Transcript Business Organizations

Business Organizations
2009-2010 Lectures
PARTNERSHIPS,
CORPORATIONS
AND THE VARIANTS
PROF. BRUCE MCCANN
SPRING SEMESTER LECTURE 7
INDEMNIFICATION AND INTRO TO SEC
PP. 811-845
Protecting Directors and Officers
 Three principal approaches:
 1. Buy “D&O” insurance
 2. Provide “contractual indemnification” through agreements
with directors and officers
 3. Exculpate directors through available statutes and/or bylaws
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Permissive Indemnification
 Delaware: Corporation may indemnify where
director sued “by reason of the fact” he or she was a
director. Heffernan says policy of exculpation
requires expansive interpretation of “by reason of the
fact.”
 Model Act: Indemnification authorized if director
acting in good faith and in best interests of
corporation, even if her conduct didn’t satisfy duty of
care.

Articles/By-laws may expand or limit this duty to indemnify
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Permissive Indemnification
 DGCL Sec. 145(a):
 (a) A corporation shall have power to indemnify any person who was or is a party or
is threatened to be made a party to any threatened, pending or completed action,
suit or proceeding, whether civil, criminal, administrative or investigative (other
than an action by or in the right of the corporation) by reason of the fact that the
person is or was a director, officer, employee or agent of the corporation, or is or
was serving at the request of the corporation as a director, officer, employee or
agent of another corporation, partnership, joint venture, trust or other enterprise,
against expenses (including attorneys' fees), judgments, fines and amounts paid in
settlement actually and reasonably incurred by the person in connection with such
action, suit or proceeding if the person acted in good faith and in a manner the
person reasonably believed to be in or not opposed to the best interests of the
corporation, and, with respect to any criminal action or proceeding, had no
reasonable cause to believe the person's conduct was unlawful. The termination of
any action, suit or proceeding by judgment, order, settlement, conviction, or upon a
plea of nolo contendere or its equivalent, shall not, of itself, create a presumption
that the person did not act in good faith and in a manner which the person
reasonably believed to be in or not opposed to the best interests of the corporation,
and, with respect to any criminal action or proceeding, had reasonable cause to
believe that the person's conduct was unlawful.
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145(f)
 (f) The indemnification and advancement of expenses provided by,
or granted pursuant to, the other subsections of this section shall
not be deemed exclusive of any other rights to which those seeking
indemnification or advancement of expenses may be entitled under
any bylaw, agreement, vote of stockholders or disinterested
directors or otherwise, both as to action in such person's official
capacity and as to action in another capacity while holding such
office. A right to indemnification or to advancement of expenses
arising under a provision of the certificate of incorporation or a
bylaw shall not be eliminated or impaired by an amendment to such
provision after the occurrence of the act or omission that is the
subject of the civil, criminal, administrative or investigative action,
suit or proceeding for which indemnification or advancement of
expenses is sought, unless the provision in effect at the time of such
act or omission explicitly authorizes such elimination or
impairment after such action or omission has occurred.
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Waltuch
 Corporation may agree to broader indemnification
rights for its directors and officers than are provided
by statute, but
 Those rights cannot be inconsistent with the
statutory scheme
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Schoon and Vesting of Indemnification Right
 In Schoon v. Troy Corporation, 948 A.2d 1157 (2008), the court
allowed the board of directors of Troy Corporation (“Troy”) to
amend Troy’s bylaws to revoke a former director’s right to receive
advancement even though the bylaws that were in place during his
service expressly stated that the director’s right to receive
advancement would continue even after his tenure on the board
ended.
 Before Schoon, it was commonly believed that a director’s right to
require a company to provide advancement vested upon the
director’s service and could not be singlehandedly terminated by the
company after the director’s tenure ended. This belief was at least in
part based on a prior Delaware Superior Court case where the court
stated that the director’s “right to advancement…[was] a vested
contract right which [could not] be unilaterally terminated.” The
court held that a director’s right to receive advancement
provided for in charter documents does not vest until a
“triggering event” occurs.
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Response To Schoon
 In 2009, the Delaware legislature amended Section 145(f ) of the
DGCL to adopt a rule that was contrary to the holding in Schoon.
 As revised, Section 145(f ) provides that a director’s right to receive
indemnification or advancement pursuant to a company’s charter or
bylaws generally may not be impaired or eliminated after the
occurrence of the act or the omission that is the subject of the
indemnification or advancement. Note, however, that an exception
to this rule occurs if the company’s charter or bylaws as in effect at
the time of the act or omission contains a provision that expressly
authorizes such elimination or impairment after the occurrence of
the questioned act or omission. The amendment resolves the
uncertainty surrounding the occurrence of a “triggering event” by
clarifying that the right to receive indemnification or advancement
vests upon the occurrence of a potentially litigious act, rather than
upon the filing of a lawsuit or the threat of litigation
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Insurance Issues
 A corporation can often use D&O (“Directors and
Officers”) coverage to indemnify risks that the
corporation itself could not indemnify.
 Insurance Coverage can be broader than statutory
limits of indemnification allowed the corporation
itself.
 BUT
 Public policy forbids indemnifying against criminal
conduct, willful conduct or fraudulent conduct
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D&O Policies
 Typically provide:
 1. “Company Reimbursement” – compensates
company for monies it expends for mandatory
indemnification expenses. (Side B)
 2. “Directors and Officers Liability” – covers losses
incurred by the directors and officers and not
reimbursed by the company for statutory or other
reasons. (Side A)
 3. “Entity Coverage” – insures for the company’s
direct liability to the plaintiff. (Side C)
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What is a Security?

"Security" means any note; stock; treasury stock; membership in an incorporated or unincorporated association; bond;
debenture; evidence of indebtedness; certificate of interest or participation in any profit-sharing agreement; collateral
trust certificate; preorganization certificate or subscription; transferable share; investment contract; viatical settlement
contract or a fractionalized or pooled interest therein; life settlement contract or a fractionalized or pooled interest
therein; voting trust certificate; certificate of deposit for a security; interest in a limited liability company and any class
or series of those interests (including any fractional or other interest in that interest…; certificate of interest or
participation in an oil, gas or mining title or lease or in payments out of production under that title or lease; put, call,
straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest
therein or based on the value thereof); or any put, call, straddle, option, or privilege entered into on a national securities
exchange relating to foreign currency; any beneficial interest or other security issued in connection with a funded
employees' pension, profit sharing, stock bonus, or similar benefit plan; or, in general, any interest or instrument
commonly known as a "security"; or any certificate of interest or participation in, temporary or interim certificate
for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing. All of the foregoing
are securities whether or not evidenced by a written document. "Security" does not include: (1) any beneficial interest in
any voluntary inter vivos trust which is not created for the purpose of carrying on any business or solely for the purpose
of voting, or (2) any beneficial interest in any testamentary trust, or (3) any insurance or endowment policy or annuity
contract under which an insurance company admitted in this state promises to pay a sum of money (whether or not
based upon the investment performance of a segregated fund) either in a lump sum or periodically for life or some other
specified period, or (4) any franchise subject to registration under the Franchise Investment Law (Division 5
(commencing with Section 31000)), or exempted from registration by Section 31100 or 31101.

Calif. Corporations Code Sec. 25019.
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Sarbanes-Oxley
 Section 302 of the Act mandates a set of internal procedures designed to ensure
accurate financial disclosure. The signing officers must certify that they are
“responsible for establishing and maintaining internal controls” and “have designed
such internal controls to ensure that material information relating to the company
and its consolidated subsidiaries is made known to such officers
 Under Section 404 of the Act, management is required to produce an “internal
control report” as part of each annual Exchange Act report. See 15 U.S.C. § 7262.
The report must affirm “the responsibility of management for establishing and
maintaining an adequate internal control structure and procedures for financial
reporting.” 15 U.S.C. § 7262(a). The report must also “contain an assessment, as of
the end of the most recent fiscal year of the Company, of the effectiveness of the
internal control structure and procedures of the issuer for financial reporting.
 Section 802(a) of the SOX, 18 U.S.C. § 1519 states:
 “ Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or
makes a false entry in any record, document, or tangible object with the intent to
impede, obstruct, or influence the investigation or proper administration of any
matter within the jurisdiction of any department or agency of the United States or
any case filed under title 11, or in relation to or contemplation of any such matter or
case, shall be fined under this title, imprisoned not more than 20 years, or both.
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SEC Rule 14(a)
 Rule 14a-9 -- False or Misleading Statements

No solicitation subject to this regulation shall be made by
means of any proxy statement, form of proxy, notice of
meeting or other communication, written or oral,
containing any statement which, at the time and in the
light of the circumstances under which it is made, is false
or misleading with respect to any material fact, or which
omits to state any material fact necessary in order to
make the statements therein not false or misleading or
necessary to correct any statement in any earlier
communication with respect to the solicitation of a proxy
for the same meeting or subject matter which has
become false or misleading.
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