Out-Law Guide | 17 Jun 2010 | 11:47 am | 5 min. read
This article is based on UK law as at 1st February 2010, unless otherwise stated.
To what extent can a company protect its directors from some of the liabilities outlined in our guides to directors' duties, including any legal costs that might be involved? There are two possible options:
The giving of exemptions is banned by the Companies Act, and indemnities are restricted; insurance policies need to be carefully read to ensure they cover the desired risks.
A company can indemnify its directors against personal liability so long as the indemnity does not cover:
So a company can give an indemnity that will commit it to paying any or all of the following:
A company’s articles will usually permit the giving of these indemnities. But it is a mistake to think an indemnity in the articles is all that isn required. A director cannot enforce an indemnity through the articles alone. A separate commitment from the company is needed in a service contract or other document.
The general restrictions on a company making loans to its directors (See: Loans to directors, an OUT-LAW guide) do not prevent a company from funding a director’s ongoing defence costs in either civil or criminal proceedings, provided that the terms on which the funding is advanced require the director to repay the money if they are convicted or final judgment is given against them. This applies even when it is the company itself that is suing the director.
Any indemnities given to directors have to be disclosed each year in the directors’ report that accompanies the audited accounts and their terms have to be available to shareholders at all times. These rules apply also where one company in a group indemnifies the directors of another.
Whether companies should take full advantage of this ability to give indemnities is not a straightforward question. Given the growing burden of their responsibilities and liabilities, and a fear that litigation is on the increase, directors will be keen to have the benefit of every permissible form of protection. But in setting its policy, a board will need to decide whether it believes it is right to give an indemnity in every case – for example, where a director has clearly acted dishonestly or beyond their authority. If money is advanced to a director to meet defence costs in actions brought by the company, it will be necessary to:
A company is allowed to take out and pay for insurance to cover liabilities incurred by its directors. Indeed, doing so can be considered part of best practice. The UK Corporate Governance Code, whose guidelines are followed by a wide range of organisations (see: our Corporate Governance page), states that: ‘The company should arrange appropriate insurance cover in respect of legal action against its directors’.
The question of insurance needs to be looked at in the context of any indemnities given by the company, as discussed above. If the company decides to insure, it may want to take out cover in respect of those risks it cannot indemnify its directors against – or chooses not to do so. The an indemnity to its directors.
Whatever the company decides to do, it is important for the board as a whole, and for individual directors, to appreciate that there is no standard insurance policy that answers all needs. The exact terms of a policy will be interpreted restrictively, and so all concerned must have a clear understanding of what is covered and what is not. A director is taking a big risk if they simply assume that a directors’ and officers’ (D&O) insurance policy is in place and will cover them without taking the time to establish exactly what protection it affords.
A new director should at least establish that the insurer is aware of their appointment and that they will be covered by the policy. And both new and existing directors need to satisfy themselves on the terms of the policy. Some of the key points to consider are listed in the following box.
Like a company indemnity, insurance will not provide a complete safeguard for a director against personal liability. It is only part of the answer. Clarification from the company secretary and, if necessary, from insurance brokers and legal advisers, is advisable where there is any doubt.