Indemnifying directors against legal liabilities and costs

Directors can ask their companies to foot the bill for legal claims made against them. This leaves company directors less vulnerable to the risk of personal bankruptcy, but does that leave the company exposed?

Company directors can be made personally liable, sometimes for unlimited damages, if they are accused of negligence or other wrongdoing. Legal liabilities lurk everywhere – company law, health and safety rules, trading law can all land you in trouble. Having to pay your legal costs as they arise in a heavyweight legal claim against you might mean you face bankruptcy before the court even reaches a decision.

Security offered by the company

Companies can give you security by indemnifying you against your legal liabilities or costs in more of these situations – sometimes even when the claim against you is by the company itself.

What costs can be covered?

For creditor, employee or shareholder claims against you the indemnity agreement can state that the company will pay your legal costs as they arise. If you lose, the company can also agree to pay the damages awarded against you, and any of the other side’s costs awarded against you. Alternatively, it can provide that you will get nothing further – and must pay back any money it’s already paid towards your legal costs.

If the claim is by the company itself – for breach of your duty to act in its best interests, for example - it can agree to pay your legal costs as they arise, but you must repay them if you lose.

Of course, your company can’t indemnify you for any damages awarded against you, or for any of its legal costs that the court says you have to pay.

The company can pay your legal costs if a criminal case is brought against you, as they arise, but you have to repay them if you are found guilty. You can’t be indemnified against fines from regulatory authorities, or fines imposed if you are found guilty of a criminal offence.

Put indemnities in writing

So the company has a choice whether and how it will indemnify its directors. If it wants to protect its directors, it should:

• Make sure the company’s articles of association authorise the directors to make the necessary arrangements.
• Ensure the directors disclose indemnity arrangements in their annual report and accounts. The disclosure requirement applies to each year the indemnity arrangement is in force, not just the year in which it was granted.
• Retain all indemnity provisions, and make them available for inspection, for a further year after they have expired or terminated.
• Consider Directors’ and Officers’ Indemnity insurance to ensure that there is no situation which would not be covered by the insurance policy or the protection given by the company.
• Consider entering into separate indemnity agreements with the directors.

If in doubt, take legal advice.