High Court breaks new ground on assessing solvency of insurers in voidable transaction case
The High Court has held that an insurer's outstanding claims liabilities (OCL) are to be considered “due debts” when assessing an insurance company's (in)solvency. This was a novel and live issue with significant consequences for insurers and another example of the CBL Insurance Limited (CBLI) collapse breaking new legal ground.
- The judgment demonstrates a wider application of s 292 of the Companies Act 1993 (Act) than has been seen previously.
- As the law stands, an insurance company's OCL are “due debts”, despite the precise quantum not having been notified to the insurer.
- This highlights the importance of insurance companies calculating their OCL accurately and reliably.
DLA Piper acted for CBLI's liquidators, successfully applying to set aside transactions made by CBLI as insolvent transactions under s 292 of the Act.
Background
CBLI was one of New Zealand’s largest licensed insurers, predominantly providing reinsurance services in over 20 jurisdictions. In exchange for a proportion of insurance company premiums, CBLI would cover a proportion of those insurance companies' claims. Of these insurance companies, CBLI insured the respondent, Alpha, a Danish company who provided insurance primarily in the French commercial building construction market including workers’ accident insurance. The long tail for claims in that market could be up to 16 years after construction was complete.
Given that CBLI was a licensed insurer, the Reserve Bank of New Zealand (RBNZ) had regulatory oversight over CBLI's operations. In 2016, the RBNZ became concerned about the management of CBLI and the level of its reserves, including its OCL. In November 2017, the RBNZ then made directions preventing CBLI from entering any transaction involving payment or transfer of more than NZ USD5 million without first consulting RBNZ.
However, on 14 February 2018, CBLI paid GBP397,000 to Alpha and, on 16 February 2018, it paid EUR25 million to Alpha (Transactions), without consulting RBNZ.
Following the Transactions, on the RBNZ's application, CBLI was put into interim liquidation on 23 February 2018, with Kare Johnstone and Andrew Grenfell of McGrathNicol being appointed interim liquidators. Final liquidation orders were made in November 2018. Meanwhile, Alpha was also declared bankrupt by a Danish court on 8 May 2018.
The issues in the proceeding
CBLI's liquidators applied to set aside the Transactions as voidable transactions under section 292 of the Act on the basis that they were entered into at a time when CBLI was unable to pay its due debts.
The hearing and judgment focused on two key issues:
- what constitutes “due debts” under s 292(2) of the Act in the context of the business of insurance and reinsurance companies; and
- whether in this case CBLI could pay its “due debts” at the time of the Transactions.
This article focuses on the first key issue.
What is OCL?
Generally, insurers in NZ are required to maintain a solvency margin of 100%, meaning its solvency capital must be greater than 100% of its minimum solvency capital. To determine its minimum solvency capital, an insurer must calculate its OCL. The OCL is an estimate of the insurer’s total likely claims exposure for the cover it has written, including claims reported and not finalised, and claims unreported and not known. The OCL is a mandatory requirement and approved by an actuary.
Whether OCL falls within the definition of “due debts” was a central issue in this case.
What constitutes “due debts”?
It was common ground that (a) at the time of the Transactions, CBLI was “balance sheet” insolvent and couldn't pay its OCL in full, (b) the Transactions were entered into during the “restricted period” and (c) Alpha had the onus to rebut the presumption that CBLI was “unable to pay its due debts” at that time.
But the parties disputed whether the OCL should be considered “due debts”. In short, Alpha argued that the OCL are not sufficiently certain liabilities to be a due debt for the purposes of s 292, while the liquidators argued that OCL is an estimate of unpaid claims that have already occurred.
The High Court preferred the wider definition of “due debts” contended by the liquidators, and therefore held that OCL fell within the definition, based on five principle reasons:
- Treating the OCL as a due debt is the only way to truly and reliably establish whether a reinsurance company is cash flow solvent, i.e., able to pay its due debts.
- Expert accountants/actuaries believe the OCL should be regarded as a due debt.
- Classifying the OCL as a due debt is consistent with the Supreme Court’s wide interpretation of “due debts”.
- This approach is consistent with the Australian jurisprudence.
- The purpose of the Act is best served by treating the OCL as a due debt, and there are sound policy reasons for doing so.
Overall, the High Court emphasised the practical realities of the insurance and reinsurance industry, holding that “treating the OCL as a present, accrued liability is the only effective way of determining a reinsurance company's ability to pay its due debts”.
The High Court cited David Browne Contractors v Petterson (2017) NZSC 116, (2018) 1 NZLR 112, in which the Supreme Court stated that “the issue of “how far into the future the inquiry as to present solvency is to go … is a fact sensitive question depending upon the nature of the company's business and if known, of its future liabilities”.1 The High Court held that the particular nature of a reinsurance business means it is necessary to look a long way into the future to avoid painting an artificial picture of the company's ability to pay due debts.
In this case, the relevant market resulted in a long tail of claims, ranging up to 16 years after the completion of construction.
Ultimately, the High Court held that CBLI was unable to pay its due debts at the time of the Transactions and granted the liquidators' application, setting aside the Transactions.
Next steps
If you would like more information on this judgment, and how this may impact your insurance business, please get in touch.
1 David Browne Contractors Ltd v Petterson [2017] NZSC 116, [2018] 1 NZLR 112 at [90], quoting Re Cheyne Finance Plc (No 2) [2007] EWHC 2402, [2008] 2 All ER 987 (Ch) at [50].
