Dishonesty exclusion in PI policies: further refinement from the NZ Court of Appeal
/Zurich Australian Insurance Ltd v Mark Donald Withers [2016] NZCA 618
Facts
Mr Withers was engaged as an accountant for the Vintage group of companies, which produced and sold wine from Matakana. Vintage was loaned $3 million by the (ironically named) Swindles on the basis that the money lent would be used solely to meet Vintage’s production costs. For each loan, the Swindles required an undertaking from Mr Withers to the effect that the money advanced would be used exclusively for this purpose, and that Mr Withers would be a mandatory joint signatory to the costs account. From the Swindles’ perspective, this would ensure that Withers’ signature was on every cheque drawn on the costs account, such that he could supervise Vintage’s costs and see to it that their money would not be diverted elsewhere.
Despite these undertakings, it turned out that Mr Withers was not a signatory to the Vintage costs account and that the money loaned by the Swindles was applied, not the agreed purpose, but to intercompany loans within the Vintage group. The Swindles were repaid only $380,000 before the company defaulted and was wound up.
The Swindles claimed a net loss of $2.6 million from Mr Withers, arguing that they had relied on his undertakings when advancing the money and would not have advanced it without them. Mr Withers was found liable for misleading and deceptive conduct under the Fair Trading Act and liable for half the losses the Swindles claimed, the other half being attributable to their own contributory negligence.
The Policy
Mr Withers had professional indemnity insurance with Zurich which covered civil liability for any breach of his professional duties, with an automatic extension that expressly included liability under the Fair Trading Act. The policy was subject to a dishonesty exclusion which disentitled Mr Withers to cover “arising out of or connected with any actual or alleged dishonest, fraudulent…act or omission.” The FTA extension was also subject to a proviso which made it clear that there was no cover where the claim arose from dishonest conduct.
The Court's Decision
The High Court found Zurich was liable to indemnify Mr Withers, citing evidence that suggested Mr Withers misunderstood the context of his undertakings, rather than being wilfully dishonest. The Court of Appeal reached a different view. It affirmed that the test for dishonesty involves an inquiry into both subjective and objective elements; the Court is required to measure the insured’s actual conduct and knowledge against an objective moral standard of what constitutes honest conduct by a person having that knowledge.
In terms of his subjective knowledge, it was argued by Mr Withers that he believed himself to be a co- or alternate signatory only, and that he did not understand “mandatory joint signatory” to mean he was required to sign every cheque. This argument, the Court of Appeal held, was “simply not available for an experienced chartered accountant,” and did not believe that a person in his position would be so confused. The evidence showed that he must have known that the Swindles were relying on his undertakings, and that his being a mandatory signatory was a condition precedent to the loan agreements.
Mr Withers also argued that he was not acting dishonestly because he had a longstanding professional relationship with Vintage and felt he could rely on them. So despite the fact that he had not made any inquiries to ensure the Swindles’ funds were directed to the agreed purpose, he honesty assumed they would be. The Court did not accept this; whatever assumptions Withers might have made about his client, he must have understood the undertakings were expressly designed to be personal to him, and knew that the Swindles’ control mechanisms, which he was supposed to oversee, were not in place.
Withers also argued the undertakings were routine, and a “formality” from his point of view as the “financing structure seem to be working.” This, the Court held, constituted a “reckless disregard” of the Swindles’ interest.
The Court of Appeal affirmed the “singular relevance” of professional standards in providing the objective measure of dishonesty. The Court placed considerable weight on a rule in the New Zealand Institute of Chartered Accountants’ Code of Ethics, which provided that members “must not give an undertaking…unless the member has reasonable grounds for believing that the undertaking…will be honoured.” More generally, it had no doubt that a “prudent and honest accountant” would not have provided these undertakings without first ensuring personally that they were correct.
Finally, it was said that the objective inquiry must take into account the degree of trust that the public reposes in professionals. Mr Withers, being a chartered accountant, must be held to a higher standard of honesty than an ordinary person, this being important to maintain public confidence in regulated professions.
Comment
Philippa Fee of Fee Langstone says that the significance of the decision is that “the Court elevated compliance with professional standards to being the most significant factor in determining whether the insured has been honest." While this approach may well be correct when considering a claim arising from a breach of an undertaking, an ethical rule closely aligned to a professional’s obligation of integrity, it may well prove to be a less robust basis for a dishonesty finding when there has been a breach of other professional standards.
If you have any questions or comments about this article, you can contact Philippa Fee via philippa.fee@feelangstone.co.nz, or Elliot Macdonald via elliot.macdonald@feelangstone.co.nz
