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California's D&O Loan Ban And Advancement Of Expenses

Yesterday's post outlined the general scope of the ban on loans to directors and officers found in Section 315 of the California Corporations Code.  Because Section 315 doesn't define "loan", it may not always be clear whether an arrangement is a verboten loan.  Fortunately, no time need be wasted on the question of routine travel and other advances for expenses incurred in performance of a director's or officer's duties.  The statute specifically excludes these provided that in the absence of the advance, the director or officer would be entitled to be reimbursed for the expenses by the corporation, its parent or a subsidiary.  Cal. Corp. Code § 315(d).

But what about advancement of expenses for defending litigation?  Section 315 makes no mention of this type of advancement and the same question has been litigated with respect to the Sarbanes-Oxley Act's ban on loans to directors and executive officers.  Envirokare Tech, Inc. v. Pappas, 420 F. Supp. 2d 291, 294 (S.D.N.Y. 2006) ("The Court need not for present purposes define "personal loan," but an advance of defense costs pursuant to state law and corporate by-laws is not within that term. The Sarbanes-Oxley Act does not prohibit such advances.").

California answers the question directly in Section 317(f).  That statute authorizes a corporation to advance expenses to an agent (including a director or officer) incurred in defending a proceeding upon receipt of an undertaking by or on behalf of the agent to repay the amount advanced if it is determined ultimately that the agent is not entitled to indemnification.  Section 317(f) further provides that Section 315(a) does not apply to advances made pursuant to Section 317(f).

 

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