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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.

A recent Delaware Court of Chancery decision interpreted an indemnification clause and rejected the applicability of equitable defenses to a strictly legal claim.  I highlighted the recent decision in NASDI Holdings v. North American Leasing, Inc., C.A. No. 2017-0399-KSJM (Del. Ch. Apr. 8, 2019), in an article published in the current issue of the Delaware Business Court Insider, that I co-authored with Jessica Reno of Eckert Seamans.  The article is copied below:

Chancery Interprets Contractual Indemnification Clause

By: Francis G.X. Pileggi and Jessica L. Reno

The Delaware Court of Chancery recently analyzed an indemnification clause and performed other contract interpretation in NASDI Holdings, LLC, et al. v. North American Leasing, Inc., et al., C.A. No. 2017-0399-KSJM (Del. Ch. Apr. 8, 2019). The Court also rejected the applicability of equitable defenses to strictly legal claims.

The dispute involved the sale of a demolition and site-redevelopment company pursuant to an Ownership Interest Purchase Agreement (“Purchase Agreement” or “Agreement”).  Under the Agreement, the seller Plaintiffs were obligated to maintain payment bonds secured by a letter of credit for ongoing construction projects.  The purchaser eventually withdrew from one of the projects, and the surety drew more than $20 million on the letter of credit that the seller maintained.  The seller demanded indemnification for their losses pursuant to the Agreement, and the purchaser refused.

It appears the purchaser did not dispute whether the seller incurred losses, as defined in the Purchase Agreement.  Rather, the purchaser argued the seller’s claims for indemnification were barred by the “Notice of Claim” requirements in the Purchase Agreement.

In an attempt to avoid indemnifying the seller for their losses under the Agreement, the purchaser argued that the language in the Notice of Claim provision included a qualification, thereby limiting the amount of time during which seller could make a claim for indemnification.  Specifically, the purchaser argued that the first clause of the Notice of Claim provision that required notice of indemnification within a reasonable time, and which applied to letters of credit, was limited by the second clause.  The second clause of the provision provided a deadline of the termination date or the survival period for claims pertaining to representations or warranties.  The purchaser attempted to argue that the second clause did not deal only with representations or warranties, but to all claims, including those for letters of credit.

In determining that the purchaser was required to indemnify the seller, the Court interpreted the Notice of Claim provision to include an exception to the reasonable time standard, rather than a qualification.  Applying longstanding principles of contract interpretation, the Court held that the clear language of the first clause applied to all claims of indemnification, including letters of credit, while the second clause, an exception to the general provision, applied only to representations or warranties.  This opinion features many useful footnotes with citations to sources that support the court’s reasoning, including the court’s analysis of sentence structure and syntax.

The Court noted that the purchaser’s reading of the Notice of Claim provision would have undermined the entire purpose in the Purchase Agreement of indemnification.  See generally, Glidepath, Ltd. v. Beumer Corp., C.A. No. 12220-VCL (Del. Ch. Nov. 26, 2018) (Transcript at 4-6) (In a bench ruling, the Court rejected an argument that the indemnification clause could be used as a broad liability cap, such as for a claim that the payment provision of an agreement of sale was breached—as opposed to a breach of the representations and warranties clause).

The Court also agreed with the seller’s additional arguments in their motion for summary judgment related to the purchaser’s third and fourth affirmative defenses of unclean hands and failure to mitigate damages, respectively.  The Court granted the motion with respect to unclean hands, holding that equitable defenses, including that of unclean hands, do not apply to purely legal claims.

Had the present dispute been brought in a court of law, the purchaser would not be entitled to that equitable defense, and it should not have an advantage simply because the claims were pending in a court of equity.  With respect to purchaser’s affirmative defense related to mitigation of damages, the Court held that the purchaser’s argument relied on events that occurred before the breach relevant to the litigation, whereas the duty to mitigate arises only after a breach has occurred.

A recent decision by the Complex Commercial Litigation Division of the Delaware Superior Court in Winshall, et al. v. Viacom International, Inc., C.A. No. N15C-06-137 EMD CCLD (Del. Super., Feb. 25, 2019), ruled that a claim for indemnification was not ripe until a final adjudication, after appeal, was decided.  In a matter involving a claim for indemnification for attorneys’ fees based on a finding of a breach of a merger agreement by the Court of Chancery, which was affirmed by the Delaware Supreme Court, the Superior Court held that a subsequently filed indemnification claim was not barred by the statute of limitations because the claim did not become ripe until the affirmance by the Delaware Supreme Court. See Slip op. at 17-19.

The indemnification claim for “losses” which was defined in the agreement to include attorneys’ fees, was based on the Court of Chancery’s prior finding of a breach of agreement. The court also discussed several rebuttals to a statute of limitations argument and how they applied to the facts of this case. Id. at 22.

Compare a recent decision highlighted on these pages which held that the statute of limitations of three-years for a breach of contract claim for indemnification did not begin to accrue until the claim for indemnification was rejected.

A recent Delaware decision is noteworthy because of its clarification of when the statute of limitations begins to run in connection with the alleged breach of a contractual indemnification clause.

The Superior Court ruled that an indemnification claim for environmental remediation liability accrued when the seller refused to indemnify the buyer–and not when the buyer discovered the contamination on which the indemnification claim was based. See Cooper Industries v. CBS Corp., C.A. No. N18C-03-175-WCC-CCLD (Del. Super., Jan. 10, 2019). The agreement at issue provided that the duty to indemnify was triggered when the buyer sustained losses. See footnote 58 and accompanying text, citing cases for the position that the breach does not occur until the claim was rejected. In light of that finding, suit was filed within the three-year SOL for contract claims. A more careful review of the detailed facts described in the court’s opinion is warranted for those who need to be familiar with the nuances of the latest iteration of Delaware law on this topic.

 

 

A common theme in cases before the Delaware Court of Chancery involves a buyer and a seller of a business disagreeing about some aspect of the deal.  So it was in the matter of Great Hill Equity Partners IV, L.P. v. SIG Growth Equity Fund I, LLLP, C.A. No. 7906-VCG (Del. Ch. Dec. 3, 2018).

This opinion weighs in at 153-pages and provides extensive factual details especially in the first 90-pages.  There were several prior decisions in this case highlighted on these pages, that provide more background information. 

Key Issues:

The key issues in this post-trial decision relate to whether fraud was proven, and whether damages were established in an amount that exceeded the cap on indemnification claims provided in the agreement of the parties.  In addition to allegations of breach of the representations and warranties in the agreement, the case included allegations of fraud, primarily relating to the knowledge of the sellers regarding excessive chargebacks that endangered the business model of the seller.

The legal analysis begins with a review of the claims for indemnification, as well as the argument that due to alleged fraud, the damages should not be limited to the escrow funds established by the merger agreement.  See page 91.

Key Takeaways:

·     Notably, the court explains that in Delaware the elements of fraud and “fraud in the inducement” are the same.  The court expounds at length on the various nuances and subtleties of such claims.  See Slip op. at 93 to 97.  The court applies those elements and nuances of the claims in an analysis that extends from page 97 to page 134.

·     A thorough analysis of the indemnification claims begins at page 134, and the key holdings on the indemnification claims are found at pages 147 to 150.

·     Although many indemnification claims and merger agreements have common themes, naturally their precise terms differ.  Many indemnification provisions have a cap on damages related to those claims.

Highlights of Court’s Holdings:

In this case, the court read the indemnification provisions to provide exclusive remedies only for specific types of claims, but the clause excluded damages based on fraud, for which the agreement did not provide a cap or limitation.  That is, the court explained that when the contract is viewed as a whole, the indemnification language involved exempts fraudsters from the benefits of the negotiated limits on liability.  See page 146 (emphasis on the word “fraudsters” in original).

The court also explained that the indemnification provision was part of a bargained-for liability structure that was intended to limit losses only from breaches of representations and warranties, that would be paid for from a fund that was created from the sale proceeds.

Damages for fraud were not limited to those referenced in the indemnification clause.  The court explained that this exclusion in the indemnification clause allowed an action to be brought against tortfeasers for damages without the limitations of the indemnification clause.  See pages 149 to 150.

SUPPLEMENT: In a recent bench ruling, the Court rejected an argument that the indemnification clause could be used as a broad liability cap, such as for a claim that the payment provision of an agreement of sale was breached–as opposed to a breach of the representations and warranties clause. See Glidepath, Ltd. v. Beumer Corp., C.A. No. 12220-VCL (Del. Ch. Nov. 26, 2018)(Transcript at 4-6). The court referred to the Curo case in the transcript ruling. The advancement aspects of that case were highlighted on these pages. (Yours truly represents Glidepath, Ltd. in a pending earn-out matter.)

The Delaware Court of Chancery in Daugherty v. Highland Capital Management, L.P., C.A. No. 2017-0488-SG (Del. Ch. June 29, 2018), primarily addressed the issue of laches and equitable tolling that constituted the majority of the 29-page decision, but the last two pages relating to indemnification are the most memorable parts of the opinion.  The procedural history of the case is relatively lengthy and somewhat involved.

The most noteworthy aspect of this case is the indemnification claim. The parties in this case were involved in lengthy litigation in Texas after which the party seeking indemnification brought suit in Delaware.  One of the issues was whether it took too long to proceed in Delaware.  The indemnification claim was not barred by laches based on an extensive analysis by the court of the facts of the case.

The most widely applicable bullet points from this case regarding indemnification are the following:

  • “A cause of action for indemnification accrues when the officer or director entitled to indemnification can be confident any claims against him have been resolved with certainty.” See footnote 120 (quotations omitted).
  • The court explained that the “certainty” required as a prerequisite for indemnification “requires the resolution of any appellate review.”
  • As a general matter, “adjudicating indemnification claims piecemeal is highly inefficient.” See footnote 122.
  • The court also rejected the defense that the indemnification claims related to personal contractual obligations as opposed to acts performed in the name of the entity against whom indemnification was sought, but the court found at the early pleading stage it was reasonably conceivable that the claimant was acting in his position as an employee of the entity with respect to at least some of the claims defended in the Texas litigation for which he is seeking indemnification.

The Delaware Court of Chancery in a recent opinion allocates the precise amount of fees payable, as a result of a prior indemnification ruling, in light of the total amount of fees incurred by various parties and proceedings that were not all subject to indemnification obligations. The decision in Meyers v Quiz-Dia LLC, et al., C.A. No 9878-VCL (Del. Ch., Mar. 16, 2018), needs to be read by anyone who wants to know how, according to Delaware law, the exact of amount of fees will be allocated when indemnification is owed to less than all the parties, and for fewer than all of the underlying lawsuits, for which fees have been incurred and that may not be easily separated for purposes of determining what amounts are covered by an indemnification obligation. Several of the many prior Chancery decisions in this case have been highlighted on these pages and should be referred to for detailed background facts and procedural history.

After 13 years of highlighting Delaware decisions on indemnification and advancement rights of officers and directors, and publishing an annual book chapter on those cases for several years, this is the most helpful decision that I recall for its analysis of how to determine the allocation and exact amount of fees incurred and payable among multiple parties and different lawsuits, when not all the parties and not all the underlying litigations are covered by indemnification.

Noteworthy Aspects of Indemnification Law from This Decision

  • The court addresses the rare issue of a subrogation right to indemnification pursued by one of the companies involved that paid the fees for the officers and directors based on secondary liability for indemnification. [The company with the primary indemnification obligation initially refused to pay.] This opinion explains the prerequisites that need to be satisfied for one seeking reimbursement via subrogation of fees paid pursuant to a secondary obligation to indemnify. One of the requirements for subrogation in this context is that the payor not be a “volunteer” though that term in this context is not strictly defined and may be satisfied by the desire of a company to support its management.
  • Chancery Rule 88 was the procedural mechanism that the parties resorted to, in connection with the motion to quantify the exact amount of fees, because the prior opinion in June 2017 establishing the right to indemnification, highlighted on these pages, did not determine the amount of fees due–and the parties could not agree on the amount or allocation. A total of about $552,000 (out of a total of about $785,000) was sought for the underlying litigations, and about $820,000 for “fees on fees” out of a total of about $1.9 million was sought in this latest ruling. [Yes, the “fees on fees” amount exceeded the total of fees incurred, and now sought, for the underlying lawsuits.]
  • Allocation of fees payable for the two indemnitees in this matter was  determined by the court to be controlled by a prior agreement among the parties to share the fees for the underlying litigations. See footnotes 56 to 59. The court reasoned that the two persons entitled to indemnification pursuant to the prior ruling of the court, Smythe and MacDonald, had previously agreed that they would be allocated 20% of the fees in the underlying lawsuits. The company seeking subrogation on their behalf in this instant decision, therefore, was not entitled to seek reimbursement for more than the 20% that Smythe and MacDonald had previously agreed to be apportioned to them in a separate allocation agreement. The net amount awarded in this decision was about $145, 00o, therefore, instead of the more than $700,000 sought.
  • The allocation of “fees on fees” was based on a slightly different analysis. Citing to prior decisions that applied the principle of “reasonably proportionate to the level of success” to an award of “fees on fees”, and in light of the request in this matter for about $820,000 out of the $1.9 million in “fees on fees” incurred for both covered and uncovered parties, or 39% of the total, the court explained that based on the total number of initial claims and the amount of work on the successful claims, 50% success was the appropriate starting point for allocation of fees on fees in this case. The court then used the 20% allocation explained above for the underlying litigation and: “Multiplying the two percentages results in a fees-on-fees percentage of 10%.” Applying that percentage to the “base amount”, results in a fee award of $125,000.
  • The court compared that award with what the court described as “its experience” that briefing on summary judgment in this case “likely would have cost between $100,000 and $200,000”, and because the success achieved in this case could have been achieved via summary judgment motion, the court determined that the amount awarded was reasonable.
  • Pre-judgment interest was also awarded and the discussion about the date when that interest starts is worth reading verbatim. See footnotes 67 to 70 and accompanying text.

In a recent Delaware Chancery opinion, the court clarified that a corporate officer who was “successful on the merits or otherwise in the defense of an action” need not show good faith in order to be entitled to mandatory indemnification.  Meyers v. Quiz-Dia LLC, C.A. No. 9870-VCL (Del. Ch. June 6, 2017). See also DGCL Section 145(c). Several prior Delaware decisions in this case, which provide background details, have been highlighted on these pages.

Key Aspects of the Decision:  Many cases highlighted on this blog have addressed the various permutations of indemnification and advancement for officers and directors, so this decision will be limited to the nuances that make this ruling noteworthy (and “blog-worthy”).

The court explained that when mandatory indemnification is provided to the fullest extent permitted by applicable law, that includes the fees incurred to investigate claims  prior to a lawsuit.  In particular, in this matter, former officers had reason to believe that they would be sued, and thus began an investigation of those potential claims in order to prepare their defense.  Fees for that investigation are included in the indemnification rights to which they were entitled.

Although the indemnification provisions in this case were in the LLC context, because the language used in the LLC documents mirrored DGCL Section 145(c), the case law and statutory interpretation approach that construed that language was applicable.

The phrase in Section 145(c) that provides mandatory indemnification when a former director or officer has been “successful on the merits or otherwise in defense of any action . . ..”, has been interpreted very broadly to include almost anything short of a complete loss.  It permits an indemnitee to be indemnified as a matter of right even if the success includes, for example, dismissal without prejudice of a federal action – – and the same claims are later asserted again in a state court action.

Notably, the good faith requirement does not apply under Section 145(c) to a director or an officer who is “successful” in defending a claim.  See footnotes 39 and 40 and accompanying text.

As we have written on these pages for several years, in my capacity as the Chair of the American Bar Association’s Advancement and Indemnification Subcommittee of the Business Law Section’s Corporate Litigation Committee, yours truly co-authors a chapter each year that highlights the most noteworthy court decisions on advancement and indemnification of directors and officers, as part of an annual publication of the American Bar Association entitled: Recent Developments in Business and Corporate Litigation. The 2017 edition was recently published, and the chapter this year is co-authored by yours truly along with litigators who work with me in the Delaware office of Eckert Seamans, including: Gary Lipkin, Aimee Czachorowski. Even though we do a survey of cases on this topic from around the country, the majority of the decisions have been from Delaware and typically are highlighted on these pages as well.