The Regulator for Charities in England and Wales
This guidance considers changes in the law which grant greater flexibility to charitable companies (charcoms) to offer an indemnity to company officers, including directors. The guidance reviews the provisions for providing indemnities to auditors and reporting accountants, and concludes with alternative options for clauses in a charity’s governing document. Our model Memorandum and Articles of Association (GD1) has been updated to reflect these options.
Former standard indemnity provisions in Articles of Association will not cover the range of indemnities now allowed for directors. Since these are “trustee benefits”, a charcom wishing to adopt them will require explicit authority, and we will provide consent to constitutional changes under s.64(2)(b) of the Charities Act 1993. Changes that are clearly within our guidelines will routinely be approved.
Under section 310 of the Companies Act 1985 a company could only indemnify its officers (including directors, secretary, managers) or auditor against liability for negligence default, breach of duty or breach of trust in circumstances where the indemnity related to the officer’s costs of -
Provision for this type of limited indemnity is commonly set out in the company’s articles of association, and in the case of a charcom, it has been the normal practice to include a provision which requires the company to indemnify an officer or auditor in the permitted circumstances.
One difficulty with the former law was that payment of a director’s legal costs could be made only when the outcome of the legal action was known. This is because there are statutory restrictions on companies making loans to directors, and until the outcome of the proceedings are known, any payment to a director to cover the costs could only be by way of loan. In the absence of insurance cover, the director would have to pay any costs personally, unless and until the proceedings were successful.
Section 309A of the Companies Act 1985, inserted by The Companies (Audit, Investigations and Community Enterprise) Act 2004 (hereafter called ”the 2004 Act”) sets out the restrictions that now apply to the indemnity by a company of its directors. The effect is to relax the restrictions that, before 6 April 2005, applied under s.310 to the indemnity of directors.
Broadly, read with new section 337A Companies Act 1985, also inserted by the 2004 Act to modify the director loan restrictions, provided certain conditions are met, the relevant provisions now remove the statutory restrictions which formerly prevented companies from:
These statutory provisions do not provide any actual authority to indemnify directors. This authority must usually come from the company’s constitution; the statutory provisions simply identify what indemnities cannot be provided.
(Note:- The director indemnity restrictions code is now set out entirely in section 309A. Section 310 now applies only to company auditors - see below).
The 2004 Act also closes a loophole in respect of associated companies (in effect, defined as being part of the same group). A parent company is now restricted in its ability to indemnify not only its own directors but also to indemnify directors of its subsidiaries. A subsidiary is now restricted in its ability to indemnify not only its own directors, but also to indemnify directors of its parent company, or of a fellow subsidiary of that parent company.
Broadly, there cannot be any “cross-indemnities” where a director or other officer is expressly prohibited from indemnity in relation to his or her own company. This is intended to prevent parent companies and subsidiaries from assuming liabilities in circumstances where the company itself would not be permitted to assume such liabilities. The continuing statutory restrictions on the indemnity of directors cannot be “side-stepped” by the provision of an indemnity through another associated company.
However, a company is not prohibited from indemnifying its own directors and/or the director of another group company if it is providing what is known as a qualifying third party indemnity on the terms summarised in section 9 below.
The changes made by the 2004 Act mean there is no longer any statutory prohibition on indemnity of officers other than directors or auditors. Companies are no longer subject to any statutory restriction on the type or extent of indemnity which they can provide for the protection of officers such as company secretaries, deputy secretaries, and managers. Charcoms have an implied power to indemnify such officers, in the absence of an express power or restriction.
(Note:- The position for reporting accountants is not viewed as being comparable with that of other officers, and is subject to separate guidance in section 8 below.)
However, the absence of statutory restriction does not mean there is an automatic entitlement to such protection; it is a matter for the directors of the company, subject to the articles of association, to decide on the nature and extent of the indemnity that may be provided to officers in the company’s interests. The directors must be satisfied that the giving of the indemnity is expedient in the interests of the charity. The board of a charcom does not have the power to grant a “blanket indemnity” to its officers in respect of all potential liabilities, regardless of the circumstances of wrong-doing or the merits of an individual case.
Provisions along the lines of article 49 of GD1 will only give officers an entitlement to an indemnity in the limited circumstances specified in that article. A constitutional right to an indemnity must be reasonable, and any attempt to alter the constitution of a charcom to give officers an entitlement to an indemnity regardless of the circumstances of the default will be resisted.
There does not appear to be any need for a constitutional provision specifically authorising the provision of an indemnity for officers in appropriate circumstances, but we have no objection to the promoters or members of a charcom including one if they consider it is in the charity’s interests.
There is a general prohibition in s.310 of the Companies Act 1985 against any provision that exempts an auditor from liability, or which confers a right of indemnity from the company. These statutory restrictions now apply only to auditors, and there can be no question of our giving approval to a change in the constitution of a company that would appear to “side-step” them.
However, charcoms are not prevented from providing indemnities for auditors that are within the exceptions mentioned in s.310 - eg liability for the costs of a successful defence against civil or criminal prosecution - as noted in section 3 above.
The “explicit authorisation of benefit” rule does not apply in such cases (auditors are not directors), but if the directors of a charcom are concerned about relying on an implied power to indemnify the auditor, and wish to amend the constitution to include an express power to the extent permitted by s.310, then we will approve it.
A reporting accountant appointed by a charcom is no longer subject to the restrictions in section 310. But whilst an audit exemption report (also referred to as an accountant’s report) is not as rigorous a form of scrutiny as an audit, a reporting accountant has (like a company auditor) a specific statutory duty to discharge, and that duty is discharged in the public interest.
Our view is that a charcom cannot contract out of such a duty, since the duty does not exist simply for the benefit of the company. The duty exists to protect the wider public interest in the proper administration of charities. It cannot be possible for those concerned with the formation and management of a charcom to “write off” this statutory function through the provision of indemnities.
It follows that a charcom cannot properly provide any indemnity to its reporting accountant in circumstances where a reasonable person might see such provision as encouraging the discharge of the reporting accountant’s statutory duty to a lower standard.
In effect, this means that we will normally approve indemnities for reporting accountants where these are on a comparable basis to those of an auditor, ie within the scope of the exceptions in s.310, since such a provision could not be said to undermine the proper discharge of a statutory function.
The reformed law represents a relaxation of the prohibition on director indemnity. Basically, directors may not be indemnified against any liability for negligence, default, breach of duty or breach of trust, unless the liability is what is termed a qualifying third party indemnity provision or is otherwise covered by an exception. The continuing restrictions mean that a company still:
(a) in defending any criminal proceedings in which he/she is convicted;
(b) in defending any civil proceedings brought by the company, or an associated company, in which judgment is given against him/her;
(c) in an unsuccessful application for relief from liability under the provisions for relief in the Companies Act.
Inasmuch as the prime mover for change appears to have been risk of shareholder action, or actions following mergers or takeovers, the overall impact on charcoms may not be great, given the “not-for-profit” context in which they operate. But there may still be risk of claims from creditors or employees.
It is important to recognise that the reformed provisions do not permit companies to exempt directors from liability to the company, or to limit a director’s liability to the company. Nor do they allow companies to indemnify directors against liabilities to the company or to any associated company, or against criminal or regulatory penalties.
Any charcom wishing to make use of the law permitting the indemnification of directors in a wider range of circumstances will need to take action, since the former standard indemnity provision will not cover the qualifying third party indemnification. Although the change in the law simply modifies the statutory prohibition, as a director benefit the wider indemnity requires explicit constitutional authority, and charcoms will need to come to us for our prior written consent to any requisite constitutional change.
Charcoms may wish to seek professional legal advice as to whether and how their Articles of Association should be modified to reflect the scope of the reforms. They will need to consider carefully whether the directors should have a right to the wider indemnity (as they do to the limited indemnity under article 49 of GD1), or whether the unconflicted directors should be in a position to decide whether or not to provide the indemnity in individual cases, on the basis of expediency in the interests of the charity.
We have no objection to either course, but we will need to authorise any special resolution to effect the change to the Articles of Association under s.64(2) of the Charities Act 1993.
Although the 2004 Act (by virtue of s.337A of the 1985 Act, inserted by s.20 of the 2004 Act) removes the restriction against the making of loans to directors in connection with the upfront payment of legal costs, it does not confer on a charcom a power to make such loans.
But, in our view, no explicit constitutional provision is needed for this purpose; as long as the indemnity itself is authorised or required by the constitution, the making of the loan by the charcom to the director can be regarded as incidental.
However, in our view, a right to such a loan cannot be implied, even though there may be a right to an indemnity. The board of directors should consider carefully whether it would be in the best interests of the charcom to make a loan to provide up-front funding for the director's legal costs. In doing so, they would need to take account of the risk that the charcom might not, in practice, be able to enforce repayment of the loan if the director's proceedings are unsuccessful. Relevant to that is the perceived strength or weakness of the director's case; the weaker the case, the more likely it is that the charcom will have to enforce repayment of the loan.
Our model paragraph 49 in the GD1 has been updated to allow the provision of the wider indemnity, either at the discretion of the directors or where there will be an entitlement to it. An equivalent provision may be used, but for charcoms wishing to use the GD1, we would suggest one of the following options:
Option 1A
49 The Charity may indemnify any Director against any liability incurred by him or her in that capacity, to the extent permitted by section 309A of the Companies Act 1985.
This option applies where the charcom:
(a) is content to rely on an implied power to indemnify officers other than directors (subject in the case of auditors to the section 310 limitations); and
(b) wants to be able to indemnify directors in any circumstances permitted by section 309A; and
(c) does not want to confer any right on any officer to an indemnity.
Option 1B
49 The Charity may indemnify any Director, Auditor, Reporting Accountant, or other officer of the Charity against any liability incurred by him or her in that capacity: in the case of a Director, to the extent permitted by section 309A of the Companies Act 1985; in the case of an Auditor, to the extent permitted by section 310 of that Act.
This option applies where the charcom:
(a) considers that an express power to indemnify all officers is necessary, subject in the case of directors and auditors to the statutory limitations; and
(b) does not want to confer any right on any officer to an indemnity.
Option 2
49 The Charity shall indemnify any Director or Auditor of the charity against any liability incurred by him or her in that capacity: in the case of a Director, to the extent permitted by section 309A of The Companies Act 1985; in the case of an Auditor, to the extent permitted by section 310 of that Act.
This option applies where the charcom wants to provide a right to an indemnity for directors and auditors. The scope of that right will be limited by the restrictions in sections 309A and 310. A power to indemnify other officers may be implied.
Option 3
49 The Charity shall indemnify every Director, Auditor, Reporting Accountant, or other officer of the Charity against any liability incurred in successfully defending legal proceedings in that capacity, or in connection with any application in which relief is granted by the court from liability for negligence, default, or breach of duty or trust in relation to the Charity.
This option applies if the company simply wishes to confer on all officers the right to the limited indemnity which was permissible under section 310 before 6 April 2005.
There may be other permissible options, but we would expect these to cover most eventualities.
(Note: - There can be no question of providing charcom officers (other than directors and auditors) with an unqualified right to an indemnity. Provisions which purport to give such officers the right to an indemnity in any circumstances permitted by law are not acceptable. This would have been different prior to April 2005, in view of the limited circumstances in which indemnities could then be granted. But since all statutory restrictions have now been removed, the effect of an “as permitted by law” provision could be to give an officer a right to an indemnity regardless of the circumstances of their default.)
More detailed guidance on the effect of the legislation is available on the Department of Trade and Industry website.