A guide for directors of subsidiary companies in the US. August 2011

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1 A guide for directors of subsidiary companies in the US August 2011

2 Welcome to our guide for directors and prospective directors of subsidiary companies in the US. While the duties of a subsidiary company s directors often coincide with the strategy and requirements of the parent company, this is not always the case. Depending on the jurisdiction or the circumstances, a subsidiary company s directors may need to act independently of the parent. The directors may also risk personal liability. Increasingly, for example, regulators and enforcement agencies around the world are taking a much tougher line on bribery, corruption and cartel abuses. So directors will wish to know the extent to which they can be protected against these risks, for example through being indemnified and/or insured. We hope you find this guide useful as an introduction to your role as director. Kind regards, Barry O Brien Co-chair Corporate governance client solutions group Andreas Fabritius Co-chair Corporate governance client solutions group Matthew Herman Head of US corporate practice, New York

3 Contents The regulatory framework for directors duties and corporate governance 2 What is the regulatory framework for unlisted/private corporations incorporated in Delaware? 2 General duties 3 Where do these duties come from and to whom do I owe them? 3 What are my general duties? 3 How to minimise the risk of breaching these duties the business judgement rule presumption 6 What are the consequences if I breach these duties? 7 Conflicts 8 What are my duties relating to conflicts? 8 What are the types of conflict that may need to be authorised? 8 Are only my interests taken into account? What about connected persons? 8 Am I expected to be aware of conflicts? 8 How does authorisation work? 9 What practical steps can I take to deal with conflicts? 9 The environment, health and safety and competition 10 What are my obligations towards the environment? 10 What are my obligations for health and safety? 10 What are my obligations concerning competition law? 10 Restricted transactions 12 Are there restrictions on particular transactions between me and the corporation? 12 What about the corporation giving me a loan? 12 Insolvency 13 To whom do I owe my duties in an insolvency situation? 13 Is there an equivalent offence to the UK offence of wrongful trading, ie of continuing to trade after insolvency is assured and so causing loss to creditors? 13 What practical steps can I take if my corporation s solvency is in question? 14 What if I sit on the board of two companies within the same group and one of those companies is in financial trouble? 14 Indemnification, insurance and ratification 16 What do I need protection from? 16 Is it possible for the corporation to indemnify me against liabilities? 16 Where should the indemnity be given? 17 What about insurance? 17 Is it possible for shareholders to ratify a breach of duty that I committed? 18 Recent developments 19 Increased Enforcement of the Foreign Corrupt Practices Act 19 Contacts For further information please contact Matthew Herman T E matthew.herman@freshfields.com This material is for general information only and is not intended to provide legal advice. Freshfields Bruckhaus Deringer LLP 2011

4 Note about this guide This client guide addresses the duties of directors of an unlisted subsidiary corporation incorporated in the State of Delaware in the US. Each US state has its own statutory and common law framework applicable to corporations incorporated in that state. This guide refers only to those laws applicable to Delaware corporations, the state commonly chosen for business entity formation. Please note that laws and regulations (including the US federal securities laws and corporate governance standards) applicable to publicly traded corporations and that are applicable in the context of a change of control transaction are not covered by this guide. Please also note that this guide does not cover laws and regulations of foreign jurisdictions that may be applicable to Delaware corporations. 1 Freshfields Bruckhaus Deringer LLP, August 2011

5 The regulatory framework for directors duties and corporate governance What is the regulatory framework for unlisted/private corporations incorporated in Delaware? Delaware General Corporation Law (the DGCL). The DGCL sets forth certain mandatory and default rules with which a corporation and its directors must comply. Common law. There is an extensive body of judicial authority in the State of Delaware regarding the nature and scope of directors duties and corporate governance. Constitutional documents. These comprise a Delaware corporation s certificate of incorporation and bylaws, which can modify default rules of the DGCL, among other things. 2 Freshfields Bruckhaus Deringer LLP, August 2011

6 General duties Where do these duties come from and to whom do I owe them? Under the DGCL, unless otherwise set forth in a corporation s certificate of incorporation, a corporation s business and affairs are managed by or under the direction of the board of directors. Management here means supervision, direction and control. Your and the other directors responsibility to manage the business and affairs of a corporation is subject to fiduciary duties prescribed in the judicial decisions of the courts of the State of Delaware. Those fiduciary duties are owed to the corporation and its stockholders as a whole, not to other group companies, individual stockholders or groups of stockholders. The rights of preferred stockholders are principally fixed by provisions in the corporation s constitutional documents and are narrowly construed against the preferred stockholders. Fiduciary duties are not owed to other constituencies, such as employees. The Insolvency section below addresses the rights owed to creditors in the context of insolvency. What are my general duties? In carrying out the responsibility of managing the corporation, at all times you owe fiduciary duties of care and loyalty. In addition, there are several identifiable duties that are applications of these two general fiduciary duties. Fiduciary duties Duty of care. This requires you to exercise the requisite degree of care on an informed basis when taking actions. Liability will arise for breach of the duty of care if you are found to have acted in a grossly negligent manner amounting to: reckless indifference to, or a deliberate disregard for, the whole body of stockholders; or taking actions that are outside the bounds of reason. It is implicit in any assessment of whether a director acted with due care that there was action. Consequently, an intentional failure to act will potentially give rise to a breach of your duty of loyalty (through the obligation to act in good faith, see below), rather than a claim for breach of the duty of care. Note, though, that a significant degree of deference is granted to directors under the business judgement rule presumption, which is considered below. 3 Freshfields Bruckhaus Deringer LLP, August 2011

7 Duty of loyalty. This requires you to make decisions based on the best interests of the corporation and its stockholders and refrain from transactions motivated by personal interest. In essence, the duty seeks to ensure that directors do not engage in self-dealing and that transactions are substantively fair to the corporation. Breaches of the duty of loyalty can arise as a result of a director being on both sides of a transaction (an interested transaction) or acting fraudulently or in bad faith. Transactions between the corporation and entities in which a director has an interest, misuse of corporate funds, usurpation of corporate opportunities, engaging in competition with the corporation or improper use of corporate property, including information, can be grounds for breach of loyalty claims. Specific applications Duty of good faith. This is a fundamental element of the duty of loyalty and you therefore have a duty to act in good faith. In this context, Delaware courts have recognised two categories of behaviour constituting bad faith: subjective bad faith, where a director is motivated by an actual intent to do harm; and intentional bad faith, where a director intentionally acts with a purpose other than advancing the interests of the corporation or intentionally fails to act in the face of a known duty to act or acts with intent to violate applicable positive law, demonstrating a conscious disregard for his duties. Duty of independence. The business judgement rule presumption is predicated on independence, meaning your decision making must not be dominated or tainted by a close personal or family relationship, and you must not be beholden to a controlling entity (for example, by virtue of a benefit flowing to you from that controlling entity). Directors are therefore said to have a duty to act independently and free from considerations or influences outside of what the board presents as the corporate merits of a subject. However, it is well-settled that being appointed to the board of directors by a controlling shareholder is not enough to establish a lack of independence. Equally, assertions of personal friendships, without more, do not credibly establish a lack of independence. Duty to protect corporate information. You are under an obligation to maintain the confidences of the corporation. Confidential information may be legitimately used as part of discussions among directors, but a corporation may bring a suit for breach of fiduciary duty if a director misuses his position by releasing information to unauthorised persons. 4 Freshfields Bruckhaus Deringer LLP, August 2011

8 Whether corporate information is confidential is a question of fact and protection of this information must be considered together with your duty of disclosure. Duty of disclosure. Without a specific request or recommendation for stockholder action, there is no general obligation to disclose to stockholders information about the corporation s business affairs. However, when directors seek or recommend stockholder action they have a duty to disclose all information that is material to the action of stockholders being requested or recommended. The standard of materiality under state law generally mirrors the rule applied in the US federal securities laws: an omitted fact is material if there is a substantial likelihood that a reasonable stockholder would consider it important in deciding how to vote. For communications among directors, the duty of disclosure will be triggered where a director is a party to an interested transaction, is aware of a fraud on the corporation or otherwise faces a conflict of interest. Where there is reason to believe that disclosure was made in bad faith, the duty of loyalty will be implicated. However, a misstatement or omission made as a result of good faith erroneous judgement would violate only the duty of care. Duty to monitor corporate operations. As well as your duty to make decisions, you have a duty to oversee the corporation s operations. The design of a business monitoring system is a matter of business judgement for a corporation s board of directors, but should function to ensure that appropriate information comes to the attention of the board in a timely manner as a matter of ordinary operations. A claim for breach of the duty of oversight (often referred to as a Caremark claim, after the landmark decision on the subject) implicates a breach of the duty of loyalty because of the need to demonstrate a director s failure to act in good faith. Such a claim will arise if there is either (i) an utter failure to implement any reporting, or information, system or controls or (ii) having implemented such a system or controls, there is a conscious failure to monitor or oversee the corporation s operations. In essence, liability arises where there is a conscious failure to do your job or you ignore red flags. This duty does not require you to monitor particular business risks and the possession of specific professional qualifications will not result in you being held to a greater standard. However, actual knowledge of facts suggesting a material problem gives rise to an obligation to initiate board or management action to address that problem. 5 Freshfields Bruckhaus Deringer LLP, August 2011

9 Corporate opportunity doctrine. Without a specific renunciation in the corporation s certificate of incorporation (see Conflicts below), you may not appropriate an opportunity belonging to the corporation without first offering it to the corporation. A breach by a director in this circumstance can give the corporation a legal basis for reclaiming the opportunity for itself. An opportunity will be considered as belonging to the corporation if the corporation is financially able to exploit the opportunity, the opportunity is within the corporation s line of business or the corporation has an interest or expectancy in the opportunity, and by taking the opportunity for your own, you will thereby be placed in a position in conflict with your duties to the corporation. You may therefore take an opportunity presented to you in your individual capacity, that is not essential to the corporation, in which the corporation holds neither expectancy nor interest and that you have not pursued or exploited with the corporation s resources. When evaluating an opportunity, including whether the corporation is financially able to exploit it, you are not required to consider the corporation s contingent and uncertain plans or speculate about the future, and any evaluation of whether an opportunity has been appropriated will be considered in light of the prevailing facts and circumstances. Whether an opportunity is in the corporation s line of business will turn on whether the opportunity is likely to generate income and whether the corporation has the fundamental knowledge, practical experience and ability to pursue it. Whether the corporation had an expectancy or interest in an opportunity will require a showing of some connection between the opportunity and the corporation s plans, purpose or business. How to minimise the risk of breaching these duties the business judgement rule presumption Delaware law applies a business judgement rule presumption under which a board decision will not be second-guessed by a court, even if it may appear unwise in retrospect or resulted in loss to the corporation, if: directors have no direct or indirect personal interest (ie directors are independent); the decision is made on an informed basis in light of all reasonably available material information after prudent consideration of alternatives; the decision is made in the good faith belief that it was in the best interests of the corporation; and the decision is made in furtherance of a rational corporate purpose. 6 Freshfields Bruckhaus Deringer LLP, August 2011

10 The burden of rebutting the business judgement rule presumption is placed on the party seeking to overturn or enjoin the conduct at issue or to impose liability on a director in respect of a decision. To ensure that decisions are shielded by the business judgement rule presumption, it is advisable to: avoid undue haste in decision making; review relevant materials before making any decision; ask questions about materials presented to the board by officers or experts; and ensure that a contemporaneous record of meetings exists for any important decisions. Note also that, in making decisions, the DGCL provides a statutory safe harbour from liability for reliance by directors on reports provided by officers and outside experts, provided that this reliance is in good faith, in the reasonable belief in the competence of the officer or expert and reasonable care was exercised in choosing the officer or expert. What are the consequences if I breach these duties? Delaware law permits derivative actions to be brought by stockholders, and in certain instances by creditors, in the name of the corporation to recover losses suffered by the corporation as a result of a breach of fiduciary duty. Assuming the inclusion of an exculpation provision in the corporation s certificate of incorporation, or a suitably drafted indemnification agreement (see indemnification section below), personal liability will not arise for actions amounting to a breach of the duty of care. However, such a provision has no impact on the availability of equitable remedies and an injunction, or rescission, may therefore be imposed despite the existence of an exculpation provision. Liability for breaches of the duty of loyalty cannot be shielded in the same way, so breach of the duty of loyalty may result in: personal liability to compensate the corporation for a loss caused by the breach; personal liability to restore corporation property; personal liability to account for profits made or received; and rescission of a contract entered into in the face of a conflict of interest. 7 Freshfields Bruckhaus Deringer LLP, August 2011

11 Conflicts What are my duties relating to conflicts? As a director of a Delaware corporation, you owe a duty of loyalty to the corporation that prohibits you from standing on both sides of a transaction and from deriving a personal benefit through self-dealing. What are the types of conflict that may need to be authorised? To avoid a decision being invalid solely because of your participation in it when you have an interest in the subject matter, all direct and indirect conflicts must be fully disclosed and approved by disinterested directors or stockholders. However, such approval and disclosure do not provide immunity from judicial scrutiny if a transaction is unfair to the corporation. The following represents a non-exhaustive list of circumstances that should be fully disclosed to, and approved by, disinterested directors or stockholders to avoid per se invalidity: being appointed as director of another corporate entity; the acquisition of shares in a competing corporation or a corporation that is an actual, or potential, customer of, or supplier to, the corporation; buying assets (eg real estate) potentially of value to your corporation that could affect, or be affected by, your corporation s activities; being appointed to an advisory role (eg financial, accountancy, legal or consultancy) with respect to the corporation or having an interest in, or relationship with, an advisory firm appointed by the corporation; being appointed to any management position in respect of your corporation s pension scheme; buying assets from or selling assets to the corporation; taking up an opportunity that may be of interest to the corporation, even if the corporation has previously declined the opportunity; or being offered anything of value (eg a management role) by a potential buyer of the corporation. Are only my interests taken into account? What about connected persons? Connected persons are relevant to evaluating whether you face a conflict of interest. Transactions between the corporation and your family member, your business partner, or another corporation on whose board you serve may give rise to a conflict of interest. Am I expected to be aware of conflicts? Yes. To satisfy your fiduciary duty of loyalty to make decisions in the best interests of the corporation, you should be aware of any conflicts that you face. 8 Freshfields Bruckhaus Deringer LLP, August 2011

12 How does authorisation work? Section 144 of the DGCL provides a safe harbour, such that no transaction between you and the corporation, or between the corporation and any other entity of which you are a director or officer or in which you have a financial interest, shall be void or voidable solely for that reason, or solely because you participate in the meeting of the board authorising the relevant contract or transaction, if: you fully disclose the material facts of the conflict of interest to the board of directors, or a committee of the board, and a majority of disinterested directors authorises the transaction in good faith; you fully disclose the material facts of the conflict of interest to the stockholders and a majority of the stockholders approves the transaction in good faith; or the contract or transaction is fair to the corporation at the time it is authorised, approved or ratified by the board of directors, a committee or the shareholders. Note, however, that following this procedure does not sanction an otherwise unfair transaction. See also ratification section below. What practical steps can I take to deal with conflicts? Always disclose to the board of directors all material details relating to an actual or potential conflict (or circumstances that could reasonably give rise to the appearance of a conflict) so that the disinterested directors are able to make an informed decision after careful consideration of all available information. Where there is a conflict or potential conflict, seek advice as to how best to ensure the fairness of the transaction as a whole. This may require you to abstain from taking part in any board decision on the transaction or that a special committee of disinterested members of the board is formed to insulate the decision-making process regarding the interested transaction from being tainted by your conflict. Special negotiating committees provide strong evidence of the fairness of a transaction, provided that the committee is authorised to, and does, operate independently without influence or domination by a third party, and with the ability to refuse to enter into the interested transaction. If corporate opportunities are regularly likely to present conflicts, it is possible for the corporation to renounce in its certificate of incorporation, or by action of the board of directors, any interest or expectancy in specific business opportunities or categories of opportunities. In certain circumstances, for example where you simultaneously owe fiduciary duties to the corporation and another entity, resigning from the corporation s board may be necessary because it will not be possible to discharge those duties, although this course of action should only be taken after receiving independent legal advice. 9 Freshfields Bruckhaus Deringer LLP, August 2011

13 The environment, health and safety and competition What are my obligations towards the environment? In addition to the duties described above, US states and the federal government have enacted legislation regulating air quality, water quality and the handling of hazardous materials. The most notable US federal statutes are the Comprehensive Environmental Response, Compensation and Liability Act and the Resource Conservation and Recovery Act. Liability may be directly imposed on a director for violations of these statutes or under a theory of agency by virtue of the acts of others. Civil enforcement actions are common, but criminal sanctions cannot be ruled out. What are my obligations for health and safety? Directors do not have any obligations for health and safety that are independent from their general duties as a director of a Delaware corporation (which are described in the General duties section above). In other words, only if a director is acting as an employer (ie directing employment actions outside the corporate structure) and has knowledge of a safety issue and fails to exercise the general duty of care can there be liability. What are my obligations concerning competition law? Directors of a corporation (just like its employees) may be held liable personally for violating certain provisions of the US antitrust laws. In particular, an individual may be held liable personally for engaging in cartel behaviour, ie entering into an agreement to fix prices, rig bids, limit output or allocate markets. A violation can occur whether or not the agreement is implemented; the agreement itself constitutes a violation. A violation can also occur whether or not the agreement is written or otherwise formalised: a meeting of the minds is enough and can be charged based on circumstantial evidence. As a director of a corporation, you may be liable for participating directly or indirectly in an illegal agreement. You may be deemed to have participated directly if you personally enter into an illegal agreement with a competitor. In addition, as a director with authority to manage and direct the affairs of a corporation you also may be deemed to have participated indirectly if you support, facilitate or further such conduct on the part of others. In either case, both you and the corporation may be deemed liable and penalised. 10 Freshfields Bruckhaus Deringer LLP, August 2011

14 The statutory maximum penalty to which an individual can be sentenced for such violations is 10 years imprisonment and $1m. Additionally, the corporation may be fined up to $100m. However, under an alternative sentencing provision allowing a fine to be imposed of up to twice the gain or loss resulting from a violation, companies have been fined up to $500m for engaging in cartel behaviour. Violating the antitrust laws also may result in the initiation by private plaintiffs of suits seeking treble damages for injuries sustained as a result of the illegal conduct. Furthermore, a corporation can be subject to debarment, ie disqualification from government contracts. 11 Freshfields Bruckhaus Deringer LLP, August 2011

15 Restricted transactions Are there restrictions on particular transactions between me and the corporation? See Conflicts above. What about the corporation giving me a loan? Your corporation may give you a loan whenever, in the directors judgement, that loan may reasonably be expected to benefit the corporation. The loan may be without interest, and may be secured or unsecured in such manner as the board shall approve. We note in passing that this is an area where there is a key distinction between private/ unlisted Delaware corporations and publicly traded corporations, the latter of which are subject to restrictions regarding corporate loans to directors and officers under the US federal securities laws. 12 Freshfields Bruckhaus Deringer LLP, August 2011

16 Insolvency To whom do I owe my duties in an insolvency situation? Under Delaware law, a corporation is considered to be insolvent when either it is unable to pay its debts as they become due in the ordinary course of business or its liabilities exceed the value of its assets. On insolvency, the constituencies to whom duties are owed are expanded to include creditors. Consequently, on insolvency, your fiduciary duties may require you to take actions in the interests of stockholders and creditors that can present a potential conflict, because actions benefiting creditors may not maximise the value of stockholders interests. In these circumstances, it is advisable to take the course of action that best serves the entire corporate enterprise rather than any single group interested in the corporation. Delaware case law suggests that before a corporation s likely insolvency (often referred to as the zone of insolvency ) directors must continue to discharge their fiduciary duties to the corporation and its stockholders by exercising their business judgement in the best interests of the corporation for the benefit of its stockholder owners. In the zone of insolvency, creditors have no standing to start a derivative claim against a corporation s directors. However, to determine the point at which insolvency occurs is difficult and will be determined by a court with the benefit of hindsight. Accordingly, it is advisable to be alert to the interests of creditors if a corporation is in a zone of insolvency. In addition, a failure to be suitably informed so as to know to whom fiduciary duties are owed may itself be grounds for a breach of fiduciary duty. The duties that are owed are the same as those ordinarily owed to the corporation and its shareholders as a whole. Note that filing a Chapter 11 proceeding under the Federal Bankruptcy Code to plan a reorganisation transforms the role of a corporation s board of directors and is beyond the scope of this guide. Is there an equivalent offence to the UK offence of wrongful trading, ie of continuing to trade after insolvency is assured and so causing loss to creditors? There is no equivalent offence under Delaware law. It is settled Delaware law that when a corporation is insolvent the board of directors may pursue, in good faith, strategies to maximise the value of the firm, which permits the continued operation of the firm, including adopting good faith business decisions to incur additional liabilities. Therefore, the business judgement rule continues to protect your ability to make good faith, informed, prudent judgements about the risks that should be undertaken on behalf of the corporation. 13 Freshfields Bruckhaus Deringer LLP, August 2011

17 In addition, the Delaware courts have dismissed the theory of deepening insolvency, by taking actions that are detrimental to creditors, as an independent cause of action. However, the consequences of taking such actions cannot be entirely ignored as there is authority that damages for breach of fiduciary duty could be determined by reference to the theory of deepening insolvency. What practical steps can I take if my corporation s solvency is in question? The most advisable course of action if the corporation is nearing insolvency would be to focus on protecting the value of the corporation (including, to the extent possible, relationships with employees and trading partners) and to be informed of the financial circumstances of the corporation so as to know to whom duties are owed. Directors should, of course, be aware of the risk of breaching any contractual covenants (for example in loan documentation) with financial and trade creditors. Given the risk that transactions will be unwound after entering insolvency as having been fraudulent transfers (ie transactions that defrauded creditors), directors should be aware of risk taking in fulfilling their duty to protect the value of the corporation and so should act cautiously on an informed basis following thorough diligence with detailed documentation of any deliberations. What if I sit on the board of two companies within the same group and one of those companies is in financial trouble? This may present very difficult conflict of interest issues (see Conflicts above). In this situation, you must take additional care that you are not running afoul of your duties as a director, particularly the duty of loyalty, and you must be aware of to whom duties are owed. Importantly, you should take independent legal advice and monitor the decision-making process at every stage in light of that advice. The following practical guidance may be of assistance: review the financial position of the financially troubled corporation before taking action that may adversely affect its stockholders or creditors, and seek to avoid impairment of assets that may otherwise be available to creditors; ensure that all procedural steps are followed to make decisions on an informed basis after thorough consideration of all available material information, in good faith and for a rational corporate purpose; 14 Freshfields Bruckhaus Deringer LLP, August 2011

18 if a board is to discuss issues relevant to another group corporation that are not to be disclosed to that corporation, it should consider excluding a director who is on the board of both companies from those discussions, or the director in question should ask to be excluded. This should be recorded in the minutes so that there is a proper record should this ever become an issue; and both boards should check that they have adequate directors and officers (D&O) insurance (see insurance section below). In this context, directors often consider providing credit support to the financially troubled company from elsewhere in the group. Any such transaction should be examined closely for, among other things, the risk of piercing the corporate veil. 15 Freshfields Bruckhaus Deringer LLP, August 2011

19 Indemnification, insurance and ratification What do I need protection from? You need protection from the costs of criminal, civil or administrative actions or investigations in which you are named as a result of your position as a director. Under Delaware law, a corporation may include in its certificate of incorporation a provision limiting or eliminating your personal liability to the corporation or stockholders for breaches of your fiduciary duty of care. Is it possible for the corporation to indemnify me against liabilities? Under Delaware law, statutory and contractual indemnification of directors is available in respect of third-party actions and actions brought by the corporation. The availability of statutory indemnification is subject to determination by a majority of disinterested directors, a committee of the board, or independent legal counsel (each an appropriate decision maker ) and also to the following prerequisites: being sued because you are a director of the corporation, albeit this standard is interpreted broadly in favour of indemnification; having acted in good faith in a manner you reasonably believed to be in, or not opposed to, the best interests of the corporation (this involves a subjective test that would be met if there was a mistake in judgement, even if the challenged decision was unwise by objective standards); having acted in a manner that you reasonably believed was in, or not opposed to, the best interests of the corporation (essentially another aspect of examining the bona fides of director action as being genuinely motivated by the best interests of the corporate enterprise rather than the director s own interest); and in respect of criminal actions, having had no reasonable cause to believe that your conduct was unlawful. For these purposes, good faith is assessed by reference to the fiduciary duty of loyalty and so grossly negligent conduct amounting to a breach of the duty of care can fall within the scope of statutory indemnification, whereas breach of the duty of loyalty will not be indemnifiable. In a proceeding brought by the corporation itself, or derivatively by a stockholder, statutory indemnification is only available for expenses actually and reasonably incurred in defending or settling the proceeding. 16 Freshfields Bruckhaus Deringer LLP, August 2011

20 In third-party claims, including criminal prosecutions and private litigation, statutory indemnification is available in respect of judgments, fines and amounts paid in settlement, in addition to any expenses incurred. Since determination of the availability of indemnification by an appropriate decision maker can be the basis for disputes in the event of, for example, insolvency or change of control, indemnification is commonly provided for through a bylaw provision or separate indemnification agreement contemplating: mandatory indemnification except to the extent prohibited by law; mandatory advancement of expenses on demand (subject to an undertaking to repay on determination of no entitlement to indemnification); funding mechanisms, such as a trust or letter of credit, to ensure funds are available if a director has a right to be indemnified; and the right to claim expenses for prosecuting a claim for indemnification and the right to start action against a corporation for failure to discharge an indemnification obligation within a specified period of time. Where should the indemnity be given? As noted above, under Delaware law directors may be indemnified irrespective of whether a provision is included in a corporation s charter documents or elsewhere. Since statutory indemnification is non-exclusive, indemnification provisions may be included in a corporation s bylaws, although it is common to secure inclusion of an indemnification provision in a separate contract with the corporation so that the protection cannot be amended without the director s consent. What about insurance? A corporation can take out insurance (commonly known as D&O insurance) to offer protection where indemnification is unavailable (eg for failure to establish one of the prerequisites detailed above), providing funds where a corporation is unwilling (eg following a change of control), or unable (eg following insolvency), to provide indemnification and reimbursing the corporation for amounts paid in respect of its contractual indemnification obligations. Most D&O insurance policies provide protection only for so long as the policy remains in effect (referred to as claims-made policies). D&O insurance will also customarily include a series of exclusions 17 Freshfields Bruckhaus Deringer LLP, August 2011

21 from coverage, including fraud or deliberate dishonesty, liability for environmental pollution and illegal payments. Is it possible for shareholders to ratify a breach of duty that I committed? The legal effect of stockholder ratification is complex and fact specific. Ratification will not necessarily extinguish a claim for breach of duty, but may only shift the burden of proof onto a plaintiff by granting you the benefit of the business judgement rule presumption. In addition, ratification is limited to circumstances in which your actions do not require stockholder approval to become legally effective and is only available in respect of actions that stockholders are specifically asked to approve. Stockholder ratification cannot validate acts that are void for being contrary to public policy. Other acts deemed to be void because the board or corporation has no implicit or explicit authority to undertake them may be ratified by fully informed unanimous stockholder approval. Voidable acts performed in the corporation s best interests but beyond the board of director s explicit authority may be ratified by the approval of a majority of disinterested stockholders fully informed of the consequences of their vote. 18 Freshfields Bruckhaus Deringer LLP, August 2011

22 Recent developments Increased enforcement of the Foreign Corrupt Practices Act As a director of a US-based subsidiary of a non-us group, the Foreign Corrupt Practices Act (the FCPA) may be important to you. A US subsidiary of a non-us entity, and such subsidiary s officers, directors and employees, are required to comply with the FCPA s anti-bribery provisions. In addition, if you are a US national, you are required to comply with these provisions, wherever in the world you may be located. Furthermore, under the broad approach taken by the US government, even a non-us entity and its non-us personnel could be caught by the FCPA anti-bribery provisions, to the extent that any such person takes action within the US, or with any person in the US, on any prohibited offer, payment, promise or gift. The FCPA anti-bribery provisions prohibit any offer, payment or promise of anything of value made corruptly directly, or through one or more intermediaries, to (i) any foreign official (defined to include any official, functionary or employee of a non-us government, state-owned enterprise or public international organisation) or (ii) any non-us political party or candidate with the intention of influencing their acts or decisions, or inducing them to exercise their influence with a non-us government, or to assist in obtaining or retaining business, directing business to any other person or securing any improper advantage. Each of the elements above is broad in scope and some key terms (such as foreign official ) are interpreted more broadly than a first reading may suggest. The application of the FCPA to any officer, director, employee, agent or stockholder of a US entity or a non-us entity with registered US securities is frequently overlooked. Non-US persons acting outside the US have been subject to FCPA enforcement solely on the basis of being employed by such entity. In fact, the number of individual prosecutions under the FCPA has increased materially in recent years. In light of the increasingly vigilant approach to enforcement of the FCPA, companies should consider the steps they have taken with respect to FCPA compliance. 19 Freshfields Bruckhaus Deringer LLP, August 2011

23 Freshfields Bruckhaus Deringer LLP is a limited liability partnership registered in England and Wales with registered number OC It is regulated by the Solicitors Regulation Authority. For regulatory information please refer to Any reference to a partner means a member, or a consultant or employee with equivalent standing and qualifications, of Freshfields Bruckhaus Deringer LLP or any of its affiliated firms or entities. Freshfields Bruckhaus Deringer LLP 2011 August