Key Points:

New Zealand and NSW differ on whether an insurer can advance defence costs while on notice of a statutory charge before liability to the third party is established.

If a directors' and officers' liability policy obliges an insurer to advance defence costs to a director or officer, is that sum also subject to a charge in favour of the third party who has a claim against the directors and officers?

This has been a live question in recent years, and has led to some insurers withholding defence costs needed by directors and officers. In the latest development, the Supreme Court of New Zealand has in effect, concluded that a statutory charge over insurance money under section 9(1) of the New Zealand Law Reform Act 1936 (NZLRA) secures the amount available to cover liability to a third party, so that the insurance cannot be diminished by an advance of defence costs made to the insured after the charge came into existence (in BFSL and Bridgecorp v Steigrad, Houghton v AIG [2013] NZSC 156).

The court declined to form a view on whether this means an insurer would be entitled to refuse to pay defence costs where there was a risk that the payment of such costs, together with any outstanding third party claims of which the insurer has notice, may exceed the relevant policy limit. However, it indicated that an insurer "may be entitled to be cautious" about meeting such claims for defence costs.

It acknowledged that the risk that payments would exceed the policy limit was to be borne by the insurer, noting that the insurer and insured in question had made a poor bargain by overlooking the effect of the statutory charge.

New Zealand vs Australia

In New South Wales (and certain other Australian jurisdictions) there is legislation in similar terms to the NZLRA. The NSW Court of Appeal last year effectively concluded that an insurer could advance defence costs while on notice of a charge under section 6 of the Law Reform (Miscellaneous Provisions) Act 1946 (NSW) without fear of ultimately becoming liable for amounts in excess of the policy limit. The position in New Zealand now appears to be different to the position in New South Wales (and, potentially, those Australian jurisdictions with an equivalent statutory provision).

A key point of difference between the judgments of the Supreme Court of New Zealand and the NSW Court of Appeal's decision in Chubb Insurance Company of Australia Limited v Moore [2013] NSWCA 212 lies in its answer to the question: must a liability of the insured to a third party be established (eg. through the entry of a judgment or entry into a settlement) for the statutory charge to take effect? If it is, an insurer would only be prevented from making payments for defence costs after liability is established.

The NSW Court of Appeal took the view that, until the insured becomes liable to pay damages or compensation, there is nothing to which the statutory charge can attach or on to which it can descend. Accordingly, until such time as an actual liability to a third party has been established, the charge does not relevantly take effect and the insurer was able to pay defence costs incurred by the insured as it had a contractual obligation to so.

On the other hand, the judges of the Supreme Court of New Zealand have decided that there is nothing in the wording of section 9 of the NZLRA to specify that the charge crystallises on judgment or settlement and that the charge is not analogous to a floating charge. That being the case, it is irrelevant that the insured may be obliged to pay defence costs for which it has insurance cover, before liability is established on third party claims for damages or compensation.

Where does this leave us?

In New Zealand, persons who may have claims against parties who are insured will be pleased to know that any entitlement their defendants may have to cover under a liability policy should, by reason of a charge arising under section 9 of the NZLRA, not be diminished by an insurer subsequently advancing defence costs under the same policy. However, an insurer who is on notice of a charge under section 9 of the NZLRA is now faced with uncertainty as to whether it will become liable to make payments in excess of policy limits either by:

  • performing its contractual promise to advance defence costs and subsequently becoming liable to a third party claimant as a result of the statutory charge; or
  • non-performance of its contractual promise to advance defence costs and subsequently becoming liable to the insured for that non-performance (in addition to its liability to the third party claimant).

Similarly, directors with D&O policies which cover both liability to pay compensation to third parties and defence costs under a single limit of liability will be concerned that a statutory charge may prevent access to insurance desperately needed for defence costs.

In Australia, we do not yet to have the benefit of a High Court decision on the issue. We should know in coming months whether the High Court grants leave to appeal against the decision in Chubb Insurance Company of Australia Limited v Moore [2013] NSWCA 212.

Therefore, as it stands, the current law (at least in New South Wales) is that an insurer is able to advance defence costs from funds that would otherwise be available to cover liability to a third party claimant until such time as liability of the insured is established through a judgment or settlement.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.