Bridgecorp Decision Freezes Defence Costs Tap for Directors

On the day before Christmas Eve 2013, the Supreme Court of New Zealand handed down a judgment dramatically changing the landscape for D&O (and E&O) indemnity insurance claims in New Zealand. In one of my last blogs of 2013 I had floated the idea that perhaps it was time for the D&O industry once again to consider “defence costs in addition” policies.  Little did I know that, so far as New Zealand was concerned, this was about to become a necessity.

Bridgecorp case is a case I (and others) have followed from the first instance decision through to the Court of Appeal. It arose out of the collapse of that company in 2007, owing investors nearly NZ$500m.

The liquidators had gone to court in an attempt to prevent the directors, who were facing civil proceedings, from depleting the limits of a NZ$20m D&O policy by paying defence costs out of that limit.  The liquidators’ application was based on Section 9 of the New Zealand Law Reform Act 1936, which stipulates that insurance funds under a liability policy must be made available to creditors if the court rules in their favour.

The Court of Appeal denied the liquidators’ claim concluding that it was never within the contemplation of the New Zealand legislature to impair the contractual entitlement to receive defence costs with statutory restrictions on the separate right to indemnity in respect of judgements and settlements.

The Supreme Court Differs on Section 9

The Supreme Court of New Zealand by majority decision (3:2) rejected the Court of Appeal’s interpretation of Section 9.

The Court started from the premise that” the clear intent behind the legislation” had been to impose a statutory charge on the proceeds of any relevant insurance

… at the time of the occurrence of the event giving rise to the claim for compensation or damages in respect of the liability to third parties which is covered by the policy….

The “event” for this purpose is the alleged negligence/breach of duty of the directors concerned rather than the ascertainment (by judgment, settlement or otherwise) of the extent of such liability.

The Supreme Court acknowledged that the legislative history surrounding section 9 had nothing to do with directors and officers or professional indemnity liability insurance.  Instead the original aim of the 1936 legislation had been to consolidate existing legislation dealing with workers’ compensation, simplifying the procedure for employees to sue their employers for workplace-related accidents and to consolidate the law relating to motor vehicle insurance.

Access to Justice Not Affected

The Court also accepted that the practice of purchasing a single aggregate limit of insurance covering both defence costs and potential liabilities was widespread (as indeed we know it to be). The Court, however, rejected the directors’ claim that the imposition of the statutory charge, in effect freezing the defence costs element of the insurance limit, would inhibit their access to justice.  Somewhat chillingly, the Court commented:

An insured would only be deprived of the ability to mount a defence if he or she had no other funds available for a defence and where no lawyer would act on a contingency basis…

The Court’s reflection on the nature of the shared (defence costs and liability) aggregate approach to indemnity insurance is perhaps especially harsh. It concluded:

… the statutory charge protects the third party claimant and prevents performance of the defence cost obligation without risk to the insurer.  This means that the insured and the insurer have made a poor bargain because the policy has not been properly drawn: overlooking the effect of the statutory charge. (Emphasis added)

To what extent this criticism of apparent oversight by the insurance industry is really justified may be open to question.  Of the nine New Zealand judges (one at first instance, three in the Appeal Court and five in the Supreme Court), five (the three Court of Appeal judges and the two dissenting judges in the Supreme Court) supported the directors’ case that the contractual sanctity of the defence costs limit should be respected, whereas only four judges (the first instance judge and three Supreme Court judges) decided in the liquidators’ favour.

Australia Decides Differently–for Now

What is more, in the State of New South Wales in Australia, legislation to similar purpose and effect and with a similar history to Section 9 exists.  The New South Wales Court of Appeal, when asked to decide the same question last year, came to the opposite conclusion and said that there was nothing to suggest that the purpose of the New South Wales equivalent of Section 9 was to prevent insurance money being paid to discharge defence costs and other obligations the insurer may have had under a contract of insurance. That case is itself subject to appeal, as to which see below.

Serious Implications for D&O Contracts

The effect of this judgment, from which there is no further appeal, is to fundamentally alter the basis on which D&O (and E&O) contracts will be underwritten and rated in New Zealand in the future.

For new risks incepting after 23rd December 2013 (or renewing after that date), insureds will surely be seeking to purchase either separate defence costs–only policies or separate limits of indemnity for defence costs (with the attendant additional costs that this may entail).

The real potential injustices and difficulties lie within  the “poor bargain” policies issued prior to 23rd December 2013 and underwritten on an entirely conventional shared-aggregate limit basis.

The insurers and insured under these policies must grapple with very real and considerable uncertainties as to the way in which claims currently being defended should be funded.

  • On the one hand, insurers will be acutely aware of the dangers to them in consenting to defence costs where there is any appreciable risk of the limit of liability ultimately being exceeded.
  • On the other hand, insureds will have concerns about the funding of the defence of all of their current claims.

The problem is particularly acute when you factor in the layered towers of insurance typically employed for the larger risks (both domestic and international). For example, a director may have a $20 million limit divided into four equal $5 million layers. If there is a claim for $10 million, the primary and first excess carriers are likely to refuse to consent to payment of defence costs on the basis that their proportion of the overall limit is likely to be exceeded. The other two excess carriers are most unlikely to drop down and plug this gap. (I also have doubts whether the so-called DIC or difference in conditions policies would provide a solution here, but that will the subject for a separate blog).

The only real answer seems to be specific legislation to overturn the effect of the Supreme Court decision. That will require lobbying and clamour from commerce and industry in New Zealand.

By way of final ominous post script I would add that High Court of Australia (its supreme court) is due shortly to pronounce on an appeal under the equivalent legislation in New South Wales, and it is entirely possible that it will go down the same path as New Zealand.

About Francis Kean

Francis is an Executive Director in Willis Towers Watson's FINEX Global, where he specializes in insurance for Dir…
Categories: Australasia, Directors & Officers | Tags: , ,

4 Responses to Bridgecorp Decision Freezes Defence Costs Tap for Directors

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