One of the main reasons why directors buy Directors & Officers (D&O) insurance cover is to pay for expensive defense costs should they find themselves in the dock. But a surprise decision by a New Zealand court means directors will have to fund their own legal fees until such time as all claimants’ claims have been settled.
In September, a High Court ruling in Auckland prevented directors from using their D&O policy to fund the defense of criminal actions brought against them by the New Zealand Financial Markets Authority. The decision favors the claimants who naturally want to preserve the insurance limit to fund the final judgment or settlement.
With similar claimant-friendly laws in place in other countries, the case should lead directors around the world to wonder whether their aggregate D&O policy limit is enough to cover their legal costs.
The ongoing New Zealand case concerns claims against certain directors of Bridgecorp Group — an amalgam of finance companies that borrowed money from the investing public to fund property development.
Bridgecorp collapsed in 2007 owing investors nearly NZD 500 million. The defendant directors had the benefit of a D&O policy with a limit of NZD 20 million. The directors estimated that they would require approximately NZD 3 million of this limit by way of defense costs through to the end of trial. They also faced the prospect of future civil proceedings for many millions of NZ$.
Insurer Push Back
As is often the case with hefty D&O claims, the insurers involved had yet to confirm that the claim was covered. Quite apart from any coverage issues which may have existed, the issue with which the New Zealand High Court had to grapple was thrown up by Section 9 of the New Zealand Law Reform Act 1936. This stipulates that insurance funds under a liability policy must be made available to creditors if the court rules in their favor. The issue was whether this provision in effect prevented the directors from accessing the policy until after the final judgment.
As the judge in the Bridgecorp case put it when he delivered the verdict that the directors would not be allowed to use their D&O policies to pay their defense costs:
“Although this result may be harsh for the directors, it is clearly in accordance with the object and purpose of Section 9. If the directors are able to obtain access to funds under the policy to meet their defense costs, the pool of funds available to meet civil claims will be significantly depleted…”
Other countries have similar legislation aimed at protecting claimants in this type of situation:
|Australia||New South Wales has a similar law to the Reform Act to protect plaintiffs in civil proceedings from being unable to gain compensation awarded from defendants who were insolvent. Read more in our Australian team’s recent client bulletin.|
|Israel||Requirement for directors to purchase D&O insurance limits with defense costs in addition|
|Italy||Requires an additional 25% of the limit to be purchased and ring-fenced for defense costs|
Companies with significant undertakings or operations in jurisdictions anywhere in the world which have claimant friendly legislation of this kind would do well to consider whether they need to purchase separate and or additional defense costs protection for their directors. This is not the only type of claimant friendly insurance based legislation and in my next blog I will highlight another.