D&O Indemnification for Legal Fees
August 30, 2007
Corporate statutes permit corporations to indemnify former directors and officers who, by virtue of their offices, reasonably incur legal costs in actions or proceedings against such costs and any related judgments, provided that these individuals acted honestly and in good faith with a view to the best interests of their corporations and had reasonable grounds for believing that their conduct was lawful. But what happens if a corporation is in the hands of a receiver and facing investigation by its regulators?
This was recently considered by the Manitoba Court of Appeal in Manitoba (Securities Commission) v. Crocus Investment Fund. Several former directors and officers of Crocus were involved in various legal proceedings relating to the corporation, including an investigation conducted by the Office of the Auditor General, an investigation by the Manitoba Securities Commission (MSC) and a proposed class action.
After the mass resignation of the Crocus board, the court appointed a receiver and manager. Prior to that appointment, Crocus had made arrangements to pay the legal counsel representing the officers and directors in these investigations. The receiver asked the court to authorize it to pay such legal expenses up to the date of the appointment of the receiver and to refrain from paying any ongoing legal expenses after that date until the completion of the proceedings.
At trial, the judge authorized and directed the receiver to pay all reasonably incurred ongoing legal expenses of the former directors and officers, as well as the amounts of any related unfavourable judgments. However, a shareholder of Crocus, who was a plaintiff in the proposed class action lawsuit, appealed the decision.
The main issue on appeal was whether Crocus, a corporation that was not insolvent (although under the control of a receiver), should pay ongoing legal defence costs incurred by its former directors and officers prior to the conclusion of the legal matters it was facing.
The court dismissed the appeal, concluding that the former directors and officers were presumed to have acted in good faith, had an immediate and legitimate need for counsel and should not be obliged to finance their own defence. The appeal court concluded that the trial judge had the discretion to order Crocus to advance funds for such costs and properly did so (subject to certain requirements for reimbursement to Crocus that protected the interests of the other stakeholders).
Both the trial judge and the appeal court were guided by the three conditions identified by the Supreme Court of Canada in Blair v. Consolidated Enfield Corp. that must exist "in order to receive indemnification for the costs of defending in litigation":
- The person must have been made a party to the litigation by reason of being a director or an officer of the corporation.
- The costs must have been reasonably incurred.
- The person must have acted honestly and in good faith with a view to promoting the best interests of the corporation.
The trial judge concluded that those who are entitled to potential indemnification should be presumed to have acted in good faith in the absence of evidence to the contrary.
The Court of Appeal agreed, concluding that allegations in pleadings or by the MSC or the extra-judicial conclusions of the Auditor General are not evidence and cannot displace the presumption of good faith, which is well-recognized at law, unless and until they are established in a legal proceeding.
McCarthy Tétrault Notes:
This decision affirms the power and authority of a board of directors and a court-directed receiver to decide that the corporation should advance defence costs to former directors and officers under the indemnification provisions of the applicable corporate statute and by-law, provided that the board is satisfied that the three Blair conditions are met.
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In the Matter of the Securities Act R.S.O. 1990, c. S.5, as amended, and In the Matter of Falconbridge Limited