Most senior corporate executive have a general understanding of the importance to them of their corporate indemnification rights. As discussed here, a related but sometimes even more important corporate benefit is the right to advancement – that is, the right to have their defense fees paid on a contemporaneous basis while legal proceedings against them are pending, subject only to the individual director or officer’s undertaking to repay the amounts if it ultimately is determined that the individual is not entitled to indemnification.
As I have noted in prior posts (refer for example here), an issue that frequently recurs is question of when the company may withhold advancement. The question is particularly common when new management has come in and the prior management is facing ongoing litigation as a result of their action prior to leaving the company.
From the perspective of the Delaware judiciary, corporate attempts to withhold advancement arise all too often, apparently. Delaware Chancellor Andre Bouchard began May 28, 2015 opinion in a case involving former Massey Energy Company CEO Donald Blankenship by saying that the case involves an “all too common scenario” – that is “the termination of mandatory advancement to a former director and officer when trial is approaching and it is needed the most.” In his May 29, 2015 post on his Delaware Corporate and Commercial Litigation Blog (here) about the Blankenship case, Francis Pileggi characterizes Bouchard’s preface to his opinion as “an expression of exasperation,” as if to say, “Here we go again – another company trying to evade its advancement obligations.”
Blankenship had been seeking to have the fees he was incurring in defense of a criminal case pending against him, arising out of the April 5, 2010 disaster in Massey’s Upper Big Branch Mine in Montcoal, West Virginia, in which 29 miners were killed. (Further background regarding the Upper Big Branch disaster and the litigation that followed can be found here.) Blankenship was Massey’s CEO at the time. Blankenship retired as Massey’s CEO effective December 31, 2010. On June 1, 2011, Alpha Natural Resources completed a $7.1 billion acquisition of Massey. For several years, Alpha advanced Blankenship’s legal fees incurred in the numerous legal proceedings arising out of the Big Branch Mine disaster.
On November 13, 2014, the U.S. Attorney indicted Blankenship in connection with the Upper Big Branch Mine disaster. Among other things, the four count criminal indictment accused Blankenship of conspiracy to willfully violate mandatory mine safety and health standards, conspiracy to defraud the United States by concealing mine safety violations, and making false statements to the U.S. Securities and Exchange Commission, as well as securities fraud for making false public statements. The criminal matter is scheduled to go to trial on July 13, 2015.
In early 2015, shortly after the indictment, Alpha stopped advancing Blankenship’s legal fees, primarily in reliance on an undertaking Blankenship had signed in which he acknowledged that his indemnification and advancement rights were contingent upon certain representations and undertakings (the “undertaking”), including a representation that Blankenship had “no reasonable cause to believe that his conduct was ever unlawful.” The decision to withhold advancement was based on a determination by an officer of Alpha that Blankenship had breached this representation. Blankenship initiated an action against Alpha in Delaware Chancery Court seeking advancement of his unpaid legal expenses. At the time of the April 8, 2015 trial in Chancery Court action, Blankenship’s unpaid legal bills totaled over $5.8 million.
In his May 28, 2015 opinion, Chancellor Bouchard concluded that the undertaking cannot reasonably be interpreted as Alpha had and that the company’s conclusion that Blankenship had breached the representation does not provide a valid basis for Alpha to terminate Blankenship’s advancement rights under Massey’s corporate charter. (Indeed, Bouchard concluded that a reasonable person would not have thought Blankenship’s advancement rights could be terminated.) Bouchard not only concluded that Blankenship was entitled to advancement of his legal fees incurred in the criminal action but also that he was entitled to recover the attorneys’ fees he incurred in enforcing his advancement rights.
In ruling in Blankenship’s favor, Bouchard noted that while he found the undertaking on which Alpha relied to be unambiguous, even if the undertaking were to be viewed as ambiguous, Delaware law “supports resolving ambiguity in favor of indemnification and advancement.” As Francis Pileggi noted in his blog post about the ruling, if a company is going to try to withhold advancement on the basis of conditions in an agreement, “the terms of that condition must be beyond unambiguous, because all doubts will be resolved in favor of the claimant.”
However, even if under Delaware law strongly favors advancement and indemnification, there is no iron clad rule that individual directors and officers are going to prevail when they seek advancement. (For examples of cases where a court, applying Canadian provincial law, determined that a company properly withheld advancement, refer here and here.) As these cases show – and the tone of exasperated weariness with which Bouchard commenced his opinion underscores – all too often companies will try to renege on their advancement obligations when disputes arise.
The reason for these advancement disputes is no mystery. By definition, an advancement question will only arise if there is a corporate dispute in the form of legal proceedings pending. Sometimes, as is the case here, the legal proceedings involve significant problems at the company, a factor that can only be exacerbated if, as was also the case here, there has also been a change in management since the time of the conduct that gave rise to the problems. In other words, advancement rights are often construed while a battle is raging. All too often, the hostilities include skirmishing between the corporate executives and the corporate entity.
The frequency with which these kinds of dispute arise is one of the most significant reason why well-advices corporate executives will not depend just on the indemnification and advancement provisions of the company charter or by-laws, but will in addition seek to have their rights memorialized in a separate, written indemnification and advancement agreement.
One very good reason that directors and officers will seek to put contractual indemnification agreements in place is so that if the individuals are the target of claims after they have left the company, they can claim their rights of indemnification notwithstanding the arrival of new management. The contractual indemnification provides them an extra measure of protection and some level of assurance that their rights will be protected if claims later arise. A separate written indemnification provision can not only provide much greater procedural specificity but it can also provide certain protections against wrongful withholding of indemnification, by providing presumptions in favor of indemnification and providing for “fees on fees” (that is, fees incurred in order to enforce rights to advancement or indemnification).
A May 26, 2015 post on the Mintz Levin law firm’s Securities Matters blog (here) details the importance for corporate officers of having a separate written indemnification agreement and discusses the key features that this type of agreement should include. As the blog post notes, written indemnification agreements have several advantages for corporate officers over the indemnification provisions of articles of incorporation or bylaws. Among other things, written agreements are “more easily enforced by D&Os because they are bilateral contracts reflecting bargained-for consideration in the form of an individual’s agreement to accept or continue service with the company.” Written agreements “typically provide broader and more thorough protection of D&O’s indemnity rights than statutes and organizational documents.”
As the blog post discusses, among other key provisions, a written agreement will include: definitions of key terms (such as “expenses” and “proceedings,” to ensure that the advancement and indemnification rights apply to the broadest possible range of costs and legal actions); procedures and time-frames for the provision of advancement and the resolution of any disputes that might arise; and the provision for fees-on-fees. In addition, “the indemnification agreement typically will require that the company provide D&O liability insurance that protects the indemnitee to the same extent as the most favorably insured of the company’s and its affiliates’ current D&Os,” to the extent commercially available.
In short, the use of a separate written agreement is one way to take steps while times are calm and relationships are cooperative to ensure that the individual directors and officers’ rights will be protected even when things are no longer time and relationships have turned combative.
Unfortunately, the most a written indemnification agreement can do is to try and ensure that the rights of directors and officers will be protected if disputes arise; an agreement alone can not prevent disputes from arising.
Because these kinds of disputes can and all to often do arise, it is important to keep in mind a critical component that should be a part of every public and sizeable private company’s D&O insurance program. A well-designed D&O insurance program will include within its overall structure a layer of so-called Side A/DIC insurance. These kinds of policies have a number of important features that are available to protect individual directors and officers in certain kinds of catastrophic claims.
Among the parts of many of these policies’ “difference in conditions” insurance protection is a feature by which the Side A/DIC insurer will “drop down” and provide corporate executives first dollar protection if the corporate entity for any reason wrongfully withholds corporate advancement or indemnification. The idea of this insurance protection is that the individual should never be in a position where they cannot defend themselves because the company is withholding advancement. The insurer will step in and advance payment on the individual’s behalf and where appropriate seek to be reimbursed by company that wrongfully withheld advancement.
The critical importance of these and other features of a well-designed D&O insurance program underscores the importance for corporate insurance buyers and their executives to have a knowledgeable and experienced insurance broker involved in the corporate insurance acquisition process, so that these kinds of issues are identified and taking into account when the insurance program is put together. A knowledgeable and experience broker will understand how directors’ and officers’ advancement and indemnification rights operate and how the operation of these rights will and should interact with the company’s D&O insurance program.
One final note. I know that there will be those who might be outraged that Blankenship is having his defense fees advanced, given the magnitude of the mining disaster and the nature of the criminal allegations against him. However, as I noted in an earlier post in which I discussed BoA’s decision to advance the defense fees of former Countrywide CEO (and poster-child for the excesses that led to the financial crisis) Angelo Mozilo, “under Delaware law and under the legal understandings that BofA reached when it acquired Countrywide, BofA has a legal obligation to advance Mozilo’s expenses. The only outrage would be if BofA refused to do so.”
That’s the thing about advancement, the corporate obligation applies even when controversy arises — indeed, the moment when controversy arises often is precisely the moment when advancement is most needed. As I said at the time about the objections to advancing Mozilo’s defense expenses, “the objection about Mozilo’s defense expenses is not to advancement of defense expenses as a general matter, but to advancement for Mozilo in particular. There is no principled basis on which to isolate one individual, no matter how unpopular he may be, and single him out as the one person retroactively disentitled to his otherwise enforceable rights.” As with Mozilo, so too with Blankenship.
For a basic description of the the interaction between indemnification and D&O insurance, refer to my prior post here, which was the first installment in my “Nuts and Bolts of D&O Insurance” series. (The entire series can be found here.)
Special thanks to the several readers who send me copies of the Delaware Chancery Court’s opinion in the Blankenship case.