Director’s Indemnity And Insurance

Director’s Indemnity And Insurance

INTRODUCTION

Directors are considered fiduciaries of their company and have to act in good faith in the interest of the company. They also have a duty to exercise reasonable care, skill and diligence when performing their function as directors. A director in breach of any of these duties would be personally liable to the company, and, in some cases, would also be in contravention of statute, making him or her liable to a fine or imprisonment or both.[1]

The risk of personal liability provides a form of safeguard against a director acting without due regard to the interest of the company. That safeguard, to some extent, would be circumvented if directors, having the powers of management, could get the company to exempt them from liability, or to indemnify them against such liability. It has therefore been the policy of the law to prohibit a company from exempting and indemnifying a director from liability for wrongful conduct or breach of duty.

Before the Companies Act 2016 came into force, the prohibition took the form of section 140 of the Companies Act 1965. There was however some uncertainty whether section 140 prohibited a company from taking out insurance for the benefit of its directors to cover them against liability to the company and to other persons of the type commonly known as a D&O[2] insurance.

Section 289 of the 2016 Act has clarified the position. But the provisions of this section are not without problem themselves. This article deals with these issues.

 

SECTION 140 COMPANIES ACT 1965

Section 140 made any article of association of, or any agreement with, a company that exempts a director from, or indemnifies a director against, liability for negligence, default, breach of duty, or breach of trust, of which the director may be guilty in relation to the company, void.

Any form of agreement between a company and its director to exempt the latter from liability to the company for negligence, default, breach of duty, or breach of trust is therefore unenforceable. A company is also prohibited by the section from having any form of agreement which indemnify a director against such liability.

The section however permits a company to indemnify a director against any liability incurred by him (namely, costs) in defending any civil proceedings in which judgment is given in his favour, or in defending any criminal proceedings in which he is acquitted.

Section 140 however did not expressly deal with insurance, that is, whether the prohibition in respect of indemnity mentioned in the section includes insurance[3] effected by a company with a third party insurer for the benefit of a director. In particular, there was uncertainty whether the section also prohibited a company from effecting insurance for the benefit of a director in relation to the director’s liability to the company for negligence, default, breach of duty, or breach of trust.[4]

The position has been made clearer under section 289 of the Companies Act 2016[5].

 

SECTIONS 288 AND 289 COMPANIES ACT 2016

The provisions regulating a company’s ability to exempt, indemnify, and effect insurance for, a director are now found in sections 288 and 289 of the Companies Act 2016.

Section 288 of the 2016 Act is essentially the same as subsection (1) of section 140 of the 1965 Act. Any form of agreement with a company which exempts a director from, or indemnifies a director against, liability to the company for negligence, breach of duty, or breach of trust, is therefore still void.

Section 289 however provides the conditions upon which a company may indemnify a director against liability arising from his or her conduct in his or her capacity as such director, or effect insurance for the director to cover him or her against such liability.

 

Permissible indemnity

Third party claims

It is now expressly provided in section 289[6] of the 2016 Act that a company may indemnify a director against liability to any third party (that is, any person other than the company) arising out of any act or omission of that director in his or her capacity as such director.[7] This means that if a director of a company becomes liable to a third party for his or her actions carried out in his or her capacity as a director of that company, the company may indemnify him or her against such liability.

This express statutory provision is welcome. It enables a company to assure any person who may otherwise not serve as a director for fear of personal liability to a third party that any protection from such liability given by the company to him or her is valid.

However, a company is not permitted to indemnify its director against liability to pay a fine imposed in any criminal proceedings, or to pay a penalty to a regulatory authority for non-compliance with any requirements of a regulatory nature.[8] This prohibition is appropriate as company should not be allowed to relieve its director from personal burden for any breach of law that lead to a fine or penalty even if the director’s act or omission which led to the fine or penalty has benefitted the company.

Legal costs

Section 289[9] also permits a company to indemnify a director for costs incurred by him or her in defending or settling any claim or legal proceedings relating to his or her liability to a third party arising from his actions in his or her capacity as such director.

The exception to this is where the costs incurred by a director in defending or settling a claim or proceedings relates to the defence of a criminal proceedings brought against him in which the director is convicted, or to the defence of a civil proceedings brought against him by the company, or by an associated company, in which judgment is given against the director.[10] In those cases, a company is not permitted to indemnify a director for such costs incurred.

Costs of proceedings where relief is granted

A company may also indemnify a director:

(a) in connection with an application for relief under section 581

(b) for costs incurred in respect of proceedings in which the director is granted relief

Section 581 enables any officer or auditor who has acted honestly and reasonably and which the court considering the circumstances ought fairly to be excused from liability

Agreement to indemnify

The indemnity which a company is permitted to give to a director in accordance with s.289(4) against liability to third party or to costs may also be in the form of an agreement to indemnify, before any liability arises.[11]

Restriction

However, the liability against which a company is permitted to indemnify a director does not extend to liability of the director to a third party (whether civil or criminal liability) arising from a breach of any of the duties of director specified in section 213 of the Companies Act 2016.[12] In other words, a company is not permitted to indemnify a director against liability to a third party which arises from the director’s failure to exercise the powers of directors for a proper purpose of the company and in good faith in the best interest of a company, and failure to exercise reasonable care skill diligence.

 

Permissible insurance

Civil liability and costs in defending claims relating to such liability

It is now made clear that a company may, with the prior approval of its board, take out insurance for a director of the company to provide cover for him or her:

(a) against any civil liability arising out of any act or omission in his or her capacity as a director of the company, and

(b) for any costs incurred by the director in defending or settling any claim or proceeding relating to such liability.

No insurance for breach of director’s duties

However, similar to the exception to the authority given to a company to indemnify a director, the liability in respect of which a company is permitted to effect insurance does not extend to the civil liability arising from a director’s:

(a) failure to exercise his powers for a proper purpose of the company;

(b) failure to exercise his powers in good faith in the best interest of a company; or

(b) failure to exercise reasonable care, skill and diligence as director.[13]

This means that the two possible types of civil liability, that is, the civil liability of a director to the company, and the civil liability of a director to a third party, which may arise from the director’s failure to act for a proper purpose of the company, or failure to act in good faith in the interest of the company, or failure to exercise reasonable care, skill and diligence, cannot be effected by the company for the director.

While prohibiting a company from effecting insurance for a director in respect of civil liability to the company arising from failure to act for a proper purpose of the company, or failure to act in good faith in the interest of the company is consistent with the policy behind sections 288 and 289 of the Act (that is, a director who has failed to act for the proper purpose, or in the interest, of the company, should not get the company whose interest he has acted against to relieve him from liability), it is hard to see the mischief against which s.289(6) is attempting to prevent by not allowing a company to take out insurance for a director to protect him against civil liability to a person other than the company (the third party) arising from any of such failures.

A company can therefore procure D&O insurance for its directors against any form of civil liability to a third party arising out of their conduct as directors of the company except liability arising out of the breach of any of the duties stated in section 213.

Costs in defending criminal proceedings

Section 289(5) also allows a company to effect insurance for costs incurred in defending any criminal proceedings brought against a director in relation to his act or omission of in the capacity as such director in which that director is acquitted or where the proceedings are discontinued.

Costs of proceedings where relief is granted

A company is also allowed to effect insurance for costs incurred by the director in defending any proceedings (civil or criminal) in which the director is granted relief under section 581 of the Act.

 

Officer and auditor

It should be noted that the type of indemnity and insurance which a company may effect for a director in accordance with section 289[14] of the Companies Act 2016 may also be effected by the company for other officers[15] and for the auditor of the company.

However, the proscription[16] against a company indemnifying, or effecting insurance for, a director in relation to liability arising from the director’s breach of the duties prescribed under section 213[17] of the Act does not apply to these other officers, and the auditor, of the company.

 

Requirements for indemnity and insurance

Indemnity

The directors of a company are required to ensure that the particulars of any indemnity given by the company to its officer or auditor are recorded in the minutes of the meeting of the board, and disclosed in the directors’ report of the relevant financial year.[18]

The consequence of a failure to meet these requirements on the indemnity is not clearly specified. Nevertheless, because subsection (2) of section 289 provides that any indemnity given by a company to a director in breach of the section is void, it is suggested that any failure to have the particulars of the indemnity recorded in the minutes of the meeting of the board of directors of the company, or disclosed in the directors’ report, will render the indemnity unenforceable against the company.

A director who have obtained an indemnity from the company would do well to ensure the recording and disclosure are done by the company, less he finds the indemnity given by the company to him invalid.

Insurance

The approval of the board of directors of the company is required to obtained before[19] any insurance can be effected by the company for its officer or auditor.

Similar to indemnity, the directors of a company are also required to ensure that the particulars of any insurance effected for its officer or auditor are recorded in the minutes of the meeting of the board, and disclosed in the directors’ report of the relevant financial year.[20]

It is however unclear from section 289 the exact legal consequence of a failure to meet any of the aforesaid requirements.

As mentioned earlier, subsection (2) of section 289 states that an indemnity given in breach of the section shall be void. It is unclear whether “indemnity” in the context of the section includes insurance effected by a company for its officer or auditor such that any breach of the requirements of section 289 would render the insurance void.

Secondly, further uncertainty comes about from a possible typographical error in subsection (8) of section 289. Subsection (8) prescribes that if “subsection (6) or (7)” has not been complied with, the officer (including director) shall be personally liable to the company for the cost of effecting insurance. The problem lies with the reference to subsection (6) − which does not set out any requirements to follow for effecting insurance – instead of subsection (5).

The writer is of the view that the harm which subsections (5) and (7) of section 289 aim to prevent is the company bearing the cost of effecting insurance for its officer or auditor without approval of its board and without disclosure in the directors’ report. So, at most, the legal consequence of failure to comply with any of the requirements in those subsections is that the officer or auditor for whom the insurance is effected would be personally liable to the company for the cost of effecting the insurance. The validity of the insurance should not be affected.

 

[1] E.g. section 213(3) Companies Act 2016.

[2] Directors and officers insurance.

[3] Insurance is a form of indemnity.

[4] Some commentators have suggested that section 140 did not prohibit a company from taking out insurance for the benefit of an officer or auditor to cover him or her against liability to the company for negligence, default or breach of duty. It is said that such insurance falls outside the mischief which the section aimed to prevent.

[5] The 2016 Act (which came into force on 31 January 2017) replaces the Companies Act 1965.

[6] Section 289(4).

[7] Sub-paragraph (a) of s.289(4).

[8] Sub-paragraph (i) in s.289(4). Note that due to the unfortunate drafting placement of sub-paragraph (i), there is some uncertainty whether the sub-paragraph is an exception to sub-paragraph (a) of s.289(4) or to sub-paragraph (b) of s.289(4). Based on context, however, sub-paragraph (i) should be an exception to sub-paragraph (a) of s.289(4).

[9] Sub-paragraph (b) of s.289(4).

[10] Section 289(4)(b)(ii).

[11] See s.289(9) definition of ‘indemnify’.

[12] Section 289(6).

[13] Section 289(6).

[14] The section in fact regulates what a company may effect as indemnity and insurance for an “officer or auditor” of the company.

[15] “Officer” is defined in section 289(9) as including any director, manager, secretary, employee, a former officer, a receiver or receiver and manager of any undertaking of the company appointed under a power contained in an instrument, and a liquidator of the company appointed in a voluntary winding-up.

[16] Found in section 289(6).

[17] Duty to act in good faith in the interest of the company, and duty to exercise reasonable care, skill and diligence.

[18] Section 289(7).

[19] Section 289(5).

[20] Section 289(7).

 


By H.Y. Chong (view profile)
Managing Partner, Azman Davidson & Co

+603 2164 0200 (ext no. 140)
chong.hy@azmandavidson.com.my

Recent Posts