JUNE 2011

 

            Officers and directors of corporations, as well as managers and other representatives of business entities such as limited liability companies, may be individually named as parties to litigation in a number of situations, ranging from securities law claims to claims for breach of fiduciary duty to routine business disputes. In addition to facing a potential judgment at the end of the case, individuals who have been sued will need to obtain legal counsel, and often cannot be represented by the same counsel that represents the entity itself. Corporations and their directors and officers should therefore be aware of the various ways in which directors and officers can sometimes be shielded from liability and defense costs. 

 

            State corporate laws usually provide that a corporation may indemnify its officers and directors with regard to certain actions they take or omit to take in their capacity as officers and directors. Such indemnification, if available, may cover both any liability in the litigation, in the form of a judgment or settlement, and legal defense costs such as attorneys’ fees. Indemnification is unavailable under the laws of most jurisdictions where it is ultimately determined that the officer or director knowingly acted disloyally toward the corporation or committed a criminal act. In addition, many corporation statutes authorize a corporation to pay officers’ and directors’ expenses incurred in litigation on an ongoing basis, before the litigation is concluded, provided that the officer or director undertakes to repay the amount advanced if it is determined that he or she was not entitled to indemnification. 

 

            Significantly, however, under the laws of most jurisdictions (including New York and Delaware), the protections of indemnification and advancement are not necessarily automatic, but should be addressed in the corporation’s Certificate or Articles of Incorporation, By-laws, other appropriate corporate documentation, or by contract. Because the relevant statutes and case law in this area have evolved over time, we recommend that all corporations and other business entities review their governing documents and ensure that they provide the appropriate level of protection – before rather than after officials of the corporation are named as defendants in a lawsuit.

 

            In addition, many corporation statutes, including those of New York and Delaware, provide that a corporation may include in its Certificate or Articles of Incorporation a provision exculpating directors and officers from liability for any acts or omissions in the course of their work for the corporation, except for certain excluded claims such as intentional breach of their duty of loyalty. If a company does not currently have such a provision, the shareholders may vote to amend the corporate documents to include it.

 

            In addition to these protections, there is an active market for the sale of directors’ and officers’ liability insurance. This is insurance purchased by the corporation for the payment of liabilities that could be the subject of indemnification by the corporation. Most companies would be well-advised to purchase such insurance. The insurance may not, as a matter of law, cover liability for, among other things, fraud or deliberately dishonest conduct. If the company has purchased such insurance, it should be reviewed periodically to make sure that the coverage remains sufficient for the company’s needs. If you have any questions about the adequacy of your company’s indemnification provisions or D&O coverage, we would be pleased to have the opportunity to assist you.

 

 

            Both state and federal courts recognize the obligation of parties to pending litigation, or parties who are aware that litigation is reasonably anticipated, to preserve documents and electronically stored information that may be relevant to the litigation. Accordingly, whenever litigation is pending or reasonably anticipated, it is imperative that companies and individuals discuss this issue with counsel having experience in this area. The obligation to preserve documents and electronically stored information will require steps such as suspending document destruction policies that might otherwise apply and suspending routine information technology practices such as the automatic overwriting of e-mails or back-up tapes.

 

            Ganfer & Shore, LLP has substantial expertise in this area and would be pleased to assist you in formulating appropriate document retention and destruction policies that contemplate the possibility of litigation from time to time, as well as interacting with companies’ in-house counsel or IT professionals to ensure that applicable preservation obligations are complied with.

 

 

            A recent New York court decision addresses the application of the attorney-client privilege in an insurance coverage dispute. In Ferreira v. Capitol Specialty Ins. Corp., 31 Misc. 3d 1209(A), 2011 WL 1364459 (Sup. Ct. Kings Co. Apr. 6, 2011), the plaintiff sought disclosure of the defendant insurer’s underwriting file. She also subpoenaed an attorney who had been involved in the case to produce documents and testify regarding his work on the case and the insurer’s disclaimer of coverage. The issue was whether the attorney-client privilege applies where an attorney was initially retained for an insured by an insurance carrier, but the carrier later disclaims coverage. 

 

            The court noted that attorney-client privilege belongs to, and may only be waived by, the insured. Even where counsel is initially retained for an insured by the carrier, the client is the insured and therefore the privilege belongs to the insured, not the insurer. The court concluded that reports and materials that were prepared by attorneys to assist the carrier in deciding whether to cover the plaintiff’s claim were not covered by the attorney-client privilege. Rather, these were materials prepared in the ordinary course of business and not entitled to an exemption from discovery. 

 

            Corporate officers and employees as well as lawyers must be careful about communications with any third parties, including insurance carriers, to avoid the potential for inadvertent waiver of the attorney-client privilege or other protections for private communications. If you have any questions about this case or other corporate or securities law issues, please contact Martin E. Schloss, Esq., who heads this practice area at Ganfer & Shore, LLP, or your contact at the firm.