Will your company defend you? Proving your innocence in a securities class action may be a luxury you can no longer afford.

• Author: Quaintance, Robert F., Jr.

The well-established principle that indemnified directors and officers who are sued are entitled to have their companies advance their defense costs, without any prior showing of lack of culpability, is under attack. Ironically, the attackers' chosen weapon is a provision of the Private Litigation Securities Reform Act (PSLRA), a law whose principal purpose was to protect public companies and their directors and officers from unfounded and potentially extortionate lawsuits. Under the laws of Delaware and other states, a corporation's charter, bylaws or indemnification agreements may require it to advance a corporate official's defense costs, subject only to the official's promise to repay the advance if he or she ultimately is found not to have been entitled to indemnification. The right to have defense costs advanced is an important inducement to qualified persons to serve as directors and officers of public companies.

In the recent securities class action involving HealthSouth Corporation and its founder and former CEO, Richard Scrushy, HealthSouth settled, Scrushy did not (he was not even invited to participate in the settlement talks), and a federal court of appeals approved, over Scrushy's objection, a "bar order" that prevented Scrushy from enforcing HealthSouth's contractual obligation to advance his continuing defense costs.

The PSLRA calls for bar orders in order to encourage settlements. The orders typically prohibit plaintiffs from seeking additional money from settling defendants and extinguish rights of contribution among settling and non-settling defendants (thus preventing a non-settling defendant from claiming later that the settling defendant did not pay its fair share of the loss). The HealthSouth court, in a novel ruling, held that a bar order could prohibit advancement of defense costs to non-settling corporate officials.

In reaching this unprecedented result, the court said that the public policies in favor of settlement and against indemnification for securities law violations outweigh the public policy in favor of advancement (and, apparently, although the court did not say it this way, the public policy in favor of enforcing customary corporate obligations valid under the law of the corporation's state of organization). The court did not cite any actual wrongdoing by Scrushy in support of its decision, but seemed moved by the plaintiffs' allegations that "Scrushy was a central figure in the violations." The court...