The Judicial Committee of the Privy Council Decisions

Privy Council Appeal No. 39 of 1996

 

New Zealand Forest Products Limited Appellants

v.

The New Zealand Insurance Company Limited Respondents

 

FROM

 

THE COURT OF APPEAL OF NEW ZEALAND

 

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JUDGMENT OF THE LORDS OF THE JUDICIAL

COMMITTEE OF THE PRIVY COUNCIL,

Delivered the 21st July 1997

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Present at the hearing:-

Lord Goff of Chieveley

Lord Slynn of Hadley

Lord Clyde

Lord Hutton

Justice Henry

  ·[Delivered by Lord Clyde]

 

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1. This appeal concerns the extent of the cover provided by a Company Reimbursement Policy ("the policy").  The policy was effected by the appellants (then named Elders Resources NZFP Limited) with the respondents who are an insurance company.  Clause 1.1 of the policy provides as follows:-

"1.1In consideration of payment of the required premium and subject to the Declarations made a part hereof and the limitations, conditions, provisions and other terms of this policy, the Company agrees to pay on behalf of the Insured Organisation all Loss for which the Insured Organisation grants indemnification to any Officer (as defined in Item 6 of the Declarations) as permitted or required by law, which such Officer has become legally obligated to pay on account of any claim(s) made against him/her, individually or otherwise, during or after the Policy Period for a Wrongful Act:

 

 (A)committed, attempted or allegedly committed or attempted by such Officer before or during the Policy Period and

(B)reported to the Company, in accordance with Section 4, during the Policy Period or, if exercised, the Extended Reporting Period."

 

2. In this clause "the Company" is a reference to the respondents in the present appeal.  From Clause 9.1, which sets out a number of definitions, it is apparent that the expression "Insured Organisation" includes all or any of Elders Resources NZFP Limited and its Associated Companies declared to and accepted by the Company.  It also includes its "Subsidiary Companies" as defined in Clause 9.1.  The expression "Officer" means (subject to certain other provisions set out in the definition) all directors and officers of Elders Resources NZFP Limited who agreed to pay a portion of the premium.  Of more particular importance for the present case however are the following three definitions:-

"Loss means the total amount of Defence Costs which the Insured Organisation is permitted or required to indemnify any Officer for Wrongful Acts with respect to which coverage hereunder applies. Loss does not include fines or penalties imposed by law."

"Defence Costs means that part of Loss consisting of costs, charges and expenses (other than regular or overtime wages, salaries or fees of the directors, officers or employees of the Insured Organisation) incurred in the defence of legal actions (whether criminal or civil), claims, or proceedings and appeals therefrom and the cost of appeal, attachment or similar bonds."

"Wrongful Act means any error, misstatement or misleading statement, act or omission, or neglect or breach of duty made, committed, attempted or allegedly made, committed or attempted by any Officer, individually or otherwise, in the course of his/her duties to the Insured Organisation, or any matter claimed against him/her solely by reason of his/her serving the Insured Organisation ..."

 

3. The appellants have made a claim under this policy.  The occasion which gave rise to this was a litigation which was raised and conducted in California.  The proceedings were brought by a number of plaintiffs conveniently referred to as "Bridgestream".  The substance of the litigation is not of immediate relevance and it is sufficient to record that it was developed by Bridgestream under five Causes of Action all of which arose out of the allegation that some joint venture agreement had been entered into with  Bridgestream  by  a  Mr.  Taylor  on  behalf  of  one of the companies associated with the appellants.  Mr. Taylor was said to be a director of that company and possibly of other companies in the appellants' group.  The defendants in these Causes of Action included various combinations of companies each of whom may be taken to be within the Insured Organisation.  In only one of them, the Third Cause of Action, Mr. Taylor was also joined as a defendant along with a Mr. Sealy, who was not an officer within the meaning of the policy.  In the First and Second Causes of Action the plaintiffs sought damages respectively for alleged breach of contract and breach of fiduciary duty.  In the third they sought damages for alleged fraud by the companies and Mr. Taylor and Mr. Sealy.  In the Fourth Cause of Action they sought damages for alleged interference with contract or business opportunity and in the Fifth Cause of Action they sought certain declarations.  Plainly all of the five Causes of Action were closely related with each other and the factual material relevant to each was to a significant extent common to them all.  At the heart of the whole matter were the statements allegedly made by Mr. Taylor by virtue of which the alleged joint adventure agreement was said to have come about.  The same attorneys acted for and represented all the defendants in all of the proceedings.  On the instructions of the defendant companies the attorneys pursued a vigorous defence.  Eventually the proceedings were settled for US$3.3 million.  But the defence costs were said to amount in total to more than US$8 million.

 

4. A question then arose regarding any liability which the respondents might have under the policy.  With a view to resolving various issues in that connection the respondents raised the present proceedings seeking various declarations.  In the course of these an order was sought and granted for a trial limited to resolving a number of specific questions as agreed by counsel for the parties.  On 5th December 1994 Barker J. delivered a judgment giving his specific answers to the questions.  The first question was whether the present appellants were entitled under the policy to be indemnified by the respondents for any part of the settlement sum.  That question the judge answered in the negative and that answer has been accepted by the appellants.  The other questions related to the indemnification of defence costs and in particular to the problems whether there should be any allocation of such costs between Mr. Taylor and the other defendants, who were not insured, and if so what principles should be applied.  Without detailing his specific answers, some of which in any event referred to the terms of the judgment which he delivered, it is sufficient to say that the judge considered that the loss and defence costs to which the policy referred were limited to such parts  of  the  costs  as  had been incurred solely in the defence

 

pleaded in the Third Cause of Action and that an allocation fell to be made in a broad way following the principles in two American cases, namely Perini Corporation v. National Union Fire Insurance Co. of Pittsburgh, Pennsylvania (No. Civ. 86-3522-S. D.Mass, June 2nd 1988) and Safeway Stores Inc. v. National Union Fire Insurance Co. of Pittsburgh, P.A. (No. C-88-3440-DLJ, 1993 U.S.Dist.).  The appellants appealed to the Court of Appeal [1996] 2 N.Z.L.R. 20 but while the judges there formally allowed the appeal the conclusions which they reached were not materially different from those reached by Barker J.  They took the view at page 44 that they "should decline to answer the specific questions posed in the absence of the necessary factual assessment".  They did however set out the principles which they considered were applicable to the present case and it is because the appellants challenge that guidance that the present appeal has been brought.

 

5. It should at this stage be noted that there are various other issues still outstanding.  Quite apart from the matters considered in these preliminary proceedings the respondents have further grounds on which they may seek to deny liability under the policy.  Furthermore one area of fact which is highly relevant to the present debate remains unresolved, namely the extent to which Mr. Taylor is in fact "legally obligated to pay" the attorneys in respect of the defence costs.  It is understood that the appellants, as part of the Insured Organisation, have granted indemnification to Mr. Taylor in respect of defence costs incurred by him to the defence attorneys in the Californian litigation.  It has not been suggested that he has no liability to them but the nature and extent of his liability is not explained.

 

6. It is not disputed that any costs incurred solely and exclusively in relation to the defence of the claims against Mr. Taylor would fall within the scope of the policy.  It is also not disputed that costs which do not relate in any way to his defence, such as costs which relate wholly and exclusively to the defence of another defendant, would not be covered by the policy.  The dispute concerns those costs which relate both to his defence and to the defence of some other defendant or defendants.  The view expressed by Gault J. at page 43 in delivering the judgment of the Court of Appeal, which the respondent accepts, was that "to the extent that the costs incurred in resisting the liability of NZFP and other defendants may be said to be reasonably related to Mr. Taylor's liability, we see no reason why Mr. Taylor should be legally obliged to pay more than an appropriate share".  What would be an appropriate share would be a matter for assessment on the facts by reference to such factors as relative exposure, relative benefit and even the relative significance, or insignificance, of the claim.  Gault J. also stated at page 43 that the factors which had  been  approved  in  the Perini case and in the Safeway case at District Court level should be employed.  On the other hand the appellants argue that the policy covers all the costs which are reasonably related to the claims against Mr. Taylor, that is to say that all the costs incurred in the defence should be included in the cover, except for such of them as are not related to him at all.  The appellants submit that the costs reasonably related to Mr. Taylor's claim may thus include costs incurred for the use or benefit of other uncovered defendants.

 

7. Much of the discussion in the lower courts has been taken up with consideration of case-law, particularly from courts in the United States of America.  But their Lordships are clearly of the view that the true question here is one of construction of the terms of the policy.  The important words are "all Loss ... which such Officer has become legally obligated to pay on account of any claim made against him ... for a Wrongful Act".  As has already been explained the answer cannot be found at least at present through a consideration of the extent of the legal obligation. Resolution of that issue might resolve the present debate and without the explanation the debate may be thought to be somewhat artificial. But the courts below have proceeded on this basis and it is obviously desirable to give guidance on the matters which have been raised for determination. In the opening part of her submissions to the Board counsel for the respondents indeed presented her argument on the basis that the contract between Mr. Taylor and the attorneys did not determine the question and it is certainly possible to treat the clause as providing at least two requirements for liability to arise under the policy, namely, first that the costs in question were costs which the officer was legally obligated to pay, and second, that the costs were costs incurred on account of a claim made against the officer for a wrongful act.  On this approach the present debate can be seen as concerned only with the latter question, although it might be thought that the first question comes logically before it.

 

8. So the issue in the present appeal comes to be one of construction of the policy without regard to the extent of Mr. Taylor's actual legal obligation. At this stage the respondents can only point to the phrase "on account of any claim made against him" and argue that that somehow limits the extent of the costs intended to be covered.  But the words by themselves fall far short of expressing the substance of what the respondents seek to establish and it seems to their Lordships that the respondents could only succeed in showing that an allocation of common costs was to be made by reading in to the clause words which could have been but are not there. On the other hand there are strong arguments to support the appellants' contention that no allocation  is  intended.  On the ordinary meaning of the words which have been used it is reasonable to understand that the cover would extend to the whole costs incurred in the defence where the officer was the sole defendant.  Why then should the meaning of the words change simply because there is another defendant who is not covered by the policy?  Moreover if an uninsured co-defendant was bankrupt or otherwise without means it would seem an odd result of the insurance that it should not cover the whole of the officer's costs even although some of them related also to the defence of the co-defendant.  Once it is accepted that the costs are not confined to those which relate solely and exclusively to the officer it is hard to find anything in the language which prevents the cover extending to all the costs which also relate to another defendant.  On the contrary the language points to the conclusion that all such costs are covered.  The clause expressly refers to "all" loss.  And "loss" means "the total amount of Defence Costs".  In contrast to such general terms there is no provision generally requiring the kind of allocation to be made for which the respondents contend.  It cannot be assumed that the insurers would not have anticipated the likelihood of the company being joined as a defendant along with one of its officers and if provision of the kind contended for was intended that could readily have been included.  What is significant here is that in clause 8.2 express provision is made for restriction of the loss to be covered in the event of there being a duplication of insurance cover.  The obvious inference is that where, as here, the other defendants are not covered by insurance there is to be no restriction in the extent of the loss covered by the policy provided that it reasonably relates to the claim against the officer in terms of clause 1.1.  The insurers are not left without any protection in all of this because by clause 6.1 they are not to be liable with respect to settlements or defence costs to which they have not consented.

 

9. As matter of the proper construction of the contract of insurance their Lordships are persuaded that the conclusion for which the appellants have contended is correct.  Some further support for that conclusion can be obtained from a study of the various cases which have been found in the American jurisprudence.  As counsel for the appellants submitted there is particular justification in looking at this source of material since some at least of the cases concern policies with similar wording to the present one and the problem raised in the present case has been argued in the American courts.  On the other hand it is necessary to recognise the possibility that differences may exist between the various state and federal systems of law in the United States and to give due weight to the status of a particular court and the extent to which the particular problem has been analysed and explored.  Moreover in the particular context of the present case   it  is  desirable  to  recognise  a  distinction  between  the application of policies to settlement sums following on a litigation and their application to defence costs.  Their Lordships are not persuaded that the guidance given in relation to the one class of case is necessarily applicable to the other.  Furthermore there seems to their Lordships to be a possible danger in concentrating on the case-law in that the problem might seem to be one of applying principles of general application rather than construing the language of the particular policy.  In that connection phrases such as "the larger settlement rule" or "the reasonably related rule" require to be used with care.  The point was clearly noticed in Caterpillar Inc. v. Great American Insurance Co. (62 F.3d 955 (7th Cir.1995 at page 961) where Circuit Judge Flaum observed:-

"In selecting one rule over the other, our role is to interpret the insurance contract between Caterpillar and Great American based on the applicable contract law, in this case that of Illinois.  We do not sit to develop general canons of allocation for every conflict between D. & O. insurers and their insureds; rather we read a particular insurance contract and decide what method of allocation, if any, that contract envisions."

 

10. Subject to these qualifications it is undoubtedly of value and interest to have regard to this body of jurisprudence.

 

11. Their Lordships do not propose to set out any detailed review of the cases to which they were referred.  Counsel for the appellants presented a very helpful summary and analysis of the American cases and this immediately discloses that they provide a strong body of support for the appellants' construction of the policy.  The so-called reasonably related rule can be regarded as a convenient shorthand way of indicating that all costs related to the officer are to be covered by the policy whether or not they are costs which also relate to another defendant whose costs are not covered, even though that other defendant may thereby be benefited.  Application of the rule can be traced in a succession of cases from Continental Casualty Company v. Board of Education of Charles County (489 A.2d 536 (Md. 1985)), through such cases as Nodaway Valley Bank v. Continental Casualty Co. (in the District Court, 715 F.Supp.1458 (W.D.Mo.1989) and upheld in the Court of Appeals 916 F.2d 1362, (8th Circuit 1990)) and Raychem Corporation v. Federal Insurance Co. (853 F. Supp.1170, N.D. Cal. 1994) to First National Bank of Iron Mountain v. American Casualty Co. of Reading, Pennsylvania (No. 2:94-CV-306 (W.D.Mich. Nov. 21 1995)).  Such comments as counsel for the respondents was able to make about the cases did not affect the strength of the support which they give to the appellants' contentions.  It is unnecessary to consider the cases to which  reference  was  made  where what is referred to as the larger settlement principle has been followed in relation to the treatment of sums paid in settlement.  It is sufficient to notice that at least by analogy some further assistance can be found there to support the appellants' case.  The whole matter was put concisely by Judge Rodowsky in the Continental Casualty case (at page 545):-

"Having purchased this form of litigation insurance, the Board is entitled to the full benefit of its bargain.  So long as an item of service or expense is reasonably related to defense of a covered claim, it may be apportioned wholly to the covered claim."

 

12. The American cases feature prominently in the approach taken in the courts below in the present proceedings.  Two require particular notice.  Perini Corporation v. National Union Fire Insurance Co. of Pittsburgh, Pennsylvania was one of the two cases particularly founded on by Barker J.  But on a close consideration of that decision, while the judge quotes the factors which had been identified by Ishel in a published study of D. & O. policies, it is not obvious that he in fact adopted them.  The initial proceedings in that case had been a single claim brought against Perini Corporation and two of its officers, Simms and Neal.  Perini retained one firm of attorneys (Slawson & Burman) to represent Neal and another firm (Gunster Yoakley) to represent Simms and the corporation.  Under what was referred to as a typical director and officer liability insurance contract the insurance company agreed that the whole of Slawson & Burman's account was covered by the policy but they argued that one half of the fees due to Gunster Yoakley should be allocated to the corporation and so would fall outside the cover provided by the policy.  The judge decided that the major part of that firm's fees should be allocated to the defence of Simms.  This appears to have been based on the fact that the action was focused primarily on the wrongdoing of Simms.  Counsel for the appellants before this Board not unreasonably argued that at least in the result an allocation on a basis of reasonable relationship was achieved.  Certainly it does not seem that the court in Perini approved the list of suggested factors nor adopted an approach which involved a general examination of the circumstances and the application of a series of factors such as those suggested.  The reliance which was placed on this case in the courts below as assisting the respondents' contentions is open to question.

 

13. The other decision on which Barker J. particularly relied was that of the District Court in Safeway Stores Inc. v. National Union Fire Insurance Co. of Pittsburgh, P.A.  The decision which was referred to in that case concerned the reconsideration and the clarification of a discovery order.  The discovery was on the issue of the allocation of fees between covered and uncovered parties.  At  that  stage  it  seems that both sides were agreed that the proper method of allocation was to determine the relative exposure of the covered persons as distinct from the uninsured defendants.  The judge quoted a list of factors which had been formulated in a work by Knepper and Bailey for the allocation of a settlement sum among the beneficiaries of the settlement.  He then identified certain of them on which further information was required and made an order for discovery.  It appears that eventually in the District Court an allocation of the settlement and defence costs was made whereby a three-quarter portion was allocated to the covered directors and officers and one quarter was allocated to Safeway and another defendant (KKR).  But while the evident adoption of the list of factors gave Barker J. some support for his view, the decision was overturned on appeal by the Court of Appeals (reported 64 F. 3d 1282) (9th Cir. Aug. 23 1995).  That court agreed with Safeway's submission that any allocation was improper.  In relation in particular to the matter of defence costs the Court recognised the applicability of the "reasonably related test" and stated (page 1289) "Defense costs are thus covered by a D. & O. policy if they are reasonably related to the defense of the insured directors and officers, even though they may also have been useful in defense of the uninsured corporation".  Safeway had excluded from its claim fees attributable to the defence of KKR and its whole claim was admitted as reasonably related to the defence of its officers.

 

14. The decision in the Court of Appeals in the Safeway case was evidently made after the argument was heard in the present case but before the decision in the present case was given.  Unfortunately while the judges in the present case were aware that the decision in Safeway had been reversed and refer to it in their review of the American cases they did not have the assistance of argument upon the significance of the reversal in its affirmation of the reasonably related test.  Moreover it is not altogether evident why the Court of Appeal preferred to adopt an approach based on the factual circumstances rather than one of the construction of the policy under the guidance of what they recognised was a strong body of authority supportive of the appellants' case.  The approach which the Court of Appeal advocated was one which would avoid the giving of effective cover to non-covered parties or claims.  But the intentions of the parties to the policy have to be ascertained from its terms; and as their Lordships have already indicated on a proper construction of the policy the intention must have been that a non-covered party might well derive benefit from expenditure falling within the cover where that expenditure was related to the defence of an officer covered by the policy.

 

15. The Court of Appeal considered at page 43 that the factors identified  by  Ichel  and  by Knepper and Bailey were appropriate, and while recognising that the latter list was intended for allocation of settlement payments nevertheless considered that it could be "adapted to a costs allocation".  But, as counsel for the appellants pointed out, the costs which the officer is legally obliged to pay on account of the claim against him cannot be measured by factors designed to assess relative exposure to liability in the litigation.  The factors may however be helpful and relevant in problems of assessing an allocation of settlement sums.  Moreover if the problem was one of finding a fair allocation of a total bill of costs as between various defendants then a variety of factors including some or all of those suggested might reasonably be brought into the exercise.  A number of decisions from courts in the United Kingdom were referred to in the judgment of the Court of Appeal in that connection.  But that is not the problem in the present case.  This case is concerned with the proper construction of the policy of insurance.  In the view of their Lordships the judges in the Court of Appeal erred in the approach which they adopted and in the guidance which they sought to give.

 

16. Counsel for the appellants suggested that if their Lordships' Board was prepared to allow the appeal the original questions put before Barker J. should be resurrected and answered by the Board.  But their Lordships consider it preferable to express their views on a general basis rather than endeavour to relate them specifically to any of the original questions.  Two propositions are not disputed: that any item of cost which is wholly and exclusively related to Mr. Taylor's defence falls within the scope of the policy, and that any item of cost which is in no way related to the defence of the claim against him is not covered by the policy.  So far as any defence costs are concerned which reasonably relate to the defence of the claim against Mr. Taylor but do not exclusively do so, they are covered by the policy even although they also relate to the defence of some other party who is not insured.  That this may be of use and benefit to a party who is not insured does not exclude the costs from cover because they are still costs which are reasonably related to the defence of the covered claim.  On the other hand costs which have been incurred for the defence which are not reasonably related to the defence of the claim against Mr. Taylor are not covered by the policy and require to be excluded.  The question whether costs are or are not reasonably related to Mr. Taylor's defence is essentially one of fact but there is no clear reason to anticipate that the costs which relate wholly or partly to Mr. Taylor's defence will be as relatively insignificant as the judges in the courts below may have envisaged on the approach which they sought to follow.  Their Lordships do not consider it to be useful to spell out in any detail what kinds of costs might or might not be found to be reasonably related to the defence of the covered  claim.   Correspondingly it would not be useful to attempt any more detailed description of costs which would not be covered by the policy because they do not reasonably relate to the claim against Mr. Taylor.  It may be found that in a case such as the present the most practical way of proceeding may be to go through the bill of costs with a view to excluding all items which do not reasonably relate to the claim against Mr. Taylor; but that is a matter for the fact-finder and not for this Board.  Nor is it to be forgotten that the further question of the extent to which Mr. Taylor is "legally obligated" to pay the costs has still to be explored.  Their Lordships should also record that no issue was explored in the present appeal regarding any possibility of contribution or of subrogation operating in relation to the policy in respect of all or any of Mr. Taylor's co-defendants and their Lordships refrain from expressing any views about such matters.  With that general guidance their Lordships will humbly advise Her Majesty that the appeal should be allowed and the matter remitted afresh for trial on the facts or such other disposition as may be agreed.

 

17. Their Lordships consider that the order as to costs in the High Court should be allowed to stand, but that the respondents should pay the appellants' costs both before the Court of Appeal and before their Lordships' Board.

 

© CROWN COPYRIGHT as at the date of judgment.