Introduction
Under policies of liability insurance, the consent of the insurer is usually required before the insured can do or say anything that could be construed as an admission of liability for the fault insured under the policy. This applies in cases where the insured has an opportunity to settle a claim asserted against it by a third-party claimant. Given that it is the insurer that is ultimately liable to indemnify the insured for this liability, such a requirement is understandable.
What happens, though, when the insurer denies (or reserves its position) that it is liable to indemnify the insured and the insured is then provided with an opportunity to settle the claim? The usual rule is that the insured is required to act as a “prudent uninsured”. What this means is that, until the insurer confirms indemnity, the insured is required to act as prudently with regards to its own interests as it would do where it was uninsured for the liability asserted against it by the third-party claimant.
Negotiating an Insurance Claim without Insurer’s Consent
This state of affairs does not prevent the insured from negotiating with the third-party claimant with a view to settling the claim. It just requires that the insured participate in those negotiations in a prudent way - which usually means that it does not admit liability for the claim. Similarly, where the insured elects to settle the claim, it needs to do so in a way that reflects the risks of the insured being found liable for the claim and at a figure that is commensurate with the value of the claim.
Where, by contrast, an insured agrees to settle a claim for reasons that may have more to do with the insured’s own commercial or reputational reasons than it has with reasons relating to the insured’s legal liability for the claim, the insurer may avoid liability for the claim even if it is subsequently found that the ground on which the insurer initially relied to deny the insured cover under the policy, or to reserve its position with respect to the claim, is unfounded. An example of this occurred in CGU Insurance Ltd v AMP Financial Planning Pty Ltd [2007] HCA 36 (CGU v AMP).
In that case, AMP became aware of possible claims against it by persons who had received inappropriate financial advice from AMP’s representatives. ASIC came to apply pressure to AMP and advised it that its security dealer’s license may be at risk if AMP did not satisfactorily resolve the claims. CGU reserved its position with respect to the claims and advised AMP to act as a prudent uninsured. However, for its own commercial reasons and partly to appease ASIC, AMP took the view that it had a liability towards some of the claimants and proceeded to settle their claims. AMP did this without any of these claimants first making a claim against AMP as the term “claim” was defined under the policy. After the settlements were made, AMP sought indemnity under the policy for the settlements and CGU denied liability.
One of the issues remitted to the High Court was whether AMP had settled the claims against it on reasonable terms. Two members of the majority found that AMP’s settlements with the investors were not reasonable because, on the evidence, AMP was unable to demonstrate that it had a liability to the investors. The other two members of the majority found against AMP on the ground that it had changed the case that it had run on appeal.
Requirement for Settlements to be Reasonable
Because an insurer’s denial of cover will typically force the insured to sue the insurer in court to enforce the insured’s right to be indemnified for the claim, the question of whether the insured’s settlement of the claim was reasonable will often arise in a context where it is unclear whether the insurer was justified in seeking to avoid the policy.
So, recently, in AIG Australia Ltd v Hanna [2024] NSWCA 91 (Hanna), the insured entered into a settlement with a third-party claimant who had been injured by the insured’s negligence. The settlement resulted in judgment being entered against the insured for $430,000 inclusive of costs. Because the insured had misrepresented a fact to the insurer in entering the policy, the insurer sought to avoid the policy on the basis of the misrepresentation and refused to indemnify the insured for the settlement with the result that the judgment was entered without the insurer’s consent. The insured then sued the insurer to enforce its right to be indemnified for the settlement.
The court found that the policy responded to the claim despite the insured’s misrepresentation. However, the insurer argued that it was not liable to indemnify the insured because the insured had failed to prove that:
it was liable for the injury sustained by the third-party claimant in the manner alleged by the third party; and
the settlement was “objectively reasonable”.
The NSW Court of Appeal rejected the insurer’s characterisation of the first issue. In finding that the amount for which the insured had settled the claim was reasonable, the Court referred to the decision of Weir Services Australia Pty Ltd v AXA Corporate Solutions Assurance [2017] NSWSC 259.
In that case, the primary judge had held that an insured can rely on a reasonable settlement to found a claim against an insurer only if four conditions are satisfied:
the insurer has wrongfully repudiated the contract;
the insured accepted that repudiation and brought the contract to an end;
the insured enters into an arrangement with a third-party claimant to pay an amount in respect of a liability to which, if found, the policy would have responded;
the amount of the settlement is reasonable having regard to the relevant circumstances at the time.
Relevant circumstances can include the position in which the insured finds itself as a result of the repudiation and what it might have been held liable to pay if there had been a contest leading to a judgment or arbitral award.
The insurer’s contention in Hanna that the insured had to show that he was liable to the third party in the manner alleged by the third party was wrong and the insurer’s reliance on CGU v AMP for that contention was misplaced. For one thing, the third-party claimants in CGU v AMP had never formalised their claims, let alone commenced proceedings, whereas the third-party claimant in Hanna had initiated court proceedings against the insured. For another, the proper construction of the term “liability” in the policy in Hanna was found to have extended to a liability assumed under a bona fide settlement.
Conclusion
As the court noted in Hanna, the liability that an insured has to a third-party claimant and the liability that the insurer assumes under a policy of liability insurance to indemnify the insured for that liability are different. For that reason, it does not follow that, because an insured in the absence of the insurer’s consent settles a claim with a third-party claimant, that settlement binds the insurer to indemnify the insured for the claim under the policy.
Provided that the policy itself responds to the claim, whether the insurer is so bound will depend on a number of things, including most importantly whether the settlement was reasonable. Whether a settlement is reasonable, however, will typically depend on whether the settlement reflected the risks of the insured being found liable for the claim and at a figure that was commensurate with the value of the claim.
ABOUT THE AUTHOR
Justin is a commercial disputes partner and has practised in the Middle East, the UK and Australia. Justin’s practice focuses mainly on public and professional liability, insurance coverage issues, defamation, property damage and engineering claims. Justin has acted for clients in state and federal court proceedings in Australia as well as in arbitral proceedings under the ICC, LCIA and DIAC rules.
Justin’s clients include insurers and insureds, litigation funders, company directors, professionals and small and medium businesses.
