The New York Court of Appeals, the state's highest court, recently handed down an important decision regarding indemnification of officers and directors. In Baker v. Health Management Systems, 2002 WL 724707, the court answered a question certified to it by the U.S. Court of Appeals for the Second Circuit ruling that Article 7 of the Business Corporation Law of New York ("BCL") does not require a corporation to pay "fees on fees", i.e., a corporation is not required to indemnify an officer/director for expenses incurred in enforcing indemnification obligations against the corporation.

In Baker, one director (Siegel) retained separate counsel to defend him against a lawsuit that named the corporation and its directors as defendants. Siegel succeeded in having all of the claims against him dismissed. Health Management balked at paying Siegel's separate counsel fees as it felt separate counsel was unnecessary.

Siegel sued to force Health Management to pay his legal fees related to the original lawsuit and his legal fees related to enforcing his indemnification rights. The Southern District Court awarded him counsel fees related to the original lawsuit but ruled that he was not entitled to recoup the amount spent to enforce indemnification. Siegel appealed and the Second Circuit, finding no relevant precedent in New York, certified the fees on fees question to the Court of Appeals.

The Court of Appeals ruled that Article 7 of the BCL required only that the corporation indemnify for fees "actually and necessarily incurred as a result of" the underlying action or proceeding. However, other expenses incurred as a result of the corporation's refusal to indemnify would not be indemnifiable under Article 7 of the BCL.

The decision in Baker affects New York corporations in two ways. First, a corporation may use its refusal to indemnify as leverage against an officer or director with seeming impunity as it will not be forced to pay the fees expended to enforce indemnification (assuming of course, that the corporation had a good faith basis to refuse to indemnify); and second, the corporation may find it more difficult to retain qualified officers or directors unless it contractually obligates itself (through by-laws, employment agreements or indemnification agreements) to pay fees on fees.

Every corporation should consider and review its current obligations and policies to determine whether it is desirable to implement measures to obligate itself to pay "fees on fees". In addition, each potential director/officer is strongly encouraged to consider whether to request that a corporation contractually obligate itself to pay fees on fees before joining such corporation.

Any person who has a question about this memorandum or its application to specific circumstances may obtain additional guidance by contacting this firm.