by Neal T. Buethe
First, find the map. It is there somewhere in the glove compartment and is labeled Minn. Stat. §302A.521 “Indemnification.” This statute establishes mandatory indemnification rights for any corporate director, officer or employee named or threatened to be named in a “proceeding” due to their past or present “official capacity”:
If all criteria are satisfied, indemnification is mandatory.2 The indemnification protection of the statute extends to any monetary exposure, including judgments and attorneys’ fees and costs, and it has advancement provisions that cover fees and costs as they are incurred. The Reporter’s Notes provide insight to the purpose of the mandatory indemnification statute:
For the individual defendant it is a map to a good place.
you have the right map? If
the corporation is a
Make sure the route is open. The statute allows the corporation’s articles and bylaws to prohibit indemnification. The bylaws can also establish different terms and conditions for extending indemnification if done equally to all persons otherwise eligible (i.e., to all directors, officers or employees) or equally to all persons within the class of officer, director or employee. Typically, corporate bylaws provide that the statutory indemnification requirements apply — but check to make sure the road hasn’t been closed.
Even if the statutory path is open, there may be other, better routes to be explored as well, since the statute allows corporations to purchase directors and officers (“D&O”) liability insurance that can expand coverage beyond what is provided for by statute. Nothing in the statute, however, requires a corporation to purchase insurance, in which case an officer, director, or employee’s claim is only so good as the corporation has assets to pay. Of course, the typical D&O policy will have coverage exclusions of significance.
Multiple recovery is not permitted due to the statute’s requirement that no other organization can have paid the expense for which indemnification is sought. You can only take the trip once.
Can You Go?
Decide who can go on the trip. The map is good only for directors, officers, and employees. Other persons, such as shareholders and agents, can be indemnified, but that is a matter of contract or voluntary board action.
In order for a director, officer or employee to be eligible for mandatory indemnification, there are several prerequisites. A proceeding must have been brought against the individual by reason of his or her “official capacity,” that is, for actions they took or didn’t take as part of their official position within the corporation. The statute extends the right of mandatory indemnification to former offices, directors, or employees sued by reason of their former official capacity.
“By reason of” is a causal requirement that can disqualify an officer, director, or employee seeking indemnification and advancement if the suit concerns matters unrelated to their position as officer, director or employee. In cases where the corporation is not a codefendant, this might be a particularly important point. Courts that have considered this requirement have generally applied a liberal interpretation in favor of indemnification. Barry v. Barry, 824 F.Supp. 178 (D.Minn. 1993), in which the U.S. District Court considered an indemnification claim under Minn. Stat. §302A.521, is instructive on this issue. The plaintiff in Barry had sold to the defendants her interest in a family-owned, closely held corporation. The plaintiff later sued the defendants for fraudulent inducement, alleging inter alia that they had provided her with false financial information.4 Two of the defendants sought from the corporation an advance on their legal defense expenses based on their status as former officers and directors.5 The corporation denied their request, and the defendants asked the court to order the corporation to advance their expenses.
Some of the other defendants, who still retained roles and interests in the corporation, argued against an advance on the ground that the claims against the former officers and directors were not related to their former officer or director status. The court rejected that argument, and ordered the corporation to advance the former officers/directors’ reasonable fees under the repayment provisions of the statute discussed below.6 The court held that, although the former officers/directors may have provided the false financial information in their role as minority shareholders, rather than officers/directors, it was because of their officer/director positions that they were able to provide any information at all.7 The court explained that where the allegations against a former officer or director are related to both their official capacity and nonofficial capacity, and the two are “intertwined,” the former officer or director is entitled to advances and indemnification.8 The court stated: “the mere fact that the [former officers/directors] wore two hats in their dealings with [the corporation] and with plaintiff does not compel the conclusion that they were not sued, at least in part, because of their official status.”9 The Court of Appeals for the 8th Circuit affirmed that ruling.10
In Heffernan v. Pacific Dunlop GNB Corp., 965 F.2d 369 (7th Cir. 1992), a 7th Circuit case interpreting similar “by reason of” language in the Delaware Code and cited by the 8th Circuit, the corporation against whom indemnification was sought argued that the former director was not entitled to indemnification because his wrongs were committed as an individual, not as a director.11 Applying the Delaware indemnification statute, the court held that the former director was entitled to indemnification despite the fact that he was sued based on the sale of his own stock in the corporation.12 The primary allegations against the former director were that he had made the sale pursuant to a misleading prospectus, and due to his failure to disclose environmental and other liabilities of the corporation.13 The court concluded that those actions/omissions were related to his status as a director; it emphasized that the plaintiff’s complaint against the former director repeatedly alleged that the former director’s “status as a director put him in a position where, in the performance of his duties as a director, he either learned or should have learned of those liabilities.”14 Finally, the court noted that the “by reason of” language should be interpreted expansively, in favor of indemnification, to advance the statute’s goals of encouraging capable people to serve without fear as directors and officers, and of deterring unjustified suits by corporations against corporate officials.15
The real challenge in qualifying to take the trip may not be the “by reason of” requirement, which is a very objective determination, but the more subjective “good faith” requirements of the statute, which are part of the “reward and protection” purposes of mandatory indemnification:
The eligible officer, director or employee will have acted in “good faith” defined as “honesty in fact” which sounds in the question of the person’s motivation. The statute specifically identifies receiving an improper personal benefit as a disqualifying act. As the Reporter stated, “Only honest behavior is protected by indemnification.”17 If the covered individual seeks indemnification for monetary exposure in a criminal proceeding, “good faith” means that he or she had no reasonable cause to believe the conduct was unlawful. A corollary requirement concerning the motivation of the officer, director or employee seeking indemnification is that the person must have acted in a way he or she reasonably believed was in the best interests of the corporation. That is, the person must prove, based on a reasonable, prudent person standard, that they were acting in a manner they believed in the corporation’s best interests, whether right or wrong. Thus, a manager seeking indemnification for a sexual harassment claim to which he already admitted misconduct, and for which he accepted discipline, would be hard-pressed to meet this standard.
These requirements regarding the eligible employee’s motivation create a threshold question of fact as to who can go down the path of indemnification and advancement. More below on how a corporation can call the question.
But this question doesn’t come up if the trip can’t yet begin, which can be only when the eligible person has been subject to a “proceeding.” This is a rather broad gate. Mandatory indemnification rights arise when a proceeding is a pending, threatened, or completed action. This is broader than the typical tender of defense requirements of an insurance policy, since the indemnification and advancement right does not require service of an actual lawsuit and is not barred because the indemnification request occurs after the conclusion of a proceeding. And mandatory indemnification can be there for an individual facing a civil, criminal, administrative proceeding arbitration or investigative proceeding.
A proceeding by or on behalf of the corporation can be a “proceeding.” For the corporate plaintiff, this can be an unpleasant result indeed since there is no automatic exclusion from indemnification or advancement by the corporation just because the corporation itself is the plaintiff. This seems counterintuitive unless you bear in mind the fundamental purpose of the mandatory indemnification statute, which is to assure protection for the accused person acting in his or her official capacity. Also, the corporation can obtain reimbursement of its advance if it meets its burden of proof in the underlying claim against a defendant officer, director, or employee. But the fact remains that a person sued by the corporation can seek advancement of fees — and that is a troublesome complication in such situations.
There is no shortcut for a corporation contesting a request for indemnification since the settlement of the proceeding, or even an adverse determination in the proceeding, are not in themselves conclusive that the person is ineligible for indemnification. Indeed that would be the very definition of an indemnification — otherwise, what is there to indemnify? The standards of indemnification are not necessarily the same as the standards of liability in a civil action.
Costs for the Trip
Planning the trip to indemnification is useless if you cannot afford it; therefore, the statute mandating indemnification has advancement-of-fees provisions.
By an advancement request, the eligible director, officer or employee seeks reimbursement of attorney’s fees and costs for defending the litigation. The officer, director or employee provide affidavits affirming their good faith belief that they have met the statutory standards for indemnification and their promise to repay the corporation in full if they are ultimately determined to be ineligible for indemnification. The decision on an advancement request is made by the corporation in the same way as an indemnification request. No bond is required and there can be no consideration of the person’s financial ability to repay. The corporation’s bylaws can place monetary limits on any advance or set other terms or conditions (such as the corporation’s approval of counsel and counsel’s rates) if done equally to all persons within a given class of officer, director or employee.
Although it is a bit of a side trip, it is worth noting that the statute allows a corporation to reimburse the fees and expenses of a person appearing as a witness in a deposition or at trial, and expenses in connection with that appearance, even though the person has not been made or threatened to be made a party to a proceeding. This is the vehicle by which a former employee witness can have counsel paid for by the corporation when called upon to testify in subsequent litigation. It can also apply to the corporation’s agents, shareholders, or any other person making appearance as a witness in an action against the corporation.
Making the Trip
The officer, employee or director eligible to make the trip to indemnification then gets the application before a corporate decision maker: the board, special counsel of the shareholders. The question for the decision maker is whether the statutory standards for indemnification have been met or, in the case of advancements, a determination “that the facts then known to those making the determination would not preclude indemnification under this section.”18 The steps to follow are listed in Minn. Stat. §302A.521. subd6.
The statute first lists the board of directors. This trip to indemnification and advancement is simple if no directors or less than a majority of the quorum of the directors are parties to the proceeding. In such cases, the directors can make the determination subject to court review as set forth below.
If this is impossible, a committee of the board is appointed with two or more directors not parties to the proceeding designated to act by the majority of the board.
If that is not possible, trace the route on the map and see that special legal counsel can be appointed to make the determination of eligibility. Who does the appointing? A majority of a quorum, if the directors are not subject to the proceeding, or a majority of a committee if the committee members are not subject to the proceeding, or, if such committee cannot be established, the full board of directors including all of the directors who are parties. This is allowable since any special legal counsel hired by the corporation cannot have represented the corporation or any related organization or a director, officer or member of the committee of the board whose indemnification is at issue. The idea is that the board, including conflicted directors, can appoint a special legal counsel with no ties to the corporation or the directors to make the eligibility determination. And, again, such determination is subject to court review, another failsafe.
As an alternative, the indemnification or advancement request might go directly to the shareholders. If the shareholders consider the matter, the shares held by any shareholder who is an interested party in the proceeding cannot count towards determination of a quorum or be counted in any vote on the question.
Must the indemnification or advancement requests go down one route to determine whether it is a blind alley before backing out and trying another? The statute may at first give the impression that the person seeking indemnification or advancement starts with the board or board committee, then goes on to special legal counsel if the board is conflicted out, and continues last to the shareholders if the other two paths are barred. But a close reading of the statute shows that there is no required order. Indeed, some commentators prefer the impartiality of shareholder or special counsel determination even if the board of directors is without direct conflict.19
If application is made to a corporate decision maker and no determination is made within 60 days after the termination of proceedings or the request for indemnification, then the party has one place left to go: district court. The statute provides that the court:
In other words, an officer, director or employee who has been denied an indemnification or advance request can petition any court in the state for determination that the statutory requirements for indemnification have been met, or that the facts as then known do not preclude indemnification in order to obtain an advance.
This petition procedure sounds simple, but it can be quite extensive since the court is being called upon to determine whether an officer, director or employee, for whom the corporate decision makers or special counsel has denied indemnification or advancement of fees, is actually entitled to them. The court makes an independent determination that the petitioner is being sued for acts by reason of their official capacity, in good faith and for reasons they believed at the time were in the best interest of the corporation. The statute does not provide that the court must defer to the previous corporate decision — it is truly one last chance.
2 Barry v. Barry, 824 F.Supp. 178, 183 (D.Minn. 1993), aff., 28 F.3d 848, 851 (8th Cir. 1994).
4 Barry v. Barry, 824 F.Supp. 178 (D.Minn. 1993), at 180, 184.
10 Barry v. Barry, 28 F.3d 848, 851 (8th Cir. 1994).
11 Heffernan v. Pacific Dunlop GNB Corp., 965 F.2d 369 (7th Cir. 1992), at 372.
19 See e.g., Mathison & Garon, Minn. Practice: Corp. Law & Practice at 10.21 (d). Matheson & Garon disagree with the reporter’s apparent position that the steps in §302A.521, subd.6 are in descending order. Rather, they make a strong case that there is a public policy reason for a corporation to prefer shareholder or specialty counsel review.
NEAL BUETHEis a shareholder at Briggs & Morgan, PA in St. Paul where he concentrates his practice in employment law and civil litigation.