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The battle for defence costs

Feature Articles

Cite as: Cite as: March 2012 86 (03) LIJ, p.22

Disputes between insured parties and their insurance companies over who pays for the cost of defending claims against the insured in court have tended to favour the insured.

By Robin Shute and Rebecca Hosking

The decision of the Supreme Court of Victoria Court of Appeal in Major Engineering Pty Limited v CGU Insurance Limited1 (Major Engineering) has highlighted the question of the recoverability of defence costs under an insurance policy in circumstances where the insurer has declined to grant coverage, yet the insured has successfully defended allegations made in litigation.

Liability insurance policies, as their name suggests, operate to indemnify an insured against its legal liability in a variety of situations, depending on the exact nature of the coverage. An integral and often determinative aspect of such coverage is the availability of the indemnity afforded by the policy for the costs of defending claims or allegations made against the insured. The insured is usually given, in addition to the limit of liability, additional coverage (by way of supplementary payments) for the legal and other expenses which will be incurred by the insured in defence of allegations. In fact, defence costs are often one of the most important parts of the coverage.

The purpose of this article is to discuss some of the intricacies which may arise in circumstances where coverage may not be granted – many of which were highlighted in the decision of Major Engineering, discussed below.


Before turning to the decision itself, it is worthwhile considering the way insurance policies are usually structured in the area of defence costs, and where that practice is varied in certain categories of risk that cater for circumstances where it is not possible to determine the availability of an entitlement to defence costs until the allegations themselves have been resolved.

Typically, a liability policy will give coverage in respect of sums which an insured will be legally liable to pay as compensation for personal injury or property damage happening during the period of the cover and caused by an occurrence. This coverage (known as “occurrence based coverage”) is triggered by the happening of either personal injury or property damage during the policy period. An alternative trigger mechanism is known as “claims made”. The policy is operative if a claim is made in the policy period. Claims made policies are common in professional indemnity and directors and officers (D&O) policies.

Defence costs will be paid as supplementary payments if indemnity is provided by the policy. The insurer will, in addition to the limit of indemnity, pay all expenses and legal costs incurred with the insurer’s written consent in the investigation, defence or settlement of the claim. In some instances defence costs form part of the sum insured.

Policies covering professional indemnity and D&O risks include provision for the “advance payment of defence costs”. The need for such a clause arises because it is often unclear from the outset of these claims whether or not any of the policy exclusions would apply to the claim. Such coverage issues are often incapable of resolution until the claim itself is resolved.

In most cases the payment of defence costs does not become an issue since the insurer accepts liability under the policy and costs are advanced or paid as they arise in the normal way. Problems can arise in relation to defence costs in circumstances where no indemnity may be provided by the policy or where the insurer relies on grounds to deny indemnity. Such denial can arise where, for example, there is an allegation of non-disclosure or misrepresentation or where the insurer relies on policy exclusions. There is also a need to consider the situation where some elements in the claim are not covered but some are. These situations are now examined in detail by reference to decided authority.


The circumstance of the insurer relying on policy exclusions to deny liability for the claim arose in Major Engineering.

Major Engineering had taken out a liability insurance policy with CGU Insurance Limited covering “product liability” or “public liability”. The policy also provided “additional benefits”, which included cover in respect of defence legal costs incurred by Major Engineering, but costs were payable only if the policy responded.

Major Engineering supplied hydraulic cylinders that were fitted to a yacht, Skandia, owned by Timelink Pacific Pty Ltd. Damage was caused to the yacht during the December 2004 Sydney to Hobart yacht race when the cylinders caused the yacht to capsize, resulting in loss and damage.

Timelink sued Major Engineering for damages, alleging that the cylinders “were inadequately specified, were not properly manufactured and not fit for purpose”. There were express allegations of failure to design.

Major Engineering sought indemnity from CGU. CGU declined indemnity, in reliance on exclusions in the policy relating to:

  • ‌“liability caused by or arising out of . . . the rendering of professional advice or service” (Clause 19(a)); and/or
  • ‌“liability caused by or arising out of . . . making or formulating a design or specification within the domain of the . . . engineering . . . profession” (Clause 19(c)).

The Timelink litigation was protracted, with a number of appeals, with Major Engineering being successful in its defence. Major Engineering incurred substantial costs notwithstanding a costs recovery from Timelink. Major Engineering sought to recover these costs from CGU under the costs extension. Liability to pay defence costs was denied by reason of the exclusions.

Before the question of the applicability of the exclusions could be decided, the Court was required to consider the nature of the claim and, in effect, to conduct a trial within a trial. CGU prevailed at first instance, but not on appeal.

On appeal the Court held that:

“the purpose of the costs extension was to provide cover to a policyholder for costs in a case where the policyholder has incurred a legal liability, being Public Liability or Products Liability . . . and in a case where it has had a claim made against it” and “the claim is one in respect of which indemnity would be available under the policy if it were successful”.

As the Timelink claim had failed, Major Engineering had to persuade the court that had the Timelink claim succeeded, it “would have resulted in a liability in respect of which Major [Engineering] would have been entitled to indemnity under the Policy”.

The Court, after hearing the evidence, characterised Timelink’s claim as a “simple breach of a contract to supply hydraulic cylinders which met particular specifications”.

In relation to exclusion clause 19(a), which excluded “liability caused by or arising out of . . . the rendering of professional advice or service”, the Court:

  • ‌rejected CGU’s submission that the contract was one of “professional service”;
  • ‌considered Major Engineering’s business description in the policy, which included manufacture and sales of hydraulic equipment, and identified the risks the policy covered to enable it to adopt a “businesslike” and purposive interpretation to the costs extension;
  • ‌stated that any ambiguity in the terms of the policy was to be construed in Major Engineering’s favour in accordance with the contra proferentem rule; and
  • ‌found that exclusion clause 19(a) did not apply and stated that:

“if clause 19(a) were to operate so as to exclude indemnity in respect of the supply of defective hydraulic cylinders by a business, one of whose specific objects known to the insurer was the supply of such equipment, the purpose of the Policy would be severely compromised”.

In relation to exclusion clause 19(c), which excluded “liability caused by or arising out of . . . making or formulating a design or specification within the domain of the . . . engineering . . . profession”, the court found that:

  • ‌despite references to the design issue in the pleadings, the facts of the claim showed that Major Engineering was never engaged to design; and
  • ‌exclusion clause 19(c) did not apply as CGU could not establish that Major Engineering’s notional liability to Timelink was related to design.

The Court of Appeal found that the exclusion clauses relied on by CGU had no application. Hence, as a result of the trial within the trial, CGU was liable for Major Engineering’s costs of defending the Timelink claim.


A different situation relating to the obligation to pay defence costs arises where the claim involves both items that are covered by the policy and ones that are not covered. How far is the insurer obliged to pay for defence costs where there are insured and uninsured items?

This issue was considered in the Privy Council decision of New Zealand Forest Products Limited v The New Zealand Insurance Company Limited.2 The claim arose out of litigation conducted in California alleging misleading or deceptive conduct in respect of a joint venture agreement during the conduct of which one of the directors had made allegedly erroneous statements. The question that arose was whether the insurer was obliged to indemnify the company for the defence costs or whether there could be any allocation of such costs between the director and the defendants, and if so what principle should be applied. The Privy Council, on the construction of the policy, indicated that it was reasonable to understand that the cover would extend to the whole costs incurred in the defence of the claim. On the important issue of allocation between insured and uninsured items the Court concluded (at [58]):

“So far as any defence costs are concerned which reasonably relate to the defence of the claim against Mr Taylor but do not exclusively do so, they are covered by the policy even although they also relate to the defence of some other party who is not insured. That this may be of use and benefit to a party who is not insured does not exclude the costs from cover because they are still costs which are reasonably related to the defence of the covered claim. On the other hand costs which have been incurred for the defence which are not reasonably related to the defence of the claim against Mr Taylor are not covered by the policy and require to be excluded”.

Thus it has been generally accepted that common costs of defence fall to the account of the insurer, even though the insured, who is uninsured for the allegations, obtains the benefit of defence for uninsured items. Only in respect of the costs which are not common and which are incremental will cover not be provided.

This issue was considered in Australia by Rothman J in Miskovic v Stryke Corporation Pty Ltd trading as KSS Security (No 2).3

Mr Miskovic claimed that he suffered psychiatric injuries precipitated by his employment as a security guard with Stryke. The unusual aspect of this case is that in addition to pleading that his injuries were caused by Stryke’s negligence, Mr Miskovic pleaded that Stryke engaged in conduct liable to mislead Mr Miskovic in contravention of s53B of the Trade Practices Act 1974 (Cth) (TPA).

Stryke joined, by way of cross-claim, the Workers Compensation Nominal Insurer to the proceedings. The insurer disputed its liability to indemnify Stryke in relation to the TPA claim and to pay any defence costs incurred in defending the TPA claim.

In the judgment the Court found that Stryke was not liable in negligence or for any breach of the TPA. The Court then affirmed that insurer’s denial in relation to the TPA claim. The relevant policy provided:

“The insurer will indemnify the Employer against all of the following sums for which the Employer becomes liable during or in respect of the period of insurance: . . .

(c) costs and expenses incurred with the written consent of the Insurer in connection with the defence of any legal proceeding in which any such liability is alleged”.

The Court nevertheless held that the clause was broadly worded and required the insurer to indemnify Stryke in relation to all costs and expenses incurred in defending the proceedings “including those costs incurred in defending the claim under the Trade Practices Act”. The case was determined in favour of the insured.


The court decisions have tended to favour the insured in the area of the availability of defence costs. This is consistent with the approach that a policy of insurance, as a business document, should be construed as conferring a benefit wherever possible. The decisions we have discussed in this article also have an element of fairness.

ROBIN SHUTE is a partner at Wotton + Kearney, practising predominantly in professional indemnity, public and product liability, and directors’ and officers’ claims. REBECCA HOSKING is a senior associate at Wotton + Kearney, practising predominantly in public and product liability and professional indemnity claims.

1. (2011) VSCA 226.

2. [1996] 2 NZLR 20 (CA).

3. [2010] NSWSC 1495.


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