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Managing risk<br />
Federal securities filings by type (January 2005–December 2012)<br />
Number of federal filings<br />
300<br />
250<br />
200<br />
150<br />
100<br />
50<br />
0<br />
Merger objection cases<br />
Cases related to credit crisis<br />
Ponzi scheme cases<br />
Other cases<br />
2005 2006 2007 2008 2009 2010 2011 2012<br />
In Delaware, for example, the statute<br />
merely authorizes indemnification where<br />
not considered mandatory by statute<br />
(as further discussed below), meaning<br />
a director or officer is not necessarily<br />
entitled to indemnification unless the<br />
company charter or bylaws contain<br />
necessary authorizing language to permit<br />
indemnification. Delaware corporations<br />
may structure their certificates of<br />
incorporation to limit the liability of their<br />
directors to situations involving:<br />
• breaches of their duty of loyalty<br />
(including improper personal benefit) to<br />
the company and its stockholders; and<br />
• acts or omissions not in good faith or<br />
that involve intentional misconduct or<br />
a knowing violation of the law.<br />
It is important for directors and officers<br />
of public and nonpublic companies to<br />
seek counsel on and understand the<br />
indemnification provisions of company<br />
bylaws and/or indemnification agreements<br />
to which they will be subject. Review of<br />
the provisions and/or agreements should<br />
occur not simply prior to an initial public<br />
offering, but on a periodic basis as well.<br />
Be mindful of features (or absence of<br />
features) in the company bylaws, charter<br />
or corporate indemnification agreements<br />
that could impair one’s ability to seek<br />
indemnification. Two examples of such<br />
provisions include:<br />
• a provision that fails to obligate the<br />
company to reimburse a director’s or<br />
Filing year<br />
officer’s claim for costs and expenses<br />
for enforcing the company’s obligation<br />
to indemnify;<br />
• a provision that forces a director or<br />
officer to bear the burden of proof<br />
to demonstrate entitlement to<br />
indemnification.<br />
Several common questions that arise<br />
regarding indemnification follow.<br />
When must the company indemnify<br />
its directors and officers? Section 145(c)<br />
of the Delaware General Corporation Law<br />
requires a corporation to indemnify a<br />
director or officer when the person to be<br />
indemnified has been successful on the<br />
merits with respect to a claim against him<br />
or her. In other words, if the director or<br />
officer defends the claim on the merits<br />
and is vindicated of any wrongdoing, it is<br />
mandatory that the company indemnify<br />
that individual for the costs and expenses,<br />
including attorneys’ fees, incurred in<br />
connection with the claim. As a practical<br />
note, a recent Delaware Chancery court<br />
decision in early 2012 has cast some<br />
uncertainty around whether an officer<br />
or director has been “successful on the<br />
merits” of a claim against him or her<br />
(see Hermelin v. K-V Pharmaceutical<br />
Company, C.A. No. 6936-VCG (Del.Ch.<br />
Feb. 7, 2012).<br />
What is the nature of the conduct<br />
required for the company to indemnify<br />
its directors and officers? Under<br />
Section 145(a) of the Delaware General<br />
Corporation Law, a corporation may (but<br />
need not) indemnify a director or officer<br />
only “if such person acted in good faith<br />
and in a manner reasonably believed to<br />
be in or not opposed to the best interest<br />
of the corporation.” In the criminal<br />
context, a director or officer must also<br />
have had no reason to believe his or her<br />
conduct was unlawful in order to be<br />
indemnified. Outside of the mandatory<br />
indemnification discussed in the prior<br />
paragraph, companies frequently provide<br />
broader indemnification protections in<br />
recognition that only a small proportion<br />
of situations may require a company<br />
to indemnify with a larger proportion<br />
of situations permitting a company to<br />
indemnify.<br />
Even if a director’s or officer’s conduct<br />
is of the type that can be indemnified, the<br />
company’s ability to indemnify him or<br />
her may be limited or prohibited by state<br />
statute. For example, the Delaware statute<br />
authorizes the company to indemnify<br />
directors and officers only for expenses<br />
incurred by them in defending shareholder<br />
derivative suits brought by or on behalf<br />
of the company. The Delaware statute<br />
does not authorize indemnification of<br />
settlements or judgments in such actions.<br />
The rationale is that if the company<br />
indemnified the directors or officers for<br />
amounts they owed to the company, the<br />
result would be a return of funds back<br />
from the company, rendering the debt<br />
owed to the company meaningless.<br />
To what extent is an individual’s<br />
liability limited as a matter of law?<br />
The state in which the company is<br />
incorporated will determine the extent to<br />
which a director’s or officer’s liability to<br />
the company is limited as a matter of law.<br />
Almost all states have adopted statutes<br />
that limit the liability of directors—and,<br />
in some instances, officers—under state<br />
law. Like Delaware, many states allow<br />
companies in their charters to limit or<br />
eliminate the personal liability of directors<br />
for damages in claims by the company<br />
and its shareholders (Section 102(b)(7) of<br />
the Delaware General Corporation Law).<br />
Notably, the Delaware statute does not<br />
eliminate liability for conduct not taken<br />
in good faith or for breach of a director’s<br />
duty of loyalty.<br />
From whom does a director or officer<br />
seek indemnification? In short, it depends.<br />
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