In April last year, companies were afforded greater flexibility in the protection of their directors against certain liabilities as a result of changes to the Companies Act 1985 (the "Act"). The changes were made in recognition of increasing concern over directors' exposure to liability arising from legal proceedings brought by third parties.
The original position, set out in s310 of the Companies Act 1985, prohibits a company from exempting or indemnifying its directors in respect of liability if negligent, in default or in breach of duty or trust. Prior to last April, it only allowed reimbursement of a director's costs arising from any civil or criminal proceedings, in which judgment was given in favour of the director, and the payment could only be made after judgment.
The new regime was brought into force with the insertion of new ss 309A, 309B, 309C and 337 into the Act. The basic prohibition in respect of exempting or indemnifying directors in respect of liability still remains. However, companies can now take advantage of an exemption to indemnify directors against liabilities to third parties and to pay a director's defence costs as they are incurred (subject to an undertaking from the director that he will repay these if the defence is unsuccessful).
In practice this means that a director can be indemnified in civil proceedings brought by a third party both against the claim itself and against the costs of defending the proceedings provided that the indemnity does not extend to the payment of criminal fines or regulatory penalties. Even in cases where the company itself brings a claim against a director, the company may pay the director's costs in defending the proceedings as the claim progresses, provided the director is obliged to repay those costs if judgment is given against him.
It is important to note that these changes are merely permissive and that companies are not obliged to indemnify their directors in such a way. Companies must therefore consider what levels of protection they are willing to provide to directors and take action accordingly. Most companies already have directors' indemnity provisions in their articles based on regulation 118 of Table A of the Act but these are likely to be more restricted than the law now permits. If directors are to benefit to the fullest extent permitted by law the articles may need to be amended.
By law the articles are a contract between the company and its members and are therefore not enforceable by an outside third party. This would include a director who is not a member. Directors may now wish to consider having separate indemnity agreements drawn up or re-negotiating existing arrangements in their service contracts to reflect the changes to the law.
This can often be a difficult process for both the company and the director with the necessity of balancing potentially opposing interests. Dealing with this at the commencement of an appointment can be particularly sensitive when both parties are keen to start the relationship on a positive note.
At the same time as considering the protection provided for directors, companies should also review their existing directors' and officers' (D&O) liability insurance. Under the changes to the Act, companies are permitted (but not required) to purchase and maintain insurance for the benefit of a director against any liability arising in connection with any negligence, default breach of duty or breach of trust by him in relation to the company. Having adequate D&O insurance cover in place is in the interests of both the company and the directors to ensure that there is sufficient protection for all parties in the event of a claim.