Whether they are new executives or long-time board members, directors and executives should consider two layers of protection: a robust insurance program and a tailored indemnification agreement.
Directors and officers can face significant personal exposure whenever their business is involved in a dispute or investigation. For example, over the past 10+ years, shareholder litigation has accompanied 80% to 90% of public M&A transactions, in which shareholders allege breach of fiduciary duty or disclosure claims. Continued market volatility and increased regulatory efforts add to the potential for exposure. Prudent directors and officers – and any funds that place them on boards or in management positions – must avail themselves of all legal protections available in the provisions of the charter, A&D insurance and compensation agreements tailored to their needs.
In fact, looking to the company for indemnification against its charter provisions and indemnification agreements is usually the first line of defense. First, individualized indemnification agreements offer several advantages over any indemnification provision in organizational documents, as shown below.
Indemnification agreements can be more easily enforced by directors and officers because they are bilateral contracts reflecting negotiated consideration in the form of an agreement by an individual to accept or continue to work with the company. – and cannot be modified without the consent of the directors and officers.
Broader and more comprehensive protection
Indemnification agreements also generally provide broader and more comprehensive protection of directors’ and officers’ indemnification rights than articles of incorporation and organizational documents. A well-drafted indemnity agreement should include, for example:
- Definitions of key terms – Pay attention to terms that define the scope of compensation, such as ‘claims’, ‘procedures’, ‘expenses’ and ‘losses’.
- External directors and venture capital funds – Where applicable, include language that extends the rights of indemnification and advancement afforded to the individual nominated by a venture capital fund (an outside director) to the venture capital fund appointing the director.
- Advancement of defense costs – Advancement is not automatically mandatory, so a good agreement should specify that the company “shall” offer the advancement. The language of advancement should also cover expenses incurred by the individual as both a current and former director or officer.
- Fees on fees – The agreement may also specifically provide for or exclude expenses incurred in successfully asserting a claim for compensation or advancement under the agreement or the company’s governing documents. Although it is common for directors to be indemnified in third-party lawsuits, they are not necessarily entitled to indemnification for attorneys’ fees and costs if they have to sue the company to enforce their rights. compensation under an agreement, organizational document or applicable law. . An indemnification agreement may expressly provide for the right to be indemnified in such “costs upon costs” disputes.
- Procedure for determining rights and deadlines – The agreement should establish a time limit for determining whether compensation is due and establish a means by which the compensated can appeal or challenge the decision, as well as provide for procedures and time limits. This can be essential to move the claim forward and provide clarification to the person seeking compensation.
- Priority – Often a director or officer may have indemnification rights separate from those offered by the company, including a private equity fund or other sponsor. In this case, it is important that both parties specify the relative priority of each source of indemnification in the event that several parties are required to indemnify the director or officer.
- Insurance – The indemnification agreement will generally require the company to provide D&D liability insurance that protects the indemnitee to the same extent as the most favorably insured insured among the current directors and officers of the company and its affiliates.
D&O insurance fills the gaps
The next line of defense – D&O insurance – has terms that incorporate by reference the company’s indemnification obligations and then serve to fill gaps where indemnification is not otherwise available to directors and officers ( i.e. bankruptcy or derivative lawsuits). For those who become directors or officers, the extent of D&O policy protections should be assessed, in conjunction with an indemnification agreement. In the event of a claim against a director and officer, the availability of relief and reimbursement should be assessed under the indemnity policy and agreement to seek all possible sources of recovery.