Retroactive Repeal of Rights for Corporate Directors
By Steven H. Goldberg and Michael B. Jacobson
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 sgoldberg@bakerlaw.com. Michael B. Jacobson is an associate in the firm’s New York office. His email is mjacobson@bakerlaw.com.
Note
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.
