Australia: D&O Insurance: Liquidators Can´t Have Their Cake And Eat It

Liquidators cannot settle with directors and expect to obtain far greater compensation from the directors' and officers' insurance against insolvent trading, as a case last week shows. Nor can liquidators expect to recover under a policy granted when directors have given inadequate disclosure of the company's finances.

Settlement with directors

In Green (as liquidator of Arimco Mining Limited) v CGU [2008] NSWSC 875, the liquidator settled insolvent trading proceedings with the directors on the following terms:

  • Judgment against each of the directors in the amount of $15 million.
  • The following amounts were payable within seven days of the liquidator's confirmation of creditor approval under section 477 of the Corporations Act:
  • $270,000 from three of the directors;
  • $30,000 and $20,000 payable from two other directors separately;
  • a further $180,000 from the three jointly liable directors, within 28 days of the termination of the proceedings if the insurer was successful in the proceedings, but not if the directors performed their obligations above and the liquidator obtained judgment against the insurer or reached a compromise with the insurer.
  • This agreement was conditional upon approval of creditors being obtained under section 477 of the Corporations Act.

The effect of this settlement agreement was that five directors agreed to pay $320,000 amongst themselves to the liquidator, with agreement to entry of a judgment of $15 million against each of themselves. Only $320,000 was enforceable against the directors personally plus a possible further $180,000 in the event that recovery or compromise of the $15 million purported judgment against the insurer did not occur.

Judgment against insurer ineffective

Justice Einstein of the Supreme Court of New South Wales found that the liquidator, in respect of the judgment for $15 million, agreed not to enforce it and to discharge it regardless of the outcome with the insurer.

The insurer contended that the approach taken by the liquidator involved an inconsistent stance where the liquidator was seen to have both accepted and rejected the terms of the judgment. Because the insurer must be pictured in the shoes of the directors, the liquidator must be seen to have reached an agreement with the insurer also to take the limited amount of the settlement which had been agreed with the directors.

The doctrine whereby the insurer "stands in the shoes of" the insured arises under section 6(4) of the Law Reform (Miscellaneous Provisions) Act 1946. Einstein J declined to make a finding on this point given his earlier finding that the liquidator had agreed to discharge the judgment.

Inadequate disclosure made by directors

Had the insurer known of all material facts which should have been disclosed, the court found on the balance of probabilities that the D&O policy would not have been renewed without imposing an exclusion as to insolvency events. In respect of one particular potential liability, had that claim alone been disclosed to the insurer, the court found that the probabilities were that the insurer would have issued the policy with a specific exclusion for that claim. This was on the basis that "the company had a substantial amount of money sitting in the bank, and that if there was any insolvent trading claim it would only extend over a very short period on the basis that if they lost the claim they would have to pay the money immediately".

The insurer called officers to give evidence as to the insurer's practices when granting a policy. Had proper disclosure been made, Einstein J found that the insurer would have excluded insolvent trading from coverage. The directors failed to disclose matters required to be disclosed, which they should have known were matters relevant to the insurer.

Details of insolvency

The precarious financial circumstances of the company can be summarised as follows:

  • a rights issue of approximately $10.2 million net, for the purpose of expanding exploration drilling programmes, was used largely to meet creditor payments, contrary to the prospectus;
  • a history of monthly losses;
  • the withholding of cheques due to creditors;
  • a decline in cash resources, current assets and working capital.

Was there insolvent trading?

The court found the above factors attributed to the directors reasonable suspicion that the company was insolvent, for the purposes of s588G(2) of the Corporations Act, namely that the company could not pay its debts as and when they became due and payable for the purposes of s95A of that Act. Insolvent trading was thus established.

The test for suspicion of insolvency, according to Einstein J, is not made on the balance of probabilities. Repeating previous authority, the court found that it "is more than a mere wondering as to insolvency; it requires a view or a mistrust of appearances as to ability to pay debts to be formed, even if the evidence is insufficient to warrant a positive belief".

Tips for liquidators

The liquidator in this case was able to sue the insurer directly because he had obtained leave pursuant to section 6 of the Law Reform (Miscellaneous Provisions) Act 1946 (NSW). Also, one of the deceased directors had joined the insurer pursuant to section 51 of the Insurance Contracts Act 1984 (Cth).

Before commencing proceedings against an insurer, liquidators should investigate the disclosures given by the directors to the insurer. Both directors and arguably insurance company records and relevant underwriters are susceptible to the public examination and document production provisions of Part 5.9 of the Corporations Act.

Liquidators should only settle insolvent trading proceedings with directors if they do not intend to recover from an insurer under a relevant D&O policy The insurer "stands in the shoes" of the directors and cannot be subjected to a harsher order.

Depending upon the time of the alleged insolvent trading, there may be evidential difficulties establishing the information known to the directors and also, in this case, to the insurer. The costs of adducing this evidence will need to be factored into the overall cost/benefit analysis of prosecuting proceedings.

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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