NAB v Nautilus Insurance (No 3) - The Conclusion?

While many of us were distracted by the end of the year, the Federal Court ended the dispute between National Australia Bank and its insurers I wrote about in October last year. Well, kind of. It did not decide whether NAB is entitled to indemnity. It was not asked to make that judgment. Instead, it determined the proper construction of two essential terms to NAB’s entitlement. 

National Australia Bank Limited v Nautilus Insurance Pte Ltd (No 3) [2019] FCA 2139 concerned the construction of the terms ‘civil liability’ and ‘loss’ in “Comprehensive Crime/Electronic Crime and Civil Liability Insurance Policies” (Policies) under which NAB was insured. 

Lee J held the proper construction of each term included liabilities incurred as a result of settlement agreements with third-parties without NAB needing to establish an independent liability to the third-party. NAB won this round. However, the judgment left open the question of NAB’s entitlement to indemnity, which may turn on a condition in the policies designed to prohibit NAB from settling third party claims without Nautilus’s consent.

Background

Those of you who read my previous piece on the dispute will remember, NAB claimed indemnity for its losses and liabilities incurred as a result of review and redress programs implemented to address apparent misconduct by its subsidiary, Clydesdale Bank. One of those programs began as a result of an agreement between NAB and Clydesdale, on the one side, and the United Kingdom’s Financial Services Authority on the other.

Over the course of the programs, NAB made substantial redress payments to Clydesdale customers who had made claims. Importantly, for the dispute with its insurer, NAB’s payments were made without the customers’ claims being adjudicated by a court, tribunal or arbitrator.

NAB subsequently sought indemnity under multiple Policies covering the programs’ lives.

This should be sufficient background to understand the decision. For those who want more detail, my previous post is here.

The decision, or why you always need to read the contract

The academic question that many observers may have hoped Lee J would grapple with is whether an insured is entitled to indemnity under a liability insurance policy where they have settled the third party claim without the insurer’s consent. 

This question has been the topic of a number of Insurance Law Journal articles, including one authored by Kirsty Sutherland entitled “An Uneasy Compromise: An Analysis of the Effect of a Settlement Reached by an Insured with a Third Party Claimant vis-a-vis his or her Insurer” (1998) 9 ILJ 1, which Lee J cited.

Sutherland’s article established the ‘Sutherland dichotomy’ (though, she did not use the phrase), which identified two, apparently contradictory, lines of authority. The first of these lines of authority is said to support a view that an insured is entitled to indemnity for reasonable settlements. The second line of authority supports the proposition that an insured must establish their actual liability to the third party, apart from the agreement, before they will be entitled to indemnity.

I have put these two limbs of the Sutherland dichotomy at this level of generality because that is the way in which much of the judgment’s discussion of them is put. In fact, Sutherland’s article contains much more nuance and explanation as to the divergences between the two lines. It does not support a view, advanced by NAB in written submissions, that the insurer is liable to pay a settlement sum if the settlement is reasonable. In fact, as the reinsurers submitted, and Lee J held, this is contrary to the High Court’s authority in The Distillers Co Bio-Chemicals (Aust) Pty Ltd v Ajax Insurance Co Ltd (1973-74) 130 CLR 1.

In Distillers, the majority held that because the insurer had not repudiated the contract, the insurer was prohibited from entering into a settlement without the insurer’s consent. The effect of which was to deny the insured indemnity for such settlements. Thus, while it was not dispositive, Lee J lent support to the general rule that an insured will only be able to claim indemnity for a settlement made without the insurer’s consent if the insurer had first wrongfully denied the insurance contract’s application to the third party claim and thus had repudiated the contract. 

This discussion was ultimately not dispositive of proceeding as the terms could be construed from the contract itself. This reinforces one of the earliest, most basic and most fundamental pieces of advice I received when starting out practising in insurance law: read the contract.

Unlike many of the cases forming the ‘Sutherland dichotomy’ the Policies did not promise indemnity for undefined liabilities. Instead, it promised indemnity for:

(A) Civil Liability arising out of:

(a) The provision by or on behalf of the Assured (or failure to provide) Financial or Professional Services to third parties;

…

(B) the incurring of Defence Costs in relation to any actual or alleged Civil Liability as described in (A) above.

The Policies defined “Civil Liability” to include the uncontroversial limbs of liability determined through judgment. It went on to set out:

“Civil Liability” shall mean:

…

(b) a legally enforceable obligation to a third party for compensation, damages, legal costs or a Restitutionary Order acknowledged (subject always to the provisions of General Condition 2, Notification of Losses or Third Party Claims and General Condition 7, Defence and Defence Costs, clause (c)2)) by an agreement made between the Assured and a Third Party in settlement of a Claim;

…

While the reinsurers argued the use of the word ‘acknowledged’ demonstrated that any settlement agreement must be in relation to a anterior legal liability. Lee J held that a Civil Liability meant a liability created by the settlement agreement itself.

The words in parentheses also provided the reinsurers an argument that it did not include settlements entered into without the insurer’s consent. This was because General Condition 7 provided:

The Assured or their legal representatives shall not:

(1) take any action which is prejudicial to the Underwriters’ interests; or 

(2) without the prior consent of the Underwriters (such consent not to be unreasonably withheld, denied or delayed), admit liability for or settle any third party Claim in excess of the Retention specified in the Schedule.

The reinsurers argued that GC 7 was incorporated into the definition. However, Lee J held that these arguments were more relevant to determining whether NAB is entitled to indemnity, not construction of the Policies’ terms. His Honour stated at [37]:

It seems to me, however, that the bracketed words in GD11(b) do no more than to make it clear that the provision does not negate or override the requirements of General Condition 2 and General Condition 7 in cases where the insured enters into a settlement agreement. Put another way, a Civil Liability can include a legally enforceable obligation to pay a third party by way of a settlement agreement, but this does not affect (is “subject always” to) the operation of General Conditions 2 and 7.

In relation to the definition of ‘Loss’, Lee J held it included a legal liability to pay on entry into a settlement agreement. Obviously, this is also dependent on the operation of GC 7 (and on s41 of the Insurance Contracts Act 1984 (Cth)).

Discretion - the reinsurers’ second bite

This proceeding was not intended to finally determine NAB’s right to indemnity. This formed the basis for the reinsurers’ objection to the proceeding considered in the interlocutory proceeding that was the subject of my earlier post. Despite losing there, the reinsurers attempted to have Lee J exercise his discretion to refuse to grant the declarations NAB sought on the basis that the proceeding was an incomplete adjudication of the dispute. This submission failed again.

However, Lee J held the declarations NAB initially sought were too broad. As a result, he requested a revised form of order confined to the construction issues.

Conclusion - is there one?

It is difficult to find a general principle to extract from this judgment, beyond that which I have already pointed out: it is crucial to read the insurance contract you wish to construe.

More generally, my reading of Sutherland and subsequent articles on an insured’s entitlement to indemnity for settlements makes me wonder if there is, in fact, a dichotomy in the lines of reasoning. The cases cited as support for the proposition that an insured will be indemnified for a reasonable settlement seem to turn on the insurers’ repudiation of the contract. Also, those authorities that support a strict view that an insured will always have to prove an anterior liability seem to turn on the nature of the policy (in particular reinsurance policies) or their specific terms. However, I will have to make that the subject of a future post or article because this one is already too long.