Barrett v. American Country Holdings, Inc., (Del. Ch., June 20, 2008), read opinion here.

This opinion was flagged for us courtesy of Wilmington attorney and Potter Anderson partner Scott Waxman of eDelaware fame, as well as through the Del. Bus. Litigation Report.

In essence, the Chancery Court in this opinion excoriates a company for refusing to fulfill its obligation to provide advancement rights to former directors. Moreover, it suggests that the unnecessary costs and fees incurred by the company in defending the suit by the directors seeking advancement–ultimately an expense borne by the shareholders–may be a basis for claims against the company’s management for breach of their fiduciary duties.

The court’s own overview of the case in the introduction to the opinion is more pithy that I can quickly imitate:

A corporation has accused its former directors of engaging in intentional fraud in their official capacities. The former directors have a clear right to have their fees advanced to defend themselves against those charges. To date, however, a directors and officers’ (“D & O”) insurance policy has covered their fees, but the former directors brought this suit because the policy limits were nearly exhausted.

The corporation has refused to acknowledge the former directors’ right to advancement despite the clear terms of the certificate of incorporation of the corporation they served as directors. It has done so because the former directors refused to accept settlement proposals in the underlying securities litigation, each of which required the entry of a judgment in favor of the corporation in that suit and the assignment of any rights the former directors have against the D & O insurer. Because the corporation has offered not to collect on the judgment, the corporation argues that the former directors have forfeited their right to advancement by unreasonably refusing settlement. The corporation makes this outlandish argument even while admitting that the former directors have received millions of dollars in advanced fees from the D & O insurer under a reservation of rights, and that the policy requires them to obtain approval from the D & O insurer before settling. That approval has not been forthcoming, in large measure because the corporation wishes to extract the judgment from the former directors and wield it as a club against the D & O insurer in a bad faith action it has pending against the insurer. Thus, the corporation says that even though the former directors must breach their contract with the D & O insurer to agree to the settlements it has proposed, the  former directors’ failure to do so has rendered them ineligible to receive the contractual advancement benefits due them.

The corporation’s position is remarkable, but in a regrettable way. Its stockholders will now endure not only the cost of honoring the corporation’s promise to the former directors, but also the costs needlessly run up by the corporation because it chose to assert a baseless and illogical defense that wasted the resources of the former directors, this court, and the corporation itself.

If a corporation sues its former directors for intentional fraud in their official capacity and owes those directors advancement rights, it has no right to require them to accept a judgment against themselves of any kind, much less to say that the officials whose reputations and wealth the corporation has put at risk lose their advancement rights by failing to agree to such a demand. The very purpose of an advancement right is to enable a corporate official to protect herself against claims of official wrongdoing. If the corporation here wishes to drop its suit, it is free to do so. But it has no right to breach its obligation to those it has sued on the pretense that the former directors will not agree to the entry of an adverse judgment in a securities case. The former directors have every right to defend the case and to seek a complete vindication, one which will minimize the reputational consequences they have already suffered as a result of the corporation’s charges of intentional fraud.

Equally obvious is that the former directors do not have to engage in behavior that will breach their obligations under the D & O policy. Although the corporation raises all sorts of arguments as to why the former directors face no material risk of liability to the insurer, those arguments are self-serving, weak in material respects, and, most important, irrelevant. The former directors have no duty to take legally problematic action simply
because the corporation that has sued them wants them to do so. Again, if the corporation wishes to drop its suit against the former directors, it is free to do so. What it is not free to do is to condition the former directors’ advancement rights on their willingness to suffer a judgment and put themselves in the midst of a struggle between the corporation and their D & O insurer.

A judgment and order shall be entered for the former directors and all of their fees and expenses in this case shall be paid by the corporation.