Why Advancement is a Key Component of an Executive Indemnity Agreement

Originally published by Alyson Brown.

Barnes & Noble recently learned that it must advance attorneys’ fees to its ousted CEO, Demos Parneros, for defense of the company’s counterclaims against the CEO for allegedly sabotaging a potential company acquisition. The court granted the former CEO’s motion for advancement of attorneys’ fees and expenses, relying on provisions of a New York state law and the executive’s employment contract.

Key to the court’s ruling were provisions in the employment agreement that entitled the CEO to advanced fees — including fees connected with making the application for advanced fees — not just a reimbursement of fees.

The court noted that state law (New York, in this case) permits a court to direct advance payment of fees where indemnification was provided for by a corporate bylaw or contract. A broadly drafted indemnity provision can support the advancement of fees even for claims between an executive and his employer, if such claims arise from the executive’s employment and have a relationship to duties performed in the scope of employment. Executives and companies alike must be aware of their rights and responsibilities under indemnity agreements, corporate documents, and applicable state law.

Company bylaws or governing documents (such as LLC Agreements or Limited Partnership Agreements) often contain indemnification and advancement provisions. While these provisions provide some degree of protection for senior executives if they are named in claims relating to actions undertaken in their corporate capacities, these general provisions alone may not provide sufficient protection.

The corporate documents may not address all of the issues that can arise and may not provide sufficient protection for the individuals when there are indemnification or advancement disputes. Moreover, these provisions can protect executives from changes to corporate bylaws after the individuals have left the company.

Executives should consider negotiating a separate, written indemnification and advancement agreement with their employer.

Indemnity vs. Advancement

Indemnification is the reimbursement of fees after those fees have been incurred. This right, as the Delaware Supreme Court has written, “allows corporate officials to defend themselves in legal proceedings secure in the knowledge that, if vindicated, the corporation will bear the expense of litigation.” The words “if vindicated” cannot be emphasized enough: they show that in order to establish a right to indemnification, the officer may have to prevail in the proceeding.

Advancement, meanwhile, is exactly what it sounds like: payment of fees by the company in advance of the final resolution of the proceeding. Advancement is an important companion to the right of indemnification, because it provides officials with immediate relief from the financial burden of investigations and legal proceedings. No vindication required — although the official may have to pay back what she receives if the final decision doesn’t go her way.

To determine an individual’s right to indemnification or advancement, courts will first look to the statutes governing the business, which may either require or permit those rights. Because many companies are incorporated in Delaware, Delaware law provides the most robust guidance on this subject.

Opt for a Bespoke Agreement

An individually negotiated employment or indemnity agreement typically provides more comprehensive protection than corporate bylaws or statutory provisions. Company bylaws may provide for permissive indemnification, whereas most written agreements are written on a mandatory basis. Moreover, the rights enumerated in the agreement are enforceable obligations that cannot be amended or terminated without the individual executive’s agreement.

Contractual indemnity provisions can also protect executives from changes in management — and corresponding amendments to bylaws and other corporate documents. An indemnity agreement provides an extra measure of protection and some level of assurance that their rights will be protected if claims arise after they have left the company.

There are a number of important issues that a written indemnification agreement can address that the corporate bylaws typically do not address.

First, a written indemnification agreement can provide definitions of important terms.

For example, the written agreement can provide an expansive definition of the types of “expenses” for which indemnification and advancement are available, and of the types of “proceedings” in connection with which the executive is entitled to advancement. A written indemnification agreement might also clarify that the executive is entitled to indemnification or advancement even if just a witness in a proceeding, and not only as a named party.

Second, the written agreement can preserve the executive’s right to select their own counsel.

This could be particularly critical if the issues arise after the individual has left the company and new management is in place. There may be a host of potential conflicts between the individual and the new management, which could militate in favor of the individual having his or her own counsel.

Third, the written agreement can specify the procedures to be followed if disputes arise with regard to indemnification or advancement.

Among other things, the written agreement can provide a presumption in favor of indemnification or advancement of fees. The agreement will also provide a mechanism for resolving issues about disputed amounts or items. The agreement can also provide for an expedited dispute resolution procedure. Perhaps most importantly the agreement can provide for so-called “fees on fees” — that is, for reimbursement of expenses that an individual must incur to enforce indemnification or advancement rights.

In addition to legal benefits, indemnification agreements provide psychological benefits that cannot be provided by generally applicable statutory, charter, or bylaw provisions. Indemnification agreements provide the peace of mind that comes with having the maximum protection that is legally possible for directors and officers. Employers benefit as well, by allowing a company to build trust among its officers and directors by demonstrating a strong level of commitment and support.

A variety of legal and practical considerations go into drafting an effective indemnity agreement. Clouse Brown attorneys are available to counsel executives who need assistance negotiating indemnity and advancement provisions. We also advise employers and business owners on minimizing risks associated with indemnity provisions and drafting executive employment agreements.

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