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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).