In April last year, in recognition of increasing concern about directors’ exposure to claims brought by investors, creditors, regulators and other third parties, the restrictions on companies indemnifying their directors, and lending them money to fund their defence costs, were significantly relaxed. But because the new rules are quite complex, and taking advantage of them often requires specific documents to be drafted, and company articles to be amended, take-up has been fairly slow, particularly amongst non-listed companies.
What can I be indemnified against?
Any UK company can now indemnify any of its directors, and any director of a company in the same group, against damages, costs and interest awarded against him in civil proceedings brought by a third party, and against legal and other costs incurred in defending both civil and criminal proceedings if and when the director wins or is acquitted, or the claim is settled or dropped. But an indemnity cannot cover fines or penalties (as this would be contrary to public policy), nor can it cover damages etc for a director’s negligence or breach of fiduciary duty towards his own company or another group company (as this would compromise director accountability).
Can I insist on being given an indemnity?
No. The changes are merely permissive, so boards must decide whether, and to what extent, any particular director should be indemnified. Amongst other things, boards should consider the size of possible claims compared to the company’s assets; whether the company’s liability should be capped; how an indemnity should dovetail with any D & O policy; and generally whether an indemnity is in the company’s best interests. However, it is becoming quite common for companies which do business or have securities listed in the US to grant wide-ranging indemnities to directors who may be exposed to class actions and other claims.
What about loans to fund defence costs?
In practice, this could be at least as important, particularly where there is a risk that any D & O cover could be exhausted before a case has even reached trial. Companies can now agree to advance funds to a director to meet any defence costs in civil or criminal proceedings on an ‘as incurred’ basis. All advances are repayable, but if the director wins or is acquitted, or the claim is settled or dropped, the company can in principle agree to waive repayment. As with an indemnity, the board will need to decide on a case-by-case basis whether and on what terms to make such a loan.
My company’s articles of association say that directors “shall be indemnified” – is this sufficient?
Although such wording may appear to provide an indemnity, or to instruct the board to put indemnity arrangements in place, case law indicates that, because directors (in their capacity as such) are not ‘parties’ to the articles, such wording does not give them an enforceable right against the company. A director therefore needs either a service contract which expressly incorporates this part of the articles or a stand-alone indemnity agreement.
What if I’m the company’s representative on the board of a non-group company, such as a 50:50 joint venture?
Although the issue is not free from doubt, the statutory rules probably do not restrict the scope of indemnity that your company can give you. However, it is all the more important that any indemnity can be justified as being in the best interests of your company. Also, an indemnity for fines or penalties is unlikely to be valid.
What about overseas companies?
Clearly, the above rules on indemnities and loans to directors only apply to UK companies. For an overseas company, its local law will dictate whether and on what terms it can provide an indemnity or loan to its own directors or to directors of another company. But the UK rules do not appear to restrict the type of indemnity that a UK company can provide to a director of an overseas group member, such as a US subsidiary.
This article first appeared in our Directors’ digest bulletin July 2006. To view this publication, please click here to open a new window.
To view previous articles on this topic, please click here.
