Shielding Directors & Officers from Liability with Indemnification

July 11, 2016
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Indemnification agreements & their role in litigation

In addition to the ever-growing rise in business litigation, regulatory enforcement is also increasingly focused on individual accountability. These trends have put directors and officers in the crosshairs when it comes to legal liability. A successful business lawsuit can be devastating for the directors and officers of a small business, particularly if the company does not have the proper insurance in place. Even defending meritless business litigation can be extremely expensive – this is where indemnification agreements come into play.

The Right to Indemnification

Indemnification agreements are one of the most powerful tools to protect company officials from legal liability because they provide indemnification for expenses related to lawsuits arising out of directors or officers’ performance of their duties. Corporate indemnification is mainly governed, overall, by statute. For instance, state statutory law may dictate indemnification in certain circumstances and establish indemnification as permissive in others. Under most statutes —including New Jersey — indemnification may be available if the corporate agent acted in good faith and in a manner he or she reasonably believed to be in, or not opposed to, the best interests of the corporation. In most cases, specific provisions are generally set forth in a company’s charter and bylaws. Therefore, directors and officers and their corporations should review these provisions from time to time.

D&O Insurance Policies

Directors and officers insurance (D&O) coverage is integral to shielding top management from personal liability and also allows businesses to pursue reimbursement when they do indemnify their executives. Therefore, it is important to understand the general scope of protection the policy provides and become aware of any unusual provisions. New Jersey law grants express power to a New Jersey corporation to purchase liability insurance for its corporate agents, regardless of whether any such person is otherwise eligible for indemnification by the corporation. Advancement of expenses is typically permitted, but a person receiving such advances often must repay those expenses if it is ultimately determined that he is not entitled to indemnification. D&O policy forms vary materially by insurer. In essence, they generally contain two forms of coverage in relation to company officials. One coverage provision provides company officials with insurance protection when indemnification is not otherwise available, i.e. the company is insolvent or legally prohibited from providing indemnification. The other primary coverage provision provides for reimbursement of a business’s indemnification responsibilities. Since D&O policies are intended to complement other forms of liability insurance, they contain a wide number of exclusions. In most cases, D&O policies are complicated but the terms of the policies may be subject to negotiation. In order to understand the impact of a new policy form or a new endorsement in relation to the potential claims, it may be advisable to consult a knowledgeable attorney. If you have any questions or are still unsure how indemnification agreements come into play when dealing with litigation, please contact me, Charles Yuen.