Opinion ID: 774046
Heading Depth: 2
Heading Rank: 2

Heading: Propriety of Indemnification

Text: 20 The ability of a Delaware corporation to indemnify its directors for the consequences of their acts is constrained by Delaware's General Corporation Law § 145. This section defines a basic structure that can be modified, within limits, by the adoption of by-laws. Del. Code Ann. tit. 8, § 145(f). The basic structure has two types of indemnification, mandatory and permissive. Mandatory indemnification for defense expenses occurs when the director is successful on the merits or otherwise in defense of the action brought against him. § 145(c). Permissive indemnification may occur, if the corporation so chooses, for the costs imposed on directors who have been determined to have acted in good faith. §§ 145(a),(b). It is common for corporations to adopt through their by-laws a requirement that they must (as opposed to may) reimburse directors for their costs. Owens Corning has done this. The requirement of good faith on the part of the directors indemnified under §§ 145(a),(b) however, is statutory, and cannot be waived by attempting to extend indemnification even further. See VonFeldt v. Stifel Fin. Corp., No. 15688, 1999 WL 413393 at  2 (Del. Ch. June 11, 1999); Cochran v. Stifel Fin. Corp., No. 17350, 2000 WL 286722 at  (Del. Ch. Mar. 8, 2000). See also Waltuch v. Conti Comm. Serv. Inc., 88 F.3d 87, 95 (2d Cir. 1996) (discussing why Delaware law requires good faith in such circumstances). 21 A default method for the determination of good faith by the corporation is described by § 145(d). It is National Union's contention that Owens Corning failed to comply with this, and therefore the indemnification was not pursuant to law as the Policy requires. Consequently, National Union claims it owes its policyholder nothing for the Lavalle settlement. This argument was attempted by the appellant (and rejected) in the Ninth Circuit. Safeway Stores, Inc. v. Nat'l Union Fire Ins. Co., 64 F.3d 1282, 1290 (9th Cir. 1995) (interpreting Maryland corporation law, however). 22 Owens Corning claims that its by-laws provide an independent basis for indemnification without reference to good faith, 5 or in the alternative, that its indemnification was mandatory under § 145(c) and that the settlement constituted success on the merits or otherwise. Although we find the indemnification did not violate Delaware law, we reject both of Owens Corning's arguments for that conclusion. First, Owens Corning cannot avoid the good-faith requirement through provision of an alternative basis for indemnification; the ability to provide indemnification is constrained by its corporate form as governed by the law of Delaware. As discussed earlier, the Delaware chancery courts have generally required good faith to be present for permissive indemnification, an interpretation also followed by the well-reasoned opinion of the Second Circuit in Waltuch. 23 With regard to Owens Corning's second argument, it is also extremely dubious that a payout of almost ten million dollars would be deemed success by the courts of Delaware. Both of the main cases on the issue, VonFeldt and Waltuch, have declined to define the term precisely, but a reading of them suggests they would have rejected labeling Lavalle as a success appropriate for § 145(c). See Waltuch, 88 F.3d at 96 & n.12 (stating [e]scape from . . . detriment, for whatever reason, is determinative but also we need not decide whether a defendant's settlement payment automatically renders that defendant 'unsuccessful' under § 145(c)); Von Feldt, 1999 WL 413393 at  (not reaching question of whether roommight exist for viewing nominal consideration as consistent with success) (emphasis added). By contrast, the Ninth Circuit's interpretation of Maryland law in Safeway appears willing to extend the meaning of success to payment of a substantial monetary settlement, so long as the defendant has not conceded liability. See 64 F.3d at 1290 n.24. This definition arguably creates the potential for moral hazard and collusion, because it allows directors to structure settlement terms that shift costs on to their insurer. Moreover, since indemnification arising from such a success could presumably be challenged under Delaware law for lack of directorial good faith, equating compromise with success would create considerable tension with the mandatory nature of § 145(c) indemnification. 6 24 Whatever may be the merits of the Ninth Circuit's view as a general matter, an inspection of the Delaware statute shows that the provisions in sections 145(a) and 145(b) are much more clearly designed for situations where settlements are paid out. Both sections (a) and (b) explicitly mention settlement, whereas § 145(c) does not, limiting itself to costs and attorney's fees. This provides a strong indication that section (c), unlike (a) and (b), is not intended to be ordinarily applicable to settlements. Therefore, we hold that Owens Corning's indemnification arising from the Lavalle settlement could not have proceeded under § 145(c). 25 However, corporations do have significant flexibility regarding their procedures, as long as they remain consistent with public policy and the controlling corporate law. See Hibbert v. Hollywood Park, Inc., 457 A.2d 339, 344 (Del. 1983);Waltuch, 88 F.3d at 92-93. It is not impermissible for a Delaware corporation to accord a director seeking indemnification a rebuttable presumption of good faith. See VonFeldt, 1999 WL 413393, at . Therefore, where a corporation has extended indemnification to the maximum permissible extent, as Owens Corning has done, such a presumption may be applied. This accords with learned commentary on Delaware law, which describes the powers of the corporation to include provision of accelerated procedures for the 'determination' required by Section 145(d) . . . [or] procedures under which a favorable determination will be deemed to have been made under circumstances where the board fails or refused to act[.] 1 R. Franklin Balotti & Jesse A. Finkelstein, Delaware Law of Corporations and Business Organizations, § 4.16; Waltuch, 88 F.3d at 95 n.10 (citing this treatise section). Thus, the specific provisions of § 145(d) are not mandatory in these circumstances with regard to indemnification under §§145(a),(b). Our reading of these rules is that good faith may be presumed under the expansive by-laws of Owens Corning, even if the relevant determination is not specifically made. National Union could still challenge, under Delaware law, whether Owens Corning's directors were in fact acting in good faith back in 1989 and thereafter, when the factual predicate of the Lavalle action arose. See supra n.4. However, National Union does not seem to have offered specific allegations on this issue in its appeal. 7 26 It is not precisely clear on what grounds the district court determined that the indemnification here comported with Delaware law. The court's opinion appears to rely primarily on the claim that there was a success by the directors, resulting in mandatory indemnification under § 145(c). Although for the reasons discussed we cannot support this interpretation, we may affirm on any grounds supported by the record. City Management Corp. v. U.S. Chem. Co., Inc., 43 F.3d 244, 251 (6th Cir. 1994). We conclude that the indemnification occurred in relation to a settlement under §145(a), 8 in which good faith was required. But we further conclude that good faith was made subject to a presumption through the corporate by-laws, and that this presumption was allowable under the corporate flexibility we believe a Delaware court would find conferred by § 145(f). Given that this presumption of good faith stands unrebutted by the party ultimately made responsible, the indemnification proceeded according to law, and was not made in breach of the Policy.