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Director and Officer Indemnification Agreements

Posted by: Morgan Hay · January 14th, 2013

In order to attract and retain qualified individuals to act as directors and officers, public companies commonly enter into director and officer indemnification agreements to enhance the protections provided to directors and officers under statutory and corporate by-law indemnification rights and directors’ and officers’ (“D&O”) insurance policies. An indemnification agreement provides each director and officer with contractual indemnity rights enforceable against a company in respect of claims and liabilities arising from serving as a director or officer of the company, along with other rights such as a requirement for the company to advance expenses to the director or officer in connection with the defence of a claim.

Although both the Canada Business Corporations Act (the “CBCA”) and the Business Corporations Act (British Columbia) (the “BC BCA”) permit the indemnification of directors and officers where the individual meets a certain conduct threshold, mandatory statutory indemnification is limited and the advancement of defence costs is not required.

Under the CBCA, a company is only required to indemnify a director or officer in respect of all costs, charges and expenses reasonably incurred by the individual in connection with the defence of any civil, criminal, administrative, investigative or other proceeding where, in addition to meeting the conduct threshold stated above, the director or officer was not judged by a court to have committed any fault or omitted to do anything that the individual ought to have done. The BC BCA only provides for mandatory indemnification of expenses actually and reasonably incurred following the end of a proceeding where, in addition to meeting the conduct threshold stated above, the director or officer is wholly successful, on the merits or otherwise, in the outcome of the proceeding or is substantially successful on the merits in the outcome of the proceeding. Unless the applicable requirements of the company’s governing corporate statute have been met, the indemnification of directors and officers is at the discretion of the company.

Relying on a company’s D&O insurance policy in the absence of an indemnity agreement also poses certain risks, as D&O insurance policies must be renewed annually, with possible changes to policy terms and conditions.

In order to provide greater protection than that which is available under the company’s governing corporate statute and D&O insurance policy, directors and officers should have their right to indemnification and advancement of defence costs set out in the company’s by-laws and in an indemnification agreement. An indemnification agreement is a stand-alone agreement between the company and each director and officer that cannot be amended without the director’s or officer’s consent. Indemnification agreements also extend beyond what is set out in the company’s by-laws and can provide that the company will indemnify the director or officer to the fullest extent of the law and have the added advantage of enabling the parties to deal expressly with many practical issues which are not set out in the company’s governing statute or by-laws, such as the procedure to be followed to receive an advancement of defence costs or to govern the selection and instruction of defence counsel.

Care must be taken when drafting an indemnification agreement to ensure that it properly interfaces with the company’s D&O insurance policy and is consistent with the provisions of the company’s governing corporate statute and by-laws. In order to provide the company’s directors and officers with a high level of protection (which will also assist the company in attracting and retaining qualified directors and officers), an indemnification agreement may contemplate the following:

– the process directors or officers must follow in order to make a claim for reimbursement or for an advancement of defence costs and an explicit statement that the company must advance defence costs (unless prohibited by law from doing so), subject to the director or officer providing a written undertaking to repay the advances if his or her conduct is found to not have met the required conduct threshold;

– a requirement for immediate advancement of defence costs where the director or officer provides a certification that he or she believes in good faith that his or her conduct in the matter satisfied the required conduct threshold, and the undertaking discussed above;

– an exclusion of any requirement for directors or officers to provide security for the repayment of advances of defence costs or to pay interest on such advances;

– a clear statement that the company agrees to indemnify the director or officer to the fullest extent permitted by law;

– the procedure for governing the selection of the director’s or officer’s defence counsel and clarification as to whether the company must provide separate defence counsel for each director and officer if they could be represented commonly;

– an expanded definition of the type of proceeding against which the director or officer may be indemnified, including investigative proceedings;

– a broad definition of the type of expenses subject to indemnification, including legal fees and any expenses of establishing a right to indemnification, together with an entitlement to any and all judgments, fines, penalties, amounts paid in settlement and other amounts paid and incurred by the director or officer in connection with any proceeding to which the director or officer is subject by reason of serving as a director or officer of the company;

– an on-going obligation of the company to provide indemnification and to advance defence costs even after the director or officer ceases to be a director or officer of the company;

– a requirement for the company to provide the director or officer with D&O insurance coverage during his or her period of service as a director or officer and for a period of time thereafter (i.e., a minimum of 6 years), together with evidence of compliance;

– a prohibition of the company against repealing any existing by-laws granting indemnification rights or implementing any amendments diminishing such rights; and

– a provision stating that no determination in any proceeding against the director or officer by judgment, order, settlement or conviction shall, of itself, create a presumption that the director or officer did not meet the required conduct threshold.

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