Indemnification Holes After a Company is Sold: Can a buyer cancel insurance, or amend bylaws after a sale?

Author:Raymond, Doug

A good directors & officers insurance policy frequently is the first and best line of defense. But what happens to these layered protections when the company is sold? Can the buyer cancel the insurance and amend the bylaws?

A recent Delaware case that deals with indemnification provisions for executives and board members when the company is sold highlights these issues.

ServiceMesh, Inc. had been sold to Computer Sciences Corporation (CSC), and following the sale, CSC brought an indemnity claim against the former CEO, alleging that he had taken actions that fraudulently inflated the amount CSC paid to the Service-Mesh shareholders. The CEO, pointing to the bylaw provisions in the Service-Mesh bylaws, demanded that Service-Mesh (now a CSC subsidiary) advance to him the fees and expenses he would incur in defending himself against the CSC lawsuit. Soon after, the CEO demanded advancement for expenses he would incur in a related federal criminal bribery investigation.

Despite objections from CSC in an earlier proceeding, the Delaware Court of Chancery largely granted the CEO's request, as many of the claims related to his position as an officer of ServiceMesh before the acquisition. While the federal investigation ultimately was dropped, the CEO incurred over $18 million in expenses defending himself from the numerous actions and investigations.

There are few events as significant for the board of directors as the decision to sell the company. Whether public, family-owned or PE-backed, the sale of control to a third party typically severs the long-standing ties of the directors to the company, turning over control and management to a new group of unfamiliar faces. Readers of this magazine have seen many discussions of the board's obligations to the shareholders when a sale of control becomes likely.

There are other consequences of the sale that are important for the directors. Before a sale, the directors and officers of a corporation enjoy overlapping layers of protection against challenges to their decisions. The corporation laws of every state mandate, or allow, indemnification of directors and officers who are brought into an actual or threatened suit, or other legal action as a director or officer. This protection is an essential protection for the board, and is at risk in a sale of control.

Corporations can adopt bylaws or other provisions that provide a broad indemnity so long as the director or officer satisfies a base level of care...

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