An appellate court in New Zealand has “quashed” the controversial ruling of a  lower court ruling that former directors of the defunct Bridgecorp companies are not entitled to defense expense reimbursement under the companies’ D&O insurance policy where the companies’ liquidators have raised (but not yet proven) claims against them exceeding the policy’s limits of liability. The appellate court’s ruling ensures that the companies’ directors have access to the insurance to defend themselves against claims pending against them. A copy of the Court of Appeal of New Zealand’s December 20, 2012 judgment and opinion can be found here.

Background

The Bridgecorp liquidators, who have claims against the former Bridgecorp directors in connection with the companies’ collapse, have asserted a “charge” on the Bridgecorp companies’ D&O insurance policy under Section 9 of Law Reform Act of 1936. The liquidators allege that their claims exceed the policy’s limits of liability and that this “charge” gives them priority rights to the policy proceeds. The Bridgecorp directors initiated an action seeking a judicial declaration that the “charge” does not prevent the D&O insurer from meeting its contractual obligations under its policy to reimburse them for their defense expenses.

As discussed at length here, on September 15, 2011, New Zealand High Court (Auckland Registry) Justice Graham Lang ruled that the liquidators’ “charge” against the D&O insurance policy proceeds “prevents the directors from having access to the D&O policy to meet their defence costs.” Although Justice Lang acknowledged that this result is “harsh” and even “unsatisfactory,” he reasoned that Section 9 was designed to “keep the insurance fund intact” for the benefit of claimants and that this legislative purpose should not be defeated merely because coverage for both defense costs and indemnity were combined in a single policy.

The Bridgecorp directors appealed Justice Lang’s ruling. The appellate court combined their appeal with the application of the directors and officers of the Feltex Carpets. The Feltex officials had been sued in a group action by Feltex shareholders alleging that the Feltex defendants had made misrepresentations in connection with the company’s 2004 IPO. The Feltex directors sought a judicial declaration that they were entitled to have their defense expenses reimbursed under the Feltex D&O policy. Their application to have their petition combined with the Bridgecorp directors’ appeal was  granted. Even though the December 20, 2012 opinion of the Court of Appeal addresses only the Bridgecorp case, the Court’s judgment applies to both cases.

The Court of Appeal’s Ruling

In its December 20, 2012 opinion, a three-Justice panel of the Court of Appeal of New Zealand allowed the directors’ appeal and quashed Justice Lang’s lower court ruling. The Court of Appeal overturned the Justice Lang’s ruling on two ground: first, that the Section 9 “charge” does not apply to insurance funds payable with respect to defense costs, even where the defense cost coverage is combined with third-party liability coverage in a policy with a single limit of liability; and second, that Section 9 is not intended to “rewrite or interfere with contractual rights as to cover and reimbursement.”

In ruling that the Section 9 does not apply to the D&O policy’s defense cost coverage, the Court of Appeal noted that the policy provides coverage for “two distinct kinds of losses” that operate “independently.” The court reasoned that if the two coverages had been set up in separate policies, Section 9 could not have applied to the defense cost policy, and that the combination of the two coverages into a single policy should not affect the analysis. The court also reasoned that “it is irrelevant” that the policy proceeds would be depleted by payment of defense costs, as that is that is “the necessary consequence of the policy’s structure.”

The Court of Appeal also noted that the practical effect of Justice Lang’e ruling was to deny the directors of their contractual rights to defense cost reimbursement. The Court noted that a “charge” under Section 9 is “subject to the terms of the contract of insurance as they stand at the time the charge descends” and it “cannot operate to interfere with or suspend the performance of mutual contractual rights and obligations relating to another liability.” The Section 9 charge cannot deprive the directors of their rights to defense cost protection under the D&O policy.

Discussion

There were many troublesome aspects to Justice Lang’s decision, not least of which was that it operated to deprive the insuredsof one of the most important aspects of the policy’s protection at the time they needed it most. The Court of Appeal’s ruling ensures that the directors and officers of Bridgecorp (and of Feltex Carpets) will have access to the proceeds of their companies’ D&O insurance policies to defend the claims pending against them. Justice Lang himself noted that the need for this type of defense cost protection was among the most important reasons companies procure D&O insurance, yet his ruling, had it stood, would have frustrated this most  basic purpose of the policy.

Had the Court of Appeals affirmed Justice Lang’s decision, the New Zealand insurance marketplace would have had to have evolved an insurance solution ensuring that the D&O policy’s defense cost protection could not be stymied by a Section 9 charge. The marketplace would have had to come up with some structure separating defense cost coverage from indemnity coverage. While the marketplace certainly could have developed such a structure, it could have added complexity and cost to the insurance equation. . (I am aware that some insurers had already been offering alternatives designed to try to address this concern.)

More importantly, the need for a New Zealand insureds to have access to customized insurance solutions would have added further complexity to the already difficult equation of trying to provide insurance solutions that operate consistently and predictably across the globe. As I noted in my discussion of Justice Lang’s earlier ruling, D&O insurers are already struggling to provide insurance products that apply globally and operate locally. Those struggles will continue, but the Court of Appeal’s decision in the Bridgecorp case removes at least one factor that had even further complicated the efforts to provide global D&O insurance protection.

A December 20, 2012 New Zealand Herald article discussing the Court of Appeal’s ruling can be found here. Special thanks to a loyal reader for providing me with a link to the Court of Appeal’s ruling.