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NSW Court of Appeal rules COVID-19 claims must be paid by insurers

Businesses affected by COVID-19 may be entitled to insurance payments under business interruption policies after the NSW Supreme Court of Appeal (NSWCA) ruled so-called ‘pandemic exclusions’ were not valid.[1]

As the temporary insolvency relief measures come to an end, which will likely trigger a wave of insolvencies in 2021, external administrators should consider the potential claims under business interruption policies available to companies impacted by COVID-19.

Summary of NSWCA judgment

The test case was initiated by the Australian Financial Complaints Authority (AFCA) and the Insurance Council of Australia (ICA) to determine if pandemic exclusions in business interruption policies that referenced the Quarantine Act 1908 (Cth) (Quarantine Act) could be used to reject claims under those policies, noting the Quarantine Act has been replaced by the Biosecurity Act 2015 (Cth) (Biosecurity Act).

The defendants were insured against interruption to their tourist park businesses under business interruption policies issued by their respective insurers and the plaintiffs in this case, HDI and HDI Global Specialty (collectively, the Insurers). Each of the business interruption insurance policies provided cover for interruption or interference caused by outbreaks of certain infectious diseases within a 20 kilometre radius of the insured’s premises. The Insurers sought declarations on the proper construction of this coverage. They argued that each of the business interruption policies were subject to an exclusion for “…diseases declared to be quarantinable diseases under the Quarantine Act 1908 (Cth) and subsequent amendments", and while the Quarantine Act was no longer in force, this applied to COVID-19 for the following reasons:

  1. The Biosecurity Act was a “subsequent amendment”. As such, the exclusion should extend to diseases listed as human diseases under the Biosecurity Act, which includes COVID-19, on the basis that the Biosecurity Act was a “subsequent amendment”; or
  1. That references to the Quarantine Act were ‘obvious mistakes’ which should be construed as if they were, or included references to, the Biosecurity Act.

The five judges presiding over the case rejected both arguments, unanimously. As a matter of statutory interpretation, the words “and subsequent amendments” do not extend to or include the Biosecurity Act, which was a separate enactment entirely. The NSWCA also rejected the second argument based on principles of contractual construction.

As a result of the ruling, businesses may now be eligible to make business interruption claims as a result of the COVID-19 pandemic, subject to any appeal to the High Court of Australia (HCA) and the terms of the policy itself. The Board of the ICA have announced they intend to make an application for special leave to the HCA to appeal the decision of the NSWCA as well as an additional test case. You can read the official media release here.

In addition, this case has several important implications for external administrators, shareholders and/or creditors in an external administration scenario.

Business interruption claims – a shiny new asset

External administrators (be it an administrator, liquidator or receiver in certain scenarios discussed below) should consider their ability to step into the shoes of the company and make a business interruption insurance claim as agent of the company, on behalf of creditors.

Liquidation

A liquidator is required to investigate the affairs of the company to determine any potential causes of action that could increase the assets of the company, thereby maximising any return to creditors. One such asset which may now be available is the proceeds of a business interruption claim.

As an agent of the company, a liquidator has the power to:

  • make a business interruption claim on behalf of the company to increase the assets of the company and distribution payable to creditors; and/or
  • if a company’s claim under a business interruption insurance policy was previously rejected, a liquidator may be able to request a reassessment.

Administration

When investigating the affairs of the company, a voluntary administrator (VA) should consider the potential proceeds of a business interruption claim as an asset of the company in administration. Such an asset may influence a VA’s decision to recommend in its second report to creditors a deed of company arrangement (DOCA) or to otherwise recommend the winding up of the company. It may also influence a VA’s need to extend the convening period.

As is the case with the winding up of a company, a VA, as agent of the company, has the power to make a business interruption claim on behalf of the company, or request a reassessment.

The proceeds of a business interruption claim may form part of any pool of funds available under a deed of company arrangement either:

  • as a liquid asset in circumstances where a VA has obtained the proceeds of a business interruption claim on behalf of the company; or
  • as a right for the deed administrator to make a business interruption claim on behalf of the company.

Alternatively, if the company cannot be saved, a business interruption claim may form part of the assets available to creditors upon the winding up of the company.

Secured creditors

Depending on the terms of a secured creditor’s security agreement, a secured creditor’s security interest may extend to insurance proceeds from a business interruption claim. Secured creditors with such an interest should be alive to their right to be paid in priority from any proceeds of a business interruption claim.

Additionally, secured creditors who hold a security interest over the proceeds of a business interruption claim should be aware of their right to appoint a receiver who is able to make a business interruption claim as agent of the company and pay the proceeds to the secured creditor in priority in reduction of the secured debt.

It is important to seek legal advice as to the scope of a secured creditor’s security, to consider whether proceeds of a business interruption claim are included and whether the powers of appointment extend to the receiver being able to make the claim. Two common examples of where such security may exist are:

  • If a secured creditor has taken a security interest in all of a grantor’s present and after-acquired personal property that includes security over proceeds, a receiver may be appointed over the company to, among other things, make a business interruption claim on behalf of the company and pay the proceeds to the secured creditor.
  • If a secured creditor holds security specifically over insurance contracts of the grantor, or insurance contracts of the grantor otherwise fall within the collateral secured, a secured creditor may appoint a receiver to make a business interruption claim on behalf of the company and pay the proceeds to the secured creditor.

Safe Harbour

Companies considering safe harbour contingency plans as a result of distress, should also be alive to any potential recoveries available to them under insurance policies as a part of any plan to achieve a ‘better outcome’. Clearly the likely issue here will be one of timing on recovery and outcome, against the backdrop of incurring ongoing debts.

What next?

External administrators and secured creditors should take active steps to investigate the potential recovery of such a claim in businesses that were heavily impacted by COVID-19, particularly as we look to the likely wave of insolvencies in Australia as the temporary relief measures are rolled back on 31 December 2020 and stimulus measures, such as JobKeeper 2.0, conclude on 28 March 2021. In particular, they should seek legal advice as to the terms of any insurance policies and security agreements.

We recommend reaching out for expert advice should you have a query, or wish to consider your options, either as an insolvency practitioner looking to understand their options or as a creditor. The Hamilton Locke restructuring and insolvency team have a broad range of top-tier experience acting for a variety of stakeholders in distressed scenarios.  For more information please contact Nicholas Edwards, Zina Edwards or Brit Ibanez.


Sources for this article include:

[1] HDI Global Specialty SE v Wonkana No. 3 Pty Ltd [2020] NSWCA 296.