Tag: Director liability

Limits of Indemnification for Directors in Post-Employment Conduct Suits

David A. Katz is a partner specializing in the areas of mergers and acquisitions, corporate governance and activism, and crisis management at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton memorandum by Mr. Katz, William Savitt, and Nicholas Walter. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

Recent rulings by the Delaware Court of Chancery have clarified the availability and limits of indemnification and advancement for former directors and officers of Delaware corporations in lawsuits concerning post-employment behavior.

In Lieberman v. Electrolytic Ozone, Inc., C.A. No. 10152-VCN (Aug. 31, 2015) , two former officers of a company sought advancement for defending claims brought against them by the company for breach of a noncompete agreement. Each former officer had signed an indemnification agreement providing that the company would indemnify him against lawsuits brought “by reason of the fact” that he was an officer-the greatest extent of indemnification possible under Delaware law. In addition, the company had agreed to advance the officers’ expenses for any lawsuit against which the officers were indemnified. The Court denied their claim for advancement: “Importantly, [the company’s] contractual claims are not dependent on any alleged on-the-job misconduct.” Therefore, the Court held, the lawsuits were not claims brought “by reason of the fact” that the defendants had been corporate officers, and they were accordingly not entitled to indemnification or advancement.


Seven Myths of Boards of Directors

David Larcker is Professor of Accounting at Stanford University. This post is based on an article authored by Professor Larcker and Brian Tayan, Researcher with the Corporate Governance Research Initiative at Stanford University. Related research from the Program on Corporate Governance includes The Costs of Entrenched Boards by Lucian Bebchuk and Alma Cohen, and How Do Staggered Boards Affect Shareholder Value? Evidence from a Natural Experiment by Alma Cohen and Charles C. Y. Wang.

Corporate governance experts pay considerable attention to issues involving the board of directors. Because of the scope of the board’s role and the vast responsibilities that come with directorship, companies are expected to adhere to common best practices in board structure, composition, and procedures. Our paper, Seven Myths of Boards of Directors, which was recently made publicly available on SSRN, reviews seven commonly accepted beliefs about boards of directors that are not substantiated by empirical evidence.


The Delaware Courts and the Investment Banks

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton memorandum by Mr. Lipton, Theodore N. Mirvis, and William Savitt. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

A doctrinal innovation in Delaware law that first appeared a year ago is threatening to mature into a full-on trend: through the tort of “aiding-and-abetting” fiduciary breach, the Delaware courts, accepting the invitation of the stockholder-plaintiffs’ bar, have begun to take on the task of regulating the M&A advisory function of investment banks. In October 2014, the Court of Chancery awarded stockholder plaintiffs $76 million in damages against an investment bank for aiding and abetting breaches of the duty of care by the directors of Rural Metro, an ambulance company that was sold for a 37% premium in 2011 and was bankrupt by the time of trial. The novel theory of the decision was that conflicted bankers dispensed self-interested advice, which left Rural Metro’s directors uninformed and hence induced them to breach their duty of care in approving the sale. Although the directors were not liable for the breach (because they had settled and were exculpated at any rate), the court found that the bankers were.


The Important Work of Boards of Directors

Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s recent address at the 12th Annual Boardroom Summit and Peer Exchange. The full text, including footnotes, is available here. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

It’s a great honor to be back again speaking at an event sponsored by the New York Stock Exchange. It has been more than six years since, as a relatively new SEC Commissioner, I had the opportunity to ring the closing bell at the Exchange. Of course, a lot has changed since then.

At the time, the country was in the midst of the worst financial crisis since the Great Depression, and our capital markets were in turmoil. Some of our most storied financial institutions had suffered unparalleled economic damage. The money market fund industry was mired in a crisis of confidence, interbank lending had collapsed, and our short-term capital markets had seized up. To stem the bleeding, the federal government engaged in an unprecedented intervention in the financial sector to inject stability and confidence into the capital markets and to the greater economy.

Banker Loyalty in Mergers and Acquisitions

Andrew F. Tuch is Associate Professor of Law at Washington University School of Law. This post is based on an article authored by Dr. Tuch, and is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

As recent decisions of the Delaware Court of Chancery illustrate, investment banks can face conflicts of interest in their role as advisors on merger and acquisition (“M&A”) transactions. In a trilogy of recent decisions—Del Monte[1] El Paso [2] and Rural Metro [3]—the court signaled its concern, making clear that potentially disloyal investment banking conduct may lead to Revlon breaches by corporate directors and even expose bank advisors (“M&A advisors”) themselves to aiding and abetting liability. But the law is developing incrementally, and uncertainty remains as to the proper obligations of M&A advisors and the directors who retain them. For example, are M&A advisors in this context properly regarded as fiduciaries and thus obliged to act loyally toward their clients; gatekeepers, and thus expected to perform a guardian-like function for investors; or simply arm’s length counterparties with no other-regarding duties? [4] The Chancery Court in Rural Metro potentially muddied the waters by labelling M&A advisors as gatekeepers and—in an underappreciated part of its opinion—by also suggesting they act consistently with “established fiduciary norms.” [5]


D&O Liability: A Downside of Being a Corporate Director

Alex R. Lajoux is chief knowledge officer at the National Association of Corporate Directors (NACD). This post is based on a NACD publication authored by Ms. Lajoux. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

One of the few downsides to board service is the exposure to liability that directors of all corporations potentially face, day in and day out, as they perform their fiduciary duties. The chance of being sued for a major merger decision is now 90 percent; but that well known statistic is just the tip of an even larger iceberg. The Court of Chancery for the state of Delaware, where some one million corporations are incorporated (among them most major public companies), hears more than 200 cases per year, most of them involving director and officer liability. And given the high esteem in which Delaware courts are held, these influential D&O liability decisions impact the entire nation.

This ongoing story, covered in the May-June issue of NACD Directorship magazine, recently prompted the National Association of Corporate Directors (NACD) to take action. Represented by the law firm Gibson Dunn & Crutcher LLP, NACD filed an amicus curiae (“friend-of-the-court”) brief in the matter of In re Rural/Metro, a complex case likely to continue throughout the summer. Essentially, the Court of Chancery ruled against directors and their advisors, questioning their conduct in the sale of Rural/Metro to a private equity firm.


Holding Corporate Officers and Directors Accountable for Failures of Corporate Governance

The following post comes to us from Greg M. Zipes, a trial attorney with the United States Department of Justice. This post is based on his article Ties that Bind: Codes of Conduct that Require Automatic Reductions to the Pay of Directors, Officers, and Their Advisors for Failures of Corporate Governance that was recently published in the Journal of Business and Securities Law. All comments are in Mr. Zipes’ individual capacity and do not reflect the views of the Department of Justice.

Executives and directors at large corporations rarely face personal liability for failures of oversight that lead to large penalties or losses to their companies. As outlined in my recent article, the American consumer can help provide a solution to this lack of accountability.

I propose that corporate executives and directors sign binding codes of conduct requiring them to uphold specific standards within their corporations. They would agree to specific, transparent reductions in compensation if they fail to live up to these standards. This proposal does not rely on the altruism of these corporate heads to sign. Rather, it assumes that those consumers, dismayed by corporate excesses, will direct at least a portion of their business towards those companies with executives who are willing to put their compensation on the line.


How Much Protection Do Indemnification and D&O Insurance Provide?

The following post comes to us from Jon N. Eisenberg, partner in the Government Enforcement practice at K&L Gates LLP, and is based on a K&L Gates publication by Mr. Eisenberg; the complete publication, including footnotes, is available here. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

We consider below how advancement of legal fees, indemnification, and insurance operate when officers and directors become involved in regulatory investigations and proceedings. Part I addresses the enhanced risk officers and directors face today in an Age of Accountability. Part II addresses advancement of legal fees, which may be discretionary or mandatory depending on a company’s by-laws. Part III covers indemnification, which generally requires at least a conclusion that the officers and directors acted in good faith and reasonably believed that their conduct was in, or at least not contrary to, the best interests of the corporation. Part IV examines insurance coverage, which varies from carrier to carrier and may or may not provide meaningful protection. Finally, Part V summarizes the principal lessons from the analysis. Although there is significant overlap with similar principles that apply to private litigation, we limit our discussion here to advancement, indemnification, and insurance for regulatory investigations and proceedings.


FDIC Lawsuits against Directors and Officers of Failed Financial Institutions

John Gould is senior vice president at Cornerstone Research. The following post discusses a Cornerstone Research report by Abe Chernin, Katie Galley, Yesim C. Richardson, and Joseph T. Schertler, titled “Characteristics of FDIC Lawsuits against Directors and Officers of Failed Financial Institutions—February 2014,” available here.

Federal Deposit Insurance Corporation (FDIC) litigation activity associated with failed financial institutions increased significantly in 2013, according to Characteristics of FDIC Lawsuits against Directors and Officers of Failed Financial Institutions—February 2014, a new report by Cornerstone Research. The FDIC filed 40 director and officer (D&O) lawsuits in 2013, compared with 26 in 2012, a 54 percent increase.

The surge in FDIC D&O lawsuits stems from the high number of financial institution failures in 2009 and 2010. Of the 140 financial institutions that failed in 2009, the directors and officers of 64 (or 46 percent) either have been the subject of an FDIC lawsuit or settled claims with the FDIC prior to the filing of a lawsuit. Of the 157 institutions that failed in 2010, 53 (or 34 percent) have either been the subject of a lawsuit or have settled with the FDIC.


FDIC Cautions Financial Institutions Regarding Increase in D&O Insurance Exclusions

The following post comes to us from John Dugan, partner and chair of the Financial Institutions Group at Covington & Burling LLP, and is based on a Covington & Burling E-Alert.

The FDIC last week issued a Financial Institution Letter advising financial institutions and their directors and officers of the increased use of exclusionary terms or provisions in D&O policies, and the resulting increased risk of uninsured personal civil liability for directors and officers. (FIL-47-2013, October 10, 2013).

The FDIC Letter urges the directors of financial institutions to make well-informed choices about D&O coverage, including consideration of costs and benefits, exclusions and other restrictive terms in proposed policies, and the implications for personal financial liability for directors and officers.

D&O insurance is a critical asset for financial institutions and their directors and officers, and the FDIC Letter expressly affirms that the purchase of D&O insurance serves a valid business purpose. The FDIC’s Letter is also a timely reminder that the D&O insurance market is in constant flux and that—in addition to seeking advice from insurance brokers—directors should consider seeking advice from experienced coverage counsel to gain a better understanding of the potential impact of restrictive provisions in proposed policies.


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