Insurers win on failure to notify and professional services exclusion in D&O policy

Legal Directions

DIF III – Global Co-Investment Fund LP v Babcock & Brown International Pty Limited [2019] NSWSC 527

Babcock and Brown (B&B) was a specialist investment and advisory firm. B&B’s business included funds management carried on through a subsidiary (the Manager).

The business of the Manager involved managing the investments of a number of Funds, including the DIF III Fund invested in by the first plaintiff (the Partnership). The Manager made decisions or recommendations on how the Partnership’s funds were to be invested and delegated investment recommendations to the members of its Investment Committee.

The Investment Committee comprised five individuals, two of whom were directors of a number of B&B entities, two of whom were part of the Manager’s management and one who was an independent non-executive director of the Manager.

The Partnership’s funds for investment in the DIF III Fund were received from external investors and B&B entities. The second plaintiff (the General Partner of the Partnership) had responsibility for the management of the Partnership’s affairs. The Investment Committee made investment recommendations to the General Partner.

In November 2007, the Investment Committee recommended to the General Partner that the Partnership invest $25 million in ‘Coinmach’ on behalf of DIF III Fund and it did so. Coinmach was an automated laundry business in the United States. In 2009, the Partnership’s investment in Coinmach was worthless.

The Plaintiffs sought to recover the initial investment of $25 million, associated costs and interest from November 2007. The total claim was approximately $80 million plus legal costs. The Plaintiffs brought various claims for breach of fiduciary duty, breach of common law duty of care, breach of contract and misleading and deceptive conduct. The Court ultimately found that the evidence did not reflect the allegations made by the Plaintiffs and they were wholly unsuccessful.

By cross claims, the Investment Committee members sought indemnity from the D&O insurers for any liability they might have to the Plaintiffs as well as defence costs. The D&O insurers declined indemnity and argued that:

  1. the claims in respect of which indemnity was sought did not arise out of the notice of circumstances relied on by the Insureds, and
  2. the professional services exclusion applied. Other denial grounds were also relied on.

The Investment Committee members also sought indemnity from B&B’s PI insurers by cross claims. The PI Insurers also declined indemnity on the notification point and also relevantly argued that a directorial acts exclusion and a conflict of interest exclusion applied. The plaintiffs also made a third party claim directly against the PI insurers, joining them as defendants to the proceeding in respect of the Manager’s liability (the Manager did not defend the proceedings).

Notification

The Insureds relied upon a notification to each of the D&O and PI insurers of a potential claim by another investor (BBGP), which also made an investment in Coinmach through the BBGP Fund, based on an investment recommendation from a different investment committee and different manager (albeit a B&B entity too). The relevant question was whether the claim that was made by the Plaintiffs (who were not investors in the BBGP Fund) arose out of the circumstances that were notified.

There was no suggestion in the notification to insurers that the Plaintiffs in this proceeding might make a claim or that such claim might arise out of the conduct of the members of the Manager’s Investment Committee for the purposes of DIF III Fund. The fact that the Coinmach investment performed badly was not of itself a reason for concluding that the Plaintiffs would make a claim against the Manager or its Investment Committee members.

Justice Ball concluded that there was not a sufficient connection between the notification and the Plaintiffs’ claim. The difficulty was that what was notified was a potential claim by BBGP, not by the Plaintiffs, and BBGP’s claim depended on the relationship and conduct between BBGP and those against whom that claim might be brought (not the defendants in this proceeding). On the other hand, the claims in this case depended on the relationship and conduct between the Plaintiffs and a different group of potential defendants.

Justice Ball held that it could not reasonably be expected that the Plaintiffs would bring a claim based on the way in which their investment was recommended / managed because there were circumstances that suggested some other entity might bring a claim because of the way its investment in the same entity (Coinmach) was recommended / made by another entity. For that reason alone, all the claims against the D&O insurers and the PI insurers failed.

Section 54 of the Insurance Contracts Act 1984 (Cth) did not operate to assist the Insureds in relation to:

  • the PI policy because the Insureds did not adduce any evidence of knowledge during the policy period of circumstances that might give rise to the Plaintiffs’ claim (as the relevant term in the PI policy required) and therefore, section 54 did not assist to back or late notify the Plaintiffs’ claim; and
  • the D&O policy because the claim that was made simply did not arise out of the circumstances notified. Due to the way the notification provision was drafted in the D&O policy, the Insured’s awareness of circumstances was not a relevant factor for the purpose of section 54.

Professional services

The D&O policy contained the following exclusion:

‘The Insurer shall not be liable to make any payment under this policy in connection with any Claim arising out of, based upon or attributable to … the provision of third party professional services of any kind.’

The Insureds argued that this exclusion did not apply because the relevant services were not ‘third party … services’ and were not ‘professional services’.

As to the former, the Insureds submitted that the services provided by the Investment Committee members were provided to the Manager, not the Plaintiffs, and that the Manager was not a third party. Justice Ball rejected this submission and held that the services were provided by the Investment Committee members, by way of a delegation from the Manager, directly to the General Partner on behalf of the Partnership and it was plainly a ‘third party’ in that context.

As to the latter, the Insureds relied on the decision in Chubb Insurance Company of Australia Ltd v Robinson [2016] FCAFC 17 at [150] for the proposition that the Professional Services exclusion in this D&O policy had no operation. There was a debate about whether the investment recommendation was a professional service. The Insureds claimed that the Investment Committee members were not involved in the provision of professional services because the recommendation did not fall within a vocational discipline which is generally regarded as a profession.

Justice Ball rejected the Insured’s submission. He found the decisions in 470 St Kilda Road v Robinson and Chubb v Robinson to be of limited assistance to the facts of this matter. He distinguished between the expression of ‘professional services’ when used in a professional indemnity policy as part of the description of cover and that of an exclusion clause in a D&O policy as in the present case. Justice Ball noted that courts frequently give the expression a broader meaning in the former context than they do in the latter, and commented that the St Kilda Road decisions were examples of that general approach. However, Justice Ball found the investment recommendation to be professional in nature and held that the Professional Services exclusion would have no other operation if it did not apply to such a recommendation.

Justice Ball concluded that:

  • It is to be expected that the professional services exclusion would have some operation so as to reduce the degree of overlap between the cover provided by the D&O policy and the cover under a professional indemnity policy
  • The task of evaluating particular investments and making recommendations to, or decisions for, others on those investments involved the application of skill and judgment of a professional nature
  • As the exclusion applied to professional services of ‘any kind’, it is difficult to see that it would have any application at all if it did not apply to the types of services the Investment Committee performed.

PI insurers’ exclusions

While succeeding on notification, the PI insurers failed on:

  • The directorial acts exclusion – the acts the Investment Committee members in approving the investment could not be described as ‘acts of directors of the Manager’ in that capacity. They were acting as Investment Committee members under a delegation.
  • The conflicts exclusion – the required causal connection for this exclusion was not established.Although the Insureds sought cover under two separate towers of insurance, they ultimately fell between two stools by reason of the notification point. It cannot be assumed by an Insured that one or other of the programs of insurance will apply. If the notification point had been resolved in favour of the Insureds, then they would have succeeded against the PI insurers but not the D&O insurers.

Conclusion

Although the Insureds sought cover under two separate towers of insurance, they ultimately fell between two stools by reason of the notification point. It cannot be assumed by an Insured that one or other of the programs of insurance will apply. If the notification point had been resolved in favour of the Insureds, then they would have succeeded against the PI insurers but not the D&O insurers.

It should not be assumed that 470 St Kilda Road will apply to every D&O policy that contains a professional services exclusion. The application of 470 St Kilda Road is fact-dependent.

Further information / assistance regarding the issues raised in this article is available from the authors, Peter Tredinnick and Michael Polorotoff, Partners, and Rebecca McIntyre, Associate, or your usual contact at Moray & Agnew.


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