Protecting Directors & Officers: Waiver, Indemnification & D&O Insurance

By statute: MBCA 209(c) & 561571 By Contract: Insurance & Indemnification Agreements

Waiver of Duty of Care: 209(c)

Articles may include a provision waiving or limiting a directors liability to corporation or shareholders for money damages for acts or omissions as a director, except liability for,
Amount of a financial benefit improperly received Intentional infliction of harm on corporation Illegal distributions & loans Intentional criminal acts

 Whats covered/not covered?

Corporation not required to provide waiver
Many/most do

Only directors get benefit of waiver

Not officers, employees or agents

Applies to actions as directors only Only actions for money damages covered
Injunctions and other equitable proceedings still permitted

 Broadly stated, waiver shields directors from money claims for money damages for breaches of the duty of care, but not for breaches of the duty of loyalty
Waiver doesnt alter directors standard of care Shield of greater importance in Michigan than Delaware
Michigan: Standard is negligence Delaware: Standard is gross negligence

Indemnification
Most corporate statutes provide comprehensive protection for directors and officers & employees
Persons who, currently or formerly, serve(d) as directors, officers, employees or agents (collectively covered persons) of
The corporation, or Any other corporation or other entity if service was requested by the corporation

 Scope of Indemnification
Protection extended to any covered person who is a party (or threatened to be made a party) to any suit or proceeding (civil, criminal, administrative or investigative) by reason of being a covered person
Acts or omissions while acting in his/her official capacity

 Indemnification is mandatory or permissive Mandatory: Expense reimbursement by the corporation is mandatory to the extent the covered person is successful on the merits or otherwise in defense of an action, or in defense of a claim, issue, or matter MBCA 563
Unless restricted by Articles

 If covered person wins (or at least doesnt lose) then corporation required to cover defense costs Note: covers only directors & officers
Employees and agents covered by employment and agency law

The problem of partial success Merritt-Chapman & Scott Corp. v. Wolfson, 264 A.2d 358 (Del. 1970)
If director is convicted on (or pleads guilty to) one charge but is exonerated (or has dropped) other charges, has he been successful, therefore entitle to at least partial indemnification?

 Permissive Indemnification 561-562

Covers situations where corporation may (but is not required to) indemnify directors & officers and employees & agents Provisions differentiate between third party claims/suits and derivative claims/suits
For claims brought by third parties, indemnification can extend to defense costs, fines, penalties and judgments, both civil and criminal For derivative claims, whats covered is the same except for judgments
Judgments in derivative claims cannot be indemnified

 Indemnification standard: Covered person must have acted,

In good faith, and In a manner he/she believes to be in or not opposed to the best interests of the corporation or its shareholders
Additional requirement for criminal actions: covered person has no reason to believe that his/her conduct was unlawful

Who makes determination? (entitlement & payment)

 By the majority vote of a quorum of the board consisting of directors not involved in the suit or proceeding By the majority vote of a board committee of directors not involved in the suit or proceeding By the majority vote of the shareholders, excluding shares held by covered persons seeking indemnification By independent legal counsel Determination not required prior to mandatory indemnification or indemnification of directors when 209(c) waiver is in place

 Expense Advancements.
Defense costs can be a huge (sometimes overwhelming) burden on covered persons if the must wait months/years for reimbursement (indemnification) by corporation Most state statutes (including MBCA) permits but does not require a corporation to pay defense costs of covered persons in advance of final disposition of proceeding
Exception: corporation can make mandatory in articles of bylaws or by resolution or contract

 When advanced payments are permitted, covered person gives corporation an undertaking to repay advance payments if it is ultimately determined that he/she was not entitled to indemnification
Most likely situation: covered person loses a derivative action or receives a guilty verdict in a criminal proceeding Generally, not a significant issue since most claim/cases against covered persons are dismissed or settled without a determination of liability

 Determination of reasonableness of expenses and authorization for payment required

For reasonableness, determination is made in same way as for indemnification Authorization for payment is the same as for indemnification, except where advancement is made mandatory
If mandatory, once undertaking is given and reasonableness determination is made, corporation just cuts the check

D & O Insurance
Most state statutes give corporations power to provide insurance protection for officers and directors
In Michigan, provision is 567

Basic D&O policy provides broader coverage than indemnification alone

Often covers matters for which indemnification by the corporation is not permitted

 Adverse judgments in derivative actions Avoids some public policy limitations on indemnification

Protects covered persons against insolvency or inability of corporation to pay Provides protection against changes in articles or bylaws withdrawing or limiting indemnification rights

Summary for D & O Protection

Protecting directors (and possibly others) starts with taking full advantage of available statutory protections
Most statutory provisions are permissive, so some corporate action is required to take advantage Most statutory provisions are not exclusive with respect to permissible indemnification rights

 Can provide greater/expanded coverage and certainty in articles or bylaws or by contract However, cannot expand indemnification standards
Covered person must act in good faith, and In the best interests of the corporation or its shareholders

Matters to consider:
Add waiver of director duties to articles?
In Michigan, 209(c) Shareholder approval might be required to amend articles

 Make indemnification mandatory?

Can be done in the articles or bylaws or by resolution or contract

Indemnification agreements with directors (and officers)?

Reason: Articles, bylaws and resolutions can be changed without consent of covered persons
Contracts cant

D & O insurance?
For public companies, virtually mandatory Cost and availability