Stockman v. Heartland Industrial Partners L.P., No. 4227-VCS (July 14, 2009), read opinion here.
Peter Ladig, lead Delaware counsel for one of the plaintiffs in this matter, was kind enough to forward a copy of this opinion to me when it was issued by the Court.
Claims for advancement of legal fees and indemnification by former officers and directors of a corporate partner of a limited partnership, based on the terms of the Partnership Agreement, were addressed in this 42-page decision. The Court granted the motion for summary judgment in favor of the advancement claims, and denied the motion to dismiss of the partnership, Heartland, regarding the indemnification claims.
The Court’s opinion serves in some ways as a “mini-treatise” of contract interpretation principles and also provides an extensive analysis of the public policy reasons and statutory intent behind the indemnification statute, DGCL § 145, on which the indemnification provisions in the Partnership Agreement were found to have been generally patterned. The Court found in favor of the former officers and directors, Stockman and Stepp, “because the plain language of the Partnership Agreement does not unambiguously support Heartland’s reading of that document,” and any ambiguity was interpreted against Heartland. As for the advancement claims, the Court concluded that there is only one reasonable reading of the Partnership Agreement, which is that Heartland’s General Partner did not have the discretion to withhold its written approval and defeat Stockman and Stepp’s contractual right to mandatory advancement.
In addition, the Court determined that an underlying criminal proceeding was considered to have been successfully concluded when it was withdrawn by the prosecutor and therefore, the Partnership Agreement did not clearly require Stockman and Stepp to “plead and demonstrate good faith, lawfulness, and a lack of scienter.”
Contract Interpretation Principles
The Court recited the general rule that a party is only entitled to summary judgment on a contract when its interpretation “is the only reasonable one”. However, where the contract in dispute is an organizing document of the entity, as here, a “dispositive order following motion practice may be appropriate even where the contract is ambiguous”. That is so, for example, where the principle of contra proferentum, which holds that ambiguous terms should be construed against their drafter, applies to protect the reasonable expectations of people who join a partnership or other entity after it was formed as they must rely on the fact of the operating agreement to understand their rights and obligations when making the decision to join. See footnote 18.
Provision Requiring Written Approval of the General Partner Prior to Honoring Advancement Claims Did Not Allow for Unfettered Discretion.
There was a provision in the Partnership Agreement that provided as follows: “No advances shall be made by the Partnership … without the prior written approval of the General Partner.” The Court agreed with Stockman and Stepp that such language in the context of a mandatory advancement provision, made the written approval requirement merely ministerial to insure that the requirements of the advancement provision, such as an undertaking, were met before the money was paid, as opposed to allowing for unbridled discretion to withhold advancement payments or to impose additional prerequisites not required by the terms of the Partnership Agreement. See footnote 34.
The Court recognized that § 17-108 of the Delaware Revised Uniform Limited Partnership Act gives limited partnerships wider freedom to contract for their own indemnification scheme for partners as compared to the provisions available to corporations pursuant to DGCL § 145 which creates mandatory indemnification rights for corporate indemnitees in some circumstances and also bars indemnification in others. In the indemnification provision provided in the Partnership Agreement in this case, the Court concluded that § 145 was used as a model but only in a selective way. In sum, the Partnership Agreement indemnification provision adopted the standard in § 145 for good faith and lawful conduct, but was silent about the impact of a disposition in the underlying proceeding in favor of the indemnitee–which is a key consideration when determining whether a corporate official would be entitled to indemnification under § 145.
Because all the parties in this case made arguments based on the language and policies of § 145, the Court first provided an expansive analysis of the statutory scheme created by Section 145 and the public policy behind it, and then applied that reasoning to its analysis of the Partnership Agreement provisions for indemnification in this case.
The Court parsed subsections (a), (b) and (c) of § 145 and recognized that the purpose of the limits on indemnifiable conduct in §§ 145(a) and (b) is “in part to insure that the corporate officials do not evade the consequences of their own misconduct in such a way that they are rewarded for or encouraged to violate applicable laws and to breach their fiduciary duties to the corporation.”
However, § 145 (c), explained the Court: “assures corporate indemnitees that their reasonable legal expenses will be paid any time they are ‘successful’ in a proceeding.” See footnote 43 (citing cases that provide as follows: "subsection (c) grants an absolute right of indemnification to the movant, provided that he has been successful on the merits or otherwise.”) See also footnote 44 (citing cases providing that “success under § 145 (c) does not mean moral exoneration. Escape from an adverse judgment or other detriment, for whatever reason, is determinative.”)
The Court also put to rest what it referred to as a question that some believe still remains as to “whether a corporate indemnitee is successful when an action is dismissed without prejudice and could theoretically be revived, as is the case here”. The Court relied on two recent decisions that support the an affirmative answer to that question for the following reasons:
“… awarding indemnification after a dismissal without prejudice on the basis that indemnification decisions should be made on a case-by-case basis especially when the governing bylaw or organizational document provides broad, mandatory indemnification rights. To do otherwise would be the same as requiring indemnitees to wait for all proceedings against them arising from the same set of operative facts to be concluded before receiving indemnification for any of them, which this court has held to be improper in similar circumstances.”
See footnote 47. See also footnote 54 referring to a case that concluded: indemnitees were entitled to indemnification on federal claims that were dismissed without prejudice for lack of subject matter jurisdiction, and that the indemnitees did not have to wait until the dismissed claims were resolved in state court.
Pleading Standard for Indemnification Claim
The Court cited prior decisions to buttress the principle that, contrary to the normal burden of pleading the plaintiff must bear to establish the elements of her claim, in the case of a mandatory indemnification provision, the burden rests on the party from whom indemnification is sought to prove that indemnification is not required.
Unlike the cross motions for summary judgment on the advancement claim, there was only a motion to dismiss pending on the indemnification claim. Although the Court observed that it was not necessary to complete an analysis beyond denying the motion, the court dilated on the topic to emphasize how odd it would be if an indemnification provision would require an indemnitee to “endure a plenary trial on the conduct underlying a favorably dismissed case as the price of indemnification." That is, “must the indemnitee endure the equivalent of the very proceeding she has already won to get her costs indemnified?”
The Court reasoned that § 145(c) shields corporate indemnitees from any inquiry into their conduct when the underlying proceeding was dismissed with no finding of guilt and no admission of guilt.
This is so because
“the requirements of §§145(a) and (b) seem best read as public policy limits designed to prevent corporations from indemnifying corporate officials in only the most incentive-distorting circumstances: when the officials have been convicted or otherwise incurred liability as a result of culpable conduct and that liability was the result of conduct that involved a certain level of scienter.”
Moreover, the Court reasoned that “turning an indemnification case into a hypothetical trial on the merits of a dismissed case is a bizarre notion to propose and would be counterproductive to Delaware’s policy goal of assuring indemnitees ‘that their reasonable expenses will be borne by the corporation they have served if they are vindicated.’” In addition, the Court observed that requiring a full trial on the conduct that Stockman and Stepp engaged in would require the expenditure of much more money than would be necessary for the advancement of funds in the case that was already dismissed, in addition to paying the costs for Stockman and Stepp to defend an additional trial if Heartland loses.
The drafters of the Partnership Agreement could have exercised their freedom of contract to provide for less expansive indemnification provisions than are provided in § 145, but they did not do so.
To the extent that there was any doubt about whether the indemnification provisions required mandatory indemnification, important principles of contract interpretation and public policy supported a reading in favor of providing the indemnification. See footnote 75.