Napier City Council v Local Government Mutual Funds Trustee [2022] NZCA 422

The Court of Appeal’s recent decision in Napier City Council v Local Government Mutual Funds Trustee provides helpful clarification on the interpretation of exclusion clauses when assessing liability for ‘mixed cause’ claims. The Court also affirmed its previous approach in respect of an insured’s right to recover the amount of its reasonable settlement under an insurance policy in circumstances where the insurer has wrongfully repudiated cover. [1]

Background

Local Government Mutual Funds Trustee (RiskPool) insured the Napier City Council under a professional indemnity policy covering its potential civil liability arising from its public functions, including in relation to building defect claims. The Council sought indemnity under the policy in respect of negligence claims made against it by the owners of an apartment building on the Napier waterfront (Claims). The Claims were ‘mixed’ in that they arose from weathertightness and non-weathertightness defects.

RiskPool declined the Council’s claim on the basis that an exclusion for weathertightness defects applied to the Claims in their entirety.

The exclusion relevantly provided that the policy did not cover (our emphasis):

“…liability for Claims alleging or arising directly or indirectly out of, or in respect of:

1. the failure of any building or structure to meet or conform to the requirements of the New Zealand Building Code contained in the First Schedule to
2. the Building Regulations 1992… in relation to leaks, water penetration, weatherproofing, moisture, or any water exit or control system; or mould, fungi, mildew, rot, decay, gradual deterioration, micro-organisms, bacteria, protozoa or any similar life forms, in building or structure.”

Claim was defined as… “the demand for compensation made by a third party against the Member…”

Following RiskPool’s declinature, the Council settled the owners’ Claims for a global sum. It then issued proceedings against RiskPool in which it sought to recover the amounts paid by it in settling non-weathertightness Claims.

The High Court found that RiskPool was not liable to indemnify the Council because the Claims were excluded in their entirety, finding that the definition of “Claim” was sufficiently broad as to encompass both weathertightness and non-weathertightness claims. [2] The Council appealed.

RiskPool cross-appealed on the extent to which the settlement reached between the Council and the owners in respect of their claims fixed the amount that RiskPool must pay to the Council under the policy, specifically whether RiskPool was entitled to challenge the same.

Appeal allowed

The Council’s liability for non-weathertightness defects is covered by the policy

The Court of Appeal overturned the High Court’s decision and found that the Claims were only excluded to the extent that the Council’s liability arose out of weathertightness defects. It rejected RiskPool’s contention that if part of a Claim (as defined by the policy) was causally attributable to weathertightness issues, cover was excluded for the whole Claim.

The Court focussed on the following issues in determining that certain parts of the Claims that were not causally attributed to weathertightness defects fell within the scope of cover:

1. The structure of the parties’ bargain: The Court acknowledged that RiskPool clearly intended to exclude all cover for weathertightness defects. However, the structure of the parties’ bargain, as evidenced by the terms of the policy, was not to exclude cover for non-weathertightness defects when made together with separate Claims for weathertightness defects.
2. The real nature of the Council’s liability for a ‘Claim’: While the Court accepted that a Claim for policy purposes is a demand for compensation, and not a cause of action, it held that an inquiry into the real nature of the Council’s liability was needed in order to determine the proper application of the exclusion to the Claims. The Court considered that this analysis could “descend to the level of particulars”. In other words, the Court held that each Claim could be assessed and divided in accordance with the Council’s liability for weathertightness defects on one hand, and its liability for other defects on the other. The Court held that the exclusion operated such that the owners’ claims would be excluded only to the extent that the Council’s alleged liability arose directly, or indirectly, out of weathertightness defects.
3. Prior negotiations between the parties: The High Court placed emphasis on extrinsic evidence advanced by RiskPool in support of its position, including correspondence sent by RiskPool to the Council in relation to a previous unrelated claim. RiskPool had declined a similar claim in reliance on its interpretation of the exclusion, and the Council had not objected. RiskPool argued that this correspondence demonstrated a mutual understanding that the exclusion excluded cover for mixed defect claims. Having regard to the principles established by the Supreme Court in Bathurst, the Court found that the Council’s silence was ambiguous and did not evidence a mutual understanding. The correspondence was therefore irrelevant and inadmissible in the interpretation of the policy – the words of which retained primacy.
4. Interpretation of exclusion clauses: The Court referred to the ‘settled’ approach to interpreting exclusion clauses in insurance law, whereby insuring clauses should be given a liberal construction, and exclusion clauses ought to be read narrowly.
5. The de minimis principle: The Court gave short shrift to RiskPool’s argument (as advanced before the High Court) that the de minimis principle applied in respect of non-weathertightness claims that were “tainted” by weathertightness, such that they would be excluded in their entirety. The Court found that the principle could not be applied neatly to the question of how to interpret the relevant policy terms on the basis that the threshold for its application could not be defined with sufficient precision, and –from a common sense perspective – it would lead to an outcome whereby the “tail is wagging the dog”.

Cross-appeal dismissed

The Council did not need to prove its at-trial liability to recover under the policy

The key issue to be determined in RiskPool’s cross-appeal was whether, having established that it was entitled to be indemnified, the Council had to prove what its at-trial liability to the apartment owners would have been in order to recover under the policy.

In considering the issue, the High Court relied on the Court of Appeal’s decision in Mainfreight in support of the proposition that [3]:

• where an insurer wrongfully declines cover, leaving the insured to act as a ‘prudent uninsured’, then the insurer has committed a “repudiatory” breach, in general terms, of the essence of the contract of indemnity;
• the insured is entitled to claim damages based on that breach; and
• provided the insured has acted reasonably in settling the claim, the measure of damages is equivalent to the amount paid in settlement, together with costs.

RiskPool contended that it had not repudiated cover but it had rather mistakenly interpreted the policy. It also argued that the High Court was wrong to hold that an insurer which had repudiated liability was prevented from contending that the insured was not legally liable for the amount of the settlement reasonably paid by it. RiskPool instead argued that the insured must establish its ‘at trial’ or actual liability, and that the amount recovered under the policy must reflect the same.

The Court of Appeal rejected RiskPool’s submissions on both fronts. The Court helpfully clarified that the relevant insurance authorities use “repudiation” in a narrower sense to describe the circumstances in which an insurer makes it clear that it will not indemnify the insured in respect of a claim notified under the policy. Here, while RiskPool had not repudiated the entire policy, the Court found that its conduct “unmistakeably” amounted to repudiation in the sense that it had forced the Council to act as an uninsured by denying it indemnity.

The Court went on to affirm that, where an insurer has wrongfully denied cover, the amount paid by the insured to a third party as a settlement sum crystallises the loss for which it is entitled to indemnity – provided that it was objectively reasonable to settle, the settlement negotiated was honest and objectively reasonable, and the express terms of the policy do not require the insured to ‘prove’ its at-trial liability to the third party.

In finding that the Council’s settlement was reasonable, the Court noted that the reasonableness of any settlement must be assessed against the information available at the time, and will, to a certain extent, be informed by prospective ‘at trial’ liability. The Court helpfully opined that “[g]enerally, a settlement is reasonable if, judged objectively, it is made to compensate the claimant for the value of the claim, by reference to its prospects of success”.

The Court held that the same approach should be taken where a Claim is ‘mixed’, in that the settlement must be shown to be reasonable by reference to the insured liability, having regard to the value of the total claim, what defects were included in the settlement, and the proportion of the settlement that should be attributed to insured liabilities.

Our view

The Court’s decision provides helpful clarity on the interpretation of exclusion clauses as they apply to ‘mixed’ claims which include both insured and uninsured liabilities. We consider the Court’s approach to determining policy response to be sensible and reflective of the pragmatic approach that ought to be adopted in dealing with claims of this nature.

It is apparent that, in the absence of relevant admissible extrinsic evidence of sufficient probative value, the policy wordings will retain their primacy. Parties should pay close attention to the drafting and scope of policy terms and conditions insofar as they determine both the approach to be adopted in interpreting the scope of cover, and the structure of the parties’ bargain.

Insurers should also be particularly mindful of the consequences of ‘repudiating’ cover in circumstances where doing so leaves insureds in the compromised position of having to settle claims as prudent uninsureds.

This article was co-authored by Rosa Laugesen, a Solicitor in our Litigation and Dispute Resolution team.

Read Cover to Cover – Issue 26

Footnotes 

[1] Napier City Council v Local Government Mutual Funds Trustee Limited [2022] NZCA 422.

[2] Napier City Council v Local Government Mutual Funds Trustee Limited [2021] NZHC 1477.

[3] Royal Insurance Fire & General (New Zealand) Ltd v Mainfreight Transport Ltd (1993) 7 ANZ Insurance Cases 61-172 (CA).