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Barrett v. American Country Holdings, Inc., C.A. No. 3071-VCS, (Del. Ch. June 20, 2008) (V.C. Strine)

June 20, 2008

In this decision, the Court of Chancery held that certain former directors of American Country Holdings, Inc. were entitled to (1) mandatory advancement of fees and expenses in connection with a securities fraud action brought by American Country and its parent company Kingsway Financial Services (collectively, “Kingsway”)in the U.S. District Court of the Southern District of New York (the “Underlying Action”), and (2) payment of all of the fees and expenses incurred in connection with the advancement action (or “fees on fees”). In the case, Kingsway admitted that the former directors were entitled to advancement under the unambiguous terms of American Country’s certificate of incorporation, but Kingsway claimed that such rights had been forfeited by the directors’ “unreasonable” failure to agree to settle the Underlying Action on the terms proposed by Kingsway.

The court determined that the settlement proposals offered by Kingsway contained at least two elements that were problematic from the perspective of the former directors: (1) the settlement proposals required the entry of a judgment against at least one of them, but Kingsway agreed not to seek to collect on it, and (2) the settlement proposals required an assignment of the former directors’ rights, including rights they might have against their D&O insurer, Great American. Kingsway wanted the assignment so it could pursue broader bad-faith claims against Great American. Under the D&O policy, the directors were required to obtain Great American's consent to any settlement, but Great American indicated it would not consent to a settlement that included an assignment of rights. The directors were unwilling to breach the D&O policy by agreeing to a settlement without Great American’s consent. Kingsway nonetheless argued that the directors unreasonably rejected its settlement proposals because it had agreed not to pursue their personal assets and was willing to indemnify the directors should Great American sue them for breach of the D&O policy.

In a strongly worded opinion, Vice Chancellor Strine wholly rejected Kingsway’s argument, characterizing it as “truly astounding . . . in the sense that it is stunning for its lack of basis in law, logic, or common sense.” The Court pointed out that “[t]he Former Directors are under no obligation to settle the [Underlying Action] for anything other than a full release and dismissal of claims,” and that none of Kingsway’s settlement offers provided for a cost-free release. In particular, the Court noted that the judgment component alone was a valid reason to reject the settlement offers because a company had “no right to require [directors/former directors] to accept a judgment against themselves of any kind.” The Court went on to state that a company certainly could not make advancement rights contingent upon the failure to accept a judgment as such a requirement would vitiate the stated policy and purpose of having advancement rights in the first place--“to enable a corporate official to protect herself against claims of official wrongdoing.” The Court noted that, even if Kingsway did not intend to collect on the judgment, “[n]o judgment in a fraud or other reputation-implicating case is costfree.”  With regard to Kingsway’s argument that the directors should not be concerned about breaching the D&O policy by failing to obtain Great American’s consent to the settlement, the Court ruled that the former directors were not obligated to take “legally problematic action” as part of a settlement. The Court characterized Kingsway’s assurance that it would indemnify the former directors if Great American sued as “humorous” since the directors had no reason to be comforted by any such assurance in light of Kingsway’s lawsuits and conduct.

The Court also awarded fees on fees to the former directors, commenting that “[s]adly, Kingsway’s
stockholders will end up paying for this time- and resource-wasting litigation.” Importantly, the Court noted that when a corporation refuses to honor mandatory advancement contracts in the manner that Kingsway had done here, “at some point, a case of sufficient dollar value will arise such that a board is sued for wasting the corporation’s resources by putting up a clearly frivolous defense.”

The full opinion is available here