A broker sued by a client typically has a lot of questions about rights and responsibilities. But none is more important than: “Who is liable for my defense and for the possible damages that follow?”
What we're talking about here is indemnification — essentially, the protection a firm will (or won't) afford a broker in a legal crisis. The issues surrounding indemnity can be complex, but a rep in legal trouble might be pleasantly surprised at the level of protection a firm can provide.
You Have Rights
Too often, a rep might not even know that the right to defense or indemnification exists. The right to defend and indemnify oneself traditionally arises from one of several sources. A hiring letter or employment contract is the most obvious. Such rights might also exist in the firm's charter, its by-laws or in an insurance policy. Further, state statutory law or common law may also provide for indemnity. The right to indemnification extends to many different areas, including judgments, fines, amounts paid in settlements and expenses — including attorney's fees related to the lawsuit.
As a general proposition, there are three types of statutory indemnification for corporate officers. First, the firm may be required by law to indemnify the broker. Second, the firm may be permitted by law, but not required, to indemnify. Or, third, the firm may be prohibited from doing so, regardless of its intentions or desires.
Because the law only deals with indemnification in certain situations, a broker trying to determine whether his or her firm must indemnify should first determine why he or she is being sued. A broker does not have to be a current employee of the firm in order to be entitled to indemnification. However, it is important that the claim asserted against the broker arise from actions that the broker performed as an officer of the firm.
Moreover, a broker who is an officer is not automatically entitled to be indemnified for every act committed while an officer. Generally, the act must be in connection with being an officer, not merely during the time while a broker is an officer. The distinction is a fine, but important, one. If a broker is sued for an act he could have performed without being an officer, the law will not impose an obligation upon the corporation to indemnify. Moreover, the law prohibits indemnification by a firm against certain types of acts that the law finds reprehensible.
What You Give Away
Several practical considerations also need to be factored in. First, indemnification usually carries with it some right to control defense. That might mean that the firm has reserved the right to decide who will represent the broker in any litigation, and may even elect to have common counsel. The obvious advantage, of course, is that this practice tends to be a low- or no-cost proposition for the broker. However, the interests of the firm and broker may not always remain convergent.
Moreover, the benefits of having the firm pay the costs of any judgment or award can be illusory. To be sure, knowing that the firm will stand behind the broker and pay any judgment or award is comforting. But just because someone else pays the damages does not necessarily mean that the broker has not suffered any loss or injury. And a firm may well pursue a scorched-earth litigation strategy, possibly wreaking havoc on the broker's name and reputation in an effort to minimize the amount it must pay in monetary damage.
In addition, a broker needs to be careful when entering into any type of separation, severance or release agreement with a firm upon departure. Drafters of such documents are most commonly concerned only with getting the broker up and running again, and with dissolving any restrictions on the broker's right to do business. But these documents commonly contain broad-based releases that may affect the right to defense and indemnification after the document is signed.
Writer's BIO: Jonathan P. Arfa is a New York employment lawyer representing brokers. arfalaw.com