By Dennis Smith, Esq.
Many corporate by-laws contain provisions that obligate corporations to advance litigation expenses to corporate officers and directors who are sued by reason of their corporate position in advance of the final disposition of the litigation upon a promise to repay the sums advanced if it is determined that the officer or director is not entitled to indemnification (for example if they are found guilty or liable for the conduct alleged). These advancement provisions typically are thought about in the context of a company paying to defend its officers against claims by third parties.
However, the language in common advancement provisions also would require the company to advance defense costs in actions by the corporation against the officer. Why is this type of provision significant? If a corporation sues an officer or director for breach of fiduciary duty the officer can turn around and request that the corporation advance him his defense costs pending resolution of the lawsuit. Thus a corporation can wind up paying a lawyer for its affirmative action and also pay the lawyer defending the corporate officer it sued. Similarly, if the officer sues the corporation and the corporation counterclaims that the officer breached his fiduciary duty the corporation may have to advance the officer’s costs for defending the counterclaim. Now if the corporation ultimately succeeds in the lawsuit, it can try to recoup its defense expenses; however, the officer may not have the financial capacity to reimburse.
Under Delaware law (which New Jersey court’s look to for guidance) the question of entitlement to advancement is generally handled in a summary fashion—usually involving briefing and argument before the court. Thus, it is important for corporations to carefully review the advancement provisions of their by-laws and not rely upon boilerplate language. Also before contemplating suing an officer or director you may want to engage counsel to review the corporation’s bylaws so that you can be fully informed on claims subject to advancement and the potential financial ramifications of bringing suit.