3.7.4 Insulation of directors from out-of-pocket payments

Indemnification

Most listed companies have a clause in their articles by which the directors are indemnified against all claims of the company and of third parties, including criminal fines. Legal costs too can be reimbursed if the director wins. Indemnification is conditional upon the director having acted "in good faith and in a manner such person reasonably believed to be in or not opposed to the best interests of the corporation".1 Indemnification against the consequences of securities laws is sometimes refused by the courts, in any case if the infringement is committed "with knowledge". Sections 102(b)(7) and 145 of the Delarware GCL make it possible for the articles of companies to eliminate or limit the personal liability of a director for all cases except for (i) authorising unlawful corporate distributions, (ii) failing to act in good faith, (iii) international misconduct or (iv) knowing violations of the law. This means, provided there is good faith, there is even indemnification in cases of gross negligence. There is therefore indemnification in "care" cases, but not in "disloyalty" cases.2

Indemnification does not have a positive effect for the directors in case the company is insolvent or insufficiently solvent to cover the directors' damages. The SEC precludes indemnification in Section 11 cases, i.e. prospectus liability.3 Indemnification works in Section 10(b) cases, i.e. in connection with regular disclosure and it works as exculpation in derivative cases and especially in derivative oversight cases.4 The scope for indemnification is greater than in the UK, where indemnity against claims of the company and criminal fines is excluded.

D&O insurance

Section 145(a) of the Delaware GCL also permits the corporation to buy D&O (directors and officers liability) insurance. The policies exclude "criminal or deliberately fraudulent misconduct" or "any personal profit or advantage to which he is not legally entitled". These definitions are narrower than the "good faith" standards of indemnifications. Sometimes policies have full "severability of conduct" clauses, which cause outside directors to suffer from acts of inside directors. Insurance can furthermore be rescinded in case of incorrect information of the inside directors to the insurance company. New policies have clauses to provide separate coverage for innocent outside directors. Problems can also arise in the event of the corporation's bankruptcy. The court may decide that the corporation is entitled to the insurance proceeds. However, the policy may cover this eventuality as well.