My colleague at the University of Cincinnati College of Law, Sean Mangan, has written this guest post on Ohio’s corporate advancement statute, and the Ohio Supreme Court’s recent decision in Miller v. Miller. Read the blog’s analysis of the Miller case here. Sean’s focus at the U.C. College of Law is the practice of law in non-litigation contexts, including contract drafting, client counseling, and corporate governance.
Guest Post by Sean Mangan
The Ohio Supreme Court got it right in Miller v. Miller, a recent decision that clarifies the relationship between indemnification and advancement under Ohio Revised Code section 1701.13(E). In the case, a corporation sued one of its directors for breach of fiduciary duty; the director responded by seeking advancement of his legal fees and costs from the corporation under R.C. 1701. 13 (E)(5). The central question is whether advancement is mandatory even when the corporation is the opposing litigant and the director seeking advancement has breached fiduciary duties. The court sided with the director, finding that advancement is required under the terms of the Ohio statute.
The corporation’s argument against advancement is appealing at first blush. Advancement does not seem to make much sense when a director is sued by the very party paying the advance, particularly if the director is not entitled to indemnification because of fiduciary breach. In essence, the court’s decision requires a corporation to pay the legal fees of its adversary throughout the course of litigation, even if it is known at the outset that such fees must be repaid to the corporation because indemnification is not available. The whole exercise seems circular and rather silly.
Underlying this argument is the assumption that indemnification and advancement are intertwined to such a degree that advancement is not merely related to indemnification, but actually dependent on it. In other words, advancement exists only when indemnification is available; a party that is not entitled to indemnification is consequently barred from advancement. The logic of this approach is seductive, as common sense suggests that pre-judgment advancement can exist only when post-judgment indemnification rights exist.
Ohio law – through the plain words of R.C. section 1701.13(E) and the Miller decision – rejects this approach and instead recognizes advancement and indemnification as distinct and independent concepts, albeit related. Indemnification works like insurance: when the dust has settled and the case is over, the parties look at what happened and determine if a reimbursement payment is appropriate. Advancement is more like credit in that litigation costs are paid up front as the case proceeds, and the funds are remitted only if indemnification does not exist following the post-judgment determination.
The operative difference between the two concepts is the shift of cash flow risk: the corporation bears the risk in advancement, but the director bears it in indemnification. While parties often use advancement to enhance the attractiveness of indemnification rights, the concepts remain temporally and qualitatively distinct. Indemnification looks backwards in time and depends on the ultimate disposition of the case or the actions of the parties, while advancement looks forward in time and attaches regardless of case outcome.
Ohio’s recognition of these distinctions is evident in the statutory text. Indemnification rights under R.C. section 1701.13(E)(1) and (2) are permissive (“may”), apply to a broad class of individuals that serve the corporation now or in the past, and depend on the conduct of the parties and the ultimate disposition of the case. In contrast, the advancement provision under R.C. section 1701.13(E)(5) is mandatory (“shall”), applies only to directors, and applies only to those currently serving as directors by omitting the words “past or present.” Also absent from the advancement statute is any qualification based on the nature of the case, the actions of the parties, or the outcome of the case. While the statute is hardly a model of clarity, its import is clear following Miller: advancement to current directors is a mandatory obligation that attaches to the corporation immediately upon receipt of the director’s undertaking, regardless of the nature of the underlying case, the identity of the litigating parties, or the prior actions of the director.
The result is an either/or advancement regime, where the corporation must advance litigation costs for a director unless the corporation has expressly opted out of the statutory requirement through an explicit provision in its articles or regulations as permitted by section 1701.13(E)(5)(a). This opt-out is the first line of defense for a corporation that seeks to avoid advancement, and the first step following Miller is to determine if a corporation’s governing documents effectively execute this option in accord with the statute.
Between the pendulums of a wholesale opt-out or the statutory mandate, however, a number of options exist to craft a custom approach to advancement. A corporation should consider whether to (i) extend advancement rights to past directors and other officers or executives, (ii) prohibit advancement where the corporation is the opposing party, and (iii) prohibit advancement in cases alleging breach of fiduciary duty. Another attractive option is to expressly tie advancement directly to indemnification under the governing documents such that advancement is contingent on a right to indemnification. In drafting the option chosen, the corporate document should clearly address indemnification and advancement separately in order to avoid the confused comingling of these concepts that adversely impacted the corporation in Miller. In addition, offset rights should clearly and expressly permit the corporation to deduct advancement costs from amounts owed to the corporation from the director.
A corporation’s approach to indemnification and advancement is fundamentally related to its choice of leadership structure, the quality of outside directors it can attract, and the bargain reached between owners in a closely held corporation. These provisions are often given short shrift when drafting organizational documents and may be forgotten as time goes on. The result in Miller demands a re-examination of these provisions and a thoughtful conversation as to the relationship among executives, directors, and shareholders.