Wake-up call over liability insurance
A Supreme Court ruling issued just before Christmas is a wake-up call for businesses with liability insurance, say lawyers.
The ruling had the final say on a long-running issue involving how much directors and officers, or "D and O", insurance cover was available to meet claims against directors of collapsed companies Bridgecorp and Feltex.
Directors had argued that part of the insurance cover, which had a maximum payout limit, was available to pay for the legal costs of their defences against liability claims.
Any successful claim would therefore be paid out of whatever was left from the insurance pot after funding those costs.
On December 23 the Supreme Court decided otherwise. The legal argument related to the Law Reform Act of 1936, which imposed a statutory charge over insurance money indemnifying the insured for damages or compensation payable to third party claimants.
The Supreme Court said the charge meant all the money from the policy was reserved for paying the third party claim, so defence costs would be met only if there was any money left over.
In the Bridgecorp and Feltex cases the amount being claimed by third parties vastly exceeds the policy limits (Bridgecorp directors were covered by a $20m "D and O" policy but faced claims of more than $340m), so the directors affected can no longer rely on the insurance to cover their defence, although the court left open the question of whether insurers could refuse to pay defence costs where there was a risk a successful claim would breach policy limits.
A spokesman for insurer QBE, which provided the Bridgecorp policy, declined to comment on whether it would fund the defence, citing continuing legal proceedings.
Law firm Chapman Tripp, which was on the losing side in the Supreme Court, having represented insurer AIG in the Feltex case, has advised businesses to review their insurance policies in light of the judgment. In a note published on Monday the firm said businesses should not assume the ruling affected only directors and officers liability insurance.
"It also affects professional indemnity policies (covering professional negligence), prospectus liability, employers' liability, statutory liability and general or public liability, and may extend to prevent advancement of defence costs in any prosecutions which could result in a reparations award for the victim (eg for a workplace accident)."
The ruling should particularly concern firms with low insurance limits and those with tiered insurance arrangements - "if the first layer is relatively low, a serious claim could lock up defence costs, forcing the insured to go cap-in-hand to excess layers, which may or may not respond". The firm advised businesses to consult their brokers or insurance company and check that their insurance would provide the required cover.
Murray Tingey of law firm Bell Gully, who successfully represented Bridgecorp's receivers in the case, said many businesses had already reviewed their policies after the High Court ruled on the case in 2011, but there was a straightforward solution available for those yet to do so.
"A lot of insurers and insureds changed their policies back then," he said. Generally they've entered into two policies or had two sums available. So before you'd have an amount that would cover both, but to avoid this issue, if you have, say, a $20m policy you might have a separate $5m policy covering defence costs, which means if there was a charge against the $20m on the policy, you can still draw on the defence costs because that money can never go to the claimant."
While the issue would not be a concern if a policy limit was large enough to cover both the claim and the defence costs, the key detail businesses should check is whether their policy was a single sum covering both risks, or had separate cover for defence costs.
Insurers did not like the ruling because it placed them in an awkward financial position, said Tingey.
"On the Bridgecorp case the insurers may have to pay the claim, but now they have to face a decision on whether to fund the directors' defence, because the directors can't afford it," he said.
"If you're a defendant to a claim normally you've got to choose whether to spend money defending your case. If you've got a good defence, you'd choose to spend money. If the claim is strong and you think you're going to lose, you may not think it's worth spending money defending and you'll settle it."
The Supreme Court's ruling said: "[A]llowing defence costs to diminish the sum available to third parties is tantamount to requiring third party claimants to fund an unsuccessful defence, which would normally not occur under ordinary court cost rules."