Can we still have faith in prior known circumstances exclusions?

Introduction

In a judgment spanning over 200 pages, the Full Federal Court has overturned the first instance decision in the ongoing dispute between the Uniting Church in Australia Property Trust (NSW) (UCPT) and Allianz Australia Insurance Limited (Allianz). The Court found in favour of Allianz in denying certain professional indemnity insurance claims arising from historical sexual abuse at Knox Grammar School. The key issues in the appeal include the applicability of s 40(3) of the Insurance Contracts Act 1984 (Cth) (ICA) and the operation of prior known circumstances exclusions. The effectiveness of such exclusions is now in doubt subject to any appeal.

Background

Between 31 March 1999 and 31 March 2011, Allianz issued successive professional indemnity insurance policies to the Uniting Church in Australia (UCA). The UCA is an unincorporated association comprising various entities, including the UCPT, which owns and holds property for the UCA in New South Wales. Knox Grammar School (Knox) is one of the institutions under the UCA's umbrella.

From 2007, numerous civil claims were brought by former Knox students or their parents regarding historical sexual and physical abuse by former teachers. The UCPT, acting as a nominal defendant, settled several claims and sought indemnity from Allianz under the policies. Initially, Allianz granted indemnity but later declined further requests from May 2014, asserting that the relevant insureds were aware of facts or circumstances likely to give rise to claims before the inception of the policies due to the LKA2 Report (discussed below). Allianz submitted that none of the insureds gave adequate notification of the circumstances to Allianz under the prior policies. Accordingly s 40(3) of the ICA did not apply on those prior policies, and the new policies did not respond due to the prior known circumstances exclusion and/or non-disclosure. Allianz ultimately did not press the non-disclosure case and relied solely on untimely notification under s 40(3). Alternatively, they were not covered absent the effect of s 40 if no claim was made during those periods.

The decision is based on a complex factual matrix and is highly technical. This case note aims to provide a summary of the key issues on the appeal only. The Full Court comprised Derrington J, and Colvin and McEvoy JJ who constituted the majority.

What was known by the Insured? The LKA2 Report

For the purposes of proving that UCPT had the requisite knowledge of notifiable facts, and failed to notify them to Allianz as soon as reasonably practicable, Allianz had to prove what was relevantly known. At the nucleus its case is the LKA2 Report provided to the headmaster of Knox on 7 May 2004, which was an investigation conducted by Mr Grahame Wilson of LKA Risk Services Pty Ltd. The extensive report included interviews with former headmasters, teachers, staff, and students, revealing a pattern of inappropriate behaviour and systemic issues within the school.

LKA2 contained facts that might give rise to claims beyond the specific allegations against one teacher, Mr Nisbett, in 2002. The report indicated a real risk of potential sexual abuse by multiple other teachers at Knox, including Mr Vance and Mr Fotis. It also revealed a substandard management culture at the school including persistent failure to take appropriate action in relation to information about the possible sexual abuse of students.

Additionally, the Full Court noted that the risk assessment provided by Mr Wilson in LKA2 highlighted the school's exposure to potential claims. The risk assessment prepared by LKA noted the risk to the school was ‘Extreme’.

On appeal, the potential for claims to arise from the facts disclosed in the LKA2 Report was held to be ‘far from benign’, overturning the primary judge’s finding that LKA2 revealed only a ‘bare possibility’ of potential claims. The Full Court held that LKA2 disclosed significant facts that could lead to claims. The LKA2 report revealed “many years of paedophilic conduct by Mr Nisbett and other teachers, the persistent grooming and sexual abuse of boys, and the existence of a school culture where that could occur”. This was sufficient to give rise to notifiable facts for the purposes of s 40 of the ICA.

Attribution of knowledge and timeliness of notification

Although LKA2 contained notifiable facts, in issue was whether these notifiable facts were known by the relevant entity for insurance purposes. At first instance, the primary judge held that the knowledge of Knox's headmaster and school council could not be attributed to the UCPT. The Full Court overturned this decision, finding that the UCPT had the requisite knowledge through these persons.

The UCPT argued that it did not have the requisite knowledge because it was separate from the school and was the entity that simply assumed liability for the school in relation to litigation against the school or the school council. Accordingly, it argued that s 40 should still be available to it because only the school and its council had the relevant knowledge at the time. Derrington J rejected this argument as it would mean that the assumption of liability by a third party could ‘immunise’ the insureds under the policy from their failure to comply with obligations owed to Allianz.

The Full Court undertook an extensive analysis of the circumstances, the UCA’s unique structure and internal policies and procedures.

Derrington J held that knowledge of Knox was sufficient for the purposes of the policy, and that when the UCPT makes a claim under a policy against Allianz on behalf of another insured entity, it is fixed with the knowledge of that entity. His Honour held that the headmaster and school council were integral to the school's operations and that their knowledge constituted knowledge of Knox. Although it was not strictly necessary for Derrington J to make this finding, His Honour held that since the UCPT operated Knox, the knowledge of those conducting its management (being the headmaster and school council) would constitute knowledge of UCPT for the purposes of insurance.

The majority (Colvin and McEvoy JJ) largely came to the same view, but offered an alternative route to attribution. They held that where insurance cover is for liability assumed as a nominal defendant (i.e. the UCPT), awareness of facts that might give rise to a claim includes awareness on the part of the person whose actions might give rise to liability on the part of the nominal defendant. This was because a claimant could proceed against either UCPT or Knox, and whilst the facts will concern Knox, the liabilities of the two are co-extensive and in both instances arise from the legal liability of Knox to the claimant.

The Court ultimately held that both Knox and the UCPT were aware of LKA2 and its contents in 2004, and the failure to notify Allianz ‘as soon as reasonably practicable’ precluded the operation of s 40(3) in 2007 or thereafter. The Full Court noted that the Knox’s awareness of the report's findings, which included serious allegations of sexual misconduct, required prompt notification to Allianz. The insureds’ delay in notifying Allianz of the facts in LKA2 was found to be unreasonable and not in compliance with the requirements of section 40(3).

The prior known circumstances exclusion

Having found that the UCPT had failed to notify Allianz of the LKA2 report in the 2004/05 policy year in accordance with s 40, it was necessary to consider the prior known circumstances exclusion (Exclusion 7(c)).

At this juncture, the majority (Colvin and McEvoy JJ) took a different approach from Derrington J. Justice Derrington considered that the subsequent Allianz policies would not respond due to the prior known circumstances exclusion. In His Honour’s view, that exclusion was enforceable and not void as submitted by the UCPT. The ultimate result being that Allianz’s subsequent policies did not respond.

The majority still came to the same conclusion that the policies did not respond, but on the grounds that the LKA2 report was not notified ‘as soon as reasonably practicable’ within the requirements of section 40(3). The majority found that Exclusion 7(c) was void.

The professional indemnity policies contained a typical ‘prior known circumstances’ exclusion. It applied to ‘any Claim, fact, circumstance or occurrence … of which the Insured is aware before the commencement of the Period of Insurance, which may give rise to a claim’. The UCPT challenged the exclusion on the grounds that it was void because it provided the insurer with an additional remedy for non-disclosure (prohibited by section 33) or purported to exclude, modify or restrict the ICA provisions (prohibited by section 52).

Decision of Derrington J on the exclusion

Derrington J’s view on Exclusion 7(c) was that it was not void on the two grounds proposed by UCPT, being ss 33 and 52 of the ICA respectively.

On section 33, His Honour agreed with the primary judge that section 33 deals with remedies for non-disclosure or misrepresentation which impact the validity of the policy itself only and not rights in respect of the scope of a policy. This is a technical and nuanced view, but His Honour found it was supported given that s 40(3) would have no work to do if s 33 operated to void the exclusion. This is because the policy would always respond to facts subject to the insurer demonstrating non-compliance with the duty of disclosure and the prejudice it has suffered.

On section 52, His Honour concluded that Exclusion 7(c) did not affect the operation of the ICA. In His Honour’s view, Exclusion 7(c) was concerned only with the scope of cover regardless of whether there was any non-disclosure. On this basis, it did not exclude, restrict or modify the operation of the ICA.

Decision of the majority on the exclusion

The majority (Colvin and McEvoy JJ) largely agreed with Derrington J in rejecting the application of section 33 to Exclusion 7(c). However, the majority found for the UCPT on the section 52 argument which relates to ‘contracting out’ of the ICA provisions and ultimately held that Exclusion 7(c) was void.

The majority found that Exclusion 7(c) excluded, restricted, or modified the operation of the ICA to the prejudice of the insured by ‘contracting out’ of the insurer’s usual remedies for non-disclosure. The exclusion, in their view, had the effect of substantially excluding the application of the duty of disclosure provisions to the policy, thereby undermining the statutory protections provided by the ICA.

The majority also relied on the fact that section 40(3) the ICA requires insurers to extend cover to facts that might give rise to a claim if they are notified during the policy period, and Exclusion 7(c) conflicted with this requirement by excluding coverage for known facts, circumstances, or occurrences.

Given this finding of Colvin and McEvoy JJ, the validity of prior known circumstances exclusions are in doubt. Insurers may not be able to confidently rely on such exclusions and the issue is ripe for a special leave application to appeal to the High Court.

Although Exclusion 7(c) was void, it was held that Allianz still rightfully denied the UCPT’s claims because the UCPT had failed to notify the LKA2 report to it as soon as reasonably practicable as required by s 40(3) of the ICA.

Effect of section 54 of the ICA

In an effort to save the claim, the UCPT also argued that s 54 of the ICA should apply to excuse any failure to notify Allianz as soon as practicable, notwithstanding this area of the law is reasonably well settled. Allianz contended that s 54 could not cure a failure to notify under s 40(3) in accordance with precedent.

Applying the decision in Gosford City Council v GIO General Ltd (2003) 56 NSWLR 542, Derrington J affirmed that s 54 could not be used to remedy a failure to comply with the notification requirements of s 40(3). Section 54 is intended to address issues of non-compliance with policy terms, not to extend the statutory notification period.

The conduct of Allianz

Another point of appeal was whether it was open for Allianz to change its mind after it had accepted multiple claims and bulk notifications relating to other third party claimants, and also had knowledge of the LKA2 Report. This line of argument is reminiscent of Allianz Australia Insurance Limited v. Delor Vue Apartments CTS 39788 [2022] HCA 38.

Derrington J noted that, to some extent, Allianz was fixed with the knowledge of the appointed defence counsel, Ms Blacker. However, His Honour held that it was only when Allianz itself received and examined the report in detail that its position changed. His Honour held that although Ms Blacker defended the claims on behalf of UCPT, she did not have an overriding obligation to advise Allianz that the policies may no longer respond. Ms Blacker’s retainer with Allianz was not in evidence and so it is not known whether it required her to inform Allianz if such information came to light.

Furthermore, the Full Court agreed that the UCPT had not made out estoppel, waiver or breaches of the duty of utmost good faith in respect of Allianz’s conduct.

Conclusion

For insurers, it is of significant concern that the majority of the Full Court has found that a fairly typical ‘prior known circumstances’ exclusion is void because it is a ‘contracting out’ from the insurer’s usual remedies for non-disclosure. This has significant ramifications for insurers whose liability under claims made policies may now be increased.

The only remedy remaining to insurers for known matters is non-disclosure, which may be more challenging to prove in some circumstances and requires insurers to show they have been prejudiced under section 28 of the ICA (except in the case of fraud). It is also theoretically possible for facts to not reach the threshold for requiring disclosure under the duty of disclosure, yet could have been subject of a prior known circumstance exclusion.

Policyholders may also be again questioning the utility of ‘continuous cover’ provisions if prior known circumstances exclusions are void, as the purpose of such provisions is to override these exclusions. The recent case of Zurich Australian Insurance Limited v CIMIC Group Limited & Ors [2024] NSWCA 229 is already support for the view that such provisions may be of limited utility to policyholders because insurers can still assert their non-disclosure remedies unless there is very clear language to the contrary.

There may now be a reduced incentive to stay with the same insurer and obtain a ‘continuous cover’ policy feature upon renewal of a claims made policies.

The case also provides some useful guidance on when section 40(3) may be unavailable due to late notification and reaffirms that section 54 is unable to come to the rescue of the insured. It highlights the importance of timely notification of facts that might give rise to claims under claims made insurance policies in order to avail the protection of section 40(3) of the ICA.