What is a personal indemnification agreement?

By Priya Cherian Huskins
44 directors & boards Director LiabiLity policies change over time, sometimes for the worse. By contrast, personal indemnification agreements are not renegotiated annually, and corporations cannot amend these agreements to the detriment of directors or officers without their consent. Also consider what would happen if a corpora- tion simply refused to advance legal fees. Normally if a claim is made against the direc- tors or officers of a corporation, they can expect the corporation to advance their legal fees immediately. The corporation then in turn seeks reimbursement or advancement of costs from the insurance car- rier when the amounts paid exceed the D&O pol- icy’s stated “self-insured retention” — roughly the equivalent of a deductible. For large public corpo- rations, the amount of the retention can run into A personal indemnification agreement is a written contract between a company and an individual director, officer or other person — known, in the typical language of such agreements, as the “indemnitee.” The agree- ment obligates the company to indemnify the indemnitee for legal actions brought against him or her. A properly constructed indemnifica- tion agreement contains myriad provisions designed to protect the indemnitee as long as the indemnitee acted in good faith and a manner reasonably believed to be in, and not opposed to, the best interests of the company. With respect to criminal matters, the indem- nitee must have had no reason to believe that the conduct in question was unlawful. Collectively, these provisions ensure that, when an indemnitee is sued, the indemnitee will be entitled to a vigorous defense at the company’s expense as well as reimburse- ment for any losses suffered. Experience tells us that within the United States these agreements can cause a com- pany to pay for nearly everything — defense costs, expert witness fees, settlements, and even judgments — except for civil and crimi- nal fines and penalties. Civil and criminal fines and penalties are generally not indemnifiable (or insurable) as a matter of public policy. A good indemnification agreement pro- vides not only for indemnification but also for the advancement of legal fees. By granting an indemnitee the right to the advancement of legal fees, the company becomes obligated to pay for an indemnitee’s defense from the moment the indemnitee is summoned as a witness or accused of wrongdoing. These advances can be unsecured, interest free, and made without regard to the indemnitee’s ability to repay the loan or even whether the indemnitee has met any applicable standard of conduct. Typically, to qualify for the advancement of legal fees, the indemnitee need only sign an “undertaking” promising to return the money if it is ultimately determined that the indemnitee was not entitled to indemnifica- tion. By contrast, the right to indemnification is an “after-the-fact” reimbursement for an indemnitee who has suffered a loss, and can be paid only after a determination has been made that the indemnitee met the applicable standard of conduct. Having the right to the advancement of legal fees is critical for directors and offi- cers. When it comes to suits against directors and officers, getting to the “after-the-fact” moment can take years. During this time, the indemnitee’s defense attorneys will expect prompt payment of their monthly bills. If an individual indemnitee has to wait until after the litigation is resolved for reimbursement of legal fees, he or she may face several long and expensive years. Thus, although indem- nification is important, for most indemnitees the right to the advancement of legal fees is the more immediate need when they are first accused of wrongdoing and need to defend themselves. Companies that are publicly listed in the United States must file their indemnification agreements with the Securities and Exchange Commission. When first adopting or later amending a company’s form of indemnifica- tion agreement, companies do not normally ask for shareholder approval before putting a new form of indemnification agreement into place. The potential exception to this custom and practice is when there is already a con- troversy pending against a board of directors, such as a lawsuit. If the board has already been sued, the adoption of a personal indem- nification agreement could be regarded as self-interested. To avoid this risk, companies should consider the issue of personal indem- nification agreements as part of their normal review of risk management for the directors and officers of the company. In the absence of a pending controversy, personal indemnification agreements fall within the scope of authority for the board of directors. The approval of personal indemnifi- cation agreements is much like the purchase of D&O insurance and other housekeeping decisions designed to recruit and retain good directors and officers for the benefit of a com- pany’s shareholders. — Priya Cherian Huskins What is a personal indemnification agreement? Indemnification and advancement of legal fees Indemnificiation $$$Indemnitee Suit is is sued settled This can take years… © 2008 Priya Huskins Final settlement negotiated • Plaintiffs • Defendants • Insurers Advancement of legal feesLegal defense fees first incurred
 

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