Here’s the scenario: A former company CEO faces criminal charges for alleged bribery in which he was involved while he was at the company. The company’s D&O insurance provides funding for his defense, but the amount of the insurance available proves to be insufficient to take him through trial. The officer then seeks to have his former company indemnify him for his continuing defense expenses. The company refuses, saying that applicable law prohibits the company from indemnifying him for criminal matters until it is known whether or not the criminal proceedings will result in a guilty verdict against him. The former officer files an action against the company seeking a judgment declaring that the company must advance his defense expenses while the criminal action is pending. The trial court rules in his favor and the company appeals.
In an appellate ruling that may not be all that surprising but that nevertheless has some noteworthy implications, on May 20, 2015, the Supreme Court of Victoria (Australia) Court of Appeal held in the case of Note Printing Australia, Ltd. v. John Leckenby (here) that Leckenby had a “present entitlement to be indemnified prior to verdict.”
The court’s ruling is discussed in an interesting June 8, 2015 post on The FCPA Blog (here), written by Alistair Craig, a London commercial barrister. Among other things, the case shows the importance of corporate indemnities and also demonstrates the problems that can arise when the applicable D&O limits are insufficient to needs when they arise, a consideration that has obvious limits selection implications.
John Leckenby was CEO of Note Printing Australia, Ltd. (NPAL) from September 1998 to June 2004. Along with other NPAL officers and NPAL itself, Leckenby has been charged with conspiring to bribe foreign officials to secure bank note printing contracts for NPAL. The trial in the criminal matter is expected to take place in 2015.
Leckenby’s legal costs had been being paid by NPAL’s D&O insurer. However, the D&O insurance policy’s limits of liability will be insufficient to meet all of Leckenby’s legal costs in defending himself through trial. He sought to have NPAL pay his legal costs pursuant to a separate Deed of Indemnity into which Leckenby and NPAL entered in 2001. The company refused to indemnify him on the grounds that is not permitted under the Australian Corporations Act of 2001 to indemnify him until it has been determined whether or not he is found guilty in the criminal proceedings.
Leckenby filed an action in the Supreme Court of Victoria Trial Division seeking a judicial declaration that he is entitled to have NPAL indemnify his continuing legal costs, unless and until he is found guilty, under which circumstances he agreed he would have to refund the amounts that NPAL paid. The trial judge upheld his present entitlement to be indemnified for his ongoing legal costs, holding among other things that the statutory provision on which NPAL relied does not specifically or directly address the question of costs prior to verdict. NPAL appealed.
The appellate court, in an opinion by Judge Pamela Mary Tate, reviewed the provisions of the indemnity agreement as well as the statutory provisions on which NPAL relied. The appellate court found that the conclusion that Leckenby had a present entitlement to have his legal fees paid unless and until his is found guilty to be consistent with the statutory provisions on which NPAL relied. The court found that Leckenby was not required to provide security toward any repayment he might later be required to make.
The issues in this case turned on the particulars of a contract between Leckenby and NPAL and an interpretation of Australian law. It nevertheless presents a set of circumstances that would be familiar to the judicial officers of the Delaware Chancery Court – indeed, perhaps all too familiar, if the comments of the Chancellor in a recent case in the Delaware Court are representative.
As I noted here in a recent blog post discussing the rights of former Massey Energy CEO Donald Blankenship for the advancement of his defense fees in connection with the criminal proceedings pending against him, Chancellor Andre Bouchard began his opinion in the case (in which Bouchard ruled that Blankenship was entitled to have his fees advanced), by saying that the case involves an “all too common scenario” – that is “the termination of mandatory advancement to a former director and officer when trial is approaching and it is needed the most.” In other words, though the setting was different and though the interpretation of a private contract and of Australian law were involved, the case nevertheless involved the all too familiar scenario of a company seeking to avoid or limit its obligations to provide a former officer’s defense expense, at the very moment when it is needed the most.
As Alistair Craig noted in his blog post about the Australian Court’s decision, the “result of the case may not be surprising.” But it nevertheless does underscore some important points.
The first is that the D&O insurance potentially can be critically important when a company’s directors or officers find themselves in legal difficulties. Here, Leckenby and other former officers of NPAL face criminal bribery charges. Even though the case involved criminal proceedings, the D&O insurance responded to the claim. Unfortunately for Leckenby – and presumably for the other officers facing the charges — the amount of D&O insurance will not be sufficient to pay for all of the costs to be incurred in the crisis. The problem of the insurance’s insufficiency may not have been a result of inadequate limits. I suspect that the limits proved insufficient because of the fact that it was a criminal proceeding, and therefore it is likely that each of the individual former officers involved in the case had their own counsel. With multiple counsel defending their clients in an unquestionably serious situation, the policy limits were quickly eroded and will soon be exhausted.
There is a lesson here for anyone considering or advising others with respect to the sufficiency of limits in a D&O insurance program. D&O insurance is what is referred to in the insurance industry as a low frequency, high severity line of business. That is, the claims are not common but when they arise they are serious. The insurance can, as this case arguably demonstrates, serve as a form of catastrophe protection. In assessing whether any given insurance buyer’s insurance program is sufficient to respond in a catastrophe, it is not enough to imagine that serious claims may arise. It must also be considered that when the claim arises, there could be multiple insureds seeking access to the limits of liability. Because the limits are shared, they can be eroded quickly, as this case also demonstrates. This potential for rapid erosion because the limits are shared is an obviously an important lesson to be considered in any limits selection analysis.
It is probably worth noting as well that though the D&O insurance policy here is responding to fund the defenses at least until the policy limits are entirely exhausted, if in the end the criminal proceedings result in guilty verdicts against Lackenby or any of the other criminal defendants, the insurer likely would have the right to seek recoupment of any fees or costs it paid on behalf of any individual against whom a guilty verdict is entered (assuming here that the applicable policy contains language giving the insurer the right to seek recoupment) – just as NPAL will have the right to seek recoupment of any amounts it has paid.
As Alistair Craig noted in his blog post, “While it may be tempting for exposed officers to retain expensive and high powered legal services on the back of such cover, there could be a nasty financial sting in the tail if guilt is eventually conceded or ultimately established.”
For a recent post in which I discussed the insurer’s rights to seek recoupment of amounts paid, please refer here.