In the recent Delaware Chancery Court decision, Schoon v. Troy Corp., the Court held that a former director’s right to expense advancement contained in the corporation’s bylaws did not vest until an indemnifiable claim was asserted against the director and that the corporation could amend its bylaws at any time before an indemnifiable claim against the director was asserted to eliminate the director’s rights to expense advancement.
As a result of this case, Delaware companies should be mindful that while current indemnification provisions contained in bylaws may provide for expense advancement, there is no guarantee that the bylaws will not be subsequently amended to reduce or eliminate these critical rights if an activist stockholder ultimately takes control of the board. Even though a former director may have broad indemnification rights, a loss of expense advancement can place an enormous personal financial burden on the former director in the event that litigation ultimately arises.
To protect against such a situation where the bylaws are later amended to narrow expense advancement and indemnification rights, companies should consider entering into contractual indemnification agreements with directors.
Without such agreements, some directors may feel pressure to settle with activists or to resign hastily from the board due to fear that they will be exposed to personal financial harm if the activist ultimately takes control. In addition, without such contractual indemnification, directors may be perceived as being more willing to permit the activist to obtain board representation in exchange for a settlement and release agreement in which the activist agrees not to sue the company or members of the board.
By instituting a contractual indemnification agreement with its directors in advance, a company may be more likely to maintain a united board in the face of an aggressive stockholder activist.