Writing Indemnification and Advancement Provisions to Protect Former Officers and Directors

There is both a distinction and a definite difference between an advancement obligation and an indemnification obligation under Delaware corporate law.  Indeed, a simple obligation to indemnify an individual does not by itself include any obligation to advance expenses that may ultimately be indemnifiable. And board members want to be covered for one and the other both while they occupy their seats on the board and after they leave the board.  But failure to make that intent clear in the Charter or other agreement governing indemnification and advancement can result in a failure of that expectation.

To illustrate a Charter provision that can result in a “former” officer and director not being entitled to advancement of expenses, even though entitled to indemnification, whereas current officers and directors were entitled to both advancement of expenses and indemnification— let’s look at a recent Delaware Court of Chancery decision, Charney v. American Apparel, Inc. The Charter provision (there was a separate indemnification agreement that was also analyzed, but let’s keep this simple) read as follows:

The Corporation, to the full extent permitted by Section 145 of the [Delaware General Corporation Law (“DGCL”)], as amended from time to time, shall indemnify all persons whom it may indemnify pursuant thereto. Expenses (including attorneys’ fees) incurred by an officer or director in defending any civil, criminal, administrative, or investigative action, suit or proceeding for which such officer or director may be entitled to indemnification hereunder shall be paid by the Corporation in advance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of such director or officer to repay such amount if it shall ultimately be determined that he is not entitled to be indemnified by the Corporation as authorized hereby.

Note that the first sentence of this provision of the Charter specifically obligates the Corporation to indemnify “all persons whom it may indemnify pursuant [to Section 145 of the DGCL].”  The persons whom may be indemnified pursuant to Section 145 specifically includes both current and former officers and directors.  So, the indemnification part of this provision makes mandatory what is permitted by Section 145 and covers both current and former officers and directors.  But then in the second sentence the persons entitled to advancement of expenses is not all persons who may be statutorily entitled to advancement of expenses, which would necessarily include former officers and directors, but instead is limited to only “an officer or director.”  The court noted that the Delaware courts have always construed such a provision (i.e., a provision that does not explicitly modify the phrase “officer or director” with a phrase such as “who is or was” or  “current or former”) so that the meaning of the phrase “officer or director” is limited to only those officers and directors who are currently serving in such capacity on behalf of the Corporation—i.e., former officers and directors are excluded.

In the PE world, you want PE designees on the board to be indemnified and to have the benefit of advancement of expenses, to full extent permitted by law, for any act committed while they were an officer or director and acting in such capacity, even though they may now no longer be so serving (as for example after a sale of control).  This case is also worth a read for a better understanding of the limits of indemnification and advancement generally—i.e., as only covering claims made “by reason of” a person’s current or former service as an officer and director. And that is what ultimately caused the former officer and director in this case to have his claims for indemnification and advancement denied under both the Charter and his separate indemnification agreement.