A recent decision of the NSW Court of Appeal highlights some pitfalls with targeted industry insurance policies where insurers ultimately accept undisclosed risks. Underwriters of an insurance package targeting the adult industry and insuring premises operating as a brothel were found to have accepted the risk that persons operating or frequenting the premises may have affiliations with criminal networks.
Stealth Enterprises Pty Ltd (Stealth) owned and operated a brothel in the ACT under the name 'The Gentlemen's Club'. The premises were damaged by fire in 2012.
At the time of the fire, Stealth was insured by Calliden Insurance Limited (Calliden) through a policy described as a 'Business Pack, Adult Industry Insurance Policy'.
At first instance, Calliden successfully reduced its liability to nil by claiming Stealth had failed to disclose that its sole director and manager were members of the Comancheros bikie gang and that, at the time of renewal, Stealth's registration under the Prostitution Act 1992 (ACT) had lapsed.
Unsatisfied with the result, Stealth appealed.
Issues on appeal
The issues to be decided on appeal were:
- Whether a reasonable person in Stealth's circumstances could have been expected to know that the association with the Comancheros was relevant to Calliden's decision whether to accept the risk by renewing the policy;
- Whether, had that association been disclosed to Calliden, it would have renewed the policy; and
- Whether at the time of renewal, Stealth knew the company's registration as a brothel had lapsed and, if so, had that disclosure been made to Calliden, whether it would have renewed the policy and been on risk at the time the premises was damaged by fire.
The industry specific hypothetical person test – should Stealth have expected the link to criminal organisations to be relevant to Calliden's decision?
The test for disclosure in s 21 of the Insurance Contracts Act 1984 (Cth) is whether a hypothetical reasonable person, in the circumstances of the insured, would know the undisclosed matter would have been relevant to the insurer in deciding whether, and on what terms, to grant insurance.
In determining the circumstances of the hypothetical reasonable insured in this case, the Court considered the "nature of the business conducted by Stealth, the type of insurance sought, the identity of the insurer, the circumstances in which the insurance was entered into and renewed, as well as the fact of the association between the insured's director and general manager and the Comancheros".
The Court found that a reasonable insured could understand that an insurer specialising in the insurance of brothels would expect that people with criminal connections were likely to be involved in the use of the premises. If it was relevant to the insurer to know of any particular association between the insured and any particular criminal activity or organisation, a reasonable insured would expect the proposal to contain questions directed to the subject.
In this instance, the proposal directed specific questions to the claims histories of the insured and the criminal history of its directors. Quite crucially, however, the proposal did not direct any questions to any criminal or other associations of the directors.
The Court therefore found that a hypothetical reasonable brothel owner in Stealth's circumstances would not have been expected to know the association with the Comancheros was relevant to Calliden in renewing the policy, given it did not feature anywhere in the questions asked in the proposal. Rather, the Court saw this as "the sort of association the insurer would expect and take into account as part of the general risk of insuring a brothel".
Failure to disclose lapse of registration
Though the Court found Stealth was aware of the fact its registration as a brothel had lapsed, there was evidence from Stealth that the issue would have been remedied. It was otherwise not established that, had such disclosure been made, Calliden would not have renewed or otherwise insured the premises at the time of the fire.
Calliden was therefore unable to reduce its liability to nil and judgment was awarded in Stealth's favour.
The takeaway message
It is clear from the Court's reasoning that insurers should be aware of inherent risks for targeted policies having regard to the nature of an insured's business. If insurers want to place any weight on these risks, questions need be directed towards the issue in the proposal.
In this instance, had Calliden asked more probing and specific questions in its proposal the outcome might have been quite different.
Post script – further developments?
Just prior to publication, an interesting development arose. On 6 June 2017, Calliden was successful in staying enforcement of the judgment pending determination of Calliden's special leave application. This was in part because Justice Macfarlan accepted that, once paid, Calliden was unlikely to see its money again even if successful.
Further, in granting the stay, his Honour stated Calliden's application for special leave was "strongly arguable" and had a "significant chance of success". His Honour's comments made clear that should the High Court choose to address this question, its judgment is "likely to provide guidance to practitioners in an important area of insurance law and practice".
We'll be keeping a close eye on this one.