A.
INTRODUCTION
A U.S. court decision
in 2008 may result in individuals who consider becoming
a corporate director (whether it be for a for-profit corporation
or a non-profit corporation) wanting to obtain personal
indemnity agreements from the corporation in order not to
face responsibility for paying their own legal costs. This
Charity Law Bulletin (“Bulletin”) provides a brief
commentary on Schoon v. Troy Corp.,
a Delaware court decision (the “Troy case”).
In the Troy case, the board of directors approved
an amendment to the general operating bylaw that resulted
in former directors no longer being entitled to the advancement
of costs by the corporation when defending against legal
actions arising from the execution of director duties. The
amendment was upheld by the Delaware court thereby leaving
the director who had resigned shortly before the bylaw amendment
was made, responsible for paying his own legal costs.
Whether or not the Troy case will
be followed by the courts in other jurisdictions, including
Canada, is uncertain at this time. However, much of the
case law that has emanated from the Delaware courts over
the years has proven in the past to be influential throughout
the United States and Canada, and for this reason, the legal
principles emanating from the Troy case may be of
interest to corporations and their directors.
B.
SYNOPSIS OF THE TROY DECISION
1.
Background Facts
The Troy case involves a number
of consolidated lawsuits surrounding Troy, a privately held
Delaware for-profit corporation; one by Richard Schoon,
a current director of Troy, the second by Steel Investment
Company (“Steel”), a major stockholder in Troy, and a counterclaim
by Troy. The Schoon and the Steel actions were to compel
the production of books and records by Troy for inspection,
while the Troy claim asserted breach of fiduciary duty claims
against Schoon and William Bohnen, a former director of
Troy. Bohnen and Schoon both sued Troy for advancement of
legal fees and expenses incurred in defending against the
lawsuits brought against them.
Shortly after the first lawsuit was
filed, the board of directors for Troy, not including Schoon,
approved several amendments to the Troy general operating
bylaws, which included among other amendments, the removal
of the word “former” in describing those directors who would
be entitled to advancement of monies required to defend
against legal actions arising as a result of duties owed
to the Troy corporation. In other words, the director indemnity
provision as it relates to former directors was removed
from the general operating bylaw.
Troy established a committee to consider
the requests by Bohnen and Schoon to receive advancements
of funds from Troy for legal fees and expenses and the committee
later concluded that only Schoon would be entitled to the
advancement of fees he had incurred in defending against
the fiduciary duty claims against him.
2.
Ruling
In the Troy case, the court concluded
that under the general operating bylaw amended on November
3, 2005 (the “Revised Bylaw”), Bohnen, as a former director,
would not be entitled to advancement of costs. The court
found that Schoon, as a current director of the corporation,
was entitled to advancement for defending the threatened
and pending fiduciary duty based claims. In arriving at
this decision the court noted that section 145 of the Delaware
Code permits Delaware corporations to indemnify directors
and sub-part (e) of that provision authorizes advancement
of the expenses a director incurs in defending a lawsuit
so as long as the director undertakes to “repay such an
amount if it should ultimately be determined such person
is not entitled to be indemnified by the corporation …”,
and provided “such expenses…may be so paid upon such terms
and conditions … as the corporation deems appropriate.”
In light of the flexibility inherent
in section 145 of the Delaware Code, the court in Troy
indicated that it would be guided by the terms of the advancement
provisions in Troy’s Revised Bylaw. The court noted that
the amendments to the Revised Bylaw established different
advancement rights for Bohnen, as a former director, and
Schoon, as a then current director.
In this regard, the pre-amendment bylaws
had provided that the “Corporation shall pay the expenses
incurred by a new president or former director…” The court
noted that Troy purported to remove former directors, including
Bohnen, from the class of Troy officials entitled to advancement
under its November 2005 by-law amendments (“November Bylaw
Amendments”). Following the November Bylaw Amendments, the
new provision read “[L]osses reasonably incurred by a director
or officer in defending any threatened or pending proceeding
… shall be paid by the corporation in advancement of the
final disposition,” thereby removing former directors from
that provision.
In response, Bohnen asserted that in
accordance with the Salaman v. National Media Corp.
decision, the November Bylaw Amendments do not terminate
Bohnen’s right to advancement on the basis that his rights
under the pre-amendment bylaws (which granted former
directors the right to advancement) had vested prior to
the adoption of the November Bylaw Amendments. In Salaman,
the plaintiff was a former director who had sought advancement
for fees and expenses incurred in defending a legal claim
that he had breached his fiduciary duties in his capacity
as a director. The defendant corporation, after advancing
the plaintiff a portion of his fees, amended its bylaws
to repeal the basis for the claimed advancement and then
refused any further advancement to the former director.
In the Salaman case, the court held that Salaman’s
contractual rights, as embodied in the pre-amendment bylaws,
had vested when the defendant corporation’s obligations
were triggered on the date the pleadings were filed against
him. The court arrived at this conclusion by relying on
the principle that “the right to advancement and indemnification
in a vested contract right cannot be unilaterally terminated.”
The court in Salaman therefore concluded that the
bylaw amendment did not affect Salaman’s advancements rights
since the claim against Salaman was commenced and his advancement
rights had vested prior to the amendment to the corporation’s
by-laws.
The court in Troy found that
the principles in the Salaman case did not apply
on the basis that the court in Salaman had only upheld
Salaman’s right to advancement because he was named as a
defendant in a legal action that was commenced before
the corporate bylaw was amended. In this regard, the court
rejected Bohnen’s assertion that a director’s rights to
advancement under a company’s bylaws vest at the time the
director takes office. In other words, the court in Troy
concluded that Bohnen’s rights under the pre-amendment Troy
bylaws had not been triggered before the November Bylaw
Amendments, since Bohnen had not been named as a defendant
in legal actions prior to the November Bylaw Amendments.
C.
CONCLUDING COMMENTS
As previously indicated, it is uncertain
whether or not the Troy case will be followed by
the courts in Canada, which would trigger the need for corporations
(both for-profit and non-profit) and directors to consider
the need for indemnity agreements to prevent a similar situation
from occurring. Notwithstanding the above, corporations
and their directors would be well advised to be aware of
the implications of the Troy case and stay tuned
for any further developments in Canada in that regard.
