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| Reading
the Roadmap: by Neal T. Buethe For
a Starting
Out 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”:
But do
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:
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:
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). 3
4 Barry
v. Barry, 824 F.Supp.
178 (D.Minn. 1993), at 180, 184. 5
6
7
8
9 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. 12
13
14
15
16
17
18
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. 20 |
