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Delaware Court Upholds Bylaw Amendment that Cuts Off Advancement Rights to Former Directors

By Harvard Law School Program on Corporate Governance

On March 28, the Delaware Court of Chancery issued a decision in Schoon v. Troy Corporation, upholding a board-approved bylaw amendment that cut-off advancement rights to a former director. I previously posted here on related litigation between the parties where the court held that directors do not have standing to bring derivative suits.

At issue this time was an amendment to the company?s advancement bylaw, which originally provided that ?the Corporation shall pay the expenses incurred by any present or former director.? After a director left the board but shortly before he became involved in litigation with the company, the existing board amended the bylaw to delete the reference to ?former? directors.

Once litigation began, the director claimed a vested right to mandatory advancement because the lawsuit related to his official capacity as a former director when the original bylaw was in place. As a result, the bylaw amendment arguably had no affect on his advancement rights. He relied on a prior Delaware decision, Salaman v. National Media Corp., 1992 WL 808095 (Del. Super. Oct. 8, 1992), holding that a board of directors cannot unilaterally terminate a former director?s right to advancement through a bylaw amendment while litigation is pending.

The Court of Chancery rejected the former director?s argument and upheld the bylaw amendment that denied him mandatory advancements. It reasoned that a director?s right to advancement becomes ?vested? when litigation is filed, not when the underlying conduct allegedly occurred. This holding may surprise some practitioners, given that the purpose of indemnification and advancement is to encourage board service and assure directors that their expenses relating to their official actions will be paid?even if litigation arises after they resign from the board. In addition, this holding was in spite of another bylaw provision providing that ?[t]he rights conferred by this Article shall continue as to a person who has ceased to be a director or officer and shall inure to the benefit of such person.? The court explained that this provision ?is better understood as providing that a director, whose right to advancement is triggered while in office, does not lose that right by ceasing to serve as a director? (emphasis added).

Decisions affecting directors? rights to advancement and indemnification are always significant. This decision, in particular, may have important implications for dissident directors and directors who are ousted in proxy contests. Both litigators and drafters should take note.

The opinion is available here.

Full post as published by The Harvard Law School Corporate Governance Blog on April 19, 2008 (boomark / email).