Prior to 6 April 2005 a company could only indemnify its officers (ie directors or secretary) or auditor against any liability for negligence, default, breach of duty or breach of trust if the officer or auditor was successful in defending legal proceedings brought against him or if relief was granted by the court on the basis that the director acted honestly and reasonably (section 310, Companies Act 1985). This indemnity is commonly set out in the company's articles of association.

The main problem with this is that the indemnity is only enforceable by the officer once the outcome of the court proceedings is known. Whilst it is possible to take out insurance against liability, which may cover the costs incurred in defending any claim as they arise, if the insurance cover is insufficient to meet the costs the director is not entitled to any further financial assistance from the company until the successful outcome is achieved. Directors may, therefore find that they have to fund their defence costs from their own resources.

New provisions

Qualifying third party indemnity

With effect from 6 April 2005 the situations in which companies may grant indemnities to their directors were extended.

Under the "qualifying third party indemnity" provisions of section 234, Companies Act 2006, a company may now indemnify a director against liability to a third party other than the company or an associated company (for example to shareholders or creditors in negligence), as long as the indemnity does not extend to criminal fines or penalties incurred – whether or not judgement is given against the director.

However, if a civil action is brought by the company, the indemnity will only be valid in relation to the director's third party costs if the director is either successful in defending the claim or the action is otherwise settled out of court.

Interim funding of defence costs

In addition, a company may now advance funds to a director to meet legal and other costs in defending any proceedings brought against him. If the director is found guilty the funds must be repaid by him, but otherwise, for example if the case is settled out of court, the company and director can agree their own terms of repayment.

Other changes

Other changes brought in on 6 April 2005 include:

• obligations to disclose the existence of a qualifying third party indemnity in the company’s accounts;
  
  
• the removal of the company secretary from the scope of Section 310 (allowing any indemnity to be given to a company secretary). Section 310, as it currently stands, will be restricted to auditors only; and
  
  
• clarification that a company may not indemnify a director of another group company unless it is a qualifying third party indemnity – thus closing the accepted ‘loophole’ that a parent company may indemnify a director of its subsidiary. However, the validity of such indemnities granted prior to 29 October 2004 is not affected.

Taking advantage of these new provisions

Whilst this sounds like good news for directors, in practice action must be taken to benefit from these provisions. Any company incorporated prior to 6 April 2005 will contain the standard indemnity provision in its articles of association (either Table A or tailored articles) which will only reflect the prior law. To take advantage of this new legislation directors will either have to amend the articles of association, or put in place of a separate contractual indemnity. The drafting of the indemnity is crucial, as an indemnity that goes beyond the scope of the new legislation is void in its entirety.

Our directors' indemnity updating service allows directors to benefit from this new legislation by incorporating the indemnity in the company's articles of association.

There are 3 options open to the company:

• to provide a qualifying third party indemnity to directors;
  
  
• to include power for the company to provide interim defence cost funding; and
  
  
• to either include an unlimited indemnity for the company secretary or to give the company the power to provide an unlimited indemnity for the company secretary as and when required.

Our updating service includes:

(a) minutes and resolutions to amend the articles to incorporate any or all of these options; and
(b) text of the new indemnity article drafted by Senior Counsel.

Reprints of the memorandum and articles can also be provided for an additional fee.

Next steps

Our fee for this service is £200 + VAT. Our fee for reprints of the memorandum and articles start at £50 + VAT. Download our information sheet and order form.