Author
Max Cash  
Senior Associate

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Peter Stockdale  
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Philip Ward  
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Brisbane
Justin McDonnell  
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Canberra
John Topfer  
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Hong Kong
Stuart Valentine  (萬思陶)
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The House of Lords decision in McGrath and others v Riddell and Another [2008] UKHL 21 was good news for Australian insureds as it gives priority to insurance and reinsurance creditors in respect of reinsurance recoveries which may now be remitted from the UK to Australia for purposes of distribution in accordance with the Australian insolvency regime.

Facts

Four HIH companies presented winding up petitions to the Supreme Court of NSW. Some of their assets, being reinsurance claims on reinsurance contracts underwritten in the London Market, were situated in England. Liquidators had been appointed in Australia and provisional liquidators were appointed in England. In 2005, a letter of request was sent by the New South Wales Supreme Court to the English High Court seeking a direction that the English provisional liquidators remit English assets to the liquidators in Australia for distribution.

Australian insolvency legislative regime

In broad terms, the Australian insolvency regime requires that:

• first, assets in Australia are to be applied to the discharge of debts payable in Australia although this would not include the English assets as these were not in Australia at the time the companies were wound up); and
• second, the proceeds from reinsurance policies should be applied towards the discharge of liabilities which were reinsured (see section 562A of the Corporations Act 2001 (Cth)) (Corporations Act).

In essence, insurance and reinsurance creditors are given priority in distribution over other creditors on insolvency of a company. This differed from the UK law in force at the time the provisional liquidators in England were appointed (which has since changed), whereby insurance creditors would not have been given priority, and the assets would have been distributed equally, without preference among the ordinary creditors.

Decision

The House of Lords overturned the decisions of the English High Court and Court of Appeal, and held that the assets could be remitted to Australia.

The decision largely turned on the application of section 426(4) of the UK Insolvency Act 1986 (Insolvency Act) which enables a court in the UK which has insolvency jurisdiction to assist courts in any relevant country that is designated under the Insolvency Act, including Australia. The Court also referred to section 426(5) of the Insolvency Act which provided that a court in any part of the UK, in exercising its discretion to provide assistance, was to consider rules of private international law, including the principle of “modified universalism”. This principle effectively requires courts in the UK, as far as is consistent with justice and UK public policy, to cooperate with Australian courts to ensure that all the assets are distributed under a single system of distribution.

The Court observed that a refusal to remit the assets might be appropriate if it causes “manifest injustice to a creditor”. It nevertheless formed the view that the operation of the Australian statutory scheme in its preferential treatment of insurance and reinsurance creditors was not “unacceptably discriminatory or otherwise contrary to public policy”.

Implications of decision

The decision shows that section 426 of the Insolvency Act affords a channel of remission of assets where a principal liquidation takes place in Australia and an ancillary liquidation takes place in the UK. The fact that under Australian law insurance and reinsurance creditors would be given priority to other creditors in respect of remitted reinsurance recoveries, is not a bar to remission, so long as the requirements of section 426 of the Insolvency Act are satisfied. The decision affirmed the principle of ‘modified universalism’ (subject to certain limitations) which is a fundamental part of cross-border insolvency law.

The House of Lords decision post-dates APRA’s response to submissions concerning refinement to the Australian general insurance prudential framework in which APRA stated that “in the event of the insolvency of an Australian insurer, there may be circumstances where the recoverables from its reinsurers are not readily accessible in Australia” (see Response to Submissions - Refinements to the General Insurance Prudential Framework, www.apra.gov.au, 19 December 2007, p 14), where the reinsurers are located in the UK. This concern has partly driven reforms to the treatment of reinsurance for capital adequacy purposes. However, there has been no indication from APRA that it intends to revise its treatment of UK reinsurance following the House of Lords decision.

In the current economic climate, this decision should bring some comfort to insureds that any reinsurance assets located in the UK will be remitted to Australia in the event of the insolvency of an insurer, to be applied to the benefit of insureds and reinsureds in accordance with section 562A of the Corporations Act. However, when placing large insurance programmes, insureds should also consider whether they require additional security over reinsurance recoverables, including (depending on the commercial viability of such measures) the benefit of cut-through clauses or charges over reinsurance recoverables.