The Delaware Court of Chancery’s opinion in Marino v. Patriot Rail Company LLC, C.A. No. 11605-VCL (Del. Ch. Feb. 29, 2016), is noteworthy for providing the most detailed historical analysis and doctrinal underpinning for the legislative scheme that requires corporations under certain circumstances to provide advancement to former directors and officers, that has come along in many years. The decision also explains why companies are barred from terminating such advancement for former directors and officers unless certain prerequisites are satisfied.
Although the factual background has many moving parts, for purposes of this short blog post that focuses on the legal analysis, the basic facts include a former chairman, president and CEO who had a controlling interest in the company involved. While a lawsuit was pending against the company by a former potential merger partner, the company was sold and an allegation was made that money from the sale was diverted in a manner that would make it difficult for the creditors to collect in the event of a judgment. After obtaining a judgment in the underlying suit that was pending prior to the sale, the creditor attempted to modify the judgment to add the former chairman as an individual party.
The former chairman sought advancement to cover the legal fees to defend against the efforts to add him as an individual party and to defend efforts to collect against him as a judgment debtor.
This opinion provides one of the “deepest dives” into legislative history and the policies underpinning advancement rights under Section 145(e); Section 145(f) and Section 145(j) of the Delaware General Corporation Law this writer ever recalls. This opinion also provides practical assistance for those handling this common form of corporate litigation.
In sum, Section 145(e) authorizes advancement; Section 145(j) suggests the extent to which a covered person’s indemnification and advancement rights for actions taken during the person’s period of service continued after the person ceased to serve; and Section 145(f) limits a corporation’s ability to cause a covered person’s rights to terminate after the person has served in reliance upon them. The court noted that Section 145(e) is permissive and therefore a corporation is free to limit the terms of advancement and even preclude advancement entirely at the outset.
The distinction in 145(e) between current and former directors and officers was not intended to do anything other than underscore the ability of current directors and officers to receive advancement if an undertaking is provided, and not be presumed to be engaged in self-interested transactions. See generally DGCL Section 144. Compare: principle of corporate actions being “twice tested.” See, e.g., footnotes 11 and 13.
The court refers to Section 145(j) as the “Continuation Clause” which requires an explicit opt-out before the advancement rights of a former director and officer can be terminated. So, although subsection (e) makes advancement permissive, once it is provided, this provision is mandatory to the extent that it prohibits termination of coverage for former directors unless this provision is satisfied.
The court explained that under the Continuation Clause in subsection (j), “the only way that a covered person loses coverage after having ceased to be a director is if the source of the coverage otherwise provided when authorized or ratified.” (emphasis added.)
By comparison and consistent with the Continuation Clause, the court explained that section 145(a) grants authority to a corporation to indemnify a person who “is or was” a director for actions that they took while a director. The “was” compliments the default rule of the Continuation Clause which states that unless the indemnification or advancement right specifies otherwise, coverage for actions taken while in a covered capacity continues after the person “has ceased” to serve in the covered capacity. Section 145(a) addresses whether an individual became involved in the litigation “by reason of” the individual’s service in a covered capacity.
Section 145(b) authorizes indemnification for actions by or in the right of a corporation and includes parallel usages of the words “is or was.”
The court next addressed Section 145(f) which “answers the more serious question of whether a corporation can cause those rights [of advancement] not to continue by altering or eliminating them.” The court refers to Section 145(f) as the “No Termination Clause.” It was added as an amendment to the statute in 2009 as a result of a decision which was superseded by this new statutory provision to negate the court ruling that allowed the corporation to terminate coverage of a former director after the former director left this position. This No Termination Clause provides prerequisites that must be satisfied before such coverage can be terminated.
The court discusses the policy reasons and doctrinal underpinning of the importance of providing advancement to former directors and officers for actions taken during their periods of service. Advancement has often been described as an important corollary to indemnification because of their use as inducements for attracting key individuals to perform corporate service. The court explained that the statute was designed to counter the natural human inclination to deny advancement to former directors and officers perceived to have harmed the corporation. Still, the court explained that: “by establishing a statutory presumption of continuing coverage for actions taken during the period of service, the Continuation Clause and the No Termination Clause ensure that the public policy interest prevails, unless the individuals know when they choose to serve that their rights will terminate or can be cut off later.” See Slip op. at 30.
The court explained why some actions that were taken after the resignation of the chairman in his personal capacity in this case would not be covered, but the actions taken while he was the chairman would be covered.
There are many parts of this opinion that make it required reading for anyone interested in this area of Delaware corporate law. One of the key parts of this opinion at pages 39 and 40 should be consulted not for its uniqueness but because it describes a detailed procedure that the parties and their counsel must follow to address disputed claims for advancement. This procedure is similar to prior procedures used in Chancery and will inevitably be needed to address disputes as this opinion is applied to specific bills that are received on a monthly basis and that will engender disagreement about which bills are properly covered pursuant to this opinion and which are not.
N.B.: This decision should be closely compared and contrasted with the Delaware Court of Chancery’s opinion styled Charney v. American Apparel, Inc., C.A. No. 11098-CB (Del. Ch., Sept. 11, 2015), which rejected the advancement claims by a former chairman and CEO (and founder), based on the provisions for advancement in the company’s charter and in an indemnification agreement. That ruling was highlighted on these pages.