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Allens Arthur Robinson

Focus: Insurance & Reinsurance – September 2008

Costs extension clauses

In brief: Can an insured recover legal costs under a costs extension clause in an indemnity policy, even if it is expressed as being subject to 'an entitlement to be indemnified'? Partner John Edmond (view CV) and Lawyer Carl Xu report on a recent NSW Court of Appeal decision.

How does it affect you?

  • Wesfarmers Federation Insurance Ltd v Stephen Wells t/as Wells Plumbing [2008] NSWCA 186 shows that insurers need to carefully check the wording of the costs extension clauses to make sure they reflect the intended meaning. If the intention is to reimburse the insured for legal costs only if primary liability is established, the drafting should make that clear.
  • When drafting letters denying indemnity, insurers need to avoid inadvertently implying that they consent to covering the insured's legal costs. Even something as indirect as recommending that the insured seek independent legal advice may amount to consent.
  • This case confirms that costs extension clauses generally cover legal costs incurred by the insured only for defending or settling claims brought by third party claimants. It does not ordinarily cover costs incurred in opposing the insurer.

Background

Wesfarmers Federation Insurance (the insurer) issued Stephen Wells a business liability policy, which insured him against liability to independent contractors but not employees (the policy). The policy had a costs extension clause (the costs clause) which provided as follows:

If you are entitled to be indemnified under this policy for a claim made against you, we pay the reasonable legal costs incurred with our prior written consent in defending or settling the claim. (emphasis added).

  

On 18 December 2001, Mr Hubbard, the plaintiff, suffered minor burns while carrying out plumbing work for Mr Wells and he sued in the NSW District Court on the basis that he was injured as an independent contractor engaged by Wells.1 For reasons related to the NSW workers' compensation legislation, had he sued instead as an employee, he would have probably failed.2 Mr Hubbard succeeded at first instance as the primary judge ruled that he was an independent contractor, and was awarded $174,120 in damages.

In the same proceedings, Mr Wells joined the insurer in a cross-claim, and the primary judge ordered the insurer to pay Mr Wells the judgment amount under the policy and his legal costs pursuant to the costs clause.

The insurer appealed, arguing that:

  • the plaintiff was an employee of Mr Wells rather than an independent contractor; and
  • Mr Wells should not be entitled to costs from the insurer under the costs clause.

The NSW Court of Appeal unanimously agreed that Mr Hubbard was not an independent contractor. He did not operate his own business since he did not have a plumbing licence or an ABN, and was under a fair amount of control and supervision from Mr Wells. These factors ultimately led the court to find that Mr Hubbard was an employee, and the judgment for Mr Hubbard was set aside.

Of more interest from an insurance perspective is the court's treatment of the costs clause.

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The decision

Since the court found that Mr Hubbard was an employee, which the policy specifically excluded, the first issue was whether the insurer met the precondition 'of being entitled to' indemnity (the precondition) in the first place. A related question was whether Mr Wells failed to meet the precondition because Mr Hubbard's claim was successfully defended on appeal, thus negating any indemnity.

The insurer argued that the precondition was not met. Mr Wells argued that the mere allegation in the statement of claim that Mr Hubbard was 'engaged as an independent contractor' was enough to meet the precondition.

The Court of Appeal found for Mr Wells on this point. It distinguished the wording 'entitled to be indemnified' in the precondition from other formulations that make legal costs dependent upon actual legal liability. Justice Basten applied Fitzpatrick v Job,3 where, in respect to a similar precondition, the court held that 'entitlement to indemnity' means 'entitlement to indemnity with respect to claims made by the claimant against the insured'.4 His Honour focused on the 'claim' aspect of the wording and held that the costs of defending the claim 'falls within the scope of the indemnity' even where a legal liability does not ultimately result. His Honour also indicated that the result would have been different if the precondition was expressed in relation to 'legal liability for which the insured is entitled to be indemnified under this policy'.

The second issue was whether the insurer actually consented to the insured incurring legal costs, as required under the costs clause. The parties disputed whether the insurer admitted liability under the policy, but accepted that the insurer appointed lawyers to protect Mr Wells from Mr Hubbard's claim. They also accepted that those lawyers wrote to Mr Wells on 11 November 2005 to advise that the insurer denied indemnity under the policy and to recommend that Mr Wells immediately obtain other legal representation. Based on that recommendation, the court inferred that the insurer consented to Mr Wells incurring legal costs in defending the proceedings. In our view, the letter was ambiguous and this part of the case highlights the need for insurers to be clear when declining indemnity that they are declining indemnity for both the underlying liability and the costs liability (if that is indeed their position).

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Conclusion and costs

The insurer was therefore liable to pay for Mr Wells' legal costs incurred defending Mr Hubbard's claim – ie in proving that Mr Hubbard was an employee. This covered Mr Wells for 100 per cent of the costs in the primary proceedings against Mr Hubbard in the District Court.

But as far as the cross-claim in the District Court and the appeal went, Mr Wells' legal costs were mostly incurred in opposing the insurer by trying to prove that Mr Hubbard was an independent contractor. The court therefore ordered that Mr Wells pay 75 per cent of the insurer's costs for these proceedings.

Aside from the need to be clear in correspondence declining indemnity, this case also illustrates the importance of clearly defining in the policy the circumstances in which cover will be extended for costs. Clearly where any uncertainty exists, the court will be more likely to favour insureds.

Footnotes
  1. Hubbard v Stephen Wells t/as Wells Plumbing & Anor [2007] NSWDC 93.
  2. Mr Hubbard's injuries were probably not serious enough to meet the threshold required by section 151H of the Workers Compensation Act 1987 (NSW) for an employee to make a claim – a degree of permanent impairment of at least 15 per cent.
  3. [2007] WASCA 63.
  4. Ibid at [177]-[179].

     

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