In the recent decision of AIG Australia Ltd v Hanna [2024] NSWCA 91, the Court of Appeal clarified the circumstances in which an insured who enters in a bona fide settlement agreement without the insurer's consent will be entitled to indemnity on the basis that the insured is "legally liable" to pay compensation.

A formworker (Kahlil Hasan) engaged on a construction project was injured when he slipped and fell while walking on scaffolding. Mr Hasan commenced proceedings against George Hanna (the builder responsible for the construction site) in the District Court seeking damages for negligence and breach of statutory duty.
 
Mr Hanna brought a cross-claim against AIG, who had issued Mr Hanna a liability policy for the project. The policy required AIG to indemnify Mr Hanna "for all sums that you become legally liable to pay as compensation" (clause 5.00). It also provided that, unless Mr Hanna obtained AIG’s prior written consent, he was not to admit liability for or settle any third-party claim (clause 10.1).
 
AIG had previously avoided the policy on the basis that Mr Hanna had made fraudulent non-disclosures to it regarding the project.
 
Mr Hasan settled his claim against Mr Hanna on the second day of trial. Orders were made by consent giving judgment for Mr Hasan against Mr Hanna and ordering Mr Hanna to pay Mr Hasan $430,000 with each party to pay their own costs.
 
The trial judge also gave judgment for Mr Hanna against AIG on the basis that Mr Hanna was the builder responsible for the performance and administration of the project and the policy should have responded to Mr Hasan’s claim. The trial judge found that clause 5.00 of the policy was activated by the entry of consent judgment given AIG’s consent was not available (as it had avoided the policy) and the settlement to which the consent judgment gave effect was objectively reasonable, based on a reasonable assessment of the risk that Mr Hanna faced as the defendant to Mr Hasan’s claim, having regard to:

• the value of the claim (Mr Hasan’s claim was for $1 million plus costs - by contrast, the consent judgment was for $430,000 inclusive of costs); and

• Mr Hanna's liability (the trial judge found that the most likely outcome in the proceedings would have been a finding that Mr Hanna was liable in negligence).

AIG appealed.

Mr Hanna submitted that, to show that he was "legally liable" within the meaning of clause 5.00, it was sufficient for him to rely on the consent judgment and to establish that the settlement was reasonable in the circumstances. AIG contended that Mr Hanna had to establish by admissible evidence that he was legally liable to Mr Hasan, which had not been done.
 
The Court of Appeal dismissed AIG's appeal.
 
It found that, on its proper construction, the scope of the indemnity provided in clause 5.00 of the policy included a liability that had been determined by a bona fide compromise agreement. It was not necessary for Mr Hanna to establish that he was liable to Mr Hasan in the manner alleged.
 
Rather, it was sufficient for Mr Hanna to show that the amount of the settlement was reasonable having regard to the relevant circumstances, which the trial judge had correctly considered having regard to both quantum and liability.

Having regard to the wording in issue in the dispute, the Court of Appeal determined that the insured could rely on a reasonable settlement to found a claim against its insurer if four conditions were satisfied:

1. the insurer has wrongfully repudiated the contract;

2. the insured accepted that repudiation and brought the contract to an end;

3. the insured enters into an arrangement with a third party claimant to pay an amount in respect of a liability, to which, if found, the policy would have responded; and

4. the amount of the settlement is reasonable having regard to the relevant circumstances at the time. Relevant circumstances can include the position in which the insured finds itself as a result of the repudiation and what it might have been held liable to pay if there had been a contest leading to a judgment or arbitral award.

The Court of Appeal found that all conditions were satisfied here. In other situations, the policy may not have been repudiated, but instead policy coverage denied in which case the third and fourth criteria would apply.

The decision is a restatement of the existing principle that, where an insurer has denied indemnity for reasons that the Court later overturns, the relevant inquiry is not into whether the insured has established that it was legally liability to the claimant, but whether the settlement the insured entered into was objectively reasonable (having regard to the amount in issue, liability and the costs associated with defending a claim at trial).
 
However, the case was also fact and policy specific: the trial judge found that there was at least a "substantial likelihood" that Mr Hanna would have been found liable. Further, the trial judge also relied on clause 10.01 of policy to support her Honour's construction that clause 5.00 applied to "legal liabilities" incurred as a result of settlement. It is possible that slight differences in the facts and policy wording may have led to a different result.
 
Careful consideration of the facts and policy wording in each case will therefore be required.