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Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article     

The Delaware Court of Chancery recently ordered biotech firm InterMune Inc.’s former CEO to repay nearly $6 million in director and officer insurance funds he spent trying to overturn his felony wire fraud conviction for misleading investors about the effectiveness of a lung disease treatment in InterMune Inc. et al. v. Harkonen, No. 2021-0694-NAC (Del.Ch. Aug. 1, 2024)

Vice Chancellor Nathan Cook found that in nearly two decades of investigation, negotiation and litigation stemming from a false 2002 press release about the commercial prospects for his interferon gamma-1b treatment Harkonen never successfully appealed his convictions or proved that he should not be liable for all the defense funds advanced to him from various D&O insurers and InterMune’s coffers. 

He ruled that two D&O insurers that had advanced funds had been paid by InterMune in a settlement after Harkonen was convicted and that under Section 145 of the Delaware General Corporation Law the company had a right to sue its ex-officer to repayment since the litigation was found to be non-indemnifiable.  

In addition, the vice chancellor rejected Harkonen’s counterclaims seeking a declaration that the Company must reimburse him for various legal expenses he accrued in a related California Medical Board disciplinary proceeding, two insurance arbitrations, advancement negotiations with InterMune, and a presidential pardon. 

He found that then-President Donald Trump’s pardon of the wire fraud conviction came long after a final adjudication of the case and could not qualify as a “successful defense of the charges.”  And “In addition to being procedurally improper, each of Dr. Harkonnen’s claims is either untimely or fails to satisfy the requirements for indemnification under Section 145.” 

Background

Harkonen founded InterMune in 2000 and issued a press release two years later extolling his new product, Actimmune which he claimed was “a major breakthrough” with “results [that] will support the use of Actimmune and lead to peak sales in the range of $400–$500 million per year[.]” – even though the study’s results indicated a failure.  One year later, Harkonen and InterMune negotiated a mutual release of claims against each other, and he resigned, only to face a 2004 justice department investigation that led to a 2008 indictment and a 2009 conviction.

That conviction carried an up to 20-year prison sentence; meanwhile InterMune’s D&O insurers began to seek repayment after learning that the charges and advancement would not qualify for indemnification and Harkonen began a decade of appeals.

At the same time, InterMune and its insurers pressed objections to what they insisted was Harkonen’s continuing “profligate” spending on attorney fees in many appeals and other legal proceedings.

The indemnification ruling

The vice chancellor laid out the ground rules for this type of indemnification case, noting that:

*”The corporation, rather than the employee, bears the burden of proof in an advancement claw-back action.”

*“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.”

*The applicable evidentiary burden in this post-trial context is proof by a preponderance of the evidence. [P]roof by a preponderance of the evidence means proof that something is more likely than not.”

*”Bylaw[s] not only mandate indemnification; [they] also effectively place the burden on [the Company] to demonstrate that the indemnification mandated is not required.”

Fraud = bad faith conviction

“Dr. “Harkonen is precluded from establishing good faith under Section 145(a) because his [wire fraud] conviction is conclusive evidence that he acted in bad faith,” Vice   Chancellor Cook wrote. “Dr. Harkonen is therefore ineligible to be indemnified for the advanced amounts he spent defending his wire fraud charge and appealing his conviction.”

Therefore Dr. Harkonen must repay the Company for the $5,906,927.02 it paid to settle the insurance disputes and six defenses Harkonen presented fail to prevent that, the court ruled, noting why each argument fails:     .

  • The Company waived and released all claims under the Mutual Release. The Court said: “Nowhere in Dr. Harkonen’s affirmative defenses did he assert the Mutual Release as a defense to InterMune’s claims. “
  •  The Company is barred by hold harmless provisions in the Indemnity Agreement and the Mutual Release. The Court said, “This defense, like the Mutual Release defense, was raised for the first time in the pre-trial briefings, which was too late for InterMune to focus its discovery on the hold harmless provisions of the two agreements.”
  •  The settlement payment was voluntary. The Court said: “InterMune devoted not insignificant portions of its briefing to rebutting this defense. And Dr. Harkonen ultimately withdrew the defense of voluntary payment at trial. “
  •  The Company’s claims are time-barred, The Court said: “InterMune filed its Complaint on August 11, 2021, well within the 3-year window under either alternative.  Harkonen’s time-bar defense therefore fails.” 
  •  The Company is barred by the unclean hands doctrine. The Court said: “The Company’s efforts to win the insurance arbitrations, or at least minimize any award, are not unclean hands. If they were, companies would be confronted with conflicting and strange incentives.” 
  •  The settlements themselves are not advancement fees. The Court said, “By mentioning the defense for the first time in passing at the trial on a paper record, the defense is waived. The analysis ends there.” 

Additional indemnification requests

The vice chancellor said Dr. Harkonen now requests indemnification “under 8 Del. C. § 145(c) for expenses incurred in (1) litigating the MBC action, (2) seeking advancements from the Company, (3) litigating the D&O insurance arbitrations, and (4) seeking the Pardon.” 

No fees or fees-on-fees

The Court held that Dr. Harkonen is not entitled to indemnification for the costs incurred in the medical board proceeding either, because the claim is both untimely and he was unsuccessful in the respective proceeding. This advancement claim regarding any of the legal actions is brought too late for the three-year time limit, the court said.  Finally, Dr. Harkonen also requests an award of fees on fees for this action, but given that he did not prevail on any claim, Dr. Harkonen is not entitled to fees on fees, Vice Chancellor Cook concluded

I want to thank my partner, Sean Brennecke, for his valuable contribution to this post.

The titular holding was rendered in the context of whether substantial compliance was established as a defense to a breach of contract claim in a recent decision of the Delaware Court of Chancery in the matter styled LPPAS Representative, LLC v. ATH Holding Company, LLC, et al., C.A. No. 2022-0241-KSJM (Del. Ch., May 2, 2023).

This useful decision deserves a spot in the toolbox of all commercial litigators. It addresses several noteworthy issues beyond substantial compliance, including whether the right to participate by the indemnitee as part of a right to indemnification was honored–but for purposes of this short post I will limit my highlights to only a few aspects of the decision.

The court’s discussion begins with its holding that the defendant breached the terms of the contract it entered into with plaintiff by, among other things, not including the plaintiff in discussions with a government agency, not allowing plaintiff to review and comment on filings and submissions the defendant made to a court or government agency, and otherwise failed to allow plaintiff to participate in the defense of claims for which the defendants were providing indemnification. 

In so holding, the court rejected the defendants’ arguments, including that they substantially complied with the contract’s requirements. The court discusses the substantial compliance issue primarily from pages 34 to 39 of the slip opinion.  Initially, the court observed that the parties disagreed on whether Delaware law required a party to strictly comply with the terms of a contract or whether substantial compliance was sufficient. In footnote 163 the court reviewed the cases cited by the parties on this issue although the court did not view the parties as having “meaningfully” briefed the question and noted that the limited authority cited by the parties did not fully support their respective positions.

In order to “streamline this decision,” the court assumed that the applicable standard is substantial compliance as that is the lower standard. 

Applying that assumption, the court considered whether the defendants’ failure was “material.”  The court instructed that Delaware followed the Restatement (Second) of Contracts for determining materiality in the substantial compliance context and identified five circumstances which are particularly significant, including “the extent to which the injured party will be deprived of the benefit which he reasonably expected, and the extent to which the injured party can be adequately compensated for the part of the benefit of which he will be deprived….”  See Slip Op. at 35-36.  The court added that the materiality standard is “necessarily imprecise and flexible” and must be “applied in the light of the facts of each case in such a way as to further the purpose for securing for each party his expectations of an exchange of performance.”

The court reasoned that the plaintiff was deprived of the benefit which it reasonably expected, which in this case was the ability to participate in the defense in connection with its right to indemnification and that because that benefit was intangible, “it is hard to imagine how to adequately compensate” for the breach.  Under the circumstances of this case, the court found those factors to weigh in favor of a finding of materiality.

The defendant raised, and the court rejected, five arguments in support of their claim that their breach was immaterial.  One such argument was that their obligations to include plaintiff in critical discussions was not triggered because the plaintiff did not approach the defendant and request that they enter into joint defense agreement.  In rejecting this argument, the court held that the language of the indemnification provision did not impose an affirmative duty to contact the other party to put a joint defense agreement in place. 

The court further observed that the lack of such language in the agreement suggested that “neither party alone bears the burden of first contact.”  Slip Op. at 39.

Therefore, the court concluded that the failure to propose a joint defense agreement proactively did not necessarily absolve the defendants of their own obligation to work with the plaintiff to get one in place or honor their other contractual obligations. 

The Delaware Business Court Insider published in its current edition my commentary on a recent Delaware Supreme Court opinion on the titular topic. Courtesy of the Delaware Business Court Insider, the article is reprinted below.

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A recent Delaware Supreme Court decision provides a lesson for drafters of agreements for the sale of a business by providing an example of the problems caused by a lack of clarity in describing a deadline to send notices of claims for indemnification post-closing. To paraphrase a former member of the U.S. Supreme Court, the Delaware Supreme Court is always right when it comes to deciding Delaware law not because the members of the Court are infallible, but rather because they always have the last word.  The reader can decide how that aphorism applies to the decision of a divided court in the matter of North American Leasing v. NASDI Holdings, Del. Supr., No. 192, 2020 (April 11, 2022).

The court decided three issues in this case. First, whether the Delaware Court of Chancery erred in interpreting an agreement of sale according to the principles of Delaware contract law in connection with determining what the deadline was in the agreement for giving notices of indemnification claims. Second, the court decided whether an affirmative defense of set-off and recoupment was waived. Lastly, the court decided whether it was appropriate for the Court of Chancery not to consider evidence that the total amount of the claims should have been reduced. Three members of the Delaware Supreme Court affirmed the decision of the Court of Chancery, and two dissented from the majority opinion.

Key Background Facts

This case involved the sale of a company that, among other things, was involved in the construction of bridges. One of the bridge projects underway at the time of the closing on the sale of the business had a bond in place that the seller posted in the approximate amount of $20 million. After the closing, because the buyer decided to discontinue work on the bridge project, the letter of credit was drawn down in the full amount of the bond. The seller sued the buyer setting forth three causes of action: breach of contract regarding an indemnity obligation; equitable subrogation; and a claim for declaratory judgment that the defendants breached their indemnity obligation.

The Court of Chancery granted summary judgment in favor of the seller and also denied a motion for reargument. In connection with the motion for the entry of the final judgment, the Court of Chancery determined that the affirmative defense of set-off/recoupment was waived because it was not raised in response to the motion for summary judgment, or in the motion for reargument.

Legal Analysis

The majority decision acknowledged that questions of contract interpretation on appeal are reviewed de novo. Delaware’s high court observed that Delaware law adheres to an objective theory of contracts, which means that the construction of a contract should be “that which would be understood by an objective, reasonable third party.” That theory gives priority to the intentions of the parties reflected in the four corners of the agreement, “construing the agreement as a whole and giving effect to all its provisions.”

The majority opinion carefully considered the various provisions of the agreement at issue and examined the reasoning of the Court of Chancery which rejected the buyer’s arguments that Section 9.3(a) provided for a deadline which ended before the indemnification claim of the seller arose, which would have rendered the indemnification notice untimely.

The decision turned in large measure on the reading of one phrase. The majority explained its reasoning for the interpretation of the phrase “but in any event” as introducing an exception to the sentence that followed—not a limitation of the phrase that followed.

The majority also agreed with the Court of Chancery’s conclusion that the set-off/recoupment defense was waived.  The buyer argued that set-off/recoupment was a defense that pertained to damages, and damages did not need to be briefed in the motion for summary judgment.  Not so, according to those with the last word on the topic, because damages were central to the relief requested in the motion.

Regarding the last issue of damages, the Supreme Court concluded that the Court of Chancery did not err when it did not consider the evidence regarding the reduction of damages because the set-off/recoupment defense was waived.

Dissent

Notably, both the majority and the dissent agreed on the basic contract principles of Delaware law that applied to this case, although they disagreed on the result after applying those principles to the facts.

A substantial focus of the dissent was its different interpretation of the phrase “ in any event,” and whether: it applied to all indemnification claims; or it only applied to the “representations and warranties” claims. The majority held that the phrase created an exception, but the dissent explained why in its view the phrase introduced a limiting or qualifying clause. The dissent referred to a dictionary definition for the adjective “any” as meaning “without limitation.” The phrase “in any event” means “no matter when [an event] happens.”

The dissenters explained that the drafters of the agreement could have used the verb “the” instead of the word “any”—if the drafters wanted to establish an exception to the deadline for sending a notice of claim.

Moreover, the dissent noted that even if the deadline for the notice of a claim were missed, the seller could still rely on equitable subrogation as a basis for a claim. The dissent added that the availability of that remedy supports the view that an earlier notice deadline would make an indefinite period for indemnification claims unnecessary.

The dissent included the following memorable quote: “The majority sacrifices the plain meaning of Section 9.3 on the altar of the context of the provision and the contract as a whole.” The dissent concluded by explaining that its view demonstrated more than one reasonable interpretation of the agreement, which is one definition of an ambiguous contract. Therefore, the trial court should not have granted summary judgment and, in the view of the dissenting opinion, should have considered extrinsic evidence.

In a short letter ruling, with widespread applicability, the Court of Chancery explained in Paul Elton, LLC v. Rommel Delaware, LLC, et al., C.A. No. 2019-0750-KSJM (Del. Ch. Mar. 16, 2022), that typical indemnification provisions ordinarily:

“are presumed not to require reimbursement for attorneys’ fees incurred as a result of substantive litigation between the parties to the agreement absent a clear and unequivocal articulation of the intent.  This presumption prevents broadly written indemnification provisions, which may be intended only to hold the indemnitee harmless from claims brought by third parties to the contract, from swallowing the American Rule.  Thus, purely contractual indemnification provisions only shift first-party claims if the contract explicitly so provides.”

See Slip op. at 2-3.  See also footnotes 8-10.

During the 17 years or so of this blog’s existence, we have featured many Delaware decisions on the topic of indemnification and advancement for directors and officers, interpreting a company’s obligations to make those payments pursuant to Delaware General Corporation Law (DGCL) Section 145, in addition to contract-based claims for advancement and indemnification. See also several book chapters I have published on advancement and indemnification as the Chair of the Indemnification and Advancement Subcommittee of the ABA Business Law Section’s Corporate Litigation Committee.  Enough background, and now for the main event:

The purpose of this short post is to make note of a consequential amendment, recently passed by the Delaware Legislature and signed by Gov. Carney, to DGCL Section 145, which as amended allows Delaware companies to use a captive insurance company to provide coverage for directors and officers–such as for purposes contemplated by Section 145–but with a few key exceptions. Relevant to this statutory amendment is a recent Delaware Supreme Court decision that concluded: Delaware’s statutory indemnification provisions allow corporations to purchase D&O insurance “against any liability,” whether or not the corporation has the power to indemnify against such liability.  

One of Delaware’s favorite nationally recognized corporate law scholars and one of the leading indigenous Delaware firms have provided exemplary commentary on this new development in corporate law. Those interested in this development should also read the reliably thoughtful insights by D&O insurance expert Kevin LaCroix on his widely-read blog, The D&O Diary.

 

The recent Delaware Court of Chancery opinion in Evans v. Avande, Inc., C.A. No. 2018-0454-LWW (Del. Ch. Sept. 23, 2021), provided much needed clarification for the rather unsettled nuance of indemnification under Section 145 of the Delaware General Corporation Law regarding when indemnification can be proportionate to the extent that the party seeking indemnification was not 100% successful in the underlying litigation.

Brief Background:
This case involved a request for mandatory indemnification under DGCL Section 145 based on what the court described as a “novel theory of proportional indemnification.” The plaintiff argued that he should be indemnified for his “partial success” on fiduciary duty claims against him because the damages awarded to his former company were much less than the company originally sought.

Basic Principles:
The court provided a very helpful primer on the basics of indemnification under DGCL Section 145. In particular, the court explained that Section 145 grants corporations the discretion under subsections (a) and (b) to indemnify officers or directors where a minimum standard of conduct is met. The permissive language of Section 145(a) and Section 145(b) provides that indemnification may be available to an officer or a director if she is found to have acted in good faith.

By contrast, Section 145(c) contains mandatory language providing for an entitlement to indemnification. Under Section 145(c), whether an individual acted in good faith, or what she perceived to be in the best interest of the corporation, is irrelevant. The court explained that: “Section 145(c) is triggered when a covered person prevails in a proceeding that is covered by Section 145(a) or 145(b).”

The court further clarified that indemnification is compulsory where: “a present or former director or officer of a corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding” (citing Section 145(c), and where that person was made a party to such action “by reason of the fact that the person is or was a director or officer . . . of the corporation.” (citing Section 145(a) – (b)).

The court emphasized that to satisfy the statutory prerequisite for mandatory indemnification “success” does not mean exoneration, and a corporate official “need not have been adjudged innocent in some ethical or moral sense.” See footnotes 39 and 40 and related text.

Highlights of Decision:
The most noteworthy aspects of this decision are the parts where the court addresses the standard for “proportionate indemnification” based on “partial success.”

The court observed that it was not aware of any authority where “partial success” was analyzed based on the percentages of damages the prevailing party recovered against an indemnitee. The court held that such an approach was “unworkable” in addition to being unprecedented; that is: to define partial success for indemnification purposes based on the proportion of damages recovered on a single claim. Such an approach would be untethered from the policy at the root of Section 145 because the overarching purpose of Section 145 is to encourage capable persons to serve as corporate directors knowing that expenses incurred by them will be borne by the corporation they serve. The court added that a director adjudged to have acted in bad faith in breach of his duty of loyalty can hardly assert that he is entitled to indemnification for a claim where the director’s integrity that the policy is intended to uphold while serving as a director, was found lacking.

Moreover, the court cited to other cases for the prevailing view that Delaware courts have made a determination on whether a person was successful for purposes of being entitled to indemnification “on a claim by claim basis,” as opposed to determining the percentage of damages that was awarded compared to the amount of damages that was initially sought. See footnotes 48 – 52 and accompanying text.

 

A recent Delaware decision addressed the request for a claw-back of legal expenses that a company was ordered to advance to an LLC manager in a prior Court of Chancery decision. In the case styled: New Wood Resources, LLC v. Baldwin, C.A. No. N20C-10-231-AML-CCLD, Order (Del. Super. Aug. 23, 2021), the Complex Commercial Litigation Division of the Delaware Superior Court determined that pursuant to the terms of an LLC Agreement (for which the Delaware LLC Act allows much greater latitude than Section 145 of the Delaware General Corporation Law on this issue), the court determined that some of the amounts advanced were required to be returned.

Most noteworthy, however, about this decision, is that the court determined that the undertaking to repay the amounts advanced did not apply to the “fees on fees” that the Court of Chancery had also required that the company pay in the prior advancement action. The court explained that the undertaking only applied to “funds advanced,” but that undertaking did not apply to the repayment of “fees on fees” because the court reasoned that “such sums constitute indemnification, rather than advancement.” Order at 12. [Readers should be aware that in Delaware, court decisions issued by Order may also be cited in briefs, even if the decision is not a formal opinion.] See footnote 43 (judge explains that even though the parties did not raise the distinction between advancement and indemnification in connection with the claw-back arguments, the court determined that: it was “compelled by principles of comity to raise the issue sua sponte about the “fees on fees” that the Court of Chancery ordered the company to pay which should be considered differently from the advancement ordered by the court and governed by the undertaking.”)

This post was prepared by Frank Reynolds, who has been following Delaware corporate law, and writing about it for various legal publications, for over 30 years.

The Delaware  Court of Chancery recently refused most of B. Riley Financial, Inc.’s motion to dismiss an ex-officer and director’s complaint for indemnification for his settlement of underlying breach-of-duty and fraud charges against him and companies he had founded and later sold to Riley in Wunderlich v. B. Riley Financial, Inc., et al., No. 2020-0453-PAF (Del. Ch. March 24, 2021).

In a March 24 letter ruling, Vice Chancellor Paul Fioravanti Jr. ruled that Riley’s dismissal bid cannot rely on the limits in its interpretation of an indemnification contract plaintiff Gary Wunderlich signed as part of his companies’ 2017 merger with that financial services firm, since it is not the only reasonable reading.

In addition, Wunderlich makes a plausible argument that Riley took over his investment and securities companies’ indemnification obligations when it made them subsidiaries, and Riley had been paying Wunderlich’s legal costs until the two parted ways in Nov. 2018 and Wunderlich was hit with a $10.5 million arbitration award, the vice chancellor said. The Chancery Court let Wunderlich continue to pursue his indemnification claim but dismissed as unripe a declaratory judgment count seeking to hold Riley separately liable for any judgment in the arbitration action.

The opinion could be of value to advancement and indemnification specialists in how it employs Delaware contract law principles to determine the scope of rights and responsibilities in the various indemnification agreements.

Background
Gary Wunderlich founded Wunderlich Investment Company, Inc. and parent Wunderlich Securities, Inc. in 1996 and sold them to Riley in May 2017 but two months later investment and merchant banking firm Dominick & Dickerman LLC brought an arbitration proceeding against Wunderlich and his two companies in the Financial Industry Regulatory Authority. At the time, he was an officer and director of his companies and Riley; Riley initially took over attorney selection and payment, the vice chancellor said.

After the April 2020 award of $10.5 million jointly and severally against Wunderlich and his companies, the claimants filed a petition to confirm the award in May and Riley petitioned to vacate it the next day in the U.S. District Court for the Southern District of New York. Meanwhile, Wunderlich, in April 2020, formally demanded that B. Riley “confirm” that it would indemnify him for “all costs, expenses, awards, losses and liabilities incurred by reason of the fact that he was an officer or director” of B. Riley, WIC, and WSI.

Riley threatened to pursue claims against Wunderlich for actions relating to the Arbitration and to recover from Wunderlich amounts Defendants paid in the Settlement Agreement, and Wunderlich filed this indemnification action in June seeking indemnification from his two companies, and Riley under the merger agreement.

The suit includes claims for:
•Reasonable attorneys’ fees and other expenses incurred in connection with defending against and pursuing vacatur of the Award and negotiating the terms of the Settlement
•Wunderlich’s fees and expenses incurred in this action, or “fees-on-fees.”
•A declaratory judgment obligating Defendants to indemnify Wunderlich for any contribution claim that Defendants “may seek to assert against him in connection with the Arbitration
•B. Riley’s alleged failure to tender payment in response to Wunderlich’s indemnification demand breached the Indemnification Agreement.

Declaratory judgment on contribution
The vice chancellor said “our courts will decline ‘to enter a declaratory judgment with respect to indemnity until there is a judgment against the party seeking it.’” quoting Wal-Mart Stores, Inc. v. AIG Life Ins. Co., 572 A.2d 611, 632 (Del. Ch. 2005). He said, “Defendants have not asserted a contribution action against Wunderlich, and Wunderlich does not presently owe any amounts to be paid in connection with the Settlement Agreement.” If the defendants do not assert a contribution claim against Wunderlich “judicial intervention may be unnecessary.”

Breach of the Indemnification Agreement
“Defendants principally argue that Wunderlich waived his indemnity rights when he executed the Severance Agreement,” the court said. “Central to this decision is whether the indemnification provisions in the bylaws are preserved through a carve-out in the Severance Agreement, which, in turn, requires the construction of the terms of the Merger Agreement.”

But ‘[d]ismissal, pursuant to Rule 12(b)(6), is proper only if the defendants’ interpretation[s] [are] the only reasonable construction[s] as a matter of law” and that is not the case here the court said. “Wunderlich has stated a claim for indemnification…because he has advanced a reasonable interpretation of the WIC Bylaws, the Merger Agreement, and the Severance Agreement.”

Defendants rely on Julian v. Julian for the proposition that the only rights that “arise under” a contract are those that exist within its four corners,” Vice Chancellor but “Julian is factually inapposite because the relevant language in the Merger Agreement and the Severance Agreement are different from the arbitration provision at issue in Julian. Julian v. Julian, 2009 WL 2937121 (Del. Ch. Sept. 9, 2009).

He said he cannot determine as a matter of law that the Severance Agreement only released the indemnification rights listed in the Merger Agreement to the exclusion of any indemnification rights but he doesn’t need to at this stage.

Fees on Fees
Wunderlich’s claim for fees-on-fees in enforcing his indemnification rights, need not be dismissed just because he has not identified any applicable indemnification provisions, the court said, because under Section 145 of the DGCL, “without an award of attorneys’ fees for the indemnification suit itself, indemnification would be incomplete” and Wunderlich’s indemnification requires WIC to provide indemnification “to the fullest extent permitted by the Delaware General Corporation Law”.

A recent Delaware Court of Chancery decision ordered mandatory indemnification based on success in underlying litigation pursuant to DGCL § 145(c), in the matter styled:  Brown v. Rite Aid Corporation, C.A. No. 2017-0480-MTZ (Del. Ch. May 24, 2019).

Issue Addressed:  Whether dismissal of the underlying litigation based on a technical argument was “success” for purposes of mandatory indemnification under DGCL Section 145(c)–even if all of the arguments in the underlying litigation were not successful?

Answer:  Yes.

Procedural Background:

The procedural history of this litigation involves multiple court decisions in several jurisdictions over the span of a decade.  See, e.g., cases cited at footnotes 4, and 13 through 17.

Even though Brown was convicted and sentenced for certain financial crimes in connection with his role as an officer and a director of Rite Aid, in separate civil litigation pursued against him by Rite Aid, Brown was successful in having that litigation dismissed based on technical procedural arguments.  See footnotes 18 through 20 and accompanying text.

Key Aspects of Court’s Legal Analysis:

The court began its analysis by explaining that indemnification sought in this matter was based on three separate sources.

First, Brown relied on DGCL Section 145(c) which requires indemnification when a present or former director or officer has been “successful on the merits or otherwise” . . ..  The court noted that Section 145(c) is independent and non-exclusive of any right based in the charter, which in turn is independent and non-exclusive of any bylaw right, which in turn is independent and non-exclusive of any contract right, absent specific agreement to the contrary.  See Section 145(f), which makes this clear in both the indemnification and the advancement context.

The second basis for indemnification in this case was a provision in the corporate bylaws.

The third basis for indemnification sought in this matter was a provision in the corporate charter.

Notably, the court observed that even though Section 145(c), in the current version of the statute, covers officers and directors, the court added : 

“But when a corporation has provided other authorized individuals with mandatory indemnification to the fullest extent of the law, then that right extends the mandatory indemnification contemplated by Section 145(c) to those individuals”  (citing Dore v. Sweports, Ltd., 2017 WL 415469, at * 18 (Del. Ch. Jan. 31, 2017)).

The foregoing extension of the mandatory indemnification of Section 145(c), which in its current form only benefits directors and officers–to employees, agents and others that are expressly granted indemnification in the bylaws “to the fullest extent allowed by law”–is not well-known even by those familiar generally with the nuances of advancement law in Delaware.

The court explained that Section 145(c) provides for mandatory indemnification for an officer and a director who meets the requirements of the statutory provision, which is when: “a covered person defending himself in a covered proceeding . . . succeeds on the merits or otherwise . . ..”  See Slip op. at 10.  See also footnotes 39-41.

Other Notable Bullet Points:

·     The court recited the public policy rationale behind mandatory indemnification as including the need to encourage capable individuals to serve as corporate directors, which is viewed less as an individual benefit and more as a desirable mechanism in return for greater corporate benefits.

·     A key point and an essential aspect of the court’s reasoning is its reliance on an abundance of case law that interprets the “success” requirement in Section 145(c) very broadly.  That is, in order to satisfy the requirement of success “on the merits or otherwise” under Section 145(c), one must merely obtain any result in a lawsuit “other than conviction,” which does not equate with moral exoneration, but rather can be satisfied merely from:  “escape from an adverse judgment or other detriment, for whatever reason . . ..”  See footnotes 54 to 55 and accompanying text.

·     Moreover, if such a broad definition of success is achieved, it is not relevant, and the court will not inquire into, whether all arguments were won, or if preliminary motions or other efforts in the underlying litigation failed before the final successful result was reached.  See footnote 56 and accompanying text.  See also footnotes 72 to 80 and accompanying text.

·     The court also granted fees on fees and required Brown to file an affidavit under Rule 88, itemizing the fees for which he seeks indemnification, along with a motion seeking an entry of an order requiring the corporation to indemnify him in the amount specified in the damages motion.

A recent Court of Chancery decision rejected an attempt to recoup advancement based on the terms of an indemnification clause. See Computer Sciences Corporation v. Pulier, C.A. No. 11011-CB (Del. Ch. May 21, 2019), for this recurring issue in Delaware corporate and commercial litigation.

Issue Addressed:  May a company recoup, via an indemnification claim, the amounts it previously was required to pay via an advancement ruling, based on the applicable contractual indemnification provisions.

Prior Procedural History:

·     Prior rulings in this matter were highlighted in prior blog posts on these pages–including rulings granting advancement.  See also transcript ruling in this matter cited at footnotes 12 and 13, that granted advancement based on the prior holding that: “conduct as an officer . . . was squarely at issue.”  Slip op. at 4 (citing footnotes 12 and 13).

Court’s Holding:

·     Based on the applicable terms of the indemnification provision in the agreement of sale, the court determined that the indemnification provisions only covered post-closing losses for “board-approved” liabilities related to the sale, which was not the basis for the prior advancement granted in this case.