Indemnification, Advancement, and D&O Coverage for Executives

An officer named in a lawsuit or called into an investigation faces one question before any other: who is paying for the defense. If the company advances your fees as they are incurred, you can retain the counsel the matter requires and litigate it properly. If it does not, you are funding a defense personally, against an adversary that is not, and the pressure to settle on bad terms becomes overwhelming within months.

That question is answered by documents written years before the dispute: the certificate of incorporation, the bylaws, an individual indemnification agreement if you have one, and the directors and officers liability policy. The Law Offices of Albert Goodwin represents officers and directors in New York City in securing and enforcing those rights.

Advancement and Indemnification Are Not the Same Thing

This distinction decides cases, and it is routinely missed.

Advancement is the company's obligation to pay your defense costs as they are incurred, before anyone knows whether you did anything wrong. It is ordinarily conditioned on your written undertaking to repay the amounts if it is ultimately determined that you were not entitled to indemnification. The undertaking generally need not be secured, and your personal ability to repay is usually not a permitted objection.

Indemnification is the company's obligation to make you whole at the end, once the outcome and your conduct are known. It depends on whether you met the applicable conduct standard, typically acting in good faith and in a manner you reasonably believed to be in or not opposed to the corporation's best interests.

An executive with a strong indemnification right and no advancement right can still be ruined by the defense costs of a case they eventually win. When we review documents for an incoming executive, advancement is the provision we press hardest on, and when we enforce rights for a departing one, it is usually the first relief we seek.

New York Law: Business Corporation Law Article 7

For New York corporations, indemnification of directors and officers is governed by sections 721 through 726 of the Business Corporation Law.

• Section 722 permits a corporation to indemnify a director or officer who acted in good faith, for a purpose reasonably believed to be in, or in the case of service to another entity at the corporation's request not opposed to, the best interests of the corporation, with an additional standard for criminal proceedings and limitations on indemnification in derivative actions.
• Section 723 makes indemnification mandatory for a director or officer who has been successful, on the merits or otherwise, in defending a proceeding. Success on procedural grounds counts. It also provides the mechanism for advancement of expenses upon an undertaking to repay.
• Section 724 allows a court to award indemnification where the corporation refuses, which is the provision under which contested claims are actually litigated.
• Section 721 confirms that indemnification rights may be provided by the certificate of incorporation, the bylaws, or an agreement, and that those rights are in addition to the statute, subject to the limitation that indemnification is unavailable where a judgment establishes that the acts were committed in bad faith or were the result of active and deliberate dishonesty and material to the cause of action, or that the officer personally gained a financial profit or other advantage to which they were not legally entitled.
• Section 726 authorizes the purchase of insurance, which is why the policy matters independently of the statute.

Many New York executives serve companies incorporated in Delaware, where section 145 of the General Corporation Law performs the same function, with mandatory indemnification to the extent the officer is successful on the merits or otherwise, and express authorization of advancement. Delaware has a well-developed body of summary advancement litigation, and advancement disputes there are frequently resolved quickly. New York limited liability companies are governed by their own provisions and, more importantly, by the operating agreement, which for an LLC officer is usually the entire source of the right.

The Documents We Ask For First

1. The certificate of incorporation. Does it contain an exculpation provision and a mandatory indemnification commitment.
2. The bylaws. Whether indemnification and advancement are mandatory or permissive, meaning subject to a discretionary board determination. Permissive language is close to worthless once the board has turned against you.
3. An individual indemnification agreement. The strongest form of protection, because it is a contract that the company cannot amend unilaterally, and because it can address procedure: presumptions in your favor, who decides, deadlines for payment, the right to select counsel, priority as against other indemnitors, and fee shifting if you have to sue to enforce it.
4. The D&O policy, all of it, including endorsements. Executives are frequently shown a certificate or a summary. The exclusions and definitions are where coverage is won and lost.
5. Board minutes and resolutions concerning your election as an officer, since coverage and indemnification often turn on whether you actually held the office you are being sued for.

How Companies Resist

Once a dispute begins, companies raise a predictable set of objections:

• You were not an officer for this purpose. Title inflation is common, and "Chief Revenue Officer" on a business card is not the same as an officer elected by the board. Bylaw definitions and board resolutions control.
• The conduct falls outside the scope, because you were not acting in your official capacity, or the claim arises from your role as an employee rather than as an officer. Employment claims are a recurring battleground here.
• The board has not made the required determination, and it declines to convene to make one.
• A bad faith or personal profit exclusion applies, asserted at the outset even though such exclusions typically require a final adjudication before they operate.
• The bylaws were amended. Companies sometimes amend indemnification provisions after the conduct occurred. Whether an amendment can strip rights that had already accrued is a real question, and one reason a separate indemnification agreement with an anti-amendment provision matters.
• Setoff against severance. The company offers to advance fees if you release your compensation claims. That is a negotiation, not a legal position, and it should be recognized as one.

The D&O Policy in Practice

A typical policy has three insuring agreements. Side A covers the individual where the company does not indemnify, whether because it is unable to, as in insolvency, or because it refuses. Side B reimburses the company when it does indemnify. Side C covers the entity itself for securities claims. For an executive in conflict with the company, Side A is the part that matters, and dedicated Side A difference in conditions coverage, which sits above the tower and responds where the main policy does not, is worth confirming exists.

Issues that recur:

• Claims made and reported. These policies respond to claims first made during the policy period and reported as required. Late notice is the most common reason coverage is lost, and notice obligations can be triggered by a subpoena, a demand letter, or a written allegation, not only by a filed lawsuit.
• The insured versus insured exclusion, which can bar coverage for claims brought by the company against its own officers. Modern policies carve out derivative actions, claims by a bankruptcy trustee, and employment claims, but the wording varies and the carve-outs are worth reading before a dispute.
• Conduct exclusions for fraud, dishonesty, and personal profit, which should be triggered only by a final, non-appealable adjudication, and ideally in the underlying action rather than a separate coverage proceeding.
• Severability, ensuring that one officer's misconduct or misstatement in the application does not void coverage for everyone else.
• Allocation between covered and uncovered claims and between insured and uninsured parties.
• Priority of payments, ensuring individual insureds are paid before the entity when limits are inadequate.
• Change in control and runoff. When the company is sold, the policy typically converts to runoff for claims arising from pre-closing conduct. Confirming that a tail of adequate length was purchased is part of any executive's exit checklist, and it is far easier to obtain as a closing condition than afterward.

Enforcing the Right

Where a company refuses, the remedies are contractual and statutory. A claim for advancement is usually pleaded as a breach of contract under the bylaws or indemnification agreement, together with a statutory claim, and it is well suited to expedited treatment because the entire point is timing. Where the indemnification agreement contains a fee shifting provision covering the cost of enforcement, sometimes called fees on fees, the economics of the dispute change substantially in the executive's favor. Where the company is insolvent, the practical path runs through the D&O carrier rather than the company, which makes early tender and correct notice essential.

Getting It Right Before You Need It

For an executive accepting a new role, the protections to negotiate are a written indemnification agreement rather than reliance on bylaws alone, mandatory advancement with a short payment deadline and a simple undertaking, the right to select independent counsel where a conflict exists, a commitment to maintain D&O coverage at a stated limit during service and to purchase a tail after departure, a priority provision if you were placed by an investor, and confirmation that the protections survive termination for any reason. These points are ordinary and are usually granted when raised at the offer stage. They are almost never granted later. See employment contract review and our C-suite practice overview.

You can contact us by phone at 212-233-1233 or by email at [email protected].