Briefings
Directors, Shareholders and Owner Managers: Legal Costs and Liability - Positive News for Company Directors
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Directors, Shareholders & Owner Managers
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| March 2005 |
Concerns about personal liability are not new to directors. Although, it is fair to say that such concerns have increased over recent years. Directors are finding that their duties are becoming more and more onerous, that they have a mass of corporate governance issues to deal with and that class actions are becoming more prevalent (especially in the US). In addition, companies have been unable as a matter of English law to offer directors much of an indemnity. It is perhaps no surprise that there has increasingly been news of directors declining new appointments.
There is now some encouraging news. Proposals to amend the Companies Act 1985 in a number of key respects for directors made their way through Parliament last year. After some debate, new laws on directors were finally agreed and are scheduled to come into force in April of this year, as part of the Companies (Audit, Investigations and Community Enterprise) Act 2004. The amendments have a number of important implications for both directors and companies.
Companies will be permitted to indemnify their directors in respect of costs and liability for civil proceedings brought by third parties. This is an important development as companies were previously unable to indemnify directors, unless they were effectively found not to be negligent. This provided little comfort to directors, who may have found that help came too late to ensure a vigorous defence to the action. It should be noted however that this new provision only permits companies to indemnify their directors, it does not require them to do so. In that sense, the indemnity is up for negotiation. Another drawback of the new provision is that it does not allow companies to indemnify their directors in respect of criminal fines or penalties levied by a regulator, or in respect of any liability to the company itself. The new law goes some way towards assisting directors, but it still has the potential to leave them exposed in important ways.
The new law brings in a further relaxation by allowing companies to loan to their directors the defence costs of civil and criminal proceedings. However, it stipulates some fairly strict circumstances in which the loan would become repayable. For example, a loan would need to be repaid immediately on final conviction against the director in criminal proceedings. On the surface, this appears to be a useful provision, providing cash flow for a proper defence of proceedings. However, this provision deals only with the ability of the company to make a loan, not its ability to grant an indemnity. Directors may accordingly be wary of borrowing money from the company against potentially expensive legal defence costs, only to face the prospect of having to repay them imminently if they lose. It should also be noted that different rules apply in respect of quasi-loans.
How to harness the new law
Directors will want to ensure that they do all they can to provide themselves with the maximum reasonable protection against personal liability. One aspect of protection may well be D&O insurance. Exactly what protection such insurance offers will depend on a variety of factors. Some are more certain, such as the precise scope of the policy and the type of run off, while others are less so, such as the period the policy is maintained. Directors will need to consider the new law carefully to see how it may offer protection. They should consider what indemnities (or advances of costs) their companies are permitted to offer them, whether their companies are in fact prepared to offer them and how this sits with any insurance policies they may have the benefit of. If they want these new protections, they will need to negotiate them, probably in their employment contracts, and make sure that the Articles of Association permit the company to give them.
For its part, a company will want to consider its position on indemnities and loans. It will want to assess whether any desire to assist directors might be better achieved by advancing legal costs as and when the situation arises, rather than by offering an indemnity or an advance at the outset of a contract. Further, if a company is to offer loans, it will need to ensure that the loans do not fall foul of the new requirements. It will also need to consider its disclosure requirements under the new Act in respect of any such arrangements.
The new provisions offer some cause for optimism for directors. It remains to be seen how, in practice, the new provisions will alter the landscape for directors.