The Perils of Advancement

by Morris James LLP
Contact

Delaware Business Court Insider - March 14, 2017

There is perhaps one single obligation that most aggravates corporate boards of directors: Paying your opponent's legal fees when you are convinced he has done you wrong. How then is that not just possible, but a regular occurrence?

Delaware law permits a corporation to agree to pay an officer or director's litigation expenses "in advance of the final disposition of such action, suit or proceedings." Persons considering serving on the boards of directors of a publicly traded corporation almost always insist that such "advancement rights" be provided to them, by contract or corporate bylaw. Thus, if their corporation later claims that the director acted improperly, such as by obtaining an unauthorized benefit or by deliberately neglecting her duties, that director will ask the corporation to pay for her defense.

Over the last few years, corporations have tried to avoid that obligation in many ways. For example, corporations have claimed they were fraudulently duped into hiring the defendant and therefore the advancement contract should be rescinded. More frequently, corporations have argued that the defendant's actions leading to filing suit did not "arise out the defendant's actions" as a director or officer (the commonly used qualifier in advancement contracts that must be met before fees are advanced). None of those defenses generally works, however.

Moreover, apart from the irritant of having to pay an allegedly "bad actor's" fees, the right to advancement often involves real money. The recent decision in White v. Curo Texas Holdings, Del. Ch. C. A. 12369-VCL (Feb. 21), involved an advancement claim for $5,121,651.73 and other decisions have involved similar large amounts. Under those circumstances, it is no surprise that corporations and other legal entities have sometimes resisted the advancement claims of their former directors or officers.

Once the advancement claim is denied, the claimant has the right to file suit in the Delaware Court of Chancery to compel payment, 8 Del. C. Section 145(k). Typically, that court will treat such a suit "summarily," meaning the litigation will be given priority on the curt's docket and scheduled for as prompt a hearing as circumstances permit. The Court of Chancery will then first determine if advancement is required. If so, then the parties will often be required to follow the procedures set out in Danenberg v. Fitracks , 58 A.3d 991 (Del. Ch. 2012) (the Fitracks procedures).

Briefly, the Fitracks procedures require that senior Delaware counsel for the parties review invoices for fees and expenses, meet to resolve any disputes and then no more frequently than quarterly, submit any still disputed amounts to the Chancery Court for its decision. In the meantime, the party who is required to pay advancement must pay at least 50 percent of the amount sought. Most significantly, the Court of Chancery's review is very limited with respect to what claims will be denied advancement. The Curo decision sets out in detail the limits of that review. Generally, only "grossly" overstated claims will be denied.

There are good reasons for limiting the Court of Chancery's scope of review in advancement cases. To begin with, advancements are subject to the claimant's providing "an undertaking to repay such amount if it shall ultimately be determined that such person is not entitled to be indemnified by the corporation," 8 Del. C. Section 145(e). That determination occurs after the litigation is resolved, such as by judgment or settlement. Hence, the corporation has some safeguard to get its money back if the claimant is judged not to be entitled to keep it. Moreover, as the Curo court reminded, it would be inappropriate to seek a granular review of the advancement claim while the underlying litigation continues for months or years. Accordingly, the court typically adopts the Fitracks procedures requiring the parties to first use their own efforts to avoid unnecessary waste of the court's limited resources. In fact, as Curo also points out, a party who inappropriately resists a claim despite using the Fitracks procedures may be required to pay the claimant's attorney fees incurred in pursuing the advancement claim.

Given the summary nature of advancement proceedings and the often lack of any effective client restraint on lawyers who are being paid by someone other than the actual client, there is a natural concern that the claims for fees are inflated. Moreover, even if the claimant has agreed to repay the fees if she loses, it is often doubtful that an individual has the unencumbered assets to do so, particularly if millions of dollars are involved.

This then finally brings us to the question of what can be done to avoid the perils of advancement obligations to former directors or officers. To some degree, those obligations can be insured against. A typical director and officer liability policy will reimburse a corporation that pays the legal bills of current or former directors or officers. For this reason, actual advancement cases are not all that common, compared to the number of suits filed against boards of directors.

Unfortunately, insurance does not always solve the problem. A typical D&O policy will exclude coverage for potentially collusive litigation, such as by denying insurance payments for "insured versus insured" suits. Thus, if the corporation is the plaintiff suing a former director, both the corporation and the director are considered an "insured" and there is no insurance coverage. This exclusion is not all that easy to avoid. Even stockholder derivative suits may be subject to the insured versus insured exclusion if the suit has been instigated by a director or by the corporation having a stockholder file the claim in her name.

Nonetheless, there are some potential ways to limit the perils of advancement. While the right to advancement will almost always be provided just as a matter of common practice, the right is essentially contractual. Hence, it may be subject to limitations set out in a contract or bylaw. Insurance companies have the same concerns as corporations providing advancement rights in terms of excessive fees unrestrained by the real client's oversight. To at least try to limit that exposure, insurers often retain the right to select counsel (with whom they have pre-existing reduced fee agreements) or to consent to settlements. While the designated counsel must be independent of the nonclient party paying his fees, it might be expected that the promise of future referrals will dim his ardor for fees. At least the counsel designated should be chosen on the basis of their experience and expertise and not a lawyer learning the substantive law at someone else's expense.

There have been few proposals on how to limit advancement claims. That may well be because that is no easy task given the strong demand for unlimited advancement rights. But if insurance companies can negotiate cost controls with their clients, perhaps corporations can also do so with their prospective and often highly paid directors.

Delaware Business Court Insider | March 14, 2017

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morris James LLP | Attorney Advertising

Written by:

Morris James LLP
Contact
more
less

Morris James LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.