Directors' Insurance - Lessons from Bridgecorp
Monday April 15, 2013
In a decision that sent shockwaves through the Australasian insurance industry, the High Court held that three of Bridgecorp's directors (Messrs Steigrad, Davidson and Urwin) (the directors) were not able to access the Directors and Officer's Insurance Policy held by the Bridgecorp companies (the D & O Policy) in order to obtain reimbursement for the defence costs that they had incurred, and would incur, in defending the civil and criminal proceedings brought against them.
The High Court's decision was overturned on appeal. The Court of Appeal held that directors were entitled to reimbursement of their defence costs from a combined insurance policy that also provided for payment of compensation or damages to third party claimants out of the same fund.
The collapse of the Bridgecorp companies is well-known. Bridgecorp was placed in receivership in July 2007, leaving around 14,500 investors out of pocket to the tune of approximately $450 million.
The Bridgecorp companies had two insurance policies with QBE:
- The D & O Policy: this policy was taken out by Bridgecorp in 1996. It indemnified the directors to a limit of $20 million against civil and criminal claims brought against them arising out of their actions or omissions as directors, and also indemnified the directors for defence costs incurred in defending the same. This was a combined policy, which means that the defence costs were not ring-fenced from the general pool of funds.
- The Statutory Liability Policy (the SL Policy): this policy was taken out by Bridgecorp in 2000 and indemnified the directors to a limit of $2 million for defence costs incurred for claims against them for breaches of their statutory obligations.
When the Securities Commission issued criminal and civil proceedings against the five directors, the directors agreed with QBE to call on the SL Policy first, splitting it five ways. By August 2011, four of the directors had exhausted their share, and needed to call on the D & O Policy to meet their ongoing defence costs in the proceedings, which were estimated at $3 million.
However, back in 2009, the Bridgecorp companies advised QBE that they asserted a charge over the D & O Policy pursuant to section 9 of the Law Reform Act 1936 in respect of civil proceedings that they intended to bring against the directors, estimated at $450 million.
Section 9 reads as follows:
Section 9 Amount of liability to be charge on insurance money payable against that liability
(1) If any person…has, whether before or after the passing of this 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.
Section 9 enables a third party claimant to essentially bypass an insured and gain direct access to the insurance funds by creating a charge over the insurance fund in so far as it provides cover for liability to pay damages or compensation to third parties. Section 9 does not apply to statutory liability policies, as cover is only provided in respect of an insured's defence costs, which brings defence costs policies outside the ambit of the section.
Bridgecorp's main concern was that any payment made by QBE from the D & O Policy would whittle down any compensation payable to the Bridgecorp companies in the event the civil proceedings were successful.
As the directors and the Bridgecorp companies could not agree on the allocation of funds under the D & O Policy, QBE refused to advance the defence costs under the D & O Policy. The directors sought a declaration from the High Court that they were entitled to access the D & O Policy to obtain reimbursement for their defence costs.
The High Court
Steigrad v BFSL 2007 Limited & Ors
The High Court found that the section 9 charge prevented the directors from obtaining access to the D & O Policy for their defence costs. The decision can be broadly summarised as follows:
- Section 9 was enacted to protect claims by personal injury victims in the employment context against insolvent defendants. However, the plain wording of the section means that it applies to all insurance policies that provide cover for damages or compensation payable to third party claimants.
- To carve out defence costs in a D & O Policy would undermine the purpose of section 9, which is to protect the integrity of the compensation fund that may be payable to third party claimants, especially in the case of an insolvent insured.
- The charge arises upon the date of the event giving rise to the claim. The Court said that the charge arose at the date that the Bridgecorp group collapsed.
- The charge arises even if the claimant's claim has not yet been quantified, and even if the insurer has not yet accepted the claim. If the insurer does not accept cover, the charge will not exist.
- The party asserting the charge must notify the insurer about the charge.
- The charge preserves the compensation fund for the benefit of third parties. If QBE chose to make payment for defence costs under the D & O Policy whilst having knowledge of the charge, it would be acting as a "volunteer" and would have to account for any monies paid out to the directors under the D & O Poilcy to ensure that the fund was not depleted.
The Court's primary concern was to protect the fund for the third parties. His Honour recognised that the whilst the result of the decision was "harsh for the directors, it is clearly in accordance with the object and purpose of s 9. If the directors are able to obtain access to funds under the policy to meet their defence costs, the pool of funds available to meet civil claims will be significantly depleted."
Unsurprisingly, the High Court's decision was appealed.
The Court of Appeal
Steigrad v BFSL 2007 Ltd & Ors and Chartis Insurance New Zealand Limited & anor v Hougton
Following the High Court's decision in Steigrad, Mr Houghton, the shareholder representing the shareholders of Feltex, asserted a section 9 charge over the Feltex's directors' prospectus liability insurance policy. Prior to asserting a charge, the shareholders had filed a civil claim against the directors, seeking approximately $150 million in damages.
In response, the insurer, Chartis, and Feltex's directors sought a declaration that the charge did not prevent the insurer from paying the directors' reasonable defence costs under the policy. This matter was heard at the same time as Steigrad's appeal.
The Court of Appeal quashed the High Court's decision in Steigrad. It also declared that the Feltex shareholders were not entitled to assert a charge pursuant to section 9 over the Feltex's directors' insurance policy.
Key principles from the Court of Appeal's decision can be summarised as follows:
- The Court's primary concern was not to interfere with the insured and the insurer's contractual rights. The Court's decision focused on the wording of the Policy, and the obligations that it created for the insurer.
- Under the terms of the Policy, QBE had two distinct liabilities to the insured. The first liability was cover for the payment of damages or compensation. The second liability was cover of the insured's defence costs. QBE's obligation to pay Steigrad had arisen as a result of the claims brought against him, whereas the obligation to pay damages or compensation was contingent upon the happening of certain events including settlement, a court award, or an arbitral award.
- As a result, the section 9 did not apply to deny. Steigrad was entitled to reimbursement of his defence costs, which he had incurred in accordance with the terms of the Policy, and QBE was required to reimburse him for those costs. QBE's obligation to pay compensation or damages had not yet arisen, as the liability was contingent upon the awarding of damages or compensation or settlement.
- The Court said that combining the policies did not make any difference to the analysis, as the D & O Policy provided for two distinct liabilities to be met. A section 9 charge could not apply to defence costs, so would only apply to the fund's balance once QBE had met its defence costs liability.
- The Court was also concerned to ensure that claims were defended properly. If defence costs could not be accessed by an insured, that may compromise the insured's defence.
- Even if the result was unfair to the third parties, the Court said:
"That is the necessary consequence of the policy's structure in providing for the one sum insured to be available to meet claims for indemnity for two separate liabilities, consistently with the contractual contemplation that by incurring defence costs the insurer may avoid its contingent liability to Bridgecorp. And it would always be open for the parties to strike a compromise on terms designed to ensure that the sum insured is not further exhausted by defence costs."
"This approach reflects what has long been recognised about s 9, namely that it takes effect subject to the terms of the contract of insurance as they stand at the time the charge descends. So the charge is subject to the limit of liability in the policy, even though that may be less than the amount of the claim(s). It is also subject to the right of the insurer to avoid the contract for material non-disclosure or for breach of a contractual term (such as the obligation to notify claims promptly or to co-operate with the insurer)."
This is not the end of the road for the directors. Further defence costs are on the horizon (although presumably the $20 million fund will certainly satisfy any defence costs incurred). Since the Court of Appeal's decision, the receivers for the Bridgecorp companies, PwC, have filed a $442 million civil claim against the directors for alleged breaches of their directors duties (the other two directors, Rob Roest, and Rod Petricevic are bankrupt and exempt from proceedings commenced after the date of the bankruptcy). The Court of Appeal has recorded that the Bridgecorp companies incorporated in Australia are also considering filing proceedings against the directors in Australia.
The Bridgecorp companies have indicated that they will appeal the Court of Appeal's decision. Although the Court of Appeal's decision confirmed what the insurance industry had perceived as the status quo, directors and insurers are still advised to proceed with caution:
- Talk to your insurers to determine the extent of coverage of your policy:
- Is your policy sufficient to cover both anticipated defence costs and possible compensation payments to third parties?
- Check the wording of your policy: is it clear enough to ensure your defence costs are covered regardless of your liability to pay compensation to third party claimants?
- Should you consider a separate defence costs policy?
- If you have a separate defence costs policy, is it sufficient to protect you in the event of a large civil claim?
Of course, most directors aren't at risk of such enormous claims, but it is worth having a level of comfort in knowing that you are covered if a claim is brought against you.
Elizabeth Smith, Senior Solicitor.
For further information, please contact the lawyers listed below.