"Sinners Who Find Religion": Advancement of Litigation Expenses to Corporate Officials Accused of Wrongdoing

Article excerpt

I. INTRODUCTION

Recent decisions in Delaware-"the Mother Court of corporate law"1 and the state whose "rich abundance of corporate law"2 guides courts throughout the country due to "the special expertise and body of case law developed in the Delaware Chancery Court and the Delaware Supreme Court"3-address an important but infrequently discussed corporate governance issue: charter, bylaw, and indemnification or employment agreement provisions that mandate advancement of attorneys' fees and other defense costs for corporate directors, officers, and employees accused of wrongdoing by the corporation or by federal or state law authorities.

These recent decisions repeatedly have rejected efforts by corporations that have promised mandatory advancement to disavow those promises due to the alleged-and in some cases admitted or proven-wrongful nature of the conduct for which advancement is sought. As the Delaware Court of Chancery colorfully has put it, corporations that adopt mandatory advancement provisions and then, after drawing "harsh conclusions about the integrity and fidelity of the corporate official seeking advancement,"4 defend against claims for mandatory advancement are like the "sinner who suddenly finds religion": "[c]ontent to adopt advancement and indemnification bylaws drafted with holes large enough to drive a truck through, the . . . company . . . suddenly 'finds religion'-insisting on a rigorous interpretation of its loosely written bylaws."5

The underlying principles, as stated by the Delaware Supreme Court as recently as November 17, 2005, in Homestore, Inc. v. Tafeen,6 are simple:

Indemnification encourages corporate service by capable individuals by protecting their personal financial resources from depletion by the expenses they incur during an investigation or litigation that results by reason of that service . . . .

Advancement is an especially important corollary to indemnification as an inducement for attracting capable individuals into corporate service. Advancement provides corporate officials with immediate interim relief from the personal out-of-pocket financial burden of paying the significant on-going expenses inevitably involved with investigations and legal proceedings . . . .7

The limited and narrow focus of an advancement proceeding precludes litigation of the merits of entitlement to indemnification for defending one self in the underlying proceedings. If it is subsequently determined that a corporate official is not entitled to indemnification, he or she will have to repay the funds advanced.8

Courts reach this result even where the director, officer, or employee receiving advancement does not have the resources required to repay the amounts advanced-often hundreds of thousands of dollars, and in some cases millions of dollars.

The Homestore litigation illustrates the requirement that corporations honor agreements to advance expenses under as harsh a set of circumstances as possible. The case involved a request for advancement by Peter Tafeen, a former officer of Homestore, Inc., for attorneys' fees incurred in connection with criminal and civil proceedings brought against him following an accounting restatement. The Supreme Court affirmed a Court of Chancery judgment ordering Homestore to advance over $3.9 million in defense costs.9 This award included, as has been the practice in indemnification and advancement cases in Delaware since the Supreme Court's 2002 decision in Stifel Financial Corp. v. Cochran,10 the attorneys' fees incurred by Tafeen in successfully enforcing his right to advancement-so called "fees on fees."11 The court also awarded pre-and post-judgment interest at the rate of seven percent, totaling $206,015.84 through the date of the Court of Chancery's judgment plus $756.40 per day during the appeal,12 in accordance with "settled Delaware law" providing for "prejudgment interest... as a matter of right."13

The Court of Chancery and the Supreme Court rejected allegations that "'Tafeen purchased an expensive home in Florida, a state that has extremely protective 'homestead' provisions against creditor claims,' in order to shelter assets, thus avoiding repayment should Tafeen's claims ultimately be found to be nonindemnifiable. …