Contents

Chapter 15
Insurance and indemnity

Implications for pecuniary penalty regimes

Express clarification

15.21We have considered whether it is desirable, in the interests of regulatory certainty, for pecuniary penalty regimes to pre-empt arguments about whether the availability of insurance and indemnification is potentially void for public policy considerations. Statutes could do this by expressly authorising or confirming the extent to which such measures are available.

15.22Justice Bathurst has expressed particular concerns about the uncertainty inherent in applying the rule of public policy to avoid contracts of liability insurance or indemnity:408

What I do think is undesirable however is the lack of clarity around these issues. At the moment, the market’s best guess seems to be that insurance for criminal penalties is likely to be deemed illegal or unenforceable by the courts, and that it is not clear if a similar situation applies in relation to civil penalties.

I have spoken on previous occasions about the need for certainty in the legal rules applicable to commercial activity. That need is acute in this context. Directors and officers need to know whether their policies are enforceable and will protect them against the risk of personal liability and possible bankruptcy. Insurers need to be able to properly assess variables in order to accurately price risk. ASIC [the Australian Securities and Investments Commission] needs to assess how insurance may affect its corporate regulation strategy. At present, it is questionable whether sufficient clarity exists to enable those assessments to be made satisfactorily.

15.23The advantages of express statutory confirmation include greater certainty for directors and officers, as identified by Justice Bathurst. It would also confirm that the impacts of indemnification on the regulatory regime have been addressed by policymakers in designing the regime, thus ensuring a robust regime and providing a clearer indication to the public of how issues of liability may be dealt with.

15.24On this basis we conclude that pecuniary penalty statutes should expressly confirm whether contracts that indemnify or insure against liability to a pecuniary penalty are legal, or whether they are subject to any particular prohibition or limitation.

Limiting indemnification?Top

15.25A further question for policymakers designing pecuniary penalty regimes is whether to squarely prohibit or limit the availability of indemnification in any respect, as in the case of price fixing under the Commerce Act. Whether any such measure is necessary will depend on the nature of the pecuniary penalty regime and its underlying objectives.

15.26The arguments for and against permitting cover for pecuniary penalty liability were summarised by Justice Bathurst in his address to Australian insurance lawyers:409

The question of whether indemnity should be available for civil penalties, or for the personal financial consequences of breaching a civil penalty provision is a difficult one.

On the one hand allowing insurance in such circumstances tends to negate, or at least significantly undermine the deterrent and punitive goals that underlie the imposition of such penalties … Nonetheless … [to] my mind, excluding indemnity for civil penalty provisions would be at odds with the general acceptance that insurance is available for the civil consequences of negligent behaviour. Breaches amounting to civil penalty provisions may often be the result of honest but careless behaviour… it does not seem unreasonable to me that directors should be able to protect themselves from liability for civil penalties …

15.27In Auckland Regional Council v Gubbs Motors Ltd, concerning breaches of the Resource Management Act, Judge Moore also observed that the law is unclear on the extent to which certain penalties are insurable:410

Traditionally, a person could not insure themselves against the consequences of deliberate criminal acts and, in particular, to purchase indemnity for a fine or other punishment imposed for the commission of a crime. But where the law was broken by an act or omission which was negligent, different considerations intruded and the consequential case law is byzantine, in part because of particular statutory provisions or policy considerations in particular areas of human activity. As a matter of commercial reality much will depend upon the type of cover that insurers are prepared to provide rather than the limits of what the law permits.

15.28His Honour noted the effectiveness of insurance in deterring risk and the policy advantages in permitting insurer participation:411

Theirs is the business of evaluating risk likelihood and likely levels of loss when loss occurs. They are entitled as a matter of law, and compelled by practical reality, to make careful inquiry of those seeking cover. Those who want cover need to be truthful and complete in their responses or risk being denied indemnity. When a claim is made, the nature and extent of it may result in future cover being available (if at all) only at the cost of increased premiums. Above all insurance companies can and frequently do affect the future conduct of insured persons by requiring of the taking of precautions against loss. Where the criminal law merely hopes to deter by threat or example an insurance company has much more effective tools at its disposal, particularly in the context of commercial activities. Insurers can require safety precautions and distribute financial burdens according to risk far more effectively than any warranted inspector.

… as a matter of policy, when considering areas of human activity in which there is a required process of taking precautions against foreseeable risk the policy advantages of permitting insurer participation seem compelling. Insurance against the consequences of unintentional breaches of public or environmental welfare laws, far from undermining those laws, adds in a factor tending to promote their adherence. There is a vast difference between profiting from a deliberately unlawful act, or at least taking prior steps to reduce the impact of its consequences, and insuring, that is paying in advance for at least some protection against, the consequences of prosecutions flowing from unintentional shortcomings of a type which many people would characterise as part of the human condition ‒ one which can be reduced though probably never eliminated.

15.29Another consideration is whether the availability of indemnification would significantly dilute the deterrent effect or the punitive impact of a pecuniary penalty on an individual, as they do not personally pay the penalty imposed on them for the contravention. However, adverse publicity, reputational impacts and any other applicable consequences may provide adequate deterrent and punishment.

15.30The effects on rational behaviours and potential moral hazard also need to be assessed. This is highlighted in regimes such as health and safety, but may potentially arise in other contexts:412

Knowing that they are “insured” for the criminal and civil liability of industrial accidents, some firms will find it harder to economically justify the large investment in systems designed to prevent such accidents from taking place. Economists call this moral hazard. Leaving aside ethical considerations, if a company will not face the consequences of deficiencies in its systems, it is less likely to maintain such systems. The vigilance around safety may be lost …

15.31We expect that the availability of indemnification and insurance may have a disciplinary effect that contributes to the deterrence objectives of pecuniary penalty regimes. However, in some specific instances it may be necessary to reinforce the impact of a pecuniary penalty by expressly penalising indemnification against statutory liability. Jurgeleit suggests that such instances will need to be carefully justified, given the consequences for the personal liability of directors and managers.413
15.32The following factors may offer guidance to policymakers on this issue:414
(a) The nature and gravity of the illegal conduct. Would the conduct shock the conscience of reasonable people, or cause them to regard the contravener as a “criminal”, or as so anti-social that courts should decline to enforce the contract of insurance in order to protect the public?
(b) The extent to which allowing the indemnity will hinder any deterrent effect the law was intended to have. If the provision was enacted purely or primarily for its deterrent effect, would it actually deter the contravener or future contraveners if imposed in the particular circumstances? Was the breach purely inadvertent? If so, does it nevertheless have morally or socially reprehensible outcomes?
(c) The potential for encouraging similar future acts if the indemnity is allowed. Will those insured under these policies prefer to allow the breach and recover under their insurance policies rather than to avoid the breach altogether? Will other sanctions make the contravener prefer to avoid the breach – for example, loss of customer satisfaction or poor corporate image?
(d) The purpose of the statutory provision that was breached. Was it enacted purely or primarily for deterrent purposes, or does it have some other objective?
(e) The contravener’s knowledge of facts or law that make the conduct unlawful. In subjective terms, was the conduct morally reprehensible, so that it warrants a punishment that will be borne personally? This requires an assessment of whether the conduct subject to a proposed penalty is likely to be advertent, or includes an express element of intent or fault.
(f) Whether enforcement of the indemnity would promote or be detrimental to the interests of innocent third parties. For example, does the penalty go to a fund to compensate for loss caused by the event insured against, to a general fund to promote the Act’s purposes generally, or to fund education to prevent future breaches? If so, will the contravener be able to pay the penalty if the indemnity is not allowed?
15.33Other relevant considerations are the potential impact on penalty imposition by the courts, the potential impact on prosecution strategies, and the impact on the personal liability of directors and managers.415
15.34Where it is necessary to impose statutory limits on insurance and indemnification in a pecuniary penalty regime, policymakers should consider penalising the provision of insurance or indemnification in breach of that restriction.416

Guideline

G16 Pecuniary penalty statutes should deal expressly with the question of insurance or indemnification in relation to pecuniary penalty liability

Policy makers should consider whether there should be no bar on insurance or indemnification in respect to pecuniary penalty liability under the proposed regime, or whether policy reasons justify a particular prohibition or limitation. In either case, an express statutory statement confirming or restricting the legality of contracts to indemnify or insure is desirable.

Factors to be considered include:

The nature and gravity of the illegal conduct. Are there public policy reasons why indemnification or insurance in respect of the conduct / breach should be barred? For example, was the conduct so morally reprehensible that punishment should be borne personally?

The deterrent effect of the penalty. Would the availability of indemnification significantly dilute the deterrent effect of a pecuniary penalty provision? Or does the disciplinary effect of indemnification and insurance contribute to the deterrence objectives of the pecuniary penalty regime? Similarly, would those insured prefer to allow the breach and recover under their insurance policies rather than to avoid the breach altogether?

Interests of innocent third parties. Will the penalty be diverted for reparative purposes or to fund education to prevent future breaches? If so, will the contravener be able to pay the penalty if the indemnity is not allowed?

Other relevant considerations are the potential impact of insurance and indemnification on penalty imposition by the courts, the potential impact on prosecution strategies, and the impact on the personal liability of directors and managers.

Where it is necessary to impose statutory restrictions on insurance and indemnification in a pecuniary penalty regime, policymakers should consider penalising the provision of insurance or indemnification in breach of those restrictions.

408Bathurst, above n 381, at [49]–[50].
409At [42]–[43], [46] and [48].
410Auckland Regional Council v Gubbs Motors Ltd DC Auckland CRN 08084500006, 20 March 2009 at [20].
411At [22]–[23].
412Tooma, above n 394.
413See Jurgeleit, above n 384, on the risk that if statutory penalties are not insurable, businesses will become excessively risk-averse, the risk of stifling enterprise and the threat to the certainty necessary for efficient business management.
414Derived from Jurgeleit's summary of the Powell factors, above n 384, at 743.
415See Tooma, above n 394.
416As, for example, the case of price fixing under the Commerce Act 1986, ss 30, 80A and 80B.