Directors to refrain from personal gain – issues of policy construction in a D&O policy

29 September 2022

The Federal Court considers the application of 'improper profit' and 'prior circumstances' exclusions in a D&O policy.

In Issue

  • Whether 'improper profit' and 'prior circumstances' exclusions were triggered under a D&O policy.

The Background

On 12 October 2012, Hakea Holdings Pty Ltd (Hakea) entered into a contract with Denham Constructions Pty Ltd (Denham) in relation to the design and construction of an aged care facility in Hamlyn Terrace, NSW (the Project). By 21 May 2015, Hakea alleged that Denham was unable to complete the Project, and Hakea was forced to appoint a new builder resulting in a significant delay and associated losses.

On 24 April 2017, Hakea commenced proceedings against Steven McGrath (McGrath), who was both a director of Hakea; and the sole director, shareholder, secretary and general manager of Denham. Hakea alleged that a reasonable director in McGrath’s position should have known of Denham’s financial difficulties and, as a director of Hakea, disclosed these difficulties to Hakea. Hakea alleged that had it been informed of Denham’s financial situation, it would have appointed another builder to the Project.

Hakea held a Directors & Officers liability policy with Neon Underwriting Ltd (Neon), underwritten on a claims made basis for the period 23 January 2016 to 23 January 2017 (Policy). The insuring clause was triggered on there being a Claim made against a Director or Officer (in this case McGrath) during the Period of Insurance. Neon disputed liability under the Policy and was joined to the proceedings by Hakea.

The contest between Hakea and Neon concerned the application of the following exclusions in the Policy:

  1. an exclusion in respect of loss in connection with a director or officer 'gaining any personal profit or advantage or receiving any remuneration to which he or she is not legally entitled' (Improper Profit Exclusion); and
  2. an exclusion in respect to any circumstance / claim known about by a director or officer prior to the period of insurance (Prior Circumstances Exclusion).

The Decision

Improper Profit Exclusion

The court found that the Improper Profit Exclusion had been engaged. In coming to this conclusion, the court said that:

  • by keeping the contract on foot, Denham gained an advantage to which it was not legally entitled; and
  • Denham’s advantage was in fact a 'personal advantage' enjoyed by McGrath. As Denham was in reality controlled by McGrath, and their respective interests were one and the same, any benefit received by Denham under the contract would in turn be enjoyed by McGrath.

Prior Circumstances Exclusion

The court found that the Prior Circumstance Exclusion had not been engaged.

While the court was satisfied that McGrath knew Denham was in severe financial stress (and could not complete the contract) prior to the Policy incepting, it found that McGrath did not know that his conduct exposed him to any potential liability to Hakea. To this end, it found that McGrath was not aware of any relevant 'circumstance' for the purpose of the Prior Circumstance Exclusion.

The court’s finding on the Prior Circumstances Exclusion was strictly obiter as it found that the Improper Profit Exclusion had been engaged and therefore indemnity was not available.

Implications for you

The court’s decision provides some guidance on the application of 'personal profit' exclusions in D&O policies, and the appropriate circumstances by which a court may find that a corporate benefit is in fact a personal benefit, despite principles of separate legal personality.

The decision is also suggestive of a rather narrow interpretation of 'prior known circumstances' exclusions. We expect this point to be tested in future litigation.

Updated 16 March 2023: On 10 March 2023, the Full Court of the Federal Court dismissed an appeal against the trial judge’s decision that the relevant policy exclusion applied to entitle the insurer to deny indemnity for the claim.

Hakea Holdings Pty Ltd v McGrath (No 2) [2022] FCA 995

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