When the Supreme Court overturned the Court of Appeal decision in Steigrad just before Christmas, directors and their insurers were again faced with the need to alter the structure of their liability policies to safeguard defence costs cover. As well as changing the landscape for future liability policies, the decision leaves a number of important questions unanswered for insurers and insureds who are facing or who may yet face claims under existing liability policies where the availability of defence costs cover is now unclear.
This alert looks at the implications of the decision for directors, insured companies and their liability insurers.
The Supreme Court decision is the latest in a long-running dispute regarding the Bridgecorp directors' rights to claim reimbursement of their defence costs under a D&O policy with a combined limit for liability and defence costs.
High Court decision
In September 2011, the High Court held that section 9 of the Law Reform Act 1936 prevented Bridgecorp's directors from accessing their D&O cover to meet defence costs where the claims against them significantly exceeded their $20 million policy limit (see Russell McVeagh's September 2011 update on the judgment here).
The Court ruled that where a person is insured against liability for damages or compensation payable to a third party, section 9 gives that third party direct recourse (by way of a first ranking charge) to those insurance monies. It held that the intention of the Act is to keep insurance funds intact for the benefit of claimants, and any payment toward the directors' defence costs under the policy would have the effect of reducing the insurance fund.
The Bridgecorp directors were therefore not entitled to have their defence costs met out of their combined D&O cover.
Court of Appeal decision
In December 2012, the Court of Appeal overturned the High Court decision, stating that s 9 is not intended to rewrite or interfere with contractual rights to cover and reimbursement.
The Court of Appeal held that the insurance money protected for claimants under s 9 is thebalance of insurance policy limits at the date that payment is required by the insurer on the insured's legal liability. The ruling allowed the advancement of defence costs prior to that date in accordance with policy terms.
Supreme Court decision
The Supreme Court, by a majority of three to two, has now reversed the Court of Appeal decision.
The Supreme Court has ruled that section 9 secures the full amount of liability to third party claimants (subject only to the policy limit) from the time of the event giving rise to the claim. As a result, the insurer cannot diminish the sum available to third party claimants by advancing defence costs to the insured from that same combined policy limit.
The decision has significant implications for the way that insurers, insureds and brokers structure and apportion cover for liability and defence costs.
Implications of the decision
Following the initial High Court judgment, many insurers now offer separate policies that provide specific defence costs cover or which "ring-fence" cover for defence costs within a liability policy.
Directors and other insureds who do not yet have separate or ring-fenced defence costs cover should contact their brokers or legal advisors to discuss available options.
Uncertainty and risks for existing combined limit policies
In the meantime the Supreme Court decision, in giving preference to the interests of third party claimants, creates concerns for both insurers and insureds under liability policies which still have a combined limit for liability and defence costs.
- Can insurers refuse payment of defence costs?
The Supreme Court left open the question of whether insurers are entitled to refuse to pay defence costs where the section 9 charge applies to the whole (or a significant part) of the insurance fund. Until further guidance on this issue is provided by the Court, there are likely to be separate disputes between insurers and insureds running alongside the third party actions.
- If insurers are not entitled to refuse to pay defence costs until third party claims are resolved, they may ultimately end up paying amounts in excess of the policy limit - a risk that is unlikely to have been factored in when pricing the premium level.
- If insurers are entitled to refuse to pay defence costs where there is a risk that policy limits may be exhausted by the claim, we can expect to see insurers taking a conservative view of the potential value of claims. A claim that is initially modest when first notified could conceivably increase substantially as proceedings progress, or if additional claimants are added.
- Implications for legal representation
The uncertainty of insurers' rights has the potential to tie up insurance funds for years, in circumstances where they could otherwise have been used by insureds to fund their defence.
This could leave insureds without access to proper legal representation, or insurers with the unpalatable choice of either funding the defence despite no legal obligation to do so, or facing an increased risk of losing the claim owing to inadequate defence resources.
- Complications for reinsurance recoveries
If insurers pay out sums in excess of policy limits or fund defence costs without any obligation to do so, they may face potential difficulties and complications with their own reinsurance recoveries.
These issues should fall away as the market fully adjusts to the practice of separating defence costs cover in liability policies. In the meantime, as existing policies run their course, we can expect to see these issues vexing both insurers and insureds under liability policies.