Fraatz, Andrew --- "Payments in mass tort litigation: Accounting to insurers" [2021] PrecedentAULA 45; (2021) 165 Precedent 40

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PAYMENTS IN MASS TORT LITIGATION

ACCOUNTING TO INSURERS

By Andrew Fraatz

Since at least the 1970s, catastrophic bushfires in Victoria have sparked litigation from both plaintiffs and their insurers against at-fault companies. Insurers of affected property owners have historically cooperated with plaintiff lawyers in recovering damages from tortfeasors. On occasion, such cooperation has extended to insurers funding recovery actions (at least in part) and the prosecution of such claims.

The law recognises that in recovery proceedings brought by plaintiffs, to the extent that an insurer is entitled to subrogation in respect of a loss, there is an equitable interest in the damages payable by the tortfeasor to the insured plaintiff. When a person has suffered loss in compensable circumstances and has received an insurance payment for part of that loss, a question then arises as to the extent to which a person is required to account to their insurer. Further, does the extent vary if the plaintiff brings recovery proceedings in their own name or is a member of a class action?

These questions have been considered in recent class actions issued by Victorian lawyers in both NSW and Victoria, including in the Victorian Supreme Court case of Francis v Powercor Australia Ltd and Lenehan v Powercor Australia Ltd.^[1]

PRIORITY OF DISTRIBUTION BETWEEN INSURER AND INSURED

The 2009 Black Saturday bushfires in Victoria resulted in a number of class actions being issued against the state’s two major electricity distribution companies, AusNet Services and Powercor. The total settlement amounts in those class actions approached $1 billion, of which a substantial proportion was in respect of uninsured property. The legal costs of securing those settlements were also substantial. For example, the payment of $60 million in costs to the plaintiff’s lawyers (in a settlement sum of $500 million) was ordered in the Kinglake bushfire case Matthews v AusNet,^[2] and $20 million in costs (in a settlement sum of $300 million) was ordered in a case involving the Murrindindi bushfires.^[3]

As the settlement amounts were less than the total assessed damages, the issue of priority of distribution of the amounts recovered became significant. It is clearly in the interests of class action group members, as dominus litis,^[4] to first recover their uninsured losses before accounting to their insurer. A combination of these factors may result in instances where an insurer may not be able to recover any amount under such a settlement, despite the fact that the insured has received a substantial proportion of uninsured losses in damages.

In Matthews v AusNet,^[5] Osborn JA, in approving the Kinglake settlement, noted the interests of the insurers in a settlement scheme that distributed relevant property damage claims as between insured group members and their insurers on a pro rata basis, with each paying the pro rata proportion of the common legal costs incurred.

Justice Osborn stated that:

‘The scheme adopts this approach because the plaintiff’s legal advisers have taken the view that there is considerable legal uncertainty in the circumstances of this proceeding regarding the appropriate order of priority as between insurer and insured in the distribution of the settlement sum.’^[6]

At the time of the bushfire, while s67 of the Insurance Contracts Act 1984 (Cth) (IC Act) had yet to be amended, Osborn JA stated that the proposal for settlement ‘may be thought to reflect the policy of the current form of section 67’.^[7]

Rights to recovery under subrogation

Section 67 of the IC Act currently provides some guidance in circumstances of recovery actions. Where applicable, the amended s67 sets out the priority rights as between insured and insurer to a sum of money recovered from a third party in respect of an insured loss. Under s67(1), s67 applies if:

‘

(a) an insurer is liable under a contract of general insurance in respect of a loss; and

(b) the insurer has a right of subrogation in respect of the loss; and

(c) an amount is recovered (whether by the insurer or the insured) from another person in respect of the loss.’

Subsections 67(2)–(7) then provide for different priorities of entitlement to the sum recovered, depending on whether it was recovered by the insurer, the insured, or jointly. Under s67(2), ‘[i]f the amount is recovered by the insurer in exercising the insurer's right of subrogation in respect of the loss’, the insurer is entitled to recover (in priority to the insured) the amount paid by the insurer to the insured in respect of the loss, and the administrative and legal costs incurred in respect of the recovery.

Subsection 67(3) reverses the priorities in s67(2) such that if the insured recovers the amount, the insured is entitled to so much of the amount as does not exceed the sum of the insured’s overall loss and the administrative and legal costs paid by the insured.

Subsection 67(4) provides that ‘if an amount is recovered by the insurer and the insured jointly’, the priorities set out in ss67(5)–(7) apply. In a case where the amount recovered is less than full recovery, s67(5) provides that ‘the insurer and the insured are each entitled to a portion of the amount recovered, calculated on a pro rata basis’ [emphasis added].

Importantly, s67(9) provides that the ‘rights of the insurer and the insured under this section in respect of a loss are subject to ... the relevant contract of insurance; and ... any agreement made between the insurer and the insured after the loss occurred’.

For that reason, the way in which s67 applies in any particular case will require an examination of the terms of the specific insurance contract.^[8]

WHERE INSURERS HAD NO ROLE IN LITIGATION OR RECOVERY

Since the approval of the Matthews v AusNet settlement in 2014, there have been a number of Supreme Court rulings approving settlements of similar claims on the basis of pro rata recovery as between insurer and insured. However, there has been a degree of contention for plaintiffs with regard to whether such a distribution should follow in circumstances where insurers neither played any part in the conduct of the litigation nor contributed to any funding towards the recovery.

Johnston v Endeavour Energy

Some of the issue was explored in Johnston v Endeavour Energy^[9] in the Supreme Court of NSW, which involved an extensive fire caused by the assets of a utility company in the Blue Mountains. Following the commencement of a class action under the state’s rules, certain insurers purported to exercise their rights under their insurance policies to ‘opt out’ group members in order to pursue separate insurer recovery proceedings against the same defendant. In that instance, the insurers were largely unsuccessful upon a challenge to the validity of those opt out notices. The Court held that the majority of the relevant insurance policies did not authorise the opting out of insureds by the insurer in the absence of a specific provision in the insurance contract.^[10]

Ultimately, upon the hearing regarding the insurers’ objection to a settlement other than on a pro rata basis between insured and insurer, a distribution scheme was approved by the Court without testing the provisions of the IC Act, an agreement having been reached between the insurers and the insureds which resolved the question of priorities.^[11]

St Patrick’s Day bushfires class actions

Background

This issue came to a head in Victoria in the context of the St Patrick’s Day bushfires of 2018. By April 2018, Maddens Lawyers had issued two representative proceedings arising from separate bushfires which occurred on 17 March 2018: the first caused by sparks from a clash of conductors on the Princes Highway at Terang (Lenehan v Powercor^[12]); and the second involving a wooden power pole which failed and brought conductors to the ground at Garvoc (Francis v Powercor and Electrix^[13]).

On 12 April 2019, certain insurers commenced recovery proceedings in the name of their insureds who had suffered loss and damage as a result of the St Patrick’s Day bushfires and consented to be opted out of the Maddens group proceedings. The litigation proceeded with the parties being ordered by the Court to cooperate in the delivery of expert evidence and other case management issues which were designed to facilitate an efficient and cost-effective resolution.

Francis was resolved at mediation in early 2019, while Lenehan ran for a period of time in the Warrnambool Supreme Court in late 2019 before settling. Although both cases resulted in excellent settlements, neither proceeding brought about a complete recovery of damages. Both proceedings were settled on a lump sum basis (inclusive of costs)^[14] to be distributed between group members via a court-approved settlement distribution scheme, pursuant to s33V of the Supreme Court Act 1986 (Vic) (Supreme Court Act).

Upon application for approval of the settlements, the plaintiffs’ solicitors proposed to distribute the settlement money on the basis that it was the plaintiff and the group members who had recovered the damages within the meaning of s67(3) of the IC Act, with the effect that some insured group members would receive their uninsured losses and deduct legal costs before accounting to their insurers. This would result in a significantly reduced distribution to insurers relative to distribution if the pro rata model were adopted.^[15]

The insurers supported the overall settlement between the group members and Powercor; the proposed mechanism of distribution of compensation (to the extent that it involved deduction from the settlement sum of an amount approved by the court for legal costs); and a reimbursement payment to the lead plaintiffs. However, there was dispute as to how any reimbursement payment to insurers ought to be calculated and paid, having regard to payments made under the various insurance contracts of insured group members. The insurers ultimately objected to the proposed settlement distribution schemes in each proceeding.

The Court had no difficulty approving the settlements inter partes. In Lenehan, the Court stated that it was:

‘satisfied in all the circumstances that the benefits of the settlement – namely payment of a very high proportion of the likely damages obtainable based on a reasonable assessment of quantum and a certainty of that result – is clear and that the settlement is in the interest of group members as a whole’.^[16]

The residual priorities issue, however, was stood over for further argument and was hotly contested.

Francis v Powercor Australia Ltd and Lenehan v Powercor Australia Ltd^[17] (Francis and Lenehan)

A point of interest for the Supreme Court of Victoria was that there was no existing authority considering the application of s67 to a class action issued under Part 4A of the Supreme Court Act (or cognate Australian legislation). Further, there were no similar proceedings in any comparable jurisdiction and there was scant authority on the application of s67 generally.

It was not disputed that the insurer objectors had an interest in the proceedings, having made payments under policies of indemnity and possessing rights of subrogation to the interests of their insureds. However, the extent and implications of their interests in the allocation of recovered proceeds were in issue; particularly in question was who would have priority in a representative proceeding.

The proposed schemes involved assessing each group member’s notional entitlement to compensation and then dividing the aggregate compensation pool between them according to the relative values of their assessed entitlements.

The plaintiffs proposed that the administrator of the scheme should determine any insurance repayment, having regard to certain discrete considerations including, relevantly, the terms of each individual group member’s insurance policy and the terms of the IC Act.^[18]

The insurers unsuccessfully sought to adopt an alternative approach whereby the compensation pool was to be divided between group members and their registered insurers on a pro rata basis, according to the value that the above-insurance losses (comprising uninsured and underinsured losses of individual group members) bore to the insurance amounts paid, except where the contract of insurance expressly provided otherwise.^[19]

At the heart of the objection was a significant proportion of uninsured losses of group members who had received payments under policies of indemnity across the two proceedings, together with the allocation of responsibility for substantial legal fees. In other group proceedings in which the question of priority between insured group members and insurers was raised, priorities were agreed on a pro rata basis.

In Francis and Lenehan, both parties agreed that, in accordance with the terms of the IC Act, any contract of insurance would apply to determine priorities. However, where those policies were silent as to priorities – which applied to nearly all of the relevant insurance policies – the questions became:

• Who ‘recovered’ the amounts (being the settlement achieved) for the purposes of s67 of the IC Act?

• Did (as was submitted by the insurers) the practice in previous group proceedings in effect create a rule that prevented the plaintiffs in the Francis and Lenehan proceedings from asserting rights otherwise enjoyed under the IC Act?

Unsurprisingly, the insurers’ objection was dismissed and the Court found that the group members had recovered the damages. There was no basis for a rule to be applied requiring the settlement sum to be distributed on a pro rata basis as between the insurer and their insured.^[20]

The insurers variously contended that:

• they recovered the settlement moneys and were therefore entitled to priority;

• notwithstanding, they were prepared to accept the allocation of settlement proceeds on a pro rata basis, which amounted to a compromise in favour of group members; and

• it would be unconscionable to apply any discount accepted on settlement other than proportionately to insured and above-insurance losses.^[21]

The fundamental submission of the insurers was that ‘the insured group members remained in the proceedings because the Insurers permitted them to do so; the Insurers were entitled to require their insureds to opt out of the proceedings but chose not to do so, and therefore, in effect, “the insurers took over the insureds’ recovery actions...”’.^[22]

The Court rejected this argument.^[23] The Court held that if an insurance contract did not confer upon the insurer the right to require its insured to opt out of the proceedings, there was no election to be made in relation to those rights. Where those rights existed, a non-exercise of contractual rights in each case was insufficient to exercise a right of subrogation. The existence of rights must be distinguished as a matter of principle and practicality from the exercise of those rights.^[24] In contrast, the plaintiffs (on behalf of the group members) assumed the risk of incurring legal costs in respect of the proceedings and recovery of damages, including seeking court approval for the settlements.

In finding that the plaintiffs recovered the ‘amounts’ in question, and that they did so on behalf of group members, Nichols J stated:

‘Although group members do not conduct representative proceedings, it is their claims that are advanced in the proceeding. In these proceedings the amounts recovered from the defendants in respect of which the Insurers had subrogated rights (that is, the amounts falling within s67(1)) were recovered by the pursuit of common claims, including by the plaintiffs’ settling those claims on behalf of group members, by proffering releases that were intended to bind group members, in exchange for payment of the settlement sums. Accordingly, while the plaintiffs did the things ... which produced the recovery, they did those things on behalf of group members, including the insured group members.

I consider that s67(3) is broad enough to encompass recovery by an insured through or by its representative, at least in the sense that representation is constructed by Part 4A ... The report that preceded the amendments to the present form of s67 ... made plain that the intended purpose of the amendment was to provide a comprehensive scheme for the distribution of moneys when recovered from third parties.’^[25]

Justice Nichols also considered the general law, in particular the insurers’ submission that a pro rata approach to priorities in respect of recovered moneys ought to be applied in the ‘special situation’ of settlements at less than the full value of the claim. Her Honour found that the insurers simply had ‘not demonstrated that any such principle must be applied as an exception or supplement to the priorities rules set out in s67, at least as a general proposition, absent any particular conduct by an insured amounting to a failure to give bona fide consideration to the interest of its insurer’.^[26]

Justice Nichols appears to have accepted that the insured was dominus litis because each insured group member was not fully indemnified for total actual loss, and the accompanying right to control proceedings carries with it the right to reach a bona fide settlement with the third party tortfeasor for less than the insured’s total losses.^[27] The Court confirmed that the question in such cases is ‘whether the settlement is objectively reasonable, having regard to the material available to the insured at the time of the settlement’. It stated that there is no general rule to the effect that once settlement proceeds have been obtained in that way there is an additional requirement to distribute the settlement proceeds pro rata in order to protect the insurers’ interests.^[28]

CONCLUSION

The Francis and Lenehan decision confirms the importance of considering insurer interests in settlements where payments have been made under a contract of insurance in respect of the loss. This decision also confirms, at least indirectly, that insurance payments do not necessarily reflect the loss recoverable against a tortfeasor at common law. And, subject to s67(9) of the IC Act, the decision establishes that insured plaintiffs and group members in representative proceedings are entitled to rely on the priorities in the Act to recover their uninsured losses first, the reasonable costs in securing that outcome second, and then account to their insurer if there is any residue of a bona fide settlement that is reached for less than full value.

Andrew Fraatz is a barrister at the Victorian Bar. He appeared as junior counsel for the plaintiffs in the Francis and Lenehan proceedings.

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^[1] [2020] VSC 836.

^[2] Electricity Services Pty Ltd & Ors [2014] VSC 663 (Matthews v AusNet).

^[3] Rowe v AusNet Electricity Services Pty Ltd [2015] VSC 232.

^[4] Until the insured has been fully indemnified for his total loss, the insured remains entitled to control the litigation as dominus litis: see for example Baulderstone Hornibrook Engineering Pty Ltd v Gordin Runoff Ltd & Ors [2008] NSWCA 243 (per Allsop P, Beazley and Campbell JJA agreeing), [307]; Johnston v Endeavour Energy [2015] NSWSC 1117, [157]–[158], [174]; Santos Ltd v American Home Assurance Co (1987) 4 ANX Insurance Cases 60–795 (White J); Small Business Consortium Lloyd’s Consortium No. 9056 v Angas Securities Limited [2015] NSWSC 1511 (Ball J), [34]. See also M Ball and D Kelly, Kelly and Ball Principles of Insurance Law, LexisNexis Australia, May 2019, [9.0110].

^[5] Matthews v AusNet, above note 2.

^[6] Ibid, [396]–[398].

^[7] Ibid, [398].

^[8] See for example Matthews v AusNet, above note 2 (Osborn JA), [398](c) with respect to the previous iteration of s67.

^[9] Johnston v Endeavour Energy [2015] NSWSC 1117.

^[10] Ibid, [261]–[272].

^[11] Johnston v Endeavour Energy [2016] NSWSC 1132.

^[12] Lenehan v Powercor Australia Limited (No. 2) [2020] VSC 159.

^[13] (S CI 2018 01113).

^[14] $5 million in the Francis matter; and $17.5 million in Lenehan.

^[15] The issue arose where group members had entered into contracts of insurance under which, after the fires, they were indemnified for part of their losses arising out of the fires.

^[16] Lenehan v Powercor Australia Limited (No. 2) [2020] VSC 159, [41].

^[17] [2020] VSC 836 (a joint ruling in each of the Francis and Lenehan proceedings).

^[18] Ibid, [18].

^[19] Ibid, [20].

^[20] Ibid, [97].

^[21] Ibid, [95]–[111].

^[22] Ibid, [54].

^[23] Ibid, [55].

^[24] Ibid, [82].

^[25] Ibid, [90]–[91].

^[26] Ibid, [97].

^[27] Ibid, [102].

^[28] Ibid, [104].