The Effect of Indemnity Clauses in Danish Capital Companies

Abstract

The number of claims for damages raised against directors and officers, has increased significantly during the last 10-15 years, which has led to an increase in insurance premiums and a decrease in the provided insurance coverage. Because of this fact, companies have been using indemnity clauses in order to protect the management against liability, even though the legality of indemnity clauses have been questioned. This master thesis examines the Danish regulation of indemnity clauses and is divided into three analyses. The purpose of the analyses is to examine whether the decision to indemnify members of the management is legal in accordance with the Danish Company Law (‘Selskabsloven’), and whether the clauses have an effect on the managements’ decisionmaking. The legal analysis examines whether corporate indemnity clauses are legal in accordance with current Danish Law. It is concluded, that according to current Danish law, indemnity clauses are legal as long as the decision to indemnify the management has been made by the right authority in the company. Furthermore, it is a requirement that the decision is in accordance with the interests of the company. The economic analysis investigates the P/A-relationship, to determine whether indemnity clauses can change the risk profile of any of the parties. The analysis also examines whether an indemnity clause has an effect on the managements’ decisionmaking, and whether the contract can contribute to generating relational rents, by use of strategic contracting. It is concluded that indemnity clauses have a positive effect on the managements’risk profile, hence they are willing to take more risky decisions. The clauses were also found to generate relational rents in the relationship. The thesis concludes that indemnity clauses can be used to prevent the P/A-problem and minimize asymmetric information in the relationship between the parties. The clauses are used to attract and maintain qualified members in management positions. Based on the economic analysis the contract should take into consideration which kind of behavior that is covered by the clause, since it was found that coverage of gross negligence and intentional actions can lead to moral hazard. Based on the results from the legal and economic analyses, the integrated analysis examines whether indemnity clauses can be considered efficient. The conclusion is that use of indemnity clauses can be considered Kaldor-Hicks efficient, as long as the winners’ reward is big enough to compensate the losers for their loss. The analysis presents two initiatives to decrease the information asymmetry between the parties, resulting in a legal position closer to an efficient situation. Finally, the integrated analysis presents an example of an indemnity clause, based on the considerations from the legal and economic analyses.