The chairman of the board of trustees has lunch with a prospective trustee, or the board is looking to bring in a new executive director, and the candidate asks, "What are my indemnification protections?" How do you respond?
The articles of incorporation or bylaws of most nonprofit organizations include an "indemnification" section. The indemnification section often was not given considerable thought when first included in the document, and probably was given even less as time has gone on. It is sometimes mistakenly referred to as "boilerplate."
Indemnification generally refers to an obligation of the organization to pay an ultimate liability and associated expense incurred by a trustee, officer or employee who becomes the subject of a claim and for whom indemnification under the organization's governing documents is to be provided.
Indemnification provisions are an important protection for trustees and officers and should be regularly reviewed. There are numerous questions and issues regarding to whom, and for what, indemnification should apply.
Take, for example, a situation in which one or more trustees or officers become subject to a claim that a guest of the organization was injured while on its premises. Often in such a case, third-party insurance would cover the personal injury claim; in addition, the statutes of the particular jurisdiction may expressly "exculpate" trustees and officers from liability for such a claim. But other third-party claims might not be covered by insurance or by any "exculpation," such as if an individual is accused by a third party or by a governmental agency of having engaged in some particular wrongdoing or misconduct. Whereas it is possible the organization has directors' and officers' liability insurance, more likely there exists no third-party insurance coverage or exculpation for such claim, in which case indemnification rights in favor of the trustee, officer or employee are very much at issue.
Most organizations provide for "mandatory" indemnification of trustees and officers and, more often, "discretionary" indemnification in favor of employees. That way, the board of trustees can determine whether indemnification of a particular employee (as compared with a trustee or officer) who is the subject of a claim is warranted under the circumstances. But what of an executive director? Is that person entitled to mandatory indemnification if the position of executive director is not an "officer" position under the organization's bylaws? And if indemnification is discretionary (rather than mandatory) for trustees or officers, should you, as a trustee or an officer, be concerned? These are issues to consider when reviewing the indemnification provisions of the organization's governing documents.
Further, even when indemnification protection exists, the statutes of all jurisdictions nevertheless require the proposed indemnitee to satisfy a particular standard of conduct -- generally, that the person acted in good faith and in a manner that he or she reasonably believed to be in (or not opposed to) the best interests of the organization and, in a criminal proceeding, that the individual had no reason to believe the conduct was unlawful. So indemnification rights are not automatic; they require, even under mandatory indemnification provisions, the individual to have met a particular standard of conduct.
In addition, indemnification is distinct from "advancement of expenses." For example, a trustee or an officer becomes subject to a particular claim, complaint or government proceeding, and at the very outset, the individual wishes to hire a lawyer to defend the claim. Indemnification rights, by themselves, typically do not apply to the expenses incurred by an individual in his or her defense, at least until there is an ultimate determination of liability on the underlying claim. This is why many indemnification provisions also include provisions for advancement of expenses. Such provisions may be mandatory or discretionary and, in any case, generally require the individual to deliver to the organization an "undertaking" to repay the organization any "advanced expenses" if it is ultimately determined that the individual is not entitled to indemnification. But an organization should be very cautious with advancement rights, because the particular circumstances of the claim, such as alleged corporate wrongdoing, might militate against mandatory advancement of expenses.
Other issues that should be considered in reviewing indemnification/provisions include:
- What types of proceedings are covered by the organization's indemnification protection? Are investigations, arbitrations and governmental proceedings covered, in addition to civil court actions and criminal court actions?
- What if the particular "proceeding" is brought by the individual against the organization?
- Do the governing documents provide indemnification protection to "former" trustees, officers or employees, after the individual has left the organization and no longer is a current trustee, officer or employee?
The key takeaway is that your organization's indemnification provisions need to be regularly reviewed and should never be considered boilerplate.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
