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The “double direct” trumps proximate cause

Authors

Paul O’Brien – Director
Anna Williams – Director

On 1 August 2022, Justice Jagot of the Federal Court delivered judgment in Inchcape Australia Limited v Chubb Insurance Australia Limited [2022] FCA 883.  This is the first case we know of in Australia that considers the expression “Direct Financial loss….directly caused by” for the purposes of a Fidelity or Crime Coverage Policy.

The applicant sought declaratory relief in respect of indemnity for a ransomware attack under a Financial Institutions Electronic and Computer Crime Insurance Policy (Policy) issued by Chubb.  Inchcape claimed that the ransomware attack caused it to incur, and continue to incur, financial losses in repairing and/or replacing hardware, software and data, including investigation costs, hardware costs, resources costs, additional staffing costs, and data recovery costs.

“….the compound requirement that there was direct financial loss resulting directly from the relevant events in Insuring Agreements 2 and 3 suggests a more stringent causal connection than ‘proximate cause’.” 

Inchcape’s claim for indemnity was based on Insuring Agreements 2 and 3 of the Policy.  On Inchcape’s application, the Court ordered the separate determination of certain Policy construction questions.

Whilst Chubb successfully argued that any cover available under Insuring Agreements 2 and 3 was limited by the valuation clause (GC4(i), the general importance of this decision is her Honour’s finding that the Policy required more than merely any loss resulting directly from an insured event.  It required direct financial loss a direct (that is, proximate) cause of which is an insured event, and for there to be direct financial loss a proximate cause of which is an insured event, the connection required excluded the prospect of any intervening step and losses that would not be necessarily and inevitably incurred by every insured given the occurrence of the insured event.

Relevant policy terms

The terms of the relevant Insuring Agreements are as follows (underlining added for emphasis):

In consideration of the payment of the Premium and in reliance upon all statements made and information furnished to Chubb Insurance Australia Limited ABN 23 001 642 020 (‘Chubb’), including statements made in the proposal form and materials accompanying it, and subject to all terms, conditions, exclusions and limitations of this Policy, Chubb agrees to pay the Insured for:

Insuring Agreement 2 – Computer Virus

Direct Financial Loss by reason of the loss resulting directly from the damage or destruction of Electronic Data, Electronic Media or Electronic Instruction owned by the Insured or for which the Insured is legally liable while stored within a Computer System covered under Insuring Agreement 1, provided such damage or destruction was caused by a computer program or similar instruction which was written or altered to intentionally incorporate a hidden instruction designed to damage or destroy Electronic Data, Electronic Media or Electronic Instruction in the Computer System in which the computer program or instruction so written or so altered is used.

Insuring Agreement 3 – Electronic Data, Electronic Media, Electronic Instruction

Direct Financial Loss resulting directly from:

(a)    the fraudulent modification of Electronic Data, Electronic Media or Electronic Instruction being stored within or being run within any system covered under Insuring Agreement 1,

(b)    robbery, burglary, larceny or theft of Electronic Data, Electronic Media or Electronic Instruction, or

(c)    the acts of a hacker causing damage or destruction of Electronic Data, Electronic Media or Electronic Instruction owned by the Insured or for which the Insured is legally liable while stored within a Computer System covered under Insuring Agreement 1.

Relevant definitions included:

Direct Financial Loss’ means direct financial loss first discovered by an officer of the Insured during the Policy Period.

General Condition 4(i) of the Policy, titled ‘Valuation’, states as follows:

Electronic Data, Electronic Media, or Electronic Instruction

In case of loss of, or damage to, Electronic Data, Electronic Media or Electronic Instruction used by the Insured in its business, Chubb shall be liable under this Policy only if such items are actually reproduced by other Electronic Data, Electronic Media or Electronic Instruction of the same kind of quality and then for not more than the cost of the blank media plus the cost of labour for the actual transcription or copying of data which shall have been furnished by the Insured in order to reproduce such Electronic Data, Electronic Media or Electronic Instruction, subject to the applicable Aggregate Limit of Indemnity and/or One -Loss Sub-Limit.

However, if such Electronic Data cannot be reproduced and such Electronic Data represents securities, or financial instruments having a value then the loss will be valued as indicated in the Securities and Other Property paragraphs of this Section.

The Separate Question

The question relevant to the causal criterion for cover was as follows:

Whether the expression ‘direct financial loss resulting directly from’ in Insuring Agreements 2 and 3 included financial loss incurred, as a result of damage or destruction to Electronic Data, Electronic Media or Electronic Instruction, in relation to:

      • investigating the ransomware attack and preventing further effects of the attack;
      • replacing computer hardware;
      • ancillary tasks in respect to reproducing damaged or destroyed Electronic Data, Electronic Media or Electronic Instruction (as defined); and/or
      • manual processing of orders.

This question raised a number of issues, most importantly the significance of the repetition of the concept of ‘directness’ as the causal criterion for cover under Insuring Agreements 2 and 3, and its impact on the scope of cover offered under those insuring clauses.

Chubb contented that:

  • the losses identified were not “Direct Financial Loss…resulting directly from…”. Rather, the losses were insufficiently direct for the purpose of Insuring Agreements 2 and 3, or were indirect or consequential losses excluded by cl 3(e); and
  • the compound requirement that there was direct financial loss resulting directly from the relevant events in Insuring Agreements 2 and 3 suggested a more stringent causal connection than ‘proximate cause’.

The definition of ‘Direct Financial Loss’ meaning ‘direct financial loss’, did not shed light on the issue.

Her Honour referred to recent authorities that considered the terms “direct financial loss”, “direct” and “effective cause” at [38], [39], [40]:

[38]      In Australian Capital Financial Management Pty Ltd v Australian Financial Complaints Authority Limited [2021] NSWSC 1577 Ball J said:

[69]      The expressions “direct financial loss” and “indirect financial loss” are not terms of art, and their meaning depends on the context in which the issue arises. The expressions invite consideration of the question whether there is a sufficiently clear and direct connection between the breach and the loss that it can be said that the loss is a direct consequence of the breach or whether the connection falls short of that requirement. As Mitchell J explained in Patersons Securities Ltd v Financial Ombudsman Service Ltd [2015] WASC 321 “the essence of the distinction evoked by that meaning is, in general terms, between direct loss which flows naturally from the breach without other intervening cause and indirect loss which does not so flow. Whether particular loss – including loss of profits – is direct or indirect depends on all the circumstances of the particular case”: at [132] (citations omitted).

[70]      In the present case, there is a question whether there is a sufficient connection between ACFM’s conduct in failing to provide adequate information to the guarantors and the legal costs they ultimately incurred to say that one is a direct consequence of the other. In my opinion, there is not. The obligation to pay legal costs did not arise from the guarantees…They were not a ““normal loss” … [being] loss that every plaintiff in a like situation will suffer …” to quote from the judgment of Nettle JA in Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd (2008) 19 VR 358 at [87], [93]. .

[39]      In Lasermax Engineering Pty Ltd v QBE Insurance (Australia) Limited [2005] NSWCA 66; (2005) 13 ANZ Ins Cas 61-643 the Court concluded that “direct” meant “proximate” in an insuring policy and did not exclude the possibility of intervening events: [82]–[83], [101].  However, in Lasermax, McColl JA (with whom Ipp and Tobias JJA agreed) was careful to stress that “the expression “directly caused by” in an insurance contract is, subject to the terms of the policy, to be construed as referring to the concept of proximate cause” and did not exclude all claims involving a “step between the cause and the consequence”.

[40]      In Outerbridge t/as Century 21 Plateau Lifestyle Real Estate v Hall [2020] NSWCA 205; (2020) 102 NSWLR 921, Beech-Jones J (with whom Leeming JA and Emmett AJA agreed) explained at [60] that, in the context of a contractual right to a sales commission (where the concept of “effective cause” applies):

A test requiring proof of “effective cause” is different from and more stringent than the test of proximate cause which is often applicable to insurance contracts which in turn is more stringent than the ‘but for’ test of causation (Moneywood Pty Ltd v Salamon Nominees Pty Ltd (2001) 202 CLR 351; [2001] HCA 2 at [83] per Gummow J…

Her Honour concluded at [41], that the application of these authorities meant that “loss resulting directly from”, as used in Insuring Agreements 2 and 3, meant loss the proximate cause of which was an insured event.  However, it was not any “loss” which was covered.  It was only “Direct Financial Loss”.

As such, her Honour found that the cover in Insuring Agreements 2 and 3 was for direct financial loss a direct (that is, proximate) cause of which is an insured event, and for there to be direct financial loss a proximate cause of which is an insured event, the connection required excluded the prospect of any intervening step and losses that would not be necessarily and inevitably incurred by every insured given the occurrence of the insured event.

This finding was consistent with Lasermax and other authorities because, as her Honour states at [41], it gave effect to the fact that Insuring Agreement 2 and 3 required not merely any loss resulting directly from an insured event, but direct financial loss resulting directly from an insured event which any and every insured would have suffered by reason of the insured event.

Take aways

In our view, the decision is closer to the United States “direct means direct”, rather than “proximate cause” approach to policy construction.

However, this outcome arises from the “double direct” wording used, and the same outcome might not arise if a policy of insurance only responds to “losses directly resulting from” a particular insured event, or to “Direct Financial Loss”.

DISCLAIMER
This article is intended to provide a general summary only and does not purport to be comprehensive. It is not, and not intended to be, legal advice.
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