UK: The Move To Limited Directors´ Liability - A Lifeline Or Another Missed Opportunity?

When directors are sued, they expect their companies to stand by them, and with good reason; they have worked hard for the company and expect their loyalty to be repaid. Sometimes the company is inclined to stand by them and sometimes it is not. But what many directors may not realise until too late is that there are severe restrictions on the indemnity a company can give its directors against even the costs of legal proceedings.

At present, a company cannot indemnify a director against proceedings for negligence and related matters unless judgment is given in his favour, or if he is acquitted. What this invariably means is that a director needs to fund the entire proceedings from another source. It is only if the result at the end of the case is favourable that the company can safely indemnify the director. As the Government has put it, this may come too late. What the director really wants is to ensure that his defence costs can be funded properly so that he can prepare the best defence available. Indeed, the indications from the Government consultation on the matter are that such issues have been affecting the recruitment and behaviour of directors.

The Government has now introduced a suite of proposals to change the position.

The background to this is the Government's consultation on the extent to which the indemnification regime for directors should be relaxed. Having received responses from a number of sources, it has recently suggested several amendments to the Companies Act 1985 to relax the regime. It has now introduced these as proposals into the Companies (Audit, Investigations and Community Enterprise) Bill, as amendments to the Companies Act. However, the amendments suggested do not quite deliver what the Government has promised and the matter will be debated further before final revisions are agreed.

If passed, the suggested amendments will allow companies in certain specified circumstances to pay directors' legal costs in advance of the outcome of proceedings. This would be a very welcome result for directors. There are however a number of important restrictions on the proposals that detract from the good news.

First, there would be no relaxation of the rules where the company itself is suing the director, or where an associated company is doing so. This is surprising given the Government's announcement to the Houses of Parliament on 7 September that it would allow this in certain circumstances.

Second, the proposals would not allow a company to indemnify a director against fines in criminal proceedings or penalties payable to a regulatory authority. Many directors will be very concerned about this and question why they should be left to meet those costs if they were honestly and diligently doing their jobs. The position appears even more unfair where the director is not even personally culpable, but where he has instead had to accept corporate responsibility for a failure. Such directors might be forgiven for thinking that they have been hung out to dry.

Third, the proposals would not allow the funding of defence costs in criminal proceedings until after the result was known and then only if the director was not convicted. This would effectively be a return to the current position for criminal proceedings. That is, directors would have to fund the proceedings from another source right up until final judgment. Any help that they may be offered by the regime would come too late for those directors who are unable or unwilling to fund defence proceedings properly themselves.

Directors would be well advised to watch the progress of the proposed amendments very carefully. The devil really is in the detail of these proposals and their actual significance needs to be assessed once the wording of the amendments is agreed upon. We have already seen for example that the Government has failed to deliver on one of its suggestions about the relaxation, and it remains to be seen what else may change.

Once the amendments have been debated and agreed, directors will need to analyse carefully the extent to which their companies will be permitted to indemnify them. Armed with that analysis, directors will want to negotiate with their companies to obtain a valid commitment to indemnify them to the maximum extent possible.