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Striving for Equilibrium: A Critical Analysis of Section 54 of The Australian Insurance Contracts Act

Authors: Kate Lewins BJuris, LLB, LLM
Lecturer, Murdoch University School of Law
Simon Lo BCom, LLB(Hons)
Solicitor
Issue: Volume 10, Number 2 (June 2003)

Contents:

    Introduction: The art of balancing interests in insurance law

    'Balance is no place
    is a becoming,
    a lovely tension
    between holding on
    and letting go
    risk and safety
    up and down.
    Edward D. Depew III [1]

    Insurance in society

  1. Insurance is an 'ambiguous phenomenon.'[2] When compared to our grocery or water bills where money is paid in return for something tangible, insurance is intangible. 'What is purchased is neither goods nor services, but a set of promises by the insurer which the insured hopes never to have to enforce.'[3]

  2. Historically, insurance was a means of guarding against basic and individual risks, such as the loss of a ship or the outbreak of a fire.[4] Over time, it has grown into a set of intricate arrangements, facilitating business dealings and 'harmonious social existence.'[5]

  3. Insurance is a commercial transaction[6] which involves sharing risks with others.[7] The insured pays the insurer a premium as consideration for the insurer accepting the risk. The insurer, in return, agrees to pay the insured for any loss suffered if the risk eventuates.[8] Insurers will group various prospective insureds into risk categories which attract progressively higher premiums as the categories move from low risk to high risk.[9]

  4. The insured's premiums are often invested in stocks, bonds, mortgages, government securities and other income-producing enterprises. The insurer uses the collected premiums and income earned from investing the premiums to compensate the insureds who suffer losses.[10]

  5. Insurers play a pivotal role in the financial system as a whole.[11] They contribute to a country's economic stability by compensating individuals and businesses for financial losses and liabilities that might otherwise ruin them.[12] Insurance companies also help to increase the production of goods and services by allowing entrepreneurs to reduce the risks of starting a new business or acquiring a property.[13] There are obvious benefits from having a healthy insurance sector and therefore it is vital that the legislative environment is conducive to insurers. However it is also important that insureds have access to insurance policies that provide effective cover in the event of a claim, with limited and clearly delineated circumstances where an insurer may deny indemnity.

    Insurers and insureds under the microscope

  6. The insurer and the insured are the two principal parties to an insurance contract. An insurer has interests to protect before the contract is entered into, during the period of cover and after a loss has occurred.[14] In the pre-contractual stage, the insurer has an interest in ensuring that all relevant facts are disclosed.[15] Once the contract is on foot, the insurer seeks to prevent the risk which they have assessed and accepted from increasing.[16] When a loss occurs, insurers want to be certain that they can properly investigate and assess a claim.[17] They achieve these objectives by drafting specific clauses and incorporating them into the insurance contract. These include clauses requiring disclosure, terms imposing certain obligations on the insured and terms which exclude claims that arise or are caused by a particular risk.[18]

  7. With a constant demand for insurance cover in today's society,[19] it can be argued that the insurers and the insureds do not possess equal bargaining power.[20] The insureds, similar to the tenant in a landlord-tenant scenario, are vulnerable to any potential rise in premiums or an insurer's refusal to accept cover. The insurer may, through the medium of an insurance contract, often impose terms which are unfair to the insured.[21] By paying insurance premiums, the insureds expect to be compensated financially for losses which they may incur as a result of a future uncertain event. The traditional legal environment did not, however, function properly in protecting those expectations. Insurers could, for example, refuse to pay under the policy, even where the breach by the insured had not caused or contributed to the loss.

    Legislative intervention: section 54

  8. Compared to other common law countries, Australia is unique in that it has a comprehensive legislative regime covering non-marine general insurance.[22] The Insurance Contracts Act 1984 (Cth) ('the ICA') is a remedial statute which was designed to reform the pre-existing law of insurance.[23] It radically altered the law of insurance in many ways.[24] According to the Australian Law Reform Commission (the 'ALRC'), a central problem of the pre-existing law was that insurers were allowed to avoid a contract whenever the insured had failed to disclose a material fact during the policy period.[25] It was suggested that;

    '[there was a] 'disproportion' between the loss to the insured where the insurance contract was avoided...and the prejudice to the insurer occasioned by the non-disclosure.'[26]

  9. As a result of the ALRC's report on insurance contracts, section 54 was drafted to address that disproportion.[27] It has broken new ground in traditional insurance law by limiting the insurer's ability to avoid the contract where there has been a breach of or non-compliance with a term. The section imposes upon an insurer a prima facie liability to indemnify an insured under every policy to which the Act applies.[28] It alters the operation of provisions of an insurance contract, reducing the circumstances in which the insurer can deny a claim because of the insured's conduct after the contract is entered into. Whilst this could be seen as a major swing in favour of the insured, the second limb of section 54 ('the prejudice limb') has sought to limit this effect. The prejudice limb allows the insurer to reduce its liability when the insured's action or omission has adversely affected the insurer's interests. Although section 54 is 'reformatory,' it does not intend to favour a particular party at the expense of the other.[29]

  10. The operation of section 54, however, has had a controversial history. Compared to other countries, such as the United Kingdom, Australian courts have appeared to be more judicially active and creative in their role in administering the law to the facts.[30] Whilst judicial activism has its advantages in allowing the law to adapt to the ever-changing society, recent decisions concerning section 54 have raised concerns. Examples to be considered in this paper are the court's decisions regarding the applicability of section 54 in cases where the insurance policy requires the insured to give notice of a claim or an occurrence[31] and the insurer's ability to reduce the insured's claim to nil in offsetting the prejudice suffered.[32] As will be discussed below, some of the decisions regarding section 54 have tended to thwart the aim of the ALRC in reforming the insurance legal environment.[33]

  11. Since the ICA has been in operation for over a decade, a review of section 54 in light of recent case law is timely.[34] This paper will investigate the mechanics of what is arguably the Act's most controversial and difficult section. It will provide an insight into the treatment of the interests of the insurer, insured and 'other parties' where there has been a breach of or non-compliance with a term of an insurance policy. It will examine the strengths and weaknesses of the section, especially regarding the issues of 'claims' policies and the notion of prejudice.[35] Other countries such as the United States and New Zealand will also be considered to illustrate how they deal with these issues. Reference will also be made to recent marine insurance reforms which have considered using the words of section 54 in amending the Marine Insurance Act 1909 (Cth). This paper will conclude by making suggestions for improving the overall operation of section 54 in balancing the competing interests of the insurer and the insured.

    The basic features of an insurance contract

  12. An insurance policy contains the details of the contractual arrangement between the relevant parties. It records the nature and extent of the cover, the exclusions from cover and the obligations which are imposed on both the insurer and the insured during the term of the contract.[36] A brief examination of terms that define and limit the insurer's liability to the insured under the policy is necessary to understand the motivation behind section 54.

    Armour for the insurer

  13. There are two periods which are crucial to the insurer in an insurance arrangement. Prior to entering into the contract, the insurer has an interest in ensuring that the insured has disclosed and properly represented all material facts.[37] During the policy period, the great significance to the insurer is in making sure that their risk remains static.[38] It is the latter period which is pertinent to the operation of section 54. Thus, sections of the ICA that deal with the issue of pre-contractual nondisclosure are outside the scope of this paper.[39]

  14. Insurers employ various drafting techniques to protect themselves against a change in risk during the policy period. They may include:

    A comprehensive motor vehicle insurance policy[40] will be used as a hypothetical example in explaining these clauses.

    Ambit of cover clauses

  15. An ambit of cover clause is a term commonly used in an insurance contract.[41] The insurer often uses such a clause to outline their obligation to indemnify the insured where there is a loss.[42] They specifically describe the risk that the insurer will agree to underwrite. An example of such a term may be,

    This policy will indemnify an insured for loss arising from the insured's use of the vehicle on a public road.[43]

  16. The clause covers an insured for using the vehicle on a public road. The insured is not therefore covered for any damage sustained where the vehicle was used on a rally racetrack or on private property such as the insured's own driveway.[44] The damage must also arise out of using 'the vehicle' specified under the policy, not, for instance, some other vehicle the insured may have been driving at the time.

  17. Ideally, insurers want to limit the likelihood of a claim arising during the policy period. Nevertheless, events may occur that alter the risk originally agreed upon between the parties. Some events may have no effect on the cover or other events may be foreseeable as incidental to the risk.[45] For instance, the fitting of wider wheels to a motor vehicle is an act which may have caused minor alterations to the risk, but are nevertheless insufficient to take the risk outside the policy cover.[46] In the context of life insurance, the fact that the insured's health will inevitably deteriorate is a foreseeable risk factor which the insurer would consider when issuing the policy.[47]

  18. In some cases, however, the risk may be altered in a way that affects the cover or may not be foreseeable as incidental to the risk. An example is a marine policy which covers the risks associated with a particular voyage. Where there has been a change of voyage, the risks are likely to be different. In that case, as a matter of law, the insurer will not be liable.[48]

    Exclusion clauses

  19. Whilst an ambit of cover clause is used to describe the risk and broadly establish liability, it is common for insurers to incorporate specific exclusion clauses in their contracts to restrict the boundary of cover.[49] Many such exclusions are aimed at avoiding liability for loss caused by an alteration in the risk during the period of cover.[50] It could be worded as a causal exclusion clause which excludes liability resulting from specific causes.[51]

    This policy excludes cover for loss caused by using the vehicle in 'either practising for or taking part in any race, time trial, rally, sprint or drag race, or similar motor sport event, demonstration, or test.'[52]

    The policy excludes cover for loss resulting from the use of the car in, for example, a drag race. Alternatively, the insurer could reword the same exclusion clause as;

    This policy excludes cover for loss occurring whilst the vehicle is 'either practising for or taking part in any race, time trial, rally, sprint or drag race, or similar motor sport event, demonstration, or test.'[53]

  20. This is an example of a temporal exclusion clause which will not cover a loss where a particular set of circumstances exists. It excludes cover for loss whenever the insured uses the car in a drag race, even where the use of the car in that manner did not cause the loss. For example, consider a racetrack surrounded by gum nut trees. If by pure chance, a gum nut drops, hits and cracks the insured's windscreen, the insurer could argue that insured will not be able to claim from its insurance policy, since it was using the car in a race.

  21. Compared to a causal exclusion, therefore, a temporal exclusion clause has wider and harsher implications for an insured. On the other hand, it provides better protection for an insurer against an increase in risk. It excludes liability for a loss caused whilst the relevant circumstances exist, whether or not those circumstances are the cause of a particular loss.[54]

    Terms imposing obligations

  22. To further protect itself, the insurer may also incorporate a term which imposes an obligation on the insured or creates a condition precedent to liability. Warranties are terms which an insurer may use to protect itself against an increase in the risk during the period of cover.[55] A warranty, in the insurance context, is a term of the insurance contract which, if breached, entitles the insurer to repudiate the contract.[56] In this clause, for example;

    The insured warrants that '...the vehicle...has not been and will not be specially modified...'[57]

    Where the insured modifies the vehicle without the insurer's consent before an accident occurs, the insurer would be entitled to terminate the contract.[58]

  23. Clauses aimed at preventing an increase in risk can also be expressed as imposing an obligation on the insured, as opposed to a warranty. The remedy for breach of such an obligation is the same as for breach of a warranty.[59] Here is an example from a motor vehicle policy;

    '...the insured shall take reasonable precautions for the safety and protection of the vehicle.'[60]

    If, instead of parking the vehicle under the roof of a garage, the insured had chosen to park it on the side of a main road, the insurer may well terminate the contract for failure to take reasonable care of the vehicle. These terms are especially effective, since they require the insured to take positive steps in preventing an increase in risk for the insurer.

    Summary

  24. The main source of the rights and obligations of the parties to an insurance contract is to be found in the contract itself.[61] Insurers often incorporate terms which define the limits of their liabilities. These boundaries are further restricted by temporal and causal exclusion clauses. Another common feature of an insurance policy is a term which imposes an obligation on the insured to act or refrain from acting in a certain way before the insurer becomes liable to pay a claim. All of these terms are usual features of an insurance contract which are focused on giving the insurer grounds to deny cover if the risk turns out to be different from that which it intended to originally take on. Without statutory intervention, they provide one-sided protection for the insurer. The consequences can be extremely harsh on the insured. As will be discussed,[62] insurers were heavily favoured under the previous legal environment as they could rely on a technical breach of the contract to reject the insured's claim.[63] The ALRC strongly asserted that the law must be amended to better protect the interests of the insureds where their conduct which had caused little or no prejudice to the insurer.[64]

  25. Having examined the basic features of an insurance contract, the next section will focus on the development of insurance law in Australia. It will consider the reforms that were initially proposed by the ALRC and subsequently adopted in section 54 of the ICA. The basic mechanics of section 54 will also be discussed.

    Outline of Australian insurance law

    The Australian insurance industry

  26. The Australian insurance industry as a whole has undergone massive changes in the last decade. It has had to adapt to pressures generated by globalisation and the dominance of information technology.[65] Over 170 Australian and multinational companies actively compete for domestic and international business within the insurance market.[66]

  27. With more than two hundred years of experience, Australia has been able to develop a mature, diversified and highly competitive insurance industry.[67] Australia already has the eleventh largest insurance market in the world and the eighth highest per capita spending on general insurance.[68]

    Law prior to the Insurance Contracts Act 1984 (the 'ICA')

  28. Prior to the enactment of the ICA, the law governing insurance contracts was confusing.[69] English law governed the new-founded country when the British 'colonised' Australia in 1788.[70] Australian law is therefore, 'not only the historical successor of, but is an organic development from, the law of England.'[71] Principles and rules developed by judges on a case-by-case basis were subjected to the statutes of the Imperial, State and Commonwealth parliaments. The Imperial Acts, part of the legal 'baggage' shipped to Australia, were often expressed in a code-like manner, rather than in plain English.[72] State intervention was minimal, with legislative provisions limited to particular types of transactions.[73] Commonwealth legislation dealing with insurance contracts was restricted to the area of life insurance.[74] Both State and Commonwealth legislation possessed problems which demanded the attention of legislators.[75]

    Common law and the freedom of contract

  29. Predominantly common law principles governed insurance contracts before the commencement of the ICA.[76] Any breach of a warranty would entitle the insurer to avoid the contract or to reject the claim. Insurer's liabilities were effectively limited by the various exclusion clauses incorporated in the insurance contracts. The position reflected the nineteenth century laissez-faire philosophy.[77] Parties were free to enter into any contracts they desired and could agree on such terms as suited their particular needs.[78] The insurer's legal rights were ultimately determined by the form in which the contract was drafted, rather than by reference to the harm caused.[79]

  30. In a few instances, various statutory laws have served to limit the effect of the contract. For example, section 18 of the Insurance Act 1902 (NSW) provides that a court can excuse a breach of a term or condition which does not prejudice the insurer.[80] The legislation was designed to 'prevent advantage being taken of a mere technicality.'[81] The section does not apply where the insured has breached a common law duty.[82] At the federal level, an insured could be excused from complying with a warranty of a marine insurance policy where compliance would be unlawful or where circumstances had changed.[83] Similarly, any warranty or exclusion in an insurance contract would be ineffective to relieve an insurer's liability to indemnify a carrier against personal injuries.[84]

  31. The courts were also willing to construe a temporal exclusion clause in such a way as to allow recovery where the relevant circumstances could not have caused or contributed to the loss.[85] In Bashtannyk v New India Assurance Co Ltd[86] the insured's vehicle was travelling at a moderate speed when it was struck, through no fault of its own, by another car. The insurer relied on an exclusion 'while the motor vehicle ... is being used in an unsafe condition' to deny liability to the insured. The insurer alleged that because the tyres were bald, the vehicle was unsafe when the accident happened. The Supreme Court of Victoria held that the clause only excluded liability if the vehicle was being used in an unsafe condition at the time of the loss.[87] Chief Justice Winneke used the example of a car's lighting system and stressed that where the system had failed, its safety condition may vary depending on whether the person was using the car 'in daylight or in darkness.'[88] In this case, despite the baldness of the tyres, the court was not satisfied that the tyres were unsafe and the insured was entitled to recover for the loss.

    A call for reform

  32. The common law proved sadly deficient in most of the relevant areas of an insured's needs. In a situation where an insurer could avoid a claim on the basis of a warranty, condition or exclusion, the result was harsh and unjust.[89] An insured might, for example, have suffered a loss within the scope of the policy, but failed to give notice of the loss within the time warranted. The common law allowed the insurer to terminate the contract even where it had suffered no prejudice.[90] Although an insurer had a legitimate interest to ensure that the risk it had agreed to cover would not increase during the policy period, in some instances, the common law remedies available depended on matters of form rather than substance.[91] Statutory law prior to the ICA had made no real impact on the common law position of the insured. It was piecemeal, confusing and was more concerned with improving the legal process than reforming the law.[92]

  33. An example in the marine insurance context (which represented the general law at that time) was Azevedeo v Australian and International Insurances Ltd[93] where the insured brought an action under a marine policy after his fishing vessel had been destroyed by fire. The insurer denied liability on several grounds. One was that the insured was in breach of warranty. In the proposal form, the insured had stated that the vessel would not be 'let out on hire or charter or used for the carriage of paying passengers.'[94] The proposal form was stipulated to be the basis of the contract. When the loss occurred, the vessel was being used by the insured. The insured had, however, informally hired it on earlier occasions to a friend.[95] The court held that the insured was in breach of warranty and that the insurer was entitled to avoid the contract from the time of the original breach. Consequently, it was not liable for the insured's loss.[96]

  34. Following the Attorney General's reference in 1976 which required an assessment of the law governing insurance contracts, the ALRC suggested that a national Insurance Contracts Act was required to correct the faults in the existing law.[97] An Act was also needed to provide a uniform and fair set of rules for the industry nation-wide.[98] In 1982, the ALRC's report on insurance contracts included a draft Bill which was enacted with few changes in 1984.[99] The ICA applies to insurance contracts entered into on or after 1 January 1986. Some types of insurance are excluded from its operation.[100]

    Important ALRC recommendations: substance over form and the principle of proportionality

  35. The ALRC had made several important suggestions in regard to reforming the law of insurance.[101] One of the more significant proposals relevant to this paper is the issue of 'substance over form.' The ALRC noted that the problem with the previous legal environment was that the precise remedy available to an insurer in the event of a breach depended on matters of form, rather than of substance.[102] The wording of the particular clause was crucial.[103] As was discussed in section 2, insurers could use different drafting techniques to accommodate their desired level of protection.[104] The ALRC found that the difference in effect between, for example, a causal and a temporal exclusion clause, 'is not justified.'[105] It commented that;

    'The rights of the parties should depend on matters of substance, not on subtle differences in form.'[106]

  36. Another problem, as identified by the ALRC, concerned the legal effect of the insured's conduct.[107] The fact that the insurer could terminate the contract for a breach of term was found to be a 'far harsher remedy in the context of insurance [when compared] to other contracts.'[108] The ALRC noted that it could 'impose heavy loss upon the insured [although] the insurer [had] suffered little or no prejudice [from] the insured's breach.'[109]

  37. In promoting the spirit of 'substance over form,' the ALRC recommended that all breaches be treated the same.[110] Whether it be a breach of a causal or temporal exclusion, the insurer would be liable to indemnify the insured if the insured had not caused or contributed to the loss.[111] In adopting this approach, the ALRC commented that the result was most 'satisfactory' where the tests of causation and proportionality were combined.[112] Where the insured's conduct might, in principle, have caused or contributed to a loss, a causal connection approach should be adopted. The insurer may refuse to pay the claim where the insured's act or omission had caused or contributed to the whole loss.[113] Where the insured's conduct could not, in principle, have caused or contributed to the loss, the insurer is limited to a right of damages if it had been prejudiced by the insured's act or omission.[114] An example is where the insured had modified its vehicle without the insurer's consent. The ALRC proposed that the amount of damages should be assessed via ordinary contractual principles and the application of the principle of proportionality.[115]

  38. According to the principle, the insurer would only be responsible for its proportion of the total risk. Where the additional risk was insurable, but that the insurer would have charged a higher premium had it known the insured's act or omission, an objective assessment of the appropriate premium would be made and the principle of proportionality would be applied.[116] Where the additional risk was not insurable at all, the insured would be unable to recover any part of its claim from the insurer.[117]

  39. Given the importance of these recommendations in reforming the previous legal environment, it was essential that they be accurately implemented and reflected in the wording of the legislation. As was aptly put by President Mason, the identification of particular problems was only a 'prelude to legislative drafting,'[118] as the court must still struggle through issues of construction and application of the words adopted by legislators.[119] The next section will briefly examine the overall mechanics of section 54.

    The inherent balance in section 54: a brief overview of the section

  40. Although limited in its scope, the Act has made substantial changes to almost all areas of insurance law.[120] Amongst other sections of the Act[121] section 54 has contributed much to balance the interests of both the insurer and the insured without 'cutting a jagged swathe through [their] respective rights.'[122]

  41. Section 54 provides that:

    (1)       Subject to this section, where the effect of a contract of insurance would, but for this section, be that the insurer may refuse to pay a claim, either in whole or in part, by reason of some act of the insured or of some other person, being an act that occurred after the contract was entered into but not being an act in respect of which subsection (2) applies, the insurer may not refuse to pay the claim by reason only of that act but the insurer's liability in respect of the claim is reduced by the amount that fairly represents the extent to which the insurer's interests were prejudiced as a result of that act.

    (2)       Subject to the succeeding provisions of this section, where the act could reasonably be regarded as being capable of causing or contributing to a loss in respect of which insurance cover is provided by the contract, the insurer may refuse to pay the claim.

    (3)       Where the insured proves that no part of the loss that gave rise to the claim was caused by the act, the insurer may not refuse to pay the claim by reason only of the act.

    (4)       Where the insured proves that some part of the loss that gave rise to the claim was not caused by the act, the insurer may not refuse to pay the claim, so far as it concerns that part of the loss, by reason only of the act.

    (5)       Where:

    (a)     the act was necessary to protect the safety of a person or to preserve property; or

    (b)     it was not reasonably possible for the insured or other person not to do the act;

    the insurer may not refuse to pay the claim by reason only of the act.

    (6)       A reference in this section to an act includes a reference to:

    (a)     an omission; and

    (b)     an act or omission that has the effect of altering the state or condition of the subject-matter of the contract or of allowing the state or condition of that subject-matter to alter.

    (emphasis added.)

    The first limb of section 54

  42. There are two limbs to section 54. The first limb distinguishes between two kinds of acts during the policy period.[123] These are acts which 'could reasonably be regarded as being capable of causing or contributing to a loss'[124] and acts which were incapable of achieving such an effect. In the former case, the insurer may refuse to pay the claim. The act is presumed to have caused the loss and the insurer is relieved from liability where the act has possibly caused the loss.[125] The insured must then rebut that presumption and prove that the act is not wholly or even partly responsible for the relevant loss.[126] The insurer only needs to show a fairly tenuous link between the act and the loss for the presumption to apply.[127]

  43. Where an act is not capable of causing the loss, the insurer may not refuse to pay the claim. Section 54 imposes on the insurer a prima facie liability to pay under the policy by 'sterilising the operation of the change-of-risk clause.'[128] In Australian Associated Motor Insurers Ltd v Ellis, for example, a term of the contract prohibited the insured from modifying the insured vehicle without the insurer's consent. The vehicle was modified without obtaining consent and an accident occurred whilst it was being driven by the insured's 23-year-old daughter. In this case, since the daughter was not at fault and the modification did not cause the loss, the insurer could not refuse to pay the claim.[129]

  44. Although this first limb goes some way to eliminate the inequality of bargaining power as often existed previously between the parties, it could not operate fairly on its own. Equality requires the law to protect the interests of all parties. A law which entirely favours the insured is equally disastrous. In FAI General Insurance Ltd. v Jarvis, an insured was injured after falling on a slippery shop floor. The insurance policy required the insured to give written notice to the insurer of 'the happening of any event likely to produce a claim under any section of this policy.'[130] This included any injury that the insured had sustained. The insurer was only notified of proceedings one month before the hearing and therefore had no time to investigate the cause of the accident.[131]

  45. Clearly, it would be unfair for the insured to succeed against the insurer who had lost the opportunity to gather information in establishing a viable defence.[132] It is submitted that had the law been so, an insurer would most likely charge a much higher premium to protect against the increased risk of indemnifying an insured. As a consequence, many low-income earners and small businesses would struggle to obtain an appropriate cover for their situation, since the cost would tend to outweigh the benefit of being insured under a policy.[133]

    The second limb of section 54

  46. Although the insurer is prohibited from refusing to pay a claim where the insured has not contributed to the loss, the second limb of section 54(1) allows the insurer to reduce its liability by the amount of prejudice suffered in the circumstances.[134] The second limb is important in helping to establish equilibrium between the insurer and the insured. In the Ellis example, the insurer legitimately argued under the second limb of section 54 that, had it known of the modification, it would have still continued the current policy, but excluded liability for persons driving under 25 years of age. The South Australian Supreme Court allowed the insured's claim to be reduced by the amount that 'fairly represented the extent to which the insurer's interests were prejudiced as a result of' the modification.[135] This was held to represent the full amount of the claim.[136]

  47. As will be discussed,[137] the High Court has broadly interpreted the words 'act' or 'omission' in section 54(1).[138] By doing so, the High Court has evinced an intention to allow an insured more readily to take the benefit of section 54(1) in appropriate circumstances.[139] More importantly, the court has adopted the view that an insurer will be provided with adequate protection of its interests via the operation of the prejudice test within the second limb of section 54(1).[140]

  48. This view could be compared with the equitable jurisdiction of a court. In equity, a plaintiff must come to the court with clean hands.[141] Section 54(1) limits the insured's prima facie ability to claim where the insurer's interest was prejudiced by the insured's conduct. The prejudice limb is required to prevent unfair outcomes for the insurer and to prevent the insured from recovering more than what it is entitled to in the circumstances. The problem for the courts is to decide how to interpret the wording of section 54 so as to balance the interests of the insurer and the insured.

    The position in New Zealand: a brief insight

  49. Australia is unique in that other common law countries do not have a provision similar to section 54. New Zealand is the only jurisdiction which has legislated a remedial provision comparable to the section.

  50. Under section 9 of the Insurance Law Reform Act 1977 (NZ) ('the NZ Act'), a term which requires an insured to promptly notify a claim will bind the insured only if it would otherwise prejudice the insurers' interests.[142] The section effectively 'excuses' an insured from the consequences of giving late notice of a claim where the late notice has not prejudiced the insurer.[143] In Sinclair Horder O'Malley & Co v National Insurance Co of New Zealand Ltd, the NZ Court of Appeal held that section 9 applied to a 'claims made and occurrence notified' policy which required the insured to give immediate notice of an occurrence.[144] Although section 9 specifically referred to the notification of a 'claim,' Justice McKay held that the section was broad enough to cover the notification of an 'occurrence.'[145] His Honour found that the distinction between the two was one which could be made, but lacked substance.[146]

  51. Section 11 of the NZ Act also alters the insurer's remedies where the insured has breached a term of the contract.[147] It changes the operation of provisions which limit the insurer's liability by reference to the happening of certain events or the existence of certain circumstances.[148] The effect of the section is that an insured is only entitled to indemnity if they can establish that the circumstances falling within the provision did not cause or contribute to the loss. If they did, then the insurer is entitled to decline indemnity.[149]

  52. The section makes less radical changes than those made by section 54 of the ICA.[150] Although the section mainly serves to modify the effect of temporal exclusions, its wording seems to suggest a wider application.[151] The section has been held to apply where the limitation on the insurer's liability is expressed as an exclusion[152] or in the form of a warranty.[153]

  53. In State Insurance Ltd v Electronic Navigation Ltd, for example, a motor vehicle policy excluded loss while an unlicensed driver was driving the vehicle.[154] One of the insured's employees had been disqualified from holding a driver's licence for six months following a conviction for a drink driving offence.[155] The insured believed that the disqualification period had ended, when it in fact had a further two weeks to run and permitted the employee to drive the insured vehicle.[156] The vehicle was involved in an accident while being driven by the employee. The insurer denied liability and argued that since the driver was unlicensed, his driving had caused or contributed to the accident, hence, excluding the operation of section 11.[157] The High Court of New Zealand held for the insured, that section 11 would apply, since the absence of the licence did not cause or contribute to the loss.[158]

    Summary

  54. Although 'words are only pictures of ideas on paper,'[159] in law they may determine the substance of the legislative response to a problem, 'sometimes intentionally sometimes unintentionally.'[160] The wording of section 54 generally indicates the drafters' attempt to incorporate the spirit of the reform into the section. It provides that the insurer is liable to indemnify the insured where the insured's act or omission has not caused or contributed to the loss. This liability may be reduced by the amount of prejudice suffered by the insurer in the circumstances. However, as will be discussed in the balance of this paper, the wording of section 54 has raised problems which legislators had not envisaged. Furthermore, although the recommendations of 'substance over form' and 'proportionality' are sound theoretically, in reality, they are harder to apply.[161]

  55. New Zealand is the only other common law nation that has legislation akin to section 54. Its provisions are, however, overly simplistic and are not as well developed as its Australian counterpart, as will be demonstrated below.

  56. Having established the background, purpose and features of section 54, the next two sections will examine the mechanics of the section in detailed. Recommendations will be made to improve its overall effectiveness in attempting to achieve a balance between the interests of the insured and the insurer.

    Section 54 and 'claims' policies

  57. The insured's failure to comply with the notification provision of a 'claims made and notified' or 'claims made and occurrence notified' policy has contributed much to judicial and academic controversies regarding the construction of section 54(1).[162] This section will examine the various cases concerning these policies and expose the courts' vacillation in construing the term 'omission' under section 54(1). A critical discussion regarding judicial activism in this area will follow.

  58. An understanding of the nature of 'claims made and notified' and 'claims made and occurrence notified' policies is essential to appreciate the issue at hand. The next section will focus on explaining the general aspects of these policies.

    The evolution of 'claims made and notified' policies

  59. The law regarding 'claims made and notified' policies is complex. It involves specialised versions of the clauses that were discussed in section 2. It is useful, therefore, to draw a distinction between the different types of policies that have emerged in this area.

    'Occurrence based' policies

  60. Historically, policies were written to cover loss caused by events during the policy period. An 'occurrence based' policy covers the insured for liability regarding defined events occurring within the policy period. Even if the claim is reported to the insurer after the policy has expired or been cancelled, the policy will cover the insured for any incident that occurred while the policy was in force.[163] The trigger is the loss that occurs during the specified policy period. An example being;

    'We will pay those sums that the insured becomes legally obligated to pay as damages because of "bodily injury" or "property damage" to which this insurance applies....

    This insurance applies to "bodily injury" and "property damage" only if: (1) The "bodily injury" or "property damage" is caused by an "occurrence" that takes place in the "coverage territory"; and (2) The "bodily injury" or "property damage" occurs during the policy period.'[164]

  61. This type of policy is well suited to the needs of insureds such as motor vehicle owners.[165] Where a mechanic, for example, is negligent and accidentally scratches the insured's vehicle, the nature of the negligent act and the resultant damage are often known upon the happening of the negligent act.[166]

  62. The 'long tail' nature of the risk under an 'occurrence' based policy has, however, presented a problem for insurers when providing cover for the insured.[167] When insuring professionals such as doctors or lawyers for losses caused by their negligence,[168] damages can eventuate many years after a negligent act is committed.[169] This is also the case for manufacturers who can cause damages by producing hazardous products or toxic waste.[170] Recent asbestosis claims[171] are examples: it takes at least 20 to 30 years for a person to develop mesothelioma, an asbestos-related cancer, after being exposed to the asbestos.[172] Insurers, in these cases, face the risk of having to pay out an unknown number of claims that may be made many years after the particular policy has expired.[173] This is referred to as 'long tail' business.[174]

  63. The 'long-tail' nature of 'occurrence' policies has also caused problems where the insured had taken out insurance covers from different insurers over the years.[175] Disputes might arise between insurers regarding the actual period in which the relevant 'occurrence' happened and which the insurer must indemnify the insured for the loss.[176] These disputes have created unnecessary expense for the insurance industry.[177] They have also produced uncertainty for the insurer in calculating their actuarial risk and setting aside adequate reserves for future claims.[178]

    'Claims made' policies

  64. Insurance contracts drafted as 'claims made' policies have helped to curtail the 'long-tail' problems associated with 'occurrence' policies.[179] 'Claims made' policies cover the insured for liability only where a claim is made against the insured by the third party during the policy period.[180] They have evolved 'from difficulties within the insurance industry flowing from claims being made under [insurance policies] for a year long past.'[181] Here is an example of a 'claims made' clause under a 'claims made' policy;

    'GIO will pay on behalf of the insured all sums for which the insured shall become legally liable to pay by way of compensation ... in respect of: ...
      (c) Professional Liability
      A claim or claims made against the insured during the Period of Insurance arising out of any negligent act, error or omission committed or alleged to have been committed, by the insured in the conduct of the insured's business as specified in the Schedule.[182]

  65. It became clear that the problem with 'claims made' policies, however, is that they do not specify notification to the insurer as a requirement for an indemnity. Notification is important for the insurer to estimate possible future liabilities so that 'appropriate provision' can be made to meet its commitments.[183] It can also allow the insurer to investigate events within a reasonable time of their happening and possibly settle the matter 'in a financial climate [not] materially different from that in which the risk had been undertaken and the premium for that risk assessed and agreed.'[184] As a result, 'claims made and notified' policies have evolved to provide a more effective protection for the insurer.[185]

    'Claims made and notified' policies

  66. In contrast with 'claims made' policies, which do not insist on notification as a basis for indemnity, 'claims made and notified' policies provide coverage only for claims which are both made and notified to the insurer within the policy period.[186] These policies have evolved to answer the particular demands of third party liability type cover, particularly professional indemnity cover. They cover the insured against a third party's claim made for the first time during the currency of the policy, provided the existence of the claim was notified to the insurer during that period. Notification is required to activate the cover under the policy.[187] Professional indemnity policies and legal expenses policies are common examples where the insured must seek the insurer's consent before commencing any litigation.[188]

  67. An example of a 'claims made and notified' clause under a 'claims made and notified' policy is as follows;

    'On the terms and conditions herein contained the Insurers shall Indemnify the Assured up to an amount not exceeding the Sum Insured and Related Costs against all loss to the Assured (including claimants' costs) whensoever occurring arising from any claim or claims first made against the Assured during the Period of Insurance and reported to the Insurers during such period, in respect of any description of civil liability whatsoever incurred in connection with the Practice...'[189]

  68. Apart from the benefit of requiring the insured to notify the insurer,[190] 'claims made and notified' policies also limit the 'long-tail' problems of an occurrence policy.[191] The date at which a claim was made is easier to ascertain than the date at which an 'occurrence' happened.[192] Compared to 'claims made' policies, 'claims made and notified' policies also better equip insurers in forecasting the likely level of claims that will be payable under liability insurance policies.[193]

    The evolution of 'claims made and occurrence notified' policies

  69. Apart from 'claims made and notified' policies where the insured is required to notify an actual claim made against the insured during the policy period, 'claims made and occurrence notified' policies have evolved to impose a greater onus on the insured to disclose material facts. Under a 'claims made and occurrence notified' policy, potential claims against the insured are covered under the policy provided notice of these was given during the policy period.[194] Where the insured has notified the insurer during the policy period of any circumstances that may subsequently give rise to a claim against them, any third party claims which are later made outside the policy period are deemed to have been made during the policy period.[195]

  70. In reality, the courts make no clear distinction between a 'claims made and notified' policy and a 'claims made and occurrence notified' policy. Facts in case law suggest that insurers tend to include 'occurrence notified' provisions as extension clauses in expanding the scope of a 'claims made and notified' policy.[196] To avoid confusion, however, this paper will maintain the distinction between these two different types of insurance.

  71. When compared to a pure 'claims made and notified' policy, a 'claims made and occurrence notified' policy helps to ensure that claims which are not made until a later policy period will be covered under the existing policy.[197] If the insured does not notify the insurer of the occurrence under the existing policy, then the insured must disclose the existence of circumstances that may lead to a future claim before entering into any subsequent insurance policy.[198] This enables the insurer to decide whether to, either expressly or via a general exclusion clause, exclude the possible claim from the cover under the terms of the new policy.[199] An example of an 'occurrence notified' clause is as follows;

    'If during the [policy period,] the insured shall become aware of any occurrence which may subsequently give rise to a claim against him or them for breach of professional duty by reason of any negligence, whether by way of act, error or omission and shall during the [policy period,] give written notice to the insurer of such occurrence, then any such claim which may subsequently be made against the insured arising out of such negligence shall for the purposes of this Policy be deemed to have been made during the [policy period].'[200]

    This policy excludes cover for 'loss arising out of any circumstance or occurrence [which] has been notified under any other insurance attaching prior to the inception of this Certificate of Insurance, or of which the Assured was aware at the commencement of the Period of Insurance. ......'[201]

  72. It is the notification of 'awareness' that has caused problems for the courts. The extent of awareness required under a 'claims made and occurrence notified' policy refers to the insured's awareness of the prospect of a claim against it, rather than to knowledge of the occurrence itself.[202] The insured must appreciate that the circumstances will subsequently give rise to a claim. It is not enough merely to have knowledge of the circumstances,[203] as otherwise, the insured would be ineligible to be indemnified merely by being aware of the occurrence which resulted in a claim, but without having any reason to anticipate that claim.[204] The insured does not, however, have to be aware of why a possible claim might be made or whether such a claim is justified or might be expected to be successful.[205] The insured merely has to be aware of the possibility, however remote, of a claim being made in the future.[206]

    A brief sketch of case law development regarding 'claims' policies

  73. Although it is important for the insureds to notify the insurer of claims and circumstances that may give rise to a claim, there are instances where they do not notify the insurer when they receive a claim from a third party or become aware of an occurrence.[207] The insured may simply have forgotten to notify, notified the wrong insurer or not realised that a claim has been received.[208] The insured might have regarded the possibility of a future claim as being remote.[209] In other cases, the insured may be gambling on the fact that a claim will not be made against it and choose not to notify the insurer of an occurrence to avoid the risk of a higher premium for future cover.[210]

  74. Section 54(1) provides that an insurer may not use the insured's act or omission as a reason for refusing to pay a claim where that act or omission occurs during the policy period and could not have contributed to the loss.[211] Although the following is not an exhaustive list, a policy may provide that the insured is obliged to notify the insurer:

    The issue arises as to whether a non-compliance with these terms can be excused as an 'omission' under section 54(1).

  75. From the insurer's standpoint, it is important that section 54 does not operate at all in this context, since the section imposes a prima facie liability on the insurer to pay. Insurers have therefore argued that the insured's failure to comply with the notification term of the policy is not an 'omission' under section 54. On the other hand, from the insured's perspective, it is essential that section 54(1) is operative, so that the insurer is barred from refusing their claim for a failure to give notification. As will be discussed later, an insured may, for various reasons, be without cover after the original insurance policy has expired, since later policies may not always respond to the insured's claim.[212] In these instances, it is imperative that the earlier insurance policy will apply in their favour. As the wording of section 54 does not provide guidance regarding the matter, the courts have been left with the unenviable task of resolving the battle of interests between the insurer and the insured regarding the operation of section 54 in this context.

    East End - A controversial beginning for insurers and the insureds

  76. East End Real Estate P/L v CE Heath Casualty & General Insurance Co Ltd[213] is the first major case to deal with the issue of whether the insured's failure to notify a claim under a 'claims made and notified' policy could be classified as an omission under section 54(1).[214] The policy contained an 'ambit of cover clause,' which required the insured to notify the insurer during the policy period of any claims made against them for breach of professional duty within the period of cover.[215] In this case, a third party made a claim against the insured during the policy period. The insured had, however, failed to notify the insurer of this. The insurer argued that section 54 was not concerned with acts or omissions which formed part of the definition of the risk insured.[216] Section 54 dealt with matters such as warranties, conditions and exclusions, but not matters concerning the ambit of insurance cover. The insurer argued, referring to Justice Handley in Ferrcom, that the intention behind section 54 was not to widen the cover in an insurance policy.[217]

  77. The NSW Court of Appeal held that the insured's failure to give notification could be excused as an omission under section 54. The court found that the section was designed to remedy the 'mischief' under the previous legal environment where the insurer could rely on particular drafting techniques and virtually decide the outcome in the case of litigation.[218] It was enacted so that substance would triumph over form.[219] In this case, 'the effect' of the policy allowed the insurer to refuse to pay the claim where there had been a lack of notification 'by the insured or some other person.'[220] The court held that section 54 used general words to show clearly that the section would operate whether the insurance policy had used an ambit of cover clause, an exclusion clause or a condition in the body of the policy to deny cover for certain act or omission.[221] The High Court refused an application for special leave to appeal from the Court of Appeal's decision.[222]

  78. The High Court has also subsequently endorsed the East End decision.[223] The case must therefore, be taken as representing the law.[224] There have, however, been attempts to limit the ramifications of the decision.

    Perry - A disagreement over East End; 'omission/inaction' dichotomy

  79. The NSW Court of Appeal in FAI General Insurance Co Ltd v Perry ('Perry') had another opportunity to examine the issues raised in East End.[225] In Perry, a 'claims made and notified' policy contained an 'occurrence reported' extension clause where the insured could exercise the option to notify the insurer of circumstances that might subsequently give rise to a claim and expand the cover accordingly.[226] The insured, an accountant, discovered irregularities regarding his client's statement of financial position. He became aware that the errors had existed for the time that he was engaged as an auditor for his client and that he had been negligent in not discovering the irregularities earlier.[227] The insured decided not to advise the insurer of this discovery during the policy period. A claim was made against the insured after the policy had expired and the insured sought cover under the policy. The insurer refused to pay the claim because the insured had failed to notify it of the relevant circumstances during the policy period. The insured relied on East End to argue that the failure to notify was an omission under section 54(1).[228]

  80. The majority of the Court of Appeal[229] refused to apply section 54 in favour of the insured.[230] The court held that the insured's failure to notify under an optional provision did not constitute an omission under section 54. Rather, it was an 'inaction' to which section 54 did not apply.[231] Chief Justice Gleeson held that where the insured had an option to notify the insurer of an occurrence, a failure to notify was an 'inaction' rather than an 'omission' under section 54.[232] Where the insured was obliged to notify the insurer of an occurrence, a failure to notify would be an 'omission' under section 54(1).[233] 'The words inaction and omission are not synonyms.'[234] Judges and academics have referred to this as the 'omission/inaction' dichotomy.

  81. According to Chief Justice Gleeson, where an insured had exercised the optional right to notify the insurer of an occurrence, the original contract would be changed so as to create a 'new contract.'[235] If, as in Perry, the insured had chosen not to notify, his Honour held that section 54 could not be allowed to operate to cure that omission so as to create a 'new contract' by altering the original nature of the contract.[236] If, as in East End, the insured had failed to discharge the mandatory obligation to notify the insurer of a claim, his Honour believed it would be appropriate to allow section 54 to 'cure' that omission as it would not alter the original nature of the contract.[237] It would affect the entitlement to claim, but not the extent of the cover.[238]

  82. As will be discussed, Perry has been criticised by judges and academics for devising an artificial distinction between an omission and inaction.[239] To classify an optional right to notify as an inaction and a mandatory obligation to notify as an 'omission,' the decision would leave the way open for insurers to draft notification clauses as optional, so as to deny the insured the benefit of section 54. Such a result is contrary to the ALRC's spirit in achieving 'substance over form' in the law.[240]

    Antico - Judgement day for Perry?

  83. Despite the various criticisms,[241] the Perry decision was nevertheless followed by the NSW Supreme Court and the Full Court of the WA Supreme Court.[242] The High Court reviewed the law regarding 'claims made and notified' and 'claims made and occurrence notified' policies in Antico v Heath Fielding Australia P/L ('Antico')[243] In this case, the insured failed to seek the insurer's consent before proceeding to defend claims made against him. The insured argued that the failure to obtain the necessary consent was an omission under section 54. The argument was successful before the High Court.

  84. The majority of the High Court stressed that section 54 is 'clearly remedial legislation.'[244] The section must therefore be,

    'beneficially construed so as to provide the most complete remedy of the situation with which they are intended to deal [but consistent with] the actual language employed."[245]

  85. In adopting that construction, the majority found that the term 'omission' under section 54 was not limited to the insured's failure to discharge an obligation.[246] The section was broad enough to cover cases where the insured had failed to exercise the 'right, choice or liberty' to take certain actions as allowed under the contract.[247] This means that whether the insured failed to notify a claim under a 'claims made and notified' policy or failed to exercise the right to notify the insured of an occurrence under an optional 'occurrence notified' extension clause, both are construed as 'omissions' under section 54.[248]

  86. Although the High Court had not expressly overruled Perry, many commentators believed a rejection of the 'omission-inaction' dichotomy meant that Perry was as good as dead.[249] Subsequent decisions, however, have held that Perry was still good law.[250]

    Greentree and Permanent Trustee - The 'omission-non-event' dichotomy

  87. In Greentree v FAI General Insurance Co Ltd ('Greentree'), the insured, an engineer, was negligent in designing a building. Although the negligent act occurred during the policy period, it was only later discovered by the third party plaintiff owner well after the policy had expired.[251] When the plaintiff owner was unable to recover its losses from the insured,[252] the owner sought to recover against the insurer.[253] The insurer denied liability by arguing that the plaintiff did not make a claim within the policy period. The plaintiff relied on section 54 and argued that his failure to make a claim on the insured during the policy period was an omission to act by 'some other person' under section 54.[254] The NSW Court of Appeal held that such a failure was not the sort of omission to which section 54 applied. The absence of a claim in the policy year meant that there was nothing to activate the policy. The High Court refused leave to appeal.[255]

  88. Chief Justice Spigelman held that there was a distinction between a 'non-event' and an 'omission' under section 54.[256] A 'non-event' is an event 'wholly external to the policy.'[257] It is where the act or omission was an event which preceded any consideration of whether the effect of the contract was that the insurer might refuse to pay a claim made by the insured. In such situation, section 54 would not apply because the issue of whether the insurer might refuse to pay the insured's claim arises only after a third party has made a claim against the insured during the policy period.[258]

  89. Chief Justice Hodgson used a simpler approach in Permanent Trustee Australia Ltd v FAI General Insurance Co Ltd ('Permanent Trustee').[259] The case was similar to Greentree where the third party did not make a claim against the insured during the policy period. The difference between the two cases was that in Permanent Trustee, it was the insured, rather than the third party, that was making a claim against the insurer.[260]

  90. In analysing the distinction between an 'omission' and a 'non-event,' Chief Justice Hodgson found that where a claim was not made within the policy period, the crux of the reason why the insurer had refused to indemnify was not that someone omitted to do something, but that something did not happen.[261] His Honour used 'a plainly absurd' example to explain his argument.[262] An insured may have taken out insurance cover against fire damage for 1995. Suppose that an arsonist set fire to the insured's house which causes seriously damages in 1996. The insured seeks cover under the 1995, arguing that section 54 prohibits the insurer from refusing to pay claim due to the arsonist's omission to burn down the house in 1995. Chief Justice Hodgson argued that it was clear in this example that the insurer's refusal to pay was that there was no fire in 1995. It would be 'bizarre' to argue that the insurer's refusal was due to the arsonist's omission to destroy the house earlier.[263]

  91. The approach adopted by Chief Justices Spigelman and Hodgson in distinguishing between an 'omission' and a 'non-event' in the sense of conduct 'wholly external to the policy' has met various criticisms. The approach was problematic in that one could never determine 'the effect of a contract of insurance' without considering the external facts and circumstances.[264] In many cases, the fundamental reason why something does not happen is because someone does not do something.[265] Judges have described the approach as 'elusive'[266] and 'a little difficult to understand.'[267] The High Court in FAI General Insurance Company Ltd v Australian Hospital Care P/L ('Australian Hospital Care') [268] finally clarified the matter.

    Australian Hospital Care - Curing 'claims made and occurrence notified' policies

  92. The factual scenario in Australian Hospital Care[269] stretched the minds of the justices of the Queensland Court of Appeal regarding the issue of whether an insured should be allowed to invoke section 54 where they had failed to notify an occurrence.[270] The court refused to follow the lead given in Greentree and held that the High Court had overruled Perry in Antico.[271] The Full Federal Court of Australia's decision in HIH Casualty & General Insurance Aust P/L v DellaVedova[272] was cited in supporting this point.[273]

  93. Australian Hospital Care involved circumstances substantially similar to Perry in that both involved a 'claims made and notified' policy with an 'occurrence notified' extension clause. Essentially, the clause provided that where the insured had chosen to notify the insurer of an occurrence that may subsequently give rise to a claim during the policy period, any relevant subsequent claims would be deemed to have been made within that policy period.[274] During the policy period, the insured became aware that a patient had contracted septicaemia whilst in hospital. The patient's solicitor had made enquiries with the insured regarding the matter as a preliminary step to taking possible legal action against the insured. Following the investigation and the insured's own study into the matter, it was found that there was no ground for complaint. The patient was satisfied with this outcome.[275] The insured therefore did not advise the insurer of this occurrence as it was 'not expected...that a claim would be made.'[276] The patient had, however, later made a claim against the insured after the policy had expired. The insurer refused to indemnify the insured on the ground that it had failed to notify the occurrence during the policy period. The insured argued that this was an omission that section 54(1) could cure.[277]

  94. Justice Derrington rejected Chief Justice Gleeson's approach in Perry that a 'new contract' would come into place where an insured had chosen to notify the insurer of an occurrence under an 'occurrence notified' clause and hence, expand the level of cover.[278] His Honour commented that the 'claims made and notified' and 'occurrence notified' components of the policy were 'interlocked' together to form an 'integrated whole.'[279] The policy in this case was not merely a 'claims made and notified' cover during the policy period, it embraced claims made after that period as well.[280] The latter formed part of the insurer's total promise and was equally important to the insured in arranging their affairs.[281] When insurers calculated their premium, both aspects of the promised indemnity would have been incorporated into their calculations.

  95. The court noted that the High Court in Antico had already disapproved the approach in Perry.[282] It concluded that the insured's failure to notify an occurrence in this case was an 'omission' under section 54(1). Before this Queensland Court of Appeal's decision could be appealed to the High Court, another case which involved facts that were virtually indistinguishable from Perry arose for consideration in the NSW Supreme Court.[283]

    Einfield - A decision on the fate of Perry

  96. The case of Einfeld v HIH Casualty & General Insurance ('Einfeld')[284] involved a 'claims made and notified' policy with an 'occurrence notified' extension clause. During the policy period, the insured became aware of circumstances that may have subsequently given rise to a claim. The insured obtained legal advice and chose not to take advantage of the 'occurrence notified' extension clause by advising the insurer of these circumstances. The basis of the insured's decision was to avoid the possibility of having to pay a higher premium for later policies as a result of the notification. A claim was subsequently made against the insured. The insured sought cover under the original policy and relied on section 54(1) to 'excuse' his failure to notify when the insurer declined to indemnify the insured against the claim.[285]

  97. The NSW Supreme Court was therefore faced with the task of deciding whether Perry was valid, given the decisions of Antico, Greentree, Della Vedova, and Australian Hospital Care. After examining the High Court's decision in Antico, Justice Rolfe found that the reasoning in Perry had been rejected and therefore the case could no longer stand.[286] His Honour held that in light of the decisions in Della Vedova and Australian Hospital Care, the plaintiff's failure to notify the occurrence was an omission under section 54.[287]

  98. Justice Rolfe concurred with Justice Chesterman's view in Australian Hospital Care that it was unfortunate that section 54(1) had been held to 'excuse' the insured's failure to notify the insurer of relevant circumstances. Justice Rolfe had also expressed concern regarding the different judicial opinions on this area of law. His Honour stressed that as matters stood, different results could be expected depending on the jurisdiction in which the litigation was brought.[288] Perry, for example, is not binding in all States. Courts could therefore hand down inconsistent decisions.[289]

    Australian Hospital Care again - The final outcome for 'claims' policies

  99. The insurer's decision to appeal against the findings of the Queensland Court of Appeal provided the High Court with an opportunity resolve a matter that has 'agitated courts and commentators for several years,' once and for all.[290] With a majority of four to one, the High Court found in favour of the insured.[291] The court reaffirmed the Court of Appeal's finding that section 54 would prevent an insurer from denying a claim on the basis that an insured had failed to give notice of circumstances during the policy period even where the claim was made after that policy period had expired.[292]

  100. Justices McHugh, Gummow and Hayne criticised the reasoning in Greentree and Permanent Trustee although their Honours agreed with the actual decision in each case.[293] In devising a better approach, their Honours commented that section 54(1) would not apply to relieve the insured of certain 'restrictions or limitations that were inherent in a claim.'[294] In other words, where a failure concerned an element that was inherently essential to a claim as a matter of law, as opposed to matters that were merely ancillary or procedural, section 54 would not apply to 'cure' that failure.[295] Under an 'occurrence' policy, for example, the 'occurrence' of an event is the essential element. Section 54(1) will not operate to cure a failure of the event to occur which has subsequently given rise to liability under the policy.[296] The essential element under a 'claims made' or 'claims made and notified' policy is a third party's 'demand' made within the policy period. The third party's failure to make the demand would not be classified as an 'omission' under section 54(1).[297] Under a 'claims made and occurrence notified' policy, the essential element is the insured becoming aware of facts which may subsequently give rise to claims. Section 54(1) will not apply to 'excuse' a failure to become aware of certain facts.[298]

  101. The inherent limitation test was recently considered and applied by the District Court of Queensland in Stapleton & Anor v NTI Limited.[299] Justice McGill found the test difficult when determining how to distinguish between restrictions inherent in a claim, which could not be overcome under section 54(1), and other restrictions to which the section would apply.[300] His Honour held that the manner in which the test will operate in a particular case 'may well be largely a matter of impression,' but concluded that in this case, the causal relationship required under section 54(1) was not satisfied.[301]

  102. On the question of the term 'omission,' Justice Kirby, the other justice in the majority, described previous distinctions as simply artificial.[302] These included Justice Handley's approach of the 'failure to act for the insured's benefit' and Chief Justice Spigelmans' 'omission-non-event' dichotomy in Greentree.[303] Chief Justice Hodgson's distinction between 'someone's omission to do something' and a relevant event that 'did not happen' was also criticised.[304] Similar to President Mason's approach in Greentree,[305] Justice Kirby had instead argued for the approach of causation in determining whether the insurer's 'real reason' for refusing to pay was because of the failure of the insured or of some other person or because the claim did not fall within the policy. If the former was the insurer's 'real reason' for refusing to pay, then section 54 would apply and vice versa.[306] In Greentree, for example, the 'real reason' for the insurer's refusal was not some act or omission of the insured or some other person. Instead, it was because the policy did not extend cover to a claim that was made outside the policy period.[307]

  103. The dissenting judge was Chief Justice Gleeson. His Honour also applied the causal connection test and found that the insurer's reason for refusing to pay in this case was due to the third party patient not making a claim on the insured during the policy period. The refusal was not due to the insured's failure to notify the insurer of the occurrence under the optional notification provision.[308] The problem with his Honour's approach is, however, that it would depend very much on how the notification provision was drafted in the first place. If, rather than being optional, the notification provision were included in the policy's scope of cover itself, Chief Justice Gleeson's approach might lead to a different result. The insurer's real reason for refusing to pay in the latter case would be the insured's failure to discharge their obligation to notify. The approach is therefore problematic and undesirable, in that its result would depend on matters of form rather than substance,[309] contrary to the ALRC's original recommendations.[310]

    General overview of the case law

  104. In general, where the insured had failed to notify a claim under a 'claims made and notified' policy, section 54 would apply to 'cure' that failure.[311] Similarly, where the insured had failed to notify an occurrence under a 'claims made and occurrence notified' policy, whether the notification was optional or mandatory, section 54 would apply to 'excuse' that failure. It was irrelevant whether the failure would be intentional or otherwise.[312] Where the case concerns facts which are the same as or similar to Permanent Trustee or Greentree, the relevant failure would not be an omission pursuant to the omission/non-event dichotomy.[313]

  105. It took the courts at least a decade to come to these conclusions. The controversy began with the NSW Court of Appeal in East End giving a liberal interpretation to the expression 'the effect of the contract' in section 54(1).[314] The same court then attempted to change its direction by devising a distinction between an 'omission' and an 'inaction' in Perry.[315] That attempt failed to gain support of the courts in Antico, Australian Hospital Care, Della Vedova and Einfeld. The cases unanimously supported the original direction taken by East End.

  106. These decisions have produced an insurance policy different to the one originally agreed upon by the parties.[316] A 'claims made and notified' policy is effectively transformed into a 'claims made' policy.[317] Provided the claim is made during the policy period and the insured notifies the insurer of that claim at some stage, perhaps years later, the insurer may not refuse to pay the claim under section 54.[318] The parties' freedom to contract has also 'gone largely by the board,' because they cannot set the extent of the exposure.[319]

  107. The same could be said in regard to a 'claims made and occurrence notified' policy, where the High Court in Australian Hospital Care effectively changed it into an 'occurrence based' policy.[320] As a result, an insured who becomes aware of an occurrence during the policy period may notify the insurer of that occurrence at a much later stage.

  108. There is much to criticise in the end result of these decisions. From the insurer's perspective, the decisions have therefore nullified the intended purpose of the notification provisions of a 'claims made and notified' policy and a 'claims made and occurrence notified' policy. They have revived the 'long tail' problem with claims being made many years later and the conflict as to exactly when an insured became aware of facts and therefore, which policy applied.[321] Contrary to the original aim of 'claims made' policies, insurers must set aside reserves to cover future claims under expired policies in order to satisfy any 'long tail' claims that these policies sought to avoid.[322] Increased exposure may lead to an increase in reinsurance[323] and other costs which will ultimately be passed onto the insured as increased premium costs.[324] Overseas and Australian insurers and reinsurers may also not continue to write business in and for the Australian market,[325] as it may also cause a degree of uncertainty for the insurer in determining its financial position.[326]

  109. As Justice Cole commented in Breville Appliances P/L v Ducrou, this leaves Australia in a 'unique position throughout the world.' Australian insurers could no longer offer an effective 'claims made and notified' policy or 'claims made and occurrence notified' policy as opposed to a 'claims made' policy.[327] The ultimate outcome would be a decline in the demand for and the supply of insurance cover, a deterioration in the economy's productive capacity and overall standard of living.[328]

  110. As can be seen from the recent public liability crisis, insureds have found it almost impossible to obtain cover. Those who are offered cover have been faced with grossly inflated premiums.[329] Ironically, the consequences may be even harsher for the insured than if the High Court had ruled the first limb in the insurer's favour.

    Finding a middle ground for section 54 for 'claims' policies

  111. Section 54 was enacted to remedy the previous legal environment where insurers were heavily favoured.[330] However, a law which entirely favours the insured is equally disastrous. Given that section 54(1) applies to both a failure to notify a claim and a failure to notify an occurrence, it is important that its effect be shackled to a certain extent to achieve a balance between the interests of the insurer and the insured. As Justice Pincus commented in Australian Hospital Care, to allow section 54 to operate in such a way that unfairly favoured the insureds would create 'so extreme an outcome that [the legislators] could hardly have intended it.'[331] It would impose on the insurer a risk 'much more uncertain in scope' and 'quite different in character' than that which it had originally agreed to undertake.[332]

    The benchmarks for reform and methods for 'shackling' the effect of section 54

  112. The following discussion covers the controversial situations where the insured has failed to notify a claim or an occurrence and is seeking to raise section 54(1) to 'excuse' that failure so as to be indemnified under the original insurance policy. It will not deal with the Greentree-type situations where the insured had no knowledge of an occurrence during the policy period and a claim did not arise until some time after the original policy had expired. It is submitted that the High Court in Australian Hospital Care had adequately resolved such 'non-event' situations by treating such claims as falling within the period in correspondence with when the claim is first made against the insured, or when the insured first becomes aware of an occurrence, rather than the original policy period.[333]

  113. The crux of the problem is whether the insureds should be protected from a failure to notify certain facts that are important to the insurers in determining their positions under the contract. Where the failure to notify a claim or an occurrence is deliberate, it would be contrary to the legislator's intention to allow section 54 to 'cure' that omission in favour of the insured. On the other hand, to exclude section 54 from coming into operation every time the insured had omitted to notify a fact would favour the insurer so much as to defeat the original purpose of the legislation. Hypothetically, an insured may become aware of an occurrence at 4pm on the last day of the policy period and decide to notify the insurer of that occurrence. By the time the insured is able to notify the insurer, the last insurance officer leaves for the day. To allow the insurer to deny the claim in such a circumstance would be harsh indeed.[334]

  114. Any reform to the law must therefore make section 54 fair for both parties who are vulnerable to the abuse of the other. The insured is vulnerable to the insurer who relies on technicalities to deny liability. The insurer, on the other hand, is vulnerable to the insured who does not inform it of certain facts that are important to it in assessing its risks. It follows that there are several factors which form the benchmarks for reforming the first limb of section 54. As was discussed earlier, the ALRC's recommendation of 'substance over form' is an important consideration. The solution must be practical and capable of being easily and fairly implemented so as to avoid lengthy litigation. The solution must also create certainty for both the insurer and the insured. This could be in the form of legislative or contractual certainty. Resolving the 'long-tail' problems faced by insurers under 'claims made and notified' and 'claims made and occurrence notified' policies is a priority. An aim to achieve certainty should not, however, affect the parties' right to a certain degree of contractual freedom.

  115. Judges and academics have proposed various methods that might be used in balancing the interests of the insurer and the insured whilst achieving the above benchmarks and also the broad aims of the legislation. The alternative proposals are:

    The next sections will critically examine each of these methods in turn. An additional alternative will then be proposed for consideration.

    Reviving the 'omission/inaction' dichotomy

  116. The 'omission/inaction' dichotomy is immensely unpopular amongst judges and academics because it creates an artificial distinction between the effects of a failure to notify a claim and an occurrence under a mandatory and optional notification provision respectively.[335] As Sutton argues, the whole point of notification is to enable the insurer to set aside appropriate reserves to meet future claims and to properly investigate a matter.[336] There is no difference between a mandatory obligation to notify and an optional provision to notify.[337] They produce the same result in that notification will affect the entitlement to claim in both the 'primary' insurance and the expanded cover.[338] 'Consistency would demand' that if a failure to notify a claim were 'excused' under section 54, a failure to notify an occurrence should also be similarly 'excused.'[339]

  117. Apart from these criticisms, the dichotomy is problematic in situations where the insureds have legitimate reasons for failing to notify an occurrence. The insured might honestly believe that the occurrence would not later give rise to a claim after, for example, having obtained appropriate legal advice.[340] There is no reason why the insured's failure to notify should be treated as an 'inaction' rather than an 'omission' in these instances.

  118. Despite these arguments, the 'omission/inaction' dichotomy still holds some attraction as it recognises the 'opt-in' nature of an optional notification clause. If the insured was aware of and had chosen not to notify an occurrence, it would lack common sense to later allow that decision to be 'excused' as an omission. As the Insurance and Superannuation Commission ('ISC') argues, there are practical reasons for having an option to notify facts, as distinct from an option to notify claims.[341] Amongst other things, the insured may feel that the possibility that the occurrence may actually turn into a claim is so remote that notification is not warranted. This is given the fact that notification may lead to an increase in premium or that the insurer may refuse to provide cover in a subsequent year.[342] There is also the expectation that any claim will fall into a later policy period.[343] Where the insured has made the commercial decision to not notify an occurrence, it is at least only fair to both parties that section 54 does not apply.[344]

  119. The 'long-tail' problems of 'claims made and notified' and 'claims made and occurrence notified' policies are sought to be resolved by drawing a distinction between an omission and an inaction. The recent medical indemnity crisis is an example where insurers face difficulties in indemnifying doctors for claims that arise many years later.[345] Insurance premiums have skyrocketed due to rising payouts and increasing litigation.[346] The problem was so serious that the government has recently proposed a package where it will subsidise insurance premiums for 'obstetricians, neurosurgeons and GP proceduralists.'[347] It will also pay half the cost of payouts over $2 million from January 2003. The package is likely to cost the government between $45 and $50 million a year.[348] The fact that the government has intervened and is willing to spend money to resolve the issue shows that the 'long tail' problem is significant to other issues that currently exist in the insurance sector.[349]

  120. There is, however, no such thing as an Utopian legislation. The hard edges of the law are liable to produce unfortunate results in certain cases. As Shakespeare aptly said, 'the web of our life is of a mingled yarn, good and ill together.'[350] Although insureds might have legitimate reasons for not notifying an occurrence, ideally they should always err on the side of caution and notify the insurer to ensure that they are covered should a claim later arise.[351]

  121. To allow a degree of fairness and flexibility, where the insured honestly believes in good faith that an occurrence will not later give rise to a claim,