This month we review an individual’s right to indemnification pursuant to the New York Business Corporation Law (“BCL”) for counsel fees incurred to defend a civil action or proceeding, other than a derivative suit.
In typical fashion, directors and officers are sued for conduct in the course of their duties as directors or officers of a corporation. Indemnification of expenses granted pursuant to, or provided by, the BCL is not to be deemed exclusive of any other rights to which a director or officer seeking indemnification may be entitled to, whether contained in the certificate of incorporation or the by-laws or, when authorized by such certificate of incorporation or by-laws, (i) a resolution of shareholders, (ii) a resolution of directors, or (iii) an agreement providing for such indemnification. N.Y. BCL § 721. However, no indemnification may be made to or on behalf of any director or officer if a judgment (or other final adjudication adverse to the director or officer) establishes that his acts were committed in bad faith or were the result of active and deliberate dishonesty and were material to the cause of action so adjudicated, or that he personally gained in fact a financial profit or other advantage to which he was not legally entitled. N.Y. BCL § 721.
Whether the Defendant is entitled to indemnification in defending such an action depends on the particular facts and circumstances of the case and whether those facts fit into the provisions of the BCL that allow for indemnification. In that regard, the indemnification statutes under the BCL fall into two categories: (1) those allowing for permissive indemnification by the corporation; and (2) those where a court will require mandatory indemnification. Under the permissive indemnification framework, a corporation may indemnify any person made a party to a civil action (other than one by or in the right of the corporation to procure a judgment in its favor [a derivative suit]) against judgments, fines, amounts paid in settlement and reasonable expenses, including attorneys’ fees, if such director or officer acted in good faith, for a purpose which he reasonably believed to be in the best interests of the corporation. N.Y. BCL § 722(a).
Permissive indemnification is allowed only if it is authorized by the corporation. N.Y. BCL § 723(b). Authorization under the BCL occurs: (1) by the board of directors acting by a quorum consisting of directors who are not parties to the action or proceeding, upon a finding that the director or officer to be indemnified has met the standard of conduct set forth in BCL § 722 (that the person has acted in good faith, for a purpose which he reasonably believed to be in the best interests of the corporation), or established pursuant to BCL § 721 [N.Y. BCL §§ 723(b)(1)]; or (2) if such a quorum is not obtainable or, even if obtainable, a quorum of disinterested directors so directs, by the board of directors upon the written opinion of independent legal counsel that indemnification is proper in the circumstances because the applicable standard of conduct has been met by such director or officer, or by the shareholders or members upon a similar finding [N.Y. BCL § 723(b)(2)].
If the corporation does not choose to indemnify the officer or director at its own volition (i.e., there is no permissive indemnification), a director or officer can still apply to the court for mandatory indemnification under BCL § 724. BCL § 723(a) mandates indemnification of a person who has been completely successful, on the merits or otherwise, in the defense of a civil or criminal action or proceeding. Pursuant to BCL § 724(a), notwithstanding the failure of a corporation to provide indemnification, and despite any contrary resolution of the board, indemnification shall be awarded by a court to the extent authorized by BCL sections 722 and 723(a). Note that the BCL statutes requiring a corporation to indemnify officers and directors who successfully defend non-derivative actions in which they are parties for both liability and litigation costs do not independently provide for the recovery of fees incurred by a corporate officer in obtaining indemnification. Baker v. Health Management Systems, Inc., 98 N.Y.2d 80 (2002). Consistent with BCL § 722(a) and § 723(a), the standard for indemnification under BCL § 724 is whether the officer or director acted in good faith, for a purpose believed to be in the best interests of the corporation.
However, counsel must keep in mind that notwithstanding anything in the BCL sections set forth above, the BCL provides that no indemnification, advancement, or allowance can be made in any circumstance where it appears: (1) that the indemnification would be inconsistent with the law of the jurisdiction of incorporation of a foreign corporation which prohibits or otherwise limits such indemnification; (2) that the indemnification would be inconsistent with a provision of the certificate of incorporation, a bylaw, a resolution of the board of directors or of the shareholders or members, or an agreement or other proper corporate action, in effect at the time of the accrual of the alleged cause of action asserted in the threatened or pending action or proceeding in which the expenses were incurred or other amounts were paid, which prohibits or otherwise limits indemnification; or (3) if there has been a settlement approved by the court, that the indemnification would be inconsistent with any condition with respect to indemnification expressly imposed by the court in approving the settlement. N.Y. BCL § 725(b).
Recently, the right of an officer and fifty-percent shareholder to indemnification was addressed in Tulino v. Tulino (Nassau County Index No. 7081/09). In Tulino, plaintiff Antonio Tulino entered into a written agreement to sell his 50% interest in Tulino Realty, in which the corporation’s main asset was a commercial building. Plaintiff’s brother (Defendant Michele Tulino), who owned the other 50% of Tulino Realty, refused to consent to the sale.
Plaintiff brought an action both individually and on behalf of the corporation seeking an order compelling defendant Michele Tulino, as president of Tulino Realty, to issue a stock certificate representing Plaintiff’s 50% interest in the corporation. In addition, Plaintiff alleged breach of fiduciary duty, and sought a declaratory judgment that Michele did not have a right of first refusal with regard to Antonio’s shares. In the amended answer, defendants Michele Tulino and Tulino Realty asserted various counterclaims against Antonio.
After the action was filed, Plaintiff cancelled the contract to sell the 50% interest in Tulino Realty. Thereafter, plaintiff voluntarily discontinued the claims asserted in the complaint without prejudice. However, the stipulation of voluntary discontinuance provided that the action was to continue as to defendants’ counterclaims.
Subsequently, defendant Michele Tulino moved for an order directing plaintiff Antonio Tulino and Tulino Realty to reimburse Michele for his attorneys fees incurred in defending the actions pursuant to § 724 of the BCL. The Court held that permissive indemnification was inapplicable because plaintiff Antonio, as a 50% shareholder, objected to the corporation’s reimbursement of defendant Michele’s legal fees. With regard to defendant’s right to mandatory indemnification, the Court found “plaintiff’s voluntary discontinuance without prejudice as a ‘settlement’ of the main action, rather than a ‘completely successful’ disposition in favor of the defendant.” Id., at 4. As such, the Court held that Michele was not entitled to indemnification pursuant to BCL § 723. Further, the Court held that there was no basis upon which the Court could determine that Michele’s actions were taken in the best interests of Tulino Realty, and thus it was not shown that defendant Michele Tulino was entitled to indemnification under BCL § 724.