March 2014
Insurers pay defence costs at own risk
New Zealand Supreme Court judges, like everyone else in New Zealand, want to clear their desks before the Christmas vacation arrives.
So it was that the Supreme Court’s landmark Steigrad decision was released on December 23, a time when most lawyers are thinking of rest and relaxation, rather than ground-breaking court cases.
The history
Mr Steigrad was a director of Bridgecorp which collapsed in 2007 owing investors about $NZ500 million. Bridgecorp held a D&O policy which insured the company’s directors against liability and defence costs. The aggregate limit of indemnity for defence costs and liability was $NZ20 million.
Bridgecorp’s receivers made a claim against the directors for about $NZ340 million and asserted a charge under s9(1) of the New Zealand Law Reform Act 1936 over the $NZ20 million insurance policy proceeds. The D&O insurer refused to pay the directors’ defence costs as the entire $NZ20 million policy limit was potentially within the scope of the s9(1) charge.
The New Zealand High Court found there was a charge in favour of the receivers and this charge prevented payment of the directors’ defence costs, but the Court of Appeal subsequently reversed the High Court’s controversial decision. The Court of Appeal upheld the right of the directors in the Bridgecorp litigation to payment of defence costs, notwithstanding the plaintiffs’ assertion of a charge over the entire proceeds of the D&O policy. But the Supreme Court has surprisingly now reversed the Court of Appeal’s decision.
The decision
The directors argued ‘the insurance money that is or may become payable in respect of that liability’ (as referred to in s9) can only be ascertained once judgement in a claimant’s favour is given or the claim settles. Before that point no charge attaches and therefore the directors are able to resort to the policy to pay defence costs.
The Supreme Court rejected that argument. Somewhat surprisingly it did so without any substantial discussion of the policy of insurance or analysis of the contractual obligation to indemnify provided for in the contract. That is in contrast to the minority, which was concerned it would be a major interference with the contractual rights of the insurer and the insureds if s9(1) was interpreted in a way that prevented payment of defence costs. The insured has a contractual right under the policy to payment of defence costs as they are incurred and the minority considered there was no indication Parliament intended to interfere with those contractual rights.
The directors argued that upholding the charge would inhibit the directors’ access to justice as there would be no funds to pay for the defence of the claim. The majority rejected that argument saying:
“An insured would only be deprived of the ability to mount a defence if he or she had no other funds available for a defence and where no lawyer would act on a contingency basis. Further, an insurer may well have an incentive to fund a good defence out of its own funds as that would reduce the insurer’s exposure under the policy.”
The first two ‘solutions’ offered by the court to the problem, namely that directors fund their own defence or lawyers work on a contingency, are wholly unrealistic. The third option is likely to be the only feasible one.
If directors do not defend, a claimant will have an easy route to judgement and then, following judgement, an absolute right to payment under the policy. Any defence that might have been available to the insurer either on liability or quantum will be lost. As noted by the Supreme Court, that may provide the incentive for an insurer to pay for the defence not from the policy but ‘out of its own funds’.
As a result of the Supreme Court decision it is clear liability policies with a costs-inclusive sum insured do not enable an insurer to protect its own position and those of its insureds in the event of a claim. As the majority phrased it, “the insurer and insured have made a poor bargain because the policy has not been properly drawn, overlooking the effect of the statutory charge”.
Oddly, the majority seems to have thought it left open ‘whether an insurer would be entitled to refuse to pay defence costs where there was a risk the policy limit may be exceeded’. That issue was at the heart of the litigation before the court, given the size of the claims asserted compared with the policy limit. The implication for directors in upholding the charge is self-evident.
Now more than ever insurers need to carefully consider and analyse the strength of a plaintiff’s case, the defences available to the insured and the likely cost of a properly funded defence to make well-reasoned claims management decisions. Probably at their own cost in large litigation.
New Zealand/Australia dichotomy
The legislation in New Zealand and many states of Australia is virtually the same but, because of the New Zealand Supreme Court decision, there is now a difference between the law in New Zealand and Australia on the issue. The NSW Court of Appeal in Chubb Insurance Co of Australasia Ltd v Moore adopted a similar view to the minority of the Supreme Court, ie the statutory charge was not intended to interfere with the contractual right to a fully funded defence. Given most insurers in New Zealand are either owned or managed by Australian insurers, any difference between New Zealand and Australian insurance law is regrettable, to say the least.
