A CEO charged with a criminal offence recovers some of their defence costs by claiming under the company’s D&O policy. However, their ongoing legal costs exceed the policy limit, so they also seek indemnity from the company. The company refuses, arguing that it is not required to indemnify the CEO unless or until s/he is acquitted.
These were the facts in Leckenby v Note Printing Australia Limited  VSC 538, a case that considered one of the legislative provisions that affect insurance and indemnity arrangements between companies and their directors and officers (Ds&Os). These provisions, and similar provisions in other jurisdictions, attempt to strike a balance between protecting honest, competent Ds&Os from the risks inherent in commercial undertakings, while guarding against providing them with too much ‘insulation’ from personal liability for their conduct.
Several aspects of the legislation are less than clear, a point raised by the Chief Justice of New South Wales (Insurance Law – a view from the Bench, Australian Insurance Lawyers Association National Conference, Sydney, 19 September 2013) and a recent report by the New Zealand Law Commission (Pecuniary penalties, Report 133, August 2014).
Corporations Act 2001 (Cth) (CA) ss 199A-199C (Pt 2D.2 Div 1) apply to certain arrangements between companies and Ds&Os governing payment of insurance premiums (Premiums provisions), indemnities against liability (Liability provisions) and indemnities against legal costs (Legal costs provisions). These provisions (CA provisions) are summarised below, but note that there is other legislation that also impacts on insurance and indemnity arrangements (eg Competition and Consumer Act 2010 (Cth) s 77A; Australian Consumer Law s 229; Australian Securities and Investments Commission Act 2001 (Cth) s 12GBD and provisions in workplace health and safety and environment legislation).
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The above provisions do not oust or replace existing common law principles relating to contracts that may be unenforceable because they involve unlawful conduct. This means that, in addition to considering whether any of the above provisions apply, thought must be given to whether an indemnity may be precluded on grounds of illegality or public policy (as to which, see the discussion in Safeway Stores Limited v Twigger  EWHC 11 (Comm)).
Effect of contravening the legislation
However, providing an indemnity to an officer under an agreement that is void (because it falls within the Liability or Legal costs provisions) will likely constitute a related party benefit for the purposes of the CA Pt 2E.1 (Related Party Benefits) regime. Unless one of the exceptions in Pt 2E.1 applies, it will be necessary for a public company to comply with the member notification and approval procedure under that Part in order for it (or an entity it controls) to agree to pay (or pay) an indemnity or premium to or for the benefit of a person who is a related party of the public company (or controlling entity).
One exception to the related party benefits regime is found in CA s 212(1). Under that section, member approval is not required if:
- the benefit is an indemnity (or insurance premium) in respect of a liability incurred as an officer of the public company (or controlled entity), or an agreement to give an indemnity or pay a premium of that kind; and
- to give the benefit would be reasonable in the circumstances of the public company (or controlled entity) giving the benefit.
Section 212(3) sets out what is, and what is not, to be weighed in the scales in working out whether the giving of a benefit of this kind is reasonable in the circumstances.
For present purposes, we simply note that if the giving of the benefit was not reasonable in the circumstances, the company must have complied with the member notification and approval procedure under Pt 2E, failing which persons involved in the contravention, including the Ds&Os of the public company (but not the public company itself) may be liable to a civil penalty: s 209. Further, the Court may in any event, on the application of ASIC or a person whose interests have been or would be affected, injunct the giving of the benefit.
Applying the legislation
In most cases, the Premiums, Liability and Legal costs provisions clearly identify the CA sections to which they apply. Difficulties arise where the provisions are said to apply to a ‘wilful breach of duty’, ‘conduct not in good faith’ and ‘criminal proceedings’.
In some instances, there will be no doubt about whether proceedings are ‘criminal’ (as was the case inLeckenby, where the CEO was charged with conspiring to bribe foreign officials). However, in other cases there may be uncertainty. There is no clear distinction in law between ‘criminal’ and ‘civil’ proceedings. Some statutory penalties may be ‘hybrids’ that fall somwhere between civil and criminal: Chief Executive Officer of Customs v Labrador Liquor Wholesale Pty Ltd  HCA 49 at , , . Where the penalty is imposed by Commonwealth legislation, it may be easier to work out whether proceedings are ‘criminal’ because Commonwealth legislation usually specifies whether the Criminal Code (Cth) principles apply to that penalty. It may be more difficult to characterise State or Territory statutory penalties as criminal or non-criminal.
If the reference to ‘criminal proceedings’ means all types of criminal proceedings, including those of strict liability (where intention is not necessary), this will be inconsistent with the approach taken in the NSW Court of Appeal, where a policy exclusion for a ‘criminal act or omission’ was taken to apply only to an intentional criminal act or omission: Horsell International Pty Ltd v Divetwo Pty Ltd  NSWCA 368. As Chief Justice Bathurst noted in the paper referred to above, while ‘wilful criminal conduct’ is generally considered uninsurable on public policy grounds, courts have been known to accept that a person can insure for liability incurred as a result of negligence, even where those acts are also criminal.
The meaning of ‘wilful breach of duty in relation to the company’ (Premiums provision) and liability that ‘did not arise out of conduct in good faith’ (Liability provision) are even less clear. The exclusion for conduct that does not arise out of ‘good faith’ applies only to liability owed to someone other than the company or a related body corporate. This means that judgments that consider good faith in the context of duties owed to the company or related body corporate may be of limited assistance; ‘good faith’ may have a different meaning when applied to someone other than the company or related body corporate.
Advance payments: The dispute in Leckenby was over the CEO’s ability to be indemnified for his legal costs prior to any verdict. The CEO was only entitled to an indemnity for legal costs if he was not found guilty, and the company in question argued that he was not entitled to be indemnified unless or until he was found not guilty. This argument was rejected, the court holding that the prohibition in CA s 199A(3)(b), if it did apply to the facts, would not ‘bite’ prior to a verdict of guilty. Unless or until he was found guilty, the CEO was entitled to be indemnified in accordance with the terms of his deed of indemnity with the company.
Drafting: In some cases, the CA provisions are picked up and repeated, or incorporated by reference, in D&O indemnity agreements and company constitutions. D&O insurance policies may also expressly exclude from cover conduct within the nexus of the Premiums provisions. Not uncommonly, this is done by expressly incorporating by reference the Premiums provisions into the scope of the exclusion. However, the CA provisions will apply even where they are not part of the agreement or constitution: Rickus v Motor Trades Assn of Australia Superannuation Fund Pty Ltd  FCAFC 16 at .
D&O insurance policies that extend cover to fines and penalties may also carve back from the notion of covered ‘Loss’ fines and penalties that are not legally insurable, or fines and penalties imposed for deliberate and intentional breaches of the law. Given that most statutes imposing pecuniary penalties do not specify whether or not the penalty is insurable, this approach - whereby covered ‘Loss’ is subject to an exception for which there are no precise legal parameters – leaves Ds&Os uncertain about their entitlements under the policy. Even if it seems that the policy provides for an indemnity, the insurer may assert that the situation is one where the policy is unenforceable under the CA provisions or other legislation, or on public policy grounds.
Could policies be drafted to clarify the circumstances in which statutory penalties will or won’t fall within cover? If, for example, a policy provided that a statutory penalty would only be uninsurable where (a) there was a express prohibition in the relevant legislation precluding an insurer from making a payment in respect of the penalty or (b) a court held that the insurer is precluded from indemnifying an insured in respect of the penalty, would this eliminate or minimise uncertainty? Commercially, an insurer may be less inclined to invoke public policy considerations as a ground for denying payment where it has clearly delineated insurable and uninsurable penalties. However, the CA provisions (and comparable legislative provisions) would still apply, as well as the common law principles relating to unenforceability on public policy grounds (although there may be a countervailing public policy interest in parties being held to agreements voluntarily entered into).
The scenarios where there is greatest uncertainty are not intentional breaches of the law where the proscribed conduct and resulting effect or damage are both intended (which would be universally regarded as within the ambit of the uninsurability principle). It is those circumstances where there are unintended effects or damage flowing from an unintended act or omission, or even unintended effects or damage flowing from intended conduct. The law in this respect is unsettled. Conduct exclusions in D&O policies do not usually encompass all conduct which may give rise to unenforceability on public policy ground. Deliberately dishonest and deliberately fraudulent conduct, and conduct within the nexus of the Premiums Provisions, will usually be excluded. But many policies will not exclude any and all criminal acts or omissions, given the plethora of conduct in modern commercial law that may constitute commission of a criminal offence (including by way of accessorial liability). Some criminal offences are strict liability offences where intention or fault is not relevant to the commission of the offence. Sensible arguments may be made that it does not offend public policy to provide indemnification for some such offences.
Unfortunately, this article raises more questions than it answers. As Chief Justice Bathurst observed, the legal rules that apply to commercial activity must deliver certainty, and the need for greater certainty in this area is ‘acute’. The New Zealand Law Commission has echoed the need for greater clarity. The uncertainty that attends the application of the CA provisions greatly complicates the task of policy drafting. If it is difficult to know, after the event, whether certain conduct can be indemnified, it is often impossible to know it beforehand. This in turn dilutes the deterrent effect that the statutory prohibitions and contractual exclusions are designed to have.