Section 140 of the Companies Act 1997 starts from a prohibition and then carves out what is permitted.
Sections 140(1) and (2) — the starting point
Except as provided in this section, a company shall not indemnify, or directly or indirectly effect insurance for, a director or employee of the company or a related company in respect of —
(a) liability for any act or omission in his capacity as a director or employee; or
(b) costs incurred in defending or settling any claim or proceeding relating to any such liability.
An indemnity given in breach of this section is void.
Section 140(9) defines the terms broadly: “director” includes a former director; “employee” includes a former employee; “effect insurance” includes paying, directly or indirectly, the costs of the insurance; and “indemnify” includes relieve or excuse from liability, whether before or after the liability arises.
Because “indemnify” includes relieve or excuse from liability, a clause in a service contract, a board resolution waiving a claim, or a release given on a director’s departure can all be indemnities within section 140 — and void if outside the permitted categories.
And because “effect insurance” includes paying the costs of insurance, a company that reimburses a director’s own policy premium is effecting insurance and must comply with subsections (5) and (6).
Section 140(3) — costs where the director wins
A company may, if expressly authorised by its constitution, indemnify a director or employee for any costs incurred in any proceeding —
(a) that relates to liability for any act or omission in his capacity as a director or employee; and
(b) in which judgment is given in his favour, or in which he is acquitted, or which is discontinued.
This covers the vindicated director. Note it is confined to costs, and only where the proceeding ended in the director’s favour, in an acquittal, or by discontinuance. A settlement on terms is not within paragraph (b).
Section 140(4) — third party liability
A company may, if expressly authorised by its constitution, indemnify a director or employee in respect of —
(a) liability to any person other than the company or a related company for any act or omission in his capacity; or
(b) costs incurred in defending or settling any claim or proceeding relating to any such liability,
not being criminal liability or liability in respect of a breach, in the case of a director, of the duty specified in section 112, or, in the case of an employee, of any fiduciary duty owed to the company or related company.
- Only liability to third parties. A company can never indemnify a director against liability to the company itself or to a related company. That would defeat the whole scheme of directors’ duties.
- Never criminal liability. The Act creates numerous offences — sections 112(5), 114(2), 115(6), 118(4), 123(4), 126(2) and 127(6) among them — and none may be indemnified.
- Never a breach of section 112 — the duty to act in good faith and in what the director believes to be the best interests of the company. For an employee, no breach of any fiduciary duty owed to the company.
Unlike section 140(3), this covers settlements as well as defended proceedings — provided the liability is to a third party and outside the excluded categories.
Sections 140(5) and (6) — insurance
(a) liability, not being criminal liability, for any act or omission in his capacity; or
(b) costs incurred in defending or settling any claim or proceeding relating to such liability; or
(c) costs incurred in defending any criminal proceedings that (i) have been brought in relation to an act or omission in his capacity, and (ii) in which he or she is acquitted.
Compare the two. An indemnity under subsection (4) is limited to third party liability and excludes any breach of section 112. Insurance under subsection (5)(a) excludes only criminal liability — so a policy may respond to liability to the company itself, and to breaches of duty short of the criminal.
Paragraph (c) permits insurance for the defence costs of criminal proceedings, but only where the director is acquitted. A conviction means the costs are not covered.
The directors who vote in favour of authorising the insurance shall forthwith sign a certificate stating that, in their opinion, the cost of effecting the insurance is fair to the company.
Sections 140(7) and (8) — the register, and personal liability
The board shall ensure that particulars of any indemnity given to, or insurance effected for, any director or employee of the company or a related company are forthwith entered in the interests register.
Where insurance is effected and either (a) subsection (5) or (6) has not been complied with, or (b) reasonable grounds did not exist for the opinion in the certificate, the director or employee is personally liable to the company for the cost of effecting the insurance — except to the extent that he proves that it was fair to the company at the time.
As with section 139(5) and (6), the onus is on the beneficiary to prove fairness.
Getting it right
| Cover | Permitted? | Requirements |
|---|---|---|
| Costs where the director wins, is acquitted, or the claim is discontinued | Indemnity — s 140(3) | Express constitutional authority |
| Third party liability and related costs, including settlement | Indemnity — s 140(4) | Express authority; not criminal, not a s 112 breach |
| Liability to the company itself | Insurance only — s 140(5)(a) | Express authority, prior board approval, certificate, register entry |
| Criminal liability | Never | — |
| Defence costs of criminal proceedings ending in acquittal | Insurance — s 140(5)(c) | As above |
| Anything else | Void — s 140(2) | — |
- Adopt or amend the constitution first. Every permitted category requires express authorisation by the constitution; a company with no constitution can do none of it.
- Pass a board resolution approving the insurance before it is effected — subsection (5) requires prior approval.
- Sign the section 140(6) certificate forthwith.
- Enter particulars in the interests register forthwith — a company record under section 164.
- Check the policy against the section. A policy that purports to cover criminal liability is not authorised, and the company’s payment of that part of the premium is exposed under subsection (8).
- Remember section 121 — an indemnity or insurance in accordance with section 140 is outside the interested transaction regime in sections 118 and 119. One that is not in accordance with section 140 loses that protection as well as being void.
Sources
- Companies Act 1997 — ss 112–115, 118, 119, 121, 123, 126, 127, 139, 140, 164
Before relying on anything here, read the current text of the Companies Act 1997 and check for later amendments. If a decision matters to you, get advice — start with the Office of the Public Solicitor, or find a firm in the law firms directory.