In carrying out their duties and functions, directors of a company are exposed to many risks and liabilities and it is important for directors to understand the legal rights and protections which they are afforded under South African law. One such protection mechanism which is afforded to directors is that of indemnification, which refers to the company’s obligation to cover certain legal expenses and damages incurred by directors in the course of their duties – although not all expenses and damages can be indemnified.
Section 78 of the Companies Act No. 71 of 2008 (“Companies Act”) governs director indemnification in South Africa. This section provides that, unless the memorandum of incorporation of the company provides otherwise, a company may indemnify a director against any liability incurred by the director in connection with the performance of their duties, save for certain circumstances. The company may also pay for the legal expenses incurred by the director in defending themselves against such liability. It is common for South African companies to take out directors and officers liability insurance on behalf of directors in order to cover the risks incurred by directors.
The indemnification provided by a company can cover a variety of expenses and damages and may include instances whereby a company indemnifies a director against claims arising from alleged negligent breaches of their fiduciary duties which may include, amongst other things, where directors have failed to act in the best interest of the company, have signed off on misleading financial statements, have authorised the issue of unauthorised shares and/or have authorised the providing of financial assistance without a special resolution of the shareholders of the company.
The Companies Act however prescribes certain situations in which a director may not be indemnified. Section 78 of the Companies Act prescribes that a director may not be indemnified:
- if the director acted in the name of the company, signed anything on behalf of the company, purported to bind the company or authorised the taking of any action by or on behalf of the company, despite knowing that they lacked the authority to do so;
- if the director acquiesced in the carrying on of the company’s business despite knowing that it was being conducted reckless, with gross negligence, with the intent to defraud any person or for any fraudulent purpose;
- if the director had been a party to an act or omission by the company despite knowing that the act or omission was calculated to defraud a creditor, employee or shareholder of the company or had another fraudulent purpose;
- for any liability arising from wilful misconduct or wilful breach of trust on the part of the director concerned; and/or
- for any fine imposed on the director as a consequence of the director having been convicted of an offence, unless the conviction was based on strict liability.
Directors of companies should therefore be aware that indemnification is not a guaranteed protection. It is ultimately subject to the memorandum of incorporation of the company, the instances for which a director may not be indemnified in terms of section 78 of the Companies Act and the agreements concluded between the director and the company.
In conclusion, director indemnification is an important protection for directors in South Africa. It is important for directors to negotiate surrounding indemnification with companies and to understand the limitations of this protection and the circumstances under which they may not be indemnified. Directors should take steps to ensure that they act in good faith and in the best interests of the company, and that they comply with their legal duties to minimise the risk of liability. Companies may also take out directors and officers liability insurance on behalf of directors as a risk mitigation tool to protect directors.
VDMA’s team of experts are available to assist directors and companies with any legal requirements pertaining to director indemnification, including amending the memorandum of incorporation of the company, indemnification agreements and/or the drafting of resolutions.
Published 30 May 2023