Chancery Clarifies Prerequisites to Advancement and Indemnification

Rizk v. TractManager, Inc., C.A. No. 9073-ML (Del. Ch. May 30, 2014).

This Court of Chancery Master’s Report decided cross-motions for summary judgment involving indemnification and advancement.  The most noteworthy aspects of the opinion include the analysis of the phrase “by reason of the fact” which is a statutory prerequisite for advancement and indemnification pursuant to DGCL Section 145.

Highlights

DGCL Section 145 provides advancement and indemnification to directors and officers if certain prerequisites are satisfied.  These rights are granted to support the public policy of encouraging qualified persons to serve as corporate directors and officers, who would be more willing to serve knowing that they will have the protection and financial support of the corporation if they are sued.

The bylaws in this case mirror the language of Section 145 and allow for indemnification when a person is made a party to an actual or threatened action “by reason of the fact” that he or she is a director or officer of the company.  The corollary also provides a right to be paid by the company for the “expenses incurred in defending any such proceeding in advance of its final disposition, subject to an undertaking required by DGCL” (i.e.:  advancement).

The court observed that the phrase “by reason of the fact” has been the subject of many decisions by Delaware courts.  It is well established that a claim or a proceeding: “is by reason of the fact” that one was a corporate officer if there is a nexus or causal connection between the underlying proceeding and one’s official capacity.  See footnote 34.

Moreover, the “necessary causal connection is established if the corporate powers were used or necessary for the commission of the alleged misconduct, even if the cause of action does not specify a claim for breach of fiduciary duty.”  (emphasis added).  The “by reason of the fact” standard is interpreted broadly in favor of advancement in order to further the goals of Section 145.  See footnotes 35 and 36.

However, it has been emphasized by the Delaware courts that the phrase “by reason of the fact . . . should not be construed so as to draw within its ambit every claim brought against an officer or a director ….” In the context of a dispute related to an employment agreement, a corporation seeking to avoid advancement on the basis that this phrase does not apply must show that the claims “clearly involve a specific and limited contractual obligation without any nexus or causal connection to official duties.”  See footnotes 42 and 43.

The Court of Chancery has previously ruled that advancement rights do not arise when the parties are litigating issues that do not involve “the exercise of judgment, discretion or decision-making authority on behalf of the corporation.”  See footnote 47.

Importantly, the court cited to a prior Chancery ruling in which advancement was denied when the underlying claim had been adjudicated, and the claim ultimately may not have been indemnifiable.  See Haseotes v. Cumberland Farms, Inc., C.A. No. 4921 (Del. Ch. July 23, 1996) (Transcript) at 5-8.

Postscript: In some ways, Section 145 has some analogous similarities to DGCL Section 220 to the extent that despite the terms of the statute being relatively simple and hundreds of cases over the years interpreting each of the statutes, new cases are regularly filed which purport to address nuances or applications of nuances to new facts which have not previously been decided.