An underlying principle of company law has been that a company should be managed for the main purpose of increasing its share price, or for returning shareholder value. Against this backdrop of the interest of the shareholders being paramount and the main driver in the pursuit of profits, there is also the need to give directors who manage the company latitude to be able to take risks within certain parameters. This brings into focus the need for indemnification and directors' and officers' insurance as a means of protecting management, provided that they operate within the rules while they go about the business of maximising shareholder value.
BVI law provides for directors, former directors and in certain cases other persons to be indemnified. The law is reasonably clear on this, and on the advancement of expenses in that context. However, the risks that former directors face and how one might attempt to alleviate those risks after resignation are less clear.
The following persons (subject to the company's memorandum or articles of association) may be indemnified by a BVI company under the BVI Business Companies Act 2004:
- a director of the BVI company;
- a former director of the BVI company;
- a director of another company or enterprise (with or without legal personality), serving as such at the request of the BVI company;
- a former director of another company or enterprise (with or without legal personality), serving as such at the request of the BVI company;
- a person in another capacity (other than as a director) and acting for another company or enterprise (with or without legal personality), serving as such at the request of the BVI company; and
- a person formerly serving in another capacity (other than as a director) for another company or enterprise (with or without legal personality), serving as such at the request of the BVI company.
None of the persons referred to above may be indemnified by the BVI company unless they acted honestly and in good faith and in what they believed to be the best interests of the company. A purported indemnity in breach of the honesty and good-faith requirement is void. Furthermore, such a person must be indemnified by the company if he or she has been successful in the defence of any proceedings.
Otherwise, subject to the foregoing (in particular the category of persons that may be indemnified and the honesty and good-faith requirement), indemnification is permitted under the law and the relevant provisions are usually set out in the company's memorandum and articles of association.
As the person seeking to be indemnified must be "successful in the defence of any proceedings" or must act "honestly and in good faith", the issue of the cost of defending the proceedings can be a concern. Accordingly, BVI law allows the company to advance expenses to the director or former director. This occurs in much the same way that a company may advance credit subject to an undertaking by the director or former director to be indemnified to repay if it shall ultimately be determined by the court that that person is not entitled to be indemnified. The reference to "ultimately be determined" is a reference to final determination by a court or the final appeal. There is no statutory requirement that expenses be advanced, as the section states that "Expenses ....may be paid".
The general thrust of the indemnification provisions is such that:
- certain categories of persons may be indemnified;
- indemnification flows only if certain conditions are present;
- it is mandatory in one situation; and
- the law recognises the difficulty attached to the cost of defending proceedings and provides for the advancement of expenses (but this is not mandatory).
However, as the indemnification provisions are almost invariably in the company's memorandum and articles, this has a direct impact on a former director. A director of a BVI company is not a party to the statutory contract that constitutes the memorandum and articles. Pursuant to Section 11 of the act, the memorandum and articles are binding as between:
- the company and each member of the company; and
- each member of the company.
Directors are not a party and there is no privity of contract. Third-party enforcement rights are not permitted under BVI law. Accordingly, a director or former director cannot enforce any provisions of the memorandum and articles. More importantly, he is also unable to prevent an amendment to the memorandum and articles to remove the indemnification provisions or the advancement of expenses provisions on which a former director might have placed reliance. While the fact that members may amend the memorandum and articles to the detriment of the former directors may appear draconian, it is an unfortunate reality and one that a former director would do well to consider.
Because the memorandum and articles of the company can potentially be amended to remove the ability to indemnify or advance expenses to former directors, it is advisable for the director to require a separate agreement with the company. Such an agreement should not, of course, be amended without the consent of both parties. In that way, the director has more control over the indemnification process and is not subject to the whims of others after he has left the company.
A lot of responsibility is placed on directors in terms of the fundamental principle of shareholder value. Directors are expected to demonstrate greater returns year after year, and there is accordingly an inherent, if unspoken, demand for risk so as to be able to produce those returns. Directors naturally want such protection as the law may afford. It would be remiss of a director or former director to fail to consider their position both before and after they cease to be a director. As a director, there is an element of control over the company and specifically the issue of indemnification and advancement of expenses; but once a director resigns that is lost and it becomes important to have had in place an indemnification agreement over which the director has some authority.
This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.