A primary benefit of Directors & Officers (D&O) cover is the costs protection it provides for directors and officers. The recent High Court of New Zealand case of Steigrad v BFSL puts this cover at risk when a company collapses and a third party claimant seeks a charge over the insurance proceeds of the D&O policy.
The Bridgecorp group collapsed and was placed into receivership owing investors nearly $500 million. The directors of Bridgecorp faced numerous criminal and civil claims following the collapse.
The Bridgecorp companies held D&O cover with QBE. The directors also held separate defence costs cover which had been fully eroded by the defence costs incurred to date. The directors were therefore relying on the cover available under the D&O policy to cover their defence costs going forward. Significantly for the directors, the D&O policy responded to the directors' legal liability to third parties and the limit of indemnity under the D&O policy was inclusive of defence costs.
The investors of Bridgecorp who had lost their money in the collapse claimed a charge over the monies payable under the D&O policy pursuant to section 9 of the New Zealand Law Reform Act 1936 (the NZ Act) which is written in substantially similar terms to section 6 of the New South Wales (NSW) Law Reform (Miscellaneous Provisions) Act 1946 (the NSW Act). Section 9 of the NZ Act relevantly provides as follows:
- If…the insured has, whether before or after the passing of the Act, entered into a contract of insurance by which he is indemnified against liability to pay any damages or compensation, the amount of his liability shall, on the happening of the event giving rise to the claim for damages or compensation, and notwithstanding that the amount of such liability may not then have been determined, be a charge on all insurance money that is or may become payable in respect of that liability.
- If, on the happening of the event giving rise to any claim for damages or compensation, the insured…is being wound up, the provisions of [subsection (1)] shall apply notwithstanding the…insolvency…of the insured.
- Every charge…shall be enforceable by way of an action against the insurer in the same way and in the same Court as if the action were an action to recover damages or compensation from the insured…
Section 9 of the NZ Act (and section 6 of the NSW Act) creates a charge in favour of a claimant over insurance proceeds enabling the claimant to directly access these funds in certain specified circumstances. The purpose of this statutory charge is to ensure that enforcement of a claimant's entitlements is not frustrated by, relevantly, the insolvency of the insured.
The charge having being claimed, QBE advised the directors that it could not make any payments under the D&O policy in respect of their defence costs until the directors and the investors agreed on an allocation of the funds available under the D&O policy. When the parties were unable to agree on this allocation, the directors approached the court seeking a declaration that the charge did not prevent QBE from funding their defence costs.
The High Court's ruling
The High Court determined that the payment of the directors' defence costs could not be permitted to reduce the pool of funds that would otherwise be available to meet claims to which the charge applied. The NZ Act (and the NSW Act) charged "all insurance money" that was or may become payable in respect of "liability to pay damages or compensation". According to the High Court, this meant that where the level of cover was less than the amount of a notified claim, the entire cover under the policy was subject to the charge. As the investors' claim was significantly greater than the limit of indemnity under the D&O policy, QBE was obliged to keep the insurance proceeds intact for the benefit of the investors. The High Court noted that the position would be different in circumstances where the amount of the claim was well within the amount of cover available under the policy. In that case, an insured director may be able to gain access to the policy to meet defence costs.
The High Court warned that the risk to QBE in meeting the directors' defence costs where a charge had been claimed was that it could become liable to restore that amount to the pool of money available under the policy to meet the investors' claim.
While observing that this ruling produced unsatisfactory consequences for the directors, the High Court commented that this outcome was party a consequence of the decision by the Bridgecorp companies to take out a policy that provided cover for both defence costs and claims for damages and compensation.
In NSW, where the limit of indemnity under a traditional D&O policy is costs-inclusive, directors are at risk of losing their defence costs protection should the company become insolvent. It was accepted in Steigrad that the separate defence costs cover held by the directors, which had already been eroded at the time of this action, would not have been subject to the statutory charge as it did not indemnify the directors for damages or compensation - it covered only defence costs. This decision has caused debate in the industry as to whether new language in D&O products can be devised to prevent this outcome or whether it is necessary to take out separate defence costs cover to ensure that this protection will be in place for directors when they need it.