Indemnity and D&O Insurance: A brief summary for directors and officers

Directors and officers of companies are subject to numerous statutory duties and can face a wide range of claims giving rise to civil and criminal liability for breaching them. Regulators with the power to investigate and pursue civil or criminal penalties for wrongful conduct include the Australian Securities and Investments Commission (ASIC), the Australian Competition and Consumer Commission (ACCC), the Australian Taxation Office, the Australian Federal Police, and the Environmental Protection Authority, amongst others.

The amount of legal and other professional costs incurred by a director or officer in the defence of a claim against them or in connection with an investigation is often substantial, as are the civil and criminal liabilities.

As regulation increases in corporate Australia, directors and officers face a growing financial risk. It is therefore important for companies to safeguard individuals who are exposed to risk on a company’s behalf and ensure they receive adequate protection.

This article outlines:

• the primary sources of financial protection to directors and officers being indemnity under a company’s constitution and/or in a Deed of Access, Indemnity and Insurance, and Directors and Officers Insurance (D&O Insurance)
• some of the important limitations on the extent to which a director or officer can or will be indemnified by the company or insured under D&O Insurance.

Indemnity

Companies can agree to indemnify their directors and officers for liability incurred by them in their capacity.

A company’s constitution usually sets out indemnification rights for directors and officers and provides for D&O Insurance. However, it is preferable for them to also enter into a Deed of Access, Indemnity and Insurance with the company, considering that constitutions can be amended by members and often, the indemnity provided for in the constitution ceases to apply if the director or officer vacates office.

A Deed of Access, Indemnity and Insurance is an agreement between the company and a director that:

• gives the director/officer access to company records (including after the director/officer ceases to be a director/officer of the company)
• indemnifies directors/officers for liabilities and legal costs that arise from being a director/officer of the company (to the extent permitted by law)
• mandates that the company arrange D&O Insurance on the director’s/officer’s behalf.

There are statutory limitations on the extent to which a director or officer can be indemnified by the company. These restrictions effectively establish the minimum standard required for a director to be indemnified or insured and conversely, what conduct could expose the director to personal liability without the protection of an indemnity or insurance.

Section 199A(2) of the Corporations Act 2001 (Cth) (CA Act) prohibits a company from indemnifying a person against any of the following liabilities incurred as an officer of the company (other than a liability for legal costs):

• a liability owed to the company or a related body corporate
• a liability for a pecuniary penalty order under section 1317G, or a compensation order under sections 961M, 1317H, 1317HA, 1317HB, 1317HC or 1317HE of the CA Act
• a liability the director owes to someone other than the company or a related body corporate which did not arise out of conduct by the person acting in good faith.

In addition, section 199A(3) of the CA Act prohibits a company (or its related body corporate) from indemnifying a director for legal costs where the costs are incurred:

• in defending or resisting an action for a liability where the director is found to have a liability for which they could not be indemnified in the situations referred to in section 199A(2) (summarised above)
• in defending or resisting criminal proceedings in which the director is found guilty
• in defending or resisting proceedings brought by ASIC or a liquidator for a court order if the court finds the grounds for making the order to be valid (unless the costs are incurred in responding to actions taken by ASIC or a liquidator as part of an investigation before commencing proceedings for the court order)
• in connection with proceedings for relief under the CA Act where the court denies relief.

In considering the limitation on the indemnification of legal costs provided in the CA Act, it is important to note that:

• a director may be indemnified by a company for legal costs arising out of criminal or civil proceedings the director successfully defends
• a company can make payments to a director or officer in the course of litigation in respect of legal costs incurred by them in defending a liability described in section 199A(3). To comply with the CA Act, the director or officer must repay these costs if later they are found to have a liability described in section 199A(3). 

D&O Insurance

Given the various prohibitions on company indemnities and that such indemnities are based on the company’s financial capacity and willingness to pay, D&O Insurance is an important part of the protection afforded to directors and officers for liability resulting from claims against their managerial decisions and actions.

D&O Insurance typically is comprised of three separate agreements, called Side A, B and C:

• Side A covers claims against directors and officers not indemnified by the corporation, for example, in the case of a company’s insolvency
• Side B is for the benefit of the corporation. When a corporation does indemnify directors and officers, Side B provides reimbursement to the company
• Side C is triggered when a securities class action is made against an entity.

The scope of coverage under a D&O Insurance Policy depends on the agreement’s provisions. Such policy needs careful review as it contains exclusion clauses ranging from insolvency exclusions to non-disclosure that the insurer can rely upon to deny coverage.

In addition, section 199B of the CA Act prohibits a company from purchasing insurance for its directors and officers against a liability (other than one for legal costs) arising out of:

• conduct involving a wilful breach of duty in relation to the company
• a contravention of sections 182 or 183 of the CA Act (being improper use of their position to gain a personal advantage or cause detriment to the organisation, or improper use of information to gain a personal advantage or cause detriment to the organisation).

To reflect this prohibition, D&O Insurance Policies typically contain an exclusion that excludes cover for claims arising out of conduct in respect of which a liability is the subject of a prohibition in section 199B.

Key takeaways

A person seeking to take on a director’s/officer’s role should carefully review the company’s constitution, any Deed of Access, Indemnity and Insurance, and applicable D&O Insurance Policy to ensure that they are adequately protected against financial risk arising from their position. This should involve obtaining a copy of the whole D&O Insurance Policy and carefully reviewing it.

If a claim is made or an investigation is commenced against a director or officer, they should seek legal advice to clarify the scope of the financial protection provided in respect to the particular claim made against them.

If you have any questions about your company’s D&O Insurance Policy or need assistance with any disputes with insurers, please get in touch with our team below.

Disclaimer
The information in this article is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this article is accurate at the date it is received or that it will continue to be accurate in the future.

Published by:

Howard Rapke

Anthea McGurty

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