This article is the final in a series of 4 articles on director protection.

Section 140(1)(b) of the Corporations Act 2001 provides that a company's constitution has effect as a contract between the company and each director and company secretary.  A company's constitution will typically contain an indemnity clause (i.e. a clause in which the company agrees to indemnify its directors and officers against liability incurred by them as directors and officers).  Current directors are able to enforce an indemnity clause against the company, just as they would any other contract.  Whilst an indemnity clause is an important line of defence, it has its limitations.

The issue relating to former directors

An indemnity clause may not offer protection to former directors and officers (even where it purports to do so).  Once a person ceases to be a director of a company, they are unable to enforce the constitution of the company against the company just as they would any other contract.  If a person ceases to be a director of a company, but remains a shareholder of the company, they can still enforce the constitution against the company.  However, there is a question as to whether or not the shareholder will be able to enforce a right claimed by the shareholder, not as a shareholder, but as a former director.

What protection is typically offered

A company will, in a typical indemnity clause, agree to:

• indemnify its directors and officers against liability incurred by them (other than liability which the company is prohibited from indemnifying a person against under section 199A of the Corporations Act 2001) as directors and officers; and
• indemnify its directors and officers against legal costs and expenses incurred by them in defending legal proceedings in which they are alleged to have done or omitted to do some act or thing in their capacity as directors and officers.

As part of the indemnity clause, a company may also agree to:

• make an advanced payment of legal costs in certain circumstances;
• enter into a deed of indemnity in favour of its directors and officers; and
• obtain and maintain a policy of D&O insurance on behalf of its directors and officers.

Inconsistency between deed of indemnity and constitution

As an indemnity clause in a company constitution may not offer protection to former directors, many directors insist that a deed of indemnity, access and insurance be signed.  A deed of indemnity can be drafted to protect former directors (as well as current directors).  It is therefore not unusual for directors to have the benefit of an indemnity in both the company constitution and in a deed of indemnity.  As the constitution and the deed both constitute a contract, it is important that they are not inconsistent.

Where there is inconsistency between the company constitution and the deed, complex issues arise as to which one applies.  It is likely that the director will seek to enforce the most generous indemnity, and the company will seek to enforce the least generous indemnity.

To avoid any difficulties:

• the constitution may contain a provision to the effect that the company will, by deed, indemnify or agree to indemnify a person who is, or has been, a director or officer of the company; and
• the deed could then be the sole contract providing an indemnity.

This way, the constitution and the deed will complement each other, and the deed will be the operative document.  Alternatively, either contract may contain a provision to the effect that, to the extent that there is inconsistency, that contract will prevail.

Overview

Directors' and officers' liability is no small matter.  In its 2011 quarter 1 report, Aon noted that, "Increased insolvency activity continues to cause concern for insurers in the D&O segment".  Most directors are aware of their duties under the Corporations Act 2001, including their duty to prevent insolvent trading (s 588G).  In Commonwealth Bank of Australia v Friedrich (1991) 5 ACSR 115 the Supreme Court of Victoria held that Maxwell Walter Eise, a company director, was liable to pay the Commonwealth Bank $96,704,998 for breaching section 556 of the Corporations Act 2001 (the predecessor to section 588G).

Given the escalating number of duties placed on directors and officers and their vulnerability to claims, and the current economic climate, the role of D&O insurance, deeds of indemnity and company constitutions is becoming increasingly more important.  As each line of defence offers varying degrees of protection, it is recommended that they are effected together, in a manner that is complementary.

Required Action

If you are a director, ensure that you are adequately protected against liability which you may incur in your capacity as a director.  Ask an experienced solicitor who acts for you to review your existing arrangements, and notify you of any changes which may be required to protect your interests.

Other articles in this series include:

1. Protection for directors - insurance, deeds of indemnity and constitutions
2. Are you protected?  Transferring risk with D&O insurance
3. Directors and officers:  Transferring risk with deeds of indemnity