COMMENTARY: Court of Appeal overturns Steigrad decision on directors' defence costs

The Court of Appeal released its decision this week in the Steigrad litigation, ruling that third party claimants do not have a charge under the Law Reform Act 1936 that gives them priority over insurance money ahead of a director's claim to defence costs under a D&O policy with a single indemnity.

Peter Steigrad was one of three Bridgecorp directors found guilty at trial of misleading investors in the $459 million Bridgecorp collapse. Two other directors pleaded guilty.

The Court of Appeal reversed a High Court decision, which had held that third party claimants have a charge with priority over all insurance moneys payable under a policy with a single indemnity.

The market had responded to the High Court decision by offering separate policies or single policies with separate indemnities for third party liability and defence costs. Given the likelihood that the Court of Appeal's decision will be appealed, directors should continue to ensure that they separate their cover in this way.

Background

The decision, Steigrad v BFSL 2007 Ltd [2012] NZCA 604, concerned the Bridgecorp group, which collapsed in July 2007 owing investors nearly $500 million.

Mr Steigrad and his fellow directors were convicted of offences under the Securities Act. The receivers of Bridgecorp have brought civil proceedings against Mr Steigrad and two other directors, seeking damages of $442 million on the basis that they breached their duties as directors.

Bridgecorp holds a D&O policy with a $20 million limit of indemnity.

The D&O policy indemnifies the directors for any liability they may incur to third parties as a result of their actions as directors. It also provides cover for costs incurred in defending civil or criminal proceedings seeking to establish the directors' liability.

In addition, Bridgecorp has a statutory liability policy with a $2 million limit of indemnity. That policy covers directors' defence costs, but does not cover directors for any liability to third party claimants.

By August 2011, all but one of the directors had exhausted their entitlements under the statutory liability policy. The directors estimated that they would incur another $3 million in costs to defend their criminal trial, and sought to claim these costs under the D&O policy.

This created a problem for Bridgecorp, because it meant that there would be less insurance money available for investors under the D&O policy. Bridgecorp therefore asserted a charge under section 9 of the Law Reform Act, and claimed that as a result, it had a claim to the insurance money in priority to the directors. The directors disagreed, and sought a ruling from the High Court.

High Court

Section 9 of the Law Reform Act 1936 gives a charge over any insurance money that is or may become payable in respect of an insured's liability to pay damages or compensation.

The High Court ruled that because all of the $20 million of insurance money may become payable to Bridgecorp, Bridgecorp had a charge over that entire sum, and that the directors were not able to access that sum to pay their defence costs.

Court of Appeal

Steigrad appealed to the Court of Appeal. A second proceeding, brought by the directors of Feltex against a third party claimant, was heard at the same time.

The Court of Appeal disagreed with the High Court.

It ruled that the Bridgecorp D&O policy provided for a single, aggregated fund of $20 million from which two distinct liabilities can be met – liabilities to third parties and defence costs. The Court said that under section 9, a third party only has a charge over "the balance that is available to meet third party claims after any defence costs liability has been met".

In support of its conclusion, the High Court had relied on a decision from the Chief Justice released shortly after the Law Reform Act was passed.

However, the Court of Appeal dismissed this authority, saying that it was decided in a different context, that the judgment was brief, and that it was obiter (not necessary for the Court's decision).

The Court of Appeal also ruled that the purpose of section 9 of the Law Reform Act is not to "rewrite the bargain struck between the parties". The Court concluded that the section cannot operate to "interfere with or suspend the performance of mutual contractual rights and obligations relating to another liability".

Comment

The High Court's decision was significant, both for D&O policies and for any other liability policies that were defence costs-inclusive. In response to the High Court decision, insurers began offering separate defence costs-only policies, as well as single policies with separate indemnities for third party liability and defence costs.

It is likely that the Court of Appeal's decision will be appealed to the Supreme Court.

As a result, we recommend directors continue to ensure that they have sufficient cover for their defence costs by taking out separate policies or policies with separate indemnities for defence costs.

Murray Tingey is a partner and David Friar a senior associate at Bell Gully. Bell Gully acts for the receivers of Bridgecorp.