While pursuing the upside of a growth stage company, it’s easy to forget to hedge against downside risks. Corporate officers and directors can face immense financial liabilities if sued in connection with their service to the corporate entity. With this in mind, the prudent officer/ director will ensure entitlement to indemnification for legal expenses AND advancement of funds to cover their defense.
What is Indemnification? Advancement?
So, what exactly is advancement and how is that different from Indemnification? Although the terms are often used interchangeably, there is a difference. Indemnification refers to the ultimate obligation of the corporate entity to pay, among other things, the legal costs of a proceeding involving a director/officer. Advancement is the obligation of the corporate entity to pay those costs as they are incurred.
Whether or not you are entitled to indemnification or advancement is governed by state law. In Delaware, for instance, corporate entities have great flexibility in their ability to indemnify officers. While there are some mandatory indemnification obligations by statute, most authority is permissive, which means it has to be drafted into documents in order to apply. Officers and directors who have not ensured adequate indemnification AND advancement rights have been created might find themselves depleting their own personal savings to pay for the costs of litigation. Worse yet, if those individuals don’t have adequate funds to defend themselves, they might not be able to defend themselves at all. Knowing these risks, the next question is what potential officers and directors should do to ensure that personal assets are protected from litigation costs associated with the duties performed in their corporate capacity. [Read more…]