Australia: Circumventing the usual allocation of reinsurance proceeds: in the matter of HIH Casualty & General Insurance Limited [2015] NSWSC 923

Insurance Quarterly Newsletter

Winding up – proof and ranking of claims – proceeds of contracts of reinsurance – reinsurance company in liquidation – liquidator sold debts to third party under an assignment agreement – court held s562A(1)of Corporations Act 2001 not applicable – payment under assignment agreement not a payment received by liquidator "under the contract of reinsurance"

The NSW Supreme Court recently considered whether s 562A of the Corporations Act 2001 (Cth) applies to moneys received by a liquidator in exchange for the assignment of debts under a reinsurance contract to a third party.

Black J held the provision did not apply in such circumstances because the relevant payments were received pursuant to an assignment agreement between the liquidator and a third party and not "under the contract of reinsurance."

Show me the money

HIH was an insurance company in liquidation and had outstanding debts under contracts of reinsurance. HIH's liquidators anticipated having difficulty recovering certain of these debts, and so sold them at a discount to a third party under an Assignment Agreement.

Section 562A generally provides that reinsurance payments to an insolvent insurer must first be applied to meet amounts payable under contracts of insurance. Accordingly, if s 562A(1) applied, then pursuant to s 562A(2)-(3) the liquidators would be required to distribute the reinsurance proceeds among the insured creditors.

The Plaintiffs in this case sought an order under s 562A(4) to the effect that s 562A(2)-(3) (the broad pooling provisions) would not apply and the moneys could be applied to specific liabilities.

However, the relevant reinsurance debts had been assigned to a third party under the Assignment Agreement, which provided that the HIH companies would "absolutely assign to the third party all rights, title, benefit and interest in the Debts (as defined)". The assignment was not a novation or assignment of the insurance contracts themselves, but only of the relevant debts. Black J accepted the Plaintiffs' submission that the Assignment Agreement was in the nature of a 'factoring agreement', in that it involved the transfer to a third party of the ability to receive the proceeds of a debt in return for a discounted sum of money.

Was the payment 'under' the reinsurance contract?

The Plaintiffs submitted that the terms of the provision were satisfied as the payment arose 'under' the reinsurance contract, notwithstanding the fact that it arose because of the Assignment Agreement.

In response to this submission, Black J held that s 562A had only been partially satisfied in this case. His Honour said the Plaintiffs were insured under a contract of reinsurance and an amount in respect of the liability insured against was received by the liquidator in respect of that liability. However, the requirement in s 562A(1)(b) that this amount was received "under the contract of reinsurance" was not satisfied. His Honour suggested that the amounts received by the liquidator under the Assignment Agreement were not received "under the contracts of reinsurance", whether that phrase was interpreted in a broad or narrow sense. The receipt of moneys under the Assignment Agreement could be differentiated from those received under the reinsurance contracts on the grounds that:

  1. the sale of the debts at a discount reflected the risk that they were potentially uncollectable;
  2. the assignment was in substitution for receipt of debts under the contracts of insurance; and
  3. the amount paid by the third party was paid irrespective of whether the debts were ever collected by it, and the third party was not required to account to the liquidators for debts that it bought and later recovered.

In holding that s 562A did not apply to this case, Black J summarised his reasoning as follows:

the relevant payment under the Assignment Agreement was made, not under the contract of reinsurance, but in substitution for any payments that the liquidator would have received had it received a payment under the contract of reinsurance. The requirements of s562A(1) are therefore not satisfied and that section does not apply to the relevant payment.

A frustrating result?

The Plaintiffs also argued that a finding that the moneys were paid under the Assignment Agreement and not under the reinsurance contract would frustrate the policy of s 562A, or at least an insured's expectation that they would receive the benefits of payments made under the contracts of reinsurance in the circumstances.

His Honour rejected this submission on the ground that the terms of the section clearly allow for an alteration of priority among insured parties, and that a "general appeal to policy" would only serve to "divert attention" from that fact.

The Plaintiffs' final argument was that a "literal" (or narrow) interpretation of s 562A would allow liquidators to routinely defeat the purpose of the section by assigning debts to third parties. Black J summarily rejected the submission, opining that any liquidator taking such a course would be liable to have their conducted investigated by the court under s 536.

Getting your priorities right

The major takeaway from this case is that reinsurance proceeds, if assigned, may not in fact be quarantined from the normal claims of creditors of insolvent companies and allocated to insurance creditors. If so, the 'proceeds' will be available to the general body of unsecured creditors.

Alternatively, assignment may be a mechanism employed to frustrate the usual priority afforded by s562A. It remains to be seen whether s 536 (allowing the Court or ASIC to intervene if a liquidator is not performing their functions faithfully) provides an adequate safeguard in this respect.

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