Promises Made, Promises Enforced: D&O Advancement Rights Vindicated Again (This Time in Ohio)

| Andrew N. Goldfarb

2018.06.26_Business Man Writing

This post deals with two related protections that state laws and companies provide for directors and officers—indemnification and advancement. Corporations usually commit to indemnify officers and directors (and sometimes employees) when, because of their connection to the company, they are pulled into legal proceedings. Corporation also usually agree to advancement - paying legal fees and costs in advance of a final determination about the individual’s right to indemnification - so that officers and directors don’t have to foot the legal bills themselves while such a matter is going on. 

State laws typically provide a baseline level of protection for executives and directors, and companies can either expand or narrow that protection in their corporate documents and employment agreements. (Given that Delaware is a leading hub for corporate activity, it is not surprising that many of the leading decisions on advancement and indemnification were issued by Delaware courts applying Delaware law.)

Of course, when a director is accused of wrongdoing—especially when the company itself is the accuser—the prospect of paying the defendant’s legal fees suddenly becomes far less appealing. Companies often try to find ways to evade their advancement obligations. But they rarely succeed.

A recent decision issued not from Delaware, but from the Ohio Court of Appeals, is one such example. In Magnus International Group, Inc. v. Forster, 2018 WL 2937871, the Ohio court reversed the trial court’s denial of the defendant’s motion for advancement. Forster was a 50% co-owner and director of a privately owned company that manufactured animal food ingredients. His co-owner, in the name of the company, sued Forster for converting corporate checks and misappropriating substantial corporate funds for his personal benefit. Indeed, Forster admitted he had endorsed company checks, claiming that he was doing so to even things up with amounts withdrawn from the company by his co-owner. 

Forster moved for advancement under Ohio law (R.C. 1701.13(E)(5)(a)), which mandates advancement for a director unless the company expressly disclaims it in its corporate documents. To secure advancement, the director must provide an undertaking promising:

  1. to repay advanced amounts if it is proved “clear and convincing evidence” that the director acted “with deliberate intent to cause injury to the corporation” or “with reckless disregard for the best interests of the corporation;” and
  2. to reasonably cooperate with the corporation concerning the action, suit, or proceeding. 

There was no dispute that the company had not explicitly disclaimed its obligations to mandatory advancement, or that Forster had given the required undertaking. But the trial court denied the motion, finding that because the suit was brought against Forster by the company itself, he was not entitled to advancement. The trial court based its decision on the section of Ohio law stating that a corporation may indemnify a director (and others) who is a party to a legal proceeding by reason of the fact that the person was a director, “other than an action by or in the right of the corporation.”

But the Court of Appeals correctly reversed that decision. The Court reiterated the distinction between advancement and indemnification. Since advancement must be decided before the company knows whether the director will be entitled to indemnification, the company cannot require the director to also meet all of the standards for indemnification before granting advancement. Forster met the requirements for mandatory advancement, but the trial court had wrongly relied upon a separate provision of the law dealing with indemnification. The Court of Appeals relied on a decision of the Ohio Supreme Court, Miller v. Miller, 973 N.E.2d 228 (Ohio 2012). The Forster court noted that a dissenter in Miller had called upon the Ohio legislature to change the law so that a company suing its director would not have to provide advancement, but that no such legislative change had occurred. 

Advancement and indemnification are benefits that corporations understand are important to attract talented people to corporate service. As the Magnus court and Delaware courts have so often instructed, companies should expect to be held to their promise to provide those benefits, even when it is the company accusing the director or officer of wrongdoing.