Indemnity clauses and criminal proceedings

Earlier this week, the Court of Appeal decided another interesting case involving contractual interpretation – this time interpreting and determining the scope of an indemnity clause. The case was one of the many fall-outs of the ongoing News of the World (“NOTW”) saga, and involved a claim brought by Mr Coulson, former editor of NOTW, against his former employers.


On the termination of Mr Coulson’s employment in 2007, News Group Newspapers Limited (“NGN”) and Mr Coulson had entered into an agreement which included the following clause:

To the extent that it is lawfully able to do so, [NGN] will pay any reasonable professional (including, without limitation, legal and accounting) costs and expenses properly incurred by [Mr Coulson] after the Termination Date [viz. 28 February 2007] which arise from his having to defend, or appear in, any administrative, regulatory, judicial or quasi-judicial proceedings* as a result of his having been the Editor of the News of the World.


In 2011, Mr Coulson was arrested as part of the investigations into NOTW; and he sought to recover from NGN the costs of defending the criminal proceedings brought against him. NGN agreed to indemnify him for costs incurred on account of the civil inquiries, but argued that the costs incurred in defending criminal proceedings were not recoverable under the indemnity clause. In his subsequent claim, Mr Coulson failed in the High Court, but succeeded on appeal in Andrew Coulson v News Group Newspapers Limited.


NGN denied liability to indemnify Mr Coulson for the costs incurred in defending the criminal proceedings on the principal ground that criminal proceedings fell outside the scope of the indemnity clause.

First, NGN argued that since illegal/criminal activities were not within the scope of Mr Coulson’s employment as editor, the criminal proceedings were not ‘a result of his having been the Editor of the News of the World’. Therefore, the costs and expenses of defending these proceedings were not recoverable pursuant to the clause.

Secondly, NGN contended that the clause only allowed the recovery of costs and expenses which were ‘reasonable’ and ‘properly incurred’. The costs incurred in defending criminal proceedings did not satisfy these requirements.


McCombe LJ, delivering the decision of the Court, rejected both these contentions. He observed that there was “nothing inherently objectionable” in a clause which applied to the defence of criminal proceedings; the applicability of the clause depended instead on the nexus between the employment and the subject matter of the criminal proceedings. The relevant question was “whether the criminal allegations arise out of how the employee went about the performance of his job or whether they arise out of some act having nothing whatever to do with performing the job”.


The Court of Appeal disagreed with the the judge at first instance that since Mr Coulson’s duties as editor comprised only lawful duties, it cannot have been intended that activities outside his lawful responsibilities would be covered by the indemnity. If that were true, the clause would also not apply to libel or contempt of court proceedings, which would certainly be expected to fall within the scope of an indemnity granted to the editor of a newspaper. Admittedly, if the charge arose out of conduct which had nothing whatever to do with Mr Coulson’s job or its attempted performance, the clause would not apply. However, the charges here arose “out of the allegedly criminal manner of his performance of his role as editor” and therefore were covered by the clause.


As to whether the costs were ‘reasonable’ and ‘properly incurred’, the Court held that ‘reasonable’ refers only to the quantum claimed and not the circumstances in which the costs were incurred. The phrase ‘properly incurred’ posed the question whether Mr Coulson could claim the costs only if his defence was successful, or whether even costs incurred in unsuccessfully defending the criminal proceedings could be recovered. Applying the principles laid down in Investor Compensation Scheme, the Court held that given the circumstances at the time of the agreement, the costs of defending criminal charges cannot have been outside the contemplation of the parties. It would be “artificial in such circumstances to have expected that the indemnity would be subject to a scrutiny of the nature or merits of the intended defence to the charges or subject to the outcome of the trial itself … ‘properly incurred’ in this contract simply means costs of a nature properly to be regarded as required in the defence of the particular proceedings in question”.


In addition, NGN relied on the common law maxim ex turpi causa non oritur actio, which states that a claim cannot be founded on a criminal/illegal act. This is a controversial area in English law, with conflicting decisions on the strength of the nexus required between the illegality and the claim. However, in this case, the Court of Appeal (and the judge at first instance) rightly held that “there is nothing contrary to public policy in one person providing funds to another for that other to defend himself against a criminal charge”. If the claim had sought to recover a fine imposed for an illegality, the maxim would apply. It did not, however, have the effect of precluding a claim for recovering costs incurred in merely defending criminal proceedings.


This decision is of significance for indemnity clauses in employment or retainer contracts and even for D&O (directors and officers) insurance policies. Many such contracts contain indemnity clauses which are similarly widely drafted. Admittedly, the special circumstances of this case meant that criminal proceedings were certainly in the contemplation of the parties at the time of the agreement. It is also important to note that the Court of Appeal relied on the fact that this indemnity clause was wider than the clause in Mr Coulson’s employment contract, which indicated that it was intended to have a wider scope. However, notwithstanding these distinguishing aspects of the case, some important lessons to take away are:

• The alleged criminality of the conduct does not necessarily take it outside scope of employment- if the charge arises from the criminal manner of performing the job, it can fall within the indemnity clause;

• ‘Reasonable costs’ usually refers to the quantum of the costs and not the purpose for which they have been incurred;

• ‘Properly incurred’ does not require that the criminal proceedings be defended successfully. (However, it is not clear to what extent the Court’s conclusion on this point was influenced by the peculiar circumstances of this case); and

• The ex turpi causa maxim cannot be applied to reject a claim to recover the costs of defending criminal proceedings.


* The interpretation of 'proceedings' (and whether this required the bringing of a charge) was also an issue in this case. However, given its procedural nature, this issue is of limited relevance for present purposes.

Low Take-up Rate on D&O Insurance Policies

The Mint has a report today stating that “only 5-6% of publicly traded companies in India have taken D&O insurance policies, compared with nearly 95% of Fortune 500 companies”. This seems striking considering the fear that various corporate governance episodes in India have generated among directors and managements.

One of the key reasons for lack of D&O insurance policies is generally the expensive nature of such policies (with their hefty premia) given that a competitive market for such policies might be absent in India. But, the Mint report suggests that is not true and that rates of premia are in fact falling.

The other reason is usually the absence of a track record of successful legal action against directors and officers of the company where the threat perception may be low. The report suggests that this is determinative of the low D&O take-up rate in India. Not only are there limited substantive legal principles that allow shareholders (or other interested parties) to bring actions against directors and officers, but procedural delays and costs could make it uneconomical to bring them. Since directors’ and officers’ potential to be sued in other developed jurisdictions might be higher, that offers an explanation as to why Indian companies with international operations (or international listings) are more likely to avail of enhanced D&O insurance policies compared to other companies.

I recently had occasion to listen to a presentation on the D&O insurance market in China, and the position seems to mirror that of India on nearly all of these counts.

MCA Circular on Prosecution of Directors

One of the disincentives that operate against directors, particularly non-executive directors, is that they are often susceptible to prosecution for offences committed by the company that it not within their knowledge. Occasionally, innocent directors have been subject to victimization by requiring to answer allegations that are often frivolous in nature. This concern has now been addressed, at least partially, by a Circular issued on March 25, 2011 by the Ministry of Corporate Affairs to all Regional Directors, Registrars of Companies (ROC) and Official Liquidators.

The Circular relates primarily to independent directors and nominee directors, who are not in charge of the day-to-day affairs of the company. It calls upon the ROC to take extra care in examining the cases where such directors are identified as “officers in default” for the purposes of actions to be taken under the relevant penal provisions of the Companies Act. The Circular further states:

No such Directors as indicated above shall be held liable for any act of omission or commission by the company or by any officers of the company which constitute a breach or violation of any provision of the Companies Act, 1956, and which occurred without his knowledge attributable through Board process and without his consent or connivance or where he has acted diligently in the Board process. The Board process includes meeting of any committee of the Board and any information which the Director was authorised to receive as Director of the Board as per the decision of the Board.

The Circular imposes greater obligations on the ROC to verify relevant information and records before initiating prosecution against independent or nominee directors. These include the status of the director and timing of resignation relative to the commission of the offence by the company. Special provisions have been made for identification of the appropriate “officer in default” in connection with violation of the provisions relating to accounting and financial statements. In sum, the Circular moves away from the erstwhile regime where ROC could potentially adopt a trigger-happy approach while initiating criminal prosecution of directors to one where the ROC is compelled to exercise “proper application of mind”. 

This is a welcome move as it prevents harassment of innocent directors who have been kept in the dark by managements. The Circular, however, does not go as far as proposals discussed in the context of the Companies Bill, 2009 that call for complete immunity to independent directors from prosecution. By conferring discretion on the ROC (to be exercised in an informed manner), the Circular adopts a principles-based approached by avoiding the rigidity involved in complete immunity. This would continue to spur non-executive directors to perform their role diligently, but at the same time protect them against prosecution risks in the event of their innocence.

Advisory Boards for Indian Companies

About a week ago the Economic Times’ Corporate Dossier carried two columns (here and here) highlighting the growing popularity of advisory boards in Indian companies. The individuals on such boards perform advisory functions and almost no monitoring functions. In that sense, an advisory board is distinct from the statutorily required board of directors of a company. As one column notes:

Fiduciary boards are mandated as per statute. They are created at the company level and at times their formal nature & structure can prohibit an effective leverage of their capability. Advisory boards, on the other hand, are their non-fiduciary, informal and non binding. They can be set up for a CEO or promoter rather than for the company. They are inherently flexible and can have a narrowly focussed objective to a wider governance role.

Having access to a high quality advisory can enhance an company’s odds of success. An advisory board can serve as a feeder group for board directors. Development of a board of directors is a long term project and by observing the commitment and contribution of some of the advisory board members they can be appointed to the board of directors.

Advisory board formation and its objectives vary across diverse contexts. Multinational corporations (MNCs), for example, are reluctant to give meaningful authority to a fiduciary board of their local subsidiary.

The other column goes on to discuss the viability of the concept:

But why form an additional board when all registered companies already have a statutory board of directors mandated by law? The raison d'être for advisory boards is different for different sets of companies. For conglomerates, there's a need for a set of senior leaders with relevant expertise who can look at opportunities and issues at the group level. The various company level boards within a conglomerate provide strategic input and compliance for a particular company, but at the group level a different kind of strategic insight is needed.
…

But like any management practice, advisory boards have its fair share of critics too. The toothless nature of the board is what critics point out as its biggest drawback. And the ills of the statutory boardrooms, like 'Groupthink' and the 'golf buddies syndrome' affect advisory boards too. Companies are known to constitute advisory boards to get access and credibility.

For the companies wanting to constitute advisory boards, getting candidates can be tricky. Some experienced members are not comfortable with providing just advice - they'd rather have some level of control that being a statutory board member provides. For some, an advisory role suits just fine because it doesn't come with liabilities listed companies throw up.

Advisory boards are non-statutory and hence the acts of their members are unlikely to carry legal consequences. However, in certain limited circumstances, the Companies Act imposes duties and liabilities on a person “in accordance with whose directions or instructions” the board of directors of a company is accustomed to act. Such person is otherwise referred to as a “shadow director”, and is generally subject to all the duties and liabilities of any other director.

So long as the advice from the advisory board is not binding on the statutory board of directors and that the statutory board is not accustomed to following their advice, the advisors will not be treated as shadow directors. This position is somewhat reinforced by section 7 of the Companies Act, which provides: “Except where this Act expressly provides otherwise, a person shall not be deemed to be, within the meaning of any provision in this Act, a person in accordance with whose directions or instructions the Board of directors of a company is accustomed to act, by reason only that the Board acts on advice given by him in a professional capacity.” Complete reliance on this section may, however, require demonstration that the advice was provided in a professional capacity.

Nomination of Directors by Shareholders

Earlier this week, the U.S. Securities and Exchange Commission (SEC) adopted the much anticipated proxy access rule which allows shareholders to nominate candidates for directorship. The essence of the new rules is as follows:

The new rules require companies to include the nominees of significant, long-term shareholders in their proxy materials, alongside the nominees of management. This "proxy access" is designed to facilitate the ability of shareholders to exercise their traditional rights under state law to nominate and elect members to company boards of directors.

Under the rules, shareholders will be eligible to have their nominees included in the proxy materials if they own at least 3 percent of the company's shares continuously for at least the prior three years.

This has generated an extensive debate (e.g. on the Conglomerate Blog) as to whether such proxy access to shareholders has merit when it comes to nomination and appointment of directors.

All of this might seem like “much-ado-about-nothing” in parts of the Commonwealth where shareholder rights to nominate directors have been available traditionally within law. For example, in India, shareholders have extensive rights under the Companies Act, 1956 to determine the composition of the board (Sec. 257: propose candidates for directorship; Sec. 263: vote for appointment of directors; Sec. 284: vote for removal of directors). To that extent, the developments under U.S. federal law continue to trail behind the position in many parts of the Commonwealth such as India as regards shareholder democracy under corporate law. Even though proxy access has enhanced rights of shareholders in U.S. companies, those additional rights come along with stringent conditions (such as the requirement to own 3% over 3 continuous years).