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Conduct and Procedure for Indemnification of Directors in Tennessee

Conduct and Procedures for Indemnification Under Tenn. Code Ann. § 48-18-502

 Tenn. Code Ann. § 48-18-502 defines the requisite conduct of directors in three distinct situations: (1) conduct made in their official capacity as a director, (2) conduct not made in their official capacity as a director, and (3) conduct with respect to an employee benefit plan. See Tenn. Code Ann. § 48-18-502.

i.               Director Action/Official Capacity

When acting in their official capacity as a director — but not in respect to an employee benefit plan — a director has complied with the requirements of Tenn. Code Ann. § 48-18-504(a)(1) if they execute a written affirmation stating that:

(1)  Their conduct was made in good faith, and;

(2) They reasonably believed that their conduct was in the best interests of the corporation. Tenn. Code Ann. §§ 48-18-502(a)(1)-(2)(A).

ii.         Director Action/Not in Official Capacity

A director whose actions were not made in their official capacity — but not in respect to an employee benefit plan — has satisfied the requirements of Tenn. Code Ann. § 48-18-504(a)(1) if they execute a written affirmation stating that:

(1) Their conduct was made in good faith, and;

(2) They reasonably believed that their conduct was at least not opposed to the corporation’s best interests. Tenn. Code Ann. §§ 48-18-502(a)(1), (2)(B). 

iii.        Director Action with Respect to Employee Benefit Plan

Tennessee law remains clear regarding director actions with respect to employee benefit plans. A director only satisfies the requirement of Tenn. Code Ann. § 48-18-504(a)(1) if they execute a writing affirming that (1) Their action was made in good faith, and; (2) They reasonably believed that their conduct was “in the interest of the participants in and beneficiaries of the [employee benefit] plan.” Tenn. Code Ann. §§ 48-18-502(a)(1), (b).

 Conduct and Procedures for Indemnification Under Tenn. Code Ann. § 48-18-504(2)

 In addition to the written affirmation stating that their conduct has met the standards of Tenn. Code Ann. § 48-18-502, to qualify for indemnification a director must furnish a written undertaking. Tenn. Code Ann. § 48-18-502(a)(2). This undertaking must be an unlimited general obligation that promises to repay the corporation any funds advanced on their behalf if the court determines that they are not entitled to indemnification for whatever reason. Tenn. Code Ann. §§ 48-18-502(a)(2), (b).

 Determination that Director is not Precluded from Indemnification

Even if a director satisfies the written requirements of Tenn. Code Ann. § 48-18-504(a)(1) and (a)(2), before a director may be indemnified there must be a determination made that the director is not precluded from indemnification under Tenn. Code Ann. §§ 48-18-501 through -509. Tenn. Code Ann. § 48-18-504(3) (A determination is made that the director would not be precluded from being indemnified “under this part.”). The determination of whether a director is precluded from indemnification under the provisions of Tenn. Code Ann. §§ 48-18-501 through -509 are made in the manner specified in Tenn. Code Ann. § 48-18-506. Tenn. Code Ann. § 48-18-504(c).

            A corporation cannot indemnify a director unless it is specifically authorized to do so after a determination is made that are not precluded from being indemnified. Tenn. Code Ann. § 48-18-504(a)(3) (“Determinations and authorizations of payments [for indemnification] . . . shall be made in the manner specified in § 48-18-506.” (Tenn. Code Ann. § 48-18-506 requires that a corporation cannot indemnify a director until after a determination is made.)). A determination of whether a corporation can indemnify a director can be made in several ways, depending on the circumstances and involvement of the board of directors in the proceeding for which the indemnification is sought. Tenn. Code Ann. § 48-18-506(b).

 i.               Determination by Directors

The directors themselves can make the determination that indemnification is permissible under only two sets of circumstances. The first is by a “majority vote of a quorum consisting of directors [who are] not at the time [of the determination] parties to the proceeding.” Tenn. Code Ann. § 48-18-506(b)(1). If the directors cannot form a quorum under Tenn. Code Ann. § 48-18-506(b)(1), then the determination can be made by a committee of 2 or more directors who are not parties to the proceeding. Tenn. Code Ann. § 48-18-506(b)(2). If, however, quorum cannot be met under (b)(1) and a committee cannot be formed under (b)(2), then determination can only be made either by independent special legal counsel or by the shareholders of the corporation. Tenn. Code Ann. §§ 48-18-506(3), (4).

 

ii.              Determination by Special Legal Counsel

 Independent special legal counsel (“ISLC”) can determine whether a director is precluded from indemnification, but before they can make such a determination they must first be selected for the task. Tenn. Code Ann. § 48-18-506(3). ISLC can be selected by the directors themselves by a majority vote, so long as they have a quorum of directors who are not parties to the action. Id. If a quorum of directors who are not parties to the action cannot be established, the board of directors may designate a committee to select the ISLC made up of 2 or more directors who are not parties to the action for which indemnification is sought. Id. If a committee cannot be designated because there are not 2 or more directors who are themselves not parties to the action, then, and only then, may the full board of directors vote — regardless of whether they are parties to the action. Id.  

Irrespective of the method by which the ISLC is selected, they must be selected as ISLC for the task of determining whether indemnification is precluded. See id. Once selected, the ISLC can then make the determination of whether indemnification is precluded. Id. Only after a determination is made by the ISLC that the director is not precluded from indemnification, can a corporation indemnify that director. Tenn. Code Ann. § 48-18-506(a) (“A corporation may not indemnify a director . . . unless authorized in the specific case after a determination has been made . . .” (emphasis added)). This process must be completed for each director in a proceeding who is seeking indemnification, whether by advancement or repayment. See Id.; Tenn. Code Ann. § 48-18-504 (“A corporation may pay for or reimburse the reasonable expenses incurred by a director . . . the director furnishes the corporation a written affirmation of the director’s . . . that the director has met the standard of conduct . . .” (emphasis added)).

 iii.            Determination by Shareholders

 The shareholders of a corporation may vote to determine whether a director is precluded from indemnification, but, during this vote the directors who are parties to the proceeding may not vote their shares. Tenn. Code Ann. § 48-18-506.

 Mandatory Notice Requirement to Shareholders of Director Indemnification

Regardless of the method chosen, once a corporation indemnifies or advances expenses to a director pursuant to §§ 48-18-502, -503, -504, or -505, the corporation has a duty to, and must report the indemnification or advance in writing to the shareholders of the corporation either with, or before, the notice of the next shareholders’ meeting. Tenn. Code Ann. § 48-26-202.