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Insight Developing an Executive Protection Plan Part III: Indemnity

This third part in our series on developing an executive protection plan addresses indemnity.  It provides practical information on indemnification; not only indemnification of the executive by the business but also indemnity of the business by the executive.

Before taking an officer or board position, executives must be clear on the extent to which they will be indemnified by the applicable business and the extent to which the business expects indemnification from the executive.  Similarly, to attract talented and sophisticated executives, business entities must understand executives’ expectations in terms of indemnifications; both indemnities from the business and indemnification of the business.

Fundamentally, “indemnity” involves one party’s agreement to assure another party bears no liability for the indemnified actions.  Typically, indemnity should encompass the rights to both advancement of defense expenses and indemnification.  The types of claims and expenses covered are often case-specific and will be addressed below.

A business entity’s standard indemnity obligations to executives usually appear in corporate documents such as articles of incorporation, by-laws or operating agreements.  Often additional, more focused provisions appear in employment agreements, consulting agreements or other agreements addressing the contractual relationship between the business and a specific executive.  Parties must be careful to address conflicts between similar provisions that appear in different documents.

In the context of a business indemnifying corporate executives, typically business entities agree to “indemnify, defend and hold harmless” the corporate officer for all (with some exceptions) actions taken in the course of performing that corporate officer’s duties to the business.  The corporate indemnification is often broad and covers any kind of claim or proceeding including an action, law suit, arbitration, investigation, or administrative proceeding.  It should also apply to both civil and criminal actions, investigations, and proceedings and cover attorneys’ fees, judgments, interest, expense of investigation, fines, penalties and amounts paid or to be paid by executive in any settlement.

Often, acts or omissions by an executive involving intentional misconduct and, in some cases, negligence or “gross” negligence are excluded from indemnity coverage.  Executives found liable in shareholders’ derivative suits often aren’t covered either.  Similarly, some indemnification provisions contain language allowing the business to recoup amounts advanced to the executive if it is ultimately determined that the Executive was not entitled to indemnification for the subject costs and expenses.

Business indemnification represents important protection for executives even for those at businesses that purchase and maintain significant levels of directors and officers liability insurance (D&O insurance).  Indemnification is often very broad and extends “to the maximum extent permitted by law” (although, of course, practically limited by the indemnifying businesses’ financial resources), whereas D&O insurance policies contain numerous exclusions and conditions and is subject to limits of liability.  This latter issue is important and is one reason why executives must assure that both the indemnification provisions and proper D&O insurance are in place.  Executives are also wise to insist on contractual language requiring the business to maintain certain types and amounts of D&O insurance during the executive’s term of service and for a period of years afterward.

Businesses must also consider the type of indemnities to expect or demand from executives.  Businesses often require executive’s to “indemnify, defend and hold harmless” the business from any uninsured portion of any claim, loss or expense arising from the executive’s act or omission that contravenes applicable laws or regulations or that arise from intentional misconduct, negligence or “gross” negligence.  Some businesses seek similar indemnity for acts or omission in contravention of the rules and policies of the business, though that is a somewhat more aggressive approach.

Businesses may expect new employees to warrant that they are under no obligations that contravene the new employer’s employment agreement and that execution of the employment agreement doesn’t breach any existing agreement binding the employee.  These are designed to protect the new employer against claims by a former employer resulting from the breach of an employee’s existing non-competition agreement.  In conjunction with this, a business should consider requiring prospective employees to provide copies of all employment and separation agreements containing restrictive covenants like non-compete, non-solicitation, and confidential information.

Clearly written indemnification provisions should not only address what acts and omissions are covered, and to what extent, but also the procedures that must be followed in order to obtain indemnification.  They can also provide protections against wrongful withholding of indemnification by containing presumptions favoring indemnification and requiring an indemnifying party to pay fees incurred in order to enforce the indemnified party’s indemnification rights.

Ultimately, final terms and conditions related to indemnity between businesses and their executives should result from fair and open negotiation.  The parties should agree to indemnify, defend and hold harmless one another from claims that aren’t covered by insurance and for which the indemnifying party should reasonably expect to be responsible.

For more information please contact a member of our Business group or call 208.344.6000.

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