Each of the Corporations Act (Section 562) and the Bankruptcy Act (Section 117) make it abundantly clear that, where the insolvent was insured against claims from third parties, and any proceeds from that insurance are received by a liquidator or the trustee those proceeds (after payment of proper costs) must be passed on to the injured third party.
For example, if a solicitor was negligent and subsequently became bankrupt the client who suffered the loss as a result of the negligence would be entitled to:
- Receive all of the proceeds received from the professional indemnity insurer (net of costs), and
- To prove as a creditor for any shortfall
So the law regarding who is entitled to the insurance proceeds is relatively straight forward; to reiterate the insured gets the funds in the first instance but must pass on the net proceeds to the injured party. Clearly the funds cannot be used generally in the insolvent administration.
What is not so clear, from a practical view point, is who will (or can) take action to recover from the insurance company. Anecdotally at least some insurance companies will only “pay out” when forced to and forcing them to may involve very considerable legal costs and delays. In such cases insolvency practioners will often be reluctant to get involved. This issue was recently canvassed in Tapp v LawCover Insurance Pty Ltd (2013FCA35), which dealt with the problem in a bankruptcy context.
The following points summarise what guidance can be taken from the decision in Tapp:
- Section 117 of the Bankruptcy Act vests any recovery action against the insurer in the trustee of the bankrupt estate. This is the case notwithstanding that ultimately any proceeds must be paid to the injured party and not used in the estate generally.
- Section 19 of the Bankruptcy Act obliges all trustees to take appropriate steps to recover property for the benefit of the estate. This refers to all property vested in the trustee including the right to take action against the insurer. Thus the trustee must turn his or her attention, in a timely way, to what steps need to be taken to recover the insurance proceeds.
- Section 19 also imposes a duty on trustees to act “as efficiently as possible by avoiding unnecessary expense” and to act in a “commercially sound way”. This part of the section suggests that the trustee has no obligation to incur costs in a recovery action which he does not believe will be well spent and or recovered.
- Where the trustee does not intend to take or to proceed with action against the insurer he may assign to the injured party the trustee’s right to proceed against the insurer. Although not specifically dealt with in Tapp we suggest that having reached a decision not to proceed the trustee must promptly communicate that decision to the injured party and offer to assign the action on appropriate terms. An alternative strategy open to the trustee is to seek indemnity from the injured party before proceeding.
- The right to take action against the insurer does not lapse on the discharge of the bankrupt. Although the Court was asked to decide this point we would have thought that the position was already clear.
In providing judgment in Tapp the Court was strong in its criticism of the trustee (the Official Trustee) for a perceived failure to efficiently carry out its duties under s19 of the Bankruptcy Act.