UK: Ability of Companies to Indemnify Their Directors

On 6 April 2005 changes in the law came into effect which widen the circumstances in which a company can protect its directors against liability incurred by them in their capacity as directors. The Companies (Audit, Investigations and Community Enterprise) Act 2004 has effected these changes by amending the Companies Act 1985 (the "Companies Act").

Under the Companies Act, companies were previously not permitted to exempt directors and auditors from, nor indemnify them against, liability where they were negligent, in default or in breach of duty or trust; the reason for this was that Parliament thought that if a director breached his duties to the company, he should have to face the consequences of his dereliction of duty.

Most companies included in their Articles of Association a very limited form of indemnity for their directors, but in reality directors relied on the directors’ and officers’ liability insurance maintained for them by the company.

The basic prohibition against a company indemnifying its directors against liabilities incurred by them as directors still stands, but, in order to address concerns that directors of companies with a US listing may face class actions in the US, and to help alleviate the costs to directors of lengthy court proceedings, the new Act provides that companies will be permitted to:

• indemnify directors against any liability for costs or damages incurred by them in a civil action brought by a third party (i.e. not the company or any associated company), whether they win or lose;

• indemnify directors against any costs relating to criminal proceedings or a civil action by a third party or an action by the company or any associated company where the director wins;

• pay directors’ legal costs upfront, provided that the director repays such costs if he is convicted in any criminal proceedings or judgement is given against him in any civil proceedings brought by any third party or the company or any associated company;

• do anything to enable him to avoid incurring such expenditure (such as providing a guarantee as to a solicitor’s costs);

• exempt the company secretary from, or indemnify him against, liability, including liability to the company; and

• purchase directors’ and officers’ liability insurance, as permitted previously.

However, companies may not:

• indemnify directors against liabilities to the company or to any associated company;

• indemnify directors against criminal penalties or penalties imposed by regulatory bodies such as the Financial Services Authority;

• indemnify a director against any liability incurred by him in defending any criminal proceedings in which he is convicted or in an unsuccessful application for relief from liability under the provisions for relief in the Companies Act.

In practice, many directors will still rely on directors’ and officers’ liability insurance as their primary protection against such claims. However, companies may consider it worthwhile to pass a shareholders’ resolution to amend their Articles of Association in order to update their Articles to reflect the new law.

Jones Day would be happy to assist any company that wishes to effect such changes to its Articles of Association.

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.