Australia: Will a Directors and Officers insurance policy respond to a creditor's claim for damages for breach of director's duties?

Last Updated: 15 June 2013
Article by Tebony Justins

Creditors can claim damages against directors for breach of director's duties by two mechanisms. The first is to supplement a Section 1324 injunction to restrain such breaches; the second is under Section 588R for breach of the duty not to trade while insolvent. Does a Directors and Officers insurance policy ("D&O policy") respond to such claims by creditors?

It is necessary to consider whether the conduct in question falls within Sections 199B(1) and 199C(2) of the Corporations Act 2001 (Cth), the Dishonesty and Fraud exclusion clause under the D&O policy, and any Insured v Insured exclusion clause (if there is one).

Section 1324 of the Corporations Act 2001 (Cth)

Subsection 1324(1) allows a creditor, as "a person whose interests are affected" by the director's conduct, to seek an injunction to stop breaches of directors duties. Subsection 1324(10) allows an award of damages where the court has the power to grant an injunction.

In McCracken v Phoenix Constructions (Qld) Pty Ltd [2012] QCA 129, the Queensland Court of Appeal held that damages are available to supplement a Section 1324 injunction, even though the section does not grant a creditor or other interested person a general right to damages.

Relief in Insolvency and Section 588R of the Corporations Act 2001 (Cth)

Once a company is in liquidation, Section 588R allows a creditor, with the written consent of the liquidator, to directly bring a damages action for breach of the Section 588G duty not to trade while insolvent. Sections 588S and 588T allow a creditor to directly bring an action if the liquidator has not commenced an action within 6 months of receiving notice from the creditor. Pursuant to Section 588M, any such damages are "a debt due to the creditor", not the company.

There are no equivalent provisions for other director's duties, and any creditor seeking to recover damages for breach must do so through the liquidator. The D&O policy will generally respond to the liquidator action and it is not relevant (for this purpose) that the liquidator is funded by a creditor.

Sections 199B(1) and 199C(2), Dishonesty and Fraud exclusion clauses

The D&O policy will not respond to a damages action by a creditor (or indeed any other plaintiff) if the breach of director's duties was deliberate and thereby excluded by Statute and/or a Dishonesty and Fraud exclusion clause.

Sections 199B(1) and 199C(2) prevent a company from indemnifying or insuring a director for 'wilful' breach of directors duties. D&O policies will also have a Dishonesty and Fraud exclusion clause stating the policy will not respond where the offending conduct is finally determined (eg by express admission or court judgment) to be wilful, dishonest, fraudulent, malicious, or otherwise conducted with criminal intent.

Actions for breach of director's duties typically incur disproportionate investigation and defence costs regardless of the nature of the party who brings the action. Subject to the specific terms of the policy, the Insurer will usually fund defence and investigation costs until a final determination is made that the conduct is 'wilful' and therefore barred from insurance by Statute, or the conduct is of the type excluded by in the Dishonesty and Fraud exclusion clause.

Insured v Insured exclusion clause

Director's duties are owed to the company. There is no duty owed by directors to creditors (see Spies v R (2000) 18 ACLC 727). There is no provision in the Corporations Act 2001 (Cth) for creditors to bring a derivative action on behalf of a company against the directors (shareholders do have this ability pursuant to Section 236).

Until recently, D&O policies often included an Insured v Insured exclusion clause to prevent actions by the company (and derivative actions in the company's name) against the directors from falling within the policy. The policy may also have specified that certain actions such as liquidator or shareholder derivative actions would still be covered.

The Insured v Insured exclusion clause has become much less common in the Australian market. However, even a D&O policy which does include an Insured v Insured exclusion clause should not exclude proceedings by a creditor under Sections 1324 or 588R because such actions are by the creditor in its own name and not a derivative action by the company.

Lessons for Directors

While there is no provision in the Corporations Act 2001 (Cth) for a creditor to bring a derivative action in the company's name for damages for breach of director's duties, there are circumstances where a creditor may claim such damages in its own right.

Provided the conduct in question is not finally determined to be 'wilful' for the purposes of Sections 199B(1) and 199C(2), or to otherwise fall within the Dishonesty and Fraud exclusion clause, a Directors and Officers insurance policy should respond to a damages action brought by a creditor.

If the Directors and Officers insurance policy does include an Insured v Insured exclusion clause, proceedings by a creditor under Sections 1324 and 588R will not be excluded because such actions are initiated in the creditor's own name and are not a derivative action in the name of the company.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Tebony Justins
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