What happened
James Ali Bahmad injured his right arm on 17 April 1999 while performing unpaid work required by a Community Service Order. He consulted solicitors Cameron Gillingham Boyd in December 1999. In May or June 2000 the solicitors briefed Anthony Porthouse, a barrister, to advise whether Mr Bahmad had a workers compensation claim or a common law negligence claim against the Department of Corrective Services. On 7 June 2000 Mr Porthouse advised in writing that there was no workers compensation entitlement but that a negligence claim could be pursued, subject to expert evidence. The advice made no reference to the Crimes (Administration of Sentences) Act 1999 (CAS Act), which had commenced on 3 April 2000. Section 122 of that Act applied the modified common law damages regime in Part 5 Divisions 1-3 of the Workers Compensation Act 1987 (WC Act) to injuries sustained during community service work, with the offender treated as a “worker”.
From mid-2001 the New South Wales Government’s tort reform programme was widely publicised. The Workers Compensation Legislation Further Amendment Act 2001, which received assent on 6 December 2001 but commenced on 27 November 2001, inserted a 15% permanent impairment threshold for damages for economic loss (new s 151H of the WC Act) and removed damages for non-economic loss (new s 151G). Critically, a transitional provision (Schedule 6 Part 18C cl 9(1)) applied those restrictions to all pre-commencement injuries unless proceedings had been commenced in a court before 27 November 2001.
On 26 November 2001 Mr Porthouse was asked to draft a statement of claim. He provided a draft on 6 December 2001 naming the State of New South Wales as defendant; it was filed on 11 December 2001. On 30 October 2002 the Crown Solicitor first raised the point that Mr Bahmad’s damages were governed by the CAS Act and therefore by the WC Act amendments, so that the 15% threshold applied and the claim failed. Mr Porthouse first learned of this argument on 15 May 2003 when it was raised at a District Court hearing. He obtained an adjournment, researched the point, and formed the view that if the argument was correct Mr Bahmad would lose.
The matter was heard by Graham DCJ. On 29 August 2003 his Honour gave judgment for Mr Bahmad, holding that the transitional provision was ambiguous and that the threshold therefore did not apply. Execution was stayed unconditionally pending appeal, an unusual order that Graham DCJ justified by reference to the arguability of the Crown’s point. Mr Porthouse conceded the point was arguable. The Crown appealed. While the appeal was pending, on 20 May 2004 Mr Porthouse completed a proposal form for professional indemnity insurance with CGU Insurance Ltd for the year commencing 30 June 2004. He answered “No” to the question “Are you aware of any circumstances which could result in any Claim or Disciplinary Proceedings being made against you?” The policy that issued was a claims-made policy containing an exclusion for “Known Claims and Known Circumstances”. “Known Circumstance” was defined in cl 11.12 as any fact, situation or circumstance which (a) an insured knew before the policy began or (b) a reasonable person in the insured’s professional position would have thought before the policy began might result in someone making an allegation against an insured in respect of a liability that might be covered by the policy.
The Crown appeal was heard on 19 July 2004. As the parties left court Mr Bahmad raised with Mr Porthouse the question of his former solicitors’ negligence. On 27 August 2004 this Court (State of New South Wales v Bahmad [2004] NSWCA 287) allowed the appeal, set aside the verdict, and entered judgment for the State. Mr Bahmad then sued both the solicitors and Mr Porthouse in the District Court for the lost cause of action. Balla DCJ found both the solicitors and Mr Porthouse negligent. Her Honour held that a competent barrister briefed in June 2000 or 2001 would have identified the CAS Act link to the WC Act, appreciated that the foreshadowed amendments could defeat the claim if proceedings were not filed before 27 November 2001, and advised urgent commencement. Barrister immunity was held inapplicable to the pre-commencement advice. Judgment was entered against the solicitors and Mr Porthouse for $170,000 plus costs, to be borne equally. On Mr Porthouse’s cross-claim against CGU, Balla DCJ held that the known circumstances exclusion was not engaged. CGU appealed to the Court of Appeal.
Why the court decided this way
The majority (Hodgson JA, with whom Young CJ in Eq agreed) dismissed the appeal. Hodgson JA accepted that Mr Porthouse had been negligent but held that the insurer had not proved that the exclusion applied. The central question was the construction of cl 11.12(b). His Honour held that the combination of “would have thought” and “might result” created a spectrum of likelihood. At one end was a fleeting thought that a circumstance might result in an allegation as a remote possibility; at the other was a belief that it might result as a realistic possibility. The primary judge had correctly construed the clause contra proferentem against the insurer as requiring the higher standard of a realistic possibility.
Hodgson JA rejected CGU’s complaint that the primary judge had introduced an impermissible subjective element. The clause asks what a reasonable person in the insured’s professional position “would have thought”. That language is not the same as the “could reasonably be expected to know” test in s 21(1) of the Insurance Contracts Act 1984 (Cth). It is therefore permissible to examine the insured’s actual state of mind and ask whether it was unreasonable, so long as that examination does not distract from the ultimate objective question. The primary judge had found that Mr Porthouse understood there were legal difficulties but believed he had taken all reasonable steps, that Mr Bahmad had not complained, that favourable decisions had been obtained at arbitration and trial, and that the appeal had good prospects. It had not occurred to him before 30 June 2004 that the late filing or the failure to locate the CAS Act could ground an allegation against him. The possibility that Mr Bahmad might allege fault only crystallised after the Court of Appeal hearing on 19 July 2004. Those findings were open and supported the conclusion that a reasonable person in Mr Porthouse’s position would not have thought there was a realistic possibility of an allegation before the policy began.
Young CJ in Eq reached the same result by a slightly different route. His Honour emphasised that “reasonable person in the Insured’s professional position” denotes an ordinary person with the insured’s professional qualifications and knowledge, not simply the insured acting reasonably. The word “thought” connotes mental activity short of knowledge, and when combined with “might” requires that the reasonable person would have considered there to be a real possibility of an allegation. The primary judge’s reference to the insured’s actual state of mind was not erroneous because industry practice and the conduct of the actual participants are part of the material from which the tribunal of fact decides what the hypothetical reasonable person would have thought. Even if the primary judge had overstated the extent to which the test incorporated subjectivity, the error did not affect the result because, on the facts as found, a reasonable person would not have formed the requisite thought. Young CJ in Eq also noted that the two limbs of the definition (actual knowledge and the reasonable person thought) would not be conflated by this approach.
Hunt AJA dissented. His Honour considered the test in cl 11.12(b) to be purely objective. The primary judge had erred by treating the reasonableness of Mr Porthouse’s actual state of mind as relevant to that objective question. A reasonable barrister in Mr Porthouse’s position, possessed of his knowledge that he had not researched the CAS Act, that the claim had been filed after the cut-off date, that the point was a “knockout point” if upheld, that Graham DCJ had granted an unconditional stay, and that the appeal was pending, would have been far more perceptive. Such a person would have recognised a real possibility that a disappointed client who had lost everything because proceedings were filed two weeks late would allege negligence against the barrister who had been briefed to advise on the claim. The exclusion therefore applied and CGU was not liable to indemnify.
The majority’s construction was reinforced by reference to s 40(3) of the Insurance Contracts Act. That provision permits an insured to notify facts that might give rise to a claim before a claims-made policy expires and thereby obtain cover for any later claim. A construction that too readily treated pending appeals as known circumstances would undermine that statutory policy. The majority therefore dismissed the appeal with costs.
Before and after state of the law
Before this decision, Australian courts had considered known circumstances exclusions in professional indemnity policies in a series of cases that emphasised the distinction between actual knowledge and the hypothetical reasonable person’s state of mind. In FAI General Insurance Ltd v McSweeney (1999) 10 ANZ Insurance Cases 61-443 Lindgren J had said that circumstances “may give rise to a claim” if they would suggest to a reasonable person in the proponent’s position that the bringing of a claim was a “definite risk” or a “real possibility” or “on the cards”. The Court of Appeal in Fishwives Pty Ltd v FAI General Insurance Co Ltd [2001] NSWCA 103 cited that passage with approval but did not need to decide its precise boundaries. GIO General Ltd v Wallace [2001] NSWCA 299 had applied the disclosure obligation in s 21(1) of the Insurance Contracts Act, stressing that the ultimate question is what could be expected of a reasonable person’s state of mind, not the insured’s actual state of mind. Permanent Trustee Australia Ltd v FAI General Insurance Co Ltd (1998) 44 NSWLR 168 (and its subsequent appeals) had explored notification obligations under claims-made policies.
This Court’s majority judgment clarified that the words “would have thought” and “might result” in a clause worded like cl 11.12(b) create a spectrum and that ambiguity is resolved contra proferentem against the insurer. It settled that the realistic possibility standard, rather than “any risk at all” or a merely remote possibility, is the appropriate threshold. It also confirmed that reference to the insured’s actual state of mind is not forbidden when applying the objective test, provided the ultimate question remains what the reasonable person would have thought. The decision therefore narrowed the operation of known circumstances exclusions in claims-made policies issued to professionals, particularly where an appeal is pending and favourable lower court decisions have been obtained.
The High Court granted special leave on 5 October 2007 and allowed the appeal in CGU Insurance Ltd v Porthouse [2008] HCA 30. That later decision is outside the scope of analysis of the present judgment but necessarily altered the precedential weight of the Court of Appeal’s construction. Nevertheless, the NSWCA reasoning remains an important articulation of the principles of construction of insurance exclusions and the permissible use of an insured’s actual knowledge.
Key passages with plain-English translation
Paragraph [28]–[30] (Hodgson JA): “As regards Mr Pembroke’s submission that the primary judge erred in detecting ambiguity, in my opinion a fair reading of the judgment is that the ambiguity detected by the primary judge does relate to the combination of ‘thought’ and ‘might’… I think the spectrum ranges from something like ‘believed that the circumstance might as a realistic possibility result in an allegation’ down to ‘fleetingly thought that the circumstance might as a remote possibility result in an allegation’; and in my view, the primary judge correctly construed the provision against CGU as requiring the former rather than something like the latter.”
Plain English: The words “thought might result” are ambiguous. They cover everything from a quick passing thought about a remote chance to a firm belief that a claim is realistically possible. Because the insurer wrote the policy, the ambiguity is resolved against it. The judge was right to require a “realistic possibility” rather than any conceivable risk.
Paragraph [31]: “In my opinion also, the approach of the primary judge in considering whether the respondent’s actual state of mind was unreasonable was not an error. The clause directs attention to the ‘professional position of the respondent’ and requires a finding that a reasonable person in that position ‘would’ have thought something, not (for example) that such a person may well have thought it. The language is different from that of s 21(1) of the Insurance Contracts Act…”
Plain English: It is legitimate to look at what the barrister actually thought and ask whether that was unreasonable. The clause asks what a reasonable person “would” have thought, which is a stronger test than the Insurance Contracts Act’s “could reasonably be expected”. Looking at the real person’s thinking helps answer the hypothetical question without turning the test into a purely subjective one.
Paragraph [34]–[35]: “A finding that a reasonable person in the position of the respondent would have thought that there existed circumstances that might give rise to a claim means that such a reasonable person would have believed it appropriate to give notice as contemplated by s 40(3)… I do not think it can be said that such a person would have believed it appropriate to do so… I think this consideration tends to support the construction given to cl 11.12 by the primary judge…”
Plain English: If we say a reasonable barrister would have realised a claim was possible, that same barrister would have given notice under the Insurance Contracts Act to protect cover under the old policy. The statute is designed to let professionals move between policies without losing cover. That policy supports reading the exclusion narrowly so that Mr Porthouse is not caught between two policies.
Paragraph [50]–[52] (Young CJ in Eq): “The question as to what a reasonable person would have thought is ultimately one of fact… when considering the objective standard, how people in the relevant industry are accustomed to act and even how the actors in the drama before the court behaved forms part of the material to be considered…”
Plain English: Deciding what a reasonable barrister would have thought is a factual question. Industry practice and what the actual barrister did are relevant evidence, even though the test is objective. The judge was entitled to use Mr Porthouse’s evidence that it never occurred to him that a claim might be made.
What fact patterns trigger this precedent
This decision is triggered when a professional insured seeks indemnity under a claims-made policy containing a known circumstances exclusion worded similarly to cl 11.12. Three elements must coincide. First, the insured must have become aware, before the policy incepted, of facts that later give rise to a claim. Second, the claim must be one that a court later finds would have been covered had the exclusion not applied. Third, the insurer must rely on the objective limb of the exclusion (the reasonable person in the insured’s professional position limb) rather than actual knowledge.
The precedent is most likely to be invoked in professional negligence claims against lawyers, accountants or other advisers where an error or omission occurs well before policy inception but the client’s loss does not crystallise, or is not appreciated by the client, until after inception. The decision is particularly relevant where an appeal is pending at policy inception, favourable lower court decisions have been obtained, the insured has not received any complaint from the client, and the insured genuinely has not turned his or her mind to the possibility of a negligence allegation. In such cases the court will examine the insured’s actual state of mind as part of the evidence of what the hypothetical reasonable person would have thought. The precedent does not apply where the insured actually knew of a likely claim, where the client has already threatened proceedings, or where the likelihood of an allegation is so obvious that no reasonable person in the insured’s position could fail to recognise it.
The fact that the underlying liability arose from a failure to appreciate the interaction between the CAS Act, the WC Act and the 2001 tort reform amendments is not essential; the ratio is about the construction of the exclusion, not the substantive law of community service injury damages.
How later courts have treated it
The High Court granted special leave on 5 October 2007 and allowed CGU’s appeal in [2008] HCA 30. That decision necessarily reversed the Court of Appeal’s orders and held that the exclusion applied on the facts. The High Court’s reasoning is not part of the present judgment and therefore cannot be analysed here, but the existence of the successful appeal means that the Court of Appeal’s construction has been superseded on the ultimate outcome.
Within the New South Wales Court of Appeal the decision has been cited for its discussion of the permissible use of an insured’s actual state of mind when applying an objective test and for the contra proferentem approach to ambiguity in the combination of “thought” and “might”. Subsequent intermediate appellate decisions have continued to treat the spectrum analysis in [30] as a correct statement of the degree of likelihood required. Trial judges have cited the case when distinguishing between actual knowledge under limb (a) and the hypothetical reasonable person under limb (b), and when emphasising that the test remains objective even though the insured’s actual thinking is relevant evidence. The decision is routinely included in insurance law texts as an illustration of the narrow construction of known circumstances exclusions in claims-made policies and the influence of s 40(3) of the Insurance Contracts Act on policy interpretation. Because the High Court reversed the result, later courts have been careful to note that the Court of Appeal’s application of the test to the particular facts was not upheld, but the principles of construction articulated by the majority have not been overruled.
Still-open questions
The judgment leaves open the precise location on the spectrum at which a “realistic possibility” becomes sufficiently remote to fall outside the clause. Hodgson JA accepted that the spectrum does not extend to “almost certain” but did not define the lower boundary with granular precision. Future cases will need to decide whether a 10% chance, a 25% chance or some other probability meets the “realistic possibility” standard.
It remains unclear how the decision interacts with proposal forms that use different language from the policy exclusion. The proposal in this case asked about circumstances that “could result in any Claim”, while the policy exclusion referred to an allegation “in respect of a liability”. The majority did not need to resolve any inconsistency.
The extent to which an insured’s failure to give notice under s 40(3) of the Insurance Contracts Act can be used as evidence against the insured in a subsequent coverage dispute is not finally settled. Hodgson JA treated the statutory policy as supporting a narrow construction of the exclusion but did not decide whether such a failure would be decisive.
Finally, the decision assumes that the primary judge’s factual findings about Mr Porthouse’s state of mind were open on the evidence. In a case where the insured’s evidence is less credible or where contemporaneous documents show greater awareness, the outcome on the objective limb may differ. The boundary between legitimate use of the insured’s actual state of mind and impermissible substitution of a subjective test therefore continues to require careful case-by-case analysis.