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Filtering by Tag: Tenn. Code Ann. § 48-18-504

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.

Corporate Indemnification of Directors in Tennessee

Corporate Indemnification

Tennessee law recognizes two types of director indemnification, discretionary and mandatory. See Tenn. Code Ann. § 48-18-502 “Circumstances where indemnification is appropriate”; Tenn. Code Ann. § 48-18-503 “Required Indemnification.” For each, indemnification is only proper if the director was a party to a lawsuit specifically because they are a director of the corporation. See Tenn. Code Ann. §§ 48-18-502 and -503.

Mandatory Indemnification

A corporation is required to indemnify a director only if that director was “wholly successful, on the merits or otherwise, in the defense of any proceeding to which the director was a party . . .” Tenn. Code Ann. § 48-18-503. A director is “wholly successful” in defending the proceeding only if the entirety of the claims alleged against the director in the suit are disposed of without a finding that the director is liable to the company on any of the claims alleged in the suit. Sherman v. Am. Water Heater Co., 50 S.W.3d 455, 461 (Tenn. 2001) (“[Tenn. Code Ann. § 48-18-503] was patterned after the indemnification section of the Revised Model Business Corporation Act. . . . The Official Comment to the Model Act gives light to the meaning of those words. ‘A defendant is “wholly successful” only if the entire proceeding is disposed of on a basis which does not involve a finding of liability. . .’” (quoting the Rev. Model Bus. Corp. Act § 8.52, cmt. (1984) (internal quotation marks added) (emphasis added))). Thus, if a director is adjudged liable for one claim out of several brought in a derivative suit, they have not been “wholly successful” and indemnification of their expenses is not mandatory. See id.

Discretionary Indemnification — Advancement of Costs

Under Tenn. Code Ann. § 48-18-504, a corporation may, but does not have to, advance or reimburse “the reasonable expenses incurred by a director” if, and only if, certain requirements are met. Id. First, the director must furnish the corporation with a written affirmation that they have met the conduct prescribed in Tenn. Code Ann. § 48-18-502 for discretionary indemnification. Tenn. Code Ann. § 48-18-504(a)(1). Second, the director must furnish the corporation with a written undertaking to repay any advances if they are ultimately adjudged to not be entitled to indemnification. Tenn. Code Ann. § 48-18-504(a)(2). Finally, there must me a determination that the director is not precluded from receiving an advancement pursuant to Tenn. Code Ann. § 48-18-506. Tenn. Code Ann. § 48-18-504(a)(3).

But, even if all of this conduct is satisfied (which it is not in this case), the corporation is not compelled to indemnify a director. Tenn. Code Ann. § 48-18-504(a) (“A corporation may pay for or reimburse . . .” (emphasis added)). Regardless of whether the provisions allowing for indemnification are satisfied, indemnification is prohibited in derivative actions if, in the proceedings brought against them, the director is found liable to the corporation for their actions, or if they have received an improper personal benefit, which includes the unauthorized use of corporate assets. Tenn. Code Ann. § 48-18-502(d); Rev. Model Bus. Corp. Act § 8.31, cmt. (2007) (noting that under § 8.61(b)(3), which sets forth the directors’ exculpation from liability for a conflicting interest transaction if they can establish that the transaction was fair to the corporation, an improper financial benefit includes unauthorized use of corporate assets, facilities, or proprietary information).