Australia: Defence costs under D&O policies can be advanced safely, says NSW Court of Appeal

Directors and officers involved in legal proceedings should be able to access defence costs under their D&O policies without fear that they will be subject to a statutory charge imposed by section 6 of the Law Reform (Miscellaneous Provisions) Act 1946, following the NSW Court of Appeal's decision in Chubb Insurance Company of Australia Limited v Moore [2013] NSWCA 212 (Chubb v Moore).

Why was access to defence costs under D&O policies in doubt?

If a person is insured against a liability and that liability arises and the person is sued, they can then turn to their insurer to be indemnified up to the limit for which they are insured.

Section 6 of the Law Reform (Miscellaneous Provisions) Act 1946 was designed to stop defendants from depleting insurance moneys to the detriment of a third party claimant. It provides "direct access" by imposing a statutory charge on the moneys payable under the insurance policy. Essentially, the intention of the section was to prevent an insured spending those moneys until any claims against them were determined.

The underlying reason is easy enough to understand, but the section is drafted in such a way that there has been some confusion about what, exactly, it covers. If a D&O 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 claimant?

In 2011, the New Zealand High Court said that a charge under New Zealand's equivalent of section 6 prevented access to defence costs.¹ That decision, colloquially referred to as the "Bridgecorp" case, was then overturned by the NZ Court of Appeal.² Until now, there has been some doubt as to what may be the position in Australia.

What is the scope of section 6?

The NSW Court of Appeal has now considered the Bridgecorp issue in Chubb v Moore. It also addressed a number of other issues arising out of section 6.

First, the court held that section 6 is not limited to "occurrence" based liability policies, but also applies to "claims made" insurance.

Second, the court held that section 6 does not create a charge where the alleged conduct of the insured giving rise to the claim for damages or compensation happened before the policy came into effect.

Third, the court held that the section also does not apply to claims brought in courts outside New South Wales, only those brought within it.

Defence costs are not caught by section 6

On the Bridgecorp issue, the court held that any statutory charge created by section 6 cannot apply to:

• defence costs;
• legal representation expenses; or
• other costs and expenses

that are paid by the insurers in accordance with the policy before judgment is entered or settlement is agreed in respect of the claim for damages or compensation.

This is because the insured has a contractual right to his or her defence costs, and section 6 would have to state very clearly that it is altering that contractual relationship. It does not do so. If section 6 did apply, then an insurer could not safely pay defence costs if there was any possibility that the ultimate liability of the insured might exceed the amount available to meet that liability at that time. The wording of section 6 does not show that the NSW Parliament intended to have such a drastic impact on the contractual rights of insureds.

What about other payments under an insurance policy when there are multiple claims against an insured?

Finally, the NSW Court of Appeal held that if there is a valid basis on which to apply a charge under section 6 on insurance moneys, and the insured is faced with multiple claims, any payment made by the insurer under the policy by way of indemnity for the liability of the insured to pay damages or compensation to a third party claimant (excluding a payment of defence costs, legal representation expenses or costs and expenses) will constitute a valid discharge of the insurer. This is so as long as the payment is made before:

• judgment is entered;
• or a settlement is agreed,

in respect of a claim for damages or compensation of any other third party claimant.

Key messages for directors and officers

The NSW Court of Appeal, like the New Zealand Court of Appeal, has reached a decision on the application of a statutory charge which is different to that of the original Bridgecorp decision. This should provide some comfort to directors and officers needing access to defence costs that their insurers ought not to refuse to advance those costs when they are needed most.

Companies that purchased a defence costs only policy solely to avoid the statutory charge may find that they can reduce insurance costs if their directors are now comfortable to abandon the safety net of a costs only policy. They should of course consider any obligations to retired directors that may impact their ability to change their D&O program.

More generally for insureds, the Court's views on section 6 have somewhat limited its scope. A statutory charge will only arise if:

• the third party begins proceedings in New South Wales; and
• the event on which their claim is based occurred after the policy incepted.

The New Zealand Court of Appeal decision is subject to an appeal to the Supreme Court of New Zealand. It is not yet known whether the Chubb v Moore decision will be appealed to the High Court of Australia.

You might also be interested in...

• Bridgecorp appeal: The latest on defence costs under a D&O policy and the application of a statutory charge

Footnotes

¹Steigrad v BFSL 2007 Ltd [2011] NZHC 1037

²Steigrad v BFSL 2007 Ltd [2012] NZCA 604.

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.