Over the past few months we have focused our newsletters on how to develop an effective executive protection plan. Past newsletters have discussed exculpatory clauses and indemnification. This month’s newsletter focuses on advancement of defense expenses incurred by directors or officers (collectively, “executives”).
The concept of “advancement of expenses” is that a provision in the company’s governing documents requires the company to pay the defense costs for executives who are drawn into law suits, investigations, or related proceedings in their capacity as company executives.
An executive’s right to advancement of expenses complements the executive’s right to indemnification. The difference between the two is timing. Advancement of expenses requires the company to pay the executive’s expenses as they are incurred. Indemnification, by contrast, requires the company to reimburse the executive only after the suit, investigation, or other proceeding is resolved.
Almost all states, including Idaho, permit a company to include a provision in the company’s governing documents that requires the company to advance expenses. Sometimes the advancement provisions are carefully worded and detailed, but often the language is generic and sometimes bundled with indemnification as an obligation to “defend and indemnify” the company’s executives. In the broadest form, these provisions apply to claims by the company, the shareholders, third parties, counterclaims, internal investigations, and to claims of a criminal nature. Further, in most cases the only pre-requisite for an executive to obtain advancement is that the executive must agree to repay the amounts advanced if a court subsequently holds that the executive was not entitled to indemnification.
As a result, advancement provisions can be a very valuable tool for executives, especially because the courts tend to enforce these provisions against the company. In other words, if a company grants executives a right to advancement, then a court will treat this as a binding commitment by the company to advance expenses in accordance with the company’s governing documents. When the advancement provisions are not clear, the court will tend to find in favor of the executive seeking advancement.
To avoid uncertainty and costly litigation, companies should draft their indemnification and advancement provisions carefully. The more detailed and integrated these provisions, the better for the company and the executives. Both parties benefit from clearly outlining the scope of protection and the procedures required for an executive to access the protections.
There are many decisions to be made, and factors to be considered, when implementing an advancement provision into your company’s executive protection plan. State laws can vary significantly and thus we advise you to look at your state’s governing statutes specifically.
For more information please contact a member of our Business Group or call 208.344.6000.