In Baker v. Impact Holdings, Inc., C.A. No. 5144-VCP (Del. Ch., July 30, 2010), read opinion here, the Court of Chancery granted a motion to dismiss an action for advancement for litigation expenses incurred in two prior preemptive and affirmative actions filed by the petitioner, Baker. Baker argued that he was entitled to mandatory advancement because he claimed that he brought the actions “in defense of” allegations made and actions taken by Respondent Impact following what Baker characterized as an investigation into his performance as a director and officer of Impact. See highlights of prior Chancery decision in this case here.

This summary was prepared by Kevin F. Brady of Connolly Bove Lodge & Hutz LLP.

In January 2008, Impact purchased stock in two entities beneficially owned by Baker, and as a result of this sale, Baker became an officer and director of Impact. Impact later took ownership of Impact Confections, Inc. and asked Baker to serve as an officer and director of Confections. Subsequent to the Confections’ acquisition, Impact initiated a financial audit at Confections that allegedly led to an investigation into Baker’s performance as an officer and director of Impact and Confections. Allegedly as a result of that investigation, Impact removed Baker as a director of Impact. After his removal, Baker initiated several actions including an action seeking advancement of his fees and expenses incurred in the other actions.

In a counterclaim filed in one of the actions, Impact alleged that Baker breached his fiduciary duties to Impact and Confections. Importantly for this motion, Impact did not assert any claims against Baker for these alleged breaches. Baker claimed that Impact’s allegations arose as a result of Impact’s internal investigation, and that he filed those actions “to defend against” the effect of the investigation which was “his removal as a director of Impact and the damage to his reputation caused by Impact’s accusations.”

In its analysis, the Court examined Article VIII of Impact’s Certificate of Incorporation which governed indemnification and advancement and mandated advancement as follows:

[Impact] shall indemnify any person who was, is, or is threatened to be made a party to a proceeding (as hereinafter defined) by reason of the fact that he or she (i) is or was a director or officer of [Impact] or (ii) while a director or officer of [Impact], is or was serving at the request of [Impact] as a director, officer… or similar functionary of another foreign or domestic corporation…or other enterprise, to the fullest extent permitted under the Delaware General Corporation Law, as the same exists or may hereafter be amended…Such right shall include the right to be paid by [Impact] expenses (including without limitation attorneys’ fees) actually and reasonably incurred by him in defending any such proceeding in advance of its final disposition to the maximum extent permitted under the Delaware General Corporation Law, [DGCL] as the same exists or may hereafter be amended.

It is also important for this motion that the Court noted that Article VIII broadly defined a “proceeding” as “any threatened, pending, or completed action, suit, or proceeding, whether civil, criminal, administrative, arbitrative, or investigative, any appeal in such an action, suit, or proceeding, [or] any inquiry or investigation that could lead to such an action, suit, or proceeding.”

On October 12, 2009, Baker sent a letter to Impact demanding advancement for fees and expenses incurred in connection with the actions he filed. After Impact refused that demand, Baker filed his petition.

Parties’ Contentions

Impact moved to dismiss arguing that, among other things: (i) the petition did not sufficiently show how that investigation (audit of Confection’s financial records) constituted a “proceeding;” and (ii) the actions were not “in defense of” an action, but in fact were affirmatively filed by Baker not to defend against any proceeding, but “to preemptively ameliorate certain negative effects he claims resulted from the Investigation.” Baker responded that: (i) the investigation constituted a “proceeding” under the expansive definition in the Certificate because Impact used information gained during the investigation to support its allegations in the counterclaim that Baker breached his fiduciary duties and as the basis for removing him as a director of Impact; and (ii) he filed the actions to defend himself from the allegations in and results of the purported investigation.

Baker Entitled to Advancement for Affirmative Litigation

DGCL § 145(e) grants a corporation authority to advance expenses, including attorneys’ fees incurred “in defending” a covered proceeding, to a director or officer. Section 145(e) provides only that a corporation “may” pay the defensive expenses of its directors, officers, or employees in advance of the final disposition of a covered proceeding. However, corporations frequently “make the right to advancement of expenses mandatory, through a provision in its certificate or bylaws or…a contract specifically addressing the issue.”

To determine whether a director has such a mandatory right, the Court examined the language of the Certificate finding “unambiguous language” of the advancement provision. As a result, the Court found that even though Baker had alleged facts sufficient to show that Impact’s investigation may fit within the definition of a “proceeding,” he did not bring the actions “in defense of” that investigation.”

The Investigation Was a “Proceeding”

Based upon what Impact alleged in its Counterclaim concerning various actions and omissions by Baker purportedly revealed by the investigation, and, specifically, its characterization of the Investigation, the Court rejected Baker’s contention that Impact conducted an internal investigation specifically into his conduct as a director of Impact or Confections. Rather, the Court found that the investigation referred to in the Counterclaim appeared to be primarily an audit of Confections’ financial records that “happened to lead, as an understandable by-product, to the accusations about which Baker complains.”

However, the Court did not dismiss the claim because of the broad definition of “proceeding” in the Certificate. The Court noted that “the language of that definition seems broad enough to encompass, at its widest point, even a threatened inquiry that could lead to an action, suit, or formal proceeding against Baker. Under this expansive designation, it is conceivable that the financial audit of Confections could constitute an inquiry…that could lead to such an action, suit, or proceeding against Baker, including a possible further investigation specifically into his conduct as a director.” As a result the Court found that Baker had sufficiently alleged the existence of a “proceeding” under the Certificate.

The Actions Were Not Brought “In Defense Of” the Investigation

The advancement provision expressly limited advancement to expenses incurred by a covered person “in defending” a proceeding to which that person “was, is, or is threatened to be made a party.” The Court referenced Citadel Holding v. Roven, 603 A.2d 818, 824 (Del. 1991), where the Delaware Supreme Court found that, “in addition to expenses normally incurred in the context of litigation naming a covered person as a defendant, i.e., attorneys’ fees accrued while defending that litigation, the “in defending” language also applies to: (1) a covered person’s affirmative defenses and (2) compulsory counterclaims directly responding to and negating an affirmative claim against that person…” In this action, however, the Court found that because Impact had not asserted any claims against Baker, he could not reasonably argue that the actions he filed directly relate to and negate claims since no claims were raised.
 

Professor Larry Ribstein has a thoughtful analysis here of an issue that is attracting increasing attention: Why are Delaware governance issues being litigated in courts other than in Delaware? In particular he refers to the recent Delaware Court of Chancery decision in Baker v. Impact Holding, Inc., which we highlighted here, as well as academic writings on the topic. We have written about this topic on these pages in the past and I suspect we will hear more about this matter anon.

In Schoon v. Smith, (Del. Supr., Feb. 12, 2008), read opinion here, the Delaware Supreme Court ruled yesterday that a director qua director may not sue fellow directors of a corporation derivatively. This may sound esoteric for some, but any time the Delaware Supreme Court decides an issue that relates to the duties and/or rights of directors of a Delaware corporation, most serious students of corporate law and Delaware litigation pull up their socks and pay attention. Three prior decisions by the Chancery Court regarding litigation between (at least some of) the parties in this case were summarized here, here and here. 

 Fortunately for me, we have the benefit of a prompt and insightful comment on the case here, that comes to us courtesy of Steven M. Haas of Hunton and Williams LLP via the Harvard Corporate Governance Law Blog.

Does a Director Qua Director Have Standing to Sue Derivatively? No, so said the Delaware Supreme Court yesterday in Schoon v. Smith. The Supreme Court affirmed the Court of Chancery’s little-noticed ruling last year that dismissed a derivative claim brought by a director against the company’s other directors, including its controlling stockholder. The plaintiff-director, who was not a stockholder of the company, charged his fellow directors with, among other things, breach of fiduciary duty and unjust enrichment. The court held that, notwithstanding the equitable origins of derivative suits, the issue of director standing today is best left to the legislature. “Although the Delaware General Assembly has the prerogative to confer standing upon directors by statute,” the court wrote, “it has not chosen to do so.” Rejecting the American Law Institute Principles that give individual directors standing to sue on behalf of their corporations, the court continued that, “[b]ecause a stockholder derivative action is available to redress any breach of fiduciary duty, we decline to extend the doctrine of equitable standing to allow a director to bring a similar action.” The court concluded, however, by leaving itself a little room to permit directors to bring derivative suits, but only where the failure to do so would result in a “complete failure of justice”—a seemingly high standard.

As a practical matter, the decision is unlikely to have much significance because most directors are also stockholders. But the decision is still significant and may draw criticism with respect to its implications for corporate governance and director duties. In particular, the court noted that the concept of being an “independent director” does not mandate “a duty to sue on behalf of the corporation.”

UPDATE: Here is a post on the case by Professor Bainbridge who was kind enough to link to this post but more importantly he provides a prescient excerpt from his treatise on Corporation Law and Economics that addresses the same issue decided by the court in this opinion.

 

Here is a post from the Delaware Business Litigation Report that flags a recent decision from the U.S. District Court for the District of Delaware which found personal jurisdiction based on aspects of a transaction that created ties to Delaware.  See G & G LLC v. White. Read opinion here. The post included the following summary:

Plaintiff pointed to numerous instances where the Utah corporation, the Delaware corporation, their counsel, the directors/officers of the Delaware corporation (who were appointed by the investor defendants), and the investor defendants failed to notify Plaintiff of the merger and/or made misrepresentations regarding the continuing status of the corporation as a Utah corporation. Taking the allegations as true, the Court found that the actions of the investor defendants and the directors they appointed was sufficient to confer specific jurisdiction over them.

The opinion discusses the application of the Delaware long-arm statute in the context of both general and specific jurisdiction and cites to the many federal decisions in Delaware that have applied the statute. Interestingly, the opinion does not cite to the recent Chancery Court opinion that  found personal jurisdiction based on the actions of an outside attorney of a corporation in connection with aspects of a transaction that created ties to Delaware. See Sample v. Morgan summarized here.

Notably,  however, the District Court  did cite to the recent Troy Corp. v. Schoon Chancery decision, summarized here, that also dealt with a forum selection clause that was not artfully drafted. In particular, even though one of the clauses quoted by the court gave exclusive jurisdiction to the Delaware Chancery Court, the District Court for the District of Delaware could not rely of that provision to impose jurisdiction in federal court simply because it was also in Delaware.