By agreeing to serve on the board of a corporation, directors expose themselves to potential legal troubles and, in particular, claims from shareholders or third parties. For that reason, corporations typically agree to indemnify their directors against these losses and agree to pay the legal fees and costs associated with certain lawsuits as a result of the director’s service on the board. In Ohio, there is an additional statutory protection that encourages highly skilled individuals to serve on corporate boards. Under Ohio Revised Code 1701.13(E)(5)(a), a corporation is required to advance the costs and expenses of a lawsuit to a director who is involved in the lawsuit as a result of his service. The Ohio Supreme Court recently analyzed this statute in, Miller et al. v. Miller, 2012-Ohio-2928.
In this case, director Sam M. Miller was sued by two other directors of Trumball Industries, Inc. for allegedly violating his fiduciary duties to the shareholders and the corporation. Mr. Miller subsequently notified these two directors that he had reimbursed himself with corporate funds for his legal fees and expenses associated with the case. As required by the Revised Code, 1701.13(E)(5)(a), Mr. Miller presented the corporation with an “undertaking”. In this ‘undertaking”, Mr. Miller agreed to (1) repay the corporation the advancement amount if his acts or omissions were found to deliberately or recklessly injure the corporation and (2) reasonably cooperate with the corporation regarding the lawsuit. Both the complaining directors and Mr. Miller then filed motions to determine whether Mr. Miller was entitled to advancement of the funds. The trial court found in favor of Mr. Miller, but the appellate court determined that Mr. Miller was not entitled to advancement.
The Ohio Supreme Court overturned the appellate court. The Supreme Court held that a corporation is required to advance expenses to a director upon receipt of an undertaking pursuant to R.C. 1701.13(E)(5)(a), unless the corporation has specifically opted out of this requirement in its articles or regulations. The Supreme Court also held that a corporation cannot avoid its duty to advance expenses simply by claiming that the director’s alleged misconduct would not entitle him to indemnification. In reaching these conclusions, the Supreme Court distinguished between advancement and indemnification. In contrast to indemnification, advancement is either granted or denied while the underlying action is ongoing. It is not automatic, but arises upon the receipt of an undertaking. Advancement is not dependent on the potential for indemnification; it is a statutory requirement that mandates the advancement of funds. The only way for a corporation to avoid the requirement of advancement is to specifically state in its articles of incorporation or regulations that this statute does not apply to the corporation.
This ruling has three important implications for both corporations and directors. First, the only way that a corporation may escape advancement is by specifically stating that R.C. 1701.13(E)(5)(a) does not apply to it in either its Articles of Incorporation or its Code of Regulations. Second, advancement is distinct from indemnification, which is the right to be reimbursed for any amounts the director is ultimately required to pay the complaining parties, and is not dependent on a future right to indemnification. It is mandatory under R.C. 1701.13(E)(5)(a). Third, advancement is not automatic; the obligation arises only upon the receipt of a signed undertaking.
If you have any further questions or concerns regarding advancement or indemnification issues pertaining to your business entity, or wish a review of your corporate documents, please do not hesitate to contact one of our Corporate & General Business or Commercial Litigation attorneys.