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.
Chancery Grants Indemnification for Former Officer
An associate in the Delaware office of Eckert Seamans prepared this overview.
The Court of Chancery opinion in Horne v. OptimisCorp, C.A. No. 12268-VCS (Del. Ch. Mar. 3, 2017) explores Delaware’s indemnification provisions.
Background: Plaintiff William Horne (“Horne”) brought an action for indemnification for fees and expenses against OptimisCorp (the “Company”). Horne’s fees stemmed from an action brought against him by the controlling stockholder of the Company, Alan Morelli (“Morelli”), which alleged Morelli was wrongfully removed from the board of directors and as the Company’s CEO. After a six-day trial, the Court of Chancery found that Morelli failed to prove any of his claims. Horne then filed for indemnification of his expenses incurred to defend the action brought by Morelli. The Company opposed those expenses, arguing that they were not incurred by reason of the fact that Horne was an officer of the Company, and also that the amount of fees was unreasonable.
Analysis: The court began its analysis by quoting DGCL Section 145(c), which states in part that present or former officers and directors that have been successful on the merits or otherwise shall be indemnified against expenses (including attorneys’ fees) actually and reasonably incurred.
To determine whether Horne can satisfy the “by reason of the fact” standard, the court explained that only a nexus or causal connection between the underlying proceedings and one’s official corporate capacity is needed. This test was easily met by Horne, because claims were brought against him for breach of fiduciary duty in his role as the Company’s CFO. A claim for aiding and abetting was also brought “by reason of the fact” that Horne was the CFO, because the underlying conduct was consistent with his fiduciary duties.
Moving to reasonableness of the fee amount, the court stated that it considers three factors: (1) whether the expenses were actually paid; (2) if the services were in good faith, thought prudent, and appropriate by competent counsel; and (3) the rates charged were comparable to similar circumstances.
The Company only challenged the second factor. The Company asserted that Horne’s litigation strategy racked up a considerable amount in fees, but was largely abandoned prior to trial. The court remarked that it would review a litigation strategy only if those decisions are “unmistakably unreasonable.” And the court will not engage in a line-by-line review of bills. Therefore, the court rejected this argument in whole and award Horne with full indemnification.
Chancery Addresses Indemnification for Affirmative Claims of Directors
The Delaware Court of Chancery recently addressed an issue of importance to directors of companies as well as those interested in corporate litigation. In the case of Dore v. Sweports, Ltd., C.A. No. 10513-VCL (Del. Ch. Jan. 31, 2017), the court addressed situations where a director conceivably could be indemnified for fees incurred in pursuing an affirmative claim against the company as compared to the typical situation where indemnification is sought for reimbursement of fees incurred to defend a claim successfully. This opinion also provides an excellent overview of basic indemnification principles based on DGCL Section 145.
Background: The various lawsuits that gave rise to this indemnification action were based in large part on the attempts of the law firm of Sweports, Ltd. to collect legal fees. One of the partners in the law firm was on the board of the company and also had to defend himself when the company filed counterclaims against the plaintiffs that were unsuccessful. The lawyers who were seeking to collect their fees against the company ultimately commenced involuntary bankruptcy proceedings against the company. The Delaware lawsuit was initiated after the lawyers for the company were largely successful in their lawsuits against the company to collect fees, and in defending claims against them made by the company.
Indemnification Principles
Section 145(a) of the Delaware General Corporation Law (DGCL) allows for indemnification in an action “other than by or in the right of the corporation.” Section 145(b) provides for indemnification in an action “by or in the right of the corporation.” Section 145(c) mandates that a Delaware corporation indemnify an individual who was sued by reason of the fact that the individual served as a director or officer if the individual was successful on the merits or otherwise in defending against the claim. Although Section 145(c) only covers directors and officers, 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.
When assessing an indemnification claim, typically the first inquiry is whether the expense has been incurred in connection with a covered proceeding. A covered proceeding is a civil, criminal, administrative or investigative action in which the individual seeking indemnification was a “party or threatened to be made a party by reason of the fact that the individual is or was a director, officer, employee or agent of the corporation.” The corporation has the burden of proof when it has provided individuals with mandatory indemnification to the fullest extent of the law, to prove that an individual is not entitled to indemnification.
Typically, step two in the analysis after it is determined that a proceeding is covered, is to analyze whether the expenses incurred “were actually and reasonably incurred” in connection with the proceeding. The court determined that only a small fraction of the expenses sought were actually incurred, and some of the expenses claimed were inflated.
The key aspect of this 58-page opinion of the Delaware Court of Chancery that makes it notable is that it addresses those situations in which an affirmative claim is indemnifiable, as compared with the more common claim for indemnification based on fees and expenses incurred to defend a claim brought against a director.
In this opinion, the Vice Chancellor explained that “it is conceivable that indemnification might be warranted for preemptive litigation involving personal claims that sought to negate a threatened breach of fiduciary duty claim . . ..” The court explained that “. . . indemnification might be available if disposition of the personal claims would determine definitively whether the plaintiffs had breached their fiduciary duties.” Typically, indemnification claims are not allowed for personal claims that are not brought “by reason of” the director’s duties, for example, in connection with an employment agreement that does not involve the exercise of judgment, discretion, or decision-making authority on behalf of the corporation. The court referred to a prior Delaware decision in which indemnification was permitted for an intervenor where collateral estoppel might have barred a claim in a subsequent proceeding.
In this case, the plaintiffs chose to pursue their claims based on pure breach of contract theories untethered to their conduct as fiduciaries of Sweports. Although they could have proceeded in a different manner, they only proceeded on a breach of contract theory. The contract claims were personal to the plaintiffs in their capacity as lenders, creditors and guarantors – – which did not have a sufficient nexus implicating corporate duties.
The court did allow a portion of the fees and expenses incurred to defend against counterclaims which plaintiffs successfully defended, as well as related claims that were defensive in nature. Finally, because the plaintiffs were only successful to a small degree in their claims seeking indemnification, the court only allowed a small percentage of the “fees on fees” that were incurred in connection with their effort in this case to collect fees.
Postscript: For the past several years, I have co-written a chapter of a book published by the ABA that compiles key court decisions from Delaware and around the country regarding both advancement and indemnification of corporate officers and directors, for example, pursuant to DGCL section 145.
Chancery Issues Additional Advancement and Indemnification Rulings in Quiznos Restructuring
An Eckert Seamans associate prepared this overview.
The Court of Chancery issued two opinions relating to a web of advancement and indemnification claims brought on behalf of multiple, separate plaintiffs: (1) Meyers v. Quiz-Dia LLC, C.A. No. 9878-VCL (Del. Ch. Jan. 9, 2017); and (2) Meyers v. Quiz-Dia LLC, C.A. No. 9878-VCL (Del. Ch. Jan. 10, 2017). A previous blog post summarized the Chancery Court’s December 2, 2016 order to stay certain indemnification claims pending a determination as to arbitrability in the same case.
The January 9, 2017 Memorandum Opinion:
In the January 9, 2017 Memorandum Opinion, the Court concluded from an analysis of contractual drafting history that the plaintiffs were not entitled to advancement and indemnification. This decision is important because it addresses the relatively rare instance in which the Court will consider extrinsic evidence. Of cautionary note, draft agreements with attorney comments were discoverable under the circumstances.
Background: An in-depth overview of the background of this litigation can be found here. The plaintiffs, previously affiliated with a non-party parent entity, Quiznos, brought suit asserting entitlement to advancement and indemnification from the defendant subsidiaries pursuant to multiple agreements. The parties filed cross-motions for summary judgment regarding the question of whether the defendants assumed advancement and indemnification obligations. The Court explained that the claims turned on whether the defendants assumed the obligations pursuant to a post-restructuring Assignment, Assumption, and Release Agreement (the “Assignment Agreement”).
Court’s Analysis: The Assignment Agreement was subject to New York law. Under New York law, contracts should be construed in accordance with the parties’ intent. To determine whether the parties intended for defendants to assume the obligations, the Court conducted an extensive analysis of the drafting history of the Assignment Agreement.
The Assignment Agreement was prepared during the restructuring negotiations and contained two separate deal points: (1) a release of any claims that the post-restructuring entities might have against the sell-side parties, and (2) the assumption and continuation of indemnification rights. The parties drafted the Assignment Agreement late in the restructuring process after negotiating multiple contracts, including a principal restructuring agreement.
Because the Assignment Agreement was ambiguous as to which entities were to assume the obligations, the Court was permitted to consider extrinsic evidence regarding the parties’ intent. Thus, the Court reviewed deposition testimony and considered the parties’ multiple agreements. The Court reviewed draft versions of the agreements, including attorney comments, and it read the documents as a whole.
Conclusion: After considering drafting history, context provided by the multiple agreements, and deposition testimony, the Court held that the defendants did not assume the indemnification and advancement obligations. Therefore, the Court granted summary judgment in the defendants’ favor as to certain non-stayed claims left in the case.
The January 10, 2017 Memorandum Opinion:
Background: The Court’s January 10, 2017 Memorandum Opinion addressed a motion to vacate its November 30, 2016 order dismissing certain indemnification claims as premature pending related litigation in Colorado (the “Colorado Action”). The plaintiffs had advancement claims pending simultaneously in the Delaware court.
Parties’ Arguments: The moving plaintiffs argued that because the Colorado Action had been dismissed, and the dismissal was affirmed by the appellate court, there was a final disposition in the Colorado Action. Therefore, the plaintiffs argued that their indemnification claims became ripe in Delaware.
Court’s Analysis: The Court explained that although the federal appellate court affirmed dismissal in the Colorado Action, the deadline to petition the U.S. Supreme Court for a writ of certiorari does not pass until March 13, 2017. As long as the decision in the Colorado Action is not final, outstanding Delaware advancement claims were ripe. However, when the decision in the Colorado Action becomes final, the Delaware advancement claim will be moot, and the indemnification claims will become ripe.
The Court reiterated that advancement and indemnification are distinct legal concepts. A claim for advancement is a summary proceeding, and ordinarily, the Court would not await developments in another jurisdiction before adjudicating an advancement claim. However, in the present action, questions had been raised about the ability of the Court to rule on the plaintiffs’ advancement rights, as the plaintiffs did not produce detailed invoices in support of their claims until after the discovery cutoff. The Court also pointed out that the plaintiffs were well-off and another plaintiff was funding their litigation efforts. Additionally, the plaintiffs’ legal representation was not compromised by the lack of advancement to date. Therefore, the Court determined that the plaintiffs would not suffer harm if it withheld a decision on advancement and indemnification until it was clear whether the Colorado Action would proceed to the Supreme Court.
Conclusion: Citing its inherent authority to control its own docket, the Court denied the plaintiffs’ motion to vacate. The Court explained that whether the plaintiffs had a right to advancement or indemnification would soon become clear pending a final determination in the Colorado Action. Therefore, the Court stayed further outstanding advancement and indemnification claims in the interim.
Chancery Grants Stay and Refers Indemnification Claims to Arbitrator to Determine Arbitrator’s Jurisdiction
An Eckert Seamans associate prepared this overview.
In Meyers v. Quiz-Dia LLC, C.A. No. 9878-VCL (Dec. 2, 2016), the Chancery Court stayed indemnification claims to determine whether they were arbitrable.
Background: This matter involves the perenial issue of arbitrability. Plaintiffs sued three Quiznos sandwich shop entities for indemnification and advancement pursuant to multiple agreements. Plaintiffs Greg MacDonald and Dennis Smythe were officers of Quiznos’ primary operating entity, QCE LLC (“OpCo”). MacDonald and Smythe left the company after it restructured a large amount of debt in 2012, which transferred ownership of OpCo and its subsidiaries to investors who owned the debt (the “Funds”).
In 2014, OpCo filed for bankruptcy and disclosed that the Funds would pursue litigation against various individuals, including MacDonald and Smythe. Thereafter, the two former officers demanded indemnification and advancement for expenses incurred in connection with the threatened litigation. The plaintiffs then filed the present action, asserting, inter alia, indemnification claims pursuant to various agreements. The original complaint did not seek indemnification under the plaintiffs’ respective employment agreements.
Approximately two weeks later, the Funds asserted fraud and securities-related claims against MacDonald, Smythe, and other individuals, alleging that they induced the Funds to participate in the restructuring by creating financial projections that made it appear that the post-restructuring debt burden would be sustainable. After that litigation had been pending for two years, MacDonald and Smythe amended the complaint in the present action to assert indemnification claims pursuant to their employment agreements, which contained broad arbitration provisions.
Parties’ Allegations: The defendants argued that the amended claims should be dismissed because they were subject to arbitration pursuant to the employment agreements. In response, MacDonald and Smythe argued that the defendants waived their right to arbitrate. Although the employment agreements were not previously explicitly raised, the original claims were rooted in the employment agreements. Therefore, the plaintiffs argued that the defendants should have demanded arbitration sooner, as the provisions in those agreements extended to claims for indemnification and advancement under separate and distinct agreements.
Court’s Analysis: The Court first decided the threshold question of whether it or an arbitrator should decide the issue of arbitrability. The employment agreements, which were governed by Colorado law, provided that any claims arising out of the agreements were to be settled by arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association (the “Rules”). The Rules provided that the arbitrator shall have the power to rule on his or her own jurisdiction. Thus, according to the employment agreements, it was for the arbitrator to decide arbitrability.
The Court then determined whether it was appropriate to stay or dismiss the action pending the arbitrator’s decision. Because that question was procedural, the Court analyzed the issue under Delaware law, more specifically, the Delaware Uniform Arbitration Act, which generally incorporates the terms of the Federal Arbitration Act (the “FAA”). Under the FAA, proceedings should be stayed when the issue involved is referable to arbitration. Because the issue of arbitrability was referable to arbitration, the Court stayed MacDonald’s and Smythe’s claims pending the arbitrator’s decision. See generally, the Delaware Supreme Court’s seminal Willie Gary opinion on this topic highlighted by this blog here.
The Court noted that if the arbitrator determined that the claims were arbitrable, it would dismiss the action for lack of jurisdiction, and it would defer to the arbitrator to determine whether the defendants waived their right to arbitrate. Finally, the Court explained that the stay was restricted solely to the claims under the employment agreements. Although there existed some risk for overlap, because those claims were not sufficiently intertwined with other agreements at issue in the action, a broader stay was not warranted.
Conclusion: The Court issued a limited stay pending referral to an arbitrator to determine the issue of arbitrability of the indemnification claims under the employment agreements. This decision is notable for those who may not have realized that indemnification claims are subject to arbitration provisions.
Johnston on Advancement and Indemnification of Directors and Officers
William Johnston, one of Delaware’s premier practitioners of corporate litigation, is the lead author of a treatise recently published by Bloomberg BNA on the law of advancement and indemnification of directors and officers as well as insurance and exculpation as a means of providing protection for those who serve in such positions. The scholarship of Bill and his co-authors may be cited, according to its publisher, as William Johnston, et al., Indemnification and Insurance for Directors and Officers, 54-3rd Corporate Practice Portfolio Series (BNA). Although this important work has a national focus, as one would expect, the several hundred footnotes are heavily weighted with citations from Delaware’s Court of Chancery and Supreme Court. The book also features sample provisions for advancement and indemnification.
[By comparison, the much more modest work for the chapter of a recent ABA publication that I co-authored on key cases from 2014 on advancement and indemnification, was an assignment I took on at Bill’s request when I succeeded him as the Chair of the Subcommittee on Advancement and Indemnification of the ABA Business and Corporate Litigation Committee.]
Director Advancement and Indemnification Rights
The Delaware law of advancement and indemnification for directors and officers is not for the fainthearted. Much of the statutory interpretation in the case law is counterintuitive. Each year the ABA Business and Corporate Litigation Committee publishes recent developments in the eponymous areas of the law in a two volume publication.
The chapter on the key cases around the country (most of which are in Delaware) regarding advancement and indemnification involving directors and officers was co-written by yours truly along with my colleagues Gary Lipkin and Aimee Czachorowski. Included are the most noteworthy cases from 2014 involving DGCL Section 145. Information about the publication is available at this link. (The 2016 edition is also available from the ABA.)
Indemnification Rights Not Stymied by Amendment to Operating Agreement
The case of Branin v. Stein Roe Investment Counsel, LLC, 2014 WL 2961084 (Del. Ch. June 30, 2014) raised the interesting question of whether the operating agreement in effect at the time the suit was filed or the operating agreement in effect at the time the indemnification claim was made will control the right to indemnification. The first operating agreement had a broad indemnification provision, but was amended after suit was brought against an indemnified person to intentionally preclude indemnification for that particular claim. The amended operating agreement clearly excluded indemnification for that claim, and the claim for indemnification was not made until after the operating agreement was amended.[1]
On cross-motions for judgment on the pleadings, the Chancery Court determined that the LLC’s liability for the indemnification claim was fixed upon the filing of the action; before the operating agreement was amended. The Court noted that it generally looks to the operating agreement in place when the lawsuit is filed or the events giving rise to the suit occurred. The decision was limited only to a denial of both motions for judgment on the pleadings; the court determined that a factual inquiry into whether Branin’s actions were in good faith was necessary before determining his entitlement to indemnification.
Interestingly, nothing in the LLC agreement prohibited the LLC from amending its operating agreement on a prospective basis, and a notable question, which was not argued by the parties, was whether the operating agreement could have been amended to eliminate liability from the date of the amendment forward, limiting the LLC’s exposure to legal fees already accrued as of the date of the amendment.
[1] Note that 8 Del. C. §145(f) explicitly prohibits an amendment to the certificate of incorporation or the bylaw providing for advancement and indemnification which eliminates or impairs the right to advancement or indemnification after the occurrence of the act or omission giving rise to the action for which advancement or indemnification is sought, unless the provision in question explicitly authorizes such amendment.
Chancery Addresses Advancement and Indemnification of Corporate Officer
In Pontone v. Milso Industries Corp., C.A. No. 8842-VCP (Del. Ch. Aug. 22, 2014), the Delaware Court of Chancery addressed the rights to advancement and indemnification of attorneys’ fees for a corporate officer pursuant to both DGCL Section 145 and applicable agreements among the parties. The most notable aspect of this 65-page scholarly treatment of this recurring issue in corporate litigation is how indemnification claims will be treated when two parties have arguably overlapping obligations to indemnify, and what percentage of “fees on fees” will be awarded if a party is not 100% successful. This opinion deserves careful reading, not only by those who want to know the latest iteration of Delaware law on this topic, but also by those who want a primer on the prerequisites and nuances of Delaware law on the perennial issues presented that are of importance to directors, officers and the companies they serve. 
It remains remarkable how, despite hundreds of Delaware decisions on these issues, new cases seem to present nuances that have not been addressed before. I co-author a chapter of an annually updated multi-volume treatise on corporate litigation developments that surveys court decisions around the country on indemnification and advancement, and even though the majority of cases nationwide, by far, are decided in Delaware, subtle differences in the facts of new cases often present new complexities not previously addressed by the myriad of decisions already published.
A prior related Delaware decision in this matter was highlighted on these pages.
Chancery Clarifies Prerequisites to Advancement and Indemnification
Rizk v. TractManager, Inc., C.A. No. 9073-ML (Del. Ch. May 30, 2014).
This Court of Chancery Master’s Report decided cross-motions for summary judgment involving indemnification and advancement. The most noteworthy aspects of the opinion include the analysis of the phrase “by reason of the fact” which is a statutory prerequisite for advancement and indemnification pursuant to DGCL Section 145.
Highlights
DGCL Section 145 provides advancement and indemnification to directors and officers if certain prerequisites are satisfied. These rights are granted to support the public policy of encouraging qualified persons to serve as corporate directors and officers, who would be more willing to serve knowing that they will have the protection and financial support of the corporation if they are sued.
The bylaws in this case mirror the language of Section 145 and allow for indemnification when a person is made a party to an actual or threatened action “by reason of the fact” that he or she is a director or officer of the company. The corollary also provides a right to be paid by the company for the “expenses incurred in defending any such proceeding in advance of its final disposition, subject to an undertaking required by DGCL” (i.e.: advancement).
The court observed that the phrase “by reason of the fact” has been the subject of many decisions by Delaware courts. It is well established that a claim or a proceeding: “is by reason of the fact” that one was a corporate officer if there is a nexus or causal connection between the underlying proceeding and one’s official capacity. See footnote 34.
Moreover, the “necessary causal connection is established if the corporate powers were used or necessary for the commission of the alleged misconduct, even if the cause of action does not specify a claim for breach of fiduciary duty.” (emphasis added). The “by reason of the fact” standard is interpreted broadly in favor of advancement in order to further the goals of Section 145. See footnotes 35 and 36.
However, it has been emphasized by the Delaware courts that the phrase “by reason of the fact . . . should not be construed so as to draw within its ambit every claim brought against an officer or a director ….” In the context of a dispute related to an employment agreement, a corporation seeking to avoid advancement on the basis that this phrase does not apply must show that the claims “clearly involve a specific and limited contractual obligation without any nexus or causal connection to official duties.” See footnotes 42 and 43.
The Court of Chancery has previously ruled that advancement rights do not arise when the parties are litigating issues that do not involve “the exercise of judgment, discretion or decision-making authority on behalf of the corporation.” See footnote 47.
Importantly, the court cited to a prior Chancery ruling in which advancement was denied when the underlying claim had been adjudicated, and the claim ultimately may not have been indemnifiable. See Haseotes v. Cumberland Farms, Inc., C.A. No. 4921 (Del. Ch. July 23, 1996) (Transcript) at 5-8.
Postscript: In some ways, Section 145 has some analogous similarities to DGCL Section 220 to the extent that despite the terms of the statute being relatively simple and hundreds of cases over the years interpreting each of the statutes, new cases are regularly filed which purport to address nuances or applications of nuances to new facts which have not previously been decided.