Australia: Directors and officers indemnities: Key components and practical tips

INTRODUCTION

Being appointed a director or officer of a company is an important step in an individual's commercial life. However, the appointment also carries with it a great deal of responsibility, and a certain level of risk. The duties owed by a director to a company are spelt out in the Corporations Act 2001 (Cth). A director or officer is entitled to expect that the company will safeguard him or her in the event that he or she is subject to litigation arising out of his or her conduct as a director. A common means of achieving this is through the use of an indemnity between the company and its directors and officers.

This article will examine:

  • the key components of a directors' and officers' indemnity and access deed (Indemnity Deed) and some practical considerations for in-house counsel when drafting an Indemnity Deed;
  • prohibitions on indemnities and payment of legal costs under the Corporations Act; and
  • the relationship between the Indemnity Deed and directors' and officers' insurance (D&O Insurance). Indemnity Deeds are just one part of effective and necessary risk management for directors and officers. As we will discuss, the scope of directors' and officers' conduct which may be protected by Indemnity Deeds is in fact limited. Accordingly, there is also a need for a director or officer to hold effective D&O Insurance.

Indemnity Deeds are just one part of effective and necessary risk management for directors and officers. As we will discuss, the scope of directors' and officers' conduct which may be protected by Indemnity Deeds is in fact limited. Accordingly, there is also a need for a director or officer to hold effective D&O Insurance.

KEY COMPONENTS OF AN INDEMNITY DEED AND PRACTICAL CONSIDERATIONS

There are several limbs to a typical Indemnity Deed and practical considerations which in-house counsel should take into account when drafting an Indemnity Deed.

Indemnity

First, an Indemnity Deed provides that the company indemnifies the director or officer "to the maximum extent permitted by law" in respect of legal proceedings and any clams made against that director or officer.

The phrase "to the maximum extent permitted by law" in an Indemnity Deed is important as it incorporates limitations and prohibitions, imposed by the Corporations Act, on a company's right to indemnify its directors and officers for liability and legal costs (which is discussed further below). This limits the scope, operation and effect of the Indemnity Deed.

In drafting the indemnity clause in the Indemnity Deed, in-house counsel ought to consider:

  • The scope of the indemnity. A director would seek an indemnity which is as broad as possible, while a company may seek to limit the scope of the indemnity. The scope of the indemnity is usually governed by the definition of "legal proceedings" in the Indemnity Deed, which is incorporated into the indemnity clause. This definition usually extends to civil or criminal claims, actions, suits, demands and enquiries, and includes legal costs; although the scope of the indemnity clause is also often greatly expanded by the catch-all phrase "any claims of any kind". In drafting the indemnity, in-house counsel should give great care to the scope of the definition of "legal proceedings".
  • The length of the indemnity. A director or officer would seek an indemnity that he or she could continue to enforce even after he or she ceases to be a director or officer of the company. To meet this, an indemnity may be drafted so that it is expressly not affected by a director or officer resigning or ceasing to act as a director or officer of the company.

D&O Insurance

Second, under the Indemnity Deed, the company agrees to procure and maintain D&O Insurance and pay any premiums to the maximum extent permitted by law, and gives the director or officer a "reasonable opportunity to contribute" any portion of the premium which the company is not permitted to pay by law.

The phrase "to the maximum extent permitted by law" again incorporates limitations and prohibitions under the Corporations Act on the company paying premiums for coverage under D&O Insurance policies which is prohibited under the Corporations Act. However, allowing a director or officer to pay a portion of the premium which the company is prohibited to pay, permits a director or officer to be covered by D&O Insurance which the company could not otherwise provide. This prohibition on the company paying premiums is discussed further below.

Access to company documents

Third, the Indemnity Deed provides a director or officer a right of access to company documents and to waive legal professional privilege claimed by the company. This right is of particular importance to directors or officers in defending legal proceedings brought against them.

There are three main components to this limb of an Indemnity Deed:

  • the company provides the director or officer access to company documents on request;
  • the director or officer is permitted to disclose confidential information contained in such company documents for the purpose of defending legal proceedings; and
  • the company authorises the director or officer to waive legal professional privilege over company documents for the purpose of defending legal proceedings.

Usually, the documents which the directors and officers require and over which they exercise their right to waive legal professional privilege claimed by the company are legal advices from in-house counsel or external legal advisers, provided to the company in respect to the matter which is now the subject of the litigation. It is in the interests of the directors and officers who are defending the litigation to exercise their rights to access that legal advice and waive the company's privilege so that they can rely on that legal advice in defending the claims against them.

However, this right may give rise to risk of disclosure of confidential information or privileged legal advice which the company itself wishes to protect. This may give rise to a tension between the company itself and its directors and officers. If an Indemnity Deed contains such clauses, there is little that a company, or its in-house counsel, can do to prevent a director or officer from exercising his or her right to disclose confidential and privileged information. However, in-house counsel ought to be aware of such a risk of disclosure of confidential or privileged documents and the potential for such a conflict to arise.

PROHIBITIONS ON DEEDS OF INDEMNITY

Notwithstanding the discussion above, the reach of Indemnity Deeds is in fact limited by the Corporations Act. Section 199A of the Corporations Act limits a company's ability to indemnify a director or officer for liability or legal costs.

Indemnity

Section 199A(2) of the Corporations Act prohibits a company from indemnifying its directors and officers against liability for certain conduct.Acompany must not indemnify a director or officer against:

  • a liability owed to the company;
  • liability for a pecuniary penalty order or compensation order arising out of breaches of civil penalty provisions under s 1317E of the Corporations Act; and
  • a liability which did not arise out of conduct in good faith.

Section 199A(2) prohibits a company from indemnifying a director or officer for pecuniary penalty orders or compensation orders flowing from conduct which is caught by the civil penalty provisions in s 1317E of the CorporationsAct, including breaches of directors' duties, insolvent trading, and breaches of continuous disclosure obligations.

Indemnity for legal costs

A question that often arises is whether a company is permitted or obliged to indemnify directors and officers for, or to pay for, their legal costs of defending a claim brought against them. When a director or officer is served with proceedings, an issue at the forefront of his or her mind is how he or she could fund the defence of the proceedings and whether his or her company will assist in this regard.

Section 199A(3) of the Corporations Act prohibits a company from indemnifying a director or officer against legal costs which are incurred:

  • in defending proceedings for which he or she could not be indemnified by the company; that is, proceedings relating to liability for which indemnity is prohibited pursuant to s 199A(2);
  • in defending criminal proceedings in which he or she is found guilty;
  • in defending proceedings brought by the Australian Securities and Investments Commission or a liquidator for a court order if the grounds for making the order are established; and
  • in connection with proceedings for relief from liability in which the court denies the relief sought.

Section 212 of the Corporations Act provides a way for a company to assist a director or officer in meeting his or her legal costs of defending a non-indemnifiable claim, notwithstanding the prohibition in s 199A(3). Section 212(2) permits a company to make payments in respect of legal costs if s 199A does not apply; or if s199A does apply, the director must repay the amount paid. Further, the giving of the benefit would need to be reasonable in the circumstances.

Leckenby v Note Printing Australia Ltd

The prohibition on a company paying the legal costs of a director or officer in defending criminal proceedings has given rise to some uncertainty. Is a director or officer entitled to be indemnified for his or her legal costs in defending ongoing criminal proceedings, or must he or she wait for a not guilty verdict? This issue was considered in Leckenby v Note Printing Australia Ltd (Leckenby)1.

The Chief Executive Officer (Mr Leckenby) of Note Printing Australia Ltd (NPA) was charged with conspiring to bribe foreign officials. Mr Leckenby sought indemnity from NPA in respect of his ongoing legal costs under a Deed of Indemnity.

The Supreme Court of Victoria held that it was clearly the intention of the parties, from a reading of the Deed of Indemnity, that NPA provide funding for legal costs prior to verdict. The court rejected NPA's submission that the right to indemnity under the Deed only arose from a not guilty verdict. The indemnity was no more than an agreement providing for an advance of legal fees, which required repayment on a guilty verdict and thus did not infringe the prohibition. The prohibition in s 199A(3) does not apply prior to a guilty verdict. The court held that Mr Leckenby was entitled to be indemnified for his legal costs incurred in defending the criminal proceedings.

The Victorian Court of Appeal dismissed an appeal by NPA,2 holding that NPA's obligation under the Deed of Indemnity to indemnify Mr Leckenby unless and until he was found guilty, was consistent with the prohibition under the Corporations Act. The Deed of Indemnity conferred a present entitlement upon Mr Leckenby to be paid for his legal costs in defending the criminal proceeding - unless and until a guilty verdict was reached, in which case he would be obliged to repay NPA.

These decisions are recent authority for the proposition that a director or officer is entitled to be indemnified for his or her legal costs incurred during the defence of criminal proceedings and that he or she is not required to wait for a not guilty verdict to be indemnified by his or her company for those legal costs.

D&O INSURANCE

The prohibitions on a company indemnifying its directors and officers put focus on the importance of a company holding comprehensive and effective D&O Insurance. Typically, D&O Insurance falls into three "sides":

  • Side A which indemnifies directors and officers for liabilities where the company does not, or is not permitted to, indemnify them (for example, because the company is not financially able to do so, or because the claim relates to a liability to which the prohibitions apply).
  • Side B which reimburses the company for the indemnity which the company grants to a director or officer pursuant to an Indemnity Deed (for example, permitting the company to recoup the legal costs for which it has indemnified the director or officer).
  • Side C which indemnifies the company for claims relating to its securities brought by shareholders, such as for alleged breaches of continuous disclosure or other market conduct requirements. In the current environment in which we are seeing an increasing number of securities class actions being issued against publicly listed companies, side C cover is becoming an important element of a company's risk management.

Prohibition against paying insurance premiums

In most instances, a director or officer will be covered by D&O Insurance (side A) for liabilities and legal costs which the company is prohibited from indemnifying. However, s 199B of the Corporations Act goes one step further, prohibiting a company from paying premiums for an insurance policy which indemnifies a director against liability for:

  • wilful breaches of duty; or
  • misuse of their position (s 182 of the Corporations Act) or misuse of information (s 183 of the Corporations Act).

This is a narrower prohibition than the prohibition on indemnity for liability and legal costs. This prohibition focuses on wilful acts by directors or officers for which they should not indemnified by D&O Insurance. As noted above, an Indemnity Deed may provide for a director or officer to pay for the portion of a premium which the company is not permitted to pay, which enables a director or officer to ensure that he or she is still adequately covered by D&O Insurance.

Subject to the prohibition in s 199B of the Corporations Act on a company paying premiums for certain D&O Insurance policies, D&O Insurance policies can fill the gap and provide indemnity to a director or officer in circumstances in which a company is prohibited from
indemnifying him or her.

CONCLUSIONS

A company's in-house counsel should pay close attention to the prohibitions in s 199A in drafting an Indemnity Deed in favour of the company's directors or officers to ensure that it provides adequate protection and includes the key components usually found in an Indemnity Deed, while at the same time, ensuring that it does not contravene any of the prohibitions on indemnity or payment of legal costs under s 199A.

The crux of the prohibitions under s 199A and s 199B of the Corporations Act is that they focus on conduct towards the company itself, or on conduct which is accompanied by some intention, lack of good faith and wilful breach. A company may properly indemnify a director for liability which is not motivated by such conduct.

The prohibitions on a company indemnifying or paying legal costs for claims against a director or officer shift the focus to ensuring that a company procures and maintains adequate D&O Insurance. A director or officer may feel comforted by entering an Indemnity Deed with his or her company. However, he or she must bear in mind that an Indemnity Deed will not indemnify him or her, or meet his or her legal costs, for all claims.

A director or officer should ensure that he or she has adequate cover, through D&O Insurance, for the risks that he or she may face as a director which are not covered by their Indemnity Deed. Companies and their directors and officers should pay close attention to the terms and exclusion clauses of their D&O Insurance policies to ensure that they provide adequate cover (or indemnity) for the risks of litigation which their directors and officers may potentially face, and take advice from their insurance brokers and lawyers as appropriate.

Footnotes

1 Leckenby v Note Printing Australia Ltd (2014) 291 FLR 32; [2014] VSC 538; BC201409444.
2 Note Printing Australia Ltd v Leckenby (2015) 106 ACSR 147; [2015] VSCA 105; BC201504058.

Andrew Komesaroff Andrew Probert Adam Meyer
Directors and officers
Colin Biggers & Paisley

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Andrew Probert
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