Nuances on Advancement of Fees for Counterclaims Against Directors and Officers

Pontone v. Milso Industries Corp., C.A. No. 7615-VCP (Del. Ch. May 29, 2014).

Issue Addressed: The appropriate standard to apply to determine whether counterclaims are covered for purposes of a former director’s entitlement to advancement of attorneys’ fees.

Short Background

The Delaware Court of Chancery previously determined in a motion for partial summary judgment in this case that the former officer and director was entitled to advancement for certain counterclaims.  The court directed the parties to follow the procedures set forth in Fuhlendorf v. Isilon Systems, Inc., 2010 WL 4570225 (Del. Ch. Nov. 9, 2010), to process the request for advancement.  The court also previously appointed a Special Master to resolve any disputes between the parties regarding the amount of fees subject to advancement.  This memorandum opinion is a ruling on exceptions to the second report of the Special Master.

Key Rulings

The court observed some inconsistency between decisions of the Delaware Supreme Court and the Delaware Court of Chancery regarding the types of counterclaims eligible for advancement.

The court in this decision determined that the governing standard is the one established in Roven, under which compulsory counterclaims “advanced to defeat, or offset affirmative claims may be subject to advancement” (citing 603 A.2d at 824 (emphasis in original)).

The Court of Chancery concluded that the following two-part test would control:

A counterclaim will be considered to be ‘defending’ and thus advanceable, if it is: (1) ‘necessarily part of the same dispute,’ in the sense that it qualifies as a compulsory counterclaim under the prevailing Delaware and federal procedural standard; and (2) ‘advanced to defeat, or offset’ the affirmative claims.

Procedure to Determine Which Particular Fees from Among Multiple Claims Are Subject to Advancement (When Bills Are Not Clear On the Point)

The court also determined that when not all claims are subject to advancement, the procedure to follow in order to determine which time charges apply to only those claims that are subject to advancement, should be the procedure utilized by the Court of Chancery in Fasciana v. Electronic Data Systems Corp., 829 A.2d 160 (Del. Ch. 2003).

That methodology will determine what portion of the fees and expenses incurred by the parties seeking advancement relate to matters that were subject to advancement.  In that decision, the court directed the plaintiff to:  “Submit a good faith estimate of expenses incurred to date” that relate to the precise allegations that triggered advancement.  Id. at 177.

The court in that case also required the attorneys to provide a sworn affidavit certifying their good faith belief that the identified litigation expenses relate solely to “defense activity” undertaken in response to allegations for which advancement was owed.

Noting that “some level of imprecision will be involved in the retrospective accomplishment of this task,” the court nevertheless found that the procedure put in place provided adequate protection so that the defendant can reserve any ultimate fight about the precise amounts until a later notification proceeding.

The Fasciana decision provides a methodology, and accounts for different work required for various counterclaims.

The court addressed the concern that time entries that were redacted to avoid the revelation of work product or mental impressions created a problem to the extent that redacted time entries lacked meaningful indication of, for example, what general legal issues the billing individuals were researching or working on as a result of the heavy redactions.

The court emphasized that the company making the advancement payments was entitled to information “sufficient to indicate that the claimed expenses do not relate to counterclaims for which advancement has been disallowed, to the extent such information can be provided without revealing attorneys’ work product or mental impressions.”

The court resolved this concern by requiring counsel for the plaintiff to “indicate, under oath, whether any of those time entries [which were inadequately described] relate to those counterclaims [that were non-advanceable], and Milso’s advancement obligations shall be offset accordingly.” See generally, Paolino v. Mace Security International, No. 4462-VCL (Del. Ch., revised December 14, 2009), read opinion here. (In Paolino, the court bound the company by its attorney’s representation that the former director should not be entitled to advancement because the work on his complaint could not be distinguished from the counterclaim as the issues were so interwined. Based on that representation in that case, the court held that the former director was entitled to all the fees incurred and not just those for defending a counterclaim.)

The court also observed that the person seeking advancement needs to present a specific bill for a specific amount demanded in order to trigger the clock for pre-judgment interest, but in this case the court found that a blanket denial made that requirement futile.