Indemnity and Infidelity: Advancement of Defence Costs in Actions 'By...The Corporation'

Abstract:     
Indemnification refers to the financial protection provided by the corporation for its directors. It shields directors from expenses and liability of legal proceedings alleging breaches of their duty to the corporation. The author argues that although Canada's current federal statutory indemnification scheme, s.124 of the Canada Business Corporations Act ("CBCA") was intended to provide a comprehensive scheme for dealing with indemnification, it does not encompass actions brought directly by a corporation against its directors for a breach of duty to the corporation. Although direct actions would seem to fall naturally into subsection 124(4), which authorizes indemnification for actions "by...the corporation" this was intended to apply only to derivative actions. Nor can direct actions be appropriately accommodated by subsection 124(1), which is intended to deal with indemnification in actions brought by third parties. Derivative suits brought by corporate stakeholders, and direct suits brought by the corporation itself, are not the same; in direct suits the corporation and its management are truly adverse. It is contended that advancement in such cases is inappropriate and judicial inclination to interpret direct actions as falling within the purview of the section should be avoided.

This article reviews policy issues raised by advancement of defence costs to directors incurred in both derivative actions and direct actions by the corporation. This article begins with s. 124. The historical development of the section is canvassed to demonstrate that direct actions were never considered within its purview. Canadian federal indemnity laws have been heavily influenced by American corporation law, particularly that of Delaware, New York, and the Model Business Corporations Act. The impact of these statutes on the development of s. 124 is considered, concluding with a discussion of the merits of interpreting this section to encompass direct actions.

Keywords: indemnification, defence costs, defense costs, direct action, reimburse, derivative action, corporation, advancement, legal fees, company, directors, officers, indemnity, D&O, liability, CBCA, bad faith, mala fides, s. 124, corporate governance, regulation, litigation, lawsuit, financial protection

JEL Classification: G28, G30, G34, G39, K40, K42, K49, L20, L29, L50, M14

Accepted Paper Series