California Agreements and Contracts

Proposal No. 2: Approval of Indemnification Agreements

Introduction

The State of California adopted legislation, effective September 27, 1987, (the “Legislation”), which amended the California General Corporation Law to permit limitation of liability of directors and indemnification of directors, officers and other agents to a greater extent than permitted under prior California law. Similar legislation has been adopted in Delaware, New York and other states.

The Legislation permits a California corporation to adopt a provision in its articles of incorporation reducing or eliminating the liability of a director to the corporation or its shareholders for monetary damages for breach of the fiduciary duty of care, provided that such liability does not arise from certain proscribed conduct (including intentional misconduct and breach of the duty of loyalty). The Legislation in this regard relates only to actions brought by shareholders on behalf of the corporation (i.e., "derivative actions") and does not apply to claims brought by outside parties. The Legislation also permits a corporation to include a provision in its articles of incorporation allowing the corporation to include in its bylaws, and in agreements between the corporation and its directors, officers and other agents, provisions expanding the scope of indemnification beyond that specifically provided under California law.

Prior Amendments to Articles and Bylaws

In response to the Legislation, the Board of Directors and shareholders previously approved amendments to Northern Empire Bancshares' (the “Corporation") Articles of Incorporation (the "Article Amendment”) and the Board of Directors approved amendments to the Corporation's Bylaws (the "Bylaw Amendment") (collectively, the "Amendments"), which limit the personal liability of directors for monetary damages for a breach of such directors' fiduciary duty of care and allow the Corporation to expand the scope of its indemnification of directors, officers and other agents to the fullest extent permitted by California law. Attached hereto as Exhibits A and B are copies of the Amendments.

In order to provide full protection to the Corporation's directors, officers and other agents, the Board of Directors has approved the use of Indemnification Agreements. The Board of Directors believes that the Indemnification Agreements will serve the best interests of the Corporation and its shareholders by strengthening the Corporation's ability to attract and retain the services of knowledgeable and experienced persons to serve as directors, officers and other agents of the Corporation.

Similar action has previously been taken respecting Articles, Bylaws and Indemnification Agreements for Sonoma National Bank, the Corporation's wholly owned bank subsidiary.

The Shareholders are requested to approve and ratify the proposed Indemnification Agreement(s) between the Corporation and its current and future directors, and such current and future officers and other agents as the directors may designate, in substantially the form attached hereto as Exhibit C.

Other Protection

Indemnification Under State Statutes and Bylaws. The Corporation is subject to the California General Corporation Law, which provides a detailed statutory framework covering indemnification of any officer, director or other agent of a corporation who is made or threatened to be made a party to any legal proceeding by reason of his or her service on behalf of the corporation. Such law provides that indemnification against expenses actually and reasonably incurred in connection with any such proceeding shall be made to any such person who has been successful won the merits" in the defense of any such proceeding, but does not require indemnification in any other circumstance. The law provides that a corporation may indemnify any agent of the corporation, including officers and directors, against expenses, judgments, fines, settlements and other amounts actually and reasonable incurred in a third party proceeding against such person by reason of his or her services on behalf of the corporation, provided the person acted in good faith and in a manner he or she reasonably believed to be in the best interests of the corporation. The law further provides that in derivative suits the corporation may indemnify such a person against expenses incurred in such a proceeding, provided such person acted in good faith and in a manner he or she reasonably believed to be in the best interests of the corporation and its shareholders. Indemnification is not available in derivative actions (i) for amounts paid or expenses incurred in connection with a matter that is settled or otherwise disposed of without court approval or (ii) with respect to matters for which the agent shall have been adjudged to be liable to the corporation unless the court shall determine that such person is entitled to indemnification.

The law permits the advancing of expenses incurred in defending any proceeding against a corporate agent by reason of his or her service on behalf of the corporation upon the giving of a promise to repay any such sums in the event it is later determined that such person is not entitled to be indemnified. Finally, the California General Corporation Law, as amended by the Legislation, provides that the indemnification provided by the statute is not exclusive of other rights to which those seeking indemnification may be entitled, by bylaw, agreement or otherwise, to the extent additional rights are authorized in a corporation's articles of incorporation. The law further permits a corporation to procure insurance on behalf of its directors, officers and agents against any liability incurred by any such individual, even if a corporation would not otherwise have the power under applicable law to indemnify the director, officer or agent for such expenses. The Articles and Bylaws of the Corporation have been amended to implement the applicable statutory framework as amended by the Legislation and to provide for indemnification of directors, officers and other corporate agents to the fullest extent under the law.

Directors' and Officers' Liability Insurance. The Corporation presently maintains a policy of directors' and officers' liability insurance. However, there is no assurance that such coverage will continue to be available with such breadth of coverage as the Corporation deems advisable and at reasonable expense. Accordingly, the Board of Directors believes that it serves the Corporation's interest to supplement any coverage which the Corporation may maintain in the future by agreeing by contract to indemnify directors and officers to the fullest extent permitted under applicable law.

Indemnification Agreements

The proposed Indemnification Agreements attempt to provide to the Corporation's current and future directors, and such current and future officers and other agents of the Corporation as the directors may designate, the maximum indemnification allowed under applicable law and under the Corporation's Articles of Incorporation and Bylaws. The Indemnification Agreements provide indemnification which expands the scope of indemnification provided by Section 317 of the California General Corporation Law (the "Statute"). It has not yet been determined, however, to what extent the indemnification expressly permitted by Statute may be expanded, and therefore the validity and scope of indemnification provided by the Indemnification Agreements may be subject to future judicial interpretation.

Any award of indemnification to a director, officer or other agent would come directly from the assets of the Corporation, thereby affecting a shareholder's investment. It should be noted that if the Indemnification Agreements are approved by the shareholders, they will by their terms apply to conduct of the Corporation's directors, officers and other agents occurring prior to the effective date of such Agreements. However, under California law, indemnification may not be permissible for acts occurring prior to the filing of the Article Amendment with the California Secretary of State, if such indemnification exceeds the scope of the Statute.

The Indemnification Agreements set forth a number of procedural and substantive matters which are not addressed or are addressed in less detail in the Statute, including the following:

1. The Indemnification Agreements establish a standard of conduct that the person to be indemnified must have acted "in a manner such person did not believe to be contrary to the best interests of the corporation." This standard is an expansion of the standard under the Statute that the person must have acted 'in a manner such person reasonably believed to be in the best interests of the corporation."

2. The Indemnification Agreements establish the presumption that the indemnified party has met the applicable standard of conduct required for indemnification. In addition, an arbitrator may make the determination that indemnification is proper in any arbitration proceeding in which such determination is pending. The Statute requires a finding in each specific case by the board of directors, independent legal counsel or the shareholders that the applicable standard of conduct has been met.

3. The Indemnification Agreements provide that litigation expenses shall be advanced to an indemnified party at his request provided that he undertakes to repay the amount advanced if it is ultimately determined that he is not entitled to indemnification for such expenses. The Statute provides that such expenses may be advanced against such an undertaking upon authorization by the board of directors.

4. The Indemnification Agreements explicitly provide that in a derivative suit the indemnified party will be entitled to indemnification against amounts paid in settlement, to the fullest extent permitted by law, where the indemnified party meets the applicable standard of conduct. As noted above, indemnification of any such amount would be paid out of the Corporation's funds. The Statute does not provide for such indemnification without court approval. The enforceability of the provisions in the Indemnification Agreements providing for settlement payments in derivative suits has not been judicially interpreted by the courts and may be subject to public policy limitations. The Board of Directors has not sought a legal opinion as to the enforceability of these provisions because of the lack of judicial interpretation of the Legislation to date.

5. In the event the Corporation does not pay a requested indemnification amount, the Indemnification Agreements allow the indemnified party to contest this determination by petitioning a court to make an independent determination of whether such party is entitled to indemnification under the Indemnification Agreements. In the event of such a contest, the burden of proving that the indemnified party did not meet the applicable standard of conduct will be on the Corporation. If the Corporation fails to establish that the applicable standard of conduct has not been met, the indemnified party will be entitled to indemnification, which will include reimbursement for expenses incurred by the indemnified party in such contest in establishing the right to indemnification. The Statute does not set forth any procedure for contesting a corporation's determination of a party's right to indemnification or establish which party bears the burden of proof with respect to a challenge to such a determination.

6. The Indemnification Agreements explicitly provide for partial indemnification of costs and expenses in the event that an indemnified party is not entitled to full indemnification under the terms of the Indemnification Agreements. The Statute does not specifically address this issue. It does, however, provide that to the extent that an indemnified party has been successful on the merits, he shall be entitled to such indemnification.

7. The Indemnification Agreements automatically incorporate future changes in the laws which increase the protection available to the indemnitee. Such changes will apply to the Corporation without further shareholder approval and may further impair shareholders' rights or subject the Corporation's assets to risk of loss in the event of large indemnification claims. Each Indemnification Agreement constitutes a binding, legal obligation of the Corporation, and may not be amended without the consent of the individual who is protected by such Indemnification Agreement.

8. The Indemnification Agreements explicitly provide that actions by an indemnified party serving at the request of the Corporation as a director, officer or agent of an employee benefit plan, corporation, partnership, joint venture or other enterprise, owned or controlled by the Corporation, shall be covered by the indemnification. The Statute provides that a corporation may so indemnify such parties. It should be noted that by agreeing by contract to indemnify such parties, the Corporation may be exposed to liability for actions of an entity over which it may not exercise control, which liability could adversely affect the Corporation's financial position.

The proposed Indemnification Agreements, together with the limitation on the directors' liability and the indemnification provided by the Article and Bylaw Amendments, reduce significantly the number of instances in which directors might be held liable to the Corporation for monetary damages for breach of their fiduciary duties. Therefore, it should be noted that the current directors of the Corporation have a direct personal interest in the approval and ratification of the Indemnification Agreements.

THE FOREGOING DISCUSSION OF THE INDEMNIFICATION AGREEMENTS IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE FORM OF INDEMNIFICATION AGREEMENT ATTACHED TO THIS PROXY STATEMENT AS EXHIBIT C, WHICH YOU ARE URGED TO READ AND CONSIDER CAREFULLY.

Certain Proceedings. The Corporation is not aware of any material pending or threatened legal proceedings against any of its directors or officers which may result in a claim for indemnification.

Indemnification for Liabilities Under the Securities Act of 1933

The Securities and Exchange Commission has expressed its opinion that indemnification of directors, officers and controlling persons of the Corporation against liabilities arising under the Securities Act of 1933, as amended (the "Act"), is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Corporation of expenses incurred or paid by a director, officer or controlling person of the Corporation in the successful defense of any such action, suit or proceeding) is asserted by such director, officer or controlling person in connection with securities which have been registered, the Corporation will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.

Vote Required to Approve the Indemnification Agreements

Section 310 of the California General Corporation Law provides that no contract between a corporation and one or more of its directors is either void or voidable because such director or directors are parties to such contract if the material facts as to the transaction and as to such directors' interests are disclosed or known to the shareholders and such contract is approved by the affirmative vote of a majority of the shares voting at the meeting, with the shares owned by the interested directors not entitled to vote thereon, or the contract has been approved by a disinterested majority of the Board of Directors. If the contract has not been so approved, the contract is not void or voidable if the person asserting the validity of the contract sustains the burden of proving that the contract was just and reasonable to the corporation at the time it was authorized.

Although the Corporation believes that the form of Indemnification Agreement is just and reasonable to the Corporation, and that shareholder approval may not therefore be required to validate the Indemnification Agreements, the Corporation believes that it is appropriate to submit the Indemnification Agreements to the shareholders for their consideration. If the Indemnification Agreements are approved by the shareholders, they will not be void or voidable and the Corporation's shareholders may not later assert a claim that the Indemnification Agreements are invalid due to improper authorization; however, the shareholders may challenge the validity of the Indemnification Agreements on other grounds. If the Indemnification Agreements are not approved by the shareholders, the Corporation may reconsider the implementation of such agreements. Whether or not the shareholders approve the Indemnification Agreements, the Board of Directors may in the future approve other forms of Indemnification Agreements which may or may not be submitted to shareholders for approval. If such agreements were implemented in the absence of shareholder approval, the invalidity of such agreements could thereafter be asserted by any shareholder. In such an instance, the person asserting the validity of the contracts bears the burden of proving that they were just and reasonable to the corporation at the time they were authorized.

Approval of the Indemnification Agreements will require the affirmative vote of a majority of the shares of the Corporation's Common Stock voting in person and by proxy at the Annual Meeting.

The Board of Directors has approved the Indemnification Agreements and recommends that shareholders vote FOR the approval of the Indemnification Agreements.

EXHIBIT “A”

ARTICLE AMENDMENT

Articles designated SIX and SEVEN were added to the corporation's articles of incorporation as follows:

SIX: LIMITATION ON LIABILITY OF DIRECTORS

The liability of the directors of this corporation for monetary damages shall be eliminated to the fullest extent permissible under California law.

SEVEN: INDEMNIFICATION OF AGENTS

The corporation is authorized to provide indemnification of agents (as defined in Section 317 of the California Corporations Code) through bylaw provisions, agreements with the agents, vote of shareholders or disinterested directors, or otherwise permitted by Section 317 of the California Corporations Code, subject only to the applicable limits set forth in Section 204 of the California Corporations Code with respect to actions for breach of duty to the corporation and its shareholders.

EXHIBIT B

AMENDMENT TO BYLAWS

ARTICLE VI

Indemnification

Section 1. Extent of Indemnification. The Corporation shall have the power to indemnify agents (as defined in Section 317 of the California Corporations Code), including directors, officers and employees, in accordance with the provisions of Section 317 or as otherwise permitted under the Corporation's Articles of Incorporation.

Section 2. Expense Advancement. Expenses incurred in defending any proceeding may be advanced by the Corporation prior to the final disposition of such proceeding upon receipt of an undertaking by or on behalf of the agent to repay such amount unless it shall be determined ultimately that the agent is entitled to be indemnified.

Section 3. Insurance. The Corporation may purchase and maintain insurance on behalf of any agent of the Corporation against any liability asserted against or incurred by the agent in such capacity or arising out of the agent's status as such whether or not the Corporation would have the power to indemnify the agent against such liability under the provisions of Section 317 of the California Corporations Code.