Australia: Who is a non-executive director in a D&O insurance policy? Victorian Court of Appeal decision in AIG Australia v Jaques

In brief - D&O liability insurance policies should be clear on who may access any additional cover for non-executive directors

A recent Victorian Court of Appeal decision in AIG Australia Limited v Jaques [2014] VSCA 332 demonstrates that it is not always easy to determine whether a particular individual is acting as an executive director or as a non-executive director when considering who has the right to access additional insurance cover.

D&O liability insurance may offer additional cover to non-executive directors

Many directors' and officers' liability insurance policies provide extra limit protection for non-executive directors, giving them access to additional cover in the event that the main policy limit is exhausted. This is an important benefit for those individuals.

However, as the AIG v Jaques case shows, it is in the interests of both insurers and insureds to make sure that the relevant policy wording makes it clear which individuals are entitled to access the additional cover.

AIG agrees to cover claims for wrongful managerial acts

AIG Insurance Limited issued an investment management insurance policy to Australian Property Custodian Holdings Limited ("Holdings"). Holdings was the responsible entity for, and trustee of, the Prime Retirement and Aged Care Property Trust, a property unit trust dedicated to retirement and aged care facilities.

Under the policy, AIG agreed to indemnify insured persons for claims made against them during the policy period for a wrongful managerial act. Mr Jaques, an insured person under the policy, sought indemnity for claims made against him alleging wrongful managerial acts committed by him as a director of Holdings.

AIG asserts that respondent was not a non-executive director

The limit of liability under the policy was $5 million, with a separate excess or additional limit of a further $1 million for each non-executive director. Following the collapse of the Prime Trust, proceedings were brought against the directors of Holdings, including Mr Jaques.

Claims for defence costs by all directors had exhausted the $5 million limit of indemnity and Mr Jaques sought indemnity for the additional $1 million to continue to fund his own defence costs. AIG declined to extend that cover to him, asserting that he was not a non-executive director, so Mr Jaques sought a declaration from the court that he was entitled to that cover.

The alleged wrongful managerial acts took place in 2006, 2007 and 2008. It was agreed that Mr Jaques was a non-executive director of Holdings prior to 6 April 2004 and that he was an executive director from 26 June 2007, but the parties disagreed as to Mr Jaques' status in the intervening period.

The court had to consider two questions: a legal question as to the meaning of the phrase "non-executive director" in the policy and a factual question as to whether Mr Jaques fell within that description in the relevant period. Dixon J at first instance answered both questions in Mr Jaques' favour. AIG appealed.

Corporations Act does not define executive and non-executive director

The policy, somewhat circuitously, defined a non-executive director as any natural person who serves as a non-executive director of Holdings at the time of any wrongful managerial act.

Perhaps surprisingly, there are very few circumstances where the distinction between an executive director and a non-executive director has any legal consequence. The distinction has not been given content by the legislature (or by the courts): the Corporations Act 2001 (Cth) does not contain a definition of "executive director" or "non-executive director", or any list of criteria that would aid in identifying whether a particular director was one or the other.

As the parties agreed, at law, the essential characteristic of an executive director is his or her discharge, usually as an employee, of executive functions in the management and administration of the company. The critical aspect of any enquiry into whether a director is an executive or a non-executive director is whether the company approved or acquiesced in the assumption by the director, for the purposes of the policy, of the powers of an executive director, or whether there is some evidence of the delegation of executive function to that director.

Court of Appeal agrees that conferring of authority determines executive powers

AIG argued that other factors also should be taken into account in determining whether Mr Jaques was a non-executive director for the purposes of the policy. These included:

  • how he was represented to the investing public
  • how he was regarded internally
  • whether he was involved in the operations of the company or performing work in connection with the business of the company
  • how he saw himself

Mr Jaques submitted that a director is necessarily a non-executive director in the absence of any further authority conferred upon him or her by the company and that many of the additional factors raised by AIG were irrelevant. The Court of Appeal agreed.

Appointment as a director alone does not give executive powers

The starting point must be that the mere fact of appointment as a director does not normally give a director any executive powers. In the absence of some further authority conferred by the company, such as under a contract of employment or services agreement or via an express delegation or acquiescence in a director's exercise of executive powers, all directors should generally be treated as non-executive directors.

The subjective views of either the board or of the director are of limited relevance. Contemporaneous records kept by the company may be relevant in determining a director's status, but only to the extent that they provide evidence of any tasks undertaken by a particular director in the management and administration of the company, or of a delegation of authority to perform such functions.

Also, the way in which a director's status is represented to investors is of limited relevance at least in construing the meaning of the term "non-executive director" in the policy (although it might be relevant in other circumstances, for example, in an action by a unit holder for misleading and deceptive conduct).

Was Mr Jaques a non-executive director in the relevant period?

On the basis of the court's answer to the legal question, whether Mr Jaques fell within the definition of non-executive director in the policy as a matter of fact required an examination of whether Mr Jaques was performing executive functions for Holdings and whether Holdings delegated to him the authority to perform those functions, or acquiesced in him doing so.

The Prime Trust owned retirement village properties. If the Trust merely owned land and derived rent from it, it was not assessable to income tax and could distribute all of its profits to unit holders. If it were to participate in the management of the villages, it would no longer be entitled to its tax-exempt status and be subject to the company tax rate on its earnings.

For at least this reason, other entities managed the retirement villages. These were related entities because they were all owned or controlled by the same person, but the group structure was not one of parent and subsidiary companies.

Mr Jaques became a non-executive director of Holdings in March 2001. In April 2004, Mr Jaques commenced employment as General Manager with the related entity, Australian Property Custodians Pty Limited ("Custodians"). Initially his duties involved managing retirement villages in Queensland, but he later became involved in investigating the feasibility of possible acquisitions of other retirement villages by the Trust. While employed by Custodians, Mr Jaques continued as a director of Holdings. In 2007, Holdings and Mr Jaques entered into a Deed of Appointment (executive director).

AIG fails in bid to contest trial judge's finding

AIG contended that Mr Jaques was not a non-executive director of Holdings during the relevant period because:

  • he was represented to the investing public as an executive director through statements made, or not made, in certain Product Disclosure Statements (PDSs)
  • the board of Holdings regarded the respondent as an executive director, as evidenced by the minutes of two meetings
  • Mr Jaques saw himself as an executive director because when examined under oath by the Australian Securities and Investments Commission (ASIC) he stated that he changed his role from non-executive to executive director in April 2004 (when he took up employment with Custodians)
  • Mr Jaques' responsibilities and his management role did not change in 2007 after the Deed of Appointment was entered into

The Court of Appeal refused to overturn the trial judge's finding of fact that Mr Jaques was acting as a non-executive director.

Although Mr Jaques had signed one PDS as an executive director and was listed in its corporate directory as an executive director, his evidence was that this was a mistake and that "he was not very experienced at being a director". Further, in the two following PDSs, Mr Jaques was not described as an executive director but merely as a director.

As to the second point, an assumption by the board that Mr Jaques was acting as an executive director could not be determinative. The minutes fell short of evidencing a delegation to Mr Jaques of any authority to perform any executive function for Holdings.

While they strongly supported the proposition that Mr Jaques had an operational role in the management of the retirement villages, they did not show that this was done as part of the business of Holdings, rather than the business of his employer, Custodians.

As to his evidence at the ASIC examination, Mr Jaques gave evidence that his answer was wrong and that he had been confused in a stressful environment.

Appeal dismissed due to more compelling evidence as to how business of Holdings structured

The court found that any inferences to be drawn from circumstances where it appeared that Mr Jaques was performing executive functions on behalf of Holdings were outweighed by more compelling evidence, namely, that in order to maintain its tax- exempt status, the business of Holdings had to be carefully structured such that Mr Jaques was not performing any executive function in the management of Holdings when carrying out the work that he did (although the evidence demonstrated that the arrangements put in place to separate the work of the different companies were not always adhered to).

Under this structure, Holdings was a passive investor as a landlord taking no part in active management of the tenant businesses that generated rentals or annual fees paid to the trust. Its business activity was investment decisions, that is, the selection of the properties included in its portfolio, and it was the registered proprietor of those properties.

Holdings also kept accounts, determined and coordinated distributions to unit holders, prepared financial statements and made all relevant ongoing investment decisions. In his employment by Custodians, Mr Jaques had no duties in respect of these responsibilities. Nor was the Court persuaded that any relevant executive function of Holdings' business had been delegated by the board to Mr Jaques.

Accordingly, AIG's appeal was dismissed.

D&O policies should be clear on who can access any additional non-executive director cover

The case demonstrates that determining whether a particular director is an executive or a non-executive director is not as simple or straightforward as it might at first seem. There were a number of objective factors which led AIG to the view that Mr Jaques was not acting as a non-executive director. Mr Jaques himself clearly had been confused as to whether he was an executive or a non-executive director.

It is in the interests of both insurers and insureds to avoid any uncertainty as to which individuals will be entitled to access the additional cover for non-executive directors. One way to do this might be to name the non-executive directors in a schedule to the policy.

Kathryn Rigney
Directors and officers
CBP Lawyers

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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