INDEMNIFICATION AND D & O INSURANCE IN EMPLOYMENT CONTRACTS

By G. A. Finch

Indemnification By Employer

In my law practice covering executive employment contracts, I see too infrequently a provision requiring an employer to indemnify an executive for any costs, expenses, liabilities, and losses incurred by the executive in the performance of his duties with the company.  Usually, the indemnification arises in the context of litigation costs.  It should apply to any kind of claim or proceeding including an action, law suit, arbitration, investigation, or administrative proceeding.  It should also apply to both civil and criminal actions, investigation, and proceedings.

The costs, expenses, liabilities and losses should include, but not be limited to, reasonable attorneys’ fees, judgments, interest, expenses of investigation, fines, excise taxes or penalties and amounts paid or to be paid by executive in any settlement.

A well drafted indemnification provision will require the employer to advance to the Executive all his costs and expenses concerning a claim or proceeding.

An indemnification provision may have qualifying language that, as a precondition for indemnification, the Executive must be properly performing his obligations in good faith.

Claw Black of Indemnification Payments

Some indemnification provisions will have a mechanism allowing the employer to claw back the amounts advanced to an Executive if a determination has been made that the Executive was not entitled to indemnification for the subject costs and expenses.

The most comprehensive indemnification provision I have seen used reads as follows: “Employee shall be held harmless and fully indemnified by Employer to the fullest extent permitted by [State X] law without qualification or limitation.”

A companion provision that would be prudent for the Executive to include in his employment agreement is that the employer be required to keep in place directors and officers’ liability insurance coverage for the Executive during his employment with the employer and for four years afterward.

Executives get investigated, prosecuted, and sued all the time.  An Executive’s having indemnification and insurance provisions will offer the Executive some peace of mind.

Indemnification By Employee  

Employers sometimes require an Executive to indemnify the Company.

One kind of Executive’s obligation to indemnify  involves the Executive’s indemnifying, defending, and holding his company harmless from any uninsured portion of any claim, loss or expense arising from any action by the Executive that contravenes the rules and policies of the company, any applicable laws or that arise from intentional misconduct by the Executive.

New Employer’s Protection from Old Employer’s Restrictive Covenants

Another kind of Executive’s obligation to indemnify involves the Executive warranting that Executive is not under any legal or contractual obligations that contravenes the new employer’s employment agreement and execution of the employment agreement will not breach any other agreement by the Executive.  If there is such a breach, then the Executive must indemnify the new employer and must hold the new employer harmless from and against any and all loss, damage, and expense emanating from the claim against the Executive or the new employer arising from Executive’s relationship with his previous employer.  The breaches would typically involve non-compete provisions, non-solicitation provisions, and confidentiality provisions.

Employers must protect themselves from new employees who know they have valid legal obligations to previous employers like confidentiality agreements. One additional way to protect themselves is for the employers to require the prospective employee to provide copies of all employment and separation agreements containing restrictive covenants like non-compete, non-solicitation, and confidential information.

Employers should also be able to be made whole from the bad conduct of their employees giving rise to uninsured liability.

The scope and kind of indemnification by an employee must be appropriately negotiated by each side.  Obviously indemnification amounts can be quite burdensome and even financially catastrophic for an employee.

TERMINATION FOR CAUSE: MORAL TURPITUDE

BY G. A. FINCH

Employment contracts may have a termination-for-cause provision.  This kind of provision may include the term “moral turpitude.”  The following are two different examples of a termination-for-cause definition clause containing moral turpitude:

  • Employee’s conviction of, or guilty plea or nolo contendere plea to, or confession of, a Class A-type felony or felony involving moral turpitude.
  • The Employee’s conviction of, or plea of guilty or nolo contendere to, (a) a felony (other than traffic violations), (b) a crime involving moral turpitude, or (c) a criminal act which adversely affects the business or reputation of Company, its parent or its subsidiaries.

These typical for-cause termination clauses that the use term “moral turpitude” do not define the concept.

The term turpitude means vile, depraved, shameful, or base.  It has a grave meaning, and even the sound of the word suggests a perverseness.  You add the word “moral” before “turpitude” and it suggests an egregiously bad act or conduct.  While we have a textbook definition of “moral turpitude” as being reprehensible conduct, what can it mean in practice?  Who knows?  However, an executive should care.

The term is too vague and subjective.  Crimes come in varying degrees of wrongdoing.   Felonies involve varying degrees of criminality.  Some are worse than others. In order to avoid arbitrary results and inconsistent employer or judicial application, we ought to discard this hidebound term altogether.  When representing executives or organizations seeking to enter into employment contracts, I discourage the use of this term.  I prefer an itemized list of causes for termination and plain language like the following clause:

  • Employee’s commission of any act (i) involving (A) misuse or misappropriation of money or other property of Corporation or (B) a felony or repeated use of drugs or intoxicants; or (ii) which disparages the business integrity of Corporation, its parent Corporation or subsidiaries or affiliates or their officer directors, employees or customers, and materially and adversely affects the business reputation of Corporation.

This clause makes it readily understandable, among other acts, what kind of crime would be cause for termination, i.e. a felony. In the moral turpitude clauses above, the term crime or felony is modified by the term “moral turpitude” and, consequently, makes the felony or crime more vague and difficult to determine its applicability.

The use of term moral turpitude is anachronistic and should be eliminated from employment contract termination-for-cause provisions.

Copyright © 2012 by G. A. Finch, All rights reserved.

 

PREVAILING PARTY’S LITIGATION EXPENSES

A not uncommon provision in employment agreements, separation agreements, or stand alone agreements containing restrictive covenants (e.g. non-competition and non-solicitation) is a “prevailing party” provision.  This kind of provision grants the prevailing party in any litigation over an agreement the right to be reimbursed its, his or her legal fees and costs.

A typical prevailing-party provision will read like the following: “If litigation arises under this Agreement between the Company and the Executive, the prevailing party in such litigation shall be entitled to recover its or his reasonable attorneys’ fees, court costs and out-of-pocket litigation expenses from the non-prevailing party.”

The prevailing-party provision serves as a disincentive for an individual employee to assert his legal rights or to take a risk of violating an agreement.  From the outset, the employer ordinarily would have more financial resources to litigate, and this added provision of saddling the non-prevailing party with all the litigation costs has a chilling effect on the employee’s seeking vindication of his rights.  From the employer’s standpoint, this is precisely the sobering reminder that an employer wants to send to its ex-employees who may choose to test the validity of the employer’s restrictive covenants, especially non-compete clauses.

In any event, the prevailing-party provision is one that must not be overlooked by either the employee or the employer.

 

Copyright © 2012 by G. A. Finch, All rights reserved.

EXECUTIVE EMPLOYEE’S RIGHT TO TERMINATE EMPLOYMENT

BY G. A. FINCH

Executive employment agreements will ordinarily have termination of employment provisions.  Executives will assume the termination provisions go one way, i.e. that the employer is always doing the terminating.  What about the executive terminating his own employment?

Termination for Good Reason

The sophisticated executive or professional will negotiate a provision that allows him to terminate his employment for “Good Reason” and still receive certain compensation and benefits from his employer.  The provisions for termination for good reason by the executive can range from a few sentences to several paragraphs.

Categories of Good Reason

The employment agreement should define “Good Reason.”  Such definition may include an event where the assignment to the executive of any duties inconsistent in any material respect with the executive’s position, duties, responsibilities or status with the company as of the date of his employment agreement, or if a change in control has occurred, immediately prior to such change in control.  It may include a change in the executive’s reporting responsibilities, titles or offices with the company.  It may include any failure to re-elect the executive to any position with the company held by the executive.  It may include a reduction of the executive’s rate of annual base salary.  It may include any demand that the executive be based anywhere other than at the facility where the executive is currently located.  It may include travel on company business to an extent substantially more burdensome than the ordinary travel requirements of the executive.   It may include the failure of the company to continue in effect any employee benefit plan or compensation plan in which the executive is enrolled.  It may include the failure of the company to continue to provide executive and executive’s dependents medical, dental, disability, and life insurance benefits.  It may include failure of the company to provide the executive with paid vacation.  It could include failure to reimburse promptly the executive for any reasonable employment expenses.

Negotiating Termination Clause

The list could go on and on about the various events that could be deemed a Good Reason for an executive to terminate the employment agreement.  Like anything else, it is a matter for negotiations.

The more star power an executive has, coupled with his lack of need to take the position will increase his leverage to negotiate his right to terminate with resulting substantial compensation and benefits.

It is a wise executive who controls the circumstances of his employment.  An executive employee’s right to fire his employer  is a huge step in that direction.

 

Copyright © 2010 by G. A. Finch, All rights reserved.

POWER WORD PLAY (A Word, Term or Concept an Executive Ought to Know): CONSIDERATION

 

Because this is a blog that discusses both employment agreements and severance/separation agreements, which are contracts by another name, an executive can benefit from understanding some basic contract concepts.

One of these concepts is “consideration.”  A valid employment contract must comprise the elements of offer, acceptance, and consideration.

Consideration is a legal concept and is the bargained for exchange of promises or performances.   “The test of a sufficient consideration is whether the act, forbearance or return promise results in a benefit to the promisor or a detriment to the promisee.”  (Laurence P. Simpson, Contracts 2nd Edition, p. 80).

In an employment context, sufficient consideration to support an offer of employment would be the obligation to perform services by the employee and the obligation to perform wages/benefits/ and other compensation by the employer.

In a severance agreement, you may see a clause that reads something like this: “In consideration for signing this Agreement and complying with its terms, Employer agrees to pay Employee a total sum of $xxxx.”  

The Severance Agreement might state further that the parties agree that the contract clauses pertaining to severance payment and other compensation/benefits constitute sufficient consideration for this Agreement 

Like all contracts, the terms of an employment agreement must also be clear and definite.  Of course, we are not trying to turn our readers into lawyers as we have too many as it is.  Now when you hear a lawyer discussing contract issues and she says “there is a lack of consideration,” you will now know she is not complaining about some rude person.

THE SILENT EMPLOYMENT CONTRACT PROVISION: THE IMPLIED COVENANT OF GOOD FAITH AND FAIR DEALING

Sometimes it is necessary to state the obvious: An employment agreement is a contract that is subject to basic contract principles, interpretation and construction.   

Good Faith and Fair Dealing Required

We will often see in employment agreement express covenants not to compete and not to solicit.  What is not express in contracts, but implied in the law in many states, is the Covenant of Good Faith and Fair Dealing.  For example, Illinois law reads a duty of good faith and fair dealing into all contracts.  The duty is implied in every contract.  Employment agreements are no exception.

What does “good faith” and “fair dealing mean?”  The idea is that whatever contractual discretion a party has, the party must exercise such discretion reasonably and not capriciously or arbitrarily.  Good faith is not taking an opportunistic advantage that was not contemplated by the parties when they entered into their agreement.

Not Playing Nicely

An act of bad faith could be where an employer with some discretion under a for-cause termination provision terminates an employee arbitrarily or capriciously for allegedly disreputable behavior. Or it could be where an employer terminates an employee to avoid a payment deadline for stock vesting or bonus payment.  An employee example could be where an employee makes his employment contingent on his spouse finding a similar job in the new locale as the employee but the employee and his spouse purposely fail to obtain a new job because the employee has a change of heart and does not want to move.

In short, it is a matter of fair, honest and sincere course of dealing where the parties have some discretion.

Bullet Proof Your Agreement by Expressing Yourself

Courts cannot use this implied covenant to override an express term of an agreement.  Nor does this implied covenant ordinarily create a separate cause of action.  The courts use the covenant as an aid to interpretation and construction.  A well drafted, comprehensive agreement should not fall victim to this covenant.

Without express disavowal in the employment agreement, the implied covenant exists.   Accordingly, one party, who believes the other party is engaging in sharp practices by exploiting gaps in their employment agreement, may try to invoke the covenant.