Introduction
One of the more striking features of Bermuda company law is just how difficult it is for a company to sue its directors. Section 98 of the Companies Act 1981 permits companies to exempt and indemnify their directors in respect of their personal liability for breaches of duty and breaches of trust. The only exceptions are cases of fraud or dishonesty. As a result, waivers and indemnities are prevalent in the bye-laws of most Bermuda companies and provide an effective shield for directors accused of breach of fiduciary duty. Indeed, a common working assumption is that a Bermuda company can only sue its directors if it can prove fraud or dishonesty (a high hurdle). However, it may now be time for a re-think.
The issue was debated in two recent decisions by the Court of Appeal in Global Distressed Alpha Capital I Limited v Herman and Eddlestone: [2023] CA (Bda) 12 Civ and [2024] CA (Bda) 14 Civ.
The GDACI case at first instance: no claim absent fraud or dishonesty
Global Distressed Alpha Capital I Limited (GDACI) pursued claims against two former directors, alleging that they had made substantial payments to third party entities which they personally owned or controlled. GDACI's claim had originally started out as a case based on dishonesty but was then amended and watered down. The amended claim withdrew allegations of dishonesty and pleaded simply that the payments were "wrongful" and in certain cases "not made in good faith".
The directors argued that GDACI's claim, as amended, should be struck out. It failed to allege fraud or dishonesty, which (they said) was fatal. The amended claim was defeated by the waiver and indemnity provisions in GDACI's own company bye-laws. Insofar as relevant, these provided:
"42 Indemnity
42.1 Subject to the proviso below, every Indemnified Person [defined to include any director or officer] shall be indemnified and held harmless out of the assets of the Company against all liabilities, loss, damage or expense (including but not limited to liabilities under contract, tort, and statute or any applicable foreign law or regulation and all reasonable legal and other costs and expenses properly payable) incurred or suffered by him by or by reason of any act done, conceived in or omitted in the conduct of the Company's business or in the discharge of his duties and the indemnity contained in this Bye-Law shall extent to any Indemnified Person acting in any office or trust in the reasonable belief that he has been appointed or elected to such office or trust notwithstanding any defect in such appointment or election PROVIDED ALWAYS that the indemnity contained in this Bye-Laws shall not extend to any matter which would render it void pursuant to the Companies Act.
[...]
42.5 Each Shareholder and the Company agree to waive any claim or right of action he or it may at any time have, whether individually or by or in the right of the Company, against any Indemnified Person on account of any action taken by such Indemnified Person or the failure of such Indemnified Person to take any action in the performance of his duties with or for the Company PROVIDED HOWEVER that such waiver shall not apply to any claims or rights of action arising out of the fraud of such Indemnified Person or to recover any gain, personal profit or advantage to which such Indemnified Person is not legally entitled."
[underlining added]
At first instance the former Chief Justice Hargun agreed with the directors. He held that bye-laws 42.1 and 42.5 should be read "cumulatively". The net effect was that the directors were shielded against all claims short of fraud or dishonesty. GDACI's claim (as amended) could not survive. Applying established case law, the Chief Justice struck out the claim because it disclosed no reasonable cause of action; see [2021] SC (Bda) 83 Civ (applying Intercontinental Natural Resources Ltd (in liquidation) v The Partners of Conyers, Dill & Pearman and others [1982] Bda LR 1).
The Court of Appeal's decision: an alternative reading of the bye-laws
On an appeal by GDACI, the Court of Appeal unanimously disapproved of the "cumulative" approach to construing the bye-laws. It delivered two judgments.
In its first judgment, it reasoned that "each paragraph had a separate function – otherwise one or other bye-law is surplusage or otiose".1 Applying that logic, bye-law 42.1 was outward-facing and applied to external claims against a director by third parties; while bye-law 42.5 governed internal claims against a director by GDACI and its shareholders. The final words in bye-law 42.5 (underlined above) preserved GDACI's ability to recover "any gain, personal profit or advantage to which [the directors] were not legally entitled". That potentially left room for other claims short of fraud or dishonesty (for example, a claim for disgorgement of profits).
The Court held that GDACI's amended claim was (even then) still inadequately pleaded but chose to throw it a lifeline. It gave GDACI one more chance to further amend its pleading.
Third time lucky?
GDACI's application to re-amend was contested and resulted in a further judgment from the Court of Appeal.2 In its re-amended claim – by now, its third attempt to state its case – GDACI changed tack. It argued that by authorising payments to third parties, the directors had breached their duties of undivided loyalty to GDACI and as a result had profited personally. GDACI sought an account of profits. The Court of Appeal recognised such a claim was viable in principle but refused leave to amend. Exercising its discretion, it the Court noted that even the re-amendment was inadequate (failing to formulate the "profits") and that it was in any event being advanced far too late (over 10 years since the conduct complained of). Thus the sting, for GDACI, was in the tail.
Learning points
There are several takeaways from the judgments in GDACI:
- Bye-law indemnities must be read with an open mind – often, more than one reading is possible. The Chief Justice had considered GDACI's bye-laws were clear-cut in favour of its directors; yet the Court of Appeal derived a very different meaning. It is no longer safe to assume that a director's liability will be limited to fraudulent or dishonest breaches only.
- For directors and their D&O insurers there can be no room for complacency. Now may be a good time to re-visit the company's bye-laws, especially any boilerplate indemnity clauses, to look for gaps in protection. In order to gauge a director's true exposure, a discerning eye is required to see precisely what is, or is not, covered by any indemnity or waiver. The devil will be in the detail.
- For those looking to bring claims against directors (namely, companies, their liquidators or shareholders), the GDACI case arguably encourages plaintiffs to look for chinks in the armour and to get creative with formulating their claims. An inability to plead fraud or dishonesty is not always fatal. It may be possible formulate other claims that cut through indemnities (for example, proprietary or restitution-based claims). As the second GDACI judgment illustrates, however, framing the right claim in the right way requires precision and can, of course, still be fiendishly difficult.
Marshall Diel & Myers Limited acted for Walton Eddlestone in the GDACI case.
LINKS:
2023 judgment
2024 judgment
Footnotes
1. ADD ref: first judgment, para.29
2. ADD ref
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