Australian Contract Law: A recent case study – AAI Limited trading as Vero Insurance v Technology Swiss Pty Ltd  FCAFC 168
This appeal concerned an insurer’s right to recover an indemnity payment made to an insured under a settlement arrangement, when the insured recovered for the same loss against a third party against which the insurer had a subrogated right. The matter was complicated by the fact that the settlement related to a number of matters, and did not make clear whether it was addressing the insurer’s obligation of indemnification and, if so, how much of the total settlement sum was paid in respect of that indemnity. This case, again, shows the importance of clear and unambiguous drafting of terms, in this case in a deed of settlement.
Technology Swiss Pty Ltd (Respondent) shipped a consignment of fog cannons valued at $770,095 from Melbourne to Bangkok using the freight forwarder Famous Pacific (Vic) Pty Ltd (FP Shipping). FP Shipping arranged for the consignment to be sent by ocean carrier but the fog cannons were damaged during transport due to inadequate stowage.
The Respondent had a contract of marine insurance with AAI Ltd (Applicant). The indemnity limit of the policy was $500,000. The Respondent made a claim on the policy and the Applicant accepted liability but determined that the fog cannons could be repaired for $200,000. The Respondent disagreed, arguing that the cost of repairs exceeded what the fog cannons would be worth afterwards and that the Respondent had suffered a constructive total loss; particularly since the purchaser had indicated that it would not accept the repaired fog cannons. While that dispute remained unresolved, the Respondent stored the fog cannons at its expense in a bonded warehouse in Thailand.
In August 2015, the Respondent sued the Applicant in the Federal Court of Australia claiming the full indemnity of $500,000 as well as the costs of storing the fog cannons (which the Respondent argued was recoverable under a separate term of the policy). Shortly after those proceedings commenced, the Applicant paid the Respondent the $200,000 that it had previously offered and indicated that it would also pay for the storage of the fog cannons once the Respondent had provided evidence substantiating those costs.
Two years of litigation ensued. Then, prior to trial, a meditation led to negotiations which produced a settlement. The parties entered a Deed of Settlement (Deed) that provided a lump sum payment of $425,000 in respect of multiple disputes between the parties, including the Respondent’s claim against the indemnity provided by the Applicant for the damage to the fog cannons (amongst other things, such as the Respondent’s claim for storage costs).
Subsequently, the Respondent sued FP Shipping for the loss of the fog cannons; notwithstanding the Applicant’s right of subrogation to take that action – having indemnified the Respondent against that loss. The Applicant did not take this action because it could not agree with the Respondent how much of the $425,000 lump sum payment was apportioned to the indemnity for the loss of the fog cannons. Consequently, the Respondent conducted the litigation against FP Shipping at its own expense, and was ultimately successful in recovering $863,758.70 (which included freight costs and interest up to judgement, as well as the value of the fog cannons). The Applicant commenced these proceedings in the Federal Court to recoup from the Respondent a portion of the monies recovered from FP Shipping.
The Deed relevantly stated:
'Technology Swiss agrees to accept $425,000 (the Settlement Monies) from Vero in full and final settlement of the Insurance Claim, the Storage Costs Claim, the Proceeding and the Dispute.'
The Deed preserved the Applicant’s right of subrogation, which was expressed in the marine insurance policy as follows:
When we settle a claim, we may endeavour to pursue recovery rights against the carrier or any other third party who caused loss or damage to the goods. You authorise us to act in your name in such recovery action, and undertake to give us reasonable assistance in such actions.
The Applicant claimed that the Respondent had suffered no loss at all (having fully recovered the value of the fog cannons from FP Shipping), and sought to recoup all sums paid to the Applicant ($200,000 + $425,000); notwithstanding the $500,000 limit on the insurance policy. The Applicant relied on authorities that hold that an insurer is entitled to be subrogated if it paid the insured, even though it may have had no actual liability to do so under the policy, provided that the insurer had a bona fide belief that it was paying under the insurance policy.
The Respondent accepted that the Applicant was entitled to recover the $200,000 paid by way of indemnity, but argued that the Deed created an entirely new entitlement to receipt of the $425,000 which was therefore not a payment under the indemnity.
The primary judge held that neither of these methodologies was correct and allocated $116,770.06 of the $425,000 to the indemnity payment (in addition to the $200,000), as this was the amount that could not be attributed to any of the other matters in dispute that were settled by the Deed and, according to the primary judge, represented the mutual intentions of the parties. Both parties appealed this judgement.
The Full Court of the Federal Court of Australia upheld the decision of the primary judge.
As explained by Derrington J in her reasons for judgement, the key issue on appeal was:
whether it is necessary for the triggering of a right of indemnity that an insurer’s payment to an insured have the characteristic that it be paid by way of actual indemnity. Here, the $425,000 payment was not specifically stated in the Deed to be by way of indemnity under the policy and the parties were at odds as to how it should be characterised.
While payments made pursuant to a contract of indemnification will give rise to a right of subrogation, payments that are instead made to put an end to litigation do not necessarily fit that description.
The Full Court rejected the Applicant’s argument that any payment made in good faith by an insurer leads to a right of subrogation. Derrington J held that the Applicant’s contention ‘elides any requirement of an intention that the payment is made to reduce the insured’s loss, [which] is at odds with the established authorities’.
The Full Court also rejected the Respondent’s argument that a lump sum payment to settle multiple matters cannot be divided into any part that is a payment by way of indemnity, stating (our emphasis):
the question of whether any portion of a lump sum payment can be attributed to a particular integer depends on the circumstances of the case including the terms of settlement and the availability of means to dissect it for the purposes of allocation. Rather than suggest a general rule that a lump sum payment cannot be attributed to particular elements, [the authorities] show that it is only where that is not possible to identify the parties’ mutual intention in relation to the lump sum payment, that no apportionment may take place.
In this case, the Full Court found that the various matters settled by the Deed did include the indemnification of the Respondent under the insurance policy, and the primary judge had satisfactorily determined the mutual intentions of the parties to apportion an amount to the indemnity payment; by eliminating those amounts that could reasonably be allocated to those other matters, based on the available evidence.
The Applicant criticised the primary judge’s calculations; arguing that a process of elimination resolved ambiguity in the Deed against the Applicant as the party seeking to rely on it (contra proferentum) and this rule of construction should only be used as a last resort. However, as the Full Court held, the primary judge had not undertaken an exercise in interpreting the Deed which would be subject to the rules of construction. Rather, the primary judge was determining the parties’ mutual intentions for the purposes of the assessing the extent of the Applicant’s right of subrogation.
This case illustrates the importance of drafting clear and precise contractual clauses, particularly in relation to settlements and indemnity payments. If a lump sum payment is intended to discharge a promise of indemnification (amongst other matters in dispute), but the apportionment of an amount to the indemnity payment is not made clear, a court might impose its own judgement of what the parties intended to achieve – effectively limiting the indemnifying party’s right of subrogation.
Commonwealth entities may grant indemnities to their suppliers, through the exercise of delegated power under s.60 of the Public Governance, Performance and Accountability Act 2013 (Cth) – provided that the Commonwealth entity meets the conditions set out in the Finance Minister’s instrument of delegation. In such cases, Commonwealth entities should carefully consider their right of subrogation arsing in respect of the indemnity, and clearly set out in the express terms of the contractual agreement with the indemnified party the extent and nature of the Commonwealth’s entitlement to recover losses from third parties.
You should always take the opportunity to ensure that your contracts are drafted in clear and express terms that accurately and comprehensively communicate the intended meaning of each provision. This should be done not only in pre-contractual negotiations, but whenever the term of a contract is extended or there is another cause to review the contract (such as frequent or significant disagreements between the parties over the intended meaning).
 Sydney Turf Club v Crowley  1 NSWLR 724; King v Victoria Insurance Company Ltd  AC 250.
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