Building a bridge from Bridgecorp – clarifying priorities under claims made insurance policies

Background

On 11 July 2013 the New South Wales Court of Appeal¹ delivered a judgment which is significant for parties litigating where the substantial asset is the benefit under a director’s and officer’s, or professional indemnity, policy.

Following in the footsteps of the recent New Zealand Court of Appeal decision in Steigrad v BFSL 2007 Ltd & Ors² (Bridgecorp), it is anticipated that this decision will provide greater certainty to insured directors and officers around their ability to access such policies to fund defence costs, pending the conclusion of legal proceedings, even in an insolvency context.

The case turned on the correct interpretation of section 6 of the Law Reform (Miscellaneous Provisions) Act 1946 (NSW) (Reform Act) in the context of group proceedings running in various states of Australia (including Western Australia, but not in New South Wales), arising out of the collapse of the Great Southern Group of Companies. 

Various defendants were insured under director and officer liability insurance policies. 

The claimants in the various proceedings asserted charges in their favour over the insurance policies by operation of section 6 of the Reform Act, which they argued operated to the exclusion of insurers’ advances of defence costs to the policyholders to defend those claims, thereby potentially increasing the amount available to settle a claim. 

Decision

In deciding against the claimants, the Court was required to answer the following questions (among others):

• whether there was a charge on insurance money under a contract of insurance in favour of a third party claimant;

• if so, whether that charge took priority over an insurer’s obligation to advance defence costs to its policyholders; and

• the territorial reach of the Reform Act.³

The extent of the charge

Section 6(1) of the Reform Act provides that the amount of the liability to pay damages or compensation, of any person who has entered into a contract of insurance by which that person is indemnified against that liability, is to be a charge on all insurance monies that may become payable in respect of that liability.  The charge comes into existence on the happening of the event that gives rise to the claim for damages or compensation.  That charge takes a priority over all other charges affecting the insurance monies.

Prior to the Court of Appeal’s decision in Bridgecorp, there had been some uncertainty around the issue of whether a statutory charge of this kind applied to insurance monies payable by insurers in respect of an obligation to pay damages, and if so, whether it applied to defence costs.⁴

It was unclear whether an Australian Court would follow the Bridgecorp decision.

This issue was extremely important to the litigants concerned because, on one view of the section:

• insurers could not pay any insurance monies otherwise than in accordance with section 6 from the time they were on notice of the charges; and

• if section 6 applied, the insurers could not pay defence costs on behalf of the insured defendants without:

  • imperilling themselves to having been found to have made those payments as ex gratia payments; and
  • an erosion of the limits of indemnity under the policy. 

The Court found that the Reform Act applies only to litigation in the New South Wales Courts.  Accordingly, all other questions fell away.  However, given the general importance of the questions raised the Court answered them.

On the other hand, if insurers were free to make those payments up until the time the insured parties’ liability was determined by a judgment award or settlement, then the amount available to the third party claimants would be eroded by that expenditure.

The Court rejected the insurers’ arguments that section 6 could not apply at all to claims made insurance policies.⁵  However, they noted that for the charge to apply, the relevant event and the claim must occur in the same policy period.  Where a claim is triggered in a subsequent policy period, there can be no charge and section 6 will have no operation.

The Court then turned to the question of advancement of defence costs.  The Court noted that the policies do not have one limit of liability for claims made to third parties and a separate limit of liability for defence costs.  Rather, insurers have a liability to pay up to the maximum amount of the loss as defined, which is suffered by the insured party.

The Court affirmed that the object conferred by section 6 is that insurance money paid by the insurer to an insured party in respect of a liability of the insured party to pay damages to a third party claimant, are available to meet that liability.⁶ 

The Court held that the charge under section 6 does not extend to monies payable under the policies for defence costs before any judgment award or settlement and if an entitlement for payment of defence costs arose prior to judgment award or settlement, section 6 would not apply to those monies so payable.  Payment of those sums to insureds would be a valid discharge by the insurers of their obligations.

Lavan Legal comment

In finding for the insurers, the judgment provides considerable guidance and certainty to insurers, policy holders and claimants that there is no preclusion on insurers meeting reasonable and proper defence costs of policy holders under claims made and notified policies. 

Those who are litigating to obtain the benefit of payments under the policy need to be aware that the more costly the proceedings, generally the less there will be to settle the claim.  This may have a marked impact on the prospect of litigation where such claims exist.

The operation of section 6 of the Reform Act will apply specifically in insolvency contexts, such as existed in these proceedings, so insolvency practitioners should be conscious that such policies may have an impact on post-appointment litigation in New South Wales - eg in the context of claims by liquidators against former directors or officers.  In practice, whether or not the litigation is in New South Wales, the outcome will not be affected.