TGIF 21 June 2019: Full Federal Court finds D&O insolvency exclusion does not apply, notwithstanding administration of company

This week’s TGIF considers the decision of AIG Australia Limited v Kaboko Mining Limited [2019] FCAFC 96, in which the Full Federal Court found that an insolvency exclusion in a D&O policy did not apply to exclude claims brought against directors and officers of a company under external administration.

What happened?

In July 2012, Kaboko entered into agreements with Noble, pursuant to which Noble would buy from Kaboko manganese ore from mines in Zambia.  Noble was to make advance payments to Kaboko to develop the mines and also for general corporate purposes with the delivery of manganese to Noble treated as a repayment of the advances. 

In 2014 and 2015, Noble alleged that Kaboko defaulted on the agreements and demanded payment of certain sums from Kaboko. A statutory demand was issued, then successfully set aside before the monies became due to be repaid (irrespective of any acceleration caused by a default). 

A further demand for payment was issued by Noble which ultimately led to it appointing receivers to Kaboko. Shortly thereafter, Kaboko appointed administrators and then became subject to a deed of company arrangement. 

In September 2016, Kaboko, by its administrators, commenced proceedings against its former directors and officers.   In the proceedings (which Noble funded), Kaboko alleged the former directors and officers breached their duties to Kaboko and caused it loss.  Amongst other things, it was alleged that the breaches of duty caused the loss of the opportunity to exploit the mining interests in Zambia.  The loss and damage claimed also included the costs incurred by the receivers and the administrators of Kaboko.

After the proceedings were commenced, the former directors and officers of Kaboko made a claim for indemnity under a D&O policy issued by its insurer (Insurer).  The Insurer declined indemnity on the basis of an insolvency exclusion in the policy in the following terms:

The Insurer shall not be liable under any Cover or Extension for any Loss in connection with any Claim arising out of, based upon or attributable to the actual or alleged insolvency of the Company or any actual or alleged liability of the Company to pay any or all of its debts as and when they fall due.

The Insurer was joined to the proceeding.  The issue of the operation of the insolvency exclusion was determined as a preliminary question in the proceeding. At first instance, the Court found the insolvency exclusion did not apply to preclude cover for the claims for indemnity under the D&O policy.  

The Insurer appealed with a focus in their submissions on the contention that the exception applied if there was the requisite insolvency connection. It was argued that there would have been no proceedings if Kaboko had repaid Noble such that they arose out of, were based upon or were attributable to the inability of Kaboko to pay its debts. 

What did the Full Federal Court decide?

The Court considered the key question was whether the subject matter of the claim must have an insolvency link or whether the link is also established where, by reason of the circumstances that have led to the bringing of the claim, it can be said that the claim arises out of, is based upon or is attributable to the actual or alleged insolvency of Kaboko.

The Court found that (subject to one exception) Kaboko’s claims were not founded upon any allegation of insolvency and it did not matter why they came to be brought.  Rather, the claims could be made irrespective of whether Kaboko was under external administration.  Accordingly, the exclusion was not engaged.

The exception was Kaboko’s claim for the costs of the receivers and managers and the administrator.  The Court considered that this was a loss which would not have occurred had Kaboko not been insolvent.  Therefore, the Court held that that aspect of the claim would be excluded from cover.

Comment

The reasons and motivation for commencing proceedings are not relevant when determining the scope of D&O policy insolvency exclusions. What is critical to engage the exception is that the claim itself is founded upon allegations of insolvency (for example, insolvent trading actions or claims for breaches of duty that only arise where a company is insolvent).

The decision is a timely reminder of the importance of closely considering the way in which a claim against a director or officer of an insolvent company is formulated in considering the potential application of any insolvency exclusion.