Introduction

Protection of directors from the expense of litigation is a key issue for both companies and directors. Most corporate bylaws make indemnification of directors to the fullest extent allowed by law mandatory. In addition, bylaws recognize that the expenses of defense can be crippling even if a director successfully defends against a claim. Thus, corporations generally provide for advancement of the costs of defense upon receipt of an undertaking to be repaid if the director is finally determined not to be entitled to indemnity.

In a recent case, the Delaware Court of Chancery allowed a company to eliminate a director's advancement rights after he ceased serving as a director. This Update summarizes that decision and offers practical guidance for both companies and directors.

Background on the Schoon Decision

In Schoon v. Troy Corp., 948 A.2d 1157 (Del. Ch. Mar. 28, 2008) (Lamb, V.C.), William Bohnen was a director of Troy Corporation who was designated by a major investor. He resigned in February 2005 for health reasons. During his tenure as a board of directors member, Troy's bylaws provided advancement and indemnification rights to both current and former directors. In November 2005, the Troy board amended the company's bylaws to limit the advancement of expenses to only current directors.

In January 2006, Troy sued Bohnen, alleging a breach of his fiduciary duty to the company as a director. Bohnen sought advancement of legal fees and expenses incurred in defending against these allegations. Troy refused, claiming Bohnen had no advancement rights under the company's amended bylaws. Bohnen argued that his right to advancement in the pre-amendment bylaws vested when he became a director and that Troy could not terminate this right without his consent.

The court held that Bohnen was not entitled to advancement. It reasoned that a director's rights to advancement vest at the time a claim is made against him, not simply by virtue of his having served as a director under the prior bylaws. Bohnen's pre‑amendment advancement rights did not vest because Troy did not make its claim against Bohnen prior to the amendment, nor was there any indication that Troy planned to file a claim against Bohnen at that time.

Current Bylaws Govern Rights of Former Directors

Under the court's decision, a Delaware company's current bylaws govern the rights of former directors. Former directors may not necessarily benefit from the rights afforded to them by the bylaws existing during their tenures. Although the case arose in the context of advancement, the same rationale may also apply to indemnification itself because the occurrence of a claim, not the term of service, is what causes a director's rights to vest.

Additional Information

This Update is only intended to provide a general summary of the Delaware Court of Chancery's decision in Schoon. Read the full text of the Schoon decision.