Infrastructure Bill May Broaden Definition of “Broker” to Include Cryptocurrency Miners and Developers

The United States Senate recently passed an infrastructure bill, H. R. 3684, which contains new regulations regarding the reporting of digital assets for cryptocurrency miners and software developers.

The regulations in the bill, entitled “Information Reporting for Brokers and Digital Assets” aims to extend cryptocurrency tax reporting requirements, which could raise money to help offset some infrastructure development. At issue is an addition to the definition of the term broker in Section 6045(c)(1) of the Internal Revenue Code of 1986. Currently, the bill would insert a new subparagraph which makes the definition include “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.” H. R. 3684, at 2434 (as of 8/11/2021). Such a literal addition would cause not only the intended effect of encouraging reporting from crypto exchanges, but also require that anyone who is involved with any service that involves cryptocurrency transfers be required to report their transactions, as a broker is required to do. This could include crypto miners, software developers, and others involved in crypto exchanges who cannot know who their “customers” are because of the anonymous nature of crypto mining, and are therefore incapable of reporting the necessary information that a broker is required to report by law.

The definition amendment was the source of public backlash and concern that the cryptocurrency sector could potentially be outsourced outside of the United States as a result of this legislation. A bipartisan compromise to the amendment was drafted in an attempt to correct the over-broad language of the bill. However, this amendment was blocked by the Senate on Monday, August 9th, 2021. The following day, the Senate and passed the bill in its original form without additional amendments. It is still possible for the bill to be changed in reconciliation, as it has yet to reach the floor of the House of Representatives for a vote. In addition, the IRS may further narrow the definition (should the bill be passed and signed into law) when adding the amendment to the definition of broker in the Internal Revenue Code.

Indemnification, Not as Simple as You Think

On the surface, indemnification seems like a fairly simple concept. If a company indemnifies a person, the person will be reimbursed for their expenses including legal fees. This at-a-glance view of indemnification, however, fails to answer some important questions that often get brought up when one party claims indemnity. These questions include when indemnification is due, if the outcome of a proceeding is essential to the determination of indemnification rights, whether the claim is ripe for adjudication, and the legitimacy or legality of the claim for indemnification itself. These questions can be tricky to navigate, evidenced by how often they crop up in litigation. This article provides a general overview of indemnification law and some of the intricate questions that arise when dealing with indemnification issues.

The Law of Indemnification

Delaware Indemnification Laws

As many corporations and limited liability companies (“LLC”) are incorporated and organized in Delaware, this article first examines Delaware indemnification law.

Under Delaware LLC law, indemnification is a broad concept. For these businesses, indemnification is governed by 6 Del. C. § 18-108, which states: “Subject to [restrictions and standards] in its [LLC operating] agreement, a [LLC] may, and shall have the power to, indemnify and hold harmless any member or manager or other person from and against any and all claims and demands whatsoever.” Indemnification may be offered by a Delaware LLC even if there is no obligation to indemnify. Symonds & O’Tolle on DE Limited Liability Cos. § 11.02 (2019). If there is no obligation to indemnify, Delaware courts apply the business judgement rule to determine if the company has made the decision to indemnify absent agreement which would otherwise create an obligation. See Lola Cars Int’s Ltd. v. Krohn Racing, LLC, No. 6520 -VCN.

Delaware corporations are governed by Del. Code Ann. tit. 8, § 145. This statute states in pertinent part that:

A corporation shall have power to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation) by reason of the fact that the person is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys’ fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by the person in connection with such action, suit or proceeding . . . .

In other words, corporations incorporated in Delaware have the power to indemnify anyone working for the corporation. It is required, however, that “the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe the person’s conduct was unlawful.” Del. Code Ann. tit. 8, § 145 (a).

Delaware Advancement Law

For LLCs, advancement of expenses is covered under the same statute (6 Del. C. § 18-108) as indemnification, with a similar broad scope  See Senior Tour Players 207 Mgmt. Co. v. Golftown 207 Holding Co., 2004 Del. Ch. LEXIS 22 (Del. Ch. Mar. 10, 2004) (the statute’s provisions are “broadly empowering and deferential to the contracting parties’ wishes regarding indemnification and advancement . . .”). A “right to advancement is not ordinarily dependent upon a determination that the party in question will ultimately be entitled to be indemnified . . .” Id. However, “advancement implies a general obligation to repay if the underlying conduct is ultimately judged to be not indemnifiable.” Id. In other words, a party’s right to advancement is not dependent on its right to indemnification, even if it may have to repay the funds in the future.

For corporations, section (e) of Del. Code Ann. tit. 8, § 145 states that expenses may be paid in advance. The party who receives the funds, however, must show that it will repay the funds if it is later established that they would not be entitled to indemnification. Del. Code Ann. tit. 8, § 145 (e).

New York Indemnification Laws

Pastore regularly works with New York corporations and LLCs as a going concern. As such, we next turn to a discussion New York indemnification laws. Similar to Delaware law, New York LLC indemnification law is also broadly tailored to allow indemnification and advancement for managers, members or associated persons. N.Y. Ltd. Liab. Co. Law § 420 (pursuant to the LLC agreement, “a limited liability company may, and shall have the power to, indemnify and hold harmless, and advance expenses to, any member, manager or other person . . . from and against any and all claims and demands whatsoever”). This statute differs from the Delaware LLC statute by adding that:

no indemnification may be made [for a person] if a judgment . . . adverse to such [person] establishes (a) that his or her acts were committed in bad faith or were the result of active and deliberate dishonesty and were material to the cause of action so adjudicated or (b) that he or she personally gained in fact a financial profit or other advantage to which he or she was not legally entitled.

In other words, an LLC may not indemnify a person, member, or manager if the person to be indemnified loses their case and the penultimate judgement establishes that their actions were made in bad faith, were the result of deliberate dishonesty, or that the person personally made some kind of gain that they were not legally entitled.

In New York, indemnification for corporations is governed by N.Y. Bus. Corp. Law § 722. While it is written similarly to the Delaware law, the New York law only allows for the indemnification of directors and officers. N.Y. Bus. Corp. Law § 722 (a) states:

A corporation may indemnify any person made, or threatened to be made, a party to an action or proceeding (other than one by or in the right of the corporation to procure a judgment in its favor), whether civil or criminal, including an action by or in the right of any other corporation of any type or kind, domestic or foreign, or any partnership, joint venture, trust, employee benefit plan or other enterprise, which any director or officer of the corporation served in any capacity at the request of the corporation, by reason of the fact that he, his testator or intestate, was a director or officer of the corporation, or served such other corporation, partnership, joint venture, trust, employee benefit plan or other enterprise in any capacity, against judgments, fines, amounts paid in settlement and reasonable expenses, including attorneys’ fees actually and necessarily incurred as a result of such action or proceeding, or any appeal therein, if such director or officer acted, in good faith, for a purpose which he reasonably believed to be in, or, in the case of service for any other corporation or any partnership, joint venture, trust, employee benefit plan or other enterprise, not opposed to, the best interests of the corporation and, in criminal actions or proceedings, in addition, had no reasonable cause to believe that his conduct was unlawful.

In summation, corporations can indemnify any director or officer, so long as they acted in good faith and pursuant to their fiduciary duty to the corporation. If the proceeding is a criminal one, then the director or officer needs to have had no reasonable cause to believe that their conduct was unlawful. Of course, the corporation can limit indemnification further than that, and indemnification under this statute is not required. See Donovan v. Rothman, 253 A.D.2d 627 (App. Div. 1st Dept. 1998) (where the Defendants were prevented from using corporate funds on the litigation because  there was no agreement to indemnify, there was no receipt of the corporation offering to indemnify, and the defendant may not have met the statutory requirements).

New York Advancement Laws

Similar to Delaware indemnification statutes, advancement for New York LLCs is governed by the same statute as indemnification. N.Y. Ltd. Liab. Co. Law § 420.  Rights to advancement are also based on the operating agreement of the LLC, similar to rights for indemnification under N.Y. Ltd. Liab. Co. Law § 420.

Advancement in regard to New York corporations, indemnification is governed by N.Y. Bus. Corp. Law § 723(c), and N.Y. Bus. Corp. Law § 725(a). Section 723(c) allows for indemnification, stating that “[e]xpenses incurred in defending a civil or criminal action or proceeding may be paid by the corporation in advance of the final disposition of such action” . . ., also adding that it must be done in accordance with § 725(a). Section 725(a) states that all advanced funds “shall be repaid in case the person receiving such advancement or allowance is ultimately found, under the procedure set forth in this article, not to be entitled to indemnification.”

Connecticut Indemnification Laws

In Connecticut, indemnification for LLCs is governed by Conn. Gen. Stat. § 34-255g(b), which allows for indemnification of current or former members, managers, or officers, so long as the liability does not arise from violations of §§ 34-255d (limitations on distributions), 34-255f (management of LLC), or 34-255h (standards of conduct for members and managers). Section 34-255g(c) further requires indemnification for people who are wholly successful in their defense, stating:

A limited liability company shall indemnify and hold harmless a person who was wholly successful, on the merits or otherwise, in the defense of any proceeding with respect to any claim or demand against the person by reason of the person’s former or present capacity as a member, manager or officer of the company from and against reasonable expenses, including attorney’s fees and costs incurred by the person in connection with such claim or demand.

For corporations, the relevant statute is Conn. Gen. Stat. § 33-1122, which broadly allows indemnification and advancement so long as they do not violate public policy. Section 33-1122 (a) states:

A corporation may indemnify and advance expenses under sections 33-1116 to 33-1125, inclusive, to an officer, employee or agent of the corporation who is a party to a proceeding because he is an officer, employee or agent of the corporation (1) to the same extent as a director, and (2) if he is an officer, employee or agent but not a director, to such further extent, consistent with public policy, as may be provided by contract, the certificate of incorporation, the bylaws or a resolution of the board of directors. A corporation may delegate to its general counsel or other specified officer or officers the ability under this subsection to determine that indemnification or advance for expenses to such officer, employee or agent is permissible and the ability to authorize payment of such indemnification or advance for expenses. Nothing in this subdivision shall in any way limit either the ability or the obligation of a corporation to indemnify and advance expenses under other applicable law to any officer, employee or agent who is not a director.

Conn. Gen. Stat. § 33-112(b) allows for indemnification for directors of a company if said director is also an employee or officer and indemnification is only offered to them in connection with their role as an employee or officer of the company. Section 33-1122(b) (“The provisions of subdivision (2) of subsection (a) of this section shall apply to an officer, employee or agent who is also a director if the basis on which he is made a party to the proceeding is an act or omission solely as an officer, employee or agent”).

For directors seeking indemnification in their role as a member of the board of directors, the relevant statute is C.G.S. § 33-1117, which provides that “a corporation can only indemnify a director who acted in good faith, in the best interests of the corporation, and in the case of a criminal proceeding, had no reason to believe their conduct was unlawful.” Indemnification for directors defending against a lawsuit or criminal proceeding is mandatory in Connecticut, so long as they were successful, on the merits or otherwise as provided for under C.G.S. § 33-1118 (“Mandatory Indemnification”).

Connecticut Advancement Law

For LLCs, advancement is authorized pursuant to C.G.S. § 34-255g(d), so long as the money is repaid if the person being advanced funds is, in fact, not owed advancement under § 34-255g(b).

For corporations, advancement is allowed for non-director employees. Conn. Gen. Stat. § 33-1122 (“A corporation may indemnify and advance expenses . . . .”). For directors, advancement is allowed under C.G.S. § 33-1119, which requires that the director provide the corporation a written affirmation of her good faith belief that the standard of conduct required by them has been met, and provide a written undertaking to repay all funds advanced if it is determined that the director is not entitled to mandatory indemnification under § 33-1118.

Indemnification vs. Advancement

Indemnification and advancement are often mistaken for one another. While indemnification is more common, most litigants prefer advancement of expenses.

A litigant’s right to indemnification cannot be established until the conclusion of the legal proceeding. Homestore, Inc. v. Tafeen, 888 A.2d 204, 212 (Del. 2005). This is because the litigant’s actual claim for indemnification cannot be brought until the underlying matter has been resolved with certainty. Scharf v. Edgcomb Corp., 864 A.2d 909,919-20 (Del. 2004). The matter can only be said to be resolved with certainty when the litigation or investigation has completely concluded. Id. at 919. The results of those proceedings can be determinative of whether or not the litigant has a right to indemnification, as it may not be authorized by either the terms of the agreement which gave the party the right, or the actual laws of the state.

In contrast, advancement differs from indemnification in that the party entitled to advancement receives their legal fees before the end of the underlying legal proceeding. While many states require that the party receiving the funds must repay them at the end of their lawsuit if they would not be entitled to indemnification at that time, it is still generally allowed in proceedings regardless of what kind of proceeding it is (legal or administrative, civil or criminal). See Senior Tour Players 207 Mgmt. Co. LLC v. Golftown 207 Holding Go. LLC, 853 A.2d 124, 29 (Del. Ch. 2004). Advancement has been allowed in a criminal prosecutions even after a guilty verdict, for the sake of paying for the appeal to the judgement. See Sun-Times Meia Group Inc. v. Black, 954 A2d 380 (Del. Ch. 2008). In Delaware, parties who are owed advancement may also initiate advancement actions, which are special summary proceedings to establish owed advancement. See Kaung v. Cole Nat. Corp., 884 A2d 500, 510 (Del. Sup. Ct. 2005). This type of action is not available for indemnification. Id.

Indemnification and Securities Violation Public Policy Rationale

One way a party loses their right to indemnification, even if a company is obligated to indemnify them by a violation of public policy

There is long standing public policy generally prohibiting indemnification arising from violations of federal and/or state securities laws, particularly in the case of intentional misconduct. For example, in Globus v. Law Research Service, Inc., the Second Circuit determined that it would be against public policy to permit someone who violated securities law to enforce their indemnification agreement. 418 F2d 1276, 1288 (1969). The court’s reasoning was that “one cannot insure himself against his own reckless, willful or criminal misconduct, and that allowing one to do so would run contrary to the purpose of the law that was violated.” Id. That being, to deter negligence and abuse. Id.

Indemnification may be upheld in cases when there is a determination that an indemnified party did not violate the securities laws. See, e.g., In re Residential Capital, LLC, 524 B.R. 563, 597 (Bankr. Ct. 2015) (“under New York law, Minnesota law does not preclude indemnification of fraud claims where there has not been a threshold ‘finding of illegal or even intentional misconduct’”); Credit Suisse First Boston, LLC v. Intershop Communs. AG, 407 F. Supp. 2d 541, 550-51 (S.D.N.Y. 2006) (“no court has extended Globus to preclude indemnification where, as in this case: (i) the claims against the party seeking indemnification have been dismissed with prejudice; and (ii) the ‘wrongful’ conduct that allegedly precludes indemnification was never alleged against the indemnitee in the underlying action”); Austro v. Niagara Mohwak Power Corp., 66 N.Y.2d 674 (1985) (“[i]ndemnification agreements are unenforceable as violative of public policy only to the extent that they purport to indemnify a party for damages flowing from the intentional causation of injury”).

In sum, public policy considerations can ultimately lead to a denial of indemnification despite an agreement that allows for indemnification otherwise. A party that has a contractual or legal right to indemnification may ultimately be denied that right if it is found that the party violated securities laws. Since such a determination cannot be made until after final resolution of the case, the party to be indemnified may not have a clear answer as to whether their fees will be reimbursed until after they have expensed fees to defend the action. Leaving litigants to seek to lock in their right to indemnification prior to final judgment by using tactics such as seeking a declaratory judgment that they are entitled to indemnification.

Indemnification and Declaratory Judgement

In another recent Pastore case, a former director of a Pastore client was attempting to obtain a declaratory judgement from the court declaring that they would be entitled to indemnification on a future claim for contribution. Pastore was successful in establishing that the declaratory judgment claim should be dismissed for being premature.

Indemnification is improper pending a final disposition of the underlying proceeding. Hermelin v. K-V Pharm. Co., 54 A3d 1093, 1107 n.51 (Del. Ch. 2012). Indemnification claims are premature, or not ripe, until after the merits of an action have been decided and everything has been resolved. Bamford v. Penfold, L.P., 2020 WL 967942, at *32 (Del. Ch. Fed. 28, 2020).

If there is no actual claim being made against a litigant, then they clearly cannot argue that they are owed indemnification, since the time to make that argument is after proceedings have ended. In In re Dow Chem. Co. Deriv. Litig., the Delaware Chancery Court described the plaintiff’s indemnification claim as “clearly not ripe,” because no litigation nor dispute existed nor was pending when they made their claim for indemnification. No. 4349-CC, 2010 Del. Ch. LEXIS 2, 55 (Ch. Jan. 11, 2010). As such, any claim for indemnification that arises before the existence of any litigation or dispute is obviously premature/unripe.

The Court ended up agreeing with Pastore’s argument on the count for declaratory judgement of the plaintiff’s indemnification claim. Holding, that the plaintiff was unable to get declaratory judgement for an indemnification claim based on a potential future claim that has not yet been filed. It was not the right time to establish a right to indemnification, and thus Pastore’s motion to dismiss was granted on that count.

Conclusion

In conclusion, indemnification is complicated and can cause complex questions when litigated. Indemnification is not simply something which allows for payment of fees involved in litigation whenever and however the indemnitee would like. It has its own rules and systems governing issues involving indemnification and advancement. The matters discussed here are a few of the many different issues which arise under the umbrella indemnification.