New Millennium Developments in Delaware D&O Indemnification
From The Delaware Corporate Litigation Reporter
Vol.16:8, December 26, 2001
Reprinted with permission of Andrews Publications ©2001
In the new millennium the Delaware Court of Chancery (and to a lesser degree certain non-Delaware courts) have addressed a virtual cornucopia of director and officer indemnification issues. These rulings have run the gamut of the who, what, when and where questions that arise under Section 145 of the Delaware General Corporation Law. While the decisions discussed in this article are each factually unique, they all address certain fundamental principles under 8 Del. C. § 145. These fundamental principles have broad application and the rulings discussed in this article will aid practitioners' understanding of this important area of Delaware corporate law. These recent decisions address issues of D&O indemnification law such as:
- WHO is entitled to indemnification? The court recently analyzed the traditionally thorny question of a director's or officer's entitlement to indemnification when there is uncertainty as to whether indemnification is sought for claims relating to the personal or official interests of the fiduciary;
- WHAT types of claims are covered by indemnification? Among the issues decided by recent court of chancery decisions is to what extent a director or officer of a wholly owned subsidiary is entitled to indemnification by the parent corporation with respect to litigation directed against the fiduciary for his or her conduct in managing the subsidiary;
- WHEN must a claim for indemnification be asserted? The court discusses the applicable statute of limitations that triggers the time in which a claim for indemnification must be made, and whether a separate demand for indemnification must be conveyed by the director or officer to the corporation before the initiation of a lawsuit under Section 145; and
- WHERE can indemnification claims under Section 145 be filed? While most D&O indemnification claims are brought in the Delaware Court of Chancery pursuant to the summary procedure required by Section 145(k), recent litigation shows that the choice of forum or venue (which in some cases is not Delaware) can be made by litigation conduct or by contract.
Developments in Four Major Aspects of Indemnification
Many of the who, what, when and where aspects of Delaware D&O indemnification are addressed in a series of rulings by the court of chancery in Cochran v. Stifel Financial Corp. In Cochran I, the defendant, Stifel Financial Corp., moved to dismiss plaintiff Robert Cochran's complaint that sought indemnification pursuant to Stifel's bylaws and Section 145. Cochran's claims for indemnification were based on his service as a director, officer and employee of a Stifel wholly owned subsidiary, Stifel Nicolaus & Company Inc.
Initially, the court observed that the motion to dismiss raised four fundamental issues affecting Section 145:
- What is the appropriate statute of limitations that applies to indemnification claims?
- Before filing an action in the court of chancery seeking indemnification under Section 145, must an officer or director first file a "demand" with the corporation?
- Is a suit brought by a wholly owned subsidiary an action "by or in the right of" the parent corporation for purposes of Section 145(b)? and
- Is an individual who serves as a director, officer and employee of a wholly owned subsidiary at the request of the parent corporation an "agent" of the parent corporation for purposes of Section 145?
The basic facts as alleged in Cochran's complaint were that he had served as a director, officer and employee of Stifel Nicolaus, the wholly owned subsidiary of Stifel, at the request of Stifel. Cochran had not been a director, officer or employee of the parent corporation, Stifel. Nevertheless, Cochran brought his action only against the parent corporation, Stifel, and not the subsidiary by which he had been employed.
Cochran's indemnification claim took this form based on the theory that he was an agent of Stifel because he served as a director, officer and employee of the subsidiary, Stifel Nicolaus, "at the request" of the parent corporation, Stifel.
Cochran's claim for indemnification was based upon the parent corporation's indemnification bylaw and Section 145(c) in the statutory formulation that existed before Section 145(c) was amended to its present form on July 1, 1997. Cochran's claims for indemnification related to civil and criminal actions that were filed and litigated before the 1997 amendment to Section 145 became effective.
The Stifel bylaw stated:
The Corporation [Stifel] shall indemnify to the full extent authorized by law any person made or threatened to be made a party to any action, suit, or proceeding, whether criminal, civil, administrative or investigative, by reason of the fact that he ... is or was a director, officer or employee of the Corporation or any predecessor of the Corporation or serves or served any other enterprise as a director, officer or employee at the request of the Corporation or any predecessor of the Corporation.
The language in Section 145(c), as it existed before the July 1, 1997, amendment, stated:
To the extent that a director, officer, employee or agent of a corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in subsections (a) and (b) of this section, or in defense of any claim, issue or matter therein, he shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by him in connection therewith.
There were several areas of litigation expense for which Cochran sought indemnification. First, he incurred attorneys' fees in connection with a Securities and Exchange Commission investigation of his management of Stifel Nicolaus which eventually led to a criminal action that was brought against him in federal court. Although Cochran was initially convicted in that criminal action, the conviction was reversed on appeal. As a result of that reversal of the conviction, Cochran claimed that he was completely "successful on the merits or otherwise," satisfying the standard in Section 145(c) and, thereby, triggering his mandatory right to indemnification under Section 145 and the indemnification bylaw of the parent corporation.
Alternatively, Cochran claimed that he must have met the requirements of Section 145(a) because his acquittal meant that he had acted in good faith at all times with respect to the subject matter of the SEC investigation and the criminal action and in a manner that he reasonably believed to be in or not opposed to the best interests of Stifel Nicolaus. This, in his view, triggered the coverage under Stifel's indemnification bylaws with respect to the SEC investigation and the criminal action.
Cochran also sought indemnification with respect to a civil arbitration proceeding brought against him before the National Association of Securities Dealers by Stifel Nicolaus. In that action there were four claims filed against Cochran alleging that he: (1) received unearned compensation; (2) owed money on a promissory note; (3) breached his fiduciary obligations to Stifel Nicolaus related to the refinancing of securities for which Stifel Nicolaus was the underwriter; and (4) violated a non-competition agreement, a claim subsequently dropped by Stifel Nicolaus.
The arbitration panel ruled in favor of Stifel Nicolaus as to the unearned compensation and promissory note claims and in favor of Cochran with respect to the breach-of-fiduciary-duty claim. Cochran sought indemnification on the fiduciary duty claim in the arbitration proceeding as to which he was successful, but he also sought indemnification with respect to the claims on which he lost because Cochran claimed that he met the good-faith standard of Section 145(a), thereby requiring Stifel to indemnify him pursuant to its indemnification bylaw.
Statute of Limitations
The court first addressed the issue of the applicable statute of limitations that applied to Cochran's request for indemnification. The dispute on this issue related to whether his claim was subject to the Delaware statute of limitations dealing with employment claims or the statute of limitations that addresses basic breach-of-contract actions. The former, 10 Del. C. § 8111, imposes a period of limitations of one year and the latter, 10 Del. C. § 8106, has a limitations period of three years.
The court reviewed the decisional law in Delaware addressing the parameters of these two statutes of limitation and observed that the Delaware courts had created a distinction between whether the employee was seeking benefits that arose out of work that had been performed, in which case Section 8111 would apply, as opposed to a promise of benefits for work that would have been performed but for the termination of the employee's contract, where Section 8106 would be applicable.
After reviewing the case law that discussed the above distinctions between Sections 8111 and 8106, based on the timing of the termination of employment, the Cochran I court examined the public policy and statutory policies relating to Section 145 to aid in the determination of which of the two statutes would have the most logical application to the indemnification process.
The court was influenced by Vice Chancellor Myron Steele's decision in Scharf v. Edgcomb Corp. In that action, the court held that Section 8106, the general contract statute of limitations with the longer three-year limit, applied to the indemnification claim of the director on the facts in that particular case. The rationale for that ruling in Scharf was that Delaware, by implementing special provisions in its General Corporation Law to permit indemnification of directors and officers, had intended to give greater flexibility to the indemnification of directors and officers so that they can make decisions in an environment without the chilling effect of potential liability for those decisions. The Scharf case stated that it simply made no sense to analyze D&O indemnification provisions as if they were salary, company cars or other corporate perquisites.
Thus, Vice Chancellor Leo Strine in Cochran I also concluded that Section 8106 should apply to Cochran's claims because of the Delaware public policy favoring the implementation of liberal indemnification provisions for officers and directors of Delaware corporations that benefit all corporate constituencies. The court also noted that the Delaware Supreme Court had given a broad construction to Section 145 in previous decisions and that the court of chancery should therefore be cautious about applying a relatively restrictive statute of limitations (i.e., Section 8111).
Also, Vice Chancellor Strine noted that it was significant that Section 145 had been amended in 1994 to add Section 145(k), which vested exclusive jurisdiction over D&O indemnification issues with the Delaware Court of Chancery. Because Scharf was the only court of chancery case since the implementation of Section 145(k), that factor also favored the court's decision to follow Scharf in order to achieve consistency in the interpretation of Section 145. Finally, Vice Chancellor Strine stated that when there is doubt as to which of two statutes of limitation to apply, the court should resolve that doubt in favor of the statute with the longer period of time.
The Requirement of a Preliminary Demand for Indemnification
The second issue raised by the corporation as a defense to Cochran's claim was that the request for indemnification by Cochran was defective because he did not make a preliminary demand for indemnification with a summary of the expenses for which he sought indemnification. The court observed that such an argument had appeal as a policy matter because it would give the corporation time to consider the request and perhaps narrow the issues that reached the court in the ensuing litigation.
Of course, as a practical matter in most cases, there is almost always communications between the director or officer and the corporation with respect to a request for indemnification before the filing of a lawsuit under Section 145. It is the unusual case where the corporation's first notice of a request for indemnification is made in a lawsuit.
The corporation argued that there should be a preliminary demand requirement even though there was no such requirement explicitly set forth in Section 145. Stifel analogized the situation to the derivative suit context in which, by common law, a demand requirement is imposed in derivative actions even though Section 327 of the Delaware General Corporation Law does not require such a "demand." Vice Chancellor Strine was not persuaded by this analogy because the derivative action existed in the common law before the enactment of Section 327.
Moreover, he observed, "We are now in a very different era in our corporation law's development. Given the great care and attention the [Delaware] General Assembly has given to crafting and adjusting §145, there is no legitimate basis for the judiciary to impose its own view of prudent policy." Furthermore, the court pointed out that Stifel could have included, but did not, a requirement in its bylaws that mandated a "demand" as a prerequisite to indemnification under Sections 145(a) and 145(b).
By or in the Right of the Corporation
The next issue addressed by Cochran I concerned whether the judgment obtained against Cochran with respect to his unearned compensation and his obligation on the promissory note was a claim "by or in the right" of Stifel. This distinction is important because of the fundamental differences between Sections 145(a) and 145(b). Section 145(a) relates to a recovery that is obtained against a director or officer by a third party. That section will provide indemnification for litigation expenses as well as judgments or amounts paid in settlement if the person seeking indemnification acts in a manner reasonably believed to be in and not opposed to the best interests of the corporation as to the claim made against that director or officer.
On the other hand Section 145(b) addresses actions brought "by or in the right of the corporation." That section encompasses derivative actions and direct suits brought by the corporation against the director or officer. In contrast to Section 145(a), Section 145(b) is much more restrictive with respect to the scope and availability of indemnification. Specifically, it limits the director or officer to the payment of expenses, not judgments or settlements, and with respect to the award of expenses in the event of an adverse judgment, the court of chancery in its discretion can award such expenses only if it determines that the director or officer is "fairly and reasonably entitled" to the indemnification for such expenses.
Stifel argued that the phrase "by or in the right of the corporation" should be construed to include a wholly owned subsidiary within the meaning of "corporation." The corporation asserted that it would be absurd to indemnify Cochran for judgments that he owed to the wholly owned subsidiary of Stifel. While the court recognized the logic and public policy implications of Stifel's argument, it rejected Stifel's position because it conflicted with a plain reading of Section 145(b). In that vein, the court held that the "corporation" that is referenced in the phrase "by or in the right of the corporation" is the corporation from which indemnification is sought.
In the instant case, the corporation was the parent corporation, Stifel, not the wholly owned subsidiary, Stifel Nicolaus. The court reasoned that to the extent the General Assembly had intended Section 145(b) to apply to wholly owned subsidiaries, it could have included that language in the statute. The court observed that a review of the legislative history revealed no clear indication as to the General Assembly's view of Section 145(b)'s applicability in the parent/wholly owned subsidiary context.
The court noted that Stifel could have avoided this issue by drafting its indemnification bylaw to preclude the result that it now argued was absurd. Secondly, the argument advanced by Stifel required the court to ignore the distinct corporate entities of Stifel and Stifel Nicolaus. The Delaware courts have followed a formalistic approach to the relationship between the parent corporation and its subsidiary and, absent unusual or extraordinary circumstances that require veil piercing, will not disregard separate corporate entities.
Thus, the court concluded that Section 145(a) applied to the claim made by Cochran for indemnification because the claim for indemnification by Cochran as to the adverse arbitration award against him with respect to the unearned compensation and promissory note claims did not relate to a claim "by or in the right" of Stifel, the indemnitor, but rather its wholly owned subsidiary, Stifel Nicolaus, the entity that actually obtained the award against Cochran. While it reached this conclusion, the court emphasized that whether Cochran would be able to satisfy the more liberal standards for indemnification under Section 145(a) would have to await further development of the record (as was done in Cochran IV discussed below).
Serving Another Corporate Entity as an Agent of or at the Request of the Indemnifying Corporation
The court next addressed Cochran's argument that he was entitled to mandatory indemnification under Section 145(c) with respect to those matters on which he was successful, i.e., the criminal charges, and in the arbitration proceeding, the breach-of-fiduciary-duty claim. The language of Section 145(c) that applied to Cochran's claim was the version that was in effect prior to the amendment of that section by the General Assembly in July 1997. The earlier version differs from the present version of Section 145(c) in that the prior version required mandatory indemnification for "agents" in addition to directors and officers.
In response to Cochran's argument, Stifel argued that his claim should be dismissed because he failed to demonstrate an agency relationship between him and Stifel, notwithstanding the fact that his position as a director and officer of the wholly owned subsidiary, Stifel Nicolaus, had of course been approved by Stifel. Stifel pointed out that the drafters of the earlier version of Section 145(c) had the option of including persons who served "at the request of" the corporation from which indemnity is sought (the language in the present version of the section), but chose instead to use the more restrictive language of "agents." Thus, whether Cochran was an "agent" of Stifel was at the heart of the analysis of this aspect of Section 145(c).
In analyzing this issue, Vice Chancellor Strine observed that the Delaware Supreme Court had defined an agency relationship as one that "is created when one party consents to have another act on its behalf, with the principal controlling and directing the acts of the agent." Within the context of that definition, the vice chancellor indicated that Stifel's election of Cochran as a director of Stifel Nicolaus appeared to go a long way in establishing that Stifel had consented to have Cochran act on behalf of Stifel. However, that did not end the agency analysis.
The secondary aspect of establishing the agency relationship on the facts as pleaded was whether Cochran, as a director and officer of the wholly owned subsidiary Stifel Nicolaus, was subject to the control and direction of the parent corporation. Because, as discussed above, the Delaware courts do not take the separate existence of corporations for granted, the court concluded that without more specific facts, it could not assume that the parent corporation controlled and directed the actions of Cochran in his capacity as a director and officer of Stifel's wholly owned subsidiary. Thus, without more specific facts to support his agency agreement, Cochran could not recover under his agency theory.
While the court reached this conclusion and permitted Cochran to replead his agency claim, it also held that the issue might not be of great significance in any event because of the broad scope of Stifel's indemnification bylaw. Section 145(f) expressly provides that indemnification rights provided by other subsections of Section 145 shall not limit thereby any indemnification rights which the corporation may elect to provide to its directors and officers pursuant to the enabling provision of Section 145(f), unless those broader rights are contrary to the limitations or prohibitions set forth in Section 145 generally, other statutes, court decisions or public policy.
Thus, Vice Chancellor Strine held that it was not against public policy or in conflict with other subsections of Section 145 to permit corporations voluntarily to indemnify persons who were not within the class of persons entitled to mandatory statutory indemnification but who otherwise satisfied the requirements of Section 145(c).
In 1997 the General Assembly removed "employees" and "agents" of the corporation from Section 145(c), thereby eliminating the entitlement to statutory indemnification as a matter of right to those classes. However, the court observed that the policy decision for this amendment did not prevent corporations from exercising greater freedom in deciding what indemnification coverage could be provided and the persons who would be entitled to those benefits.
The court noted that commentators, as well as the Model Business Corporation Act, had determined that it was not in the interests of a state to limit or control the indemnification that a corporation may deem appropriate for employees who were not officers or directors. The court saw no basis for concluding that the General Assembly had determined that corporations would be accorded greater flexibility in indemnifying their most important corporate personnel - their directors and officers - but be limited in their ability to indemnify employees, agents or persons serving other corporations (such as Stifel Nicolaus) at the request of the parent corporation.
Rejection of Stifel's Application for Certification of Interlocutory Appeal
Stifel filed an application for certification of interlocutory appeal with the court of chancery as to the court's decision that 10 Del. C. § 8106 was the governing statute of limitations for Cochran's claim as opposed to 10 Del. C. § 8111. In addressing this application, Vice Chancellor Strine noted that the statute of limitations issue was purely an issue of law and that there was a division within the Delaware courts as to which of these statutes should apply to indemnification claims. The vice chancellor observed that his decision to select the longer of the two statutes was in part because of the lack of a definitive ruling by the Delaware Supreme Court on this issue.
With that background, the court analyzed the various requirements of Delaware Supreme Court Rules 41 and 42 that are considered by the state's trial courts in determining whether a request for certification of an application for interlocutory appeal should be granted. The first question for the court was whether the statute-of-limitations issue determined a "substantial issue" and "established a legal right" for purposes of Supreme Court Rule 42. In reviewing the Delaware Supreme Court precedent on this issue, there were cases in which the high court had accepted and denied interlocutory appeals where a statute-of-limitations defense was raised either on a motion to dismiss or in a summary judgment context.
Vice Chancellor Strine concluded that there was no rational basis on which to distinguish the state supreme court precedent on this issue. Therefore, whether interlocutory review was appropriate would have to be based on an examination of the other factors within Rules 41 and 42 - in particular the factor as to whether the trial court's decision was predicated on an unsettled question of law of sufficient importance to merit interlocutory review by the Delaware Supreme Court.
In evaluating those factors in the context of the determination he had made in Cochran I, Vice Chancellor Strine said he would have been inclined to find that the split of authority in Delaware with respect to whether the statute of limitations in Section 8106 or Section 8111 applied involved a question of law relating to the construction or application of a state statute which had not been, but should be, settled by the Delaware Supreme Court. However, the supreme court had rejected an interlocutory appeal on that very issue in Scharf, discussed above. As in the present action, and the Scharf interlocutory appeal application, the appeals rested on purely legal questions.
The Delaware Supreme Court emphasized in Scharf, however, that an interlocutory appeal will be granted only under extraordinary circumstances and that a determination that a specific affirmative defense, such as a ruling that a statute-of-limitations defense was not available, did not, as a general proposition, establish the necessary "legal right" that would support an appeal. Thus, because Vice Chancellor Strine could not distinguish the Scharf and Stifel rulings in this regard, he declined to certify the interlocutory appeal.
After the court of chancery and the supreme court rejected Stifel's application for certification of an interlocutory appeal from the trial court's decision on the applicable statute of limitations, the parties subsequently filed cross-motions for summary judgment, which were addressed several months later by the court of chancery in Cochran IV.
In Cochran IV, the court granted Cochran's motion for summary judgment with respect to his entitlement to the reimbursement of his litigation expenses in the criminal action pursuant to Sections 145(c) and 145(f). As to the remaining issues that were subject to the cross-motions for summary judgment, the court ruled in favor of the corporation, Stifel. Specifically, the court granted summary judgment in favor of the corporation as to Cochran's claims for indemnification for the judgment and other costs he sustained in litigation with the subsidiary, Stifel Nicolaus, based upon Cochran's breach of his employment contract and a related promissory note.
The court first addressed Stifel's motion for summary judgment, which argued that Cochran was not entitled to indemnification for the adverse finding in the arbitration proceeding in which he was held to have received excessive compensation from Stifel Nicolaus and was obligated on a promissory note to Stifel Nicolaus. In this connection, Vice Chancellor Strine indicated that he would not revisit the ruling in Cochran I and reiterated his rejection of Stifel's argument that Cochran's claim for indemnification emanated from claims "by or in the right" of Stifel and was thereby subject to the more restrictive application required by Section 145(c).
Nevertheless, the court did grant Stifel's motion for summary judgment on other grounds. The vice chancellor stated that he had:
grave doubt that a person can sign a binding agreement with a wholly-owned subsidiary, commit himself to abide by the contract, and then refuse as a matter of economic reality (by seeking indemnity from the subsidiary's parent) to repay sums that the relevant decisionmaker under the contract had ruled were owed to the subsidiary. In such a situation, the key purpose of § 145 (and its predecessor) - "to permit corporate executives to be indemnified in situations where the propriety of their actions as corporate officials is brought under attack" - is not implicated.
In this regard, the court based its decision on the argument advanced by Stifel that the arbitration judgment that was adverse to Cochran on the excessive compensation and promissory note issues did not involve claims that arose by reason of the fact that Cochran was serving Stifel Nicolaus as a director, officer, employee or agent at the request of the parent corporation, Stifel. The court observed that when a corporation brings a claim and secures entitlement to relief, as was the case here with Stifel Nicolaus in the arbitration proceeding, because the officer of the subsidiary had breached his individual obligations, then that officer, i.e. Cochran, could not contend that the adverse ruling had been rendered as a result of actions undertaken in his "official capacity."
In that regard, the court held, "[w]hen a corporate officer signs an employment contract committing to fill an office, he is acting in a personal capacity in an adversarial, arms-length transaction. To the extent that he binds himself to certain obligations under that contract, he owes a personal obligation to the corporation." Indeed, in the court's view, any other conclusion would make the officer's duty to perform his contractual obligations essentially illusory.
Furthermore, the court found it simply made no sense for Cochran to have entered into certain employment contractual obligations with Stifel Nicolaus but then not be subject to those obligations to his employer by virtue of an expansive reading of the parent company's indemnification bylaw. Had the parties intended to hold Cochran harmless for excessive compensation paid to him by Stifel Nicolaus through indemnification by Stifel, it would have been a simple matter to include such a hold harmless provision in Cochran's employment agreement.
The court said:
[T]he acceptance of Cochran's argument rewrites his employment contract in just this manner. Requiring [Stifel] to indemnify Cochran for judgments he owes to Stifel Nicolaus based on his breach of his contractual duties subverts the contractual arrangement between Cochran and Stifel Nicolaus. It leaves Stifel Nicolaus without a genuine remedy against Cochran.
Further, the court stated that:
Such a result would not have been reasonably contemplated by Cochran when he entered into the Employment Agreement and signed the Promissory Note. Cochran is a sophisticated businessman and cannot have rationally believed that [Stifel] would indemnify him if he breached his own contractual obligations to [Stifel's] corporate child, Stifel Nicolaus.
Thus the court held that the adverse judgments against Cochran in the arbitration proceeding were not brought against him "by reason of the fact" that he was serving in indemnification-eligible positions at Stifel Nicolaus, but by reason of the fact that he had breached his personal contractual obligations to the subsidiary.
The next issue addressed by the court was whether Cochran was entitled to indemnification by virtue of his success in defending the criminal proceedings for which he had been acquitted and for his success in the arbitration proceeding with respect to the claim for breach of fiduciary duty that was rejected in that proceeding. Cochran's summary judgment motion was based upon the indemnification bylaw of Stifel, as discussed above. As in Cochran I, in this proceeding Cochran argued that his claim was favored by Section 145(f), which permits a corporation to expand indemnification privileges to eligible parties provided that they do not conflict with other sections of the Delaware indemnification statute, court rulings or public policy. Cochran also relied on Section 145(c), which mandates that corporations indemnify directors and officers who are successful on the merits or otherwise in any action covered by Sections 145(a) or 145(b).
The court observed first that it was important to recognize that Cochran had established that if he were an officer or director of Stifel his right to indemnification as to the criminal proceeding and the breach-of-duty claim would be mandatory pursuant to Section 145(c).
The court found that Cochran had demonstrated that Section 145(a) was satisfied because the criminal and breach-of-duty claims were brought by reason of Cochran's service in his various capacities at Stifel Nicolaus, and Cochran was successful as to those claims. In reaching that conclusion, the court rejected Stifel's argument against indemnification of Cochran as to the criminal action and the breach-of-duty claim based on a distinction between directors of Stifel (who clearly would be entitled to the indemnification sought by Cochran) and those persons in Cochran's situation, i.e., directors and officers of a wholly owned subsidiary of Stifel who had been asked to serve in that capacity by Stifel, thereby satisfying one of the requisites of the Stifel indemnification bylaw provision.
In that regard, the court held:
By contrast, if adopted, [Stifel's] approach means that Delaware law requires Delaware corporations to indemnify its most important officers (e.g., CEO's) in circumstances where Delaware law simultaneously outlaws the provision of indemnity to persons who merely serve another corporation "at the request" of the indemnifying corporation. As in the previous motion practice, [Stifel] fails to explain why this distinction is logical and why the judicial adoption of this distinction does not intrude on the opportunity for private ordering legislatively granted by §145(f).
Finally, Vice Chancellor Strine recognized that to the extent Stifel desired to include a good-faith requirement in the application of its indemnification bylaw, it had the responsibility to draft such a provision to comport with its intent. Its failure to do so supported the court's decision to adopt a very broad interpretation of the Stifel indemnification provision as applied to Cochran's claims.
The issue in Cochran I of whether a former corporate officer was entitled to indemnification because of actions he had taken at the request of the indemnifying corporation for another business entity was also a part of the decision in Manley v. AmBase Corp., a recent decision from the Southern District of New York. In that action the plaintiff, Marshall Manley, served as the president and a director of the Home Group Inc., which subsequently became AmBase Corp. Manley had been a partner at the Finley Kumble law firm before his employment at Home and then AmBase.
According to Manley, before being named the president at Home, he had been asked by the chairman and chief executive officer of Home to retain his affiliation with Finley Kumble even while serving as an officer and director at Home/AmBase (referred to hereafter as AmBase). Manley continued his relationship with the law firm, not in his individual capacity but in the form of Marshall Manley P.C.
In 1988 Finley Kumble was forced into bankruptcy. During the early stages of that bankruptcy proceeding, AmBase retained counsel to represent Manley in connection with his involvement in the bankruptcy proceedings. In 1991 Manley and Marshall Manley P.C. entered into a settlement agreement with the Finley Kumble bankruptcy trustee. Manley also filed an action against AmBase for indemnification as to certain shareholder derivative actions and other lawsuits brought against him with respect to his actions as an officer and director of AmBase. However, in that action, Manley did not seek indemnification for any of the claims arising out of the Finley Kumble bankruptcy proceeding or its settlement in 1991.
In 1993 Manley and AmBase entered into an agreement to settle the indemnification dispute that he had initiated in 1991. The key provision in the settlement agreement with AmBase, and the principal subject of this indemnification action, provided that if Manley had been or was made a party to an action by reason of the fact that he was a director or officer of AmBase or by reason of the fact that "he was serving at the request of AmBase as a director, officer, member, employee, or agent of another corporation or of a partnership ... or other enterprise ... he shall be indemnified ... to the fullest extent authorized by Delaware law...."
Later in 1993, Manley and Marshall Manley P.C. entered into another settlement agreement with the Finley Kumble bankruptcy trustee which provided for the final payment of Manley's obligations under the earlier 1991 bankruptcy settlement and, accordingly, the action against Manley and Marshall Manley P.C. was dismissed with prejudice by order of the bankruptcy court in 1994. Significantly, Manley entered into the 1993 settlement agreement with the bankruptcy trustee without the knowledge of AmBase or representation by its counsel.
In July 1996 Manley made a demand upon AmBase for indemnification for the almost $2.5 million he paid as part of the 1993 bankruptcy settlement. This was the first knowledge that AmBase had of the 1993 settlement because, as indicated above, Manley was represented by separate counsel with respect to the 1993 bankruptcy settlement agreement. When AmBase refused to provide Manley with indemnification, he brought this action against it.
With respect to the elements of Section 145 and Delaware indemnification law requirements at issue, AmBase argued in the jury trial of this matter that it should not be required to indemnify Manley for the 1993 bankruptcy settlement because Manley had not demonstrated that he acted in good faith and in a manner that he reasonably believed to be in or not opposed to the best interests of the corporation, as required by Section 145(a). The jury had rejected that argument at trial, and the court concluded that there was no error in that verdict.
Specifically, the court indicated that there was insufficient evidence that Manley's alleged failure to obtain a board resolution from AmBase recognizing his right to continue to be affiliated with Finley Kumble at the same time that he was working for AmBase made any difference, because the evidence showed that the CEO of AmBase had requested that Manley continue his Finley Kumble affiliation while working at AmBase. Furthermore, the court summarily rejected AmBase's contention that it had insufficient notice of the two bankruptcy settlements, which would have been evidence of lack of good faith by Manley. In fact AmBase provided counsel to Manley for the bankruptcy litigation leading to the original 1991 bankruptcy settlement.
As to lack of notice provided to AmBase concerning the 1993 bankruptcy settlement, the jury heard testimony indicating that in the discussions concerning the 1993 AmBase settlement agreement with Manley, there had been discussions of indemnity as to litigation in general and not as to any specific litigation. Thus, the court concluded that there was no evidence to suggest that AmBase or Manley believed that the 1993 agreement was limited to indemnification for certain actions to the exclusion of others.
The court did reverse the jury's verdict, however, with respect to one argument advanced by AmBase. The 1993 settlement agreement was limited to indemnification to Manley. However, the entity that was a partner with Finley Kumble was Marshall Manley P.C., not Manley himself. Manley contended that the distinction between Manley and Marshall Manley P.C. had no legal significance. The court disagreed.
The court reasoned that in order to be entitled to indemnification pursuant to the terms of the 1993 settlement agreement, Manley had to demonstrate that he had been requested by AmBase to remain affiliated with the Finley Kumble firm. Significantly, Marshall Manley P.C. was not a plaintiff in the action against AmBase for indemnification.
The court declined to accept the absence of any distinction between Manley and Marshall Manley P.C. Therefore, it said, as to the indemnification agreement between Manley and AmBase as contained in the 1993 settlement agreement, there was no evidence that Manley, the potential indemnitee, had in fact served Finley Kumble at the request of AmBase. Instead, an entity not a party to the indemnification agreement or the indemnification litigation, Marshall Manley P.C., was the entity that served with or was affiliated with Finley Kumble.
Notwithstanding the above determination, the court rejected AmBase's request for judgment as a matter of law on the indemnification issue because the court noted that at a new trial there were potential theories and facts that Manley could present to establish that he had satisfied the 1993 settlement agreement as to indemnification. For example, Manley could argue that he should have been indemnified by AmBase not for his service to Finley Kumble, but for his service to Marshall Manley P.C. at the request of AmBase, if in fact there was evidence to support such a position.
In any event, Manley was given another opportunity at trial to establish his indemnification claim to the 1993 bankruptcy settlement by demonstrating that AmBase had requested that Manley remain affiliated with Finley Kumble through Marshall Manley P.C.
Settlement as Success Under Section 145(c) and
Fiduciaries' Good Faith as a Prerequisite to Indemnification
The U.S. Court of Appeals for the Sixth Circuit recently analyzed Section 145 in Owens Corning v. National Union Fire Insurance Co. of Pittsburgh, Pa. The Owens Corning appeal was brought by the defendant, National Union, which sought to escape its obligations under a directors' and officers' insurance policy that it sold to Owens Corning. Owens Corning had settled a 1991 class action that had been brought against it and its directors, and National Union had refused to pay Owens Corning for the full settlement.
In Owens Corning's coverage action against National Union, the trial court had ruled that Owens Corning's directors were entitled to indemnification under Delaware law and that National Union could not avoid payment of the full settlement because National Union's contention that only a portion of the settlement payment to class plaintiffs related to the conduct and potential liability of the directors of Owens Corning.
Section 145 of the Delaware General Corporation Law came into play on this appeal because the insurance policy sold by National Union to Owens Corning provided that the insurer's coverage obligations to Owens Corning for claims brought against Owens Corning's directors and officers were predicated on a demonstration by the insured that it had indemnified its directors or officers "pursuant to law, common or statutory, or contract, or the Charter or By-laws of [Owens Corning]...."
National Union contended that Owens Corning's directors who had been defendants in the class action were not entitled to indemnification and, therefore, it had no coverage obligations to Owens Corning. Owens Corning responded that it was required to indemnify the directors pursuant to Section 145(c) because they had been successful in the underlying action by settling the case for approximately $10 million.
Also, Owens Corning had adopted the broadest indemnification provisions permitted under Delaware law and those provisions, in its view, required it to indemnify its fiduciaries, whether they acted in good faith or not. National Union contested the position that a $10 million settlement was a successful outcome and also argued that regardless of how broad Owens Corning's indemnification provisions might be, it had not demonstrated that the directors' actions were undertaken in good faith.
The Sixth Circuit agreed with National Union that it was "extremely dubious" that the Delaware courts would construe a settlement of almost $10 million to be a success and, therefore, Owens Corning had no obligation under Section 145(c) to indemnify its directors. Further, the court reasoned that Section 145(c), unlike Sections 145(a) and 145(b), made no reference to settlements and, therefore, was probably never intended to apply to them.
As to the application of Owens Corning's internal corporate indemnification requirements, the court rejected Owens Corning's position that the adoption of indemnification provisions, as permitted by Section 145(f), did not mean that the good faith of the indemnified fiduciaries was irrelevant, because the Delaware courts "have generally required good faith to be present for permissive indemnification...." However, Delaware corporations do have considerable flexibility with respect to the scope of indemnification, as long as the requirements are consistent with public policy and controlling corporate law.
Thus, when a corporation has adopted very broad indemnification provisions as Owens Corning had done, the court held that such an action created a rebuttable presumption of good faith by the parties to be indemnified. Because National Union had offered no evidence of the lack of good faith that would have rebutted this presumption, the court concluded that Owens Corning was required to indemnify the directors who were defendants in the underlying action, and that, accordingly, National Union had an obligation to provide coverage to Owens Corning under the insurance policy at issue.
Indemnification for Official Versus Personal Claims
The Delaware Court of Chancery and the Minnesota Court of Appeals (applying Delaware law), in three new-century cases, have addressed the tension that exists between claims under Section 145 submitted by a director, officer or employee as to litigation and whether the litigation relates to the personal interests of the director, officer or employee as opposed to interests in his or her official capacity as a representative of the corporation.
In the earlier of the two Delaware cases, Scharf v. Edgcomb Corp., the dispute related to legal expenses incurred by Michael J. Scharf, a former director and CEO of Edgcomb Corporation. Scharf was the subject of an SEC investigation. In his view the investigation focused primarily on his actions as an officer and director, i.e., the SEC investigation primarily addressed allegations that Scharf had provided non-public information concerning Edgcomb to third parties.
Conversely, Edgcomb argued that the investigation by the SEC focused on Scharf's trading of three securities (Edgcomb's and two unrelated entities) for his own personal account. After the conclusion of the SEC investigation, the government took action against a number of parties, but not against Scharf. The SEC investigation was prompted in part by the merger of Edgcomb with another entity. As part of the merger agreement, certain indemnification rights were provided to each person serving as an Edgcomb director or officer. Specifically, the merger agreement contained the following indemnification benefits:
The Merger Agreement provides for indemnification for each person serving as an Edgcomb director or officer against "any losses, claims, damages, expenses, judgments, and amounts paid in settlement in connection with any claim arising from actions taken or omissions to act as directors or officers." Edgcomb's obligation to provide indemnification extended six years from the effective date of the merger. Likewise, Edgcomb's Bylaws in effect at the time of the merger provided that Edgcomb "shall indemnify" any person who is or is threatened to be made a party to any action, suit or proceeding, including investigative, by reason of the fact that the person was a director of Edgcomb if "he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation." Section 3 of the Bylaws provides that if the director is "successful on the merits or otherwise in defense of any action, suit or proceeding described above, or in defense of any claim, issue or matter therein, he shall be indemnified."
In response to Scharf's motion for summary judgment (which was for partial summary judgment because he had not yet calculated all his expenses for which he sought recovery), Edgcomb argued that it was entitled to further discovery, invoking Delaware Court of Chancery Rule 56(f). Edgcomb asserted in this connection that certain SEC documents implied that the investigation centered on Scharf's personal trading and if that proved to be the case, then Section 145(c) did not require indemnification. While Scharf had already produced 4,700 documents to Edgcomb, Edgcomb contended that it still needed additional discovery, including the depositions of Scharf and his attorneys who had represented him with respect to the SEC proceeding.
The court agreed that such additional discovery was necessary. It ruled that even if it were disposed to determine the matter in favor of Scharf, the additional discovery might be required in order to determine a proper allocation of the attorneys' fees between claims that were subject to indemnification and those claims that might not be subject to indemnification.
In a more recent Delaware case, Gentile v. SinglePoint Financial Inc., the plaintiff filed an action in the court of chancery seeking the advancement of attorneys' fees and other litigation expenses from the defendant, SinglePoint. John Gentile, a former director and officer of the defendant, contended that he was entitled to the mandatory advancement of expenses under SinglePoint's bylaws with respect to a corporate investigation regarding his conduct as a director and officer and with respect to certain lawsuits initiated by him to recover property from SinglePoint.
In response, SinglePoint contended that under its bylaws, advancement was only required for those directors and officers seeking indemnification when they are "defending" against claims arising out of their service to the corporation and not, as in this case, for litigation expenses related purely to the financial self-interest of the plaintiff.
In December 1998 SinglePoint entered into an agreement with Relevant Information and Training Systems Inc., under the terms of which SinglePoint was to receive RIT stock and other consideration in exchange for services rendered. In 1999 a rift developed between SinglePoint and RIT with respect to the transfer of RIT stock to SinglePoint pursuant to the underlying contract terms. As a result, SinglePoint filed an action against RIT in Rhode Island seeking to compel RIT to issue the stock certificates in dispute, including those to Gentile.
In connection with the dispute between RIT and SinglePoint, Gentile was fired by SinglePoint and removed from its board of directors. In response, Gentile retained counsel and demanded that the company repurchase or permit the transfer of certain shares of SinglePoint held by him, permit his inspection of SinglePoint's books and records, and provide a certificate for the RIT stock that related to the dispute between SinglePoint and RIT.
SinglePoint ultimately resolved its dispute with RIT that had been in litigation in Rhode Island federal court and as part of the settlement, it was agreed that no RIT stock would be issued to Gentile. Gentile, upon learning of the settlement, sought to intervene in the federal action, but the motion was denied. Thereafter, SinglePoint sued Gentile in Rhode Island state court and alleged breach of contract and breach of fiduciary duty. Three days later, and unaware of the action filed by SinglePoint against him, Gentile sued SinglePoint in federal court in Rhode Island to recover his share of the RIT stock from SinglePoint. In the meantime, SinglePoint dismissed its action against Gentile, and Gentile's action was stayed pending the outcome of the Delaware action for advancement of his expenses.
The court first noted that under Section 145(e), a Delaware corporation is endowed with permissive authority to advance litigation expenses to a director or officer in connection with pending litigation. The Delaware Supreme Court in the Citadel case held that a Delaware corporation can make advancement of litigation expenses mandatory through its certificate of incorporation or bylaws. Indeed, it is common corporate practice to employ mandatory indemnification and advancement provisions in bylaws or certificates of incorporation.
SinglePoint's bylaws did contain a provision dealing with the advancement of litigation expenses and provided as follows:
Advancement of Expenses. Reasonable expenses (including court costs and attorney's fees) incurred by an Indemnitee who was or is a witness or was or is threatened to be made a named defendant or respondent in a Proceeding shall be paid or be reimbursed by the Corporation at reasonable intervals in advance of the final disposition of such Proceeding, and without making any of the determinations specified in Section 7.04, after receipt by the corporation of (a) a written affirmation by such Indemnitee of his good faith belief that he has met the standard of conduct necessary for indemnification by the Corporation under Section 7.02 and (b) a written undertaking by or on behalf of such Indemnitee to repay the amount paid or reimbursed by the Corporation if ultimately it shall be determined that he has not met that standard or if it is ultimately determined that he is not entitled to be indemnified against expenses incurred by him in connection with the Proceeding pursuant to Section 7.04.
In addressing the matters before it, the court of chancery first noted that there were certain basic issues relating to the interpretation of the advancement bylaw that were not in dispute. Among these were the internal investigation of Gentile and the suits initiated against him, each of which certainly constituted a "proceeding" as defined in the bylaw.
Thus, there were two major issues in contention. First, SinglePoint argued that the advancement of expenses to Gentile for expenses incurred by him as the plaintiff in the two federal court cases was not appropriate because the expenses he incurred in those venues were directed at vindicating his personal property right to share in the distribution of the RIT shares, and therefore were not incurred in defense of his interests as an officer or director of SinglePoint.
Second, SinglePoint argued that Gentile was entitled to the advancement of expenses only in those actions in which he was named as a defendant. Gentile countered that argument by contending that under Section 7.5 of the bylaws of SinglePoint, it had an obligation to advance him his litigation expenses where it was necessary for him to take proactive steps in defending against charges relating to his conduct as an officer and director, including the initiation by him of litigation to recover from the corporation property belonging to him.
Vice Chancellor Stephen Lamb analyzed Gentile's argument within the context of two key Delaware decisions -Shearin v. E.F. Hutton Group Inc. and Hibbert v. Hollywood Park Inc. In Shearin, the court of chancery held that one seeking indemnification for expenses incurred by virtue of action taken in the role of plaintiff is allowable only to the extent that suit is brought by the plaintiff as part of his or her duties to the corporation. The state high court in Hibbert also recognized that a director or officer may be entitled to indemnification if his or her claims were brought to uphold the fiduciary's "honesty and integrity as directors."
Gentile argued that the advancement of expenses incurred with respect to his effort to intervene in the federal action between SinglePoint and RIT and his own federal court action against SinglePoint were necessary to uphold his honesty and integrity as a director. In making this argument, Gentile relied upon the Delaware Supreme Court's language in Hibbert. Vice Chancellor Lamb found this reliance to be unavailing. He observed that in Hibbert the directors who filed suit sought to compel the defendants to attend board meetings and also sought to protect the corporation's internal audit procedures.
The vice chancellor found the facts involving Gentile to be substantially different. Gentile's only dispute with the corporation and its directors, in the court's view, involved their refusal to distribute any of the RIT stock to him and, therefore, was unrelated to any duty Gentile might have had as an officer or director of SinglePoint. The court emphasized that in looking at the pleadings submitted by Gentile in the two federal actions, all of the allegations related to his interest in obtaining the RIT stock, with no reference to any effort to clear his name as a director and officer of SinglePoint.
Gentile also argued that the Delaware Supreme Court's decision in Citadel supported his position in that he should be reimbursed for the affirmative steps to take action against SinglePoint in the federal actions because of the alleged nexus to the internal investigation of his conduct as a director and officer of SinglePoint. In Citadel, the high court held that the director was entitled to obtain indemnification with respect to a counterclaim that he had brought in an action in which he was being sued by his corporation. The Citadel court concluded that the director was entitled to indemnification because of the fact that the counterclaim was a compulsory one and had to be brought by the director in the context of the litigation brought against him.
In contrast, Vice Chancellor Lamb did not consider the nature of Gentile's claims against SinglePoint in the federal suits to have any proximate relationship to the internal investigation conducted by the corporation which found that he had breached his fiduciary duties. In conclusion, the court decided that Gentile was entitled to the payment of reasonable costs and expenses incurred in defending SinglePoint's action filed against him, including the internal corporate investigation of his conduct. However, SinglePoint was granted summary judgment in its favor as to all the actions Gentile filed as a plaintiff and those in which he sought to intervene in such capacity.
The "personal" versus "official" source of indemnification disputes under Delaware's indemnification law was also recently addressed in a non-Delaware action. In Rudebeck v. Paulson, the Minnesota Court of Appeals was required to determine whether a senior manager at a Ford Motor Co. plant was entitled to indemnification for expenses incurred with respect to his defense costs in a sexual harassment and defamation action brought against him and Ford by another employee. In the underlying action, the jury and the court ruled in favor of Raymond Paulson, the manager, rejecting the sexual harassment and defamation claims. However, the trial court denied Paulson's request that Ford be required to indemnify him for his litigation expenses in the action.
On appeal, the Minnesota Court of Appeals reversed the trial court's decision with respect to its determination that Paulson was not entitled to indemnification. The trial court had ruled that Paulson was not entitled to indemnification under Delaware law because the employee's claim against him was not "by reason of the fact" that Paulson was an employee, but based on his action as an individual - his personal but not his managerial conduct was the source of the plaintiff's cause of action.
The appeals court first noted that the pre-1997 version of Section 145(c), which was applicable on the facts of the case, provided mandatory indemnification for any person who is a party to a lawsuit by virtue of the fact that he was an "employee" of the corporation. The indemnification is also mandatory when the employee succeeds on the merits in defense of any action brought against him. The Minnesota court noted that under those circumstances the employee had an "absolute" right to indemnification.
Ford's argument against indemnification for Paulson was based upon its contention that claims for sexual harassment under the Minnesota Human Rights Act do not require an employment relationship and that in any event the plaintiff's claims against Paulson did not have the necessary nexus to his duties as a manager. Indeed, Ford contended that it had a zero-tolerance policy for acts of sexual harassment among its employees and, therefore, Paulson's alleged sexual harassment could not have arisen from his status as an employee.
In response to Ford's argument, the appeals court observed that social contacts among employees are a normal feature of the enterprise of the employer. Those contacts involved risks that are inherent in the workplace environment. Thus, the court concluded that Paulson was entitled to indemnification from his employer, Ford, because the claims against him arose from his actions as an employee of the company.
Advancement of Expenses
Indemnification for an Appeal Bond
The unusual situation of whether Delaware's indemnification statute covers a party who is required to obtain an appeal or supersedeas bond and seeks the advancement of the costs for such a bond was raised, although not decided, in Reddy v. PrimeCare International Inc. In that case, Prem Reddy brought an action pursuant to Section 145(k) in which he sought a determination that PrimeCare must pay all costs necessary for Reddy to obtain a supersedeas bond with respect to the appeal filed by Reddy and PrimeCare to the Ninth Circuit. Until that point in time, PrimeCare's parent corporation had indemnified Reddy's defense costs in order to avoid any prejudice that might affect PrimeCare's defense in the trial court. PrimeCare, however, declined to fund the supersedeas bond request, which prompted Reddy's action.
Reddy, a former director and officer of PrimeCare, was in a difficult position with respect to his desire to appeal the adverse judgment that had been rendered against him and PrimeCare in the trial court. In order to appeal the judgment, Reddy was required to obtain a supersedeas bond in the amount of $3.9 million which required him to pay an annual premium of 1 percent for the bond but also to provide collateral equal to the $3.9 million judgment from which he sought to appeal. Reddy requested that PrimeCare provide the necessary collateral, but PrimeCare had pledged all its assets to other creditors and had no collateral for the bond requirement.
Reddy argued that he was entitled to the appeal bond he sought as an advancement from PrimeCare because the PrimeCare certificate of incorporation required the company to advance litigation expenses to "the fullest extent" permitted by Section 145 of the Delaware General Corporation Law. In Reddy's view, the term "expense" should be construed broadly under Section 145 to include the costs of the supersedeas bond.
Reddy argued that while he could appeal the trial court ruling without posting the bond and thereby expose his personal assets to execution based on the trial court judgment, a director should not be required to risk his personal assets in order to appeal a judgment obtained against him in his capacity as a director of the corporation.