Q&A: Board Member Indemnification

Q Our board president was given a violation for doing electrical work without a permit and blamed the superintendent for reporting the work to the New York City Electrical Board. She asked the board for the reimbursement for the cost of the permit. The board voted on the issue and paid her using corporate funds. Even though the board president abstained, is this a violation of section 719 of the Business Corporation Law? If so, how should this violation be brought up to the shareholders, and what can be done?

-- Manhattan Shareholder

A According to Adam D. Finkelstein, Esq., an associate with the Manhattan law firm of Kagan Lubic Lepper Lewis Gold & Colbert, “This is an interesting question which raises two issues. First, whether a payment by a corporation to an individual can be considered a dividend that violates Section 719 of the Business Corporation Law (BCL); and second, to what extent are shareholders, officers and directors entitled to a corporation's indemnification? Specifically, the shareholder asks whether his co-op board authorized an illegal dividend and exceeded its authority in approving the payment.

“Generally, a dividend is the distribution of a corporation's assets to its shareholders which must be made on an equal pro rata basis to all holders of each particular class of stock. While the BCL permits an unequal dividend among differing classes of stock, a corporation may not discriminate against shareholders within the same class of stock. In addition, BCL Section 719 places liability on directors who, among others, declare dividends when the corporation is insolvent or when the dividend is not made out of the corporation's surplus assets.

“Although the shareholder’s question refers to a distribution of a corporation's assets to pay a fine, it does not appear that such a distribution would be considered a dividend in violation of Section 719 since the payment in question was not made to all shareholders but rather was a general corporate expenditure. Usually, a corporation's board of directors is authorized to expend corporate assets for valid corporate purposes.

“Furthermore, the bylaws for co-op apartment corporations and the BCL permit the indemnification of officers and directors. Therefore, as a general rule, a board under many circumstances would be permitted to provide an indemnity to a director for actions taken on behalf of the corporation. However, according to Section 721 of the BCL, no indemnification should be for acts that were committed, ‘in bad faith or were the result of active and deliberate dishonesty.’

“Although not specifically stated in the shareholder’s letter, there is an inference that since the president ‘blamed the superintendent for reporting the work to the New York City Electrical Board,’ the president deliberately tried to circumvent the law. If this is a correct inference, the president would not be entitled to seek the corporation's indemnity regardless of whether the work, for which the violation was issued, was performed by the corporation (i.e.: in a common area of the building) or by the president individually (i.e.: in the president's apartment).

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