Corporate & Securities Law

How to Protect Directors on Your Startup?s Board

By Ryan Roberts

Startups often desire to shield members of their board of directors from personal liability in connection with their duties on the board. And sometimes potential board members are hesitant to join a startup’s board without sufficient personal liability protection. Therefore, startups can protect their directors in a few ways:

(1) Indemnification

The startup can include language in both its charter and bylaws that indemnifies directors for expenses and losses incurred as a result of the director’s position. Indemnification is available only if permitted by the laws of the startup’s state of incorporation. Thus, language requiring the Company to indemnify its directors “to the fullest extent permitted by [State] law” is frequently incorporated into charters and bylaws.

(2) Indemnity Agreements

In addition to the indemnification provisions in the startup’s charter and bylaws, a startup may choose to sign a separate indemnity agreement with each member of the board of directors. Indemnity agreements will often contain terms that supplement the indemnification provisions found in the startup’s charters and bylaws. A board member may also desire this additional contract because the startup can’t change the indemnification contract terms without the director’s consent.

(3) Directors’ Insurance

A startup can purchase directors’ insurance (also known as a “D&O Policy”) to protect the directors. The D&O Policy doesn’t increase the directors’ personal liability protection. Rather, it helps to ensure that the director will be able to enjoy the indemnification benefits provided by the startup’s indemnification provisions and optional indemnification agreement. That is, the D&O policy’s proceeds will help supplement a startup’s likely lack the financial resources to sufficiently indemnify the directors.

But what if a director goes Patrick Bateman on my startup?

Keep in mind that the indemnity protections for directors (and the D&O policy) will include carve-outs for things like director intentional misconduct and bad faith. Thus, a director who commits intentional acts to harm the startup or acts strictly for his own personal enrichment would likely not be protected.

Full post as published by The Startup Lawyer on January 08, 2010 (boomark / email).