Court of Appeal rank directors’ defence costs first
Two recent cases heard together in the Court of Appeal overturn a prior High Court decision concerning the relationship between s 9 of the Law Reform Act 1936, and defence costs in relation to claims against an insured party.
Section 9 aims to protect third parties by creating a 'charge' in favour of the third party over any insurance money 'that is or may become payable' in respect of the insured’s liability to the third party.
In the first case the appellant, Peter Steigrad, was a director of Bridgecorp Ltd and Bridgecorp Management Services Ltd (both in receivership and liquidation). Mr Steigrad and several other directors were convicted of offences under the Securities Act 1978, and Bridgecorp now seeks $450 million worth of damages based on breaches of director duties.
Bridgecorp held two insurance policies with QBE Insurance (International) Ltd (QBE). The first was a directors and officers liability policy (D&O policy), indemnifying the directors for up to $20 million against any liability incurred in their capacity as directors, and providing for the payment of defence costs. The second was a statutory liability policy covering defence costs up to $2 million, all of which was exhausted by the directors in defending the Securities Act proceedings.
Mr Steigrad and two of his fellow directors applied to the High Court for a declaration that s 9(1) Law Reform Act 1936 did not prevent the insurer from meeting its obligation under the D&O policy of reimbursing them for their defence costs. In the High Court, Lang J held that the charge created by s 9(1) applied to the whole of the amount available under the policy at the date the charge was created (assuming notification). Accordingly, the charge prevented the directors of Bridgecorp from having access to the insurance money to meet their defence costs. Mr Steigrad appealed against that ruling.
Another case involving a materially similar insurance policy was argued alongside Mr Steigrad’s appeal. In this case, the first appellant, Chartis Insurance New Zealand Ltd (Chartis), issued a prospectus liability insurance policy to Feltex Carpets Ltd (Feltex) in 2004. It provided cover up to a specified limit for 'losses' incurred in respect of 'securities claims' against the company’s directors, and the term 'losses' was defined to include reasonable defence costs incurred. Feltex went into receivership and then liquidation in 2006.
Mr Houghton represented 3,100 shareholders in proceedings against the Feltex directors. They allege that the prospectus and investment statement issued included an untrue statement. Following the delivery of Lang J’s judgment in Steigrad, Mr Houghton gave Chartis notice of a charge over the proceeds of the prospectus liability insurance policy under s 9(1) on behalf of the shareholders. Chartis and the Feltex directors issued a proceeding against Mr Houghton, claiming a declaration that the charge did not operate to prevent Chartis from paying the directors’ reasonable defence costs under the policy.
The key issue raised by these two factual scenarios was whether the phrase 'all insurance money that is or may become payable in respect of that liability' in s 9(1) of the Law Reform Act 1936 includes insurance money that is or may become payable on account of an insurer’s liability to reimburse an insured party for defence costs incurred in defending a claim.
The Court held that Mr Steigrad’s appeal must succeed on two interrelated grounds. First, it held that Section 9 does not by its terms apply to insurance moneys payable in respect of defence costs, even where such cover is combined with third party liability cover and made subject to a single limit of liability. Furthermore, the Court noted that combining the two forms of cover – defence costs and third party liability – in a single policy with separate sums insured, or combining the two forms of cover in a single policy subject to a single sum insured, would not change this. In each case, the charge attaches to the balance that is available to meet third party claims after any defence costs liability has been met.
Second, the court noted that QBE had made a contractual promise to pay Mr Steigrad’s defence costs. It noted the established jurisprudence on s 9, affirming that it takes effect subject to the terms of the contract of insurance. Thus, it stressed that s 9 cannot operate to interfere with the performance of mutual contractual rights relating to another liability.
The Court thus allowed Mr Steigrad’s appeal, and quashed the declaration by the High Court. In relation to the Chartis case, it issued a declaration to the effect that Mr Houghton was not presently entitled under s 9 to charge the money payable by Chartis to the directors’ for their defence costs pursuant to the prospectus liability insurance policy.
This is a sensible decision by the Court of Appeal, as it ensures s 9 Law Reform Act is kept within its intended ambit. In doing so, the decision provides directors with greater certainty with respect to the insurance policies that they undertake.
Thanks to Dan Hughes, a Partner in the Auckland office of Kensington Swan for this article