Monthly Archives: September 2015

Insurer obtains stay of execution of judgment, sort of

An insurer has partially succeeded in applying to stay execution of a High Court judgment against it, pending an appeal to the Court of Appeal: AAI v 92 Lichfield Street [2015] NZHC 2190. The judgment in respect of which the stay was sought had held that a statutory demand served upon the insurer by its insured would not be set aside. The statutory demand was based on an alleged agreement that the insurer would pay the insured a sum of money for property damage to the insured’s building, outside the scope of the insurance contract. The key issue in the stay decision was whether the insurer should pay to the insured a sum reflecting the indemnity value under the policy that would be ultimately payable to the insured in any event, irrespective of the outcome of the appeal, taking into account the fact that the insured was insolvent.

In March 2015, Lichfield served a statutory demand on AAI, its insurer, stating that AAI had agreed to pay it the sum of $6.5m in respect of a property damage claim arising out of the Canterbury earthquakes.  The statutory demand was based on an alleged agreement between Lichfield and AAI that AAI would pay this amount to Lichfield, and it was not based on a claim under the relevant insurance policy. AAI applied to the High Court to set aside the demand, saying that the parties had never reached binding agreement that AAI would pay Lichfield that amount. An Associate Judge of the High Court agreed with Lichfield, holding that AAI had agreed to pay the sum in question. AAI appealed that decision to the Court of Appeal. AAI applied to stay execution of the High Court’s judgment pending determination of the appeal.

The stay application was considered by Dunningham J. The crux of the case was that Lichfield was insolvent, and in receivership. It owed liabilities of approximately $9m, with most of that owing to a secured creditor, Equitable. If the judgment sum was paid to Lichfield, it would be distributed for the benefit of Equitable, and therefore later be irrecoverable in the event AAI’s appeal to the Court of Appeal succeeded. In other words, the appeal would potentially be worthless. Whether an appeal will become worthless is one of the factors considered by a Court in the context of a stay application of this kind.

Resisting the stay application, Lichfield submitted amongst other things that (i) AAI was contractually obliged under the insurance policy to pay at least the indemnity value of the property, and (ii) AAI itself had said that if there was no binding agreement between the parties it would pay the indemnity value of the building under the policy of $4,627,000 in order to close the claim. Lichfield contended that this meant that whatever the outcome of the appeal, AAI would only ever be entitled to recover the judgment sum of $6.5 less this indemnity value: an amount of $1,873,000.

Dunningham J analysed the relevant provisions of the policy. She concluded that AAI’s minimum obligation was to pay the indemnity value of the building regardless of whether AAI succeeds or not in its appeal and regardless of how Lichfield exercises its election under the policy to either accept payment of the indemnity value or choose to reinstate the building (an election open to it under the policy). The judge concluded that to protect AAI’s appeal rights, the judgment only needed to be stayed to the extent of the difference between the insurer’s assessment of the indemnity value and the judgment sum (plus costs). In other words, there was only a stay to the extent of $1,873,000 and conversely Lichfield was entitled to enforce the High Court judgment to the extent of $4,627,000, plus costs.  An order was made to this effect.

Comment

It is not absolutely clear from a review of the decision whether AAI had ever definitively committed to the indemnity sum being $4,627,000. Dunningham J noted that her decision did not determine the quantum of the indemnity value. She noted that in the event that AAI succeeds in its appeal, and the parties reverted to making an assessment of Lichfield’s entitlements under the policy, then the correct figure would still need to be determined. This reasoning is open to question because the effect of Dunningham’s decision was in effect to crystallise the amount of the indemnity sum. This is a consequence of the fact that from the time it is paid by AAI to Lichfield under the terms of the order, it will be irrecoverable.  On the face of it, this may sound like it has the potential to be unjust. However, based on the way the Court analysed the available evidence, it seems likely that if the indemnity value is not in fact $4,627,000 this amount is probably not too far of the mark. So, in the context of a stay of execution of a judgment, it was reasonable to conclude payment of at least this amount was appropriate in terms of the balance of convenience between the parties.

It is understood that AAI has not lodged an appeal against Dunningham J’s decision.

Steve Keall
Barrister

23 September 2015

Recent case: Vero Liability v Heartland Bank

Ongoing litigation between Heartland Bank (previously Marac) and Vero Liability should be of interest to both insurers and financial institutions. It provides the first significant in-depth judicial consideration in New Zealand of fidelity cover and the issues it throws up in proving dishonesty and related matters: Vero Liability Insurance Ltd v Heartland Bank Ltd [2015] NZCA 288.

Fidelity cover is a form of insurance which covers businesses against the financial fraud of their own employees. In the marketplace this kind of product is sometimes known as a fidelity bond or a bankers blanket bond (although it is not a bond, but a simple contract of insurance).

Over the relevant period one of Marac’s senior managers, an employee, knowingly continued to commit the company to lending to a customer well in excess of the employee’s authority, causing loss to the company. The evidence was that the employee had taken steps to disguise what he was doing, including omitting relevant information about the lending from reports submitted to the company’s credit committee, instructing more junior staff to alter internal records of arrears, and failing to mention it to a close colleague in whom he usually confided about his work issues. When the situation was queried in the course of an internal audit, after making one final attempt to cover it up  the situation was uncovered and the employee did not return to work.

Marac made a claim under its “Crime Insurance” policy with Vero Liability. The policy covered direct financial loss consequent on dishonest acts of employees committed with the clear intent of causing loss to the company.

One remarkable feature of this case was that there was no suggestion, or evidence presented, that the employee ever made, or intended to make, any kind of real financial gain for himself from the transactions in question. Instead, the evidence was that he continued with the unauthorised lending transactions to disguise what he was doing to avoid or at least postpone being found out and inevitably losing his job. A further remarkable feature was that the employee, who Vero Liability called to give evidence at trial ten years after the events in question, could not explain why he started the unauthorised loans in the first place. For whatever reason, he could remember very little.

Both the High Court and Court of Appeal found  that the employee’s conduct in continuing to make the unauthorised lending available was dishonest. The more challenging issue was whether Marac had established that the employee had acted with “clear intent” to cause loss to Marac. This was a difficult question because, as outlined, the employee’s motivation did not appear to be cause any harm to the company, or obtain anything for himself. This may have been an easier question to address if the genesis of the scheme had been shown to have some malign motivation, but as already noted, this was not the evidence. Rather this aspect remained something of a historical mystery, potentially more linked to the employee lacking operational expertise and competence in managing work of the relevant kind. So, what might have begun as an incompetent mistake or error of judgment ended up turning into a dishonest scheme the employee felt he could never reveal.

The High Court held that intent to cause loss was a question of fact to be inferred from the available evidence. Knowledge that an act would result in loss was strong evidence pointing towards the required intent existing. The Court held that intent could be distinguished from desire, and the fact that an employee did not desire loss to the employer, while relevant, did not prevent a determination that intent existed for the purposes of the relevant provision of the insurance policy. In a later judgment the High Court went on to assess the quantification of the loss the insured could claim as a result.

The Court of Appeal made a different assessment of the evidence and as a result of that different assessment, it reached a different view on the intent issue. The Court noted that from a particular date onwards, the evidence was that the amounts received from the customer exceeded the sums advanced during the same period, as shown in documentary records for that period. The Court of Appeal considered that these records, and the efforts made to obtain repayments from the customer, demonstrated a concern inconsistent with a clear intent on the part of the employee to cause loss to Marac.

The Court of Appeal also considered it was relevant to the intent issue that there was no evidence of dishonesty in relation to the commencement of the lending programme and that the employee did not receive any financial advantage from the transactions, other than remaining employed (in the sense that when he was uncovered, he would inevitably be fired).

The Court of Appeal concluded that Marac had not established on the balance of probabilities that the employee had a clear intend to cause Marac loss. It therefore allowed an appeal on this issue.

The Court of Appeal’s reasoning will satisfy insurers because it aligns more closely with the historical purpose and function of fidelity cover type policies.  They are geared towards embezzlement by employees where the financial gain by the employee usually equates to the loss claimed by the company under the policy. Insurers would say that the wider scope suggested by the High Court judgment would need to be priced differently.

The Supreme Court website shows that Marac has applied for leave to appeal to the Supreme Court. This does not reveal the existence of any cross-appeal in relation to the Court of Appeal’s confirmation of the High Court finding that the employee was dishonest for the purposes of the policy. There seems to be a reasonable case for arguing that the “clear intent” issue is of sufficient significance to be considered by the Supreme Court, because the lower Court’s decision is the only New Zealand decision on point. Presumably Marac has sought to argue that it would be unsatisfactory for an incorrect decision (in its view) to regulate the way all like New Zealand fidelity policies are treated for future claims. From the point of view of legal principle and argument, this will be an attractive case for the Supreme Court to grapple with. I doubt whether any cross-appeal for leave to appeal in relation to the dishonesty issue will succeed. There was ample scope for both the trial Court and the Court of Appeal to conclude that there was dishonesty. These findings were very much of a factual nature and the Supreme Court would not be inclined to permit Vero Liability to relitigate this point. The existence of the required “clear intent” is a different matter.

The Court of Appeal also disagreed with the High Court’s assessment of the quantification of the loss. That is also the subject of Marac’s leave application to the Supreme Court.

Court of Appeal judgment
High Court judgment (liability)
High Court judgment (quantum)

Steve Keall
Barrister
13 September 2015

Amended on 15 September 2015 to reflect that Vero Liability and not Marac called the employee as a witness at trial.