Retroactive Repeal of Rights for Corporate Directors
A recent Delaware Chancery Court decision has arguably significantly eroded the protection of fee advancement and indemnification rights provided to directors in company bylaws. The decision in Schoon v. Troy Corp., 948 A.2d 1157 (2008), opens the door for companies to terminate unilaterally such rights afforded to corporate directors. Prior to this decision, it was commonly understood that indemnification and advancement rights vested upon a director’s tenure and could not be terminated unilaterally by the director’s corporation. Delaware corporations often include fee advancement and indemnification provisions for directors in their bylaws to provide extra security to directors in the event claims are asserted against them. These provisions promote board service and ensure that directors will not be held personally liable for their actions on behalf of the corporation. However, directors who have departed corporations with these bylaw provisions may not be nearly as protected as they would presume or would like. Any Delaware director with standard fee advancement and indemnification rights is at risk to lose these protections by subsequent bylaw amendment.
Troy Corporation (Troy) had originally provided these rights to both present and former directors, but then amended its bylaws in November 2005 after director William Bohnen retired, eliminating Troy’s obligation to advance fees to and indemnify former directors, Bohnen included. Prior to the bylaws’ amendment, Bohnen reasonably would have assumed that his rights to fee advancement and indemnification were to extend beyond his tenure as a director for Troy. This understanding is based on a 1992 Delaware Superior Court case where the court invalidated a Delaware corporation’s attempt to rescind a corporate director’s indemnification fees by amending its bylaws after the director was sued and the company started advancing his fees. Salaman v. Nat’l Media Corp ., 1992 WL 808095 (Del. Super. Ct. Oct. 8, 1992). Troy thereafter sued Bohnen, alleging breaches of fiduciary duty during his service as a director, and refused to advance fees to defend the suit. The court upheld the refusal and wrote that Bohnen’s rights did not vest by virtue of his directorship, but only upon his being named a defendant in a proceeding at a time when the bylaws provided for fee advancement and indemnification.
Schoon arguably gives Delaware corporations greater flexibility than was thought to exist in structuring the fee advancement and indemnification rights they provide to directors, and serves as a warning to directors that these rights may not endure. Corporations could amend their bylaws to limit advancement and indemnification rights for extant, but not-yet-discovered or litigated, wrongdoing. Such amendments, and the subsequent threat to directors of having to pay their own legal fees, may serve as a boon for corporations suing their former directors and could lead to better settlement terms in favor of the corporation.
Current and future directors should seek to ensure their fee advancement and indemnification rights in light of Schoon and in the shadow of elongated statutes of limitations pertaining to corporate malfeasance. As Sarbanes-Oxley has lengthened the statute of limitations of securities claims against a director or officer from three years to five years, and with state limitations periods extending perhaps even longer, directors now more than ever need to review their corporate documents and take appropriate preventive steps.
Companies seeking to cement rights to fee advancement and indemnification for events occurring during a director’s tenure can amend their bylaws to make clear that current bylaw provisions will apply to those events, regardless of any future bylaw amendments, when those events are discovered or when a proceeding is commenced. Companies can also cement these rights by providing fee advancement and indemnification provisions in their charters, requiring shareholder approval for amendment. However the most reliable solution to this issue is for the director and corporation to put these rights into an indemnification and advancement contract signed by both parties, so that it can not be rescinded unilaterally. Directors appointed by financial sponsors or strategic investors can also cement these rights through transaction agreements providing for indemnification and third-party beneficiary rights. Delaware corporate directors should ideally enter into or be the beneficiary of an agreement that provides indemnification and fee advancement rights separate from those contained in corporate bylaws or charters.
Steven H. Goldberg is a partner in the New York office of Baker Hostetler LLP and is National Practice Leader for M&A Transactions. His email is firstname.lastname@example.org. Michael B. Jacobson is an associate in the firm’s New York office. His email is email@example.com.
This article is a reprint of “ Keeping Current: Director Indemnification - Retroactive Repeal of Rights for Corporate Directors,” by Stephen H. Goldberg and Michael B. Jacobson, 2008, Business Law Today Magazine, 18:2¸ p. 41. Copyright 2008 © by the American Bar Association. Reprinted with permission.
© Copyright 2009, American Bar Association.