Reforms will affect more than financial services

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1 INSURANCE Inside: Financial services reforms affect insurance policies Misleading conduct under the spotlight Your publication: If you would prefer to receive our publications in electronic format, please VISIT OUR WEB SITE TO READ ALL FOCUS EDITIONS We look at the impact of the Financial Services Reform Act on the sale of insurance, and the implications of a High Court decision on recovery of damages in relation to consumer protection claims. Reforms will affect more than financial services From early next year, the sale or issue of general insurance policies following an unsolicited meeting or unsolicited personal contact may contravene the Corporations Act, as a result of recent developments in the Financial Services Reform Act. Senior Associate Mark Lindfield reports. Considering its potential to adversely affect the direct marketing of policies by insurers and agents, it's surprising that the impact of section 992A of the Financial Services Reform Act 2001 (the FSR Act) is relatively unknown in the insurance industry. The section prohibits a person from offering a financial product for issue or sale during the course of, or because of, an unsolicited meeting (subsection 1). It also prohibits the offering of financial products during the course of, or because of, unsolicited personal contact (subsection 3) unless the offeror complies with prescribed procedures. (For further information, see AAR's FSR website at Although the new regime originally contemplated a two-year transition period for compliance with section 992A, a recent proclamation by the Governor-General means that there is effectively no transition period for this section and that all financial product issuers and sellers must be compliant by 11 March The scope of the prohibition An examination of Hansard suggests that in introducing section 992A, Parliament's focus was on stopping the unsolicited offering of investment products with significant

2 and high-risk commitments. The concern seems to have been about providing consumers with an opportunity to consider all relevant information before committing to products like managed investment funds and superannuation. General insurance policies are, of course, financial products for the purposes of the FSR Act. Since the prohibition applies to the offeror, insurers and agents alike face criminal penalties under the Corporations Act for breaches of the prohibition (for each offence, a fine of $2,750 or six months imprisonment or both for individuals, or fines of up to $13,750 for corporations). So how do insurers, agents and representatives comply? Compliance Unsolicited meetings To offer an insurance policy during, or because of, an unsolicited meeting is completely prohibited. Further, if an unsolicited meeting leads to a series of correspondence and additional discussions between the consumer and an insurer or agent after which a policy is ultimately sold to the consumer, there remains a risk that the legislation will have been breached since the sale could be found to be because of the original unsolicited meeting. Unsolicited personal contact To offer an insurance policy during, or because of, unsolicited personal contact (other than a meeting) is also prohibited, unless the offeror complies with all of the procedures set out in subsection 992A(3). Under the subsection, the insurer or agent must first ensure that the prospective insured has been: contacted during the hours prescribed by the regulations - and only if he or she is not listed on the offeror's No Contact/No Call register; given an opportunity to register on the No Contact/ No Call register; given an opportunity to select the time and frequency of future contact; given a Product Disclosure Statement (PDS) before becoming bound to acquire the policy; clearly informed of the importance of using the information in the PDS when deciding whether to purchase the policy; and given the option of having the information in the PDS read out to that person. No regulations relating to section 992A have been drafted. Therefore, there are no specific hours during which contact may be made under subsection 992A(3). Similarly, there is no definition of the No Contact/No Call register, however Parliament seems to have contemplated a register similar to that required to be maintained under the new privacy legislation. The prohibitions in section 992A apply equally to offers made to retail and wholesale clients. They also apply equally to existing and new customers. The potential scope of these prohibitions is far from clear. Ambiguity The wording of section 992A is unclear. From existing definitions elsewhere in the Corporations Act we know that 'offer' includes invitations and distribution of application forms. We also know that 'issue' includes circulation, distribution and dissemination. However, neither the FSR Act nor the Corporations Act contain any definition of 'meeting', 'personal contact', 'unsolicited' or, more importantly, 'because of'. The scope of the phrase 'because of' is particularly unclear. Even if the phrase is meant to refer to the most recent, important, most causative or proximate cause of the sale, determining whether an original meeting or subsequent meetings occurred at the insured's request and what the sale was 'because of' will raise endless debates on the facts of each sale. The requirements of subsection 992A(3) seem to assume that 'personal contact' is restricted to telephone calls. However, this assumption does not sit well with the next section in the FSR Act, section 992AA, which expressly prohibits the offer of managed investment schemes by means of an 'unsolicited meeting' or an 'unsolicited telephone call'. It therefore seems that Parliament intended the prohibition to extend to other forms of personal contact such as . 2

3 Effect of the prohibition General insurers, agents and anyone offering general insurance policies for issue or sale, are affected by section 992A. This includes direct marketing agencies whose services are retained by insurers for the purpose of direct marketing or cross-selling. Any person offering an insurance policy during, or because, of a face-to-face meeting will be in breach of the Corporations Act unless the offeree has asked for that meeting. Example 1 If an agent meets with a broker and the broker's client is later sold a policy because of that meeting, the agent will be in breach of the Corporations Act unless the broker had requested the meeting. Any person offering an insurance policy during, or because of, personal contact such as a telephone call will be in breach of the Corporations Act unless the offeree has requested the contact or unless the offeror complies with each of the steps set out above. Example 2 A telemarketing company under contract to an insurer cold-calls a customer to offer a new policy. The telemarketer must first give the customer the opportunity of never being contacted again (not only in relation to that product). The telemarketer must also provide the customer with a PDS before the customer becomes bound to acquire the policy (that is, before he or she accepts the offer to purchase). The prohibitions are based on an assumption that the direct sale of financial products to consumers is inherently worthy of restriction. For insurers currently involved in direct marketing it will be necessary to review those practices for compliance with these new restrictions. Insurers will also need to maintain No Contact/No Call registers that may prevent them ever from approaching new customers or cross-selling to existing customers on an unsolicited basis. Timing The FSR (Consequential Provisions) Act that was enacted with the FSR Act provides for a transition period within which existing financial product issuers and service providers must obtain compliance with the FSR Act following its commencement. Section 992A is contained in Part 7.8 of the FSR Act and the FSR (Consequential Provisions) Bill originally provided that all currently regulated principals would have two years from commencement of the FSR Act to comply with Part 7.8. However, in final amendments to the FSR Bill on 28 August 2001, the transition period for compliance with section 992A was reduced from two years to a maximum of six months. The amendment came through section 1442A of the FSR (Consequential Provisions) Bill that provided for a transition period beginning on the commencement of the FSR Act and ending after six months, or earlier if so proclaimed by the Governor-General. On 24 October 2001 the Government Notices Gazette published proclamations made by the Governor- General that the FSR Act will commence on 11 March 2002 and that 11 March 2002 is the date for the purposes of section 1442A. That is, the transition period for compliance with section 992A begins and ends on 11 March Exemption Section 992B of the FSR Act empowers the Australian Securities and Investments Commission (ASIC) to grant exemptions from, or variations to, section 992A (see our FSR website at links.htm). ASIC has published Policy Statement 169 entitled Disclosure: Discretionary Powers and Transition (available at pdflib.nsf/lookupbyfilename/ps169.pdf/$file/ PS169.pdf) that states that ASIC will consider giving relief under s992b to address atypical or unforeseen circumstances and unintended consequences and to give relief in a way that is consistent with Parliamentary intention. [PS to 169.5] ASIC also has the power to extend the transition period for compliance. However, ASIC states in its policy statement that it will only grant extensions in exceptional cases and that it expects licensees to take the necessary steps to comply within the statutory timeframes. [PS ] However, ASIC refers here to the two-year transition period rather than the one-day transition period for section 992A. 3

4 Specific exemptions may also be granted via the regulations under section 1368 of the Corporations Act. Insurers and agents should consider how section 992A will affect their businesses As the legislation stands, section 992A will take effect on 11 March 2002 and immediately apply to all insurers, agents and representatives who offer insurance policies to both retail and wholesale clients. At the request of a number of insurers and the Insurance Council of Australia, Allens Arthur Robinson drafted a submission to Treasury concerning the operation of section 992A on the general insurance industry. The submission seeks a regulation exempting general insurance policies from section 992A. Treasury has recently released a list of major issues to be considered in the second stage of the FSR regulations (see download/issues.pdf). One of the issues identified is the prohibition contained in section 992A. In the short time left before the FSR Act commences, all members of the general insurance industry should consider the potential for section 992A to affect their operations, including distribution methods. A copy of the AAR submission to Treasury is available on our website at au/publications/pdf/inssubdec01.pdf If you would like more information, please do not hesitate to contact us. Misleading conduct under the spotlight On 6 September 2001, the High Court handed down its decision in Henville v Walker [2001] HCA 52. Senior Associate Eugene Elisara and Lawyer Rachel Nemes look at the implications for recovery of damages under section 82 of the Trade Practices Act 1974 in relation to consumer protection claims. The background to the case Henville was interested in purchasing properties for the development of residential units in Albany, Western Australia. Walker, a real estate agent, showed Henville certain properties and made representations regarding the state of the Albany market, in particular, the high demand for luxury units. In June 1995, Walker showed Henville a property at 36 View Street, Albany and stated that it would be preferable to build three, larger, high-quality units on the property, rather than the maximum four, and that such units would sell for between $250,000 and $280,000. Henville made an offer of $190,000 for the property. Henville then undertook a feasibility study to assess the profitability of the project, relying on his own expertise in estimating the costs and Walker's advice regarding the likely selling prices. On the basis of this study, Henville decided to go ahead with the development. The costs were substantially underestimated, the selling prices substantially overestimated and the project suffered various unrelated delays and setbacks. The units were finally sold in June 1997, one for $175,000 and the other two for $185,000 each, at a substantial loss to Henville. Henville subsequently brought proceedings against Walker for misleading and deceptive conduct, in contravention of s52 of the Act, and sought to recover his losses under s82(1). The High Court's findings The High Court unanimously found in favour of Henville, holding that Walker's representations regarding the units' likely selling prices were misleading. The main issue on appeal was the amount of damages to which Henville was entitled, in light of 4

5 the fact that his under-estimation of the project's costs contributed to the loss suffered. Causal connection required to trigger liability under s82 The only express guidance given by the legislation in relation to the causal connection required to trigger liability under s82 is that loss is recoverable if it is suffered by contravening conduct of another person. In this case, the feasibility study was based on two factors: the cost of the project; and the likely selling price of the units. The High Court held that if either had been estimated with reasonable accuracy, the project would not have proceeded. Therefore, neither factor was the sole cause of Henville's decision to undertake the project. Conduct will legally cause damage if it materially contributes to the damage, irrespective of whether the conduct alone was sufficient to bring about the damage. Two or more causes may jointly influence a person. Therefore, if a representation plays some part, even if only a minor one, there will be a causal connection between the representation and the course of action. 1 The High Court found that, as Walker's misrepresentations were a cause of Henville's decision to undertake the project, Henville's losses were suffered by Walker's conduct. Quantification of damages under s82 The High Court held: 'there is no ground for reading into s82 doctrines of contributory negligence and apportionment of damages.' 2 Justices McHugh, Hayne and Gummow held that if Henville had asked, he would have been entitled to damages for his actual loss of approximately $320,000 and not just the $205,000 identified in the appeal papers. Their Honours held that the refusal of trial judge Justice Anderson, in the Supreme Court of Western Australia, to treat the whole of the loss as related to Walker's misrepresentations was justified. However, it would unduly burden the plaintiff to prove which component of the loss was referable to the contravening conduct and such a finding would impose a gloss on the legislation to confine recoverable loss to that which is directly attributable to the conduct. Justices Gaudron and McHugh 3 found that once the plaintiff had established the requisite causal connection, the defendant must bear the burden of establishing why the plaintiff must not recover its total loss. Chief Justice Gleeson 4 would not support a decision whereby Walker would be required to underwrite all of Henville's losses, regardless of how they were incurred. Apportionment under s87 No reliance was placed by either side on s87(1) of the Act, which permits ancillary or additional compensation for part of the loss or damage suffered by a victim of a s52 contravention. It was held in I & L Securities v HTW Valuers 5 (I&L Securities), that damages awarded under s87 could be reduced in cases where the plaintiff is partly at fault. This decision effectively establishes a defence of contributory negligence under the Act. Justice Anderson's approach in compensating Henville at first instance only for those losses attributable to Walker's conduct may have been more successful if the legal basis for that award had been s87 as opposed to s82 TPA. As I & L Securities' appeal to the High Court was heard on 21 November 2001, the use of s87 as a means for apportioning damages in cases of contributory negligence may soon be clarified. Judgment is expected to be delivered by May Henville v Walker distinguished? Henville v Walker was recently considered and followed by the Queensland Court of Appeal in Manwelland Pty Ltd v Davies & Moore Pty Ltd. 6 In this case, after subdividing, developing and selling the land in question, the plaintiff incurred a loss of $10,259, compared to the hypothetical situation of not buying the land at all. The plaintiff claimed damages of $510,000, using the more traditional method of assessment, being the difference between the price paid for the land ($810,000) and its value ($300,000). However, the Court held that the plaintiff's loss had been quantified at $10,259 when the land was sold. Accordingly, an award of damages of $10,259 was sufficient to put the 1 See Gould v Vaggelas (1985) 157 CLR 215 per Wilson and Brennan JJ. 2 See, for example, [2001] HCA 52 at 140 (McHugh J) and 66 (Gaudron J). 3 [2001] HCA 52 at 70 and [2001] HCA 52 at 35 5 (2000) 179 ALR 89 6 [2001] QCA 436 (16 October 2001) 5

6 plaintiff back in the position it had been in before the misrepresentation was made. This decision could adversely affect a plaintiff's willingness to actively mitigate his/her losses. Implications for insurers The High Court's decision in Henville v Walker will increase insurers' exposure regarding their coverage of misleading and deceptive conduct. Insureds and their brokers might well expect a more detailed set of enquiries during the negotiations for renewal of a new policy about risk management of potentially misleading conduct. For claims managers, there will be a heightened forensic focus on identifying supervening events and losses attributable to factors other than the insured's conduct. If there's a topic that you'd like to see covered in a future edition, please contact: Melita Simic Senior Associate, Sydney Ph: Melita.Simic@aar.com.au For further information, please contact: Oscar Shub Ph: Oscar.Shub@aar.com.au Dean Carrigan Ph: Dean.Carrigan@aar.com.au Andrew Buchanan Partner, Brisbane Ph: Andrew.Buchanan@aar.com.au John Morgan Ph: John.Morgan@aar.com.au Prue Campton Special Counsel, Melbourne Ph: Prue.Campton@aar.com.au John Baartz Partner, Brisbane Ph: John.Baartz@aar.com.au Michael Quinlan Ph: Michael.Quinlan@aar.com.au Peter Hobday Partner, Melbourne Ph: Peter.Hobday@aar.com.au Jenny Thornton Partner, Perth Ph: Jenny.Thornton@aar.com.au Sydney Melbourne Brisbane Perth Gold Coast Port Moresby Singapore Hong Kong Jakarta Shanghai Bangkok Phnom Penh Andrea Martignoni Ph: Andrea.Martignoni@aar.com.au Louise Jenkins Partner, Melbourne Ph: Louise.Jenkins@aar.com.au