Corporate Misdeeds and Their Impact Upon Enforceability of Executive Employment Agreement Indemnification Provisions
An infectious greed” has caused the recent breakdown of “corporate governance checks and balances,” according to Federal Reserve Chairman Alan Greenspan.1 This greed, Greenspan suggests, stems in part from employment agreement provisions that have “perversely created incentives to artificially inflate reported earnings in order to keep stock prices high and rising.”2
Although Greenspan was specifically referring to stock option provisions, another common controversial feature of many executive employment agreements is the “indemnification” provision.3 Indemnification is the practice by which corporations pay expenses of officers or directors who are named as defendants in litigation relating to corporate affairs.4 For example, L. Dennis Kozlowski’s executive employment agreement with Tyco International Ltd. contained a standard indemnification provision, providing:
To the fullest extent permitted by law, the Company shall indemnify Executive (including the advancement of expenses) for any judgments, fines, amounts paid in settlement and reasonable expenses, including attorneys’ fees, incurred by Executive in connection with the defense of any lawsuit or other claim to which he is made a party by reason of being an officer, director employee or consultant of the Company or any of its subsidiaries or affiliates.5
Dick Cheney’s employment contract with Halliburton Company contained a similarly broad indemnification agreement, in which the company agreed to indemnify Cheney to the fullest extent permitted by applicable law in effect on the date of the execution of the agreement “and to such greater extent as applicable law may thereafter from time to time permit.”6 The company further agreed to contribute to expenses, judgments, penalties, fines, and settlement amounts “[i]n the event that the indemnity contained in. . . this Agreement is unavailable or insufficient to hold Indemnitee harmless. . . . ”7
In light of the recent and much-publicized failings of corporate boards and top executives of the country’s largest companies, it is unclear to what extent Florida courts will enforce indemnification provisions. Particularly uncertain is whether courts will uphold employment agreement clauses that purport to indemnify executives for punitive damages based on the executive’s own wrongdoing. Florida statutes are ambiguous on this point and Florida courts have yet to address the issue. However, as politicians and courts further react to the decline in public trust of traditional modes of corporate governance, heightened scrutiny of these still-common provisions is foreseeable.
Common Law Fiduciary Duties
Corporate executives have historically been bound by certain fiduciary duties.8 According to Fletcher Cyclopedia of the Law of Private Corporations, “a director. . . must be loyal to his trust, use ordinary and reasonable care, must not exceed the powers of the corporation nor his powers as an officer, and must otherwise act in good faith, and is liable for fraud or misappropriation or conversion of corporate assets, and generally is liable for negligence.. . . ”9 For instance, the landmark decision Smith v. Van Gorkum, 488 A.2d 858 (Del. 1985), emphasized that directors’ objective fiduciary duties include those of loyalty, care, and candor and imposed liability on directors who acted in grossly negligent manner in approving a sale of a corporation and established procedures to allow boards to properly evaluate management proposals.
In response to Van Gorkum, many states, including Florida, adopted statutes designed to limit director and officer liability.10 Among those reforms, indemnification provisions have become one popular method whereby states have limited traditional core fiduciary duties of corporate law.11 F. S. §607.0850, for instance, provides corporations with certain powers and certain duties regarding indemnification of officers, directors, employees, and agents. The statute makes indemnification mandatory in certain circumstances, such as when the director or officer has been successful on the merits in defense of a claim. The statute also identifies certain circumstances in which corporations may, but are not required to, indemnify directors and officers, such as in any proceeding where the executive acted in good faith and in a manner reasonably believed to be in the best interests of the corporation.
In addition, Florida’s indemnification statute prohibits a corporation from providing indemnification if a judgment or other final adjudication establishes that the director’s or officer’s actions, or omissions to act, were material to the cause of action so adjudicated, and constituted one of the following:
a) A violation of the criminal law, unless the director, officer, employee, or agent had reasonable cause to believe his or her conduct was lawful or had no reasonable cause to believe his or her conduct was unlawful;
b) A transaction from which the director, officer, employee, or agent derived an improper personal benefit;
c) In the case of a director, a violation of statutory provisions concerning the declaration of a dividend or other distribution or the purchase of the corporation’s own shares; or
d) Willful misconduct or a conscious disregard for the best interests of the corporation in a proceeding by or in the right of the corporation to procure a judgment in its favor or in a proceeding by or in the right of a shareholder.12
Significantly, the statute further provides that, other than in these four limited situations, corporations may make any other indemnification or advancement of expenses of its directors and officers under any bylaw, agreement, vote of shareholders or disinterested directors, or otherwise.13 Prior to this statute’s enactment, Florida common law generally prohibited agreements to indemnify parties against their own willful wrongful acts, at least where the willful act demonstrated “such callous or willful disregard of the rights of others as to make an indemnity agreement relating to it too shocking to be permitted under enlightened public policy.”14
Although indemnifying against punitive damages likely would be prohibited in certain circumstances under this statute, the statute does not expressly prohibit indemnification of punitive damages arising from an officer’s or director’s wrongdoing, particularly in a civil case brought by the government or a third party. Consequently, under the terms of the statute, it would appear that, unless the director’s or officer’s acts specifically fall within one of the four enumerated exceptions, the corporation may indemnify the executive for punitive damages caused by his or her malfeasance.
Despite the statutory approbation of indemnification, courts are likely to reject, as violative of public policy, a corporation’s efforts to indemnify a rogue director or officer against punitive damages arising from his or her own wrongful acts. Under general contract law, parties may incorporate into their agreements any provisions unless they are illegal or violative of public policy; however, contracts that violate public policy will not be enforced.15 Florida’s indemnification provisions express public policy in that they attempt to reconcile two competing public interests: attracting quality corporate leaders by limiting their expense and risks of litigation and deterring unacceptable behavior by corporate leaders.16
The policy supporting indemnification is based on the fact that, in many instances, corporate executives could be held personally liable for the tortious acts of the corporation, such as for violations of certain hazardous waste laws, RICO, ERISA, or other statutes, or where the executive is found to have participated in, sanctioned, or ratified the tortious acts.17 Accordingly, officers and directors potentially expose themselves to litigation expenses and liability measured not merely in terms of their own personal fortunes, but rather by the vastly larger scale of the corporation’s operations.18 Indemnification assists corporate officers and directors in resisting unjustified lawsuits and encourages corporate service by assuring individuals that the risks incurred by them as a result of their efforts on behalf of the corporation will be met, not through their personal financial resources, but by the corporation.19 As a consequence, without indemnification, many corporations likely would find it difficult to attract quality executives.
However, recent headlines highlighting the malfeasance of certain corporate leaders underscore the offsetting policy consideration of deterrence and are likely to influence a court’s interpretation of “public policy.” It is commonly believed that many of today’s corporate boards lack independence from management, directors frequently receive large cash payments authorized by corporate officers, and prosecutions or civil judgments against even the worst-performing directors are rare.20 The WorldCom and Enron breakdowns, for example, have drawn the attention of President Bush, who has declared that “[t]he misdeeds now being uncovered in some quarters of corporate America are threatening the financial well-being of many workers and many investors. At this moment, America’s greatest economic need is higher ethical standards—standards enforced by strict laws and upheld by responsible business leaders.”21
Consequently, although it is not expressly illegal under Florida statute to indemnify officers, directors, employees, and agents against punitive damages arising from their own wrongful acts, courts in today’s political climate may favor deterrence and hold indemnification against such punitive damages violative of public policy.
Although there are no reported Florida cases precisely on point, Florida courts wishing to limit indemnification of corporate executives can find support in the case law of other states.22 For instance, in Biondi v. Beekman Hill House Apt. Corp., 94 N.Y.2d 659, 663 (2000), a New York court interpreting New York law based on the Model Business Corporation Act held that “indemnification [of a corporate officer by the corporation] for punitive damages is prohibited by public policy.” In that case, a president of the board of directors of an apartment corporation was found liable, including for punitive damages, to a shareholder and prospective tenants for discriminatory leasing practices. After judgment was entered against him, the president sought indemnification by the corporation.
The Biondi court reasoned that “indemnification defeats the purpose of punitive damages, which is to punish and deter others from acting similarly.”23 The court noted that although the nonexclusivity language in the New York corporate indemnification statute “broaden[ed] the scope of indemnification, its ‘bad faith’ standard manifest[ed] a public policy limitation on indemnification.”24 The “bad faith” standard derived from language in New York’s statute that prohibited indemnification of directors or officers if a judgment “establishes that his acts were committed in bad faith or were the result of active and deliberate dishonesty. . . . ”25 Similarly, the Second Circuit has recognized public policy restrictions on indemnification of punitive damages under Delaware’s analogous nonexclusivity and bad faith provisions.26 Notably, Florida’s indemnification statute does not contain a “bad faith” provision such as those found in the indemnification statutes of New York and Delaware.27 Yet, the statute as a whole could be read as proscribing indemnification for an executive’s bad faith or deliberately dishonest acts; however, the statutory language is ambiguous on this point.
The Biondi court also stressed the principle that because insurability of punitive damages was against public policy in New York, so was indemnification.28 In Florida, it is likewise generally against public policy to insure against punitive damages arising out of one’s own conduct.29 This is so because the primary purposes of punitive damages are not to compensate a plaintiff for his or her injury, since compensatory damages already have made the plaintiff whole, but rather punishment and deterrence. Therefore, to be effective, punitive damages must rest ultimately on the party actually responsible for the wrong—if a party against whom punitive damages were assessed “were permitted to shift the burden to an insurance company, punitive damages would serve no useful purpose.”30 Thus, insurability would allow an active wrongdoer upon whom a punishment is imposed to escape that punishment by shifting it to an insurance carrier.31 As a result, those punished would ultimately be the insurance company and its customers, who would end up paying higher rates.
Applying the Case Law to Indemnification
The reasoning supporting Florida’s policy against insurability of punitive damages arising out of one’s own conduct applies equally to supporting a policy against shifting the burden of a director’s wrongful conduct to corporate shareholders through indemnification. In fact, the Biondi court saw no distinction between the two. Like insurance, indemnification against punitive damages diverts punishment away from the wrongdoing executive to the shareholders, who are likely to actually be among the greatest victims of such acts. Moreover, corporate indemnification against punitive damages arising from an executive’s own wrongful conduct, in essence, represents the corporation’s condoning of such wrongful conduct. Accordingly, indemnification of punitive damages arising from an executive’s own wrongful conduct does more than simply reimburse him or her for loss suffered by conducting corporate affairs, it lowers the standard of conduct which a corporation expects from its executives.32
In light of the recent wave of public sentiment against wrongdoing by corporate leaders combined with analogous case law, it seems likely that provisions in executive employment agreements purporting to indemnify officers or directors against punitive damages arising out of their own conduct would be found to violate public policy. Additionally, a legislature influenced by voters’ dissatisfaction with the current state of corporate governance may decide to clarify the ambiguities in Florida’s corporate indemnification statute.
1 Testimony Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate (July 16, 2002).
3 See Joseph Warren Bishop, Jr., Law of Corporate Officers and Directors: Indemnification and Insurance §1.02 (2000) (“Indemnification has become commonplace in corporate affairs”).
4 Black’s Law Dictionary 529 (6th ed. 1991).
5 Retention agreement between Tyco International Ltd. and L. Dennis Kozlowski §13 (Jan 22, 2001), available at http://contracts.corporate.findlaw.com/agreements/tyco/ kozlowski.emp.2001.01.22.html.
6 Executive employment agreement between Halliburton Company and Dick Cheney, Exhibit A (Aug. 10, 1995), available at http://contracts.corporate.findlaw.com/agreements/Halliburton/ cheney.emp.1995.10.01.html.
7 Id. See also Agreement and Plan of Merger – Dynegy Inc. and Enron Corp. §7.13 (Nov. 9, 2001) (“Newco. . . shall indemnify, defend and hold harmless to the fullest extent permitted under applicable law each. . . officer or director of Dynegy or Enron. . . against all losses, claims, damages, liabilities, costs or expenses (including attorneys’ fees), judgments, fines, penalties and amounts paid in settlement in connection with any claim, action, suit, proceeding or investigation arising out of or pertaining to acts or omissions, or alleged acts or omissions, by them in their capacities as such, whether commenced, asserted or claimed before or after the Effective Time”), available at http://contracts.corporate.findlaw.com/agreements/dynegy/enron . mer.2001.11.09.html.
8 See Orlando Orange Groves Co. v. Hale , 144 So. 674, 677 (1932).
9 3 Fletcher Cyclopedia of the Law of Private Corporations §990 (Perm Ed. 1990).
10 See Stuart R. Cohn and Stuart D. Ames, Florida Business Laws Annotated §607.0831, author commentary (2000).
11 See John C. Coffee, Jr., Contractual Freedom in Corporate Law: The Mandatory/Enabling Balance in Corporate Law: An Essay on the Judicial Role , 89 Colum. L. Rev. 1618, 1650 (1989).
12 Fla. Stat . §607.0850(7).
13 Fla. Stat. §607.0850.
14 Inland Container Corp. v. Atlantic Coast Line R. Co. , 266 F.2d 857, 860 (5th Cir. 1959).
15 17A Am. Jur. 2d, Contracts §238 (1991).
16 Cohn & Ames , supra note 10, at 111.
17 Bishop , supra note 3, at §3.13.
18 Id . at §1.02.
19 Perconti v. Thornton Oil Corp. , 2002 Del. Ch. LEXIS 51 at *9 (May 3, 2002).
20 See John Maggs, Out of the Loop , Nat’l J. (March 8, 2002).
21 Remarks by President Bush on corporate responsibility at the Regent Wall Street Hotel, New York (July 9, 2002).
22 To interpret Florida corporation law, Florida courts will look to case law of other states with similar corporation statutes, including New York and Delaware. See Greco v. Tampa Wholesale Co ., 417 So. 2d 994, 996–97 (Fla. 2d D.C.A. 1982) (referring to New York cases interpreting provisions of the New York Business Corporation Law), pet. denied , 431 So. 2d 990 (Fla. 1983); Naples Awning & Glass, Inc. v. Cirou , 358 So. 2d 211 (Fla. 2d D.C.A. 1978) (relying on Delaware case law to interpret Florida corporation law); De La Rosa v. Tropical Sandwiches, Inc ., 298 So. 2d 471 (Fla. 3d D.C.A. 1974) (same). See also International Ins. Co. v. Johns , 874 F.2d 1447, 1459 n.22 (11th Cir. 1989) (observing that the 11th Circuit “rel[ies] with confidence upon Delaware law to construe Florida corporate law”).
23 Id. (internal marks omitted).
24 Id. at 665 (citing N.Y. Bus. Corp . §721). See also Oladeinde v. City of Birmingham , 118 F. Supp. 2d 1200, 1209 (N.D. Ala. 1999) (distinguishing, in dicta, “between compensatory damages (for which indemnification would certainly be appropriate), and punitive damages (for which indemnification arguably might not be appropriate)” (parentheses in original)); National R. Passenger Corp. v. Consolidated Rail Corp ., 698 F. Supp. 951, 971–72 (D.D.C. 1988) (under District of Columbia law, contract provision providing for indemnifying intentional wrongful conduct void as against public policy), vacated on other grounds , 892 F.2d 1066 (D.C. Cir. 1990); Thomas v. Atlantic C.L.R. Co. , 201 F.2d 167, 170 (5th Cir. 1953) (finding contract provisions which appear to indemnify against willful, wanton, reckless, or intentional misconduct by the indemnitee are contrary to public policy).
25 N.Y. Bus. Corp . §721 (1999).
26 Waltuch v. Conticommodity Servs . , Inc. , 88 F.3d 87, 90–91 (2d Cir. 1996).
27 Compare N.Y. Bus. Corp . §721 with Fla. Stat . §607.0850(7), quoted in the text supra .
28 Biondi , 94 N.Y.2d at 663.
29 Hartford Acci. & Indem. Co. v. U.S. Concrete Pipe Co ., 369 So. 2d 451, 452 (Fla. 4th D.C.A. 1979) (“It is well settled in Florida that one may not insure against liability for punitive damages as the result of his own misconduct which gave rise to such damages.”); Morgan Int’l Realty v. Dade Underwriters Ins. Agency , 617 So. 2d 455, 459 (Fla. 3d D.C.A. 1993) (“[P]ublic policy in Florida prohibits liability insurance coverage for punitive damages assessed against a person because of his own wrongful conduct.”); Morrison v. Hugger , 369 So. 2d 614, 615 (Fla. 2d D.C.A. 1979) (“[I]f the jury awarded punitive damages against Wright Fruit Company because of any act of wrongdoing or misconduct on the part of the employer/owner itself, there would not be insurance coverage for the punitive damages awarded against Wright Fruit Company.”); Northwestern Nat’l Casualty Co. v. McNulty , 307 F.2d 432, 433 (5th Cir. 1962) (“We hold that under Florida law public policy prohibits insurance against liability for punitive damages.”).
30 Nicholson v. American Fire & Casualty Ins. Co ., 177 So. 2d 52, 54 (Fla. 2d D.C.A. 1965).
31 Travelers Ins. Co. v. Wilson , 261 So. 2d 545, 549 (Fla. 4th D.C.A. 1972). In contrast, Florida courts have not found public policy to be violated where one liable for punitive damages solely because of vicarious liability has shifted that burden to an insurance carrier. Id.
32 Bishop , supra note 3, at §7.16.
Jay P. Lechner , an associate with Zinober & McCrea, P.A. in Tampa, represents and advises management in labor and employment law matters. He received his J.D., with honors, from the University of Florida College of Law.