About a year ago we outlined changes to the Ontario Business Corporations Act (the "OBCA") regarding indemnification of current and former directors and officers of OBCA corporations. One of the changes allows OBCA corporations to make advance payments to indemnified directors and officers on account of expenses incurred by them in respect of any civil, criminal, administrative, investigative or other proceeding to which they may be subject that arise out of having acted as a director or officer of the corporation or other certain related entities. The foregoing is in line with the treatment given to officers and directors of Canada Business Corporations Act corporations. Proceedings can be costly. Without such advances the director or officer may be subject to severe financial hardship. Some proceedings last for years. Prior to the amendment, OBCA corporations could only indemnify such costs after the fact.
Conditions apply to the right of indemnification. First, the director or officer must have acted honestly and in good faith with a view to the best interests of the corporation in respect of the matter in question. Secondly, where the matter involves a criminal or administrative action or proceeding that is enforced by a monetary penalty, the director or officer must be found to have had reasonable grounds for believing that his/her conduct was lawful. It is an open question as to what happens when the proceeding is settled or the adjudication does not address the foregoing.
In our earlier article we made three key recommendations.
First, we recommended the board review of the indemnity provisions of the corporation's current by-law and amend it to authorize and direct (i) the indemnification of directors and officers to the full extent permitted by law and (ii) the advancement of litigation costs to directors and officers, and former directors and officers in any proceeding to which they are parties.
Secondly, we recommended that each director and officer enter into a written agreement with the corporation under which the corporation agrees (i) to indemnify the director/officer in question to the full extent permitted by law, and (ii) to advance to the officer/director litigation costs on an "as incurred" basis, subject to the qualification that if it is shown that the director or officer so indemnified did not act honestly and in good faith with a view to the best interests of the corporation in respect of the matter in question or, in appropriate circumstances, did not have reasonable grounds for believing his/her conduct was lawful, then there would be an obligation on the director or officer to repay the advances with interest.
Finally, we recommended that the corporation's directors and officers insurance policy should be carefully reviewed in the context of the permitted indemnities and qualification for coverage. Coverage changes will likely be required. Each director and officer who is so indemnified should be a named insured under the policy.
Schoon v. Troy Corporation
The importance of implementing each of the steps outlined above is highlighted by a recent Delaware Chancery Court decision. The case arose in the context of an action by Troy Corporation (the "Corporation") against two former directors for damages suffered by the Corporation as a result of the sale by the former directors of information which the Corporation alleged was proprietary and confidential. One of the former directors requested that the Corporation advance monies for legal fees and expenses incurred by him in his defence of the claim by the Corporation against him on the basis that during his term as a director the Corporation's by-laws authorized advancement and indemnification rights for both current and former directors. However, following the resignation of the director, but prior to initiating the claim against him, the Corporation amended its by-laws to disentitle former directors of the right to receive advance payment of legal costs. The amendment did not apply to directors and officers while they remained in office.
The director argued that his right to advancement had vested when he became a director and that it could not be withdrawn without his consent. In deciding in favour of the Corporation and upholding the amendment, the Court rejected the director's argument and held that a former director's right to advancement does not vest until the commencement of a lawsuit in which the director is named as a party. The court noted that the manner in which the Corporation's by-laws were drafted (i) did not create a basis on which to conclude that the granting of the ultimate indemnity necessarily included a right of advancement; and (ii) did not prevent the unequal treatment of the two class of indemnified persons (i.e. those still engaged by the Corporation and those who were no longer officers or directors of the Corporation).
This decision confirms a number of points of interest to corporations and their board members and officers:
- Provisions of a current by-law does not create a vested right to advancement in favour of an indemnified director or officer following his/her resignation or other removal from the board or employment with the corporation.
- Vesting of such advancement and indemnity rights under the corporation's by-law does not occur until an action is commenced against the affected director or officer and the rights are those set out in the by-law at that time.
- Rights arising under the corporate by-law can be changed by the indemnifying corporation without the consent of any indemnified person.
- The best protection for directors and officers is an indemnity agreement which complies with the corporation's by-laws and includes authorized advancement rights. A subsequent change in the by-law removing rights cannot unilaterally pre-empt existing contractual obligations of the corporation.
Directors and officers should still require appropriate directors and officers insurance coverage and where the creditworthiness of the corporation is in question, the indemnity agreement should be credit-enhanced with a creditworthy parent guarantee (or in extreme cases, collateral security).