Focus: D&O insurance; defence costs; charge
in respect of potential claims
Industry Focus: Insurance
Steigrad & Ors v BFSL 2007 Ltd & Ors HC AK CIV-2011-404-611  NZHC 1037 (15 September 2011)
A recent decision of the High Court of New Zealand, if followed in Australia, has serious repercussions for all directors and officers.
The receivers of various Bridgecorp companies asserted that they had claims against the Bridgecorp directors ("directors") for various breaches of directors' duties. They estimated the damages to be in excess of NZ$450 million. Those directors were also being prosecuted by the NZ equivalent of ASIC and were facing an imminent trial. They wanted to access their NZ$20 million D&O policy to fund their legal costs of the criminal trial. The receivers however asserted that they had a "charge" over the insurance proceeds that may be payable for their claim, pursuant to the NZ equivalent of s6 of the Law Reform (Miscellaneous Provisions) Act 1946 (NSW).
The Court held that, as unfortunate as the result may be for the directors, the charge stood in favour of the receivers, such that the directors could not fund their defence costs through their D&O policy.
The Bridgecorp group of finance companies ("Bridgecorp") collapsed and were placed into receivership in June 2007 owing investors nearly NZ$500 million. The directors face numerous criminal and civil claims following the collapse, including civil and criminal proceedings instituted by the NZ Securities Commission. In addition, it is likely that the directors will also face civil claims from the Bridgecorp companies in receivership.
At the time of the collapse, there were in existence 2 policies of insurance which could potentially provide cover for the directors' defence costs; firstly, a statutory liability policy ("SL policy") providing cover of NZ$2 million; secondly, a D&O policy with QBE with an overall policy limit of NZ$20 million and a limit for advance payment of defence costs (where cover has not been confirmed) of NZ$500,000.
The SL policy limit was exhausted first and the directors then called upon QBE to fund their further defence costs. In June 2009 however, Bridgecorp advised QBE that they asserted a charge over monies payable under the D&O policy for amounts they intended to claim from the directors in civil proceedings. It was alleged that the charge arose by virtue of s9 of the Law Reform Act 1936 (NZ) ("LR Act") which creates a charge in favour of a claimant over monies that may be payable under any insurance policy held by the person against whom the claim is made. As a result, QBE refused to make any payments in respect of defence costs unless agreement could be reached as to the allocation of funds under the policy. No such agreement could be reached and the directors sought a declaration that s9 of the LR Act did not prevent QBE from making payments in respect of defence costs under the policy.
The New Zealand High Court's decision
Section 9 of the LR Act is as follows:
"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.
(2) If, on the happening of the event giving rise to any claim for damages or compensation as aforesaid, the insured has died insolvent or is bankrupt or, in the case of a corporation, is being wound up, or if any subsequent bankruptcy or winding up of the insured is deemed to have commenced not later than the happening of that event, the provisions of the last preceding subsection shall apply notwithstanding the insolvency, bankruptcy, or winding up of the insured.
(3) Every charge created by this section shall have priority over all other charges affecting the said insurance money, and where the same insurance money is subject to 2 or more charges by virtue of this Part of this Act those charges shall have priority between themselves in the order of the dates of the events out of which the liability arose, or, if such charges arise out of events happening on the same date, they shall rank equally between themselves.
(4) Every such charge as aforesaid shall be enforceable by way of an action against the insurer in the same way and in the same Court as if the action were an action to recover damages or compensation from the insured; and in respect of any such action and of the judgment given therein the parties shall, to the extent of the charge, have the same rights and liabilities, and the Court shall have the same powers, as if the action were against the insured. Provided that, except where the provisions of subsection (2) of this section apply, no such action shall be commenced in any Court except with the leave of that Court.
(5) Such an action may be brought although judgment has been already recovered against the insured for damages or compensation in respect of the same matter.
(6) Any payment made by an insurer under the contract of insurance without actual notice of the existence of any such charge shall to the extent of that payment be a valid discharge to the insurer, notwithstanding anything in this Part of this Act contained.
(7) No insurer shall be liable under this Part of this Act for any sum beyond the limits fixed by the contract of insurance between himself and the insured."
It should be noted that s6 of the Law Reform (Miscellaneous Provisions) Act 1946 (NSW) ("LRMP Act") is in almost identical terms to s9 of the LR Act. His Honour, Lang J, referred to various Australian and New Zealand authorities1 and noted that the purpose of these sections was to ensure a bona fide claimant is not deprived of access to insurance monies due to a number of possible factors, including the insolvency of the insured, the application of the insurance monies to other debts or even a corrupt bargain between the insured and the insurer. His Honour also noted dicta to the effect that s9 of the LR Act 'alters the priority of claims against the assets of such an insured'.2
His Honour considered the nature of the charge and held that:
- the charge comes into existence well before liability is declared to exist by a court or other tribunal (in this case the charge arose when the Bridgecorp group collapsed)
- the fact that the quantum of the claim is yet to be determined will not prevent a charge from coming into existence
- the charge applies both to insurance money that is payable and to that which may become payable, and
- there are clearly limits to the scope and application of the charge.3
Lang J then considered whether the charge would prevent the directors from having access to the D&O policy to meet their defence costs. He referred to the case of National Insurance Company of New Zealand Ltd v Wilson4 where the court had concluded that an insurer was not entitled to deduct defence costs from an amount payable to an injured employee on behalf of an insured, as to do so could allow an insurer to 'whittle down its liability to the insured by unnecessary and extravagant litigation, and, in the long run, the employee would lose the security for compensation he would otherwise enjoy by virtue of the policy.' This was so even though the policy limit was 'inclusive of costs'.
In this case Bridgecorp submitted that, were the directors to be allowed to recover defence costs under the policy, the same result would follow – that is, that the reimbursement of defence costs would significantly reduce the amount available under the D&O policy for civil claimants, thus rendering the charge under s9 largely ineffective. Lang J agreed with this submission. He then considered 2 further authorities5 which, though not completely analagous to the current case (in that they did not involve claims against directors enlivening D&O policies), generally supported the proposition that payments made in respect of defence costs or other payments made 'after the charge has descended' under the contract to the insured6 cannot be deducted from monies owing to a claimant pursuant to the contract of insurance.
Accordingly, Lang J held that, even though the charge remained conditional (on Bridgecorp establishing liability on the part of the directors and the directors establishing entitlement to cover under their D&O policy), the charge operated to prevent the directors from accessing the D&O policy to meet their defence costs. His Honour reached this conclusion by noting:
- s9(1) charges "all insurance money" that is or may become payable
- the claim by Bridgecorp against the directors was for a sum significantly in excess of the policy limit,
- and any payment made to the directors in respect of defence costs would have the effect of reducing the fund available for the civil claimants, thereby rendering the charge created by s9 ineffective, or requiring QBE to pay defence costs in addition to the overall policy limit.
Conclusion and comment
Lang J correctly noted that his conclusion that the charge created by s9 of the LR Act prevented the directors from accessing their D&O policy to meet defence costs produced 'some unsatisfactory consequences'. This is especially so given that one of the main reasons companies and directors purchase D&O insurance is to provide cover for defence costs in relation to any civil or criminal proceedings instituted against them.
As Lang J observed, the problem lies in the in the fact the Bridgecorp 'elected to take out an insurance policy that provided cover for both defence costs and claims for damages and compensation' whereas an SL policy providing greater cover for defence costs could have been selected. The issue also arises due to the fact that Bridgecorp's claim exceeded the policy limit. Difficulties in the application of the charge may arise where claims are less than the policy limit.
Standard D&O policies on the market today provide cover for defence costs, damages and compensation in the one policy, with the one policy limit. As a result of this decision, until there is judicial clarification in New South Wales, directors may now have to consider finding and purchasing separate cover for defence costs only in order to quarantine that cover from any claim for damages and compensation and the charge arising from s6 of the LRMP Act (NSW). At least in NSW, such products are yet to be developed, although this should not prove problematic. The main difficulty will be in deciding upon the amount of cover required and pricing that cover.
At the time of publishing, the directors are still in time to appeal this decision of the NZ High Court.
1Grimson v Aviation & General (Underwriting) Agents Pty Ltd , (1991) 25 NSWLR 422; FAI (NZ) General Insurance Co Ltd v Blundell and Brown Ltd  1 NZLR 11 (CA); Ludgater Holdings Ltd v Gerling Australia Insurance Co Pty Ltd  3 NZLR 713 (SC); McMillan v Mannix (1993) 31 NSWLR 538 (CA); Body Corporate No 195843 v North Shore City Council (The Grange)  2 NZLR 222 (CA).
2 Ludgater at .
3 See s9(6) LR Act – "Any payment made by an insurer under the contract of insurance without actual notice of the existence of any such charge shall to the extent of that payment be a valid discharge to the insurer, notwithstanding anything in this Part of this Act contained."; Also, where the insurer establishes that it is entitled to disclaim liability under the policy or where there is a vitiating factor in its formation, no charge will exist – Bailey v NSW Medical Defence Union Ltd  HCA 28 at 449.
4  NZLR 639 (SC)
6 McHugh and Gummow JJ in Bailey at 449.
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