This article is a condensed version of a paper presented to a liability insurance seminar hosted by the Malaysian Insurance Institute in Kuala Lumpur, Malaysia, on 16 May 2017. It deals with the issue of indemnification of directors and officers by Malaysian companies and suggests that Directors' & Officers' (D&O) liability insurance wordings in Malaysia may need restructuring in response to the Malaysian Companies Act 2016, which replaced the Malaysian Companies Act 1965 with effect from 31 January 2017.
When a company is incorporated, the law of the jurisdiction in which it is incorporated automatically attaches to it. So, for example, the Malaysian Companies Act 1965 automatically attached to a company incorporated in Malaysia before 31 January 2017 and the Malaysian Companies Act 2016 has automatically attached to a company incorporated in Malaysia since that date.
Section 140 of the Companies Act 1965
The automatic attachment of the 1965 Act to companies incorporated in Malaysia before 31 January 2017 wasn’t ideal - at least as far as the indemnification of directors and officers was concerned - because section 140 of the 1965 Act placed heavy restrictions on Malaysian companies’ ability to indemnify their directors and officers. From a D&O liability insurance perspective, this meant that the scope of indemnifiable loss in Malaysia (i.e., the type of loss covered by Side B of a D&O policy) was very limited under the 1965 Act.
The origins of section 140 lay in section 152 of the English Companies Act 1929. The origins of section 152 lay, in turn, in a recommendation of the United Kingdom's Company Law Amendment Committee, known as the "Greene Committee", appointed in 1925 to consider what amendments to the English Companies Acts 1908 to 1917 were desirable:
47. We recommend that any contract or provision (whether contained in the company's articles or otherwise) whereby a director, manager or other officer of the company is to be excused from or indemnified against his liability under the general law for negligence or breach of duty or breach of trust should be declared void …
The Greene Committee's recommendation was reflected in section 152 of the English Companies Act 1929. Apart from some minor textual differences, section 152 was later reproduced in section 140 of the 1965 Act:
(1) Any provision, whether contained in the articles or in any contract with a company or otherwise, for exempting any officer or auditor of the company from, or indemnifying him against, any liability which by law would otherwise attach to him in respect of any negligence, default, breach of duty or breach of trust, of which he may be guilty in relation to the company, shall be void.
(2) Notwithstanding anything in this section a company may pursuant to its articles or otherwise indemnify any officer or auditor against any liability incurred by him in defending any proceedings, whether civil or criminal, in which judgment is given in his favour or in which he is acquitted or in connection with any application in relation thereto in which relief is under this Act granted to him by the Court.
It has long been recognised that section 140 (and section 152) contains a number of drafting obscurities.
First, it is not clear what the draftsman meant by the phrase "or otherwise" in subsection (1). The way in which the phrase appeared in the Greene Committee's recommendation could be read as a shorthand reference to anything other than a company's articles of association, but that is only one possibility. It has been suggested, to the contrary, that because section 140(1) refers to articles and any contract with a company, the phrase "or otherwise" should be restricted to indemnification commitments given by a company, whether oral or in writing. Neither interpretation is obviously right or wrong: the key point is that more than one interpretation is possible, so the meaning of an important statutory provision is not clear.
Second, the source of the "liability" referred to is not clear: was the draftsman referring to the liability of a director or officer to the company, or to third parties, or to both? Different courts in different commonwealth jurisdictions have reached different conclusions on the subject. Again, the key point is that more than one conclusion has been reached, leading to confusion over which conclusion is correct.
Third, it is not clear what the draftsman meant by the word "negligence". The Australian Companies and Securities Law Review Committee succinctly described the point in a 1989 discussion paper:
But 'negligence' was used before Donoghue v Stevenson in relation to company directors to refer to failure to perform the equitable fiduciary duty of acting up to a required degree of care and diligence in the conduct of a company's affairs … When 'negligence' … is read in that sense, [the Australian equivalent of section 140] invalidates provisions indemnifying a director, officer or employee against liability for breach of the fiduciary duty of care and diligence. There is a question whether the legislation should indicate more clearly what is meant by 'negligence'.
D&O Liability Insurance, section 288 and 289(1) and (2) of the Companies Act 2016
Those involved in D&O liability insurance will have had an interest in the clarification of the drafting obscurities in section 140 of the 1965 Act. Sadly, this opportunity has been missed because the same phrases which have given rise to the drafting obscurities described above have been reproduced, word for word, in section 288 of the 2016 Act. Given that the phrase "or otherwise" in section 288 is capable of being a reference to anything other than a company's articles of association which contains a provision indemnifying a director or officer against his or her liability, section 288 is potentially in direct conflict with section 289(5) of the 2016 Act, because section 288 seeks to void what section 289(5) expressly legitimises, namely the provision of an indemnity against the liability of an officer through D&O liability insurance.
This is an existential conflict, which leads to the uneasy conclusion that the retention of indemnification language in section 288 may have been a drafting error. Support for this conclusion can be derived from sections 289(1) and (2) of the 2016 Act, which prohibit a company from indemnifying or directly or indirectly effecting insurance for an officer (which includes a director) in respect of his or her liability for any act or omission in his or her capacity as an officer, unless such indemnity is permitted elsewhere in section 289, and void any indemnity given in breach of that prohibition. Whilst it is accepted that section 288 applies to exculpation as well as indemnification, the overlap between section 288 and sections 289(1) and (2) - in the sense that both void indemnification for negligence, default, breach of duty or breach of trust by virtue of the phrase "… liability for any act or omission …" seems both odd and unnecessary. Indeed, section 289 seems perfectly capable of providing a regime to govern indemnification of directors and officers without needing assistance from section 288. Perhaps the original intention was to restrict section 288 to exculpation and have section 289 deal with indemnification (mirroring the approach taken in section 172 of the Singapore Companies Act, for example) but indemnification language was inadvertently left in section 288 by the draftsman.
Perhaps one way to resolve this existential conflict is for the Companies Commission of Malaysia (SSM) to issue a guidance note stating that section 288 applies only to indemnities given by a company and does not apply to D&O liability insurance.
Section 289(6) of the Company Act 2016
The difficulties do not end there, however. Section 289(6) provides that the power of a company to:
(i) Indemnify a director (but not an officer who is not also a director) in respect of (a) any liability to any person other than the company, (b) costs incurred in defending or settling any claim or proceedings relating to such liability, or (c) in connection with any application for relief under the 2016 Act; and
(i) Arrange D&O liability insurance for a director in respect of (a) civil liability for any act or omission in his or her capacity as a director, and (b) costs incurred defending or settling any claim or proceeding relating to such civil liability,
shall not apply to civil or criminal liability in respect of a breach of the "duty specified in section 213".
Section 289(6) has the effect of retrospectively depriving a company of the power to indemnify or arrange D&O insurance where a breach of the duty specified in section 213 is established against a director. With respect to D&O insurance, this means that where a breach of the duty specified in section 213 is established against a director, the power given to a company to arrange D&O insurance will not have existed, not just in relation to section 213 liabilities, but all liabilities, both civil and criminal. This gives rise to difficulties in the D&O insurance context where defence costs have been advanced to a director who is later found to be in breach of the duties set out in section 213 of the 2016 Act. Recoupment of defence costs already advanced would not prevent non-compliance with section 289(6) because the D&O insurance arranged by the company should never have existed, so it should never have been possible to advance defence costs in the first place.
Section 289(8) makes a director personally liable for the D&O premium where section 289(6) "has not been complied with". This language suggests that section 289(6) was intended to create a duty, non-compliance with which triggers the penalty in section 289(8). If that is correct, that duty might be expressed in terms that a company must not arrange D&O insurance which provides an indemnity for liabilities arising from breach of the duties set out in section 213. This suggests that an exclusion of those liabilities should be inserted into D&O insurance wordings, but this would render D&O cover largely illusory.
There is a solution. A careful reading of section 289(6) reveals that, in conjunction with section 289(5), it does not prohibit directors and officers from arranging their own D&O insurance independently of the company, nor does the 2016 Act prevent such D&O insurance from responding where a breach of the duties set out in section 213 of the 2016 Act is established against a director, though such cover could only be for non-indemnifiable loss. Section 289(6) ought therefore to result in:
- The restructuring of D&O liability insurance in Malaysia to divorce Side A cover from Sides B and C, with exclusively Side A cover arranged by, and sold directly to, directors and officers at a nominal premium. This Side A cover ought to survive even when a breach of the duties set out in section 213 of the 2016 Act is established against a director; and
- Side B (possibly combined with Side C) cover arranged by, and sold to, companies. This cover would not need to exclude section 213 liabilities established against a director because section 289(6) prevents such liabilities from being indemnifiable loss and therefore falling within the ambit of Side B cover.
In conclusion, the Malaysian Companies Act 2016 simultaneously improves and complicates the position with respect to D&O liability insurance in Malaysia. Guidance from SSM with respect to the ambit of section 288, together with pure Side A cover in response to section 289(6), currently seem to be the most appropriate solutions to these complications.