Belt and Braces for Directors?
From 6 April 2005, new provisions in the Companies Act 1985 ("the Act") relax the prohibition against a company exempting or indemnifying a director against certain liabilities.
The Old Law
Section 310 of the Act set out the basic principle that an officer (or auditor) of a company cannot be exempted or indemnified by any provision contained in the Articles or in any contract or other document for any liability attaching to him for any "negligence, default, breach of duty or breach of trust of which he may be guilty."
A company can however, purchase indemnity insurance for such an officer (or auditor) and indemnify him, at the end of the proceedings, for costs incurred by him in successfully defending (criminal or civil) proceedings against him. However, the director(s) must still fund their defence during the proceedings and any insurance policy may not fully cover the costs incurred. In practice, this could leave a director penniless before a decision is reached in the proceedings.
The drive for change was influenced by the fact that the legislation was seen as unduly onerous and a deterrent to talented candidates taking up directorships.
New Provisions
The Companies (Audit, Investigations and Community Enterprise) Act 2004 ("CAICE") introduces new sections 309A, 309B and 309C into the Act to deal with indemnifying directors (and indeed de facto directors) for liabilities and limits the more restrictive provisions in section 310, referred to above, to auditors only.
The essence of the changes is that companies should be able to assist their directors in funding litigation while proceedings are taking place and to indemnify their directors against certain liabilities to third parties regardless of fault.
A company can now indemnify a director under what is described as "a qualifying third party indemnity provision." This is an action by a third party and which does not relate to a liability:
- to the company or a group company;
- to pay a fine under criminal law or to a regulator for breach of a regulatory requirement;
- for the costs in criminal proceedings in which he is convicted; or
- for the costs of civil proceedings against him brought by the company (or a group company) in which he is unsuccessful.
In practice, this means that a company may indemnify a director against a claim brought by a third party for negligence against a director and the director is unsuccessful in his defence. This is a clear extension of the previous position.
Crucially, a company can assist a director in defending proceedings (criminal or civil) even if it is the company that is bringing the proceedings. The assistance would be treated as a loan repayable on conclusion of the case unless the requirements for a qualifying third party indemnity provision set out above are satisfied, in which case the company may choose not to recover the amounts advanced.
This is a significant change in that one of the criticisms of the previous system was that a director would have to find the resources to fund a defence to an action brought against him from his personal means.
There are also administrative requirements following on from the above so that any indemnities granted by a company to a director (or a director of another group company) must be disclosed in the directors report regardless of whether they appear in the accounts as outstanding at the company's year end.
It is also advisable to set out the terms of any indemnity or assistance granted in a document since shareholders are entitled to inspect the same (or where there is no document, at least a memorandum of the main terms).
Effect on Company Documentation
If the issue of exemption or indemnification of directors is addressed in a company's Articles, the relevant Article may require amending to take advantage of the new provisions.
Service Agreements and letters of appointment may also need amending to take account of the new regime.
Details of any assistance given should be kept at the registered office of the company for inspection by shareholders.
For more information or advice on Directors' Indemnities please contact Mark Lewis
This article first appeared in NewsBrief, Summer 2005. Author: Mark Lewis
