Take care when it comes to policy conditions

Australian Courts have previously made clear that there is a heavy burden of proof and a number of obstacles for an insurer to decline a claim on the basis that the policyholder failed to take precautions to prevent a loss.

A recent decision of the District Court of Western Australia¹ re-affirms this position in the context of an obligation to comply with legislation and Australian Standards, a common requirement of liability insurance policies.

The key takeaways from the decision for policyholders are:

• absolute obligations of compliance can be read down by a Court to a “reasonable care” standard, where to do otherwise would defeat the commercial purpose of the insurance; and
• to show “reasonable care” it is often enough that the policyholder did no more than to avoid recklessness – proving otherwise can be a high bar for the insurer to meet in order to decline a claim.

Condition of compliance in Manitowoq

Manitowoq engaged Boss to perform the fit-out of a restaurant. Boss retained a subcontractor, Millstream to perform plumbing works. The plumbing works were defective and caused significant water damage requiring rectification. Manitowoq commenced proceedings against Boss for breach of contract and negligence.

Millstream’s plumbing work was found not to be compliant with the relevant standards dealing with plumbing and draining. The Court was then required to determine whether Manitowoq’s claim was covered under Boss’ insurance policy with WFI, which:

• contained a condition that Boss “comply with legislation and Australian Standards”; and
• explained that if Boss did not meet that condition, the insurer “may be able to refuse or reduce any claim or cancel [the] policy”.

Davis DCJ found that the insurer was not entitled to refuse indemnity to Manitowoq on the basis of Boss’ failure to comply with the policy conditions.

Policy must be given business efficacy

The Judge confirmed the fundamental principles of interpreting provisions of insurance contracts that (1) the exercise must take into account the context of the specific risks covered and commercial purpose of the policy and (2) the interpretation must give business efficacy to the policy.

These principles are sufficiently powerful to permit a Court to read down a condition to avoid a situation where the purpose of a policy and the indemnity granted by it would be substantially defeated. This is the approach that Courts have also historically taken in the context of obligations to exercise ‘due diligence’ or ‘reasonable precautions’ to avoid a loss in property insurance policies. 

Further, the Judge found that the policy was ambiguous about the consequences of a failure to comply with legislation and Australian Standards. The condition was not expressly stated to be a condition precedent to the policy responding. Instead, the policy provided that a breach of the condition may permit the insurer to reduce or refuse a claim. If the parties had intended that compliance with the relevant clause was an obligation on the insured which overrode the terms of the insuring clause, this had to be made clear.

Accordingly, the Judge held that the requirement to comply with legislation and Australian Standards should be read as a requirement to “take reasonable care to comply with legislation and Australian Standards”.

Only recklessness will suffice

The Judge also held, again by reference to previous authority on due diligence clauses in insurance policies, that where a policyholder is required to take reasonable care it is sufficient that the policyholder does no more than to avoid recklessness. The Judge then made a factual finding, based on the expert evidence, that a reasonably competent builder, having relied upon the representations of Millstream that the works were compliant with relevant standards, would not have been aware of the defects in the plumbing works. Boss was not therefore reckless, had not breached the condition, and the claim was covered.

Endnotes

1. Manitowoq Platinum Pty Ltd & Anor v WFI Insurance Ltd [2017] WADC 32 (17 March 2017)(Davis DCJ).