A recently issued opinion from Delaware highlights a  potentially problematic indemnification issue applicable  to directors and officers of corporations converting or  merging into an alternative business form (e.g., a limited  liability company).  The case may serve as a reminder to  executives of all forms of business that it may be time for  a review of their company’s indemnification policies and  agreements. 

In Grace v. Ashbridge, Civ.A. 8348- VCN, 2013 WL 6869936 (Del. Ch.  December 31, 2013), the Delaware  Court of Chancery denied a claim for  indemnification and advancement of  defense costs brought by a chairman  and member of the governing  boards of a limited liability company  (Ashbridge LLC) and its predecessor  corporation (Ashbridge Corporation).  The executive-plaintiff (Grace) sought indemnification and advancement of defense costs for claims brought  against him for, among other things, breaches of fiduciary duty as a  director of Ashbridge Corporation. 

In 2008, prior to the claims being asserted against Grace, Ashbridge  Corporation (a Pennsylvania corporation) merged with and into  a Delaware limited liability company (Ashbridge LLC) to convert  its form of business under state law, a move that had previously  been deemed innocuous.   According to the Delaware Court of  Chancery, however, a conversion from a corporation to a limited liability company reflects a “fundamental change in identity” of an entity. (Coincidentally, the court noted that the most pertinent reason underpinning the “fundamental” nature of the change rested in the differences between the indemnification statutes applicable to each entity:Whereas corporations must provide indemnification to directors in certain instances, limited liability companies are not so required but are free to structure indemnification or advancement provisions as desired by contract).

As a result of such a “fundamental change in identity” of the entity, absent a contract or provision in the operating agreement providing otherwise, the successor limited liability company could not be held liable for the actions of a director of the predecessor corporation. Ashbridge LLC’s operating agreement, while indemnifying its members and managers in their capacity as such, did not extend indemnification to the directors or officers of its predecessor entity (Ashbridge Corporation). Since the claims asserted against Grace related to alleged conduct in his capacity as a director of Ashbridge Corporation (as opposed to Ashbridge LLC), the Delaware Court of Chancery denied Grace’s claim for indemnification and advancement of defense costs.

While exposing an indemnification concern in the context of a merger/conversion of a corporation into an alternative business form, the Ashbridge case also provides an opportunity for executives and companies to revisit indemnification and advancement agreements (whether in corporate bylaws, LLC operating agreements, or individually executed contracts). Such review should  also include the company’s directors & officers liability insurance (both on the policy level and the overall program structure). For example, Grace could have obtained protection through Ashbridge LLC’s operating agreement or by a separate indemnification agreement with Ashbridge Corporation if considered earlier. Additionally, had Ashbridge Corporation maintained a director & officer liability insurance policy tailored to protect its individual directors/officers, the policy could have been placed into a six-year “run-off ” (extended reporting period) at the time of the merger/ conversion to provide continuing protection. In such an event, Grace may have been covered under that D&O policy, leaving the insurance carrier(s) to pursue the company for reimbursement or contribution.

Thus, the good news for executives and companies is that they are not without options in avoiding an outcome similar to that which befell the executive in Ashbridge. It is important, though, to reach out to counsel experienced in matters of indemnification, advancement, and directors & officers liability to review your indemnification protections – before it is too late.