New Hong Kong Companies Ordinance: Directors' liabilities - exemptions, indemnities and insurance

01 Jan 2014 | Newsletter/briefing

WHEN IN FORCE: 3 March 2014

COMPANIES AFFECTED: All Hong Kong incorporated companies

NEW PROVISIONS: Part 10, Division 3 of new CO: ss467-473

GENERAL POINTS:

References in this alert to a director’s liability mean liability incurred by a director whilst acting in his role of a director. Liabilities incurred by that person whilst acting in another work-related role (including merely as an employee) or whilst acting in a personal capacity are outside the scope of this alert.

This alert covers the following:

  • circumstances in which a company may exempt a director from liability
  • circumstances in which a company may indemnify a director for liability
  • circumstances in which insurance purchased by a company for its directors may be void
  • implications for practice

The new CO uses the defined term "associated company" instead of the existing defined term "related company". The definitions of these two terms are identical - an "associated company" or a "related company" includes each of the company’s subsidiaries or holding companies, and subsidiaries of such holding companies. The defined term "associated company" will be used throughout this alert.

1. Exemption Provisions - Exempting a director from liability under the articles or as part of the service contract

Summary of changes

Liability owed to the company or an associated company

  • under the existing legislation, a company may exempt an officer (being a director, manager or company secretary) of the company from any liability to the company or an associated company except where there has been negligence, default, breach of duty or breach of trust by the officer in relation to the company or an associated company
  • the new CO has a narrower scope. The prohibition against a company granting exemptions from liability is narrowed to a director’s liability. Exclusions from liability made in favour of managers or company secretaries are not covered by the new CO
  • the new CO permits a company to exempt a director from any liability except where there has been negligence, default, breach of duty or breach of trust by the director in relation to the company
  • it is worth noting that, in certain circumstances, a company may ratify conduct by a director involving negligence, default, breach of duty or breach of trust in relation to the company by way of shareholders’ resolution

2. Indemnification Provisions - Indemnifying a director for liability

Summary of changes

A. Liability to the company or an associated company

  • there are no changes to the indemnification position under the existing legislation in respect of liability of a director to the company or an associated company
  • under the existing legislation and the new CO, any provision which indemnifies a director of the company or a director of an associated company for any liability attaching to the director where such liability arises as a result of any negligence, default, breach of duty or breach of trust in relation to the company or the associated company, will be void
  • similar to the position on exemptions referred to above, however, the new CO has a narrower scope than the existing legislation and does not cover indemnities made in favour of managers and company secretaries
  • the new CO has an express provision regarding indemnities in respect of liabilities owed to other persons, which is discussed below

B. Liability to other persons

  • the existing legislation is silent on whether a company is permitted to indemnify a director for his liability to persons other than the company or an associated company
  • under the new CO, the starting point is that a provision is void if it provides for the company to indemnify its director (or a director of an associated company) against liability attaching to the director in connection with any negligence, default, breach of duty or breach of trust in relation to the company (or an associated company). The provision applies regardless of whether the indemnity is for a director’s liability to the company, an associated company or other persons
  • there are a number of wide exclusions to the above rule in respect of liability by a director to other persons. These exclusions effectively mean that indemnities to other persons are permitted as long as the indemnities do not relate to criminal fines, penalties imposed by regulatory bodies, defence costs in criminal proceedings where the director is found guilty and defence costs of civil proceedings brought by the company or an associated company where judgment is given against a director
  • common law rules continue to govern any potential indemnities that fall outside the statutory prohibitions and exclusions described above

3. Purchase of director’s insurance

Summary of changes

  • the existing legislation and the new CO do not prohibit a company from purchasing insurance for directors. Indeed, the new CO envisages that a company may, at the expense of the company, purchase insurance for a director of the company against:
    • primary liability: a director’s liability to any person in connection with any negligence, default, breach of duty or breach of trust (except for fraud) in relation to the company or an associated company
    • costs of proceedings: a director’s liability in defending any proceedings (civil or criminal) for any negligence, default, breach of duty or breach of trust (including fraud) in relation to the company or an associated company
  • common law rules continue to govern the circumstances in which losses may be irrecoverable under insurance purchased by a company. For example, a court may invalidate an insurance contract on public policy grounds if it seeks to insure a director for regulatory or criminal fines made against him

4. Implications for practice

  • the new CO indemnity and insurance provisions are reflected in: (i) Articles 35 and 36 of the new Model Articles for public companies; and (ii) Articles 31 and 32 of the new Model Articles for private companies. These may be helpful, for example, in drafting contractual indemnity provisions
  • however, any exemption or indemnity provided by a company to a director should be set out expressly in the director’s service contract or terms of engagement and not merely included in the articles. This is because:
    • the articles of association of a company are a contract between the members of the company and the company (and not a contract between the company and its directors)
    • an indemnity may not necessarily be implied in a director’s terms of engagement solely by virtue of the company’s articles of association requiring the company to indemnify a director against liability (Moulin Global Eyecare Holdings Limited (in liq) v Olivia Lee Sin Mei (HKCA CACV 109/2009))
  • under the new CO, a company must disclose any permitted indemnity provisions which are in force in its directors’ report and a copy of such permitted indemnity provisions should be kept at the company’s registered office and be made available upon request by a member of the company
  • given that conduct by a director resulting in liability may arise (i) from the performance by a director of his duties as a director of the company, (ii) from the performance by a director of duties whilst acting in another capacity (such as an employee, possibly as chief executive officer or chief financial officer), or (iii) in a personal capacity, it is essential for a company to determine whether the source of the conduct will have an impact on the validity of any exemption provisions, indemnity provisions or insurance provisions
  • for listed companies, paragraph A.1.8 of Appendix 14 (Corporate Governance Code and Corporate Governance Report) of the Hong Kong Listing Rules require a listed company to arrange appropriate insurance cover in respect of legal action against its directors. If the listed company does not purchase insurance for its directors, it is required to provide an explanation in its annual report as to the reasons why

Contacts

Peter Brien (partner), Lisa Chung (partner), Peter Lake (partner)


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