The Companies Ordinance in Hong Kong has been rewritten after years of discussions and consultations, with a view to modernising the legal framework and parameters within which companies must operate. The new Companies Ordinance (Cap. 622) and its subsidiary legislation commenced operation on March 3, 2014. Whilst the changes to the old Companies Ordinance (Cap. 32) are numerous, this article will focus on the new legislative provisions concerning indemnity to directors, which may be of interest to insurers providing directors and officers (D&O) cover.
One of the significant changes in the new Companies Ordinance concerns the indemnity which is (or is not) permitted to be provided by a company to its directors. Insurers’ attention should be drawn to this as clauses and exclusions in some D&O policies available in the market refer to what an insured entity is, or is not, permitted to pay by way of indemnity.
Under the old Companies Ordinance, a company is generally prohibited from indemnifying a director against any liability that, by virtue of any rule of 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 or a related company. However, the company may indemnify the director against any liability incurred by him in defending any civil or criminal proceedings, in which judgment is given in his favour or in which he is acquitted, or in connection with any application under section 358 in which relief is granted to him by the court.
Recognising the uncertainty over a director’s right to be indemnified against liabilities to third parties, the legislators in Hong Kong rewrote the Companies Ordinance to be more specific as to what a company cannot provide an indemnity against.
Similarly to the old Companies Ordinance, section 468(3) of the new Companies Ordinance prohibits a company from directly or indirectly indemnifying its director (or a director of its associated company) against any liability attaching to the director in connection with any negligence, default, breach of duty or breach of trust in relation to the company or associated company (as the case may be); any provision to provide such is void. Please note, the term ‘associated company’ under the new Companies Ordinance has the same meaning as ‘related company’ under the old Companies Ordinance, and means a subsidiary or holding company of a HK incorporated company or a subsidiary of such a holding company. There is, however, an exception to this general prohibition under section 468(3). Section 469 provides that section 468(3) will not apply to invalidate any provision for indemnity against directors’ liability to third parties (meaning a person other than the company or an associated company) if the provision is not to indemnify any of the following categories:
- any liability of the director to pay –
- a fine imposed in criminal proceedings; or
- a sum payable by way of a penalty in respect of non-compliance with any requirement of a regulatory nature; or
- any liability incurred by the director –
- in defending criminal proceedings in which the director is convicted;
- in defending civil proceedings brought by the company, or an associated company of the company, in which judgment is given against the director;
- in defending civil proceedings brought on behalf of the company by a member of the company or of an associated company, in which judgment is given against the director;
- in defending civil proceedings brought on behalf of an associated company of the company by a member of the associated company or by a member of an associated company of the associated company, in which judgment is given against the director; or
- in connection with an application for relief under section 358 of the old Companies Ordinance or section 903 or 904 of the new Companies Ordinance in which the Court refuses to grant the director relief.
In other words, a company may provide its directors or the directors of its associated company with an indemnity against liabilities to third parties unless the indemnity is within the above-mentioned categories of indemnity. Any provision of a permitted indemnity (defined as ‘permitted indemnity provision’ under the new Companies Ordinance) or the written memorandum of such provision (if the provision is not in writing), for example a director indemnification agreement, has to be kept at the registered office of the company and made available for inspection.
Consequential amendments have been made to Table A (which is now named ‘Model Articles’). The Model Articles will form part of the articles of association of any company incorporated under the new Companies Ordinance unless the company excludes or modifies those articles.
Whilst a company is generally prohibited from indemnifying a director against any liability attaching to him, it can purchase and maintain insurance for the director. The old Companies Ordinance had, since 2003, clarified previous uncertainties regarding a company’s capacity to take out insurance for its officers. Although the provisions are worded differently, section 468(3) of the new Companies Ordinance has the same effect as section 165 of the old Companies Ordinance, except that it is now made clear that a company can take out insurance for not only its directors, but also directors of its subsidiary, holding company and a subsidiary of such holding company. The new provision is also different from section 165 of the old Companies Ordinance in that it specifically refers to directors, but not ‘manager’ or ‘secretary’ (both of which were included in the definition of ‘officer’ under the old Companies Ordinance). This deletion is consequential to the removal of the prohibition on a company to exempt non-director officers such as managers or company secretaries from, or indemnify them against, any liability.
The new Companies Ordinance now clarifies what a company is not permitted to indemnify a director against. One would expect D&O policies to provide cover in respect of losses which a company is not permitted by law to pay its directors so that, if a director cannot receive an indemnity from the company, he can claim under the D&O policy. However, if an indemnity is not permitted by a company, it is unlikely that a claim will be possible against insurers. As such, a fine imposed in criminal proceedings or a penalty for non-compliance with regulatory requirements are invariably excluded from cover.