On 23 December 2013, the Supreme Court delivered a controversial decision on the operation of s 9 of the Law Reform Act 1936 on costs-inclusive liability policies, which is likely to have ongoing adverse consequences for insurers and their insureds.
Section 9(1) of the Law Reform Act 1936 provides:
If any person (hereinafter in this Part referred to as the insured) has… entered into a contract of insurance by which he is indemnified against liability to pay any damages or compensation, the amount of his liability shall, on the happening of the event giving rise to the claim for damages or compensation, and notwithstanding that the amount of such liability may not then have been determined, be a charge on all insurance moneys that are or may become payable in respect of that liability.
The receivers of the Bridgecorp group of companies and representative shareholders of Feltex Carpets Ltd (in receivership) brought claims against the directors and former directors of those companies. The directors sought cover for their defence costs under certain insurance policies, which provided both an indemnity for the directors’ liability for third party claims and cover for their defence costs. Under the terms of the policies, defence costs were payable as they fell due, but third party claims became payable only when liability was established, by a judgment or by settlement. The policies were “costs-inclusive”: payment of any defence costs reduced the total amount available for payment under the indemnity.
The receivers and shareholders argued that the charge created by s 9(1) secured the maximum cover available under the policy for the indemnity from the date of the act or event giving rise to their claim. The maximum sum secured by the charge could not, they claimed, be depleted by the payment of defence costs in the interval between the creation of the charge and the date of judgment or settlement.
The contrary argument, supported by a minority of two judges in the Supreme Court, was that the charge under s 9(1) attached to the contractual right to an indemnity under the policy. The scope of that right (including the amount which must be paid) depended on the factual circumstances at the time the insurer was required to make payment under the indemnity. If the insurer had already paid out defence costs in accordance with its obligations under the policy, then the maximum amount payable under the indemnity was reduced in accordance with the policy terms.
Notwithstanding the force of this argument, the majority held that the charge attaches to the maximum amount of cover that could ever be paid under the policy. As a result, the insurer is “at peril” if it complies with its contractual obligation to pay defence costs in circumstances where there is insufficient insurance cover to meet both insurance obligations (namely the obligation to indemnify and the obligation to pay costs).
Unhelpfully, the majority did not address whether an insurer is entitled to refuse to pay defence costs in those circumstances. Faced with a costs-inclusive policy and a claim that may exceed the policy limit, insurers have the unappealing options of breaching the contract with their insured, extending their risk above the maximum policy limit and/or litigation to establish whether or not their contractual obligation can be avoided.
Section 9 has general application to liability insurance policies. While the industry response to the High Court judgment in Steigrad has seen a move away from costs-inclusive policies, litigation has a very long tail. The judgment may have an ongoing impact on existing litigation claims, claims for which precautionary notifications have been made under costs-inclusive policies and project-specific policies under which claims have yet to surface. Insurers and insureds will need to review the status of notifications made under such policies, and consider their options for addressing liability for costs if and when a claim eventuates.