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Published 11 February 2016
It is not often the courts make non-party costs orders against directors. This is one such case, and it leads us to consider in this article how, if at all, D&O policies are relevant in this context.
Sebastian Holdings Inc ("SHI") executed numerous transactions involving foreign exchange, equities and other financial products through Deutsche Bank AG ("the Bank"). SHI was effectively a personal investment vehicle for its sole director and shareholder, Mr Vik. SHI had no employees and Mr Vik traded on SHI's behalf as a consultant. In the global financial crisis in 2008, the trades became heavily loss-making and, against SHI's wishes, the Bank foreclosed the open trades in deficit, leading to losses for SHI.
The Bank subsequently issued proceedings against SHI for US$243 million. SHI counterclaimed for US$8 billion. The court awarded judgment in the Bank's favour and granted it 85% of its costs on an indemnity basis (said to be circa £60 million). SHI defaulted on the costs payment and the Bank successfully sought a non-party costs order against Mr Vik, binding him to the judgment. On appeal, it was held that it was entirely just to make him personally responsible for SHI's costs liability.
In this article, we explore the idiosyncrasies of this case which vitiate against cover being available to directors under a D&O policy in this type of situation. It offers some food for thought for underwriters on the vacuum that exists for this type of cover.
The courts have a broad discretion when awarding costs, including making non-party cost orders under S.51 Senior Courts Act 1981. The court distinguishes "pure funders" from non-parties, which not only funded but also exercised control over the litigation, for their own benefit, and other factors can be taken into account. Four key facts were identified, which encouraged the court to bind Mr Vik to the main judgment for cost purposes:
In the plethora of satellite litigation that ensued, the court held that Mr Vik's connection to SHI was so close that he could not possibly be said to suffer injustice as a result of the court joining him as a party. In turn, it found that there was no reason why Mr Vik should not be required to pay the whole of the costs for which SHI was liable.
Is there ever any D&O cover for the purposes of paying a non-party costs order?
The starting point where a director is involved not as an actual party to litigation, but rather as a witness and as a member of the litigating company's board, is that he faces no personal liability for costs. His liability under a non-party costs order arises from his involvement in the action, not necessarily from any alleged wrongful act.
In our view, it is unlikely there will ever be cover for a non-party costs order when his liability under a non-party costs order arises from his involvement in and conduct of the action, and probably not from any alleged wrongful act which might be covered under the Policy.
Is there, therefore, a gap in cover to be filled? In our view the answer is again no. Non-party costs orders are only likely to be made against directors where they not only controlled, but also helped fund actions or defences for their personal benefit. Insurers are very unlikely to want to offer cover in such circumstances.
An extension of cover for such costs liability might be something for insurers to consider in their quest to provide policies with greater cover. However, we are only looking at a very small number of cases, probably limited to those companies that are effectively the alter ego of the main shareholder and director. Is this an area of risk insurers would wish to cover? We think not.
The primary trigger for D&O cover is an allegation of a wrongful act(s) on the part of an individual insured. Although there might be notification of such an allegation, if the director is not a party, minimal if any defence costs cover is likely to be available under Side A policies (i.e. where there is no entity cover).
Ironically, had Mr Vik been joined to the substantive proceedings from the outset rather than merely for the purposes of costs later on, it is plausible the claim might have fallen for cover under a D&O policy taken out by SHI. For example, it might have been alleged Mr Vik fraudulently diverted funds held as collateral for transactions with the Bank.
As it happens, Mr Vik was only joined after the proceedings in a summary procedure.
In conclusion, any area of potential liability for directors is of interest to the D&O market, but we think this is one area which can be left alone.
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