Directors’ defence insurance cut down by Supreme Court

POSTED BY Karl Stolberger
Stephanie Nicolson
13 February 2014

posted in Caselaw | Insurance | Litigation | Bridgecorp

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A recent Supreme Court ruling significantly impacts on the operation of Directors’ and Officers’ (D&O) insurance policies, and indeed any other insurances, which have a combined single limit of liability for compensation and defence costs.

Background

Following the well publicised failures of Bridgecorp and Feltex, the directors of those companies face claims by investors and receivers. Unsurprisingly the directors have looked to their D&O insurance for their legal and expert defence costs in responding to those claims, as well as to cover any liabilities that they may ultimately have to compensate investors.

Section 9 of the Law Reform Act 1936 allows a third party to claim a charge over insurance money that might become payable by an insurer to an insured in relation to losses which the third party has suffered because of the insured’s actions. The aim of section 9 is to ensure that insurance money intended to compensate for loss should find its way to the party which actually suffered the loss. Before the section was enacted an insured could abscond with the insurance money (or there could be complications arising on the insured’s bankruptcy) leaving the injured party out of pocket.

The problem in the Bridgecorp/Feltex cases was that the directors’ cover for liability to pay compensation to victims and cover for their defence costs were amalgamated into one single sum under the policy. Therefore, when the investors asserted their Law Reform Act claim over the compensation fund, it also threatened to prevent directors from accessing defence costs cover to defend the claims made against them.

Litigation

The matter has now proceeded through to our highest court. The proceedings began in the High Court where the directors unsuccessfully sought a declaration that the investors’ charge didn't affect the insurer’s freedom to pay out defence costs, leaving any remaining balance to cover the compensation part of the policy. The directors appealed to the Court of Appeal and won. Overturning the Court of Appeal the Supreme Court has now found, by a 3:2 majority, that the investors’ charge does indeed secure the full insurance sum, including the part that could have otherwise been paid to the directors in defence costs. As a result of the judgment any payment of defence costs in such circumstances is now clearly at the insurer’s risk. The position becomes acute when the combined liabilities to pay compensation and defence costs are likely to exceed the policy limit. Directors are potentially deprived of cover for defence costs when they really need it.

Impact

The Supreme Court’s decision reverses what until now has been the standard industry practice. It puts New Zealand at odds with the position in Australia (NSW), which was recently considered by the NSW Court of Appeal in Chubb Insurance Co v Moore [2013] NSWCA 212, (2013) 302 ALR 101 (though that case is understood to be subject to appeal to the High Court of Australia), and has been criticised at home and abroad. One US based commentator on D&O Insurances, Kevin La Croix, said in his blog

"Perhaps it is owing to its antipodal provenance, but the lead opinion’s interpretation of Section 9 stands the very idea of liability insurance on its head. Liability insurance does not exist to protect claimants, it exists to protect the insureds. Insurance buyers procure the insurance to protect themselves from third party lawsuits. The very idea that a mere assertion of an unproven claim is enough to strip the insured under a liability policy of the protection they procured for themselves is questionable in its very approach to the insurance equation.” 

Given the Supreme Court is the final court of appeal, any reversal of the judgment will need a law change.

The decision has significant impact on the insurance industry and on the way that insurance policies should be drafted in the future. In particular, cover for compensation and defence costs should now be clearly separated, either in different policies, or by providing distinct limits for each aspect of cover.

Insured’s should check with their insurers or brokers to make sure that they are adequately covered for defence costs in the future (though that will obviously not help existing policy holders who are already subject to claims).

Lowndes Jordan acted as instructing solicitors for the respondent in the Bridgecorp appeal (BFSL 2007 Ltd v Steigrad [2013] NZSC 156), which was heard together with Houghton v AIG Insurance NZLSC 21/2013 in connection with the Feltex Carpets collapse.

POSTED BY Karl Stolberger
Stephanie Nicolson
13 February 2014

posted in CaselawInsuranceLitigationBridgecorp

VIEWED 7663 TIMES

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