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Brief Counsel

The Court of Appeal on D&O policies: the "Steigrad decision"

14 February 2013

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​In the hectic run up to Christmas last year, we sent you a brief advisory note on the reversal by the Court of Appeal of the High Court’s controversial decision relating to the level of protection offered by directors’ and officers’ (D&O) liability policies.

We promised you then that we would produce a more detailed analysis in the New Year of the judgment and its effect.   This is it.

However this may not be the last word as the Bridgecorp receivers and Eric Houghton (in the Feltex proceeding) have applied for leave to appeal to the Supreme Court.

To recap

Steigrad concerned the D&O liability policy held by the former directors of Bridgecorp, who were facing criminal charges brought by the Securities Commission and civil claims by the receivers. 

The civil claims far exceeded the policy’s $20 million limit of indemnity and the receivers were concerned that the costs incurred by the directors in defending the criminal proceedings would reduce the amount available to pay any later liability judgment. 

To protect their position, they notified the insurer that they claimed a charge over the insurance money under section 9 of the Law Reform Act 1936.  The insurer responded by declining to pay any of the directors’ defence costs unless the directors reached an agreement with the receivers. 

No such agreement was forthcoming, so the directors sought a declaration from the High Court that section 9 did not apply.

The High Court

The High Court found in favour of the receivers, holding that a charge under section 9 applied to the whole of the policy’s limit of liability, preventing the advancement of defence costs to the directors.

The High Court was satisfied that the underlying purpose of section 9 was to ensure that the insurance fund – effectively the remaining limit of liability under the policy – should be available to creditors.  If the directors could have defence costs advanced to them, thereby depleting the total sum available from the insurance policy, creditors could miss out on the benefit of the policy and their charge under section 9.

The Court of Appeal

The Court of Appeal quashed the High Court’s decision, holding that the enactment of section 9:

  • does not apply to insurance money payable in respect of defence costs, even where such cover is combined with third party liability and subject to a single limit of liability, and
  • is not intended to interfere with, or to suspend the performance of, mutual contractual rights and obligations relating to another liability, such as cover for defence costs.

The words in section 9 - “all insurance money … payable in respect of” were synonymous with “towards satisfying” or “relating to”.  So, in the case of insurance policies which have a single limit that responds to both third party liability and defence costs, the section 9 charge applies to the balance that is available to meet third party claims after any defence costs have been paid.

It is irrelevant that the funds would be progressively depleted by performance of the insurer’s contractual obligation to reimburse Mr Steigrad for his defence costs.  This was a necessary consequence of the policy’s structure in providing one aggregate sum to meet two separate liabilities. 

It is also consistent with the arrangement contemplated by the insurer and insured that, by incurring defence costs, the insurer may reduce or extinguish the amount of any contingent liability to a third party. 

To find otherwise would mean an insurer is obliged to take on an additional cost burden if it wishes to ensure that third party claims are defended appropriately.

Practical effect

The Court of Appeal’s judgment has returned the position to where it was prior to September 2011.1  Whether it will remain there will depend on whether the Supreme Court decides to accept the appeal and, if it does, the interpretation the Supreme Court applies to section 9.

The High Court decision would have prevented insurers from paying defence costs if they formed part of one aggregate limit of cover.  As a result, many insurers amended and restructured their D&O (and other liability) policies to counter this effect - typically, by splitting the policy into two, so that the cover for defence costs was ring-fenced from other potential liabilities.  However, this led to additional complications, especially for insurance programmes involving more than one layer of cover.

The effect of the Court of Appeal’s decision is to remove this problem by allowing policies to provide cover for the costs of defending proceedings (whether civil or criminal), even if there is a contemporaneous civil claim which equals or exceeds the policy limit.  It makes no difference if the policy is structured with an aggregate limit, or with separate funds for the payment of third party liability and defence costs.

Chapman Tripp will continue to follow and report on this issue.

Our thanks to Gemma Peachey for writing this Brief Counsel.

For further information, please contact the lawyers featured.

Footnote

  1. Chapman Tripp represented AIG Insurance New Zealand Limited (previously Chartis Insurance New Zealand Limited) in the Court of Appeal, in a proceeding involving the same issue and heard together with the Steigrad appeal.

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