11 November 2011 New Zealand High Court says D&O policy may not be used to fund director's defence costs

By Andrew Draper, Senior Associate and Phillip Briffa, Solicitor

In Brief

On 2 July 2007 New Zealand property development company Bridgecorp Group (Bridgecorp) was placed into receivership, owing investors nearly NZ$500 million.  

In the aftermath of the collapse, the NZ Securities Commission brought numerous criminal and civil claims against the directors of Bridgecorp in relation to their conduct.  Some of the Bridgecorp Companies also indicated that they would bring proceedings against the directors.  

In addition to a policy covering breach of statutory obligations, companies in the Bridgecorp Group held a NZ$20 million D&O insurance policy which indemnified the directors in respect of both liability incurred as a result of acts or omissions as directors, as well as the costs incurred in defending legal proceedings.  When the coverage provided by Bridgecorp's statutory liability policy was exhausted, the directors sought to access the proceeds of the D&O insurance policy in order to fund their legal costs of the criminal trial.  

The receivers of a number of the Bridgecorp companies (Receivers) objected to this, asserting that they had a charge over the proceeds of the D&O insurance policy, pursuant to s 9 of the Law Reform Act 1936 (NZ) – an equivalent provision to which exists in NSW in s 6 of the Law Reform (Miscellaneous Provisions) Act 1946 (NSW).

Court finding

 In short, the court found that the Receivers' charge over the insurance proceeds meant that the directors could not fund their defence costs using the D&O policy.  The court held that the payment of defence costs "should not reduce the pool of funds that would otherwise have been available to meet claims in respect of which a charge has arisen", since to do so would deny to the Receivers the fruits of enforcing the charge.  

A big factor in the court's finding was the fact that Bridgecorp elected to bundle both its cover for defence costs and its cover for claims for damages and compensation, which left the directors vulnerable once they began to face large civil claims.  It was also noted that Bridgecorp could have obtained a statutory liability policy which provided a higher level of cover for defence costs, which would have removed (or at least delayed) the directors' need to rely on the D&O insurance policy to fund their defences.  

The court was heavily influenced by the fact that the Receivers' claim was significantly greater than the level of cover provided under the D&O policy.  The Court observed that its finding would likely have been different if the claim was for an amount significantly less than the cover available under the D&O policy, holding that in such circumstances the charge would likely only extend to the expected amount of the claim and its associated costs, meaning some funds from the policy may have remained available to the directors.

Lessons for directors and officers  

Directors and officers should consider purchasing a separate insurance policy designed specifically to provide cover for costs incurred in defending claims.  This case shows that, while cost effective, there may be risks involved in policies that bundle cover for defence costs with cover for damages and compensation.   While the decision in this case is currently only binding in New Zealand, in making its finding the court drew on a decision from the High Court of Australia and, with similar legislation existing in NSW, the principle may later be adopted by Australian courts.  

Ongoing issues  

We note that the matter is not finally settled, as a notice of appeal against the NZ High Court's decision has been filed.  

Further developments regarding the appeal will be featured in future editions of e-News.

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This article is not legal advice and the views and comments are of a general nature only. This article is not to be relied upon in substitution for detailed legal advice.

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