Australia: Hidden Dangers In Overly-Generous Deeds Of Indemnity For Directors
Last Updated: 28 October 2002

The recent community outrage over excesses of some directors will throw a sharp spotlight on deeds of indemnity that are overly-generous to directors, said Emilios Kyrou, partner, Mallesons Stephen Jaques, at the LexisNexis Corporate Governance Summit held on 28th October in Sydney.

Mr Kyrou said that, since about 1995, it had become standard practice to indemnify directors to the maximum extent permitted by the law. In some cases, this occurred without sufficient focus on whether the indemnities were fair and reasonable from the point of view of the company.

"In the current environment, there is a risk that a one-sided deed may come before a court, and that it may not survive judicial scrutiny," said Mr Kyrou.

"It is important for companies and their advisers to realise that deeds which confer benefits on directors should be reviewed regularly to ensure that they meet present-day standards of fairness and reasonableness."

Regular reviews of the benefits conferred by such deeds are also important from the perspective of directors. If a court found an indemnity to be completely one-sided (in favour of a director), it could grant an injunction preventing any payments.

"The greater the success directors have in forcing their company to agree to generous benefits, the more they run the risk of not being able to enjoy those benefits," Mr Kyrou said.

The deeds at greatest risk are those that were drawn up before 1 July 2001, as they are more likely to contain onerous indemnities and obligations to maintain a particular level of Directors’ and Officers’ insurance, which the company cannot meet in the current insurance environment.

"These deeds should be urgently reviewed," said Mr Kyrou.

Deeds of indemnity for directors have evolved since 1994. In time, the right of indemnity, the right of access (to company documents), and the right to be covered by Directors’ and Officers’ insurance were combined into one deed, and directors sought to maximise the benefits available to them.

Typical deeds are not limited to particular types of liabilities and do not have a monetary cap on the company’s exposure. "By entering into such a deed, the company is undertaking contingent liabilities of unknown amounts which may arise in unknown circumstances," Mr Kyrou said.

HIDDEN DANGERS IN OVERLY-GENEROUS DEEDS OF INDEMNITY FOR DIRECTORS

Another concern is that many deeds are inflexible and do not contain an amendment or revocation clause to enable the company to reduce its exposure to future liabilities in light of changed circumstances, unless the director consents.

Some companies are taking on contractual obligations whose performance lies largely outside the company’s control. This is irresponsible, Mr Kyrou said.

Mr Kyrou also noted that recent changes to the Corporations Act dealing with payment of the premium for Directors’ and Officers’ insurance may mean that some companies may be inadvertently committing a criminal offence of strict liability even if the directors pay part of the premium.

Mr Kyrou pointed out that in the recent ASIC v Adler case, the court held that causing a company to enter into an agreement which confers unreasonable personal benefits on a director is a breach of the director’s duties in sections 180, 181 and 182 of the Corporations Act.

Deeds of indemnity, access and insurance represent a classic conflict of interest scenario for directors, Mr Kyrou said.

Mr Kyrou warned that unless new deeds are drafted carefully, and existing deeds reviewed regularly, they may contain time bombs which could cause severe financial or legal difficulties for the company or the director in the future.

Guidelines for negotiating the "ideal" deed

The ideal deed of indemnity, access, and insurance should strike a reasonable and fair balance between the interests of the director and those of the company.

Prudent guidelines for negotiating such a deed are:

  • The director and company should be represented by different lawyers.
  • The director should be represented by lawyers who do not usually act for the company.
  • The deed should be prepared by the company’s lawyers, and the onus should be on the director to justify any changes.
  • Negotiations should be conducted on an arm’s length basis.
  • The extent to which the company’s obligations under the deed will be picked up under Directors’ and Officers’ insurance, should be taken into account.
  • The director should not participate in any board discussions or voting on the deed.
  • Although shareholder approval is not required, it should be considered in the interests of full disclosure.

For further information, please contact:
Beverley Pinder (03) 9686 5344
Rowland Pinder Pty Ltd

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