Directors unable to access D&O policy to pay defence costs
by Keith Bethlehem, Kemsley Brennan and James Stanton
In brief – Defence costs expressly covered under terms of D&O policy
In the case of Peter David Steigrad & Ors v BFSL 2007 Limited & Ors, a single judge in the New Zealand High Court1 declared that a Directors' & Officers' liability insurance policy could not be accessed by directors to cover defence costs, despite those costs being expressly covered under the terms of the policy.
Third party claimants have charge over all insurance money
Section 9 of the Law Reform Act 1936 (NZ) was held to impose a charge in favour of the third party claimants over all insurance monies, thereby preventing the insured directors from enjoying cover for their own costs under the shared limit for directors' defence costs and liability.
It is significant that the judge expected the civil claims against the directors to exceed the combined limits. It is unclear whether the decision will be followed in Australia.
Bridgecorp collapse leads to prosecution of directors
The case of Steigrad v BFSL2 flows from the collapse of the Bridgecorp group of companies in the lead-up to the global financial crisis (GFC). The companies within the Bridgecorp group are either in receivership and/or liquidation.
As a consequence of the Bridgecorp collapse, the group was investigated and the group's five directors now face criminal prosecution by the New Zealand Securities Commission, as well as civil proceedings launched by creditors. In addition, the receivers and/or liquidators of Bridgecorp intend to pursue civil remedies against the directors.
D&O policy and statutory liability policy
Bridgecorp went into liquidation owing approximately $500 million to investor creditors. Bridgecorp at the time held two discrete insurance policies issued by QBE (International) Limited.
It held a directors’ & officers' liability policy with a limit of indemnity of $20 million. Additionally, the directors had taken a statutory liability policy covering defence costs for breach of statutory obligations. The limit of that policy was $2 million. The policies together were for "any one claim and in the aggregate".
The directors opted to draw initially on the $2 million statutory liability policy. Divided between the five directors, the $2 million limit of indemnity was exhausted even before the hearing of these declaratory proceedings in late August 2011.
The directors proposed to rely on the D&O policy to fund their defence costs and sought a declaration that they were so entitled. QBE was a defendant in the proceedings.
In particular, the directors relied on the D&O policy wording which provided that QBE would pay the insured directors for "loss" flowing from a "wrongful act." The term "loss" in the D&O policy expressly included defence costs3.
However, the receivers notified QBE that they would be asserting a charge over the full limits under the D&O policy in anticipation of their claim against the directors, despite the wording of the D&O policy.
Third party claimants can have charge over all insurance money
The receivers gave notice to QBE pursuant to section 9 of the Law Reform Act 1939 (NZ), which is relevantly substantially similar to section 6 of the Law Reform (Miscellaneous Provisions) Act 1946 (NSW)4. Section 9(1) of the NZ Law Reform Act provides5:
9 Amount of liability to be charge on insurance money payable against that liability
(1) If any person (hereinafter in this Part of this Act referred to as the insured) has, whether before or after the passing of this Act, entered into a contract of insurance by which he is indemnified against liability to pay any damages or compensation, the amount of his liability shall, on the happening of the event giving rise to the claim for damages or compensation, and notwithstanding that the amount of such liability may not then have been determined, be a charge on all insurance money that is or may become payable in respect of that liability...
In effect, section 9(1) creates a charge over insurance monies in favour of third party claimants "on the happening of an event" which gives rise to the relevant claim. In this instance, his Honour held that the event was the collapse of Bridgecorp and the leaving of vast debts owing to creditors. It is not required that the claimants' cause of action is complete, it is only the happening of the event giving rise to the underlying claim.
Interpretation of Section 9 of the NZ Law Reform Act
His Honour Lang J summarised existing New Zealand and Australian authority to note that the charge will "prevent an insured from receiving and disbursing the proceeds of an insurance claim for purposes other than satisfying the claim in respect of which the insurer made the payment"6. It will additionally prevent an insured from frustrating the third party claimant's ability to access monies payable under an insurance policy"7. That much is uncontroversial.
Were the directors entitled to indemnity for defence costs?
Having described the text and purpose of section 9, his Honour turned to the real question: whether the directors were entitled to indemnity for defence costs as provided in the D&O policy. His Honour assessed two New Zealand authorities8 and a High Court of Australia decision9 relating to the extent of the charge and remarked that those authorities were of "limited assistance"10.
That in itself is significant. His Honour is making new law. For example, the New South Wales case of Bailey v New South Wales Medical Defence Union Limited11 did not concern defence costs, but the issue of whether an insurer could unilaterally vary a policy.
His Honour looked to the nature of the charge and the purpose of section 9. Having accepted that a charge created by section 9 came into existence on the collapse of Bridgecorp, his Honour noted that:
- section 9(1) causes the charge to to attach to "all insurance money"
- there was no mechanism in the section to enable funds to be released to meet obligations other than the insured's "liability" as contemplated by the section
- although the result may be harsh to the directors, it accords with the object and purpose of section 9
- the charge, which "takes priority over all other forms of security given by the insured"12, could not allow an insured to "be in a better position than his or her secured creditors"13
Directors unable to access D&O policy to pay defence costs
Lang J held that the charge under section 9 prevented the directors from accessing the D&O policy to meet defence costs despite shared limits. Any payments for defence costs would either have to be met personally by the directors, or met voluntarily by the insurer.
In his concluding remarks, his Honour acknowledged that the decision "may seem unfair given the fact that the Bridgecorp companies took the policy out at least in part"14 to meet defence costs. However he accepted submissions by the receivers that the directors could have taken out a statutory liability policy which provided higher coverage for defence costs than the $2 million selected.
In closing, the court observed that it was "almost certain"15 that the parliament, in enacting the Law Reform Act 1936 (NZ) would have viewed this outcome as being consistent with the spirit and intent of the section.
No consensus that the court’s decision was correct
With respect, we query this assertion, given that the legislation was enacted decades ago, before the prevalence of "claims made and notified" policies such as the D&O policy in issue.
We are not alone in this view. While sitting as a judge of the Court of Appeal in The Owners Strata Plan No 50530 v Walter Construction Group Limited16, his Honour Justice Giles made the following observations:
Some years ago I had occasion to suggest, writing extra-judicially, that s 6 is an unsatisfactory provision and should be reconsidered...Many others have expressed similar views... The attention of the legislature, preferably in a wide-ranging re-consideration and with regard to the availability of direct enforcement against an insurer under other legislation, is highly desirable.17
We consider that the NSW Parliament could urgently address the issue in consultation with insurers and directors in order to achieve certainty.
Decision has limited application to claims made and notified policies
We note that in Australia only NSW18, ACT19 and NT20 have legislative provisions comparable to the NZ Act. In the NSW Walter Construction Case, the court considered the application of section 6 of the NSW Act to "claims made and notified" policies.
Approving generally of the earlier authorities21 the court confirmed that section 6 did not apply to claims made and notified policies where the event was not covered in the particular policy period. Hodgson JA held that:
[i]t is true that the charge under s 6(1) is something created by statute, which does not have to conform to pre-existing general law categories; but it is difficult in the extreme to read s 6(1) as disclosing a legislative intention that there be something called a charge in existence at a time when there is no property to which it could attach, and no person against whom any rights could be asserted to have a charge attached to property if and when the property comes into existence... It is also true that the charge extends to "moneys that… may become payable"; but in the situation under discussion, there would not be in existence any circumstance giving rise to a possibility that moneys may become payable, apart from the possibility that the person against whom the cause of action has arisen might, in the future, make a contract with some as-yet unidentified insurer, which covers liability under that cause of action.22
The result is that the authority of the Walter Constructions Case will further limit the application of this decision in New South Wales to facts where the event giving rise to the claim occurs within the relevant policy period. That may be particularly significant as regards its application to many professional indemnity classes.23
No enforcement without legal proof
It is also unclear to what extent the charge in fact "defeats" recovery under the D&O policy. Here, his Honour noted that the charge created by section 9 exists whether or not a case is in fact made out against the directors. However, the charge cannot be enforced until a third party claimant such as Bridgecorp can prove that the directors are liable to them and that the directors are entitled to cover under the D&O policy.
That is to say, the charge remains conditional and floating until it can be fixed to a particular sum. It maintains priority based on the time at which the claim arises. The decision deprives the insured from accessing the insurance monies if that will deplete the amount to which the third party claimant may be entitled.
Possibility of directors’ access to D&O policy to pay defence costs
At the same time, the court noted in a somewhat contradictory paragraph that where liability to the third party claimant will be less than the full amount covered by the D&O policy, there may be some leeway to use the policy to pay out defence costs. Lang J noted:
In the present case the claim... is for a sum significantly greater than the amount of cover available under the D&O policy. As a result, QBE is now bound to keep the insurance fund intact for the benefit of the Bridgecorp defendants and any other civil claimants who might have priority over them by virtue of s 9(3). The position is likely to be different in circumstances where the amount of the claim is well within the amount of cover available under a policy. In those circumstances the charge could only extend to the likely amount of the claim and its associated costs. The insured may therefore be able to gain access to the policy to meet defence costs (emphasis added).24
It appears that the outcome of this paragraph is that with regard to defence costs recovery, the charge will only operate to prevent depletion of the "likely amount of the claim and its associated costs"25.
Do "associated costs" include defence costs?
With respect, the paragraph is somewhat internally inconsistent. The claim and its associated costs are, without explanation, circumscribed to the amount to which a third party claimant is entitled.
However, the "associated costs" may be interpreted to include defence costs, particularly in circumstances where a third party claimant is ordered to pay those in full or in part. It is not clear how a court will assess at this earlier stage whether a claim or the amount claimed are spurious.
Difference between NZ and NSW Acts
As noted above, the court relied on the wording of the section and the proposed parliamentary intention behind the enactment. The heading of section 9 in the Law Reform Act 1936 (NZ) reads "Charges on insurance money payable as indemnity for liability to pay damages or compensation" (emphasis added)26.
In contrast, the heading enacted in the New South Wales equivalent Law Reform (Miscellaneous Provisions) Act 1946 (NSW) reads "Attachment of insurance moneys". The emphasised terms above were patently dropped from the NSW Act.
Arguably, a distinction exists between the NZ provision and the NSW provision which suggests that the term "liability" in the NSW act extends beyond the liability directly to the third party claimant. Instead, the liability arguably extends to the claim amount, interest amounts, the third party claimant's legal costs and the insured's own defence costs.
If it is correct to make that assertion, then the Bridgecorp Case may be distinguishable in New South Wales. The meaning of "liability" under both acts remains unclear.
Practical effect of the Bridgecorp decision
It remains to be seen whether the High Court of New Zealand's interpretation will stand and whether Australian courts will follow the authority. Rumours abound that there are claimants preparing a test case in NSW.
However, for the time being, the decision serves as an important practical reminder for both insurers and insureds with a D&O policy of insurance to ensure that they can achieve certainty. The industry as a whole must adjust to this development, if confirmed, including by way of new products.
Implications for insurers
Insurers will be aware that despite the wording of a D&O policy, the decision is presently authority in New Zealand that courts may require the full insured amount to be available to the third party claimant in the event of a successful claim. This will be limited to the "likely amount of the claim and its associated costs", though this term itself remains open to interpretation.
Insurers will want to ensure that amounts paid to directors as defence costs in such circumstances are not paid as volunteers and will erode the limits of liability.
Implications for insureds
Insureds must be careful when choosing their level of indemnity and whether to elect for separate policies. It may be necessary to choose both a D&O policy to cover the "likely amount" of the claim and costs, while also maintaining, for example, a supplementary legal expenses policy and a statutory liability policy,27 or seek separate limits under a D&O policy to cover defence costs.
Insureds should be entitled to access D&O policies to pay defence costs
The issues raised in the decision are far from settled, though they currently pose an interesting benchmark in New Zealand law as to the High Court's interpretation of section 9 and the treatment of D&O policy wording. While the judge in New Zealand noted the principle that a third party claimant under the statutory charge has no greater rights than the insured would have, his Honour failed to explore this issue further.
The contract is clear. Insureds are entitled to share the limits to pay qualifying defence costs. This is well recognised in other jurisdictions including the United States, where the courts in California have held that where a policy clearly states that defence costs are payable within the limits of liability, they are to be eroded accordingly.
For example, in Helfand v. National Union Fire Ins. Co.27 an insured corporation sought coverage under its D&O policy for lawsuits alleging securities fraud which were filed against its directors and officers. Although cover was conceded, the insurer appealed a first instance decision that defence costs incurred by the insured did not deplete the policy's limit of liability. The Court of Appeal of California overruled the lower court's decision and held that:
[t]he plain terms of the policy make it clear that defense costs are payable against the limits of liability just like any other element of "loss" as defined in the policy. We arrive at this conclusion by examining the policy as a whole and the interplay between the defined concept of "loss" and various related provisions.28
We note that there is no similar statutory charge provision in California. For the time being in Australia, it will be necessary to monitor developments flowing from the Bridgecorp case.
1The High Court in New Zealand is the superior Court of first instance. It is equivalent to the State Supreme Courts in Australia. This is in contrast to the terminology used in Australia where the High Court in Canberra is the ultimate Appeal Court.
2Peter David Steigrad & Ors v BFSL 2007 Limited & Ors (HC Auckland, CIV-2011-404-611, 15 September 2011 per Lang J) (Bridgecorp Case). All case references are to the Bridgecorp Case unless otherwise specified.
3See clause 2.0 of the D&O policy as cited in the Bridgecorp Case at .
4Law Reform (Miscellaneous Provisions) Act 1946 (NSW) current version available online at: http://www.legislation.nsw.gov.au/maintop/view/inforce/act+33+1946+cd+0+N.
5Law Reform Act 1939 (NZ) current version available online at: http://www.legislation.govt.nz/act/public/1936/0031/latest/DLM219550.html.
7At , referring to McMillan v Mannix (1993) 31 NSWLR 538.
8National Insurance Company of New Zealand Limited v Wilson  NZLR 639 (SC); Pattinson v General Accident Fire and Life Assurance Corporation Limited  NZLR 1029.
9Bailey v New South Wales Medical Defence Union Limited (1995) 183 CLR 399.
11Bailey at n9 above.
16(2007) 14 ANZ Insurance Cases 61-734;  NSWCA 124 (Walter Construction Case).
17Walter Construction Case at  per Giles JA.
18See n4 above.
19Civil Law (Wrongs) Act 2002 (ACT), Part 15.3.
20Law Reform (Miscellaneous Provisions) Act, Part VIII.
21Manettas v Underwriters at Lloyds (1993) 7 ANZ Insurance Cases 61-180 (CBP acted for the insurer); Bailey at n9 above.
22Walter Construction Case at -.
23For example, claims against architects and engineers by their very nature often arise out of historical events.
26See NZ Act, above n5.
27Defence costs type cover under statutory liability policies is limited. Most statutory liability policies will only indemnify for legal representation expenses where the insured is potentially subject to a fine or penalty.
28Id at 299.