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Focus: Effective exercise and discharge of an insurer's payment obligations

15 September 2010

In brief: A recent Queensland Supreme Court judgment1 is a reminder that insurers must decisively elect and communicate a decision as to which basis of settlement it has chosen to apply in circumstances where it has several options open to it when responding to a claim. Partner Dean Carrigan and Law Graduate Alexander Edwards report.

How does it affect you?

  • An insurer must balance its legitimate commercial interests in conducting claim negotiations with its contractual obligation to select a basis of settlement payment option available under a policy of insurance. Communications with the insured should expressly state which option is being selected and outline how the requirements of the option will be satisfied.
  • Repairing damaged property requires the insurer to take the full responsibility for effecting repairs or to take full responsibility for paying for the repairs (excluding an applicable excess). The risk to the insurer of selecting a repair option is that the repair cost may exceed the policy limit of liability, unless a term of the policy specifies otherwise.
  • The selection of a particular performance option by the insurer must be made within a reasonable time.

Background

Cape York Airlines Pty Ltd (CYA) operated a light-aircraft mail and passenger service in North Queensland. On 8 February 2004, one of CYA's aircraft suffered engine failure and ditched into shallow waters. The aircraft was recovered two days later, but had been fully immersed in salt water because of the tides. CYA made a claim under an insurance policy for damage to the aircraft.

The insurance policy provided that 'The [Insurer] will at its option pay for, repair, or pay for the repair of, accidental loss or damage to the aircraft...not exceeding the amount insured.' The total amount insured was $1.8 million. The insurer preferred to repair rather than pay for loss, and contacted a repair facility, Aircraft Structures International Corp (Aircraft Securities), equipped for this kind of work. Aircraft Structures provided a non-binding, 'ballpark' repair estimate indicating that reconstruction would cost $895,000.

On 26 February 2004, the insurer sent CYA a letter requesting that CYA instruct Aircraft Structures to proceed with the repairs to the aircraft (as per the Aircraft Structures estimate) and to sign an enclosed 'Authority to Repair'. The letter also stated that the insurer's interest was 'limited to the cost of the accident repairs as quoted'. CYA refused to authorise Aircraft Structures to conduct the repairs or to accept a cash payout equivalent to the estimated quote.

A year of discussion, disagreements and delay followed. All this time, the aircraft steadily rotted away in storage. No resolution was reached, and proceedings were commenced by CYA against the insurer in March 2005.

At trial, the insurer argued that it had selected the option to pay for repairs under the contract. As CYA did not consent to the plane being repaired, the insurer argued that CYA had repudiated the repair contract. CYA argued that no such selection had been made by the insurer, and that the insurer was in breach of the insurance policy.

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Decision

The Queensland Supreme Court held:

  • The insurer had the option of electing between three modes of payment under the policy: either effecting repairs, paying for repairs, or paying for the loss. These three options were mutually exclusive, and constituted the only available means of performance under the policy. Election of an option may either be express and unequivocal, or it may be implied by behaviour.
  • While there is nothing objectionable about undertaking reasonable commercial negotiations in the interests of securing a better settlement, continuing such negotiations will be improper if the insurer fails to elect a basis of settlement performance option available under an insurance policy within a reasonable time. Further, although the judgment did not specifically address the issue, as contracts of insurance are contracts of the utmost good faith, insurers (and insured) need to conduct all dealings with one another, including claims negotiation, in good faith.
  • The insurer had sought to limit its liability to the amount of the estimate provided by Aircraft Structures, which was contrary to the legal principle that election to repair or pay for repair requires that the insurer be liable for the whole costs of repair (excluding any applicable policy excess) regardless what the total cost may be, unless otherwise provided for in the policy.
  • The insurer did not effectively select and communicate to the insured any of the three options available to the insurer under the policy. In effect, the insurer was not offering to validly perform the contract. Rather, it was leveraging the Aircraft Structures repair estimate to effect a cash settlement.
  • The insurer was found liable to pay the full insured amount, plus loss of income covered under the policy, in a total amount of $3.17 million including interest.

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Implications

The court did not make any new law in this decision, but rather applied settled principles to a common scenario: where negotiations take place after a claim is lodged. Under many types of property insurance covers, the insurer is empowered to decide which basis of settlement to adopt (for example: reinstate, repair or pay for repair). However, that choice is not always exercised immediately or without input from the insured.

This case makes clear that the onus is on the insurer to prevent legitimate commercial considerations (such as encouraging an early cash settlement or a mutually acceptable outcome) leading to a failure to perform the contract by not unequivocally electing an option within a reasonable time. The court in this case decided that two months was a reasonable time in which to determine that the claim fell within the policy and to select an option. If an insurer does conduct negotiations and discussions with the insured, it should be mindful of this guidance as to the relevant time period in which to select an option and to address the requirements of that option.

Footnote
  1. Cape York Airlines Pty Ltd v QBE Insurance (Australia) Ltd [2010] QSC 313.

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