d&o indemnification provisions in governance documents and...

D&O Indemnification Provisions in

Governance Documents and Agreements Drafting Effective Indemnity and Advancement Agreements to

Protect Directors and Officers From Personal Liability

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TUESDAY, JULY 10, 2012

Presenting a live 90-minute webinar with interactive Q&A

Dan A. Bailey, Member, Bailey Cavalieri, Columbus, Ohio

Amy L. Goodman, Partner, Gibson Dunn & Crutcher, Washington, D.C.

John F. Grossbauer, Partner, Potter Anderson & Corroon, Wilmington, Del.

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D&O Indemnification Provisions in Governance

Documents and Agreements

Presentation to: Strafford Webinars and Publications

July 10, 2012

Amy Goodman

<Presentation Title/Client Name>

An Overview of D&O Protection

• The Three-Legged Stool of Protection

– Exculpation

– Indemnification/Advancement

– Insurance

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An Overview of D&O Protection cont’d

• Exculpation

– Statutory right of a corporation to limit or eliminate personal monetary liability

of directors to the corporation and its stockholders from claims resulting from

directors’ breach of their fiduciary duty of care (Delaware General

Corporations Law (“DGCL”) §102(b)(7))

• Must be included in a corporation’s certificate of incorporation

– Does not protect a director from claims relating to:

• Breaches of duty of loyalty

• Acts or omissions not in good faith or involving intentional misconduct or

a knowing violation of law

– Does not protect officers

7


An Overview of D&O Protection cont’d

• Indemnification/Advancement – Indemnification: Compensates directors and officers for losses arising out of conduct relating to

their position with the corporation

• Under Delaware law, a corporation:

– Must indemnify directors and officers that are “successful on the merits or

otherwise”

– May, but is not required to, provide mandatory or permissive indemnification to

employees and agents

– Advancement: Provides directors and officers with legal fees and expenses in advance of final

disposition of the proceeding

• Under Delaware law, a corporation may, but is not required to, provide mandatory or

permissive advancement to any or all of its directors, officer, employees and agents

• D&O Insurance Policies – Provides protection to directors and officers for claims that the corporation either cannot

(legally or financially) indemnify or if indemnification is permissive, refuses to indemnify

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A. Permissive v. Mandatory

B. Protected Persons

C. Outside Positions

D. Covered Claims

E. Standard of Conduct

F. Indemnifiable Losses

G. Defense Cost Advancement

H. Non-Exclusivity Provision

9


Drafting Considerations: Who Is Protected?

• Directors and Officers – Indemnification and advancement provisions can provide mandatory and permissive coverage

• Mandatory coverage: subject to certain limitations, the corporation must advance expenses

and/or indemnify losses

• Permissive coverage: the corporation may, in its discretion, decide whether to advance expenses

and/or indemnify losses

– Delaware law requires that a corporation provide mandatory indemnification to a director or officer if

he or she is “successful on the merits or otherwise”

• A corporation may, but is not required to, provide indemnification in other situations

– Directors must still meet the statutory standard of conduct by acting “in good faith” and

“in a manner the person reasonably believed to be in or not opposed to the best interests

of the corporation”

– For a criminal proceeding, the person must also have had “no reasonably cause to believe

the person’s conduct was unlawful”

– Advancement to directors and officers is permissive under Delaware law

• A corporation can provide mandatory, permissive or no advancement rights to directors and

officers

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• Distinguishing Between Directors and Officers – Historically, most corporations provided identical indemnification and advancement

rights to directors and officers, although some exceptions existed

• Example: “Notwithstanding the foregoing…no advance shall be made by the corporation to an officer of the corporation…in any action, suit or proceeding…if a determination is reasonably and promptly made (i) by the board of directors…or (ii)…by independent legal counsel in a written opinion…that such person acted in bad faith or in a manner that such person did not believe to be in or not opposed to the best interests of the corporation.”

– Post-Enron, commentators and some corporations have begun to consider distinguishing between the rights afforded to directors and to officers, particularly with regard to advancement

• Broad advancement rights can result in a company continuing to advance legal expenses even after it is clear that an individual engaged in misconduct

• However, unlike directors, officers are not protected by the business judgment rule and thus, may have a greater need for protection

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• Directors and Officers as Plaintiffs – Broadly drafted provisions could require indemnification and advancement to a director

or officer who is personally suing the corporation

• Delaware courts will require indemnification or advancement if the court views the

suit as furthering the plaintiff’s duties to the company

– A corporation can limit its exposure by providing that indemnification and advancement

are not available for proceedings initiated by the director or officer other than:

• Proceedings to enforce the terms of indemnification provisions themselves;

• Mandatory counterclaims that must be made or waived by a defendant; and

• Proceedings authorized by the board of directors

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• Employees and Agents – Indemnification and advancement for employees and agents is permissive under

Delaware law

– A corporation can:

• Grant mandatory advancement and/or indemnification to employees and agents;

• Grant permissive advancement and/or indemnification at the corporation’s

discretion to employees and agents; or

• Be silent on advancement and/or indemnification to employees and agents

– Indemnifying employees and agents can help attract quality individuals but can also

result in substantial potential liability for a corporation

– Historically, some companies provided mandatory indemnification and advancement to

all employees and agents

– Modern practice is to grant only permissive indemnification and advancement to

employees and agents

13

D&O Indemnification Provisions in

Governance Documents and Agreements

John F. Grossbauer, Esq.

Strafford Webinar and Publications

July 10, 2012

Scope of Protection Under Delaware Law

Section 145 of the Delaware General Corporation Law

provides the framework for analysis.

Case law makes clear that, while bylaws and agreement

may vary the process by which indemnification and

advancement is provided, the substance of what may be

covered by indemnification and advancement is limited by

the public policy expressed in Section 145 (a) through (e).

Who may be covered?

Issues of coverage frequently arise in companies with

multiple tiers of subsidiaries. Case law only clearly provides

that directors of first-tier subsidiaries are “serving at the

request” of the parent as a matter of law.

Issues may also involve as to how to characterize a person

whose function does not neatly fit into the categories

defined in the statute (e.g., a “manager” of an LLC or a

benefits plan administrator).

What kinds of claims may be covered?

For third party claims, Section 145 (a) permits

indemnification of any person “made a party or threatened

to be made a party” to “any threatened, pending or

completed action, suit or proceeding, whether civil, criminal,

administrative or investigative.”

For direct or derivative claims, Section 145 (b) permits

indemnification of any person who is a “party or is

threatened to be made a party” to a “threatened, pending or

completed action or suit by or in the right of the corporation

to procure a judgment in its favor.”

What kinds of claims may be covered? (cont’d)

Interpretive issues typically center on whether a proceeding

has been “threatened” or whether a person has been

“threatened to be made a party to a proceeding” so as to

trigger obligation to indemnify and advance.

Witness expenses?

Claim must be “by reason of the fact” that the indemnitee

was or is a director, officer, employee or agent.

What kinds of loss may be covered?

For third party claims, company may indemnify for expenses as

well as “judgments, fines and amounts paid in settlement.”

For direct or derivative claims, may only cover expenses, and

expense reimbursement requires Court of Chancery approval if the

indemnitee has been “adjudged liable to the corporation.”

Must meet the standard of conduct: an indemnitee must have

acted “good faith and in a manner the person reasonably believed

to be in or not opposed to the best interests of the corporation.”

For criminal matters, the person must have had “no reasonable

cause to believe the person’s conduct was unlawful.” There is

very little law on this standard.

A. Fees on Fees (“successful in whole or in part”)

B. Burden of Proof on Company

C. De Novo Court Review (no presumption)

D. Requested Subsidiary Service

E. Prohibit Retroactive Amendments

F. Outside Position Requests

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How should coverage be provided?

Options include certificate of incorporation provisions, bylaws

and indemnification agreements.

Certificate of Incorporation is least flexible. It requires

stockholder approval for adoption and any amendments.

Bylaws are easily adopted and amended by the Board of

Directors. However, they are not individualized, and are

subject to change without the consent of the covered parties.

Delaware Section 145 (f) was amended to eliminate the risk

that amendments narrowing coverage could be applied

retroactively.

How should coverage be provided? (cont’d)

Indemnification Agreements can be drafted to cover

indemnification as well as insurance. They may be drafted in

a manner that provides procedural protection such as

standards of proof and remedies to affected parties. They

also may not be amended without the consent of each

indemnitee.

The peace of mind benefit to indemnitees who are provided

individual contracts comes at the cost of lack of flexibility for

the corporation. There also may be a number of different

forms applicable to present and former directors and officers

that will need to be considered.

How should coverage be provided? (cont’d)

Companies should consider the “package” provided to

indemnitees — certificate, bylaws, agreement, insurance —

and ensure they work together and do not subject the

company to inconsistent obligations.

A. Types of D&O Insurance Coverages

B. Presumptive Indemnification

C. Non-Indemnifiable Losses (Side A Coverage)

D. Benefits of Side A Policy

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To reach us

Dan A. Bailey

614-229-3213

[email protected]

Amy Goodman

202.955.8653

[email protected]

John F. Grossbauer

Direct dial: (302) 984-6131

[email protected]