Double-indemnity: Indemnifying directors

Those who are new to holding office in companies, whether public or private, seem to regard being a “director” as a glamorous position. And it can be. But, as many directors and office holders are only too well aware, it can also be an enormous burden. The directors of companies can, in certain circumstances, be sued directly. When things go pear shaped for a director, what do they do?

Before 6 April 2005, under the Companies Act 1985 (“the CA”) companies could not arrange for indemnities for its officers or directors, indemnifying them against liabilities incurred because of their negligence, default, breach of duty or breach of trust. The CA did, however, specify that companies could purchase directors’ & officers’ liability insurance (“D&O Insurance”) for their directors and officers and they could also reimburse directors and officers in respect of costs incurred when defending claims (subject to a successful defence by the director). D&O Insurance can prove to be extremely useful, if not vital when such claims are made against directors. However, because of the limitations of such D&O Insurance and the potentially huge costs that directors could incur in defending actions against them, new legislation was proposed and has now come into force.

New legislation has been introduced from 6 April 2005 enabling both public and private companies to indemnify their directors against claims from third parties and, sometimes, from the company itself. The new law is contained in the Companies (Audit, Investigations and Community Enterprise) Act 2004 (“the Act”).

The Act works to substantially widen the scope of indemnities which could be granted by companies to their directors, particularly in respect of liabilities to the third parties.

Examples of how the Act amends the CA include the following:

• Companies can now contribute or pay the costs of a director defending himself against civil or criminal proceedings. This is subject to directors agreeing to repay those costs if they lose civil proceedings (particularly those brought by the company itself or an associated company) or if convicted in any criminal proceedings.

Companies can now indemnify directors against the costs of defending:

• criminal proceedings (subject to them not being convicted). If the director is convicted then any defence costs must be repaid to the company. The company cannot indemnify directors in respect of any criminal penalties;
• civil proceedings brought by a third party. The company can indemnify directors against any further liabilities incurred by the director; and regulatory proceedings.

The company cannot indemnify directors against any further penalties imposed by regulatory bodies such as the FSA.

• Associated companies will not be able to indemnify directors where such indemnification by the actual company would not be permitted.
• Although companies can pay directors costs in defending themselves, regardless of whether it is the company or an associated company bringing the claim against that director, the company cannot actually indemnify directors against any further liabilities to the company or any associated company.

Companies and individual directors will now need to consider the practical issues associated with including directors indemnities in service agreements or letters of appointment. Companies will need to consider the legitimate scope of the indemnities offered as well as the exclusions that are incorporated to limit the scope of those indemnities. There may also be issues surrounding the continuance of such indemnities after termination of employment or of a directorship. D&O Insurance cover could (and probably should) still remain in place and in practice those insurance policies will probably still provide the greater comfort for directors. If new indemnities are to be given then companies should consider their effect on existing terms and conditions of D&O insurance.

We will look to see how companies and directors actually deal with this issue in practice in the years to come.