Indemnification is the process by which one party pays the legal fees and costs of another party and, at times, a judgment suffered by the party if a third party successfully brings a claim. The most common form known to most people is an insurance company defending you if you are in an auto accident.
In the corporate world, indemnification normally refers to the corporation paying defense costs and settlements, or judgments suffered by corporate officers, directors, or employees. Some indemnification is required by law (usually employees are indemnified if their actions are within the scope of the business and no intentional wrongdoing or gross negligence was involved.)
CA Corp. Code§ 317(b) states a corporation has the power to indemnify any person who,” … is or was an agent of the corporation, against expenses, judgments, fines, settlements, and other amounts actually and reasonably incurred in connection with the proceeding if that person acted in good faith.”
But that power can be limited or expanded by various corporate documents and the law itself places criteria on that indemnification.
The Basic Law:
California law restricts when a corporation may offer indemnity to one of its agents.
- Authorization of Indemnification.
CA Corp. Code§ 317(e) recites that indemnification requires a finding by the Board of Directors that indemnification of the agent is proper in the circumstances because the agent has met the applicable standard of conduct under CA Corp. Code §317(b) or (c) Indemnification may be authorized on that finding in any of the following ways:
(1) Majority Vote. By a majority vote of a quorum consisting of directors who are not parties to the proceeding;
(2) Written Opinion. If a quorum of directors cannot be obtained, by the written opinion of independent counsel;
(3) Shareholder Approval. By approval of the shareholders excluding the vote of persons to be indemnified; and /or
(4) Court Order. By order of the court in which the proceeding is or was pending.
The Courts are supportive of the concept of indemnification of corporate agents. As stated in Bancorp v. Thornton Grant, 26 Cal. App. 4th at p. 931 and People v. Treadwell, 69 Cal. at p. 236, Section 317 was enacted to encourage capable individuals to act for and in the place of the corporation by affording them indemnification for the expenses of defending against lawsuits to which they are made parties because they are agents of the corporation.
Practical Effect:
While there is usually little dispute about corporations reimbursing and protecting their employees and agents due to third party claims, there is often a great deal of tension when the indemnification is sought to defend against claims of breach of duty to the corporation, itself. A typical situation is that a disgruntled minority stock holder or director claims that another agent has breached his or her duty to the company, brings an action based on such breach of duty, and the corporation pays the defense costs of the accused agent. The minority owner or director is thus faced with having to pay the attorney and costs from his or her own pockets while the defending agent has the corporation pay the fees and costs.
This becomes even more annoying to a plaintiff who is also an owner since he or she soon realizes that money from his or her own company is being used to pay counsel to defend the very suit he or she has brought.
Thus, indemnification can be a critical and valuable tool for corporate agents for defense against claims whether warranted or not. Since the average jury trial in California costs well over a hundred thousand dollars in fees, and often four or five times that, the ability to have the corporation pay for defense is a critical aspect of the defense and must be considered by any plaintiff seeking relief.
It should be noted, however, that should the plaintiff prevail, it is common for the corporation to demand repayment of all sums so advanced and that will almost certainly be ordered by the court if the defendant was found in violation of any duty to the corporation.