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Wendy’s Indemnification Pacts Atypical; Will They Matter?"

By Melissa Klein Aguilar — August 9, 2005

There is little question that, since The Sarbanes-Oxley Act of 2002 was enacted, the issues of executive accountability, insurance and indemnification have garnered greater attention by directors and officers of public companies.

Companies have always had to concern themselves with liability issues, but, “that concern has been elevated since Enron and SOX,” notes Robert Benowitz, a partner at Rick Steiner Fell & Benowitz in New York.

That concern took an interesting turn last month, when restaurant operator Wendy's International disclosed that it had signed indemnification agreements to provide protection to all of its current executive officers as well as some other officers and employees of the company.

In an 8-K filed with the Securities and Exchange Commission on July 12, the $3.6 billion fast-food chain said it signed agreements that generally require it to indemnify and hold harmless officers and certain other employees for liabilities arising from their service to the company if they acted in good faith. Employees would also be indemnified in the case of criminal proceedings, if they believe that their conduct was lawful. The agreements also provide for the advancement of defense expenses.

Wendy’s did not return a call for comment, but the company said in its regulatory filing that the pacts were “similar to the form of indemnification agreement the Company entered into with its directors beginning in 2003.” The agreements are also apparently consistent with the indemnification provisions of its corporate bylaws.

The company did not specify what prompted the signing of the indemnification agreements.

Unusual And Atypical

Indemnification provisions, which are meant to give protection to directors and officers so they’re not discouraged from serving, on their own are not unusual. But according to Benowitz and others who specialize in employment law, most companies generally include such provisions in their bylaws, rather than signing individual contracts with executives and other employees.

“Most companies just say in their bylaws that they will indemnify their officers and directors to the extent permitted by state law,” said Maureen Brundage, a partner and head of the securities practice in the New York office of the law firm White & Case.

In recent weeks, however, several other companies have disclosed indemnification agreements for officers and directors. On July 28, for example, $225.8 million Activant Solutions disclosed that it had entered into an indemnification agreement with a recently named director, Robert Shaw. According to the company's 8-K, the agreement provides that the company "indemnify and advance expenses to Mr. Shaw to the fullest extent provided in [the company's] certificate of incorporation."

On Aug. 1, $210.6 million Commerce Energy Group disclosed that it had entered into compensation and indemnification agreements with its new CEO, Steven Boss. And also last week, Superior Well Services—which just completed its initial public offering—disclosed indemnification agreements for nine directors and officers on Form 8-K (see box above, right for the agreements).

Though such agreements aren’t as common as bylaw provisions, Brundage said spelling out the details of the indemnification in a contract benefits the employees or board members impacted. “Having a contract gives officers and directors more comfort,” said Brundage. “[A contract] may make the officers’ legal position a bit easier; it provides clarity around the process and gives them more certainty as to how the process would work.”

Benowitz said the Wendy’s contracts are atypical for another reason. He noted that while the burden usually falls on the employee to prove that they acted in good faith, in this case, that burden has been shifted onto the company.

“What’s unusual about the Wendy’s agreement is that it provides a contract right to indemnification, which includes a provision that the party seeking indemnification is presumed to have acted in good faith and the burden to prove otherwise is on the company,” said Benowitz. “That’s not typical. Under most bylaw provisions, the board has the power to determine whether someone is entitled to indemnification. In cases where the board determines that indemnification isn’t warranted because the individual hasn’t acted in good faith, the burden of proof usually rests with individual seeking indemnification that they acted in good faith.”

But Benowitz, a former attorney with the SEC in the Division of Corporate Finance and the Division of Enforcement, cautioned that—even with such agreements in place—employees may find themselves on the legal hook in the eyes of the SEC.

Benowitz said that in some recent cases he’s worked on involving senior executives who had the right to be indemnified and who were advanced legal fees, “when the decision is made to enter into settlement discussions with the SEC within the context of a consent judgment where the client is not admitting or denying the allegations and where the SEC is imposing a civil penalty, the SEC has taken the strong position that the penalty must be paid by the individual and may not be reimbursed by the company, despite the fact that the individual would be entitled to indemnification under the company bylaws or an employment agreement.”

Added Benowitz, “We believe that the SEC will continue to take this position in the context of settlement agreements, irrespective to any contract rights.”

While the reason for the agreements in Wendy’s case isn’t clear, Brundage says companies might consider such contracts if they are having difficulty attracting directors and officers due to current or past legal troubles. “To the extent that a company has a problem retaining or attracting people because of concerns about liability, this may be a way to help with that without giving up much, since most companies give what’s required by state law,” said Brundage.

Brundage at White & Case said she isn’t aware of many companies signing such pacts and none of her clients have asked for them. However, she noted that companies may have such indemnification provisions that aren’t as apparent because they may be part of another agreement, such as a change of control agreement.

“I don’t think most public companies need them, because the officers are protected by the applicable state law and by a company’s bylaw or provision,” said Brundage. Still, she added, “In light of what’s going on, I wouldn’t say it’s illogical. It’s worthy of consideration, especially if companies are having difficulty retaining or finding people.”

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