Pontone v. Milso Indus. Corp. et al., C.A. No. 8842-VCP (Del. Ch. Aug. 22, 2014) (Parsons, V.C.)
In this opinion, the Court of Chancery granted in part and denied in part defendants’ motion to dismiss a plaintiff’s claim for mandatory advancement of legal fees and expenses incurred in an underlying litigation between the parties. The Court granted the defendants’ motion to dismiss with respect to the advancement of fees and expenses that had already been paid by a second indemnitor, finding that the plaintiff did not have standing to pursue a claim for such fees and expenses. By contrast, the Court denied the motion to dismiss with respect to legal fees and expenses incurred, or that will be incurred, in the underlying litigation that had not yet been paid by the second indemnitor. The Court also considered plaintiff’s motion for partial summary judgment as to his entitlement to mandatory advancement for the claims asserted in the underlying action, as well as two of plaintiff’s counterclaims. The Court determined that the claims in the underlying action were brought “by reason of the fact” that the plaintiff was an officer or director and thus satisfied the corporate capacity standard, entitling the plaintiff to advancement. With respect to the counterclaims, the Court found that the plaintiff was entitled to advancement of expenses only for the defamation counterclaim, which was a compulsory counterclaim advanced to offset the affirmative claims, and not for the false and misleading advertising counterclaim, which was not sufficiently related to the affirmative claims to be considered a necessary part of the same dispute.
Plaintiff, Scott Pontone (“Pontone”), sued defendants, Milso Industries Corporation (“Milso”) and The York Group, Inc. (“York”), for advancement of fees and expenses incurred in an underlying litigation, which remains pending in a Pennsylvania federal court. The events giving rise to that litigation began when Milso and York’s corporate parent, Matthews International Corporation (“Matthews”), purchased Pontone’s family-owned casket-manufacturing business. After the purchase, Milso and York operated the businesses, and Pontone agreed to serve as an officer and director of both. After that relationship soured, Pontone parted ways with Milso and York and agreed to a three-year non-compete. Once that agreement expired, Pontone contracted to be a consultant to Batesville Casket Company (“Batesville”), a competitor of Milso and York. Milso, York, and Matthews brought the underlying litigation in response, asserting numerous claims against Pontone, including breach of contract, tortious interference, unfair competition, and unjust enrichment. The gravamen of those claims was that Pontone, and others, used Milso and York’s confidential and trade secret information to lure their employees and customers to Batesville. In turn, Pontone asserted several counterclaims, including defamation and false and misleading advertising. By way of the instant action, Pontone sought advancement from both Milso and York, pursuant to their bylaws, for fees and expenses he had incurred and would incur in that action. Milso and York moved to dismiss, arguing Pontone lacked standing, and Pontone cross-moved for summary judgment.
The basis of the argument that Pontone lacked standing relied upon a loan agreement executed by Pontone and Batesville as well the mandatory indemnification obligation Batesville owed Pontone. The loan agreement obligated Batesville to loan Pontone funds to pay for any fees and expenses he incurred in the underlying action and provided that those amounts would be forgiven if the underlying action were dismissed with prejudice or reached a final, non-appealable conclusion. It did not condition forgiveness on Pontone’s success. Milso and York argued that this created a de facto mandatory advancement obligation by which Batesville had advanced and was required to continue to advance Pontone’s fees and expenses in the underlying action. Because Pontone would not incur out-of-pocket expenses, he could show no injury and thus lacked standing to pursue his advancement claim. The Court agreed the loan arrangement created a de facto advancement obligation and agreed in part that Pontone lacked standing to pursue his advancement claim. In reaching the latter conclusion, the Court divided its analysis between funds already advanced by Batesville and unpaid and future fees and expenses Pontone had incurred or would incur. The Court focused on Levy v. HLI Operating Co., 924 A.2d 201 (Del. Ch. 2007), which stands for the proposition that a party who received indemnification from one entity had no standing to seek indemnification from another because it would not suffer any future injury. The Court found the situation in Levy analogous to the one before it with respect to amounts Batesville had already paid, finding Pontone could show no injury because he had already received advancement of those fees and expenses. With regard to unpaid or future expenses, the Court concluded Levy did not control and found Pontone had standing to pursue his claim for advancement of those fees and expenses. The Court found Milso and York’s refusal to abide by their contractual advancement obligations established sufficient injury for standing purposes and noted that a contrary ruling would incentivize indemnitors to refuse to honor their contractual obligations. Moreover, the Court explained that the fact that a third party honored its contractual commitment should not serve as a basis for another party to escape its own independent and commensurate contractual obligations.
Having reached the conclusion that Pontone had standing to pursue advancement of unpaid and future expenses, the Court turned to Pontone’s motion for summary judgment. As to York, the Court concluded that York’s bylaws were ambiguous because they contained conflicting provisions. The preamble stated that York “shall indemnify and advance expenses,” indicating that indemnification and advancement were mandatory. The actual advancement provision, however, indicated that advancement “may be paid by [York].” Milso, for its part, did not dispute that it had a mandatory advancement obligation. It argued, however, that the underlying action fell outside the scope of that obligation because the underlying action did not satisfy the corporate capacity standard (i.e., was not “by reason of the fact that” Pontone was an officer or director) and, even if it did, Pontone’s counterclaims were not brought in defense of that action. As to the first issue, Milso argued principally that Pontone was not expressly accused of a breach of fiduciary duty and was not a director or officer at the time of the conduct. The Court found neither argument persuasive, finding that the gravamen of the underlying action was that Pontone had used confidential and trade secret information obtained while an officer and director of Milso. This created a sufficient causal nexus between Pontone’s service as an officer and director and the claims advanced in the underlying action. As to the second argument, Pontone’s status as an officer or director at the time of the alleged conduct was not controlling. Rather, what controlled was the fact that the underlying action alleged Pontone improperly used information obtained while an officer and director.
The Court also considered whether two counterclaims, defamation and false and misleading advertising, were subject to advancement. As to the defamation claim, the Court found the facts underlying that claim to be the same facts plaintiffs in the federal action sought to prove. In other words, Pontone sought damages for statements that echoed the very charges being pursued in that litigation. On that basis, the Court concluded the counterclaim was a necessary part of the same dispute and therefore subject to advancement. As to the false and misleading advertising claim, Pontone argued that it was a necessary component of that litigation because it would demonstrate that any reduction in Milso’s business was a result of poor practice and not his competition. The Court rejected the argument, finding the claims distinct based on the elements required to prove the false and misleading advertising claim as opposed to the affirmative claims in the underlying action.