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Why Directors and Officers Should Demand a Separate Indemnification Agreement

Corporate directors and officers (“D&O’s”) face significant personal exposure whenever their corporation is involved in a dispute or investigation.  For this reason, prudent D&O’s avail themselves of all available legal protections, including charter provisions, insurance, and indemnification agreements.

Delaware law permits a corporation’s certificate of incorporation to include a provision eliminating the personal liability of a director for monetary damages for breach of the duty of care.  8 Del. C. § 102(b)(7).  It also permits a corporation to indemnify a director or officer for liability arising from a breach of the duty of care.  8 Del. C. § 145(a) & (b).  These provisions reflect the strong public policy favoring the indemnification of directors to ensure that highly qualified people will want to serve.  But the director or officer who relies exclusively on these protections does herself a disservice.  She should also demand a separate indemnification agreement between herself and the corporation.

Indemnification agreements offer several advantages over the indemnification provisions in organizational documents.  Indemnification agreements may be more easily enforced by D&O’s because they are bilateral contracts reflecting bargained-for consideration in the form of an individual’s agreement to accept or continue service with the company.

Indemnification agreements also typically provide broader and more thorough protection of D&O’s indemnity rights than statutes and organizational documents.  Indemnification agreements often include detailed procedures and time frames for determining when indemnified individuals are entitled to payment, and they clarify the types of claims and proceedings covered.  A well-written indemnification agreement should include, for example:

Definitions of Key Terms.  The scope of the D&O’s protection can be significantly expanded through definitions.  For example, an indemnification agreement typically will indemnify a person against (among other things) any “Expenses” incurred by the indemnitee in connection with any “Proceeding.”  The definition of “Expenses” can be written very broadly to cover every imaginable legal expense or cost, including (i) attorneys’ fees, experts’ fees, arbitrators’ fees, out-of-pocket expenses, and the many other costs associated with prosecuting, defending, or participating as a witness in a legal proceeding; (ii) any amounts that the Indemnitee becomes legally obligated to pay, such as damages, judgments, fines, and settlements, and even any taxes resulting from payments under the indemnification agreement; and (iii) any premium, security, bond, or appeal bond in connection with any Proceeding.  The definition of “Proceeding” can be written broadly enough to encompass any threatened or pending legal proceeding of any kind, such as a litigation, investigation, discovery request, administrative proceeding, arbitration or other ADR, and any appeal.

Fees-on-Fees.  While it is routine for a director to be indemnified in suits brought by third parties, she is not necessarily entitled to indemnification for attorneys’ fees and costs should she need to sue the corporation to enforce her indemnification rights under an agreement, organizational document, or applicable law.  An indemnification agreement can expressly provide the right to be indemnified in such “fees-on-fees” disputes.

Procedures and Time Frames.  An indemnification agreement typically includes procedures and deadlines that both clarify and strengthen the rights of the indemnitee.  For example, the agreement can require that the corporation, when settling any claim against the indemnitee, include certain settlement terms that are favorable to the director, such as an unconditional release from all liabilities relating to the Proceeding, and an acknowledgement that the indemnitee denies all wrongdoing.  The indemnification agreement can require that all indemnification payments be made within 30 days, and that all advances be made within 20 days, of the written request of the indemnitee.  The agreement can empower the D&O to choose among several dispute resolution alternatives.  The agreement can require that, in the event of an adverse determination against the indemnitee, she has the right to commence any Proceeding to challenge that determination in a court of competent jurisdiction, and be indemnified for all Expenses.  The agreement also can create evidentiary presumptions in favor of indemnification, including a presumption that the individual has met the applicable standards of conduct allowing for indemnification (i.e., conduct other than intentional wrongdoing), and that a judgment, settlement, or criminal conviction does not create a presumption against indemnification.  And the agreement can impose a reasonably short limitations period, such as two years from the date of accrual, on any claim that the corporation might have against the indemnitee.

Insurance.  The indemnification agreement typically will require that the company provide D&O liability insurance that protects the indemnitee to the same extent as the most favorably insured of the company’s and its affiliates’ current D&O’s.

These are just a small sample of the types of protections that can be included in an indemnification agreement and that might not be available from any other source.

But in addition to legal benefits, indemnification agreements provide psychological benefits that cannot be provided by generally applicable statutory, charter, or bylaw provisions.  Indemnification agreements provide the peace of mind that comes with having the maximum protection that is legally possible for D&O’s.  If you are or will be a corporate director or officer, consult with qualified counsel on the drafting and negotiation of an indemnification agreement that is appropriate for you and your business.

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Heidi Lawson

David Barres