Can A Company’s Constitution Allow An Indemnity In Favour Of Former Directors?

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One of the significant issues in company law concerns the company’s constitution and whether the constitution alone can provide an indemnity to its directors or former directors. In Perdana Petroleum Bhd v Tengku Dato’ Ibrahim Petra Tengku Indra Petra & Ors [2022] 1 CLJ 725, 4 former directors of Perdana Petroleum Bhd (the Company) sought indemnification from the Company for their legal expenses incurred while defending previous legal proceedings filed against them. The main issue before the Court of Appeal was whether the former directors could rely on the indemnity provision in the Company's constitution.

Background

The plaintiffs (who were former directors of the Company) filed a case at the High Court against the Company to indemnify themselves for legal costs which were incurred from previous lawsuits between the Company and the plaintiffs based on Sections 289(3) and 289(4) of the Companies Act 2016 (CA 2016) and Article 170 of the Company’s constitution.

Section 289(3) of the CA 2016 provides that a company may indemnify an officer or auditor of a company for any costs incurred by them in relation to any proceedings. These proceedings should pertain to the liability for any act or omission made while acting as an officer or auditor of the company. The company may indemnify them if the judgment is in favour of the officer or auditor, or if they are acquitted or granted relief under the CA 2016. Alternatively, indemnity may also be provided in cases where the proceedings are discontinued.

Section 289(4) of the CA 2016 further provides that an officer or auditor may be indemnified by the company in respect of any liability to any person, other than the company, for any act or omission in his capacity of the same. The officer or auditor may also be indemnified with the costs incurred by them in defending or settling any claim or proceedings relating to the liability. This does not include liabilities to be paid by the director such as fines or penalties. This further excludes any liability incurred by the director in defending criminal proceedings where he has been convicted, or in defending civil proceedings brought by the company where judgment is given against him.

Meanwhile, Article 170 of the Company’s constitution states as follows:

“Every director, managing director, agent, auditor, secretary, and other officer for the time being of the company shall be indemnified out of the assets of the company 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 under the Act in which relief is granted to him by the Court in respect of any negligence, default, breach of duty or breach of trust.”

The former directors had succeeded in obtaining an indemnity against the Company in the High Court. The Company subsequently appealed to the Court of Appeal.

Appeal At The Court Of Appeal

The main question in this case was whether Article 170 incorporated a term (whether expressly or impliedly) in the former directors’ appointment in the Company.

It was argued at the Court of Appeal that provisions in the Company’s constitution were mainly mandates and authority provided to directors of a company. Although it can be said that a constitution is a binding contract between a company and its members (i.e. shareholders), the same does not apply between the company and third parties (which includes directors). However, it was suggested that there was a possibility of the provisions in the constitution being incorporated into a contract between a company and a third party.

The Court of Appeal commented that:

“It may be temptingly convenient to treat provisions in the articles of association of a company, specifically those pertaining to directors, as automatically incorporated into contracts of appointment of individuals as directors. However, such an approach is not without problems.”

The incorporation of provisions in a company’s constitution relating to directors in their contracts with a company would result in contractual rights being vested in directors in their personal capacity and enforceable as a contractual right against a company. As such, there should be evidence to establish that an article was incorporated into a director’s appointment contract.

In this specific case, the former directors failed to provide evidence of their appointment contracts, the terms of their appointment or the circumstances relating to their appointment. Hence, they failed to demonstrate any incorporation of the constitution's indemnity provision into their appointment contracts as directors. Consequently, they were unsuccessful in their claim for indemnification of legal fees and expenses.

While the constitution's provisions may be incorporated into contracts between the company and third parties, such incorporation requires explicit or implicit agreement. The constitution alone does not automatically establish a contract between the Company and third parties.

Although the former directors did rely on Section 289 of the CA 2016, the Court of Appeal held that the provision merely authorises companies to indemnify their officers and auditors. It does not provide for a statutory basis for the directors or auditors of companies to rely on for a claim for indemnity.

Conclusion

The constitution of a company alone does not constitute a contract between a company and any third parties or its officers. As shown in this case, there must exist some incorporation of the constitution’s provisions into the directors’ appointments before such provision can be enforceable as a contractual right against the Company. The Court of Appeal ruled against the former directors as there was no evidence adduced in relation to their appointment contracts and there was nothing else in writing to bind the former directors to the Company’s constitution.

This decision has implications for company directors, auditors and other officers who intend to rely solely on the company's constitution for indemnity. The Court of Appeal’s ruling highlights the importance of obtaining a clear indemnity clause directly from the company, either through an express written provision or a clause in the letter of appointment with the company. This case also serves as a reminder that mere reliance on an indemnity provision within a company's constitution may not be sufficient, thus directors and officers seeking to rely on the same should be prepared to furnish clear evidence of the company’s contractual obligation to indemnify them.

18 July 2023