One theme to which I often return is the relationship between corporate indemnification and D&O insurance. I have already written about the paradox created by the relaxation of UK company law on the extent to which corporate indemnification is permissible.
By virtue of the way in which most D&O insurance contracts are constructed, the more generous indemnification regime often works to the advantage of insurers rather than that of the insured for whom the relaxation was intended.
Indeed, I have come across a number of claims recently where insurers have refused to pay loss within the so-called company side deductible in the absence of evidence that the company could not itself legally have paid such loss. This is the land of the double negatives.
I am indebted to Kevin LaCroix for the recent mention on his blog of a Canadian case shedding light on the extent to which Canadian courts become involved in deciding the entitlement of directors to corporate indemnification in that country.
The Canadian Twist
Under Section 124 of the Canadian Business Corporations Act (“CBCA”), a company may indemnify its directors and officers for legal proceedings in which individuals become involved as a result of their association with the company as long as the individual seeking indemnification has “acted in good faith and with a view to the best interests of the corporation”.
Look Communications, a technology company, enshrined these rights in its charter and bylaws and also in indemnification agreements in favour of its directors.
Despite teetering on the brink of insolvency, the company paid across C$20m in bonus compensation to certain of its officers, directors and corporate officials. Significant objections were then raised by shareholders and, following appointment of a new management board, the company commenced an action against its former directors and officers alleging that they had breached their fiduciary duties and seeking repayment of the bonus and compensation payments.
The directors and officers concerned argued that they were entitled not just to an automatic advancement by Look of their defence costs but also an automatic presumption that they had acted in good faith.
The Court concluded that Section 124 of the CBCA required it to exercise a supervisory role in ensuring that the directors and officers were entitled to advancement of their costs. Whilst the Court acknowledged that a presumption did operate in the director’s favour that they had acted in good faith, this did not mean that they had an automatic entitlement to indemnification. Indeed, on the facts of this case, the judge concluded that the company had provided enough evidence to establish that all but one of the individuals had not acted in good faith and therefore were not entitled to indemnification.
There is a balance to be struck here and indeed at least a tension if not a conflict between the Company’s position and that of the directors. Directors, if asked, are always likely to want to benefit from any doubt as to their innocence and good faith in order to maximise their entitlement to indemnification and advancement. Companies on the other hand may wish to retain some discretion around their largesse in granting indemnity in all cases.
The Canadian Court in the Look case saw it as its role to set this balance. By contrast, in the United States according to Kevin LaCroix “… the general pattern and practice is that corporate directors and officers are entitled to have their defence fees advanced subject only to an undertaking to repay in the event of an ultimate determination that the individual is not entitled to indemnification”.
The position in the UK is that there is no such “pattern or practice”. Indeed, a specific consequence of the largely permissive regime with respect to indemnification which now operates in the UK is that entitlement will more often than not be governed by contract than by statute law.
That’s all well and good in theory but may lead to real uncertainties of outcome for directors especially if D&O insurers’ commitment to step into any gaps and pay is less than wholehearted.