When interpreting an indemnity provision, whether in the articles of incorporation, bylaws or a separate agreement, the first question might be what does “indemnity” mean? Etymologically, “indemnity” is derived from the Latin words in (not) and damnum (injury or damage). Section 2772 of the California Civil Code defines “indemnity” as “a contract by which one engages to save another from a legal consequence of the conduct of one of the parties, or of some other person.”
Does it matter whether the indemnity is against “liability” or “claims”, “demands”, “damages”, or “costs”? In California, an indemnity against “liability” means that the indemnified person is entitled to recover upon becoming liable. If the indemnity is against claims, demands, damages, or costs, then the indemnified person is not entitled to recover without payment. Cal. Civ. Code § 2778(1) & (2).
What about costs of defense? Civil Code Section 2778(3) provides that an indemnity against claims, or demands, or liability, expressly, or in other equivalent terms, embraces the costs of defense against those claims, demands, or liability incurred in good faith, and in the exercise of a reasonable discretion. Perhaps more surprising is the fact that the Civil Code imposes an obligation to defend. Cal. Civ. Code § 2778(4). If the indemnifying person fails to do so after request, then a recovery against the indemnified person is conclusive in the indemnified person’s favor against the indemnifying person. Cal. Civ. Code § 2778(5).
These provisions apply to contracts of indemnity. As I mentioned yesterday, the status of articles of incorporation as contracts between the corporation and persons other than the shareholders may be a question that the courts will have to resolve.