Your corporate client and CFO have been sued for the CFO's sexual harassment of a subordinate by allegedly forcing her to go on a date one week before he was to have evaluated her performance for a pending promotion. The complaint also charges the company with negligent hiring and retention. Because he is a high level officer, your client will probably be vicariously liable for any compensatory and possibly punitive damages awarded as a result of his actions. You want him to retain a top notch litigator, but because of a messy divorce he cannot afford such a defense. In fact, you are concerned that he may ignore the complaint altogether. What can you do to protect the company's interests without violating the company's other obligations?
Although fictitious, this scenario is not uncommon. Consider the recent EEOC harassment suit against Del Laboratories and its Chief Executive for which its attorney and directors have been criticized for the manner in which the suit was handled; or the recent problems at W.R. Grace. When an employee is joined to a sexual harassment suit, it places the company in a difficult position because the defense and indemnity which a company typically provides its employees create conflicts with other policies and legal obligations of the company, e.g., the company's obligation to eradicate harassment from the workplace; the morale of other employees, especially women; the duty to shareholders to use the company's assets to advance the company's legitimate interests. What are you to do? Unfortunately, there is not yet published case law which provides a clear answer, but we have some suggestions.
I. Vicarious Liability
The analysis should begin with recognition that the company is generally vicariously liable for harassment committed by its supervisory employees and perhaps for its non-supervisory employees. In some instances liability will be strictly imposed regardless of the employer's participation in or knowledge of the harassment. As a result, it is important that the employee present the best available defense. If the employee presents no law suggesting that the company will be vicariously liable for the default judgment and without the opportunity to defend.
II. The Defense of Harassers
a. Joint Defense
Retaining one attorney to represent the corporation and the employee is the simplest method of defending a sexual harassment claim. However, this method should generally be used only when an investigation discloses that the employee did not commit the harassment. Otherwise, a conflict of interest between the employee and the employer will exist, especially if indemnity is not provided. While some conflicts can be waived, the company should be careful in requesting a waiver from the employee because of the risk that the employee may later contend that he did not receive an adequate defense as a result of the attorney's efforts to defend the company. There may also be strategic reasons to avoid using the same attorney, e.g., to avoid the suggestion that the company condones the alleged activity or that the company will pay any judgment.
If, however, a joint defense is provided, it should be pursuant to a written agreement in which the ground rules are identified, e.g., waiver of possible conflicts, no cross-claims, and sharing of information. The use of a single attorney should also be monitored carefully throughout the litigation for changes in circumstances.
If the employee is to retain separate counsel, the company may suggest possibilities but it should leave the choice to the employee so as to avoid any suggestion that the company is controlling the defense. The cost of a defense is often prohibitive for the individual, however; homeowners and D&O policies do not usually cover the cost of defending these suits. For this reason, employees usually seek reimbursement or advancement of their defense expenses from their employer. Whether the company can do this depends upon the law of the jurisdiction involved and the facts of the case.
b. Indemnification/Defense Statutes
There are several sources you must consider in deciding whether the company may defend and indemnify. First, the indemnification statues adopted in most states. While there is no published case law applying the statues to a sexual harassment case, these statutes would seem to have obvious relevance and permit the company to assume the defense of its accused employee but not to indemnify for any liability he may incur. While it is beyond the scope of this article to discuss all of the different state indemnification statutes, we will identify the general principles found in the Model Business Corporation Act of 1984.
The Act provides for permissive, prohibited and mandatory indemnification of directors, officers and employees. The Act permits indemnity of a director, including payment of his attorneys' fees, if he conducted himself in good faith and reasonably believed that his conduct was in the best interest or not opposed to the best interest of the corporation. Unless limited by its articles of incorporation, a corporation must indemnify a director who has been "wholly successful," regardless of his alleged conduct. The Act permits a corporation to pay or reimburse a director for his expenses in advance of final disposition if the director provides written affirmation that he has met the good faith standard of conduct and he agrees to repay the company if it is determined that he has not. It is not clear, however, whether the company can advance defense costs if there is substantial evidence of harassment, notwithstanding the employee's affirmation.
Prior to advancing expenses, the Act requires a determination by the board as to whether facts are know which would preclude indemnification. The determination can also be made by a specially appointed independent legal counsel or by a vote of the shareholders. In most cases, except possibly those involving senior executives, counsel generally would make the decision; however, courts have held that to be "independent", the counsel cannot be from within the company.
c. Bylaw Indemnification
Many states also permit a company to grant indemnification beyond that expressly provided by statute. The most common way is the charter option through the corporation's bylaws.
d. Common Law
Finally, if there is no statutory or bylaw provision, your state's common law may address the issue. However, under New Jersey law, a party who is at fault cannot obtain common law indemnification. Under Illinois law, an officer or agent is entitled to indemnification if he has acted in good faith.
III. Conclusion
For most companies, there are ways to assume the defense of an employee accused of sexual harassment, even if the employee is separately defended. However, if there is a finding of harassment, the employee generally must repay the defense costs advanced on his behalf. The company would also generally be barred from indemnifying the employee for his liability because it is hard to conceive of many situations when harassment would be considered to be in the best interests of the company or to have been committed in good faith.
In the case of a settlement, the company often can pay the settlement without seeking reimbursement from the employee. However, if the settlement is sizable and there is substantial evidence of harassment, the company may be obligated to seek reimbursement to protect shareholder interests. While we are unaware of any shareholder suits raising this issue, such a claim may be made in some of the recent high profile case.
Having said al this, we readily acknowledge the practical problems faced by corporate counsel, especially when an executive is involved. In fact, the legal analysis may be simple compared to the political ones. The courts and our law are not always so understanding, however.
