Many highly qualified individuals have declined to serve as directors of public companies over the past few years due to the heightened regulatory environment and the increased risk of personal liability. Those who have agreed to serve have relied upon the company's agreement to indemnify them should a claim arise in connection with their service and to advance legal fees and expenses as they are incurred in the defense of any such claim.
The right to advancement of legal fees and expenses as they are incurred (as opposed to at the very end of multi-year litigation) is critical to the ability of directors to retain experienced counsel to mount an aggressive defense. Without such advancement, directors would be forced to reach into their own pockets to finance their defense over several years at often considerable cost. Or, if unable to shoulder such expenses, directors would be compelled to resolve a claim on unattractive terms instead of putting up a fight.
In Delaware, where many public companies are incorporated, advancement of fees and expenses prior to resolution of an indemnified claim is not required. Instead, companies may choose the terms and conditions under which they will or will not provide advancement. Nevertheless, most Delaware companies do provide advancement in order to attract qualified individuals to serve on their boards.
Companies can provide for advancement in their articles of incorporation, bylaws or a separate agreement. The best practice has always been for directors to enter into contracts that spell out in detail the company's indemnification and advancement obligations. Nevertheless, some directors have chosen to rely upon a bylaw providing for advancement, assuming that if such a bylaw existed during the director's board tenure it would require advancement of fees and expenses even after the director leaves the company. A recent decision by the Delaware Chancery Court has reached a contrary conclusion.
In Schoon v. Troy Corp., 2008 WL 821666 (Del. Ch. Mar. 28, 2008) ("Schoon"), Vice Chancellor Lamb found that a company had no obligation to advance legal fees incurred in the defense of an indemnified claim to a former director. During the director's tenure on the company's board, a bylaw permitted advancement to current and former directors. After the director resigned, the board amended the bylaw to permit advancement only to current directors. Although the claim at issue concerned the former director's conduct during his service as a director, the Court held that the modified bylaw prohibited advancement.
Directors' and officers' ("D&O") liability insurance policies typically cover former and present directors and provide for advancement. Such policies still are not a complete panacea for the problem created by Schoon. First, depending upon the D&O carrier's attitude, such advancement may be delayed many months or even years. Second, a typical D&O policy excludes from coverage claims, such as those involved in Schoon, levied by the current board of a company against its former director under the "insured v. insured" exclusion. Finally, companies truly intent upon wiping out former directors' advancement rights could amend the terms and conditions of their D&O policies to deny coverage to former directors.
The Schoon decision likely will be appealed and it may be overturned. In the interim, it is imperative that all directors of Delaware private or public companies protect themselves by entering into separate indemnification agreements that address advancement. Since other jurisdictions often look to Delaware for guidance on corporate governance issues, the best practice for every director of any private or public company is to enter into a contract concerning indemnification and advancement.