In Schoon v. Troy Corporation, 948 A.2d 1157 (Del. Ch. 2008), the Delaware Chancery Court held that a former director is not entitled to advancement rights where a later board-approved amendment to the corporation’s by-laws cut off such rights. This case is important for all directors and officers who are concerned about liability coverage after leaving a company or resigning from the board of directors.
The action centered around two directors, one former and one current, who sought advancement for attorneys’ fees for lawsuits that alleged that the directors had breached their fiduciary duties. The court granted the right to advancement for the current director but denied it to the former director. At issue in the action was the corporation’s advancement by-law which had originally provided that “the corporation shall pay the expenses incurred by any present or former director.” After the former director left the corporation but before he was involved in litigation, the corporation amended the advancement by-law by removing the word “former” from its definition of directors entitled to advancement. This change, the corporation explained, was designed specifically to “delete former directors from entitlement to advancement.”
In seeking enforcement of advancement rights, the former director argued that his advancement rights under the pre-amendment by-law vested at the time he became a director, long before the adoption of the new amendment. The court rejected the former director’s argument, holding that a former director’s right to advancement does not “vest” until the commencement of litigation. Accordingly, since the court found no evidence that the corporation was even contemplating claims against the former director at the time of the by-law amendment, the court held that the corporation had effectively amended its by-laws before the former director’s right to advancement had “vested.” As a result, the former director was not entitled to advancement of defense costs.
This holding is significant in light of the salutary policies behind advancement and indemnification for corporate directors. Before Schoon, it was commonly understood that rights to advancement and indemnification could not be unilaterally terminated by a director’s corporation. Now, however, directors can be held liable for all expenses relating to their official actions if litigation arises after they resign from the board.
Since the Sarbanes-Oxley Act, the statute of limitations on securities claims against a director or officer has been extended from three years to five years following the alleged wrongdoing. State statutes of limitations for potential claims against directors can range from one to six years, even before application of tolling mechanisms. As a result, it is imperative for directors who are concerned about these circumstances to review their corporate documents to ensure that their advancement and indemnification rights are not exposed to retroactive amendments during this time period. Among other things, directors should consider whether to enter into separate indemnification agreements with the corporation to ensure advancement rights that cannot be unilaterally terminated later. Directors also should review the definition of “insured persons” under their directors and officers insurance policy to ensure this includes former directors, as well as consider seeking separate insurance to protect former directors.