DIRECTORS AND OFFICERS: TRANSFERRING RISK WITH DEEDS OF INDEMNITY

This article is the third in a series of 4 articles on director protection.  In our first article, we asked new and existing directors to consider their potential exposure, and then to consider the mechanisms which may be available to protect against that exposure.  Our second article focused on D&O insurance.  This article focuses on deeds of indemnity.

A director's deed of indemnity is, essentially, a contract between the company and the director in which the company agrees to indemnify the director against any liability, costs and expenses incurred by the director in connection with his or her role as a director.  A deed of indemnity can in many circumstances provide the director with greater protection than the director would have under a D&O insurance policy or under the company constitution.  It is not uncommon for prudent directors to have D&O insurance and a deed of indemnity in place.

However, the company cannot indemnify the director in respect of every liability.  There are some liabilities which the law precludes.  Section 199A of the Corporations Act 2001 (the "Act") provides that the company cannot indemnify the director in respect of:

The company's constitution might also contain an indemnity provision.  Section 140 of the Act provides that the company's constitution has the effect of a contract between the company, its members and its directors.  A serving director will be able to enforce the constitution against the company, and so be able to enforce the right of indemnity.  A former director, on the other hand, will be unable to enforce the right of indemnity in the constitution.  Deeds of indemnity which offer protection to former directors are therefore highly desirable.

Insurance

Ideally, the deed of indemnity will require the company to:

D&O insurance was discussed in further detail in our November newsletter, and a copy of this is available on our website.

Access to company documents and records

It is important that a director has a right to access company documents and records, as these can provide a director with the evidence they need to mount a defence.

Under sections 198F(1) and 290 of the Act, a serving director has a legal right to inspect the company's books and financial records.  However, a former director's rights are far more limited.  Section 198F(2) of the Act provides that a former director may inspect the company's books and financial records, however this right only lasts for 7 years, and only applies where access is required for the purposes of legal proceedings.  These limitations have the potential to be problematic.  It is, for example, possible that access may be required for longer than 7 years.  Also, where access is required for the purposes of an ASIC investigation, Royal Commission or parliamentary inquiry, there may be some doubt as to whether or not this constitutes "legal proceedings".  A deed of indemnity is able to expand the former director's rights to cover these situations.  It is especially important that former directors are able to inspect any relevant Board papers.

Furthermore, some documents may be subject to legal professional privilege ("LPP").  If the company chooses to claim LPP in respect of a particular document (e.g. a letter of advice from the company's lawyers), the former director will be unable to inspect that document, and will be unable to use that document in his or her defence e.g. see South Australia v Barrett (1995) 64 SASR 73.  This scenario is more common than one might think.  For example, if the company obtained legal advice in respect of a particular matter and the director conducted himself or herself in accordance with the advice, and then the director's conduct becomes the subject of an inquiry, the Company may claim LPP in respect of the advice and thereby deprive the director of the ability to rely on the advice in defending himself of herself.  Following cases like Barrett, deeds of indemnity have become far more common. 

Defence costs and legal proceedings

A typical deed of indemnity will require the company to indemnify the director in respect of reasonable legal costs and expenses incurred by the director in defending proceedings as a director (or former director). 

Often, when proceedings are commenced against a director, the director will need to seek costly legal advice, often at very short notice.  Ideally, the deed of indemnity will also require the company to pay the director an advancement of legal fees.  It can often take some time before legal fees are advanced under a D&O insurance policy.  Most deeds of indemnity which require the company to pay the director an advancement of fees also require the director to repay any fees that have been advanced, if a court makes an adverse finding of dishonesty or bad faith against the director.

Like D&O insurance policies, many deeds of indemnity enable the company to defend claims on behalf of the (current or former) director.  They may also require the director to cooperate with the company in defending any claims.  Some deeds of indemnity allow the company to settle claims without the consent of the director.

Case study

A recent well-known example of directors' liability in action is the case of Forest v Australian Securities & Investments Commission (2012) 291 ALR 399.  In that case, the High Court considered whether Andrew Forest was liable for misconduct in his capacity as chairman of Fortescue Metals Group Ltd (FMG).  Section 674 of the Corporations Act 2001 requires listed companies to notify the ASX of information about specified events or matters as they arise for the purpose of the ASX making that information available to participants in the market.  This is often called the "continuous disclosure requirement".  During 2004, FMG entered into agreements with three Chinese state-owned entities with respect to building and financing the railway, port and mine for the Pilbara Iron Ore and Infrastructure Project.  FMG represented to the market that it had entered into binding contracts with the Chinese entities to build and finance the railway, port and mine for the Project.  In March 2005, an article appeared in the financial press suggesting that the agreements were not "binding contracts".  This prompted ASIC to commence proceedings against FMG and Mr Forest.  ASIC claimed that FMG had engaged in misleading or deceptive conduct and had breached section 674 of the Act.  ASIC also claimed that Mr Forest had breached his duty as a director to exercise his powers and discharge his duties with reasonable care and diligence.  The High Court dismissed ASIC's claim, finding that FMG had not engaged in misleading or deceptive conduct, and accordingly that Mr Forest had not breached his duty as a director.

In the above scenario, it is conceivable that:

It is unlikely that FMG would have been able to recover its own legal costs in respect of the proceedings, e.g. see Intergraph Best (Vic) Pty Ltd v QBE Insurance (Australia) Limited [2004] VSC 433 which was discussed in our November newsletter.

Tips:

 

Required Action

If you are a director, ensure that you have an up to date deed of indemnity which has been checked by an experienced solicitor who acts for you.