Toward the end of the last legislative session, the Connecticut General Assembly passed Public Act 97-246 (the "Act"). The Act, which was effective on its passage, contains a number of technical changes to the Connecticut Business Corporation Act (the "CBCA"), and the Connecticut Revised Nonstock Corporation Act, both of which became effective on January 1 of this year. In addition, the Act sets forth substantive changes to the CBCA in the area of indemnification of directors, officers, employees and agents.

The genesis of these changes sprung from amendments to the Revised Model Business Corporate Act ("RMBCA") adopted by the Committee on Corporate Laws of the American Bar Association ("ABA"). These amendments were promulgated to the RMBCA by the ABA Committee at the same time that the Connecticut legislature was first considering the adoption of the CBCA. No attempt was made by the Executive Committee of the Business Law Section of the Connecticut Bar Association (the "Committee"), as the principal supporter of CBCA draft legislation, to incorporate these new indemnification provisions at that time in order not to complicate or confuse the positive attention that the General Assembly was giving to the proposed legislation before it.

The Committee is of the belief that it is in keeping with the public policy endorsed by the Connecticut General Assembly in adopting the CBCA to consider all approved changes to the RMBCA and propose them for adoption to the General Assembly, with such revision as may be in the interest of Connecticut business or as may be necessary to address standing Connecticut public policies. The Committee thus prepared and sought introduction of draft legislation, in the fall of 1996, amending the indemnification sections of the CBCA which were based on the RMBCA. This draft legislation was incorporated into an omnibus Senate bill dealing with corporate law issues. The legislature agreed with the Committee endorsement of these changes and the Act was passed.

Notwithstanding the goal of mirroring the RMBCA, a few unique Connecticut provisions have been inserted into the indemnification language of the Act to reflect varying historic policy views designed to serve the needs of Connecticut businesses. These are described below as part of the general discussion of the new indemnification provisions.

The Committee on Corporate Laws of the ABA was initially motivated in 1994 to promulgate changes in the indemnification provisions of the RMBCA principally because of the fact that the then existing indemnification provisions were not in synchroniety with the section of the RMBCA which permitted a certificate of incorporation to include a provision limiting the liability of directors. Prior to amendment, the outside limits on the avoidance of liability that could be contained in a corporation's certificate of incorporation, under the RMBCA, were more favorable to directors than the outside limits contained in the permissible indemnification provisions. Although the CBCA defines the outer limits on the ability to protect directors from liability in manner different from the RMBCA, the CBCA when it became effective, on January 1, 1997 reflected a similar dichotomy.

The CBCA, subject to certain limitations, permits a certificate of incorporation to contain a provision limiting the personal liability of a director to the corporation or its shareholders for monetary damages for breach of duty to an amount not less than the compensation received during the year of the violation. The statutory limitations on the ability of a director to avoid liability for such a breach of duty specify that the breach cannot: (i) involve a knowing and culpable violation of law; (ii) enable the director or an associate to receive an improper personal economic gain; (iii) reflect a lack of good faith and a conscious disregard for duty to the corporation under circumstances in which the director was aware that the director's conduct or omission created an unjustifiable risk of serious injury to the corporation; (iv) evidence a sustained and unexcused pattern of inattention that amounted to an abdication of duty to the corporation; or (v) create liability for an unlawful distribution to the shareholders.

Part VIII(E) of the CBCA on indemnification initially set forth as did the RMBCA, that a director may be indemnified from liability if the director met certain standards. These standards require the director to have: (i) proceeded in good faith; (ii) reasonably believed, in the case of conduct in the director's official capacity, that the conduct was in the corporation's best interest; (iii) reasonably believed in all other cases that the director's conduct was at least not opposed to the corporation's best interest; and (iv) in the case of any criminal proceeding, had no reasonable cause to believe that the director's conduct was unlawful.

Because of these differing requirements for evaluating a director's conduct, a director under the CBCA, as initially enacted, might have been able to escape liability based on a permissible provision in the certificate of incorporation limiting director liability in circumstances for which the indemnification standards could not have been satisfied. In such situations, the director would not have been capable of seeking advancement of the director's legal defense expenses if the liability exposure had been clearly outside of the coverage of the indemnification provisions. Further, a director would not have been able to recover those expenses from the corporation at the end of the proceeding if the director had been protected by the liability limiting provision in the certificate of incorporation, but not otherwise entitled to indemnification.

The Committee on Corporate Laws of the ABA in adopting the indemnification amendments to the RMBCA noted that because certificate of incorporation liability limiting provisions and indemnification provisions are each aimed at the issue of allocating the economic costs of certain actual or alleged wrongful acts of a director, they both should permit a harmonious result. The revisions that the ABA endorsed in 1994 accomplished this goal.

By adopting the Act, the Connecticut General Assembly has achieved a similar harmonious result. This was accomplished by Section 4 of the Act which amends Subsection (b) of Section 33-636 of the CBCA to add a fifth optional provision that may be contained in a certificate of incorporation. The new language permits a certificate of incorporation to include an article that permits, or makes obligatory, indemnification of a director for liability to any person for any action taken, or any failure to take action, as a director, except liability that cannot be permissively limited by an optional certificate of incorporation provision. Henceforth, when both optional provisions permitted by C.G.S. 33-636(b) (4) and (5) are present in a certificate of incorporation, a director will be entitled to advancement of legal defense expenses so long as the director has not transgressed one of the five Connecticut statutory limitations described above.

As a result of the Act, an existing Connecticut corporation may amend its certificate of incorporation to contain a provision permitting or requiring indemnification of a director in all circumstances except those for which the statute prohibits the limitation of liability. Corporation's wishing to provide maximum protection for its directors will do just so. Practitioners forming new Connecticut corporations will want to add this scenario to their checklist of matters to review with the incorporators and promoters during the formation process.

Other changes in the indemnification provisions made by the Act which parallel prior changes to the RMBCA include the following:

Clarification of the procedural process to be followed to grant indemnification and simplification of the process to authorize the advance of expenses.A change permitting a court to issue an order to enforce a legal right to indemnification or advancement of expenses.A change permitting a court to require the advancement of expenses.A change permitting a court somewhat broader latitude to order indemnification.A change expressly permitting a corporation to obligate itself to provide indemnification and advancement of expenses in situations where indemnification and advancement of expenses would be permissible under the CBCA and to limit in advance its obligations to provide indemnification or advancement of expenses when otherwise required to do so.A change clarifying that a director-officer may obtain indemnification to the same extent as an officer, provided that the director-officer was solely acting in the capacity of an officer in the circumstances in question.A new provision which indicates that a corporation cannot grant officers, directors, employees or agents broader rights of indemnification or rights to advancement of expenses than those permitted by Part VIII(E) of the CBCA.

The 1994 amendments to the RMBCA eliminated all reference to the indemnification of employees and agents of a corporation on the basis that the corporation's ability to indemnify them is more appropriately governed by the laws of contract and agency. The intent was to permit a corporation to provide indemnification and advancement of expenses for employees or agents however it chooses within the broad scope of these laws.

Similar changes affecting employees and agents under the CBCA were not proposed to the legislature by the Committee out of a concern that the legislative intent in making such a change might be misconstrued if reference were not or could not be made to clearly delineated legislative history on the subject. The Committee also perceived that, in larger Connecticut corporations, the responsibilities and decision making authority of key employees can be equal or more substantial than the authority wielded by a person holding a corporate office for titular purposes, such as an assistant secretary, assistant treasurer or vice president. As such, it was deemed appropriate to make it explicitly clear for the benefit of such employees that indemnification was permissibly or obligatorily available to them under the statute. While there was no strong consensus on the Committee with respect to indemnification of agents, it was determined not to change the applicability of the indemnification provisions to agents since no change was being made for employees. Thus, employees and agents remain within the scope of the CBCA indemnification provisions.

The Act makes one important change to one of the indemnification grandfathering provisions of the CBCA. Prior to the passage of the Act, the grandfathering provision, which benefits officers, employees, and agents, required a corporation, which was in existence on December 31, 1996, to provide indemnification and advancement of expenses to officers, employees, and agents who are not also directors to the same extent as the corporation is permissively allowed to provide indemnification to a director under the other provisions of the CBCA. This provision differs from the grandfathering provision for directors that is set forth in the CBCA. The grandfathering provision for directors provides only for obligatory indemnification and not for obligatory advancement of expenses under similar circumstances. It was the belief of the Committee that the difference between these two grandfathering provisions was accidental and unintentional and that an amendment was in order to produce a similar result.

The Committee determined to eliminate the grandfathering of advancement of expenses to officers, employees, and agents rather than add an obligatory right to advancement of expenses to similarly situated directors. The rationale for this decision was founded upon the facts that a substantial number of Connecticut corporations are small, closely-held businesses which could experience material, financial hardship if forced to provide advance funds to a person, who is potentially eligible for indemnification, but as to whom facts prove that indemnification was not appropriate. While repayment of such advancements by the person who received the advances is required in such circumstances by the CBCA, a corporation which suffered a hardship in making the initial advances would not truly be made whole if the financial hardship translated to lost opportunities.

While obligatory advancement of expenses is thus no longer grandfathered under the CBCA, permissive advancement of expenses to directors, officers, employees, and agents within the confines of the statutory requirements remains available. By endorsing the permissive standard, the legislature gave all pre-CBCA corporations the same right that new CBCA companies have to make their own decisions as how best to handle the advancement of defense expenses to meet the needs of their own situation. The choices include the ability to provide for obligatory advancement of expenses in the certificate of incorporation, the bylaws, or by contract or to handle it on a case-by-case basis under the statute. However, all pre-CBCA corporations and their officers, employees, and agents should be alerted by business law practitioners to focus on this change and how it alters their current expectations.