United States: Indemnification, Advancement, And Insurance Coverage: Food For Thought When An Employee Is Charged With A Crime

A recent high-profile decision by the Third Circuit Court of Appeals is a reminder that ambiguity in a company's by-laws can have a real-world impact when a former employee has been charged with a crime and looks to the company for indemnification. The decision should also prompt in-house counsel to consider the interplay between a company's indemnification obligations and its D&O insurance coverage.

In Sergey Aleynikov v. The Goldman Sachs Group, Inc., No. 13-4237, the Third Circuit considered Mr. Aleynikov's attempt to force Goldman, his former employer, to reimburse him for the legal expenses he incurred after being charged by federal authorities with stealing computer code from Goldman. Mr. Aleynikov was convicted of trade secret theft under 18 U.S.C. § 1832, but had this conviction overturned on appeal after a finding that the statute did not encompass the trading software at issue.

Shortly after this success in federal court, Mr. Aleynikov was charged in New York state court on the same alleged facts. Those state charges are pending, and as a result, the Third Circuit was also presented with Mr. Aleynikov's claim that Goldman must pay or "advance" his legal costs in the state matter pending its resolution.

The Third Circuit's analysis of Mr. Aleynikov's demands for payment of his legal fees focused on Goldman Sachs' by-laws. Those by-laws give Goldman Sachs "officers" two valuable rights when accused of wrongdoing in the course of his or her work. The first is the right to indemnification, i.e. the right to be reimbursed for legal expenses after the employee has been successfully defended. The second is the right to advancement, i.e. the right to have legal expenses paid in advance of a final disposition of a proceeding against the employee. The statutory basis for these rights in the corporate by-laws is Title 8 of the Delaware Code, Section 145.

The key question for the Court of Appeals was whether Mr. Aleynikov, who held the title of Vice President, was an "officer," as that term was used in the by-laws. The by-laws defined the term "officers" to "include in addition to any officer of such entity, any person serving in a similar capacity or as the manager of such entity." The Court found this definition to be ambiguous – "circuitous, repetitive, and most importantly, 'fairly or reasonably susceptible to more than one meaning.'" A major problem with the application of the term in the by-laws to Mr. Aleynikov was the fact that the Goldman Sachs subsidiary where Mr. Aleynikov worked was a limited partnership, and therefore was not required to have any officers. Such a requirement would presumably have resulted in a far more concrete conception of who was or was not serving as an "officer."

The Third Circuit examined two types of extrinsic evidence that had been offered by Goldman Sachs to clear up the ambiguity in the by-laws. First, the Court considered "course of dealing" evidence. The Court reviewed evidence of the procedures used by the partnership for appointing officers, evidence the district court had discounted because those procedures were not widely disseminated or known within the organization. The Court also noted evidence of Goldman's track record of providing indemnification and advancement to Vice Presidents. (The court noted that, aside from Mr. Aleynikov, 15 of 16 Goldman Vice Presidents had been provided those benefits after requesting them.) Second, the court considered "trade usage" evidence found in various periodicals, speaking to how titles such as Vice President were viewed in the industry.

The Third Circuit concluded that this evidence had been improperly discounted by the district court, and was sufficient to permit the question of whether the term "officer" in Goldman's by-laws includes a Vice President to go to trial. In reaching this conclusion, the Court of Appeals also differed with the district court on the key issue of contra proferentem – whether the ambiguity in the by-laws should be construed against Goldman because Goldman was the drafter. The Third Circuit refused to apply this doctrine, reasoning that it had no application where the question was whether a person has rights under the by-laws in the first place.

As the parties consider a trial in this matter, what are the lessons with respect to an organization's indemnification of its employees? Indemnification and advancement rights, generally found in the organization's by-laws, may be ambiguous. An organization may decide that such ambiguity allows for a level of discretion in granting indemnification in specific cases, and that discretion of this type is more important to the organization in the long run than the risk of prolonged litigation. Goldman itself had exercised what it understood to be its discretion by indemnifying all but two of the Vice Presidents seeking that benefit. However, if this discretion is challenged, as in this case, millions of dollars in legal fees may be at stake, representing both the amount of indemnification and the fees consumed in a dispute over an employee's entitlement to the benefit.

Therefore, corporate entities with complex structures should consider separate indemnification provisions, as opposed to Goldman's "one size fits all" approach – if the partnership agreement of the Goldman subsidiary had addressed the issue of indemnification of its employees, the ambiguity in this case about who is entitled to the benefit might have been avoided. Another lesson can be drawn from the Third Circuit's discussion of the Goldman partnership's procedures for appointing officers. If the availability of valuable rights hinges on whether an employee is a member of a select group, like officers, and the organization has a process for assigning that role, the wide dissemination of how the assignment process works may prevent an employee excluded from that process from claiming he or she should nonetheless be considered a member of that group.

One issue the Aleynikov court did not address was whether Mr. Aleynikov, or Goldman, sought insurance coverage for the former employee's defense costs. The issue was not before the Third Circuit, possibly because the applicable Directors & Officers Liability ("D&O") insurance policy held by Goldman may have contained a "misappropriation of trade secrets" or similar exclusion, which is not uncommon. However, insurance coverage usually is a crucial issue when an employee seeks indemnification from the company for claims made against the employee. Companies and employees facing these situations should be aware that the company's D&O policies may provide broader coverage than the company's indemnification obligations.

First, assuming the claim was otherwise covered, a company's D&O policy often insures a broader swath of employees than technically are entitled to indemnification under the company's by-laws. Many D&O policies now cover not just "directors" and "officers," but also "employees," as individual insureds. D&O policies for limited liability partnerships and limited liability companies often include "managers," or "functional equivalents." Thus, under the D&O policy, Mr. Aleynikov would not need to worry about whether he was an "officer" of the company; instead, he would be arguing that he was a member of the broader category of managers, or employees.

Second, D&O policies contain what is known as "Side A" coverage, which applies when the company does not indemnify the individual insured, even if the company is permitted or required to indemnify the individual insured under the by-laws. Usually, there is no retention or deductible applied in "Side A" coverage situations, although the carrier may be entitled to seek recovery of a retention if the organization was permitted, but did not, indemnify the individual.

Third, some D&O policies explicitly cover actions against individual insureds where the company's by-laws are less than clear. For example, some D&O policies now explicitly cover the costs for an individual to respond to a subpoena, a Wells Notice, or a governmental agency interview, while an organization's by-laws often are not as explicit.

Of course, as noted above, the claim must otherwise be covered. In a situation like the Aleynikov case, where the company and Mr. Aleynikov are at odds, it is not uncommon for the company to have sued the individual in a civil action. (Indeed, Goldman has filed counterclaims against Mr. Aleynikov for breach of contract, misappropriation of trade secrets, and conversion.) Such claims typically are excluded under the so-called "insured v. insured" provision in most D&O policies. Most policies also contain a "bad acts" exclusion, which applies to loss (including defense costs) when there has been a "final adjudication" of criminal or fraudulent activity. The insurance carrier should advance defense costs prior to the final adjudication, but usually reserves the right to seek reimbursement of defense costs if there has been a final adjudication that supports the application of this exclusion. Not all D&O policies specify that the "final adjudication" must be "non-appealable." Mr. Aleynikov's situation is precisely why insureds should push their carriers to specify that the final adjudication be a non-appealable one. Mr. Aleynikov was convicted after trial – arguably a "final adjudication" – but this conviction was overturned on appeal. An insurance carrier (and not the company) should pay for the insured's appeal, and should not be permitted to seek reimbursement of defense costs if the insured is pursuing an appeal of a final adjudication of criminal or fraudulent activity.

Time will tell how the interplay between a company's indemnification obligations, as addressed by the Aleynikov court, and insureds' rights under a company's D&O policies, develops in future cases. The Third Circuit's determination that the term "officers" is ambiguous, its discussion of the contra proferentem doctrine, and its acceptance of course-of-dealing and trade usage evidence likely will be cited by companies, employees, and carriers in indemnification and coverage disputes to support their respective positions. The most important message to both companies and "officers" in the short term, however, is that they pay closer attention to what the company's indemnification obligations may be, and consider how those obligations will function, should a crisis similar to the one involving Goldman Sachs and Mr. Aleynikov arise.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions