Hertz’s Complaint:

Earlier this year, Hertz Corporation filed suit against several former executives, including its former CEO, CFO and general counsel, seeking to recover under its claw-back policies approximately $70 million in incentive compensation paid to the former executives and more than $200 million in damages. Hertz alleges that wrongdoing by the executives caused Hertz’s income for several years to be improperly inflated, resulting in the need for Hertz to restate its financial statements for those years. A claw-back suit by a corporation against former executives is very rare.

Hertz’s claw-back policy generally required any executive officer receiving any incentive award to repay or forfeit such compensation if (i) the payment was based on the achievement of financial results that were the subject of a restatement filed with the SEC, (ii) the compensation committee of Hertz’s board of directors determined that the executive officer’s gross negligence, fraud or misconduct caused or contributed to the need for the restatement, and (iii) certain other conditions were satisfied.

According to the complaint filed by Hertz, the former executives’ gross negligence and other misconduct was evidenced by, among other alleged wrongdoing, an inconsistent and inappropriate “tone at the top,” with the CEO’s inappropriate emphasis on meeting internal budgets, business plans and current estimates leading to inappropriate accounting decisions and the failure to disclose critical information.

The complaint contains several counts for breach of contract, including that the former executives breached their obligations under the claw-back policy, various incentive compensation agreements and separation agreements by failing to repay their incentive-based compensation upon demand by Hertz.

Advancement Issues:

Each of the former executives filed suit in Delaware’s Court of Chancery seeking advancement of expenses in defending against the complaint filed against such executives by Hertz. Hertz’s bylaws generally required legal advancement when a claim against an officer was a direct result of actions taken in the officer’s corporate capacity.

In May 2019, a Delaware Chancery Court judge ruled in favor of the former executives on the advancement issue, stating that the former executives were entitled to have their legal defense costs advanced by Hertz because the claw-back suit arose from their work as officers of the company and is covered by the broad advancement rights in the by-laws. The judge also noted that although Hertz would have to cover the former executives’ legal fees as they defend the claw-back suits, the outcome of the claw-back suits could require the former executives to pay back those costs if they are found to have committed negligence or misconduct.

Takeaways for Employers:

This lawsuit illustrates the need for companies to take a closer look at their claw-back policies and advancement and indemnification provisions for corporate officers in the companies’ articles of incorporation, by-laws, or separate indemnification agreements to understand how these provisions work together.