Indemnification Clauses: A Practical Look at Everyday Issues

Indemnification Clauses
A Practical Look at Everyday Issues
General Reinsurance Corporation

120 Long Ridge Road | Stamford, Connecticut
April 1, 2011
8:45 a.m. to 12:30 p.m.
Your Presenters
H. Kennedy Hudner
860.240.6029
khudner@murthalaw.com
Richard S. Smith, Jr.

860.240.6053
rsmith@murthalaw.com
Elizabeth J. Stewart
203.772.7710
estewart@murthalaw.com
Edward B. Whittemore
860.240.6075
ewhittemore@murthalaw.com
Program Agenda
Indemnifications in Sale of Goods Contracts
H. Kennedy Hudner
Drafting Indemnifications with an Eye to Insurance

Coverage
Indemnifications in Corporate Mergers and

Acquisitions
Recent Developments in D&O Indemnification Issues
Indemnification Clauses:
Where Obtuse Meets Terrifying
H. Kennedy Hudner
Education is what you get when you read the

contract.
Experience is what you get when you dont.
- Pete Seeger
If you think words dont have power, read an

indemnification clause.
5
In the Beginning,
There was Darkness
Your in-house client reads the indemnification.
You Take Charge

You give an inspiring explanation to the
business people
Your Client Wants the Sale

Client looks to you.
You need to understand the
transaction in order to give
good advice.
You need to understand the
contract.
The Big Picture

One size does not fit all.
Context of your transaction
Are you buyer or seller? Or both?
Giving an indemnification or receiving one?
Sale of goods? Services? Intellectual Property?
Sale to end user? Distributor? OEM?
What happens to your product downstream?
Off the shelf? Or custom product?
Your design? Made to Buyers specifications?

9
The Big Picture

Does indemnification cover only 3rd-party claims, or
the Buyers claims as well?
Cover Buyers customers?
Does it cover Buyers negligence?
Cover cost of recalls? Replacement goods only, or
cost of labor in the field as well?
Interplay with disclaimer of consequential damages
and limitation of liability???
10
Pretty Standard
Indemnification for infringement of patent,
copyright, trademark and trade secret.
Any IP, or United States IP only?
Also, indemnification for breach of
confidentiality.
Pay close attention to what is described as

confidential.
11
Hypothetical #1
Sale of Bottling/Packing Equipment
$1.5 Million bottling/packing equipment
Sell to Coca Cola.
If machine fails:
Loss of Cokes product
Inability to package and ship
Loss of revenues ($250k/day). Damages for late

delivery.
Coke offers its indemnification clause

12
Buyers Indemnification
Clause
Seller will indemnify and hold harmless Buyer, its
employees, agents, directors, shareholders,
distributors, and customers (Indemnified Parties)
from any and all claims, judgments, damages,
losses, costs and expenses (including Buyers
attorneys fees) incurred by Indemnified Parties and
arising directly or indirectly from this transaction
and/or the use of the Goods.
13
Break it Down
The 7 Questions
1. Who?
2. What?
3. Trigger?
4. Control of defense?
5. Dollar caps?
6. Interplay with other clauses.
7. Covered by insurance?
14
Who?
1. Who are you indemnifying?
Coke, its distributors and customers. Each may

have separate damages.
First negotiation point narrow the indemnified

party to just Coca Cola.
Dont indemnify non-parties. No contractual

control. Too many variables.
Multiple levels of independent damages.

15
What?
2. Indemnifying from what?
Any and all damages, losses, etc.
Includes (i) Cokes internal losses and (ii) 3rd-party

claims.
Also includes damages suffered by distributors and

end users. Many layers of damages.
Includes Cokes attorneys fees. Note this is more

significant because you are not allowed to control
the defense. Coke defends and sends you a bill for
their lawyers.
16
What is the Trigger???

You are obligated to defend if Coke incurs losses or
damages arising directly or indirectly from this
transaction and/or the use of the Goods.
Seems reasonable, no?
17
Watch the Trigger Clause

Under this trigger clause:
Seller does not have to be in breach of contract.
Does not have to be negligent.
In fact, Seller does not have to be at fault!

As long as Coke incurs losses related to transaction
or use of Goods, Seller is liable.
This is how the parties have contractually assigned
the risk.
18
Trigger Clause
Congratulations, you are
an insurance company!
Is this enforceable? How
much do you want to
spend to find out?
Will your boss be happy?
19
Control of Defense
Absent extraordinary reasons, indemnifying
party should control the defense.
Need the good faith cooperation of
indemnified party.
Spell out witness costs
Access
20
Control of Settlement
Indemnifying party should be able to make
any monetary settlement without consent of
indemnified party.
Non-monetary settlement with consent, which
shall not be unreasonably withheld, delayed
or conditioned.
21
Unlimited Liability?
Standard to have unlimited liability for:
IP infringement
Breach of confidentiality
Can you accept risk of unlimited liability for breach

of contract? Breach of warranty?
Coca Cola example: $1.5 M machine.
Cokes damages will run @ $1.6 Million per week.
22
Know Your Risk Tolerance

Companies are like people, some are more
risk tolerant, some less.
Which is your company???
And who decides? Sales? Division chief?
CFO? CEO?
23
Liability $$$$
If cant limit the trigger, try an aggregate
dollar cap over life of contract.
No magic bullet, just straight horse trading.
Beware of indemnification up to the limits of
Sellers liability insurance.
You are stuck paying this amount even if your

insurance doesnt cover.
24
Layered Approach to Limiting

Indemnification Liability
Indemnify only the buyer.
Narrow the trigger:
Indemnify for personal injury or property damage caused solely

and directly by you while on Buyers premises.
Indemnify only for Epidemic Failure. (And pray it never
happens.)
For product recalls (Labor only? Parts only? Aggregate cap?
Per year or total contract?)
Dollar cap? Revenues from past 3/6/12 months?
25
Never Forget
If unlimited liability, this is a bet-yourcompany clause.
26
So, Will Your

Insurance Cover?
Need to check your policy and perhaps your
broker.
(And listen carefully to Elizabeth Stewart)
But if you cannot track language of your
policy, assume that you are NOT covered.
27
Indemnify up to
Policy Limits
Two variations:
Dollar cap at policy limits

Dollar cap at amounts actually paid by insurance
company
#1 Seller shall indemnify and hold Buyer

harmlessup to the coverage limits specified in
Sellers liability insurance policy, including its
umbrella policy.
28
But What If?

This is dangerous for the Seller
Insurance company might not pay.
Seller still obligated up to insurance limits.
29
Tying Indemnification to
Insurance
#2 Sellers obligation to indemnify Buyer
shall be limited to the amount of money
actually paid by Sellers liability insurance
policy.
Dangerous for Buyer
Payment too uncertain.
Amount of payment also uncertain.

30
Interplay with Other

Clauses
How does it affect Limitation of Liability and
Disclaimer of Consequential Damages???
As Seller, you want to make sure that your limitation
of liability and disclaimer take priority over your
indemnification obligations.
Need clear language.
Notwithstanding Section 5 (Indemnification), in no
event shall Seller be liable for consequential
damages
31
Or: This provision shall take precedence

over Section 5 (Indemnification).
Or: The provisions of this indemnification
clause shall be limited by the limitations on
liability set forth in Sections 3 (Limitation of
Liabilities) and 4 (Disclaimer of
Consequential Damages).
32
Alternatives
Personal Injury Only
There are alternatives you can try for:
Seller will indemnify Buyer for any claims,
judgments, damages, settlements, costs and
expenses (including but not limited to Buyers
attorneys fees) arising out of personal injury
or property damage caused solely and
directly by Seller while on Buyers premises.
33
Case Study #1: Loss of

Product with $$ Cap
Seller sells growth medium to drug company
for $1,000. Buyer uses medium with
$100,000 worth of its product. Bad growth
medium results in loss of $100,000 product
and schedule delays.
Starting positions: Buyer wanted full
indemnification; Seller wanted replacement of
medium only.
34
The Resolution
Buyer has obligation to test 100% of
purchased medium batches.
If Buyer finds bad batch before use in
manufacture, sole remedy is replacement of
medium.
35
The Resolution
In event bad medium spoils the
manufacturing batch:
Seller will pay $20,000 for first bad batch
$30,000 for second
$50,000 for third
$100,000 for any other
36
Case Study #2:

Seller sells component part to an OEM.
#1 Electronic board in printer assembly
#2 Small motor in windmill
OEM wants indemnification for field failures:
Cost of part
Cost of lost profit on OEMs printer (or windmill) units
Cost of labor
37
Two Sellers, Two Outcomes

Printer component
Seller accepted the indemnification as is.
This part wont fail.
Windmill component
Seller tried to negotiate caps.
Buyer refused.
Seller walked away from deal. Risk too high for

returns.
38
Contractual Indemnity
Provisions and Insurance
Off-The-Rack Rules
Contribution
The right of a tortfeasor to recover from other
tortfeasors shares of the amount paid to the
injured party.
Often governed by statutes.
Can apply to judgment, settlement and/or
defense costs.
New York Statutes

Tortfeasor who is jointly and severally liable
may seek contribution for excess over its
equitable share of liability (NY CPLR 1401).
Tortfeasor who is 50% or less liable shall only
be liable for its equitable share of noneconomic loss (NY CPLR 1601).
Connecticut Statutes
In negligence cases, each tortfeasor is liable only
for its proportionate share of damages.
But the uncollectible amounts may be reallocated
among the remaining tortfeasors on the basis of
their proportionate fault (C.G.S. 52-572h).
A tortfeasor may seek contribution for the amount
it paid in excess of its proportionate share (C.G.S.
52-572h).
Settlements and Contribution in

New York and Connecticut
A release, settlement or similar agreement
between a claimant and a tortfeasor
discharges the tortfeasor from all liability for
contribution to other joint tortfeasors.
Settlement reduces amount plaintiff can
recover from nonsettling parties.
Indemnity
A shift of liability between parties, either through
tort law or contract, for the entire judgment,
settlement and/or defense or defense costs.
Typically applies where contribution statutes do
not apply.
Typically shifts whole loss.
New York and Connecticut

Common Law
Shifts the entire liability to one who is negligent.
If party is partially negligent, it can only seek
contribution, not indemnification.
Indemnification includes attorneys fees and costs
of defense of underlying action, but does not
include costs of prosecuting an action to be
indemnified.
Contracting Around
Off-The-Rack Rules
Indemnitees Own
Negligence
Unless prohibited by statute, a party may
contract for indemnification of its sole
negligence.
That indemnification provision must explicitly
state the intent to contract for indemnification
of sole negligence.
Indemnification for Sole

Negligence
New York Prohibits this for:
Construction (N.Y. Gen. Oblig. Law 5-322.1)
Leases (N.Y. Gen. Oblig. Law 5-321)
Caterers (N.Y. Gen. Oblig. Law 5-322)
Building service and maintenance

(N.Y. Gen. Oblig. Law 5-323)
Architectural and engineering services
(N.Y.Gen. Oblig. Law 5-324)
Places of public recreation
(N.Y. Gen. Oblig. Law 5-326)
Indemnification for Sole

Negligence
Connecticut Prohibits this for:
Construction (C.G.S. 52-572k)
Residential Leases (C.G.S. 47a-4)
Effect of Insurance on Contracts

with Indemnification Clauses
Issues to Consider
Duty to Defend
Duty to Indemnify
Whose insurance policy should pay?
Under what circumstances?
Read the policies when drafting
indemnification clauses
Make sure to get the necessary endorsements and
make sure indemnitees are covered as additional
insureds
For long tail claims, hold onto policies
Duty to Defend
Broader than duty to indemnify because duty to
defend is based on allegations of complaint, not
ultimate judgment or settlement.
Duty to defend vs. right to receive
reimbursement for defense costs.
Is there a right to independent counsel? What if
there is a conflict of interest?
Areas Where Indemnification

and Insurance Can Collide
Other insurance clause.
Exclusion for liability assumed by contract.
Additional insured coverage.
Other Insurance Clause

Typical Language of a Pro Rata Clause:
If a loss covered by this policy is also covered
by other insurance, we will pay only the
proportions of the loss that the limit of liability
that applies under this policy bears to the total
amount of insurance covering the loss.

Typical Language of an Excess Clause:
Unless otherwise endorsed, this policy shall be
excess over any other insurance whether prior or
subsequent hereto, and by whomsoever effected,
directly or indirectly covering loss or damage insured
hereunder, and this Company shall be liable only for
the excess of such loss or damage beyond the
amount due from such other insurance, whether
collectible or not, however, not exceeding the limits as
set forth in the Declarations.
Majority rule: if 2 insurance companies with the same insured

have identical other insurance clauses, there is a pro rata
sharing by the 2 insurance companies.
Majority rule: if 2 insurance companies have different other

insurance clauses, courts will try to interpret each of them
together.
Exception: indemnity agreement between

named insured (indemnitor) and additional insured (indemnitee)
and additional insured has its own insurance coverage. The
entire loss is shifted to the insurance carrier for the named
insured (indemnitor).
New York and Other

Insurance Clause
New York does not follow this exception.
The terms of insurance policies govern
coverage and cannot be overridden by
contracts between the parties.
Connecticut and Other

Insurance Clause
CT follows the majority rule for more than one
insurance policy.
No CT law as to whether the exception for
indemnification applies.
Exclusion for Liability

Assumed by Contract
Typical Language:
This insurance does not apply to:

Bodily injury or property damage for which the insured is
obligated to pay damages by reason of the assumption of liability
in a contract or agreement. This exclusion does not apply to
liability for damages:
(1) That the insured would have in the absence of the
contract or agreement; or
(2) Assumed in a contract or agreement that is an insured
contract, provided the bodily injury or property damage
occurs subsequent to the execution of the contract or
agreement . . . .
Exception If Insured Would Have

Been Liable Without Contract:
If the policyholder-indemnitors conduct contributed

to the liability, the policyholder would be liable
anyway even if it did not have an indemnification
contract, so the first exception would apply.
If the indemnitor would not be liable but for the

indemnification agreement, the exclusion would bar
coverage because the first exception would not
apply
Exception for Insured Contract

Insured contract a contract entered into by the
policyholder that assumes the liability of another,
which contract (and corresponding liability) the
insurance company specifically agrees to insure.
NOTE: If an indemnification agreement is
important to you, you may be able to purchase a
Contractual Liability Coverage Endorsement to
cover it.
Additional Insureds
Need to be specifically identified as additional insureds
in the policy.
Contractual Liability Coverage Endorsement does not
make an indemnitee a party to a policy.
Even if an indemnitee is listed as an Additional
Insured, a carriers duties are what the carrier
promised to do in the policy, not what the indemnitorinsured promised to do in an indemnification
agreement.
Vendor Endorsements
Protect retailers and distributors of products.
Issue: What if named insured manufactures
a component of a vendors product?
Additional Insureds
Issue: What if both the named insured and the
additional insured are negligent?
Watch coverage typically coverage is only for
vicarious liability of the additional insured for
something the named insured did.
But there are cases in Connecticut and New York
where carriers had to cover additional insureds
regardless of whether the additional insured or the
named insured was negligent.
Issues Relating to Indemnification

in M&A Transactions
Valuable Resources
ABA Model Asset Purchase Agreement.
ABA Model Stock Purchase Agreement.
ABA 2009 Private Target Mergers & Acquisitions Deal
Points Study (for Transactions Announced in 2008) (the
2009 Deal Points Study).
ABA 2010 Strategic Buyer/Public Target Mergers &
Acquisitions Deal Points Study (for Transactions
Announced in 2009).
Interplay Between Various

Provisions of the Agreement
Indemnification Provisions.
Definitions.
Representations and Warranties.
Covenants.
Purchase Price Adjustment Provisions.
Other Miscellaneous Provisions.
Survival
In order to ensure that representations and warranties may serve as the

basis for post-closing liability, acquisition agreements typically include
an express survival clause to avoid the potential application of the
doctrine of merger and specify the extent to which the representations
and warranties survive the closing.
Certain representations, particularly those covering fundamental

corporate matters (such as organization and authority), title to the
purchased assets, sufficiency of the purchased assets, taxes,
environmental matters and ERISA, typically have longer survival
periods.
Covenants and agreements typically survive indefinitely or for the

shorter period specified within the particular covenant or agreement.
Survival
Time to Assert Claims
Survival provisions, without more, may not be the same as the
time to assert claims.
A bare survival clause may be interpreted to specify the time
during which a breach may occur, not when an action must be
filed. See, e.g., Western Filter Corp. v. Argan, Inc., 2008 U.S.
App. LEXIS 18147 (9th Cir. Aug. 25, 2008).
To avoid ambiguity, the survival provision should be carefully
drafted to specify whether it is intended to specify the time during
by which an action must be filed.
Survival
Sample Provision
Section 8.01 Survival. Subject to the limitations and other provisions of this
Agreement, the representations and warranties contained herein shall survive
the Closing and shall remain in full force and effect until the date that is [___]
[years/months] from the Closing Date; provided, however, that the
representations and warranties in Sections [__] shall survive indefinitely and the
representations and warranties in Sections [__] shall survive for the full period of all
applicable statutes of limitations (giving effect to any waiver, mitigation or extension
thereof) plus 60 days. All covenants and agreements of the parties contained
herein shall survive the Closing indefinitely or for the period explicitly specified
therein. Notwithstanding the foregoing, any claims asserted in good faith with
reasonable specificity (to the extent known at such time) and in writing by notice
from the non-breaching party to the breaching party prior to the expiration date of
the applicable period shall not thereafter be barred by the expiration of the relevant
representation or warranty and such claims shall survive until finally resolved.
Survival
Whats Market?
According to the 2009 Deal Points Study, 70% of the
transactions surveyed had a general survival period
of 18 months or less.
The most common carve outs were for taxes (74%),
due authority (64%), capitalization (62%), due
organization (44%), ownership of shares (39%),
fraud (37%), breach of covenants (36%,
intentional breach (34%), brokers/finders fees
(34%), environmental (33%), and employee
benefits (31%).
Sample Provision
Asset Purchase Agreement
Subject to the other terms and conditions of this Article VIII, Seller
and each Shareholder, jointly and severally, shall indemnify and
defend each of Buyer and its Affiliates and their respective
Representatives (collectively, the Buyer Indemnitees) against,
and shall hold each of them harmless from and against, and shall
pay and reimburse each of them for, any and all Losses incurred or
sustained by, or imposed upon, the Buyer Indemnitees, whether or
not involving a Third-Party Claim, based upon, arising out of, with
respect to or by reason of.
Who are the Indemnitors?

Seller.
Each shareholder.
Joint and several liability.
Consider need for other indemnitors (i.e.,
parent companies, sister companies and
other affiliates).
Who are the Indemnitees?
Buyer.
Buyers Affiliates.
An affiliate of a person is generally defined to mean any other Person

that directly or indirectly, through one or more intermediaries, controls, is
controlled by, or is under common control with, such Person.
The term control (including the terms controlled by and under
common control with) generally means the possession, directly or
indirectly, of the power to direct or cause the direction of the
management and policies of a Person, whether through the ownership
of voting securities, by contract or otherwise.
Buyers Representatives.
The term representative" is generally defined to mean, with respect to

any Person, any and all directors, officers, employees, consultants,
financial advisors, counsel, accountants and other agents of such
Person.
How are Damages/Losses

Calculated?
Typical provision:
Losses means losses, damages, liabilities, deficiencies,
Actions, judgments, interest, awards, penalties, fines, costs or
expenses of whatever kind, including reasonable attorneys fees
and the cost of enforcing any right to indemnification hereunder
and the cost of pursuing any insurance providers; provided,
however, that Losses shall not include punitive damages,
except in the case of fraud or to the extent actually awarded to a
Governmental Authority or other third party.
Diminution in value.
Incidental, consequential, special and punitive damages.
Breach of Reps & Warranties

Knowledge and materiality are frequently utilized to qualify
specific representations and warranties and, if utilized,
significantly effect the Sellers obligation to indemnify the Buyer
from and against alleged breaches.
The Seller generally prefers to use a knowledge qualifier, as
opposed to a materiality qualifier, because its availability
depends on what the Seller knew, or should have known, rather
than the magnitude of the problem.
Breach of Reps & Warranties

continued
Buyers frequently take the position that the representations and

warranties should not be qualified in any respect because they
simply serve to allocate the risk of liability and the purchase price
was determined based on the assumption that there are no
unknown liabilities.
Furthermore, Buyers argue that the basket provides the
appropriate level of protection for immaterial claims.
Knowledge
Sample Provision
Knowledge an individual will be deemed to have Knowledge
of a particular fact or other matter if:
(a) such individual is actually aware of such fact or other matter;
or
(b) a prudent individual could be expected to discover or
otherwise become aware of such fact or other matter in the
course of conducting a reasonably comprehensive
investigation regarding the accuracy of any representation or
warranty contained in this Agreement.
Knowledge
Sample Provision continued
A Person (other than an individual) will be deemed to have
Knowledge of a particular fact or other matter if any individual who
is serving, or who has at any time served, as a director, officer,
partner, executor, or trustee of such Person (or in any similar
capacity) has, or at any time had, Knowledge of such fact or other
matter (as set forth in (a) and (b) above), any such individual (and
any individual Party to this Agreement) will be deemed to have
conducted a reasonably comprehensive investigation regarding the
accuracy of the representations and warranties made herein by that
Person or individual.
ABA Model Asset Purchase Agreement.
Material Adverse Effect

Sample Provisions
Material Adverse Effect means any result, occurrence, fact, change, event or
effect that has a materially adverse effect on the business, assets, liabilities,
capitalization, condition (financial or other), results of operations of Target.
effect that has, or [could/would] reasonably be expected to have, a materially
adverse effect on the business, assets, liabilities, capitalization, condition
(financial or other), results of operations or prospects of Target.
effect that is or could reasonably be expected to have a materially adverse effect
on (i) the business, assets, liabilities, capitalization, condition (financial or other),
or results of operations of Target, (ii) Sellers ability to consummate the
transactions contemplated hereby, or (iii) Buyers ability to operate the
business of Target immediately after Closing in the manner operated by
Seller before Closing.
Material Adverse Effect

Sample Provisions continued
Material Adverse Effect means, except to the extent resulting from (A)
changes in general local, domestic, foreign, or international economic conditions,
(B) changes affecting generally the industries or markets in which Company
operates, (C) acts of war, sabotage or terrorism, military actions or the escalation
thereof, (D) any changes in applicable laws or accounting rules or principles,
including changes in GAAP, (E) any other action required by this Agreement, or
(F) the announcement of the Transactions.
Material Adverse Effect means, except to the extent resulting from (A)
changes in general local, domestic, foreign, or international economic conditions,
(B) changes affecting generally the industries or markets in which Company
operates, (C) acts of war, sabotage or terrorism, military actions or the escalation
thereof, (D) any changes in applicable laws or accounting rules or principles,
including changes in GAAP, (E) any other action required by this Agreement, or
(F) the announcement of the Transactions (provided that such event, change,
or action does not affect Company in a substantially disproportionate
manner).
Baskets and Caps

Baskets.
Thresholds.
Deductibles.
Caps.
Carve Outs.
Baskets
Typical Provision
Seller shall not be liable to the Buyer Indemnitees for indemnification
under Section 8.02(a) (other than with respect to a claim for
indemnification based upon, arising out of, with respect to or by reason
of any inaccuracy in or breach of any representation or warranty in
Sections __, __, __, and __ (the Buyer Basket Exclusions)), until
the aggregate amount of all Losses in respect of indemnification under
Section 8.02(a) (other than those based upon, arising out of, with
respect to or by reason of the Buyer Basket Exclusions) exceeds
$____, in which event [Seller shall be required to pay or be liable for all
such Losses from the first dollar OR Seller shall be required to pay or
be liable for the Losses that exceed $_____].
Baskets
Whats Market?
According to the 2009 Deal Points Survey, 95% of the
transactions surveyed included some sort of basket.
Within the subset of transactions that included a basket:
50% were drafted as deductibles;
37% were drafted as first dollar thresholds; and
13% were drafted as combination thresholds.
Baskets as a percentage of transaction value:
44% had baskets equal to .5% or less;
45% had baskets that were .5% to 1% of transaction value; and
11% had baskets that exceeded 1% of transaction value.
Caps
Typical Provision
Sellers aggregate liability to the Buyer
Indemnified Parties for indemnification under
this Article VIII for any and all Losses incurred
by the Buyer Indemnified Parties shall not
exceed $_____.
Caps
Whats Market?
Similarly, 92% of the transactions surveyed included some sort of
indemnification cap.
Within the subset of transactions that included a determinable
cap:
The minimum cap was 1.23% of transaction value;
The maximum cap was 100% of the transaction value;
The mean cap was 21.72% of the transaction value; and
The median cap was 11.19% of the transaction value.
Baskets/Caps
Carve Outs
The most frequent carve outs were for fraud (59%/66%),
capitalization (57%/49%); taxes (57%/48%); due
authority (55%/49%); intentional breach (41%/38%);
brokers/finders fees (40%/33%); due organization
(37%/29%); ownership of shares (35%/33%); title
to/sufficiency of assets (24%/21%); employee
benefits/ERISA (23%/15%); no conflicts (22%/22%); and
environmental (15%/10%).
Third Party Claims
Most acquisition agreements contain a separate provision governing

third party claims.
These provisions generally specify the extent to which the

indemnifying parties may participate in, or assume, the defense of
proceedings for which indemnification is sought.
Because acquisition agreements are generally drafted by the Buyer,

and the Buyer is more likely to be the indemnified party, these
provisions typically impose significant limitations substantive and
procedural limitations.
Third Party Claims

Typical Provisions
Notice requirement:
Applicable to formal proceedings only.

Failure to give notice does not affect the indemnifying
partys obligations, unless such failure prejudices the
defense.
Right to Assume Defense generally subject to:
No conflict of interest.
Financial capacity.
Use of counsel satisfactory to Indemnified parties.
Third Party Claims

Typical Provisions continued
The indemnifying party is bound by the indemnified
partys defense if it does not assume defense.
Assuming the defense conclusively establishes that
the claims are within the scope of the indemnifying
partys indemnification obligations.
Sandbagging
The Buyers first draft typically provides that the Buyers right to
indemnification will not be affected by any investigation
conducted, or any knowledge acquired, with respect to the
accuracy or inaccuracy of any representation or warranty of the
Seller.
This leads to the possibility that the Buyer may assert a claim for
a breach of representations and warranties even if the Buyer
knew they were untrue when the transaction was consummated.
This provision is frequently subject to considerable negotiation
between the parties.
Sandbagging
Typical Provisions
Pro-Sandbagging:
Section 8.08 Effect of Investigation. The representations, warranties

and covenants of the Indemnifying Party, and the Indemnified Party's
right to indemnification with respect thereto, shall not be affected or
deemed waived by reason of any investigation made by or on behalf of
the Indemnified Party (including by any of its Representatives) or by
reason of the fact that the Indemnified Party or any of its
Representatives knew or should have known that any such
representation or warranty is, was or might be inaccurate or by reason
of the Indemnified Party's waiver of any condition set forth in Section
7.02 or Section 7.03, as the case may be.
Anti-Sandbagging:
Seller shall not be liable under this Article VIII with respect to any
Losses arising out of matters within the knowledge of Buyer at the
Closing Date.
Sandbagging
Whats Market?
According to the 2009 Deal Points Survey:
53% of the transactions surveyed were silent

on the issue;
39% included a pro-sandbagging provision;
and
8% included an anti-sandbagging provision.
Sandbagging
Whats Market?
Within the transactions that contained an anti-sandbagging
provision:
74% of the transactions limited the requisite knowledge to actual

knowledge;
13% included constructive knowledge; and
13% did not differentiate between the two.
With respect to timing:
50% of the transactions limited the requisite knowledge to

knowledge acquired pre-signing; and
50% did not differentiate between pre-signing and post-signing.
Materiality Scrapes
After a typical negotiation, many of the representations and
warranties are qualified by materiality.
A typical negotiated acquisition agreement also contains some
sort of basket, whether it be a deductible or a threshold, which
must be reached before the Buyer can asset a claim against the
Seller.
Under this scenario, the Buyer cannot assert a claim unless the
particular problem is severe enough to rise to the level of a
breach of a particular representation or warranty and the
damages suffered by the Buyer are in excess of the relevant
basket amount.
Materiality Scrapes
A materiality scrape is a contractual provision that eliminates all

materiality qualifiers for purposes of determining whether a breach of a
particular representation or warranty has occurred and/or the amount
damages that have resulted from such breach.
Under this approach, the materiality qualifiers continue to be relevant for

purposes of determining whether the Seller has fulfilled its disclosure
obligations and whether all relevant closing conditions have been
satisfied but they effectively disappear at closing.
After the closing, the Sellers representations are either right or wrong in
their unqualified form and the relevant basket serves as the Sellers
single line of defense against claims asserted by the Buyer.
Materiality Scrapes
Typical Provision
Notwithstanding anything in this Agreement to the contrary, for
purposes of the parties indemnification obligations under this
Article VIII, all of the representations and warranties set forth in
this Agreement or any certificate or schedule that are qualified by
the words material, materiality, material respects,
Material Adverse Effect or words or similar import or effect shall
be deemed to have been made without any such qualification
for purposes of determining (i) whether a breach of any such
representation or warranty has occurred, and (ii) the amount of
losses resulting from, arising out of or relating to any such
breach of representation or warranty.
Materiality Scrapes
Whats Market?
76% of the transactions surveyed did not contain a

materiality scrape; and
24% did.
Within the subset of those that did:
68% did not limit the scrape to the calculation of

damages; and
32% did.
Escrows, Holdbacks and

Other Deferred Payments
Many acquisition agreements include some sort of escrow,
holdback or other deferred payment mechanism, pursuant to
which some portion of the purchase price is not paid until well
after the closing.
These techniques favor the Buyer by helping to ensure that the
Seller Indemnitors will have the financial resources to fulfill their
indemnification obligations in the event that problems are
discovered post-closing.
Sellers, in turn, often turn the presence of an escrow or holdback
to a positive by negotiating for corresponding provisions that limit
its aggregate indemnification obligation to the amount of the
escrow or holdback amount.
Escrows & Holdbacks

Whats Market?
19% of the transactions surveyed did not contain any

sort of escrow or holdback; and
81% did.
Within the subset of those that did:
41% provided that the escrow/holdback was the

exclusive remedy; and
59% provided that it was not the exclusive remedy.
Escrows & Holdbacks

Whats Market?
16% of determinable escrows or holdbacks had a value that was

less than or equal to 5% of the aggregate transaction value;
26% had a value that was less than or equal to 7% of the
aggregate transaction value; and
69% had a value that was less than or equal to 10% of the
aggregate transaction value.
Only 15% of the escrows or holdbacks had a value in excess of

15% of the aggregate transaction value.
Exclusivity
Given the extensive indemnification provisions that typically are
heavily negotiated between the parties and included in most
acquisition agreements, the Seller frequently argues that those
provisions should serve as the Buyers exclusive remedy in the
event of a breach of the representations, warranties, covenants
or other obligations set forth in the agreement.
Although Buyers often agree to include an exclusive remedy
provision, it generally excludes claims based on fraud, criminal
activity or willful misconduct and claims for equitable relief (such
as specific performance).
Exclusivity
Typical Provision
Section 8.09 Exclusive Remedies. Subject to Section 10.11 [Specific
Performance], the parties acknowledge and agree that their sole and exclusive
remedy with respect to any and all claims (other than claims arising from fraud,
criminal activity or willful misconduct on the part of a party hereto in
connection with the transactions contemplated by this Agreement) for any
breach of any representation, warranty, covenant, agreement or obligation set forth
herein or otherwise relating to the subject matter of this Agreement, shall be
pursuant to the indemnification provisions set forth in this Article VIII. In furtherance
of the foregoing, each party hereby waives, to the fullest extent permitted under
Law, any and all rights, claims and causes of action for any breach of any
representation, warranty, covenant, agreement or obligation set forth herein or
otherwise relating to the subject matter of this Agreement it may have against the
other parties hereto and their Affiliates and each of their respective Representatives
arising under or based upon any Law, except pursuant to the indemnification
provisions set forth in this Article VIII. Nothing in this Section 8.09 shall limit any
Person's right to seek and obtain any equitable relief to which any Person shall be
entitled or to seek any remedy on account of any Person's fraudulent, criminal or
intentional misconduct.
Exclusivity
Whats Market?
85% of the transactions surveyed included an exclusive remedy

provision;
9% expressly provided that indemnification did not represent
the exclusive remedy; and
6% were silent on the issue.
Within the subset of that included an exclusivity provision:
69% included a carve out for fraud;
35% included a carve out for equitable remedies; and
27% included a carve out for intentional misrepresentation.
Recent Developments in D&O

Indemnification Issues
April 1, 2011
Recent Developments in D&O

Indemnification Issues
Topic 1 Recent statutory changes in Delaware
Topic 2 Can a company indemnify its officers for SOX Section 304
clawback liability?
Topic 3 Determining Indemnifiable Conduct (official capacity

claims vs. personal obligation claims)
Topic 4 Can Bylaws contain conditions to advancement rights?
Topic 5 What are reasonable fees and costs in an advancement

case?
Conclusion: Board should make the Business Judgment
Recent Statutory Changes

in Delaware
Overview of DGCL Statutory Indemnification
and Advancement Rights
Retroactive Elimination of Indemnification
Rights / The Schoon case and the 2009
amendment to Section 145(f) of the DGCL
2010 Delaware amendments
Overview of Indemnification and

Advancement under the DGCL
The statutory authority for indemnification rights for directors, officers,

employees, and agents of Delaware corporations is Section 145 of the
Delaware General Corporation Law (the DGCL) (see handout).
This section provides for mandatory indemnification in one limited

context, while permitting (but not requiring) such indemnification in
others.
Under 145(a), a Delaware corporation may indemnify any person who

was or is a party or is threatened to be made a party to a proceeding.
by reason of the fact that such person is or was a director, officer,
employee or agent of the corporation or is or was serving at its request
in such capacity in another corporation or business association, against
expenses (including attorneys fees), judgments, fines and amounts
paid in settlement actually and reasonably incurred by such person in
connection with such action, suit or proceeding

continued
Good Faith/Conduct requirement: indemnification only possible if

such person 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 and, with respect to any criminal action or proceeding, had
no reasonable cause to believe such persons conduct was unlawful.
Section 145(b) derivative actions (actions brought by or in the right of

the corporation), similar in scope and language to Section 145(a)
Section 145(c) success on the merits indemnification:

continued
(c) To the extent that a present or former director or officer of a

corporation has been successful on the merits or otherwise in defense
of any action, suit or proceeding referred to in subsections (a) and (b) of
this section, or in defense of any claim, issue or matter therein, such
person shall be indemnified against expenses (including attorneys'
fees) actually and reasonably incurred by such person in connection
therewith.
Most Delaware public companies, in their charters and/or bylaws, agree

to provide broad indemnification rights that encompass these statutory
requirements.
Meaning of to the fullest extent permitted by law held to encompass

145(a), (b) and (c) claims. See Paolino case.

continued
Advancement, while similar to indemnification, differs in that a director

or officer who is entitled to receive advancement has the right to have
his or her legal expenses paid on an as-incurred basis, rather than at
the conclusion of the litigation or proceeding. See DGCL Section
145(e).
However, if a director or officer receives advancement and a court later

determines that the director or officer was not entitled to indemnification,
then the advanced amounts must be repaid.
Most Delaware corporations provide broad and mandatory

advancement rights to any covered person who must defend a
proceeding for which indemnification could be available at the
conclusion of the proceeding.

continued
Why are broad indemnification and advancement rights so

common? According to the Delaware Supreme Court (2005):
Indemnification: encourages corporate service by the most

capable individuals by protecting their personal financing
resources from depletion by the expenses they incur during an
investigation or litigation that results by reason of that service.
Advancement: Although advancement provides an individual
benefit to corporate officials (immediate relief from a financial
burden), it is also a desirable underwriting of risk by the
corporation in anticipation of greater corporate-wide rewards for
its shareholders.
Retroactive Elimination of
Indemnification Rights
General belief prior to Schoon a directors right to require a company

to provide advancement of expenses vested upon the commencement
of the directors service and could not be unilaterally terminated or
changed by the company after the directors tenure ended.
In Schoon v. Troy Corp., 948 A.2d 1157 (Del. Ch. 2008), the Chancery
Court allowed the Schoon Board to amend the Bylaws to revoke a
former directors right to receive advancement of legal expenses even
though the bylaws that were in place during his board service expressly
stated that the directors right to receive advancement would continue
even after his tenure on the board ended.
Former director argued, under Salaman v. National Media Corp., a 1992

Delaware decision, that a bylaw advancement right is a vested contract
right that commences when the director takes office and thereafter
cannot be unilaterally terminated.
Indemnification Rights continued
Reactions: The decision was broadly criticized.
M&A bar also was concerned that indemnification and
advancement rights of target company directors and officers
could be adversely impacted after a transaction.
Result: Greater use of bilateral indemnification agreements.
Result: Practitioners and other affected constituents asked the

Delaware legislature to amend the statute to resolve the uncertainty
created by the Schoon decision.
Section 145(f) amended (effective 8/1/09) by adding the following

sentence at the end:
A right to indemnification or to advancement of expenses arising

under a provision of the certificate of incorporation or a bylaw
shall not be eliminated or impaired by an amendment to such
provision after the occurrence of the act or omission that is the
subject of the civil, criminal, administrative or investigative
action, suit or proceeding for which indemnification or
advancement of expenses is sought, unless the provision in
effect at the time of such act or omission explicitly authorizes
such elimination or impairment after such action or omission has
occurred.
Note: similar amendments to Section 8.58 of the MBCA were

recently proposed, see 65 Bus. Lawyer 1149 (Aug. 2010).
Post-Schoon, indemnification agreements remain an increasingly

attractive option for directors and officers.

2010 Amendments to 145
The 2010 amendments to 145 were intended to distinguish

between the indemnification rights of a corporations current
directors and officers and the indemnification rights of a former
officer or director or persons serving at the request of the
corporation as directors, officers, employees, or agents of other
entities.
Section 145(d) was revised to make clear that the provision in that
Section requiring a specific determination that indemnification is
proper in certain circumstances applies only when the person
requesting indemnification is a director or officer of the corporation
at the time the determination is made (as opposed to when the
person so requesting is a director, officer, agent, or employee of
another entity or a former director or officer).

2010 Amendments to 145
continued
Section 145(e) was amended to make clear that persons serving at

the request of the corporation as directors, officers, employees or
agents of another entity may receive advancement of expenses
from the corporation on such terms and conditions, if any, as the
corporation deems appropriate.
Section 145(e) previously had expressly authorized advancement

only to persons serving as directors, officers, employees, and
agents of the corporation itself, leading to some ambiguity as to the
source of the authority to provide advancement to persons serving
at the request of the corporation.
Can a Company Indemnify its

Officers for SOX Section 304
Clawback Liability
SOX Provision: Section 304 requires that a CEO or CFO of a
public company reimburse the company for any incentive
compensation received or stock sale profits recognized during
the 12-month period following the filing of a financial statement
that is subsequently required to be restated as a result of
misconduct (see handout).
In 8+ years since SOXs passage, Section 304 cases have been

relatively rare. Courts have determined that only the SEC may
bring Section 304 actions and the SEC brought cases under
Section 304 alleging that the CEO and CFO were personally
engaged in the misconduct alleged.

Clawback Liability continued
Whose misconduct is required? The issuer only, or must the
CEO/CFO be personally involved in the misconduct?
SECs Position: No-fault clawbacks are authorized by the
statute, and the only required misconduct that must be shown is
that of the issuer, acting through any of its directors, officers,
employees or agents. (See SEC v. Jenkins.)

Post-SOX, a common scenario company restates its financials, and

misconduct of the CEO/CFO or other senior management is or may be
present.
What should a company do? Seek reimbursement directly from the

officer or wait for the SEC to bring the action against the officer(s) to
compel the officer(s) to reimburse the company? Tough decision.
But can public companies indemnify an officer for the amounts that
must actually be repaid to the company as disgorgement?
NO U.S. Court of Appeals for the 2nd Circuit recently ruled, in a case
of first impression, that a company may not agree to indemnify its CEO
or CFO for any compensation or stock sale profits that the officers are
required to disgorge under Section 304. See Cohen v. Viray, 622 F. 2d
188 (2d Cir., Sept. 30, 2010).

DHB Industries, a body armor manufacturer, collapsed in late 2005

following revelations that it had used an inferior material to
manufacture its products.
August 2006 civil and criminal cases were filed against DHBs
former CFO and COO, alleging widespread accounting fraud at the
company in the years leading up to the collapse in its share value.
2007 DHB restated its annual financials for 2003, 2004 and 2005,
and soon afterward civil and criminal cases were filed against DHBs
former CEO David H. Brooks.

2007 Civil suit the SEC alleged that the former CEO had violated
various securities laws and demanded disgorgement from Brooks of
more than $186 million in stock sale proceeds and bonuses under
Section 304.
July 2008 Fed. Dist. Ct. overseeing the consolidated derivative

and class action suits against DHB, approved a settlement under
which DHB agreed to release and indemnify Brooks and DHBs
former CFO from any liabilities they might incur under Section 304
(see handout).
United States (DOJ and SEC) objected to the settlement on several

grounds, including that it undermined the SECs ability to hold
Brooks and the former CFO accountable under Section 304.

The 2nd Circuit rejected the settlement, ruling in the governments favor
that a company may not conduct an end-run around the statute,
by agreeing to indemnify a former CEO or CFO from potential Section
304 liability.
Second Circuit found that:
private parties may not sue to enforce Section 304 (consistent with other
courts)
since only the SEC can enforce Section 304, only the SEC should be
permitted to exempt a CEO or CFO from the section and the
indemnification agreement was effectively an attempt to settle Brooks
Section 304 liability (at $0).
Court noted that its holding is similar to case law interpreting Section
29(a) of the Exchange Act to void contractual attempts to indemnify
persons for Rule 10b-5 liability under the Exchange Act.

Any impact on the Dodd Frank Clawback provision? Unclear may

depend on whether the courts will imply a private right of action under new
Dodd Frank section.
Dodd Frank Provision: Effective July 22, 2010, Section 954 of Dodd Frank
added a new Section 10D to the Exchange Act requires that the national
securities exchange prohibit the listing of any companys securities where
the company has not developed and implemented a policy providing that :
in the event that the issuer is required to prepare an accounting restatement due
to the material noncompliance of the issuer with any financial reporting
requirement under the securities laws, the issuer will recover from any current or
former executive officer of the issuer who received incentive-based
compensation (including stock options awarded as compensation) during the 3year period preceding the date on which the issuer is required to prepare an
accounting restatement, based on the erroneous data, in excess of what would
have been paid to the executive officer under the accounting restatement.
Comparison of SOX and Dodd Frank provisions (see handout).
Determining Indemnifiable
Conduct
What is the conduct that triggers indemnification/advancement rights?
Common problem for companies management determines that the

corporate official seeking corporate funds for legal expenses has acted,
or may have acted, disloyally or even deliberately harmed the company.
Must an official always be advanced expenses? Very frequently, the

answer is YES, because contractual advancement typically is provided
under Delaware law granting corporations the power to indemnify and
advance litigation expenses to any person made a party to a proceeding
by reason of the fact that the person is or was a director, officer,
employee or agent of the corporation.
What does this phrase mean? A claim is by reason of corporate

service when the allegations challenge conduct by the proposed
indemnitee in his or her official corporate capacity.
Conduct continued
Official Capacity Doctrine Delaware courts have interpreted the 145

by reason of language broadly, requiring only a nexus or causal
connection between the officials corporate capacity and the matter for
which advancement or indemnification is sought.
The key question in determining whether a causal nexus linked the

underlying claims and corporate service is what capacity the official
was acting in when he or she engaged in what is alleged to have
been wrongful.
This determination is dispositive of an advancement request too

because officials, to be eligible for advancement, must establish that
they were acting in their capacity as an indemnification-eligible
position when undertaking the conduct underlying the allegations
against them.
Conduct continued
As long as the officials corporate powers were used or necessary for

the commission of the alleged misconduct, capacity-based challenges
to advancement and indemnification have typically been rejected even
when the underlying proceeding involves serious misconduct
actuated by personal greed.
Examples/Litigated Cases (a/k/a officers behaving badly)
Perconti v. Thornton Oil Corp. (C.A. No. 18630-NC, Del. Ch. May 3,
2002) the Court of Chancery held that a former CEO was entitled to
mandatory indemnification after criminal charges arising from his
embezzlement of corporate funds were dropped after a mistrial.
Conduct continued
Tafeen v. Homestore Inc., 888 A.2d 204 (Del. 2005) the Delaware Supreme
Court held that a broad advancement bylaw provision required advanced
payment of $3.9 million in legal expenses to a former officer (VP business
development and sales) whose alleged conduct had drawn a mountain of
litigation, including a criminal indictment, arising from the officers fraudulent
scheme to inflate the companys revenues, which generated $15 million in sales
of inflated stock.
Supreme Court stated: The broader salient benefits that the public policy
behind Section 145 seeks to accomplish for Delaware corporations will only be
achieved if the promissory terms of advancement contracts are enforced by
courts even when corporate officials, such as Tafeen, are accused of serious
misconduct.
Corollary to the Official Capacity Doctrine is the Personal Obligation Doctrine

No advancement if the alleged wrongdoing did not implicate the officials use of
corporate powers entrusted to him or her.
Conduct continued
See Cochran case (809 A.2d 555, Del. 2002).
When a corporate officer signs an employment contract

committing to fill an office, he is acting in a personal capacity in
an adversarial, arms-length transaction. To the extent that he
binds himself to certain obligations under that contract, he owes
a personal obligation to the corporation. When the corporation
brings a claim and proves its entitlement to relief because the
officer has breached his individual obligations, it is problematic
to conclude that the suit has been rendered an "official capacity"
suit subject to indemnification under DGCL 145 and
implementing bylaws. Such a conclusion would render the
officer's duty to perform his side of the contract in many respects
illusory.
Conduct continued
Weaver v. ZeniMax Media, Inc. (Del. Ch. 2004) Count I breach of

fiduciary duty for officers failure to properly manage R&D expenses
(advancement available) but in Count II the court rejected claims by
former officer for advancement of expenses related to claims by the
company that officer breached his employment agreement with the
company by taking excessive paid vacation time and his wrongful
receipt of corporate reimbursement for personal travel expenses.
But, the personal obligation doctrine has limits. See Paolino v. Mace
Security International, 985 A.2d 392 (Del. Ch. 2009).
Paolino, former Chairman/CEO was found to be entitled to

advancement for contractual, statutory and fiduciary counterclaims by
the corporation alleging that the CEO failed to discharge his oversight
and supervisory duties.
Conduct continued
Paolino served from 1999-2008 as Chair/CEO and had a 2006 employment

agreement with severance protections. In May 2008, CEO was terminated
for cause. Maces Bylaws provided broad right to mandatory advancement
for expenses incurred in defending any action, suit, or proceeding for which
indemnification might potentially be available.
Mace argued that the counterclaims did not arise by reason of the fact that
Paolino was serving as Chairman and CEO, but rather out of breaches of
his employment agreement.
Court found that when an employment agreement is at issue, Section 145

does not go out the window.
A claim for which the corporation seeks to avoid advancement must clearly
involve a specific and limited contractual obligation without any nexus or
causal connection to official duties.
Can Bylaws Contain Conditions

to Advancement Rights Provided
in the Certificate
Does Delaware law require that all of the terms regarding
advancement rights to which a person is entitled must be located
in one document?
In Xu Hong Bin v. Heckmann Corporation, 2010 Del. Ch. LEXIS 3
(Jan. 8, 2010), the Chancery Court assessed competing claims
of whether and when a corporations bylaws authorize the Board
to impose reasonable conditions prior to advancing legal fees
were consistent with or contrary to the right to advancement
contained in the Certificate of Incorporation.
Xu founded China Water, which was acquired by Heckmann
Corp. in 2008. Xu became a Heckmann director and received
cash and stock proceeds from the 2008 sale of China Water.

in the Certificate continued
The parties soon got into a dispute about the China Water business, its
poor performance and related escrow payments. In early 2009, they
negotiated and signed an agreement to resolve the dispute, which also
called for Xu to resign as a Heckmann director, for 13.03 million shares
of Heckmann being held in escrow to be sold back to Heckmann for $14
million, for the release of restrictions on the remaining 3.5 million
Heckmann shares to Xu and for Heckmann to pay Xu an additional $6
million in cash.
Heckmann paid the cash amounts but decided to cancel the remaining
3.5 million shares owed to Xu. Xu later filed suit, and Heckmann
counterclaimed, asserting (Count I) breaches of Xus fiduciary duties as
a Heckmann director, (Count II) breached of the settlement agreement
and (Count III) a conversion claim on the $ 6 million payment which was
allegedly fraudulently obtained.

Xu filed a separate suit in Delaware to enforce his advancement rights

with respect to the breach of fiduciary duty claims and the conversion
claim, under the provisions of Heckmanns Certificate. Xu sought
summary judgment that advancement of his expenses incurred in
defending Counts I and III of the Heckmann counterclaims. The
Chancery Court in a late 2009 opinion dismissed Count III with
prejudice.
Heckmanns Certificate and Bylaws each contained provisions related to

indemnification and advancement (see handout).
The Chancery Court found that Xu had succeeded on the merits of

Count III (success on the merits indemnification under 145(c)) and
was thus entitled to advancement of those expenses. As to Count I,
however, the Court denied Xus motion.

Xu argued that the Bylaw provision regarding terms and conditions

for advancement violated DGCL 109(b) (see handout).
Xu also made the same document argument.
Held: no violation of DGCL 109(b) in connection with the

provisions in the bylaws that allowed the board to impose
reasonable conditions on advancement, for two reasons.

First, because the Court determined that the bylaw provisions were
drafted and made effective contemporaneous with the provisions in
the charter regarding advancement rights and thus must be
reconciled as simultaneously enacted founding documents, if at all
possible.
Second, both documents were in effect when Xu began his service

as a director and he should have been aware of the
advancement provisions when he began his service as a director.
What are Reasonable Fees and

Costs in an Advancement Case
advance only those expenses that are actually and reasonably incurred
...
Scenario: former officer is entitled to advancement under corporate

Bylaws, and company agrees to advance expenses. Former officer
hires top firm to defend him in an SEC investigation, and defense team
begins to work. Legal fees mount quickly, and sure enough, STICKER
SHOCK. If the company refuses to pay invoiced amounts of counsel to
the former officer, or holds back a % of the billed fees and expenses,
what happens?
Answer: A lawsuit by the officer to enforce his advancement rights, and

if the parties cannot agree on the reasonableness of the fees/expenses,
often the appointment of a Special Master by the Chancery Court.
Example: Fuhlendorf v. Isilon Systems, Inc., C.A. No. 5772-VCN (Aug.

30, 2010).

continued
Facts: Isilon Systems, Inc., a Seattle based data storage computer

company acquired by EMC in late 2010.
Former CFO sought advancement in 4 separate civil actions and

related investigations. Isilon had signed an indemnification
agreement with the former CFO, providing him with advancement
rights.
SEC action involved 5 transactions recognized in the first three

quarters after Isilons Dec. 2006 IPO, which resulted in a
restatement by Isilon because of allegedly misstated revenues of
$4.8 million because of side agreements providing a right of
return or by so-called round trip arrangements.

continued
All fees and expenses were advanced for actions other than the
SEC investigation, except when Isilons enthusiasm waned
according to the Court. See 2010 Del. Ch. LEXIS 222 (Nov. 9,
2010).
Isilon held back a portion of the billed amounts (Jan. to Nov. 2010)
by Dorsey & Whitney, LLP, the CFOs counsel, in relation to the SEC
investigation, because the company and its counsel found that the
fees and expenses to be unreasonable and that D&W statements
vague and overly redacted.
By late 2010, the fees and expenses totaled $7 million, with a jury
trial scheduled for April 2011.

continued
Bills for 2010 totaled $6.096 million. Isilon agreed to pay 66%, or
$4.027 million, but held back 34%, or $2.068 million, because of its own
effort to impose cost controls on the CFOs counsel and disallowance of
vague or redacted time entries set forth is the D&W invoices.
Parties could not agree on the reasonableness of the fees and

expenses.
Chancery Court confirmed advancement in November 2010 and later

appointed a Special Master to resolve the dispute.
Feb. 8, 2011 Special Master, Lawrence Ashby of Ashby & Geddes

LLP, issues his final report to the Court.

continued
The Special Master explained:
Recognizing that delays inherent in any interim effort to resolve

reasonableness issues could readily defeat the advancement
right altogether, this Court in this and other cases has tried to
articulate a flexible right to advancement that still affords a
measure of interim protection against clearly unreasonable
advancement requests.
Master rejected Isilons request for discovery/depositions of the

tasks performed by D&W, but noted that D&W was engaged in a
very expansive litigation approach that reflects little concern for
costs or explanations.

continued
Master recommended that a 10% discount be applied to the $2.068

million amount in dispute, and applied the Duthie v. CorSolutions
Medical, Inc. (2008 Del. Ch. LEXIS 128) standard, as follows:
Advancement is not the proper stage for a detailed analytical review

of the fees, whether in terms of the strategy followed or the staffing
and time committed. Typically, a good faith certification form
counsel should suffice. In the absence of clear abuse, the fees
should be advanced.

continued
The Report offers a range of practical advice for Delaware

advancement cases/fee disputes, as follows:
the number of lawyers who can attend a deposition (generally, two if

actively defending or taking).
whether "working lunches" in one's office should be included as part of
the costs advanced (typically no, if you would not charge the client
otherwise)
paid travel time
billing of online research to the client
allocation of tasks (e.g., document reviews) to senior/junior attorneys
and/or paralegals
Conclusion Have Your Board

Make (and then revisit) the
Business Judgment
A number of Delaware decisions (2002+) have rejected efforts by

corporations that have promised mandatory advancement to disavow
those promises due to the alleged and in some cases admitted or
proven wrongful nature of the conduct for which advancement is
sought.
In his 2006 law review article Sinners Who Find Religion, 25 Texas.
Rev. Litig. 251, Stephen Fraidin of Weil, Gotshal & Manges LLP, the
author cautioned Delaware companies their directors, and legal
advisers that they need to understand that the often reflexive decision
to grant broad advancement rights to directors, officers, and employees
can have unintended consequences to the corporation (and its
shareholders) and to the directors who grant these rights.
e.g., Bergonzi v. Rite Aid Corp. (former CFO who pled guilty to criminal
fraud, but entitled to advancement after convictions and through criminal
appeals).

Business Judgment continued
How Does the Board perceive mandatory advancement after the
fact? Answer: Maddening
Like other business decisions, the decision to provide broad and
mandatory advancement rights should be made by the Board in
the deliberate exercise of its business judgment, BEFORE
adopting broad/mandatory charter, bylaw or agreement
provisions mandating advancement in all cases, and should
strike a proper balance.
Considerations to weigh (Pros and Cons) and Alternatives:

Business Judgment continued
Requiring a secured undertaking (and permitting Board waivers
in appropriate cases)
Distinguishing between direct suits by the corporation and
derivative suits by shareholders
Watch your Bylaw definition of officers (lots of vice presidents?)
No mandatory advancement at all, use a case by case basis
approach and weigh all relevant factors at the time of a
potential advancement
Indemnification Clauses
THANK YOU
Questions?
Follow-Up
H. Kennedy Hudner, 860.240.6029, khudner@murthalaw.com
Elizabeth J. Stewart, 203.772.7710, estewart@murthalaw.com
Richard S. Smith, Jr., 860.240.6053, rsmith@murthalaw.com
Edward B. Whittemore, 860.240.6075, ewhittemore@murthalaw.com

Indemnification Clauses: A Practical Look at Everyday Issues

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Indemnification Clauses: A Practical Look at Everyday Issues

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Indemnification Clauses

A Practical Look at Everyday Issues

General Reinsurance Corporation

Richard S. Smith, Jr.

Drafting Indemnifications with an Eye to Insurance

Indemnifications in Corporate Mergers and

Richard S. Smith, Jr.

Recent Developments in D&O Indemnification Issues

Education is what you get when you read the

If you think words dont have power, read an

You Take Charge

Your Client Wants the Sale

The Big Picture

Are you buyer or seller? Or both?

Giving an indemnification or receiving one?

Sale of goods? Services? Intellectual Property?

Sale to end user? Distributor? OEM?

What happens to your product downstream?

Off the shelf? Or custom product?

Your design? Made to Buyers specifications?

The Big Picture

Pay close attention to what is described as

Loss of Cokes product

Inability to package and ship

Loss of revenues ($250k/day). Damages for late

Coke offers its indemnification clause

Coke, its distributors and customers. Each may

First negotiation point narrow the indemnified

Dont indemnify non-parties. No contractual

Multiple levels of independent damages.

Any and all damages, losses, etc.

Includes (i) Cokes internal losses and (ii) 3rd-party

Also includes damages suffered by distributors and

Includes Cokes attorneys fees. Note this is more

What is the Trigger???

Seems reasonable, no?

Watch the Trigger Clause

Seller does not have to be in breach of contract.

Does not have to be negligent.

In fact, Seller does not have to be at fault!

Spell out witness costs

Can you accept risk of unlimited liability for breach

Know Your Risk Tolerance

You are stuck paying this amount even if your

Layered Approach to Limiting

Indemnify for personal injury or property damage caused solely

So, Will Your

Dollar cap at policy limits

#1 Seller shall indemnify and hold Buyer

But What If?

Insurance company might not pay.

Seller still obligated up to insurance limits.

Payment too uncertain.

Amount of payment also uncertain.

Interplay with Other

Or: This provision shall take precedence

Case Study #1: Loss of

Seller will pay $20,000 for first bad batch

$30,000 for second

$50,000 for third

$100,000 for any other

Case Study #2:

#1 Electronic board in printer assembly