Paolino v. Mace Security International Inc., C.A. No. 4462-VCL (Del. Ch. Dec. 8, 2009) (V.C. Laster)

Plaintiff Louis D. Paolino (“Paolino”) sought indemnification and advancement of fees and expenses incurred in defending against counterclaims asserted by the defendant, Mace Security International, Inc. (“Mace”), in an arbitration proceeding that Paolino initiated.  Vice Chancellor Laster denied Mace’s motion to dismiss, finding that Paolino had a right to advancement under Mace’s amended and restated bylaws, which provide current and former directors and officers of Mace with mandatory indemnification and advancement rights to the fullest extent permitted by Delaware law, qualified only by a carve-out eliminating indemnification for any “proceeding (or part thereof) initiated by [an indemnitee]” without prior board approval. With regard to the indemnification claims, the Vice Chancellor sua sponte stayed the matter pending the outcome of the underlying arbitration.

From 1999 until his termination in 2008, Paolino was the chairman and CEO of Mace. His employment was governed by an employment agreement that provided in relevant part that if Mace’s board of directors terminated Paolino, he would be entitled to a large severance payment unless he was terminated for cause. After the board terminated Paolino for cause, he filed an arbitration demand against Mace, and Mace asserted counterclaims.

The court rejected all of Mace’s arguments against advancement. First, the court rejected Mace’s “linguistically odd,” “artificial, and counter-intuitive” argument that if a covered person initiates a proceeding and a corporation asserts defensive counterclaims, the counterclaims are nonetheless part of the covered person’s offensive proceeding. The court stated that “[f]or purposes of determining whether someone is ‘defending’ a proceeding, the operative question is not ‘who started the lawsuit’… but rather ‘has a claim been asserted against the covered person?’” The court also noted that corporations are free to tailor advancement provisions more narrowly.

Second, the court found that the carve-out in Mace’s bylaws did not foreclose advancement, based on the plain language of the carveout, and the interaction of the bylaws with Section 145(c). Section 145(c) provides for mandatory indemnification to any covered person who is successful not only “in defense of any action, suit or proceeding referred to in subsections (a) and (b) of this section,” but also “in defense of any claim, issue or matter therein.” Thus, the court reasoned, if Paolino were successful in defending against the counterclaims, he would be entitled to mandatory indemnification. Because the bylaws expressly grant a right to mandatory advancements in proceedings in which indemnification could be available under Section 145(c), Paolino was accordingly entitled to advancement for defense of the counterclaims.

Finally, the court found that Paolino’s employment agreement did not alter his rights to advancement, because the counterclaims facially implicated Paolino’s duties as an officer and director.

Notably, as to the scope of the expenses Paolino could seek under his advancement right, the court ruled that all of Paolino’s reasonable expenses for the arbitration must be advanced because Mace’s counsel represented at oral argument that it was impossible to distinguish between expenses incurred in connection with the counterclaims and expenses incurred on the affirmative claims.

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