Claims made policy sows the seeds of doubt – but not on appeal Claims made policy sows the seeds of doubt – but not on appeal

Claims made policy sows the seeds of doubt – but not on appeal

20 February 2018 | Insurance Issues

Unsuccessful appeal by Insurer against finding of obligation to indemnify water treatment engineering business under professional indemnity policy.

In Issue

  • Interpretation of Professional Indemnity insurance policy.

The Background

Aquagenics Pty Limited (Aquagenics) operated a water treatment engineering business. It had effected a professional indemnity policy, under which the insurers agreed to indemnify Aquagenics for all sums it became:

legally obliged to pay…as a result of any Claim first made against the company…and notified to [Insurers] during the period of the policy arising out of any Wrongful Act committed by [Aquagenics] in the course of [its] professional activities”.

In early 2006, Aquagenics was contracted by Break O’Day Council (the Council) to design, construct, test and commission a wastewater treatment plant. In May 2007, towards the end of the construction process, a dispute arose between Aquagenics and the Council over whether pre-commissioning tests had been carried out as required under the contract. The Council subsequently refused to provide the seed sludge for the establishment of the treatment process. Aquagenics then left the site as it could not proceed without the seed sludge.

The Council completed the remaining work using its own staff and other contractors. The Council expressed its intention in four separate letters between June 2007 and October 2007 to bring a claim for damages/compensation for Aquagenics’ failure to complete the pre-commissioning and the costs of outsourcing the unfinished work. The parties entered into arbitration, which resulted in a determination that Aquagenics was liable to pay $1,346,111.57 in damages to the Council. The damages comprised losses arising from the pre-commissioning failure but also defective aspects of Aquagenics’ design.

Aquagenics had notified its insurers of the claim, however indemnity was denied on the basis that the Council’s claim did not arise from a “Wrongful Act” as defined by the policy and that the sum of the arbitration award extended beyond the “Claim” made by the Council against Aquagenics during its policy period. In June 2017, the Federal Court found that Aquagenics was entitled to indemnity. The Insurer appealed to the Full Federal Court.

The Decision on Appeal         

The appeal was dismissed with costs, with the Full Federal Court rejecting all grounds of appeal. The key questions were:

  • whether the Claim arose from a Wrongful Act
  • whether the Wrongful Act was committed in the course of professional activities
  • whether the Claim engaged an exclusion for  contractually assumed liability.

As to the first issue, the policy relevantly defined a Wrongful Act as an “act, error or omission, misstatement or misrepresentation” or various “unintentional” breaches of duty.

On appeal, the Insurer argued that Wrongful Act did not include intentional acts, errors and omissions and therefore the decision by Aquagenics to leave the site was not a Wrongful Act. However, the Full Court disagreed, affirming the primary judge’s reasoning and emphasising the importance of undertaking a businesslike interpretation taking into account a policy’s commercial purpose. To confine the covered acts, errors and omissions to those that were inadvertent or unintentional was inconsistent with the policy’s commercial purpose and the ordinary meaning of the phrase “act, error or omission”.

The Insurer also disputed whether Aquagenics’ Wrongful Act occurred “in the course of its professional activities”, arguing that Aquagenics’ decision to stop work and leave the site was merely an assertion of a contractual position, rather than an exercise of professional judgment or skill. The Full Court rejected this argument as the relevant Wrongful Act of refusing to take steps under the contract was one committed in the professional activities of a water treatment engineer. Moreover the contract clearly indicated that pre-commissioning and commissioning involved professional skill.

While the Insurers argued that the original Claim did not extend to design costs - as a result of the Claim the pre-commissioning and commissioning work was undertaken by others which lead to defective design being discovered - the design costs were causally connected to the Claim as they were the result of the Claim.

The Insurer’s final ground of appeal concerned the contractually assumed liability exclusion clause in the policy. The Insurer argued that Aquagenics’ liability to the Council arose from its obligation to provide compliant works for a contract price. However, the Full Court affirmed the primary judge’s findings and found that Aquagenics had not assumed any liability beyond what was imposed by general law.  

For these reasons, the Full Court dismissed the Insurer’s appeal and upheld Aquagenics’ entitlement to indemnity.

Implications for you

The decision is a telling example of the risks present for insurers when appealing an adverse finding on a denial of indemnity. It appears that while the Insurers had changed counsel between the first instance and appeal hearings, the arguments raised on appeal were essentially the same as those raised at first instance - with predictable results.

As with the first instance decision, being favourable to insureds, the court construed and imposed a broader scope of cover than initially granted by the Insurer and accommodated the commercial realities of professional liability claims, where additional defects often come to light following the injured party’s original claim.

Certain Underwriters at Lloyd's Subscribing to Contract Number NCP106108663 v Aquagenics Pty Limited (in liquidation) [2018] FCAFC 9 (2 February 2018)

Nick Bell

Nick Bell

Special Counsel