Corporate Insolvency & Restructuring Forum

Transcription

1 Corporate Insolvency & Restructuring Forum How to tell if an insurance company is insolvent: what lessons we can learn from past insurance company collapses Michael Quinlan Partner Allens Arthur Robinson 5 December 2007 Copyright Allens Arthur Robinson mcqs A v Page 1

2 Table of Contents 1. Introduction 4 2. The Elements and Proof of Insolvency What is insolvency? 4 3. What is a debt? Can an insurance claim be debt? Statutory demands Insolvent Trading Should an insurance claim be a 'debt' for statutory demands? Consequences of Insolvency Winding Up in Insolvency Priority of Payments 16 (a) Re HIH Casualty and General Insurance Ltd 17 (i) The HIH Schemes 18 (ii) The Letter of request 19 (iii) English proceedings 20 (iv) Decision against transfer of assets to Australia 20 (v) Relevant UK insolvency legislation 20 (vi) First instance case law on section (vii) The English Court of Appeal judgment in Hughes v Hannover 22 (viii) The First Instance HIH Decision 23 (ix) The Court of Appeal's decision in HIH 23 (x) Consequences for the HIH Schemes 25 (xi) Conclusions Re HIH judgment 25 (b) Independent Insurance 26 (i) Letter of request 26 (ii) Scope and effect of ss581(2)(a) and 581(3) of the Act 26 (iii) Recognition of the English liquidation 28 (iv) Claim for declaratory relief 28 (v) Claim for injunctive relief 29 (vi) Order directed to unidentified persons 29 (vii) Reciprocity 30 (viii) Similar auxiliary relief in other countries 30 (ix) Conclusions Independent Insurance 31 (c) AssetInsure Pty Limited v New Cap Reinsurance Corporation Limited 31 (i) Background 31 (ii) Revisiting the decision of the Supreme Court at first instance 32 (iii) Findings of the NSW Court of Appeal 32 (iv) Decision of the High Court of Australia 32 (v) Meaning and interpretation of s31(4) of the Insurance Act 33 (vi) Meaning and interpretation of s562a of the Act 34 (vii) Conclusions arising from the New Cap Re decision 34 mcqs A v Page 2

3 5. Voluntary Administration Schemes of Arrangement Creditors' schemes Other types of schemes of arrangement Implementing a scheme of arrangement 41 (a) Identifying creditors and the Explanatory Statement 41 (b) Convening a meeting of creditors 41 (c) Meeting of creditors 42 (d) Approval of the Court Principal features of solvent Schemes of Arrangement Advantages of solvent schemes of arrangement Class issues in a solvent scheme of arrangement Post-Approval amendments to Schemes of Arrangement Cross-border recognition of solvent schemes of arrangement Conclusion 49 mcqs A v Page 3

4 1. Introduction In this paper we will address a number of interesting issues impacting insurance and reinsurance companies (which for ease of reference will be referred to simply as 'insurers' or 'insurance companies') relating to the Corporations Act 2001 (Cth) (the Act) insolvency and restructuring provisions. In particular, the paper will deal with: defining when an insurer is insolvent for the purposes of the Act and outlining the implications; answering the vexed question of when an insurance claim is a 'debt'; outlining the exposure of directors and parent companies of insurance companies for insolvent trading; considering whether statutory demands can be used by insureds against their insurer; examining issues relating to the distribution and availability of onshore and offshore assets of an insolvent insurer; considering whether or not voluntary administration is an option for insurers in runoff; and discussing the increasing use of solvent schemes of arrangement. 2. The Elements and Proof of Insolvency 2.1 What is insolvency? Solvency is defined in section 95A(1) of the Act which states that: A person is solvent if, and only if, the person is able to pay all the persons' debts, as and when they become due and payable. An assessment of cash flow rather than a company's balance sheet or net assets is therefore the accepted test for determining solvency for the purposes of the Act. Justice Emmett in Quick v Stoland 1 set out four factors which should be taken into account in determining a company's solvency: all of the company's debts as at the time in order to determine when those debts were due and payable; all of the assets of the company as at the time in order to determine the extent to which those assets are liquid or are realisable within a time frame that would allow each of the debts to be paid as and when they become payable; 1 (1998) 87 FCR 371; (1998) 157 ALR 615; (1998) 29 ACSR 130; BC mcqs A v Page 4

5 the company's business as at the time in order to determine its expected net cash flow from business by deducting from projected future sales the cash expenses which would be necessary to generate those sales; and arrangements between the company and prospective lenders such as its bankers and shareholders in order to determine whether any shortfall in liquid and realisable assets and cash flow could be made up by borrowings which would be repayable at a later time than the debts. The words 'as they become due' mean, as they become legally due. 2 The case law demonstrates that whether or not an insurance company is or is not insolvent at any given point of time for the purposes of the Act will depend upon issues including: cash reserves expected to be available at the time when debts become due; adequacy of working capital/cash flow; available (and reliable) sources of funding; the company's ability to borrow; times and dates for payment; timing of anticipated reinsurance recoveries; timing of receipt premium income; claims incurred and paid and claims incurred but not reported; reliability of promises which have been made by creditors to pay; assets available for realisation and the value they will realise; whether insurance claims should be treated as a debt and if so when; and how far it is necessary to look into the future. The critical thing about a cash flow test is that it is a test based on timing - the company needs the money to pay its debts when they fall due, not just an expectation that it will ultimately be able to pay its debts after they have fallen due. In relation to insurance the time at which an insurance claim becomes a debt may therefore be determinative of insolvency depending upon how far into the future it is necessary to look. As the test is not whether the company has the ability to pay all of its debts which have in fact fallen due but rather that it has the ability to pay its debts as and when they fall due there is some degree of looking into the future involved in assessing present solvency. The Courts are normally prepared to only look into the future for a very short period say a month or so but interestingly the most extreme case of forward looking in assessing present solvency is an insurance case. 2 see Richardson J in Re Northbridge Properties (unreported M 46/75 13 December 1997) which was quoted with approval by Davison J in Re Universal Management Ltd (in liq) (1981) NZCLC at mcqs A v Page 5

6 In Insurance Commissioner v Associated Dominions Assurance Society Pty Limited 3 the High Court ordered that a life insurance company be wound up and a liquidator appointed to it. Fullagar J took the approach that an ability to pay contingent and future claims must be taken into account along with an ability to pay present claims, in assessing the solvency of an insurer. His Honour noted the peculiar features of an insurer's liabilities, being both substantial and often largely contingent. He noted that the task of assessing a life insurance company's financial position is more difficult than in the case of an ordinary commercial concern, because of these peculiar features. He noted: While the immediate liabilities may be quite small, those which are payable in the future upon death, or in the case of endowment assurances upon survival, are likely to be very substantial 4. Fullagar J observed that it was therefore necessary to begin by estimating the cost of future claims and future receipts from premiums as well as income from investments. Fullagar J also sounded a note of caution, observing that solvency is: not such a clear-cut question as it normally is in the case of an ordinary commercial undertaking 5. Having regard to the company's contingent and prospective liabilities, Fullagar J was satisfied that this life insurance company was insolvent. He found as follows: The central and outstanding fact in the whole case appears to me to be that the company is insolvent. I regard this as quite clearly established. The company is insolvent not merely in a technical sense but in a practical and commercial sense, not merely in slight degree but in a very serious and substantial degree. This does not mean that it is unable at the moment to pay its debts as they fall due. It could, so far as the evidence goes, discharge its current liabilities tomorrow, and it will for some time to come be able to pay its policy holders in full as and when their claims mature. But it is highly probable - practically certain, I think, as matters stand - that it will in the not very distant future be unable to discharge in full claims under maturing policies. When that event will occur cannot in the nature of things, be precisely stated. I did not understand it to be suggested that it was likely to occur before 1960 [i.e. 7 years after the date of the decision]. That being the position of the company, there is, in my opinion, a high degree of probability that, if it is not placed in liquidation, policy holders whose claims mature in the near future will be paid in full at the expense of those whose claims mature in the more distant future. Many, of course, will already have been paid in full, and nothing can be done about that. But such a state of affairs ought not, in my opinion, to be allowed to continue. In a winding up all policy holders will stand on an equal footing, whether their claims are due to mature soon or late. It seems to me to be prima facie just and equitable - just and equitable from the point of view of the policy holders generally - that a company which finds itself in the position of this company should be wound up. I would, of course, agree that an assessment of future prospects is a vital element in the case which the commissioner makes. To a motion based merely on present insolvency - 3 (1953) 89 CLR ibid., at ibid., at p110. mcqs A v Page 6

7 even a substantial degree of insolvency - it might be possible for a company to make a number of answers. For example, it might be said that it was a young company which had not had time to recover from heavy initial expenditure and which, though at the moment insolvent, was rapidly building up reserves. No such answer, however, could be made in this case, because this company has been carrying on business for twenty-five years. Again. some satisfactory explanation of a company's present insolvency might be forthcoming: it might be shown to be due to misfortunes which were not likely to recur, or to errors in management or policy which had been remedied. Again, however, no such answer is really put forward in this case. It should be noted that Fullagar J found that the company was insolvent in 1953 even though the evidence was that it would not run out of money to pay claims until This was not merely a case where the company was likely to become insolvent at some future time. Fullagar J also acknowledged that it would be possible for an insurer to lead evidence before a court pointing to facts which would establish a reasonable prospect that the insurer's finances would improve in the future and its reserves would increase, such that it would be able to pay contingent and prospective liabilities as they fell due for payment. In the case before him, His Honour found that those facts were not present. Nevertheless, Associated Dominions suggests that courts will be prepared to make a determination that an insurer is insolvent having regard to its contingent and prospective liabilities although it will be cautious in doing so, in view of the inherent uncertainties involved in assessing those liabilities and the ability of the insurer to pay them as they become due and payable. 3. What is a debt? As can be seen, the meaning of debt is of importance to many significant provisions in the Act. For that reason you might expect there to be a very clear definition of the term and that the term would mean the same thing wherever it is used in the Act. You might also think that if the Act only used the word debt that word would only mean presently payable debts and not future or contingent debts because where the Act means to include not just presently payable debts, it says so, for example, in section 459D (in relation to winding up in insolvency) and in section 553 (in relation to proofs of debt). Unfortunately the position revealed by the cases is that debt seems to mean different things in different parts of the Act. The problem arises because there is no definition of debt within the Act. There is no quick and fast rule of what constitutes a debt and its meaning varies according to the type of transaction in question and the context in which it is used. Generally, a company incurs a debt when by its choice, it does or omits to do something which, as a matter of substance and commercial reality, renders it liable for a debt for which it otherwise would not have been liable. Debt has been interpreted as something recoverable by an action for debt and thus must be ascertained or capable of being ascertained. Many authorities suggest that the obligation must be for an ascertained liquidated sum. mcqs A v Page 7

8 3.1 Can an insurance claim be debt? Whether or not an insurance claim is a debt or not sounds like a very esoteric question and one which is not likely to be of much practical concern to those who deal with insurers. In fact, it is a very important question for a number of reasons, including the assessment of the validity of statutory demands and whether a company has traded while insolvent. It should first be clarified however that in this context, the expression insurance claim means an insurance claim which has been made by an insured under an insurance policy which has not yet been found to be payable by an arbitral or judicial award and has not yet been the subject of a binding settlement between an insured and its insurer. 3.2 Statutory demands Creditors of companies regularly use the statutory demand procedure. A creditor can only issue a statutory demand if it is owed a debt of $2,000 or more that is due and payable. The ability to access this procedure is a very important lever to an unsecured creditor because once a statutory demand is served on a company if the company does not pay or compromise the debt or commence proceedings to have the demand set aside within 21 days of receipt of the demand, it is deemed to be insolvent for the purposes of the Act. So for an insured the question of whether an insurance claim is or is not a debt is of critical importance. The answer to that question determines whether or not the insured can issue a statutory demand for an unpaid claim or not. There are a limited number of cases which consider the meaning of debt in the context of insurers. One such case is Reinsurance Australia Corporation Limited v Odyssey Re (Bermuda) Limited 6 and the appeal from that decision in which Master Macready and Justice Windeyer considered the meaning of debt in the context of insurance claims and statutory demands in Supreme Court of New South Wales proceedings. In these proceedings the reinsurer, Reinsurance Australia Corporation Limited (REAC), sought to set aside a statutory demand made on it on 9 June 2000 by Odyssey Re (Odyssey), its reinsured. Odyssey alleged that it was owed about $5 million under a policy of reinsurance which it held with REAC. The claim arose from an earthquake which occurred in Turkey on 17 August REAC was a listed Australian based reinsurance company with net assets said to be in the order of some $42 million. Since February 2000, REAC had been in run off meaning that it had written no new business since that time and was then involved in the process of paying out its liabilities under its existing reinsurance contracts. That process included discussions with various companies for a commutation or settlement of REAC's liability in respect of existing reinsurance contracts. REAC asserted that after that process was completed it would pay a substantial dividend to shareholders. Following notification of the possible claim by Odyssey, on 25 January 2000 REAC created a case reserve of $5M on the relevant policy of reinsurance. In late February 2000 the parties began to discuss a potential commutation, not only of the reinsurance policy the 6 (2001) 19 ACLC 987; [2001] NSWSC 266; BC mcqs A v Page 8

9 subject of the proceedings but of a number of reinsurance policies between a number of companies in the group of which Odyssey formed part. On or about 29 March 2000 Odyssey informed REAC that its insurance claim related solely to the Turkish earthquake. REAC raised a query with the insurance brokers, AON, on 3 April 2000 as to whether the loss was properly characterised as being in Europe. If it was in Europe a claim of the size of this claim would not have been covered. There was evidence that within REAC consideration was given to whether the place of the loss was in Europe for the purposes of the policy and ultimately certain people within REAC rejected the argument that the earthquake had occurred in Europe and would fall outside cover for that reason. On 18 April 2000 Mr Smith on behalf of REAC sent a fax to Odyssey's broker requesting information about the discount which Odyssey would accept on the claim. Critically, Master Macready found that by 18 April 2000, when REAC asked Odyssey's broker what discount it would accept on the claim: Given the terms of the correspondence and the evidence of usual practice, it seems clear that by this time the reinsured had provided 'reasonable evidence of the amount paid' under Article 16. The liability to pay had thus arisen. In other words, the situation by 18 April 2000 was this: Odyssey had written policies of insurance to its insureds and had paid out on claims made by its insureds in relation to the Turkish earthquake; REAC had agreed to reinsure Odyssey for those claims and to pay those claims on the provision by Odyssey of reasonable evidence of the amount paid; and Master Macready accepted that by 18 April 2000 Odyssey had provided reasonable evidence of the amount paid to REAC in accordance with the reinsurance policy. REAC's case was that unless or until there had been a binding arbitral award in Odyssey's favour, after REAC had refused to pay the reinsurance claim under the reinsurance policy, there could be no debt. The underpinning of that argument rested on a number of cases which had considered the nature of an insurance claim and found that an insurance claim was a claim for unliquidated damages. The argument was that no claim for unliquidated damages could be a debt for the purposes of section 459E of the Act but only a claim for liquidated damages could be such a debt. Master Macready observed that a number of English decisions provided clear support for the view that in English law a policy of insurance was only a promise of indemnity which gave rise to a right of action for unliquidated damages if the insurer failed to pay. He made the point that the English law position was particularly important because the relevant reinsurance contract provided for English law to be the proper law of the contract. Master Macready then turned to consider cases which dealt with section 459E of the Act or its predecessor to examine what the requirements were for a debt in that context. He found that that expression referred to a debt which was a liquidated sum in money presently due mcqs A v Page 9

10 and owing and payable by one person called the debtor to another person called the creditor. Master Macready found that under the reinsurance contract REAC had agreed to indemnify Odyssey for part of its ultimate net loss. He found that Article 1 of the contract of reinsurance was clearly a contract of indemnity. In those circumstances he found that Odyssey's claim was a right for damages for breach of the contract of indemnity and that there was no debt unless or until Odyssey by an appropriate arbitration obtained an award and ultimately a judgment debt for the purposes of enforcement. He therefore found that there was a genuine dispute in relation to the debt for the demand to be set aside. Article 16 of the reinsurance policy wording provided that loss settlements made by Odyssey as the Reinsured were binding upon REAC as reinsurer and that all that was necessary for Odyssey to make a claim was for it to present reasonable evidence of the amount which it had paid out to claimants to the reinsurer. The obligation of REAC to make those payments was subject to two conditions; firstly, that the settlements made by Odyssey were within the terms of the original policies which it had written and, secondly, that the settlements were within the terms of the policy of the reinsurer. The normal way in which reinsurance works is that the reinsured provides evidence of the amounts it has paid to the reinsurer and the reinsurer reviews the material provided and pays the claim. The reinsurer normally does not know all of the details of every claim made on an underlying policy to the reinsured. The relationship between a reinsured and a reinsurer, like the relationship between an insured and an insurer, is one characterised by the duty of utmost good faith and reinsurers have to have a significant degree of trust in their reinsured. Odyssey appealed from the decision of Master Macready and the appeal was heard by Windeyer J on 12 April Windeyer J noted that there was a possible exception to insurance claims being characterised as claims for unliquidated damages, being a claim for total loss under a valued policy. However importantly Windeyer J did not go into any detailed discussion or analysis of why such an exception should exist. Odyssey argued that the cases Windeyer J was referred to were all claims under policies of marine, fire or accident insurance. Windeyer J agreed with Master Macready that Odyssey's reinsurance claim was not in all the circumstances a debt. 3.3 Insolvent Trading Section 588G(1) of the Act imposes liability on a director of a company who allows that company to incur a debt at a time when the company is insolvent and at the time that the debt was incurred there existed reasonable grounds for suspecting that the company was, or may become as a result of incurring the debt, insolvent. A director can include not just formally appointed directors but also anyone who acts in the position of a director and anyone with whose wishes or directions the directors normally act (a so called 'shadow director'). The Act also imposes liability on a holding company for the insolvent trading of its subsidiary in certain circumstances. mcqs A v Page 10

11 Liability will arise if at the time the debt was incurred the director or other relevant person was actually aware of the existence of reasonable grounds to suspect insolvency or a reasonable person in a similar position within a similar company would have been aware. So for a director, shadow director and holding company of an insurer whether or not an insurance claim is a debt or not may be critical in determining both whether or not the company has incurred a debt and whether or not if a debt has been incurred the company was insolvent at the time that the debt was incurred. Similarly for a liquidator of an insurer wanting to bring a claim against the insurer's directors for insolvent trading the question of whether or not an insurance claim is a debt may be of critical importance. The term debt has been discussed in a number of cases dealing with the insolvent trading provisions of the Act. It is often said that in this context debts have been found to include contingent debts, relying on the decision in Hawkins v Bank of China 7. A contingent debt exists where there is a doubt as to whether there will be a debt at all - a contingent debt only becomes payable on the occurrence of certain events. In Hawkins the New South Wales Court of Appeal considered whether a debt for the purposes of director's liability for insolvent trading could include a liability under a guarantee which was clearly a contingent debt. Hawkins concerned the entry in January 1989 by Equiticorp into a guarantee to the Bank of China in respect of liabilities of two other companies in the group. Within a few weeks of the execution of the guarantee the two principal debtors went into provisional liquidation and demand was made on Equiticorp as the guarantor. The Court was faced with two principal arguments: the liquidator argued that a debt could include a contingent liability and that Equiticorp had incurred a debt when it entered into the guarantee (i.e. two weeks before the guarantee was called upon) and that the directors of Equiticorp should therefore be liable for that debt because at the time they entered into it they should have suspected that Equiticorp was insolvent. On the facts of the case that seems like a fair enough argument; and Equiticorp argued that entering into a guarantee is a contingent liability and not a debt and that therefore the company did not incur a debt at the time the guarantee was entered into. Equiticorp argued that the crystallisation of a contingent liability was not properly the incurring of a debt so that no debt was ever incurred within the meaning of section 556 in the events which occurred. It is easy to understand why the Court would not have wished to endorse that approach. The leading judgment in the decision is that of Gleeson CJ who took particular care to limit his findings to the particular case before him rather than decide that every contingent liability will be a debt. He also acknowledged that his approach to the decision turned not on the ordinary meaning of debt but on a construction of the intention of the legislature in introducing section 556 of the former New South Wales Companies Code (the forerunner to section 588G(1) of the Act). 7 (1992) 26 NSWLR 562; (1992) 7 ACSR 349; (1992) 10 ACLC 588. mcqs A v Page 11

12 Gleeson CJ considered the particular guarantee before him and determined that the liability which arose under it was not an obligation to pay unliquidated damages but was an obligation to pay a liquidated sum. He therefore side-stepped resolving the question of whether a debt could only exist in relation to a liquidated rather than an unliquidated claim. An esoteric question you might think but critical to determining when an insurance claim is a debt as we shall see. The statutory purpose of the definition of debt in the context of insolvent trading is to encourage directors to focus on the overall management of their company's financial affairs. In those circumstances where the central focus of the definition is to achieve an appropriate level of vigilance by directors for the overall financial affairs of their company the Hawkins approach is understandable at least on the facts there before the Court. The more recent New South Wales Court of Appeal decision in Box Valley Pty Limited v Elizabeth Kidd and David John Kid 8 considered Hawkins and applied similar reasoning in finding that a future claim for unliquidated damages arising from a possible future breach of contract was not a 'debt' for the purposes of assessing solvency. David Kidd Grain Trading Pty Limited (David Kidd Grain) was incorporated on 1 February 1993 and traded in grains and other rural commodities. It entered into futures contracts for the sale of these commodities at a specified price or on future dates. On 29 May 2001 David Kidd Grain signed an agreement to purchase a quantity of grain from the claimant, Box Valley Pty Limited (Box Valley). Between approximately 5 June 2001 and 15 June 2001, Box Valley delivered the grain to David Kidd Grain and the price payable was $100, David Kidd Grain entered into voluntary administration on 21 June 2001 as a result of its contingent liabilities under a number of unrelated sale contracts involving grain. It subsequently went into liquidation on 27 June 2001 upon a resolution of its creditors and a liquidator was appointed. Box Valley received a dividend of $5, in the liquidation leaving a shortfall of $95, from the amount owing to Box Valley at the date of the commencement of the liquidation. Following an investigation by the liquidator into the affairs of David Kidd Grain, the liquidator consented to Box Valley bringing its own proceedings against them under s588m of the Act which provides that a creditor, who has suffered loss or damage 'in relation to the debt because of the company's insolvency' can recover from a director an amount equal to the amount of loss or damage. In order to secure recovery a director must have breached s588g(2) or (3) of the Act in relation to the incurring of the debt by the company. Accordingly, Box Valley needed to prove the following principal facts to succeed in its claim, that David Kidd Grain incurred the debt to Box Valley at a time when: the company was insolvent: there were reasonable grounds for suspecting that the company was insolvent; 8 [2006] NSWCA 26. mcqs A v Page 12

13 awareness of insolvency which can alternatively be: actual awareness of reasonable grounds for suspecting insolvency; or a reasonable person would be so aware. The directors of David Kidd grain relied upon two of the defences set out in s 588H of the Act including that there were reasonable grounds to expect David Kidd Grain was solvent and reliance upon a competent and reliable person. The question which arose for consideration was whether a liability for damages to be incurred in the future was a debt which fell within the test for insolvency. Box Valley retained a chartered accountant to analyse David Kidd Grain's financial position at the time of the sale on credit taking into account its ability to meet its debts as and when they fell due. Box Valley placed considerable reliance upon the expert evidence given by the accountant which concluded that David Kidd Grain's exposure on its futures contracts at market prices and the size of debts owed to trade creditors were grounds for concluding that the company was insolvent. The trial judge rejected the expert evidence with little analysis on the basis that the expert had taken into account unrealised losses from trading in grain in determining the insolvency of the company and dismissed the claim. The Court of Appeal upheld the first instance decision and found that Box Valley had failed to establish that David Kidd Grain was insolvent at the time of the sale because the accountant's report was flawed and therefore could not be relied on. The report was flawed because the accountant was not entitled to take into account David Kidd Grain's exposure under the futures contracts when calculating the size of its debts to creditors. The exposure under the contracts at the time of the sale on credit, although unsustainable to the company, did not create a contingent liability to pay a liquidated sum. At most, it was an unliquidated sum because the market price of the commodity could have changed from the time of the sale to the expiry of the contracts. This meant that the exposure under the contracts would have fluctuated when the precise amount payable was not ascertainable until expiry. Additionally, even though it was likely that David Kidd Grain would default on the contracts at expiry, it would only be liable to a claim for damages for breach of contract. Unfortunately for Box Valley, liabilities giving rise to a claim to pay unliquidated damages are not a debt for the purposes of s 95A of the Act. A debt would only arise when: default on the contracts occurred; the amount owing was ascertained by the counter parties purchasing on the market against the contracts entered into by David Kidd Grain; and notice of default and the amount owing was given to David Kidd Grain. The crux of the issue in this case is that in order for a liability to constitute a 'debt' within s95a for solvency purposes, it must be ascertainable. Here, a futures contract could not mcqs A v Page 13

14 give rise to a liquidated claim until notice of default and details of the quantum of the claim had been given to the company. In relation to insurance claims the company's potential exposure to pay a claim arises when the policy is written. Whilst it is true that no obligation to pay arises until some trigger event covered by the policy occurs at some later time, normally once the policy is written the insurance company is subject to exposure under the policy if that trigger event later occurs. 9 For insolvent trading purposes it is submitted that the comments in Hawkins relating to contracts of guarantee could be applied with equal force to contracts of insurance and that the safest approach for directors to take is that an insurer incurs a debt at the point in time when it underwrites a policy of insurance. However, insurance policies are very peculiar contracts as most insurance contracts if breached give rise to a claim for unliquidated damages. 10 As we have seen claims for unliquidated damages are not a debt for insolvent trading purposes. 11 If the proper characterisation of an insurance policy is that a claim under the policy is a claim merely for unliquidated damages an insolvent trading claim may never arise. 3.4 Should an insurance claim be a 'debt' for statutory demands? The purpose of the statutory demand procedure is to facilitate the liquidation of companies which are insolvent. Obviously enough, it would be an unsatisfactory position for statutory demands to be available for claims in which the precise amount sought to be recovered was not objectively able to be established with certainty in accordance with the terms of the insurance contract. For example, following a fire an insured with a claim for reimbursement or indemnity could hardly immediately shoot off a statutory demand seeking to recover whatever amount was ultimately established to be its loss because there would be far too much uncertainty about the accuracy of the figure put forward. The interesting thing about the REAC case, however, is that there was no doubt that Odyssey had paid the underlying claims and Master Macready found that the requirement under Article 16 for Odyssey to provide reasonable evidence of the amount paid by it to REAC had been satisfied by 18 April On that date, having been provided with information by Odyssey, REAC sent a fax to Odyssey's broker, AON, asking what discount their client would accept. The sending of that fax clearly suggests that REAC had accepted that it had received sufficient evidence to trigger a payment obligation. As Master Macready found: 9 see Channell J in Prudential Insurance Co v Cmr of Inland Revenue [1904] 2 KB 658 at see Bankstown Football Club Limited v CIC Insurance (1997) 187 CLR 384 (per Brennan CJ, Dawson, Toohey and Gummow JJ) (HC); (1998) 10 ANZ Ins cases 74,447 (NSWCA). 11 see Jelin Pty Ltd v Johnson (1987) 5 ACLC 463 where it was held that the liability for damages resulting from misleading or deceptive conduct under the Trade Practices Act 1974 (Cth) did not, even if the subject of a judgment, constitute the incurring of a debt within the meaning of the Companies (Western Australia) Code (WA), s 556. mcqs A v Page 14

15 Given the terms of the correspondence and the evidence of usual practice, it seems clear that by this time that the reinsured had provided 'reasonable evidence of the amount paid' under Article 16. The liability to pay had thus arisen. In our view (at least under Australian law) it is incorrect to characterise every claim under an insurance policy or a reinsurance policy as a claim for unliquidated damages and perhaps, more importantly, as a claim which cannot be a debt for the purposes of the Act. In the REAC case the claim was for an amount which could be proven to be correct because it relied upon objective circumstances. It was effectively a claim which could be calculated rather than estimated or valued and was more like a valued policy rather than a policy of indemnity which included no value. In these circumstances it is difficult to see how the purpose or object of the statutory demand provisions of the Act are advanced by an unduly technical approach to the meaning of debt. A very important authority, which was not considered by Master Macready or by Windeyer J in the REAC decisions is the decision of the High Court in Spain v The Union Steamship Company 12. The High Court found in that case that a debt or liquidated demand arose when an employee sought to recover expenses incurred by him by relying on a clause in an employment award. The relevant award provided that: The Employer shall pay any reasonable expenses of an Employee incurred in the service or in the interests of the Employer. The High Court reached this conclusion 13 by reference to a statement in Odgers: Pleading and Practice that: whenever the amount to which the Plaintiff is entitled... can be ascertained by calculation or fixed by any scale of charges, or other positive data, it is... liquidated 14 So, in Spain, the High Court recognised that although the clause required a consideration of whether the expenses were or were not reasonable, the claim was nevertheless a liquidated rather than an unliquidated damages claim. The approach in Spain's case has been followed in a number of cases. 15 In our view, Spain's case would support the view that so long as the claim was objectively capable of being proven, the claim would be a claim for liquidated damages and a debt. Having said that, it is undoubtable that unless or until this issue reaches a superior Court (and probably the High Court) and a determination is made by it there is very significant doubt as to whether any claim under an insurance or reinsurance policy is a debt for the purposes of the statutory demand provisions of the Act, at least, pending a binding judicial 12 (1923) 32 CLR (1923)32 CLR 138 at th edition at page Norilya Minerals Pty Ltd v Adam Jonathon Ireland as Named Executor of Ule Estate of Dean Edward Ireland [2OO6] FCA 1235: Metropolitan Fire Systems Pty Ltd v Miller (1997) 23 ACSR 699: Dalgety Futures Pty Ltd v Poretsky [I980] 2 NSWLR 646: Lombard Australia Ltd v Smeaton [I966] VR 272, 60 QJP 92; Merchant Service Guild of Australasia v Commonwealth Steamship Owners Association (1934) 33 CAR 1. mcqs A v Page 15

16 or arbitral award or a binding settlement between the insurer and insured as to the amount of the claim. If this is correct, then insurers and reinsurers who are in financial difficulties can feel reasonably comfortable that an insured is unlikely to seek to pursue the insurer by use of the statutory demand procedure for unpaid claims. Unless the insured is willing to take the proceedings probably to the High Court (presuming special leave could be obtained), the statutory demand is likely to be defeated at first instance on the basis that there is no debt to found the demand. 4. Consequences of Insolvency 4.1 Winding Up in Insolvency Section 459P of the Act governs the application for orders to wind up companies in insolvency. In relation to any application for an order that a company be wound up in insolvency the Court is not restricted in considering the debts of the company in determining whether or not it is insolvent but the Court may also take into account contingent or prospective liabilities of the company pursuant to section 459D(1) of the Act. If a company is insolvent there is a risk that a creditor, ASIC, APRA or others authorised by the Act may ask the Court to make a winding up order. If that occurs various things happen including the following: a liquidator takes control of the company; the liquidator will attempt to realise the company's assets and ascertain its liabilities; actions may be began against directors and parent companies in relation to insolvent trading; certain transactions may be avoided; the liquidator may seek to recover amounts from creditors as unfair preferences; the liquidator may disclaim contracts; and the fact of the company's insolvency and/or the appointment of the liquidator may trigger contractual obligations entitling counter parties to terminate agreements with the company. In relation to insurance and reinsurance companies, particular issues arise as to the availability for distribution of certain assets to creditors or certain classes of creditors. 4.2 Priority of Payments The priority in which debts rank in an insolvency of an insurance company is generally similar to other companies. However, there are important distinctions as to the rights of general commercial creditors as opposed to those of insurance and reinsurance policyholders. Important distinctions also exist as to the multi-jurisdictional insolvencies and mcqs A v Page 16

17 in particular the operation of certain provisions of the Act which purport to provide Australian creditors with priority. Section 581 of the Act provides for courts to act in aid of each other by severally acting in aid of and being auxiliary to each other in all external administration matters. Where a letter of request from a court of a country other than Australia, requesting aid in an external administration matter, is filed in an Australian court, the court may exercise such powers with respect to the matter as it could exercise if the matter had arisen in its own jurisdiction. Reciprocally, the Australian court may request a court of a foreign country that has jurisdiction in external administration matters to act in aid of and be auxiliary to it in an external administration matter. In two recent insurance related decisions, one of the High Court and subsequently the Court of Appeal of England and Wales (the English Court) in Re HIH Casualty and General Insurance Ltd 16 and the other a decision of the Supreme Court of New South Wales (NSWSC) in Independent Insurance Company Ltd 17, the respective courts have been confronted with letters of request from foreign Commonwealth countries and have discussed the principles to be applied in consideration of them. (a) Re HIH Casualty and General Insurance Ltd An originating process to wind up HIH Casualty and General Insurance Ltd (HIH) and three associated companies was presented to the New South Wales Supreme Court (NSWSC) in March 2001 and liquidators of HIH were appointed in August Also in March 2001, the NSWSC issued a letter of request to the English court for the appointment in England of provisional liquidators over HIH pursuant to section 426 of the UK Insolvency Act 1986 (England and Wales) (the UK Insolvency Act). The English provisional liquidators were duly appointed to HIH, the liquidation of which in the UK was ancillary to the principal Australian liquidation. It subsequently became clear in Australia that unless the sums collected by the English provisional liquidators were remitted to Australia for the Australian liquidators to apply in the due course of winding up HIH or in accordance with a scheme of arrangement, insurance creditors of HIH would lose the benefit of section 562A of the Act. At the relevant time, English law contained no equivalent to this statutory provision. Whilst the provision is complex, in essence section 562A of the Act gives insurance creditors the right to participate in reinsurance recoveries in priority to other creditors. It is a very important provision because it is intended to provide a protection of significance to insureds in the event that their insurer goes into liquidation. In those circumstances, rather than reinsurance recoveries simply being treated as just another of the assets of the insurance company in liquidation, so that insureds would simply line up for a pari passu or equal distribution of the 16 High Court decision [2005] EWHC 2125 (Ch) and Court of Appeal decision [2006] EWCA CIV [2005] NSWSC 587, judgment dated 22 June mcqs A v Page 17

18 company's assets with all other creditors, the reinsurance recoveries are isolated and only insurance creditors are able to share in them. For some insurance creditors the position may be even more favourable because of the discretion given to the Court under section 562A(4) of the Act to give particular insureds the right to recover all of the proceeds of particular policies of reinsurance. Whilst we have not yet seen a judgment in any case in which the Court has been asked to exercise this discretion, section 562A(5) of the Act sets out some of the factors the Court could take into account, including whether: the reinsurance was entered into in respect of the particular insurance policy; the insured paid extra for the comfort of knowing the insurer was reinsured; the insurance policy included a statement that reinsurance was in place; and an insured would otherwise be severely prejudiced. Most reinsurance of Australian insurers is written overseas. Clearly, section 562A of the Act assumes that when an Australian insurer goes into liquidation its foreign reinsurers will pay reinsurance proceeds to the Australian insurer or its liquidator in Australia so that those reinsurance recoveries can be distributed by the liquidator to insureds in the manner provided by section 562A. The section simply cannot work to achieve that goal if the reinsurance proceeds never make it to Australia nor come into the Australian liquidator's control. Like most Australian insurers, HIH went to the London market to place much of its reinsurance with London-based reinsurers. If the reinsurance proceeds payable to HIH by English reinsurers were not remitted to Australia and English law were applied to their distribution, insurance creditors would lose out because English law did not have an equivalent to section 562A of the Act at the relevant time. (i) The HIH Schemes Which result would apply came to a head in the HIH liquidations because, with the aim of simplifying the liquidations to enable an early distribution to creditors, the liquidators proposed a scheme of arrangement under section 411 of the Act. The intention of the HIH liquidators was to have essentially the same scheme of arrangement in Australia and in the UK. To achieve this outcome, the liquidators first needed approval of the Australian Courts to take their proposed scheme to the creditors. The initially proposed scheme made certain assumptions about the operation of section 562A of the Act and section 116 of the Insurance Act 1973 (NSW) (the Insurance Act). Some HIH insureds objected to the scheme as proposed and conflicting expert evidence as to the likely position in England was filed. On 29 March 2005, Justice Barrett of the NSWSC refused to approve the convening of a creditors' meeting under section 411 of the Act for the mcqs A v Page 18

19 consideration of the scheme of arrangement proposed by the HIH liquidators for three main reasons: The scheme did not respect the priority conferred by section 562A of the Act on insurance creditors. In reaching this conclusion, Justice Barrett held that a scheme purporting to modify the effect of section 562A was way beyond the scope of section 411 of the Act. The scheme would cause assets to be applied in a manner that contravened section 116(3) of the Insurance Act. In particular, the scheme contained rules that fixed in advance the costs to be paid out of 'assets in Australia' within the meaning of section 116(3). Justice Barrett held that expenses incurred in realising assets in a fund for the purposes of meeting a preferred claim must be borne by that fund. As costs and expenses involved in one collection may be substantially more than those involved in another collection, the liquidators had to allocate costs fairly between the resulting funds. The liquidators could not allocate a disproportionate share of the costs to the fund of Australian assets. The scheme criteria for determining what was an 'asset in Australia' or 'liabilities in Australia' created the potential for the misclassification of assets and liabilities for the purposes of section 116(3) of the Insurance Act. One way of resolving the uncertainties as to what the correct approach under English law would be was to have that issue raised before an English Court. In June 2005, the Australian liquidators demanded that assets collected by and held by the English provisional liquidators in England be remitted by them to Australia for distribution. The English provisional liquidators resisted, instead seeking directions from the English court as to the appropriate distribution of the assets collected in England. Accordingly, the Australian liquidators applied to the NSWSC for a letter of request to the English High Court to be issued to this effect. (ii) The Letter of request On the application of the Australian liquidators, on 4 July 2005 Justice Barrett ordered the transmission of a letter of request to the English High Court. The letter of request stated that the Australian liquidators had shown to the satisfaction of the NSWSC that it was necessary that the English provisional liquidators remit the sums to be collected by them to the Australian liquidators for application in the due course of the winding up of HIH. What is interesting, however, is that the letter of request did not directly request the English court to direct the English provisional liquidators to pay over to the Australian liquidators the sums collected in their official mcqs A v Page 19