In the recent Chancery decision of Lieberman v. Electrolytic Ozone, Inc., C.A. No. 10152-VCN (Del. Ch. Aug. 31, 2015), the court rejected claims for advancement by former officers and directors who sought to have their former company pay for the attorneys’ fees they incurred in defending a suit brought against them by the company for whom they served as corporate officers. This Delaware opinion is noteworthy for two main reasons. I highlight the following two points based on my perspective as the author of an annually updated chapter in a book published by the ABA that provides an annual review of the key decisions from Delaware and around the country on the topic of advancement and indemnification of directors and officers.
First, it remains rare, in general, for claims for advancement to be rejected by Delaware courts, especially based on a failure to satisfy the prerequisite of DGCL Section 145 that the actions for which the former directors or officers are being sued is “by reason of the fact” of their position as a former director. Regardless of what an “ordinary” meaning of that phrase might suggest, the reality is that prevailing case law interprets that phrase to mean “almost anything”, in my view, but this case is an exception from the norm. And it is an exception that other Delaware decisions have recognized when the dispute is based on an employment contract–though the distinction between an employment dispute and a claim asserted “by reason of the fact” that the defendant was a corporate officer or director is not always “black and white”.
Second, as a matter of public policy, statute and case law, this decision makes clear that a provision in a contract is not enforceable if it purports to allow a former director or officer to have her attorneys’ fees paid in connection with a lawsuit–even if she is not successful in the claims she makes in the lawsuit. In this case, the court refused to enforce a provision in the parties’ agreement that provided that the company was required to pay for attorneys’ fees in any suit seeking advancement–even if the claimant lost–as long as the claims were made in good faith. Not so, according to this Delaware opinion, addressing this important nuance of corporate and commercial litigation. See footnote 48-49 and accompanying text.
- A few important facts that may distinguish this case from many other advancement cases, include: (i) the focus of the conduct of the former director and officer was a period of time after their employment was terminated; (ii) the claims were based on an alleged breach of their employment agreement that prohibited disclosure of certain proprietary information and also had a non-compete provision.
- A key fact that may distinguish this case from many others, is that the claims that the former officers were defending were held to be “confined to post-termination actions and do not depend on Plaintiffs’ use of corporate authority or position”. See footnote 42. This conclusion was not impacted by what claims the former company “could have” but did not assert, based on the same facts.
- The decision rejected an argument that if the current employers were providing advancement, the former officers did not have “standing” to seek advancement from their former employer. But the court noted at footnote 17 that Delaware case law has recognized the ability of a party to seek advancement from more than one source when one obligor has refused to honor its obligations.
- A discussion of prior Delaware cases in the opinion addresses the requirement that the claims for which advancement is sought be brought “by reason of the fact” that the plaintiffs were former directors or officers. See footnotes 18-22 and accompanying test. Regardless of those discussions and the “test” for that prerequisite, it remains rare that a company can successfully argue that the test is not met. This case serves as a rare exception to that observation.
- The opinion distinguished a case at footnote 38, which held that when a former officer was charged with wrongfully retaining proprietary information while he was still employed, and allegedly conspired to breach his fiduciary duties while he was an officer, unlike the current case, those facts satisfied the “by reason of the fact” test. See also footnote 25-28 and accompanying text.