YourABA: October 2012
YourABA October 2012 Masthead

Protecting directors and officers
from personal financial, criminal liability

In lawsuits against private or public companies, claims against directors and officers are increasingly common, says James Wing, who has represented a number of executives in advancement and indemnity disputes. Wing, moderator of the CLE panel discussion “Protecting the Corporate Director” and an adviser to corporations and boards on executive protection programs, says there is a rapid increase in the sources from which claims can arise: mergers and acquisitions, administrative agencies, whistleblowers, attorneys general and federal prosecutors, to name just a few.

Wing says middle managers often have fingers pointed at them by underlings, or a “rogue CEO” may get them in trouble. They find themselves being summoned into an internal investigation meeting and given an Upjohn warning, also known as a corporate Miranda warning.

If you take the Fifth Amendment, you may lose your right to any kind of defense cost advancement.

When that happens, the officer or director should seek counsel, as privilege may not extend to company employees. The privilege is often owned by the company, Wing says, which reserves the right to “take everything you tell us and turn it over to prosecutorial authorities, in the worst case.”

The question then becomes who pays for the officer or director’s counsel. If you take the Fifth Amendment, not only could you be fired but you could also lose your right to any kind of defense cost advancement, says Wing, who is the co-chairman of an ABA Business Section director-and-officer insurance subcommittee.

These matters can be life-altering. Officers and directors face the potential risk for catastrophic financial loss because of claims made against them. Incredible pressures will be placed on them to turn against other members of their company or other companies in order to give prosecutors testimony against the executives, Wing says. “This is enormously stressful,” he says. “I have seen families disintegrate over this.”

Mitigating risk. The CLE panelists shared measures that can help directors and officers caught in lawsuits. A potential safeguard they discussed is putting an executive protection program in place. Such programs are intended to balance the needs of the corporation and officers and directors to avoid a result in which either side is unduly punished — the corporation by advancing enormous defense costs and the director by being held personally responsible for those costs.

The ideal program, Wing says, coordinates common-law and statutory protections with insurance. The approach is often referred to as the three-legged stool: “If one of the legs is weak, it will affect the stability of the entire structure.”

State statutes may offer directors protection and can be incorporated into an executive protection program. In almost every state, there are provisions in the statutes that essentially insulate the directors of for-profit corporations from claims “for breach of the fiduciary duty of due care, which essentially is a negligence claim,” Wing says. “There’s something similar in the not-for-profit area. There is a federal law that immunizes volunteers from suits from third parties.

“The first and the easiest aspect of devising one of these programs is to make sure, if you can, that this degree of protection is there.”

Second, the program should spell out whether directors’ advancement and indemnity rights are contractually mandatory, or are they only to be conferred by separate action of a board on a discretionary basis after a claim arises? “Are the directors and officers protected or not as a matter of contract?” asks Wing. Does that protection begin as early as being called into an internal investigation meeting? And if there is potential personal criminal exposure, “does the indemnified officer have access to the corporate documents useful to his defense?

“There is a Delaware case on that point that says in some circumstances, yes,” Wing adds. “This is rarely seen, if ever, and you ask yourself, how can a person defend himself properly if he can’t get access to the documents, which particularly happens after he has asserted his Fifth Amendment right and been fired.”

Still, there is nothing that specifically says that if you assert your Fifth Amendment right and refuse to cooperate with a request by your insurance company, then the company won’t cover you, Wing says.

Footing the bill. In the courts, there are different approaches to handling petitions for advancement or indemnification, explains Kevin Brady, a litigation partner at Eckert Seamans Cherin & Mellott LLC in Wilmington, Del. In the Delaware court, for instance, petitions are submitted with supporting documentation, and if the responding party challenges the fees, the court can ask the petitioning party to turn in all legal bills to the court; the responding party will turn in all of theirs. “The court will then take a look at it and measure reasonableness in the petition based upon not only what’s in the petition but how the other side acts in litigation,” Brady says.

The same Delaware court, Brady says, also can employ a five-step approach with the parties. First, the plaintiff’s counsel is required to “certify in good faith that the fees and expenses for which advancement was sought were incurred in a reasonable manner and a matter of sound professional judgment,” he says. Then the opposing party has to “identify those fees for which it thought fell outside the standard of Delaware law for advancement, and that counsel [has] to certify in good faith that they believed the advancement of those fees was inappropriate. Then for the fees for which there was no dispute would be paid, and the fees in dispute would be submitted to a special master as opposed to the court.”

Some changes in insurance coverage have been helpful in picking up nonindemnified claims, says Ann Longmore of Willis Executive Risks Practice in New York. One such change has been the growth in A-side director-and-officer coverage. A-side coverage is a portion of the policy that provides direct indemnification to directors and officers for acts that the corporate organization is not legally required to indemnify.

The good news is that “the insurance market is open for most clients to really be innovative and expand coverage in ways we wouldn’t have anticipated before,” Longmore says.

This CLE was sponsored by the ABA’s Business Law Section.

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