under cl.2 of the Accountant's policy it is Mr Martin's civil liability that must have been incurred in connection with his practice as an accountant.  The Draytons' case, as pleaded in the amended statement of claim filed in the Federal Court, alleged that at all material times Mr Martin carried on business as an accountant or, in the alternative, as an investment adviser.  It further alleged that Mr Martin was employed for reward to prepare accounts for all business activities conducted by the Draytons; to prepare accounts and monitor the performance of the tractor company; to prepare tax returns; to advise the Draytons as to the investment of the capital sum of $1.5 million held by William and Nancy Drayton; and to advise Bruce and Ross Drayton as to their investments. It was said that, by reason of these matters and the fact that Mr Martin held himself out as having the skill and experience to perform the various services for the Draytons, he owed a duty to each of them to exercise reasonable care in performing the services.  The amended statement of claim went on to allege that Mr Martin made representations to the Draytons concerning the suitability of the cash flow plan and that these representations were made in breach of his duty of care.

It is clear enough that the Draytons' claim, as pleaded, does not attempt to draw a clear distinction between Mr Martin's services as an accountant and those as an investment adviser.  The pleadings allege that the duty of care flowed from the services undertaken by Mr Martin on behalf of the Draytons, many of which, on any view, can be described as forming part of the professional business of acting as an accountant.  The fact that the Draytons pleaded their case in this manner suggests that Mr Martin's liability is connected with his practice as an accountant, in the sense that the services he performed as an accountant for the Draytons were important in establishing the duty of care that he breached.  But the pleading cannot of itself establish that Mr Martin's liability to the Draytons was incurred, as a matter of fact, in connection with his accountancy practice. 

In support of his contention that, in fact, Mr Martin's liability was not so incurred, Mr Williams relied on Mr Martin's own practices and understanding.  In particular he pointed to the following:

l    Mr Martin had recognised that he was conducting two different practices by taking out two separate liability policies.

l    Mr Martin, when dealing with investment issues as opposed to accountancy matters, had a practice of corresponding on Inscorp letterhead.  When dealing with accountancy questions he generally used his own letterhead.  Letters to the Draytons on investment questions were on Inscorp's letterhead.

l    Mr Martin recognised in his evidence that he performed separate functions as an accountant and as an investment adviser.

The force of these submissions is, in my view, very much diminished by Mr Martin's own evidence.  He accepted that the various services provided to the Draytons could not be disentangled:

     "MR WILLIAMS: It is fair to say, is it not, that the general differentiation you made between investment advising and rendering accounting services, insofar as keeping the activities separate for your records, occurred in the case of the Draytons, did it not?---Yes, they were separate functions.

     But in the Draytons' case?---In the Draytons' case they may have been so involved that it was maybe difficult to draw such a clear line.

     But you purported to do this at the time by writing on different letterheads?---Most certainly, if I felt one was one way or the other.

     So, when you felt it was investment advice you wrote on the letterhead of Inscorp Financial Services Group and when you thought it was accounting advice
you wrote on your private letterhead as a certified practising accountant?---Correct.

     HIS HONOUR: I do [sic - dare] say it may have been difficult to draw a clear line, Mr Martin?---Your Honour, the Drayton's affairs were so complex that I don't believe you could consider one aspect of the services I provided without considering the other aspect of the services I provided.  I think they were inextricably interwoven."

Mr Martin readily accepted that his accountancy practice involved giving advice to clients in minimisation of tax.  In relation to the Draytons, his evidence was to the following effect:

l    on each occasion he visited them, both accounting and investment matters were discussed;

l    when discussing the records and accounts of the tractor business, he discussed with the Draytons the performance of the business; and

l    an integral part of the cash flow plan was the fact that the interest payments in respect of borrowings could be deducted from assessable income derived by the tractor business.

Mr Martin summarised the position as follows:

     "MR DONALDSON: What I was asking Mr Martin was to tell us what connection there was, bearing in mind this demarcation that has been put to you as to investment activities and accounting activities - what connection was there, if any, between the accounting related discussions and advice that you had with Draytons and the recommendations that you gave them to enter into these policies?---I believe that if I had been acting for the Draytons simply to the monitoring of their investment portfolios, ie. the shares and the like that we had in place for them, that this particular investment medium would  not have formed part of such a portfolio.  Its major attraction was its integration with the conduct of a business in order to minimise your exposure to income tax.

     That business being?---The tractor company."

The simple fact of the matter is that, so far as the Draytons were concerned, Mr Martin's advice to them to invest in the cash flow plan was, to use his words "inextricably interwoven" with his role as their accountant and his business or profession as an accountant.  In practice, the stringent demarcation identified by Mr Williams was blurred, at least in Mr Martin's dealings with the Draytons.  His work as the accountant for the tractor business provided the impetus for his recommendation that the Draytons participate in the tax-driven cash flow plan.  His role as an accountant was undertaken at the same time as his role as an investment adviser.  His function as an adviser, however imperfectly performed, depended on information obtained as the accountant for the Draytons.  In these circumstances, it seems to me inevitable that the liability Mr Martin incurred to the Draytons was incurred 'in connection with' his practice as an accountant.

In my opinion, little significance can be attached to Mr Martin's use of Inscorp's letterhead.  In his evidence, Mr Martin said that he had not thought carefully about the use of the letterhead.  In any event, Inscorp had nothing to do with the cash flow plan in which the Draytons participated.

Mr Williams referred to the provision of the Corporations Law (formerly contained in the Securities Industries Code) relating to persons carrying on an investment advice business.  However, these provisions govern businesses involving the giving of advice to other persons about "securities": see now Corporations Law,  ss.77,92, 781.  They do not bear on the current case, which does not concern an investment in "securities", as defined in the Corporations Law.

Nor do I think it to the point that Mr Martin's fees from his accounting practice were modest in comparison to the commission of $54,750 derived from his procuring the Draytons to participate in the cash flow plan.  The magnitude of the undisclosed commission is in no way inconsistent with Mr Martin's liability to the Draytons being incurred in connection with his practice as an accountant.

Accordingly, I think that the liability incurred by Mr Martin to the Drayton was within the scope of the Accountant's policy.

VII.SETTLEMENT WITHOUT CONSENT OF THE ACCOUNTING UNDERWRITERS

 

The accounting underwriters contended that they were not liable to Mr Martin because he had settled the Draytons' claim against him by the Draytons without the underwriters' consent.  They relied on cl.4(a)(i) of the Accountant's policy:

     "The Assured shall not admit liability for, or settle, any claim within the Insuring Clauses hereof or incur any costs or expenses in connection therewith without the consent of the Insurers (such consent not to be unreasonably withheld)..."

On 29 April 1996, the accounting underwriters' solicitors wrote to Mr Martin purporting to terminate the insurance contract on the ground that the settlement without the underwriters' consent had breached cl.4(a)(i) and thus Mr Martin had repudiated his obligations under that contract.

Prior to the settlement of the Draytons' claim, the accounting underwriters were requested, on a number of occasions, to confirm that they were prepared to grant indemnity to Mr Martin under the Accountant's policy.  On 1 March 1994, the accounting underwriters' solicitors informed FAI's solicitors that the underwriters had denied liability to Mr Martin, on the ground that the claim alleged against him did not fall within the terms of the policy.  That decision was confirmed in a letter of 25 March 1994, to Mr Martin:

     "We refer to previous correspondence in this matter and wish to inform you that Underwriters do not consider that the claim alleged against you in these proceedings falls within the terms of the Accountants Professional Indemnity Insurance Policy.  Accordingly Underwriters have instructed us to deny indemnity to you under the Policy.  Underwriters consider that your liability in these proceedings was not incurred in connection with your practice as a professional accountant but rather in connection with your practice as a professional investment adviser.  Accordingly, your claim does not fall within the insuring clause of the Policy.

 

     We have informed the solicitors for FAI, Tress Cocks & Maddox, of Underwriters' denial. We have asked Tress Crocks & Maddox to keep us informed of developments without prejudice to Underwriters' position...."

 

In these circumstances, the accounting underwriters wrongfully repudiated their obligations under cl.2 of the policy, which required them to indemnify Mr Martin against all loss arising from the Drayton's claim, subject of course to the other provisions of the policy.  The ground relied on by the underwriters (as I have found) was not sustainable.  No other ground for refusing to indemnify Mr Martin was available to them.  They had the opportunity to participate in the settlement, but declined to do so.

Where an insurer wrongfully repudiates liability under a policy, it cannot rely on a condition requiring it to consent to any compromise of a claim against the insured: Captain Boyton's World's Water Show Syndicate (Limited) v Employers' Liability Assurance Corporation (Limited) (1895) 11 TLR 384 (CA); General Omnibus Company Limited v London General Insurance Company Ltd [1936] IR 596 (S Ct Irish Free State), at 608, per Kennedy CJ; 614-615, per FitzGibbon J.  In Distillers Company Bio-Chemicals (Australia) Pty Ltd v  Ajax Insurance Company Ltd (1974) 130 CLR 1, at 9-10, Menzies J. cited these cases in support of the proposition that

     "[t]he insured may make a reasonable settlement where the insurer breaches the contract by denying liability and refusing to defend or settle."

The other members of the Court implicitly accepted this proposition: see at 12-13, per Gibbs J.; at 26, per Stephen J.

In my opinion, this principle applies to the present case.  Indeed, it would be curious if the position were otherwise.  An insurer could repudiate its contractual obligations and place the insured in a difficult, if not impossible, position.  The insured would be forced to defend the proceedings brought by the claimant to a conclusion and to forego all opportunities of a reasonable compromise for fear of losing the indemnity under the policy.  I have already found that the compromise was reasonable in the circumstances of the present case: compare Royal Insurance Fire and General (NZ) Ltd v Mainfreight Transport Ltd (1993) 7 ANZ Ins.Cas. 61-172 (NZ CA), at 77,975-77,976.

An alternative answer to the accounting underwriters' contention was put by Mr Donaldson.  He submitted that s.41 of the IC Act prevented the accounting underwriters from relying on cl.4(a)(i) of the policy in order to refuse to indemnify Mr Martin.  Section 41 of the IC Act provides as follows:

     "41(1)  This section applies where it would constitute a breach of a contract of liability insurance if, without the consent of the insurer, the insured were to:

     (a)  settle or compromise a claim made against him; or

     (b)  make an admission or payment in respect of such a claim.

     (2)  An insured who has made a claim under a contract of liability insurance may at any time, by notice in writing given to the insurer, require the insurer to inform him in writing:

     (a)  whether the insurer admits that the contract applies to the claim; and

     (b)  if the insurer so admits, whether he proposes to conduct, on behalf of the insured, the negotiations and any legal proceedings in respect of the claim made against the insured.

     (3)  Where the insurer does not, within a reasonable time after the notice as given, inform the insured that the insurer admits that the contract of liability insurance applies to the claim and that the insurer proposes to conduct, on behalf of the insured, the negotiations and any legal proceedings in respect of the claim made against the insured, the insurer may not refuse payment of the claim and the amount payable in respect of the claim is not reduced, by reason only that the insured breached the contract as mentioned in subsection (1)."

Mr Williams argued that s.41 did not apply to the circumstances of the present case, because the letter sent on behalf of Mr Martin did not comply with s.41(2).  Those letters specifically asked the accounting underwriters to advise as to their "determination with respect to the claim made by Mr Martin under [the] policy" and as to their "position regarding indemnity".  Mr Williams submitted, however, that it is necessary, in order for s.41(2) to be satisfied, that the letter expressly ask

l    whether the insurer admits that the contract applies to the claim; and

l    if the insurer so admits, whether it proposes to conduct the legal proceedings.

The letter sent on behalf of Mr Martin sought only an admission that the underwriters were bound to indemnify him and did not explicitly address the second issue identified by Mr Williams.

It is not necessary, in view of the conclusion I have already reached, to address this argument, and I think it undesirable that I should do so.  Section 41 follows the form proposed by the Law Reform Commission in its report on Insurance Contracts.   The Commission was addressing what it described as "the special problem" raised in Distillers v Ajax, where an insurer had not admitted any liability to indemnify the insured and had elected not to take over and conduct the defence or settlement of the actions against the insured.  Unlike the present case, the failure to admit liability to indemnify was not a breach of contract, since the occasion for indemnity had arisen and the insurer had not repudiated its obligations: 130 CLR at 10, 26.  The Commission assumed that there was no need to address the situation where an insurer improperly denied liability, since in that case the insured could settle or compromise the claim without penalty: Insurance Contracts, para.244.  It would seem therefore, that s.41 is simply not intended to address the case where an insurer has wrongfully repudiated its obligations to indemnify the insured.  It is preferable to construe the interaction between s.41(2) and s.41(3) in a case which necessarily raises the question of construction.

VIII.     EXTENT OF CONTRIBUTION

The final issue is the extent of the contribution the accounting underwriters should be required to make to the payment of $292,000 made by FAI in discharge of Mr Martin's liability to the Draytons.  Mr Williams contended that the appropriate approach was to apply the "maximum potential liabilities test".  Under this test, the contribution of the insurer having the lesser liability is limited to the proportion that its maximum liability bears to the aggregate of maximum liabilities under both policies: CCH, Australian and New Zealand Insurance Reporter, para.27-140.  Since the maximum liability under the Accountant's policy was $250,000 for each claim, and the maximum liability under the PI policy was $1,500,000 for each claim, the accounting underwriters should be required to pay only 14.28% of the settlement sum, calculated in accordance with the following formula:

          250,000             

          250,000  +  1,500,000        =    14.28%

This produces a liability to contribute $41,697.60 of the settlement sum of $292,000.  (Mr Williams' calculations ignored the costs component of the settlement sum, but there is no justification in my opinion for taking this course.)

Mr Donaldson submitted that the "independent liabilities test" should be applied.  Under this test, the contributions are assessed according to the proportions that the independent liability of each insurer, if it were the only insurer, bears to the total of such independent liabilities: ANZ Ins. Reporter, para.27-140.  This test would require the accounting underwriters to contribute 46.13% of the settlement sum, or $134,686.34.  The formula is as follows:

          250,000            

          250,000  +  292,000          =    46.13%

Reference has been made to the principle of contribution stated in Albion Insurance v GIO.  The rationale underlying the principle is that all persons liable to satisfy the same debt must contribute to its payment equitably.  The court should take into consideration all matters which go towards ensuring a just result: Government Insurance Office of New South Wales v Crowley [1975] 2 NSWLR 78 (S Ct NSW/Helsham CJ in Eq.); GRE v QBE, at 103-104, per McGarvie J.; American Surety Company of New York v Wrightson (1910) 103 LT 663 (KBD/Hamilton J.), at 666-668.  As these cases demonstrate, there is no rule of law that the maximum liabilities test must be applied.  Helsham CJ in Eq. put the matter this way in GIO v Crowley (at 84):

     "[The maximum liabilities test] may do justice and equity in a case where the amount of the cover bears some direct relationship to the amount of the loss, such as where each policy relates solely to the loss in question.  But in many cases that will not be so, and the present is one.  Neither insurance policy in the present case related solely to the loss suffered; each indemnified against a wide range of events, with each amount of cover fixed no doubt by reference to what was being indemnified against, and both covering almost fortuitously, as it were, and indeed contrary to the assertions of both insurers, the particular loss that occurred.  In no way would the respective amounts of the insurance cover present any basis for adjusting in any fair manner what proportion each should bear of the loss."

In the present case, I think that the appropriate course is that the "amount which has been paid should be borne in proportion to the burden of liability which that payment has lifted from the respective insurers": GRE v QBE, at 104.  Neither policy related solely to the loss sustained by Mr Martin.  Like the policies in GIO v Crowley, each indemnified against a wide range of events.  The premiums payable under each policy were relatively modest ($448.95 for the Accountant's policy and $296.50 for the PI policy).  Mr Williams pointed out that Mr Martin had disclosed in his proposal for the 1992 Accountant's policy estimated fees from his accounting practice of only $17,500.  But it was not suggested that this was not a genuine estimate or that it justified the accounting underwriters in avoiding the policy.  It is difficult to see why that estimate means that justice and equity between the two insurers would not be served by applying the independent liabilities test.  No evidence was directed to that point.

The only other matter raised by Mr Williams was that FAI's entitlement to contribution depended in part upon s.54 of the IC Act.  But the accounting underwriters knew of s.54 when they accepted the risk, framed their policy, and set the premium.  Again, in my opinion, this has no material bearing on the question of contribution.

The accounting indemnities should contribute 46.13% of the settlement sum paid by FAI.  This is a total of $134,686.34.

IX.  CONCLUSION

There should be judgment for FAI in the claim for contribution in the sum of $134,686.34.  No interest was sought in the cross claim and Mr Donaldson did not refer to interest in his submissions.  The accounting underwriters should pay FAI's costs.

                   I certify that this and the preceding 78 pages are a true copy of the Reasons for Judgment of Justice Sackville.

                   Associate:

                   Dated:    24 May, 196

Heard:             1 & 2 May, 1996

Place:             Sydney

Decision:          24 May, 1996

Appearances:       Mr S.R. Donaldson, instructed by Tress Cocks & Maddox, Solicitors, appeared for the Cross Claimant on the Seventh Cross-Claim

                   Mr D.L. Williams, instructed by Ebsworth and Ebsworth, Solicitors, appeared for the Cross Respondents to the Seventh Cross Claim.