Complete Home & Office Legal Guide/Complete Home and Office Legal Guide (Chestnut) (1993).ISO/stat/mbiz/busi5t.asc

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/* Part 5 of 8. */

8.33 Liability for Unlawful Distributions

(a) A director who votes for or assents to a distribution made in
violation of section 6.40 or the articles of incorporation is
personally liable to the corporation for the amount of the
distribution that exceeds what could have been distributed
without violating section 6.40 or the articles of incorporation
if it is established that he did not perform his duties in
compliance with section 8.30.  In any proceeding commenced under
this section, a director has all of the defenses ordinarily
available to a director.

(b) A director held liable under subsection (a) for an unlawful
distribution is entitled to contribution:

(1) from every other director who could be held liable under
subsection (a) for the unlawful distribution; and

(2) from each shareholder for the amount the shareholder accepted
knowing the distribution was made in violation of section 6.40 or
the articles of incorporation.

(c) A proceeding under this section is barred unless it is
commenced within two years after the date on which the effect of
the distribution was measured under section 6.40(e) or (g).

Subchapter D

Officers

8.40 Required Officers

(a) A corporation has the officers described in its bylaws or
appointed by the board of directors in accordance with the
bylaws.

(b) A duly appointed officer may appoint one or more officers or
assistant officers if authorized by the bylaws or the board of
directors.

(c) The bylaws or the board of directors shall delegate to one of
the officers responsibility for preparing minutes of the
directors' and shareholders' meetings and for authenticating
records of the corporation.

(d) The same individual may simultaneously hold more than one
office in a corporation.

8.41 Duties of Officers

Each officer has the authority and shall perform the duties set
forth in the bylaws or, to the extent consistent with the bylaws,
the duties prescribed by the board of directors or by direction

of an officer authorized by the board of directors to prescribe
the duties of other officers.

8.42 Standards of Conduct for Officers

(a) An officer with discretionary authority shall discharge his
duties under that authority:


(1) in good faith;

(2) with the care an ordinarily prudent person in a like position
would exercise under similar circumstances; and

(3) in a manner he reasonably believes to be in the best
interests of the corporation.

(b) In discharging his duties an officer is entitled to rely on
information, opinions, reports, or statements, including
financial statements and other financial data, if prepared or
presented by:

(1) one or more officers or employees of the corporation whom the
officer reasonably believes to be reliable and competent in the
matters presented; or

(2) legal counsel, public accountants, or other persons as to
matters the officer reasonably believes are within the person's
professional or expert competence.

(c) An officer is not acting in good faith if he has knowledge
concerning the matter in question that makes reliance otherwise
permitted by subsection (b) unwarranted.

(d) An officer is not liable for any action taken as an officer,
or any failure to take any action, if he performed the duties of
his office in compliance with this section.

/* A standard quite similar to that for directors. */

8.43 Resignation and Removal of Officers

(a) An officer may resign at any time by delivering notice to the
corporation.  A resignation is effective when the notice is
delivered unless the notice specifies a later effective date.  If
a resignation is made effective at a later date and the
corporation accepts the future effective date, its board of
directors may fill the pending vacancy before the effective date
if the board of directors provides that the successor does not
take office until the effective date.

(b) A board of directors may remove any officer at any time with
or without cause.


8.44 Contract Rights of Officers

(a) The appointment of an officer does not itself create contract
rights.

(b) An officer's removal does not affect the officer's contract
rights, if any. with the corporation.  An officer's resignation
does not affect the corporation's contract rights, if any, with
the officer.

/* This separates the appointment of office from the compensation
related to the office. */

Subchapter E


INDEMNIFICATION

INTRODUCTORY COMMENT

The indemnification provisions of the Model Act are among the
most complex and important in the entire Act.  Subchapter E of
chapter 8 is an integrated treatment of this subject and strikes
a balance between important social policies.

Indemnification provides financial protection by the corporation
for its directors, officers and employees against expenses and
liabilities incurred by them in connection with proceedings based
on an alleged breach of some duty in their service to or on
behalf of the corporation.  Today, when both the amount and the
cost of litigation have skyrocketed, it would be difficult or
impossible to persuade responsible persons to serve as directors
if they were compelled to bear personally the cost of vindicating
the propriety of their conduct in every instance in which it
might be challenged.

Indemnification if permitted too broadly, may violate basic
tenets of public policy.  It is inappropriate to permit
management to use corporate funds to avoid the consequences of
wrongful conduct or conduct involving bad faith. A director,
officer, or employee who acted wrongfully or in bad faith should
not expect to receive assistance from the corporation for legal
or other expenses and should be required to satisfy not only any
judgment entered against him but also expenses incurred in
connection with the proceeding from his personal assets.  Any
other rule would tend to encourage socially undesirable conduct.

A further policy issue is raised in connection with
indemnification against liabilities or sanctions imposed under
express provisions of state or federal civil or criminal
statutes. A shift of these liabilities from the individual
director or officer to the corporation by way of indemnification
may in some instances be viewed as frustrating the public policy
of those statutes which expressly impose the sanctions on the
director or officer.

The fundamental issue that must be addressed by an
indemnification statute is the establishment of policies
consistent with these broad principles: to ensure that
indemnification is permitted only where it will further accepted
corporate goals and to prohibit indemnification where it might
protect or encourage wrongful or improper conduct. As phrased by
one commentator, the goal of indemnification is to "seek the
middle ground between encouraging fiduciaries to violate their
trust, and discouraging them from serving at all." Johnston,
"Corporate Indemnification and Liability Insurance for Directors
and Officers," 33 BusLaw 1993, 1994 (1978).  The increasing
number of suits against directors, the increasing cost of
defense, and the increasing emphasis on broadening membership of
boards of directors of public companies all militate in favor of
establishing workable arrangements to protect directors and
officers against liability for action taken in good faith to the
extent consistent with broad public policy.


8.50 Subchapter Definitions

In this subchapter:

(1) "Corporation" includes any domestic or foreign predecessor
entity of a corporation in a merger or other transaction in which
the predecessor's existence ceased upon consummation of the
transaction.

(2) "Director" means an individual who is or was a director of a
corporation or an individual who, while a director of a
corporation, is or was serving at the corporation's request as a
director, officer, partner, trustee, employee, or agent of
another foreign or domestic corporation, partnership, joint
venture, trust, employee benefit plan, or other enterprise. A
director is considered to be serving an employee benefit plan at
the corporation's request if his duties to the corporation also
impose duties on, or otherwise involve services by, him to the
plan or to participants in or beneficiaries of the plan.
"Director" includes, unless the context requires otherwise, the
estate or personal representative of a director.

(3) "Expenses" include counsel fees.

(4) "Liability" means the obligation to pay a judgment,
settlement, penalty, fine (including an excise tax assessed with
respect to an employee benefit plan), or reasonable expenses
incurred with respect to a proceeding.

(5) "Official capacity" means: (i) when used with respect to a
director, the office of director in a corporation; and (ii) when
used with respect to an individual other than a director, as
contemplated in section 8.56, the office in a corporation held by
the officer or the employment or agency relationship undertaken
by the employee or agent on behalf of the corporation.  "Official
capacity" does not include service for any other foreign or
domestic corporation or any partnership, joint venture, trust,
employee benefit plan, or other enterprise.

(6) "Party" includes an individual who was, is, or is threatened
to be made a named defendant or respondent in a proceeding.

(7) "Proceeding" means any threatened, pending, or completed
action, suit, or proceeding, whether civil, criminal,
administrative, or investigative and whether formal or informal.

Official Comment

The definitions set forth in section 8.50 apply only to
subchapter E and have no application elsewhere in the Model Act.

2. Director

The second sentence of section 8.50(2) addresses the question of
liabilities arising under the Employee Retirement Income Security
Act (ERISA). It makes clear that a director who is serving as a
fiduciary of an employee benefit plan is nevertheless viewed as
acting as a director for purposes of this subchapter. Special
treatment is felt to be necessary because of the broad definition
of "fiduciary" in section 3(21) of ERISA, 29 U.S.C.  1002)21)
(1974), and the requirement of section 404 ( 1104(a)) that a
"fiduciary" must discharge his duties "solely in the interest" of
the participants and beneficiaries of the employee benefit plan.
Decisions by a director serving as a fiduciary under the plan on
questions regarding eligibility for benefits, investment
decisions, and interpretation of plan provisions regarding
qualifying service, years of service, and retroactivity are all
subject to the protections of this subchapter.  See also sections
8.50(4) and 8.51(b) of this subchapter.

4. Liability

"Liability" is defined for convenience, to avoid repeated
references to recoverable items throughout the subchapter.  Even
though the definition of "liability" includes both expenses and
amounts paid to satisfy or to settle substantive claims,
indemnification against substantive claims is not allowed in
several provisions in subchapter E.  For example, indemnification
in suits brought by or in the name of the corporation is limited
to expenses.  See section 8.51(e).

5. Official Capacity

The definition of "official capacity" is necessary because the
term determines which of the two alternative standards of conduct
set forth in section 8.51 applies: if action is taken in an
"official capacity," the person to be indemnified must have
reasonably believed he was acting in the best interests of the
corporation, while if the action in question was not taken in his
"official capacity," he need only have reasonably believed that
the conduct was not opposed to the best interests of the
corporation.

8.51    Authority to Indemnify

(a) Except as provided in subsection (d), a corporation may
indemnify an individual made a party to a proceeding because he
is or was a director against liability incurred in the proceeding
if:

(1) he conducted himself in good faith; and

(2) he reasonably believed:

(i) in the case of conduct in his official capacity with the
corporation, that his conduct was in its best interests; and

(ii) in all other cases, that his conduct was at least not
opposed to its best interests; and

(3) in the case of any criminal proceeding, he had no reasonable
cause to believe his conduct was unlawful.

A director's conduct with respect to an employee benefit plan for
a purpose he reasonably believed to be in the interests of the
participants in and beneficiaries of the plan is conduct that
satisfies the requirement of subsection (a)(2Xii).

(c) The termination of a proceeding by judgment, order,
settlement, conviction, or upon a plea of nolo contendere or its
equivalent is not, of itself, determinative that the director did
not meet the standard of conduct described in this section.

/* An important note that opens the possibility of a corporation
nevertheles indemnifying a person if their actions may be wrong
in a criminal (or plea bargain sense) but were not improper by
conisderaiton of the requirements of the corporation. */

(d) A corporation may not indemnify a director under this
section:

(1) in connection with a proceeding by or in the right of the
corporation in which the director was adjudged liable to the
corporation; or

(2) in connection with any other proceeding charging improper
personal benefit to him, whether or not involving action in his
official capacity, in which he was adjudged liable on the basis
that personal benefit was improperly received by him.

(e) Indemnification permitted under this section in connection
with a proceeding by or in the right of the corporation is
limited to reasonable expenses incurred in connection with the
proceeding.


Official Comment

1.  Section 8.51(a)

The standards for indemnification of directors contained in this
subsection define the outer limits for which voluntary
indemnification is permitted under the Model Act. Conduct which
does not meet these standards is not eligible for voluntary
indemnification under the Model Act, although court-ordered
indemnification may be available under section 8.54(2).  Conduct
that falls within these outer limits does not automatically
entitle directors to indemnification, although many corporations
have adopted bylaw provisions that obligate the corporation to
indemnify directors to the maximum extent permitted by statute.
Absent such a bylaw provision, section 8.52 defines a much
narrower area in which the directors are entitled as a matter of
right to indemnification.

Some state statutes provide separate, but usually similarly
worded, standards for indemnification in third-party suits and
indemnification in suits brought by or in the name of the
corporation. The Model Act establishes a single uniform test to
make clear that the outer limits of conduct for which
indemnification is permitted should not be dependent on the type
of proceeding in which the claim arises.  To prevent circularity
in recovery, however, section 8.51(e) limits indemnification in
connection with suits brought by or in the name of the
corporation to expenses incurred and excludes amounts paid to
settle or satisfy substantive claims.

The standards of conduct described in sections 8.51(a)(1) and
8.51(a)(2)(i) that a director's conduct in his official capacity
was in "good faith" and in the corporation's "best interests" is
closely related to the basic standards of conduct imposed by
section 8.30, but the two standards are not identical. No attempt
is made to define "good faith," a term used in both section 8.30
and section 8.51.  The concept of good faith involves a
subjective test, which would include "a mistake of judgment," in
the words of the Official Comment to section 8.30, even though
made unwisely by objective standards.  But the affirmative
requirement of section 8.3 that the "care of an ordinarily
prudent person in a like position" be exercised-is not included
in the standard of conduct for indemnification.  On the other
hand, section 8.51 requires that there be a "reasonable" belief
on the part of the director in most instances, and in the case of
criminal proceedings that there be no "reasonable" cause to
believe the conduct was unlawful. Accordingly, it is possible
that a director who has not acted "with the care an ordinarily
prudent person in a like position would exercise under similar
circumstances," as required by section 8.30, could nevertheless
be indemnified if the standard of section 8.51 were met. As a
corollary, it is clear that a director who has met the section
8.30 standards of conduct would be eligible in virtually every
case to be indemnified under section 8.51.

Section 8.51(a)(2)(ii) requires, if a director is not acting in
his official capacity, that his action be "at least not opposed
to" the corporation's best interests. This standard is applicable
to the director when serving another entity at the request of the
corporation or when sued simply because he is or was a director.
The words "at least" were added to qualify "not opposed to" in
order to make it clear that this test is an outer limit for
conduct other than in an official capacity.

4. Section 8.51(d)

This subsection makes clear that indemnification is not
permissible under section 8.51 in the face of a finding of
improper conduct either because liability is imposed in favor of
the corporation in a suit brought by or in its name or because
there is a finding that the director improperly received a
personal benefit as a result of his conduct.  Indemnification
under this subsection is prohibited if a director is adjudged
liable in a derivative suit because it is believed that there
should be no indemnification in this situation unless a court
first finds it proper. Section 8.54 permits a director found
liable to the corporation to petition a court for a judicial
determination of entitlement to indemnification. Voluntary
indemnification is also prohibited if there has been an
adjudication that a director improperly received a personal
benefit, even if, for example, he acted in a manner not opposed
to the best interests of the corporation.  Improper use of inside
information for personal benefit should not be an action for
which the corporation may provide indemnification, even if the
corporation was not thereby harmed. Although it is unlikely that
a person found liable for receiving an improper personal benefit
would be found to have met the statutory standard of conduct set
forth in section 8.51(a)(2)(ii), this limitation is made explicit
in section 8.51(d)(2).  Recourse to a court under section 8.54
may also be appropriate in some improper benefit cases-for
example, where it would be unfair for a small personal benefit to
foreclose indemnification in an expensive and complicated matter.


5. Section 8.51(e)

This subsection limits indemnification in suits brought by or in
the right of the corporation to expenses incurred in connection
with the proceeding. Its purpose is to avoid circularity that
would be involved if a corporation seeks to indemnify a director
for payments made in settlement by the director to the
corporation. This subsection applies only to settlements since
all indemnification is prohibited by section 8.51(d)(1)- subject
to the right to seek judicially approved indemnification under
section 8.54- in cases where a director is "adjudged" liable to
the corporation.

8.52 Mandatory Indemnification

Unless limited by its articles of incorporation, a corporation
shall indemnify a director who was wholly successful, on the
merits or otherwise, in the defense of any proceeding to which he
was a party because he is or was a director of the corporation
against reasonable expenses incurred by him in connection with
the proceeding.

Official Comment

Section 8.51 determines whether indemnification may be made
voluntarily by a corporation if it elects to do so.  Section 8.52
determines whether a corporation must indemnify a director for
his expenses; in other words, section 8.52 creates a statutory
right of indemnification in favor of the director who meets the
requirements of that section. Enforcement of this right by
judicial proceeding is specifically contemplated by section
8.54(1), which also gives the director a statutory right to
recover expenses incurred by him in enforcing his statutory right
to indemnification under section 8.52.

The basic standard for mandatory indemnification is that the
director has been "wholly successful, on the merits or
otherwise," in the defense of the proceeding.  The word "wholly"
is added to avoid the argument accepted in Merritt-Chapman &
Scott Corp. v. Wolfson, 321 A.2d 138 (Del.1974), that a defendant
may be entitled to partial mandatory indemnification if he
succeeded by plea bargaining or otherwise to obtain the dismissal
of some but not all counts of an indictment.  A defendant is
"wholly successful" only if the entire proceeding is disposed of
on a basis which involves a finding of nonliability. However, the
language in earlier versions of the Model Act and in many other
state statutes that the basis of success may be "on the merits or
otherwise" is retained. While this standard may result in an
occasional defendant becoming entitled to indemnification because
of procedural defenses not related to the merits-e.g. the statute
of limitations or disqualification of the plaintiff, it is
unreasonable to require a defendant with a valid procedural
defense to undergo a possibly prolonged and expensive trial on
the merits in order to establish eligibility for mandatory
indemnification.


8.53 Advance for Expenses

(a) A corporation may pay for or reimburse the reasonable
expenses incurred by a director who is a party to a proceeding in
advance of final disposition of the proceeding if:

(1) the director furnishes the corporation a written affirmation
of his good faith belief that he has met the standard of conduct
described in section 8.51;

(2) the director furnishes the corporation a written undertaking,
executed personally or on his behalf, to repay the advance if it
is ultimately determined that he did not meet the standard of
conduct; and

(3) a determination is made that the facts then known to those
making the determination would not preclude indemnification under
this subchapter.

(b) The undertaking required by subsection (a)(2) must be an
unlimited general obligation of the director but need not be
secured and may be accepted without reference to financial
ability to make repayment.

/* The provision of an advance for expense can in many cases be
determinative of whether the corporation indemnifies the director
as a realistic manner, since corporate litigation is expensive
and in many cases can be result in the expenditures of millions
of dollars. Since no proof that the director can repay the
advance is required, it can be money down the "drain" with the
directors receiving the best of professional help at the
corporations realisitic expense. */

(c) Determinations and authorizations of payments under this
section shall be made in the manner specified in section 8.55.

Official Comment

It is often critically important to a director who is made a
party to a complex proceeding that the corporation he served have
power to make advances for expenses at the beginning of and
during the proceeding.  Adequate legal representation and
adequate preparation of a defense may require substantial
payments of expenses before a final determination, and unless the
corporation may make advances for expenses, a defendant m%v be
unable to finance his own defense. This problem is complicated by
reason or the fact that during the early stages of a proceeding
(when advances are often needed) the facts underlying the claim
cannot be fully evaluated and the board of directors therefore
cannot accurately ascertain the ultimate propriety of
indemnification.

Section 8.53 establishes a workable standard: indemnification is
permitted if the facts then known to those making the
determination do not establish that indemnification would be
precluded under section 8.51.    The directors or special legal
counsel) making the determination under section 8.53(c would
normally communicate with counsel and the person or persons
monitoring the matter for the corporation in order to gain
familiarity with the status of the proceeding and the relevant
facts that have emerged, but it is not required (or expected)
that any form of independent investigation be undertaken for
purposes of the determination.  Thus, an advance may be made
under section 8.53 unless it becomes clear, from the facts at
hand, that indemnification under section 8.51 cannot be provided.
As additional facts become known, a different determination may
be required.


8.54 Court-Ordered Indemnification

Unless a corporation's articles of incorporation provide
otherwise, a director of the corporation who is a party to a
proceeding may apply for indemnification to the court conducting
the proceeding or to another court of competent jurisdiction. On
receipt of an application, the court after giving any notice the
court considers necessary may order indemnification if it
determines:

(1) the director is entitled to mandatory indemnification under
section 8.52, in which case the court shall also order the
corporation to pay the director's reasonable expenses incurred to
obtain court-ordered indemnification: or

(2) the director is fairly and reasonably entitled to
indemnification in view of all the relevant circumstances,
whether or not he met the standard of conduct set forth in
section 8.51 or was adjudged liable as described in section
8.51(d), but if he was adjudged so liable his indemnification is
limited to reasonable expenses incurred.

8.55 Determination and Authorization of Indemnification

(a) A corporation may not indemnify a director under section 8.51
unless authorized in the specific case after a determination has
been made that indemnification of the director is permissible in
the circumstances because he has met the standard of conduct set
forth in section 8.51.

(b) The determination shall be made:

(1) by the board of directors by majority vote of a quorum
consisting of directors not at the time parties to the
proceeding;

(2) if a quorum cannot be obtained under subdivision (1), by
majority vote of a committee duly designated by the board of
directors (in which designation directors who are parties may
participate), consisting solely of two or more directors not at
the time parties to the proceeding;

(3) by special legal counsel:

(i) selected by the board of directors or its committee in the
manner prescribed in subdivision (1) or (2); or

(ii) if a quorum of the board of directors cannot be obtained
under subdivision (1) and a committee cannot be designated
under subdivision (2), selected by majority vote of the full
board of directors (in which selection directors who are parties
may participate); or

(4) by the shareholders, but shares owned by or voted under the
control of directors who are at the time parties to the
proceeding may not be voted on the determination.

(c)  Authorization of indemnification and evaluation as to
reasonableness of expenses shall be made in the same manner as
the determination that indemnification is permissible, except
that if the determination is made by special legal counsel,
authorization of indemnification and evaluation as to
reasonableness of expenses shall be made by those entitled under
subsection (b)(3) to select counsel.

Official Comment

Section 8.55 provides the method for determining whether a
corporation should voluntarily indemnify directors under section
8.51.  In this section a distinction is made between a
"determination" and an "authorization." A "determination"
involves a decision whether under the circumstances the person
seeking indemnification has met the requisite standard of conduct
under section 8.51 and is therefore eligible for indemnification.
This decision may be made by the persons or groups described in
section 8.55(0).  In addition, after a favorable "determination"
is made, the corporation must "authorize" indemnification; this
includes a review of the reasonableness of the expenses, the
financial ability of the corporation to make the payment, and the
judgment whether limited financial resources should be devoted to
this or some other use by the corporation.

Section 8.55(b) establishes a procedure for selecting the person
or persons who will make the determination of eligibility for
indemnification. Even though directors who are parties to the
proceeding may not participate in the decision determining
eligibility for indemnification, they may, if necessary to permit
valid action by the board of directors, participate in the
decision establishing a committee of independent directors or
selecting special legal counsel.  Directors who are parties may
also participate in the decision to "authorize" indemnification
on the basis of a favorable "determination" if necessary to
permit action by board of directors.  This limited participation
of interested directors in the decision is justified by a
principle of necessity.

Legal counsel authorized to make the required determination is
referred to as "special legal counsel." In earlier versions of
the Model Act, and in the statutes of many states, he is referred
to as "independent legal counsel. The word "special" is felt to
be more descriptive of the role to be performed and is not
intended to indicate that the counsel selected should not be
independent in accordance with governing legal precepts. "Special
legal counsel" should normally be counsel having no prior
professional relationship with those seeking indemnification,
should be retained for the specific occasion, and should not be
either inside counsel or regular outside counsel.  It is
important that the selection process be sufficiently flexible to
permit selection of counsel in light of the particular
circumstances and so that unnecessary expense may be avoided.
Hence the phrase "special legal counsel" is not defined in the
statute.

8.56 Indemnification of Officers, Employees, and Agents

Unless a corporation's articles of incorporation provide
otherwise:

(1) an officer of the corporation who is not a director is
entitled to mandatory indemnification under section 8.52, and is
entitled to apply for court-ordered indemnification under section
8.54, in each case to the same extent as a director;

(2) The corporation may indemnify and advance expenses under this
subchapter to an officer, employee, or agent of the corporation
who is not a director to the same extent as to a director; and

(3) a corporation may also indemnify and advance expenses to an
officer, employee, or agent who is not a director to the extent,
consistent with public policy, that may be provided by its
articles of incorporation, bylaws, general or specific action of
its board of directors, or contract.

/* A provision giving specific authorization for contractual
indemnification. */

Official Comment

1. Officers, Employees, or Agents Who Are Not Directors

Section 8.56(3) authorizes indemnification for officers,
employees, and agents who are not directors, but neither requires
nor prescribes standards for their indemnification and expressly
states that their indemnification may be broader than the right
of indemnification granted to directors by this subchapter.  The
rights of employees or agents may derive from principles of
agency, the doctrine of respondeat superior, or collective
bargaining or other contractual agreement, rather than from the
statute.  . . . But indemnification under section 8.5(3(3) must
ultimately be "consistent with law." In effect, this leaves
public policy determinations as to what are permissible limits,
in a particular case, to the courts. For example, in Koster v.
Warren, 297 F.2d 418, 423 (9th Cir.1961), the court allowed
indemnification of an officer and an employee, both of whom
pleaded nolo contendere to an antitrust indictment at the
corporation's request, the court reasoning that they had foregone
their personal right to defend for the corporation's benefit. On
the other hand, the court indicated in dictum that an agreement
in advance by the corporation to indemnify anyone convicted of
antitrust violations would be against public policy.

2. Directors Who Are Also Officers, Employees, or Agents

Section 8.56 provides that officers, employees, or agents who are
also directors are subject to the same standards of
indemnification as other directors.  Consideration was given to
whether these officer-directors, if acting in their capacity as
an officer but not as a director, should have the benefit of the
additional flexibility afforded by section 8.56(3) for officers
who are not directors.  It was concluded, however, that all
directors should be treated alike; complications may be created
if directors who are not officers have potentially less
protection under the statute than directors who are officers. It
would also be difficult in many instances to distinguish in what
capacity an officer-director is acting. Finally, this subchapter
offers sufficient flexibility in indemnifying directors so that,
as a practical matter, foreseeable problems for officer-directors
can be handled within the statutory framework.

8.57 Insurance

A corporation may purchase and maintain insurance on behalf of an
individual who is or was a director, officer, employee, or agent
of the corporation, or who, while a director, officer, employee,
or agent of the corporation, is or was serving at the request of
the corporation as a director, officer, partner, trustee,
employee, or agent of another foreign or domestic corporation,
partnership, joint venture, trust, employee benefit plan, or
other enterprise, against liability asserted against or incurred
by him in that capacity or arising from his status as a director,
officer, employee, or agent, whether or not the corporation would
have power to indemnify him against the same liability under
section 8.51 or 8.52.


8.58 Application of Subchapter

(a) A provision treating a corporation's indemnification of or
advance for expenses to directors that is contained in its
articles of incorporation, bylaws, a resolution of its
shareholders or board of directors, or in a contract or
otherwise, is valid only if and to the extent the provision is
consistent with this subchapter. If articles of incorporation
limit indemnification or advance for expenses, indemnification
and advance for expenses are valid only to the extent consistent
with the articles.

(b) This subchapter does not limit a corporation's power to pay
or reimburse expenses incurred by a director in connection with
his appearance as a witness in a proceeding at a time when he has
not been made a named defendant or respondent to the proceeding.

Official Comment

Section 8.58(a) provides that a provision treating the
indemnification of directors by the corporation in articles of
incorporation, bylaws, shareholders' or directors' resolution, or
contract "is valid only if and to the extent it is consistent
with" this subchapter.  Earlier versions of the Model Act and the
statutes of many states provided that the statutory provisions
were not "exclusive" and made no attempt to limit the
nonstatutory creation of rights of indemnification.  This kind of
language is subject to misconstruction, however, since
nonstatutory conceptions of public policy limit the power of a
corporation to indemnify or to contract to indemnify directors,
officers, employees, or agents.

It is important to recognize that "to the extent it is consistent
with" is not synonymous with "exclusive." Situations may well
develop from time to time in which indemnification is permissible
under section 8.58 but would be precluded if all portions of
subchapter E were viewed as exclusive. But indemnification
provisions protecting against the consequences of bad faith or
willful misconduct are not consistent with this subchapter and
would not be valid. Furthermore, they would violate
well-understood principles of public policy and doubtless would
be invalidated on that ground even under statutes purporting to
make "nonexclusive" the statutory provisions for indemnification.
To the extent the consistency language may preclude
indemnification in circumstances where it is reasonable and
violates no statutory policy, an escape valve is provided in
section 8.55(2), which authorizes a court to grant
indemnification if a director "is fairly and reasonably entitled
to indemnification in view of all the relevant circumstances,"
even though he may not have fully met the standards of conduct
set forth in section 8.51.

Section 8.58 does not preclude provisions in articles of
incorporation, bylaws, resolutions, or contracts designed to
provide procedural machinery different from that provided by
section 8.55 or to make mandatory the permissive provisions of
subchapter E. For example, a corporation may properly obligate
the board of directors to consider and act expeditiously on an
application for indemnification or advances, or obligate the
board of directors to cooperate in the procedural steps required
to obtain a judicial determination under section 8.54.

Some corporations currently commit themselves, in one form or
another, to indemnify directors to the fullest extent permitted
by applicable law. These commitments are consistent with
subchapter E, subject to appropriate interpretation in light of
the facts and circumstances of the particular case.  Furthermore,
a commitment to maintain liability insurance for a director,
pursuant to section 8.57, is consistent with this subchapter.

Subchapter F

Directors' Conflicting Interest Transactions

Introductory Comment

2. Scope of Subchapter F

The focus of subchapter F is sharply defined and limited.  First,
the subchapter is targeted on legal challenges based on interest
conflicts only.  Subchapter F does not undertake to define,
regulate, or provide any form of procedure regarding other
possible claims.  For example, subchapter F does not address a
claim that a controlling shareholder has violated a duty owed to
the corporation or minority shareholders.

Second, the subchapter is applicable only when there is a
"transaction" by or with the corporation.  For purposes of
subchapter F, "transaction" generally connotes negotiations or a
consensual bilateral arrangement between the corporation and
another party or parties that concern their respective and
differing economic rights or interests-not simply a unilateral
action by the corporation but rather a "deal." See the discussion
regarding "transaction" under clause (2) of Section 8.60(2).

Third, subchapter F deals with directors only.

Subchapter F contemplates deletion of former Model Act section
8.32 dealing specially with loans to directors; a loan to a
director is simply a subspecies of directors' conflicting
interest transactions and is procedurally governed by subchapter
F. See the Note on Fair Transactions in the Official Comment to
section 8.61(0).

3. Structure of Subchapter F

The skeleton of subchapter F has only four parts. Definitions are
in section 8.60. Section 8.61 prescribes what a court may or may
not do in various situations. Section 8.62 prescribes procedures
for action by boards of directors regarding a director's
conflicting interest transaction.  Section 8.63 prescribes
corresponding procedures for shareholders.  Thus, the most
important operative section of the subchapter is section 8.61.

Note

In the Official Comments to subchapter F, the director who has a
conflicting interest is for convenience referred to as "the
director" or "D", the corporation of which he is a director is
referred to as "the corporation" or "X Co.," and another
corporation dealing with X Co. is referred to as "Y Co."

8.60 Subchapter Definitions

In this subchapter:

(1) "Conflicting interest with respect to a corporation means the
interest a director of the corporation has respecting a
transaction effected or proposed to be effected by the
corporation (or by a subsidiary of the corporation or any other
entity in which the corporation has a controlling interest) if

(i) whether or not the transaction is brought before the board of
directors of the corporation for action, the director knows at
the time of commitment that he or a related person is a party to
the transaction or has a beneficial financial interest in or so
closely linked to the transaction and of such financial
significance to the director or a related person that the
interest would reasonably be expected to exert an influence on
the director's judgment if he were called upon to vote on the
transaction; or

(ii) the transaction is brought (or is of such character and
significance to the corporation that it would in the normal
course be brought) before the board of directors of the
corporation for action, and the director knows at the time of
commitment that any of the following persons is either a party to
the transaction or has a beneficial financial interest in or so
closely linked to the transaction and of such financial
significance to the person that the interest would reasonably be
expected to exert an influence on the director's judgment if he
were called upon to vote on the transaction: (A) an entity (other
than the corporation) of which the director is a director,
general partner, agent, or employee; (B) a person that controls
one or more of the entities specified in subclause (A) or an
entity that is controlled by, or is under common control with,
one or more of the entities specified in subclause (A); or C) an
individual who is a general partner, principal, or employer of
the director.

(2) "Director's conflicting interest transaction" with respect to
a corporation means a transaction effected or proposed to be
effected by the corporation (or by a subsidiary of the
corporation or any other entity in which the corporation has a
controlling interest) respecting which a director of the
corporation has a conflicting interest.

(3) "Related person" of a director means (i) the spouse (or a
parent or sibling thereof) of the director, or a child,
grandchild, sibling, parent (or spouse of any thereof) of the
director, or an individual having the same home as the director,
or a trust or estate of which an individual specified in this
clause (i) is a substantial beneficiary; or (ii) a trust, estate,
incompetent, conservatee, or minor of which the director is a
fiduciary.

(4) "Required disclosure" means disclosure by the director who
has a conflicting interest of (i) the existence and nature of his
conflicting interest, and (ii) all facts known to him respecting
the subject matter of the transaction that an ordinarily prudent
person would reasonably believe to be material to a judgment
about whether or not to proceed with the transaction.

(5) "Time of commitment" respecting a transaction means the time
when the transaction is consummated or, if made pursuant to
contract, the time when the corporation (or its subsidiary or the
entity in which it has a controlling interest) becomes
contractually obligated so that its unilateral withdrawal from
the transaction would entail significant loss, liability, or
other damage.

Official Comment

The definitions set forth in section 8.60 apply to subchapter F
only and have no application elsewhere in the Model Act.


1. Conflicting Interest

The definition of conflicting interest requires that the director
know of the transaction. More than that, it requires that he know
of his interest conflict at the time of the corporation's
commitment to the transaction.  Absent that knowledge by the
director, the risk to the corporation addressed by subchapter F
is not present. In a corporation of significant size, routine
transactions in the ordinary course of business, involving
decision-making at lower management levels, will usually not be
known to the director and will thus be excluded by the
"knowledge" criterion in the definition.

The term "conflicting interest" as defined in subchapter F is
never abstract or freestanding; its use must always be linked to
a particular director, to a particular transaction and to a
particular corporation.

The definition of "conflicting interest" is exclusive. An
interest of a director is a conflicting interest if and only if
it meets the requirements of subdivision (1).

D can have a conflicting interest in only three ways.

First a conflicting interest of D will obviously arise if the
transaction is between D and X Co.

A conflicting interest will also arise under subdivision (1)(i)
if D is not a party but has a beneficial financial interest in
the transaction that is separate from his interest as a director
or shareholder and is of such significance to the director that
it would reasonably be expected to exert an influence on his
judgment if he were called upon to vote on the matter.  The
personal economic stake of the director must be in or closely
linked to the transaction-that is, his gain must hinge directly
on the transaction itself. A contingent or remote gain (such as a
future reduction in tax rates in the local community) is not
enough to give rise to a conflicting interest under subdivision
(1)(i).  See the discussion of "transaction" under the Official
Comment to subdivision (2).

If Y Co. is a party to or interested in the transaction with X
Co. and Y Co. is somehow linked to D, the matter is in general
governed by subdivision (1 )(ii).  But D's economic interest in Y
Co. could be so substantial and the impact of the transaction so
important to Y Co. that D could also have a conflicting interest
under subdivision (1)(i).

Note that basic standard set by subdivision (1)(i) and throughout
subchapter F-"would reasonably be expected to exert an
influence"-is an objective, not a subjective, criterion.

Second, a conflicting interest of D can arise under subdivision
(1)(i) from the involvement in the transaction of a "related
person" of D.  "Related person" is defined in subdivision (3).

Third, in limited circumstances, subsequently discussed, a
conflicting interest of D can arise through the economic
involvement of certain other persons specified in subdivision
(1)(ii).  These are any entity (other than X Co.) of which the
director is a director, general partner, agent, or employee; a
person that controls, or an entity that is controlled by, or is
under common control with one or more of the entities specified
in the preceding clause; and any individual who is a general
partner, principal, or employer of D.

The terms "principal" and "employer" as used in subdivision
(1)(ii) are not separately defined but should be interpreted
sensibly in the context of the purpose of the subdivision. The
key question is whether D is, by force of an overt or covert tie
to an employer or a principal who has a significant stake in the
outcome of the transaction, beholden to act in the interest of
that outside employer or principal rather than in the interest of
X Co.

The "would reasonably be expected" criterion of subdivision
(1)(i) applies also to subdivision (1)(ii).

Any director will, of course, have countless relationships and
linkages to persons and institutions other than those specified
in subdivision (1)(ii) and those defined in subdivision (3) to be
related persons.  But . . the subcategories of persons
encompassed by subdivision (1)(ii) are expressly intended to be
exclusive and to cover the field for purposes of subchapter F and
particularly section 8.61(a). Thus, if, in a case involving a
transaction between X Co. and Y Co., a court is presented with
the argument that D, a director of X Co., is also a major
creditor of Y Co. and that that stake in Y Co. gives D a
conflicting interest, the court should reply that D's creditor
interest in Y Co. does not fit any subcategory of subdivision
(1)(ii) or subdivision (3) and therefore the conflict of interest
claim must be rejected by force of section 8.61(a). The result
would be otherwise if Y Co.'s debt to D is of such economic
significance to D that it would fall under subdivision or put him
in control of Y Co. and thus come within subdivision


Subdivision (1)(ii) has a differentiated threshold keyed to the
significance of the transaction. See the Official Comment to
subdivision (2).

It is to be noted that under subdivision (1) of Section 8.60, any
interest that the director has that meets the criteria set forth
is considered a "conflicting interest".  If a director has an
interest that meets those criteria, subchapter F draws no further
distinction between a director's interest that clashes with the
interests of the corporation and a director's interest that
coincides with or is parallel to the interests of the
corporation.  If the director's "interest" is present, "conflict"
is assumed.


2. Director's Conflicting Interest Transaction

The definition of "director's conflicting interest transaction"
in subdivision (2) is the key concept of subchapter F,
establishing the area that lies within-and without-the scope of
the subchapter's provisions.  The definition operates
preclusively; it not only designates the area within which the
rules of subchapter F are to be applied but also denies the power
of the court to act with respect to conflict of interest claims
against directors in circumstances that lie outside the statutory
definition of "director's conflicting interest transaction." See
section 8.61(a).


(1) Transaction

To constitute a director's conflicting interest transaction,
there must first be a transaction by the corporation, its
subsidiary, or controlled entity in which the director has a
financial interest.  As discussed earlier, the safe harbor
provisions provided by subchapter F have no application to
circumstances in which there is no "transaction" by the
corporation, however apparent the director's conflicting
interest.  Other strictures of the law prohibit a director from
seizing corporate opportunities for himself and from competing
against the corporation of which he is a director; subchapter F
has no application to such situations. Moreover, a director might
personally benefit if the corporation takes no action, as where
the corporation decides not to make a bid.  Subchapter F has no
application to such instances. The limited thrust of the
subchapter is to establish procedures which, if followed,
immunize a corporate transaction and the interested director
against the common law doctrine of voidability grounded on the
director's conflicting interest.

However, a policy decision and a transactional decision can blur
and overlap. Assume X Co. operates a steel mini-mill that is
running at a loss. A real estate developer offers to buy the land
on which the mill is located and the X Co. board, having no other
use for the land, accepts the offer.  This corporate action can
readily be characterized either as a transaction-the sale of the
land-or as a business policy decision-to go out of an
unprofitable business. If D is a partner of the real estate
developer, D has a stake in the sale transaction and subdivisions
(1)(i) and (l)(iii) and all of subchapter F apply. But what if D,
having no such interest, is in the local trucking business and a
predictable consequence of closing the local mini-mill is that D
will benefit from a future increase in demand for hauling
services to bring in steel from more distant supply sources. An
intent of the words "in or so closely linked to the transaction"
in subdivisions (1)(i) and (1)(ii) is to focus subchapter F on
the transaction itself. D's financial stake as a trucker in this
situation lies not in the transaction, which is governed by
subchapter F, but in the corporate business decision, which is
not; accordingly, section 8.61(a) is inapplicable and imposes no
bar to the court's discretion.  Board action, though in
compliance with section 8.62, will not, ipso facto, yield safe
harbor protection for D or the transaction under section 8.61(b).

As another feature of the key term "transaction", the text of
subdivision (1) emphasizes that the term implies and is limited
to action by the corporation itself. The language of subchapter F
has no application one way or the other to economic actions by
the director in which the corporation is not a party or in which
the corporation takes no action. Thus, a purchase by the director
of the corporation's shares on the open market or from a third
party is not a "transaction" within the scope of subchapter F and
the subchapter does not govern an attack made on the propriety of
such a share purchase.

If the board of directors of X Co. decides to distribute "poison
pill" rights in order to fend off a possible takeover, that
occurrence does not constitute a "transaction" as contemplated by
subchapter F. . . . If, on the other hand, a board of directors
commits the corporation to a crown jewel" option granted to a
third party, there would be a "transaction".

But as noted earlier, for the transaction to be covered by sub
chapter F, the director (or other person designated by Section
8.60(i)) must have a beneficial interest respecting the
transaction. Subchapter F would obviously govern such a crown
jewel contract if a director was himself (or had a defined
relationship to) the third party. But the fact that the crown
jewel contract was in part motivated by the directors' desire to
keep themselves on the board would not, taken alone, constitute a
sufficiently direct interest in the transaction to bring it with
subchapter F.