On 15 September 2011, the extent of cover available for defence costs under a directors and officers (D&O) policy was thrown into doubt by the New Zealand High Court in Steigrad & Ors v BFSL2007 Ltd & Ors HC Auckland CIV-2011-404-611. The High Court relied on section 9 of the Law Reform Act 1936 (NZ) in deciding that the former Bridgecorp directors could not rely on their D&O policy to meet the cost of defending civil and criminal claims against them. Several Australian states have similar legislation.
In the High Court, Lang J held that the charge created by section 9 applies to the entire sum insured available for both liability and defence costs cover. Thus, where the potential liability the insured is facing to a claimant exceeds the sum insured, the charge exhausts the sum insured and nothing is left to pay defence costs in the meantime.
Just before Christmas 2012, the New Zealand Court of Appeal overturned this decision due to the unfair effect it has on the insured. It found it to be irrelevant that the payment of the defence costs depletes the funds available to meet a claimant's claim, should it succeed. This is a necessary consequence of the policy's structure and is consistent with an insurer wishing to avoid its contingent liability under the policy by incurring defence costs first to avoid the insured's alleged liability to the claimant.
In the D&O policy before the court, there was a single aggregated sum insured, from which defence costs and third-party liability were to be met. The Court of Appeal was of the view that if these two insurer obligations were in two separate policies then a charge would not apply to the defence costs policy. The fact of combining the two distinct liabilities into one policy and having a single sum insured does not change the principle that section 9 does not apply to the defence costs cover. Section 9 does not operate to provide a charge over insurance money that will not be payable in settlement or discharge of that liability.
The Court of Appeal also held that section 9 cannot interfere with a contractual arrangement between an insurer and the insured as section 9 is merely a procedural mechanism enabling a claimant to directly access funds payable by an insurer under a policy to meet the insured's liability to the claimant. The section must take effect subject to the terms of the contract, meaning that the charge is subject to the limit of indemnity for legal liability to claimants. The amount of funds available for indemnity must be determined after the insurer's liability to meet defence costs under the policy is determined. If the insured is deprived of the right to reimbursement of defence costs under the policy, then this cover would be rendered useless in practice.
This reversal of the High Court's decision will come as a relief to some. We wait with interest to see if the claimants will seek leave to appeal this decision in New Zealand's highest court, the Supreme Court.
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