Indemnification in Exec Separation Deals: Read the Fine Print
Executives whose employment is terminated by their employer often receive severance benefits, in exchange for which they are typically required to sign a separation agreement that includes a broad waiver and release of any claims they may have against their employer and its officers, directors and other related parties.
The importance to executives who sign separation agreements of considering how the agreement's release affects the executive's rights of indemnification and advancement was recently highlighted by the Delaware Chancery Court's opinion in Mikhail Kokorich v. Momentus Inc.
Relatedly, the 2019 Delaware Chancery Court decision in Ephrat v. MedCPU Inc. demonstrates how the wording of an executive separation agreement release can be equally important to the executive's employer.
Former CEO Seeks Indemnification of Legal Fees
Kokorich, the founder and former CEO of Momentus, sued the company after it refused to indemnify him for legal fees he incurred in connection with investigations of Momentus by the U.S. Securities and Exchange Commission and the Committee on Foreign Investment in the United States.
Among the questions before their court, two important ones were whether Momentus should advance Kokorich's legal expenses — that is, pay the expenses as Kokorich incurred them — and what standard should apply in determining whether he was entitled to reimbursement.
Releases That Limited Former CEO's Indemnification Rights
By way of background, Section 145(c) of the Delaware General Corporation Law requires a corporation to indemnify its current and former officers and directors for expenses they incur if they "are successful on the merits or otherwise" in defending themselves in lawsuits and other proceedings, including investigations, in which they are made a party by reason of having been an officer, director, employee or agent of the corporation. Legal fees are included among such expenses.
DGCL Section 145, however, gives corporations the discretion to go beyond the mandatory indemnification required by Section 145(c), including, for example, advancing the legal fees of a current or former officer or director before there has been a successful defense of a lawsuit or proceeding.
It is this discretionary advancement of legal costs that Kokorich sought, pointing to an indemnification agreement he had signed with the corporation in which Momentum agreed to indemnify him "to the fullest extent permitted by law," and which provided for advancement rights. The company's bylaws contained similar provisions.
Following the commencement of government investigations, Kokorich resigned and entered into a separation agreement. Kokorich also sold his stock to Momentus pursuant to a stock repurchase agreement.
Both the separation agreement and the stock repurchase agreement contained broad releases of claims against the company. The separation agreement release carved out Kokorich's rights under the indemnification agreement and Momentum's internal governing documents. However, the stock repurchase agreement release, which was signed after the separation agreement, omitted this carveout — with the result of it overriding the carveout in the separation agreement release.
The court acknowledged that the stock repurchase release did not waive any rights Kokorich had under DGCL Section 145(c). The court characterized those as statutory rights that can only be waived by a clear and affirmative waiver, which was lacking in the stock purchase agreement.
The broader rights afforded to Kokorich under the indemnification agreement and Momentum's bylaws, on the other hand, were contractual rights that fell within the scope of the separation agreement release. In sum, any indemnification of Kokorich's legal expenses is deferred until it can be determined whether he avoided an adverse result in the matters to which the expenses relate.
A Release That Worked in Favor of Executives
In Ephrat, the court reached the opposite outcome from that in Momentus. The litigation in Ephrat arose when two former officers and directors of MedCPU Inc. brought an action to enforce payment rights under separation agreements that they had signed.
The company had stopped making payments on the grounds that, among other things, the former executives had breached their obligations not to use or disclose confidential company information. The company asserted a number of counterclaims against the former executives, including their breach of their confidentiality obligations.
The former executives sought advancement of their legal fees in defending against the counterclaims. The company had a charter provision that indemnified its directors, officers and employees "to the fullest extent permitted by the provisions of DGCL," which as discussed above, would include advancement of legal expenses.
This wording not only encompassed legal expenses incurred in defending claims brought by third parties, but by the company as well.
The case raised a number of issues, including whether advancement — or indemnification for that matter — of the former executives' legal expenses met the standard under Section 145 that, in order to be indemnified, a claim must have arisen by reason of the fact of a person's corporate status as an officer or a director.
The Chancery Court held that the confidentiality breach counterclaims met this standard, although other counterclaims did not. As to whether the release in the separation agreements cut off the former executives' rights to advancement of expenses, the court focused on the wording of the release, which applied to "claims relating to or arising out of Executive's employment."
The court concluded that this wording meant that the separation agreements released "rights in connection with the contractual employer-employee relationship, and not the advancement and indemnification rights the Charter provides to [the former executives] in their roles as officers, director employees, and agents."
Lessons to Be Learned
Many companies prefer to have terminated executives sign separation agreement releases that extend to all claims, not just those tied to employment or termination of employment. In such instances, executives would do well to make sure that when they sign the release, they are not giving up their indemnification and advancement rights — or for that matter, any rights under the company's directors and officers insurance policies.
In the event that the release carves out contractual advancement and indemnification rights, or is limited to employment-related claims, as was the case in Ephrat, the company will need to make some determinations. In particular, the company will need to consider whether the executive should be entitled to post-employment advancement and indemnification with respect to claims made by the company that the executive violated a duty in the executive's capacity as an officer or director.
"Indemnification in Exec Separation Deals: Read the Fine Print," by Daniel L. Morgan was published in Law360 on June 22, 2023.