Directors Beware: Indemnity In A Company's Constitution Is Not Foolproof

The constitution (formerly known as articles of association) of companies in Malaysia generally contains an indemnity provision in favour of directors, indemnifying them against liabilities (for example, associated legal fees and financial costs) incurred by the directors in defending legal suits by third parties where judgement has been given in their favour in respect of any negligence, default, breach of duty or breach of trust. However, to what extent can the directors solely rely on an indemnity provision in a company's constitution to bring an indemnity claim against the company? This question was considered by the Malaysian Court of Appeal in the case of Perdana Petroleum Bhd (formerly known as Petra Perdana Bhd) v Tengku Dato' Ibrahim Petra bin Tengku Indra Petra & Ors [2021] 6 MLJ 663.

Facts of the Case

In this case, four former directors of Perdana Petroleum Berhad (Company) filed an action at the High Court to seek an indemnity against the Company to claim for their legal fees and expenses incurred in defending two previous lawsuits commenced by the Company (or on the Company's behalf) against the directors for, among other things, breaches of statutory and fiduciary duties.

The directors successfully sought an order from the High Court, requiring the Company to indemnify the directors in respect of their legal expenses (approximately RM2.6 million) in connection with the previous lawsuits. The directors had largely relied on Article 170 of the Company's constitution (which followed Article 113 of the Table A model articles under the now repealed Malaysian Companies Act 1965) in their indemnity claim, which provided as follows:

Dissatisfied with the outcome, an appeal was brought by the Company to the Court of Appeal. One of the principal issues before the Court of Appeal, which forms the focus of this article, was whether the former directors were entitled to avail themselves of the above indemnity provision found in the Company's constitution. To the directors' dismay, the Court of Appeal answered the question in the negative and ruled that the former directors could not rely on Article 170 alone to claim for indemnity.

The Court of Appeal's Decision

In coming to this decision, the Court of Appeal reasoned that the Company's constitution constituted a binding contract only between the Company and its shareholders, and not between the Company and other third parties such as its directors or officers. As a result, even though the Company's constitution contained Article 170 which provided an indemnity in favour of the directors, this alone, without more, could not give the directors a contractual right to enforce the relevant article against the Company. The Court of Appeal justified its reasoning based not only on local and other common law cases, but also the wording of Section 33(1) of the Malaysian Companies Act 2016 which, in essence, states that a constitution shall, "when adopted, bind the company and the members".

The Court of Appeal also highlighted that for the directors to avail themselves of the protection offered by the Company's constitution, Article 170 had to be incorporated into a separate binding contract between the directors and the Company. This can be done by way of an agreement, whether expressly or impliedly, like any other terms of a contract. In this regard, the court observed that "comparatively little is required for the incorporation of a term in the article that provides indemnity to an auditor or director who is appointed." Without such incorporation, the provision in the Company's constitution will not automatically become terms of a contract between the Company and the directors.

In the present case, since the directors were unable to point to any binding contract (whether in oral or written form) with the Company containing or incorporating Article 170, there was no contractual basis for the directors to seek an indemnity against the Company.

Comments and Takeaways

The Perdana Petroleum Berhad decision is not entirely surprising, and, in fact, it is consistent with the position in the United Kingdom. In Globalink Telecommunications Ltd v Wilmbury Ltd [2003] 1 BCLC 145, for example, Stanley Burnton J held that the articles of association of a company were not automatically binding between a company and its directors, unless they were expressly or impliedly incorporated into an agreement between them.

It goes without saying that directors are exposed to the risks of being held personally liable for wrongdoing arising in the course of managing a company. This is understandably so given that a host of different obligations and fiduciary duties are imposed on directors by either common law or statutory provisions. Given the Perdana Petroleum Berhad decision, there is now more reason for directors in Malaysia to look for other means to protect themselves from potential liabilities since merely having indemnity provisions in a company's constitution is not sufficient.

At the very least, as guided by the Court of Appeal, one of the protections which directors could look to is to ensure that the relevant indemnity provisions are expressly incorporated in their contract of appointment or employment (which governs the overall contractual relationship between the directors and the company), or a separate deed of indemnity. It is worth noting that it takes very little effort to incorporate such indemnity provision as a term in the directors' contract, but such incorporation is absolutely necessary if reliance is to be placed upon it.

One thing to bear in mind is that mere appointment of the director is not a valid argument for the directors to rely on the relevant indemnity provision in a company's constitution. Appointing a director in accordance with the constitution of a company merely attests to the fact that the appointment was validly made. Provisions in the constitution are mainly mandates and authority given to directors of a company, and appointment does not per se, automatically constitute a binding contract between a director and a company. The company's obligations in other contracts entered into with third parties would ultimately depend on the terms of these separate contracts.

Alternatively, directors may also consider taking up a directors' and officers' insurance to obtain additional protection against potential liabilities arising in the course of their duties. Taking the relevant steps as mentioned above is critical to give directors the peace of mind they need while discharging their onerous and demanding directors' duties.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Mr Glynn Cooper
Herbert Smith Freehills
Exchange House
Primrose Street
London
EC2A 2HS
UK

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