Directors

1
Directors Officers Insurance - An update on
Market ConditionsPresentation to FEI Australia

• 29 October, 2004

Ray Armstrong
2
Report on DO Insurance

• The Corporations and Market Advisory Committee
  released a report on Directors Officers
  Insurance on 22 July 2003.
• According to the report
• the period 2000 - 2004 has seen a general
  tightening of the market.
• The number of insurers and the capacity of the
  market have declined.
• Insurers have placed greater limitations on the
  coverage of policies offered

3
Report on DO Insurance (Cont)

• premiums have increased markedly but the rate of
  increase may be levelling out.
• in deciding whether to provide cover in a
  particular case and on what terms insurers are
  influenced by general market factors (global as
  well as Australian) the nature of the insureds
  business, financial condition and claims history.
• while most listed companies take out some form of
  DO cover, there is an indication that some
  companies may have reduced their cover to contain
  the increasing costs of DO insurance.

4
Lloyds Annual Report 2003

• Combined ratios 2003
• Overall 90.7
• Casualty 110.4
• DO has had the greatest effect on results with
  claims arising from major corporate collapses
  such as Enron and Worldcom.
• Accusations at Directors that they improperly
  represented the financial health of their
  companies.

5
The DO Market - The Marsh Experience

• While the DO environment remains somewhat
  fragile we are happy to report some positive
  developments which we expect to continue with
• Insurers releasing premium quotations in a
  reasonable time frame
• more favourable pricing including rate
  stabilization and decreases
• a willingness to accommodate coverage requests
  and concerns
• insurers working with insureds to facilitate the
  resolving and payment of claims.

6
Market Outlook3-5 Years
7
Market Outlook

• The hard international market may come to an end
  by the end of 2004. However, how soon and to
  what extent the market will soften overall
  depends on
• uncertainty over the economic impact of the war
  with Iraq and the continuing threat of terrorist
  attacks
• global and regional investment market
  performance
• continuing capital injection into the market
• frequency and severity of natural and man-made
  catastrophes.
• The market in general should plateau in 2004.
  However, it will not come down quickly, and we
  doubt will go back to the rating level before
  2001 in the next 5 years.

8
Mega Settlements
1999 Cendant 3.5B Waste Mgmt. I
220M Informix 142M Medpartners 56M Mercury
Finance 56.4M
2004 Citigroup 2.65B Raytheon 410M Janus
Capital 225M Global Crossings 325M Mass
Mutual 250M
2002 Dollar General 163M Conseco 120M Bank
of America 490M Legato Systems 88M Waste
Mgmt. II 457M Mattel 122M Sunbeam 141M
2000 Aetna, Inc. 82.5M 3Com Corp 259M Rite
Aid Corp 320M Microstrategy 193M Ikon
111M Prison Realty Trust 104M Sothebys
Holdings 70M
2003 Dayton Power Light 140M Computer Assoc.
133M Lucent 300M Hanover Comp.
80M Sprint 50M Dupont 77M Campbell Soup
35M Laidlaw, Inc 42M Andersen W SC
40M Providian Financial 38M Rent-Way
25M PNC 115M Daimler Chrysler 300M Oxford
Health 300M MCI (Worldcom) 750M
Unresolved Large Cases Enron, Worldcom, Tyco,
Xerox, Royal Dutch/Shell, Dynegy, Adelphia,
Health South, Qwest and the Mutual Funds Cases
2001 Sunbeam Corp 125M Vesta Insurance
61M Alcatel 75M Boeing 93M Reliance
Acceptance 58M Proctor Gamble 49M Prison
Realty 105M
(Source public information and NERA, June 2004)
9
Who might bring an action against a Director or
Officer?

• Australian Securities Investment Commission
  (ASIC)
• Australian Competition and Consumer Commission
  (ACCC)
• Australian Prudential Regulatory Authority
  (APRA)
• Australian Taxation Commission (ATO)
• Shareholders
• Employees (past, present and prospective)
• Creditors
• Customers
• Competitors
• Public Interest Groups
• Company liquidators receivers.

10
Examples of Corporate Wrongdoing

• Corporations Act 2001 violations such as
• insolvent trading
• infringement of shareholder rights
• illegal payment of dividends
• misuse of insider information
• misleading statements in Annual Report
• breach of a Companys Constitution
• merger and acquisitions misconduct
• public prospectus misrepresentation.

11
Examples of Corporate Wrongdoing (Cont)

• Trade Practices Act violations such as
• misleading and deceptive conduct
• misrepresentation in advertising
• restrictive trade practices.
• Anti-Discrimination Equal Opportunity breaches
  such as
• wrongful dismissal
• workplace harassment
• discrimination based on race, sex, age, religion
  etc.

12
Examples of Corporate Wrongdoing (Cont)

• Workplace and Environmental safety violations
  such as
• Unsafe workplaces and practices
• environmental pollution.
• Contractual breaches such as
• conflict of interest
• Failure to maintain insurance.

13
Significant recent case law in relation to
Directors Officers Insurance

• Silbermann v CGU 2003 NSWCA 203
• Highlights the potential problem words such as
  discretion and may can have in the event of a
  claim particularly one that involves allegations
  of fraudulent or dishonest conduct.
• The NSW Court of Appeal in that case had to
  decide whether CGU had to advance defence costs
  until there was an adverse judgment against
  Silbermann in accordance with its dishonesty
  exclusion or whether CGU could exercise its
  discretion not to pay defence costs until
  Silbermann had been adjudged to be innocent.

14
Significant recent case law in relation to
Directors Officers Insurance

• By 2-1 the Court of Appeal found that, providing
  that CGU was acting in good faith, it could
  exercise its discretion not to pay defence costs
  until Silbermann had been adjudged to be
  innocent.
• The dishonesty and fraud exclusion was found to
  apply to both payment of claims and advancement
  of defence costs. Since CGU was not expected to
  pay a claim up-front when dishonesty/fraud is
  alleged, it was held that neither should it be
  required to advance defence costs in the same
  situation.

15
Significant recent case law in relation to
Directors Officers Insurance

• The decision was based on the specific CGU
  wording, which says
  
  
• CGU may, in its discretion, pay Defence Costs
  as they are incurred. ..
• Some insurers policies retain the words, its
  discretion in their Advancement of Defence
  Clauses.
• Others have shall advance or shall pay
  which seems to place a clearer duty on
  insurers to advance defence costs.

16
Significant recent case law in relation to
Directors Officers Insurance

• Baycorp Advantage Limited v Royal Sun Alliance
• Insurance Australia Limited 2003 NSWSC 941
• the first Australian decision regarding
  allocation under a Directors Officers
  policy.
• The facts of the case can be summarised as
  follows
• Baycorp and certain officers were sued in three
  separate (but related) proceedings in the Supreme
  Court of New South Wales.

17
Significant recent case law in relation to
Directors Officers Insurance

• RSA were its Directors Officers insurers but
  elected not to take over and defend the
  proceedings under the policy.
• Consequently, Baycorp retained a law firm to
  represent both itself and the named officers in
  the proceedings.

18
Significant recent case law in relation to
Directors Officers Insurance

• Baycorp subsequently paid 10 million to settle
  the proceedings on behalf of all defendants
  pursuant to a Settlement Deed which Baycorp's
  Senior Counsel had recommended.
• Although RSA didn't agree to the settlement,
  Baycorp was obliged under the policy to use 'due
  diligence and do all things reasonably
  practicable to avoid or diminish any Loss under
  the policy'.
• Baycorp sought to recover from RSA the 10
  million settlement as a 'Loss' under the policy.
  It also sought to recover legal costs of 7
  million.

19
Significant recent case law in relation to
Directors Officers Insurance

• The main questions the Court had to determine
  were
• 1. Was the 10 million settlement a 'Loss' under
  the Directors Officers policy?
• Yes.
• The definition of 'Loss' in the policy expressly
  referred to "an amount (whether determined by
  judgment or settlement which a Baycorp Officer
  is legally liable to pay "). Upon execution, the
  deed became an independent source of legal
  liability for the officers.

20
Significant recent case law in relation to
Directors Officers Insurance

• 2. Could RSA decline to pay the 7 million
  incurred by way of defence costs simply because
  they represented both 'covered costs' (ie costs
  incurred in defending the proceedings for the
  officers) and 'uninsured costs' ( ie costs
  incurred in defending the proceedings for Baycorp
  which were not covered by the policy)?
• No, on the basis that there was nothing in the
  policy which allowed this. The Court noted that
  the definition of "Defence Costs" neither
  referred to costs incurred solely in defending
  claims against insured persons nor did it exclude
  costs from which an uninsured company benefits.

21
Significant recent case law in relation to
Directors Officers Insurance

• 3. Was the Allocation clause a valid means of
  apportioning the 7million defence costs?
• The 'old' RSA Directors Officers policy
  provided allocation under Claims Condition 6.
  Relevantly, it read as follows
• In the event that (b) both an Insured Person
  and others (including the Insured Entity)are a
  party to the proceedings to which a Claim
  relates, then the Insureds and the Insurer will
  agree on a fair and proper allocation between
  Loss covered and not covered by this Policy.

22
Significant recent case law in relation to
Directors Officers Insurance

• The Court held that the clause was unenforceable,
  as an agreement to agree and therefore void for
  uncertainty. The clause offered no guidance as
  to what was a 'fair and proper allocation', nor
  did it provide any mechanism to achieve a fair
  result, such as arbitration. The allocation
  clause accordingly, was severed from the policy
  and this issue was referred to a referee.

23
Significant recent case law in relation to
Directors Officers Insurance

• Leave to appeal the decision of the New South
  Wales Supreme Court was granted to Vero (formerly
  RSA).
• Watch out for the outcome of the appeal which was
  listed for hearing before the New South Wales
  Court of Appeal on 14 October 2004.

24
Section 199B

• Payment of Premium
• Historically it has been customary for directors
  to contribute 1 of premium towards payment of
  the policy. This relates to provisions of
  section 199B of the Corporations Act.
• In essence, s199B provides that a company cannot
  pay a premium for a contract of insurance that
  covers liabilities arising out of a wilful breach
  of duty to the company or contravention of s182
  or s183 (which relate to improper use of
  position).

25
Section 199B

• Payment of Premium (Cont)
• A breach of s199B renders such cover void, and
  invokes a penalty of up to 2,750 for the company
  under strict liability provisions under the
  Criminal Code.
• There is uncertainty as to whether payment of 1
  of the premium by directors in itself overcomes
  the provisions of s199B where cover for the
  prohibited liabilities is provided in the policy
  (ie as the policy is a single contract and the
  company is paying premium for such contract).

26
Section 199B

• Payment of Premium (Cont)
• There is also uncertainty as to whether s199B is
  intended to apply only to the acts of the officer
  committing the breach (narrow interpretation) or
  if it is intended to apply to innocent officers
  also (broad interpretation).

27
Section 199B

• Wilful Breach Exclusion
• Most DO policies contain a wilful breach
  exclusion which excludes cover for any director
  or officer committing such a breach. The
  exclusion (in most cases however) does not impute
  to innocent officers (ie assumes the narrow
  interpretation of the section).
• As the exclusion does not impute to innocent
  officers, there does remain a possibility that
  this in itself is a breach of s199B should the
  broad interpretation of the Act prevail.

28
Section 199B

• Wilful Breach Exclusion (Cont)
• To avoid this possibility completely would
  require a full wilful breach exclusion which
  excludes cover for innocent directors who may
  have action against them due to the wilful breach
  of a co-director / officer.
• No clarity in any legal advice
• To pay or not to pay the 1?

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Directors Officers Benchmarking
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DO Insurance Australian Companies
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DO Benchmark Australian Public Listed Companies
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Questions