Directors reluctant to delve into the murky world of D&O insurance have finally been given the protection they need, after a court ruled insurers can use insurance proceeds to pay their clients’ defence costs.
A number of insurers including AIG have persuaded the NSW Court of Appeal that the insurers of the defendants should not be preventing from paying their client’s legal costs until the claim is settled under section six of the Law Reform (miscellaneous provisions) Act 1946.
Prior to the ruling, under section six, plaintiffs could freeze the defence’s insurance proceeds until the claim had been settled. It meant that insurers could not use the funds to pay their client’s defence costs and that the defendant was likely to lose the case and be rendered bankrupt in the process.
The decision handed down by the NSW Court of Appeal last week has been met with praise across the industry. “It’s fantastic news – it allows the directors to have their day in court and insurers can do what they are contracted to do,” Jeremy Scott-Mackenzie, commercial institutions manager of financial lines at AIG Australia, told Insurance Business.
“For brokers, it provides them certainty. They can tell their clients that if they are sued their policy will be able to do certain things. Section six stopped them from doing that.
“Most clients buy D&O so they can defend themselves. This gives them piece of mind and the certainty that they can do that.”
The issue first surfaced in the case of failed New Zealand business Bridgecorp. The NZ High Court found a statutory charge applies to the defendant’s insurance proceeds for the benefit of the plaintiff/third party claimant. The decision was quashed by the court of appeal.
A similar case, however, emerged in NSW, Australia, concerning the collapsed Great Southern Group. The group’s directors are covered under the D&O policy but the claimants argued a charge on the defendant’s insurance proceeds under section six of the act.
“The plaintiff had first dibs on the money,” said Scott-Mackenzie. “As a result, the insurer can’t even pay money to defend the directors. If the directors can’t pay for a defence and have their day in court, they are likely to lose and have to pay out many millions of dollars. The insurer is only liable to the limit of their liability so the directors are liable for the rest. They’ll go bankrupt.”
Scott-Mackenzie said the lack of protection had posed problems for boards of directors.
“If they have a spectre of this type of massive litigation over their shoulder, it will be difficult to convince qualified directors to sit on boards. They were exposed to litigation, whether spurious or credible.
“There were directors who were concerned about D&O because of [circumstances before this decision]. It might have been an inhibitor for some buyers who were unsure if the policy would cover what they want. We can now deal with those inhibitions with this decision.”
Scott-Mackenzie warned, however, that the decision could be appealed by the plaintiffs but this would not be known for another four weeks. He added that the NZ decision is also subject to appeal.