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21 Feb 13
Director's entitlement to insurance cover for defence costs

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The New Zealand Court of Appeal has recently provided temporary comfort for company directors concerning the question of their entitlement to insurance cover for defence costs arising from legal proceedings brought against them.

The Court in essence resolved in the case of Bridgecorp1that the insurance cover provided under Directors and Officers Liability Insurance (D&O Insurance) is two-fold.  One element of the policy provides cover for any legal liability which a director may be liable to pay with respect to a claim, e.g. damage awards and/or settlements.  The other, and quite distinct element of cover is for defence costs incurred by directors responding to any claim against them.  The effect of this distinction is that a statutory charge over proceeds of an insurance policy cannot apply to the defence costs coverage.  To do so, according to the Court, would interfere with the contractual obligations between directors and their insurer.

The Court’s recognition of the distinction in the D&O Insurance response may seem logical but is significant in the determination of the application of a statutory charge over the proceeds of an insurance policy and, in turn, a director’s entitlement to cover under D&O Insurance.

While a New Zealand case, the decision is relevant because of similarities in legislation at the centre of these proceedings and that applicable in New South Wales, the ACT and the Northern Territory.

Background

The case of Bridgecorp2 arose from the civil and criminal prosecution of directors pursued by receivers of various Bridgecorp companies following their financial collapse.  The action against the directors concerned, among a variety of allegations, claims that they had breached their duties.

In the first instance decision, Justice Lang held that the application of a statutory charge over the proceeds of an insurance policy arising under section 9 of the Law Reform Act 1936 (NZ) disentitled directors to cover for legal costs incurred in defending the proceedings.  The entire limit of cover under the D&O Insurance was thereby preserved for the benefit of plaintiffs in the proceedings, although their entitlement to a positive judgment was far from resolved.

The judgment outcome was that the directors could not seek reimbursement or payment of defence costs incurred in the legal proceedings.  Prior to recourse to the D&O Insurance, the directors had eroded the full limit of cover i.e. $2 million available under a Statutory Liability Insurance Policy.  The D&O Insurance had a limit of $20 million.  Given the multiple proceedings and potential lengthy duration, it is not unreasonable to anticipate the significant defence costs incurred by the directors that for which, at first instance, no insurance cover was available.

The latest machination

The Court of Appeal judgment recognised and correlated the scope of the section 9 charge, which could apply to a contract of insurance providing indemnity against liability to pay damages or compensation, to a single element of cover afforded under D&O Insurance.  Such a charge could not be brought against the separate element of coverage for defence costs.

The Court highlighted the intrinsic benefit of defence costs being incurred for the behalf of both directors and insurers as to do otherwise may result in legal liability being attributed to a director where they may otherwise be entitled to a vigorous defence.

The expectation that the relief to directors by the latest Bridgecorp decision may only be temporary is that a further avenue for appeal is open to the Supreme Court of New Zealand.  The question of a similar ruling in Australian courts has also not been resolved.

What should directors do?

Many insurance companies responded to the initial Bridgecorp decision offering a variety of separate policy limits and options for directors.  The utility of many of these policies is questionable.  We would recommend D&O Insurance arrangements be reviewed to assess the actual scope of coverage, particularly the triggers to activate cover, to determine if they are beneficial for directors.

Brad Russell, partner and insurance expert in the Insurance and Corporate Risk Practice, frequently encounters ‘competition’ for the limited amount of insurance cover available to directors.  ’The frequent outcome of our insurance reviews is highlighting to companies and their directors that when cover for D&O Insurance forms part of any ‘package’ policy arrangement, the cover available to directors is potentially eroded not only by each director’s entitlement to cover under the D&O Insurance, but also by any claims under any of the additional insurance policies e.g. Professional Indemnity, offered within these ‘packages’.  While a convenient policy arrangement, recognition should be held of the potential limitation of these ’package’ policies for directors.’

It is also important to recognise that D&O Insurance policies rarely have a priority regime for payment of defence costs or any other entitlements under the policy.  It is often only a ‘first in - best dressed’ approach to exhaust the available limit of cover.  We therefore recommend directors understand and assess the breadth and amount of their D&O Insurance cover.

Also arising from the recent Bridgecorp decision is commentary concerning the operation of the ‘advancement of defence costs’ coverage under the D&O Insurance.  This provision usually operates to pay defence costs incurred by a director, subject to insurer’s consent, from the time of notification of the claim until a coverage response has been issued by the insurer or for a prescribed period of time.  Interestingly, the D&O Insurance for the Bridgecorp directors entitled them to payment of an amount of 20% of the policy limit or $500,000 (whichever is the lesser) if the insurer had not issued their policy coverage response.  The insurer in Bridgecorp had neither issued their coverage response, nor advanced defence costs as they were obliged to do under the policy since 12 June 2009 when Bridgecorp gave the insurer notice of the charge under section 9.

Recently some insurers have been ‘tinkering’ with the advancement of defence costs policy provisions.  It is therefore important that directors understand this particularly element under their D&O Insurance to ensure they pursue any policy entitlement should the need arise.

The circumstances of Bridgecorp and directors entitlement to cover under D&O Insurance can in some respects still be considered unresolved.  A full review and understanding of a director’s position in relation to their D&O Insurance is therefore the recommended position.

Steigrad & Ors v BFSL 2007 Ltd & Ors [2012] NZCA 604
Steigrad & Ors v BFSL 2007 Ltd & Ors [2011] NZHC 1037

Focus covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. Focus is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.

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