1

FORMER DIRECTORS OF TRIO CAPITAL LTD v ACE INSURANCE LTD

MEMORANDUM

1. My instructing solicitors act for GSA Insurance Brokers Pty Limited (GSA).

GSA was the broker involved in the issuing by Ace Insurance Limited (Ace)

of certain Investment Management policies to Astarra Capital Limited in

respect of the period 15 September 2009 to 15 March 2011.1 The cover

provided by the policies includes professional indemnity cover.

2. Astarra Capital Limited, later known as Trio Capital Limited (Trio) carried

on business as a funds manager. However, it failed and has gone into

liquidation. ASIC commenced an investigation into the failure of Trio, and a

number of former directors of Trio made claims (as Insured Persons) under the

policies in respect of their legal expenses. Ace initially provided such cover,

but has recently indicated that, in reliance upon certain admissions made by

Mr Shawn Richard, a former director and senior executive of Trio, of

fraudulent conduct in relation to managed funds, it is declining indemnity

under the policies to Trio and its directors, officers and employees. In so

doing, Ace relies upon on Exclusion 4.1(d) the Prior Known Fact exclusion.

3. Ace contends that Mr Richards dishonest conduct amounts to a Prior Known

Fact as defined in the policies, and, further, that it is entitled to deny indemnity

in respect of any claims where the relevant Loss is one which is directly or

indirectly caused by, or arising out of, or in any way connected with such

conduct. According to Ace, the claims made by ACT Super Management Pty

Limited on 7 March 2011 fall into this category, as will any claims that may

be made in the future which arise from such conduct.

1 The terms of the policies do not differ in any respect which is material to the issues about which I

have been asked to advise.

2

4. GSA has challenged Aces position. It has suggested to Ace that various

former directors of Trio deny all knowledge of Mr Richards activities and so

should get the benefit of General Condition 6.9 (Proposal Disclosure) which

prevents certain information being imputed to Insured Persons. GSA says that

this has the effect of overcoming the Prior Known Fact exclusion.

5. My advice has been sought as to whether reasonable grounds might exist upon

which to challenge the basis of Aces denial of indemnity. I provided my

views on this question in conference on 7 June. In summary, I advised that

Aces position on the policy construction issue was stronger than that

advanced by GSA. However, there may be a reasonable argument available to

the effect that the Prior Known Fact exclusion is in substance concerned with

failures by the insured to disclose matters prior to the contract being entered

into, and hence cannot operate to exclude indemnity because to do so would

be to provide a remedy in respect of such a failure which stands outside the

exclusive code found within Division 3 of Part IV of the Insurance Contracts

Act (the Act).

6. The purpose of this Memorandum is to briefly set out the reasons for that

advice. Before doing so, I set out below the salient provisions of the policies.

7. Insuring clause 1.3 relevantly provides that Ace will pay to or on behalf of the

Insured all Loss arising from any Claim2 first made against the Insured in the

Policy Period for Wrongful Acts3 of the Insured .. while performing or

failing to perform Investment Services.4

8. I note in passing that the demands made on behalf of ACT Super Management

on 7 March 2011 seem to constitute Claims which satisfy the requirements of

insuring clause 1.3, and Ace has apparently treated them as such.

2 Any Claim must be for a Wrongful Act or series of related or continuing Wrongful Acts.

3 Wrongful Act is defined in clause 3.49.

4 Investment Services is defined in clause 3.22.

3

9. Exclusion 4.1(d) provides that Ace will not pay for any Loss directly or

indirectly caused by, arising out of or in any way connected with any Prior

Known Fact.

10. Prior Known Fact is relevantly defined to mean any fact which:

(a) an Insured was aware of after the Continuity Date [15.3.08] but prior to the

commencement of the Policy Period [15.9.09], and

(b) the Insured knew, or a reasonable Insured would have considered, at any

time after the Continuity Date but prior to the commencement of the

Policy Period

might result in an allegation against an Insured of a Wrongful Act or might

result in an Investigation.

11. The Prior Known Fact exclusion must be read in the light of Extension clause

2.8 (Continuous Cover), which relevantly provides: Notwithstanding

Exclusion 4.1(d) Prior Matters ..Ace will pay Loss for any

Claim first made against the Insured during the Policy Period..arising

from a Prior Known fact provided that:

(a) the Claim would be covered under this Policy but for the operation of

Exclusion 4.1(d) Prior Matters; and

(b) the Insured has maintained without interruption Investment Management

Insurance with Ace or another insurer from the Continuity Date up until

the date this Policy commenced; and

(c) the Insured would have been indemnified under such policy in force at the

relevant time if the Prior Known Fact had been notified to the applicable

insurer when the Insured first became aware of it; and

4

(d) neither the Claim nor the Prior Known Fact has been notified to Ace or to

any other insurer under any other policy; and

(e) there has been no fraudulent non-disclosure or fraudulent

misrepresentation to Ace in respect to such Prior Known Fact; and

(f) cover under this Extension will be in accordance with the terms,

conditions, exclusions and limitations. of the policy in force at the

time the Insured first became aware of the Prior Known Fact, but only

where such earlier policy affords no broader cover in respect of the Claim

than the provisions of this Policy.

12. Ace has asserted that this Extension does not apply because each of the

provisos of the extension are not satisfied. This may well be correct, but it

seems to me that this is an issue which needs to be considered further in the

light of details of any relevant cover which was in place during the period 15

March 2008 to 15 September 2009.5

13. Leaving that matter aside, and assuming that Mr Richard had the knowledge

described in Aces letters of 13 April 2011 by which they decline indemnity,

there seems little doubt that an Insured (being Mr Richard) was aware of facts

after 15 March 2008 but prior to 15 September 2009 which might give rise to

an allegation of a Wrongful Act against an Insured, and a reasonable Insured

would have considered at any time after 15 March 2008 but prior to 15

September 2009 that such facts might give rise to an allegation of a Wrongful

Act against an Insured. Accordingly, it seems that the definition of Prior

Known Fact is satisfied in relation to Mr Richards knowledge of such facts.6

5 There are some difficult construction issues involved with this provision, including what is meant by

the expression when the Insured first became aware of it in paragraph (c) see also the expression the policy in force at the time the Insured first became aware of the Prior Known Fact in paragraph (f). 6 Mr Richards acquired knowledge of at least some of those facts before 15 March 2008. However, I

think that paragraph (a) of the definition is unlikely to be read as requiring that the relevant Insured

only become aware of the facts after 15 March 2008. It is enough if the Insured was aware of the facts

at some time during the period 15 March 2008 to 15 September 2009.

5

14. It would follow that, subject to the possible effect of other provisions of the

policy, exclusion 4.1(d) would operate so that Ace would not be bound to

indemnify in respect of any Loss which arises out of or is connected with any

such Prior Known Fact.

15. I think it is unlikely that General Condition 6.9 would operate to bring about a

different result. That condition deals with a number of matters in relation to

the proposal. It states that the declarations and statements in the proposal have

been relied upon by Ace, are the basis of the coverage provided by the policy

and are incorporated in and form part of the policy. It then goes on to state that

the proposal is to be construed as a separate proposal by each of the Insureds

and that with respect to statements made and particulars provided in the

Proposal no statements or particulars and no information possessed by an

Insured Person shall be imputed to any other Insured Persons, and only certain

statements or knowledge is imputed to the Insured Organisation.

16. I am instructed that the relevant proposal was signed by the then managing

director of Astarra Capital Limited (not Mr Richard). Question 13(b) asked

whether the Applicant, or any director, officer or employee was aware, after

enquiry, of any fact, circumstance, act or omission which may give rise to a

claim. The answer given was No. So, at least in so far as the proposal was

construed in accordance with General Condition 6.9 as a separate proposal by

Mr Richard as an Insured, the statement in answer to the question 13(b) would

be regarded as a misrepresentation. General Condition 6.9 then provides that

neither such statement nor any information possessed by Mr Richard would be

imputed to any other Insured Person.

17. However, the operation of exclusion 4.1(d), which concerns knowledge, does

not require any knowledge to be imputed to an Insured. In its terms, exclusion

4.1(d) requires that an Insured must be aware of a certain fact which might

result in an allegation against an Insured of a Wrongful Act (or an

Investigation), and either the Insured must know or a reasonable Insured

would have considered that such fact might result in an allegation against an

Insured of a Wrongful Act (or an Investigation).

6

18. It is of course necessary for the exclusion to be read in the context of the

policy as a whole (see Selected Seeds Pty Limited v QBEMM Pty Limited

(2010) 85 ALJR 1 at [29] & [34]). However, bearing in mind that the

exclusion and General Condition 6.9 perform somewhat different functions it

seems unlikely that exclusion 4.1(d) would be held to have no application to

innocent directors merely because the knowledge of Mr Richard (which is the

subject of the Prior Known Fact and could have been disclosed on the

proposal in answer to question 13(b)) cannot, by reason of General Condition

6.9, be imputed to them.

19. In order to counter Aces reliance upon exclusion 4.1(d) an argument could be

raised to the effect that the exclusion, viewed as a matter of substance,

operates in relation to matters which the insured was under a duty to disclose

prior to the making of the contract of insurance (see s21 of the Act) and

provides a remedy in respect of a failure to so disclose which goes beyond

the remedies provided in the Act, thereby infringing s 33 of the Act.

20. Section 33 provides that the provisions of Div 3 of Part IV are exclusive of

any right that the insurer has otherwise than under the Act in respect of a

failure of the insured to disclose a matter to the insurer before the contract was

entered into. (It should also be noted that by s52 of the Act a provision is

void if it would have the effect of restricting or modifying, to the prejudice of

a person other than the insurer, the operation of the Act.)

21. I am not aware of any cases in which it has been held that a provision of a

contract of insurance governed by the Act purports to give remedies wider

than those given to insurers under Div 3 of Part IV. However, the argument

has been put in relation to provisions similar to exclusion 4.1(d), and such

arguments have not been dismissed.

22. In Permanent Trustee Australia Limited v FAI General Insurance

Company Limited (1998) 153 ALR 529 the argument was put in relation to a

limitation on retroactive cover. The policy provided for unlimited retroactive

7

liability omitting claims or circumstances which are known to the insured

prior to the inception of this insurance. Hodgson CJ in Eq at 568 held that as

a matter of construction the provision only applied where the insured knows

the circumstances as circumstances which might give rise to a claim. On the

facts the provision did not apply but at 589 his Honour stated: If the

retroactive clause had the effect of excluding liability for something which

was in substance a non-disclosure, then I think s33 would in any event prevent

the retroactive clause excluding liability.

23. It is not known whether the earlier case of Pech v Tilgals (1994) 94 ATC

4206 was cited to Hodgson CJ in Eq. In that case, Dunford J took a different

approach in relation to a provision which excluded claims arising from any

circumstances of which the insured was aware prior to the commencement of

the insurance and which a reasonable accountant in the insureds position

would at any time prior to the commencement of cover have considered may

give rise to a claim. His Honour held that the exclusion did not apply on the

facts, but went on to state that the exclusion was not void under s52 for

modifying the operation of the Act relevant to non-disclosure because it was

not concerned with non-disclosure and the claims specified are excluded

whether the circumstances are disclosed or not so the remedies in s28 are

not excluded or modified.

24. The above cases were referred to by Conti J in Permanent Custodians

Limited v ARMA Pty Limited (2006) 14 ANZ Ins Cas 61-707 at 75,636-7 in

relation to an exclusion which excluded claims arising from circumstances of

which the insured was aware prior to the Insurance Period and which the

insured or a person in the insureds position ought reasonably to have realised

to be circumstances which might result in a claim. On appeal, in Macquarie

Underwriting Pty Limited v Permanent Custodians Limited [2007]

FCAFC 60 Allsop and Buchanan JJ at [28] stated that the contention of the

insured that the exclusion was in substance a non-disclosure provision which

offended s33 of the Act was arguable. They went on to note that insurers of

claims made policies often attempted to identify the notification of a claim

within the policy period as an essential attribute of the cover, rather than a

8

contractual condition of the policy regulating the conduct of the insured. Some

similarity with the case before them was discerned, where the insurers by the

exclusion were attempting to exclude from cover matters which would

otherwise be disclosable. Their Honours said: The aim may readily be seen to

be definitional, but it is arguable that s33 is engaged.

25. This issue is without doubt difficult. It plainly raises important issues,

touching as it does upon the ability of liability insurers, in contracts governed

by the Act, to restrict the extent to which retroactive cover is given (that is,

cover for claims which arise from acts which occur before the making of the

contract). Nonetheless, as matters currently stand, the point must be regarded

as reasonably arguable.

26. Of course, even if exclusion 4.1(d) was not available to Ace in this case, it

may well be able to rely, as against innocent directors, upon failures by the

insured to comply with the duty of disclosure. Even if no fraudulent non-

disclosure was established Ace would be in a very strong position to contend

that had Mr Richards activities been disclosed it would have either declined

to give any cover at all, or imposed a specific exclusion, such that any liability

it would otherwise have for claims arising out of such conduct should be

reduced to nil (see s28(3) of the Act). The question whether such defences

would be available as against innocent directors is beyond the scope of that

which I have been asked to consider, but I note that it may depend upon

whether they are regarded as parties to the contract (or merely persons with

rights under s48 of the Act7), and upon the effect of General Condition 6.9.

10 June 2011

Chambers RJH DARKE SC

Liability limited by a scheme approved under Professional Standards Legislation

7 See CE Heath Casualty & General Insurance Limited v Grey (1993) 32 NSWLR 25.

9