Many contemporary management liability insurance policies draw distinctions between types of directors. For example, many private company D&O insurance policies provide additional excess defense expense coverage for the benefit of “non-executive directors.” However, these kinds of provisions beg the question of who exactly is a “non-executive director”? A recent decision by an appellate court in the Australian state of Victoria construing this type of provision– in a case in which an individual director was seeking access to the excess defense cost protection available only to “non-executive directors” — underscores how difficult this determination can sometimes be.
A copy of the Supreme Court of Victoria Court of Appeal’s December 16, 2014 opinion can be found here. Francis Kean’s February 9, 2015 post about the decision on the Willis Wire blog can be found here. A January 27, 2015 memo about the decision by Kathryn Rigney of the Colin Biggers and Paisley law firm in Sydney can be found here.
Australian Property Custodian Holdings Limited was the responsible entity for and trustee of a property unit trust owning retirement and aged care facilities. Many of the property management functions for the unit trust’s various properties were undertaken by entities that, while characterized by overlapping ownership, were separate companies from Holdings.
Kim Samuel Jacques was a director of Holdings. He and other members of the Holdings board were subject to various claims for alleged wrongful acts that allegedly took place during the period 2006-08.
Holdings maintained an Investment Management Insurance Policy at the time the claims were made. The defendants’ costs of defending themselves from the claims exhausted the policy’s $5 million limit. Jacques sought the protection of an additional $1 million excess defense cost limit that was available under the policy for the benefit of “non-executive directors.” The insurance carrier denied that Jacques had the right to access the $1 million limit, contending that at the critical period, Jacques was an executive director and not a non-executive director. Jacques filed an action against the insurer seeking a judicial declaration that he was entitled to the benefit of the additional $1 million excess defense expense limit.
The policy defined “Director” as “any person who was, now is, or during the policy period becomes, an executive or non-executive director” of Holdings. The policy defined a “Non-Executive Director” as “any natural person who serves as a non-executive director of” Holdings. The policy definitions did not specify any criteria to be used in determining whether or not a director is a non-executive director.
The parties agreed that Jacques has been a non-executive director of the company before April 6, 2004 and that he functioned as an executive director of the company after June 26, 2007. The issue at trial was whether Jacques was a non-executive director during the period between those two dates.
The trial court determined that there were two issues to be decided: first, the court had to decide the meaning of the phrase “non-executive director” in the policy; and second, the court had to make a factual determination whether Jacques met the definition during the relevant time period. The trial court said that for purposes of interpreting and applying the policy language the critical inquiry was whether the company approved or acquiesced in the assumption by the director of the powers of an executive director, or whether there is evidence that the delegation of executive function to that director.
Following trial, the trial judge held that Jacques was not an executive director during the relevant period and was entitled to the benefit of the excess defense cost limit under the policy. The insurer appealed.
The December 16, 2014 Opinion
On December 16, 2014, a three-judge panel of the Victorian Court of Appeal dismissed the insurer’s appeal and affirmed the lower court’s ruling.
The insurer had tried to argue on appeal that in addition to the issues considered by the trial court, the determination of whether or not Jacques was an executive director during the relevant time period, the court should also consider how Jacques’s role was portrayed to investors; how his role was perceived internally within Holdings; and how he perceived his own role. In support of these arguments, the insurer relied on documents that were provided to investors identifying him as an executive director and on board of directors’ minutes that described him as an executive director. The insurer also relied on testimony that Jacques had provided under oath in an Australian Securities and Investments Commission examination, in which he described his role during the relevant time period as that of an executive director.
The Court of Appeal essentially found that the views of the board itself or even of the director himself are of “limited relevance.” While the company’s records and documents may be relevant, they are relevant only to the extent they help to determine whether or not the individual was “performing executive functions in the management or administration of the company.” The Court of Appeal also found that the way a director’s status as depicted to investors obviously might be of relevance in other circumstances, it is of “limited relevance” for purposes of construing the meaning of the term “non-executive director” in the policy.
The “essential element” to be considered, the Court of Appeal said, for purposes of construing the term “non-executive director” in the policy is not necessarily how he is described but rather “whether the director is performing executive functions in the management and administration of the company.”
The Court of Appeal said that the various statements to investors, in board minutes and even by Jacques himself in his examination testimony fell short of providing evidence of any delegation to Jacques of authority to perform executive functions. The Court of Appeal said that while the record showed that Jacques was performing an operational role in the management of the retirement villages, the record did not establish that this was done as part of the business of Holdings, rather than for the separate business enterprise by which he was employed. The Court of Appeal rejected the appeal and affirmed the trial court.
I think that the language included in insurance policies drawing the distinctions between executive and non-executive directors (or similar language distinguishing “outside directors” or “independent directors”) is incorporated with an unconscious assumption that distinguishing between these types of directors will be clear or even self-evident. As this court found, there is not even that much case authority that is helpful on this issue, because, as Francis Kean notes in his memo about this case, under the common law all company directors are subject to the same duties and are judged by the same standard, so the need for judicial pronouncements in this area has been limited.
At a minimum, as the law firm memo to which I linked above puts it, this case “demonstrates” that “it is not always easy to determine whether a particular individual is acting as an executive director.”
You can certainly see how the carrier might have felt that Jacques was an executive director. After all, materials provided to investors identified him as an executive director. The company’s board minutes identified him as an executive director. He even testified under oath that during the relevant time period he was an executive director. (Jacques testified at trial in the insurance coverage action that his prior answer was wrong and that he had been confused in a stressful environment.)
The Court of Appeal said that these various instances in which Jacques was identified or described –both externally and internally — as an executive director were not only not determinative but were of “limited relevance.” The more important was how he actually functioned and whether he participated in the management or administration of the company.
The larger question this case asks is how can parties to an insurance contract avoid these kinds of disputes. As the law firm memo puts it, “it is in the interests of both insurers and insureds to make sure that the relevant policy wording makes it clear which individuals are entitled to access the additional cover.”
So how can the parties avoid the kind of dispute that arose in this case? The law firm memo suggests that the way to solve the problem is to name the non-executive directors in a schedule to the policy. My experience suggests that this approach would be fraught with potential problems. For one thing, the inclusion of a list of specified individuals does not allow for the possibility that new non-executive directors might be added during the policy period. In addition, individuals might change their status during the policy period. Even worse, names can be omitted by oversight.
Compounding the difficulty of trying to solve this issue through policy language is the fact that, as this case makes clear, the question of whether or not a person was an executive director is highly factual issue. It really depends on how the individual functioned within the company.
It is possible that the policy could specify the criteria that are to be used in determining whether or not an individual was functioning as an executive director. My concern there is that the specific facts at different companies and for different individuals will vary – and will change over time. It might be very difficult to provide specific criteria that accurately encompass any given individual’s function at any given company. And as the specific facts of this case show, an individual’s function in an enterprise may change over time.
While it may be difficult to eliminate these kinds of disputes through policy language alone, there may be things companies can to try to try to help avoid trouble. The first is for companies themselves to understand the differences between the various director roles and to be careful in maintaining the distinction between the roles, particularly in the ways in which directors are identified or described. If this company had been more attentive to the way Jacques was described, perhaps some of the trouble here could have been avoided. As Kean puts it in his blog post, “it is important to ensure that any transition from executive to non-executive function or vice versa is carefully and accurately reflected in the company documentation.”
In the end, it may be very difficult to avoid these kinds of disputes under the particular circumstances of a given individual and company. However, the possibility of avoiding these kinds of disputes begins with the understanding that the distinction between who is and who is not a non-executive director may not be self-evident. An appreciation for this fact will be the starting point for trying to find a solution and it can be hoped avoiding disputes in the future.
Special thanks to Francis Kean for calling my attention to this decision and for providing me with a link to his blog post.