Boardroom Briefing May 2019

Boardroom Briefing
Directors and Insolvency Exclusions – reaffirming the commercial purpose of your cover.

Just because an insured company is insolvent at the time of a claim does not mean that the insolvency exclusion will necessarily apply to exclude D&O cover. This recent Federal Court case gives directors reassurance and guidance.

The Insurer relied on the Insolvency Exclusion to deny cover to Company Directors who were facing claims for alleged breaches of directors’ and officers’ duties under the Corporations Act. The Company had entered into a mining project prepayment agreement to supply manganese ore. A default on the agreement resulted in the appointment of Administrators who identified the possible breaches. The Insurer argued that those alleged breaches also resulted in the insolvency of the Company so the Insolvency Exclusion applied. This meant the Directors had no cover for legal fees in defending the proceedings or for any judgment against them. 

On the face of it, it didn’t look good for the directors. The Insolvency Exclusion was broadly worded, excluding liability for any Claim “arising out of, based upon or attributable to the actual or alleged insolvency of the Company or any actual or alleged inability of the Company to pay any or all of its debts as and when they fall due.” The Directors argued that claims for breaches of duties are exactly the type of risk intended to be covered by a D&O Policy and the real measure of the Company’s loss was the missed opportunity to develop the mining project. 

The Federal Court had a lot of important things to say about exclusion clauses generally and in particular about the Insolvency Exclusion. The loss, said the Court, did not arise out of the Company’s insolvency but rather the Company’s lost opportunity to exploit a valuable commercial opportunity. This was reinforced by looking at the commercial purpose of the Policy because in the absence of such cover individuals would be unwilling to act as directors. 

The claims against the Directors are “the exact class of risk the Policy is intended to insure against” and to accept the Insurer’s argument “would result in the Insolvency Exclusion operating to exclude from cover under the Policy claims against directors of any nature whatsoever if the relevant conduct of the directors giving rise to the claim also played some part in the eventual or alleged insolvency of the company.” The Exclusion, determined the Court, did not operate to prevent the Directors from cover under the D&O Policy. 

In brief: this pragmatic Federal Court decision reassures directors and officers that the efficacy of D&O cover has an important commercial purpose.  Insolvency exclusions will not necessarily exclude cover if a company goes into administration or liquidation; there must be a sufficient nexus between the claims against the directors or officers and the insolvency of the company before the exclusion is activated.

It always pays to interrogate the apparently routine application of an exclusion by an insurer and your Lockton broker is experienced in challenging any denial of cover.  

Kaboko Mining Ltd v Van Heerden (No.3) [2018] FCA 2055

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