Insureds, interested and named parties

Insureds, interested and named parties When considering insurance cover in relation to multi-party transactions and operations, a fundamental issue for insurers, brokers and insureds alike is whether a party should be named as an insured or simply have its interests noted on the Policy. This paper examines the difference and significance of being listed as an interested or named party on a policy of insurance (ie a Third Party Beneficiary), rather than being named as an insured. In this paper, we: (a) (b) (c) (d) (e) review the development of the common law in this area; consider the operation of s48 of the Insurance Contracts Act 1984 (Cth) (the Act), in particular, whether a Third Party Beneficiary s claim for indemnity can be prejudiced by the conduct of an insured; consider the disclosure obligations of a Third Party Beneficiary as opposed to an insured; consider whether a duty of good faith exists in relation to an insurer-third Party Beneficiary situation; and consider whether a plaintiff can have a direct action against an insurer where the plaintiff's primary action is against a Third Party Beneficiary as opposed to a named insured. 1. The common law position 1.1 Historical Approach A policy of insurance is essentially a commercial contract between an insurer and the relevant insured(s). Accordingly, the fundamental principles of contract law apply in respect of the interpretation of insurance contracts, subject to legislative amendments and common law exceptions. A fundamental contract law principle, which has long haunted those not party to an insurance contract, is the doctrine of privity, which essentially states that only parties to a contract may enforce the contract. Third parties, or persons who are not party to a contract, have no cause of action in respect of the contract. Another doctrine, that of consideration, also poses a further hurdle for those not a party to the contract. Prior to the legislative intervention effected by the Act, insurance was commonly expressed to cover/provide benefit for third parties. However, in law, the insured could not recover the non-party claimant's loss because it was not his or her loss and the non-party claimant could not recover his or her loss because they were not party to the contract of insurance and the privity doctrine prevented the non-party claimant from suing under the contract. In practice, no doubt due largely to commercial considerations, insurers often recognised the claims of Third Party Beneficiaries, although this was not always the case: Vandepitte v Preferred Accident Insurance Corporation of New York [1933] AC 70. laub B0110522117v4 150340 18.2.2004 Page 1

Agency and trust have been often noted as 'exceptions' to the doctrine of privity in respect of Third Party Beneficiaries' claims arising from contracts of insurance, but often they failed to provide a satisfactory basis for recovery by a Third Party Beneficiary. 1.2 The Trident decision The above position under the common law in Australia was altered by the decision of the High Court in Trident General Insurance Co Ltd v McNiece Bros Pty Ltd (1988) 165 CLR 107. (a) Facts Blue Circle Southern Cement Ltd (Blue Circle) obtained a policy of insurance with Trident General Insurance Co Ltd (Trident) providing it with a public liability cover (the Policy). In the Policy, "The Assured" was defined as: Blue Circle Southern Cement Limited, all its subsidiary, associated and related Companies, all Contractors and Sub-Contractors and/or Suppliers Under the "Public Liability" section of the Policy the Assured was indemnified against: all sums which the assured shall become liable to pay in respect of: 1. Death of or bodily injury to or illness of any person not being a person who at the time of the occurrence is engaged in and upon the service of the Assured under a Contract of service or apprenticeship Garry Hammond (Mr Hammond) was injured while working at one of the specified sites covered by the Policy. At the time of his accident, Mr Hammond was working under the direction of the site engineer employed by McNiece Bros Pty Ltd (McNiece), although he was employed by another person. Mr Hammond recovered damages against McNiece and McNiece in turn sought indemnity from Trident under the Policy. Trident denied liability to McNiece. (b) First instance At first instance, Justice Yeldham held that McNiece was a party to the contract of insurance issued by Trident. Justice Yeldham inferred an agency relationship between Blue Circle and McNiece. He held that McNiece gave consideration to Trident through Blue Circle in that Blue Circle contracted with Trident on behalf of McNiece, and paid a premium. Although Justice Yeldham also held that Blue Circle had no authority to enter into the contract of insurance on behalf of McNiece, His Honour accepted that the service of the statement of claim by McNiece constituted ratification of the policy by McNiece, entitling it to sue on the policy. Trident appealed the decision. (c) Court of Appeal The Court of Appeal dismissed Trident's appeal, although McHugh JA rejected Justice Yeldham's view that Blue Circle acted as agent for McNiece and that McNiece was a party to the contract of insurance. laub B0110522117v4 150340 18.2.2004 Page 2

The Court of Appeal instead accepted the submission made on behalf of McNiece, arguing that a common law beneficiary under a policy of insurance can sue on the policy even though it is not party to the policy and provides no consideration: Commercial and social convenience have also compelled the creation of exceptions to the rigidity of the doctrine of privity of contract even in jurisdictions which retain it. Common law, Equity and statute have all created exceptions. The doctrine of the undisclosed principal, privity of estate and the holding of the promise in trust for beneficiaries are well known exceptions. 1 Trident appealed to the High Court. (d) High Court The High Court dismissed the appeal and allowed McNiece to recover under the Policy by a majority of five to two, although it is a difficult task to establish a clear majority approach from the judgment. Mason CJ and Wilson J effectively agreed with the Court of Appeal and recognised an exception to the doctrine of privity with respect to insurance contracts. Toohey J also held that McNiece could recover under the policy, however, he recognised an exception far narrower than that accepted by Mason CJ and Wilson J. Deane J believed that the injustice caused by the doctrine of privity could be remedied by inferring a trust relationship between the non-party claimant and the insured. Gaudron J also allowed McNiece to recover, however Gaudron J approach the issue by utilising the concept of unjust enrichment. Finally, Dawson J and Brennan J dissented and considered that allowing an exception to the doctrine of privity in the circumstances would overthrow a doctrine which is settled and fundamental. In essence, the majority decision in Trident recognised that the privity doctrine could no longer apply unmodified to contracts of insurance. 2. Section 48 of the Insurance Contract Act 1984 (Cth) 2.1 Section 48 The Australian legislature recognising the injustices that resulted from the old common law position, attempted to remedy the situation by the insertion of s48 in the Act which states: Entitlement of named persons to claim (1) Where a person who is not a party to a contract of general insurance is specified or referred to in the contract, whether by name or otherwise, as a person to whom the insurance cover provided by the contract extends, that person has a right to 1 Trident General Insurance Co Ltd v McNiece Bros Pty Ltd (1987) 8 NSWLR 270 per McHugh JA at 285 laub B0110522117v4 150340 18.2.2004 Page 3

recover the amount of the person's loss from the insurer in accordance with the contract notwithstanding that the person is not a party to the contract. (2) Subject to the contract, a person who has such a right: (a) (b) has, in relation to the person's claim, the same obligations to the insurer as the person would have if he were the insured; and may discharge the insured's obligations in relation to the loss. (3) The insurer has the same defences to an action under this section as the insurer would have in an action by the insured. In effect, s48 overrides the doctrine of privity and allows a Third Party Beneficiary to recover directly from the insurer. However, s48 does not make a Third Party Beneficiary a party to the contract of insurance nor an insured for the purposes of the Act. Further, it appears to be accepted law that s48 cannot be used to widen the cover provided by the policy itself 2. However, the drafting of s48 has given rise to considerable ambiguity in relation to defining the rights and obligations of a Third Party Beneficiary claiming under s48 compared to the rights of an insured under a relevant policy. In particular, confusion has arisen as to the meaning of "same defences" in s48(3) in relation to whether an insured s conduct can prejudice an innocent Third Party Beneficiary s claim for indemnity. 3. Can an Insured's conduct prejudice a Third Party Beneficiary's claim for indemnity? There appears to be at least 2 schools of thought on the interpretation to be given to "same defences" in s48(3) of the Act. On one view, the reference to an insurer having the "same defences" against a Third Party Beneficiary means that the Third Party Beneficiary has no better rights in relation to a claim than the insured, for example, if the insurer is entitled to avoid or reduce its liability because of the insured s conduct, the insurer is also entitled to exercise those rights against the Third Party Beneficiary (ie the conduct of the insured prejudices the Third Party Beneficiary's claim). The other view is that s48(3) is only referring to the types of defence, as opposed to the actual defences, which would be available against an insured. The insurer will only be able to rely upon such defence if the Third Party Beneficiary s conduct gives rise to the defence. This would mean that the insured's conduct would not prejudice the Third Party Beneficiary's claim provided the Third Party Beneficiary is innocent of any breach. Further, the decisions in this area appear to have drawn a distinction between the insured s conduct that occurred prior to entering into a contract of insurance and the insured s postcontractual conduct. We discuss below the 4 key decisions on this issue. 2 MacDonald v CE Heath Underwriting & Insurance (Australia) Ltd (1997) 9 ANZ Insur Cas 61-362; GIO Australia Ltd v Ward Civil Engineering Pty Ltd (2000) 11 ANZ Insur Cas 61-467. laub B0110522117v4 150340 18.2.2004 Page 4

3.1 V.L. Credits Pty Ltd v Switzerland General Insurance Co. [1990] VR 938 The V.L. Credits case concerned a fire insurance policy which had been taken out by the lessee of the insured premises for itself and its original mortgagee jointly or, alternatively, with the lessee for itself and as trustee for the mortgagee. With the consent of the insurer, the benefits of the contract were subsequently assigned to the lessee and the plaintiff, V.L. Credits, which had provided finance to the lessee. The "Certificate of Currency " specified the insured as "John's Gourmet Food" (the trading name used by the lessee) and "V.L. Credits Ltd", and following the name of the insureds the abbreviation "F.T.R.R. & I." appeared. Tadgell J interpreted that abbreviation to mean "for their respective rights and interests". For the purposes of the hearing it was assumed that the lessee had destroyed the insured property by arson. V.L. Credits brought a claim for indemnity as a party by assignment to the contract of insurance or, alternatively, a claim for damages for its loss pursuant to s48(1) of the Act. The insurer refused indemnity alleging that, as the fire was lit deliberately by a person acting for, or with the connivance of, the lessee, condition 7 of the policy (which essentially provided that the insurer could refuse to pay a fraudulent claim), s56 (which specifies an insurer's remedies for fraudulent claims) and s48(3) of the Act afforded a defence to the plaintiff's claim for indemnity. Tadgell J found that the policy in question was a composite policy, one covering the mortgagee and the lessee for their respective rights and interests in circumstances where each had a separate insurable interest; the mortgagee's interest being its security afforded by the mortgage and the lessee's interest being that of the proprietor. Consequently, Tadgell J concluded that, on the basis that V.L. Credits was a co-insured with the lessee under a composite policy, the insurer could not rely on the wrongful conduct of its co-insured. Similarly, Tadgell J found that on the basis that the lessee was the insured and V.L. Credits rights came from s48(1), the insurer could not rely on the wrongful conduct of the insured. Tadgell J having described s48(3) of the Act as "in a sense elliptical and economic in its use of words", held that s48(3) entitles an insurer to plead in its defence to the mortgagee's claim any defence it would have had if the mortgagee had been an insured, but only to the extent that they were based on the actions of the mortgagee. Tadgell J also noted that in his view s48(3) was designed to ensure that the insurer is entitled to take advantage against a person who makes a claim pursuant to s48, of all the provisions of the contract in addition to those which might be brought in by s48(2)(a) and to prove against such claimant facts which would have provided a defence had it been the insured making the claim and not a stranger to the contract. However, Tadgell J appears to have recognised that the outcome may be different in the case of a pre-contractual non-disclosure by an insured when he noted that in circumstances where there is: laub B0110522117v4 150340 18.2.2004 Page 5

an obligation cast on the insured to disclose all relevant facts that would influence an insurer in making the contract or declining to make it may very well be a joint obligation if there is more than one insured, even if the insurance is not joint. Accordingly, V.L. Credits' case supports the view that a Third Party Beneficiary's claim for indemnity is not prejudiced by the conduct of the insured, at least, where the insured s conduct in question occurred post-contract. However, Tadgell J's comments are arguably obiter dicta given his finding that V.L. Credits may have been a co-insured. 3.2 Commonwealth Bank of Australia v Baltica General Insurance Co Ltd (1992) 28 NSWLR 579 Baltica insured a property under an Industrial Special Risk policy. The policy set out the insured as follows: INSURED: Emmanuel Karpathios & Constantine Jackos (property owner) & Erolbay Pty Ltd T/as Keiron Catering and all other related companies, for their Respective Rights and Interests MORTGAGEE: Commonwealth Bank of Australia A section headed "INTERESTS OF OTHER PARTIES" stated: The insurable interest of only those lessors, financiers, trustees, mortgagees, owners and all other parties specifically noted in the records of the Insured shall be automatically included without notification or specification; the nature and extent of such interest to be disclosed in event of damage. Where the insurance covers the interest of more than one party, any act or neglect of an individual party will not prejudice the rights of the remaining party/parties; providing the remaining party/parties shall, immediately on becoming aware of any act or neglect whereby the risk of damage has increased, give notice in writing to the Insurer(s) and on demand pay such reasonable additional premium as the Insurer(s) may require. The Bank claimed indemnity separately from Baltica under s48 in respect of its interest in the property as mortgagee, but Baltica denied indemnity arguing that it was entitled to avoid the policy by reason of fraudulent non-disclosure on the part of the insureds, Messrs Karpathios and Jacobs and Erolbay Pty Ltd. The Court had to decide whether Baltica was entitled to rely on the non-disclosure defence. It was common ground in the proceedings that the Bank was not a party to the contract of insurance but was specified or referred to in the contract as a person to whom the insurance cover provided thereby extended. Baltica's principal argument was based on the proposition that s48 of the Act did not intend to place a Third Party Beneficiary in a better position than if he had been a party to the contract of insurance. Giles J accepted the approach referred to by Mason CJ and Wilson J in the Trident decision, whereby a Third Party Beneficiary's rights are subordinated to the rights of the contracting parties. Giles J noted that if legislation intended that a Third Party Beneficiary's laub B0110522117v4 150340 18.2.2004 Page 6

rights should transcend the existence and terms of the contract of insurance, such an intention should be clearly indicated. Giles J held that having regard to the reason of the enactment of s48, the language that it used in the Act, the recognition of the interests of the parties to the contract of insurance in relation to the existence and terms of the contract and the profound consequences of a contrary view for the exposure of insurers, the insurer can rely on non-disclosure by the insured as a defence to a Third Party Beneficiary's claim under s48(1). Giles J noted that at page 580: If that [his decision on the operation of s48(3)] be thought to work injustice on the third party, it must be remembered first, that prior to s48 he had no rights of recovery at all; secondly, specific provisions protective of his rights of recovery could have been made but was not, and would be expected if it were intended to more radically reform his position; thirdly, in Advance (NSW) Insurance Agency Pty Ltd v Matthews [dealing with defences available against a claim by an innocent co-insured] it was not thought inherently unjust that an insurer is entitled to avoid a contract of insurance which it would not have entered into but for a fraudulent failure to disclose a material matter. In reaching his decision, Giles JA cast no doubt on the correctness of the decision in V.L. Credits, but simply limited it to a case involving conduct during the contract; Giles JA found that V.L. Credits provided no guidance when considering the issue of non-disclosure which affects the existence of the contract of insurance (as opposed to the operation of the terms of a contract of insurance). For completeness, Giles JA noted that the Bank did not rely upon the statement in the policy that any act or neglect of an individual party will not prejudice the rights of the remaining party or parties. Apart from noting some of the different interpretations which could be given to this statement, Giles JA did not express a view on this issue since it had not been argued by the Bank. 3.3 C E Heath Casualty & General Insurance Ltd v Grey and Others (1993) 32 NSWLR This is a decision of the NSW Court of Appeal. The appeal arose from the failure of the Compass Airline group of companies. C E Heath entered into arrangements to provide D&O insurance cover in respect of loss suffered as the result of "wrongful acts" by directors and possibly former directors of the relevant companies. C E Heath denied indemnity to the directors on the ground that it was entitled to avoid the policy as the defendants had knowledge of facts which, if revealed to C E Heath, would have affected C E Heath's decision in entering into the insurance contract. In the circumstances, the Court of Appeal unanimously found that the directors were parties to the D&O policy. As parties to the contract the directors, being the insureds, were obliged to reveal the relevant facts to C E Heath. This conclusion technically resolved the appeal. However, the Court of Appeal went on to consider whether, assuming the directors were not parties to the policy, the non-disclosure by Compass of material facts created a defence to claims made by the directors. laub B0110522117v4 150340 18.2.2004 Page 7

(a) Pre-contractual situation Clarke JA, with whom Meagher JA agreed, held that a claim under s48(1) by a Third Party Beneficiary may be resisted by the insurer under s48(3) on the grounds of the insured's pre-contractual non-disclosure or misrepresentation. Clarke JA reached this conclusion on the "plain words" of s48(3) notwithstanding its "economy of language". However, Clarke JA held that the Act does not impose any pre-contractual duty concerning disclosure or misrepresentation on a person covered by the contract but not party to it, and consequently, the insurer could not rely on a Third Party Beneficiary's failure to disclose or misrepresentation as a defence under s48(3). In this context, Clarke JA doubted Tadgell J's comments in the V.L. Credits' case that the design of s48(3) was to equate the insured with a Third Party Beneficiary such that an insurer is entitled to prove against a claimant facts which would provide a defence had it been the insured making the claim and not a stranger to the contract Mahoney JA, dissenting, reached his decision based on an analysis of the disclosure obligations imposed on a Third Party Beneficiary. His reasoning on this is discussed in section 4 below. (b) Post-contractual situation Clarke JA noted that the Act draws a distinction between an insurer's rights to avoid a policy, or reduce its liability, on the grounds of acts or omissions of the insured before the contract was concluded (eg s21, 28 and s31) and its rights in relation to the insured's conduct after the policy of insurance has been agreed (eg s54 and s56). In the former case, the defences or remedies arise out of a statutory duty of disclosure which only refers to the "insured"; in the latter case, the source of the obligations arise under the contract itself and the provisions in the Act do not refer only to the insured's conduct. On the operation of s54, Clarke JA commented that the consequences of the particular conduct by either the insured or a person entitled to claim under s48 upon the entitlements of one or the other would be spelt out in the policy itself. However, Clarke JA did note that it was possible that the conduct of the insured could prejudice a Third Party Beneficiary's claim eg if the contract provided that no claim would be allowed if the insured did not give prompt notice then, subject to s54, the failure by the insured to give such notice would, prima facie, defeat all claims, whether by the insured or by another person. Accordingly, the conduct of the insured could affect the Third Party Beneficiary in accordance with s54 of the Act. In respect of s56, Clarke JA thought that the section allows an insurer to refuse a fraudulent claim but that at the same time the insurer is bound by the terms of the contract. Therefore, where a Third Party Beneficiary is not implicated in the fraud and the contract of insurance is a composite (rather than a joint) policy, then the insurer will not be able to rely upon the fraud of the insured in order to avoid the claim by the innocent Third Party Beneficiary. laub B0110522117v4 150340 18.2.2004 Page 8

Mahoney JA appears to concur with Clarke JA's reasoning in that he found that the operation of s48(3) enables the insurer to rely, against a Third Party Beneficiary, on defences of the kind which would be available against the insured. Mahoney JA gave the example of where, if the policy stipulated that the claim must be made within 2 days, that defence would, on the face of it, be available against both the insured and the Third Party Beneficiary. Mahoney JA went on to explain: Assume a claim was lodged by both, the former [the insured] outside and the latter [the Third Party Beneficiary] inside the subjected time. The defence against the third person, as such, could not succeed In summary, this case supports the view (albeit in obiter dicta) that the insurer can rely on the pre-contractual non-disclosure by the insured as a defence to a claim by a Third Party Beneficiary under s48. The position is less clear in relation to post-contractual conduct of the insured as it will turn on the particular wording of the policy and circumstances in each case. 3.4 General Motors Acceptance Corporation Australia v RACQ Insurance Ltd [2003] QSC 80 This case concerned an application for a determination of a preliminary issue of law. General Motors Acceptance Corporation Australia (General Motors) financed the purchase of a motor vehicle by the insured. The insured insured the vehicle under an insurance policy with RACQ Insurance Ltd (RACQ). It appears that General Motors interest in the vehicle was noted on the insurance policy (although this issue was not finally determined). Either the insured, or someone at her direction, deliberately destroyed the vehicle. Cover under the policy was relevantly limited to damage to your vehicle caused by an accident. Accident was defined in the policy to mean an event that is unexpected and unintended from your point of view and that occurs during the insurance term. You was defined in the policy to mean person or persons shown as the insured on the policy certificate. General Motors sought to rely on V.L. Credits case to support an argument that the burning of the vehicle was an accident because it was unexpected and unintended from General Motors' point of view, even though it was expected and intended from the insured s point of view. However, Muir J distinguished V.L. Credits case on the basis that the construction issue in the V.L. Credits case concerned the application of a disqualifying event. In contrast, in this case, the construction issue concerned the determination of the scope of the cover afforded by the policy. Further, Muir J noted that doubt was cast on Tadgell J s comments in the V.L. Credits case on the operation of s48(3) by Clarke JA (and by agreement, Meagher JA) in Grey s case that s48(3) resulted in the Third Party Beneficiary being equated to the position of an insured. Muir J held that General Motor s right under s48(1) to recover under the contract is a right to recover in accordance with the contract. Based on the wording of the policy, neither the insured nor any person whose interest was noted on the contract had a right to recover under it for non-accidental loss or damage or for damage caused when the vehicle is being laub B0110522117v4 150340 18.2.2004 Page 9

used other than in a prescribed manner. Muir J cited with approval the statement by Priestly JA in MacDonald v C E Heath Underwriting & Insurance (Australia) Ltd 3 that: Put slightly differently, s48(1) seems to me to be dealing with cases where (i) cover is provided by a contract of general insurance to a party to the contract and (ii) that cover is extended by the contract to a person specified or referred to in the contract. In those circumstances the person has a right to recover in accordance with the indemnity provided to the contracting party. Accordingly, Muir J s decision appears to cast doubt on the approach taken by the V.L. Credits case and tends to support the view that a Third Party Beneficiary s right to claim indemnity will be prejudiced by the insured s post-contractual conduct. 3.5 Summary It appears relatively clear that an insurer is entitled to rely upon a pre-contractual nondisclosure or misrepresentation by an insured as a defence to a claim by a Third Party Beneficiary under s48 of the Act. However, there appears to be divergent judicial opinion across jurisdictions on whether an insurer can rely upon post-contractual conduct of the insured as a defence to a claim for indemnity by an innocent Third Party Beneficiary, namely: from V.L. Credits' case, the Victorian Supreme Court appears to consider that the conduct of the insured should not prejudice a Third Party Beneficiary's claim for indemnity; from Grey's case, the NSW Court of Appeal appears to recognise that the insured's post-contractual conduct does not necessarily prejudice a claim by a Third Party Beneficiary's claim but will depend upon the circumstances and policy wording involved in each case; from General Motors' case, the Queensland Supreme Court has cast doubt on the decision in V.L. Credits' case and highlights that consideration needs to be given to whether the insured's conduct results in the Third Party Beneficiary's claim falling outside the scope of the cover provided under the policy as opposed to, or in addition to, creating a defence under the policy. 4. Disclosure obligations of a Third Party Beneficiary It appears clear from the plain language of s21 of the Act that there is no duty of disclosure on a Third Party Beneficiary whose interests are only noted; only the insured is under such obligation 4. Consequently, in Grey's case, Clarke JA (Meagher JA agreeing) held that a Third Party Beneficiary's failure to make full disclosure, or to have made a 3 (1997) 9ANZ Ins Cas 61-362. Note: the other members of the court agreed with the reasons of Priestly JA. 4 Giles J in Commonwealth Bank v Baltica General Insurance at page 590; Clarke JA (Meagher JA agreeing) in Grey's case at page 47. laub B0110522117v4 150340 18.2.2004 Page 10

misrepresentation, could not provide the insurer with a defence based on non-compliance with the statutory duty of disclosure 5. However, Mahoney JA in Grey's case considered that, in certain circumstances, a Third Party Beneficiary is subject to a duty of disclosure pursuant to the duty of utmost good faith which is imposed either: (a) under s48 because: The rights given to Third Party Beneficiaries under s48 carry with them a duty of good faith (including a duty of disclosure). The obligation to disclose is imposed by s48(2)(a) which places Third Party Beneficiaries under "the same obligations to the insurer as he would have if he were the insured". Mahoney JA considered that the words "in relation to his claim" in s48(2)(a) did not limit the insurer's considerations to only what occurs after the event insured against has occurred and a claim has been made. s48(3) enables an insurer to rely on a defence of avoidance for breach of the principle of good faith. (b) at common law, at least, in relation to "trust cases" and "benefit cases". By "trust cases", Mahoney JA meant cases where the insurer contracts for insurance with an insured who in turn holds the benefit of the insurance on trust for a Third Party Beneficiary. By "benefit cases", Mahoney JA was referring to contracts entered into for the estate planning purposes with a view to conferring benefits upon third persons revocable at the wish of the proponent party to the policy. Mahoney JA did note that there may be restrictions on the duty of disclosure stating: I do not mean by this that the beneficiary under a policy held on trust is obliged to seek out or reveal relevant information to a proposed insurer. The extent of his obligation will depend upon the circumstances. It is sufficient to hold that, in appropriate circumstances, the principle of good faith may extend to him albeit he is not a party to the contract. Examples provided by Mahoney JA of when a Third Party Beneficiary may be required to disclose information to the insurer included if the Third Party Beneficiary knows that the policy is being effected for his benefit and knows facts which would affect the insurance eg leading the insurer to decline the risk or to impose a higher premium. 5. Section 48 and the duty of utmost good faith 5.1 Under the Act Section 13 of the Act imposes a duty of utmost good faith on the parties to the contract by making such an obligation an implied term of the contract. Consequently, a breach of the 5 Mahoney JA in Grey's case also agreed that s21 of the Act does not impose a duty of disclosure on a Third Party Beneficiary. laub B0110522117v4 150340 18.2.2004 Page 11

duty of good faith by one party provides the innocent party with a claim for contractual damages. The issue which therefore arises is whether, because of the wording of s48, the Act imposes a similar obligation on an insurer and Third Party Beneficiary. As previously mentioned, s48 does not make a Third Party Beneficiary a party to the insurance contract. Accordingly, s13 of the Act does not apply to the insurer-third Party Beneficiary situation. However, in relation to a Third Party Beneficiary, s48(2)(a) imposes on a Third Party Beneficiary, in relation to its claim, the same obligations to the insurer as if it was the insured. Accordingly, the Act imposes a duty of good faith on a Third Party Beneficiary in relation to its claim. As far as an insurer is concerned, the Act does not impose a duty of good faith in relation to its dealings with a Third Party Beneficiary. However, the Act does not codify the law in relation to the duty of good faith 6 and it is necessary to examine the common law to determine the extent to which an insurer may owe a duty of good faith to a Third Party Beneficiary. 5.2 At Common Law The ALRC suggested that, in principle, the duty of good faith should apply to all aspects of the relationship of a contract of insurance 7. As noted above, Mahoney JA in Grey's case seems to endorse this philosophy when he commented that the duty may not be restricted to the insurer insured context. In particular, Mahoney JA stated: The view that the operation of the principle of good faith is not limited to those who, at law, are parties to the contract of insurance flows, I believe, from the nature of the principle itself. It is a broad principle applicable to the making of insurance contracts and the performance of them. Mahoney JA did recognised that there were limitations on the duty of utmost good faith. For example, Mahoney JA noted at 38-39: There are, of course, limits to what the principle requires. In Banque Financière de la Citée SA v Westgate Insurance Co Ltd [1991] 2 AC 249, the principle was discussed in the context of fraud in the course of an insurance transaction. The House of Lords was there concerned with that aspect of the principle of good faith which involved disclosure of relevant facts. It was said, for example, by Lord Jauncey of Tullichettle (at 282) that "there is, in general, no obligation to disclose supervening facts which come to the knowledge of either party after conclusion of the contract... subject always to such exceptional cases as a ship entering a war zone or an insured failing to disclose all facts relevant to a claim". It was said that the knowledge of the broker was "irrelevant to the risk" and that there was no obligation on the insurer to tell the bank that its agent was dishonest. 6 Section 7 and 12 of the Act 7 Australian law Reform Commission, Report no 20, Insurance Contracts (1982) at paragraph 328 laub B0110522117v4 150340 18.2.2004 Page 12

5.3 Sayseng v Kellogg Superannuation Pty Ltd Although in a slightly different context, Bryson J in the recent NSW Supreme Court decision of Sayseng v Kellogg Superannuation Pty Ltd 8 considered the comments made by Mahoney JA in Grey's case and found that an insurer owes a third party a duty of utmost good faith which includes an obligation to observe procedural fairness in considering the third party's claim. Sayseng's case concerned a total and permanent disability (TPD) claim involving a discretionary trust and group life insurance. Under the relevant trust deed, the plaintiff, Mr Sayseng, was entitled to a TPD benefit if: in the opinion of the trustee he had sustained a TPD; and where the trustee had an insurance policy (as in this case), he sustained a TPD within the meaning of the policy. Mr Sayseng commenced proceedings against the trustee of his superannuation fund and the group life insurer of the fund in respect of a declined claim for a TPD benefit. In relation to the claim against the insurer, Bryson J considered that: Mr Sayseng was not a party to the insurance contract. The contract was between the insurer and the trustee of the fund; the insurance contract did not purport to directly insure Mr Sayseng or any other fund member and, accordingly, Mr Sayseng did not have standing to sue the insurer directly pursuant to the decision in Trident v McNeice; and s48 of the Act did not apply as Mr Sayseng was not specified or referred to in the policy as a person to whom the insurance cover extends because, notwithstanding that Mr Sanseng was one of the class of persons referred to in the policy as Insured Persons, the policy overall made it clear that payments were to be made only to the trustee 9. Nevertheless, Bryson J held that Mr Sayseng had standing to sue the insurer directly. In reaching this decision, Bryson J relied on comments made by Mahoney JA in Grey's Case in respect of the application of the duty of utmost good faith among persons who are not strictly contractual parties to an insurance policy and stated that: In my opinion the standing of Mr Sayseng is related to the duty of good faith in exercise by an insurer of rights under the contract including the right of controlling the settlement of claim In my view the observations of Mahoney JA support the view that a person other than a contracting party to the policy may have standing to challenge the effectiveness of an opinion formed by an insurer In my opinion there is no difficulty about the standing of Mr Sayseng to bring his claim against Hannover, notwithstanding that he is not party to the insurance policy issued by Hannover. The Trustee as first defendant is a party to the insurance policy, and is a party to this litigation. On a whole view of the trust deed, the Trustee holds the Fund, of which the 8 Unreported, Supreme Court of NSW, Bryson J, 13 November 2003 9 Bryson J also doubted whether the group life insurance policy fell within the class of general insurance referred to in s48 of the Act laub B0110522117v4 150340 18.2.2004 Page 13

Policy is an asset, on trust for persons who, in due administration, are entitled to payments out of the Fund; Mr Sayseng claims that he is such a person and that the Trustee is entitled to insurance moneys, and whether or not he is in fact so entitled can only be established by determining the proceedings as a whole. In my view these considerations show that he has standing to bring the proceedings against Hannover. Bryson J held that the insurer's decision to reject Mr Sayseng's claim was void because the insurer did not observe procedural fairness in its dealing with Mr Sayseng's claim. In reaching this decision, Bryson J noted: Both [Mr Sayseng] indirectly and the Trustee directly have interests in compliance by the insurer with its duty to proceed fairly to form its opinion. As he is not a party to the Policy Mr Sayseng does not fall within the provisions of s13 of the Insurance Contracts Act 1984 relating to obligations of good faith between parties. Extension of the obligation of good faith to persons in positions like those of Mr Sayseng is supported by the opinion of Mahoney JA in C E Heath Casualty & General Insurance Ltd v Grey. It is further supported by the structure of the insurance arrangements in the Group Life Contract, in which fair decision on the entitlement of the trustee to insurance cannot be made without dealing fairly with Mr Sayseng as claimant. In my opinion the validity of the opinion formed by the insurer falls to be tested on the basis that Mr Sayseng was entitled to fair dealing when Hannover considered the claim. Bryson J held that the insurer's failure to observe procedural fairness did not give rise to an entitlement to recover damages for breach of contract. Rather, Bryson J ordered that the question of whether or not Mr Sayseng's condition entitled him to the benefit was to be listed for a separate determination by the Court. It remains to be seen whether the position taken by Bryson J in allowing a person who was not an insured, or a Third Party Beneficiary in the sense discussed in this paper, to maintain an action against the insurer will survive subsequent scrutiny by the Courts. Further, the extent to which Courts are prepared to impose a duty of good faith at common law on insurers, in relation to their dealings with third parties, remains uncertain. 5.4 Conclusion It appears that under the Act: a duty of good faith is imposed on a Third Party Beneficiary, in relation to its claim, to the same extent that such an obligation is imposed on an insured; and there is no express duty of good faith imposed on an insurer in relation to a Third Party Beneficiary. Nevertheless, the common law may impose a duty of good faith on an insurer in relation to a Third Party Beneficiary. The scope of the duty remains uncertain but would, at least, extend to requiring an insurer to deal with a Third Party Beneficiary's claim in good faith. It is unclear whether the duty extends to include imposing an obligation on an insurer to make disclosure of material facts such as: where the parties cancel or alter the policy (as it is unlikely that a Third Party Beneficiary would be entitled to the benefit of the s59 notice of cancellation); laub B0110522117v4 150340 18.2.2004 Page 14

where conduct occurs which is relevant to the application of the terms of the contract (eg. the broker's dishonesty); where the insured breaches the terms of the contract. 6. Does s6 of the Law Reform (Miscellaneous Provisions) Act and s51 of the Act operate where the defendant is a Third Party Beneficiary? The recent NSW Supreme Court decision of Aspioti v Leigh & Ors 10 considered whether a plaintiff is able to rely on s6 of the Law Reform (Miscellaneous Provisions) Act 1946 (NSW) (the LR Act) or s51 of the Act to pursue an insurer directly where the plaintiff's claim is against a Third Party Beneficiary, as opposed to an insured. Section 6 of the LR Act relevantly provides: 6(1) If any person (hereinafter in this Part referred to as the "insured") has, whether before or after the commencement of this Act, entered into a contract of insurance by which the person is indemnified against liability to pay any damages or compensation, the amount of the person's liability shall on the happening of the event giving rise to the claim for damages or compensation, and notwithstanding that the amount of such liability may not then have been determined, be a charge on all insurance moneys that are or may become payable in respect of that liability. (4) Every such charge as aforesaid shall be enforceable by way of an action against the insurer in the same way and in the same court as if the action were an action to recover damages or compensation from the insured; and in respect of any such action of the judgment given therein the parties shall, to the extent of the charge, have the same rights and liabilities, and the court shall have the same powers, as if the action were against the insured: provided that, except where the provisions of subsection (2) apply, no such action shall be commenced in any court except with leave of that court. Section 51 of the Act provides: 51(1) Where (a) (b) (c) the insured under a contract of liability insurance is liable in damages to a person (in this section called the "third party"); the insured has died or cannot, after reasonable enquiry, be found; and the contract provides insurance cover in respect of the liability, the third party may recover from the insurer an amount equal to the insurer's liability under the contract in respect of the insured's liability in damages. In Aspioti's case, the plaintiffs sustained injuries when the plane they were travelling in crashed. The pilot, a Mr Collins, was killed in the crash. The plaintiffs brought proceedings against the personal representative of Mr Collins, the owner of the aircraft and the manufacturer of the aircraft. Mr Collins' representative sought indemnity from Australian 10 [2003] NSWSC 1224 laub B0110522117v4 150340 18.2.2004 Page 15

Aviation Underwriting Pool Pty Ltd (AAUP) on the basis that the owner of the aircraft had entered into a contract of insurance with AAUP and Mr Collins was a Third Party Beneficiary under that contract. Ultimately, Hulme J held that the owner of the aircraft did hold a relevant insurance policy from AAUP but that Mr Collins was not covered by that policy. Notwithstanding this finding, Hulme J went on to consider whether the plaintiffs could have had a direct action against AAUP under s6 of the LR Act if Mr Collins' interests had been noted on the policy. Hulme J held that s6 of the LR Act confers rights on persons who have "entered into a contract of insurance". Hulme J held that a Third Party Beneficiary under s48 was not such a person. 11 Similarly, Hulme J considered that it was not possible to regard the references to "insured" in s51 of the Act as intending to encompass third parties to whom cover is expressed to extend pursuant to s48 of the Act. In reaching his decision, Hulme J acknowledged that: It is liable to create or amount to an impediment to actual recovery by someone in the plaintiff's position of any verdict against such third party beneficiaries of a policy. Should the third party not be in a position to meet the verdict, but not disposed himself to sue the insurer, and an insurer be recalcitrant, a plaintiff will presumably be obliged to bankrupt the third party's estate and then induce the trustee of that estate to sue the insurer. Such a result is less than ideal but short of giving to s51 of the Act or s6 of the Law Reform (Miscellaneous Provisions) Act, an operation which the language does not bear is, in my view, inevitable. 7. Review of the Act The Federal Government is currently undertaking a comprehensive review of the Act (the Review). The Review has been divided into 2 stages. The first stage of the Review examined the operation of s54 of the Act and recommendations have been made for the suggested improvement of s54. The second stage of the Review is currently being undertaken and involves an examination of the balance of the Act. As part of that second stage, the Review Panel has called for submissions "at large" to facilitate identification of the issues that require consideration. Submissions received to date by the Review Panel include suggestions that the rights and obligations of Third Party Beneficiaries and, in particular, the operation of s48 be considered. These include: the meaning of the words "same defences in s48(3) should not differ depending on whether one is dealing with policy terms, questions of disclosure or just simply fraud. Section 48 claimants should be treated the same way as the insured and tainted by their conduct 12 ; 11 This is consistent with the earlier decision of GIO Australia Ltd v P Ward Civil Engineering Pty Ltd [2000] NSWSC 371. 12 Submission by the Insurance Council of Australia laub B0110522117v4 150340 18.2.2004 Page 16

s48(3) should be expanded and clarified so as to make it clear that a Third Party Beneficiary should be in no better position to recover under a contract of insurance than a named insured 13 ; consideration should be given to the operation of s48 in cases of fraud by a Third Party Beneficiary 14 ; the "persons" referred to in s48 should be limited to existing beneficiaries at the time the contract is entered into and not to future or possible beneficiaries 15 ; the definition of "insured" in s11 should be extended to make it clear that persons entitled to the protection under the insurance contract (eg Third Party Beneficiaries) are also entitled, where appropriate, to protection under the Act 16 ; the obligations of Third Party Beneficiaries should be more clearly specified in the Act, eg. s48(2) should be amended to clearly state that the duty of disclosure equally applies to named insureds and other beneficiaries under the contract who are not parties to the contract but who are aware that the contract is being entered into by the insured 17 ; s13 of the Act (creating an implied term of a duty of good faith into an insurance contract) should apply Third Party Beneficiaries 18 ; ss 20 and 48 should be consolidated, since they both deal with unnamed beneficiaries under the policy 19. Section 20 states that an insurer is not relieved of liability under an insurance contract by reason only that the names of the person who may benefit are not specified in the policy document; and the rights of subrogation contained in ss65, 66 and 67 of the Act, which currently apply to insureds, should also apply to claims made by Interested Parties, given the rights of such parties contained in s48 to recover 20. The Review Panel has announced that it intends: releasing an issues paper in late February or early March identifying the topics to be considered and seeking more detailed submissions from the public; and giving its final report to the Federal Government at the end of May 2004. 13 Submission by Vero Insurance Limited 14 Submission by Law Council of Australia 15 Submission by Vero Insurance Limited 16 Submission by IEC Ltd 17 Submission by Vero Insurance Limited 18 Submission by Vero Insurance Limited 19 Submission by Vero Insurance Limited 20 Submission by Vero Insurance Limited laub B0110522117v4 150340 18.2.2004 Page 17

8. Conclusion The rights and obligations of a Third Party Beneficiary differ to that of a named insured, in particular: The Act does not impose a pre-contractual duty of disclosure on a Third Party Beneficiary. To the extent that s48(2)(a) of the Act imposes on a Third Party Beneficiary the same obligations as an insured to the insurer, the Act imposes a duty of good faith on the Third Party Beneficiary. However, the obligations imposed under s48(2)(a) are subject to the contract and only apply in relation to a claim by the Third Party Beneficiary. The Act does not impose on an insurer a duty of good faith in relation to a Third Party Beneficiary. However, such duty may be imposed by the common law. Non-disclosure or misrepresentation by a named insured will prejudice a Third Party Beneficiary's claim for indemnity; the insured's non-disclosure or misrepresentation gives rise to a defence for an insurer against a claim by a Third Party Beneficiary under s48(3) of the Act. The law remains uncertain in relation to: whether, and to what extent, post-contractual conduct by the insured can prejudice an innocent Third Party Beneficiary's claim under s48 of the Act; and the existence and scope of an insurer's duty of utmost good faith to a Third Party Beneficiary. Depending upon the recommendations arising from the Federal Government's current review of the Act, the rights and obligations of a Third Party Beneficiary may be clarified and/or expanded in the near future. In the meantime, we suggest that, from the perspective of a potential "insured", it is preferable for the party to be a named insured as opposed to a Third Party Beneficiary because: provided the policy contains relevant cross-liability and non-imputation clauses, it provides greater certainty as to the party's rights and obligations and the party's rights will largely be independent of its co-insured's conduct; the party will be able to take advantage of the benefits provided by the Act to insureds; the party will have rights under the contract and under the Act to receive relevant notices from the insurer. The main disadvantages in being a named insured are: the party will be subject to a duty of disclosure; and there could be an increased premium. Of course, a party can only be a named insured if the insurer is prepared to accept such risk. Despite the greater certainty which arises when a party is a named insured, an insurer may be reluctant to have further parties as named insureds because: laub B0110522117v4 150340 18.2.2004 Page 18

arguably, its exposure is greater given that the conduct of one insured will not necessarily prejudice an innocent insured's right to claim under the policy; and there are increased management issues eg compliance with notification requirements. These disadvantages may be offset by an increased premium. Whether an increase in premium is a commercially viable option for an insurer will depend, to a large extent, upon the state of the insurance market. John Baartz, Luisa Uriarte and Stephen Sanders Allens Arthur Robinson February 2004 This paper is intended only to provide an alert service on matters of concern or interest to readers. It should not be relied upon as advice. Matters differ according to their facts. The law changes. You should seek legal advice on specific fact situations as they arise. Visit our website, www.aar.com.au, for: An electronic, fully-searchable version of this paper; Past papers presented at Allens Arthur Robinson Insurance Forums; The 1999, 2000, 2001, 2002 and 2003 Annual Reviews of Insurance & Reinsurance Law. laub B0110522117v4 150340 18.2.2004 Page 19