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Companies Act clears some muddy water

23rd July 2009

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One of the most controversial aspects of our company law concerns whether a company can indemnify its directors when they breach their common law or fiduciary duties, and, related to this, whether a company can take out an insurance policy protecting itself and its directors against this type of liability.

These issues are currently regulated by section 247 of the Companies Act, 1973. This provision is far from a model of clarity, and few will mourn its demise once the new Companies Act, 2008, comes into force next year. Section 247 voids any provision in the articles of the company or in any contact with the company which exempts any director from liability for negligence and breach of his fiduciary duties in relation to the company, or which indemnifies the director against such liability. This prohibition appears to hit liabilities owed by directors towards the company - these liabilities cannot be indemnified. On this interpretation, companies are, however, permitted to indemnify their directors against liabilities owed to third parties.

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In 1998, in an amendment to the act, a proviso was added to section 247, which was meant to take into account the recommendations in the second King report that directors should be given greater protection in this context. The proviso that was inserted into section 247, however, muddied the waters even further: on a proper interpretation, it simply states that the prohibition against indemnifying or exempting directors does not affect a company's ability to take out insurance to protect itself against any liability of a director towards the company. But this point is obvious and it was certainly not necessary for the legislature to intervene to make it . What was intended, but not achieved, in the amendment was to stipulate that companies are permitted to take out insurance that will benefit their directors. As the position stands, thus, it may be the case that many insurance policies taken out by companies that purport to protect directors and officers offend the prohibition against indemnifying directors, unless those policies are limited to liabilities owed by the director to third parties.

The question is whether the new Companies Act fixes this mess. It does so to a large extent, in section 78. Four principles inform the new provision. First, any provision of the memorandum of incorporation, an agreement, the company's rules, or any of its resolutions, which purport to relieve a director of a duty or liability, is void. But second, and important, section 78 changes the point of departure from the existing act radically. Whereas the existing provision prohibits indemnification by the company of its directors, the new act allows for indemnification in respect of both directors' liabilities owed to the company as well to third parties. There are three categories of liability where this general rule does not apply:

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* Wilful misconduct or wilful breach of trust by a director;
* Fines imposed on the director due to his or her conviction of an offence in terms of any national legislation; and
* Where the director knowingly acts without authority in relation to the company; acquiesces in the carrying on of the company's business recklessly, with gross negligence, with intent to defraud any person, or in insolvent circumstances; or was a party to an act calculated to defraud a creditor, employee or shareholder.

The third principle is that the ability of the company to purchase insurance to protect itself or its directors is now linked to its ability to indemnify its directors. This means that, provided the insurance does not relate to any of the three categories mentioned above, insurance can be purchased, regardless of whether the liability of the director concerns the company or third parties, and regardless of whether the insurance benefits the company or the directors.

In summary, section 78 must be welcomed to the extent that it removes some of the anomalies that have plagued the present regime. Amid all the alarmist talk about how the new Companies Act will make directors run for the hills, at least the act's provisions on indemnification and insurance should provide them with some solace.

Written by: Dario Milo, partner at Webber Wentzel.


First published in Business Report, 13 July 2009.

 

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