Dore v. Sweports, Ltd., C.A. No. 10513-VCL (Del. Ch. Jan. 31, 2017) (Laster, V.C.)

In this memorandum opinion, the Court of Chancery found that former directors and agents were entitled to indemnification under the corporation’s bylaws for expenses incurred in defending against claims by the corporation, as well as for expenses incurred in enforcing indemnification rights.  The Court, however, denied indemnification for expenses incurred in litigation concerning the plaintiffs’ personal contract rights.

The plaintiffs were former directors and outside attorneys of Sweports, Ltd. (the “Company”), a corporation controlled by George Clarke (“Clarke”).  After a series of business disputes with the plaintiffs, Clarke executed a document (the “Informal Action”) purporting to remove the plaintiffs as directors, terminate any attorney-client relationship with the plaintiffs, declare that the Company would not honor a promissory note that the plaintiffs had guaranteed (the “Note”), and rescind the plaintiffs’ equity interests granted pursuant to a guarantee agreement (the “Guarantee”). 

The plaintiffs brought suit in Illinois state court alleging, among other things, that the Company and Clarke had breached the terms of the Note and the Guarantee.  In response, the Company asserted lengthy counterclaims alleging that the plaintiffs had breached their fiduciary duties to the Company and engaged in fraud.  Ultimately, the Company’s counterclaims, as well as a substantively identical suit filed against the plaintiffs by a Company affiliate, were dismissed.  The plaintiffs, on the other hand, prevailed on their breach of contract claims.  The plaintiffs then commenced involuntary bankruptcy proceedings against the Company in an attempt to collect in their capacity as judgment creditors.  After the bankruptcy court rejected the proposed plans of reorganization, the case was dismissed without any recovery.

The plaintiffs next filed the instant action in the Court of Chancery seeking indemnification under the Company’s bylaws, which provided mandatory indemnification rights pursuant to Section 145 of the Delaware General Corporation Law.  In an earlier decision on summary judgment, the Court held that the litigation regarding the Company’s counterclaims and the claims by the Company’s affiliate constituted “covered proceedings” under Delaware law.  At trial, the parties litigated whether the plaintiffs’ expenses were “actually and reasonably incurred” in connection with those proceedings.  The trial also focused on whether the plaintiffs were entitled to indemnification for expenses incurred in other proceedings, including the plaintiffs’ initial response to the Informal Action, litigation regarding the plaintiffs’ breach of contract claims against the Company, litigation regarding the value of plaintiffs’ rescinded equity, and litigation in the bankruptcy court. 

In this post-trial opinion, the Court found that the plaintiffs’ indemnification rights encompassed expenses incurred in responding to the Company’s Informal Action.  The Court reasoned that the Informal Action effectively threatened litigation against the plaintiffs by detailing their alleged misconduct at considerable length.  The Court rejected, however, the plaintiffs’ argument that they were entitled to indemnification for any other proceedings.  The Court held that the breach of contract claims were personal to the plaintiffs as lenders and guarantors and that the claims lacked a sufficient nexus to the fiduciary duty claims to warrant indemnification.  For the same reasons, the Court rejected the plaintiffs’ request for expenses incurred in litigating the value of their rescinded equity.  The Court likewise rejected the plaintiffs’ argument that the bankruptcy proceeding was a “covered proceeding,” finding that it instead was a collection vehicle for the plaintiffs’ breach of contract claims.

Although the Court held that the plaintiffs were entitled to indemnification for certain proceedings, the Court limited the recovery sought by the plaintiffs.  The Court found that the plaintiffs had improperly altered their legal bills by adding entries years after the fact and by changing entries so they would relate to covered proceedings.  The Court explained that fee affidavits filed by the plaintiffs in the underlying proceedings demonstrated that the fees were later inflated. 

Lastly, the Court determined that the plaintiffs were entitled to indemnification for expenses incurred in enforcing their indemnification rights.  Because the plaintiffs were able to recover only a portion of the fees they sought in the indemnification action, however, the Court limited the amount of recovery to 20% of the requested amount.  This figure represented the total indemnification awarded to the plaintiffs divided by the amount originally sought.  The Court also noted that it would have considered denying any enforcement expenses on the grounds of bad faith or unclean hands, but the argument was not raised.

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