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How does a right to indemnity under a D&O Insurance policy operate when a bankrupt insured has been discharged?

The Federal Court of Australia recently considered the application of an insurance policy in indemnifying a bankrupt director and his estate in respect to their liability to a Company and its Liquidator.

Background

In Taylor (liquidator), in the matter of Heading Contractors (in liq) v Heading [2021] FCA 770, a Mr Heading was the sole director of Heading Contractors Pty Ltd which went into voluntary liquidation in 2014. The following year Mr Heading became bankrupt.

After the Bankrupt’s automatic discharge and shortly before the relevant time limit expired the Liquidator and Company issued proceedings pursuant to s 588M of the Corporations Act 2001 alleging insolvent trading on the part of the Bankrupt. The Court granted leave to continue the proceeding pursuant to s58(3) of the Bankruptcy Act 1966 in its earlier judgment of Taylor (liquidator) v Trustee, bankrupt estate of Heading, in the matter of Heading [2020] FCA 1450.

The insolvent trading proceedings named the Bankrupt, his trustee in bankruptcy and an insurer which had issued a Directors & Officers Insurance policy as Defendants. By the time of the judgment the Trustee had assigned his statutory right of indemnity pursuant to s117 of the Bankruptcy Act 1966 under the policy to the Plaintiffs.

In the proceedings the Plaintiffs, in addition to a judgment against the Trustee, also sought declarations that:

  • Mr Heading incurred, prior to the date of his discharge from bankruptcy, a liability pursuant to section 588M(2) of the Act to the Company and Liquidator in the sum of $4,105,953.07; and
  • Alternatively, that the Policy should apply to the estate of Mr Heading in respect of such liability pursuant to extension 2(g), being a liability for which Mr Heading would have received cover under the Policy other than in the event of his bankruptcy.

The Decision

The issue at hand was whether the Insurer had an obligation to indemnify the Trustee. The case turned upon construing a clause within Policy. Extension 2(g) provided that:

“the policy shall apply in the event of the death or incompetency or bankruptcy of a Director or Officer to their estate, heirs, legal representatives or assigns, for Loss incurred due to any wrongful act of such director or officer for which he would have received cover under this policy.”

Charlesworth J found that the trustee, under Extension 2(g) of the Policy, may enforce the contract of insurance for the benefit of the estate whilst standing in the shoes of Mr Heading. Following from the words of the clause, Mr Heading’s bankrupt estate was entitled to enjoy the same protection in response to the claim that Mr Heading would have had he not been bankrupt.

Her Honour also found there was no need to rely on s 117 of the Bankruptcy Act because the policy wording was sufficient in conferring a right of recovery from the insurer.

A Warning for Insurers

This decision demonstrates the extent of a trustee’s rights under a contract of insurance of a director in relation to his or her liability to an external claimant. The clause in this case operated in a way that not only protected the director but also his bankrupt estate. For insurance companies, the case serves as a caution to carefully consider policy extensions and understand the consequences of enabling an estate to receive the benefit of the insurance in the event that the primary insured had been discharged from his or her debts as a result of bankruptcy.

Cowell Clarke’s Insolvency & Turnaround team can help distressed businesses to prevent or manage insolvency and bankruptcy. Please contact us if you would like to discuss any matters in this regard.

This publication has been prepared for general guidance on matters of interest only and does not constitute professional legal advice. You should not act upon the information contained in this publication without obtaining specific professional legal advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication and to the extent permitted by law, Cowell Clarke does not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting or refraining to act in relation on the information contained in this publication or for any decision based on it.

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