The NSW Court of Appeal has made a major decision clarifying that where insurers allege fraudulent misrepresentation or non-disclosure, the court must inquire into the subjective state of mind of the maker of the statement.
The Court decided analysis of whether a person’s conduct is careless or reckless from an objective viewpoint is insufficient. In doing so, the Court of Appeal has arguably re-set the bar for fraud in its proper place by correcting the first instance decision which in effect held that honest but careless errors amounted to fraud.
Pulling up short
In 2007, Atradius Credit Insurance N.V. (Atradius) issued a trade credit insurance policy in favour of the appellants, a collection of telco companies including Prepaid Services (PPS). The policy insured against the failure of Bill Express Limited (BXP) to pay amounts due to any of the appellants.
BXP controlled more than 14,000 point-of-sale terminals, where customers could purchase pre-paid phone cards. The company subsequently became insolvent, with alleged debts to the appellants of more than $62 million.
Atradius’ potential exposure was $27 million. However, among other claims, the insurer claimed it was entitled to avoid the policy for fraudulent non-disclosure and misrepresentation, or alternatively was entitled to reduce its liability to nil in the absence of fraud. Atradius asserted that a Mr McQuade, the senior commercial manager of PPS, on behalf of the appellants, made three representations in the insurance proposal form regarding the payment history of BXP. The Supreme Court primary judge found all three answers were wrong and that in two instances McQuade had been recklessly indifferent to the truth, making the representations fraudulent, entitling Atradius to avoid the policy.
The Court of Appeal has re-set the bar to clarify that honest but careless or even reckless errors will not amount to fraud.
If fraud was not established, the appellants asserted that Atradius had sufficient information (BXP’s management accounts as at April 2007) as to the financial position of BXP before it went on risk. The appellants asserted that Atradius was precluded, pursuant to ss 21(2)(c), 21(2)(d) and 27 of the Insurance Contracts Act, from relying on the plaintiff’s answers as Atradius already possessed information providing accurate answers to the questions.
For similar reasons, the appellants contended that Atradius was not entitled to reduce its liability to nil pursuant to s 28(3) of the Act.
Honesty is the best policy
On appeal, the court found the primary judge had misdirected himself as to what was necessary to justify a finding of fraud based upon ‘reckless indifference’. Where the primary judge found McQuade acted recklessly in the way that he checked, printed and signed the proposal form, the Court of Appeal found the primary judge gave no consideration in his reasons to the ultimate question, which was whether McQuade was consciously indifferent to the truth of the answers given.
In addressing that question it would have been necessary for the primary judge to consider McQuade’s intention and state of mind in participating in the completion of the proposal form.
As such, the Court of Appeal found Atradius was not entitled to avoid the policy for fraudulent misrepresentation. Having recognised the mischief that a mere objective assessment of recklessness could amount to fraud (a low threshold), the decision broadens the test to take into account more subjective considerations.
Lessons to be learned
A welcome decision for insureds, as the formulation at first instance could arguably result in honest but careless answers amounting to fraud.
The Court of Appeal has re-set the bar to clarify that honest but careless errors (even if reckless when viewed objectively) will not amount to fraud. Where insurers allege fraudulent misrepresentation or non-disclosure, the court must inquire into the subjective state of mind of the maker of the statement. Analysis of whether a person’s conduct is careless or reckless from an objective viewpoint is insufficient.
Ray Giblett is a partner at Gadens Sydney. Email: firstname.lastname@example.org.
Wendy Blacker is a partner at Gadens Sydney. Email: email@example.com.
William Chapman-Smith is a solicitor at Gadens Sydney.