Providing for valid hold harmless covenants in favor of directors in Italy.

In doing business are commonly set up hold harmless (or indemnity) covenants to protect directors against actions initiated by the company managed by them, company’s shareholders or any third party, in relation to the activities carried out by directors in their office. Such covenants are entered into at the beginning, in the meanwhile or at the end of a corporate management office or in connection with extraordinary operations (such as, by way of example, M&A transactions) as well. It is, therefore, of importance to examine the constituent elements and the extent of the validity of hold harmless covenants.

Under Italian law such covenants are not specifically envisaged in the Civil Code, nor in any other law or regulation, whilst they are qualified atypical guarantees to be considered valid in case interests worthy of protection are pursued pursuant to articles 1322 (Freedom of contract), 1343 (Unlawful consideration) and 1418 (Causes of nullity of the contract) of the Italian Civil Code.

Therefore, in the Italian system, it is firstly necessary to ascertain if limits of public policy exist to the eligibility of atypical guarantees (or atypical contracts / hold harmless covenants). To this regards, it is commonly accepted that it is contrary to the public policy only the covenant to indemnify a party from damages deriving from its willful misconduct (or damages related to intentional abuse). As a consequence, a valid hold harmless covenant may be entered into in all cases in which a guarantor assumes damages or liabilities arising from negligent or grossly negligent actions of the guaranteed towards third parties.

Nevertheless, it has to be considered that in case the indemnity covenant refers to the liability of the guaranteed for acts committed by itself against the guarantor such indemnity cannot cover grossly negligent actions, because the exemption in advance between creditor (guarantor) and debtor (guaranteed) from responsibility for grossly negligent actions (or for willful misconduct) is forbidden pursuant to article 1229 of the Italian Civil Code.

Given the above, it is necessary to check whether the above considerations may also apply as regards the hold harmless covenant to cover the consequences of criminal or administrative illegal actions.

Regarding the violation of criminal laws, the above criteria apply, for which the indemnity is invalid only if the responsibility of the person indemnified was caused by his/her willful misconduct. To this regards it is worthy to mention that it is not admissible a hold harmless covenant to protect the directors who committed the crime of false accounting as envisaged by article 2621 of the Italian Civil Code, which is by nature a fraudulent offense (see article 2621 of the Italian Civil Code, as amended by Law May 27, 2015, no. 69; see also Court of Cassation on June 16, 2015, no. 33774).

With respect, however, to the breach of administrative provisions of law, it has to be noted that, in application of secondary legislation that regulates the insurance sector, it is not valid any form of indemnity to cover risks relating to the imposition of administrative fines. This is because such an indemnity agreement would deprive the power of reaction of the State towards the administrative offenses provided for by provisions for the protection of the public interest. Nevertheless, an exception to this principle is made by fiscal rules, by which for cases of infringement carried out without fraud or gross negligence, the individual, the company, the association or the entity may assume the debt of the person (director) responsible of the infringement (usually, the CEO or the director charged with the responsibility of Tax compliance) (see Article 11, section 6 of the legislative Decree December 18, 1997, no. 472, as subsequently amended).

An important aspect for the purposes of setting up a valid hold harmless covenant is represented by providing for a determined or determinable object. In fact, it could be argued that a wide hold harmless covenant – with no indication of a specific event or behavior from which future liability might arise – may be held invalid for conflict with Article 1346 of the Italian Civil Code, by which the object of the contract has to be possible, lawful, determined or determinable.

A valid and enforceable indemnity, therefore, requires that the facts from which the liability (or the debt or the damage) can arise are indicated and well-specified so that the potential extent of the risk can be defined economically. These facts can be represented by any act, fact or circumstance, to the extent they are determined or determinable: such as behaviors that are related to the duties of the person to be indemnified or activities carried out by the latter, breaches of any nature, facts or acts concerning specific sectors, provided they are not committed with fraudulent behavior (nor with gross negligence, in case the acts covered by the indemnity covenant are committed by the guaranteed towards the guarantor).

An additional element to be necessary for the validity of the hold harmless covenant – except the cases (difficult to implement concretely) in which the liability or debt positions are well-specified and well-limited – is represented, then, by the determination or determinability of a maximum amount for the assumption of debt.

To this regards, it is however necessary to keep in mind that, if responsibility, damages or debt positions could not be determined to certain economic extents, the provision of a cap that defines the boundaries of the economic value of the indemnity is to be considered necessary on the basis of the application of the principle of public policy, imperative, envisaged by Article 1938 of the Italian Civil Code on the guarantee related to future or conditional obligations, according to which if the object of the contract (indemnity) is a future obligation, it is necessary that a maximum amount is set up (see A. Franchi, Il contratto di manleva e la manleva verso gli amministratori, in Contratto e Impresa, 2006, page 187; A. Franchi, La responsabilità degli amministratori di S.p.A. e gli strumenti di esonero da responsabilità, Milan, 2014; Court of Rome on December 18, 2002; Court of Cassation on January 26, 2010, no. 1520; Court of Cassation on September 23, 2015, no. 18777).

In this regard, it is clear that this principle also applies to the hold harmless covenant, due that by entering into such a type of contract (atypical guarantee) the guarantor, as we have seen, is to take on future liabilities that may be unknown or unpredictable.

Moreover, it should, then, be noted that it is in the interest of the guarantor to set a cap, in order, on the one hand, of being able to determine with certainty the possible future economic expenditure and, on the other hand, also resorting to the possible insurance coverage of risks arising from the agreed hold harmless covenant.

Alberto Rittatore Vonwiller

Alberto Rittatore Vonwiller

Email: alrittatore@carnelutti.com
Tel: +39 02 65585 1

Alberto Rittatore Vonwiller is a partner in Carnelutti Studio Legale Associato. He is a member of the firm's corporate and M&A department, where his practice focuses on mergers and acquisitions and corporate finance work, including joint ventures, shareholder agreements, securitizations, loans, and commercial contracts in Italy and abroad.

Antonio Franchi

Antonio Franchi

Email: afranchi@carnelutti.com
Tel: +39 02 65585 1

Antonio Franchi is a partner in Carnelutti Studio Legale Associato. He is a member of the corporate and M&A department, where his practice focuses on civil, commercial and corporate law.
He advises Italian and foreign entities, including listed companies, in corporate and M&A matters, capital contributions in the form of transfers of businesses and shares, joint ventures, shareholders’ agreements, sale and purchase of real estate properties and commercial contracts.

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About Alberto Rittatore Vonwiller

Email: alrittatore@carnelutti.com Tel: +39 02 65585 1
Alberto Rittatore Vonwiller is a partner in Carnelutti Studio Legale Associato. He is a member of the firm's corporate and M&A department, where his practice focuses on mergers and acquisitions and corporate finance work, including joint ventures, shareholder agreements, securitizations, loans, and commercial contracts in Italy and abroad.