D&O Policy insured defence costs in NSW saved by a New Act

One of the protections offered under a directors’ and officers’ Insurance policy (D&O Policy) is that the insurer may offer advance defence costs (legal representation expenses) to enable a director/officer of a defendant company to defend claims brought by third parties. This coverage is one of the most valuable policy aspects offered to directors and officers.  If indemnity is ultimately granted, the advancement usually forms part of the policy limit of indemnity, eroding the amount available to satisfy the claimant.

Particularly with those companies that are facing insolvency, an insurance policy may be the only means by which a third party can satisfy its claim for damages or compensation.  This money could be put at risk if an insurer and insured enter a collusive arrangement or if the insured receives the available insurance money, which it then uses as this may limit, or extinguish, the amount available to pay a successful plaintiff against the insured defendant.

S 6 Law Reform (Miscellaneous Provisions) Act 1946 (NSW)

To deal with this potential unfairness, in 1946 s 6 of the Law Reform (Miscellaneous Provisions) Act 1946 (NSW) (s 6) was enacted, it created a statutory charge over insurance money in favour of a third party claimant in a situation where potential proceedings against the insured defendant would be pointless, for example, where the defendant is facing insolvent or missing.  Section 6 is almost entirely mirrored from the New Zealand Act s 9 of the Law Reform Act 1936 (NZ) provision (s 9).

This provision is unique to NSW in Australia and has impacted on the question of whether there is a benefit to litigate in NSW where a defendant is insolvent, but insured.  The section applied only to proceedings in NSW.  In recent years, it has become a topical question.

Comparison to s 601AG Corporations Act 2001 (Cth)

It is useful to note that all jurisdictions can rely on s 601AG of the Corporations Act 2001 (Cth) which acts to allow a third party to claim directly through a defendant’s insurer where that defendant has since become bankrupt or insolvent.

Ambiguity of ss 6 and 9

However, due to the ambiguity of the drafting of ss 6 and 9, as well as the significant changes to the insurance industry over the (70+) years, the judicial interpretation of s 6 has had conflicting results.  In particular, whether it can operate to place a charge over all insurance money, including defence costs available to directors and officers under the policy who are involved in a third party claim.  This is specifically illustrated in two leading cases: Steigrad v BFSL 2007 Ltd¹ (Bridgecorp) and Chubb Insurance Company of Australia Ltd v Moore² (Chubb).

New Zealand’s Position - Steigrad v BFSL

In New Zealand, in Bridgecorp the majority took a literal and broad interpretation of s 9 and found it operated to create a charge over all insurance money available under the policy in favour of a third party claimant, on the happening of the event giving rise to the claim, which amount is established on finality of the claim.³  The effect of s 9 was to override the insurance contractual terms over insurance money obligated to the insured’s defence costs of a claim.  In effect, the operation of s 9 applied to prevent defence costs being advanced to directors to defend the claim.

New Sough Wales’ Position – Chubb v Moore

Conversely, in Chubb, the court took a narrow approach and found that s 6 did not apply to extinguish the contractual rights under the insurance policy applying to defence costs being advanced to the insured defendant, distinguishing this insurance cover from insured liability to third parties, thereby allowing the insurer to fund the defence of the directors and officers of the defendant company.  Before this decision was appealed to the High Court a settlement was reached between the parties.

These two contrasting cases left significant uncertainties about the operation of s 6.  It remained unclear whether, in future decisions, s 6 would to permit or prevent the advancement of defence costs to insured directors and officers of impecunious entities, leaving directors and officers extremely vulnerable.  On the other hand, there were concerns that if s 6 did not apply to the advancement of defence costs and the insurer is free to cover all of these costs up until a final verdict, the funds available to a successful plaintiff could well be eroded away to nil.

Review of s 6

The NSW Government conducted a Review of s 6 and issued “Report 143: Third Party Claims on insurance money: Review of s 6 of the Law Reform (Miscellaneous Provisions) Act 1946” (Report 143).

New Act Emerges: Civil Liability (Third Party Claims Against Insurers) Act 2017 (NSW)

The Civil Liability (Third Party Claims Against Insurers) Act 2017 (NSW) (New Act) was assented to on 1 June 2017 and adopted all of the recommendations contained in Report 143 and repealed section 6.

The reported effect of the New Act, as outlined in Report 143 and the Second Reading Speech⁴ is as follows:

• The concept of a charge is removed (as being unnecessary);⁵
• The intention of s 6 is said to remain in that in proceedings in NSW, the claimant can recover an amount limited to the amount the insurer would have paid in respect of the defendant’s liability to the plaintiff to pay compensation. Protection to the third party claimant is provided under s10 to discourage collusion between and insured and insurer by ensuring that until any money paid by the insurer to the insured in respect of the insured liability is paid to the plaintiff, the insurer’s liability is not fulfilled.
• A third party can claim directly from the insurer (s 4(2)). Here, the insurer stands in the shoes of the insured defendant in the proceedings to recover damages, compensation or costs from its insured and has the same rights and liabilities as if it were the insured defendant.  It is noted in the Report that this has the same effect as s 601AG Corporations Act 2001 (Cth), which is relied on in other jurisdictions.⁶
• However the wording of s 4(2) of the New Act:

“The amount of the insured liability is the amount of indemnity (if any) payable pursuant to the terms of the contract of insurance in respect of the insured person’s liability to the claimant”,

particularly by the inclusion of the words “if any”, is stated to acknowledge the possibility that the amount liable to a third party could be reduced by other payments under the insurance contract, for example, by the insurer paying the defence costs of directors and officers.⁷

• The wording in s 7 of the New Act is said, among other things, to confirm the position that this section “…is not intended to and will not impact on the insurer’s liability to meet the cost of defending a claim.”⁸
• Further the Second Reading Speech provides support: “…to confirm that the insurer can rely on the operation of the insurance contract to reduce its liability to the plaintiff.”⁹

Application of New Act

Given it has only just come into force, the Act has yet to be adjudicated on, but it seems its application will be more in line with the decision of Chubb and the position in other jurisdictions, including Western Australia, that there remains a distinction between contractual obligations to pay defence costs and insured liability owing to a third party under the D&O Policy.  A third party is entitled to liability paid by the insurer under the policy up to the amount the defendant is liable and is further protected by keeping an insurer on risk until any insured liability paid to the defendant is paid to the plaintiff, discouraging collusion.  However there remains the potential to impact on the pool of money available to third party claims via the provisions allowing contractual obligations to advance defence, but would appear to be limited to the extent of reasonable defence expenses, necessary in establishing liability.

In turn, the potential desirability of forum shopping to litigate in NSW to obtain any advantage under the old s 6 is likely to have been eliminated.  That provides increased certainty for directors and officers