Getting Blood From A Stone: Claims Against A D&O Policy Where The Director Has Been Made Bankrupt

In the recent case of Markel Syndicate Management Limited v Taylor as Liquidator of Heading Contractors Pty Ltd (In Liquidation) [2021] FCAFC 198 the Full Court of the Federal Court of Australia considered whether the directors and officers liability insurance policy (Policy) taken out by Heading Contractors Pty Ltd (the Company) could cover an insolvent trading claim against the sole director of the Company where the director had been made bankrupt and was then discharged from bankruptcy before any liability was established.

The answer to that question in this case was yes.

While the answer depended on the proper construction of the specific Policy in question, the terms of the Policy were relatively standard and the approach taken by the Court provides useful guidance as to how this issue might be addressed in other cases.

Background

The Company was placed into liquidation on 15 September 2014 via a creditors voluntary winding up.  On 15 April 2015 the sole director of the Company (Director) was declared bankrupt by his own petition.  On 16 April 2018 the Director was automatically discharged from bankruptcy by operation of section 149(1) of the Bankruptcy Act 1966 (Bankruptcy Act), and his discharge operated to release him from all debts provable in the bankruptcy. On 10 September 2020 after the Director’s automatic discharge from bankruptcy and shortly before the relevant time limit for commencing insolvent trading proceedings expired, the liquidator of the Company (Liquidator):

  • commenced insolvent trading proceedings against the Director pursuant to s 588G(2) of the Corporations Act 2001 (Corporations Act).  The Liquidator subsequently amended the claim to include a claim against the trustee in bankruptcy (Trustee).  The purpose of this amendment was to facilitate a claim by the Trustee against the Policy, as any right of indemnity that the Director might previously have enjoyed under the Policy had vested in the Trustee by virtue of s 117 of the Bankruptcy Act; and
  • applied for leave under section 58(3)(b) of the Bankruptcy Act to commence the insolvent trading proceedings.  Leave was required due to the operation of s 153 and s 58(3)(1) of the Bankruptcy Act which prohibited the Liquidator (as a creditor of the Director’s bankrupt estate) from enforcing any remedy against the Director or his property.1

After considering the matter, the Court granted leave to the Liquidator to bring the insolvent trading proceedings and noted that:

  • although the Director’s discharge from bankruptcy may have operated to release him from personal liability for debts, it did not operate to absolve him from other consequences that may follow from his status as an officer of the Company and the performance of his duties in that role; and
  • the insolvent trading claim was captured by s 82 of the Bankruptcy Act such that that all debts and liabilities, present and future, certain or contingent by reason of an obligation incurred before the date of the bankruptcy would be provable in the Director’s bankruptcy.

Importantly, the grant of leave was made conditional on the relief in the insolvent trading claim being limited to the extent of the cover provided for under the Policy.

Following the grant of leave, the Liquidator then applied for a declaration to confirm that the Policy would respond if the insolvent trading claim was made out.  The issuer of the Policy (the Insurer) was joined to the proceedings so it could be heard on this issue.

Decision at First Instance

The application for declaratory relief in relation to the Policy was heard at first instance before Charlesworth J.

The key terms of the Policy considered by the Court included that:

  • the Policy required the Insurer to pay any “Loss” arising from any “Claim” made against the Director during the period of insurance;
  • “Loss” was exhaustively defined and included loss by reason of the legal liability of the Director to pay damages or costs awarded against the Director; and
  • “Claim” encompassed claims in respect of “Wrongful Acts” which included contravention of the insolvent trading provisions of the Corporations Act.

However, the most critical aspect of the Policy was Extension 2(g) which relevantly provided that:

This Policy shall apply in the event the lawful spouse of any Director or Officer is the subject of enforcement proceedings in respect of a judgment against such Director or Officer for a Wrongful Act of that Director or Officer for which he would have received cover under this Policy and at his request.

This Policy shall apply in the event of the death or incompetency or bankruptcy of a Director or Officer to their estate, heirs, legal representatives or assigns, for Loss incurred due to any Wrongful Act of such Director or Officer for which he would have received cover under this Policy. (emphasis added)

The Liquidator argued that the terms of the Extension meant that the Director’s bankruptcy did not displace the Policy, and that the Policy (as vested in the Trustee) should respond (in favour of the Director’s estate in the hands of the Trustee) if the Director would have been covered but for his bankruptcy.

The Insurer on the other hand argued in essence that the “Loss” must have been suffered before the Director became bankrupt, and that as there had not been any liability on the part of the Director established by way of Court order, arbitral award or settlement by that time, then no compensable “Loss” could have been suffered.  

Charlesworth J ultimately agreed with the Liquidators that the clear meaning of the Extension was to extend the Policy for the benefit of the Director’s estate for any Loss that would have been covered but for the Director’s bankruptcy.

Charlesworth J also held (in accordance with existing authority) that the discharge from bankruptcy of the Director operated to release the Director from personal liability for the insolvent trading claim but did not release the estate.2

Given the above, Charlesworth J granted the Liquidator’s application for declaratory relief.

The Appeal

The Insurer appealed the decision to the Full Court and repeated its claim that the liability of the Director must have been established by way of judgment, award or settlement before the Director became bankrupt in order for there to have been a “Loss” and for the Policy to respond.

The appeal was dismissed, and the Full Court noted that there were two key flaws in the Insurer’s argument:

  • first, it over-emphasised the definition of “Loss”, when the correct question was (and should have been understood to have been) what was the purpose, scope and reach of the “Extension” clause having regard to its language and context in the Policy; and
  • secondly, it gave inadequate attention to the phrase “for which he would have received cover under this Policy”, and almost left no room for these words to have any meaning or effect.

Lavan comment

This decision has important ramifications for the proper construction and effect of D&O policies where the relevant director or officer has been made bankrupt.

It should be carefully considered by insurers, directors and officers, and insolvency practitioners in terms of its effect on existing and potential future claims under such policies.

If you have any questions about this case, or about insolvent trading claims and D&O policies generally, the Lavan team is here to help.

AUTHOR
Jemma Huntsman
Associate
AUTHOR
Lawrence Lee
Partner
SERVICES
Recovery, Reconstruction and Insolvency


FOOTNOTES

[1] Taylor (liquidator) v Trustee, bankrupt estate of Heading, in the matter of Heading [2020] FCA 1450.

[2] Tarea Management (North Shore) Pty Ltd (In Liquidation) v Glass [1991] FCA 73; 28 FCR 93 at [99].