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Baker v. Impact Holding, Inc., C.A. No. 5144-VCP (Del. Ch. July 30, 2010) (Vice Chancellor Parsons)

July 30, 2010

In this memorandum opinion, the Court of Chancery granted a Delaware corporation’s motion to dismiss its former director’s claim for advancement. Petitioner, Bradley Baker (“Baker”) served as director of Impact Holding, Inc. (“Impact”) and, at Impact’s request, Baker served as an officer and director of Impact Confections, Inc. (“Confections”). Impact initiated a financial audit of Confections and ultimately removed Baker from his position as a director of Impact. Thereafter, Baker initiated suit against Impact (the “Escrow Action”), wherein Impact’s counterclaim alleged that Baker breached his fiduciary duties to Impact and Confections. Impact did not, however, assert any claims against Baker for such alleged breaches. Thereafter, Baker filed two additional actions against Impact, including a Section 225 action and a declaratory judgment action (the “Related Actions”), purportedly to defend against the effects of Impact’s “investigation.” Impact’s charter provides for mandatory indemnification of fees incurred “in defending” a “threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative, arbitrative, or investigative … or any inquiry or investigation that could lead to such an action, suit or proceeding.”

In the instant matter, Baker sought advancement of fees and expenses incurred in connection with the Related Actions. Impact argued that Baker was not entitled to mandatory advancement because (i) the financial audit of Confections does not constitute a “proceeding” within the meaning of the charter and (ii) Baker did not incur such costs “in defending” a purported proceeding because the Related Actions were affirmatively filed by Baker. The Court began its analysis by examining the language of the advancement provision. The Court expressed doubt that the audit constituted an investigation into Baker’s conduct as a director, but noted that under the expansive definition of “proceeding,” it was at least conceivable that the financial audit of Confections could constitute an inquiry that “could lead to such an action, suit or proceeding” against Baker. The Court then turned to the question of whether Baker’s claims were brought “in defense” of a proceeding asserted against him. Although Baker acknowledged that no claims were affirmatively initiated against him, he argued that he should be entitled to advancement because the costs incurred with the Related Actions were the only way he could defend himself against Impact’s actions. The Court rejected this argument, finding that the Related Actions were not initiated in defense of the purported investigation by Impact; rather, Baker filed the Related Actions independent of the alleged investigation and in the absence of any threat by Impact to proceed against him personally. For such reasons, the Related Actions were not filed “in defense” of the purported investigation and Baker was not, therefore, entitled to mandatory advancement. In so holding, the Court distinguished Zaman v. Amedeo Holdings, 2008 WL 2168397 (Del. Ch. May 23, 2008) and Citadel Hldg. Corp. v. Roven, 603 A.2d 818 (Del. 1992), on the grounds that those cases held only that Delaware courts consider the “in defending” language broad enough to cover affirmative defenses and compulsory counterclaims, under certain circumstances, none of which were applicable in this matter. Similarly, the Court rejected Baker’s allegations that Hibbert v. Hollywood Park, 457 A.2d 33 (Del. 1983) and Shearin v. E.F. Hutton Group, 652 A.2d 578 (Del. Ch. 1994) require the advancement of reasonable fees incurred in connection with the Section 225 action because the action was initiated, at least in part, to determine whether he still owes duties to Impact as a director. The Court observed that although Hibbert and Shearin suggest that a corporation may adopt a charter or bylaw provision providing for advancement for affirmatively filed actions brought as part of a director’s fiduciary duties, the Impact charter does not mandate advancement under such circumstances.

The full opinion is available here