Indemnification is an obligation by one party to pay or compensate for the losses, damages, or liabilities incurred by another party to the contract. Contractual indemnification enables a party to shift the risk of liability onto another party.
Public policy favors the indemnification of directors and officers to ensure that qualified individuals want to serve in those roles. For example, Delaware law permits a corporation’s certificate of incorporation to eliminate the personal liability of a director or officer for monetary damages for breaches of fiduciary duty. Delaware law also enables corporations to indemnify directors or officers for liability stemming from breaches of fiduciary duties. 8 Del. C. § 145.
While Delaware and many other states offer legal protections, these indemnification provisions are permissive. Corporations do not have to implement or enforce them. Furthermore, bylaws are subject to amendment, which enables future management to remove indemnification provisions from the bylaws.
To ensure personal protection in corporate disputes, officers, directors, and partners should obtain a separate written indemnification agreement with their corporation. These offer several advantages over the indemnification provisions in a corporation’s bylaws or articles of incorporation. Namely, indemnification agreements are generally easier to enforce than provisions because they are bilateral contracts. Additionally, indemnification agreements typically provide broader and more thorough protections than a corporation’s bylaws or articles of incorporation.
When pursuing an indemnification agreement, officers, directors, or managers should ensure that the agreement has a few key features. First, the agreement should provide the right to be indemnified in “fees-on-fees” disputes. This indemnifies officers and directors for both damages incurred in third party suits and attorney’s fees accumulated during the suit. Second, the agreement should establish procedures and time frames to ensure that the officer or director receives payment in an efficient and timely manner. Finally, the corporation should be required to obtain D&O insurance. Thus, in the event of the corporation’s financial ruin, the director, officer, or manager can still be indemnified via an insurance policy. (Beware, however, of exclusions such as the insured vs. insured exclusion.)
Indemnification questions arise in a variety of contexts. Get in touch with us at (312) 223-1699 or email Thomas E. Patterson at firstname.lastname@example.org for more advice and information.