Minimising directors liability

This article explores a potential method of minimising directors liability. Company directors have many responsibilities when carrying out their duties. Generally, company directors are not personally liable for a company’s debts. However, certain circumstances can arise in which directors may find themselves personally facing legal or other regulatory action.

In addition to potential civil proceedings being brought against a company and personally against its directors, regulatory bodies such as the Australian Securities and Investment Commission (ASIC) have the power to personally fine directors for certain breaches of company law.

The threat of personal liability could cause directors to become overly risk-averse which may jeopardise potential opportunities for the company’s growth and development. It is therefore appropriate that companies might wish to protect its directors against such liability and that company directors should insist on that protection.

What is a deed of indemnity, access and insurance?

It is important to note that liability cannot be completely avoided. However, directors may minimise personal exposure through a deed of indemnity, access and insurance. This is a contract by which a company agrees to indemnify its director for liability incurred in his or her capacity as director during the period they hold that office.

Company constitutions may contain indemnification clauses for directors and company officers; however, these alone are not usually sufficient or tailored to provide maximum protection. Further, a constitution may be amended without a director’s consent and any protection afforded generally ceases to bind the company once a director no longer holds office.

In addition to indemnification, the deed should allow directors ongoing access to company records and information and require the company to hold directors or officers insurance.

Following is an overview of the main components of a deed of indemnity, access and insurance.

Indemnification

The level of protection under the deed will be the outcome of negotiations between the company and director and subject to statutory restrictions.

The indemnity should endure beyond resignation/termination of the director’s position. Ideally, it should be unlimited in duration. However, at the very least, it should extend to the seventh anniversary after the date a director vacates the position, to allow for the expiration of the six-year limitation period for a majority of civil claims.

Directors should insist on protection for all personal liability including legal costs arising from any proceedings or claims made against the company or the director personally. The indemnification should cover, not only legal proceedings but the costs of participating in investigations and complying with audits, etc.

Protection should be as broad as possible noting this will be limited by legislation that prohibits a company from indemnifying its officers in certain circumstances, such as:

  • a liability owed to the company or a related body corporate. For example, a liability arising from a breach of statutory and common law duties owed to the company such as fraud, dishonest conduct, criminal behaviour or a lack of good faith; and
  • certain penalties and compensation orders specified in s.199A(2)(b) of the Corporations Act 2001 (Cth) (“Corporations Act”).
  • a liability owed to someone other than the company or a related body corporate that did not arise out of something the director did in good faith.

The indemnification provided is usually expressed as ‘indemnification for all liabilities incurred to the maximum extent permitted by law’.

The deed should allow immediate funding to enable a director to respond effectively to a request for compliance or to defend potential or actual legal proceedings. Provisions should also allow the director to exercise some level of control over proceedings, for example, consenting to or rejecting settlement offers and obtaining independent legal advice if a conflict of interest arises.

Access to company documents

Access to company records, during and after holding office as a director, is essential to ensure directors can properly answer an audit or defend themselves if they are personally sued.

The Corporations Act provides statutory rights for directors to access company documents and inspect financial records for the purposes of legal proceedings for up to seven years after ceasing to be a director. However, this right is restricted to circumstances where the person requiring access is a party, or prospective party, to legal proceedings. Consequently, a former director may not be able to access material relevant to an ASIC investigation or Australian Taxation Office audit.

The deed should specify the access required and include, but not be limited to, board papers, minutes, agendas, register of members, legal advice or opinions provided during the course of the director’s tenure, emails and documents sent and received by the director and all financial records and statements for an indefinite period or at least seven years after ceasing to be a director.

The deed should also make it mandatory for the company to maintain all compulsory financial and other records.

Directors and officers insurance

For optimum protection, the deed should require the company to hold and maintain directors’ and officers’ insurance (known as D&O insurance). The level of protection is set out in the policy document which may protect directors for:

  • damages or compensation awarded to claimants in legal proceedings including their own legal costs and, in some circumstances, those of the claimant;
  • civil penalties raised by regulators such as ASIC (subject to some exclusions);
  • other expenses arising out of the claim.

A claim may include legal action taken by shareholders, employees, regulatory authorities, creditors, competitors and clients, as well as the company itself and other directors of the company.

The policy may not provide cover against a director’s conduct involving a wilful breach of his duty towards the company, or a contravention of s.182 (improper use of information), or s.183 (improper use of position) of the Corporations Act.

The director should obtain a copy of the policy document itself and take advice from a knowledgeable insurance broker concerning the different cover options available.

It is advisable to insist on a policy that will provide cover to the director even when the company is under administration or in liquidation.

The Australian Institute of Company Directors has published some useful information about D&O insurance on its website.

Conclusion

Directors may be exposed to personal liability for losses incurred while directing and managing a company. Such risks, however, should not prevent a director from appropriately exploiting commercial opportunities and may be mitigated by having in place a deed of indemnity, access and insurance.

Directors negotiating such deeds should obtain independent legal advice to ensure optimum protection appropriate to their personal circumstances.

If you or someone you know wants more information or needs help or advice, please don’t hesitate to contact us.

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