By: Jeremy Johnson
Published: 14/01/2013
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On 20 December 2012, the Court of Appeal released its decision in Steigrad v BFSL 2007 Ltd [2012] NZCA 604.  The decision impacts negatively upon attempts by liquidators and receivers of, and investors in, failed finance companies to recover losses by pursuing directors of those companies for breaches of their directors' duties and also for breaches of the Securities Act 1978.

The decision dealt with two separate cases.  The first was an appeal from the judgment of Lang J in the High Court in Steigrad v BFSL 2007 Ltd (High Court, Auckland, CIV-2011-404-611, 15 September 2011) which involved a claim by the liquidators of Bridgecorp and associated entities against its directors; the second was an application brought by the former directors of Feltex Carpets Ltd in the class action suit brought against them by investors.  Both cases dealt with the same issue, namely the application of section 9(1) of the Law Reform Act 1936 to directors and officers liability policies.

Section 9(1) of the Law Reform Act 1936 creates a "charge in favour of [a] third party over any insurance money "that is or may become payable" in respect of the insured's liability to the third party" (paragraph [15] of the Court of Appeal judgment).  In simpler terms, it means where third parties suffer loss caused by an insured, and the insured has insurance to cover the loss suffered by the third party, then the third party has a 'charge' over the insurance moneys paid.  The obvious example is where person A has third party car insurance and causes an accident that damages B's car.  In that case, B has a charge over the money paid out under the third party policy; that means B has a claim to those proceeds ahead of any of A's other creditors.

The question confronting the Court in the two cases dealt with in Steigrad was how section 9(1) works where directors have a policy that covers both the liability of directors to third parties for losses caused by breach of their directors' duties and by breach of the Securities Act 1978 and associated defence costs, up to a specified limit.  In both cases there was a single cap on the directors and officers policies held by the directors; the effect of that was that any defence costs taken by the directors in defending the claims against them would reduce the amounts available from the insurance to payout for any losses suffered by the investors. 

In the High Court in Steigrad Lang J had held that the effect of section 9(1) was that a charge was created over the whole of the amount available under the policy.  The effect of that decision was to prevent the directors from using the insurance policy to access money to meet their defence costs.  The directors, not surprisingly, appealed that decision while, following it, the directors of Feltex Carpets Ltd made an application to the High Court on the issue and then successfully applied to have the application removed to the Court of Appeal.

The Court of Appeal over-turned the decision of the High Court and held that section 9(1) did not create a charge over the whole amount available under the policy.  The effect of the decision is to reduce the amount that might be available under the policy to meet the claims of investors and receivers as it allows the directors to use the policy to fund their defence of claims made against them. That has obvious negative implications for cases such as these where receivers and liquidators of companies, and investors, attempt to recover losses from directors that hold insurance; it gives scope to directors to conduct vigorous (and expensive) defences to these claims as a result of which insurance funds available will reduce.

However, the decision of the Court of Appeal is the right one.  The Court reached its decision in a relatively straightforward manner, and primarily relied on "two interrelated grounds:

(a)  s9 does not by its terms apply to insurance monies payable in respect of defence costs, even where such cover is combined with third party liability cover and made subject to a single limit of liability; and

(b) s9 has limited effect and is not intended to rewrite or interfere with contractual rights as to cover and reimbursement." (paragraph [19] of the judgment)

On the first ground, the Court of Appeal correctly held that section 9(1) only applies to moneys payable under an insurance policy "in respect of" liability to pay "any damages or compensation" to the third party.  However, the defence costs component of the insurance policies is not money payable "in respect of" liability pay "any damages or compensation" to the third party; it is money payable in respect of costs incurred in resisting liability.  That is a straightforward matter of statutory and contractual interpretation; the contract has one monetary limit that covers two aspects of cover and the "charge attaches to the balance that is available to meet third party claims after any defence costs liability has been met."  (paragraph [27] of the judgment).  Such an approach must be correct; that it is so is shown by the neat counter-factual posed by the Court which is that section 9(1) would not operate against a separate policy to cover defence costs (paragraph [27] of the judgment).

On the second ground, the Court of Appeal held that section 9(1) cannot operate so as "to interfere with or suspend the performance of mutual contractual rights and obligations relating to another liability" (paragraph [36] of the judgment).  Again, that approach must be correct; the arrangement entered into by the parties to the insurance contract provides for two different types of liabilities to be covered under one limit.  Following the decision of the High Court would have been to effectively exclude cover for one of those types of liabilities; that is not a result that would ever have been intended by the contracting parties.  That is also consistent with the fact that section 9(1) operates subject to the rights of contracting parties, such as that of the insurer to avoid the contract for material non-disclosure (paragraph [41] of the judgment).  It simply does not operate to elevate the rights of third parties over and above what is contractually allowed for.

The comparatively short analysis of the Court of Appeal highlights the attractive nature of its reasoning; even if the outcome is not so attractive to those that have lost money by investing in companies like Bridgecorp and Feltex Carpets Ltd.  The result of the case is to create an incentive on the part of those bringing these claims to settle them at an early stage so as to ensure an economic return on the case and avoid a pyrrhic victory at trial.  

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